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Coronavirus – What makes debt buy-backs an option right now?- UK

  • United Kingdom
  • Banking and finance
  • Coronavirus - Country overview

04-05-2020

In light of the recent market events, the trading prices of many loans have fallen dramatically. As a result, companies (or their private equity sponsors) may consider utilising the debt buy-back mechanics in their credit agreements. A debt buy-back is where a borrower or a related party buys back part of the borrower’s debt. This is similar to the approach taken during the 2008 financial crisis when a number of borrowers put in place debt buy-back programmes.

The below note highlights certain key issues to be considered when considering debt buy-backs.

Why do a debt buy-back?

Each particular credit agreement would need to be reviewed and specific analysis provided but a borrower may look to put in place a debt buy-back for many reasons including the following:

  • if a company’s debt is trading at below par and the business has sufficient liquidity, a debt buy-back can serve as a discounted means of repaying debt
  • a debt buy-back programme when debt is extinguished can be used to reduce: (i) leverage to comply with financial covenants and prevent triggering a default; and (ii) interest burden
  • it allows sponsors to put money to work and increase returns with no additional due diligence required
  • in a restructuring scenario, a debt buy-back programme can be used by the sponsor to build a blocking stake in future negotiations but this would require some specific analysis of the credit agreement in relation to disenfranchisement provisions

Key considerations

  • Purchasing entity – consider who will be purchasing the debt. Will this be a member of the group or the sponsor (or an affiliate of the sponsor)?
  • Purchase Agent – is the current intention for the parent or a financial institution to take this role.
  • Disenfranchisement – to be discussed if the expectation is for the purchaser to be disenfranchised and the effects of this.
  • Capital Structure – consider restrictions in intercreditor agreements / other debt instruments in the structure.
  • Directors’ duties – due consideration to be given to the rationale for the proposed debt buy-back and if this is consistent with the directors’ duties in the relevant jurisdictions.
  • Ratings – consider if the debt purchase will have any effect on the rating of the obligor group. Could obtain a preliminary view from the rating agency ahead of implementation.
  • Tax considerations - purchasing debt at a discount by the borrower may trigger a tax charge. Often existing tax losses can be used to offset any gain. Specific tax advice would need to be sought.

Process

The LMA includes two options when it comes to debt purchases. The first option (entitled “Restriction on Debt Purchase Transactions”) envisages that members of the obligor group are not allowed to purchase their own debt (without all lender consent). The second option (entitled “Debt Purchase Transactions”) envisages that borrowers are allowed, in certain circumstances, to purchase their own debt and regulates that process. The below sets out the circumstances when debt purchase are permitted and the process which regulates them.

Generally a borrower can purchase its debt where:

  • the consideration is less than par
  • such purchase must be made at a time when no default (or event of default) is continuing
  • purchases are typically limited to term debt
  • the purchase is made using one of the following processes:
    • Solicitation Process

Typical timeline / steps: 

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    •  
      • Day 1 – The parent or a financial institution acting on its behalf (the “Purchase Agent”) invites each lender to offer to sell participations (the “Solicitation Day”).
      • Day 1 + 2 – Any lender can make an offer to sell specifying the participation amount and the price at which it offers to sell. Offers to be received by 11am on the second business day following such Solicitation Day.
      • Day 1 + 3 – Such offer is irrevocable until 11am on the third business day following such Solicitation Day. The parent can accept the offers before that time by notifying the Purchase Agent (if it isn’t the parent) or the relevant lenders. If the Purchase Agent is not the parent, the Purchase Agent will  communicate to the relevant lenders which offers have been accepted by 12 noon.
      • Day 1 + 4 – Accepted offers are notified to the facility agent by the parent. The facility agent shall promptly disclose this information to the lenders.

The parent is free to choose which offers to accept other than if multiple offers relate to the same term facility. In that situation the parent must accept offers in inverse order of the price offered and if it received offers at the same price it shall only accept such offers on a pro rata basis.

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    •  
      • Day 1 + 5 – Purchases are settled.

Open Order Process

Typical timeline / steps are as follows:

  • Day 1 – The Purchase Agent (i.e. the parent or a third party financial institution) places an open order to each current lender stating the amount and the set price.
  • Day 1 + 1BD to 5BDs – Lenders communicate to the Purchase Agent if they would like to sell on the specified terms.

If the Purchase Agent receives on the same day 2 or more offers at the set price such that the maximum amount of the Open Order would be exceeded, the offers shall be accepted on a pro rata basis.

  • Day 1 + 4BDs  – Any purchase of participations will be settled on the fourth business day after an agreed trade.
  • Day 1 + 6 – Accepted offers are notified to the facility agent by the parent. The facility agent shall promptly disclose this information to the lenders.

 

  • The consideration is derived from certain permitted funding sources this varies between credit agreements but may include:
    • shareholder injections;
    • any retained excess cashflow;
    • any retained proceeds; and/or
    • any cash overfunding.

Sponsor affiliate buy-backs

If the debt buy-back is conducted by the sponsor or its affiliates, no solicitation process or open order process is required.

Each lender shall notify the facility agent in writing (the form of such notification is typically scheduled to the credit agreement) of the Debt Purchase Transaction, if not an assignment or transfer.

Customary disenfranchisement applies, for example no attendance or participating in lender meetings or calls, no receipt of information and no vote / not deemed to be a lender when ascertaining majority, super majority or all lender consents and waivers.

Benefits to lenders

Each transaction would require specific analysis but some of the benefits to lenders in the implementation of a debt buy-back programme are as follows:

  • if the lender is willing to leave on the set price, they are able to exit the transaction early and put capital to work elsewhere.
  • increased stakeholder investment may de-lever the business whilst also increasing sponsors' skin in the game.

The above is intended to be a high level summary of the considerations of implementing a debt buy-back programme. If you have any further questions on the above please feel free to contact your usual member of the Eversheds Sutherland team.