Is What You Hold As Sacred Included in Your Sacred Rights?

One of the most critical provisions of a syndicated loan facility is what is commonly referred to as sacred rights. Sacred rights provisions typically require 100% of the co-lenders’ consent before certain changes may be made to the syndicated loan agreements. There are certain things the agent can do in its discretion, others that require a majority of the co-lenders, and others that require consent by a supermajority of the co-lenders. But sacred rights are those rights in which even the smallest lender in the syndication has veto rights.

Sacred rights typically include reductions in interest rates, extending payment and maturity dates, releases of collateral and other significant business terms. A recent trend affecting syndicated loans is what has become known as uptiering. Some recent notorious uptiering cases include Serta Simmons (LCM XXII Ltd. V Serta Simmons Bedding LLC) and TriMark (Audax Credit Opportunities Offshore Ltd. V TMK Hawk Parent Corp.). In a very recent decision from the Delaware Bankruptcy Court (Bayside Capital Inc. and Cerberus Capital Management, L.P. v. TPC Group Inc. (2022 WL 2498751, DE Bankr. July 7, 2022)), the Court focuses on yet another syndicated facility where some minority noteholders found their senior security interests subordinated to new loans made by a supermajority of their co-lenders.

The judge in the TPC case began his decision by saying:

There has been a flurry of litigation in recent years over transactions that seem to take advantage of technical constructions of loan documents in ways that some view as breaking with commercial norms….

He then describes uptiering:

In its most aggressive form, such a transaction is one in which the debtor and a majority (but not all) holders of a syndicated debt issuance agree to enter into a new loan that is supported by a superior lien in the same collateral that secured the original debt…. While such a transaction would typically require an amendment to the original credit agreement or indenture, those documents are typically drafted to permit a majority (or, in some cases, a supermajority) of the holders to amend the agreement without the consent of the minority.

Although this did not occur in the Delaware case, he pointed out that often

the debtor [then] repurchases the participating lenders’ share in the prior (now junior) loan – effectively leaving behind the minority holders in a tranche of debt that is now junior to that held by the majority lenders.

The underlying transaction closed in 2019 and involved TPC issuing $930 million in senior secured notes, about 10% of which were purchased by Bayside Capital and Cerberus. The notes were secured by a first lien on substantially all of the TPC’s assets and a second lien on inventory and receivables subject to the first liens in favor of an asset-based facility agented by Bank of America.

The loan agreement provided:

[TPC], the Guarantors and the Trustee … may amend or supplement this Indenture … and the Notes … with the consent of the Holders of at least a majority in the aggregate principal amount of the then outstanding Notes voting as a single class….

It also provided:

[any] amendment to, or waiver of, the provisions of this Indenture … that has the effect of releasing all or substantially all of the Collateral from the Liens securing the Notes … will require the consent of the holders of at least 66-2/3% in aggregate principal amount of the Notes….

The Court noted:

The “sacred right” at issue here… provides that without such consent “an amendment, supplement or waiver… may not…. make any change in the provisions in the Intercreditor Agreement or this Indenture dealing with the application of proceeds of Collateral that would adversely affect the Holders.

At the time of the later transaction that subordinated the interests of Bayside and Cerebus, the holders of the “new” notes also held a supermajority of the then-outstanding “old” note, thus giving them the authority to amend the “old” notes in any way that did not violate a holder’s sacred rights. The parties also entered into a new intercreditor agreement that operated to subordinate the “old” notes to the “new” notes with respect to the common collateral securing both sets of notes. The consents were executed by more than 67% of the holders of the “old” notes, which was expressly authorized under the initial agreements.

The result? The Court found that the subsequent transaction which subordinated otherwise senior debt was permitted within the terms of the documents entered into by the objecting parties.

In recent years, in their mission to maximize their funds employed, lenders are often fearful of being excluded from a syndication by making waves in reviewing the syndicated loan documents. While lenders understand that they must perform their own due diligence and document review, they are reluctant to request changes, especially in the agency provisions. Because it is rare that a borrower will pay for a syndicate member’s due diligence costs (especially its legal costs), co-lenders often retain counsel at a low flat-fee rate to perform a review to confirm that the terms of the loan agreements conform with those of the underwriting. Banks often tell their lawyers to stand down when suggesting changes to agency provisions fearing that any requested change will cause the agent to exclude the bank from the syndicate.

Co-lenders are advised to keep a careful eye out for sacred rights provisions that do not include prohibitions against subordinating the lien priorities of the co-lenders. The lesson for not doing so could be costly.

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