Understanding Collateral Leakage terms

Collateral Leakage refers to actions which reduce or restrict lenders’ claim on collateral. Borrowers such as J. Crew, Serta, and Chewy are most well-known for taking such actions in response to financial distress. Serta amended its credit documents with a select group of lenders to create a brand new first-out lien that subordinated the non-participating lenders’ claim to collateral and payments. Chewy was released as a guarantor from its parent company, PetSmart, following a de minimis transfer of subsidiary equity. J. Crew reallocated intellectual property assets beyond the lender's control, resulting in a $250 million loss of valuable intellectual property for the lenders.

Our product isolates and identifies vulnerable clauses in each transaction through our platform. Additionally, it identifies the presence and absence of blockers which have been developed by market participants, helping users evaluate both vulnerability and protection to fully assess collateral leakage risk.

You can access the analysis of collateral leakage concepts in the Term Analysis for both the deal and the agreement level of analysis. For each of the three case studies, Serta, Chewy, and J. Crew, we identify several concepts bucketed into concept groups. Use the search bar or scroll to find the concept groups related to each vulnerability:

We identify the presence of the loophole, and then identify one or more blockers. From this, we can make an assessment on if there is vulnerability and if there is protection from the vulnerability.

In the case of Serta-type protection, our product identifies whether amendments that subordinate the existing liens are prohibited without all or affected lender consent. If no such language is present, then the agreement is vulnerable to Serta-like up-tiering transactions.

In the case of Chewy-type risks, if the agreement permits a guarantor to be released upon becoming non-wholly owned, this indicates a potential vulnerability. From there, we then track whether there are any mitigating conditions to such release such as requiring that the de minimis equity transfer resulting in the release be to a non-affiliate of the borrower. This additional clause would provide partial protection against guarantor release.

J. Crew-type risks are mitigated by analyzing the investment covenant section to determine if a borrower can make investments into unrestricted subsidiaries. If not, then the agreement is effectively protected from J. Crew-like down-tiering transactions. In addition to unrestricted subsidiary vulnerability, we also track whether the agreement permits non-loan party restricted subsidiary investment capacity to be used to make investments into unrestricted subsidiaries, known as the J. Crew “trapdoor”. For identifying blockers to adverse unrestricted subsidiary investment, we identify whether unrestricted subsidiaries are prohibited from owning material intellectual property.