PRIVILEGED & CONFIDENTIAL — ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP One Liberty Plaza, 45th Floor New York, New York 10006 Tel: (212) 555-7800
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MEMORANDUM
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I. Executive Summary and Purpose
The purpose of this memorandum is to analyze and benchmark the proposed incurrence-based covenant package for the Indenture (the "Indenture") governing Verimark Hospitality Group Inc.'s ("VHG" or the "Issuer") proposed issuance of $500,000,000 in aggregate principal amount of 8.250% Senior Notes due 2031 (the "Notes"). This memorandum is intended to support the deal team's preparation for negotiations with initial purchasers' counsel and to serve as a comprehensive reference for internal discussions regarding the optimal covenant package for the Issuer.
Transaction Overview. The proposed transaction is a private placement of the Notes conducted pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended (the "Securities Act"). The Notes will constitute senior unsecured obligations of VHG, ranking pari passu in right of payment with all existing and future senior unsecured Indebtedness of VHG and senior in right of payment to any future subordinated Indebtedness of VHG.
Use of Proceeds. VHG intends to use the net proceeds of the offering to refinance approximately $467,342,819.16 outstanding under the Amended and Restated Credit Agreement, dated as of March 15, 2021 (as amended, restated, supplemented, or otherwise modified from time to time, the "Existing Credit Agreement"), among VHG, the subsidiary guarantors party thereto, the lenders from time to time party thereto, and Greystone National Bank, N.A. ("Greystone"), as administrative agent. The refinancing will retire all outstanding obligations under the Existing Credit Agreement, including accrued and unpaid interest, any applicable prepayment premium, and related transaction expenses.
Net Proceeds. The aggregate net proceeds to VHG are expected to be approximately $483,750,000, reflecting a 1.500% original issue discount ("OID") and a 1.750% initial purchasers' discount. The difference between net proceeds and the amount required to retire the Existing Credit Agreement obligations will be used to pay transaction fees and expenses, with any remaining amounts available for general corporate purposes.
Subsidiary Guarantees. The Notes will be guaranteed on a senior unsecured basis by five subsidiary guarantors (collectively, the "Guarantors"):
(i) Verimark Resort Holdings LLC;
(ii) VHG Properties Inc.;
(iii) Bayshore Hotel Management LLC;
(iv) Verimark Capital Holdings LLC; and
(v) Pinnacle Lodging Enterprises Inc.
Indenture Parties and Governing Law. The Indenture will be entered into among VHG, as Issuer, the Guarantors, and Fidelitas Trust Company, N.A., as Trustee (the "Trustee"). The Indenture will be governed by and construed in accordance with the laws of the State of New York.
Scope of Analysis. This memorandum analyzes each major covenant in the proposed Indenture, benchmarks the proposed terms against recent hospitality-sector high yield precedent transactions, and provides specific recommendations for the initial draft of the Indenture that was circulated on May 3, 2024 (the "Initial Draft"). These recommendations are provided in advance of anticipated negotiations with Whitfield, Crane & Aldrich LLP ("WCA"), counsel to the initial purchasers, whose deal team is led by Nathaniel R. Bosch. We expect to receive WCA's markup of the Initial Draft in mid-May and wish to have a fully developed negotiation strategy in place prior to that time.
Ratings Context. Rating agency presentations to Crestline Ratings Group ("Crestline") and Broadmark Rating Services Inc. ("Broadmark") are scheduled for May 14–15, 2024. Based on preliminary discussions, VHG anticipates ratings of B1 (Crestline) and B+ (Broadmark) for the Notes. The anticipated ratings are relevant to several aspects of the covenant analysis, including the Change of Control provisions and general market expectations for the covenant package. It is important that the term sheet presented to the rating agencies be consistent with the final negotiated covenant terms, underscoring the need to reach substantial agreement on the covenant package before or promptly after the rating agency presentations.
II. Issuer Financial Profile and Pro Forma Capitalization
An understanding of VHG's current financial profile and its anticipated post-offering capitalization is essential to evaluating the appropriateness of the proposed covenant package. The incurrence covenants in the Indenture are fundamentally ratio-based, and the degree of headroom that VHG will have above the proposed thresholds directly informs both the negotiation strategy and the risk assessment for noteholders.
A. Key Financial Metrics (LTM as of March 31, 2024)
VHG's financial performance over the last twelve months ("LTM") ending March 31, 2024, reflects a strong recovery from the COVID-era disruptions and positions the Issuer favorably relative to its proposed covenant levels.
Total Revenue: $1,820,000,000
Adjusted EBITDA: $412,000,000
Adjusted EBITDA Margin: Approximately 22.6%
VHG operates a diversified portfolio of 47 full-service hotels and 12 resort properties located across 19 U.S. states and the U.S. Virgin Islands, comprising approximately 18,400 rooms. The portfolio is geographically diversified, with concentrations in key gateway markets and destination resort locations that have demonstrated robust demand recovery in the post-pandemic period.
It is important to note that VHG drew heavily on its revolving credit facility and incurred approximately $475 million in term loan debt during the 2020–2021 period to fund operations during the COVID-19 pandemic. The current offering is designed to refinance the remaining balance of that pandemic-era indebtedness, replacing it with a more flexible capital structure consisting of the senior unsecured Notes and an undrawn revolving credit facility. This deleveraging transaction significantly improves VHG's financial profile and provides the Issuer with considerable operational flexibility going forward.
B. Pro Forma Capitalization Post-Offering
The following table summarizes VHG's anticipated capitalization upon consummation of the offering and the application of net proceeds to retire the Existing Credit Agreement:
Key pro forma leverage and coverage ratios are as follows:
Pro Forma Total Leverage Ratio: $500,000,000 ÷ $412,000,000 = approximately 1.21x
Pro Forma Net Leverage Ratio: $458,000,000 ÷ $412,000,000 = approximately 1.11x
Pro Forma Interest Coverage Ratio: $412,000,000 ÷ $41,250,000 (annual interest expense at 8.250% on $500,000,000 aggregate principal amount) = approximately 9.99x
Pro Forma Fixed Charge Coverage Ratio: ($412,000,000 − $48,000,000 estimated maintenance capital expenditures) ÷ ($41,250,000 interest expense + $0 required principal amortization) = $364,000,000 ÷ $41,250,000 = approximately 8.83x
It is noteworthy that the Notes have a bullet maturity on July 1, 2031, with no required amortization of principal prior to maturity. This is a meaningful distinction from the Existing Credit Agreement, which included quarterly amortization payments on the term loan component. The absence of scheduled principal payments reduces VHG's Fixed Charges and results in a higher FCCR than would be the case under an amortizing structure. This structural feature is favorable to VHG for purposes of the incurrence test and should be highlighted in discussions with management regarding future debt capacity.
C. Significance for Covenant Analysis
VHG's current financial metrics are strong relative to the proposed covenant thresholds, providing substantial headroom that is important for both the Issuer's operational flexibility and the negotiation posture with the initial purchasers' counsel.
The pro forma FCCR of approximately 8.83x provides roughly 4.4x of cushion above the proposed 2.00x incurrence test. This means that VHG could experience a significant decline in Adjusted EBITDA — or a significant increase in Fixed Charges — before the incurrence test would restrict VHG's ability to incur additional Indebtedness or make Restricted Payments under the ratio prong.
However, hospitality-sector cyclicality warrants careful attention in setting covenant levels. The COVID-19 pandemic demonstrated the potential for rapid and severe deterioration in hospitality-sector EBITDA. VHG's Adjusted EBITDA declined to approximately $85 million in fiscal year 2020 and approximately $195 million in fiscal year 2021 before recovering to current levels. Had the proposed covenant package been in place during that period, the incurrence test would have become restrictive, which is the intended protective function of the covenant. The proposed covenant levels should thus be evaluated not solely against current performance but against a range of potential downside scenarios.
The covenants proposed in the Initial Draft are designed to reflect VHG's recovery trajectory and current strong financial position while providing meaningful protection for noteholders in a cyclical downturn. The analysis that follows evaluates each major covenant in this context.
III. Fixed Charge Coverage Ratio — Incurrence Test
The FCCR incurrence test is the central covenant governing VHG's ability to incur additional Indebtedness and make Restricted Payments under the Indenture. As an incurrence-based (rather than maintenance-based) covenant, the FCCR is tested only at the time VHG proposes to take a specified action — not on an ongoing periodic basis. This distinction is significant because a maintenance covenant would require VHG to satisfy the ratio at each reporting date, whereas the incurrence test permits VHG to operate without restriction so long as it does not seek to incur additional Indebtedness or make Restricted Payments in excess of available baskets.
A. Proposed Terms
The Initial Draft proposes a minimum Fixed Charge Coverage Ratio of 2.00 to 1.00, tested on an incurrence basis only. The FCCR is to be tested when:
(i) VHG or any Restricted Subsidiary proposes to incur Indebtedness other than Permitted Indebtedness (i.e., Indebtedness that does not fit within one of the specific basket exceptions described in Section V below); or
(ii) VHG or any Restricted Subsidiary proposes to make Restricted Payments other than from available baskets (i.e., Restricted Payments that exceed the capacity of the builder basket, starter basket, and other carve-outs described in Section IV below).
The FCCR is to be calculated on a pro forma basis using the four most recently completed fiscal quarters for which financial statements are available (or are required to be available under the Reports covenant), giving pro forma effect to the proposed Indebtedness incurrence or Restricted Payment and all other Indebtedness incurred or retired since the beginning of such four-quarter period as if each such incurrence or retirement had occurred on the first day of such period.
B. Definition of Fixed Charges
The Initial Draft defines "Fixed Charges" to include the following items, determined on a consolidated basis for VHG and its Restricted Subsidiaries:
(i) consolidated interest expense (including capitalized interest) for the relevant period;
(ii) scheduled principal payments on Indebtedness for the relevant period (excluding balloon or bullet maturities, which are not included in Fixed Charges until the fiscal quarter in which the maturity date falls); and
(iii) dividends on preferred stock of Restricted Subsidiaries paid to persons other than VHG or its affiliates during the relevant period.
The definition of Fixed Charges excludes the following items:
(i) non-cash interest charges arising from the amortization of original issue discount;
(ii) amortization of deferred financing costs (including costs incurred in connection with the offering of the Notes); and
(iii) interest on intercompany Indebtedness that is eliminated in consolidation.
These exclusions are consistent with market practice and are appropriate given that they represent non-cash charges or items that do not represent a cash outflow at the consolidated level. The exclusion of OID amortization is particularly relevant here because the Notes are being issued at a 1.500% OID, which would otherwise create an artificial drag on the FCCR throughout the life of the Notes.
C. Definition of Consolidated EBITDA / Adjusted EBITDA
The numerator of the FCCR is "Consolidated EBITDA" (referred to in certain sections of the Initial Draft as "Adjusted EBITDA"), which is computed as follows:
Starting Point: Consolidated Net Income for the relevant period.
Add-Backs:
(i) income tax expense (including federal, state, local, and foreign income taxes);
(ii) consolidated interest expense to the extent deducted in computing Consolidated Net Income;
(iii) depreciation and amortization expense;
(iv) non-cash charges, including stock-based compensation expense;
(v) transaction costs and fees incurred in connection with the offering of the Notes and the related refinancing of the Existing Credit Agreement (to the extent incurred during the relevant period);
(vi) restructuring charges, capped at $15,000,000 in the aggregate during any four-consecutive-quarter period;
(vii) non-recurring litigation expenses incurred in connection with the settlement or resolution of litigation matters that VHG determines in good faith are non-recurring in nature;
(viii) adjustments related to COVID-era government relief income (to the extent such income was included in Consolidated Net Income and is no longer expected to recur); and
(ix) pro forma cost savings and synergies from acquisitions completed during the relevant period, to the extent such savings are (a) factually supportable, (b) reasonably expected to be achievable within 18 months of the closing of the relevant acquisition, and (c) set forth in a certificate of a financial officer of VHG delivered to the Trustee.
Deductions:
(i) non-cash income items (to the extent included in Consolidated Net Income); and
(ii) extraordinary gains (to the extent included in Consolidated Net Income).
The proposed add-back provisions are broadly consistent with market practice for high yield indentures in the hospitality sector. The restructuring charge cap of $15 million per four-quarter period is a significant provision that limits the extent to which VHG can inflate its EBITDA through restructuring add-backs. The pro forma cost savings limitation — requiring factual supportability and a maximum 18-month realization period — is designed to prevent aggressive forward-looking adjustments that are not grounded in concrete, identifiable savings.
D. Benchmarking Against Hospitality-Sector Precedents
We surveyed five recent hospitality and lodging-sector high yield issuances from the 2022–2024 period (described in greater detail in Appendix B) to benchmark the proposed FCCR incurrence test against current market standards. The results are summarized below:
Analysis:
VHG's proposed FCCR of 2.00x is at the lower (more issuer-friendly) end of the range observed in recent hospitality-sector precedents. Two of the five precedent transactions (Precedent A and Precedent D) used a 2.00x FCCR test, while Precedent B used 2.25x and Precedents C and E used 2.00x and 2.15x, respectively. The 2.00x threshold is particularly defensible for VHG given its strong pro forma FCCR of approximately 8.83x, which provides substantial headroom above the test level.
The restructuring charge add-back cap of $15 million per four-quarter period is squarely within the market range of $10 million to $20 million observed across the precedent set. This cap is appropriate for an issuer of VHG's size and is consistent with the median of the precedent transactions.
The pro forma cost savings limitation to factually supportable savings achievable within 18 months is consistent with the market standard. One precedent transaction (Precedent B) used a stricter 12-month realization period, while another (Precedent C) permitted a 24-month period. The "factually supportable" standard is the most common formulation and strikes an appropriate balance between flexibility and rigor.
Recommendation: The proposed 2.00x FCCR is defensible given VHG's strong pro forma coverage ratio of approximately 8.83x. We anticipate that initial purchasers' counsel at WCA may request a higher FCCR of 2.25x, citing the upper end of the precedent range and the inherent cyclicality of the hospitality sector. We advise the client to hold firmly at 2.00x, with room to move to 2.10x–2.15x if necessary to close the negotiation on the overall covenant package. A concession to 2.10x would reduce VHG's current headroom from approximately 4.4x to approximately 4.2x — a marginal reduction that should not materially impair VHG's operational flexibility. We do not recommend conceding beyond 2.15x.
IV. Limitation on Restricted Payments
The Limitation on Restricted Payments covenant restricts VHG's ability to distribute value to equity holders or make certain investments, ensuring that cash generated by the business is available to service the Notes. This is a critical covenant from the noteholder perspective, as it is the primary mechanism preventing equity value extraction at the expense of creditors.
A. Proposed Terms
Under the Initial Draft, VHG and its Restricted Subsidiaries may not, directly or indirectly, make any Restricted Payment — including (a) dividends or other distributions on equity interests of VHG, (b) purchases, redemptions, or other acquisitions of equity interests of VHG or any direct or indirect parent of VHG, (c) purchases, redemptions, defeasances, or other acquisitions or retirements of subordinated Indebtedness prior to any scheduled maturity, repayment, or sinking fund payment, and (d) Restricted Investments — unless each of the following conditions is satisfied at the time of, and after giving pro forma effect to, such Restricted Payment:
(i) No Default. No Default or Event of Default has occurred and is continuing or would result from such Restricted Payment;
(ii) FCCR Compliance. VHG could incur at least $1.00 of additional Indebtedness under the FCCR incurrence test set forth in Section 4.07 of the Indenture (i.e., the pro forma FCCR after giving effect to such Restricted Payment is at least 2.00 to 1.00); and
(iii) Builder Basket Compliance. The aggregate amount of all Restricted Payments made by VHG and its Restricted Subsidiaries since July 1, 2024 (the "Builder Basket Start Date," which corresponds to the first interest accrual date on the Notes) does not exceed the sum of:
(a) Starter Basket: $50,000,000; plus
(b) CNI Builder: 50% of Consolidated Net Income for the period from July 1, 2024 to the end of the most recently ended fiscal quarter for which financial statements are available (or, if such Consolidated Net Income is a loss, minus 100% of such loss); plus
(c) Equity Contribution Credit: 100% of the aggregate net cash proceeds and the fair market value of property or assets received by VHG from the issuance and sale of Equity Interests of VHG (other than Disqualified Stock) after July 1, 2024, and 100% of the aggregate amount of contributions to the equity capital of VHG received in cash after July 1, 2024; plus
(d) Investment Returns: the aggregate amount of all returns of capital on, and all returns on, Restricted Investments made after July 1, 2024 (including dividends, distributions, interest payments, repayments of principal, and proceeds from the sale or other disposition of such Restricted Investments), net of any amounts previously credited under this clause.
The Builder Basket Start Date of July 1, 2024 aligns with the first interest accrual date on the Notes, which is the conventional approach in high yield indentures. This ensures that the builder basket commences accumulating only from the date on which the Notes begin bearing interest, preventing VHG from obtaining credit for pre-offering income.
B. Permitted Investments and Carve-Outs
The Initial Draft includes the following customary carve-outs from the Limitation on Restricted Payments, which do not count against the builder basket capacity and do not require satisfaction of the conditions set forth in clause (i), (ii), or (iii) above:
(i) Equity Dividends. Dividends payable solely in Equity Interests (other than Disqualified Stock) of VHG;
(ii) Employee Benefit Plan Repurchases. Repurchases of Equity Interests of VHG held by current or former officers, directors, or employees (or their estates or beneficiaries) pursuant to the terms of employee benefit plans, equity incentive plans, or similar agreements, in an aggregate amount not to exceed $10,000,000 per fiscal year (with unused amounts in any fiscal year carried over to the two succeeding fiscal years, but not to exceed $20,000,000 in any single fiscal year after giving effect to such carry-forward);
(iii) Subordinated Debt Redemptions with Equity Proceeds. Payments to redeem, repurchase, defease, or retire subordinated Indebtedness of VHG with the net cash proceeds of a substantially concurrent issuance of Equity Interests of VHG (other than Disqualified Stock), provided that such net cash proceeds are excluded from the Equity Contribution Credit under clause (c) of the builder basket;
(iv) Permitted Investments. Investments that constitute Permitted Investments as defined in Section 1.01 of the Indenture (see Appendix A); and
(v) De Minimis Basket. Restricted Payments in an aggregate amount not to exceed $5,000,000 in any fiscal year, for immaterial restricted payments that do not otherwise fit within the foregoing carve-outs.
C. Benchmarking
The following table compares VHG's proposed Restricted Payments terms against recent hospitality-sector precedents:
The starter basket of $50,000,000 is within the range observed for comparable issuers. Precedent A used a $75 million starter basket (the highest in our data set), while Precedent E used a $25 million starter basket (the lowest). For an issuer of VHG's size, with $1.82 billion in annual revenue and $412 million in Adjusted EBITDA, a $50 million starter basket is reasonable and proportionate.
The 50% Consolidated Net Income builder is the universal market standard for high yield indentures. We note that certain precedent transactions in other sectors have used a 50% of Excess Cash Flow formulation in lieu of a CNI-based builder, but the CNI-based approach is more common in unsecured high yield issuances where the indenture does not include an Excess Cash Flow sweep mechanism.
The $10 million per annum employee benefit plan repurchase cap is consistent with the midpoint of the observed range ($5 million to $15 million). The carry-forward feature (allowing unused amounts to roll over for up to two years, with a $20 million single-year cap) provides reasonable flexibility and is seen in approximately half of the precedent transactions surveyed.
Recommendation: The proposed Restricted Payments package is balanced and should be maintainable in negotiations. We anticipate that WCA may seek to reduce the starter basket to $35 million–$40 million, which is a common initial purchaser request. We recommend holding at $50 million, noting that the starter basket represents only approximately 12.1% of VHG's Adjusted EBITDA and less than 2.8% of total revenue — metrics that are well within the range observed for comparable issuers. The CNI builder is already at the market-standard 50% level, and we do not anticipate meaningful pushback on this term. Overall, this covenant package should be maintainable through negotiations.
V. Limitation on Indebtedness
The Limitation on Indebtedness covenant controls VHG's ability to incur additional debt, ensuring that the capital structure does not become excessively leveraged to the detriment of the noteholders. The covenant operates through two parallel mechanisms: (1) a ratio-based incurrence test (the FCCR test discussed in Section III), and (2) a series of specific baskets for Permitted Indebtedness that may be incurred regardless of compliance with the FCCR test.
A. Proposed Terms — Ratio-Based Incurrence
Under the Initial Draft, VHG and its Restricted Subsidiaries may incur additional Indebtedness if, after giving pro forma effect to the incurrence of such Indebtedness (and the application of the proceeds therefrom), VHG's FCCR is at least 2.00 to 1.00. This ratio test serves as the gating mechanism for any Indebtedness that does not fit within one of the Permitted Indebtedness baskets. The pro forma calculation methodology is the same as described in Section III above, utilizing the most recently completed four fiscal quarters and giving pro forma effect to all Indebtedness incurred or retired during the relevant period.
B. Permitted Indebtedness Baskets (Exceptions Not Requiring Ratio Compliance)
The following Permitted Indebtedness baskets are proposed in the Initial Draft, permitting specified categories of Indebtedness to be incurred without regard to compliance with the FCCR incurrence test:
1. General Basket
Indebtedness of VHG and its Restricted Subsidiaries in an aggregate principal amount at any time outstanding not to exceed $75,000,000. This is a "free and clear" basket that provides VHG with flexibility to incur Indebtedness for general corporate purposes without needing to satisfy the ratio test. The general basket is measured on a "net outstanding" basis, such that repayments of Indebtedness previously incurred under this basket restore availability.
2. Credit Facility Basket
Indebtedness incurred under a Credit Facility (including any replacement, renewal, or refinancing credit facility) in an aggregate principal amount at any time outstanding not to exceed the greater of (x) $150,000,000 and (y) the Borrowing Base Amount (as defined in the applicable Credit Facility agreement). This basket corresponds to VHG's existing $150 million committed revolving credit facility, which is expected to be undrawn at closing. The inclusion of the Borrowing Base Amount as an alternative prong provides flexibility in the event that VHG's borrowing base (which is asset-based and tied to the appraised value of pledged hotel properties) exceeds the $150 million fixed cap.
3. Capital Lease / Purchase Money Basket
Indebtedness arising under capital leases and purchase money obligations in an aggregate principal amount at any time outstanding not to exceed $25,000,000. This basket is intended to accommodate ordinary course property improvements, furniture, fixtures, and equipment ("FF&E") financing, and other capital-intensive expenditures typical of the hospitality industry.
4. Intercompany Indebtedness
Indebtedness among VHG and its Restricted Subsidiaries in an unlimited amount, subject to the following subordination requirements: any Indebtedness owed by VHG or a Guarantor to a Restricted Subsidiary that is not a Guarantor must be unsecured and expressly subordinated in right of payment to VHG's obligations under the Notes or such Guarantor's obligations under its Guarantee, as applicable. This subordination requirement is designed to prevent structural leakage through intercompany lending arrangements.
5. Acquired Indebtedness
Indebtedness of a person existing at the time such person becomes a Restricted Subsidiary or is merged into or consolidated with VHG or a Restricted Subsidiary, provided that either (a) after giving pro forma effect to such acquisition, merger, or consolidation and the assumption of such Indebtedness, VHG's FCCR is at least 2.00 to 1.00, or (b) such Indebtedness was outstanding at the time of the acquisition and was not incurred in contemplation of or in connection with such acquisition. The second prong (the "not incurred in contemplation" exception) is an important flexibility mechanism that permits VHG to acquire targets with existing debt without the need to satisfy the ratio test, so long as the target's debt was not recently incurred specifically to facilitate the transaction.
6. Non-Recourse Property Indebtedness
Indebtedness of Restricted Subsidiaries that is (a) secured solely by one or more hotel properties of such Restricted Subsidiary and (b) non-recourse to VHG and the other Restricted Subsidiaries (other than the Restricted Subsidiary that is the borrower and any Restricted Subsidiary whose sole assets consist of the equity interests in such borrower), in an aggregate principal amount at any time outstanding not to exceed $50,000,000. This basket is specific to the hospitality industry and reflects the common practice of financing individual hotel properties on a non-recourse basis.
7. Refinancing Indebtedness
Indebtedness issued in exchange for, or the net proceeds of which are used to refinance, extend, renew, or replace, existing Indebtedness, subject to the following customary conditions: (a) the principal amount of such Refinancing Indebtedness does not exceed the principal amount of the Indebtedness being refinanced (plus accrued interest, premiums, and fees and expenses), (b) the Refinancing Indebtedness has a final maturity no earlier than the final maturity of the Indebtedness being refinanced, (c) the Refinancing Indebtedness has a Weighted Average Life to Maturity no shorter than that of the Indebtedness being refinanced, and (d) the Refinancing Indebtedness is not guaranteed by any person that did not guarantee the Indebtedness being refinanced.
8. Hedging Obligations
Indebtedness arising under Hedging Obligations entered into for bona fide hedging purposes and not for speculative purposes. This permits VHG to enter into interest rate swaps, caps, collars, and similar instruments to manage interest rate risk on its floating-rate Credit Facility obligations or other Indebtedness, as well as foreign currency hedging arrangements to the extent applicable.
9. Working Capital Facilities
Indebtedness arising under short-term working capital facilities in an aggregate principal amount at any time outstanding not to exceed $20,000,000. This basket is intended to accommodate seasonal working capital needs, which can be significant in the hospitality industry given the cyclical nature of hotel occupancy and revenue.
C. Benchmarking
The general basket of $75 million is positioned at the midpoint of the range observed for hospitality issuers of comparable size. We note that some precedent transactions utilize a "grower" component for the general basket, typically expressed as a percentage of Consolidated Total Assets (e.g., 10% of CTA). Based on VHG's estimated Consolidated Total Assets of approximately $850 million to $1.0 billion, a 10% of CTA grower would yield approximately $85 million to $100 million — which is actually less favorable to VHG than the proposed fixed cap of $75 million if total assets are at the lower end of the range but potentially more favorable if assets grow. We advise VHG to consider whether adding a grower component would be advantageous, but note that the $150 million fixed Credit Facility basket is currently more favorable than a percentage-based alternative, and the combination of the general basket and the Credit Facility basket provides VHG with substantial flexibility.
The non-recourse property debt basket of $50 million is a feature specific to hospitality and REIT-adjacent issuers. This basket recognizes the common practice of financing individual hotel properties on a non-recourse basis and was present in all five precedent transactions surveyed, at levels ranging from $25 million to $75 million.
Recommendation: We anticipate that WCA will push to reduce the general basket from $75 million to $50 million, which is the lower end of the observed range. We advise VHG to hold at $75 million, noting that VHG's property-intensive business model requires operational flexibility for ordinary course property financings, FF&E replacements, and opportunistic acquisitions that may not satisfy the ratio test at the time of incurrence. The general basket provides a critical safety valve for such purposes. If a concession is necessary to resolve the broader covenant negotiation, $60 million is the recommended floor position. We do not recommend conceding below $60 million.
VI. Limitation on Liens
The Limitation on Liens covenant protects the noteholders' position as senior unsecured creditors by restricting the ability of VHG and its Restricted Subsidiaries to grant security interests or other liens on their assets, which would effectively subordinate the Notes to the secured claims. Given that the Notes are unsecured obligations, this covenant is of particular importance.
A. Proposed Terms
Under the Initial Draft, VHG and its Restricted Subsidiaries may not directly or indirectly create, incur, assume, or permit to exist any Lien (other than Permitted Liens) on any of their respective assets or properties (including Equity Interests of any Restricted Subsidiary) to secure any Indebtedness, unless:
(i) the Notes (and the related Guarantees) are equally and ratably secured by a Lien on the same assets or properties that is senior in priority to, or pari passu with, the Lien securing such Indebtedness; or
(ii) the Lien constitutes a Permitted Lien as defined in Section 1.01 of the Indenture.
The equal and ratable security requirement in clause (i) is a standard "negative pledge" formulation that operates as a practical deterrent against VHG granting liens to other creditors. Because granting equal and ratable security to the Notes would trigger additional complexity and potential cross-default issues under VHG's other debt instruments, VHG's ability to encumber its assets is effectively limited to the categories of Permitted Liens.
B. Permitted Liens Basket
The Initial Draft defines "Permitted Liens" to include the following categories:
(i) General Basket. Liens securing Indebtedness in an aggregate principal amount at any time outstanding not to exceed $50,000,000;
(ii) Existing Liens. Liens existing on the Issue Date, as identified on a schedule to be attached to the Indenture (the "Existing Liens Schedule");
(iii) Credit Facility Liens. Liens securing Indebtedness incurred under the Credit Facility basket (up to the greater of $150,000,000 and the Borrowing Base Amount);
(iv) Purchase Money / Capital Lease Liens. Liens securing purchase money obligations and capital lease obligations incurred under the Capital Lease / Purchase Money basket (up to $25,000,000), provided that such Liens attach only to the assets acquired with the proceeds of such obligations;
(v) Tax Liens. Liens for taxes, assessments, and governmental charges not yet due and payable or the amount or validity of which is being contested in good faith by appropriate proceedings and for which adequate reserves have been established in conformity with GAAP;
(vi) Mechanic's and Materialmen's Liens. Mechanic's, materialmen's, carrier's, warehousemen's, landlord's, and similar Liens arising in the ordinary course of business, provided that such Liens do not secure obligations that are more than 60 days past due (unless being contested in good faith by appropriate proceedings);
(vii) Acquisition Liens. Liens on the assets of a person at the time such person becomes a Restricted Subsidiary or at the time of acquisition of such assets, provided that such Liens were not incurred in contemplation of such acquisition and do not extend to assets other than those of the acquired person or acquired assets;
(viii) Non-Recourse Property Liens. Liens securing non-recourse Indebtedness of Restricted Subsidiaries incurred under the Non-Recourse Property Indebtedness basket (up to $50,000,000), provided that such Liens attach only to the hotel property or properties that are the subject of such non-recourse Indebtedness;
(ix) Judgment Liens. Liens arising from judgments or orders that do not constitute an Event of Default under the Indenture;
(x) Landlord's and Statutory Liens. Statutory Liens of landlords, lessors, and licensors arising in the ordinary course of business; and
(xi) Refinancing Liens. Liens securing Refinancing Indebtedness, to the extent that the original Indebtedness being refinanced was secured by a Permitted Lien, provided that such Liens do not extend to any assets other than the assets that secured the original Indebtedness.
C. Benchmarking
The general permitted liens basket of $50 million is within the precedent range of $25 million to $75 million observed in recent hospitality-sector transactions. Hospitality-sector issuers typically require more extensive permitted lien carve-outs than issuers in other sectors due to the property-intensive nature of the business. Hotel properties are frequently subject to existing liens, easements, encumbrances, and restrictions that arise in the ordinary course of property operations, including mechanic's liens associated with renovation projects, landlord's liens under ground leases, and liens securing property-level financing. VHG's proposed list of Permitted Liens is comprehensive and reflects these industry-specific considerations.
A key negotiation point that we anticipate WCA will raise concerns the interplay between the non-recourse property debt liens ($50 million basket) and the general permitted liens basket ($50 million). In combination, these two baskets could permit up to $100 million in non-Notes liens to exist on VHG and Restricted Subsidiary assets. While this is a significant amount in absolute terms, it represents only approximately 24.3% of VHG's Adjusted EBITDA of $412 million and is well within the capacity of the business to service alongside the Notes. We expect this point to be raised but believe it is defensible.
Recommendation: We recommend maintaining the general permitted liens basket at $50 million. If WCA pushes for a reduction, the recommended floor position is $35 million. However, we would prefer to concede on the permitted liens basket (moving from $50 million to $40 million) rather than on the general Indebtedness basket (where we recommend holding at $75 million), if a trade-off is necessary. The permitted liens basket is less operationally critical than the general Indebtedness basket because VHG can utilize unsecured Indebtedness capacity under the general Indebtedness basket without implicating the liens covenant.
VII. Asset Sale Covenant
The Asset Sale covenant governs the disposition of assets by VHG and its Restricted Subsidiaries, ensuring that asset sale proceeds are used for the benefit of the business (and, ultimately, the noteholders) rather than distributed to equity holders or used for other purposes that do not benefit the creditor class. This covenant is of particular importance in the hospitality sector, where individual hotel properties can represent significant asset value and the sale of even a single property could generate material proceeds.
A. Proposed Terms
Under the Initial Draft, VHG and its Restricted Subsidiaries may not consummate an Asset Sale unless:
(i) Fair Market Value. VHG or the Restricted Subsidiary receives consideration at the time of such Asset Sale at least equal to the fair market value of the assets sold or disposed of. Fair market value is to be determined in good faith by the Board of Directors of VHG; provided that, for any Asset Sale in which the aggregate consideration exceeds $25,000,000, the determination of fair market value must be set forth in a resolution of the Board of Directors and evidenced by an officer's certificate delivered to the Trustee;
(ii) Cash Consideration. At least 75% of the consideration received in respect of such Asset Sale consists of cash or Cash Equivalents. For purposes of this requirement, the following are deemed to constitute cash: (a) the assumption by the transferee of Indebtedness of VHG or the applicable Restricted Subsidiary, (b) securities or other assets received by VHG or a Restricted Subsidiary that are converted into cash or Cash Equivalents within 180 days of the closing of such Asset Sale, and (c) Designated Non-Cash Consideration received in an aggregate fair market value not to exceed $25,000,000 outstanding at any time; and
(iii) Application of Net Proceeds. The Net Proceeds of such Asset Sale are applied within 365 days of the receipt thereof to one or more of the following:
(a) the repayment of senior Indebtedness of VHG or any Guarantor (including repayment of the Notes at par via open-market purchases or a tender offer to all holders on a pro rata basis);
(b) investment in Replacement Assets, which include hotel properties, capital improvements to existing hotel properties, or other assets or businesses related to the hospitality industry; or
(c) a combination of clauses (a) and (b).
Asset Sale Offer. To the extent that Net Proceeds from one or more Asset Sales exceed $25,000,000 in the aggregate and are not applied within the 365-day period in accordance with clause (iii) above (such unapplied amount, "Excess Proceeds"), VHG is required to make an offer (an "Asset Sale Offer") to all holders of the Notes to purchase the maximum principal amount of Notes that may be purchased out of such Excess Proceeds at a price equal to 100% of the principal amount of the Notes to be purchased, plus accrued and unpaid interest to the date of purchase. To the extent that the aggregate amount of Notes tendered in the Asset Sale Offer is less than the Excess Proceeds, VHG may use any remaining Excess Proceeds for general corporate purposes.
B. Benchmarking
The 365-day reinvestment period is at the longer end of the market range. Two precedent transactions used 365-day periods (Precedent A and Precedent D), while Precedent B used a 270-day period and Precedents C and E used 360-day periods. In the hospitality sector, the longer reinvestment period is particularly justifiable because hotel asset dispositions frequently involve complex regulatory approvals, franchise agreement transfers, liquor license transfers, and other time-consuming processes that can delay the identification and closing of replacement asset investments. We will make this argument if WCA challenges the 365-day period.
The 75% cash consideration requirement is universally applied in high yield indentures and is not subject to negotiation.
The $25 million Excess Proceeds threshold before triggering an Asset Sale Offer is within the observed range of $10 million to $50 million. This threshold determines the point at which accumulated unapplied proceeds become material enough to require an offer to purchase Notes. At $25 million, the threshold represents approximately 5% of the outstanding principal amount of the Notes, which is a reasonable materiality standard.
Recommendation: We expect WCA to push for a shorter reinvestment period, likely 270 days or 360 days. The practical difference between 365 days and 360 days is minimal, and we advise VHG to concede to 360 days if necessary to resolve this point. We do not recommend conceding to 270 days, as the shorter period could create genuine operational difficulties for VHG in the context of complex hotel property transactions. The $25 million Excess Proceeds threshold may also face pushback, with WCA seeking a lower trigger of $15 million to $20 million. We recommend that $20 million is an acceptable fallback position on this point.
VIII. Change of Control Put
The Change of Control covenant provides noteholders with the right to require VHG to repurchase the Notes at a premium upon the occurrence of a specified change of control event. This covenant is designed to protect noteholders from the risk that a change in ownership or control of VHG could adversely affect the credit quality of the Notes.
A. Proposed Terms
Upon a "Change of Control Triggering Event," VHG is required to make an offer to repurchase all outstanding Notes (a "Change of Control Offer") at a price equal to 101.000% of the aggregate principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any, to the date of repurchase.
The Initial Draft defines "Change of Control" to include any of the following events:
(i) any "person" or "group" (as such terms are used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), other than one or more Permitted Holders, becomes the "beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of more than 50% of the total voting power of the outstanding Voting Stock of VHG;
(ii) VHG consolidates with, or merges with or into, another person, or any person consolidates with, or merges with or into, VHG, in any such event pursuant to a transaction in which the outstanding Voting Stock of VHG is converted into or exchanged for cash, securities, or other property, unless the persons who were holders of Voting Stock of VHG immediately prior to such transaction hold, directly or indirectly, at least a majority of the voting power of all classes of Voting Stock of the surviving or resulting person; or
(iii) the sale, lease, or transfer, in one transaction or a series of related transactions, of all or substantially all of the assets of VHG and the Restricted Subsidiaries, taken as a whole, to any person (other than to a Restricted Subsidiary or one or more Permitted Holders).
Critically, the Initial Draft proposes a double-trigger mechanism for the Change of Control Triggering Event. A "Change of Control Triggering Event" requires both:
(a) a Change of Control; and
(b) a Ratings Decline, defined as a downgrade of the Notes to below B3 (by Crestline Ratings Group) and below B- (by Broadmark Rating Services Inc.) within 60 days following the earlier of (x) a public notice of the occurrence of a Change of Control or (y) a public notice of the intention to effect a Change of Control, or, if the ratings are withdrawn by both rating agencies within such 60-day period.
The Ratings Decline prong requires that both rating agencies downgrade or withdraw their ratings; a downgrade by only one agency does not, by itself, constitute a Ratings Decline. The 60-day look-forward period commences upon public notice of the Change of Control (or the intention to effect one) and provides a window during which the rating agencies may evaluate and respond to the change.
"Permitted Holders" is defined to include:
(i) Marcus J. Delano and his affiliates (including any trusts, estates, family partnerships, or similar vehicles established for the benefit of Mr. Delano or his family members);
(ii) members of the Board of Directors of VHG as of the Issue Date; and
(iii) any "group" that includes one or more Permitted Holders described in clauses (i) or (ii) above, so long as the Permitted Holders described in clauses (i) and (ii), collectively, together with the other members of such group, own more than 50% of the total voting power of the outstanding Voting Stock of VHG.
Maximum Put Obligation. If all $500,000,000 in aggregate principal amount of Notes were outstanding and all holders elected to tender their Notes in a Change of Control Offer at 101%, VHG's maximum repurchase obligation would be $505,000,000, plus accrued and unpaid interest.
B. Benchmarking
The 101% put price is the universal market standard for high yield change of control offers and is not subject to negotiation.
The double-trigger mechanism (requiring both a Change of Control and a Ratings Decline) is increasingly common in high yield indentures and is more issuer-friendly than a single-trigger mechanism (which would require only a Change of Control, without regard to the impact on ratings). The double-trigger approach recognizes that not all changes of control are adverse to credit quality and avoids forcing VHG to make a put offer in connection with a transaction that does not negatively affect the noteholders' position. Three of the five precedent transactions used a double-trigger mechanism, while two used a single trigger.
The 60-day look-forward period for the Ratings Decline is at the shorter end of the observed range (60 to 90 days) and is slightly more favorable to noteholders because it provides a shorter window during which the rating agencies must act. A longer look-forward period (such as 90 days) would be more issuer-friendly because it provides additional time for rating agencies to evaluate the transaction, increasing the possibility that one or both agencies might affirm the existing rating.
Recommendation: The double-trigger change of control mechanism is favorable to VHG and may face pushback from WCA, which may request a single-trigger mechanism. We advise VHG to hold firmly on the double trigger, as it is consistent with current market trends and is supported by the anticipated B1/B+ ratings (which provide meaningful headroom above the B3/B- threshold for the Ratings Decline prong). If WCA insists on modifications to the double trigger, we recommend exploring a compromise that expands the definition of Ratings Decline — for example, by lowering the threshold to B3/B- from either rating agency (rather than both) or by extending the look-forward period from 60 days to 90 days. We do not recommend conceding to a single trigger.
IX. Optional Redemption and Equity Clawback
The optional redemption and equity clawback provisions define VHG's ability to redeem the Notes prior to their stated maturity. These provisions are among the most standardized terms in high yield indentures and, accordingly, we expect limited negotiation on these points.
A. Optional Redemption Schedule