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2024 Cash Flow Covenant Trends
In our 2023 year-end update we noted that, based on Goldberg Kohn deal data, some key covenants trended slightly more borrower favorable as compared to 2022 covenants; in others, lenders were able to gain some ground toward more conservative covenant levels and structures. A comparison of 2023 and 2024 data from Goldberg Kohn-documented deals reflects a marginal loosening of covenants in favor of borrowers, with deal terms that began in the high yield or large cap credit markets further permeating the core middle market. The shift was particularly pronounced in the last quarter of the year. To focus in on key covenant data points:
Incremental facilities: In 2023, a significant majority of deals had an incremental facility. For those that had a free and clear basket, the amount of the basket was set at an average of about .9x EBITDA. In 2024, the percentage of deals that had an incremental facility grew even further, with an average free and clear basket (for those that had one) of about .83x EBITDA.
Synergies addbacks: In 2023, about 60 percent of transactions allowed for synergies-type addbacks to EBITDA, with a cap set at about 20 percent of EBITDA (in most cases calculated prior to giving effect to the addbacks). The vast majority of deals (85 percent) set the synergies look-forward period at 12 months. In 2024, 66 percent of transactions allowed for synergies addbacks, with the average cap set at 23 percent of EBITDA (again in most cases calculated prior to giving effect to the addbacks, though a significant minority - about 35 percent - calculated after addbacks). Most deals still use a 12-month look-forward, though the share with a more aggressive look-forward increased from last year, with about 77 percent set at 12 months, and 17 percent set longer (most typically 18 months when set longer).
Debt and investment baskets: In 2023, the average dollar cap on the general catch-all debt basket equated to about 12 percent of EBITDA, and the average general catch-all investment basket equated to about 15 percent of EBITDA. In 2024, these basket sizes stayed roughly the same, with the debt basket equating to about 13 percent of EBITDA, and investment basket equating to about 12 percent of EBITDA.
Restricted payments basket: Based on data that Goldberg Kohn began tracking in 2024 on the number of transactions that tied the restricted payments basket to a builder basket, 34 percent of deals in 2024 had a builder basket that could be used for restricted payments. The average leverage requirement for use of the builder basket was 3.38x, which represented roughly a .71x deleveraging from closing leverage.
Covenant growers and builders: In 2023, about 26 percent of transactions had one or more covenant baskets that included a grower component, and 27 percent that included a builder ("available amount" basket). In 2024, these numbers were higher, at 28 percent with a grower, and 39 percent with a builder.
J.Crew and Serta protection: In 2023, the vast majority of deals did not allow for unrestricted subsidiaries at all, and all that permitted unrestricted subsidiaries contained some form of J.Crew blocker. In 2024, unrestricted subsidiaries appeared even less frequently, and again all including some form of J.Crew blocker. As it pertains to Serta protection, in both 2023 and 2024, roughly half of deals included Serta protection provisions. We have observed that Serta protection is more often included at closing when there is a club group of lenders in the deal at close.
Prepayment premiums and PIK interest: Goldberg Kohn has begun tracking prepayment premiums and the prevalence of PIK interest since they have garnered more interest recently. Based on 2024 data, about 60 percent of deals contained a prepayment premium. The most common formulation was a percentage stepdown, most frequently starting at 2 percent in year one (with 68 percent of deals having a step-down prepay premium starting at 2 percent). Though PIK interest is becoming more common, it is still largely a tool for workouts and junior capital, with only 9 percent of deals in 2024 including a PIK interest option on the front end.
Serta and "Open Market Purchase"
In a first circuit court-level decision addressing the merits of a liability management transaction, on December 31, 2024, the Fifth Circuit issued an opinion analyzing key questions related to the validity of Serta Simmons' 2020 uptier LMT. The opinion focused mainly on the bankruptcy court's earlier decision that the uptier was effected pursuant to an "open market" purchase that was permitted under Serta's credit agreement. The Fifth Circuit decision noted that, under the credit agreement, Serta had two options to bypass requirements for ratable payments on the debt, either (1) a Dutch auction (which by its terms requires certain procedures be followed, including that an offer be made pro rata to all lenders) or (2) an "open market" purchase of the debt (which term was not defined in the credit agreement).[1]
While the bankruptcy court for the Southern District of Texas had determined that an exchange of debt through private negotiations could fit in the definition of "open market purchase" absent an explicit requirement otherwise, the Fifth Circuit came to the opposite conclusion. In a detailed analysis, the court held that an open market purchase does not include one-on-one private negotiations, and further that the term "market" does not simply mean the existence of some form of competition; rather, it refers to a designated market (such as a stock or loan trading market). The court found that, in order for the exchange of existing debt in connection with the uptier to be an open market purchase, Serta would have had to purchase the relevant loans on the secondary loan trading market, rather than privately engage individual lenders outside of the designated market.
Notably, the court further discarded the argument that the excluded lenders' previous proposals for a similar LMT constituted a course of performance (a point that the bankruptcy court expressly noted as an important factor). While the court emphasized that the analysis as to whether an uptier is permissible is a case-by-case determination based on the provisions in the applicable contract, the decision does have the broad implication that generic open market purchase provisions in a credit agreement will not support an uptier transaction that is not offered to all lenders. It is important to note, however, that the opinion is somewhat limited in that it focuses entirely on defining an "open market purchase," and thus does not affect credit agreements that do not use that term – potentially leading to a situation where sponsors and borrowers may look for other ways to permit uptiers, either by specifically allowing privately negotiated borrower debt buybacks or by removing pro rata sharing provisions more generally from all lender consent items. In fact, a New York state appellate decision handed down on the same day underscores this difference, with the court upholding a 2022 uptier transaction by Mitel Networks, in part relying on the fact that the credit agreement expressly authorized the borrower to repurchase loans at any time, without a requirement that the purchase be either pro rata or on the open market.
Serta and Roll-Up DIPs
One important limitation on the Fifth Circuit decision in Serta is that it does not address the validity of subordination on its own, as opposed to subordination plus a roll-up of existing debt. The key change to many credit agreements in light of Serta's 2020 uptier was to add so called "Serta protection" provisions, which flatly prohibited subordination of the debt or liens without consent of all lenders. According to Covenant Review data through Q3 2024, about 85 percent of private credit loans and 50 percent of syndicated loans include some variation of such a provision.[2] As these provisions have proliferated in the loan market, so have nuances and carve-outs within the language.
The importance of considering exactly how these "Serta blockers" are drafted, as well as how they interact with other agreement provisions such as the post-default waterfall and requirements around pro rata sharing of payments, was recently brought to the forefront in the bankruptcy case of American Tire Distributors (ATD). A subset of ATD's creditors proposed a DIP financing that included a roll-up of a significant portion of their prepetition debt into the DIP facility. When the lenders that had been excluded from participation in the DIP objected, Delaware bankruptcy judge Craig Goldblatt agreed with their arguments, noting that if he were to approve the DIP with the roll-up, the minority lenders would be entitled to damages for a breach of the credit agreement. Key to the excluded lenders' argument was that, while the existing credit agreement contained a Serta provision, the Serta provision carved out DIP financing, without any limitation on whether the DIP financing could include a non-ratable roll-up of the existing debt. However, the excluded lenders' argument contrasted this provision with a separate provision in the credit agreement requiring unanimous consent to alter pro rata sharing requirements – which did not include any sort of DIP financing carveout. The judge thus found this contrast to be compelling evidence that while a DIP may be permitted as super-priority debt, it could not include a roll-up that was not offered to all lenders. Within days of Goldblatt's statement, the debtors modified their DIP order to remove the roll-up portion of the DIP, and the financing was subsequently approved. The case exemplifies the importance of considering Serta protection provisions, as well as other liability management blocking provisions, in the context of the credit agreement as a whole, particularly to the extent they may overlap and be applicable to the same situation in a distressed scenario.
More Developments on Third-Party Releases
As noted in the July 2024 issue of this newsletter, the U.S. Supreme Court's decision in Purdue Pharma invalidating non-consensual third-party releases in bankruptcy left open the key question of what precisely constitutes a "consensual" release. The question has already made its way back to bankruptcy courts, particularly as it relates to opt-out releases and the issuance of temporary injunctions.
Temporary injunctions: Two courts have considered how Purdue Pharma applies to temporary injunctions. The U. S. Bankruptcy Court for the District of Delaware, in denying a preliminary injunction in favor of former officers of media platform Parler, held that Purdue does not prevent bankruptcy courts from issuing a temporary injunction in favor of third parties. However, in making such a determination the court has to consider the likelihood of success on merits – namely the odds that the debtor will be able to successfully negotiate a plan that includes consensual releases. Using the same logic and relying in part on the holding in the Parler case, the Northern District of Illinois reached a different result and granted a TRO in favor of the principals of debtor Coast to Coast Leasing LLC. The decisions on preliminary injunctions in Coast to Coast Leasing and Parler demonstrate that while non-debtors are not precluded from obtaining preliminary injunctions, because nonconsensual plan releases are no longer a permissible goal, it will be more difficult for debtors to meet the required showing that the plan has a reasonable likelihood of success. Courts will likely require a greater showing of consensus building early on in a case, shorten the duration of any injunctions and impose more stringent disclosure requirements.
Opt-outs: Thus far, different standards have emerged for whether a release that requires an opt-out is valid. In the Northern District of Texas, Judge Scott Everett ruled in the bankruptcy of Ebix, Inc. that a process which involved an affirmative opt-out was impermissible, holding that whether a release is consensual should be interpreted in accordance with contract law principles, and silence is not the equivalent of consent under Texas contract law. In the same district, Judge Stacey Jernigan reached a different conclusion for opt-out releases in the bankruptcy plan of Eiger Biopharmaceuticals, applying a standard similar to that used in class actions and noting that since more than 100 creditors successfully opted out of the releases, the instructions were clear enough that the failure to opt out could be deemed to be consent. Judge Paul Baisier in the Northern District of Georgia agreed with Judge Jernigan, applying a class action standard in the bankruptcy of LaVie Care Centers and binding creditors who were given notice but failed to respond.
Meanwhile, in the bankruptcy of Smallhold Inc. in Delaware, Judge Craig Goldblatt determined that some form of affirmative consent that would be sufficient as a matter of contract law was required for a release to be consensual. Therefore, silence from the releasing party does not constitute consent for a third-party release, but creditors who voted on a bankruptcy plan and were presented with an opportunity to opt out as part of the voting process were deemed to have granted a consensual release.
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 Director of Knowledge Management and Innovation, 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] The opinion notes that the credit agreement's "deafening silence" on the meaning of "open market purchase" "…stands in sharp contrast to the meticulous definition it provides for Dutch Auction."
[2] Covenant Review, Lens on Loopholes, October 8, 2024.
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