A Focus on Proxy Puts: Change-of-Control Provisions in Perspective

A Q&A with Robert Grien

Analysis Group affiliate Robert Grien – managing director and head of the Finance and Restructuring Advisory Group at TM Capital Corp. – is an expert with respect to credit agreements, credit analysis, complex financial structuring, market pricing, due diligence, restructuring, and valuation. As a principal lender in hundreds of debt facilities aggregating to billions of dollars of committed capital, he has financed all types of leveraged transactions, including leveraged buyouts, corporate mergers and acquisitions, and recapitalizations. 

Below, he shares some insights on how change-of-control provisions are used in the marketplace. Recently, a common component of these provisions – so-called “proxy puts” in which material changes to a borrower’s board of directors trigger an acceleration of the loan repayment before it is due – has been subject to a significant amount of attention.

What are “change-of-control” provisions, and who requests them?

Change-of-control provisions are a standard component in debt agreements. This is especially true in non-investment-grade credits, such as leveraged loans, high yield bonds, and private mezzanine debt. These provisions are generally designed to protect lenders in the event that the control of the borrower changes hands due to changes in share ownership or membership of the board. 

Lenders demand these change-of-control provisions, which were originally crafted in the 1980s after lenders were burned in the aftermath of takeovers. In the world of syndicated loans and high-yield bonds, these provisions are standard “boilerplate” and, as a result, their absence could be expected to have an impact on the lender’s ability to market the paper to institutional investors. 

Why do lenders seek change-of-control provisions such as proxy puts? 

Proxy puts are provisions that allow borrowers to reevaluate their credit upon a change to the borrower’s board of directors. Proxy puts are slightly less common than similar provisions triggered by changes in equity ownership, but nevertheless still appear in the vast majority of leveraged credits, particularly if the borrower is public or is likely to go public during the term of the credit.

Broadly, change-of-control provisions protect lenders from changes in the governance of a borrower that might negatively impact the borrower’s credit quality. Lenders require these provisions to protect themselves from an event in which control of a borrower passes to an entity to which the lenders are uncomfortable lending. Seeking such protection makes business sense for lenders because the actions (or inactions) of those who control a borrower, such as the board, could have a material impact on the likelihood that the borrower will ultimately repay its debt and interest.  

Several activist investors have challenged these provisions as having the effect of entrenching existing management, and are trying to persuade the courts to force public borrowers and their lenders to revoke these proxy puts. Do you view proxy puts as entrenchment tools for a borrower’s management?

That is certainly not their motivating purpose. Change-of-control provisions are intended to protect lenders, not borrowers. Further, it is unlikely that a change-of-control provision, such as a proxy put, would preclude a merger or acquisition from happening because acquirers typically refinance a target company’s existing debt. 

I would note that a number of the proxy puts that have been subject to recent litigation have a non-standard formulation that would seem to preclude any board member put forth in a proxy contest from qualifying as a continuing director. In a typical proxy put, the board can approve any director candidate, even one put forth in a proxy contest. I have not worked on any of these particular cases, and am not in a position to express any opinions with respect to these specific provisions.

How would you expect the market for leveraged loans to change if lenders were precluded from including proxy puts in credit agreements?

I think it is highly unlikely that change-of-control provisions would go away entirely. As I said before, it is in a creditor’s interests to reevaluate a borrower’s credit when there is a change in control. So, I do not see an economic basis for doing away with these types of change-of-control provisions.

Having said that, I have noted a few instances where activists or other shareholders have successfully demanded the removal of a particular proxy put. However, these instances seemed to be fact-specific, and do not take away from why lenders require these provisions in the first place. Without these provisions, I would expect lenders to find new ways to get to the same result, or, absent that, for the cost of debt to increase. ■