“Covenant-lite” loans. Loans without “maintenance” financial covenants (that is, those which are regularly tested or “maintained”) relating to the borrower’s leverage, cash flow and interest coverage. Such loans give debt-holders fewer early warning signs that a borrower is in trouble.

Toggle instruments. Instruments that allow borrowers to switch between paying interest and issuing further notes to capitalise interest, as their cash flow allows.

Fundable termsheets. Arrangements whereby the underwriters of acquisition debt agree to provide interim finance on the basis of terms set out in a mandate letter and accompanying termsheet (rather than fully developed loan documentation). The resultant contractual provisions and protections can be ambiguous.

Bridge and interim funding agreements. While debt was abundant at attractive rates, certain (and quick) funding via interim funding agreements was viewed as essential for a successful bid in a private equity auction. However, such funding can leave the parties exposed in the longer term due to a potential lack of certainty around the terms and availability of replacement financing.

Reverse flex and absence of upward flex rights. Reverse flex, giving borrowers the right to negotiate a reduction in the price of debt where syndication is oversubscribed, has characterised deals in recent times. Lenders have also agreed to forgo rights to raise the price of debt in the instance of troubled syndications.

Equity cure rights. Equity cures permit sponsors to inject additional equity to “cure” a financial covenant breach relating to a shortfall in cash flow or even EBITDA (earnings before interest, tax, depreciation and amortisation). Some recent deals put no limit on the number of times the cure can be used, or the frequency with which the cure rights are able to be employed.

“Mulligan” rights. The infamous Mulligan clause allows financial covenants to be breached without being treated as a default unless the same covenant is breached a second time.

“B” and “C” structures, with a resultant absence of amortisation or debt service covenants. Historically, the mainstay of leveraged finance debt structures, “A Notes” (the most senior tranche of debt which, traditionally, was repaid in stages during the life of the loan) fell out of favour with lenders and borrowers alike due to the overwhelming institutional demand for “B” and “C” (and even longer-dated) paper (typically, debt which was repayable in a “bullet” seven or more years after deal completion). An absence of “A” paper resulted in a lack of amortisation and a marked reluctance on the part of borrowers to accept any form of debt service coverage ratio (a financial covenant testing a borrower’s ability to meet ongoing interest and capital repayment costs).

Transferable annual baskets and permissions. Once driven purely by business need, borrowers began to demand an annual “permission” to make acquisitions, disposals and loans and to carry out other related activities within certain limits. To the extent that any year’s “permitted allowance” was unused for any reason, it could be rolled forward.

Very limited security. Funding was often provided solely on the basis of share security, in many cases granted on a strict cost/benefit analysis sometime following completion of the associated acquisition. Tangible asset security became ever rarer.

“Yank the bank” and “snooze you lose” provisions. “Yank the bank” clauses allow borrowers to remove a lender from a deal if it dissents on a decision that all or an agreed percentage of other lenders have approved. “Snooze you lose” clauses allow borrowers to deem consent as having been given if a lender fails to respond to a consent request within a specified period.

Unlimited flex rights. Underwriters may take the view that an unlimited flex, encompassing pricing, terms and structure, would be prudent to guard against (at least in part) market volatility and illiquidity.

Market and business material adverse change. The right to walk away from an underwriting commitment before closing, if there is a material adverse change (MAC) in the position of the borrower or, in the context of an acquisition financing, the target (a so-called “business MAC”) should be carefully considered in the context of any possible economic downturn. The right to walk away from an underwriting commitment as a result of problems in the syndication markets (a so-called “market MAC”) would also seem to be prudent in a volatile market, and is particularly relevant to guard against illiquidity.

Enhanced returns commensurate with risk. Will an absence of liquidity bring about the re-emergence of warrants to enhance lenders’ returns in line with additional risk?

Debt service reserve accounts. Long-established in project financing circles, debt service reserve accounts serve to protect lenders’ yield even in circumstances where a borrower encounters economic difficulties, since a certain amount of cash is ring-fenced within the borrower group and is applied in making interest and capital payments. Not often seen in the private equity-driven leveraged buyout market, such accounts are nonetheless sometimes found in leveraged corporate and leveraged infrastructure deals, and are worth considering on a deal-by-deal basis.