Collateralized loan obligations group sues fellow lenders over new 'super priority' loans
Jin Hee Kim
Laura R. Hall
24 November 2020
On November 7, 2020, a group of CLOs holding a minority of a first lien loan to TriMark – a restaurant supply company – sued TriMark, its private equity sponsors Centerbridge and Blackstone, and a group of CLOs and other lenders sponsored by Oaktree, Ares, Blackstone, Sculptor and BlackRock in New York State court over the creation of new “super priority” loan tranches secured by the same collateral and offered only to favored lenders.
Plaintiffs allege that this lender-against-lender conduct not only breached the terms of the first lien loan agreement, but also violated universally accepted norms of the syndicated loan market and will harm leveraged lending and sub-investment grade borrowers if not punished.
Consent from affected lenders required
According to the complaint, the challenged transaction was structured as the extension of USD120 million in new “First-Out Super Senior Debt” by defendant lenders, the cashless exchange of USD307.5 million of defendant lenders’ existing first lien loan positions for new “Second-Out Super Senior Debt” at 100 cents on the dollar (despite trading below 80 cents), and exit consents amending the first lien loan agreement to permit the transaction. The amendments allegedly included:
- Subordination of the first lien loan to the new super-senior tranches by amendment to the definition of Intercreditor Agreement
- Stripping all affirmative and negative covenants
- Removing the requirement that voluntary prepayments and debt exchanges other than open market purchases be offered to all lenders on a pro rata basis and instead permitting exchanges with “one or more” lenders but not made available to all lenders
- Amending the open market purchase basket to state that open market purchases may be made at, above or below par
- Removing rights to seek indemnification from TriMark for losses incurred in connection with the credit agreement
- Amending the collective action clause to permit action against TriMark or defendant lenders only through the agent, who was replaced shortly prior to the transaction following the resignation of the initial agent, and who must be indemnified for the full amount of fees, expenses and potential liability for it to be required to commence suit
Plaintiffs argue that the debt exchange violated the pre-amendment pro rata provisions because a roll-up of the loans at well-above market price did not constitute open market purchases. They further claim that these amendments were not validly made for at least two reasons. First, the lenders who purported to constitute the Required Lenders had already agreed to sell their loan positions to TriMark, and the credit agreement excludes loans held by lenders who have committed to sell their loans back to the borrower from the definition of Required Lenders. Second, while lien subordination was not a “sacred right” requiring unanimous lender consent, the payment waterfall was explicitly “subject to the terms of the Intercreditor Agreement” and therefore modification of that term required consent of all affected lenders.
Transactions 'underline leverage loan market'
The plaintiff group’s suit against the defendants is primarily a suit for breach of contract though it also asserts that TriMark’s private equity sponsors – Centerbridge and Blackstone - engaged in tortious interference of contract. Plaintiffs –assert that transactions such as this, whether permitted by the terms of the contract or not, “undermine the leveraged loan market to the detriment of the economy”. Plaintiffs point out that the vast amount of liquidity provided through leveraged loans – which are an essential component of private equity sponsored buyouts – is only possible due to the ability to broadly syndicate such loans via the secondary market for investing in such loans (a market that is heavily fueled by CLOs). The willingness of CLOs and other investors to purchase leveraged loans in the secondary market depends on the pro rata lender protections universally provided in leveraged loan agreements. The plaintiffs’ complaint asserts that if a lender’s long-standing basic protections are subject to removal without such lender’s consent - as was accomplished through amendments by TriMark and the defendant group of lenders in this case – and the result is the effective subordination and substantial devaluing of that lender’s investment, such investors will be deterred from making future investments in the leveraged loan market and such market would, in the words of the plaintiffs, “dry up”.
It is worth noting that TriMark and its group of priming lenders are not the first players in the market to engage in a transaction such as this. Similar transactions – with some marginal variations – were entered into in recent months by Serta Simmons (a mattress manufacturer) and Boardriders (a surf-clothing producer). These priming transactions are the latest in a line of attempts by borrowers to manage liability by taking actions that they believe are permitted in flexible loan documentation.Borrowers are expected to continue requiring credit facilities provide alternative solutions to liability issues, whether in the form of easily achieved amendments or covenant relief. Given the possibility that some borrowers will continue to address liquidity crunches through aggressive interpretations of already flexible loan documentation, even at the risk of litigation, it is important that investors base their investment decisions on the credit-worthiness of a borrower. As a result, CLOs and other leveraged loan investors may need to consider taking a more active role in requiring tighter covenants and more fulsome “sacred rights” amendment provisions, in an attempt to reverse the current trend of document erosion in the syndicated loan market.
Case may influence future leveraged loan negotiations
To date, plaintiffs have had limited success in suits challenging borrowers’ liquidity-inducing moves, but each case has its differences. The TriMark and Boardriders cases are unique in terms of the parties involved. Similar previous cases were typically filed by a group of wronged lenders led by debt funds, hedge funds and other traditional debt investors, against a borrower defendant, whereas the TriMark and Boardriders cases are being brought primarily by CLOs against the borrower and fellow lenders. While the defendant group of lenders includes several CLOs, the primary defendants are other debt funds and larger institutional players in the leveraged loan market which CLOs have implicitly relied on in the past to ensure that the leveraged loan market retains necessary protective terms.
After a long run of leveraged loan covenants being increasingly weakened and the more recent protective actions of borrowers taking advantage of such weakened covenants, CLOs may need to play a critical role in re-balancing the flexibility provided to borrowers and the protections afforded to lenders in the leveraged loan market. Depending on its outcome, the pending TriMark case is expected to influence future leveraged loan negotiations and the role CLOs have in shaping the leveraged loan market.