April 24, 2019 / 3:15 PM / 3 months ago

Loan documents deteriorate further following Neiman Marcus lawsuit

NEW YORK, April 24 (LPC) - Companies emboldened by a favorable court decision for Neiman Marcus are taking advantage of the outcome to include language in loan documents curbing how corporates allocate the collateral packages of their subsidiaries, making it even harder to recover losses.

The language, which stops individual creditors from taking legal action without the agreement of a majority of lenders, is a win for borrowers and yet another sign of eroding lender protections since last year as demand for loans has exceeded supply. Typically, a lender only required approval from the administrative agent to proceed with legal action.

“We believe this new language from borrowers is in response to (Neiman Marcus’) litigation,” said Valerie Potenza, a senior covenant analyst at credit research firm Xtract Research.

Distressed fund Marble Ridge’s case, which followed the luxury retailer’s decision to transfer MyTheresa assets from the subsidiary to the parent, was dismissed last month due to a lack of standing. In December, the loan and bond holder had claimed that Neiman Marcus’ decision to reallocate its profitable e-commerce unit MyTheresa, was stripping the company of a first-lien claim on the subsidiary’s collateral and was fraudulent.

Since then, retailer PetSmart has included provisions in loan documentation limiting an individual lenders’ right to sue the borrower, according to a report from Xtract Research.

The borrower-friendly environment hinders the chance for more balanced credit agreements especially given the term loans’ loose language was drafted in agreements as far back as six years ago, market sources said.

“Once the horse is out of the barn and a mile down the road, (lenders) are stuck with trying to get an agreement based on something that is not quite the collateral you thought you were getting,” said Tyson Benson, an intellectual property attorney with Harness Dickey.

Without collateral as a form of protection, lenders could be left relying on little other than the performance of a borrower to repay debt, according to Alex Shvarts, the chief technology officer at alternative investor FundKite.

“If you have limited protections … It’s no longer a leveraged deal, but a roll of the dice,” Shvarts said. “It’s important for investors to tighten up underwriting guidelines and block such transfers from happening.”

PETSMART FOLLOWS SUIT

So long as investor demand outstrips loan supply, lenders are likely to heel to borrower requests, particularly on documentation and term loan language, hopefully in exchange for a higher interest rate.

PetSmart this month obtained consent from more than 51% of its term loan holders to pass an amendment to its loan that limits lenders’ rights to sue the company over its transfer of online business Chewy.com, effectively putting the subsidiary out of their reach.

The amendment included language that each lender would “waive its right to sue the loan parties” in actions related to the collateral of the borrower without the consent of the required lenders, according to Xtract.

Similar to Neiman Marcus, the pet retailer had decided to move a 20% stake in Chewy.com to the parent company level and a further 16.5% to an unrestricted subsidiary, a move deemed fraudulent by lenders.

PetSmart’s efforts to amend its loan initially met with pushback from investors. PetSmart then revised the offer with sweeter terms that helped get the majority on board, according to sources familiar with the proceedings.

“Subsidiaries are not regulated by the debt documents, which leaves this wide open for abuse by the companies,” said Potenza. “Companies can move assets into these (subsidiaries) and once they are there, they are gone.”

While PetSmart has obtained majority consent to amend the term loan, sources have said some creditors are still expected to fight back on the company’s transfer of Chewy.com, PetSmart’s US$3.35bn acquisition back in May 2017.

PetSmart did not respond to a request for comment. (Reporting by Aaron Weinman. Editing by Michelle Sierra and Lynn Adler.)

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