Surprisingly, some loan market participants continue to think that the term “open market purchases” included in many syndicated credit agreements today is intended to require the borrower to buy all the loans of a particular tranche on a pro rata basis, or at least make the offer to all lenders of the associated class. As Serta[1] and other liability management cases take their twists and turns through the courts, lenders are taking note of how an “open market purchase” provision can be utilized by a dominant class of lenders to subordinate a minority class. Much has been written on the need for “Serta protections” and on liability management transactions, but there has been no attempt to ink a definition for the term “open market purchases” in the credit agreements being drafted today, and there have been few, if any, successful attempts to amend the existing concept to protect against future problems. As recently as the Loan Syndications and Trading Association/Loan Market Association (LSTA/LMA) conference last quarter, when asked whether lawyers were seeing a defined term for “open market purchases,” experts drew a blank. They were not aware of any credit agreements that contained a definition, nor of any real attempts at a definition in the amendment process—shocking.
As lenders open their documents for amendments in the new year for any variety of reasons—e.g., loosening covenants, extensions of payment schedules, and enhancements to the collateral and reporting packages—they should consider amending the documents to delete the “open market purchase” option entirely, or define it as the following:
a purchase of loans that is (i) offered to all lenders on a pro rata basis, (ii) conducted on an arm’s-length basis, (iii) made in cash and at the current trading prices, (iv) subject to no default or event of default, and (iv) structured so that that the purchased debt be canceled.
The definition of “open market purchase” must also be included in the list of sacred voting rights that requires an all affected lender consent, together with the release or subordination of collateral. Otherwise, a dominant class of lenders would be able to amend the definition to delete these conditions in the process of structuring a liability management transaction. This should sufficiently neuter the ability of the borrower to utilize this mechanism to subordinate a group of lenders within the same class and strip covenants as was done in Serta and other transactions. By keeping this mechanic in the document undefined as is the status quo, the risk remains high that a portion of the debt will be subordinated in a liability management transaction. The last thing anyone should have to explain to their credit committee in the new year is why there was an “open market purchase” concept in the document that was not defined.
How Did This Concept Arise?
During the Great Financial Crisis of 2007–2008, “open market purchases” came into vogue to permit the borrower to repurchase loans on a one-off, non–pro rata basis. The concept is typically confined to the syndicated term loan B market. “Open market purchases” differed from “Dutch auctions” (where the borrower specifies a ceiling or a range to lenders and then gives the lenders a period of time to offer the debt for sale) in that they permitted a borrower to purchase loans quickly from any one of its lenders without making the offer to other lenders. This was key. During the Great Financial Crisis, financial sponsors and their borrowers saw this mechanism as an easier and more efficient way to buy back distressed debt without having to go through often lengthy and time-consuming auction procedures. Credit agreements originally permitted these “open market purchases” to be made subject to certain conditions, the most common of which were the following: the absence of a default or event of default, proceeds from the revolver could not be utilized to make these purchases, the borrower had to represent that it was not in possession of any material nonpublic information, and finally, the debt had to be canceled. The cancellation of the debt was critical. The borrower and its affiliates were not entitled to hold those loans and exercise voting rights once the debt was purchased.
A fundamental principle in syndicated credit agreements, however, is that all similarly positioned lenders should be treated equally, or, with respect to distributions, on a “pro rata” basis. This makes a lot of sense; in broadly syndicated loans, and even smaller club loans, lenders extending the credit and agreeing to be part of the syndicate (or the club) do so based on the assumption that they are going to be treated the same as the other lenders in the tranche. It is hard to imagine how a lender group could be put together on any other basis. “Sure, I will lend you money for the secured loan, but you can pay someone else back first, and without telling me,” said no senior secured lender ever. Prior to the Great Financial Crisis, most credit agreements did not even permit the borrower or its affiliates to buy back loans, and the borrower and its affiliates were not permitted assignees of the loans. If anything, the purchase was capped, and there were limitations on voting and information rights, as well as waivers of certain rights in bankruptcy. Even the rights of the borrowers’ “debt fund affiliates” were capped.
There are a number of provisions that give comfort to the fundamental principle that equally positioned lenders should be treated equally. Most credit agreements include a provision that requires any voluntary or mandatory prepayments be made on a pro rata basis to all lenders. Most credit agreements also include some kind of pro rata sharing clause that requires any lender who receives a payment in excess of its proportion to share the excess with the other lenders (either by way of a purchase of an assignment or participation in each of the other lenders’ loans).
A Call to Action
The lack of a definition to the term “open market purchase,” including any detail on the process by which the borrower repurchases the loans through this method, is directly at odds with the other provisions in the credit agreement, so it is not surprising that this mechanic ended up being the gateway to an often-used liability management transaction structure. Now is the time to build in a definition of “open market purchase” that will include appropriate parameters to protect lenders from “lender-on-lender violence” and restore the syndicated lending market to more predictable restructuring outcomes.
In re Serta Simmons Bedding, LLC, No. 23-90020, 2023 WL 3855820 (Bankr. S.D. Tex. June 6, 2023). ↑
