Covenants 101: Controlling the Vote – Disqualified Lenders – Part 1

Liability management exercises, or LMEs, come in many flavors but can generally be separated into one of two top-level categories: (1) the “deal-away” and (2) the “consensual” LME. The deal-away is the deal you do with a third party, “away” from your existing lenders (for example, a third-party drop-down financing). The consensual LME, by contrast, is the deal struck with existing lenders, typically those holding at least a majority in one or more tranches of the outstanding debt.

Looking at the past 24 months of U.S. activity – against the backdrop of relatively muted European LME activity – one thing stands out: The consensual deal dominates. The consensual LME is generally regarded as the preferred option for borrowers due to its breadth. While a deal-away offers quick liquidity without existing lender consent, a consensual LME raises new money, extends maturities and captures discounts. With the requisite majorities, it can also amend existing debt documents to allow a broader range of transaction structures.

The near inevitability of the consensual deal effectively puts borrowers and lenders in a race to control the vote, specifically the majority or “Required Lender” vote needed to amend the loan documents. Because the makeup of that majority can determine the outcome, borrowers, sponsors and lender factions all try to shape its membership. Incumbent lenders can band together to block or force negotiations on consent-based transactions, but their power as a group is hardly invulnerable, as many modern credit agreements grant borrowers latitude to dilute, deny or even divide the voting power of Required Lender groups.

In this special Covenants 101 series, we explore the evolution of the various tools that borrowers and sponsors can use to “control the vote” in anticipation of or even during an LME, such as anti-cooperation provisions, voting caps, affiliated lender assignments and yank-a-bank provisions.

In this fourth installment, we discuss the provisions governing assignments of term loans to “disqualified lenders,” which have taken on new relevance in light of recent years’ LME exercises where the borrowers can proactively prohibit particular entities from becoming lenders, thereby shaping the composition of the lender group.

Part one of this installment outlines the common architecture of disqualified‑lender provisions found in most credit agreements. Part two will examine aggressive, borrower‑friendly deviations from the standard regime. 

Borrowers have a legitimate interest in having a say over who owns their loans. For example, it is important to borrowers that their lenders are sufficiently creditworthy to make good on their commitments. Borrowers may also want to avoid lenders coming into the credit whom they perceive as aggressive or antagonistic toward them. And it is of course paramount to borrowers to be able to protect confidential information typically given to lenders from ending up in the hands of competitors.

U.S. credit agreements include an array of transfer restrictions that give the borrower certain control over who can become a lender or participant. Among these are the DQ lender provisions, which permit the borrower to designate specific entities as “disqualified lenders,” thereby prohibiting them from purchasing or participating in its loans.[1]

The general structure of DQ lender provisions used in U.S. credit agreements is based on the Loan Syndications and Trading Association’s model credit agreement provisions, or MCAPs, first published in 2014. The LSTA provisions were designed to strike a balance between the borrower’s desire to control who is admitted as a lender, and lenders’ desire to include as few transfer restrictions as possible to maintain maximum liquidity in the market. (Furthermore, theoretically, transfer restrictions also increase the borrower’s cost of capital.)

Although the LSTA provisions are not intended to be incorporated wholesale, most U.S. credit agreements follow the LSTA’s general structure. Therefore, we will first look at how these provisions work, and after that we will briefly discuss some of the more notable more borrower friendly variations we have seen in the market. 

The LSTA model DQ lender provisions are based on the approach that all assignments are permitted unless an assignment is specifically prohibited under the credit agreement. In other words, a DQ list is a form of “blacklist,” specifically prohibiting certain institutions from becoming lenders.[2] The definition of “Disqualified Institution” (the LSTA’s term for DQ lender) from the LSTA’s most recent MCAPs is set forth below: 

Breaking down this definition, the LSTA contemplates that the following are DQ lenders: 

1. Entities designated by the borrower prior to signing of the commitment letter: Under clause (a), the borrower can designate any entity as a DQ lender through the date of the commitment letter (or, depending on the context, until the credit agreement is signed). The rationale here is that the borrower should be able to dictate, at the outset, which institutions the arrangers should not be able to syndicate the loans to. However, once the commitment letter (or the credit agreement) is signed, the borrower should not be able to change those instructions unless there is a particularly compelling reason to do so. 
2. Competitors: Clause (b) deals with such a “compelling reason”: It allows the borrower to designate “Competitors” of the borrower and its subsidiaries as DQ lenders by notifying the agent thereof at any time, including after signing of the commitment letter/credit agreement. While there is nothing stopping the borrower from designating its perceived competitors as DQ lenders before signing the commitment letter under clause (a), the idea here is that the borrower should also at any point have the right to prevent competitors from becoming lenders and thereby gain access to potentially sensitive information about the borrower’s business.

   It is important to the borrower that there is no cut-off date after which it cannot add new competitors to the list – if a new competitor arrives on the scene after signing, the borrower of course needs to be able to “DQ” that entity. The word “Competitor” is not defined in the LSTA model provisions but should be tailored to what specifically makes sense for the particular borrower. 

3. Affiliates of other DQ lenders: Clause (c) captures affiliates of entities that have already been added to the DQ list under either (a) or (b) (or, in the LSTA’s terminology, “Primary Disqualified Institutions”), the idea being that DQ lenders should not be able to circumvent the DQ list by simply using an affiliate to become a lender. Affiliates become DQ lenders in either of two ways under clause (c): by the borrower designating a specific affiliate as a DQ lender (which it can also to post-closing), or by an affiliate having a name that makes it “reasonably identifiable” as an affiliate of an existing DQ lender (so, for example, if “ABC Corporation” is a competitor on the DQ list, its affiliate, “ABC Fund,” would probably be reasonably identifiable by name”).

   The affiliate prong has an exception for “bona fide debt funds,” that is, funds that are affiliated with a DQ lender but that make investment decisions independently from the DQ lender. The rationale for this exception is that funds that are operated by different personnel and owe fiduciary duties to a different set of limited partners are likely to act similarly to any other lenders even though they may be affiliated with an antagonistic institution or competitor. This exception is similar to, and has the same rationale as, the exception for “Debt Fund Affiliates” from the Affiliated Lender definition (which we have written more about HERE).

Octus Insight

Stay updated on LMEs

July 23 2025

Saying No: The Power and Peril of the LME Holdout

Read More

August 4 2025

Inside Europe’s Liability Management Landscape: RX101 Guide

Download Guide

July 21 2025

Victoria Plc Could Use Uptiering Technique Rarely Seen in Europe to Elevate 2026 Notes; Transaction Could Open Door to Similar Non-Pro-Rata Liability Management Transactions

Read More