Permitted Baskets: a Worked Example

The undertakings in a facility agreement are written broadly on purpose. A ban on other borrowing catches the company credit card; a ban on security catches the landlord's bond and the forklift on hire purchase; a ban on disposals catches the sale of an old truck. Without exceptions the borrower would be in breach in its first week, and the bank's consent desk would be approving trivia.

So each restriction carries a list. Some exceptions are named: debt owed to the lender itself, liens that arise by law, trade credit on normal terms. Others are sized: a stated amount of other debt, of other security, of disposals each year. The sized ones are the baskets, and a general basket at the end of each list catches whatever the named exceptions do not. Facilities in the style of the Loan Market Association and its Asia Pacific counterpart often gather them into defined terms such as permitted financial indebtedness, permitted security and permitted disposals.

Fixed baskets suit a business whose size is not expected to change much. A grower lets the allowance rise with the business without a consent request, and it can shrink when the business does. Builder and ratio baskets are more common in leveraged and sponsor-backed lending than in a bilateral mid-market facility. Beyond the size, four drafting points decide what a basket is worth: whether it counts amounts outstanding at any time or used in a year; whether debt under it may be secured, and over what; when a grower basket is measured, which many agreements fix at the moment the debt is incurred, so a later fall in earnings does not turn permitted debt into a breach; and whether the borrower may reclassify an item from one basket to another to free up room.

A timber processor, constructed for this page like every figure in it, owes its bank US$70m against EBITDA of US$20m. Its facility agreement carries three debt baskets and a general security basket of US$2m. Every amount is the example's, chosen to show the arithmetic, not offered as a market norm.

None of the baskets looked large in negotiation. Together they allow six-tenths of a turn of extra leverage without the bank being asked. The leverage covenant still counts the debt if the agreement's definition of borrowings includes it, so the bigger question is ranking. Up to US$10m of the US$12m can be secured: the asset financier over the saws and kilns it funded, the acquired companies' lenders over those companies' assets, and US$2m more under the general security basket. Each of those claims comes first in the assets it covers.

The grower basket has shrunk, but the debt drawn when earnings were higher stays. The basket protected the lender against new borrowing, not against the debt already in place.

A basket governs an action at the moment it is taken; a financial covenant measures the result on a test date. A borrower can stay within every basket and still fail its leverage test, or pass the test with every basket full. The two are read together because they answer different questions: what the borrower may do, and what shape the business must be in.

A basket also differs from a consent. A consent is the bank's decision on a known proposal, taken when it is made. A basket is the same decision taken in advance, before any proposal exists, which is why its size is argued so hard. Where a basket is unlimited while a ratio is met, it works like an incurrence covenant: the test is run only when the borrower wants to act.

DEFINED IN ONE PARAGRAPH → · READING YOUR FACILITY LETTER → · NEGATIVE PLEDGE →

A lender reading the baskets asks three things. What does the total come to, set against the debt and the security it is relying on? Which baskets allow security, and in New Zealand and Australia, how much of it could be a purchase money security interest that, registered in time, ranks ahead of the bank's general security in the asset financed? In the UK the same point arrives differently: equipment on hire purchase or lease belongs to the financier, so it sits outside the bank's charge from the start. And can value leave through the investment and distribution baskets to companies outside the guarantor group?

Once signed, the baskets need watching. A lender that asks for basket usage alongside the compliance certificate knows how much room is left; one that does not finds out when the room has gone. The most useful time to read them is before signing, when each one is still a number to argue rather than a right the borrower already holds.