Incurrence vs. Maintenance
High yield covenants in indentures constitute incurrence tests (i.e., covenants are only tested
when an issuer or restricted subsidiary wants to take an affirmative action, such as incur debt,
pay a dividend or grant a lien), rather than maintenance tests. In term loan B financings, bond-
style incurrence tests are typical as well. However, revolver financings and term loan A
financings will also include maintenance financial covenants, which are tested at the end of each
fiscal quarter and require the borrow to meet certain leverage ratios, interest coverage ratios,
etc. Those financial covenants may be fixed at a set ratio for the life of the deal, or may have step
downs requiring de-leveraging (or step ups, depending on the financial covenant). Note that
where a revolver/term loan A (often referred to as “pro rata” facilities) and a term loan B are
contained in the same credit agreement (and where, as is typical, the term loan B does not get
the benefit of any financial maintenance covenant), only the pro rata lenders should have a vote
to amend or waive the maintenance financial covenant, and pro rata lenders should have the
right to accelerate their loans upon an event of default as a result of breach of the financial
covenant (with a resulting default in the term loan B if accelerated).
Ability to Amend and Covenant Flexibility
Traditionally, one of the main differences between high yield indentures and credit agreements
was that high yield covenants were typically more flexible than credit agreement covenants,
based on the notion that high yield covenants were “made to last” over the entire term of the
notes, because, among other issues, amending an indenture is a complex process requiring a
formal consent solicitation process. Credit agreements, in contrast, traditionally had a more
borrower-friendly amendment process, as well as an active administrative agent that can lead
the consent process. As a result, credit agreements often had more restrictive covenants than
indentures on the theory that the borrower could seek to amend the credit agreement if it
wanted to consummate a transaction outside of the ordinary course of business.
However, a shift in the institutions that provide credit agreement loans has changed that
calculus. Whereas in the past loans were provided by traditional relationship banks, term loan B
lenders are now more typically institutions that approach amendments in the same way as
investors that invest in high yield loans. As such, those lenders are both more likely to seek fees
or increased pricing for consenting to amendments and more accustomed to flexible covenants.
Therefore, credit agreement covenants for term loan Bs (or credit agreements that include term
loan Bs) have evolved to more closely mirror the covenant flexibility in high yield indentures.
Intercreditor Arrangements
Bank loans (outside of the investment grade context) are typically secured financings, while high
yield debt securities tend to be unsecured. However, companies on occasion tap the market for
secured high-yield bonds. When a company incurs both secured bank debt and secured high
yield notes, the administrative agent for the lenders and the trustee for the noteholders enter
into an intercreditor agreement, which governs the lien priority and rights in respect of the
collateral of the two classes of creditors.
In a first lien/second lien structure where the lenders have a first-priority interest in the
collateral and the noteholders have a second-priority interest in the collateral, the intercreditor
agreement will provide that the administrative agent, as agent for the first lien creditors,
controls all matters with respect to enforcement against the collateral. Under such an