Senior secured creditors, being the anchor creditor in the capital stack, will always be focused on ensuring their priority claim is as robust as possible, with clearly delineated capacity for 'super priority' debt. However, today's documentary flexibilities, coupled with local legal restrictions, can mean senior secured creditors are not as 'senior secured' as they think. Here are some points to think about.
Super Senior Debt
The most obvious basket for priority claims, which comes ahead of senior secured debt in the enforcement waterfall.
Mitigants/things to think about
- Right-size this basket for the credit – consider limiting this to revolving working capital debt (as opposed to super priority term debt) and carefully consider the use of 'growers' and how addbacks to EBITDA can inflate the grower.
- Carefully construct super senior hedging baskets so that there is a super senior liabilities cap (as opposed to the cap attaching to the debt which can be subject to super senior hedging, but with uncapped exposure) and ensure such hedging can't be for speculative purposes.
- Look out for 'cash management facilities' (which often are classed as super senior and sometimes on an uncapped basis) and the fact they can capture a broad list of products – for example, any 'debt for working capital' purposes.
Liens on Non-Collateral
Market practice in the upper mid- to top-tier space is to have very little to no hard asset security, being limited to share pledges, key intra group receivables and some bank accounts. This, in deals with 'high-yield style' covenants, is coupled with a wide ability to secure unencumbered assets in favour of other creditors. These assets would not be subject to releases under intercreditor arrangements on an enforcement and could therefore impact the value of the group if the senior secured lenders were attempting a sale of the entire group as a going concern to maximise their chances of recovery.
Mitigants/things to think about
- Limit capacity to incur non-ordinary course liens on non-collateral – limit to one basket that is sized no larger than the general debt basket.
- Pay attention to the liens that can be incurred on your collateral – you do not want to share these if possible, in order for you to be in control of an enforcement process.
- If you have an ability to incur wide amounts of unsecured or debt secured on non-collateral – require an intercreditor accession threshold so you are controlling the narrative on an enforcement.
- Place a laser focus on the quality of the top share pledge – if possible and if it works with the Sponsor's tax and other internal structuring plans – insist on a Lender-friendly jurisdiction (e.g. Luxembourg or England) and watch for flexibility to change such jurisdiction in merger covenants or debt pushdown features in documents. Ensuring a clean enforcement at this level also ideally requires all downstream loans at the same point to be subject to the intercreditor and the ability to be released on an enforcement (i.e. without being limited to 'day 1' loans, or short term or immaterial loans).
- If there are assets of the group which are critically important to the credit, actually request security over them – key IP interests, for example, can be secured in a cost efficient manner (but, see bullet below).
- Legal restrictions on upstream and cross stream credit support – the quality of guarantees and security from operating companies can be low depending on the jurisdiction of incorporation of the operating entity, the use of proceeds of the debt secured and/or various 'net asset' or similar tests which must be run at the point of enforcement – each scenario requires a careful assessment by counsel, and in certain scenarios, it may be worth deploying your negotiating capital on other features of a transaction if local legal restrictions cannot be subject to satisfactory structuring in order to provide guarantees or security of much value.
Structurally Senior Debt
It is very common in the top-tier market to be able to incur ratio and basket debt at a structurally superior level, i.e. lower down in the structure, closer to the assets, and therefore meaning, on an insolvency, any value in such assets is distributable to such creditors before senior secured creditors.
Mitigants/things to think about
- Try to limit incurrence of incremental/side car ratio-based debt to be incurred at the same borrower level as senior secured debt, and, as an obvious point, reduce sizes of basket debt as much as possible.
- Insist on a non-guarantor debt cap on basket debt and make sure it covers as many of the larger baskets as possible – by so doing, you are reducing the amount of debt incurred at companies where the senior secured creditors have neither a borrowing nor a guarantee claim, and thus where recoveries by the senior secured creditors will be restricted to value (if any) flowing to the equity of such company and to a company where such creditors have a claim.
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