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Who’s in Control? A quick look at the Change of Control provision (9fin Educational)
Oliva Mantock
+Brian Dearing
•7 min read
Basic anatomy of the change of control covenant
The change of control provision gives bondholders the right to require an issuer to purchase some or all of the outstanding bonds at a price of 101% (customarily). At a basic level, it is a put right that provides some protection for bondholders when the issuer is acquired (or at least control is taken) by someone new. It may be the case that the bondholders disapprove of the new owner (i.e., sponsor), new management (if the old management is taken out), or it could be that it provides an opportunity for bondholders to exit their investment if the change of control happens at a time when the bonds are trading below the put right price.
Technically speaking the provision is typically triggered by:
a transaction that results in a person (or group) other than a Permitted Holder (a defined term discussed in more detail below) owning > 50% of the issuer’s voting stock (or in public companies, typically 20-40%); or
the sale of all or substantially all the assets of the issuer to a person other than a Permitted Holder.
There are of course a few key carve-outs to the above, discussed below.
What isn’t a Change of Control?
Sometimes what appears, in the ordinary sense, to be a change of control, may not be. The inclusion of portability, or a flexible definition of Permitted Holders, might dilute the nature of a change of control.
Before we dig in, it’s important to know that it is not a change of control, at least in modern European HY, when a person (or group) who currently controls the group loses that control — so long as no one else gains control.
Portability
Portability is a ‘get out of jail free’ card that allows the issuer to change hands without triggering the change of control put right. It applies when certain conditions are met. The two most common flavours of portability are ratings-based or leverage-based. Often it is only available once, but sometimes it is available multiple (or unlimited) times, meaning the issuer could change hands multiple times over the life of the bond and never trigger a change of control (however, in practice this is obviously quite unlikely).
In a ratings-based portability clause, the put right arises only if a change of control is accompanied or followed by a ratings downgrade. There is typically a set time frame, for example, beginning with when the transaction is announced, and ending 60 days after the completion of the transaction. Note there is usually a carve-out that disapplies the end date in a situation where a rating agency has publicly announced it is considering a downgrade.
In a leverage-based portability clause, the put right only arises if a change of control occurs and pro forma for the transaction the issuer’s leverage is at or below a specified ratio. In some instances, this will allow for portability if the leverage ratio is no worse (for example, in Athenahealth). In addition, sometimes there are step-downs, which require the issuer to de-lever to access portability, thereby forcing the sponsor to de-leverage (which is probably what they promised in their business plan in the first place!).
Leverage-based portability is the formulation most often used in European HY. After first appearing in 2010, leverage-based portability has since become commonplace. The majority of sponsored deals are portable, and it is increasingly included in non-sponsored deals now as well.
The specific conditions of a deal’s portability feature can typically be found in the definitions section of the Description of the Notes, under “Change of Control Triggering Event” or “Specified Change of Control Event”, but also be sure to check the “Permitted Holder” (or similar) definition as well.
Permitted Holders
The purpose of the concept of a “Permitted Holder” is to avoid triggering a “Change of Control” simply as a result of persons the bondholders are already familiar with, or who are already involved with the company, gaining sole control or increasing their control. Of course, the drafting of the definition is critical, and broad drafting is one to look out for.
So who is a Permitted Holder? The list of who constitutes a Permitted Holder can be found in the definitions section. It typically includes some variation of equity investors (i.e., the key owners, whether that's the sponsor or family) and management investors (which is often broadly drafted to include officers, directors, employees and other members of the management team).The definition may be drafted even more broadly to encompass any person who holds equity in the group at the time of issuance. This is one to be careful of, in particular if it’s not simply 1 or 2 key holders that own 100% of the equity (this phrasing is arguably useful to avoid multiple funds who are investing in the issuer at one sponsor accidentally not being caught).
However, as with anything related to covenants, there is always room to have fun. Caitlin Carey, 9fin’s Head of Legal Research, recently wrote a piece on how the drafting of “Permitted Holders” might allow Ontex to avoid the put obligation if it is taken private by one of its largest shareholders (which was not a controlling shareholder within the ordinary meaning of the phrase), Groupe Bruxelles Lambert (GBL).
Overall, it’s important to understand who is a Permitted Holder, and who might be able to take control of the company and not trigger the change of control put right.
If you need to quickly review the change of control 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.
Permitted Holder:
How broadly is the definition drafted? Who might be able to take greater control without triggering a change of control? Consider the potential consequences of our Ontex analysis.
Does the definition capture any equity investors on the issue date?
Does the transaction allow for portability?
If portability applies, how is it tested?
a. Ratings Based: Does it require more than one rating agency to downgrade the issuer? Typically it requires two. b. Leverage Based: undefinedundefinedundefined
