Uptiering and drop-downs
Also known as: Liability management exercise, Non-pro-rata transaction, Creditor-on-creditor
A majority of lenders and the borrower use permissions in their own documents to improve their position at the expense of the rest.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat actually happens?
A group of lenders all hold the same loan. In theory they are equals: same rights, same rank, paid together.
In practice that equality depends on the words in the agreement, and those words can allow a majority to do things a minority would never agree to. Two moves have become common enough to have names.
Uptiering. A majority of lenders agrees with the borrower to create a new loan that ranks ahead of the existing one, and lets themselves — but not the others — exchange into it. Everybody was equal on Monday; on Tuesday some are senior and some are not.
A drop-down. The borrower moves valuable assets into a subsidiary that the loan's restrictions do not reach, and borrows against them from a new group of lenders. The original lenders still have their loan; the assets it was supposed to be secured on have gone somewhere they cannot follow.
Both use permissions that are genuinely in the documents. The people who signed them years earlier did not imagine them being used this way, and that is the entire subject.
- 1
Reading the documents2–6 wks
Advisers look for capacity: unrestricted subsidiaries, investment baskets, amendment thresholds.
- 2
Assembling a majority2–5 wks
A group large enough to amend the agreement is put together, quietly and under confidentiality.
- 3
The transaction1–2 wks
Assets are moved to an unrestricted entity, or new debt is created that ranks ahead of the existing loans.
- 4
The responsemths–yrs
Excluded lenders litigate, and courts decide whether the documents permitted what was done.
Is the capacity there — The credit agreement decides. Everything depends on clauses agreed years earlier by people who did not imagine this use of them.
The amendment threshold — The required majority of lenders decides. Whether a simple majority can bind the rest is the single provision that makes this possible.
Who is on the deal
| Who | Side | What they are actually for |
|---|---|---|
| The participating majority | Buy side | Lenders who join the transaction and improve their own position. |
| The excluded lenders | Sell side | Held the same instrument yesterday and find themselves behind it today. |
| The borrower and its sponsor | Buy side | Get new money or a longer runway, and are the party that proposed it. |
| The lawyers | Both | Found the capacity in the documents, and will argue about it afterwards. |
| The courts | Neither | Decide whether the agreement permitted what was done, case by case and not always the same way. |
- Desk
- Restructuring
- Made possible by
- Clauses agreed years earlier, in better conditions
- Requires
- A majority large enough to amend the agreement
- Excluded lenders
- Held the same instrument yesterday, rank behind it today
- Settled by
- Courts, case by case, and not always the same way
What decides whether it completes
Not how hard this is, and not a rating — there is deliberately no total. It says which of five blockers decides whether this transaction happens at all, in the same order on all 70 transaction types so they can be compared. This publication's own reading; see the notice below.
- Pricematters
- Financingmatters
- Approvalmatters
- Diligencebarely applies
- Executiondecides it
What decides it here. Everything turns on what the documents permit and on whether a majority can be assembled to use it. There is no market price to agree and no regulator to satisfy — only clauses written years earlier by people who did not imagine this use of them, and courts that decide afterwards whether they meant it.
3 · IntermediateHow it runs in practice
What makes them possible
- The amendment threshold. If a simple majority can consent to a new tranche ranking ahead, then a majority can do it to a minority.
- Unrestricted subsidiaries. A company can designate parts of the group as outside the covenants, which is where assets go.
- Investment baskets. Permission to transfer assets between group entities, sized generously in a friendly market.
- Open market purchase provisions, permitting non-pro-rata buybacks that were written for something else entirely.
Why lenders participate
Not primarily greed. A lender offered the choice between joining a group that will rank ahead and being left behind faces a straightforward calculation, and the transaction is usually presented with a short deadline. The pressure is the same shape as in a distressed exchange: refusing is expensive, and the cost of refusing is created by other people accepting.
What the borrower gets
New money, a longer runway, or debt retired at a discount — usually all three. For a sponsor facing a maturity with no refinancing available, this is a way to buy years without writing a cheque.
What happens next
Litigation, frequently. Excluded lenders argue the transaction breached provisions requiring pro-rata treatment or the implied duty of good faith. Courts have gone different ways in different cases and different jurisdictions, and the law is still forming.
4 · AdvancedThe numbers & the documents
Why this is a documentation story rather than a conduct story
Every one of these transactions is built on clauses the excluded lenders themselves agreed to. Over a long benign credit cycle, borrowers and sponsors negotiated progressively more flexibility; lenders competing to deploy capital conceded it. The flexibility was not hidden and was frequently commented on at the time.
This page therefore does not characterise anybody's conduct. It describes a mechanism, and the honest summary is that the market wrote agreements whose full implications it did not price.
The co-operation agreement, which is the market's own answer
Lenders now increasingly sign agreements among themselves before any trouble: an undertaking not to participate in a non-pro-rata transaction without the others. It is a private solution to a private problem, it works, and its existence is the clearest evidence that the market regards the risk as real.
What has changed in drafting
- Pro-rata sharing raised to a sacred right requiring every affected lender's consent.
- Unrestricted subsidiary designations restricted, and material intellectual property carved out of what may be transferred.
- Explicit prohibitions on subordinating existing lenders without unanimous consent.
- Tighter definitions of what a permitted investment may be used for.
Which is the ordinary way markets respond to a discovered flexibility: not by litigating it away but by writing the next agreement differently.
What it means for reading any credit agreement
The questions that matter are no longer only about leverage and interest cover. They are: what can a majority do to me, where can the assets go, and what ranks ahead of me if the borrower and some of my co-lenders agree it should. That is why covenant analysis now starts with the definitions and the amendment provisions rather than with the financial tests.
The wider lesson
The same idea appears everywhere on this desk: a document written in good times governs the bad ones, and the party that reads it most carefully under pressure has an advantage the others gave away for nothing. It is the single most useful thing on this page and it applies far beyond these two transactions.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow people on the deal think about it
Now say it back
Close the page and give Uptiering and drop-downs in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — name both sides and what each one is actually trying to get.
- What has to happen, in order — the three or four stages, not the whole timetable.
- Where the money comes from — cash, new shares, or borrowed; somebody has to fund it.
- What kills it — the ordinary way, not the dramatic one.
Where this transaction shows up elsewhere
- EasyAmend and extendDealThe maturity is pushed out and the terms are adjusted, without anybody writing anything off
- EasyLeveraged buyoutDealA company bought largely with borrowed money, secured on the company itself
- MediumHigh-yield bond issueDealSame market, different transaction: here the covenants are the deal, and the roadshow exists to explain them
- MediumTerm Loan BDealThe institutional loan that funds most buyouts
- HardCLO issueDealA managed fund financed by tranched notes
- HardHow to Read a Credit AgreementPlaybooksTwo loans at the same margin are not the same loan
- HardRestructuringDeskWhat happens when a company cannot pay: the standstill, the valuation fight, classes and voting, new money and the…