How to Analyse the Asset Sales Covenant
Analysing potential value loss starts with the Restricted Payments covenant (which we wrote about last week, read it here), and continues with the Asset Sales covenant, where some of the most significant changes to the covenant package have taken place over the past decade.
On this road to Point B we will examine the following:
- What actually constitutes an “Asset Sale”?
- The effectiveness of the fair market value (FMV)and 75% cash and cash equivalents (C/CE) requirement
- A comparison of the application of proceeds provisions to the relative priority of the debt in the capital structure, and the length of time borrowers have to apply proceeds
- Checking for terms like “Declined Proceeds” and[leveraged-based step-down] to pick up any material interplay between the Asset Sales covenant and the Restricted Payments covenant
- The likelihood that lenders will ever see a par offer from Asset Sale proceeds by reviewing the Excess Proceeds provisions
This analysis will take us through the Asset Sales covenant and the definition of “Asset Sale”, in addition to (potentially) the Restricted Payments covenant.
Starting with the definition of “Asset Sale”:
- Check the size of the “de minimis” threshold, below which the Asset Sale covenant provisions will not apply.
- Look for any bespoke terms that might indicate the borrower’s ability to sell assets outside of the purview of the covenant and use the proceeds for specified purposes.
Moving onto the FMV and 75% C/CE requirements, look for the following key points:
- Is there a de minimis threshold below which these provisions do not apply at all, and how “de minimis” is it?
- How much Designated Non-Cash Consideration capacity does the borrower have? This will reduce the 75% C/CE accordingly.
For the application of proceeds waterfall, note the following:
- Do the provisions mirror the capital structure, thereby restricting the ability of subordinated debt to be repaid ahead of senior debt, and only allowing super-senior debt to be repaid ahead of other senior secured debt?
- Is there a pro rata repayment requirement applicable if the borrower repays debt that ranks pari passu to yours?
- Can non-guarantor debt be repaid with proceeds from any asset sales, or only the sale of assets of non-guarantors?
- Can proceeds be applied retrospectively to capex that has already been made, or to service debt for a period of time?
- Can the borrower use asset sale proceeds to make Restricted Payments and Permitted Investments?
- Is there a reference to “Declined Proceeds”? if so, check for a corresponding basket in the Restricted Payments covenant – both in the build-up basket and the Permitted Payments carveouts, and note that this will actually increase Restricted Payments capacity to the extent of any such Declined Proceeds.
Now that you’ve reached the Excess Proceeds Offer provisions, look for these key provisions:
- The Excess Proceeds Offer threshold, which once reached will trigger the requirement for a par offer to lenders.
- Leveraged-based step-downs, which will reduce the proportion of proceeds that must be applied in this way (with the remaining proceeds likely increasing Restricted Payments capacity – check the Permitted Payments carveouts for “Leverage Excess Proceeds”.
And that, in a nutshell, will give you a solid sense of the degree of potential value loss embedded in the Asset Sales covenant, which will directly impact your assessment of the value of the borrower’s asset base, and your collateral, on day one.
We have also published a step-by-step video lesson that pairs with this blog, and we hope you find it useful!
By Sabrina Fox