Article/Intelligence
Altice France’s Controversial Liability Management Strategy Could Pave the Way for Drop Downs in Europe; Investors Should Negotiate an “Altice Blocker” in Future Deals
French telecommunications and media company Altice France SA’s bonds have suffered a steep decline since their Q4 2023 earnings call and there has been a flurry of creditor organization activity. The trigger for these events was the company’s surprising announcement on the earnings call that it had changed its deleveraging target to below 4x, which would require participation of investors in discounted debt repurchase or exchange transactions. In a clear indication that it is pondering an aggressive liability management transaction, it also notified investors that it had designated its media business (Altice Media) and its data center company (UltraEdge) as unrestricted subsidiaries under its financing documentation, in connection with agreements to sell Altice Media and majority control in UltraEdge to third parties. The rationale for this designation was to give Altice France the full freedom to hold back disposal proceeds – and not be obligated to repay debt with such proceeds – until it assesses all its options to accomplish its new deleveraging target. Reorg’s covenant analysis on this specific situation is available HERE.
In this article we take a look at whether the risk of similar “drop down” transactions permeates through the broader European high yield bond market. We discuss the typical flexibilities available to issuers under high yield bond documentation that may enable drop down transactions to be undertaken and take a closer look at the implication for investors. We also highlight certain provisions investors could introduce in financing documentation going forward to limit the risk. These considerations are also relevant to the European leveraged loan market, especially as many European leveraged loans feature high yield bond-style covenants.
- Altice France’s Flexibility To Designate Unrestricted Subsidiaries Is Not A One-Off
- The large restricted payments and investment baskets that have become prevalent in financing documentation over the last few years could facilitate similar drop down transactions by stressed debtors.
- This risk is materially increased in the case of issuers who are allowed to use the restricted payments builder basket for investments without complying with a ratio debt incurrence test. As per Reorg’s calculations, this is the most significant source of Altice France’s €16 billion capacity (pro forma for the drop down of Ultra Edge and Altice Media). Investors should be on the lookout for this loophole which is prevalent in 12% of high yield bond deals since 2018.
- Assets of Unrestricted Subsidiaries Can Be Put Out of Reach of Bondholders
- Typical high yield bond covenants will permit the sale of unrestricted subsidiaries to third parties without requiring proceeds to be used to repay debt or be reinvested in the business. In many instances, they also allow a spin-off of the subsidiary to shareholders of the group as a dividend.
- Credit support granted by or in respect of such subsidiaries can be released without the consent of creditors once made unrestricted. Typically, there is no restriction in the financing documents on actions that can be taken by such unrestricted subsidiaries. This will allow unrestricted subsidiaries to incur priming debt supported by its assets.
- As a general matter, investors should not rely on unrestricted subsidiaries in assessing the credit.
- Bondholders Should Take The Documentation Risk Seriously and Negotiate an “Altice Blocker”
- High yield behemoth Altice France’s controversial liability management strategy will put drop down maneuvers in the spotlight and could pave the way for other stressed European issuers to do the same.
- Investors should consider negotiating meaningful documentary protection going forward to mitigate drop down risk, including: (1) expanding “J.Crew” blockers to cover all material assets rather than only material intellectual property; (2) an overall cap on investments in unrestricted subsidiaries; (3) ensuring the ratio debt test is a condition for use of the builder basket for investments; and (4) prohibiting a spin-off or transfer of value from unrestricted subsidiaries to shareholders or affiliates. These and certain other risk mitigation measures are discussed in more detail in this article.
What Are Unrestricted Subsidiaries?
An “unrestricted subsidiary” is a group subsidiary that is not deemed to be a part of the “restricted group” for the purposes of the restrictive covenants in an issuer’s bond financing documents. These covenants only govern activities of the issuer or parent guarantor and its restricted subsidiaries, i.e., the “restricted group”, and do not apply to unrestricted subsidiaries. Typically, at issuance, all subsidiaries of an issuer are restricted subsidiaries. However, it is customary for an issuer to have the ability to designate any of its subsidiaries (including those providing credit support) as unrestricted subsidiaries in the future. This ability is conditional on having sufficient investment capacity under the restricted payments covenant, which we discuss in further detail below.
Subject to certain limited exceptions, unrestricted subsidiaries are also excluded from covenant capacity calculations, i.e. their debt, EBITDA and other financial metrics are not taken into account in these calculations.
How Does a Restricted Subsidiary Become Unrestricted?
In most cases, an issuer can choose to convert or “designate” (as it is known in financing documentation) a restricted subsidiary to become unrestricted via a board resolution to this effect and filing the same with the trustee. At the time of designation of an unrestricted subsidiary or transfer of assets to an existing unrestricted subsidiary, the issuer is deemed to have made an investment in the relevant subsidiary which is measured at fair market value. If the issuer has sufficient capacity under the restricted payments covenant to make such investment then the designation or transfer will be permitted. Some financing documentation includes certain other requirements within the control of the group, such as prohibiting the unrestricted subsidiary from holding any shares, debt or liens on property of the restricted group.
Which Baskets Can Be Used to Convert a Restricted Subsidiary into an Unrestricted Subsidiary?
Investments in entities outside the restricted group are a type of restricted payment that are governed by the restricted payments covenant. The most likely sources of the required investment capacity to designate an unrestricted subsidiary will come from the following baskets that are commonly available to issuers in high yield bonds. It is also important to note that in most cases an issuer will be able to aggregate all the below baskets due to broad classification provisions.
Restricted Payments Builder Basket
Issuers have access to a builder basket which typically grows on the basis of 50% of consolidated net income generated on a cumulative basis since the issuance, plus (now common) a starter amount plus certain other customary sources of increase such as equity contributions. In some cases, the builder grows on the basis of 100% of consolidated EBITDA minus a multiple of consolidated interest expense. This is the type of formulation in Altice France and is particularly common in TMT deals.
In cases where an issuer has existing bonds outstanding, the builder basket is commonly backdated to start growing from the date of its debut issuance. When such a “repeat” issuer brings a subsequent bond to the market, it typically does not disclose the accrued capacity available under its backdated builder basket and due to the cumulative nature of the basket the accrued capacity can be very large.
This is the case in Altice France. Its builder basket started accruing a decade ago in 2014. As per Reorg’s calculations, the builder basket is the most significant source of Altice France’s €16 billion of investment capacity as of December 31, 2023 (on a pro forma basis).
Beware the Builder Basket Loophole
Access to the builder basket has traditionally been subject to a default blocker and required compliance with the applicable ratio debt incurrence test – the ratio test serving as a proxy for a credit health test to ensure that it is not available to stressed or distressed issuers that fail the ratio test. However, over time, we have seen an erosion of the conditions for accessing the basket. One such erosion, implicated in the Altice France case, allows a borrower to use the builder basket to make investments, including in unrestricted subsidiaries, without complying with the ratio test. We refer to this as the “Builder Basket Loophole”. To make it worse, in a few cases, investments could be made even after a default has occurred.
While Altice France’s extremely large investment capacity resulting from the size of the business and long accrual period may be an outlier, investors should not ignore the possibility of the Builder Basket Loophole being used by other stressed or distressed credits to implement a drop down transaction.
Other types of restricted payments such as dividend payments, share buy backs and prepayments of subordinated debt, are generally still subject to a default blocker and require compliance with the ratio debt test, although there are a few exceptions even to this rule. The original rationale for the looser standards for investments is that with an investment, the issuer still holds it as an asset and it is therefore accretive to the restricted group, whereas with other forms of restricted payments the cash or asset has left the group. However, when we dive into the implications of an unrestricted subsidiary designation under “What Recourse Do Bondholders Have To The Assets Of Unrestricted Subsidiaries?, we will see why this logic does not always hold true.
Do Other Issuers Have Similar Flexibility?
Altice France is not the only issuer to benefit from the Builder Basket Loophole. The same flexibility was present in 12% of European high yield bond deals in our Market Maker database from 2018 to date (13% of sponsor backed deals and 10% of non-sponsor deals), with the breakdown for each year represented in the graph below.
Free and Clear Investment Baskets For Transferring Value Into Unrestricted Subsidiaries
An issuer will typically have access to various other baskets that can be used for investments in unrestricted subsidiaries. These are available regardless of whether it can access (or has any capacity under) the builder basket. The use of these baskets is not subject to a ratio test. We therefore refer to them here as “free and clear” baskets. These are commonly composed of the following baskets, which in most cases will have a grower component based on EBITDA or, in a few cases, total assets:
- General basket for investments.
- Basket for investments in unrestricted subsidiaries and /or joint ventures (this may be joint or standalone baskets).
- Basket for investments in a “Similar Business”. The term “Similar Business” in high yield documentation is often defined broadly enough such that it could even be used in connection with an unrestricted subsidiary designation.
- General restricted payments basket, which can be used to make any restricted payments, including investments.
Ratio-Based Baskets
In addition to the free and clear baskets, an issuer may have further capacity under a ratio-based restricted payments basket and, now becoming a more regular feature in European documentation, a ratio-based investments basket. If included, the ratio-based investments basket will have a looser test compared to the ratio-based restricted payments basket.
Available Amount Basket
In recent years, we have seen the cross-over of a second builder basket called the “Available Amount” from the European leveraged loans market (where such basket has been prevalent in one form or another for a longer period of time) into the high yield bond market. This basket principally builds from excess cash flow that is not required to be used to prepay credit facilities under the senior credit facilities documentation.
Since 2021, 6% of high yield bonds in our Market Maker database permit restricted payments and / or investments from such an “Available Amount” basket. It is often the case that use of the basket for investments is not subject to a leverage test, which could result in another significant source of capacity for a stressed or distressed debtor.
As mentioned above, high yield bond-style covenant packages typically allow the issuer to classify and split the amount of any investment among multiple baskets, enabling unused capacity among these baskets to be aggregated in order to effect the relevant drop down transaction.
The following chart shows the average aggregated size of the free and clear baskets referred to above that could be used to designate unrestricted subsidiaries in European high yield bond deals from 2022 to date.
For the purpose of this illustration, we have (1) excluded the builder basket and available amount basket as capacity under them will fluctuate and (2) ignored the ratio-based baskets as we assume they will not be available to use in a stressed or distressed context. We have also excluded the Synlab SSNs due 2031 from the analysis as an outlier which included an off-market general restricted payments basket that is an annual basket rather than a lifetime basket.
It is now apparent why investors should pay close attention to the overall capacity of an issuer to designate unrestricted subsidiaries. To this end, we produce a Flexibility Scale for general purpose baskets in our high yield bond and leveraged loan covenant analyses. See an example of our Flexibility Scale on Merlin Entertainment’s 2031 SSNs to view the day one general use baskets that could be aggregated to generate investment capacity to designate unrestricted subsidiaries. In addition, Reorg’s Covenant Calculator provides ongoing capacity calculations based on reported financial information of the relevant group, to aid subscribers to monitor available covenant capacity under the group’s bond documentation. The below screenshot is an example from our Covenant Calculator for the Merlin Entertainment group as of Q4 2023. Please reach out to [email protected] if you are interested in learning more about the Covenant Calculator.

Once designated, any guarantees or security provided by the relevant unrestricted subsidiary and any security over its shares can be released without the consent of bondholders. In addition, as discussed above, the activities of unrestricted subsidiaries are outside the scope of the covenants in the high yield documentation. As a result, the assets of such subsidiaries could effectively be put out of reach of bondholders. Specifically, high yield bond-style covenant packages typically permit the following with respect to unrestricted subsidiaries:
No Restrictions on the Sale of Unrestricted Subsidiaries
A sale of an unrestricted subsidiary is typically deemed not to be an “Asset Disposition” and therefore excluded from the ambit of the asset sale covenant. This means that an unrestricted subsidiary can be sold without any requirement for the issuer to use the net disposal proceeds for debt repayment or reinvestment in the business.
Ability to Spin-Off Unrestricted Subsidiaries to Shareholders
A dividend or distribution of the shares of an unrestricted subsidiary is often expressly permitted as a “Permitted Payment” under the restricted payments covenant. 76% of European high yield bond deals in our Market Maker database from 2018 to date include this permission. This unrestricted subsidiary spin-off basket could be used to extract value from bondholders in favor of shareholders. In fact, this provision was utilized by Nemian Marcus in its 2018 liability management transaction. Some deals limit this basket by prohibiting such a dividend if substantially all of the assets of the unrestricted subsidiary comprises cash or cash equivalents, preventing an issuer from indirectly converting investment capacity into cash dividend capacity that may otherwise be unavailable. However, the scope of this restriction is limited and it would not apply to a spin-off of an unrestricted subsidiary that has substantial assets other than cash.
There is also some debate over whether the spin-off of an unrestricted subsidiary to a shareholder would constitute an indirect dividend and therefore be caught by the blanket prohibition on restricted payments whether made “directly or indirectly”. However, we believe this argument is weakened if the unrestricted subsidiary spin-off basket is present. Certain deals then put the matter beyond debate by including specific language permitting the onward transfer of value from unrestricted subsidiaries to shareholders or affiliates.
Ability to Raise Priming Debt Secured Against the Assets of Unrestricted Subsidiaries
As unrestricted subsidiaries are not subject to the covenants, they could raise debt against their assets. Since any guarantees or security provided by unrestricted subsidiaries are released in connection with a designation, such debt will be structurally senior to the debt of the restricted group with respect to the assets of the unrestricted subsidiary. This flexibility allows incurrence of priming debt that could be used for a liability management transaction such as a purchase or exchange of outstanding debt at a discount. The J.Crew drop down transaction brought this risk to light and resulted in the formulation of a “J.Crew Blocker” which we discuss in further detail below.
Loose documentation and large investment capacities could result in the ability of issuers to designate or transfer significant assets to unrestricted subsidiaries, putting them out of reach of existing investors. While there are other legal considerations under corporate and insolvency laws such as fraudulent conveyance, corporate benefit and director duties to creditors if an issuer is approaching insolvency that could potentially constrain the debtor’s appetite to transfer value via unrestricted subsidiaries, these are fact and jurisdiction specific considerations that will need to be assessed on a case by case basis and are often subject to litigation with an uncertain outcome. At the very least, loose credit documentation skews the negotiating leverage in a liability management context in favor of the debtor and its shareholders.
Drop down transactions have been used in the U.S. on a number of occasions such as J.Crew, PetSmart/Chewy, Neiman Marcus and Envision Healthcare, to name a few. We summarized these and other aggressive liability management transactions HERE. The use of the technique has so far been limited in Europe, although not unheard of – for example, Intralot used this in a liability management exercise in 2021 (but also in relation to a subsidiary incorporated in the U.S.). However, high yield behemoth Altice France’s liability management strategy will put such maneuvers back in the spotlight and could potentially open the floodgates for other stressed European issuers to do the same.
The extreme approach would be to include a blanket prohibition on the ability to designate unrestricted subsidiaries. This though is unlikely to be acceptable to sponsors and issuers who may have valid commercial reasons to retain some of the flexibility around designation of unrestricted subsidiaries. However, there may be other more practical risk mitigation measures available as we explore below.
Expanding the J.Crew Blocker
Currently, the principal way to reduce the risk of a drop down transaction is via a “J. Crew blocker”. Our two-part primer on J.Crew blockers is available HERE and HERE. Although the inclusion of a J.Crew blocker has increased in recent times as we recently reported on HERE, this blocker is often narrowly crafted to restrict the transfer of material intellectual property to unrestricted subsidiaries and would in most instances be ineffective to prevent the transfer of other assets to an unrestricted subsidiary. Two improvements to the blocker are proposed below.
- Expand Scope to Cover All Material Assets: A more potent approach would be to expand the scope of this blocker to include any material assets of the group and to ensure that it covers designation as well as transfers. A broader scope “J. Crew blocker” was present in Amara Nzero’s 2028 SSNs and EG Global’s 2028 SSNs.
- Aggregate Unrestricted Subsidiary Cap: However, even this expansive approach may in itself not be sufficient to prevent significant assets from being subject to a drop down transaction to the extent they do not constitute “material assets”. Unless defined to include a specific threshold, material assets can be an ambiguous test leaving it open to subjective interpretation. An even more robust approach therefore would be to place an aggregate cap on the total amount of investment capacity that could be used to designate or transfer assets to an unrestricted subsidiary that cuts across all restricted payments and investment baskets. This is probably the single most effective way to block large drop down transactions.
Going Beyond the J. Crew Blocker: Other Ways to Minimize the Drop Down Risk
In addition to the above, creditors could minimize drop down risk through the following measures:
- Ratio Test Condition to Access the Builder Basket: The ratio debt test should be a condition for accessing the restricted payment builder basket for all restricted payments, including investments. More generally, certain baskets that make an artificial distinction between investments and other types of restricted payments, such as a leverage ratio-based investment basket (which is typically set at a looser level than the corresponding leverage ratio-based restricted payment baskets) should be removed.
- Prohibit Dividends of Unrestricted Subsidiaries to Affiliates: The asset sales and restricted payments covenants in financing documentation should limit the scope of a permitted sale or spin-off of unrestricted subsidiaries so that they do not allow a transfer of such subsidiaries or their assets to affiliates of the issuer.
- Prohibit Transfer of Value from Unrestricted Subsidiaries to Affiliates: Specific language that allows the transfer of value from unrestricted subsidiaries to shareholders and affiliates and states that such transfer shall not be deemed to be a “direct or indirect” restricted payment should be deleted. Better still, explicit language should be included to prohibit such transfer of value.
- Require Ongoing Disclosure of Basket Capacity: Issuers should be required to disclose total capacity under the builder basket in annual and other periodic reports.
- Require Prompt Reporting of Unrestricted Subsidiary Designations: The reporting covenant should also include a requirement for issuers to promptly disclose any designations or transfers of assets to unrestricted subsidiaries so as to avoid any surprises.
The covenant tightening options above are not customary in high yield bond or leveraged loan documentation and are sure to receive strong push back from sponsors and issuers / borrowers. However, given the willingness of issuers / borrowers to use the documentary flexibility as highlighted by a number of aggressive liability management transactions witnessed in the U.S. in recent years, as well as Altice France’s implicit threat that it may take a similar route, we think these are reasonable asks to minimize the extraction of value from creditors in favor of issuers and sponsors.
If one or more of these measures become customary, Reorg will take some of the credit for formulating the “Altice Blocker”!