Lenders are proactively negotiating provisions in post-LME credit documents to pave the way for a smooth equitization and avoid a costly bankruptcy in case the company’s performance goes south again, according to 9fin sources.
Such ‘hand-the-keys’ language has now made its way to the broadly syndicated loan market in at least two post-LME situations, including software company Veritas Technologies and foam manufacturer FXI, sources said.
These provisions are bespoke and often tied to some form of deleveraging either through performance improvements or a junior capital injection from the sponsor or a third party, according to sources.
“Given the rising number of failed LMEs, creditors are increasingly turning their focus on avoiding double costs if the company were to subsequently restructure,” said Alex Raskin, managing director in Houlihan Lokey’s financial restructuring group. “So in addition to typical document tightening, they are also looking to amend credit documents to facilitate a quick turnover of the keys if there is a step two."
Creditors to Veritas led the charge. Following the company’s LME in December 2024, sponsor Carlyle agreed to a provision that would allow them to convert part of their holdings into 99% of the equity, if they are not paid down a specified amount by a specified date, sources said.
During the 2024 deal, Veritas creditors exchanged their term loans and notes due 2025 for a pro rata share of a new TLB and received a partial cash paydown, as 9fin reported during the time. Creditors, advised by Houlihan Lokey and Davis Polk, also received Cohesity new preferred stock and a PIK margin loan backed by Cohesity, per an S&P note at the time of the deal.
Debt at Veritas has since been paid off, neutralizing the provision, they said.
Carlyle and Houlihan declined to comment. Veritas and Davis Polk along with company-side advisors Guggenheim and Latham & Watkins, did not respond to requests for comment.
More recently, One Rock-backed FXI saw near-full participation in its non-pro rata LME last November, and included in its credit documents a debt-to-99% of equity conversion option for some of its secured noteholders if they aren’t paid down a certain amount by a certain date before the extended maturity, sources said.
One Rock must be provided with releases, and certain workarounds are in place to prevent FXI from filing for bankruptcy, they added, such as lender-appointed independent directors who have to approve a Chapter 11 filing — a structure engineered by Houlihan and Paul Weiss for the bonds, and Latham & Watkins and Perella Weinberg with company-side mandates.
FXI, One Rock, Paul Weiss and Perella Weinberg did not respond to requests for comment.
Governance provisions have been negotiated, but ultimately dropped, during a number of other deals with various structures being proposed, sources added. Overall, lenders are putting more thought into teeing up their positions for a potential bankruptcy down the road.
Saving yourself from heartache
A slightly different flavor discussed during another recent LME that didn’t end up going through relied more on amendments to the governance documents, certificating of shares, and the creation of the escrow arrangement, according to a source.
How this type of transaction could work, a source explained, is by requiring the sponsor to turn its ownership into share certificates placed into escrow with a third-party escrow agent. A collateral agent would have power of attorney on behalf of the sponsor tied to specific transactions — repayment or default. If the company’s debt was repaid in full, then the stock would be released back to the sponsor, whereas in an event of default, the stock powers and shares would be released by the escrow agent to the collateral agent, effectively transferring ownership.
Like in FXI, this type of transaction would require the placement of independent directors to vote on material events to keep the sponsor from subverting a handover by simply filing the company for bankruptcy, the source added.
Historically in a syndicated structure, lenders could take control of a company through an out-of-court restructuring or in-court process overseen by advisors, directors, and bankruptcy judges. Addressing change of control issues before a Chapter 11 filing has mainly only come up in private credit workouts, which can rely on handshake agreements rather than locking a provision into credit documents, per sources.
Sponsors and private credit lenders could agree that if specified runway or covenant parameters are breached, then that lender would take control, sources said.
Now, creditors wanting to avoid getting caught up in a second round of restructuring negotiations are behind the push to add the hand-the-keys provision into BSL, sources said.
9fin found that 30% of companies wound up restructuring again within four years of its initial LME, as those transactions often provide balance sheet relief but aren’t aimed at resolving underlying business issues. Most companies in that 30% filed for bankruptcy rather than pursuing a so-called LME 22.
To do or not to do
From the lenders’ perspective, receiving equity may not be a desired outcome, and having governance decisions pre-baked in credit documents could help avoid a bankruptcy process that’s expensive and value destructive, sources said.
“This is never an easy negotiation between the sponsor and lenders, but it could be a win-win for both and help steer the conversation away from aggressive moves by sponsors that have frustrated the market,” he added. “It allows the sponsor to see through the turnaround before investing additional dollars and the lenders to lower friction costs in the future in case the turnover event is triggered.”
The extra runway, along with the option to not put in money or give up equity at the time of the initial deal could push the sponsor to agree to this provision and even cede some governance controls, Raskin said. “Particularly if the company is going through an operational or industry turnaround where time is needed to see changes.”
Negotiations are contentious as sponsors push back and look for the greatest flexibility — as has always been the case in discussions about economics and covenants, sources said. While providing lenders with a quick trigger to seize control isn’t ideal, it may bring them to the table and buy more time for the company to attempt a turnaround, they said.
One naysayer of the strategy argues that turning over control isn’t necessarily in the best interest of all parties owed consideration. While a bankruptcy may result in a sponsor handing the keys, a formal process involving independent directors and advisors is required to ensure a company’s board isn’t just looking out for a small group of creditors, and the sponsor is fulfilling its fiduciary duty to LPs, sources said.
