Subscription Finance: Understanding Umbrella Facilities

In an effort to improve cost effectiveness and documentation efficiencies in the subscription finance market, participants have developed “umbrella facilities” to aggregate multiple fund borrowers under the same loan documentation. In this Legal Update, we provide an overview of umbrella facilities and the documentation process, explain the benefits of an umbrella facility in the subscription finance market, and discuss other considerations for borrowers and lenders.

What an Umbrella Facility Is

An umbrella facility is a credit facility created by one set of credit documents¹ that apply to multiple borrowers with separate borrowing bases. Within the umbrella facility, a separate borrowing base applies to the obligations of different groups of borrowers (“Fund Groups”). Typically, an umbrella facility has a shared aggregate maximum commitment, but because each Fund Group is only permitted to borrow up to its applicable borrowing base, specific Fund Groups may be subject to different sub-limits within the maximum commitment. The relative size of the sub-limits depends on the borrowing base availability and relative utilization needs of the Fund Groups. Therefore, the sub-limits for each specific Fund Group may be adjusted over the life of the umbrella facility.

How an Umbrella Facility Is Documented

Although there is one credit agreement for the umbrella facility, the facility can be structured so that certain terms and conditions within the documentation differ to address particular strategies and/or manage risks specific to a Fund Group rather than across all Fund Groups. For example, specific representations, warranties, covenants, and events of default may apply to only one Fund Group to address differences in organizational documents, investor subscription documents, or structural concerns. In addition, borrowers and their affiliated credit parties provide guarantees and collateral for the obligations of their Fund Group(s), but in some cases, the members of one Fund Group may be unable or unwilling to provide cross-collateralization or guarantees for the other Fund Groups.

Benefits of an Umbrella Facility

The benefits to using an umbrella facility in the subscription finance market include:

• Borrowers under an umbrella facility may negotiate more competitive economic terms by leveraging the shared maximum commitments and a higher aggregate commitment utilization rate. Sharing the same maximum commitment among Fund Groups allows lenders to comply with their cash reserve requirements more efficiently, which reduces the lenders’ cost of capital in connection with those commitments and may lead to more competitive financing options for borrowers. Similarly, the aggregate percentage of commitments drawn at any given time under an umbrella facility is typically higher than in a traditional credit facility because multiple Fund Groups share the same aggregate maximum commitment. Accordingly, the borrowers can pay less in unused fees.

• Borrowers benefit from lower documentation costs and faster execution timelines throughout the life of the facility. Umbrella facilities offer cost savings and execution efficiencies, especially when a new Fund Group joins the facility. Because the parties can use the previously agreed-on framework for multiple Fund Groups under the same umbrella facility without needing to enter into separate facility documentation, significant cost savings and timing efficiencies occur throughout the life of the facility. Additionally, only one set of documents needs to be re-negotiated as circumstances change. For instance, interest rate benchmark transitions and other market updates can be addressed simultaneously across several Fund Groups via a single amendment process.

• Umbrella facilities can account for individualized needs and circumstances within Fund Groups when necessary. The documentation in an umbrella facility will often include supplemental attachments with specific definitions, covenants, and representations applicable to a single Fund Group, which may be revised or amended without altering the entirety of the document. In this way, the facility can account for the differences among the Fund Groups when necessary while using uniform terms and conditions in a single set of documents to minimize legal and administrative costs.

• Lenders benefit from operational efficiencies. As the umbrella facility expands to account for additional fund borrowers and/or Fund Groups through a pre-negotiated joinder process, lenders continue to benefit from operating under a single, centralized set of documents. When additional Fund Groups join the umbrella facility, lead arrangers may be able to rely on lenders already party to the facility to provide the required additional commitments without the need to further syndicate or negotiate a new facility.

Other Considerations with Umbrella Facilities

In addition to the benefits described above, borrowers and lenders should be aware of other considerations that are relevant to umbrella facilities, such as:

• Umbrella facilities may involve increased initial structuring and documentation costs. While most cost savings are realized over the life of the facility, initial costs may be higher to account for the more complex umbrella structure. If an umbrella facility will use multiple Fund Groups, the initial drafting and negotiation of the loan documentation may incur additional costs at the outset in order to appropriately document individualized needs. For instance, the drafting becomes more intricate under an umbrella facility if the needs of borrowers across Fund Groups differ with respect to special jurisdictional considerations relevant only to a subset of Fund Groups, the need for cascading pledge structures in certain Fund Groups, or the need for certain Fund Groups to have the ability to borrow in alternative currencies. If a particular borrower’s constituent documents contain relevant debt limitations or other restrictions, the umbrella facility may need to build in covenants that are applicable to a specific borrower or Fund Group that do not apply to others. If applicable, differences in advance rates, concentration limits, and exclusion events across the Fund Groups will also add to the complexity of an umbrella facility.

• Allocation of fees and expenses can be more complicated. Another consideration is how to allocate fees and expenses that apply to the entire facility among the Fund Groups (both initially and as additional Fund Groups join throughout the life of the umbrella facility). In the event that one Fund Group has borne an outsized portion of the fees or expenses, there may need to be steps taken among the Fund Groups to correct this given that the borrowers across Fund Groups are likely to have different investors and need to separately track their financial performance.

• Syndication can be more challenging. Lenders review and obtain credit approvals with respect to each borrower and its underlying borrowing base, even within the same umbrella facility. Due to jurisdictional, currency, investor composition, or other credit-related factors, there may be circumstances where a lender is only able to provide loans to certain of the Fund Groups. The fact that the Fund Groups under an umbrella facility share the maximum commitments makes it challenging for a lender to provide a commitment to some, but not all, of the Fund Groups. This may ultimately limit the potential number of lenders willing to provide a commitment under an umbrella facility and may hinder syndication joinder efforts. While it is possible to address this concern while keeping the umbrella structure in place by maintaining separate commitments for each Fund Group instead of shared maximum commitments, this approach undercuts some of the efficiencies associated with umbrella facilities and raises other considerations which would need to be addressed, such as lender voting rights across Fund Groups.

• There may be competing requests for borrowings across Fund Groups. Because each Fund Group has equal rights to the shared aggregate maximum commitment, multiple Fund Groups could request borrowings simultaneously and their aggregate funding needs may exceed the availability under the shared commitment. In that case, the parties must determine how to allocate the funds among the requesting borrowers.

• The effects of defaults and exclusion events across Fund Groups require careful attention. The parties to an umbrella facility should also consider the impact of defaults and exclusion events within one Fund Group and how they permeate throughout the umbrella facility. For example, in the event of a default by a borrower within one Fund Group, the parties will need to consider whether the default applies to all Fund Groups equally and whether the lenders have the right to exercise default remedies against all Fund Groups. Similarly, if an investor that is included in multiple borrowing bases within the same umbrella facility fails to fund its capital commitment with respect to a single fund, the parties will need to consider whether the resulting exclusion event is triggered with respect to each Fund Group in which the applicable investor is included.

¹ Note that while the majority of umbrella facilities in the market today are documented in a single set of credit documents there is another umbrella facility structure, commonly referred to as the “Daisy Chain” approach, utilized under specific circumstances where separate credit documents are maintained for each Fund Group while preserving other elements of the umbrella facility (e.g. shared maximum commitments). This Legal Update focuses on umbrella facilities that are documented under one set of credit documents given their relative prevalence in the market.