TFE: Modern Priming Mechanics Deep Dive

how modern priming mechanics work, analyze landmark cases that established key precedents

Author

Arjun Lohan
October 28, 2024

Welcome to The Financial Engineer Newsletter.

Today we learn how companies manage their liabilities, particularly through increasingly sophisticated priming transactions.

Just as creditors have developed cooperation agreements to protect their interests, borrowers have responded with increasingly sophisticated priming structures. This represents an "arms race" between debtors and creditors that continues to innovate the restructuring space.

Evolution of Priming Mechanics

The evolution of priming mechanics traces back to the zero-interest rate era, when traditional covenant packages failed to anticipate the creative liability management exercises we see today.

Historical Context

Pre-2016, most credit agreements followed relatively standard structures:

  • Simple first-lien/second-lien priorities

  • Basic restricted payment covenants

  • Limited flexibility for structural changes

This changed with J.Crew's innovative 2016 transaction, which established the "trap door" precedent allowing companies to transfer valuable assets outside existing creditor liens. The transaction worked as follows:

  1. Transferred $250 million of trademark assets to an unrestricted subsidiary

  2. Used IP as collateral for new debt issuance

  3. Licensed back the trademarks to continue operations

This seemingly simple three-step process fundamentally changed how market participants approached liability management. Post J.Crew, priming mechanics have evolved into increasingly complex forms:

  • Drop-down financings

  • Up-tiering transactions

  • Triple-dip structures

  • Super-senior facilities

Key Priming Structures

Modern Priming Structures

Today's priming transactions have evolved far beyond the original J.Crew model. Let's examine the key structures that define modern priming mechanics.

The most established priming structure involves transferring valuable assets to unrestricted subsidiaries. This creates what practitioners call "structural priority" through several key steps:

  1. Formation/designation of unrestricted subsidiary

  2. Strategic asset transfer (often IP or real estate)

  3. Automatic release of existing liens through careful covenant navigation

  4. New debt issuance against transferred assets

  5. Optional license-back arrangements to continue operations

Up-Tiering Transactions

A more aggressive approach that creates contractual priority within the existing credit structure:

  • New money "super-priority" loans from existing lenders

  • Exchange of existing debt for priority positions

  • Subordination of non-participating lenders

  • Typically requires majority lender consent (50%+1)

Triple-Dip Structures

The latest evolution combines multiple priming techniques to create three separate claims on the same assets:

  1. First claim through structural priority

  2. Second claim via contractual priority

  3. Third claim through guarantee structures

Super-Senior Facilities

A specialized structure featuring:

  • Priority position in enforcement proceeds waterfall

  • Shared collateral with pari passu creditors

  • Standalone documentation rather than amendments

Recovery Waterfall Structure

Landmark Cases

The evolution of priming mechanics is best understood through analyzing landmark transactions that established key precedents.

Serta Simmons (2020)

The transaction that validated up-tiering as a viable strategy:

  • Created $200mm of new super-priority first-out debt

  • Exchanged ~$1bn of existing first-lien loans at 74%

  • Exchanged $300mm of second-lien loans at 39%

  • Established $875mm super-priority second-out tranche

Key Innovation: Demonstrated that "loose documents" could enable priority shifts without unanimous consent.

Boardriders (2020)

Attempted an aggressive up-tiering transaction that ultimately faced significant pushback:

  • Proposed new $135mm super-priority facility

  • Offered existing lenders chance to participate

  • Non-participating lenders would be subordinated

  • Transaction ultimately modified after creditor opposition

Market Response & Evolution

The market response to these priming transactions has been swift and multifaceted, creating an ongoing "arms race" between borrowers and lenders.

Documentation Changes

Credit agreements now typically include enhanced protections:

  1. "J.Crew Blockers"

    • Explicit restrictions on IP transfers

    • Limitations on investment capacity

    • Enhanced collateral protection provisions

  2. "Serta Stoppers"

    • Stricter pro rata sharing requirements

    • Modified voting thresholds

    • Anti-layering provisions

  3. "Triple-Dip Prevention"

    • Restrictions on guarantee structures

    • Limits on unrestricted subsidiary formation

    • Controls on intercompany claims

Lender Behavior

The threat of priming has changed how lenders approach distressed situations:

  • Increased focus on early intervention

  • Formation of blocking positions (>33.4%)

  • Development of cooperation agreements

  • Enhanced monitoring of covenant compliance

Recent court decisions have shaped the legal landscape around priming transactions.

  1. Contract Interpretation

    • Courts generally enforce "clear and unambiguous" contract terms

    • Technical compliance often trumps "spirit" of agreement

    • Sophisticated party standard applies

  2. Fiduciary Duties

    • Directors can prioritize company interests over individual creditors

    • Good faith requirement remains

    • Business judgment rule provides protection

Notable Decisions

Serta Simmons (2023)

  • Upheld validity of up-tiering transaction

  • Emphasized importance of explicit prohibitions

  • Confirmed non-pro rata treatment permissible under documents

Trimark (2021)

  • Validated selective refinancing rights

  • Reinforced majority lender consent provisions

  • Distinguished between prohibited subordination and permitted priming

Future Implications

The continued evolution of priming mechanics has several important implications for market participants.

For Borrowers

  • More complex liability management options

  • Higher execution risk

  • Increased documentation scrutiny

  • Need for sophisticated legal counsel

For Lenders

  • Enhanced focus on documentation

  • Premium on blocking positions

  • Importance of early intervention

  • Value of creditor cooperation

Market Evolution

We expect to see:

  1. More Complex Structures

    • Hybrid priming approaches

    • Multi-jurisdictional transactions

    • Novel collateral packages

  2. Enhanced Protections

    • Stronger sacred rights

    • Explicit priming prohibitions

    • Detailed transfer restrictions

  3. New Battlegrounds

    • Collateral valuation disputes

    • Guarantee structure challenges

    • Voting rights litigation

Conclusion

Modern priming mechanics represent an example of financial engineering driven by necessity. While these transactions provide vital flexibility for distressed companies, they also highlight the ongoing tension between debtor and creditor rights.

As we look ahead, the key question isn't whether priming mechanics will continue to evolve, but rather how the market will balance the legitimate needs of distressed borrowers against appropriate creditor protections.

Note: Above analysis is for informational purposes only and does not constitute financial or investment advice. If you observe any errors in numbers, figures, or other information presented here, please email me at [email protected].

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