Defaulting Lenders Under Unitranche Facilities

The Loan Syndications and Trading Association (LSTA) defaulting lender provisions were released in 2011 in the aftermath of the 2008 Financial Crisis. Some 12 years later, recent distress in the banking sector has thrust defaulting lenders back into the spotlight as market participants focus on the impact, and appropriate treatment, of defaulting lenders under unitranche facilities.

Unitranche facilities, driven in part by the secular rise of private credit funds, have become a common fixture of the debt finance market today. In a nod to the financing structure’s increasing popularity, the LSTA released its Form of Agreement Among Lenders (LSTA Form AAL) in March 2019.^[1] Neither the LSTA Form AAL nor any of the agreements among lenders that we have observed in our practice have addressed defaulting lenders in any detail.

It may now be time to consider a more robust treatment of defaulting lenders in the agreement among lenders used in unitranche facilities, starting with the issues highlighted below.

• Interest skim (Unfunded Revolver) — In a unitranche facility where both the first-out and last-out lender are revolving lenders, the last-out lender would receive the blended rate for the revolving loans that it funds under the credit agreement and would not have the ability to skim any additional interest if the first-out lender is a defaulting lender and has not funded its share of the revolving loans. Consider including provisions in the credit agreement and the agreement among lenders, as applicable, requiring the agent under the credit agreement to apply any amounts withheld from the defaulting lender under the credit agreement to satisfy the unpaid skim interest provided for in the agreement among lenders and allowing the impacted lender to seek recovery of the unpaid skim interest directly from the defaulting lender.
  
  
• Interest skim (Funded Loans) — Defaulting lender provisions in credit agreements generally follow the LSTA Model Credit Agreement Provisions^[2] in requiring any interest received by the agent from the borrower for the account of the defaulting lender to be held in trust by the agent and, at its discretion, be applied in accordance with the defaulting lender payment waterfall under the credit agreement. Such payment waterfall may conflict with the last-out lender’s ability to receive the benefit of the interest skim agreed to in the agreement among lenders. Consider modifying the defaulting lender provisions under the credit agreement to require the agent thereunder to distribute the amount of any skim interest to the agent under the agreement among lenders and requiring the agent under the agreement among lenders to pay such skim interest to the applicable last-out lenders in accordance with the agreement among lenders.
  
  
• Prepayment fee skim — For unitranche facilities where there is a skim of the prepayment fee, consider modifying the defaulting lender provisions under the credit agreement to require the agent thereunder to distribute the amount of any prepayment fee skim to the agent under the agreement among lenders and requiring the agent under the agreement among lenders to pay such prepayment fee skim to the applicable last-out lenders in accordance with the agreement among lenders.
  
  
• Buyout rights — Agreements among lenders often include buyout provisions similar to those contemplated in sections 10(a) and (c) of the LSTA Form AAL. Consider whether defaulting lenders should be excluded from exercising the buyout right or responding to a buyout offer. It should be noted that most credit agreements follow the LSTA Model Credit Agreement Provisions in prohibiting assignments to defaulting lenders, which would limit the ability of any defaulting lender to exercise the buyout right.
  
  
• Voting — Consider amending the “required lenders,” “required first-out lenders” and “required last-out lenders” definitions (or any other similar concepts) in the agreement among lenders such that (i) a defaulting lender is excluded for the purpose of such determination, and (ii) in the event there is no first-out or last-out lender, as the case may be, that is not a defaulting lender, voting control held by that group of lenders under the agreement among lenders passes automatically to the other group of lenders. Case in point, if the sole first-out lender is a defaulting lender, then any provision in the agreement among lenders requiring any action, vote, consent or direction of the required first-out lenders should instead require the action, vote, consent or direction of the required last-out lenders (and vice versa with respect to last-out lenders and required last-out lenders).
  
  
• Rights of first refusal — Similarly with buyout rights, consider excluding defaulting lenders from participating in the rights of first refusal commonly provided for in agreements among lenders.^[3]
  
  
• Payment waterfall — First-out lenders typically have the ability to trigger the payment waterfall under the agreement among lenders after the occurrence and during the continuance of a “waterfall triggering event.”^[4] In situations where the defaulting lender is a material holder of the first-out obligations, consider whether the first-out lenders should retain the ability to activate the payment waterfall or control should pass to the last-out lenders.
  
  
• Exercise of remedies — The authority to direct the agent to exercise remedies under the agreement among lenders also typically resides with the first-out lenders.^[5] Similarly, in situations where a first-out lender is a defaulting lender, consider whether the exercise of remedies should pass to the last-out lenders. 

^[1] _{The LSTA Form AAL can be found at https://www.lsta.org/content/form-of-agreement-among-lenders-aal-3/.} 

^[2] _{As used in this alert, the LSTA Model Credit Agreement Provisions refer to the Model Credit Agreement Provisions released by the LSTA on May 4, 2022, and available at https://www.lsta.org/content/model-credit-agreement-provisions/.}

^[3] _{See sections 10(b) and (d) of the LSTA Form AAL for an example of such rights of first refusal.} 

^[4] _{See, e.g., Section 5(b) of the LSTA Form AAL.}

^[5] _{See, e.g., Section 2 of the LSTA Form AAL.}