How Travelport's Creditors Got "J. Screwed"
Corporate borrowers have a lot of leverage over their creditors these days. This is how Travelport bested its creditors.
Over 90% of leveraged loan contracts issued in the US are lite on covenants (a.k.a. "cov lite"), according to S&P Global Market Intelligence. These debt contracts offer very little protection (covenants) for creditors like banks lending money.
Weakening covenants in debt contracts have given rise to so-called “liability management transactions.” Companies use these transactions to manage their liabilities (debts). Often, liability management transactions involve increasing overall debt while shifting around lender priority in the event of default. Some creditors would get to jump to the front of the line if their borrower defaults. In modern debt agreements, these transactions can happen without unanimous (or sometimes any) consent of affected lenders.
Through these liability management transactions, companies like Travelport increase their ability to raise debt in new and creative ways.
Debt baskets let borrowers take on more debt, but for new lenders, that's not enough
Historically, borrowers could take advantage of debt baskets that have become more permissive in cov lit loans. These debt baskets set aside pre-approved allocations for future debt. Borrowers do not need to ask existing lenders for permission to raise additional debt as long as it's below the limit of the basket.
For example, a company with a debt basket of $500 million could raise that amount of new debt without asking its existing creditors for permission. Any more, and existing lenders need to sign off on the new loan.
However, lenders want collateral. Even though debt baskets allow firms to raise new debt, lenders might not lend to a company unless they have access to collateral. This is especially true for heavily indebted borrowers.
It’s one thing to be allowed to borrow. It’s another thing to find a willing lender when you are already deep in the hole.
Many firms that don’t produce enough income to service their existing debt don't have lots of assets that they can use as collateral to raise cash – not unless they engage in distressed liability management transactions to make room for new debt.
In one kind of liability management transaction, “dropdown” financing, companies move collateral around their corporate structure (e.g., moving ownership of assets to a foreign subsidiary). This movement frees that collateral from their liens.
Borrower-friendly language in credit agreements often allows this.
When there are no liens against an asset, a company can take out a fresh loan against that asset. Travelport and J. Crew made these kinds of moves.
Travelport's creditors got J. Screwed
A quintessential example of dropdown financing is the case of J. Crew, which underwent restructuring in 2017. When it needed cash, J. Crew “J. Screwed” its creditors by transferring intellectual property (IP) to a subsidiary that wasn't bound by the company's credit agreements. The subsidiary could use those IP assets as collateral for raising new debt. J. Crew did so without its creditors agreeing to it. The weak protections in their existing loan documents allowed the transactions.
After the very-well publicized J. Crew dropdown, creditors began demanding for “J. Crew Blocker” language in credit agreements. But the protections provided by these blockers was thin.
Early in the pandemic, Travelport, a UK-based travel marketplace owned by Siris Capital and the PE arm of Elliott Management, needed cash.
One problem. Travelport was already heavily indebted. With distress coming only a year after Travelport's leveraged buyout, creditors didn't feel safe lending to Travelport again.
Worse yet, Travelport's debt contracts contained a J. Crew Blocker. However, not all of Travelport’s assets were covered by the J. Crew Blocker. Travelport was able to transfer some of its intellectual property, not covered by the blocker, to subsidiaries.
Moving assets to an unrestricted subsidiary meant that Travelport did not need to pass creditors' financial tests to raise new debt. That was good for Travelport since they would have failed the tests. While the details of a subsequent $500 million loan were not made public, lawyers at Davis Polk propose that it is most likely that Travelport was able to use the assets sequestered in that unrestricted subsidiary as collateral to raise the additional debt.
This dropdown transaction at Travelport allowed the distressed firm to raise new debt that was effectively senior to its existing loans. New creditors would get to skip ahead of existing creditors if Travelport defaulted on its debt.
Optimistically, the tactic brought liquidity to a firm that was strapped for cash. Pessimistically, it prolonged the distress of a firm needing restructuring and hurt creditors in the process.
You can read more on this case and broader topics related to corporate distress in a white paper I published titled, "How Do Zombies Stay Alive?"
