Leveraged loan agreements form key aspects of capital structures, balancing lender protection against allowing the borrower to run its business according to its business plan. In recent times, the length of such loan agreements has increased substantially, and White & Case investigates the reasons behind this.
To provide some context, consider the following. The current LMA-form senior multicurrency term and revolving facilities agreement for leveraged acquisition finance transactions (senior/mezzanine) (excluding footnotes) is 314 pages long. A sample 2010 leveraged loan agreement is 205 pages long whereas a sample 2020 equivalent is 473 pages long. This very brief summary illustrates how in market examples (and over time), the length of loan agreements has increased significantly. This can be attributed to a number of reasons, some of which are discussed below.
Practical experience, flexibility and evolution
Before focusing on specific areas, while there may be multiple reasons for longer documentation we would suggest that the primary reasons are: (i) the impact of practical experience, (ii) flexibility (or most often a mix of (i) and (ii)) and (iii), the evolution of documents.
In terms of practical experience, certain provisions have been added over time to avoid inadvertent and/or technical defaults under relevant documentation, in particular through a number of additions to a document's construction clause. On the other hand, certain additional provisions have been added to permit borrowers to have increased flexibility in achieving their operational goals and/or avoiding any inhibitions on their business. This includes an increased number of exceptions to applicable covenants to allow for additional actions which would otherwise have been prohibited for instance, additional types of debt that may be incurred and security granted in favour of other creditors.
A third reason for the additional provisions is the evolution of documentation. In older documents, there was often very limited scope for additional indebtedness (in particular, pari passu secured indebtedness) in the capital structure. With the prevalence of high yield bond-style incurrence covenants and both additional facilities and sidecar debt being introduced, the parameters for this debt need to be specified, including any "most favoured nation" provisions (which dictate certain parameters for key economic terms of such sidecar debt vis-à-vis the original loan). All of these additional provisions need careful drafting (and hence, add to the paperwork).
Below, we look closer at some sections in loan agreements that have been lengthened in accordance with the above concepts.
The construction clause aids the interpretation of certain terms and provisions in the loan agreement. For instance, it may clarify that all references to times are to "London time" to avoid clarifications throughout a document, or that a reference to a particular "person" includes its successors in title. However, as loan agreements have become more complex, the construction clause has significantly lengthened to include a variety of additional clarifications and/or interpretative provisions covering points such as what amounts outstanding under different instruments should be considered to be "debt" (i.e. treatment of hedging), currency exchange and conversion rates, and certain additional specifications on how certain terms such as "knowledge" should be assessed in practice.
The importance of the construction clause should not be underestimated. It is a benefit to all parties to a loan agreement to take the opportunity to clarify meanings of terms to avoid later disputes and perhaps to avoid repetition throughout a loan agreement. On the other hand, the construction section "qualifies" the rest of the document, and incorporates particular (or additional) meaning to words used throughout the loan agreement. Parties therefore need to read this section carefully, bearing in mind the impact on the rest of the document.
Additional facilities clause
Additional indebtedness provisions are now fairly lengthy and are important parts of loan documentation. Previously, there was little scope for additional tranches of debt and the expectation was that this would be provided on similar terms to the existing facility and often by the same lenders. In sponsor-driven leveraged finance documents, in-built flexibility has been significantly increased. This provides the borrower with an efficient document structure to raise new indebtedness using the original deal architecture, but requires additional drafting to allow the mechanics to work, as well as ensure that lenders are still protected to the extent of the negotiated deal.
There is some irony that one of the sections that has become longer in loan agreements is the financial covenants section, considering that most leveraged loan agreements are now cov-lite. However, as most readers will be aware, there is often a liquidity revolving credit facility included in the capital structure, which will include a net leverage ratio test which will apply only for the benefit of the lenders under the revolving credit facility. This will include a number of complex definitions and parameters around the financial definitions calculations, which as above can generally be categorised into language relating to practical experience, flexibility and evolution of the covenant and the complexity of capital structures. In addition, the financial covenants section typically contains the definition of "Excess Cashflow”, which is used for the excess cashflow sweep which is often a required mandatory prepayment. Again, this definition (and related definitions) now comprises significantly more substance than either historic or "standard form" versions of the covenants.
As the high yield bond and loan markets have converged over time, various high yield bond covenant components have been incorporated into leveraged loans. In several ways (and beyond the main scope of this article), this has added elements that have increased the length of loan agreements either by adding new provisions, or making existing provisions much longer. By way of examples:
- Financial incurrence ratios – many cov-lite loans permit indebtedness to be incurred in compliance with certain ratio-based financial incurrence tests. These often include either a net leverage ratio test and/or a fixed charge coverage ratio test for unsecured or junior secured indebtedness and a senior secured leverage ratio test for secured indebtedness. The LMA leveraged loan agreement, for instance, does not cater for such ratio indebtedness. The definitions for each of these ratios can reach several pages, including provisions related to acquisitions and disposals, incurrences and repayments of indebtedness, and synergies or cost-savings related to the applicable corporate actions.
- Dividends/restricted payments – bond covenants often permit dividends out of a "build-up" basket which comprises a 50 per cent of consolidated net income test, plus other build-up components. This provision and the related definitions can run to several pages.
- General exceptions – another driver behind lengthening covenants is the sheer number of exceptions included in modern day covenants. Though there are a large number of examples, the permitted security exceptions can be used as a simple example of lengthening provisions. The LMA loan agreement contains 11 "permitted security" exceptions to the prohibition on security covenant. This is contrasted with certain cov-lite loan agreements based on high yield covenants where there are many more exceptions, one example being a provision of 48 "permitted security" exceptions (and this did not take into account the further exceptions for permitted security sharing in the deal collateral package (so-called "Permitted Collateral Liens")).
Cross-border deals involve complex analysis of legal issues relating to the provision of credit support and/or guarantees by subsidiaries in a variety of jurisdictions. These can sometimes require certain language to preserve the legality of a guarantee, which may otherwise, among others things, (i) be void under local law or (ii) expose the guarantor's management to criminal or civil proceedings in the relevant jurisdiction. This guarantor limitation language can range from one or two (typically more general) paragraphs to several pages in jurisdictions where, for instance, a solvency and/or sufficient assets test or formula may be applied when calculating the liability under the applicable guarantee. In cross-border deals where there are several jurisdictions involved, this can lengthen the loan agreement to a considerable extent once the relevant language is inserted for each jurisdiction.
In sponsor-led transactions, the transfer and assignment provisions have garnered more attention, with limits on transferability becoming more prevalent. These now detail what consent rights to transfer exist, at which times and during which events of default, complete blocks on certain transfers and rules around sub-participations and sub-contracts.
As loan agreements have become more complex, the amendments provisions have followed. There are now more bespoke parts of loan agreements that only require certain parties to amend, the agents are given additional authorisations in respect of permitted documentation amendments, in particular with regard to implementation of additional facilities and permitted structural adjustment, and there may be different tiers of consent levels other than the typical "all lender" and "majority lender" consent levels (i.e. super-majority lenders). In addition, the recent addition of "net short" lender restrictions on voting on amendments has added further provisions to the documentation.
Though the finger is often pointed at lawyers for adding more and more complex drafting and provisions to applicable documentation, they are often either solving for a pre-existing issue that's been identified or documenting a commercially agreed position, that just so happens to be more involved and complex than the precedent transaction. Comparing any loan agreement to the LMA form is perhaps a bit unfair, given that while the LMA form is an extremely useful industry standard form document, the commercial transaction is often based on "market" precedent, which, as described above, has extended over time to both address the practical realities of the creditor/debtor relationship, but also to evolve documents into new forms with additional features. Ironically, a shorter time frame for deals may lead to even lengthier documents rather than shorter ones, as parties tend to add additional wording (in particular, of the "notwithstanding" over-ride nature) to make a point rather than finely tune certain equivalent terms. The future of loan agreements likely points towards documents staying in their lengthier form rather than contracting, to address the fear of inadvertently removing important borrower flexibility which the market has been able to accept to date. However, commercial parties should be mindful that all of the words in a loan agreement are important, and so agreeing new wording that is not carefully considered can be a riskier approach in terms of future conflicts or disagreements on intentions, and where possible, it may sometimes benefit parties to revisit longer provisions to attempt to create a concise agreement on a particular item, without necessarily losing anything in the process.