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Debt buybacks are particularly topical at the moment and it is easy to see why. With bank debt trading below par in the secondary loan market, borrowers and their sponsors have been exploring ways to purchase their own debt at a discount, simultaneously reducing their leverage while providing an enhanced return on the capital invested.
Optimistic purchasers may also be hopeful of significant profit if the debt was to be re-sold at par should prices in the secondary market increase.
Danish telecoms company TDC got the ball rolling, at least publicly, when in March it bought back €200m (£158.3m) of senior debt. Provided that the loan agreement does not expressly prohibit it, there is no reason why borrowers or their sponsors cannot purchase their own debt. The uncertainty, and the source of the current debate, stems from the fact that many loan agreements, including those based on the Loan Market Association (LMA) standard form document, do not contemplate the possibility of buybacks.
Legal obstacles and ways around them
This has in turn encouraged debate among lawyers over the legal ramifications of a buyback, either by the borrower or by an affiliate of the borrower (for example a private equity sponsor of a leveraged buyout).
The starting point is to consider whether the purchase of its own debt by a borrower will automatically constitute a prepayment. Since a party cannot contract with itself, a buyback will generally result in the debt being extinguished. This is effectively a prepayment. The LMA documentation does not permit a prepayment at a discount. Moreover, the prepayment will not be in accordance with the sharing provisions, which require that any prepayments are shared among all lenders pro rata to their commitments.
Therefore, to the extent that the amount paid by the borrower to the assigning lender is really a prepayment, the facility agent is unlikely to agree to the assignment.
An obvious solution to this conundrum is for an affiliate of the borrower to purchase the debt. This avoids the issue of automatic prepayment. However, the LMA documentation only permits a lender to assign or transfer its rights “to another bank or financial institution or to a trust, fund or other entity which is regularly engaged in or established for the purpose of making, purchasing or investing in loans, securities or other financial assets”. While this may prevent certain entities from purchasing the debt, it is arguable that group treasury companies would qualify as legitimate assignees.
Concerns from lenders
There are alternatives to buybacks. For instance, the assigning bank could enter into a total return swap with the borrower, or could sub-participate its interest to the borrower.
Irrespective of the approach taken, there is no doubt that debt buybacks are proving to be controversial – not least with those lenders that have voiced concerns that a borrower’s purchase of its own debt contravenes the spirit of syndicated lending.
Lenders have raised concerns about borrowers using spare cashflow to effect debt buybacks, questioning whether it is an appropriate use of cash. There has also been a particular focus on the purchaser’s voting rights in default and enforcement situations. One suggestion has been to restrict the voting rights of the borrower or any affiliate of the borrower that purchases the debt.
The LMA has announced that it considers the decision to permit or prohibit debt buyback to be “primarily a commercial one, to be agreed between the borrower and the lenders”. If permitted, however, “it should be conducted in such a way that it maintains one of the fundamental principles of syndicated lending, that the lenders be treated equally by the borrower”.
The LMA will be amending its primary facility agreements to provide the option for the lenders and borrowers to negotiate whether debt buybacks should be permitted and, assuming that they are, the terms on which they can be effected.
After several years of lenders pushing to loosen assignment restrictions in loan documentation to enable them to securitise or sell down loans in the secondary market, this new emphasis on tightening up the language is an interesting departure.
Andrew Barker is a partner and Nick Davies an associate in the banking and finance group at Jones Day