Cooperation agreements are increasingly becoming a valuable tool for distressed debtholders who wish to negotiate from a unified and strengthened position. These agreements can also assist in protecting debtholders from liability management exercises (LMEs), a strategy that has gained traction among financially stressed private equity-sponsored companies.
LMEs allow borrowers to gain additional liquidity by restructuring their funded debt, often at the expense of a subset of their existing debtholders. The use of LMEs has grown significantly, notably among private equity-sponsored portfolio companies experiencing financial stress. In such circumstances, a private equity sponsor may collaborate with a subset of debtholders, and usually a group of new lenders, to restructure the balance sheet, often to the detriment of non-participating debtholders.
Sidelining non-participating debtholders in these transactions is commonly referred to as “creditor-on-creditor violence”. In response, lenders are increasingly adopting cooperation agreements to eliminate or reduce the risk of being targeted by LMEs. In these agreements, lenders agree to negotiate with the borrower collectively, preventing side deals and encouraging a unified front.
Key stipulations in cooperation agreements include prohibiting lenders from acting inconsistently with the agreement or communicating separately with the borrower. These agreements often modify voting provisions, binding all lenders to decisions approved by a supermajority, and may even alter existing voting rights under the debt instrument.
Transferring underlying debt while under a cooperation agreement is restricted unless the transferee joins or is already a part of the agreement. Remedies for breaches are usually limited to specific performance and injunctive relief, with monetary damages often excluded, raising questions about enforcement across various jurisdictions.
Interestingly, borrowers are typically not direct parties to these agreements, contrasting with the more borrower-inclusive restructuring or plan support agreements common in bankruptcy negotiations. Cooperation agreements aim to establish rules for the lenders’ ongoing interactions with the borrower early in the distress cycle, which could be before any specific workout discussions are underway.
While cooperation agreements may be less effective in blocking pre-approved LMEs under existing credit agreement terms, they could be instrumental in preventing “uptiering” LMEs. By uniting debtholders, these agreements can prevent borrowers from exploiting divisions among lenders, presenting a formidable front and potentially leading to better recovery outcomes for all involved.
For more insights on this developing strategy, you can read the complete article by Jonathan W. Young and Jason Ulezalka here.