Unitranche facilities are the latest innovation in middle market lending. Although it was once a smaller market dominated by lenders who made loans based upon the value of a borrower’s assets, middle market origination has evolved to include a wide array of lenders. Recently, borrowers sponsored by PE have taken advantage of this to finance acquisitions or to pay out a dividend.
Middle market lending may include first lien/second lien facilities. A first lien/second lien facility is a financing arrangement under which a first lien lender is granted a security interest in collateral that is senior to the security interest granted to the second lien lender. These facilities are provided by two sets of lenders under two different sets of credit documents.
A unitranche facility is intended to accomplish the same goals as a first lien/second lien arrangement, but in a streamlined fashion, under a single set of documents. The various intercreditor arrangements for a unitranche facility are identified in the “Agreement Among Lenders” or an “AAL.” The AAL provides the economic and voting arrangements among the lenders and creates two tranches of loans a “first out” tranche and a “last out” tranche – with the first-out tranche (and the first-out lenders) receiving payment priority in certain circumstances.
The single interest rate charged to the borrower is re-allocated in the AAL among the lenders providing the first-out lenders with a lower effective interest rate than the last-out lenders. Mandatory and optional principal payments are paid ratably to the first-out and last-out lenders until the occurrence of certain “waterfall trigger events,” which could include a payment default under the credit agreement; failure of the borrower to comply with all or certain financial covenants; bankruptcy and insolvency events or failure of the borrower to conduct all or a material portion of its business. The waterfall typically applies to payments and proceeds received from sales of the collateral. Any other proceeds are distributed ratably to the lenders.
AALs typically detail voting arrangements among the parties. The first-out and last-out lenders agree amendments requiring consent of all lenders under the credit agreement will also require the sign-off of both tranches. AALs may include a right of first offer. The right of first offer requires a selling lender to first offer the loan to be assigned to the other lenders. Lenders should be aware of these provisions as they may impact the liquidity of their loans and the speed in which their loan can be assigned.
The exercise of the remedies of both the first-out and the last-out lenders against collateral is usually restricted by the AAL. Most AALs include “standstill periods” designed to restrict, for a period of time, lenders from exercising remedies against the collateral. As a general rule, first-out lenders that desire to exercise secured creditor remedies are required to standstill for 30 days, which gives the last-out lenders time to determine whether to exercise a buy-out right. Last-out lenders that desire to exercise secured creditor remedies must standstill for 90-180 days to allow the first-out lenders to determine whether to exercise remedies. If the first-out lenders do not exercise their rights against all or a material portion of the collateral following the standstill period, the agent will follow the last-out lenders’ instructions. AALs may include restrictions on the last out lenders’ rights in a bankruptcy proceeding. In particular, the AAL may limit a last-out lenders’ ability to object to a sale of the collateral in a bankruptcy proceeding or provide for limitations on the ability of the last-out lenders to receive adequate protection, post-petition interest or to vote on a bankruptcy plan. It remains to be seen whether a bankruptcy court would recognize and enforce these provisions.
Private equity sponsors have begun to use unitranche facilities, because most they can be put in place quickly – faster than a traditional first lien/second lien facility. Using a unitranche facility spares the private equity sponsor, the borrower and the lenders from negotiating separate sets of loan documents, which in theory reduces the time to document and finalize a transaction. Unitranche facilities have evolved within the past year, and are continuing to change. While unitranche facilities offer timing and simplicity advantages to private equity sponsors and borrowers, the negotiation of the AAL requires focused effort among counsel to the first-out and second-out lenders.
Nicholas A. Whitney is a partner at the New York office of Richards Kibbe & Orbe LLP. Mr. Whitney specializes in lending and finance transactions.