In the wake of the 2007 credit crunch, corporate debt was often trading in secondary markets significantly below par, largely reflecting lender liquidity concerns. This prompted certain borrowers to acquire their own debt, either as an investment opportunity or simply as a cheap way to de-lever and obtain financial covenant headroom.
Fast forward a decade and debt buybacks may again be on the agenda for corporate treasurers – but on this occasion perhaps due to the increasing prominence of non-amortising financing structures and consequently many borrowers accumulating cash reserves in a low-yield environment. This briefing explores some key considerations for corporate borrowers contemplating a debt purchase transaction.
Prohibition or permission
To address various legal and practical issues arising from debt buy-backs by borrowers and their affiliates, in September 2008 the Loan Market Association ("LMA") introduced optional debt purchase provisions in its recommended form of facilities agreement for leveraged acquisition finance transactions. Those alternative options are (1) prohibiting debt buy-backs by members of the group, or (2) permitting debt buy-backs by borrowers of fully-drawn term loans for consideration of less than par and via a specified regime. Each option permits debt purchases by Sponsor Affiliates, subject to wide-ranging disenfranchisement from lender voting and exclusion from lender calls/meetings. It is therefore key that, during negotiation of a facilities agreement, parties determine if permission for group buy-backs is appropriate (e.g. such permission will be unnecessary if all facilities are expected to be provided on a take-and-hold basis by a single lender). If parties agree to "option two" permission, the following are some additional considerations for negotiation:
- Additional permission to acquire debt in partially drawn facilities (e.g. capex or incremental lines)?
- Permission for a non-borrower group company to acquire debt? Arrangers may be willing to accommodate this if transaction security is granted over rights and interests in acquired debt.
- Funding source for buy-backs? The LMA's recommended starting-point is for group buy-backs to be funded only from retained Excess Cashflow or New Shareholder Injections. Borrowers should consider if flexibility should be included for other funding sources (e.g. surplus asset sale proceeds or other equity-like items).
Which buy-back process?
LMA "option two" contemplates two methods for a debt buy-back process:
- Solicitation: a form of Dutch auction, where lenders offer the amount of debt they are prepared to sell and at what price (the borrower is required to accept the lowest offers, pro rata where identical offers are made).
- Open order: the borrower sets the amount of debt it wishes to purchase and at what price.
The appropriate method will depend on the borrower's commercial objectives and may be guided by preliminary soundings from syndicate members. Regardless of the selected route, a buy-back offer must be made to all lenders in the relevant tranche at the same time to ensure parity of treatment. Borrowers should also note the LMA's specified timetable for completion of a buy-back process. During negotiation of a facilities agreement, borrowers might consider adjusting such timetables to ensure they have an adequate timeframe to consider lender offers and complete associated assignment documentation.
Prior to launching a buy-back process, borrowers should also consider:
1. Process management
The LMA template requires the borrower to designate a Purchase Agent to manage the buy-back process (e.g. reviewing lender offers, finalising assignment documentation). This role can be fulfilled by the Parent or a third party financial institution (e.g. an investment bank or corporate trustee, which in any event should be independent from the lender syndicate). Whether the borrower outsources this role is usually a function of cost and management time, but this need/s to be settled prior to launching a buy-back process.
2. Tax implications
This is perhaps the primary consideration for any UK borrower contemplating a debt buy-back. An acquisition by a UK group of its own debt at a discount can result in a corporation tax charge under the loan relationships regime, usually calculated on the consideration for the acquisition minus the debt's preacquisition carrying value. Whilst certain groups may have sufficient losses to cover the initial charge, it is important to consider any restrictions on the use of such reliefs, particularly given the changing landscape on the application of carry-forward losses. If a charge arises and cannot be covered by available losses, groups should be careful to factor in the cost of accounting for the tax when considering the value at which they purchase the debt and any adverse effect on financial covenants. Separately, it is possible that certain classes of shareholder might be able to buy parts of the debt at a discount without incurring tax charges, provided that they are not connected with the group. This should be carefully considered on a case-by-case basis and advice taken at an early stage as to the most appropriate structure.
If you would like to discuss any of the points outlined in this briefing, please get in touch with your usual contact in the Travers Smith Finance or Tax departments or any of the team below.