Rescue Financing And Private Equity

• Published date: 08 October 2020
• Subject Matter: Finance and Banking, Corporate/Commercial Law, Financial Services, M&A/Private Equity, Securities, Shareholders
• Law Firm: Cleary Gottlieb Steen & Hamilton LLP
• Author: Mr David J. Billington and Carlo De Vito Piscicelli

Almost no part of the business world has escaped the impact of the COVID-19 pandemic. The lockdowns that sought to control the spread of the virus had the side effect of sucking demand out of the world economy. That led to a need for liquidity: business plans were simply not designed to cope with the write-off of an entire financial quarter.

In some cases, the response was straightforward. Existing liquidity lines with relationship banks were increased, or new ones put in place. But other cases have been more complex, requiring different approaches by portfolio companies and their private equity backers.

1. Ask the Sponsor

The existing private equity sponsor is often the most obvious source of new capital for a portfolio company, and lenders will frequently call for the injection of additional equity to provide working capital. The maxim 'last money in, first money out' usually guides private equity expectations. Rescue financing - either as equity or subordinated debt - which ranks behind everybody else in the capital structure is rarely attractive. At a minimum, sponsors will want any additional funding to rank ahead of the existing equity and shareholder debt.

The trouble is that many leveraged loan documents, especially those of earlier vintages, make it difficult for shareholders to provide further funds to the company in any form other than equity or subordinated debt. It may be possible for sponsors to provide new financing via incremental facilities (see below), but in doing so they would likely be subject to provisions that disadvantage them versus other lenders. For example, they would probably be disenfranchised in any lender vote on all but the most basic matters.

Another problem in some jurisdictions is the doctrine of 'equitable subordination'. This is a legal principle that overrides the contractual documentation to ensure that any financing provided by a direct or indirect shareholder of the borrower is subordinated to third-party creditors in a bankruptcy situation. The sponsor option is often more complex than it looks.

2. Use the Accordion

Borrowers can ask the existing lenders or other third-party debt providers to lend new money under the existing debt documentation. Most recent leveraged loan agreements will allow an additional facility on a pari passu basis with the existing term loans. If a lender willing to provide the new facility, the documentation is usually very simple.¹

The amount is likely to be capped, however. While most...