Commitment Letters & Preliminary Documents PDF

COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS 1 SUMMARY COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS Introduction to Preliminary Documents Commercial lending transactions can be extremely complicated. To help organize the details...

COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS 1 SUMMARY COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS Introduction to Preliminary Documents Commercial lending transactions can be extremely complicated. To help organize the details and set up a framework for the transaction, the parties usually negotiate and sign one or more preliminary documents before they negotiate the credit agreement. The main ones are a term sheet, a commitment letter, and a fee letter, but not all deals have all three. o Sometimes the parties combine them into one or two agreements. For example, the lender’s fees might be included in the commitment letter or in the credit agreement. Generally, the larger and more complex the deal, the more likely the parties are to use all three. Lawyer Involvement Lawyers sometimes get involved in the drafting and negotiation of preliminary documents. Their involvement depends on the transaction and the practice area. o For example, they’re almost always involved in negotiating term sheets for acquisition financings. o But they’re rarely involved with term sheets for straightforward bilateral loans in the lower-middle market. NDAs One agreement not yet mentioned that’s common in most lending deals is a non- disclosure agreement (NDA). NDAs require that the signing party—in this case the lender—keep all information it receives from the other party confidential. NDAs are often the first agreement that the parties enter into, and they’re particularly important in the lending context. o That’s because before approving a loan, the lender conducts due diligence on the borrower and reviews potentially sensitive information, like the borrower’s financial statements, tax returns, and business projections. The parties usually negotiate NDAs without the help of outside lawyers—though lawyers might need to remind their clients to ask for one. Term Sheets A term sheet is a non-binding summary of the key terms of a loan. Lenders differ on the level of detail they include. Think of a term sheet as an outline of the material terms of the credit agreement. www.hotshotlegal.com [email protected] 79 Madison Avenue, 2nd Floor New York, NY 10016 COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS 2 o While the terms could technically change later during the main documentation stage, parties don’t generally deviate too much. Term sheets are usually in the form of a table or list. o At the top they typically say: The term sheet is non-binding; That it doesn’t represent an offer to make a loan; and That funding the loan is subject to conditions like diligence, internal credit approval, and final documentation. Then the terms are set out with the categories on the left and the related details of the parties’ agreement on the right. Term Sheets: Economic Terms The major economic terms of the deal are almost always decided at the term sheet stage. o The main ones the parties focus on are: The type of loan and the principal amount to be borrowed; The purpose and availability of the loans, with availability referring to when the funds can be drawn down depending on whether it’s a term loan or a revolver; The maturity dates and the amortization or payment schedule if there is one; The interest rate, usually consisting of a benchmark rate plus a margin (most loans offer borrowers a choice of rates); The identities of and requirements for any guarantors; A general description of the collateral in secured deals; and The fees the bank is charging on top of the interest—like an unused line fee or letter of credit fee. Term Sheets: Legal Terms Other terms, mainly the legal points, may not be negotiated or agreed to at any level of detail until the main documentation stage. o That happens most often with the: Reps and warranties; Conditions precedent; Covenants; and Events of Default Sections. The two exceptions to this list are financial reporting obligations and financial covenants. o These are usually ironed out early. o The borrower analyzes these covenants closely because they have to make sure that they’ll be able to meet the requirements. But with the other categories—since there may not be details to include in the term sheet yet—parties might use placeholder language instead. o Borrowers don’t generally like this approach. www.hotshotlegal.com [email protected] 79 Madison Avenue, 2nd Floor New York, NY 10016 COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS 3 o They’d rather negotiate a precise and limited list for each of these categories so there are no surprises later. This is especially true for the covenants that could affect the borrower’s operations. The parties can also take a hybrid approach to these sections. o For example, they could say: “Usual for facilities and transactions of this type,” implying that the details are to be negotiated at the main documentation stage. Then they can list specific topics that they agree to include as well. o Lenders generally like this kind of hybrid approach because it keeps the deal points as broad as possible, while also agreeing early to details that are particularly important to them. Additional Deal Points Often Negotiated Early There are some deal points that if not agreed to at the term sheet stage, can be hard to get into the final documents: o Like whether any legal opinions will be conditions precedent to close the deal; or o Whether a Material Adverse Effect (or Change) will be an Event of Default— this point often results in a lot of negotiation. Borrowers would rather not have the concept at all, or at a minimum they want to limit the definition to only things in their control, like their financial performance. But lenders try to include any material adverse change in the loan market, or in the economy in general. Introduction to Commitment Letters A commitment letter is a letter from a lender committing to make a loan to a borrower. There are two types of commitment letters: o Soft commitments; and o Hard commitments. Soft Commitments Most commitments are soft. A soft commitment is a commitment in principle by the lender, but the parties don’t agree in advance to the full list of closing conditions or conditions precedent. o In that sense, it’s very similar to a term sheet. Soft commitments are usually subject to very broad conditions, like the completion of satisfactory documentation or due diligence, or the lender receiving internal credit approval. o These give the lender a fairly easy way to back out of the commitment. www.hotshotlegal.com [email protected] 79 Madison Avenue, 2nd Floor New York, NY 10016 COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS 4 Soft commitments are especially common when the borrower doesn’t have a firm deadline for the funds or if the borrower doesn’t need certainty that the funding won’t fall through. Hard Commitments A hard commitment is when the parties agree to all of the requirements for financing in the commitment letter. o They lay out a definitive and limited list of “financing outs”—or reasons the lender could walk away from the deal. o So once the commitment letter is signed, there’s only a limited number of reasons the deal could fall through. Hard commitments are more common where the borrower needs to know with certainty that it will get funding. o Acquisition financings are a perfect example. The seller in an acquisition might not even negotiate, let alone enter into a purchase agreement with a buyer, until the buyer has a hard commitment letter from a lender. That way the seller can be sure the borrower has sufficient funding for the acquisition before moving forward. o Large, syndicated deals are another good example of where hard commitments are more common. A hard commitment can never be given with a “best efforts syndication,” since the arranger is by definition not guaranteeing any funds in those transactions. Contents of a Commitment Letter Example of a Typical Commitment Letter In a standard soft commitment letter for a middle market loan: o The lender or lenders committing to make the loan would be listed at the top and would be identified in the first paragraph as parties to the letter. o The first paragraph would also specify the purpose of the loan—like for the refinancing of existing indebtedness. Then the letter would set out the lender’s commitment to lend. o Sometimes this is as simple as listing the total dollar amount that the lender will make available to the borrower during the life of the loan. o If it’s a syndicated deal, this section could be very complex, depending on whether the arranger commits to funding some or all of the loan or just to marketing it to other lenders. In other words, whether it’s a partially underwritten, fully underwritten, or best-efforts deal. There would be other syndication-specific terms in the letter too, like the appointment of roles, how the syndication process will be run, and the borrower’s responsibilities during that process. www.hotshotlegal.com [email protected] 79 Madison Avenue, 2nd Floor New York, NY 10016 COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS 5 Typical payoff letters also lay out the fees charged by the lender for its services, or they might cross reference a separate fee letter. Another section would identify conditions to the lenders’ commitment. These are the “financing outs” mentioned above. o The letter might have conditions like the absence of any material adverse effect, the payment of all fees listed in the fee letter, and the satisfaction of the conditions precedent included in the term sheet. By referencing the term sheet, the lender softens its commitment because the term sheet might reserve the right to add conditions precedent later in the credit agreement during negotiations. The lender also incorporates the broader conditions that apply in the term sheet, like satisfactory due diligence and credit approval. SunGard Provisions It’s possible that the ultimate credit agreement could have conditions precedent that are much lengthier and more exhaustive than those in the commitment letter. o If that happens, the lender could refuse to fund because a condition in the credit agreement isn’t met, even though the express conditions in the commitment letter were fulfilled. o This could be a real problem in an acquisition financing, where it’s essential that the borrower has a true “hard commitment” in hand. o That’s why borrowers in those deals often push to include a SunGard provision in the commitment letter. Under a SunGard provision, the lender usually agrees that: o Only certain “specified representations” in the credit agreement need to be true on the day of closing, as opposed to all of the reps and warranties; o The conditions included in the credit agreement for the initial funding of the loans at closing have to match those conditions listed in the commitment letter; and o Any definition of a Material Adverse Effect in the credit agreement has to be the same as the one used in the acquisition agreement. Typical Commitment Letter Thinking back to the example of a typical soft commitment letter, it would also have a section where the borrower represents that all the information it’s providing to the lender is correct in all material respects. o This is important because the lender relies on this information to approve and market the loan. And there would be standard contract provisions. o One standard term worth noting is the Termination provision. Because these letters are legally binding commitments, lenders don’t want to be on the hook to lend indefinitely. www.hotshotlegal.com [email protected] 79 Madison Avenue, 2nd Floor New York, NY 10016 COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS 6 The Termination Date in a commitment letter is essentially another way of saying that the credit agreement must be signed by a specific date. Once the credit agreement is signed, most of the commitment letter becomes moot and the credit agreement then controls the parties’ relationship. Fee Letters In exchange for providing a loan (or arranging, underwriting, or administering a syndicated loan) lenders charge the borrower fees. o These fees are separate and unrelated to the interest rate otherwise charged on the loan. o Lender’s fees are usually a condition to funding, and they could be set out in various places. The main reason lenders use a fee letter is to keep their fees confidential. o Arrangers in large, syndicated deals almost always use a fee letter so that the arranger can keep its pricing models confidential to stay competitive in the market. o Public company borrowers also like to use fee letters to keep fees confidential, since the credit agreement is publicly filed but fee letters are generally not. Fee letters are entered into at the same time as the commitment letter. o Like the commitment letter, they’re usually given by the lender providing the loan or the arranger (or joint arrangers) if the loan is syndicated. o It’s common for borrowers to compare the fees of different banks when shopping around for a loan. Common Fees An “Arrangement Fee” (also called an “Underwriting Fee”) is a fixed fee paid to the arranger for its services in syndicating and marketing a loan. o The amount of the fee is usually based on the total loan amount. o Borrowers usually pay it when the commitment letter is signed or at closing, or sometimes they pay a portion on each date. An “Upfront Fee,” or “Origination Fee,” is also a fixed fee based on a percentage of the entire loan. It is paid on the closing date. o If there’s more than one lender, the fee is split among all lenders according to their commitments. o That usually includes lenders who come into the syndicate by assignment and assumption immediately after closing. An “Administrative Agency Fee” is an annual fee paid to the administrative agent in a syndicated deal for administering the loan, including collecting and distributing payments from the borrower to each lender. An “Unused Line Fee” or a reoccurring “Commitment Fee” compensates the lender for keeping funds available to the borrower. www.hotshotlegal.com [email protected] 79 Madison Avenue, 2nd Floor New York, NY 10016 COMMITMENT LETTERS AND OTHER PRELIMINARY DOCUMENTS 7 o It’s usually a fixed percentage paid on the unused portion of the loan. o It’s common with revolving loans. For example, if a borrower has a revolving loan facility for $20 million but only takes out $15 million, they’d owe a commitment fee on the unused $5 million until that’s borrowed. Market Flex Provisions In syndicated deals, the fee letter might also have a “Market Flex” provision. o This gives the arranger flexibility to change the terms of the deal if necessary to attract more lenders to the syndicate. These provisions are usually heavily negotiated. The borrower tries to limit the lender’s discretion by including caps or conditions to the changes that the arranger can make. www.hotshotlegal.com [email protected] 79 Madison Avenue, 2nd Floor New York, NY 10016