- During 2019 anti-net short provisions were introduced to the US leveraged loan market by financial sponsors seeking to limit the rights of lenders that hold a net short position in loans.
- Anti-net short provisions in the US leveraged loan market primarily comprise disenfranchisement of net short lenders and restrictions on transfers to such lenders but can also include a limitation period on taking action following a default and an extended cure period.
- This recent development in the US leveraged loan market is starting to migrate to the European market but, in these early days, there is no settled position on anti-net short provisions in the European leveraged loan market.
One notable development in the leveraged loan market in 2019 was the inclusion by financial sponsors of "Anti-Net Short Provisions", which are designed to provide financial sponsors with greater control over the composition of their portfolio companies' debt investors and to curtail net short debt activism. While these provisions have, to date, primarily been limited to the US leveraged loan market, such terms are now migrating to its European counterpart. This article discusses the different approaches taken to Anti-Net Short Provisions in the US leveraged loan market and provides insight as to what market participants can expect in Europe.
"NET SHORT LENDER" AND "NET SHORT DEBT ACTIVISM"
First of all, who is a "net short lender" and what is "net short debt activism"? A lender will be considered a "net short lender" when its long position in a loan is outweighed by its short position in a credit default swap or other derivative. What this means is that, in the right circumstances (for example, where a borrower is in default under its loan documentation), a net short lender will benefit from the bankruptcy or insolvency of a borrower because its payout under the credit default swap or other derivative will be greater than any losses it suffers in connection with its long position in the syndicated loan. Net short debt activism is a term used to describe net short lenders who take net short positions with a view to calling a default under the relevant loan documentation to force a pay-out under a credit default swap or other derivative.
ORIGIN AND FINANCIAL SPONSOR RESPONSE
Net short debt activism is not necessarily a new concern for financial sponsors. Certain borrowers have been alive to the (sometimes unconventional) consequences of working with entities that have net short positions with widely-known examples including Codere's 2013 restructuring and the recent events involving Hovnanian Enterprises.
However, in February 2019, Windstream entered into Chapter 11 bankruptcy after a holder of certain of its bonds, who was believed to be a net short lender, alleged that Windstream had breached one of its covenants as a consequence of a transaction that Windstream had undertaken two years prior to the date on which that holder acquired its bonds.
Upon seeing the implications of the Windstream case, financial sponsors were quick to react by introducing Anti-Net Short Provisions in an attempt to protect their portfolio companies from the motivations of net short lenders which are perceived not to be fully aligned with the interests of the company, equity stakeholders and, perhaps also, lenders who hold long positions.
EVOLUTION OF ANTI-NET SHORT PROVISIONS
At the time Anti-Net Short Provisions first appeared in the market, leveraged loans and high yield bonds took quite different approaches. The leveraged loan market typically incorporated provisions disenfranchising net short lenders whereas the high yield bond market included language which prohibited bondholders from exercising their rights with respect to an event of default that was more than two years' old. These contrasting approaches are continuing to evolve and, in respect of leveraged loans at least, it is now not uncommon for financial sponsors to propose Anti-Net Short Provisions that comprise a combination of both approaches and also extensions thereof.
ANTI-NET SHORT PROVISIONS IN THE US LOAN MARKET
In US syndicated loan documentation, Anti-Net Short Provisions are generally found in the sections governing amendments and waivers, successors and assigns and/ or remedies upon event of default. While the drafting of these provisions is far from settled, it is typical that language in leveraged loans purports to implement one or more of the following:
- –Disenfranchisement of net short lenders: language is included in the amendments and waivers section to provide that net short lenders shall have no voting rights with respect to any amendment, waiver or any other instruction to the agent to undertake (or refrain from taking) any action under any loan document. This would include, for example, the issuance of a default or acceleration notice under the loan document and the right to approve or disprove any amendment, waiver or consent request made by the borrower to its lenders. In addition to being disenfranchised with respect to their position, for the purpose of determining the votes of the "required lenders", net short lenders are also deemed to have voted their interests as a lender without discretion in the same proportion as the allocation of voting by lenders who are not short lenders.
- –Contractually shortened limitation period: language is included in the events of default section whereby the parties to the loan documentation agree to shorten the period in which the lenders may take action (including, for example, issuing a default notice) in relation to a specific default to two years after that default. This feature is more prevalent in the US high yield bond market than in the leveraged loan market. Note, however, that this has also started to appear in certain loan documentation in addition to the foregoing elements.
- –Extension of cure period: language is included in the events of default section providing that any cure period with respect to any actual or alleged default or event of default may be extended or stayed by a court of competent jurisdiction. This feature usually accompanies the contractually shortened limitation period mentioned above and therefore is more prevalent in the high yield market than in the leveraged loan market.
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