In NAV credit facilities, the mandatory prepayment section will often include a requirement for the borrower to repay a certain percentage of the loan obligations on a periodic or ongoing basis. The amount of loan obligations required to paid on the relevant payment dates are tied to a proportion of the distributions and sale proceeds received by the borrower from its portfolio investments prior to such prepayment or during the prior cash sweep period. The proportion required to be paid may in turn be affected by (i) when the actual payment date occurs relative to the duration of the credit facility, (ii) the loan-to-value (LTV) ratio at such time and (iii) whether there are any cash control events or similar credit events that are then continuing. The main terms of the cash sweep are typically negotiated upfront at the term sheet stage and are tailored to the credit profile of the borrower and the anticipated liquidity of its portfolio investments comprising the collateral portfolio. This article highlights some of the key features to consider when documenting the cash sweep requirements in the credit agreement.
I. Timing Requirements – Ongoing or Scheduled Prepayments
A common approach is to require a cash sweep prepayment within a certain amount of time (e.g., five business days) following the borrower’s receipt of any distributions in respect of its portfolio investments. Alternatively, such prepayment may be scheduled on a more periodic basis (e.g., quarterly) to provide for a fixed amortization and repayment of the loans based on the amount of distributions received by the borrower during the prior (quarterly) cash sweep period.
If the borrower’s portfolio investments are regularly paying distributions at the time the facility is entered into or the borrower does have other immediate or operational needs for such distributions or proceeds, lenders may want the quarterly cash sweep payment date to commence as early as the end of the first calendar quarter following the closing date. It is also common to delay the initial payment date (e.g., by 12 months or more) and provide a ‘cash sweep holiday’ period for the borrower. A ramp up period before the initial cash sweep payment date may be considered if the borrower’s portfolio investments are not yet paying regular distributions, or in order to provide more flexibility and timing for to the borrower’s investments that were either recently acquired or will be purchased with the proceeds of the initial loan (e.g., in an acquisition financing transaction).
II. Calculating the Cash Sweep Amount
To calculate the required prepayment amount, the common approach is to tie the amount of the prepayment to (i) the amount of the “net distributions” received by the borrower (during the prior cash sweep period, when such payment dates are fixed) multiplied by (ii) the applicable cash sweep prepayment percentage.
A. Net Distributions
Net distributions are typically defined as the gross distributions, dividends and sale proceeds actually received by the borrower (directly or indirectly through any subsidiaries) from the issuers of the portfolio investments, reduced for certain pre-agreed deductions, which may include:
(a) operating expenses of the borrower,
(b) taxes attributable to the ownership of such portfolio investments,
(c) amounts necessary to satisfy capital contribution obligations to such portfolio investments, and/or
(d) payments in respect of investment management or advisory fees, in each case, subject to agreed conditions and limits.
With respect to the other permitted payments noted above, commonly negotiated points include imposing percentage thresholds or hard caps on the amount of such deductions on an individual, aggregate or annual basis and limiting certain deductions during default events. Such limits often seek to balance the desire for repayment of the loans against the need to continue operations of the borrower and preserve the value of the investments.
B. Prepayment Percentage
Lenders will want prepayment percentages that increase over time to ensure timely repayment of the outstanding loan obligations. The amount of the prepayment percentage is generally tied to:
(a) the actual date of the prepayment relative to the duration of the credit facility (i.e., a percentage that steps up as the facility matures, often up to 100% in the final year or months leading up to the maturity date); and/or
(b) the LTV ratio in effect at the time of the prepayment (i.e., a percentage that decreases as the facility matures, often down to 0% in the final year or months leading up to the maturity date).
Lenders should also consider documenting other events that impact the relevant prepayment percentage to similarly ensure sufficient proceeds are being applied to repay the loan, such as number of ‘eligible’ portfolio investments owned by the borrower at such time (i.e., a minimum asset hold requirement). Relatedly, if there is a cash control event or event of default at the time of the prepayment, a 100% prepayment percentage will often apply.
Other Effects on the Facility
The failure by the borrower to pay the required amounts in full on a payment date could trigger an event of default, subject to any negotiated cure periods. Such prepayment requirements can also provide structural safeguards for lenders if the borrower wants to take other actions under the facility but simultaneously has a cash sweep amount that is then due and payable. For example, until the required prepayment is made, it is common to include restrictions of the ability of the borrower to draw on the facility, make withdrawals of cash from its collateral account, or make distributions or other payments to its investors and managing entities. Cash sweeps are an important feature of asset-based credit facilities and as always we are here to help you properly implement such requirements in your legal documentation.