Explore how Non-Loan Party Restricted Subsidiaries are reshaping the risk landscape for lenders. This article reveals how their EBITDA is often included in loan covenant calculations— despite not backing the debt—creating hidden vulnerabilities. Using real-world scenarios and the recent At Home transaction, it exposes the subtle, but serious, threats these subsidiaries pose, and why lenders must rethink their protections in today’s evolving market.

A sophisticated company negotiating loan terms with its lender typically apportions obligations and restrictions among various categories in such company’s corporate family – most commonly referred to as Loan Parties, Non-Loan Party Restricted
Subsidiaries and Unrestricted Subsidiaries. Over the past several years, the most aggressive liability management transactions have utilized Unrestricted Subsidiaries as the cornerstone for such transactions. As sponsors and borrowers, however, expand their playbooks and devise more creative transactions, Non-Loan Party Restricted Subsidiaries have garnered more attention. The recent At Home transaction used a Non- Loan Party Restricted Subsidiary and put a spotlight on one such risk -- the so-called “double dip”. But that is not the only potential hazard for lenders. This article highlights the treatment afforded to the EBITDA of Non-Loan Party Restricted Subsidiaries, and the adverse impact such treatment may have on lenders.

Loan documents generally refer to “Loan Parties” as company entities that have a direct obligation to repay a given loan (or, alternatively, guaranty such loan) – and such entities typically pledge collateral to secure the underlying debt. Lenders routinely bargain for covenants and other terms to restrict the activities of Loan Parties (e.g., incurrence of indebtedness, asset sales, transactions with affiliates, etc.)

A second customary category of entities in loan agreements is “Unrestricted Subsidiaries”, which do not provide any credit support or otherwise guaranty the underlying loan and, as the name suggests, are not bound by the covenants and other restrictions of the loan agreement.

A third category is “Non-Loan Party Restricted Subsidiaries” – which are entities in the borrower’s corporate family that do not have a primary obligation to repay the loan (or provide a guaranty), nor do such entities pledge collateral to secure the underlying debt. But unlike Unrestricted Subsidiaries, Non-Loan Party Restricted Subsidiaries are bound by the covenants and other restrictions of the loan agreement. As such, the failure of a Non-Loan Party Restricted Subsidiary to comply with the terms of the loan agreement (by, for example, incurring indebtedness above a specified amount) would trigger a default under such loan agreement.

Over the last few years, lenders have increasingly focused on the risks posed by Unrestricted Subsidiaries. The lenders to Envision, for example, thought they had sufficient protections around preserving the value of the borrower’s coveted ambulatory unit, only to witness that business unit become an Unrestricted Subsidiary. Similarly, the lenders to Instant Brands witnessed valuable assets transferred to an Unrestricted Subsidiary (which then raised structurally senior debt secured by those “lost” assets).

Much brainpower has been exuded, and ink has been spilled, to protect
against threats posed by Unrestricted Subsidiaries, and rightly so. But lenders should not lose sight of a key hazard posed by Non-Loan Party Restricted Subsidiaries: the application of EBITDA. 

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