Liability Management Transactions: Drop-Down Financings and Uptiering Transactions, What is a Lender to Do?

Description

Liability management exercises have become more commonplace, and typically take the form of either drop-down financings or uptiering transactions, although other variations have emerged. Each type of these transactions involves complex structuring techniques that provide additional avenues of leverage for borrowers but can negatively affect the expectations and rights of existing lenders.

In a typical drop-down structure, the borrower forms and transfers assets to a subsidiary, allowing the subsidiary to incur new debt secured by the contributed assets. This alters the lien position of existing lenders who may have assumed they had a first priority claim to assets that have now been transferred to the subsidiary.

In the uptiering transaction structure, the borrower incurs new debt provided by a group of lenders, usually a subset of the existing lenders and sometimes the sponsor that owns the borrower. The existing debt of the participating lenders is exchanged for the new tranche of debt that “primes” the debt and/or liens of the other lenders. The result is that nonparticipating lenders are subordinated to the new tranche of debt.

Lead and participating lenders should carefully review loan documents to assess a borrower's ability to enter into subsequent liability management transactions. From the lenders' standpoint, the subordination of claims should be a "sacred right," requiring lender consent, as should the ability to amend not only specific pro-rata sharing provisions but amendments to allow transactions that would have the effect of impacting pro-rata sharing. With the evolution of the various alternative structures for liability management transactions, the drafting solutions to preserve lenders’ expectations as to the priority of their liens or debt have become even more complex.