Avantor
Slight Variations in Word Choices Under Debt Documents Could Have Significant and Likely Unintended Consequences for Companies and Their Creditors
Thu 10/21/2021 09:15 AM
Debt documents are heavily negotiated contracts that seek to balance the interests of companies and their creditors. Many of these contracts can run for hundreds of pages and will include multiple multipage paragraphs with subclauses and subclauses to those subclauses.
Most debt documents can be amended with the consent of a majority of creditors, although certain “sacred right” amendments require the consent of all creditors or all affected creditors.
Nevertheless, all debt documents also allow the company and the administrative agent (under credit agreements) or the trustee (under bonds) to enter into amendments without needing consent from any creditor in order to correct “an obvious error or any error or omission of a technical or immaterial nature.”
While this theoretically makes sense, as it would be highly inefficient to have to seek majority creditor consent in order to correct an obvious drafting mistake, it could have significant consequences for creditors.
In this article we briefly highlight language in three debt documents that may seem to embody obvious drafting mistakes but which could have material unintended and adverse consequences for either the company or the creditors.
On Tuesday, Oct. 19, Avantor announced that in connection with its acquisition of the Masterflex bioprocessing business and related assets of Antylia Scientific, it would be issuing $800 million of senior unsecured notes due 2029.
Avantor, which had been controlled by affiliates of New Mountain Capital, completed its IPO in the second quarter of 2019 and received $4.235 billion of net proceeds.
At the time of the company’s IPO, the indentures governing its two series of outstanding 2024 first lien notes and 2025 unsecured notes all included an annual post-IPO dividend basket that permitted:
As highlighted above, the post-IPO dividend baskets under Avantor’s notes at the time of its IPO permitted the company to pay annual dividends equal to 6% of proceeds received from its first public offering of equity after the date of issuance for each series of notes. After the company’s IPO, these baskets would have permitted annual dividends equal to $254 million.
Although the company’s 2017 senior secured term loan and revolving credit facility included a similar basket, it did not include the same temporal limitations as the baskets under the notes. The credit agreement’s post-IPO dividend basket was also later amended and expanded by a fifth amendment to the credit agreement, dated Nov. 6, 2020, to also include annual dividends based on 7% of market capitalization:
Since Avantor’s 2019 IPO, it has replaced its 2024 first lien and 2025 unsecured notes with 2025 first lien notes and two series of 2028 unsecured notes, in addition to the newly issued 2029 unsecured notes.
While the post-IPO dividend baskets under the company’s 2024 first lien notes, 2025 unsecured notes and newly issued 2029 unsecured notes include the credit agreement’s expanded capacity, they also include the previous notes’ temporal limitations:
While the temporal limitations included in the post-IPO dividend baskets under the company’s notes that were issued prior to its IPO may have made sense, their inclusion in notes issued after the IPO technically result in a significant reduction of permitted dividend capacity under these notes.
On the basis of the company’s $23.58 billion market capitalization on Oct. 19 (market capitalization under the company’s debt documents is based on the average trading price over the prior 30 trading days) and the post-IPO dividend baskets under the credit agreement, and ignoring the temporal limitations, the notes would currently provide the company with about $1.905 billion of annual dividend capacity.
However, given that the baskets under the notes technically provide capacity only “following consummation of the first public offering of the Issuer’s common equity or the common stock of any Parent Entity after the Issue Date,” the baskets arguably will not provide Avantor with any additional dividend capacity until the company issues more equity.
On Sept. 21, Brookwood Financial Partners-owned Yesway filed its S-1 in connection with its initial public offering.
On April 2, the company entered into a new senior secured term loan and revolving credit facility to refinance its existing credit facility.
As is customary in private, sponsored credit agreements, Yesway’s new credit agreement included separate beneficial ownership change-of-control triggers for the periods prior to and following the company’s IPO.
Prior to the company going public, a change of control will be triggered under the new credit agreement if:
Under credit agreements, a change of control triggers an event of default and allows a majority of lenders to accelerate the outstanding debt. This makes sense, as it protects lenders should the ownership of, and decision making authority over, their borrowers change.
Under most private, sponsored credit agreements, a change of control prior to an IPO will be triggered if the “Permitted Holders” - typically defined as the sponsors and their nonportfolio company affiliates - cease to own a majority of the voting stock of the borrower’s holding company.
However, as highlighted above, under Yesway’s credit agreement, prior to an IPO, a change of control will be triggered if the Permitted Holders cease owning at least 50% of the holding company’s voting stock.
The result of the 50% beneficial ownership requirement, rather than the more common majority ownership one, is that Brookwood Financial Partners could sell 50% of Yesway to another private equity sponsor without triggering a change of control, even though the Permitted Holders, alone, no longer have decision-making authority over the company.
Reorg Covenants Prime has reviewed a handful of private, sponsored credit agreements in the past two years that also include similar change-of-control mechanics that could result in two separate sponsors owning 50% of the borrower’s voting stock.
In May, Sotheby’s, through its parent company, BidFair Holdings, issued $300 million of senior unsecured notes due 2029, with proceeds to be used to fund a distribution to its sponsor Next Alt Sàrl.
At issuance, one of the company’s subsidiaries, 34-35 New Bond Street Ltd., was deemed to be an unrestricted subsidiary.
Almost all debt documents include negative covenant baskets that permit transactions that existed at the time of closing (under credit agreements) or issuance (under bonds). The debt covenants permit outstanding debt, the asset sale covenants permit asset sales that have been agreed to but not completed, and the investment covenants permit existing investments.
However, the definition of “Permitted Investments” under Sotheby’s bonds included a basket that permitted:
Although the intention of this basket was almost certainly to permit existing investments in 34-35 New Bond Street Ltd. as of the issue date, the way it is worded arguably permits unlimited investments in unrestricted subsidiaries that existed as of the issue date.
Most debt documents can be amended with the consent of a majority of creditors, although certain “sacred right” amendments require the consent of all creditors or all affected creditors.
Nevertheless, all debt documents also allow the company and the administrative agent (under credit agreements) or the trustee (under bonds) to enter into amendments without needing consent from any creditor in order to correct “an obvious error or any error or omission of a technical or immaterial nature.”
While this theoretically makes sense, as it would be highly inefficient to have to seek majority creditor consent in order to correct an obvious drafting mistake, it could have significant consequences for creditors.
In this article we briefly highlight language in three debt documents that may seem to embody obvious drafting mistakes but which could have material unintended and adverse consequences for either the company or the creditors.
Avantor - Temporal Limitations Reduce Dividend Capacity
On Tuesday, Oct. 19, Avantor announced that in connection with its acquisition of the Masterflex bioprocessing business and related assets of Antylia Scientific, it would be issuing $800 million of senior unsecured notes due 2029.
Avantor, which had been controlled by affiliates of New Mountain Capital, completed its IPO in the second quarter of 2019 and received $4.235 billion of net proceeds.
At the time of the company’s IPO, the indentures governing its two series of outstanding 2024 first lien notes and 2025 unsecured notes all included an annual post-IPO dividend basket that permitted:
“The declaration and payment of dividends on the Issuer’s common equity … following consummation of the first public offering of the Issuer’s common equity or the common stock of any Parent Entity after the Effective Date, in an amount not to exceed up to 6.0% per annum of the net cash proceeds received by or contributed to the Issuer in or from any such public offering” (emphasis added).
As highlighted above, the post-IPO dividend baskets under Avantor’s notes at the time of its IPO permitted the company to pay annual dividends equal to 6% of proceeds received from its first public offering of equity after the date of issuance for each series of notes. After the company’s IPO, these baskets would have permitted annual dividends equal to $254 million.
Although the company’s 2017 senior secured term loan and revolving credit facility included a similar basket, it did not include the same temporal limitations as the baskets under the notes. The credit agreement’s post-IPO dividend basket was also later amended and expanded by a fifth amendment to the credit agreement, dated Nov. 6, 2020, to also include annual dividends based on 7% of market capitalization:
Since Avantor’s 2019 IPO, it has replaced its 2024 first lien and 2025 unsecured notes with 2025 first lien notes and two series of 2028 unsecured notes, in addition to the newly issued 2029 unsecured notes.
While the post-IPO dividend baskets under the company’s 2024 first lien notes, 2025 unsecured notes and newly issued 2029 unsecured notes include the credit agreement’s expanded capacity, they also include the previous notes’ temporal limitations:
“[T]he declaration and payment of dividends on the Issuer’s common equity ... following consummation of the first public offering of the Issuer’s common equity or the common stock of any Parent Entity after the Issue Date, in an amount not to exceed the sum of (A) 6.0% per annum of the net cash proceeds received by or contributed to the Issuer in or from any such public offering … and (B) an aggregate amount per annum not to exceed 7.0% of Market Capitalization” (emphasis added).
While the temporal limitations included in the post-IPO dividend baskets under the company’s notes that were issued prior to its IPO may have made sense, their inclusion in notes issued after the IPO technically result in a significant reduction of permitted dividend capacity under these notes.
On the basis of the company’s $23.58 billion market capitalization on Oct. 19 (market capitalization under the company’s debt documents is based on the average trading price over the prior 30 trading days) and the post-IPO dividend baskets under the credit agreement, and ignoring the temporal limitations, the notes would currently provide the company with about $1.905 billion of annual dividend capacity.
However, given that the baskets under the notes technically provide capacity only “following consummation of the first public offering of the Issuer’s common equity or the common stock of any Parent Entity after the Issue Date,” the baskets arguably will not provide Avantor with any additional dividend capacity until the company issues more equity.
Yesway - Blocking Lenders’ Ability to Exit Their Loans After a Change of Control
On Sept. 21, Brookwood Financial Partners-owned Yesway filed its S-1 in connection with its initial public offering.
On April 2, the company entered into a new senior secured term loan and revolving credit facility to refinance its existing credit facility.
As is customary in private, sponsored credit agreements, Yesway’s new credit agreement included separate beneficial ownership change-of-control triggers for the periods prior to and following the company’s IPO.
Prior to the company going public, a change of control will be triggered under the new credit agreement if:
“[A]t any time prior to the consummation of a Qualified IPO, the Permitted Holders shall cease to beneficially own and control, directly or indirectly, on a fully diluted basis Equity Interests representing at least 50.0% of the total voting power of all of the outstanding voting Equity Interests of Holdings” (emphasis added).
Under credit agreements, a change of control triggers an event of default and allows a majority of lenders to accelerate the outstanding debt. This makes sense, as it protects lenders should the ownership of, and decision making authority over, their borrowers change.
Under most private, sponsored credit agreements, a change of control prior to an IPO will be triggered if the “Permitted Holders” - typically defined as the sponsors and their nonportfolio company affiliates - cease to own a majority of the voting stock of the borrower’s holding company.
However, as highlighted above, under Yesway’s credit agreement, prior to an IPO, a change of control will be triggered if the Permitted Holders cease owning at least 50% of the holding company’s voting stock.
The result of the 50% beneficial ownership requirement, rather than the more common majority ownership one, is that Brookwood Financial Partners could sell 50% of Yesway to another private equity sponsor without triggering a change of control, even though the Permitted Holders, alone, no longer have decision-making authority over the company.
Reorg Covenants Prime has reviewed a handful of private, sponsored credit agreements in the past two years that also include similar change-of-control mechanics that could result in two separate sponsors owning 50% of the borrower’s voting stock.
Sotheby's - Modifiers Can Contract or Expand Flexibility
In May, Sotheby’s, through its parent company, BidFair Holdings, issued $300 million of senior unsecured notes due 2029, with proceeds to be used to fund a distribution to its sponsor Next Alt Sàrl.
At issuance, one of the company’s subsidiaries, 34-35 New Bond Street Ltd., was deemed to be an unrestricted subsidiary.
Almost all debt documents include negative covenant baskets that permit transactions that existed at the time of closing (under credit agreements) or issuance (under bonds). The debt covenants permit outstanding debt, the asset sale covenants permit asset sales that have been agreed to but not completed, and the investment covenants permit existing investments.
However, the definition of “Permitted Investments” under Sotheby’s bonds included a basket that permitted:
“Investments by the Issuer or a Restricted Subsidiary in an Issue Date Unrestricted Subsidiary in existence as of the Issue Date.”
Although the intention of this basket was almost certainly to permit existing investments in 34-35 New Bond Street Ltd. as of the issue date, the way it is worded arguably permits unlimited investments in unrestricted subsidiaries that existed as of the issue date.
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