As the European loan market continues to stall amid eurozone fears, borrowers are turning to the US market for leveraged buyout (LBO) financing.
But IFLR can reveal that large discrepancies between European and New York loan documentation and practices will cause a power struggle between lenders, borrowers and arrangers.
“The trend is in its in its infancy due to credit markets being closed for the last six months,” said one in-house at an investment bank. “Now people are just trying to work out how to get financings done,” he said.
There are early indications of success: Apollo’s acquisition of Taminco is the most recent example of a US financing commitment for a European LBO. Before that, Onex and CPPIB acquired Tomkins using a US syndicated bank and bond financing.
However, New York investors must get comfortable with European borrower terms, while European companies and sponsors must meet New York requirements.
This could be a challenge, say banks. There are competing covenants across New York and European markets, with differing views on everything from equity cures, intercreditor agreements and material adverse change clauses (Macs). A middle ground must be found.
Jeremy Duffy, partner at White Case, believes that where relevant local law permits and is acceptable commercially, counsel have two options. “We need to either find a compromise for each relevant documentary provision, under which the market's preferred elements from each of the English and the New York versions appear, or the form from one jurisdiction may prevail over the other,” he said.
One key issue is over market terms. Borrowers only accessing the institutional term loan market in the US will include terms specific to that market. But if parties are also inserting a pro rata term loan or a revolver with a relationship bank in Europe, then European terms absent in the US will become problematic.
Lawyers working on deals during January have largely seen the US terms winning out in this regard. “But I have seen folks pushing for a guarantor coverage test, which in the US is rare, but common in Europe,” said one lawyer.
Possibly the biggest challenge to documentation will be around the inclusion and substance of intercreditor agreements.
The general approach towards intercreditor agreements is different in the US and Europe. This is driven largely by the impact of the US bankruptcy code.
The insolvency regime in the US means that intercreditor agreements are rarely required for borrowers subject to US bankruptcy jurisdiction. However, the absence of such a code and the dominance of consensual restructurings in Europe places greater importance on intercreditor agreements.
But many lawyers believe that European style intercreditor agreements will still be needed in European LBO financings carried out under New York law.
According to a client note from Allen & Overy: “The reason those agreements have developed as they have is due to the differing European insolvency regimes and security enforcement procedures – not the governing law of the loan agreement or location of the lenders.”
Security is a contentious point in the new wave of deals. In a typical European deal, mezzanine is subordinated in right of payment as well as having a junior lien. However, US second lien is not typically subordinated in right of payment – only in right of the security interests.
“That has implications for the senior lenders in terms of their potential recovery if they don’t have full security coverage as any unsecured claim will be pari with US second lien debt,” said Jake Mincemoyer, partner at White & Case in London.
For European groups there are greater issues around not being able to obtain a floating charge in many European countries and guarantee limits. This contrasts with the ability in the US to get security interest over nearly all assets and good guarantees.
“So for deals with primarily European collateral accessing the US second lien market, it will be interesting to see whether or not the senior lenders will be able to get the payment subordination that they would from Europe mezzanine,” said Mincemoyer.
Bespoke or boilerplate?
It is unclear whether a market standard will be found. “I think terms will be more bespoke to each deal,” said a source at a bank.
Borrowers could have European assets with either some US assets or even none at all. “There may be just partially syndicated deals, or fully syndicated. The balance between those different features will drive some of the differences in documentation,” added the source.
There are further discrepancies over borrower consent. Loans in the US – with its liquid secondary loan market – are almost universally transferable but in Europe borrower consent still prevails for transferring loans.
“Borrowers and sponsors in Europe like to know who holds their debt,” said a banker. “In the US they have moved beyond that,” said the source.
Smaller, though still substantive differences centre on market practice. In Europe most deals require 66 2/3% of majority lenders to make changes to loan agreements. In the US only a simple majority is needed. While many observers believe a simple majority is better suited, it’s unclear which threshold will prevail in the terms.
US deals do not include Mac clauses in loans. European deals do. Although the value of Macs in loans is debated (calling a loan back on a Mac is perilous due to its discretionary nature) it will need to be resolved in a European/New York hybrid deal.