In today’s competitive lending market, weakened loan structures and relaxed covenants have become the norm—leaving lenders with fewer safeguards when trouble arises. This article explores practical, asset-specific strategies to preserve collateral value and strengthen exit options, from inventory and receivables to real property and equity interests.

For decades, increased competition among banks and other lenders to deploy debt capital has led to a creeping relaxation of loan structures across numerous financing segments. The proliferation of private debt has not slowed this progression, sometimes described as a “race to the bottom”.

Veterans of our industry have witnessed a retreat from the documentation and underwriting convention of multiple financial covenants in favor of a single financial covenant in most transactions. Moreover, the evisceration of the defined terms that inform calculation of the remaining covenant (by virtue of the allowance of exclusions and exceptions) can render it meaninglessly easy to satisfy. In ABL agreements, the single such covenant is often an Excess Availability covenant. While that covenant might have greater value than a fixed charge or leverage covenant in assessing the ongoing health of an ABL credit, is it really a financial covenant in the traditional sense at all?

Since lenders lack the commercial power to stem the tide of declining lending standards, it is both prudent and timely to refocus efforts on the measures that can help preserve and optimize exit strategies involving the liquidation of particular pools of assets. In other words, perfected liens only take lenders so far. In both the underwriting and documentation processes, lenders and their counsel should consider and discuss how best to address the prospect of practical realization upon collateral value.

When a borrower fi les for bankruptcy protection, much of the analysis and many of the relevant issues flow principally from the question of whether the secured lender is undersecured, adequately secured, or oversecured. Outside the context of the federal bankruptcy process, however, agents and lenders may wish to exercise a range of available creditors’ remedies against a defaulting borrower -- including foreclosure on the various types of collateral discussed below, as to each of which there are important pre closing measures and post-closing considerations that deserve special attention.

1. Inventory – The inventory of Borrowers varies as widely as the range of their business models and industries. Different types of inventory are located, stored, and maintained in different ways. For example, the apparel on the shelves of a department store chain’s locations is starkly unlike industrial co generation equipment or other heavy machinery at the locations of a heavy industrial borrower’s lessees.

Lenders are prudent to insist on rights to access, move, and dispose of inventory that can be dealt with relatively easily. In this regard, we are all familiar with landlord agreements, warehouse agreements, processor agreements, and other forms of collateral access agreement. Of course, it is important to be practical in pursuing and negotiating these agreements, focusing on locations with the greatest dollar-value concentrations of inventory (such as distribution centers and warehouses) and insisting only upon access periods and rights consistent with liquidation models used in underwriting. Further, lenders often choose to concentrate their efforts in obtaining these agreements in locations in so-called “landlord lien states” – i.e., jurisdictions such as Pennsylvania, Virginia, and Washington, where a landlord has a statutory lien that primes that of a senior secured lender. In any event, in an asset-based loan transaction, a lender may elect to institute availability reserves rather than accept an agreement whose negotiated provisions may impose undue burdens relative to the rights they afford.

If a borrower is a manufacturer, access rights to its plant and equipment may be important where the prospect of the lender retaining an agent to complete work in process would be important to ensuring a full recovery of outstanding debt. Branded goods inventory may bear trademarks that have been licensed to the borrower. In that case, it is imperative that the lender obtain, directly from the licensor, a license in its favor to liquidate the goods with the trademarks in place, thereby preserving the
full value that they add to the inventory¹.

2. Accounts Receivable – In theory, most goods and services should convert to cash collections of a borrower; in cases other than C.O.D. sales, usually after fi rst taking the form of an account receivable. But merely having a lien in A/R is rarely enough, alone, to enable an agent or lender to collect such cash and repay itself. First, if the music stops, how does the lender know the identities of the account debtors and how much each one owes? Linking back to our reference to access agreements, access to A/R data is imperative. This can take the form of a shared access arrangement with respect to borrower’s computer and accounting data network and/or a right of physical access
to the books and records of borrower (usually maintained at its headquarters).

Direct resort to A/R collections is further complicated where a third party provides invoicing and collections services to the borrower. In those cases, the lender should require an agreement that expressly allows the lender to assume the contract or otherwise compels the service provider to allow the lender or its designee to step into the borrower’s shoes and have invoicing and collections services performed at the lender’s instruction and for the lender’s direct benefit.

3. Cash and Cash Equivalents – Handled properly, few species of collateral are as “money good” as actual money. That said, if advances are being made against cash and cash equivalents, there is little flexibility in the standards that should apply to the lender’s control over this collateral class. 

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