Those legal terms in credit agreements...

Reading a credit agreement for the first time can be daunting, and the same could be said with formal legal documents. Sometimes you wonder if it is even written in English! We all know these legal terms and conditions are there for a reason. How can we quickly make sense of them?

From my experience as a lender, I view a majority of the key terms and conditions as "game rules" that are set up to ensure lenders would not be separated from (i) the core creditworthy entity that we truly want to lend to, and (ii) those quality assets where cash flows were being considered when we thought they can be used to service the debt.

It is just like getting married. At the moment you say "yes, I do", you are hoping that this person who you are marrying to will not change, and that his/her financial condition will also not change (except for being better).

So what can negatively change the core borrower entity and their quality assets? Other than poor organic business performance, the typical situations may include: (i) Mergers and acquisitions that could result in change of ownership and management; (ii) sale of quality assets, borrowing of more money, and use of the quality assets as collaterals; and (iii) other unforeseen events that could materially impact the repayment ability of the borrower. To address all these possible situations, we have the following common terms in credit agreements:

• No merger/change of control - to ensure that that we are lending to the same party.
• Restrictions on sale of assets - to ensure that we can continue to rely on the quality assets.
• Pari passu/Negative pledge/Restriction on liens - not only do we want our debt to rank the same as other debts, but we do not want good assets to be pledged elsewhere.
• Material adverse change - a general blanket condition that covers most kinds of unfavorable unforeseen events that could cause the condition of borrower to substantially change

If any of the above were violated, that provides ground for lenders to call a default on the loan financing and exit from the deal. With these fundamental purposes in mind, it will be much easier to understand these complex legal terms next time around.