Overview

Earlier this year, The Hertz Corporation (the “Company”) issued $750 million of 12.625% First Lien Senior Secured Notes due 2029 (the “Initial Notes”) under a June 28, 2024 Indenture (as supplemented by a July 19, 2024 First Supplemental Indenture, the “Indenture”). Last week, the Company marketed $500 million of add- on notes under the Indenture (the “Additional Notes” and, together with the Initial Notes, the “Notes”). The Additional Notes were marketed via a December 5, 2024 Preliminary Offering Memorandum (the “Preliminary OM”).

Concurrently with the Additional Notes offering, the Company commenced a consent solicitation with respect to certain proposed amendments to the Indenture (the “Proposed Amendments”). The most interesting feature of this consent solicitation is that the Company is rigging the vote by having the Additional Notes be deemed to consent. Due to this vote rigging, the Company has already locked in sufficient votes to ensure that the Proposed Amendments are approved. We explain the Proposed Amendments, explain how the vote rigging works, and consider whether the Proposed Amendments may not actually be allowed under the Indenture.

This report is the product of Covenant Review. Covenant Review is an affiliate of Fitch Group, which also owns Fitch Ratings. Covenant Review is solely responsible for the content of this report, which was produced independently from Fitch Ratings.

All content is copyright 2024 by Covenant Review, LLC. The recipient of this report may not redistribute or republish any of the information contained herein, in part or whole, without the express written permission of Covenant Review, LLC and we will criminally and civilly prosecute copyright violations against firms and individuals who unlawfully distribute our work. The use of this report is further limited as described in the subscription agreement between Covenant Review, LLC and the subscriber. The information contained in this report is intended to generally describe certain covenant features. This report is not comprehensive, is not confidential to any person or entity, and should not be treated as a substitute for professional advice in any specific situation. Covenant Review, LLC makes no warranty, express or implied, as to the fitness of the information in this report for any particular purpose. If you require legal or other expert advice, you should seek the services of a qualified attorney or investment professional. Covenant Review, LLC does not render, and nothing in this report constitutes, legal or investment advice, and recipients of this report will not be treated or considered by Covenant Review, LLC as clients or customers except as described in the subscription agreement between Covenant Review, LLC and the subscriber. Any covenants discussed herein may be based on those contained in the preliminary offering memorandum or draft credit agreement distributed by the issuer or borrower in connection with the issuance of the bonds or loans, and the covenants published in the final offering memorandum or contained in the final indenture or credit agreement may differ from those presented herein. The reader should be aware that the final interpretation of any bond indenture, credit agreement, security or guarantee agreement, or other bond or loan documents, will generally be determined by the issuer or its counsel, or in certain circumstances, by a court or administrative body.

Overview

According to reports in LevFin Insights and the financial press, US-based Vista Equity Partners (“Vista”) recently made a $50 million capital injection into Pluralsight, Inc. (“Pluralsight”), one of its portfolio companies.12 The proceeds were reportedly used to fund an interest payment on Pluralsight’s ~$1.5b private credit term loan. Pluralsight was unable to make the interest payments due to escalating interest rates, which also saw Vista write off the entire value of their equity investment.3 The capital injection was reportedly made by way of a loan from Vista to a newly formed non-guarantor subsidiary of Pluralsight, which then upstreamed an unspecified amount of the proceeds to Pluralsight. This new loan was secured by intellectual property assets originally pledged to the term loan lenders. The company reportedly transferred the assets from one or more guarantors of the ~$1.5b term loan to the newly formed non-guarantor subsidiary.4 This transaction set off alarm bells in the market that lender-on-lender violence is coming to private credit. Our view is that the alarm bells are premature—for now. The defining characteristic of LMEs in the modern era is lender-on-lender violence. Based on available reports, this was not the case here. More broadly, we think that while we cannot rule out the possibility of classic lender-on-lender violence style LMEs in private credit, we think plain vanilla restructurings will remain par for the course.

PluralSight – What Happened?

There are a number of key differences between what was purported to have occurred in Pluralsight versus a typical LME involving lender-on-lender violence.

• “Plain sight” Covenant Capacity
  • We suspect the company utilized “plain sight” covenant capacity to (i) transfer IP to a newly formed non-guarantor restricted subsidiary, (ii) incur debt at such restricted subsidiary and (iii) dividend a portion (or all) of such proceeds to the borrower to satisfy the upcoming interest payment.
  • This kind of flexibility is contained in nearly all credit agreements, subject to agreed caps.
  • In contrast, the typical drop-down transaction is done at unrestricted subsidiaries. This is more problematic than dropdowns done at non-guarantor restricted subsidiaries because covenant capacity is not needed for any secured debt at unrestricted subsidiaries or for dividends paid by unrestricted subsidiaries.
• Sponsor Priming Debt
  • Rather than a lender or group of lenders priming other lenders, the priming debt in this case was reportedly provided by the sponsor. Sponsor capital injections are typically done by way of additional equity. Not the case here. The Vista loan to Pluralsight’s non-guarantor subsidiary primed the secured lender group with a structurally senior claim with respect to the transferred IP and associated debt at such restricted subsidiary. And while such restricted subsidiary is subject to covenant restrictions, it is not a guarantor, nor are the transferred assets deemed collateral supporting the obligations following such permitted transfer.5

• Differences from J. Crew

• • Pluralsight effectively only utilized “step one” of the two-step J. Crew trap door, moving collateral from guarantors to non-guarantor restricted subsidiaries utilizing capped investments basket capacity. Thus, the newly formed restricted subsidiary holding the transferred IP remains subject to the credit agreement covenants and basket capacity to incur secured debt and pay dividends. In J. Crew, the collateral was moved outside of the restricted group in a subsequent second step, utilizing a hidden trap door permitting intercompany investments outside of the restricted group to unrestricted subsidiaries (so long as the initial investment was permitted). No such trap door was available here.

BSL vs Direct Lending – Key Differences and Impact on LMEs with Lender-on Lender Violence

There are key differences in the tone and tenor of broadly syndicated loans (“BSLs”) and direct lending or private loans which impact the dynamics of LME transactions.6 Private credit and direct lending generally have the following features which are not readily found in BSL transactions:

• Smaller lender groups
  • Among others, negotiations amongst direct lenders are not as fractured as those between the BSL buy-side and sell-side.
• Relationships—amongst lenders and between lenders and sponsors
  • Private credit lenders are long-term players; they are not looking for one-off opportunities.
  • Many of the private credit lenders are repeat “club” deal lenders, where sponsors will reach out to contacts at existing relationship lenders to club together a proposed deal. This often results in repeat players, with the same sponsor and lender group working together on different deals. Given this dynamic, both sponsors and private credit lenders tend to consider the overall lending relationship (existing and anticipated) more carefully, in addition to the transaction economics, when determining their course of action in any individual restructuring.
• Limited liquidity of private credit loans and lack of transparency
  • This means there is limited activity from distressed players willing to provide opportunistic new money financing that primes existing debt.
  • Also, there is limited opportunistic trading into a name at distressed levels with expectations of an oversized return even if the ultimate recovery is only at par or less.
• Lender protections
  • Certain lender favorable provisions prevalent in direct lending deals, including cross-over voting (requirements for two or more unaffiliated lenders to constitute a majority) and the increased prevalence of Serta provisions, make it more difficult to prime the minority in smaller lender groups.
• Unity of Identity
  • Even with a cov-lite structure, there is unity of identity of revolver lenders and term lenders, so all lenders get an early warning signal and have leverage to negotiate.

Each of these dynamics leads direct lending to, in the current state of the market, be less susceptible to outright evasive LME transactions and lender-on-lender violence.

However, continuing growth of the private credit market with respect to the number of players, individual deal size, and the size of the market overall could change the dynamics identified above. Increased liquidity could lead to increased distressed and opportunistic trading.7 More lenders in individual deals could create inter-lender frictions and reduce the effectiveness of cross-over voting and other lender protections. More players in the market may lessen the importance of relationships.

Takeaways and Considerations

• While Pluralsight is not a typical LME with lender-on-lender violence, it is a more vanilla restructuring which reportedly resulted in sponsor priming debt. No latent strategy was used. Instead, non-guarantor restricted subsidiary basket capacity was utilized to transfer IP, incur priming debt held by the sponsor and to distribute the proceeds to the borrower. This can be considered a version of an uptiering transaction, albeit without lender-on-lender violence.
• Lenders and their advisors should make sure they are paying close attention to covenants for non-guarantor restricted subsidiaries, including their ability to incur secured debt and to make investments and pay dividends. Lenders should pay attention to not just basket sizing, but the related guardrails and how such baskets are able to be utilized (e.g., whether non-guarantor restricted subsidiaries can pay dividends to the financial sponsor as opposed to just guarantors).
• Pluralsight is separate and distinct from drop-down transactions involving unrestricted subsidiary asset transfers, as characterized by the J. Crew transaction.
• There are key differences in broadly syndicated loans vs. direct lending loans which should place additional guardrails around the potential for LMEs with lender-on-lender violence in private credit, versus the higher frequency occurrence of these in the broadly syndicated loan market.

— Covenant Review

This report is the product of Covenant Review. Covenant Review is an affiliate of Fitch Group, which also owns Fitch Ratings. Covenant Review is solely responsible for the content of this report, which was produced independently from Fitch Ratings.

All content is copyright 2024 by Covenant Review, LLC. The recipient of this report may not redistribute or republish any of the information contained herein, in part or whole, without the express written permission of Covenant Review, LLC and we will criminally and civilly prosecute copyright violations against firms and individuals who unlawfully distribute our work. The use of this report is further limited as described in the subscription agreement between Covenant Review, LLC and the subscriber. The information contained in this report is intended to generally describe certain covenant features. This report is not comprehensive, is not confidential to any person or entity, and should not be treated as a substitute for professional advice in any specific situation. Covenant Review, LLC makes no warranty, express or implied, as to the fitness of the information in this report for any particular purpose. If you require legal or other expert advice, you should seek the services of a qualified attorney or investment professional. Covenant Review, LLC does not render, and nothing in this report constitutes, legal or investment advice, and recipients of this report will not be treated or considered by Covenant Review, LLC as clients or customers except as described in the subscription agreement between Covenant Review, LLC and the subscriber. Any covenants discussed herein may be based on those contained in the preliminary offering memorandum or draft credit agreement distributed by the issuer or borrower in connection with the issuance of the bonds or loans, and the covenants published in the final offering memorandum or contained in the final indenture or credit agreement may differ from those presented herein. The reader should be aware that the final interpretation of any bond indenture, credit agreement, security or guarantee agreement, or other bond or loan documents, will generally be determined by the issuer or its counsel, or in certain circumstances, by a court or administrative body.