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Alice Holian

Brian Dearing

This is the second in a two-part series on the Restricted Payments covenant. In part 1, (Un)Restricted Payments - Part 1 - the Builder Basket, we focused on the structure of the Restricted Payments (RPs) covenant, and then did a deep dive on the Builder Basket. In Part 2, we explore the Permitted Payment baskets.

Please note that for brevity, we do not discuss Permitted Investments (PIs) below, although it’s always important to look at them in conjunction with the broader RP covenant. PIs will be the focus of a separate 9fin Educational.

Taking a step back, in Part 1 we discussed the structure of the RP covenant, namely that it prohibits all RPs, and then goes on, in customary negative covenant fashion, to allow numerous payments and distributions via the Builder Basket, but only to the extent the issuer meets certain conditions (the “health checks”). In addition, the RP covenant allows RPs to be made utilising certain specified baskets - which are referred to as “Permitted Payments”.

Permitted Payments may be utilised without regard to whether there is capacity under the RP Builder Basket. The question is often asked whether utilising a basket (perhaps the Builder Basket) somehow reduces the other baskets, and the answer is no - unless cash leaving the group would deteriorate the leverage ratio (which might be net cash), in which case, the leverage based RP basket (discussed below) might be worse off. However, as noted in Part 1, in more conservative deals the usage of certain Permitted Payment baskets can reduce the RP builder basket. For the most part, the Permitted Payments act as standalone baskets that can be utilised at any time (unless they specify additional imitations, like no EoD or Default, etc.), and can be used in combination with one another or the Builder Basket.

Furthermore, most deals permit the issuer to “reclassify” any utilisation under the Permitted Payments basket in to the Builder Basket, i.e., replenishing the Permitted Payment basket by (in some cases, automatically) utilising any capacity that has otherwise built-up over time. Historically, this was considered aggressive, it means that if the issuer meets the leverage-based RP ratio at any time during the life of the bond, it can sweep all RPs previously made under the Permitted Payments basket into the leverage-based RP basket and have the fixed baskets made available again.

The list of Permitted Payments is lengthy, and in some cases can be quite bespoke to the industry, issuer or transaction structure. The following list is intended to provide general coverage to the baskets we see in most deals, as well as looking at a few unique / bespoke baskets that might crop up.

Generally speaking, the aim of these Permitted Payments baskets is to provide for specified capacity to make value transfers out of the Restricted Group where the issuer anticipates a need (for example, catering for known dividend policies, repaying debt, compensating employees and sponsors, making investments, etc.) or, perhaps, simply desires the flexibility. The inclusion of certain Permitted Payments baskets is also driven by market flexibility.

Note that we have omitted discussion on a number of other market-standard permissions that are not typically commercially negotiated e.g., dividends paid w/in 60 days of declaration if they were permitted on the date of declaration, RPs “substantially concurrent” with new equity / sub debt issuance, pro rata dividends to minority shareholders of non-wholly owned restricted subsidiaries.

Note, the title of each basket discussed below is a hyperlink to a Document Search on 9fin providing you with examples of standard language for the applicable basket.

General Basket: Almost every deal contains a broad basket that can be used for any purpose. A minority of deals have included a smaller, annual general RP basket alongside this more traditional general basket, typically accounting for historical dividend policies (Nomad Foods) or for parent payments, tax expenses and/or affiliate transactions (Arcaplanet).

Leverage-based RPs: Issuer’s are often allowed to make ratio based Permitted Payments if they meet a certain leverage test. The test is typically net of cash and cash equivalents - note this is tested pro forma for the dividend though! The level at which the relevant leverage ratio is set can vary widely. Traditionally, the leverage threshold for the leverage-based RP basket was set below opening leverage, meaning that capacity under this basket would only be “earned” once the issuer had de-levered. However, we’ve seen a significant number of deals in recent years where the leverage threshold is set either very close to or, in some cases, above opening leverage (see examples here). Furthermore, a “no worse” formulation has started creeping into the leverage-based RP basket in a few sponsor-based transactions — for instance, in Medline Industries, Permitted Payments can be made subject to the ratio not deteriorating pro forma (meaning, specifically, distributions or other RPs could be made even if the relevant leverage test is not met, so long as the leverage ratio wouldn’t deteriorate). This could, depending on how terms are defined, allow repayments of subordinated debt or other similar liabilities that are junior to the bonds. Additionally, it could permit assets/business units to be spun-off or transferred to an unrestricted subsidiary if they were EBITDA-negative.

Post-IPO Distributions: following a public offering, the issuer can make dividends/distributions each year up to the greater of (a) the net cash proceeds from the offering or subsequent offerings or amounts contributed to the equity, or (b) the greater of a certain percentage of either the issuer’s (x) Market Capitalization or (y) IPO Market Capitalization. This basket is typically subject to the issuer meeting a leverage test on a pro forma basis, but not always. In some deals, part (a) has been drafted using a “sum of” construction, combining the various limbs.

Management Equity Repurchases: this basket allows the issuer to make payments (via payments, loans, advances, dividends, distributions, etc.) to employees, directors, consultants or similar, whether past or present, pursuant to management equity plans or stock option plans. These baskets typically use a fixed cap, which sometimes increases upon an IPO. Additionally, unused amounts can often be carried over to the succeeding calendar years. Notably, some deals, such as Lutech, allow uncapped payments for these purposes.

Excluded Contributions: this basket allows issuers to make RPs from (or in many cases, in an amount up to) cash or non-cash equity contributions or subordinated shareholder debt that has been designated as “Excluded Contributions”. Some deals also allow RP capacity to build from disposal proceeds where the disposed asset was acquired with Excluded Contributions. This basket is similar to certain components of the Builder Basket, but it typically does not require the same “health check” conditions to be met. This means that, to the extent there have been equity injections since the issue date, the issuer could make RPs up to the amount of such injections, even during an EoD or when the FCCR is below 2x, so long as the original injections are designated as “Excluded Contributions”. Similar to the Builder Basket, Excluded Contributions should not include any day one equity contribution expected as part of the transaction being financed by the bond, and there should be protections against “round-tripping” in deals with portability. To avoid double-counting, Excluded Contributions are generally carved out of the RP builder basket and cannot be used for various other purposes, such as contribution debt.

Subordinated Debt Prepayments: this basket permits the repaying of subordinated debt ahead of the maturity date for any debt which is not subordinated in the capital structure. Depending on the deal, Subordinated Debt Prepayments can sometimes be made subject to a fixed basket and/or subject to the issuer meeting a certain leverage test. As with leverage-based RPs, the level at which the relevant leverage ratio is set in those transactions can vary widely but tends to be higher than the leverage-based RP level. It is also worth noting a customary basket that allows for subordinated debt to be prepaid from asset sale proceeds if required under its terms either (1) after compliance with the asset sales covenant and asset sales offer to bondholders (if required) and/or (2) in a change of control after a CoC offer. See our 9fin Educational on Asset Sales for further information.

Unrestricted Subsidiaries: in addition to certain “Permitted Investments” (to be discussed in a separate 9fin Educational), sometimes a standalone RP basket for Investments in Unrestricted Subsidiaries is present. Note that, when paired with unrestricted subsidiary value transfer language (which is tracked on 9fin’s Covenant Capacity tool), this essentially just becomes another RP basket.

Payments to Sponsor/Management: these Permitted Payments consist of customary expenses and fees that can typically be made in any fiscal year, including for monitoring and advisory fees, parent expenses, and other fees/expenses. These are sometimes limited to those in the ordinary course of business and/or consistent with past practice. Furthermore, these are typically capped around 1-3% of EBITDA, but in some cases are actually uncapped (but then typically accompanied by a “reasonable” qualifier).

Parent Payments: this basket permits the upstreaming of cash to fund parent payments consisting of interest and/or principal. This is typically not seen as controversial if it requires: (1) the parent debt proceeds to have been contributed to the restricted group; and (2) the parent debt to be guaranteed by / otherwise considered debt of the restricted group (which would have required debt capacity). Value leakage potential expands if the clause lacks either of these requirements.

Dividends of Capital Stock of URs: this basket is almost universally included in the RP covenant. It permits the transfer of capital stock of unrestricted subsidiaries (i.e., value). This means an issuer could transfer value to an unrestricted subsidiary using investments capacity, and then transfer that entity to its shareholders (see here for discussion on the implications of this basket).

The RP covenant can sometimes feel like Swiss cheese, and even more so when considered alongside the Permitted Investments (PIs) baskets. But, nevertheless, drafting creativity always marches on. The below are new and novel baskets creeping in to European HY bonds (albeit they have yet to “grab hold”).

Available Amount: this basket allows the issuer to make RPs and/or PIs at leverage levels higher than those that would otherwise apply (or in some cases, without even testing any leverage or other ratio), so long as those payments are funded from the conversion of certain elements, such as IPO proceeds, closing overfunding, retained cash and permitted debt. See our detailed 9fin Educational on the Available Amount here, as it is a complex and easily misunderstood basket.

Portability-Based RP Basket: in a minority number of deals, RPs can be made in relation to the exercise of portability subject to meeting a certain leverage test. If there is headroom under the leverage test, which is typically set at favourable ratio levels than the standard leverage-based RPs discussed above, the issuer can use that capacity to make RPs.

Asset Sale-Based RP Basket: In some cases, the Asset Sales covenant can build Permitted Payments capacity. This can be achieved through the following baskets:

Declined Proceeds: these arise when asset sale proceeds are offered to bondholders but are declined. This concept has become relatively common, but is important to consider in the context of the following novel innovations. Declined Proceeds is either presented as a limb of the RP builder basket (in which case it would be subject to the “health checks”) or a standalone Permitted Payment. However, in McAfee, amounts below the Excess Proceeds threshold constitute Declined Proceeds meaning the proceeds are not required to be offered to holders in the first place. As always, its important to double check defined terms!


Leverage Proceeds: customarily, the asset sale covenant requires all proceeds, once certain thresholds are met, to be used to repay debt or else reinvested (for more detail, see our 9fin Educational on Asset Sales). This novel drafting allows, if certain leverage tests are met, only a certain percentage of asset sale proceeds (e.g., 50% and then 0%) to constitute “Excess Proceeds” (and therefore require the issuer to make an offer to repay the notes with it) or more aggressively, not even be subject to the Asset Sales covenant’s application of proceeds provisions (this is known as the “Applicable Proceeds”). Any proceeds not required to be applied in accordance with the bondholder offer requirement or waterfall can also sometimes build Permitted Payments capacity (see Cerved). This basket becomes particularly significant where the leverage test for asset sales is set higher than the leverage-based RP ratio level.


Specified Asset Dispositions: proceeds of Specified Asset Dispositions are excluded from the scope of the Asset Sales covenant and instead simply build Permitted Payments capacity. They are typically defined in a number of ways: 1) specific asset sales that are anticipated (i.e., may refer to a division of the business (see our QuickTake for Manuchar), real estate, etc.), or 2) any asset sale where the assets represent up to a specified percentage of EBITDA (note: not the consideration being a percentage of EBITDA) - which is sometimes subject to a floor. The usage of Specified Asset Dispositions for RP capacity is typically subject to meeting a leverage test.


Historically, the usage of most if not all RP baskets were subject to no continuing Default or Event of Default occurring. However, it is now much more common to see just a handful of the RP baskets subject to a Default blocker, or worse, just an Event of Default blocker. Some examples of this are available here - the blockers are either within the various applicable RP baskets, or at the end of the list of the RP baskets. In many cases, usage of material RP baskets are only blocked by certain material EoDs, typically these just include no payment or insolvency.

In some cases, to prevent either (1) assets being moved to Unrestricted Subsidiaries to facilitate the incurrence of structurally senior “priming” debt; and/or (2) assets being moved to Unrestricted Subsidiaries simply to allow the group to raise more debt, make dividends, etc., “J-Crew blockers” are added to the end of the RP covenant in various forms. For a further discussion on “J-Crew blockers” see our piece “J-Screwed” - a quick look at unexpected value leakage.

If you need to quickly review the Permitted Payment baskets within the Restricted Payments covenant 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 are leverage based RP baskets set relative to opening leverage?


If there is subordinated debt in the structure, consider which baskets could be used to prepay that debt ahead of the bonds, under capacity for general RPs as well as any specific sub debt baskets that are present?


Are there provisions permitting asset sale proceeds to build RP capacity? If so, consider whether these provisions are appropriately limited, including in terms of the amount of de-leveraging required to access the provisions as well as the scope of such provisions?


Can RP capacity build from the Available Amount concept? (see Red Flag Review Checklist in our article on Available Amount)


How strong are the Default / Event of Default blockers? Do they apply to every basket, if not, which?


Does the RP covenant include any J-Crew or unrestricted subsidiary value transfer language? (Note we track this on 9fin’s Covenant Capacity tool).

(Un)Restricted Payments - Part 2 - Permitted Payments (9fin Educational)

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(Un)Restricted Payments - Part 2 - Permitted Payments (9fin Educational)

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