The Cumulus Media Decision: When a Covenant Basket Becomes Exclusive
By Wade M. Kennedy
In the world of debt finance, borrowers and lenders rely on the covenant “baskets” in their credit agreements to permit various actions by the borrowers that otherwise would be prohibited by the broad restrictions typically contained in the negative covenants. These activities are often fundamental to running the business and include making investments, selling assets, granting liens and incurring or refinancing debt. These activities, however, can only be undertaken in conformity with the negative covenants and other restrictions contained in a borrower’s applicable credit agreements. Particularly in the context of larger credit facilities with multiple tranches of debt (revolving facilities, term loan B facilities, etc.), these baskets can become important in not only permitting ordinary course activities of the borrower, but also in exceptional circumstances of determining the scope and nature of restructuring and refinancing debt of borrowers who find themselves in distressed situations.
This was the circumstance confronting the borrower and its various debt holders in the recent Cumulus Media decision handed down by the U.S. District Court for the Southern District of New York (the “Court”). The company, Cumulus Media Holdings, Inc. and Cumulus Media Inc. (collectively, “Cumulus” or the “Company”), proposed a restructuring of its debt that essentially would have allowed the holders of certain unsecured senior notes (the “Senior Notes”) to exchange their obligations for equity and new secured revolving debt ranking equally with the Company’s existing senior secured term loan (the “Term Loan”). The holders of the Term Loan (the “Term Lenders”) and the agent under the Company’s credit agreement (the “Credit Agreement”) opposed the proposed restructuring.
The Court sided with the Term Lenders and concluded that the proposed refinancing was not permitted under the Credit Agreement. In doing so, the Court relied primarily on a determination that the negative covenant basket permitting the Senior Notes and “Permitted Refinancings” actually prohibited the Company from incurring other debt with the same refinancing purpose under another negative covenant basket in the Credit Agreement. The Court read the basket permitting the Senior Notes (and permitted refinancings) as the only debt that the Company was allowed to bear in respect of the Senior Notes, notwithstanding the existence of separate baskets that might otherwise permit debt to refinance (the Senior Notes). This “negative inference” in the Cumulus decision is unique in our experience and, if applied more broadly in interpreting such baskets in the future, will compel changes in how (at least certain) negative covenants are understood and ultimately drafted. As discussed below, we believe the ultimate result was correct, but have concerns about the reasoning the Court used in reaching it.
Whether this decision will survive appeal (if any) or is adopted in other cases remains to be seen, but certain conclusions can be drawn from the reasoning employed that may inform drafting and structuring decisions today.
The general facts surrounding the Cumulus Media decision, are as follows.
In a motion for summary judgement, the Court was asked to determine whether a proposed restructuring (the “Restructuring”) violated the negative covenants in the Company’s Credit Agreement. JPMorgan Chase Bank, N.A. acted as administrative agent under the Credit Agreement (the “Agent”) and the case was initiated as a suit by the Company against the Agent for failing to approve the Restructuring.
The Credit Agreement included two facilities secured on a pari passu basis by essentially all assets of the Company: (1) the Term Loan, with an outstanding balance of approximately $1.81 billion and (2) a secured revolving facility (the “Revolver Facility”) of up to $200 million, which was then undrawn (due to a maximum leverage limitation (the “Leverage Limitation”) which the Company could not meet). The Credit Agreement also provided for an optional secured incremental revolver facility (the “Incremental Facility”) that could be exercised with the agreement of the participating revolving lenders. Total assets of the Company were approximately $1.45 billion, so, even without the obligations under the Revolver Facility, the Term Loan was materially undersecured.
The Restructuring was designed to retire all $610 million of the Senior Notes using $305 million of secured loans under the Revolver Facility ($200 million existing plus $105 million of the Incremental Facility) and certain equity to be issued. The Restructuring was to be implemented through the following process:
- Commitments of the existing lenders under Revolver Facility (unfunded) would be assigned to the holders of the Senior Notes;
- The “new” revolving lenders would then amend the Credit Agreement to, among other things, remove the Leverage Limitation; and
- The Company would exercise the Incremental Facility and then borrow a total of $305 million of secured loans under the increased Revolver Facility, which would be used (together with certain equity) to repay and retire the unsecured Senior Notes.
The end result of the Restructuring would be that the Term Lenders would be further diluted in their collateral position by the additional $305 million of secured revolving debt and the holders of the Senior Notes would have a material portion of their obligations converted to senior secured debt.
Specifics of the Dispute
The principal basis of the dispute (and the arguments presented by the parties) revolved around the negative covenant regarding “Restricted Payments”, in this case, a Restricted Payment consisting of prepayment of debt under the Senior Notes. Section 8.8 of the Credit Agreement generally prohibited any prepayment of debt but included a basket under clause (j) permitting “any refinancing of the Senior Notes or any Permitted Refinancing thereof permitted pursuant to the terms [of the Credit Agreement]” (emphasis added). Use of the lower-case “any refinancing” rather than the defined term “Permitted Refinancing” created the loophole through which the Company wished to implement a refinancing of the Senior Notes that was arguably not a “Permitted Refinancing”.
The Company argued that the proposed borrowings on the Revolver Facility were within the scope of “any refinancing…permitted hereunder” because, first, the draw under the Revolver Facility was clearly permitted under Section 8.2(a) of the Credit Agreement (post-amendment) and second, the repayment of debt was permitted as a “general corporate purpose” under the use of proceeds provision of Section 3.2 of the Credit Agreement. The position underlying this argument was that, if the Company could construct piecemeal the components of a refinancing not otherwise prohibited under the Credit Agreement (debt permitted to be incurred under one section and permitted to be used to repay debt under another section), whether the refinancing was a “Permitted Refinancing” was irrelevant (the Company asserting that this is what the parties intended in using the lower-case “refinancing”).
On the other hand, the Term Lenders and the Agent argued that the language of Section 8.8 of the Credit Agreement (the general prohibition on repayment of other debt, including the Senior Notes) only allowed a refinancing and repayment of the Senior Notes if the refinancing itself was permitted elsewhere under the Credit Agreement and nowhere was such a refinancing specifically allowed (other than as part of a “Permitted Refinancing”). The Term Lenders argued that a reading of the general use of proceeds section as an independent basis for permitting repayment of the Senior Notes would have rendered other specific limitations of Section 8.8 meaningless. As an example of this, they noted that Section 8.8(j)(ii) included an additional basket for repayment of the Senior Notes if a Leverage Ratio of 5:00 to 1:00 was met (even if not a “Permitted Refinancing”). Based on the Company’s argument, such payments could be made so long as revolving loans generally were permitted under Section 8.2(a) (requiring only a 4.00 to 1.00 Leverage Ratio), making this additional basket meaningless.
In essence, the Term Lenders agreed that the Company could incur the Revolving Loans under Section 8.2(a); however, it was prohibited from using that debt to repay the Senior Notes under Section 8.8(j). The position underlying this argument is that the intent of the parties should be determined by reading the agreement as a whole so that no material provision is nullified, and that this reading made clear the intent of the parties to limit refinancings of the Senior Notes solely to “Permitted Refinancings” (since no other specific provision expressly allowed any payment of the Senior Notes as part of any other refinancing).
After a recess and considering both oral arguments and supporting briefs, the Court concluded that the Restructuring would violate the Credit Agreement, in essence reaching the conclusion sought by the Term Lenders. But instead of relying on the payment restrictions in Section 8.8(j)(i) (the focus of the Term Lenders argument), the Court based its decision on the incurrence restrictions under Section 8.2. Specifically, the Court found an implicit restriction in Section 8.2(h) (only briefly mentioned in oral arguments) which permitted “Indebtedness of the Borrowers in respect of the Senior Notes . . . and any Permitted Refinancing thereof.” The Court determined that Section 8.2(h) encompassed the sole and exclusive debt that could be incurred in respect of the Senior Notes and, thus, such debt was limited to only the Senior Notes and “Permitted Refinancings” thereof. By implication, the Court reasoned, no other debt refinancing the Senior Notes was permitted to be incurred by the Company, even if such debt was permitted elsewhere in Section 8.2. So, rather than relying on the absence of a provision specifically permitting the repayment portion of proposed refinancing, the Court pointed to Section 8.2(h) as prohibiting the incurrence portion of the proposed refinancing, even if permitted as revolving loans under Section 8.2(a) of the Credit Agreement. In the Court’s reasoning, the use of proceeds of such debt apparently became determinative as to whether such debt could be incurred.
Not only is this approach contrary to the position advanced by the Term Lenders, but it was the primary basis for the Court’s decision despite the existence of other available rationales. Later in its decision, the Court did go on to essentially integrate an argument that the repayment portion of the refinancing was not permitted. Specifically, the Court determined that reading the general use of proceeds provision in Section 3.2 to override its reading of the specific limitations in Section 8.8 rendered Section 8.8 meaningless and was not proper. It expressly refused to agree with the Company’s position that it could cobble together disparate provisions that permit the various components of the proposed refinancing (incurrence in one provision and use of proceeds under another) and therefor such action was “permitted.” This approach was viewed by the Court as a means of avoiding a fundamental restriction intended by the parties.
Because of the blurred distinction between the incurrence of debt permitted under customary debt negative covenants and the purpose for which that debt is incurred, the decision poses real concerns for understanding negative covenant baskets and whether they are to be read as exclusive or collective in nature.
General Implications for Debt Negative Covenant Interpretation
The principal problem with this decision is the Court’s attempt to bridge a disconnect between the negative covenant restricting incurrence of debt (step one of any refinancing) and the negative covenant restricting repayment of debt (step two of any refinancing). If the intent was that no debt be incurred to refinance the Senior Notes other than a Permitted Refinancing, such restriction would almost certainly be set forth in Section 8.8 (which specifically addresses repayment), not Section 8.2 (which addresses incurrence). Had the repayment restriction been drafted to prohibit any “repayment of the Senior Notes other than a Permitted Refinancing (or a subsequent Permitted Refinancing thereof)”, the Court would not have had to look elsewhere to determine the intent (and find a limitation on the proposed refinancing as a whole). Unfortunately, rather than relying on the argument presented by the Term Lenders (e.g., that there was no other “refinancing” payment permitted elsewhere in the Agreement), the Court relied on the novel view that the incurrence of debt permitted under one basket prohibited the incurrence of debt for the same purpose under another basket.
The first take-away from this decision is that it should be read in a limited fashion, to apply only to baskets that restrict both the debt incurred and the use or application of such debt to a “permitted refinancing”. In that context, the Cumulus decision would seem to provide a basis for arguing that baskets allowing certain debt and “permitted refinancings” or similar defined terms are exclusive and, without more, prohibit the incurrence of other permitted types of debt under other baskets to refinance the debt described. Typical covenant baskets that may include “permitted refinancing” or similar terms include:
- revolving debt under the subject credit agreement,
- senior or subordinated notes or separate term loan B facilities,
- specific scheduled debt,
- capital leases and permitted purchase money debt, and
- debt acquired in connection with acquisitions.
As a drafting matter, we think care should be taken to prevent these provisions from being unduly limiting. Two potential approaches would be:
(A) specify the intent that all debt baskets are non-exclusive, particularly when referring to permitted refinancings, and rely on the restricted payment covenant to control when such debt can be used to repay other debt; or
(B) assume the debt baskets may now be interpreted as exclusive to the extent they refer to “permitted refinancings” and, consequently, provide language to the contrary in specific appropriate circumstances.
We think the first approach is likely the simpler, better option and more closely aligned with current assumptions about how negative covenant baskets are intended to operate. In fact, this approach has been implicitly adopted in many term B loan credit agreements which contain a provision in the debt negative covenant section stating that the borrower may classify debt as being incurred under various baskets in order to be permitted under the covenant. Either approach, however, should avoid confusion about the effect of negative covenant baskets and how permitted refinancings are treated.
We believe the Court reached the right conclusion regarding the proposed Restructuring, both regarding the intent of the parties that a “Permitted Refinancing” be the sole means of refinancing the Senior Notes and the fact that the general use of proceeds provision should not be viewed as superseding specific restrictions on use of funds to repay junior or unsecured debt. The argument put forward by the Company would have required the Court to find that the ability to incur general revolving debt, when read with a typically broad permitted use of proceeds, could supersede a specific provision restricting refinancing and repayment of certain debt. In this sense, the Court reached the right result albeit based on problematic reasoning. We are not sure why the Court relied on reasoning not principally put forward by either party, but given the speed in which the decision was rendered (same day as oral argument) and the context in which it occurred (a refinancing that provided no incremental cash benefit to the Company and elevated an existing unsecured tranche of debt into a secured position to the detriment of another tranche of debt), we think the Court reached the correct conclusion.
 Cumulus Media Holdings Inc. and Cumulus Media Inc., v. JPMorgan Chase Bank, N.A., et al, No. 1:16-cv-09591-KPF (S.D.N.Y. 2017) (“Cumulus”).
 The Term Loan and the existing revolving facility (then unfunded) were documented in a single amended and restated credit agreement and the Senior Notes were issued under a separate existing indenture.
 The Court also considered other arguments for and against permitting the proposed refinancing (including a provision found to restrict the ability of the Company to amend the Credit Agreement in any manner adverse to the Term Lenders), but the focus here is on the principal arguments put forward by the parties and the basis of the decision as it relates to the negative covenants in Article 8 of the Credit Agreement.
 Note that, the Credit Agreement contained a provision that would have made the Term Loans due and payable in full on an accelerated basis if the Senior Notes remained outstanding as of a certain fast approaching date, therefor the Company was highly motivated to find a way to replace and retire the Senior Notes before that date. This was the context in which the Restructuring was proposed and the dispute among the parties arose.
 The Court found a number of deficiencies in characterizing the Restructuring as a “Permitted Refinancing”.
 With respect to the argument that the general use of proceeds permitted repayment of the Senior Notes, the Court stated, “If that's the case then why -- why -- have subsection 8.8(j)([ii]) at all? For that provision to have any meaning it must exist to limit other provisions of the credit agreement such as Section 3.2.” See id. at 79.
 See id. at 44.
 See id. at 48-50.
 This amounted to a “use of proceeds” test for incurrence of debt. As the Court stated, “Section 8.2[(a)]'s permission that Cumulus borrow under revolving credit facility and/or an incremental credit facility does not allow also that Cumulus may use those funds to refinance the senior notes in a refinancing that would not qualify as a [Permitted Refinancing]. Any attempt to do so would conflict with Section 8.2[(h)] because it would leave Cumulus to bear an indebtedness related to refinancing of the senior notes that is not a [Permitted Refinancing].” See id. at 74.
 See id. at 44
 The Term Lenders advanced at least one other argument that would have resulted in the same conclusion. They argued that Section 8.16 (prohibition on the Borrower amending debt documents) prohibited any amendment to the Credit Agreement that was materially adverse to the Term Lenders and therefor the amendment removing the Leverage Limitation required Term Lender consent. See id. at 48-50.
 “What Cumulus wants me to do is extract, to pluck assorted provisions out of context, string them together in a way that may permit this refinancing but actually undermine and indeed violate the remainder of the agreement and I am not going to do that.” Id. at 80-81.
 Expanding the reading to all debt baskets that limit in some way the use to which such debt may be put is likely too broad of a reading of the holding. The Court was clearly focused on the fact that “Permitted Refinancing” was a defined term with specifically limited scope. See id. at 71. Baskets permitting purchase money obligations or capital leases would seem to be self-limiting. Similarly, application of the rationale in this decision to general baskets with no limited purpose makes almost no sense at all.
 For example, if a revolving facility is intended to be available to refinance existing scheduled debt or acquisition debt (to the extent otherwise limited to “permitted refinancings”), it may be prudent to expressly provide for repayment from other permitted baskets (i.e., “Debt outstanding on the closing date listed on Schedule , and Permitted Refinancings thereof or refinancings from indebtedness otherwise permitted under this Section ).”
 See id. at 45.
 There are certainly other interesting lessons from the Cumulus decision, including (i) the dangers of broad cross references to actions permitted elsewhere in an agreement, (ii) proper division of voting requirements between revolver lenders and term lenders and (iii) appropriate limitations on assignment of senior debt to junior debt holders, but the focus here has been the “negative inference” with respect to debt baskets.