In an earlier post, I generally discussed the structure of unitranche facilities and their growth in popularity among borrowers since the credit crisis. Of course, this explosive growth has occurred in a relatively benign economic environment. As a result, the inherent limitations of the structure have not been tested by a downturn or, in turn, by bankruptcy courts. Lenders exploring the market must do so with some caution and a fulsome understanding of the rights of, and limitations on, "first out" lenders in a distressed scenario.

By their nature, unitranche debt does not easily allow senior lenders to silence junior lenders in times of distress based on collateral valuation alone because all the borrower's obligations are secured by a single lien. Instead, protections must be carefully drafted into the AAL. These protections will include, for e.g., waivers of the ability of "last out" lenders to vote in favor of a contradictory plan of reorganization, restrictions on their rights to object to asset sales, and limitations on the rights of such lenders to provide post-petition financing. Similar provisions contained in first lien/second lien intercreditor agreements have been deemed enforceable "subordination provisions" in the context of a bankruptcy. The same should generally hold true for AALs. If an intercreditor dispute arises in the context of a borrower's bankruptcy, lenders should be mindful that a bankruptcy court might decline to accept jurisdiction (particularly if the borrower is not a party to the AAL), leaving an unrelated state or federal court to address the matter.

The existence of a common lien may also make it more difficult, and sometimes impossible, to reasonably argue that the senior lenders are over-secured and therefore entitled to post-petition interest and fees in the context of a bankruptcy case. AALs attempt to mitigate the risk, often providing that the senior tranche shall receive priority for payments in an amount as if it were a hypothetical over-secured creditor with its own lien. Of course, this inherently provides opportunity for an intercreditor dispute on valuation and other matters.

Unitranche debt is also less liquid than more traditional debt and will likely be more difficult to unload in the secondary market. Sellers must confront detailed provisions governing rights of first refusal, in favor of both lenders in their tranche and those in the other tranche, which will necessarily delay a sale transaction and the exit. Sellers may also find fewer buyers that are both familiar with the structure and willing to acquire debt in a club facility that packages a single lien in favor of lenders with differing priorities. Lenders who have come to view an active secondary market for cash flow loans as their primary exit strategy for a troubled loan may find that they need to exhibit more patience in a workout of a unitranche facility.

Many similar concerns were raised by early market participants in connection with the growth of the first lien/second lien market. And while there will be hurdles to overcome in the workout and restructuring of unitranche deals, the greater certainty that comes with experience will provide the guidance needed to manage through any future crisis.

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