Incremental Facilities and MFN (Mostly For Naught)

Jainisha Amin

1 September 2022•11 min read

Readers of our 9fin Educational pieces on European leveraged loan agreements will be familiar with our focus on loan agreements that resemble high-yield bonds, which are the majority of the €250m+ TLB market. In this piece, we look at incremental facilities (also called additional or accordion facilities) and the MFN provision in these European leveraged loan agreements.

Incremental Facilities

The incremental facility clause allows the borrower to incur additional debt under the senior facilities agreement without lender consent, and typically without an existing lender’s right of first refusal, provided certain conditions are met. Incremental facilities can either be provided as an increase to the existing term and/or revolving facilities or as a new tranche of term and/or revolving debt.

How much incremental debt?

There are usually two types of debt baskets set out in the incremental facility clause.

A soft-capped basket up to the greater of €Xm and Y% EBITDA (usually 100% EBITDA).
A ratio-based basket which permits debt in compliance with a leverage ratio. This is usually a senior secured net leverage test for pari secured incremental debt, a total secured net leverage or a total net leverage/FCCR test for second lien debt and a total net leverage/FCCR test for debt that is unsecured or not secured by the collateral. The ratio test for pari passu secured debt is usually set at opening leverage at the time the senior facilities agreement is entered into. However, it is not uncommon for there to be headroom of around a turn of leverage for second lien debt and/or unsecured debt if there is no such debt in the day one capital structure.

Note that incremental facility capacity can also be increased by the amount of voluntary prepayments of debt made prior to an incremental facility being incurred.

Senior facilities agreements that resemble high-yield bonds usually have an incremental facility clause in the body of the facilities agreement which is governed by English law, and a high-yield debt covenant in a schedule to the facilities agreement which, while governed by English law, is to be interpreted in accordance with NY law. The high-yield style debt covenant restricts debt incurrence unless it is ratio-based debt (in compliance with a 2x FCCR or a leverage ratio) or falls within a permitted debt basket. See our 9fin Educational pieces on the debt covenant: part 1 and part 2 for further discussion.

Sometimes, the incremental facility clause in the body of the facility agreement is drafted broadly and permits any incremental debt provided it is permitted under the high-yield style debt covenant. If this broad language is included, the amount of incremental debt that can be incurred is not limited to the two debt baskets detailed above but can instead be incurred under any relevant debt basket.

What ranking?

Senior facilities agreements typically include the flexibility to incur incremental facilities (as term or revolving loans) on a second lien or unsecured basis. However, in reality, incremental facilities within the senior facilities agreement are usually secured on a pari passu basis with TLB and the RCF, and any junior or unsecured debt is likely to be incurred as incremental equivalent debt.

Incremental Equivalent Debt

Incremental equivalent debt (or permitted alternative debt) is incremental debt incurred outside the loan agreement. Sometimes this type of debt is also known as a ‘sidecar facility’. The amount of debt that can be incurred as incremental equivalent debt is subject to the same (shared) cap as incremental facilities, meaning incremental equivalent debt may either be incurred under the two debt baskets in the incremental facility clause or, if the more generous formulation is included (by reference to the debt covenant generally), under any basket under the debt covenant.

As incremental equivalent debt is incurred outside the loan agreement, it can be incurred on a senior secured, second lien, unsecured and/or effectively senior basis (i.e. secured on non-collateral if there is a relevant permitted lien) and can be in the form of notes or loans.

Unsecured incremental equivalent debt which is not subject to an intercreditor agreement should be subject to a cap in order to limit the amount of debt which ranks pari passu in right of payment with the senior facilities to make sure that significant creditors are subject to the standstill and release provisions in the intercreditor agreement. However, in reality, such intercreditor accession thresholds, which require unsecured debt above a certain ‘de minimis’ amount to be subject to the intercreditor agreement, are no longer routinely included in senior facilities agreements.

Incremental equivalent debt incurred by a non-guarantor, either on an unsecured or secured basis, should also be subject to a cap to limit the amount of structurally senior and, if secured, effectively senior debt that may be incurred by the restricted group.

Conditions for Incremental and Incremental Equivalent Debt

Various conditions apply to incremental facilities including those relating to maturity, amortisation and MFN protection. As expected, these conditions have loosened over time. For example, they do not always apply to incremental equivalent debt. This is an often overlooked loophole enabling the borrower to structure incremental debt incurrence as incremental equivalent debt outside the loan agreement to avoid complying with key conditions such as maturity and MFN.

Maturity and amortisation

Incremental facilities were originally required to mature after TLB and not amortise (other than nominal amortisation) unless TLB lenders were offered earlier maturity and equivalent amortisation.

However, incremental facilities may now amortise and mature earlier than TLB if they fall within a soft-capped basket of the greater of €Xm and Y% EBITDA, otherwise known as an inside maturity basket. Inside maturity baskets first emerged in US leveraged loans but have taken off in Europe in the last couple of years and are now seen in nearly 60% of deals (over the last year-and-a-half). The size of the inside maturity basket is usually 50%-100% EBITDA in both the US and European markets though these larger baskets are more recent in the European market.

MFN

MFN stands for Most Favoured Nation and is about treating parties fairly.

The MFN clause was originally meant to protect current TLB lenders from new incremental facility lenders being offered better pricing. In Europe, the effective yield (margin, upfront or similar fees, original issue discount, interest rate floor) for a new incremental term loan could be no more than 100bps above the effective yield for TLB.

In Europe, MFN protection traditionally applied for 6-12 months after the closing date (first utilisation of TLB) whereas in the US, the protection could extend for the duration of the loan agreement. In recent times, the market standard in Europe has moved to MFN protection with a 6 month sunset, which we have seen in around 80% of European deals. In the US, the market is generally tighter than Europe with 50bps - 100bps MFN protection and 6-12 month sunsets.

MFN protection is subject to so many exceptions that over time it has become largely redundant, for example:

MFN may be by reference to margin rather than effective yield, which means that any interest rate floor, upfront fees or original issue discount would not be taken into account. We have even seen MFN by reference to the greater of the highest potential margin under the senior facilities agreement and the highest potential margin communicated to lenders during syndication. So the 100bps protection could be by reference to a margin that never made it into final documentation!
MFN does not always apply to all incremental debt. Sometimes, it is limited to incremental debt incurred under certain debt baskets, for example, the ratio-based debt basket (but not the freebie basket or the general debt basket).
MFN does not apply to incremental debt that is incurred to fund an acquisition, investment or capex. Given many incremental facilities are incurred to fund an acquisition, this carve-out effectively guts the MFN protection.
MFN protection does not apply to fixed rate debt or incremental debt which is in a different currency to TLB; instead, the protection is limited to broadly syndicated floating rate term loans in the same currency as TLB and maturing within a specified period of TLB (essentially like-for-like debt).
Sometimes, MFN protection is subject to a de minimis threshold. The threshold is usually a soft-capped amount up to the greater of €Xm and Y% EBITDA (usually 50%-100% EBITDA). In US loan agreements, we have seen de minimis thresholds as high as 200% EBITDA.
Finally, MFN protection does not always apply to loan format debt incurred outside the loan agreement as incremental equivalent debt.