PRINT THIS PAGE Debt buybacks18/06/2008. Source: SJ Berwin. Robert Andrews, Brian Carne, Simon Fulbrook 
There has been some debate in the leveraged loan market recently about whether borrowers (or the funds that have invested in them) can, legally, buy back debt. With large swathes of underwritten debt still on banks' books many months after the start of the credit crunch, there are clear opportunities for the private equity industry to buy third party debt at a discount. But there are also opportunities to increase their exposure to their own investments by buying senior and second lien acquisition debt in portfolio companies, according to Robert Andrews, Simon Fulbrook and Brian Carne of SJ Berwin. Recent months have seen a number of headline public debt buybacks – TDC, Lafarge and Fat Face are examples – and they are growing in number. Views on whether this is a good thing tend to be polarised. It is perhaps no surprise that the Loan Market Association (LMA) (Europe's trade association for the syndicated loan markets) is not enthusiastic about it, with their concern focusing on the unsuitability of their existing syndicated loan documents to deal clearly with this eventuality.
Nevertheless, given that debt buybacks have been occurring both in the UK and the US, it is quite clear that buybacks are permitted by many existing loan documents. In principle, debt buybacks are possible provided the documentation permits it (or, more particularly, does not expressly preclude it), and there would generally be no restriction on a private equity sponsor to a deal, or one of its affiliates, participating as a lender (and in effect making a debt buyback) under an LMA standard facility agreement with market standard transfer provisions. Of course, the sponsor itself will also have to consider a range of other issues - conflicts of interest and the terms of its fund documentation to name two of many.
But one area in which some lawyers have reservations is the purchase of debt by the borrower itself, or by a group member of the borrower. Here there are legal concerns about the position of the debt after the purchase, although in some cases these will be surmountable.
Any legitimate debt purchaser would obtain all the rights of a lender - these would include the benefit of the security package granted, and (crucially) the ability to participate in lender voting. Given the general requirement for majority lender consent (commonly 66²/3%) to be obtained before any major decisions can be made, there is an opportunity for a sponsor (or one of its affiliates) to acquire a blocking stake of debt in a deal in which they are an investor and, subject to certain obligations implied by law, effectively veto those decisions which run counter to their individual interests.
In addition, many participate by entering into derivatives directly with the lender which provides embedded leverage that is otherwise not currently available in the wholesale lending market. In this structure the existing lender remains as lender of record and there will be negotiation regarding the rights (including voting rights) and risks which pass to the purchaser. There are also potential US tax concerns which would make this a more suitable option than a straight purchase of debt, in particular for investors with a US nexus to avoid the negative impact of the provisions dealing with the cancellation of debt.
Given the current market conditions banks are keen to improve their balance sheets and sell on debt (written down or not). Their willingness to participate in derivative solutions, and the LMA's recent announcement that it will alter the primary facility agreements to expressly provide for the circumstances in which debt buybacks can occur, assists them with doing this. But new documentation is already being issued with limitations on this practice, and the new provisions from the LMA will be keenly awaited to see what restrictions are placed on sponsors in the future.
SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on our services to the private equity industry please contact Simon Witney in our London office 020 7533 2222 or visit our website at www.sjberwin.com.
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