Lawyer-on-Lawyer Violence: ‘Disqualified Counsel’ Provisions Emerge in US Deal Documentation

Never have leveraged finance deal documents expressly given one party the power to prohibit a counterparty from choosing its counsel – until now. Disqualified counsel provisions are here, marking the latest salvo in the ongoing battle for control over creditor group formation.

Legal representation is a concept as old as judicial history itself. And in the world of leveraged finance, the role of law firms is critical. After all, a “loan” or a “debt” owed by a person (the “borrower”) to another (the “lender”) is a legal construct, documented by lawyers.

The “lender-on-lender” violence witnessed in recent years couldn’t arguably have been done without significant law firm involvement. A leading law firm discussed their role at length when the Serta uptiering first occurred. Pitch decks for liability management exercises, by competitive necessity, often include high-level discussion of options, whether in-court or out-of-court, new or novel. Having said that, the final decision rests with the parties themselves. If a subset of the parties choose to go down an “aggressive” route, that’s the choice of the parties. Legal counsels typically provide a menu of options, and the parties to the deals choose the route they want to go down.

Based on that organizing logic, loan documents have typically been limited to “disqualification” of potential lenders (see our discussion on DQ lists here), not on their counsel. Potential lenders that are known to be “aggressive” are excluded from taking stakes in leveraged loans through the use of such “DQ” lists.
 

The “disqualified counsel” language below, seen recently in the U.S. private credit market, gives the borrower the right to name one law firm (other than existing counsel for the agent or lenders) that neither any lender nor the agent may retain in the future in connection with the credit facilities or any related transactions or documentation.
 

The main consequence of a lender appointing such a banned law firm would appear to be breach of contract. Practically speaking, however, the key pain point for such a lender is on costs, as the borrower will have no obligation to pay the fees of that law firm.

The “disqualified counsel” concept marks the latest attempt by borrowers to exercise control over lender-group formation; other attempts have included anti-cooperation provisions, aggressive disqualified-lender lists and assignment caps (so-called “cherry-picking” provisions).

Although disqualified-counsel provisions do not directly dilute or limit lender voting rights, they nevertheless hamper lenders’ negotiating leverage by allowing the borrower to veto the lenders’ first-choice counsel. Although the DQ counsel provision excludes existing lender counsel from the borrower’s disqualification right, the borrower can still use it to block lenders from engaging new counsel in a distressed scenario, a frequent occurrence when out-of-court restructuring or other alternative refinancing options are on the table.

Disqualified counsel provisions could also have a deterring effect on law firms, which are increasingly at the center of creditor-group formation, especially where an LME is anticipated. A handful of firms have emerged as dominant players in the space, with sophisticated, repeatable processes for sourcing and winning creditor group mandates. Many develop deep early-stage expertise in the documents and leverage existing relationships to proactively form groups capable of leading a transaction – sometimes long before a company is in distressed territory.

The “disqualified counsel” language marks a new frontier in sponsor-friendly debt documents, seemingly aimed at the law firms with the most active creditor-side special situations or liability management practices.

“In a way, it is a badge of honor for your law firm to be on the list,” said a leveraged finance lawyer on disqualified counsel language. “The sponsor is afraid of me fighting for your interest.”

Although borrowers and sponsors may argue that the company’s disqualification right is sufficiently constrained to a one-time veto, the language nevertheless threatens to set a troubling precedent that we expect – and encourage – lenders to resist. Taken together with the now customary practice of appointing “designated lender counsel,” DQ counsel provisions risk granting sponsors end-to-end control over which law firms may advise their lenders in good times and in bad.
 

Elite law firms consistently push the boundaries of contract interpretation and deal structuring, as they have done in recent “lender-on-lender” violence deals. But a law firm drafting a document that excludes other law firms from acting for contractual counterparties hits at the heart of freedom of representation. While not quite on the same level, it has striking similarities to recent political maneuvers that have been widely critiqued from inside and outside the legal community.

From the outside, it is hard to tell if the addition of this provision was made by the counsel themselves, or whether there was a clear instruction from one of the contracting parties. Each negotiation is also likely to have developed differently.

Although the elite legal market is competitive, it is worth noting that there are conventions and “rules” that law firms are encouraged to observe. Maintaining integrity and civility within the legal profession arguably underpins some of these conventions and “rules.” One that comes to mind for many practitioners is the “golden rule” – a law firm should not ask others to give legal opinions that the law firm itself would not give (link HERE from the American Bar Association). The loosely equivalent question that arises is: Should law firms assist (whether actively or passively) with drafting provisions that exclude other law firms from acting for their counterparties?

It is also worth noting that this particular variant of the “disqualified counsel” provision is viewed as pro-borrower only because it is aimed at lender counsel. In concept, however, “disqualified counsel” could just as easily be deployed against the borrower (for example, if the agent, acting at the direction of required lenders, were able to veto the borrower’s choice of counsel for an out-of-court transaction).

If such a veto right is reasonable in principle, one might ask why it should not be awarded to both sides of the transaction. In reality, of course, it is negotiating leverage – not abstract fairness – that dictates how these terms are allocated, and the fact that “disqualified counsel” was first weaponized against lenders speaks volumes about where the balance of power lies. Today, the language is anti-lender; tomorrow, it could be pro-borrower. In every scenario, however, it is fundamentally anti-lawyer.