The Art of M&A – A Merger/Acquisition/Buyout Guide : [PDF Download]

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“Compared with senior debt agreements, unsecured junk bond indentures are simpler, fitting the classic bond indenture mold. Unlike senior debt instruments, which provide for total information flow to lenders, hair-trigger default provisions, and, in theory, extensive second-guessing and approval of management decisions, junk bond indentures tend to rely more on the borrower’s good judgment and the value of the company as a going concern and limit themselves to protecting against major restructurings or asset transfers or increases in amounts of senior or secured debt.

This difference in approach reflects the longer-term nature of such debt and the impracticality of obtaining consents from a large, diverse group of public bondholders. In the very rare case that the junk bonds are secured, however, a more elaborate set of covenants relating to the protection of collateral will be included.

Generally, borrowers should try to limit the financial covenants in junk bond issues to incurrence tests rather than maintenance tests. In other words, the covenants should not require that any specified level of financial health be maintained and should be breached only by a voluntary act, such as the four normal circumstances: paying a prohibited dividend, incurring prohibited debt, merging or combining with another company or selling assets unless certain tests are met, or dealing with affiliates at less than arm’s length.

These covenants will often closely restrict operating subsidiaries of the borrower to ensure that all debt is incurred on the same corporate level.”

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