- Whether credit documentation moves in cycles.
- The structural factors driving its path.
- How lawyers can best advise their clients, in light of those factors.
“Can’t repeat the past? … Why, of course you can.”
When Gatsby stands at the edge of his lawn, gazing across the bay at the green light on Daisy Buchanan's dock, that lamp promises his imagination that time itself might be reversed. History will relent and desire bend the years backwards. Gatsby doesn't see what we do: that the current is running too strongly against him, that the light is a mirage, that the dream he clings to will never materialise. Every credit cycle, too, has its Gatsbys, straining to believe that the past can be repeated.
Many years ago, I worked in New York, for a period of time that included what is now known as the Great Financial Crisis. Leveraged finance ground to a halt in those days, when we would be drawn into arguments over whether an arranger could invoke flex rights based on their being necessary 'to achieve successful syndication' (rather than 'enhance the prospects of successful syndication'). Many lenders and their lawyers looked forward to the market eventually re-opening, not only for the obvious reason that those in the deal-doing business generally benefit from there being deals to do, but also because finally, after almost a decade on the back foot, the covenant erosion of the boom times would be reversed.
Centuries before, King Canute was said to have set his throne on the shore and commanded the tide to halt.
All assets capable of commoditisation are capable of bubble-isation and anything that ascends by riding a bubble is susceptible to the consequences of its bursting. This is true of stocks, tulips, real estate, cryptocurrencies and anything else traded in a market with any degree of openness, including credit. Leveraged loans, whether syndicated or private, are a relatively niche product when compared to stocks traded on major exchanges, but they are also numerous, traded and, crucially, priced in a way that reflects both underlying business performance and overarching macro sentiment, in relative degrees that fluctuate over time according to the trends and manias of the day. Prices rise and fall accordingly. How about legal terms? Is it too much of a stretch to think that the terms of legal documents, in so far as they relate to leveraged loans, are subject to bubbles and bursts?
In that autumn of 2008, one might well have been tempted to conclude that we had been in a 'legal terms bubble', that it had popped and that, like the real economy or the aggregate price of the S&P 500, a subsequent cycle would begin from a mean-reverted base, with 'sensible' terms prevailing until such time as the next mania took hold.
This memo will consider certain structural factors that might reasonably be considered to influence the trajectory of legal documentation in large-cap, sponsor-backed LBO transactions and how lawyers might best serve their clients in light of the conclusions reached. It is written from a predominantly European perspective.
What makes you beautiful: Cycles are not trajectories
Between 9th October, 2007, and 9th March, 2009, the S&P 500, the Dow Jones Industrial Average and the Nasdaq Composite each fell precipitously and it took several years for any of those markets to recover to their prior peaks. A popular AI agent reminds me that about a decade earlier, from a peak of around 5,048 in 2000 to a trough of around 1,114 in 2002, the dot-com crash cost the Nasdaq approximately 78% of its value. It would not hit 6,000 until 2017, according to the same source, meaning a holder from the peak had by then made an annualised return of around 1% nominal, ex-dividends. Famously, the DJIA took around a quarter of a century to recover its nominal value after the Great Crash and Depression. These are terrifying datapoints. For an unlucky individual, they are seriously problematic – and that's not just a highly leveraged, intentional market player. For a retail investor, worried about his SIPP (or equivalent retirement account), sequence of returns risk is critically important. You can have a pot large enough to sustain a safe 4% withdrawal rate for 30 years but get wiped out much quicker because a crash comes early, before compounding has worked its magic. If you had all-DJIA exposure when you retired, and you retired at the peak of the dot-com bubble, you very likely had some sleepless nights.
Terrifying as these scenarios can be for an individual planning a retirement, the long-term picture is, of course, completely different.
If you stand back far enough from a picture of any of the stock markets we have discussed, it will appear to describe a story of continuous upward progress. From bottom left to top right, you will see a line that is concave (on a linear basis) or roughly straight (on a logarithmic basis). Standing from across the room, you would think that you must be misremembering your old proverbs and that the timeless adage must be "What goes up, must go up". In fact, standing from across the room, you would not know, unless you had read about it already (or had been unlucky enough to retire at the time), that any of 1929, 2002, or 2008 had ever happened. The crashes and slow recoveries are just speed bumps that cause your car to take a minor jolt, but do not change the direction in which the road is taking you.
Confining ourselves (as we will throughout this piece) to the large-cap, sponsor-backed LBO market, the general direction over the long run of loan documentation has also very much been one way.
When I qualified as a banking lawyer in 2005, a typical LBO loan agreement for a top sponsor would include not one but three or four financial maintenance covenants. We would argue as if the sky were falling in about the latest attempt to erode the definitions related to, and therefore the bite of, provisions that do not exist at all today. Even equity cures were a thing of great suspicion. The notion of pre-curing a covenant that in any event had 35% headroom and compliance with which was calculated after uncapped forward looking synergies would have struck us, back then, as if we were talking about some entirely different product, not the tightly crafted loan agreements that were necessary to ensure that 'risky' LBOs were managed accordingly. Cov-lite loans were (in Europe) a few years away. High yield bonds of course existed, but they were exactly that: the senior secured note, competing directly with loans and introducing European issuers to the idea of single-digit pricing coupled with regulation on a light-touch, incurrence basis, was still some time and a financial crisis away from being introduced.
Today, loan documents are as unrecognisable to a practitioner from 2005 as would a flying DeLorean be to a horse-riding cowboy from the Old West.
Financial covenants are now rare. Operational covenants are light-touch and come with long grace periods before lenders can force themselves to the table. New debt can generally be incurred, and dividends paid, so as to recreate or improve upon the capital structure as originally designed, keeping lender attachment and detachment points forever at set-up (or going further than that) rather than imposing the discipline of continuously mandated deleveraging. Information provision is less frequent and less burdensome. The package is drafted with intentional flexibility across the piece, so that individual component parts may be aggregated together, should the need arise, and combined with fresh ingenuity to facilitate the type of transaction that it is now fashionable to call 'liability management'. All things considered, it is hard to contest the notion that the path of loan agreements, in terms of the degree to which they restrict and constrain operational behaviour, and allocate risk, also forms, when viewed from across a room of any reasonable size, a line of continuous progress in one direction akin to that shown by the path of the S&P 500 since its inception.
The period I have just described, of course, only measures the last 20 years. In assessing the aggregate timespan of the LBO market, we could argue about whether it has run for 70 years or 'really run in earnest' for 'only' about 40. But, unless I have overlooked a great many cov-lite, light-touch, low-margin loan agreements from before 2005, mysteriously now forgotten or burned like the ancient Jedi texts, that issue does not affect the analysis. That 20-year sample is not merely a datapoint; it is diagnostic and reflects the path of the LBO industry over its life.
Story of our life: The path of documentation
In my view, however, that is where the commonality with stock market trajectories comes to an end. While the path of legal terms in leveraged loan agreements has in common with stock market performance the phenomenon of only, over the long run, moving in one direction, it also has the distinctive quality, in my opinion, that it does not episodically 'burst', with serious, sustained retrenchment for meaningful periods of time.
The stock market is said to take the stairs up and the elevator down – compounding moderate annual gains for several years at a time and then suddenly dropping in dramatic fashion and taking quite some time to recover. A fair parallel in loan agreement terms, in a market that is both relatively small and only 40-70 years old, when compared to our entire-US-stock-market examples taken from the longer memoirs of their histories, would consist of a sudden tightening, broad and deep, moving legal terms back several years, but with deals nevertheless continuing to get done at scale all the while, and then those terms taking several more years to regain their prior position. But, in fact, this has not occurred.
Of course, at times, credit markets are tougher than at other times and so legal terms can get a little tighter to get a given deal done. But the movements tend to be small – a few blockers here, a synergy cap there – and very brief. After a given episode, an issue-specific retrenchment in terms might arise – say, through the inclusion of a J.Crew or Chewy blocker. From time to time, there may be more resistance to EBITDA add-backs, as for example there were at various times from 2016 to 2019. Readers will be able to point to many other examples. But I think readers are also likely to agree that these are generally movements akin to the story of the boy at the dike, with nothing akin to a redirection of the tide, or a serious re-evaluation of the entire documentation suite and its impact as a whole, ever taking place in the direction of tightening. Whereas, in the direction of loosening, there is continuous forward pressure, which compounds over time into dramatic change.
Unlike the stock market, which continues to trade when markets are in drawdown, publishing every day a scorecard that shows the world its retrenchment, in the market for loans supporting large-cap LBOs, the pattern seems to be that either the credit markets are constantly accommodating more sponsor-friendly terms, or they are shut. For example, in 2008, deals by and large stopped happening. A window where deals happened (at scale) but only on radically tighter terms simply did not arise and, crucially, when the market did reopen, it reopened from a position that was close to prior sponsor-friendly norms. Pricing changed. Equity cheques changed. But the legal terms, viewed in broad brush terms, just continued to advance. (Incidentally, we can argue about whether, in light of modern pricing and equity cheques, credit investors are actually better off, even if legal terms are looser, than they were before the Great Financial Crisis, but that is an issue for another day and in any event is either not pertinent to, or otherwise reinforces, the ideas suggested in this memo).
Recall that we are talking here about large-cap LBOs, not stressed or distressed deals, and not the mid-market deals that have at times been the preserve of document-focused private credit funds. In large-cap deals, of course, private credit funds are also now increasingly active and one might compellingly object that those funds, to a degree, continue to achieve more lender-friendly legal terms than the syndicated market, even at the large end of the deal spectrum. However, that distinction, though it contains an element of truth, does not affect the analysis, which is not about how tight or loose documents are, but rather their direction of travel over time, which such direction, in my view, is the same, regardless of whether we look at private or broadly-syndicated loans.
Of course, new LBOs are not the only reason sponsor-backed issuers issue debt. One can readily conceive of situations where supply greatly exceeds demand even if new LBOs are not happening (for example, to refinance a large maturity wall). However, it is the contention of this note that even in those circumstances, retrenchment would be felt first, and most deeply, in availability or in economic terms rather than legal terms, and that any subsequent recovery would, as has happened in the past, pick up from close to the prior high watermark, rather than from a more recent trough. In my view, the reason for this is the product of a number of factors: (1) the mechanism by which the market sets legal terms; (2) the relative opacity of legal terms and their effect on returns, as compared to factors with a more obvious and measurable impact; and (3) the relative importance attached to legal terms by market participants, as compared to other considerations. Let's look at each of those in turn.
Drag me down: Why tightening never lasts
The mechanism employed by the market to set the legal terms on which leveraged loans are made available, in common with all other commodities and markets, is, of course, supply and demand. It is not, importantly, a rigorous analysis of what is 'right'. A long time ago, documents restricted leveraged companies and their activities to a considerably greater extent than they do today. When considering the credit risk taken on a leveraged loan, the expected returns and average default risk, alongside the relative likelihood of creditor impairment in the event of a default, perhaps a neutral commentator could conclude that the former situation, the one with relatively tighter regulation, is 'right'. On the other hand, perhaps the same commentator would take the view that the leveraged loan product only exists because of the willingness of private equity owners to take the risk and employ the effort necessary to add value to businesses, and that it is 'right' that the options available to them when they are trying to do so be as unconstrained as possible.
Just as Mr Market, when he offers each day a price for the purchase of your stocks, may be in either a euphoric or despondent mood and allow that to influence that price, regardless of any change in the underlying strength or prospects of the companies in whom those stocks represent ownership stakes, it is also likely that when there is more credit available than there are deals to consummate, that fact pattern drives the direction of travel, rather than any such analysis of the 'right' level of regulation. And, we have discussed above what happens in the converse situation, where credit has become unavailable.
So, within the market universe that we are considering, the mechanism for setting legal terms is simply market clearance. Over the long run, in fact, one might expect those terms to converge around a place where the average return on a large basket of leveraged loans, after factoring in the average default percentage and the average impairment as a result of those defaults, is similar to other assets of equivalent liquidity and availability. However, even that notion is complicated, partly because the whole history of the industry does not really contain a 'long run' and partly because of the factors tackled next.
The second factor is opacity. When a business acquires an asset, it pays a price. From an accounting perspective, of course, a company issuing debt incurs a liability, rather than gaining an asset, but, for the purposes of this paragraph, that doesn't matter. That company is also buying a product from its lender(s), and that product has a price. The price has multiple components, some more obvious than others. One is the interest rate. Another is the up-front fee. There are other fees and costs and taken together with the foregoing one could consider all of those to be the 'economic terms' of the loan. But the economic terms are not the whole price. An additional factor is the degree to which the company agrees to restrain its own freedom of action via the covenants in its loan agreement. That giving up of freedom is a cost to the business, just as the economic terms are. But it is much less easy to understand.
Legal terms have some importance in an upside scenario – as to how pricing, call protection and the like are expressed – but the importance of the legal provisions tilts quite heavily toward downside scenarios. They regulate such things as (by way of non-exhaustive examples):
(a) how much value can leave the group (by way of dividends, disposals, investments and the like) rather than stay in the group and be available to creditors if a default should occur;
(b) how much the lender's claim on that value can be diluted by the claims of others (via the incurrence of future indebtedness or liens);
(c) how much ability there is for creditors, whether existing or new, to leap-frog one another and achieve differential entitlements to that value (through uptiering, for example);
(d) how much information creditors receive, so that they can allocate the best resources to monitoring a situation; and
(e) for those with quite long memories of a bygone era, how much ability the group has to do something unduly risky with its operations (such as making a bad acquisition).
Taken together, the manifestation of the impact of these provisions on credit returns is through the impact they might have on the probability of default or, more often, on the probability and extent of impairment if a default occurs. But the extent to which they do so is not straightforward to quantify.
A modern loan agreement, with its English-law 'front' and its New York-law-interpreted 'back', runs to several hundred pages in length, is internally complex and occasionally inconsistent, and is liable to facilitate outcomes that are often hard to predict. Even a consistently interpreted agreement, when carefully deployed by an expert practitioner who aggregates concepts from around the document with sustained attention and creativity, may allow outcomes that, although consistent with what the document says, have simply not been considered before. This means that the expected impact of covenants on creditor returns, across a basket of loans and accounting for default risk, is difficult to measure; certainly, it is considerably more difficult to measure than the impact of the economic terms, which are measurable by their nature. And it is my suggestion that, because of the relative opacity of the impact of legal terms on recoveries in any given situation, it is much more likely that, when the supply/demand dynamic fluctuates up or down throughout a cycle, and 'getting a deal done' becomes easier or harder, the impact will be felt through changes, one way or another, in the economic terms component of the 'price' of the loan, either before, or at least to a greater extent than, it is felt in the legal regulation component of that price.
Retrenchments show up first in price or availability, not in core covenant architecture.
In other words, because investors most readily price what they can measure (such as interest rate, OID and fees), legal flexibility is the marginal price-adjuster in hot markets and the slowest to reset in cold ones. That conclusion is magnified by the third factor: the relative importance of legal terms when weighed against other considerations.
I am a lawyer and I think that legal terms are important. Moreover, every credit investor I have ever spoken to feels, to a greater or lesser extent, the same way. In my medium-length career to date, I have not yet met a client or potential client who has said to me: "You know, I just don't care what my loan agreement says." That could conceivably be because such investors simply carry their feelings to their natural conclusion and do not even bother instructing lawyers in the first place. Or it could be that they do not have the time to be countered via a drawn-out comparison of legal terms to the performance of equities on traded markets. But I think it is more likely that such investors, if they exist, do not make up a material proportion of the market. For today's purposes we may assume that every market participant considers legal terms to be important.
However, considering something to be important does not necessarily equate to considering it to be as important as, or even nearly as important as, other important factors. When ordering a martini, I consider it critical that it be dry enough, with the frostbitten glass bearing only the trace of a brief encounter with vermouth; but I consider it quite essential that the base spirit of the drink is gin, not vodka, and, given the choice, I will take a drink that gets the first of those factors wrong over one that fails on the second. Flipped on its head, this means that one could consider legal terms to be important but still consider them to be relatively unimportant when measured against other issues.
A client, speaking for themselves, recently said to me that any analysis of credit investment opportunities involved several factors, including:
(a) robustness of legal protections;
(b) quality of credit;
(c) quality of economic proposition;
(d) sponsor track record; and
(e) management team track record,
but, they were careful to add, not necessarily in that order. The order of priority attached to those factors, just like the question of what other factors are important, will vary from investor to investor and institution to institution, and that question is a critical one. On various permutations, it could imply a willingness to lend to an exceptionally good credit on 'loose' legal terms, or a converse willingness to lend to an exceptionally bad credit on 'tight' legal terms. Additionally, it might imply a willingness to entertain a deal that ticks four or perhaps even only three of the five boxes. Will a credit investor buy debt issued by a strong credit, at a terrific margin, backed by a sponsor with a great track record of success, but with an unproven management team and a sub-optimal loan agreement? Different investors will have different views, and the situation will vary from business to business and from time to time, but I'll wager that over large enough sample sizes, such a deal will often garner more support from the market than another deal with a weaker credit, a lower interest rate and a better suite of legal terms. After all, it is hard for a loan agreement to turn a bad company into a good one.
Taken together, then, these three factors create a pressure on document terms that pushes consistently in one direction and is structural rather than cyclical. When deals are getting done at scale, credit is generally in search of deals rather than the other way around; in those circumstances, pricing is under downward pressure; legal terms are a factor of price; they are the least readily understood and they are not generally considered to have greater importance than other factors (either factors of price or of investment thesis); so legal terms rate downwards quickly and upwards only rarely and slowly. This leads to the conclusion reached a few weeks ago by another lender client, who remarked resignedly over lunch: "It is only going to get worse". Of course, a meeting with a borrower client would likely produce the opposite sentiment. This memo does not consider the question of who is right and who is wrong on the matter. We merely outline the direction of travel.
Night changes: How to sleep at night
Where does this leave us? Well, one further implication of the opacity of documents is that, just as it is hard to ascribe a specific value to having 'tighter' documents in the aggregate, it is also challenging to ascribe relative values to the provisions of those documents against one another. That fact can influence how one approaches documents on a tactical, even if not a strategic, level. In a given deal situation, with a harried and hurried execution lawyer trying to preserve house standards in the face of accusations of over-thinking, one key question is whether the limited bullets are being fired at the right targets. This is not straightforward.
Armed with checklists to assess whether a document contains blockers for all the famous liability management exercises, execution lawyers (or investors) can be conditioned, even compelled, always to be fighting the last war, and, crucially, to weight those blockers (among other things) more heavily than other issues that are not on the list. To help them in this situation, their external counsel would ideally guide them accordingly, on a holistic basis, considering all factors relevant to a given situation, so that they can make decisions with the benefit of proper, nuanced analysis. Maybe there is a Chewy blocker and maybe not; maybe the one included is well-drafted and maybe it is not. But has the client been properly walked through the relative implications of that blocker in a second lien deal, as opposed to a first lien deal, and how that analysis might mean that the issue is in some cases still important but relatively less important than other issues? Have they likewise been given considered advice on how allowing the incurrence of FCCR debt (or even an incurrence based on a looser leverage ratio) that is secured on non-collateral has somewhat different implications in Europe than in the US? And have they been briefed on that other issue, buried in some financial definition, that has been spotted by their external counsel and has no fame and no notoriety because it has never given rise to a liability management exercise…yet?
Different credit investors will have different strategies. For some, the focus may be on differentiated assets or markets (not in scope for this note), with differentiated pricing, differentiated return expectations and differentiated legal documents. Others may take overall market risk, diversifying across many credits, and aim for average market returns at average market risk and average default risk, in which case it may make sense for them to take average legal terms as well – in other words, just to fire their bullets at whichever targets everybody else fires them. There is also the case that a sponsor may be more inclined to accept a comment that they expected to receive, because it concerns a commonly raised point. One of my colleagues likes to remark that he can always tell you where a document is going to land, but everybody must do the dance on the way there anyway. The document goes out with various features, the sponsor knows exactly which ones will generate comments, it accepts whatever percentage of those comments it thinks it needs to and the deal closes having incrementally improved the sponsor's base position. Whereas if a lender eschewed all the usual points and focused on firing a handful of comments at issues that it considered had a higher expected impact on recoveries in times of stress, that may equate to raising unusual and unfamiliar points and therefore a higher level of variance when trying to predict which comments will be accepted. It's a brave move, especially when considering Keynes' famous reminder: "It is better for reputation to fail conventionally than to succeed unconventionally".
However, that analysis does not change what I think counts as good external legal advice. If one market participant, whether in accordance with the strategic house view, the specific deal-team's priorities, or the execution lawyer's preferences and own independent analyses, decides that it wants to make differentiated, situational, value-specific comments, or another decides that it wants to make ten comments that align with market norms and that it knows will be expected, or still a third takes another approach entirely, somewhere in between or to the extreme left or right of those approaches, that is a matter for them. And it is a matter for them to evaluate in light of the best possible guidance on where the value really lies, whether that be the possible risks of a hidden gremlin or, perhaps even more importantly, whether it be the relative lack of risk attached, in a given situation, to a 'normal' point.
In conclusion, the path of credit documentation in the market for large-cap LBO transactions reflects a persistent structural drift toward borrower flexibility, interrupted only occasionally by brief, issue-specific pushbacks. Markets forget pain faster than they unlearn habits, meaning that while prices correct, documents seldom do. Credit investors, whether private or syndicated, can respond to that in various ways, which may be equally legitimate even if wildly different. But they would all benefit from solid, contextual advice, so that, although they cannot direct the wind, they can adjust their sails.
Gareth Eagles, London, 27 October 2025. Views expressed are personal.
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