The basics: What is RP debt capacity?

This dubitable feature allows the borrower to reallocate or repurpose unused capacity (on paper) under some or all Restricted Payment (RP) baskets for debt incurrence. It is common to both high yield bonds and leveraged loans and has been witnessed both in the European market as well as across the pond in the United States.

In the European large-cap leveraged market, as highlighted in our 2024 annual high yield bond and loan reviews, the incidence of this wily provision is on the rise, appearing in a notable 36% of 2024 SFAs and 22% of 2024 HYBs.

Stealth Mode: Activated

The RP Debt Capacity basket often appears as a standalone and easily identifiable basket which is tagged as “Available RP Capacity Amount” or similar.

However, the avatar of this basket that we would like to draw the attention of investors to is the one that is concealed within, and an expansion of, the contribution debt basket (which permits the incurrence of debt in an amount typically equal to the equity/subordinated shareholder debt contributions made after the closing date).

The mischief is caused when the contribution debt basket is expanded to encompass not just shareholder contributions but also any unused capacity under the RP baskets.

The language varies but is often in the guise of the concept of “Available Shareholder Amounts” (particularly in European loan documentation), which is defined as “any amounts that members of the Group are permitted to pay the sponsor/its affiliates.” This, in essence, captures any RP capacity.

We have found that this variation of the contribution debt basket is rarely specified in, or discernible from, the terms of the summary term sheet and is often only unearthed in the full-form draft Senior Facilities Agreement.

This, in our view, can be obfuscating and a covert way of introducing a highly egregious and controversial provision into the debt documentation.

The Mischief caused

There are a number of inherent risks to investors from additional debt incurrence flexibility under the RP Debt Capacity basket (whether covert or explicit), which include:

• The provision does not require that the unused RP capacity being converted is underpinned by actual cash available in the Restricted Group to make such RPs and is therefore most likely to be utilised by astute sponsors when the business is in distress.

• The basket, in its most aberrant form, allows debt to be incurred in an amount equal to 200% of the available RP capacity under specified or all RP baskets.
• The RP Debt Capacity basket often benefits from a dedicated lien basket (or shares it with the lien basket associated with the contribution debt basket), allowing such debt to be secured on the Lenders’ (already severely limited) collateral, further diluting it or, even worse, secured on non-collateral assets, effectively priming the interests of the existing Lenders.
• There are rarely restrictions on who can use this basket, thereby making it available to Non-Guarantor Restricted Subsidiaries as well. The debt incurred by such entities would be structurally senior to the debt incurred by the issuer/borrower and put the lenders of such subsidiaries ahead of the existing Lenders.
• The additional flexibility, even more so where surreptitiously articulated, significantly compromises transparency and makes it nearly impossible to identify or track a Restricted Group’s actual scope for incurrence of further leverage, value leakage, collateral dilution, effective subordination (depending on the related lien permissions), or structural subordination.

The Upshot

Investors should stay alert to the presence of the stealthy RP Debt Capacity allowance within the contribution debt basket (or indeed elsewhere in the documentation where it is not easily perceptible) and insist on explicit identification of such permission in term sheets.

This would enable Lenders to argue for its removal from the preliminary papers and avoid being unpleasantly ambushed by its camouflaged appearance in the final-form documentation.