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Introduction

It used to be called getting primed; later, J. Screwed. These days there are a variety of other more polite terms: uptier, drop-down, two-step, double dip, pari plus, all of which fall under the general rubric of liability management exercise (LME), a great euphemism if ever there was one. It almost sounds like one of those low-impact spin classes we keep hearing about.

Lenders who take part in LMEs aim to maximise their recoveries at the expense of non-participating lenders, hence the term ‘lender-on-lender violence’. Put another way, there’s no “i” in lender, but there’s definitely a “me” in LME.

An equal number of terms have arisen to prevent certain specific types of transactions: J.Crew, Chewy (PetSmart), Serta, Neiman, Pluralsight, Envision, and Incora protection, which is exactly what everybody needed — a whole jumble of jargon to remember.

Maybe we can simplify: there are LME blockers and then there are LME blockers. (Hope that’s helpful). In short, those drafted by the sponsor or borrower in the primary market tend to come with exceptions that sometimes fatally weaken the protection they purport to provide. By contrast, those drafted by lenders with the benefit of counsel in a negotiated transaction (admittedly a rare sighting) tend to do what one thinks they should.

The current state of play — clear as mud

Much has been written on the various Serta (here and here), J.Crew, and Chewy blockers, with sponsors looking to limit the impact of these blockers with increasingly elastic exceptions.

Serta blockers in loans

• are privately negotiated purchases carved out from the blocker? This is a key step in allowing the company to do a non-pro rata exchange of existing loans for super priority debt.
• Is there an exception to the all/affected lender consent requirement if affected lenders are offered a bona fide opportunity to participate ratably in the priming debt?

J.Crew blockers

• is any transfer of material IP prohibited or is it limited to a transfer by way of a permitted investment (rather than any restricted payment)?
• Does the language also cover the designation of an unrestricted subsidiary holding material IP, or must there be some actual physical transfer?
• The typical language does not prohibit transfers to non-guarantor restricted subsidiaries, which is quite a glaring omission. The fix to this glaring omission is known as a "Pluralsight blocker", for those of you keeping score, and even then, the blocker sometimes only applies if the purpose is to raise additional debt secured on those assets, as distinct from an unsecured debt raise.
• Finally, are transfers of material assets other than IP, restricted?

Chewy blockers

• Is the release of a non-wholly owned subsidiary’s guarantee permitted if the “sole purpose” or “primary purpose” is not to circumvent the guarantee provisions? We might point out that in the actual PetSmart/Chewy manoeuvres, the release of Chewy as a guarantor (i.e., by virtue of ceasing to be wholly-owned) was probably a side benefit, rather than the primary purpose, which appears to have been for the sponsor to grab as much of the high growth entity for itself as possible.

Enter the new kids on the block: “double dip” and “pari plus”

Double dip and pari plus blockers prevent lenders from creating multiple pari and effectively senior claims from different group entities in respect of the same debt — a nifty tool used by underwater lenders to theoretically maximise their recoveries vis-a-vis other underwater creditors that only have a single claim of recovery.

A quick recap on the double dip — first dip: lender provides a secured loan to a non-guarantor subsidiary or an unrestricted subsidiary. This loan is guaranteed and secured by entities in the existing credit group on a pari passu basis with existing debt. Second dip: the loan proceeds are advanced to a borrower within the existing credit group via an intercompany loan which is guaranteed by the existing credit group. The intercompany loan receivable is provided as security for the initial loan.

How effective is the blocker?

• Are intercompany loans owed to a non-credit group entity (non-guarantors and unrestricted subsidiaries) unsecured and subordinated to the existing secured debt? Are guarantees of the intercompany debt by a credit group entity also unsecured and subordinated to secured debt?
• Are unrestricted subsidiaries prohibited from owning the equity or debt of the restricted group and from incurring debt which is secured by assets of the restricted group (i.e. the intercompany loan)?
• Do these restrictions apply to all entities which are unrestricted subsidiaries and at all times (including day one unrestricted subsidiaries) and not just at the time of designation?
• Is any debt that benefits from pari passu liens on the collateral prohibited from also benefiting from liens on non-collateral assets or receiving guarantees from non-loan parties?

It's exhausting, right? Like sitting through four hours of Eurovision, but don’t fret, all worries will soon disappear as we explore some arguably easier options on how to (try and) prevent an LME.

How to try and prevent an LME — option 1

Enter the Envision blocker

You could argue that the “Envision blocker” is different. In the iterations we have seen, the Envision blocker limits unrestricted subsidiary investments to a single dedicated basket, with literally no exceptions. Here is one example from a recent deal:

• notwithstanding anything to the contrary, Investments in Unrestricted Subsidiaries shall only be made pursuant to [this basket] (for the avoidance of doubt, any Investments in an Unrestricted Subsidiary made in reliance on [this basket] cannot be re-allocated or re-classified to another applicable Basket, and capacity under [this basket] cannot be increased by reallocation of capacity from other Baskets).”

What, then, are we to make of the rest of the investment baskets, such as the ratio investment provision, the general investment basket, the basket for investments in a similar business and the basket for investments in joint ventures? If they cannot be used in an unrestricted subsidiary drop-down, query whether they have effectively been converted into legitimate business investment baskets (”Non-LME Investment Baskets”).

Indeed, there can be legitimate (i.e., non-LME-related) uses of unrestricted subsidiaries. For example, some companies may need a financing structure that is separate from the general corporate financing structure; securitization transactions and project financing come to mind. However, the unrestricted subsidiary designation in modern debt documents is rarely limited to special purpose entities. The abuse of unrestricted subsidiaries in lender-on-lender violence is so prevalent that one wonders why more investors have not insisted on the removal of the unrestricted subsidiary concept from their bonds and loans in their entirety, or at least severely limited their use via the Envision blocker.

How to really prevent an LME — option 2

Enter the Total LME blocker

For the boss-level blocker, we have seen broad anti-liability management provisions included in a handful of US credit agreements. Those provisions generally prohibit any activity that is undertaken in connection with a liability management financing transaction, rather than prohibit highly specific transactions.

Here is one such provision broadly prohibiting LME’s other than under certain enumerated baskets:

• “Priming Financing/Liability Management Transaction” means any exchange, refinancing, amendment or extension transaction (or any transaction specifically designed to circumvent the restrictions set forth in [the Total LME Blocker provision] but contemporaneously achieve the same effect as an exchange, refinancing, amendment or extension transaction) of any existing Indebtedness of the Borrower or any of its Restricted Subsidiaries (the “Existing LMT Debt”) with any other Indebtedness or Preferred Stock (including that of the Borrower or any of its Affiliates or of any other Person) (the “New LMT Debt”) in a transaction that is designed to directly or indirectly “uptier”, or has the effect of, “uptiering”, holders of such Existing LMT Debt into contractually, effectively (including as to lien priority or recourse to additional assets or through a “double dip” or “pari plus” structure), temporally (i.e., having a shorter maturity) or structurally senior New LMT Debt (“Priming Debt”) or the issuance of Priming Debt, in each case, other than: [enumerated baskets].”

See Sinclair Broadcasting GroupSinclair Broadcasting Group’s term loan, summarized here. Seems pretty tight, especially in light of one court’s admonition in a recent decision in the Serta litigation:

• “The [Serta uptier] was the first major uptier. But it was far from the last. And while the loan market has seen an increase in contracts blocking uptiers (so-called “uptier blockers”) since 2020, there are doubtless still many contracts with open market purchase exceptions to ratable treatment. Though every contract should be taken on its own, today’s decision suggests that such exceptions will often not justify an uptier.” [internal citations omitted].

Naturally, any exceptions to a Total LME blocker need to be studied carefully; nevertheless with a broad general LME prohibition, the intent of the parties seems crystal clear.

Conclusion

The most obvious way to avoid getting primed would be to limit debt and restricted payment basket capacity. However, lenders and bond investors have long ago ceded ground to borrowers and sponsors on this front. See our companion piece, “Next-level LME enablers”, where we discuss “decoy baskets” (as coined by 9fin), multi-toggle basket flexibility (nearly as good a euphemism as LME), and other calculation mechanics jiggery-pokery.

These days, the discussion in the bond and loan primary world seems to focus on ranking the various lower-tier blockers, debating whether MFN protection actually means anything, asking whether anyone knows of a US deal which has recently cleared the market with a super grower, and then doing it all again.

It might be more productive to just line up the Total LME blocker against the sponsor’s ace card – the anti co-op provision (which in one draft credit agreement we reviewed was nice and visible in the counterparts clause) — and see what happens. With lenders trying to block LMEs and sponsors trying to enable them, the parameters of the tug of war in the near term appear to have been defined.

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