| ||||||||||
| ||||||||||
— Private Equity —
First, the applicable credit agreement and related documentation must be reviewed to determine whether the contemplated loan purchase is permitted and what contractual implications may arise therefrom. Unlike indentures governing publicly traded debt securities (which typically permit the underlying debt securities to be held by affiliates of the issuer while treating such debt securities as not outstanding for voting purposes), credit agreements are less standardized with respect to loan purchases by affiliates of a borrower's equity sponsor. A credit agreement's assignment section will generally describe what consents are required for sponsor affiliates to purchase loans. Some agreements require the agent's consent for the transfer of loans to anyone other than an existing lender or an affiliate, while others expressly prohibit an assignment to borrower affiliates.
In the former case, only the credit facility agent must consent to a sponsor affiliate becoming a lender, while in the latter case, consent is necessary from the broad bank group for an amendment to the applicable provisions. The exact percentage of the consent required will vary from agreement to agreement. Credit agreements will often not expressly restrict an affiliate's right to vote or otherwise exercise rights. However, where a consent is required for the debt purchase, the agent and-or the lenders may seek to condition such consent on, among other things, the equity sponsor foregoing its right to vote its loans and participate in lender meetings. Next, the applicable fund documents must be reviewed to ensure that they allow investment in the debt of either a fund portfolio company or a portfolio company of another fund affiliated with the same sponsor. Moreover, fund documentation will often limit the time in which capital can be called for follow-on investments in the portfolio companies. Sponsors must also consider the fiduciary obligations owed to their various investment funds' limited partners and co-investors, particularly when the debt of a portfolio company is proposed to be acquired by a different fund that is managed by the same sponsor. Potential equitable subordination to the claims of other creditors in the event the portfolio company files for bankruptcy must also be considered. The mere fact that a lender is also an equity owner should not be enough to sustain an equitable subordination claim. Rather, some element of wrongdoing is typically required, such as showing that undue control over the portfolio company was exercised as a result of the combined ownership of debt and equity. The acquisition of debt by a person related to a borrower also presents U.S. federal income tax issues. An acquisition at a discount will result in cancellation of indebtedness income, or COD, to the borrower and a deemed newly issued debt instrument that has "original issue discount," or OID, in an amount equal to such discount. Such OID must be taken into income by the related holder over the remaining term and is deductible by the borrower, subject to certain limitations -- including the "applicable high yield discount obligation" rules, which could disallow the OID deduction if the remaining term is more than five years. If the borrower is insolvent, as determined for tax purposes, it can generally exclude COD from income to the extent of its insolvency, but it must reduce its net operating losses and other tax attributes. If the borrower is a partnership or other pass-through entity, the determination of insolvency must be done at the partner level. The American Recovery and Reinvestment Act of 2009 permits certain borrowers to elect to defer until 2014 any such COD income if recognized in 2009 or 2010 and then take it into income ratably over five years. If it makes such an election, the borrower must also defer its OID deductions on the deemed newly issued debt instrument. Emanuel S. Cherney is a partner in and vice chairman of Kaye Scholer LLP's corporate and finance department. Laurie Abramowitz is a partner in the law firm's tax department. Lowell I. Dashefsky is counsel in its corporate and finance department. |
Private equity sponsors are increasingly identifying investment opportunities in senior bank debt of their own portfolio companies, much of which is trading at deep discounts to par. A number of issues must be considered, however, before a private equity sponsor purchases debt of a portfolio company.
|
|
|
|
|
