MFN provisions
The Most Favored Nation (MFN) provision in a loan agreement is a lender protection mechanism that is typically seen in credit facilities permitting an uncommitted incremental facility. The MFN provision, a term originating from the broadly syndicated credit market, ensures that any such pari passu debt generally has similar pricing and other terms as the initial loans the lender holds. There are generally two types of MFN provisions: (i) the Spread MFN, which addresses the loan economics for the lender (eg, interest rate, upfront fees, and other yield), and (ii) the Terms MFN, which address the loan terms binding on the borrower (eg, financial covenants, negative covenants, and events of default).
Our alert focuses on the Spread MFN and how the rise of private credit transactions with non-standard economics can impact the negotiation of Spread MFNs, along with our view on best practices from both the lender and borrower perspectives.
MOICs
In recent years, private credit funds and other non-bank lenders have been taking market share from commercial banks in the large cap and middle market lending spaces, which is a trend that only seems to accelerate. These firms are set up differently than a bank doing on-balance sheet lending or traditional broadly syndicated loan financings as they have, among other features, third-party investors that have been promised a minimum return on their invested capital. As a result, we are now seeing many financings negotiated with the inclusion of a required multiple on invested capital (MOIC) amount that the lenders must be paid in connection with the repayment of a loan facility to aim to ensure a set level of return regardless of how the loan actually performs.
The MOIC is typically expressed as a percentage of the total loan commitments less any interest and fees already paid and is similar to a prepayment premium or a “make-whole” in a loan facility. Whether the MOIC is paid on each principal amount of the loan prepaid from time to time or paid all at once upon repayment of the loan in full is a negotiated item between the lenders and the borrower.
MOICs are similar to traditional prepayment premiums but are calculated differently and, importantly, both the MOIC and traditional prepayment fees are not payable in all instances. Traditional prepayment premiums are usually either (i) a fixed percentage of the loans prepaid (eg, two percent in the first year, one percent in the second year, and no premium thereafter), or (ii) a “make-whole” calculation, which considers the future stream of interest payable from the prepayment date to either the maturity date or an earlier date (and which may discount that stream of future cash flows at a discount rate). In most leveraged loans, a make-whole premium would only apply in the earliest years of a facility.
Like a traditional prepayment premium, the MOIC is intended to compensate the lenders for lost future interest income on the loans when a loan is prepaid. The MOIC, however, looks at the interest actually paid (not the foregone future interest) and compares that to a minimum return benchmark.
For example, a loan that bears interest at a rate equal to the Secured Overnight Financing Rate (SOFR) + 550 basis points might have a MOIC of 1.3x. If (for simplicity of calculation) SOFR is 4.50 percent, resulting in an interest rate of 10 percent, no MOIC-related fee would apply after three years. However, prepayment after one year would require payment of a 20-percent MOIC fee at exit.
Relation of MOIC to MFN provisions
How are the MFN provisions and the MOIC provisions in a loan facility related? The two concepts will interact if a borrower (i) has existing financing with a Spread MFN provision, and (ii) that borrower enters into an additional facility (which may be an incremental facility, incremental equivalent debt, or other facility which falls within the scope of the Spread MFN) with a MOIC provision in it. At that point, the treatment of the MOIC in the context of the existing Spread MFN must be addressed.
The Spread MFN is based on a comparison of the “All-In Yield” payable to the incremental lenders, as compared to the “All-In Yield” payable to the existing lenders. The All-In Yield calculation typically takes into account the total loan commitments, the interest rate margin, interest rate floors, any original issue discount, and other fees payable to the lenders, subject to certain exclusions which are discussed more in depth below.
When comparing the All-In Yield of the incremental facility with the All-In Yield of the existing facility, there is usually a certain agreed cushion, which typically ranges from 50 bps to 75 bps, by which the All-In Yield of the incremental facility may exceed the All-In Yield of the existing facility, without consequence. To the extent that the All-In Yield of the incremental facility would be greater than the All-In Yield of the existing facility by more than the agreed cushion, the consequences under the loan agreement may vary.
Typically, the facility containing the Spread MFN will include a mechanism that automatically increases the applicable interest rate margin or the interest rate floor to a level that would bring the All-In Yield of the existing lenders within the agreed cushion. Depending on how loosely the definition of All-In Yield is drafted and how the MOIC is characterized in the loan agreement (eg, as a MOIC fee), there is potential for an incremental facility’s MOIC to be included in the calculation of such incremental facility’s All-In Yield. Ambiguities may be avoided with precise and explicit drafting.
Below is a sample “All-In Yield” definition, together with certain drafting points that lenders and borrowers may consider when negotiating the MFN provisions and the All-In Yield definition, and that new lenders may look out for when considering participation in an incremental loan facility.
Sample definition
“All-in Yield” means, as to any indebtedness, the yield thereof, whether in form of interest rate, margin, original issue discount, upfront fees, any interest rate floor, similar fees or otherwise in each case, incurred or payable generally to lenders (or other lenders, as applicable) providing such loans (or other indebtedness, if applicable) in the primary syndication thereof, whether in the form of interest rate, margin, original issue discount, up-front fees, rate floors, similar fees or otherwise; provided that original issue discount and up-front fees shall be equated to interest rate based on an assumed four year average life.
Drafting points
Borrowers almost universally aim to avoid triggering an MFN provision, as it adds to their interest costs for the existing financing. Lenders, however, have a more complex position with respect to MFN drafting. On the one hand, ensuring broad applicability of the MFN provision will protect their existing debt relative to any incremental financing. On the other hand, a lender who might also be a future provider of incremental financing (to the exclusion of other lenders in the existing financing) would prefer to avoid triggering the MFN provision (which would require sharing economics with the other existing lenders).
The following may be considered when drafting MFN provisions:
- Consider any broad or ambiguous terms. When negotiating the definition of “All-In Yield,” look for any general, vague references to the types of fees or other indebtedness that is covered by the calculation of the All-In Yield. An example of such a vague reference is the reference to “similar fees” included in the definition above. This allows for subjective interpretation of what fees are “similar,” potentially pulling the MOIC into the calculation. Parties may have different preferences about including such broad language, but they should each consider how it may impact future negotiations. To avoid uncertainty that the MOIC will not be included in the calculation, it is best to negotiate a definition of “All-In Yield” that does not leave any of the items to be included in the calculation up to interpretation at the time the calculation is actually needing to be made.
- Exclusions. Specific exclusions to the All-In Yield definition (which the above sample definition lacks) can make it clear that any MOIC (in addition to any other prepayment penalty or termination fee) will not be included in the All-In Yield definition. Such exclusions are typically drafted to list out the types of fees that should be included (ie, arrangement fees, structuring fees, syndication fees, advisory fees, unused fees, and exit fees) and can also include a general reference to “other similar fees.” While there is an argument that any MOIC is a fee similar to an “exit fee,” a specific reference to any MOIC as either included or excluded should be considered to eliminate ambiguity. As discussed above, leaving an ambiguous reference to “other similar fees” in the description of the fees captured by the definition of “All-In Yield” can be problematic as it opens the door to the argument that the MOIC is a fee that is captured by the MFN provision. Where a party may not be able to specifically exclude a MOIC from the definition, they can negotiate a more general reference in the exclusions to preserve the argument that the MOIC is not captured by the definition.
- Consultation right. Although not included above, the definition of All-In Yield may specifically identify the party that is responsible for calculating this amount (typically the administrative agent in respect of the existing facility, sometimes in consultation with the borrower). While not common, lenders may be able to push for a consultation right with respect to the calculation of the All-In Yield to have a better understanding of the borrower’s view when a definition is ambiguous.
- Side letter carve-outs for MFN exclusions. Parties may consider whether side letters or separate agreements may carve out specific fees (like MOICs) from triggering MFN provisions, while maintaining commercial flexibility. However, this approach must be coordinated carefully to avoid conflicts with syndicate members or administrative agents.
- Time-based exclusion of MOIC from All-In Yield. Borrowers can propose, or lenders can accept, a time-limited exclusion of a MOIC from the All-In Yield calculation. For example, the MFN provision could apply only to economic terms which would be triggered by a prepayment of the new debt in the first 12–24 months, and MOIC provisions applicable after that window would not be relevant for MFN comparisons. Note in particular the “assumed four-year average life” concept in the example definition above; if the parties wished to capture future MOICs in the All-In-Yield, calculating the same four-year life assumption could be utilized for that purpose as well. This allows flexibility while protecting lenders from aggressive early refinancings.
Ultimately, careful consideration of a range of future financing possibilities – and careful drafting to reflect intended outcomes – can help align the interests of both borrowers and lenders.
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