A unitranche loan is a term loan that combines both senior and junior components in a single credit facility. Unitranche loans are typically made by a small syndicate of lenders and are documented in a single set of loan documents. Pursuant to these documents, the borrower agrees to pay a blended interest rate on the entire principal amount of the unitranche loan and grants a single lien in favor of the administrative or collateral agent to secure the payment and performance of the entire unitranche loan.

Unitranche loans are divided into senior (“first-out”) and junior (“last-out”) components pursuant to a separate agreement among lenders (the “AAL”) to which the agent and the lenders, but typically not the borrower, are parties. The AAL is essentially the intercreditor agreement for a unitranche. Through elaborate, and often extensive and complicated, waterfall provisions, the AAL provides for a payment priority in favor of the first-out lenders. The AAL also reallocates interest payments so that the first-out lenders receive a lower interest rate and the last-out lenders a higher rate. In addition, AALs contain provisions dealing with voting rights, enforcement rights, assignments, buyout rights, and bankruptcy.

Unitranches are popular financing devices for middle-market borrowers. Since unitranches involve a single streamlined set of loan documents, a single set of financial and other covenants, a blended interest rate, and little syndication risk, borrowers value these facilities for their efficiency, speed and ease of execution.

An asset-based lender is a logical participant in the “first-out” component of a unitranche. Before entering into a unitranche, however, an asset-based lender should be aware of certain unique issues that these loans pose for first-out lenders. Following is a brief discussion of a few of these issues.

Voting Rights

Under the unitranche loan agreement, most amendments, consents and waivers require the consent of a simple majority of the unitranche lenders. AALs, however, frequently contain provisions that alter this requirement. For example, AALs traditionally have provided that the unitranche loan agreement’s majority lender consent requires an affirmative vote of a majority of both the first-out lenders and the last-out lenders – sometimes with a minimum number of required lenders within each tranche. Given the divergent approaches of first-out lenders, who view unitranches from the standpoint of fully secured creditors, and last-out lenders, who understand that they are likely undersecured, this kind of voting arrangement frequently leads to deadlock.

Some first-out lenders and last-out lenders have grown dissatisfied with this voting convention under the AAL and have negotiated different voting arrangements. It is increasingly common, for instance, to see a provision in the AAL that allows a vote of a majority of both the first-out and last-out lenders only when an event occurs that adversely impacts the tranche that would otherwise be in the minority. An example of this would be a provision that requires a vote of both the first-out and last–out lenders in a situation where the first-out lenders hold only a minority of the overall unitranche loan but an event occurs that has special significance for the first-out lender (such as a breach of the ratio of first-out loans to EBITDA of the borrower). It is also becoming common for one tranche to have the right to drag along the other tranche with respect to voting on particular issues.

Enforcement Rights

An asset-based lender, in its role as a senior-secured creditor, normally expects to be the creditor that “drives the bus” when it comes to the enforcement of creditor remedies. In first-lien/second lien financings in which the asset-based lender is the first-lien lender and in senior/mezzanine loans in which the asset-based lender is the senior lender, this is in fact the result. Pursuant to the intercreditor or subordination agreement for these financings, upon the occurrence of an event of default under the loan and security agreement between the asset-based lender and the borrower, the asset-based lender ordinarily has the right, without delay or any required advance consent of the second-lien lender or subordinated lender, to foreclose on its senior lien on the collateral and/or commence litigation or other remedies to collect its loans. But in unitranche loans, the asset-based lender does not have these same unfettered enforcement rights.

As suggested in the discussion above regarding voting rights, under the voting provisions of the unitranche loan agreement and the AAL, first-out lenders in unitranche loans could be hindered in a variety of ways when seeking the right to demand the exercise of enforcement remedies following a default under the unitranche loan agreement. The first-lien lenders may be entirely shut of the voting on the issue of enforcement if these lenders hold only a minority portion of the unitranche loan and the AAL does not alter the majority voting requirement of the unitranche loan agreement by requiring the vote of a majority of both the first-out and last-out tranches. And even if the AAL requires voting by a majority of both the first-and last-out tranches, the first-out lenders could be blocked in their desire to enforce remedies by a contrary vote of the last-out lenders.

Fortunately, most AALs contain remedies provisions that resolve these voting issues somewhat favorably for first-lien lenders. Through the use of a remedies enforcement standstill, the AAL grants first-out lenders the right to enforce their default remedies after the passage of (typically) a 30-day standstill period, well before the typical 90-days standstill period that applies to the last-out loans. It should be noted, however, that even the relatively short 30-day standstill provision applicable to the first-out loans presents an enforcement delay for asset-based lenders that they would not face under an intercreditor agreement for a first-lien loan or a subordination agreement for a senior-mezzanine loan, neither of which normally contains a standstill period applicable to the senior-secured loans.

Complexity of Agreement Among Lenders

Intercreditor agreements used in first-lien/second-lien financings and subordination agreements used in senior-mezzanine loans are typically lengthy, complicated, and, absent mutually acceptable precedent documents between the lenders, highly negotiated. Incredibly, the AAL is even longer, more complicated, and, given the emerging nature of the unitranche product and the resulting lack of widespread precedent, frequently more heavily negotiated than intercreditor agreements and subordination agreements. Prior to the occurrence of any default under the unitranche loan agreement, the first-out and last-out lenders enjoy equal rights to receive payments on the unitranche loan. However, following the occurrence of various “waterfall events,” the first-out lenders are paid before the last-out lenders under very elaborate waterfall provisions that frequently have many levels and span several pages of the AAL. Additionally, some AALs feature different waterfall triggering events that have different payment consequences. An asset-based lender that is new to the unitranche loan market may find the AAL to be a daunting document.

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