1. business and industrial
2. company
3. merger and acquisition

2015 ACIC SPRING FORUM
Merger/Consolidation/Sale of Substantially All Assets
Liens
Timothy F. Hodgdon
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Merger/Consolidation/Sale of Substantially All Assets
Present Day
• The negative covenant limiting mergers, consolidations or sale of substantially
all the assets of an Issuer is designed to preserve for creditors the financial
characteristics and earning potential of an Issuer if the Issuer undergoes a
merger or consolidation or sells substantially all of its assets. The current
Model Form No. 2 merger covenant for domestic deals is set forth as Annex 1.
• Mergers and consolidations are not prohibited, but the successor entity, if not
the existing Issuer, must be organized in an acceptable jurisdiction, and must
assume the obligations of the Issuer under the note agreement and the notes.
• In order to assure that the credit quality of the successor obligor complies with
the negative covenants of the note agreement, both immediately prior to the
merger or sale, and immediately after giving effect to such transaction, no
Default or Event of Default is permitted to exist.
• If indebtedness is tested on an incurrence basis, the note agreement should
require that the successor obligor have the ability to incur $1.00 of indebtedness
after giving effect to the transaction. If the financial covenants are tested only
periodically, the “after giving effect” requirement is sometimes spelled out more
explicitly.
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• The merger, consolidation or asset sale is typically required to be supported by
an opinion of counsel that the assumption agreement is enforceable.
• The Model Form merger covenant for domestic deals is currently limited to
testing the merger, consolidation or sale of substantially all the assets of the
Issuer, but the covenant has been expanded in the recently posted 2015 version
of Model X Form No. 2 for non-U.S. Issuers to cover mergers of subsidiary
guarantors.
• If a merger covenant tests subsidiary mergers, intra-group mergers involving
the Issuer are allowed if the survivor is the Issuer. If the merger involves a
subsidiary guarantor, the intra-group merger is allowed if the survivor is the
subsidiary guarantor. Non-guarantor subsidiaries are typically allowed to
merge into one another or into a subsidiary guarantor or the Issuer if the
subsidiary guarantor or the Issuer is the survivor.
• If the notes are guaranteed by subsidiary guarantors, it is desirable that the
subsidiary guarantors be required to confirm that their subsidiary guarantees
will remain in force following the consummation of the merger of the Issuer
into another entity. This provision was added to the Model Form for domestic
Issuers in the October 2012 revisions and Model Form X for non-U.S. Issuers in
the April 2014 revisions.
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• The limitation on transfers of “substantially all” of an Issuer’s assets may cover a
wider range of asset sales than either the Issuer or noteholders might otherwise
assume. Delaware case law has come to somewhat inconsistent conclusions as
to what constitutes “substantially all” of an entity’s assets. In Katz v. Bergman
(Del. Ch. 1981), an asset sale constituting 51% of asset value, 44.9% of sales and
52.4% of pre-tax net operating income was held to be a sale of “substantially all”
the corporation's assets. But contrast Hollinger, Inc. v. Hollinger International,
Inc. (Del. Ch. 2004). A factor for Delaware courts is whether the remaining
businesses are viable and whether the entity remaining after the asset sale is an
investment that in economic terms is qualitatively different than the
investment before the asset sale.
• If a sale of all or substantially all of an Issuer’s assets is made, the Issuer
typically is not released from liability under the note agreement. This
requirement was originally based on concerns that the negotiability of a note
would be violated if the original obligor was released from its obligations. This
concern no longer exists following the adoption in the 1960s of the Uniform
Commercial Code – specifically Sections 8-102 and 8-105.
• Since sales of “substantially all” an Issuer’s assets may permit asset transfers less
encompassing than noteholders might assume, it makes sense to require that
the transferor is not released from its obligations following the transfer, absent
noteholder consent.
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Annex 1
Domestic Model Form No. 2 Merger Covenant
The Company will not consolidate with or merge with any other Person or convey, transfer
or lease all or substantially all of its assets in a single transaction or series of transactions to
any Person unless:
(a) the successor formed by such consolidation or the survivor of such merger
or the Person that acquires by conveyance, transfer or lease all or substantially all of the
assets of the Company as an entirety, as the case may be, shall be a solvent corporation or
limited liability company organized and existing under the laws of the United States or any
state thereof (including the District of Columbia), and, if the Company is not such
corporation or limited liability company, (i) such corporation or limited liability company
shall have executed and delivered to each holder of any Notes its assumption of the due
and punctual performance and observance of each covenant and condition of this
Agreement and the Notes and (ii) such corporation or limited liability company shall have
caused to be delivered to each holder of any Notes an opinion of nationally recognized
independent counsel, or other independent counsel reasonably satisfactory to the
Required Holders, to the effect that all agreements or instruments effecting such
assumption are enforceable in accordance with their terms and comply with the terms
hereof;
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Annex 1 (cont’d)
[(b)
each Subsidiary Guarantor under any Subsidiary Guaranty that is
outstanding at the time such transaction or each transaction in such a series of transactions
occurs reaffirms its obligations under such Subsidiary Guaranty in writing at such time
pursuant to documentation that is reasonably acceptable to the Required Holders;] and
(c) immediately before and immediately after giving effect to such transaction or
each transaction in any such series of transactions, no Default or Event of Default shall have
occurred and be continuing.
No such conveyance, transfer or lease of substantially all of the assets of the Company shall
have the effect of releasing the Company or any successor corporation or limited liability
company that shall theretofore have become such in the manner prescribed in this
Section 10.2 from its liability under this Agreement or the Notes.
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The Past
• While the current Model Form merger covenant specifically addresses only
mergers, consolidations and sales of substantially all assets, the typical merger
covenant of the past was combined with the asset sale covenant that limited
partial sales of assets.
• In the past, there was at least some resistance to allowing any mergers of the
Issuer. The 1980 Prudential model form instructed that a variation of the
merger covenant prohibiting mergers of the Issuer was “always the one which is
inserted in the first draft unless otherwise specified in the memorandum of
terms.” That variation of the merger covenant allowed subsidiaries to merge
into other subsidiaries or into the Issuer if the Issuer was the surviving entity.
• The resistance to allowing Issuer mergers, even if the credit quality of a
potential merger partner was commensurate with the credit quality of the
Issuer, was explained in a treatise of the time by the fact that an institutional
investor’s credit decision to invest in an Issuer was based in part on the
investor’s confidence in the current management of the Issuer and the Issuer’s
style and method of operation. Thus, a decision to allow a merger did not
depend solely on whether or not the combined entity would comply with the
covenants on a pro-forma basis.
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• For subsidiary mergers, if subsidiaries were less than wholly-owned, the
Prudential model form specified that the survivor of a subsidiary merger should
be a wholly-owned subsidiary of the Issuer. In some note agreements of the
time, non-wholly-owned subsidiaries could merge into the Issuer only if the
Issuer was the survivor and after giving effort to such merger no Default or
Event of Default had occurred and was continuing.
• If Issuer mergers were permitted in a deal’s term sheet, the second variation of
the Prudential model form merger covenant required that the Issuer had to be
the survivor of the merger.
• The final and least restrictive variation of the Prudential model form merger
covenant, where the Issuer was not the survivor of the merger, was similar to the
present day Model Form merger covenant: the survivor or acquiror had to be
organized under the laws of the United States and was required to assume in
writing the obligations of the Issuer under the note agreement and the notes;
after giving effect to the merger or sale, no Default or Event of Default could
exist; if the transaction involved a sale of substantially all the assets, the Issuer
would not be released from its obligations under the note agreement or the
notes unless the sale was followed by the complete liquidation of the Issuer and
substantially all the assets of the Issuer were distributed in such liquidation.
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• The Prudential model form did not call, however, for the delivery of legal
opinions in support of the assumption agreement, as is now required by the
Model Form.
• Other model forms handled merger covenants in a different way. The Model
Debenture Indenture merger covenant limited mergers only in situations where
the Issuer was not the survivor of a merger. There was no restriction on mergers
where the Issuer was the survivor. Like the current day Model Form, the Model
Debenture Indenture merger covenant provided that a sale of substantially all
assets did not release the Issuer from its obligations under the notes.
• The Aetna model form also took a slightly different approach from the
Prudential model form. The Aetna model form allowed, in the first instance,
mergers of the Issuer into another corporation, although the form required that
the surviving entity be engaged in substantially the same line of business as the
Issuer. The Aetna model form only allowed mergers and consolidations and did
not permit the sale of substantially all of the Issuer’s assets. The Aetna model
form, like the Prudential model form, did not require the delivery of legal
opinions to accompany the assumption agreement.
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• By contrast, the Model Debenture Indenture merger provisions required the
delivery of an officer’s certificate and an opinion of counsel that the merger
complied with the note agreement and that all conditions precedent to the
merger had been complied with.
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Liens
Present Day
• Institutional investors are concerned about allowing other creditors to have
claims against assets of the Issuer that will come ahead of the unsecured claims
of the institutional investor in an insolvency of the Issuer. A covenant
restricting liens thus has always been an important note agreement covenant.
• Until 2011, however, the Model Form did not contain model provisions that
covered lien restrictions, leaving that task to the less often used Financial
Covenants Reference Manual. Given an Issuer’s desire to maintain covenant
consistency with its principal bank facility, it is not unusual to find that lien
restrictions are based on similar restrictions found in the Issuer’s bank credit
agreement, though lien baskets in the note agreement are often more expansive
than baskets found in the credit agreement.
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• The most notable lien restriction found in present day note agreements is the
so called “anti-Cookson” clause, which is designed to keep noteholders on lien
parity with the Issuer’s material credit agreements. This limitation was first
incorporated into the Model Form for domestic Issuers in the discussion draft
of April 2011 and evolved to its current form in October 2012 (See Annex 2). The
clause prevents the Issuer from using secured debt availability in the lien basket
to secure obligations arising under the Issuer’s principal bank credit agreement
(as was done in the Cookson restructuring) without equally and ratably
securing the notes under the note agreement.
• While the anti-Cookson clause was first put into note agreements to allow
noteholders to maintain parity with lenders under the Issuer’s principal bank
credit agreement, the Model Form has expanded the protection to “Material
Credit Facilities”, a definition which includes not only large credit facilities in
existence at closing, but also includes any future credit facility evidencing
indebtedness for borrowed money above a to-be-negotiated threshold.
• While Issuers now routinely put anti-Cookson clauses in note agreements,
there is still considerable pushback from Issuers over what credit facilities
should be included as “Material Credit Facilities”.
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• Present day lien covenants typically follow the Model Form in restricting the
creation of liens on any property or assets of the Issuer and its subsidiaries – the
lien restriction typically is not limited to liens securing indebtedness for
borrowed money. While some present day note agreements permit additional
liens to be created outside the enumerated carveouts if the notes under the
note agreement are equally and ratably secured, the Model Form only permits
liens that are set forth in the enumerated carveouts.
• Since lien covenants in present day note agreements often are designed to
conform to the lien covenant in an Issuer’s bank credit agreement and since the
Model Form does not prescribe uniform standards for lien carveouts, there is
less uniformity than in the past on what constitutes a permitted carveout from
the lien covenant. Despite the lack of uniformity, various types of liens are
customarily permitted:
− liens securing indebtedness in existence at closing
− liens for taxes and assessment not yet due and payable
− liens of carriers, mechanics and materialmen incurred in the ordinary
course
− liens in respect of performance and appeal bonds
− liens in respect of workers’ compensation and unemployment insurance
− judgment liens that have been stayed
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−
−
−
−
−
liens for easements, leases and ordinary course real estate restrictions
intercompany liens
purchase money liens
pre-existing liens on acquired properties or businesses
renewals, extensions and refundings of existing liens, purchase money
liens and liens on acquired property if the principal amount of the
indebtedness secured is not increased
− a lien basket, tied to a financial test typically based on a percentage of
assets, net tangible assets, net worth or tangible net worth
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Annex 2
Domestic Model Form No. 2 Lien Covenant
The Company will not and will not permit any of its Subsidiaries to directly or indirectly
create, incur, assume or permit to exist (upon the happening of a contingency or
otherwise) any Lien on or with respect to any property or asset (including, without
limitation, any document or instrument in respect of goods or accounts receivable) of the
Company or any such Subsidiary, whether now owned or held or hereafter acquired, or any
income or profits therefrom, or assign or otherwise convey any right to receive income or
profits, except:
(a) – (__) [Insert any desired exceptions to the prohibition as negotiated
among the parties.]
(__) other Liens securing Indebtedness of the Company or any Subsidiary not
otherwise permitted by clauses (a) through (__), provided that Priority Debt shall not at
any time exceed [__]% of [________________] (determined as of the end of the then most
recently ended fiscal quarter), provided, further, that notwithstanding the foregoing, the
Company shall not, and shall not permit any of its Subsidiaries to, secure pursuant to this
Section 10.5(__) any Indebtedness outstanding under or pursuant to any Material Credit
Facility unless and until the Notes (and any guaranty delivered in connection therewith)
shall concurrently be secured equally and ratably with such
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Annex 2 (cont’d)
Indebtedness pursuant to documentation reasonably acceptable to the Required Holders
in substance and in form, including, without limitation, an intercreditor agreement and
opinions of counsel to the Company and/or any such Subsidiary, as the case may be, from
counsel that is reasonably acceptable to the Required Holders.
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The Past
• While many past note agreements contained absolute prohibitions on liens
other than enumerated liens, other note agreements allowed additional
indebtedness not prohibited by the debt incurrence test to be secured if
effective provision was made to secure the notes under the note agreement
equally and ratably with the indebtedness so secured. The 1980 Prudential
model form contained both variations of the lien covenant – the absolute
prohibition and a separate variation that allowed additional indebtedness to be
secured if the notes were equally secured. The Aetna model form provided only
for an absolute prohibition on liens other than enumerated liens.
• Unlike the anti-Cookson clause in present day note agreements, which prevents
the lien basket from being used to secure Material Credit Facilities, the older
equal and ratable alternative theoretically allowed all of the Issuer’s
indebtedness to be secured so long as the notes shared in the same security.
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• Another notable feature of older note agreements was the equitable lien
covenant. This covenant provided that if the Issuer created or assumed a lien in
violation of the lien covenant, it would cause the notes under the note
agreement to be secured equally and ratably with the indebtedness secured in
violation of the lien covenant. The lien so created in favor of the noteholders
was not intended to cure or excuse the default created by the prohibited lien,
but rather was designed to create an equitable lien in favor of the noteholders.
Both the Prudential and Aetna model forms had provisions that required the
Issuer to grant equal and ratable security to the noteholders if it violated the
lien covenant.
• Since note agreements of the past often used the model form note agreements
of the lead institutional investor (or of the law firm selected by the lead
institutional investor), there was more consistency in the lien covenants across
note agreements than there is today, where the tendency is to track the lien
covenant in the bank credit agreement. Investor model forms of the past
allowed typical lien carveouts (such as intercompany liens, liens for taxes not
yet due or being contested, mechanics and materialmens liens, liens for bid and
performance bonds, liens for easements and rights of way), but the model form
lien carveouts were sparser than what is typically seen in today’s deals.
Presumably additional lien carveouts were added in documentation through
negotiation by the parties. Purchase money indebtedness carveouts sometimes
were subject to their own basket, rather than being generally allowed without
limit, as they are today.