Why are certain funds provisions needed?
Generally, in acquisition loan agreements (and loan agreements more generally for that matter) there are a number of conditions precedent that need to be fulfilled before lenders are obliged to disburse funds. These conditions precedent will include the requirement that no event of default or potential event of default subsists. The events of default under a loan agreement often include circumstances or events that are outside the borrower’s control. An example (which is almost always included as an event of default) is the occurrence of an event or circumstance that will have a material adverse effect on the borrower’s (or other group member’s) or target’s assets, business, operations, property or condition (financial or otherwise). This event of default is commonly described as a ‘business MAC’. An event that triggers a 'business MAC' could be as general as a change in law or the introduction of a new government requirement, or as specific as the termination of a material contract. Any of these triggers could be applicable in the current COVID-19 world we are living in.
It is therefore clear that borrowers actually have very little certainty that lenders will advance the requested loans on the requested drawdown date (including, where the loans are required to fund an acquisition, on the closing date for that acquisition). In a number of jurisdictions, given the public scrutiny of transactions involving listed entities, this uncertainty has resulted in codified requirements that a purchaser has ‘certain funds’ available to it before it is able to enter into an acquisition of a listed entity. In the UK, this requirement is regulated by the City Code on Takeover and Mergers.
In Australia, the two principal methods of acquiring listed entities are by way of a takeover bid (regulated by Chapter 6 of the Corporations Act) and a scheme of arrangement (a court approved arrangement). Unlike in the UK, neither of these methods has a strict legal requirement for certain funds but The Takeovers Panel has stated that a takeover offer will not be acceptable if the acquirer does not have reasonable grounds to believe that it will have sufficient funding to complete the takeover and, in the case of schemes of arrangement, the offeror will be required to satisfy the court that it has sufficient funds to pay the scheme consideration and complete the transaction. As such, and from a practical perspective, purchasers in these public to private transactions will generally require that their acquisition financing be provided on a certain funds basis.
Certain funds provisions are not limited to public M&A transactions and are also generally seen in the private space (including private equity backed transactions) especially in competitive bid processes. In these competitive bid processes, financing arrangements with certain funds provisions can be seen as a competitive advantage given that they mitigate the risk that the purchaser will rely on a “financing out” (being that, because the purchaser’s proposed financing arrangements did not reach financial close, the purchaser has no obligation to complete the transaction).
What are certain funds provisions?
In short, certain funds provisions are those that set out that a lender is required to fund, and is not entitled to cancel or terminate a loan facility or exercise any other rights typically conferred on the occurrence of an event of default, provided a limited number of conditions are met. These provisions therefore limit the conditions precedent that would otherwise need to be satisfied before a lender is obliged to fund and they have become largely standardised across the Australian market such they generally involve little negotiation between the parties. In addition, the Loan Market Association does provide suggested certain funds language.
The conditions that typically remain, and are required to be fulfilled before funding, are those that are either completely within the purchaser's control or are outside of the purchaser’s control but generally considered to be too remote to be triggered before the anticipated drawdown date. Certain funds provisions in the Australian market typically include the following conditions:
1. Satisfaction of mechanical conditions precedent (including signing finance documents, causing standard legal opinions to be delivered and issuing a utilisation request);
2. Absence of illegality in respect of funding by the lender;
3. Absence of a ‘major default’ being:
failure to pay an amount under the loan documentation;
insolvency of the purchaser or any other day-one obligor;
the loan documentation being unlawful, void, repudiated or rescinded;
breach of any negative covenants relating to the incurrence of financial indebtedness, granting guarantees or loans, giving security, making acquisitions, disposing of assets or entering into mergers; and
any representations becoming false or misleading and which relate to status, power and authority, binding obligations, transactions under the loan documentation being permitted and requisite authorisations to enter into the loan documentation;
4. Absence of a breach or non-compliance of the acquisition document by the purchaser or any other circumstance pursuant to which the purchaser is no longer obliged to complete the transaction; and
5. Absence of a change of control in a purchaser.
It is standard for the major defaults and major representations to be limited to the purchaser (often an acquisition SPV) or the purchaser group prior to the acquisition so that their occurrence in relation to the target or its subsidiaries is not a certain funds default and therefore does not cause a drawstop. This is because the purchaser group does not control the target until the acquisition is completed, and so could not, for example, prevent a target group member from incurring debt or granting security or taking some other action that could operate as a drawstop.
Fulfillment of lender due diligence and lender satisfaction in respect of the acquisition or scheme documents is not typically a certain funds condition as it is generally accepted that lenders should be signed off on any relevant diligence and documentation (based on a sign-off from their lawyers) prior to committing funds (either by way of a commitment letter or the loan document itself).
Given the influx of foreign lenders (banks and non-banks) into the Australian acquisition financing market, compliance with sanctions and anti-corruption laws have also, from time to time, been negotiated as conditions to the certain funds.
Certain funds provisions do not typically apply for the life of a loan document but will typically apply from the date of signing the debt commitment letter or loan documentation until the sunset date in the acquisition agreement or the latest date on which a purchaser is required to pay the cash consideration to shareholders in a public to private transaction.
Material adverse change and the current COVID-19 climate
The standard business MAC event of default that is normally found in loan documentation is not typically included as a ‘major default’ for the purposes of the certain funds provisions on the basis that it is entirely outside of the control of the purchaser and this would not be compatible with having certainty of funding. Likewise, a ‘market MAC’ or event in the financial, banking, or capital markets that could impair the syndication of any financing provided by the lenders is rarely, if ever, accepted as a condition precedent let alone a condition for certain funds provisions. The one exception to this was during the global financial crisis where lenders were simply unable to syndicate loans that they had underwritten such that, after the GFC there was a brief period where the market MAC was included.
In the UK, MAC conditions are not accepted for the purposes of the certain funds requirements of the City Code on Takeover and Mergers. In the Australian context, the guidance note issued by The Takeovers Panel provides that, if the debt facility used to fund the transaction contains material conditions precedent (including MAC clauses), these should be set out in the takeover offer documentation so that the market is aware of them.
In these times of uncertainty both as to the business or viability of purchasers or targets in certain sectors and the market conditions generally, lenders might try to introduce business or market MAC conditionality as they may be concerned with ensuring that they will not be required to make funding available in circumstances where the credit profile of the purchaser or the target group, or the lending markets generally, are no longer that on which they have based their investment thesis and risk assessment.
Going forward, sponsors and purchasers more generally will need to pay careful attention to the conditions imposed in their certain funds provisions, and also their financing arrangements more generally, so as to ensure that funds will be advanced as and when required.
The Hamilton Locke finance, restructuring and insolvency team have a broad range of top-tier experience acting for a variety of stakeholders in distressed scenarios. For more information on debt trading, distressed investing and finance, or advice on insolvency, distressed debt and restructuring generally please contact Zina Edwards (Zina.Edwards@hamiltonlocke.com.au) and Nick Edwards (Nicholas.Edwards@hamiltonlocke.com.au).