Pandemic has prompted lenders to agree to include portability clauses in private equity deals
The Covid-19 pandemic has led to changes in the way M&A agreements are being drafted, with one notable trend being the increasing willingness of lenders to agree to include portability clauses in loan documents to allow for easier private equity deals.
“This trend may be encouraging for some borrowers who may wish to discuss the possibility of including portability clauses in loan arrangements with their creditors,” Norton Rose Fulbright LLP lawyer Olga Lenova wrote in a recent blog post. “The inclusion of such clauses will depend on the circumstances of the borrower and the loan arrangement.”
Portability provisions aren’t new, but they’re being discussed with more enthusiasm lately due to the current COVID-related economic climate, says Jesse Ahuja, partner of MEP Business Counsel in Vancouver. He notes the concept originated in the private equity sector as a way to maximize returns upon exiting portfolio companies, “since savvy buyers price-in the cost of refinancing.”
“Sellers and buyers, unsurprisingly, will want to jump through as few hoops as possible, avoid delays and refinancing costs,” Ahuja says. He adds borrowers want to negotiate the best terms possible when issuing debt since they will ultimately bear the cost of refinancing with a change of control before maturity.
Credit agreements typically include change of control provisions that trigger a default event when a third buyer acquires the third party. Lenders usually require conditions that say the borrower must pay out the existing loan. If the current lender wants to continue providing credit to the buyer, it gets a chance to reassess the risks associated with a change in ownership.
These change-of-control provisions offer protection to existing lenders, but they also can make transactions more difficult. The borrower generally must make new financing arrangements, either by refinancing its current loan with its existing lender or finding new lenders to pay off existing loans.
However, recently, more lenders have agreed to include a portability clause in loan agreements, allowing the business with the loan to be sold withouth refinancing or repayment of the loan. Instead, the existing loan is transferred to the purchaser on the same terms and conditions as the current borrower.
For example, in September, broadband company Radiate Holdco — which is owned by the private equity group TPG — raised US$2.7 billion in the loan market in a refinancing deal that increased leverage, funded a payment to TPG and added portability language into the loan documents.
In commenting on this deal, Moody’s debt rating service said in a recent news release: “These [portability] features will allow a buyer to assume the existing capital structure and claim priorities, if there is a change in control . . . as permitted by the credit agreement.”
Gary Gill of Sangra Moller in Vancouver says that portability has always been something that has been “jealously guarded” by lenders in the past, but that is changing due to ultra-low interest rates. “There’s been a weakening in the power of lenders, so they are more willing to negotiate on portability,” he says.
From a potential buyer’s perspective, Gill says portability is “certainly a very nice to have,” giving them more flexibility and taking away the task of securing new financing.
There are other advantages to debt portability agreements. They can reduce transaction costs with the net savings flowing to the seller, accelerate the closing as there is no need to arrange new replacement financing, and eliminate uncertainty about the buyer’s ability to raise the debt financing for the acquisition on acceptable terms.
Lenders who agree to include such portability language do theoretically risk having the borrower’s outstanding loans assumed by a third party, but they can also build in some safeguards.
For example, they may include language that ensures the portability of existing loans will only be available to those buyers that have been deemed suitable by the lender. This provision would require careful wording on the lender’s part to outline the criteria clearly.
Another safeguard is that the borrower ensures the lender has provided consent to the transaction to ensure that there will be no issue with the debt portability on closing.
Ahuja says lenders entertaining portability provisions “should consider how liberally they are prepared to accept a change of control.”
For example, in addition to the standard buyer leverage or ratings tests, they may wish to limit the change of control to one occurrence within a specified period. A list of acceptable or prohibited buyers (or classes of buyers) and the right to a satisfactory diligence review are other safeguards to be considered.