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Covenants Transactions With Affiliates Negative Pledge. Outline

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IV. Covenants
D. Transactions with Affiliates
Petrohawk Indenture, Section 4.8
Northwest Note Agreement, Section 10.7, 10.8
Newpage Credit Agreement, Section 6.12
Problem Set #12
Assume that XYZ owns 100% of the stock of Company and 100% of the stock of ABC. Can Company enter into the following transactions (and if yes, subject to what conditions, if any)? (Answer each question with respect to the companies indicated.)

1. Beta leases office space from Alpha. The lease payments are $1 million a year. Alpha and Beta are both wholly-owned subsidiaries of the company. Beta is a Restricted Subsidiary. Compare the conditions with which this transaction must comply with (under this or any other covenant) if
(i) Alpha is and remains an Unrestricted Subsidiary and
(ii) Alpha is an Unrestricted Subsidiary, is redesignated Restricted immediately prior to the transaction, and is redesignated
Unrestricted immediately after the transaction. [Petrohawk,
Northwest]

Kahan: Petrohawk 4.8(b)(2) exempts transactions among Restricted Subs. If Alpa is unrestricted, the lease must comply with 4.8 as a transaction between Beta (a Restricted Sub)
and Alpha (an Affiliate). If Alpah is restricted, the lease is not subject to 4.8. Instead, when
Alpha is designated unrestricted after the lease, the conditions in the definition of Unrestricted
Sub apply.


Affiliated Transactions Covenant
Concern: removal of value to parent or sister entity through transactions at disadvantageous terms
Structure

Definition of covered transactions

Conditions: Substantive + Procedural

Special Rules

Petrohawk 4.8

"Affiliate" of any specified Person means any other Person that is controlled or controlled by such specified Person

(a)(1) substantive restriction
 Company will not transfer to any of its Restricted Subs
 Cannot be unfair to the company or the RS, though can be unfair to affiliate

(a)(2) operative restriction:
 If more than 10M  need disinterested board of director's approval
 More than 24M  need written opinion from Investment Bank

Conditions of making transfers "Unless…"
1 IV. Covenants

o

(b) special rules that followings are not subjected to the restriction
 (2) transactions between or among the Company and/or its RS
 Cover transaction between and among: RS of co. and another co. in the family

Between = co. and RS
o Among = RS and RS
o CS
 C
 RS
 RS
 C
 S
affiliates  S
 (3) RP that, in each case, are permitted by s4.4
 Already have a test that works well
 (4) ordinary course of business
 (7) in the case of any contract, agreement or understanding (or amendment thereto) entered into with one or more…

Here: transaction between un-RS and a RS
o Un-RS is an affiliate  requirements: 4.8(a)
 (1) fair to the RS; AND
 (2) if series of transaction involve aggregate consideration in excess of $10M
 Threshold of $10M? de minimis threshold

Don't want impose burden on disinterested directors to vote on every transaction

Rules of aggregation: cannot split up related transaction to avoid the threshold o

Can Co. funnel $ to temp. un-RS?
 Alpha changed to un-RS to RS  B enter into transaction with A  both RS
 fall under exception (b)(2) "Transactions between or among the Company and/or its RS"  after transaction  change A back to un-RS?
 Conditions of changing RS to un-RS
 "Unrestricted Subsidiary" means any Subsidiary of the
Company that is designated by the Board of Directors as an Unrestricted Subsidiary pursuant to a Board
Resolution, but only to the extent that such Subsidiary

(1) has no Indebtedness other than NonRecourse Debt;
 co. is not going to be liable to the debt of that sub

(2) not party to any agreement, contract,
arrangement or understanding with the Co/ any
RS of the Co. unless the terms of any such agreement, contract, arrangement or understanding are no less favorable to the
Company or such Restricted Subsidiary than 2 IV. Covenants

those that might be obtained at the time from
Persons who are not Affiliates of the Company;
 similar language as (a)(1), but not the same
 Missed "arms-length dealing"
 Prof: should track exactly of (a)(1)
 Conditions: (a)(1) has to be satisfied

(3) is a Person with respect to which neither the
Company nor any of its Restricted Subsidiaries has any obligation
 (a) to subscribe for additional Equity
Interests or
 (b) to maintain or preserve such Person's financial condition or to cause such
Person to achieve any specified levels of operating results; and

(4) has not Guaranteed or otherwise directly or indirectly provided credit support for any
Indebtedness of the Company or any of its
Restricted Subsidiaries.
 Conditions that are designed to ensure Co. and RS
won't be liable to the un-RS
 Incorporates Requirement of fairness
The Board of Directors may designate any Restricted
Subsidiary to be an Unrestricted Subsidiary if that designation is in compliance with the next succeeding sentence and would not otherwise cause a Default.
o If RS is designated as un-RS  such designation shall be deemed an Investment in the sub

Effects of not satisfying the condition is not a violation of covenant  co. "may"  not big deal for the co., only invalid and no breach so designated and all outstanding Investments owned by the Co. and its RS in the Sub so designated, shall be valued at their Fair Market Value at the time of such designation for purposes of determining compliance with Section 4.4 hereof, if there is any money in the
RS…"

Conditions of changing from un-RS to RS requirements:
 The Board of Directors of the Company may at any time designate any Unrestricted Subsidiary to be a
Restricted Subsidiary; provided that such designation shall be deemed to be an incurrence of Indebtedness by a Restricted Subsidiary of the Company of any outstanding Indebtedness of such un-RS and such designation shall only be permitted if (I) such
Indebtedness is permitted under Section 4.3 hereof,
3 IV. Covenants

calculated on a pro forma basis as if such designation had occurred at the beginning of the four-quarter reference period; and (2) no Default or Event of Default would be in existence following such designation
Condition: designation shall be deemed to be an incurrence of
Indebtedness by a RS of the Co. of any outstanding Indebtedness of the un-RS
Prof: don't like that this is in the definition  should only be definition, not covenant

o

Normally need to comply with (1) + (2)

o

If it is a transaction with un-RS, that temp designated as RS and re-designated as unRS?
 Then company can evade (2) procedural requirements
 but cannot evade (1)  incorporated into restrictions of making a sub un-RS
 also additional conditions (1)(3)(4) + restrictions under 4.4 [didn't need to comply under 4.8]
 With these different restrictions  co. may prefer one restriction over another  can chose to evade (2) and subject itself to different regulatory restrictions
 Arbitrage

2. What are the substantive requirements regarding any contract,
agreement or understanding with an Affiliate of a type with respect to which investment banks do not render fairness opinions? How do conditions change? Why?
- Northwest

10.7 Transaction with Affiliate
 Tougher than Petrohawk: other than fairness test, it also has to be "in the ordinary course and pursuant to reasonable requirement of the company"
 Only one exception: "10.7 not apply to the exercise by Co. of its options to purchase the land and manufacturing facility…"
 No procedural requirement, e.g. Investment Bank fairness opinion
 Not difficult to do so, hires and pays by the company, the investment bank would want to please the co.
 Since it is private placement  bondholders may be more knowledgeable
 C.f. Petrohawk's bondholder have less understanding and info of the company  outside opinion may offer more protection to them

10.8 Co. may designate any RS as un-RS
 Conditions: "The Company may designate any RS as an
Unrestricted subsidiary unless such Subsidiary has been designated an un-RS more than once previously or has previously been designated a Restricted Subsidiary and only if immediately before and after designation there exists no
Default or Event of Default"
4

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