Are relationships protecting private credit from LMEs?

If your downside case depends on a sponsor choosing not to use a contractual flexibility it has negotiated, that choice deserves careful scrutiny.

Kirkland’s H.T. Flanagan made an interesting observation on Bloomberg’s Credit Edge podcast. Some private equity sponsors resist aggressive liability management because they value their lenders’ support for future acquisitions, even where the documents leave room for a transaction.

That is a credible commercial consideration. A dependable financing relationship can be valuable, particularly when a sponsor needs decisions quickly or a business needs additional support. Whether the strength of the relationship should be treated as a sufficient answer by an investment committee to a documentation concern is another question altogether.

Test the assumption behind the relationship

Consider a hypothetical loan where the documents permit a material asset transfer without every lender’s consent. The sponsor has never attempted anything similar, and the lender expects a long pipeline of future business. So the investment committee accepts the flexibility.

Now change one assumption. The original lender can’t provide further capital, while another investor is prepared to fund a rescue if it receives access to those assets. Would the sponsor still put the same value on preserving the existing relationship?

There is no single right answer. The point is to make the assumption visible. A restriction in the documents has a defined scope and amendment threshold. A commercial incentive depends on circumstances that can – and inevitably do – change. The investment decision should explain how much weight it places on each.

Pretend the relationship itself is an aspect of the credit or the docs, and make sure the credit paper scrutinizes the actual relationship being relied on. Is it with the individual deal team, the sponsor’s wider organization, or a particular fund? Who has the authority to make the next decision? What evidence supports the expectation of continued cooperation?

Examine your own position within the lender group

A good relationship with the lead lender also leaves a question for a smaller participant. Suppose the lead can fund a new facility and negotiate enhanced protections, while another lender has reached its concentration limit. They may agree that the company needs support and still have different views about its terms.

For that smaller lender, the useful analysis is specific. Which decisions require its consent? Can other lenders approve changes that affect its position? Is it entitled to participate in new financing, and could it actually do so? Being invited into a transaction is less useful if the investment mandate prevents participation.

This is also a reason to examine a proposed amendment as a fresh allocation of risk. A maturity extension may give the company time to recover. The accompanying changes still need to be assessed on their own terms. What additional flexibility is being granted, and what does each lender receive in return?

Bake the consequences into the credit decision

I would ask the investment team to complete one sentence: if our expectation of cooperation is wrong, the documents would allow the following action, with the following consequence for our investment.

That answer should connect the drafting to an economic outcome. It might identify assets that could leave the collateral package, a change in priority that could be approved without the lender, or a financing opportunity the lender cannot afford to join. The analysis should then explain the relevant limits, including consent requirements and applicable law.

A team may decide to accept the exposure because the price, business quality or other protections justify it. What matters is that the decision acknowledges the exposure. A good relationship with the sponsor can give lenders comfort. But they still need to understand what the sponsor could do under the loan documents, and how that could affect their recovery, if its priorities change.