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Publication

07.24.24

ABL Market Trends

At the annual SFNet International Lending Conference in May 2024, Goldberg Kohn attorneys participated in panel discussions on current trends in the cross-border ABL market and topics in distressed debt and cross-border bankruptcies.  Panel participants noted a number of developments affecting ABL markets, including:

  1. A decrease in new deal cross-border activity in the first half of 2024. Increased flexibility in cash flow leveraged loan markets (including loosening covenants), a continued proliferation of liability management transactions, and more frequent use of PIK interest in workouts has allowed borrowers to maintain cash flow based structures for longer rather than moving to an ABL loan structure. In addition, regulatory uncertainty is contributing to trepidation for some lenders, particularly as it relates to the pending implementation of Basel III regulations in the United States. The regulations were jointly published by the Federal Reserve, FDIC and OCC in October 2023, and faced significant pushback from trade organizations and industry sectors across the market. While significant changes to the proposed regulations are likely, the agencies have not yet released an amended proposal. As it pertains to asset-based lending markets, one of the main concerns is that the regulations do not take into account the risk mitigating impact of collateral taken in secured lending transactions, such as receivables and inventory.  
  2. First-out ABL loans. As a growing number of lenders have both direct lending and asset-based lending groups, they are able to provide borrowers a flexible financing solution by utilizing their ABL groups to provide an ABL loan together with a cash flow loan. Although Goldberg Kohn was a pioneer in ABL unitranche structures more than a decade ago, the structure has received more attention recently as a more streamlined way for lenders to provide a first-out ABL loan under the same documentation as a cash flow loan. In a first-out ABL structure, the last-out cash flow provider serves as administrative agent, and the borrower has the benefit of more seamless documentation than a split lien or other intercreditor structure, as well as greater liquidity management flexibility and lower pricing. Also, in the current regulatory environment, the first-out ABL structure also has the benefit of a lower cost of capital for bank lenders. One potential downside for an ABL lender to consider with this structure is that they may have fewer rights than in a typical ABL deal, as the last out lenders will have more control over documentation and enforcement matters. More importantly, the ABL lender will need to negotiate its ABL enforcement rights in an agreement among lenders ("AAL") with the cash flow lender. Caution should be taken before agreeing to any precedent AAL that was not created with an ABL first-out lender in the prior transaction.   

Liability Management - Emergence in Private Credit and Litigation Update

In what is generally understood to be a "first" for the private credit market, as reported in various news outlets, technology company Pluralsight completed a drop-down liability management transaction ("LMT") in which it moved intellectual property into a new, non-loan party restricted subsidiary and obtained financing from its majority owner, Vista Equity Partners. The loan from Vista was secured by a lien on the transferred IP. The proceeds of the new financing were reportedly transferred by the non-loan party subsidiary to the borrower to make interest payments on the existing loans and prevent a payment default thereunder. The existing loan facilities included a $1 billion recurring revenue term loan and $100MM revolver, all provided by a small group of private credit lenders. While structures similar to (and in some cases more aggressive than) this transaction have been used in other LMTs, the Pluralsight transaction is notable as the first reported instance where such a transaction has been done in a private credit deal. This transaction is similar to well-known LMTs, such as the "J. Crew" transaction, but differs in that the drop-down and new financing was made to a restricted subsidiary that is subject to the covenants in the credit agreement as opposed to an unrestricted subsidiary. The transaction underscores the importance of paying close attention to debt and lien covenant baskets (and how various carve outs may be used together), particularly those that give more flexibility to non-loan party subsidiaries. It is also important to review the excluded subsidiary parameters and the structure of investment covenant baskets, particularly the caps on investments by loan parties in non-loan parties. In order to reduce the risk of this type of LMT, lenders should consider whether investment, debt and lien baskets taken on an aggregate basis (as such baskets may often be "stacked") are appropriately sized, and consider limiting investments in non-loan parties to those that are made in cash and cash equivalents versus contributions of other assets. Lenders can also consider expanding "J. Crew" blockers that traditionally restrict the transfer of material IP or other specified assets to unrestricted subsidiaries to also block the transfer of such assets to any non-loan party restricted subsidiary.

In addition to the expansion of LMTs into the private credit market, various disputes related to such transactions are making their way through the courts and consistent case law is beginning to coalesce. Recently, in the Bankruptcy Court for the Southern District of Texas, Judge Christopher Lopez issued a decision upholding certain key aspects of LMTs completed by Robertshaw US Holding Corp. and certain of its lenders (which were challenged by excluded lender Invesco Senior Secured Management). The LMTs included an uptiering to obtain additional liquidity under a new "super-priority" credit agreement and another series of transactions to form a new entity that obtained additional financing to pay off a portion of the existing debt. The bankruptcy court carefully parsed the precise terms and definitions used in the credit agreement and held that Robertshaw had breached the credit agreement by incurring unauthorized indebtedness, but rejected arguments that the sponsor had engaged in tortious interference by facilitating the LMT. The court also dismissed an argument for a breach of the implied covenant of good faith and fair dealing. In dismissing the claims for a breach of the covenant of good faith and fair dealing, the court noted that the lender who brought the lawsuit had previously engaged in a LMT itself – reasoning that echoes parts of the decision of Judge David R. Jones in Serta Simmons, and is a lesson for lenders that their participation in a LMT could be used against them in the future. A similar result was reached by a different judge in the same court related to the Wesco/Incora uptiering. There, the court found that the specific language of the loan documents did not permit the uptiering transaction, but emphasized that the decision was based on the specifics of the language in the documents and does not impugn the use of uptiering transactions generally. 

Third-Party Liability Releases

In a 5-4 ruling on June 27, 2024, the U.S. Supreme Court issued a key decision related to third-party releases in bankruptcy. Third-party releases are a key tool used in bankruptcy proceedings to discharge non-debtor entities such as directors, owners or affiliated companies from liability for claims related to the debtor's financial distress. In proceedings related to the bankruptcy case of Purdue Pharma[1], the Supreme Court held that the bankruptcy code does not authorize the non-consensual release of the Sackler family from liability for mass tort claims related to the conduct of Purdue Pharma. The ruling of the Supreme Court established that liability releases granted to entities or individuals who are not in bankruptcy are not permitted by the bankruptcy code if they are obtained without consent of creditors and claimants. While the decision complicates a key strategy used by companies facing mass tort liabilities to settle lawsuits, it also made clear that non-bankrupt parties can still obtain releases as long as they are consensual, a key point that is less than clear in the bankruptcy code. The decision also left open the question of what qualifies as "consensual," particularly whether a creditor that does not actively opt out of a settlement and liability releases in connection with a bankruptcy plan would be considered to have consented. The nuances of these questions are likely to be litigated in the near future, particularly in several pending cases where liability releases are key, including the Boy Scouts of America and various Catholic diocese bankruptcy cases.

Enforceability of Shareholder Approval Rights

Earlier this year, two key cases in Delaware called into question the enforceability of certain approval rights in favor of company shareholders, prompting the Delaware General Assembly to amend the Delaware General Corporate Law (DGCL) to specifically address these provisions. In West Palm Beach Firefighters' Pension Fund v. Moelis & Co., the Delaware Chancery Court invalidated certain provisions of a stockholder agreement that gave the stockholder pre-approval rights over some corporate actions, including incurring debt, issuing stock, removing and appointing officers, declaring dividends, and entering into material contracts. The overarching question in the case was whether the agreement constituted an internal governance arrangement (which would be unenforceable) or an external commercial agreement (which would be enforceable). Subsequently, in Wagner v. BRP Group, Inc. the Delaware Chancery Court articulated a multifactor test for making the distinction between internal governance and a commercial agreement. Shortly after these two decisions, the Delaware General Assembly passed Senate Bill 313, and the bill was signed into law on July 17, 2024.  The bill amends the DGCL to specifically authorize a corporation to enter into stockholder agreements that include certain provisions, including provisions that: (i) restrict or prevent the corporation from taking actions specified in the contract, either generally or absent the consent of one or more persons or bodies (including one or more directors or stockholders) and (ii) covenant that the corporation or one or more persons (including the board of directors or stockholders) will take or refrain from taking actions specified in the contract. While the list in the DGCL amendments is not an exhaustive list of enforceable provisions, they provide a bright-line authorization for stockholder agreement provisions that fall into those categories. The amendments passed easily in the Delaware legislature, but they were not without controversy. They were criticized by a group of law professors and by Vice Chancellor Laster (the Delaware judge who issued the Moelis decision) as being overly permissive and allowing boards to contract away powers that shareholders had entrusted to them without shareholder input.

This newsletter is provided by Goldberg Kohn's Commercial Finance and Bankruptcy & Creditors' Rights practices. The attorneys in these practices collaborate to represent a diverse group of banks, commercial finance lenders, providers of mezzanine loans and other institutional lenders engaged principally in middle market lending operations. Goldberg Kohn is known for the depth of its practice, providing practical legal guidance, efficient staffing, and ability to facilitate smooth closings.

If you have any questions about this newsletter, please contact our Knowledge Management Attorney, Laura Jakubowski, or the Goldberg Kohn attorney with whom you normally consult. The information contained herein is provided for general information purposes only, and for review and use only by the direct recipient of this newsletter. The information contained in this newsletter is not intended to be and should not be relied upon as legal advice.

[1] Harrington v. Purdue Pharma L.P., No. 23-124, 603 US       (2024).