New Tax Rules May Cause Changes in High Yield Deals and Credit Facilities with Upstream Guarantees
June 4, 2019

The details of new tax rules are described in this Locke Lord Quick Study from our tax and finance colleagues. From a capital markets perspective, the new tax rules open up interesting possibilities.

For decades, companies issuing debt securities in the high yield market could not provide a full package of credit support from non-US subsidiaries.  The same was true for borrowing money under credit facilities. That’s because IRS rules treated credit support from non-US subsidiaries as a deemed dividend to the US parent, resulting in additional taxes.  As a result, indentures and credit agreements usually required upstream guarantees only from domestic subsidiaries (and, if secured, would limit pledges to less than 2/3rds of the stock of the uppermost non-US subsidiary).

Under the new tax rules, US corporations no longer have to incur a deemed dividend in most situations. Corporations that could benefit from an increase in credit quality of their debt by adding guarantees from non-US subs may be able to do that now — and lenders can require more credit support from non-US subs.

Two points to consider when using this new opportunity  –

  • the corporate laws of some non-US countries restrict upstream guarantees.
  • from a securities law perspective, if the corporation is able to get upstream guarantees from all its subs, it can avoid the condensed consolidating footnote disclosure that has plagued so many high yield issuers and driven deals to the 144A for life market.

Also, be alert to unexpected consequences.  Some pre-existing credit agreements provide for springing guarantees once the deemed dividend problem is gone.  Corporate debt issuers should review their credit arrangements to see if they have that feature and whether they have to add guarantees through supplemental indentures and credit agreement amendments.

Please reach out to your usual Locke Lord contacts for help in addressing the effect of the new tax rules if they may be applicable to your company.

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