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Covenants – Debt Restrictions Outline

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IV. Covenants - F. Debt Restrictions
F. Debt Restrictions
Petrohawk Indenture, Section 4.3
Freeport-McMoran Indenture, Section 4.03
Northwest Note Agreement, Section 10.1
Newpage Credit Agreement, Section 6.8, 6.1
Wilmington Trust Co. v. Aames Financial Corp., 764 N.Y.S.2d 3 (P. #1)
- Debt covenant: Ratio Test, Structural Issues, Problem Area: Consolidated Net Income,
Problem Area: Conversions, Ames Financial and WALM
- Maintenance Covenants: Newpage and Northwest
- Asset Sale Covenant: structure an purpose, thresholds
Debt Covenant Overview

• Purpose and Structure
- Public Debt: Incurrence Covenant
- Structure:

• Defined term: Indebtedness

• Ratio Test (Coverage Ratio)

• Baskets: Incurrence of debt in baskets is permitted even if ratio test not satisfied
- Bank Debt, Private Placements: Maintenance

• Ratio Test has to be satisfied always (or quarterly)

• Baskets make no sense (and are not present)

• Maintenance versus Incurrence versions

• Definition of Indebtedness
- What is generally included: Financial debt
- What is generally excluded: Operational debt

• E.g.: PH (1)(c) exclusion
- Special rules for:

• Disqualified Stock

• Guarantees

• Liens securing debt of others

• Problem Area: Refinancing
- Special Basket, e.g., PH 4.03(b)(5)
- Rationale: no worse off
- Conditions - PH

• Must refinance specific debt

• Why not clause (6), (10), (12)?

• Principal amount

• Final Maturity: why care?

• Weighted Average Life to Maturity: why care

• Seniority (clauses 4 -6)

• Problem Areas: Emptying Baskets, Intra-Company Debt, Ratio Test, Consolidated Net
Income, Conversions

1 IV. Covenants - F. Debt Restrictions
Petrohawk 4.03 Incurrence of Indebtedness
- (a) Ratio Debt:
o Ratio test applies only to company and Guarantor (rationale: structural seniority)
o Can only incur debt only if Fixed Charge Coverage Ratio > 2.25:1
 Fixed Charge Coverage Ratio: earnings to interest payment ratio
 Company is earning at least 2.25 of interest payment  then can incur additional $1 debt (also determines whether co. can do other things, e.g.
make restrictive payment, merge)
 Incurrence covenant "create, incur, issue, assume, guarantee or otherwise become directly or indirectly liable"
o Easier to have maintenance covenant "Certain debt/equity ratio, ratio of fixed charges has to be complied with every quarter"  would not need any basket debts
- (b) Basket Debt:
o Debt can incur even if not complied with the ratio debt  would affect fixed charge coverage ratio

Ratio Debt is always better than Basket Debt (which reduce your ability to incur other debts)
- (c) If you have item of debt that can fall under different categories  where to put it?
- Fixed Charge Coverage Ratio's definition incorporated many other accounting elements
- Definition of indebtedness

Includes, e.g.
 money borrowed and Indebtedness evidenced by notes, debentures, bonds or other similar instruments for the payment
 reimbursement obligations under letters of credits
 all liabilities of guarantee
 indebtedness secured by a lien
 Disqualified Stock

Excluding operational liabilities, e.g. to suppliers for goods, tax authority for taxes
 This gives co. control over compliance  only when operation debt incurred to an extend that the company need more money  would be counted as indebtedness
Refinancing Indebtedness [Petrohawk 4.3(5)]
- "the incurrence by the Company or any of its Restricted Subsidiaries of
Permitted Refinancing Indebtedness in exchange for, or the Net Cash
Proceeds of which are used to refund, refinance or replace,
Indebtedness (other than intercompany Indebtedness) that was permitted by this Indenture to be incurred under paragraph (a) of this Section 4.3 covenant or clause (2), (3), (4) or (13) or this clause (5) of this paragraph
o Requires proximity in time or more?3 Conditions of the refinancing Indebtedness:
[New debt (refinancing debt) from perceptive of bondholder, cannot be worse than old debt]
(1) fall under definition of "Permitted Refinancing Indebtedness"

2 IV. Covenants - F. Debt Restrictions


means "any Indebtedness of the Company or any of its Restricted
Subsidiaries issued in exchange for, or the Net Cash Proceeds of which are used to extend, refinance, renew, replace, defease or refund other Indebtedness of the Company or any of its Restricted
Subsidiaries (other than intercompany Indebtedness); provided that:
 "used to extend, refinance, renew, replace, defease or refund"
 Unclear when and whether an amendment is a refinancing:
 If amendment is not refinancing  can evade (2) and (3)'s restrictions
 e.g. does reducing the maturity of existing debt or interest rate or creating different terms amount to refinancing?


(1) principal amount doesn't exceed the premium of the indebtedness that has been refinanced


(2) Maturity date
 "(a) if the final maturity date of the Indebtedness being refinanced is earlier than the final maturity date of the
Securities, the Permitted Refinancing Indebtedness has a final maturity date no earlier than the final maturity date of the Indebtedness being extended, or
 Old debt refinanced cannot mature after the new debt
 Addresses the time dimensional priority: debt that matures earlier may get paid earlier, unless insolence between that debt payment and maturity of your debt (earlier debt would get de facto priority)
 Bondholders would only care people ahead of them, and how far they are ahead of you (in event of bankruptcy) - if behind you, do not care how far they are behind you
 (b) if the final maturity date of the Indebtedness being refinanced is later than the final maturity date of the
Securities, the Permitted Refinancing Indebtedness has a final maturity at least 91 days later than the final maturity date of the Securities"
 Maturity date of the new debt must be at least 91 days after old debt's maturity date (as bankruptcy law may recoup payments within 90 days)
 Maturity doesn't affect payment, but if debt matures and paid prior to bankruptcy  90 days where company can be recuperated  after 90 days, debt being paid is paid in full, and you would not be paid in full
 If old debt is behind you  new debt should also be behind you
 If old debt is ahead of you  new debt cannot be more ahead of you
 So the new debt has to have the same or less priority
 Creditor don't want other creditors to pay ahead of you, e.g. in liquidation, and temporarily prior to liquidation

3 IV. Covenants - F. Debt Restrictions


(3) new debt has a Weighted Average Life to Maturity equal or greater than the old debt
 New debt's Weighted Average Maturity date is not earlier than the old debt
 Weighted Average Life to Maturity means
 Sum of (a) mount of each then remaining installments… or other required payment or principal, including payment at final maturity,
by (b) no. of years that will elapse between such date and the making of such payment, multiply by (2) outstanding principal amount of such indebtedness
 I.e. If debt doesn't have 1 maturity date, but different portion matures in different time
 E.g. 75% mature in 2020 and 25% matures in 2024  (2020 x 3) +
2020 x 1)/ 4
 If co. wants to get around (2) and (3), want new debt to have earlier maturity than the old debt, co. can:
 Avoid (2) by saying most debt comes due earlier, and little have final maturity date later on
 Avoid (3) weighted average life to maturity: can still pay 95%in 2020 and put a small amount in a completely distance year later (e.g. 100 years later), redeemable on option of company
 Weighted average life to maturity should also take account of asymmetry (as in (2)): should only apply to payments that come ahead of you - care about payment ahead of you and how far it is ahead; and not payment behind you
 Pro-company loophole that co. can exploit when applying it to transaction
 Prof: but if term is so excessive that makes it too obvious, court may get annoyed, but if co. stays within conventional maturity up to 30 years, may seem conventional and allowed
 Maintenance covenant 10.1 (a) "Consolidated Indebtedness cannot exceed 58% of Consolidated total capitalisation at any time." If amount doesn't increase in refinancing  no change
 Incurrence covenant: les straight and more complicated, e.g. cannot incur any additional debt, but not in violation of the covenant because they haven't incur anything  need to specify what counts as incurrence, can do even not complied with ratio test, but no equivalent concept in maintenance covenant


(4) if old debt is subordinated, new debt must also be subordinated
 New debt cannot have a higher ranking than the old debt
 Cannot refinance subordinated debt with unsubordinated debt


(5) if co. is obligator under the old debt, the new debt shouldn't be subsidiary debt
(structural subordination)


(6) if old debt is no recourse debt, new debt must be too


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