108 4 Debt
event of a downturn in financial performance. Second, they help to determine the
interest rate on the loans. Third, they can also be used as part of tests which must
be satisfied before distributions can be made to other investors such as sharehold-
ers or venture capital investors.^96
Restrictive covenants: pari passu, negative pledge, and permissible liens
clauses. The pari passu clause is intended to preserve the lender against the invol-
untary subordination of its loan. The borrower tends to ensure that the benchmark
indebtedness is qualified by the word unsubordinated: “All the obligations and li-
abilities of the borrower hereunder rank, and will rank, either pari passu in right of
payment with or senior to all other ubsubordinated indebtedness of the bor-
rower.”^97 The pari passu clause is complemented by the negative pledge clause.
For the lender, the purpose of the negative pledge clause is to ensure that a bor-
rower’s assets will remain unencumbered and available to satisfy the claims of all
general unsecured creditors should the borrower get into financial difficulties in
the future. From the borrower’s standpoint, the most unpopular version of the
clause contains an absolute prohibition of the borrower’s incurrence of future se-
cured indebtedness. The borrower’s negotiating objective with this clause is to re-
tain as much flexibility as possible in terms of future financing alternatives.^98
The borrower will also want certain types of secured financing transactions to
be expressly excluded from the reach of the negative pledge restrictions. These
exceptions are sometimes referred to as permissible liens. Although the lender will
not wish to give the borrower any greater latitude to create preferential security in-
terests in favour of other creditors than is strictly necessary for the efficient con-
duct of the borrower’s business, the lender will agree at least to the exclusion of
existing liens, normal operating liens and involuntary liens.^99
Assignment clause. Whether a loan can be sold down depends on the primary
documentation between the borrower and the original lender. The principal objec-
tive of the lender in the assignment clause is liquidity. Constraints on the lender’s
liquidity would mean higher costs for the borrower.
Some borrowers may nevertheless limit the right of the lender to assign the
loan. This is usually done by requiring the borrower’s consent to assignment. It is
normal to add that the consent may not unreasonably be withheld and that the con-
sent is not necessary in the case of assignments to affiliates of the assignor.^100
This means also that the third-party buyer of the loan has to check the primary
documentation to ensure that any transfer complies with it.
The actual methods of transfer are straightforward. The legal mechanisms are
novation, assignment or sub-participation.
Novation means that the new lender (A) replaces the original lender (B) as the
lender to the borrower (C) in what is, in legal terms, a completely new loan. Nova-
tion therefore involves at least three parties. If the loan is a secured one, the parties
(^96) Gayle C, op cit, p 304.
(^97) See Buchheit LC, op cit, pp 78–79.
(^98) See ibid, p 83.
(^99) See ibid, pp 89–90.
(^100) See ibid, pp 117–118.