PRINT THIS PAGE Interim funding – what is the hurry?07/11/2007. Source: Lovells. Susan Whitehead 
It has become commonplace for bidders to require their mandated lead arrangers to sign an interim financing package on or prior to exchange of a proposed acquisition. Susan Whitehead, a senior consultant in international business law firm Lovells’ leveraged and acquisition finance practice, explains why this can be necessary, what is involved and some issues the parties should consider. It used to be enough for private equity sponsors to show the seller a signed commitment and mandate letter from the bank arranging the finance to convince the seller that it had the funds to complete the bid.
Now frequently sellers, and hence sponsors, demand that interim facilities are signed up if bidders are to stand a chance of winning their competitive auction.
We have written in this newsletter on many occasions about the impact which the current strong sellers’ market we are experiencing is having on the structure and terms of leveraged finance debt packages. The rise of the interim loan agreement can be seen as another ramification of this as the bidders’ ability to exchange contracts very quickly after winning the auction process is key to the seller. This is particularly true where the seller is a private equity house looking to exit an investment.
Why interim funding has grown in use
If the sponsors have a signed commitment and mandate letter issued by the mandated lead arranger ('MLA') at the point they win the auction, whilst it will these days invariably include certain funds language, in practice the underwriter’s commitment to lend to fund the bidder’s proposed acquisition will be subject to satisfaction of the conditions precedent, a longstop date and completion of full documentation. However, some sellers are just not prepared to take the risk that a
bidder may fall out with its MLA over the terms of the full financing documentation as this would entitle the MLA to refuse to fund and leave the bidder unable to complete. The seller would be left with a claim for breach of contract against a newco with few or no assets (although sellers also frequently now expect the private equity house to stand behind its newco by providing some certainty of funding in relation to its equity participation)1. Whilst this is obviously a small risk (particularly with the existence of today’s detailed term sheets which can run to eighty odd pages and generally summarise all major terms upfront), it’s a risk which sponsors do not want to take either.
[1 This is explored further in our article 'Standing behind Newco' in the Autumn 2005 edition of this newsletter. ]
For these reasons, bidders ideally would like full banking documentation signed and in place at exchange. However, as auctions are frequently run on very short timetables, bidders often do not have the time to agree full debt documentation (particularly because the debt package will often comprise senior, second lien, mezzanine and sometimes PIK or other subordinated debt documents). Even if that exercise could be squeezed into the time available, often sponsors do not have the appetite to do so, preferring to concentrate their energies on the due diligence exercise and negotiating the terms of the sale and purchase agreement ('SPA'). To solve this problem, the MLA is now often asked to sign an interim financing package on or before exchange of the SPA.
The interim loan agreement is designed to be a tool which enables the parties to exchange the SPA. They can be (and are) used on public to private transactions as well as on private acquisitions. Whilst it must be capable of being drawn upon, it is generally not the intention of the parties to complete the acquisition using the interim loan agreement – full documentation will usually be put in place in the period between exchange and completion of the SPA. Accordingly, interim facilities are normally expressed to have a very short tenor – drafted to be just sufficient to allow completion to have occurred. However, if the gap between exchange and completion is not long enough to allow full documentation to be signed this should not delay closing and the MLA would plan to fund on the interim loan agreement and then refinance with
the proceeds drawn under the full documentation as soon as possible.
The form of interim documentation
The interim funding package is centred on a single loan agreement under which the MLA agrees to lend the full amount of the acquisition debt (including any refinancing tranche and sums required to fund acquisition costs and expenses) to the bidder to assist it to complete the acquisition. A small working capital facility is often also included.
Where there is a sole MLA, the interim facilities will be documented on a bilateral basis – the MLA will provide all the required debt itself. If there are joint MLAs, the interim loan agreement will be drafted as a syndicated facility (but there will be no intention for the joint MLAs to sell down before completion; a point covered in detail later in this article).
The interim loan agreement will be short form (on average 20-30 pages long) and will contain the mechanics for the loan together with only essential undertakings, representations and defaults, and then relating only to the bidder (and any relevant holding company of the bidder) (the 'Bidco Group'). It is unusual to see any financial covenants. Brevity and simplicity should be at the heart of the interim documentation if it is to justify its role and existence.
Interim security
Interim facilities are secured by an interim security package granted solely in favour of the MLA (or where there are joint MLAs, for one of them as security agent for the MLAs providing the interim loans). The interim security will only be given by members of the Bidco Group. This means that the value of the interim security will be limited in practice to the value of the bidder’s new shareholding in Target, the benefit of any structural intra-group loans within the Bidco Group and the benefit of the bidder’s rights under the SPA and other acquisition documents. The MLA will also look to have the professional reports co-addressed to it.
Given that it is usual (particularly on cross-border transactions) for target security only to be put in place within an agreed timeframe after completion, the interim security package will not generally provide for any target security.
Issues
Moving to full documentation:
The interim financing package is, however, only part of the financing package offered by the MLA. At the heart of that package remains the commitment and mandate letter and detailed term sheets for the different loan facilities. The commitment and mandate letter states that the MLAs will provide interim funding (and the agreed form of interim loan agreement is normally an appendix) and contains the agreement between the parties to negotiate in good faith to put full documentation in place before completion.
It is still important for both the bidder and the MLA that the commitment and mandate letter attaches a detailed term sheet, despite the existence of the interim loan agreement. Both parties need the interim facilities to be refinanced with the proceeds of the full documentation. The MLA will need full documentation to be put in place in order to start to syndicate the debt and to remove the debt from its own balance sheet. To that extent, the use of the interim loan agreement does shift the risk of getting full documentation in place onto the MLA as without an interim, the bidder would need full documentation to be put in place in order to obtain the acquisition finance in the first place. With interim documentation, the bidder needs full documentation to be put in place in order to refinance the interim facilities and to avoid a default (and potential enforcement action by the bank) but it is also very much in the interests of the MLA to get that documentation put in place. This means that it is even more important than normal that those areas which are traditionally flashpoints in negotiation on banking documentation should be dealt with in the term sheets appended to the commitment and mandate letter.
This will include, for instance, any agreed security principles, the various carve-outs to be negotiated to the negative undertakings and the exact requirements for applications of proceeds resulting from prepayments.
Conditionality:
To achieve their aim, interim loan agreements need to contain certain funds provisions. This means that in practice the interim facilities will only be conditional upon completion occurring before the longstop date and satisfaction of the conditions precedent, both of which are matters which should be within the control of the bidder. The conditions precedent, in particular, should be satisfied before exchange of the SPA or, if that is not possible, need to be in agreed form as at exchange.
Transferability:
The transfer provisions in the interim loan agreement are different to what will appear in the full documentation. Generally, the MLA(s) providing the interim funding will not be entitled to assign or transfer their obligations in the interim facilities without the bidder’s consent unless an event of default has occurred. The exception is designed to protect the MLA in case of a meltdown situation as it enables the MLA to sell its rights in the interim facility on the distressed debt market as an alternative to enforcing the interim security package itself.
The limited right to transfer is to tie into the commitment and mandate letter in which the MLA commits to arrange the refinancing of the interim facilities. The bidder will want the MLA(s) to still have an interest to refinance at full documentation stage.
Fees:
The arrangement and underwriting fee requires a little thought. It is usual for the parties to sign an interim fees letter detailing the underwriting fee payable on drawdown of the interim facilities which will happen at completion of the acquisition. Of course, it is anticipated that the interim facilities will be refinanced before completion, so the interim fee should never become payable. The interim fees letter is replaced by a new fees letter signed at the time full documentation is put in place – it is not the intention that the bidder pay this fee twice!
Whether or not a commitment fee or ticking fee is payable on the interim facilities will also be a matter for consideration by the parties.
Comment
Interim funding is not really a new concept – through the years, banks have issued 'fundable commitment letters' where the MLA has been contractually committed to lend the facilities without full documentation being in place if the particular circumstances of the case have warranted it. The interim loan agreement is a natural development in current market conditions and its use looks set to continue to flourish as it has advantages over the fundable commitment letter concept for all parties, including the MLA.
Susan Whitehead
Lovells is one of the largest international business legal practices, with over three thousand people operating from 26 offices in Europe, Asia and the United States. For more information about the firm go to http://www.lovells.com/
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