Looking beyond the margin: non-financial matters to keep in mind when negotiating corporate debt documentation

With the successful rebound of the general economy in CEE/SEE and the resultant increase in the supply of debt finance, many companies are looking to borrow additional funds and/or re-finance their existing indebtedness on better terms.

Understandably, overall pricing and, at times, financial covenants required by financiers are the key focal points for a CFO or corporate treasurer. However, the borrower's attention to the financing terms should not stop there: Certain (standard) finance agreement terms which – while often dismissed as technical/boilerplate – may have a profound impact on the corporate's business. After reminding ourselves (under 1) of the background for commonly used debt products, this article (under 2) focuses on selected borrower-/issuer-side topics and then takes a glimpse (under 3) at commonly used debt products from the perspective of modifying a multiparty contractual arrangement.

1 Starting point: Who calls the shots?

These days, terms of debt documents tend to be very much borrower/issuer driven, not only as we move up the credit-spectrum, but also the further we move into products such as sponsor-driven LBOs and real estate finance. However, it should be borne in mind that customary finance agreement precedents and templates have historically been developed by the lending side of the market and are essentially bank products. This means that the starting point of every finance documentation negotiation is usually a set of documents which has been designed by creditors – with a primary view to protecting themselves. These documents often do not sufficiently take account of the specifics of the particular borrower's financial and business reality, and borrowers should not shy away from critically reviewing and negotiating finance documents – also beyond the financial terms.

Ultimately, finding the "right" balance between legitimate lender protections and the flexibilities needed by the borrowing firm's management to successfully run the business is in the interest of both sides of a financing transaction.

2 Selected points for discussion

Sophisticated finance documents provide an almost endless source for debate between the stakeholders. Analysing arguments for and against particular positions would clearly be far beyond the scope of this publication, so we decided to focus on a few key areas where a critical forward-looking approach to contract terms will contribute to the stable finance platform needed by any successful business.

Before turning to those topics, a brief note on document architecture: as a technical matter, we firmly believe that all commercially relevant contractual stipulations – such as the ones we are going to discuss below – should be contained in the main/principal finance documents and should not be "hidden" in some ancillary (e.g. security) documentation. Having a "single catalogue" of contract terms will facilitate efficient contract monitoring and compliance, and will be crucial for addressing (risks from) finance contracts in corporate risk management and the internal control functions of a business. The areas we will touch upon broadly fall within the following categories:

1. tailoring the finance documents to the needs of the business, and
2. reducing the risk of "hiccups" in business reality spilling over into the capital structure.

The first area covers the most important (dare we say, the only important) topical legal clauses a businessperson needs to focus on when looking at finance documents. The remainder, including the second area of "spill-over control", is clearly for the internal and external legal team to focus on.

Finance documents tailored to your needs

Generally, the further down a borrower finds itself in the credit spectrum, the more its financiers will look for protections – which will translate into more restrictive contract terms. This is true at pre-funding (aka conditions precedent) stages as well as, via undertakings and representations, during the tenor of the financing.

In a typical non-investment grade (or leveraged loan) scenario, the ongoing contractual restrictions in debt documents are manifold. Regarding those weaker credits, loan documentation seeks to protect financiers by generally restricting the borrower's and its group's ability to transact in certain ways, except to the extent a particular transaction is expressly permitted in the contract. Clearly, those undertakings will determine the borrower's room for manoeuvre during the tenor of the financing, and therefore these covenants and the relevant exemptions deserve attention. Negative undertakings within that category relate to restrictions on movement of cash (e.g. limitations on additional indebtedness, distributions to shareholders and business acquisitions) as well as restrictions on dealing with assets (e.g. no-disposal and negative pledge covenants).

Even in the investment-grade realm, where documentation is far less restrictive, borrowers are well advised to take a forward-looking approach to their covenant sets. For example, changes to accounting standards and their impact on financial covenant calculations would ideally be anticipated at early stages of the process. This can be done either (ideally) during documentation stages or (less ideally) later on by proactively pursuing a covenant re-set during the lifetime of a transaction. Recent changes to IFRS 16 will, depending on the nature of the business, have far-reaching effects on financial covenants, for example.

Lately, a new breed of undertakings has arrived, irrespective of a business's credit rating. Driven by EU but also US sanctions legislation, internationally active lending institutions seek to impose ever more restrictive contractual compliance undertakings on their borrowers. Of course, sanctions compliance must be safeguarded, but care must be taken not to contract prohibitions that go beyond what the law requires and, worse, could even violate applicable anti-boycott legislation (e.g. the EU's blocking statute addressed at certain US sanctions against Iran).

Technical safeguards

Experience shows that even the strongest of borrowers are not immune to stress situations. When these occur, the contractual terms of the debt documents are decisive in containing the impact of singular events on the overall capital structure.

In those situations, it will be crucial that revolving facilities remain available for drawdown, for example. Available commitments in such situations often presuppose precise contract language, in combination with a contracting out of statutory draw-stop provisions. Related areas, where forward-looking drafting of finance contracts is essential, include cross-default mechanisms (where otherwise the "lowest denominator" may easily spark a group-wide fire) and cure rights for defaults. Moreover, banking regulation drives lending institutions towards a less "static" approach to their exposures. Tradability of debt may at times not mesh well with the concept of relationship banking and, considering regulatory pressures, it will always be worthwhile for a borrower to take a closer look at the transfer clauses in the debt documents to determine how legally robust the relationship with a particular financier in fact is.

3 Documentary adaptability?

Finally, since nobody can predict the future, the need to amend or waive a particular feature in a finance document (or in the capital structure) cannot be excluded.

Later in this Roadmap (see pages 18 to 23), our colleagues will briefly describe the statutory tools available in CEE/SEE to adjust existing finance contracts in the absence of a majority-based contractual mechanism. As a "sneak preview", however, we performed a document adaptability check of the financing arrangements that appear most popular with medium and large corporates in the region, i.e. (A) syndicated loans, (B) privately placed bonds following the German Schuldschein model, and (C) corporate bonds.

Not surprisingly, from the perspective of adapting an existing multiparty arrangement without all parties being available (or willing) to consent, a syndicated loan appears the preferred route, simply because of the contractually agreed majority decision- making in combination with a single point of contact, the agent of the syndicate. Contrary to that, from a contract law perspective, the German Schuldschein constitutes a bundle of bilateral agreements and each affected creditor would need to consent to relevant changes. Corporate bonds, certainly Austrian law ones (and practice differs from jurisdiction to jurisdiction), often do not contain any forum or methodology to amend or waive particular terms so that – absent use of the statutory tools that may be available – a time-consuming exchange offer would often seem the only alternative.

Bottom line

In a nutshell, taking a critical look at the broader set of terms – beyond the margin – is apt to contribute to the resilience of the borrower's business and to improve the efficiency of internal risk management functions. In a similar vein, corporate borrowers are well advised to consider the selection of the financing instrument – and, potentially, the governing law / jurisdiction of borrowing – in light of the fact that business reality may require a degree of flexibility as regards contract terms. 

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This article was up to date as at the date of going to publishing on 10 December 2018.