Unitranche financing began as a middle-market product, tracing its origins to the days of recovery from the global credit crisis. The credit markets re-opened with an explosion of available capital from traditional lenders, business development companies and other direct lenders. With an increasing supply of capital, leverage shifted to borrowers and private equity, allowing them to better dictate the terms and conditions of their loan facilities. With the greater prevalence of so-called “covenant-lite” loans, also came the exponential growth of the unitranche market. What began as a financing structure most often used for loans of less than $50 million, unitranche loans are now regularly used for financings exceeding $1 billion, and in 2021, up to $3 billion. A unitranche facility combines the benefits of multi-tranche debt regularly found in the syndicated lending markets (i.e., the ability to raise funds from lenders with different risk profiles and return expectations), with those of speed and certainty that are a hallmark of the private lending community. In its simplest form, unitranche facilities are structured using a single-tier, combing the senior and junior components of syndicated loans into one loan. Whereas a syndicated loan may require distinct grants of senior and junior liens on collateral to multiple lending groups, a unitranche uses a single lien to secure the entire facility. The benefits to the borrower are obvious: it is faced with a single term loan: one set of principal and interest payments, a single package of covenants to monitor, and a uniform list of defaults to avoid. Layering on the advantage of a single agent, a unitranche facility greatly streamlines loan administration from the borrower’s perspective.
These facilities are commonly “club deals” among lenders that have participated together in similar transactions; therefore, lenders are able to commit to, and document, a loan on an expedited basis (although this is shifting with the trend toward the “jumbo” unitranche). A comparable financing package in the syndicated lending space might necessitate first, second and even third lien credit facilities, each with their own agent, counsel and suite of loan documentation. The nature of a large syndicated loan necessarily requires a lengthy process of courting lenders and “building a book,” obtaining a rating, modifying loan provisions to ensure adequate participation, and entails the risk of “flex” and even a failed syndication. Not so for unitranche loans which are often unrated and underwritten without pre-closing syndication, greatly enhancing the certainty of, and time to, closing. And the cost savings is often considerable. There is only one set of loan documents to negotiate, eliminating the expense of multiple agents’ counsel, serving different masters and duplicating efforts across multiple facilities.
The relationship among the lenders in a unitranche facility is typically addressed in an “agreement among lenders” or “AAL”. The lending groups are often described as “first-out” and “last-out” lenders, with the first-out lenders enjoying rights more typical of first lien lenders, and the last-out lenders having rights typically associated with junior lenders. The AAL details the sharing of payments and the rights to exercise remedies, among other things. The interest rate, for example, is a blended rate and payments are allocated among the lenders by the agent upon receipt with the last out tranche receiving a greater share to account for enhanced risk. Under the AAL the lenders will receive payments on a ratable basis until the occurrence of certain trigger events. Following the occurrence of these trigger events payments and proceeds of collateral will be made to the first-out lenders prior to the last-out lenders. The greater risk borne by last-out lenders is found in numerous provisions in an AAL, but perhaps is most evident in the shifting of priorities following negotiated trigger events. This “waterfall” is often the most negotiated provision in any AAL, particularly when there are many forms that obligations can take (e.g., hedges, bank products, fees, etc.). The borrower may or may not be a party to the AAL, but, regardless, is less concerned with the intercreditor arrangements than it might be in a dual lien facility.
For lenders participating in the unitranche market, there are some unique risks. While first-out and last-out lender groups often have their own representatives, a single agent administers the loan. That agent often participates in the first-out facility and may, in times of the borrower’s financial distress, have interests that do not align with last-out lenders (yet has similar duties to all lenders under the loan documents). In the case of an AAL, the agent would likely need to resign its role in respect of both groups in order to avoid a conflict of interest, perhaps ceding some control to an independent party. Lenders must also pay careful attention to provisions in an AAL that may override provisions in the credit agreement, particularly in connection with voting rights. For example, required first-out lenders may be able to “drag along” last-out lenders with respect to certain matters. Other provisions may allow required last-out lenders to drag along minority holders with respect to “sacred rights.” Importantly, unitranche loans are fairly illiquid and the time for completing an assignment may be lengthy. AALs often include hurdles to assignments that do not exist in syndicated loans, including comprehensive provisions governing rights of first offer (or refusal) in favor of other lenders in both tranches. Moreover, notwithstanding their meteoric rise, secondary market participants are still getting comfortable with the structure and may be less likely to purchase debt in a closely held unitranche facility.
Further, there remain uncertainties associated with unitranche facilities, particularly in the context of the borrower’s bankruptcy. While there is much case law interpreting the many provisions of intercreditor agreements, there is little with respect to AALs as they have only come to prominence during a period of relative calm in the credit markets. For example, many courts have weighed in on the enforceability of various provisions commonly found in intercreditor agreements, and most importantly, on the enforceability of lien and payment subordination under Section 510 of the Bankruptcy Code. Less certain is the treatment of AALs in bankruptcy due to their hybrid nature. While AALs often contain provisions that are similar to those commonly found in intercreditor agreements, they do not include lien subordination (because there is only one lien). As a result, first-out lenders may be at risk of losing the benefits of being treated as “over-secured” creditors in those instances where the value of the collateral exceeds the first-out debt but not the aggregate loan. In such a case, Section 506(b) of the Bankruptcy Code may not apply, preventing the first-out lenders from the right they would otherwise have as first lien lenders to post-petition interest and expenses. Similarly, issues of classification may arise in bankruptcy given the lack of any delineation between the tranches in the credit agreement. Of course, these issues may be addressed in an AAL with turnover provisions and voting restrictions. Lastly, because the borrower is often not a counterparty to an AAL, a bankruptcy court’s jurisdiction to hear an intercreditor dispute may be challenged and a trip to a state court may be needed for enforcement. In order to mitigate this risk, borrowers are more frequently required by lenders to acknowledge the AAL in some fashion.
Takeaway: Unitranche facilities have become an integral component of the credit markets in recent years. Unless and until there is some shift in the balance of supply and demand for lending transactions, the trend should continue, with these facilities displacing syndicated lending at a greater pace and jumbo unitranches becoming more common. This is a rapidly developing market and “standards” are changing regularly. Both private lenders, and more traditional syndicated lenders, must be aware of trends in the unitranche space if they are to compete in this highly concentrated market.
 Section 510 of the Bankruptcy Code generally provides that, if a subordination agreement is enforceable outside of bankruptcy, it will be enforceable inside of bankruptcy.