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Brian Dearing

Alice Holian

In this piece, we aim to introduce you to the “Asset Sale” covenant, explain how it works, how it is evolving, and how to perform high-level analysis on actions taken by issuers.

As part of the general protection offered by the covenant package in a high yield bond there is a provision which prevents the sale of any assets (broadly defined to encompass hard assets, shares, etc.) owned by the Restricted Group (typically, the issuer and its subsidiaries), unless certain requirements are met.

The covenant exists to ensure that assets don’t leave the group without the Restricted Group receiving appropriate consideration. One could imagine a situation where the shareholder of a group could extract value by selling assets from one company to another in their portfolio at below market value. In theory this could be fine, for example, if it was structured as an investment or a dividend (so long as it complied with the other applicable covenants). However, to the extent something is considered a “sale”, and not an investment / dividend, it’s important that the covenant adequately protects investors and ensures assets don’t simply evaporate from underneath them.

Prevents the issuer from making an “Asset Sale” (defined term discussed below); unless


the following two conditions are met:
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If those two steps are complied with, and the group has sold the asset, then the remainder of the covenant addresses what to do with the proceeds from the transaction.

When analysing the asset sale covenant, it’s important to read the definition of an “Asset Sale” (sometimes referred to as an “Asset Disposition” or similar). Generally speaking, it includes a broad statement capturing what one would expect, for example, any property or assets (undefined broad words), and also the sale of equity of an entity (which is effectively the same thing as selling the asset). But, as with all covenants in a HY bond, this is followed with a long list of exceptions. Notably, a series of related transactions may be considered as one for purposes of the covenant - it attempts to look at the transactions on a substance over form basis.

The exceptions to the definition of “Asset Sale” include many items which are intended to allow the business to continuing operating as normal, such as inter-company transactions and ordinary course dispositions (worn-out equipment, etc.), but it also makes specific carve-outs, meaning those transactions are not subject to the covenant. The typical carve-outs are:

General asset sale basket - allowing for a single / related series of transaction(s) up to a specified threshold;


De minimis carve-out: any single asset sale or series of sales below this threshold are simply disregarded;


Carve-outs for specific items, such as:

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There is one final carve-out that often jumps out to people on their first read of the covenant, which is one that exempts the sale of “all or substantially all” of the assets (there may also be a “Material Asset Sale” concept). This might seem antithetical to the covenant, but the point is that in that situation you will be considering the merger or change of control covenants instead.

What is “fair market value”, and what is “cash”?

As mentioned above, Asset Sales must be for fair market value (FMV), and the group must receive at least 75% of asset sale proceeds in cash. So what does FMV actually mean? Well, that depends. It’s usually defined to be a price that would be negotiated in an “arm’s length” / free market transaction, between a willing seller and a willing and able buyer, free from pressure, etc. But, the covenant almost always includes additional language, that specifies who determines what the FMV is (and whether the definition has been met). The language goes something like: “as determined in good faith by the Issuer or such Restricted Subsidiary at the time of contractually agreeing to such Asset Sale”, which means there is a lot of discretion in favor of the issuer.

But, we said that at least 75% of the proceeds must be in cash, right? Well, that also depends. What is cash? And does it really have to be 75%?

Cash is fairly self evident, but the covenant also usually allows for cash equivalents, replacement assets (i.e., the assets or stock of a Similar Business) or asset swaps (the exchange of related assets). Cash equivalents includes a reduction in liabilities in exchange for the asset, or the receipt of securities (if they are converted to cash with 180 days). Furthermore, certain amounts may be in non-cash or cash equivalent forms, and these, on a cumulative basis, must not exceed a threshold defined as the “Designated Non-Cash Consideration”.

The concept of Designated Non-Cash Consideration means that, although there is a requirement that 75% be in cash or cash equivalents (subject to the various nuances discussed above, and its removal in some recent deals, e.g. Lutech), this 75% is diluted by the amount of Designated Non-Cash Consideration allowed. For example, if you sell an asset for $100, you receive $60 in cash, and $40 in non-cash assets, $25 of the $40 non-cash amount is acceptable due to the 75% requirement, but the remaining $15 would need to fall within the amount allowed as Designated Non-Cash Consideration.

Furthermore, we have seen a dilution in the cash consideration requirement where the typical cash consideration of at least 75% on a cumulative basis is reduced to 50% on an individual basis, see Medline Industries or Scientific Games Lottery.

This is all fine, but why do we care? Fundamentally, there are two goals: 1) ensure that the assets of the group don’t disappear, and 2) the group doesn’t simply receive illiquid or irrelevant assets.

The asset sale covenant generally requires the proceeds from an Asset Sale be used to either reinvest in other assets or reduce debt.

The time frame in which the issuer may utilise the proceeds for such purposes has historically been set at 365 days (the “Reinvestment Period”), however, this Reinvestment Period is subject to negotiation and often now is often pushed out as far as 540 days (although, this would be present in more aggressive sponsor deals). In addition, there are customary extensions, for example, if the proceeds are “committed” to some use or reinvestment, the issuer has a further 180 days to complete such transaction, and sometimes, there is an even further 180 days if the contracts get cancelled (at no fault of the issuer).

The purpose of the Reinvestment Period is to allow the issuer to use the proceeds to improve the business, for example, to repay pari passu or senior indebtedness, invest in long-term assets, invest in or acquire a similar business or to make a capital expenditure.

To the extent the issuer does not apply the proceeds in accordance with the requirements set forth above, it is required to make an offer to repurchase the high-yield notes at 100% of the principal amount plus accrued interest if they exceed a de minimis fixed threshold which are referred to as “Excess Proceeds”. Given the broad permitted use of proceeds, asset sale repurchase offers are uncommon in practice. However, it’s important to understand how the Excess Proceeds clause works.

Additionally, we have seen an increase in the use of leverage-based step downs meaning that if certain leverage tests are met, only a certain percentage of asset sale proceeds (typically 50% / 0%) will be subject to the “Excess Proceeds” bondholder offer requirement or more aggressively, be subject to the Asset Sales covenant’s application of proceeds provisions (see “Applicable Percentage”). In some cases, asset sale proceeds not required to be applied in accordance with the waterfall or excess proceeds requirement can build Restricted Payments capacity.

Lastly, in some cases, amounts that are excluded from Excess Proceeds might not only be shielded from the requirement to offer to repurchase the bonds, but it might also build Restricted Payments or Permitted Investments capacity. This has been done through a “Cumulative Credit” concept. It is present in only a few deals to date, but certainly is worth paying attention to.

What have investors been pushing back on?

In 2021, and through Q1 of 2022, we saw a number of asset sale items getting pushback. Of the 82 European HY sponsor deals in 2021 (11 YTD in 2022), 27% contained covenant changes (25% YTD in 2022), and of those ~32% (1 deal YTD in 2022) had changes in the asset sale covenant. The changes are set forth below:

- Amended or tightened leverage based step-downs for excess proceeds (Douglas GmbH), or removed altogether (Multi-Color);

- Amended the excess proceeds percentage (Advanz Pharma);

- Reduced the excess proceeds threshold (Birkenstock);

- Reduced the Designated Non-Cash Consideration amount (Multi-Color);

- Reduced the investment timeframe (Arxada and Modulaire Group); and

- Added back the 75% cash consideration requirement (Iliad).

If you need to quickly review the Asset Sale provisions on a particular transaction, what should you look out for? The following is intended to be a short list to help you focus your review on the key points.

- How is the term “Asset Sale” defined?

      Check the general and de minimis basket sizes.

      Does the definition carve-out non-core assets?

      Does the definition carve-out “Specified Asset Sales”?

      Does the Asset Sale covenant require 75% cash?

      Is the requirement diluted with an “Applicable Percentage” construct?

How is the company going to use the proceeds, and how long is the “Reinvestment Period”?

Is the amount of the Asset Sales such that it might be considered “all or substantially all” of the business?

Are any of the assets part of the security package or owned by a Guarantor?

Do items excluded from the asset sale proceeds waterfall (e.g., items excluded from Excess Proceeds) build Restricted Payment or Permitted Investments capacity?

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