Private Placement Financial Covenants Reference Manual

¹For accounting reasons some investors may prefer that offer of prepayment provisions, where the holder will be prepaid only if it accepts the offer of prepayment, be written instead as rejectible prepayment provisions, where the holder will be prepaid unless it declines the prepayment.

²While a "Change in Control" provision is considered as part of the financial covenants package in the marketing phase of a private placement, when the definitive agreement is prepared the provision is usually placed in the same section in which the payment provisions appear instead of the section containing the other financial covenants.

³Investors may view a breach of this covenant in the same light as a failure to make payment and contend that each holder have an individual remedy. The default and remedy provisions might be adjusted to permit each holder to accelerate the Notes it holds if the issuer fails to comply with its obligations to such holder provided in this covenant. Another approach is to add an obligation on the part of the issuer, arising upon a Default under this covenant, to purchase the Notes held by each holder who makes demand.

⁴See supra note 1.

⁵If a second notice is to be provided, the following language may serve: "If the Company shall not have received a written response to the offer to prepay pursuant to this Section [ ___ ] from each holder of Notes within [ ___ ] Business Days after the date of making of such offer to such holder of Notes, then the Company shall immediately send a second written notice with offer to prepay via an overnight courier of national reputation to each such holder of Notes who shall have not previously responded to the Company."

⁶Some investors may wish to provide here for a "second look": "If the offer is so accepted by any holder of Notes, the Company at least [ ___ ] days prior to the Proposed Prepayment Date shall give written notice to each holder of Notes that has not so accepted the offer, in which notice the Company shall (i) state the aggregate outstanding principal amount of Notes in respect of which the offer has been accepted and (ii) renew the offer and extend the time for acceptance by stating that any holder of Notes may yet accept the offer, whether theretofore rejected or not, by causing a notice of such acceptance to be delivered to the Company at least [ ___ ] days prior to the Proposed Prepayment Date."

⁷If no Make-Whole Amount or prepayment premium is to be payable in this circumstance, omit the entire phrase appearing between the commas.

⁸Delete clause (iv) if no prepayment premium is to apply.

⁹The reference is to the section in which the scheduled principal payments are specified, such as Section 8.1 of the September 13, 1994 versions of Model Form No. 1 of Note Purchase Agreement ("Model Form No. 1") and Model Form No. 2 of Note Purchase Agreement ("Model Form No. 2," and together with Model Form No. 1, the "Model Forms").

¹⁰See supra note 2.

¹¹See supra note 1.

¹²See supra notes 5 and 6 regarding "second notice" and "second look" provisions.

¹³If no Make-Whole Amount or prepayment premium is to be payable in this circumstance, omit the entire phrase appearing between the commas.

¹⁴Delete clause (iv) if no prepayment premium is to apply.

¹⁵The reference is to the section in which the scheduled principal payments are specified, such as Section 8.1 of the Model Forms.

¹⁶Additional conditions may be added as subsequent enumerated clauses, e.g., a limitation on Senior Funded Debt or Priority Debt, or compliance on a pro forma basis with a coverage ratio covenant such as those illustrated in Chapter 2, "Coverage Ratios."

¹⁷Concurrent maintenance tests may be added, e.g., "or Consolidated Senior Funded Debt to exceed [formula]."

¹⁸This reference is to the provision limiting the incurrence of additional Funded Debt (e.g., Covenant 4.01).

¹⁹To permit extensions, etc., the proviso should be replaced with "and any extension, renewal or refunding thereof, provided that the principal amount thereof [a: outstanding immediately before giving effect to such extension, renewal or refunding is not increased] [b: is not increased after the date hereof];".  The parties may wish to consider adding the following language: "and no Default or Event of Default exists at the time of such extension, renewal or refunding."

²⁰It may be desirable in some circumstances to omit "Wholly-Owned."

²¹See supra note 19.

²²The parties might consider whether to include here the redemption value or liquidation preference of any Preferred Stock of a Subsidiary other than Preferred Stock owned by the Company or a Wholly-Owned Subsidiary. Another approach to address the concern would be to modify the definition of "Subsidiary" to exclude any entity having any Preferred Stock outstanding that is not held by the Company or a Wholly-Owned Subsidiary.

²³It may be desirable in some circumstances to omit "Wholly-Owned."

²⁴Id.

²⁵E.g., Consolidated Operating Cash Flow or other concept derived from the income statement. Some parties may prefer expressing the limitation as a multiple ("[ ___ ] times") instead of as a percentage.

²⁶E.g., Consolidated Total Capitalization, Consolidated Net Worth, or other concept derived from the balance sheet. Some parties may prefer expressing the limitation as a multiple ("[ ___ ] times") instead of as a percentage.

²⁷Id.

²⁸E.g., Consolidated Operating Cash Flow or other concept derived from the income statement. Some parties may prefer expressing the limitation as a multiple ("[ ___ ] times") instead of as a percentage.

²⁹E.g., Consolidated Total Capitalization, Consolidated Net Worth or other concept derived from the balance sheet. Some parties may prefer expressing the limitation as a multiple ("[ ___ ] times") instead of as a percentage.

³⁰Id.

³¹Both approaches are sometimes referred to as a "Negative Pledge" or as an "Equal and Ratable Lien" clause. Since these labels do not distinguish between the two significantly different approaches, they may lead to confusion and disappointment. Covenants 6.03 and 6.06 present yet another option; they say nothing at all about equal and ratable liens.

³²The second approach (Covenants 6.04, 6.05, and 6.06) should require a shorter list of exceptions because Liens arising in the ordinary course of the operating business (e.g., Liens of the type described in Addenda 6.20 through 6.23) would not fall within the scope of the prohibition. However, practitioners sometimes observe that issuers prefer to resolve any doubts by using the first approach (Covenants 6.01, 6.02, and 6.03) with a longer, more fully articulated, list of exceptions to the prohibition.

³³Refers to the subparagraphs inserted above.

³⁴The clause at the end of this sentence regarding the form of agreement providing such "ratable" security is one way of addressing, or at least deferring discussion of, the often debated issue of what actually satisfies the "equal and ratable" requirement. Additionally, the parties may wish to consider whether an opinion of counsel should be required in connection with the delivery of such agreements.

³⁵Id.

³⁶Or "indebtedness for borrowed money", or "Indebtedness for borrowed money".

³⁷Refers to the subparagraphs inserted above.

³⁸See supra note 34.

³⁹Or "indebtedness for borrowed money", or "Indebtedness for borrowed money".

⁴⁰Id.

⁴¹See supra note 34.

⁴²Or "indebtedness for borrowed money", or "Indebtedness for borrowed money".

⁴³The reference is to the general tax compliance covenant which usually contains exceptions and/or a permitted contest provision.

⁴⁴The reference is to the general tax compliance and/or general compliance with laws provision(s), each of which usually contain exceptions and/or a permitted contest provision.

⁴⁵This version provides for a cap (which can be an absolute dollar amount, a percentage of assets or net worth test, etc.) on appeal bonds to deal with the concerns that creditors in the Texaco case were surprised to face-the prospect that all of Texaco's assets would be pledged to secure a judgment in the billions, or even tens of billions, of dollars without an Event of Default occurring under the relevant loan documents.

⁴⁶This cap addresses the same sort of concern as the Texaco case presented in respect of appeal bonds. See supra note 45.

⁴⁷The reference is to those items on the Schedule of outstanding Indebtedness that, by their terms, are secured.

⁴⁸Delete the entire bracketed phrase if the number to be otherwise inserted in the blank is 100%.

⁴⁹These three references would be to the subparagraphs shown in Addenda 6.26, 6.27, and 6.28.

⁵⁰These references would be to such of Addenda 6.20 through 6.26 as may be selected for inclusion in the Lien covenant. The references would also be to Addenda 6.27 and 6.28 if the parties intend that the basket not be diminished by the amount of the Liens described in those Addenda.

⁵¹This clause about Liens of new Subsidiaries is usually appropriate if Liens are subject to an incurrence-type test or if Addendum 6.28 is not included in the covenant. Without this clause the Company might be permitted to circumvent a prohibition on its incurrence of a Lien by arranging for the Lien to attach to property while the property is owned by a third party and acquiring the third party instead of purchasing the property directly.

⁵²This factor might be taken from the balance sheet (e.g., Consolidated Assets or consolidated tangible assets) or from the income statement (e.g., Consolidated Operating Cash Flow or consolidated revenues).

⁵³An example of an offer of prepayment provision appears in Covenants 1.01 and 1.02, "Change in Control."

⁵⁴Other forms of merger covenants appear as Section 10.2 in each of the Model Forms.

⁵⁵The style of the Model Forms would call for inserting here ", the Other Agreement[s]" if there were more than one note purchase agreement being executed in connection with the issuance of the Notes.

⁵⁶The reference is to the particular subparagraph of a debt incurrence test permitting debt to be incurred based on a particular level of financial performance or financial condition as opposed to a general permission to incur a particular type of debt. Covenant 8.01.2, which omits this clause, would generally be used instead of Covenant 8.01.3 if the debt test is a maintenance model (e.g., Covenant 4.02) and not an incurrence model (e.g., Covenant 4.01). The debate whether to include this clause is often part of the debate whether to use a maintenance or an incurrence model for the debt test.

⁵⁷Consideration should be given to limiting this term to "Wholly-Owned Subsidiaries."

⁵⁸This is a reference to the Sale of Assets covenant (e.g., Covenant 8.11).

⁵⁹See supra note 55.

⁶⁰See supra note 56.

⁶¹The reference is to the covenant limiting mergers, consolidations, etc. (e.g., Covenant 8.01 or Covenant 8.02).

⁶² This refers to the basket provision in the Sale of Assets covenant (e.g., Covenant 8.11).

⁶³Other appropriate balance sheet items may be used here.

⁶⁴Other appropriate income statement items may be used here.

⁶⁵Other appropriate balance sheet items may be used here.

⁶⁶For an example of how to permit certain types of Restricted Payments, e.g., payments on Redeemable capital stock, even when the conditions (other than no default) for other Restricted Payments are not met, see Addendum 10.21.

⁶⁷Id.

⁶⁸This date is typically the first day of the fiscal quarter of the Company in which the Closing occurs.

⁶⁹The reference is to the particular subparagraph of a debt incurrence test permitting debt to be incurred based on a particular level of financial performance or financial condition as opposed to a general permission to incur a particular type of debt. Covenant 10.01.2, which does not include this clause, would generally be used instead of Covenant 10.01.3 if the debt test is a maintenance model (e.g., Covenant 4.02) and not an incurrence model (e.g., Covenant 4.01). The debate whether to include this clause is often part of the debate whether to use a maintenance or an incurrence model for the debt test.

⁷⁰Covenants 10.01.1 and 10.02.1 may be combined into a single covenant if both are intended.

⁷¹The parties may prefer to substitute a balance sheet measurement (e.g., Formula 4.23) for the remainder of this subparagraph (i).

⁷²This date is typically the first day of the fiscal quarter of the Company in which the Closing occurs.

⁷³The reference is to the particular subparagraph of a debt incurrence test permitting debt to be incurred based on a particular level of financial performance or financial condition as opposed to a general permission to incur a particular type of debt. Covenant 10.02.2, which does not include this clause, would generally be used instead of Covenant 10.02.3 if the debt test is a maintenance model (e.g., Covenant 4.02) and not an incurrence model (e.g., Covenant 4.01). The debate whether to include this clause is often part of the debate whether to use a maintenance or an incurrence model for the debt test.

⁷⁴See supra note 66.

⁷⁵This date is typically the first day of the fiscal quarter of the Company in which the Closing occurs.

⁷⁶The reference is to the particular subparagraph of a debt incurrence test permitting debt to be incurred based on a particular level of financial performance or financial condition as opposed to a general permission to incur a particular type of debt. Covenant 10.03.2, which does not include this clause, would generally be used instead of Covenant 10.03.3 if the debt test is a maintenance model (e.g., Covenant 4.02) and not an incurrence model (e.g., Covenant 4.01). The debate whether to include this clause is often part of the debate whether to use a maintenance or an incurrence model for the debt test.

⁷⁷A different period may be provided for a Property Reinvestment Application than for Debt Prepayment Application.

⁷⁸Id.

⁷⁹E.g., Consolidated Operating Cash Flow or other concept derived from the income statement. Some parties may prefer expressing the limitation as a multiple ("[ ___ ] times") instead of as a percentage.

⁸⁰E.g., Consolidated Total Capitalization, Consolidated Net Worth, Consolidated Funded Debt or other concept derived from the balance sheet. Some parties may prefer expressing the limitation as a multiple ("[ ___ ] times") instead of as a percentage.

⁸¹Id.

⁸²This definition is identical to the one appearing in Model Form No. 2.

⁸³The reference would be to the provision, if any, for determining the reference rate in calculating a make-whole type of prepayment premium, e.g., Section 8.6 of the Model Forms.

⁸⁴This form of the definition of Consolidated Net Income begins with net income determined in accordance with GAAP but then deducts various non-cash and other extraordinary items, as well as items of a non-operating or non-recurring nature. Any combination of the exclusions shown here may be selected. Parties often agree to variations or additional exclusions specially designed for the issuer's circumstances.

⁸⁵See the commentary in Chapter 9, "Net Worth," for a discussion of the alternative definitions of "Consolidated Net Worth" and the alternative labels therefor.

⁸⁶The parties might consider inserting here "Redeemable Preferred Stock,".

⁸⁷See the commentary in Chapter 9, "Net Worth,"; for a discussion of the alternative definitions of "Consolidated Net Worth" and the alternative labels therefor.

⁸⁸Id.

⁸⁹Id.

⁹⁰Id.

⁹¹Id.

⁹²This is a narrower concept than the one, often called "Indebtedness," sometimes used in connection with financial covenants, representations and warranties, and cross-default provisions.

⁹³The parties might consider whether to include the following: "and its redemption obligations in respect of Redeemable Preferred Stock".

⁹⁴The parties might consider whether to include (a) certain types of liabilities in respect of letters of credit and (b) some measure of current net exposure in respect of interest rate swaps, currency swaps and similar obligations.

⁹⁵The reference is to the section providing for unscheduled prepayments.

⁹⁶The reference is to the section providing for offers to prepay. If a rejectible prepayment provision is to apply instead of an offer to prepay, language in this definition should be adjusted. See commentary in Chapter 8.

⁹⁷The parties might consider whether to exclude balloon payments on debt from clause (b). Also, if "Debt" is defined to include Redeemable Preferred Stock, the parties might consider whether to expressly include here in clause (b) mandatory redemptions of such stock and in the definition of "Interest Charges" dividends on such stock.

⁹⁸Except for the second parenthethical phrase, which mentions the vicarious liability of general partners, the definition of "Guaranty" presented here is verbatim from the Model Forms. The parties may wish to leave the term "indebtedness" without express definition, or capitalize it if that term is expressly defined, or replace it with the term "Debt" if that narrower concept is intended.

⁹⁹The definition of "Indebtedness" presented here is verbatim from Model Form No. 2 and is included in this manual primarily to facilitate comparison with the narrower term "Debt," which is more closely aligned with the notion of indebtedness for borrowed funds. In the Model Forms, "Indebtedness" is used only in the representations and the cross-default provision.

¹⁰⁰If the defined term "Redeemable" is used, it may be substituted for "mandatorily redeemable."

¹⁰¹If a covenant limiting Sale-and-Leasebacks such as Covenant 11.02 or 11.03 is included in the transaction, the parties might consider whether to insert here "and Attributable Debt".

¹⁰²If "Debt" is defined to include Redeemable Preferred Stock, the parties might consider whether to expressly include here dividends in respect of such stock.

¹⁰³See supra note 101.

¹⁰⁴See supra note 102.

¹⁰⁵Or "Indebtedness" or "Debt."

¹⁰⁶This definition is taken from Section 8.6 of the Model Forms.

¹⁰⁷The reference is to the section or sections in which prepayments to be made with a Make-Whole Amount are specified. These might be provisions for optional prepayments or offers of prepayments to be made in connection with a Change in Control or a Debt Prepayment Application (as defined in Definition Z.30.2 or Z.30.3).

¹⁰⁸The reference is to the acceleration provision.

¹⁰⁹If the Make-Whole Amount includes an addition to the Treasury yield, the phrase should read "_._% over the yield to maturity" instead of "the yield to maturity". Parties sometimes agree that a different Reinvestment Yield should be used in certain circumstances than is used in the case of optional prepayments. In such a case the phrase might read "the sum of (x) either _._% in the case of prepayments pursuant to Section [ ___ ] or _._% in the case of prepayments pursuant to Section [ ___ ], plus (y) the yield to maturity".

¹¹⁰Page 678 and Page 500 on the Telerate Access Service are frequently used in Note Purchase Agreements as sources for market data. However, other pages on the Telerate Access Service or other services like Bloomberg Financial Markets may be appropriate sources for market data.

¹¹¹See supra note 107.

¹¹²See supra note 108.

¹¹³See supra note 107.

¹¹⁴See supra note 108.

¹¹⁵This date is typically the first day of the fiscal quarter of the Company in which the Closing occurs.

¹¹⁶The possibility that a Subsidiary may have preferred stock outstanding may be a concern. See supra note 22.

¹¹⁷Clause (c) should be included if the parties have chosen to include a covenant restricting Sale-and-Leasebacks and the "Attributable Debt" with respect thereto.

¹¹⁸The reference is to the basket provision of the Lien covenant. See Addendum 6.30.

¹¹⁹See supra note 116.

¹²⁰The reference is to the basket provision of the covenant limiting Debt of Subsidiaries (e.g., Covenants 4.04.2 and 4.04.3).

¹²¹The reference is to the covenant limiting Sale-and-Leasebacks such as Covenant 11.02 or 11.03 and is appropriate if such a covenant is included by the parties in the particular transaction.

¹²²The reference is to the portion of the Lien covenant describing permitted Liens. See Addenda in Chapter 6, "Liens."

¹²³Consideration should be given to limiting this term to "Wholly-Owned Subsidiary."

¹²⁴The determination of whether to include clause (ii) may depend on which other covenants are included in the transaction and whether there are concerns about priorities that creditors of subsidiaries may enjoy over creditors of a parent.

¹²⁵The reference is to the Sale of Assets covenant (Covenant 8.11.2 or 8.11.3) and/or the Sale-and-Leasebacks covenant (Covenant 11.02.2 or 11.03.2) in which there are allowances for any Transfer in respect of which a Debt Prepayment Application and/or a Property Reinvestment Application is made.

¹²⁶The Model Forms use this term in the section concerning amendments but do not use it in the section concerning acceleration of the Notes. Different percentages may be specified for each type of occasion for which a vote of the holders is required.

¹²⁷Any combination of the exceptions shown here may be selected. Parties often agree to variations or additional exceptions specially designed for the issuer's circumstances.

¹²⁸The exception for Investments of the type described in this clause (c) is often limited to "Wholly-Owned Subsidiaries."

¹²⁹This definition is the same as Definition Z.64.1 except that it omits subparagraph (b), which describes voluntary prepayments on Subordinated Debt. This version is generally used if the Company does not have any Subordinated Debt outstanding on the date of Closing and if the financial covenants do not test senior Debt and Subordinated Debt separately.

¹³⁰It is assumed that concerns with Capital Leases would be addressed in the Lien covenant (see Chapter 6). Otherwise this parenthetical phrase should be omitted and the definition of "Lease Rentals" (as it is used in the definition of "Attributable Debt") should be adjusted.

¹³¹Consider adding "for a period of [ ___ ] months or longer."

¹³²The possibility that a Subsidiary may have preferred stock outstanding may be a concern. See supra note 22.

¹³³This is a very simple definition for a term that is often defined in considerable detail after spirited negotiations. Results of such negotiations vary widely and no attempt is made here to illustrate the more elaborate definitions of "Subordinated Debt."

¹³⁴The term "Swaps" is used in this manual only in the definition of "Indebtedness" and is verbatim from the Model Forms. See supra note 99 and commentary in Chapter 4, "Debt." Techniques for measuring and restricting exposure to swaps are still evolving and are not well settled. Because such exposure can be quite volatile, an issuer may face significant challenges in managing its financings and monitoring its covenant compliance if swaps are included in the term upon which indebtedness limitations are based. For this reason, swaps are omitted from the definition of "Debt" appearing in this manual. For discussion about accounting for swaps exposure, see Statement of Financial Accounting Standards No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments," Financial Accounting Standards Board (October 1994).

¹³⁵Use the income statement item or items appearing in the formulas defining the Sale of Assets baskets.

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