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The growth of the underwriting credit facility market has led many lenders to hold significant exposure to the same investors across their entire portfolio. Many lenders are required to track their overall overall exposure to these investors in addition to tracking overall exposure to sponsors. To mitigate this concentration risk, many lenders are considering adopting “cross exclusion events” across their portfolio of underwriting credit facilities. A cross exclusion event resembles a typical borrowing base exclusion event in a standard subscription credit facility, but the exclusion event is not specific to a “fund” or ” credit facility” (much like a cross default). Rather, this cross-exclusion approach addresses a concern that lenders are contractually obligated to lend against an investor’s capital commitment in Facility A even though they know that investor is subject to a failure event. exclusion in facility B.
Approaches we have seen proposed
We have seen two approaches to cross-exclusion events proposed:
(1) A “sponsor-specific” exclusion event. Under this approach, an investor or its affiliate would be excluded from Facility A’s borrowing base if it were subject to or experienced certain disqualifying events for that same sponsor in Facility B (assuming that the exclusion events at both facilities were substantially similar). For example, if the same manager sponsored two funds (Fund I in Facility A and Fund II in Facility B), any repeat investor who did not make a capital contribution to Fund I would be excluded from the base. borrowing from Fund II. This seems logical – if an investor fails to fund their capital commitment for a previous generation of the same sponsor, lenders should have the right to stop lending against that investor’s capital commitment in other facilities. Note that the foreclosure event would occur under Fund II in Facility B even though the lender did not advance or participate in the underwriting credit facility in Fund I and the sponsor would be obligated to disclose the event of exclusion. ‘exclusion.
(2) A “portfolio-wide” exclusion event. Under this approach, an investor or its affiliate would be excluded from a borrowing base if it were subject to certain disqualifying events (largely mirroring the exclusion events negotiated in the credit facility in question) throughout the lender’s portfolio (Facilities A and B) . For example, suppose (i) an investor invests in two funds, one sponsored by manager Y and the other sponsored by manager Z, which had underwriting credit facilities with the same lender (facility A and facility B) and (ii) that the investor defaults on its obligation to make capital contributions to the fund sponsored by manager Y in facility A. A “portfolio-wide” foreclosure event would allow the lender to exclude the investor from the borrowing base of the fund sponsored by manager Z in facility B.
The approach likely to be widely adopted
From an underwriting perspective, the best-case scenario would be to adopt both sponsor-specific and portfolio-wide exclusion events. However, in our experience, sponsors are likely to resist portfolio-wide disqualification events by asserting that the investor’s relationship with another sponsor should not impact their base. loan with the lender. While this position is understandable from an equity perspective, it undermines a key tenant of subscription credit facilities, which is that funding of capital commitments is not optional and must be funded by investors without compensation. , counterclaim or defence. That said, there could be situations where, without insider knowledge, the relevant fund would not be able to understand or know whether the exclusion event was, in fact, appropriate (for example, the other fund incorrectly classified the investor as a defaulting investor under the applicable limited partnership agreement). Portfolio-wide exclusion events also raise confidentiality issues (for example, do disclosure restrictions prevent the lender from applying its knowledge of a defaulting investor to other funds?) and, if desired, should be excluded from the standard confidentiality provisions currently in force in the agreements. For these reasons, we believe that portfolio-wide exclusion events are unlikely to see widespread adoption. However, we expect sponsor-specific exclusion events to sufficiently address currently under-mitigated risk and that lenders may begin to implement cross-exclusion events across their portfolio.
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This article by Mayer Brown provides information and commentary on interesting legal issues and developments. The foregoing is not a complete treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action regarding the matters discussed here.
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