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PRIVILEGED & CONFIDENTIAL — ATTORNEY WORK PRODUCT

August 10, 2023

INDENTURE NEGOTIATION ISSUES LIST AND REDLINE SUMMARY

Transaction: Driftwood CLO 2023-I

C&H Matter No.: 1024-00004

Billing Code: DARF-CLO-2023I

Prepared By: Hannah Brinkley, Lead Associate, Calderwood & Harkness LLP

Reviewed By: Samuel Eklund, Responsible Partner, Calderwood & Harkness LLP

Distribution: Internal Calderwood & Harkness only — Samuel Eklund, Linda Osei, Patrick Gallagher, Sylvia Hartwell

This memorandum is protected by the attorney-client privilege and constitutes attorney work product. It is prepared solely for internal use by Calderwood & Harkness LLP attorneys working on the Driftwood CLO 2023-I transaction and should not be distributed, forwarded, or disclosed to any person outside of the distribution list set forth above without the prior written consent of the Responsible Partner. Any inadvertent disclosure does not constitute a waiver of privilege.

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I. EXECUTIVE SUMMARY AND PURPOSE

This memorandum summarizes the open negotiation points on the Indenture (the "Indenture") for Driftwood CLO 2023-I, currently dated for execution on August 22, 2023, among Driftwood CLO 2023-I, Ltd., an exempted company incorporated under the laws of the Cayman Islands (the "Issuer" or "Cayman Issuer"), Driftwood CLO 2023-I, LLC, a Delaware limited liability company (the "Co-Issuer" or "Delaware Co-Issuer"), and Ironclad Trust Company, N.A., a national banking association organized under the laws of the United States (the "Trustee").

Calderwood & Harkness LLP ("C&H") represents Driftwood Absolute Return Fund Ltd. (the "Client" or "Issuer Parent") and Driftwood Credit Management LLC (the "Collateral Manager" or "DCM") as issuer's counsel in connection with this transaction. This memorandum is prepared for the purpose of advising the deal team on the current state of Indenture negotiations, identifying areas of disagreement with counterparty counsel, and recommending positions for resolution.

The counterparties and their respective legal counsel are as follows:

• Meridian Atlantic Securities LLC ("Meridian Atlantic"), acting as structuring lead and placement agent for the transaction, is represented by Barrington, Locke & Hayes LLP ("BLH"). The lead attorneys at BLH are Gregory Fontaine (partner) and Miriam Saldaña (associate). BLH's comments represent the interests of the rated noteholders and the placement agent's market-standard investor protections.

• Ironclad Trust Company, N.A. (the "Trustee"), is represented by Ashworth & Pratt LLP ("A&P"). The lead attorney at A&P is Lillian Marchetti (partner). A&P's comments focus on Trustee protections, indemnification, and operational clarity.

Procedural History. C&H circulated the initial draft Indenture (Version 1) to BLH and A&P on July 25, 2023. BLH circulated its combined comments and markup (Version 2) on August 5, 2023. A&P circulated its comments and markup (Version 3) on August 7, 2023. This memorandum is based on a review of all three versions and catalogs the substantive open issues arising from the counterparty markups.

This memorandum catalogs twelve (12) substantive open issues, organized by subject matter. For each issue, the memorandum tracks: (i) the C&H initial position as set forth in Version 1; (ii) the counterparty markup and rationale, as extracted from Versions 2 and 3; (iii) the current status of the issue (open, resolved, or compromised); and (iv) the recommended resolution from the C&H deal team. Internal commentary and strategic considerations are included where relevant.

Target Resolution Date. All issues must be resolved no later than August 18, 2023, to align with the finalization of the Offering Memorandum on that date. The executed Indenture must be delivered on the closing date of August 22, 2023. This timeline is aggressive, and the deal team should be prepared for an intensive negotiation period from August 14 through August 18.

II. TRANSACTION OVERVIEW — KEY STRUCTURAL PARAMETERS FOR REFERENCE

The following is a summary of the key structural parameters of the Driftwood CLO 2023-I transaction, provided for the convenience of the deal team in evaluating the negotiation issues discussed herein. These parameters are consistent with the preliminary term sheet circulated to investors by Meridian Atlantic on July 15, 2023, and with the preliminary ratings received from both rating agencies on August 4, 2023.

Total Deal Size: $400,000,000 across six tranches (five rated tranches and one subordinated/equity tranche).

Capital Structure Summary

Collateral Manager: Driftwood Credit Management LLC, a Delaware limited liability company registered as an investment adviser with the Securities and Exchange Commission (CRD #182447). David Hwan (Managing Director, Structured Credit) is the portfolio manager responsible for collateral selection and trading decisions with respect to the CLO portfolio.

Reference Rate: Compounded SOFR, calculated in accordance with the ARRC-recommended 26253 fallback convention. Day count convention is Actual/360.

Non-Call Period: Two (2) years from the closing date, ending on September 12, 2025. During the Non-Call Period, the Issuer may not optionally redeem any rated notes.

Reinvestment Period: Five (5) years from the closing date, ending on September 12, 2028. During the Reinvestment Period, the Collateral Manager has the ability to reinvest principal proceeds in additional collateral obligations, subject to the limitations discussed in the Indenture and the issues analyzed herein.

Stated Maturity: October 15, 2036.

Payment Dates: Quarterly, on the 15th day of January, April, July, and October of each year, commencing on January 15, 2024 (the first payment date).

Effective Date Deadline: December 12, 2023 (ninety (90) days following the anticipated pricing date of September 8, 2023). By the Effective Date, the Collateral Manager must have ramped the portfolio such that all Collateral Quality Tests are satisfied.

Preliminary Ratings: Preliminary ratings were received from both Brindoval Rating Services ("Brindoval") and Ridgeline Credit Ratings ("Ridgeline") on August 4, 2023. The preliminary ratings are consistent with the target capital structure set forth above. The rating agency presentations were conducted on June 12, 2023 (Brindoval; Anita Delgado and Brian Whitford) and June 19, 2023 (Ridgeline; Kenji Matsuda), with model review completed on July 28, 2023.

III. ISSUE-BY-ISSUE ANALYSIS

Issue 1: Trading Flexibility During the Reinvestment Period

This is a high-priority issue that goes to the core of the Collateral Manager's operational authority under the Indenture. The scope of the Collateral Manager's discretion to buy and sell collateral obligations during the Reinvestment Period is one of the most heavily negotiated provisions in any CLO indenture, as it reflects the fundamental tension between the Collateral Manager's need for investment flexibility and noteholder expectations of portfolio stability.

1.1 C&H Initial Position (Issuer/Collateral Manager). As set forth in Version 1 of the Indenture, C&H's initial position is that the Collateral Manager should have broad discretion to buy and sell collateral obligations during the Reinvestment Period (through September 12, 2028) without the consent of the Trustee or the noteholders, provided that the Collateral Quality Tests and Coverage Tests (including both the Overcollateralization Tests and the Interest Coverage Tests) are satisfied after giving effect to any such trade. This is consistent with market practice for broadly syndicated CLO 2.0 transactions and reflects the fundamental principle that the Collateral Manager is engaged for its credit expertise and should be permitted to exercise that expertise without undue constraint.

The C&H draft imposes no limit on aggregate trading volume during the Reinvestment Period. Discretionary sales are permitted for credit risk reasons, credit improvement reasons, and tax reasons, in addition to customary mandatory sale triggers (e.g., sales of defaulted obligations, credit risk obligations, and equity securities received in connection with restructurings). The Collateral Manager's trading authority is subject to the overarching requirement that the portfolio continue to satisfy all applicable tests after giving effect to each trade.

1.2 BLH Markup (Placement Agent's Counsel). Gregory Fontaine at BLH proposes that discretionary sales be limited to 25% of aggregate collateral par per annum during the Reinvestment Period. Fontaine's markup introduces a new defined term, "Maximum Annual Discretionary Trading Volume," and provides that any discretionary sale in excess of this limit requires the prior written consent of a majority of Class A-1 noteholders. Fontaine's stated rationale is that investors expect a degree of portfolio stability and that unlimited trading authority is inconsistent with the buy-and-hold character of a CLO vehicle. Fontaine's comments cite to investor feedback received during the preliminary marketing process, although no specific investor objections have been communicated to C&H directly.

In addition, Fontaine proposes that any sale resulting in a decline in the Weighted Average Spread below 350 basis points (the minimum WA Spread criterion under the Collateral Quality Tests) or the Diversity Score below 60 (the minimum Diversity Score criterion) should require the prior written consent of a majority of Class A-1 noteholders. This would effectively layer an additional consent requirement on top of the existing Collateral Quality Test framework.

1.3 A&P Position (Trustee's Counsel). Lillian Marchetti at A&P has deferred to the placement agent and the noteholders on the question of trading volume limits. A&P does not take an independent position on behalf of the Trustee as to whether a volume cap is appropriate. However, Marchetti requests that trade settlement procedures include a requirement that the Trustee receive notification of each sale within two (2) business days of the trade date. This notification requirement is framed as necessary for the Trustee to maintain accurate records for purposes of the Coverage Test and Collateral Quality Test compliance reporting that the Trustee performs under the Collateral Administration Agreement.

1.4 C&H Recommendation. C&H recommends the following approach to this issue:

Resist the 25% annual volume cap. This limitation is overly restrictive and is not consistent with market practice for broadly syndicated CLO transactions. A review of recent precedent transactions — including Cobalt CLO III (Ames & Aldgate LLP, 2023), Meridian Harbour CLO 2023-1 (Hale & Morriven LLP, 2023), and Pinnacle Credit CLO VI (Buchanan & Thackeray LLP, 2023) — confirms that no annual volume cap on discretionary trading during the Reinvestment Period is imposed. The annual volume cap proposed by BLH would effectively constrain the Collateral Manager to turning over no more than $100,000,000 of the $400,000,000 portfolio per year, which could significantly impair the Collateral Manager's ability to respond to market conditions and credit developments. This is a position where C&H believes there is strong market support, and we recommend holding firm.

Acceptable concessions. C&H recommends accepting the following concessions, which we believe are reasonable and do not materially impair the Collateral Manager's flexibility:

(a) Trustee Notification: Accept the requirement that the Trustee receive notification of any sale within two (2) business days of the trade date. This is a purely administrative requirement and is consistent with the Trustee's collateral administration function.

(b) Pro Forma Test Compliance: Accept the requirement that each discretionary sale must satisfy all Collateral Quality Tests on a pro forma basis after giving effect to the reinvestment of sale proceeds. This is effectively already required under the C&H draft (the "maintain or improve" standard), but we are willing to make it explicit.

WA Spread and Diversity Score Consent Threshold. C&H recommends pushing back on the requirement for majority Class A-1 noteholder consent if a sale would cause a decline in the WA Spread below 350 bps or the Diversity Score below 60. The Collateral Quality Tests already impose these constraints as hard floors; a trade that would cause the WA Spread to fall below 350 bps or the Diversity Score to fall below 60 would already fail the Collateral Quality Tests and would therefore not be permitted under the Indenture. The additional consent mechanism is duplicative and would create operational complexity (obtaining noteholder consent for individual trades is impractical in a $400 million CLO).

Issue 2: Post-Reinvestment Period Trading Constraints

This issue concerns the Collateral Manager's authority to trade collateral obligations after the expiration of the Reinvestment Period on September 12, 2028. While the Collateral Manager's trading authority is expected to be more limited after the Reinvestment Period, there are important questions regarding the scope of permitted trades and the duration of any limited reinvestment window.

2.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, after the Reinvestment Period, the Collateral Manager retains the ability to sell credit-risk obligations and credit-improved obligations and to reinvest the sale proceeds in substitute collateral obligations, subject to the following conditions: (i) all Coverage Tests (O/C Tests and I/C Tests) must be satisfied after giving effect to the substitution; (ii) all Collateral Quality Tests must be satisfied after giving effect to the substitution; (iii) the substitution may not extend the Weighted Average Life of the portfolio; and (iv) the substitution may not reduce the Weighted Average Spread below the minimum required level.

With respect to unscheduled principal proceeds (e.g., prepayments, recoveries on defaulted obligations) received after the expiration of the Reinvestment Period, the C&H draft provides that such proceeds are to be applied to the redemption of notes in accordance with the priority of payments. However, the Collateral Manager has the ability to reinvest such proceeds in eligible investments for a limited period of up to sixty (60) days following receipt. This reinvestment window is intended to allow the Collateral Manager to optimize the timing of note redemptions and avoid forced sales of newly acquired collateral.

2.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes the following modifications to the post-Reinvestment Period trading provisions:

(a) Reinvestment Window: Reduce the post-Reinvestment Period reinvestment window from sixty (60) days to thirty (30) days.

(b) Elimination of Credit-Improvement Sales: Restrict post-Reinvestment Period trading to credit-risk and credit-impaired sales only. Fontaine proposes eliminating credit-improvement sales as a permitted category of post-Reinvestment Period trades, on the theory that the Collateral Manager should not be actively trading the portfolio for profit after the Reinvestment Period has expired.

(c) Substitution Conditions: No substitutions are permitted after the Reinvestment Period except with unscheduled principal proceeds, and only if the resulting portfolio passes all O/C Tests and Collateral Quality Tests on a pro forma basis.

2.3 C&H Recommendation. C&H recommends the following approach:

Reinvestment Window: Compromise at a forty-five (45) day reinvestment window following receipt of unscheduled principal proceeds after the Reinvestment Period. This is a reasonable midpoint between the C&H position of sixty days and the BLH position of thirty days, and provides the Collateral Manager with sufficient time to evaluate reinvestment opportunities without unduly delaying note redemptions.

Credit-Improvement Sales: C&H recommends pushing back on the elimination of credit-improvement sales as a post-Reinvestment Period trading category. Credit-improvement trades are a standard tool in the Collateral Manager's toolkit and serve an important function in optimizing portfolio returns for the benefit of all noteholders. The ability to sell a credit-improved obligation at a premium and reinvest the proceeds in a higher-yielding asset benefits the entire capital structure. However, in recognition of the more limited trading authority expected after the Reinvestment Period, C&H proposes limiting credit-improvement sales to 10% of aggregate collateral par per annum after the Reinvestment Period. This represents a meaningful concession while preserving the Collateral Manager's ability to engage in this type of trading activity.

Substitution Conditions: C&H accepts the condition that each substitution must pass all O/C Tests (Class A: 128.00%, Class B: 118.00%, Class C: 110.00%, Class D: 105.50%) and all Collateral Quality Tests on a pro forma basis. This is consistent with the C&H initial position.

Issue 3: Definition of Collateral Quality Tests

The Collateral Quality Tests are among the most critical provisions of the Indenture, as they define the credit parameters within which the Collateral Manager must operate when acquiring and managing collateral obligations. Any changes to the Collateral Quality Test definitions have direct implications for the rating agency models and the preliminary ratings.

3.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the Collateral Quality Tests consist of the following eight tests:

The C&H draft further provides that the Collateral Manager may acquire an obligation that causes one or more Collateral Quality Tests to fail, or, if a Collateral Quality Test is already failing at the time of acquisition, the acquisition does not cause further deterioration of the failing test (the "maintain or improve" standard). This is a widely accepted formulation in CLO indentures and provides the Collateral Manager with the flexibility to continue acquiring collateral obligations even in a stressed market environment, so long as the acquisition does not worsen any existing test failure.

3.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes the following modifications:

(a) "Must Improve" Standard: Fontaine proposes tightening the "maintain or improve" standard to require that each acquisition actually improve a failing Collateral Quality Test, rather than merely maintaining the level of non-compliance. Under this formulation, if the Minimum Diversity Score is 60 and the current portfolio Diversity Score is 58, the Collateral Manager could only acquire an obligation that brings the Diversity Score to 59 or above — not one that maintains it at 58.

(b) Minimum Floating Rate Coupon Floor: Fontaine proposes adding a new Collateral Quality Test in the form of a Minimum Floating Rate Coupon Floor of SOFR + 250 basis points. Under this test, no loan with a floating rate spread below 250 basis points over SOFR may be acquired as a collateral obligation.

(c) CCC Bucket Reduction: Fontaine argues that the current CCC Bucket of 7.5% of aggregate collateral par is generous by current market standards and proposes reducing it to 7.0% of aggregate collateral par ($28,000,000).

3.3 A&P Position (Trustee's Counsel). Marchetti notes that the Trustee's compliance reporting obligations under the Collateral Administration Agreement will reference the Collateral Quality Test definitions set forth in the Indenture. Marchetti requests that the calculation methodology for the Weighted Average Rating Factor and the Diversity Score be set out explicitly in the Indenture itself, rather than solely by reference to the applicable rating agency model. Marchetti's concern is that the Trustee needs sufficient clarity to perform its compliance calculations without having to interpret or apply the rating agency models independently.

3.4 C&H Recommendation. "Maintain or Improve" Standard. C&H strongly recommends resisting the "must improve" standard proposed by BLH. The "maintain or improve" formulation is market standard for broadly syndicated CLO transactions and was specifically presented to and accepted by both Brindoval (Anita Delgado and Brian Whitford) and Ridgeline (Kenji Matsuda) during the rating agency presentations conducted on June 12 and June 19, 2023, respectively. The rating agency model review was completed on July 28, 2023, on the basis of the "maintain or improve" standard. Changing to a "must improve" standard at this stage could require re-engagement with both rating agencies and could potentially jeopardize the preliminary ratings received on August 4, 2023. Moreover, the "must improve" standard is operationally impractical in a stressed credit environment, where it may be difficult for the Collateral Manager to find obligations that affirmatively improve a failing test.

Minimum Floating Rate Coupon Floor. C&H recommends resisting the proposed Minimum Floating Rate Coupon Floor. This is a non-market addition that is not included in either rating agency's model and would unnecessarily constrain the Collateral Manager's ability to acquire obligations at the lower end of the credit spread spectrum. While such obligations are less common in the broadly syndicated leveraged loan market, they do exist (particularly among higher-quality investment-grade crossover credits), and the Collateral Manager should retain the flexibility to include them in the portfolio where doing so is consistent with the overall portfolio construction strategy.

CCC Bucket. The CCC Bucket at 7.5% of aggregate collateral par ($30,000,000) is consistent with the rating agency models and the preliminary ratings received on August 4, 2023. C&H recommends resisting the proposed reduction to 7.0%. A review of recent CLO transactions shows that 7.5% is within the market range (typically 7.0%–7.5%), and the preliminary ratings were issued on this basis. Additionally, the 7.5% threshold provides the Collateral Manager with meaningful flexibility to hold CCC-rated obligations without triggering excess CCC haircut adjustments in the O/C Test calculations.

Calculation Methodology. C&H recommends accepting Marchetti's request for explicit calculation methodology language. We propose adding a new definitional schedule to the Indenture (Schedule 1 — Calculation Methodology) that sets forth the methodology for calculating the WARF and the Diversity Score, in each case referencing the Brindoval methodology (the Brindoval corporate credit rating scale is the basis for the 2,850 WARF minimum). This addition is helpful for operational clarity and should not be controversial with BLH. Patrick Gallagher should prepare the initial draft of this schedule based on the Brindoval methodology document provided during the rating process.

Issue 4: Overcollateralization Test Cure Mechanics

This is a high-priority issue that directly implicates the balance of control between the Collateral Manager and the senior noteholders. The O/C test cure mechanics determine what happens when the portfolio's credit quality deteriorates to the point that the O/C Tests fail, and the extent to which the Collateral Manager may be compelled to take affirmative action to restore compliance.

4.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, if an O/C Test fails on any Determination Date (the date on which the Trustee calculates the Coverage Tests for each payment period), the cure mechanism operates automatically through the waterfall. Specifically, interest proceeds and, if necessary, principal proceeds are diverted from junior classes to redeem senior notes until the applicable O/C Test is restored. This waterfall diversion mechanism is the standard cure mechanic in CLO indentures and does not require any affirmative action by the Collateral Manager. There is no requirement for the Collateral Manager to sell collateral obligations in order to cure an O/C Test failure.

The O/C Test levels, as set forth in the C&H draft, are as follows:

4.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes a more aggressive cure framework with the following elements:

(a) Forced Sale Mechanism: If an O/C Test remains in breach for two consecutive payment dates (i.e., approximately six months), the Collateral Manager must sell collateral obligations at the direction of the Trustee, acting at the request of a majority of the controlling class (Class A-1 noteholders), in order to restore compliance. The Collateral Manager would not have discretion to select the obligations to be sold; instead, the Trustee (acting at the direction of the controlling class) would have the authority to direct the sale of specific obligations.

(b) Event of Default Trigger: If any O/C Test remains breached for three consecutive payment dates (i.e., approximately nine months), such breach would constitute an Event of Default under the Indenture, entitling the controlling class to direct the Trustee to accelerate the notes and liquidate the collateral.

Fontaine argues that these provisions are necessary to protect senior noteholders, particularly the anchor investor Marlowe Asset Management Peak Institutional Credit Fund LP, which has committed to an $80,000,000 allocation in the Class A-1 Notes (Robert Calloway, Portfolio Manager). Fontaine has indicated informally that Marlowe Asset Management Peak's investment committee has expressed a preference for enhanced noteholder protections in the event of O/C Test failures.

4.3 A&P Position (Trustee's Counsel). Marchetti supports the forced sale mechanism as a protective tool for the Trustee's fiduciary obligations. However, Marchetti requests the following modifications to the BLH proposal:

(a) Any forced sale must be conducted at market price (i.e., the Trustee should not be required to accept below-market bids), with a 10-business-day cure period before the forced sale is executed, during which the Collateral Manager may restore compliance through other means (e.g., voluntary sales, receipt of principal proceeds).

(b) The Trustee must receive explicit indemnification for any losses arising from forced sales, including any claims by the Collateral Manager, the Issuer, or any noteholder that the forced sale resulted in a loss to the portfolio.

4.4 C&H Recommendation. Forced Sale Mechanism. C&H recommends resisting the forced sale mechanism as overly aggressive and not consistent with market practice. The waterfall diversion is the standard cure mechanic in CLO indentures, and forced sales at the direction of the controlling class introduce a number of significant risks:

(i) Market Timing Risk: Forced sales in a distressed market environment may require the Collateral Manager to sell obligations at depressed prices, which would further erode the portfolio's par value and potentially exacerbate the O/C Test failure rather than curing it.

(ii) Conflict of Interest: The controlling class (Class A-1 noteholders) may have incentives that diverge from the interests of the junior noteholders and the equity holders. A forced sale directed by the Class A-1 noteholders could result in the crystallization of losses that disproportionately harm the junior tranches.

(iii) Operational Impracticality: The Collateral Manager, not the Trustee or the noteholders, has the expertise and market access to execute trades in the leveraged loan market. Allowing the controlling class to direct sales of specific obligations is operationally impractical and could result in suboptimal execution.

Recommended Compromise. If the O/C Test remains in breach for three consecutive payment dates (not two, as proposed by BLH), the Collateral Manager shall present a remediation plan to the Trustee setting forth the Collateral Manager's proposed steps to restore compliance. The Collateral Manager shall not, however, be required to sell collateral obligations at the direction of the Trustee or the controlling class. The controlling class may direct the Trustee to declare an Event of Default only after four consecutive payment dates of O/C Test breach (i.e., approximately twelve months), which provides a meaningful period for the waterfall diversion and the Collateral Manager's remediation efforts to take effect.

The three-consecutive-payment-date trigger for an O/C-related Event of Default, as proposed by BLH, is too aggressive. The standard in CLO indentures is for the existing Events of Default provisions (failure to pay, insolvency, etc.) to serve as the acceleration triggers, rather than a standalone O/C trigger. An O/C failure is a credit quality issue, not a payment default, and should be addressed through the waterfall mechanics rather than through acceleration.

Action Item: Discuss with David Hwan (Driftwood) whether any compromise on this issue should be linked to the specific O/C Test levels (e.g., the forced sale or remediation plan trigger could apply only if the Class A O/C Test is breached, as the most senior test, rather than if any O/C Test is breached) or should apply equally to all four tests. This may be a point of flexibility in the negotiation.

Issue 5: Interest Coverage Test Cure Mechanics

This issue is closely related to Issue 4 and concerns the cure mechanics for Interest Coverage Test failures. The I/C Tests measure whether the portfolio's interest income is sufficient to cover the interest obligations on the rated notes, and a failure indicates that the portfolio's income-generating capacity has deteriorated.

5.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the I/C Tests operate as waterfall diversion triggers, similar to the O/C Tests. If an I/C Test fails on a Determination Date, interest proceeds are diverted from junior classes to senior note principal redemption until the I/C Test is restored. The I/C Test levels are as follows:

As with the O/C Tests, the cure mechanic is automatic through the waterfall diversion, and there is no requirement for the Collateral Manager to take any affirmative action (such as selling collateral obligations) in order to cure an I/C Test failure.

5.2 BLH Markup (Placement Agent's Counsel). Fontaine's position on I/C Test cure mechanics mirrors his position on the O/C Tests discussed in Issue 4 — specifically, he proposes a forced sale mechanism after two consecutive payment dates of I/C Test breach. The same concerns and considerations discussed in Issue 4 apply here.

In addition, Fontaine proposes that an I/C Test failure would automatically suspend the Subordinate Collateral Management Fee (currently 0.35% per annum, or $1,400,000 per year) until the I/C Test is restored. Fontaine frames this as an alignment-of-interest mechanism, arguing that the Collateral Manager should not be compensated at the subordinate fee level when the portfolio is not generating sufficient income to cover the rated noteholders' interest obligations.

5.3 C&H Recommendation. Forced Sale Mechanism. C&H recommends resisting the forced sale mechanism for I/C Test breaches for the same reasons set forth in Issue 4. The waterfall diversion is the appropriate cure mechanic, and forced sales in a distressed market could exacerbate rather than cure the problem.

Subordinate Collateral Management Fee Suspension. This proposal is partially acceptable but requires careful drafting. The Subordinate CMA Fee is already junior in the priority of payments waterfall (payable only after Class D Note interest and senior expenses), so in practice, the fee would naturally be diverted during an I/C Test breach as the waterfall mechanics redirect cash to senior note principal redemption. However, there is an important distinction between a deferral and a suspension (which implies forfeiture):

• A deferral means that the unpaid Subordinate CMA Fee accrues as an obligation of the Issuer and is paid when the I/C Test is restored, at which point the deferred amounts become payable as a senior claim in the waterfall.

• A suspension or forfeiture means that the Collateral Manager permanently loses the right to receive the Subordinate CMA Fee for any period during which the I/C Test is in breach.

C&H recommends counter-proposing that the Subordinate CMA Fee is deferred (not forfeited) during an I/C Test breach, and that deferred amounts accrue and become payable as a senior claim once the I/C Test is restored. This approach preserves the alignment-of-interest principle (the Collateral Manager does not receive cash compensation during a period of I/C Test failure) while protecting the Collateral Manager from permanent forfeiture of earned compensation.

Issue 6: Discretionary Sale Rights — Categories and Limitations

This issue concerns the definition and scope of the Collateral Manager's discretionary sale rights. It is closely related to Issue 1 (Trading Flexibility During the Reinvestment Period) but focuses on the specific categories of permitted sales rather than overall volume limits.

6.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the Collateral Manager has the right to sell any collateral obligation during the Reinvestment Period for any of the following reasons:

(a) Credit Risk. The obligation is a Credit Risk Obligation, defined as an obligation that is rated CCC or below by any applicable rating agency, is in default or payment default, or is subject to credit deterioration in the Collateral Manager's reasonable judgment. The Collateral Manager's judgment as to credit deterioration is not subject to review by the Trustee or the noteholders.

(b) Credit Improved. The obligation has materially improved in credit quality, as evidenced by either (i) an upgrade of at least one full rating notch by any applicable rating agency or (ii) a bid price at or above 102% of par value. The Collateral Manager may sell credit-improved obligations in order to capture gains and reinvest the proceeds in higher-yielding obligations.

(c) Tax Reasons. The sale is necessary to comply with the tax structuring of the Issuer and the Co-Issuer, including the avoidance of a U.S. trade or business characterization for the Cayman Issuer and the maintenance of the disregarded entity treatment of the Delaware Co-Issuer. Sales for tax reasons are coordinated with Sylvia Hartwell's ongoing tax analysis.

(d) Other Discretionary. Any other reason determined by the Collateral Manager in its sole discretion, subject to the requirement that all Collateral Quality Tests and Coverage Tests are satisfied on a pro forma basis after giving effect to the sale and any reinvestment of sale proceeds.

6.2 BLH Markup (Placement Agent's Counsel). Fontaine's markup addresses each of the four categories as follows:

Categories (a) and (c): Accepted without objection. Fontaine agrees that credit-risk and tax-driven sales are necessary and appropriate.

Category (b) (Credit Improved): Fontaine proposes narrowing the definition of "Credit Improved Obligation" to require both an upgrade of at least one full rating notch and a price above par value (not either/or as in the C&H draft). Additionally, Fontaine proposes that credit-improved sales may not exceed 20% of aggregate collateral par per annum during the Reinvestment Period.

Category (d) (Other Discretionary): Fontaine proposes eliminating this category entirely, arguing that it effectively gives the Collateral Manager unlimited discretion to sell any collateral obligation for any reason, which is inconsistent with the noteholders' expectation of a managed portfolio with limited turnover. Fontaine argues that the first three categories (credit risk, credit improved, and tax) are sufficient to cover all legitimate sale scenarios.

Fontaine further argues that investors in the transaction — including Blackpine Insurance Holdings Ltd. ($45,000,000 combined allocation across the Class A-2 and Class B Notes; Sarah Liang, Chief Investment Officer) and Stonehill Public Employees' Retirement System ($22,000,000 combined allocation across the Class C and Class D Notes; James Whitaker, Director of Fixed Income) — expect limited Collateral Manager discretion to sell performing assets and that the "Other Discretionary" category is inconsistent with these expectations.

6.3 C&H Recommendation. Credit Improved (Category (b)). C&H recommends the following compromise: the definition of "Credit Improved Obligation" should require an upgrade of at least one full rating notch or a bid price above 101% of par (splitting the difference on the price threshold between C&H's 102% and BLH's par). The disjunctive "or" formulation is important because there are situations in which an obligation's credit quality has clearly improved (as reflected in price appreciation) but the rating agencies have not yet acted to upgrade the rating. Requiring both an upgrade and a price above par would be too restrictive. C&H recommends resisting the 20% annual volume cap on credit-improved sales as excessive, but acknowledges that some limitation may need to be conceded in the overall negotiation context.

Other Discretionary (Category (d)). This is a critical provision for the Collateral Manager and should not be eliminated. The "Other Discretionary" category provides the Collateral Manager with the flexibility to sell obligations for legitimate reasons that do not fall neatly into the credit-risk, credit-improved, or tax categories — for example, to reduce industry concentration, to manage maturity profile, or to respond to market developments that do not yet constitute "credit deterioration" but that warrant proactive portfolio management.

C&H's counter-proposal: Other Discretionary sales should be limited to 15% of aggregate collateral par per annum during the Reinvestment Period ($60,000,000), with the requirement that all Collateral Quality Tests and Coverage Tests are satisfied on a pro forma basis after giving effect to the sale and any reinvestment of sale proceeds. This cap provides a meaningful constraint on the Collateral Manager's discretion while preserving the category as a tool for active portfolio management.

Action Item: Discuss with Marcus Sorensen and David Hwan at DCM. DCM's investment philosophy requires broad trading flexibility, and the retention of the Other Discretionary category is a key business point. The deal team should understand DCM's priorities as between the various trading-related issues (Issues 1, 2, and 6) in order to develop an integrated negotiation strategy that preserves flexibility where it matters most.

Issue 7: Workout and Restructured Obligation Buckets

This issue concerns the Collateral Manager's ability to acquire and hold obligations received in connection with the restructuring of existing collateral obligations. Workout situations are an inevitable feature of leveraged loan portfolios, and the Indenture must provide a framework for the Collateral Manager to participate in restructurings and hold the resulting obligations.

7.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the Collateral Manager may acquire or retain "Workout Obligations" (defined as obligations received in connection with a restructuring, workout, or bankruptcy of an existing collateral obligation) and "Restructured Obligations" (defined as obligations that have been modified or amended in connection with a restructuring) without such obligations being required to satisfy all of the Eligibility Criteria that apply to the acquisition of new collateral obligations. This is necessary because workout obligations often do not satisfy standard eligibility criteria (e.g., they may be unrated, may not be first-lien, or may have non-standard terms).

The C&H draft provides a Workout Obligation bucket of 5.0% of aggregate collateral par ($20,000,000). Workout Obligations are required to satisfy the O/C Test requirements (i.e., they must be valued at their market value or recovery rate for purposes of the O/C Test calculations), but are otherwise exempt from the Collateral Quality Test requirements.

The C&H draft does not impose any specific limitation on the Collateral Manager's ability to participate in the restructuring process on behalf of the CLO, including voting on restructuring plans, serving on ad hoc creditor committees, and directing the Trustee to take or refrain from taking action in connection with a restructuring.

7.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes the following modifications:

(a) Reduced Bucket Size: Reduce the Workout Obligation bucket from 5.0% to 3.0% of aggregate collateral par ($12,000,000).

(b) Trustee Consent for Workout Participation: The Collateral Manager must obtain the prior written consent of the Trustee before participating in any workout or restructuring negotiation on behalf of the CLO. This would include voting on restructuring plans, serving on creditor committees, and providing direction to the Trustee in connection with restructuring proceedings.

(c) Combined Bucket: Fontaine proposes defining "Restructured Obligations" as a separate defined term but treating them as a sub-bucket within the Workout Obligation bucket (i.e., 3.0% total for both Workout Obligations and Restructured Obligations, not 3.0% plus a separate Restructured Obligation bucket).

7.3 A&P Position (Trustee's Counsel). Marchetti requests that the Trustee receive notice (rather than consent) of any workout participation by the Collateral Manager, and that the Trustee be indemnified against any claims, losses, liabilities, or expenses arising from the Collateral Manager's workout activities. Marchetti's position is more moderate than Fontaine's — the Trustee does not seek a veto right over workout participation but wants to be informed and protected.

7.4 C&H Recommendation. Bucket Size. C&H recommends resisting the reduction to 3.0%. A Workout Obligation bucket of 5.0% ($20,000,000) is within the market range for broadly syndicated CLO transactions (typically 5.0%–10.0% depending on portfolio size and credit quality). A 3.0% bucket ($12,000,000) would constrain the Collateral Manager's ability to hold workout obligations in a scenario where multiple portfolio credits experience restructurings simultaneously — a not-implausible scenario in a stressed market environment.

Combined Bucket. C&H accepts the concept of a combined Workout Obligation / Restructured Obligation bucket of 5.0% (i.e., the two categories are not additive). This is effectively consistent with the C&H initial position, since the C&H draft did not establish a separate, additional bucket for Restructured Obligations.

Trustee Consent for Workout Participation. C&H strongly recommends resisting the requirement of Trustee consent for workout participation. Such a consent requirement would be operationally impractical — restructuring negotiations often move quickly, and requiring the Trustee to evaluate and approve each instance of workout participation would create unacceptable delays. Moreover, the Trustee does not have the credit expertise to evaluate whether participation in a particular restructuring is in the best interests of the CLO and its noteholders; that judgment belongs to the Collateral Manager.

C&H recommends accepting A&P's more moderate proposal: the Collateral Manager shall provide notice to the Trustee within five (5) business days of the Collateral Manager's decision to participate in a workout or restructuring negotiation on behalf of the CLO. Notice, rather than consent, is the appropriate standard.

Trustee Indemnification. C&H recommends accepting the Trustee's request for indemnification against claims arising from the Collateral Manager's workout activities, subject to standard exceptions for the Trustee's own gross negligence and willful misconduct. This is consistent with the general Trustee indemnification framework discussed in Issue 8 and is a reasonable request.

Issue 8: Trustee Indemnification Scope

This issue concerns the scope of the Trustee's indemnification under the Indenture. Trustee indemnification is a standard feature of CLO indentures, but the specific scope of the indemnification, the exceptions to indemnification, and the Trustee's standard of care are frequently negotiated.

8.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the Trustee (Ironclad Trust Company, N.A.) is indemnified by the Issuer out of the collateral for all losses, liabilities, damages, costs, and expenses (including reasonable attorneys' fees) arising from or in connection with the Trustee's acceptance or administration of its duties under the Indenture, except where such losses result from the Trustee's own negligence, bad faith, or willful misconduct.

The indemnification obligation is payable as a senior administrative expense in the priority of payments waterfall, ahead of all note interest and principal payments. This senior positioning ensures that the Trustee can fulfill its duties without concern that its indemnification claims will be subordinated to noteholder payments.

The Trustee fee is set at $25,000 per annum (flat), and the Trustee expense cap is $50,000 per payment date (i.e., $200,000 per annum, assuming quarterly payment dates). Expenses in excess of the cap are subordinated in the waterfall and payable only after all rated note obligations have been satisfied.

8.2 A&P Markup (Trustee's Counsel). Marchetti proposes the following modifications to the Trustee indemnification provisions:

(a) Direction of Controlling Class. The Trustee should be indemnified for any action taken at the direction of the controlling class (or any action taken or omitted in reliance on such direction), even if such direction later proves to have been erroneous or results in loss to the Issuer or the noteholders. This provision protects the Trustee from liability when it acts as a "directed trustee" carrying out instructions from the noteholders, which is a significant portion of the Trustee's role in a CLO structure.

(b) Reliance on Certificates and Notices. The Trustee should be indemnified for actions taken in reliance on officer's certificates, opinions of counsel, notices, and other documents provided to the Trustee by the Issuer, the Collateral Manager, or any other party. The Trustee should not be required to independently verify the accuracy or completeness of any such document.

(c) Environmental Liabilities. The Trustee should be indemnified against any environmental liabilities arising from any collateral held by the Issuer. Marchetti acknowledges that this provision is drawn from A&P's standard form trust indenture and may not be directly applicable to a CLO backed by broadly syndicated loan participations (as opposed to a trust holding real property or other tangible assets), but includes it for the avoidance of doubt.

(d) Trustee Expense Cap. Marchetti proposes either (i) removing the $50,000 per payment date expense cap entirely, or (ii) in the alternative, increasing the cap to $100,000 per payment date ($400,000 per annum). Marchetti argues that the current $50,000 cap is inadequate to cover the Trustee's out-of-pocket expenses in a distressed scenario (e.g., an Event of Default, a collateral liquidation, or litigation involving the CLO).

Additionally, Marchetti proposes that the Trustee's standard of care be elevated from simple negligence to gross negligence or willful misconduct. Under this formulation, the Trustee would be indemnified for actions that constitute simple negligence, and the indemnification carve-out would apply only in cases of gross negligence or willful misconduct. This effectively raises the bar for noteholders or the Issuer to hold the Trustee liable for errors in the performance of its duties.

8.3 C&H Recommendation.

(a) Direction of Controlling Class Indemnification — ACCEPT. This is a market-standard provision and is present in virtually all CLO indentures. The Trustee should not bear liability for following the instructions of the controlling class. C&H recommends accepting this provision without modification.

(b) Reliance Indemnification — ACCEPT. This is also a market-standard provision. The Trustee is an administrative fiduciary, not a credit analyst, and should be entitled to rely on the accuracy of officer's certificates and opinions of counsel provided by the Issuer and the Collateral Manager. C&H recommends accepting this provision without modification.

(c) Environmental Liabilities — REJECT. This provision is drawn from A&P's standard form trust indenture and is inapplicable to a CLO backed by broadly syndicated loan participations. The collateral held by the Issuer consists of participations in senior secured and second-lien loans, not real property or other tangible assets that give rise to environmental liabilities. C&H recommends suggesting deletion of this provision as inapplicable boilerplate and providing a brief explanation to Marchetti.

(d) Trustee Expense Cap — COMPROMISE. C&H recommends compromising at $75,000 per payment date ($300,000 per annum), which represents the midpoint between the C&H position of $50,000 and the A&P position of $100,000. C&H recommends rejecting the outright removal of the expense cap, as an uncapped expense reimbursement obligation could, in a distressed scenario, consume a significant portion of the collateral proceeds that would otherwise be available for distribution to noteholders.

Standard of Care. C&H strongly recommends resisting the elevation of the Trustee's standard of care from simple negligence to gross negligence. Simple negligence is the standard set forth in C&H's form CLO indenture and provides appropriate protection for noteholders and the Issuer. Under a gross negligence standard, the Trustee could engage in careless or unreasonable conduct without facing liability, so long as such conduct did not rise to the level of "gross" negligence — a standard that is difficult to establish and provides minimal deterrent effect. This is a point on which BLH (Gregory Fontaine) is likely to support the C&H position, as the placement agent's counsel generally prefers the lower negligence threshold to maximize investor protection. C&H recommends coordinating with BLH on this issue to present a unified front against A&P.

Issue 9: Events of Default — Definitions and Remedies

This issue concerns the definition of Events of Default and the remedies available to the Trustee and the controlling class upon the occurrence of an Event of Default. The Events of Default provisions are among the most consequential provisions in the Indenture, as they define the circumstances under which the notes may be accelerated and the collateral liquidated.

9.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the following constitute Events of Default:

(a) Failure to pay interest on the Class A-1 or Class A-2 Notes when due (no cure period);

(b) Failure to pay interest on the Class B, Class C, or Class D Notes when due, subject to a five (5) business day cure period;

(d) Breach of any representation, warranty, or covenant contained in the Indenture, subject to a thirty (30) day cure period after written notice from the Trustee or holders of at least 25% in aggregate principal amount of the controlling class;

(e) Insolvency, bankruptcy, receivership, or liquidation of the Issuer or the Co-Issuer; and

(f) Acceleration or termination of the Collateral Management Agreement (other than in connection with the replacement of the Collateral Manager in accordance with the terms thereof).

Upon the occurrence of an Event of Default, the controlling class (holders of the Class A-1 Notes) may direct the Trustee to accelerate all notes, liquidate the collateral, and distribute the liquidation proceeds in accordance with the priority of payments.

9.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes the following additional Events of Default:

(g) O/C Test Breach. Any O/C Test remaining in breach for three consecutive payment dates, as discussed in Issue 4 above.

(h) Collateral Manager Removal or Resignation. Removal of the Collateral Manager for cause or resignation of the Collateral Manager without appointment of a successor Collateral Manager within sixty (60) days.

(i) Loss of SEC Registration. Loss of the Collateral Manager's SEC investment adviser registration (DCM's CRD #182447), whether through revocation, withdrawal, or lapse.

In addition to the standard acceleration and liquidation remedies, Fontaine proposes that the remedies available upon an Event of Default include a forced sale of the Collateral Manager's interest in the CLO and appointment of a substitute collateral manager at the direction of the controlling class. Fontaine frames this as a mechanism to ensure continuity of portfolio management in the event that the existing Collateral Manager is removed, resigns, or loses its regulatory status.

9.3 C&H Recommendation.

(g) O/C Test Breach. C&H recommends resisting this as a standalone Event of Default trigger. As discussed in Issue 4, the appropriate mechanism for addressing O/C Test failures is the waterfall diversion, supplemented by the compromise proposal of a remediation plan after three consecutive payment dates of breach and a controlling-class-directed Event of Default trigger only after four consecutive payment dates of breach. Adding a standalone O/C-related Event of Default at three consecutive payment dates would effectively give the controlling class the ability to accelerate and liquidate the collateral after only nine months of O/C Test failure, which is too aggressive.

(h) Collateral Manager Removal or Resignation. This is acceptable in principle. However, C&H recommends proposing a ninety (90) day period (rather than BLH's proposed sixty (60) days) for the appointment of a successor Collateral Manager. Identifying, vetting, and engaging a qualified successor CLO manager is a complex process that requires regulatory approvals, board consents, and negotiation of new management agreements. Sixty days is insufficient in practice. A ninety-day period provides adequate time while still ensuring that the CLO does not operate without a Collateral Manager for an extended period.

(i) Loss of SEC Registration. This is acceptable, subject to a ninety (90) day cure period to allow DCM to re-register with the SEC or cure any regulatory deficiency that led to the loss of registration. Loss of registration may occur due to administrative errors or regulatory disputes that can be resolved within a reasonable period; an immediate Event of Default trigger is disproportionate.

Forced Sale of Collateral Manager's Interest. C&H recommends rejecting this proposal. The Collateral Management Agreement already contains removal-for-cause provisions, including specified grounds for removal and a process for appointment of a successor. A forced sale of the equity interest in DCM is beyond the scope of the Indenture and would raise significant corporate governance issues for Driftwood Absolute Return Fund Ltd. and its subsidiaries. The Indenture governs the relationship among the Issuer, the Trustee, and the noteholders — it does not govern the corporate ownership structure of the Collateral Manager. A provision requiring the forced sale of a Collateral Manager's equity interest would be unprecedented in a CLO indenture and would raise serious questions about the enforceability and the scope of the Indenture's contractual authority.

Issue 10: Priority of Payments Waterfall — Subordinate CMA Fee Placement

This issue concerns the placement of the Subordinate Collateral Management Fee in the priority of payments waterfall. This is a high-priority economic issue for DCM, as the Subordinate CMA Fee represents approximately 70% of DCM's annual fixed compensation from the CLO.

10.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the priority of payments waterfall positions the various fees and obligations as follows:

1. Trustee fees and expenses (senior administrative expenses)

2. Senior Collateral Management Fee (0.15% per annum / $600,000 per year)

3. Class A-1 Note interest

4. Class A-2 Note interest

5. Class B Note interest

6. O/C and I/C Test waterfall diversion (if applicable)

7. Class C Note interest

8. Class D Note interest

9. Subordinate Collateral Management Fee (0.35% per annum / $1,400,000 per year)

10. Subordinated Note distributions

11. Incentive Management Fee (20% of excess above 12% IRR hurdle to subordinated noteholders)

12. Residual distributions to subordinated noteholders

Under this structure, the Subordinate CMA Fee is positioned after Class D Note interest but before Subordinated Note distributions, which ensures that DCM receives its subordinate fee before equity returns are distributed.

10.2 BLH Markup (Placement Agent's Counsel). Fontaine accepts the placement of the Senior CMA Fee as a senior administrative expense and does not contest its position in the waterfall.

However, Fontaine proposes that the Subordinate CMA Fee be positioned after Subordinated Note distributions — effectively making it the last obligation in the waterfall (other than the Incentive Management Fee). Fontaine's rationale is that the Subordinate CMA Fee should be paid only after the equity holders have received their distributions, on the theory that alignment of interest between the Collateral Manager and the equity holders is maximized when the Collateral Manager's subordinate compensation is junior to equity returns.

As an alternative, Fontaine proposes a hybrid structure: 50% of the Subordinate CMA Fee ($700,000 per year) payable before Subordinated Note distributions and 50% ($700,000 per year) payable after Subordinated Note distributions.

10.3 C&H Recommendation. C&H recommends resisting the full subordination of the Subordinate CMA Fee below equity distributions. This is below market and would effectively make $1,400,000 per year of annual collateral management compensation contingent on the CLO generating sufficient equity returns. In a stressed scenario — where the portfolio experiences credit deterioration, defaults, or market dislocation — the equity tranche may receive reduced or no distributions, and full subordination of the Subordinate CMA Fee would mean that DCM's compensation is cut by approximately 70% even though the Collateral Manager is performing its duties and managing the portfolio through a difficult period. This would create perverse incentives: the Collateral Manager would have reduced motivation to dedicate resources to a CLO from which it is receiving minimal compensation.

The hybrid proposal (50/50 split) is potentially workable as a last-resort compromise, but the C&H recommendation is to maintain the Subordinate CMA Fee above equity distributions in its entirety. The 50/50 split should be reserved for use in the negotiation only if BLH is unwilling to accept the current placement and the alternative is full subordination.

Action Item: Discuss with Marcus Sorensen and Elena Voss at Driftwood. This is a key economic point for DCM's economics on the platform and will directly affect DCM's profitability from the CLO. The client's instructions on acceptable compromise positions should be obtained before the August 15 negotiation call.

Rating Agency Impact. The current waterfall placement was presented to both rating agencies (Brindoval and Ridgeline) and was modeled accordingly. Changing the placement of the Subordinate CMA Fee could require re-engagement with both rating agencies to confirm that the modified waterfall does not affect the preliminary ratings. This is a point that should be raised with BLH as a practical obstacle to any change in fee placement.

Issue 11: Minimum Denomination and Transfer Restrictions

This issue concerns the minimum denomi

PRIVILEGED & CONFIDENTIAL — ATTORNEY WORK PRODUCT
August 10, 2023
INDENTURE NEGOTIATION ISSUES LIST AND REDLINE SUMMARY
Transaction: Driftwood CLO 2023-I
C&H Matter No.: 1024-00004
Billing Code: DARF-CLO-2023I
Prepared By: Hannah Brinkley, Lead Associate, Calderwood & Harkness LLP
Reviewed By: Samuel Eklund, Responsible Partner, Calderwood & Harkness LLP
Distribution: Internal Calderwood & Harkness only — Samuel Eklund, Linda Osei, Patrick Gallagher, Sylvia Hartwell
This memorandum is protected by the attorney-client privilege and constitutes attorney work product. It is prepared solely for internal use by Calderwood & Harkness LLP attorneys working on the Driftwood CLO 2023-I transaction and should not be distributed, forwarded, or disclosed to any person outside of the distribution list set forth above without the prior written consent of the Responsible Partner. Any inadvertent disclosure does not constitute a waiver of privilege.
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I. EXECUTIVE SUMMARY AND PURPOSE
This memorandum summarizes the open negotiation points on the Indenture (the "Indenture") for Driftwood CLO 2023-I, currently dated for execution on August 22, 2023, among Driftwood CLO 2023-I, Ltd., an exempted company incorporated under the laws of the Cayman Islands (the "Issuer" or "Cayman Issuer"), Driftwood CLO 2023-I, LLC, a Delaware limited liability company (the "Co-Issuer" or "Delaware Co-Issuer"), and Ironclad Trust Company, N.A., a national banking association organized under the laws of the United States (the "Trustee").
Calderwood & Harkness LLP ("C&H") represents Driftwood Absolute Return Fund Ltd. (the "Client" or "Issuer Parent") and Driftwood Credit Management LLC (the "Collateral Manager" or "DCM") as issuer's counsel in connection with this transaction. This memorandum is prepared for the purpose of advising the deal team on the current state of Indenture negotiations, identifying areas of disagreement with counterparty counsel, and recommending positions for resolution.
The counterparties and their respective legal counsel are as follows:
• Meridian Atlantic Securities LLC ("Meridian Atlantic"), acting as structuring lead and placement agent for the transaction, is represented by Barrington, Locke & Hayes LLP ("BLH"). The lead attorneys at BLH are Gregory Fontaine (partner) and Miriam Saldaña (associate). BLH's comments represent the interests of the rated noteholders and the placement agent's market-standard investor protections.
• Ironclad Trust Company, N.A. (the "Trustee"), is represented by Ashworth & Pratt LLP ("A&P"). The lead attorney at A&P is Lillian Marchetti (partner). A&P's comments focus on Trustee protections, indemnification, and operational clarity.
Procedural History. C&H circulated the initial draft Indenture (Version 1) to BLH and A&P on July 25, 2023. BLH circulated its combined comments and markup (Version 2) on August 5, 2023. A&P circulated its comments and markup (Version 3) on August 7, 2023. This memorandum is based on a review of all three versions and catalogs the substantive open issues arising from the counterparty markups.
This memorandum catalogs twelve (12) substantive open issues, organized by subject matter. For each issue, the memorandum tracks: (i) the C&H initial position as set forth in Version 1; (ii) the counterparty markup and rationale, as extracted from Versions 2 and 3; (iii) the current status of the issue (open, resolved, or compromised); and (iv) the recommended resolution from the C&H deal team. Internal commentary and strategic considerations are included where relevant.
Target Resolution Date. All issues must be resolved no later than August 18, 2023, to align with the finalization of the Offering Memorandum on that date. The executed Indenture must be delivered on the closing date of August 22, 2023. This timeline is aggressive, and the deal team should be prepared for an intensive negotiation period from August 14 through August 18.
II. TRANSACTION OVERVIEW — KEY STRUCTURAL PARAMETERS FOR REFERENCE
The following is a summary of the key structural parameters of the Driftwood CLO 2023-I transaction, provided for the convenience of the deal team in evaluating the negotiation issues discussed herein. These parameters are consistent with the preliminary term sheet circulated to investors by Meridian Atlantic on July 15, 2023, and with the preliminary ratings received from both rating agencies on August 4, 2023.
Total Deal Size: $400,000,000 across six tranches (five rated tranches and one subordinated/equity tranche).
Capital Structure Summary
Collateral Manager: Driftwood Credit Management LLC, a Delaware limited liability company registered as an investment adviser with the Securities and Exchange Commission (CRD #182447). David Hwan (Managing Director, Structured Credit) is the portfolio manager responsible for collateral selection and trading decisions with respect to the CLO portfolio.
Reference Rate: Compounded SOFR, calculated in accordance with the ARRC-recommended 26253 fallback convention. Day count convention is Actual/360.
Non-Call Period: Two (2) years from the closing date, ending on September 12, 2025. During the Non-Call Period, the Issuer may not optionally redeem any rated notes.
Reinvestment Period: Five (5) years from the closing date, ending on September 12, 2028. During the Reinvestment Period, the Collateral Manager has the ability to reinvest principal proceeds in additional collateral obligations, subject to the limitations discussed in the Indenture and the issues analyzed herein.
Stated Maturity: October 15, 2036.
Payment Dates: Quarterly, on the 15th day of January, April, July, and October of each year, commencing on January 15, 2024 (the first payment date).
Effective Date Deadline: December 12, 2023 (ninety (90) days following the anticipated pricing date of September 8, 2023). By the Effective Date, the Collateral Manager must have ramped the portfolio such that all Collateral Quality Tests are satisfied.
Preliminary Ratings: Preliminary ratings were received from both Brindoval Rating Services ("Brindoval") and Ridgeline Credit Ratings ("Ridgeline") on August 4, 2023. The preliminary ratings are consistent with the target capital structure set forth above. The rating agency presentations were conducted on June 12, 2023 (Brindoval; Anita Delgado and Brian Whitford) and June 19, 2023 (Ridgeline; Kenji Matsuda), with model review completed on July 28, 2023.
III. ISSUE-BY-ISSUE ANALYSIS
Issue 1: Trading Flexibility During the Reinvestment Period
This is a high-priority issue that goes to the core of the Collateral Manager's operational authority under the Indenture. The scope of the Collateral Manager's discretion to buy and sell collateral obligations during the Reinvestment Period is one of the most heavily negotiated provisions in any CLO indenture, as it reflects the fundamental tension between the Collateral Manager's need for investment flexibility and noteholder expectations of portfolio stability.
1.1 C&H Initial Position (Issuer/Collateral Manager). As set forth in Version 1 of the Indenture, C&H's initial position is that the Collateral Manager should have broad discretion to buy and sell collateral obligations during the Reinvestment Period (through September 12, 2028) without the consent of the Trustee or the noteholders, provided that the Collateral Quality Tests and Coverage Tests (including both the Overcollateralization Tests and the Interest Coverage Tests) are satisfied after giving effect to any such trade. This is consistent with market practice for broadly syndicated CLO 2.0 transactions and reflects the fundamental principle that the Collateral Manager is engaged for its credit expertise and should be permitted to exercise that expertise without undue constraint.
The C&H draft imposes no limit on aggregate trading volume during the Reinvestment Period. Discretionary sales are permitted for credit risk reasons, credit improvement reasons, and tax reasons, in addition to customary mandatory sale triggers (e.g., sales of defaulted obligations, credit risk obligations, and equity securities received in connection with restructurings). The Collateral Manager's trading authority is subject to the overarching requirement that the portfolio continue to satisfy all applicable tests after giving effect to each trade.
1.2 BLH Markup (Placement Agent's Counsel). Gregory Fontaine at BLH proposes that discretionary sales be limited to 25% of aggregate collateral par per annum during the Reinvestment Period. Fontaine's markup introduces a new defined term, "Maximum Annual Discretionary Trading Volume," and provides that any discretionary sale in excess of this limit requires the prior written consent of a majority of Class A-1 noteholders. Fontaine's stated rationale is that investors expect a degree of portfolio stability and that unlimited trading authority is inconsistent with the buy-and-hold character of a CLO vehicle. Fontaine's comments cite to investor feedback received during the preliminary marketing process, although no specific investor objections have been communicated to C&H directly.
In addition, Fontaine proposes that any sale resulting in a decline in the Weighted Average Spread below 350 basis points (the minimum WA Spread criterion under the Collateral Quality Tests) or the Diversity Score below 60 (the minimum Diversity Score criterion) should require the prior written consent of a majority of Class A-1 noteholders. This would effectively layer an additional consent requirement on top of the existing Collateral Quality Test framework.
1.3 A&P Position (Trustee's Counsel). Lillian Marchetti at A&P has deferred to the placement agent and the noteholders on the question of trading volume limits. A&P does not take an independent position on behalf of the Trustee as to whether a volume cap is appropriate. However, Marchetti requests that trade settlement procedures include a requirement that the Trustee receive notification of each sale within two (2) business days of the trade date. This notification requirement is framed as necessary for the Trustee to maintain accurate records for purposes of the Coverage Test and Collateral Quality Test compliance reporting that the Trustee performs under the Collateral Administration Agreement.
1.4 C&H Recommendation. C&H recommends the following approach to this issue:
Resist the 25% annual volume cap. This limitation is overly restrictive and is not consistent with market practice for broadly syndicated CLO transactions. A review of recent precedent transactions — including Cobalt CLO III (Ames & Aldgate LLP, 2023), Meridian Harbour CLO 2023-1 (Hale & Morriven LLP, 2023), and Pinnacle Credit CLO VI (Buchanan & Thackeray LLP, 2023) — confirms that no annual volume cap on discretionary trading during the Reinvestment Period is imposed. The annual volume cap proposed by BLH would effectively constrain the Collateral Manager to turning over no more than $100,000,000 of the $400,000,000 portfolio per year, which could significantly impair the Collateral Manager's ability to respond to market conditions and credit developments. This is a position where C&H believes there is strong market support, and we recommend holding firm.
Acceptable concessions. C&H recommends accepting the following concessions, which we believe are reasonable and do not materially impair the Collateral Manager's flexibility:
(a) Trustee Notification: Accept the requirement that the Trustee receive notification of any sale within two (2) business days of the trade date. This is a purely administrative requirement and is consistent with the Trustee's collateral administration function.
(b) Pro Forma Test Compliance: Accept the requirement that each discretionary sale must satisfy all Collateral Quality Tests on a pro forma basis after giving effect to the reinvestment of sale proceeds. This is effectively already required under the C&H draft (the "maintain or improve" standard), but we are willing to make it explicit.
WA Spread and Diversity Score Consent Threshold. C&H recommends pushing back on the requirement for majority Class A-1 noteholder consent if a sale would cause a decline in the WA Spread below 350 bps or the Diversity Score below 60. The Collateral Quality Tests already impose these constraints as hard floors; a trade that would cause the WA Spread to fall below 350 bps or the Diversity Score to fall below 60 would already fail the Collateral Quality Tests and would therefore not be permitted under the Indenture. The additional consent mechanism is duplicative and would create operational complexity (obtaining noteholder consent for individual trades is impractical in a $400 million CLO).
Issue 2: Post-Reinvestment Period Trading Constraints
This issue concerns the Collateral Manager's authority to trade collateral obligations after the expiration of the Reinvestment Period on September 12, 2028. While the Collateral Manager's trading authority is expected to be more limited after the Reinvestment Period, there are important questions regarding the scope of permitted trades and the duration of any limited reinvestment window.
2.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, after the Reinvestment Period, the Collateral Manager retains the ability to sell credit-risk obligations and credit-improved obligations and to reinvest the sale proceeds in substitute collateral obligations, subject to the following conditions: (i) all Coverage Tests (O/C Tests and I/C Tests) must be satisfied after giving effect to the substitution; (ii) all Collateral Quality Tests must be satisfied after giving effect to the substitution; (iii) the substitution may not extend the Weighted Average Life of the portfolio; and (iv) the substitution may not reduce the Weighted Average Spread below the minimum required level.
With respect to unscheduled principal proceeds (e.g., prepayments, recoveries on defaulted obligations) received after the expiration of the Reinvestment Period, the C&H draft provides that such proceeds are to be applied to the redemption of notes in accordance with the priority of payments. However, the Collateral Manager has the ability to reinvest such proceeds in eligible investments for a limited period of up to sixty (60) days following receipt. This reinvestment window is intended to allow the Collateral Manager to optimize the timing of note redemptions and avoid forced sales of newly acquired collateral.
2.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes the following modifications to the post-Reinvestment Period trading provisions:
(a) Reinvestment Window: Reduce the post-Reinvestment Period reinvestment window from sixty (60) days to thirty (30) days.
(b) Elimination of Credit-Improvement Sales: Restrict post-Reinvestment Period trading to credit-risk and credit-impaired sales only. Fontaine proposes eliminating credit-improvement sales as a permitted category of post-Reinvestment Period trades, on the theory that the Collateral Manager should not be actively trading the portfolio for profit after the Reinvestment Period has expired.
(c) Substitution Conditions: No substitutions are permitted after the Reinvestment Period except with unscheduled principal proceeds, and only if the resulting portfolio passes all O/C Tests and Collateral Quality Tests on a pro forma basis.
2.3 C&H Recommendation. C&H recommends the following approach:
Reinvestment Window: Compromise at a forty-five (45) day reinvestment window following receipt of unscheduled principal proceeds after the Reinvestment Period. This is a reasonable midpoint between the C&H position of sixty days and the BLH position of thirty days, and provides the Collateral Manager with sufficient time to evaluate reinvestment opportunities without unduly delaying note redemptions.
Credit-Improvement Sales: C&H recommends pushing back on the elimination of credit-improvement sales as a post-Reinvestment Period trading category. Credit-improvement trades are a standard tool in the Collateral Manager's toolkit and serve an important function in optimizing portfolio returns for the benefit of all noteholders. The ability to sell a credit-improved obligation at a premium and reinvest the proceeds in a higher-yielding asset benefits the entire capital structure. However, in recognition of the more limited trading authority expected after the Reinvestment Period, C&H proposes limiting credit-improvement sales to 10% of aggregate collateral par per annum after the Reinvestment Period. This represents a meaningful concession while preserving the Collateral Manager's ability to engage in this type of trading activity.
Substitution Conditions: C&H accepts the condition that each substitution must pass all O/C Tests (Class A: 128.00%, Class B: 118.00%, Class C: 110.00%, Class D: 105.50%) and all Collateral Quality Tests on a pro forma basis. This is consistent with the C&H initial position.
Issue 3: Definition of Collateral Quality Tests
The Collateral Quality Tests are among the most critical provisions of the Indenture, as they define the credit parameters within which the Collateral Manager must operate when acquiring and managing collateral obligations. Any changes to the Collateral Quality Test definitions have direct implications for the rating agency models and the preliminary ratings.
3.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the Collateral Quality Tests consist of the following eight tests:
The C&H draft further provides that the Collateral Manager may acquire an obligation that causes one or more Collateral Quality Tests to fail, or, if a Collateral Quality Test is already failing at the time of acquisition, the acquisition does not cause further deterioration of the failing test (the "maintain or improve" standard). This is a widely accepted formulation in CLO indentures and provides the Collateral Manager with the flexibility to continue acquiring collateral obligations even in a stressed market environment, so long as the acquisition does not worsen any existing test failure.
3.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes the following modifications:
(a) "Must Improve" Standard: Fontaine proposes tightening the "maintain or improve" standard to require that each acquisition actually improve a failing Collateral Quality Test, rather than merely maintaining the level of non-compliance. Under this formulation, if the Minimum Diversity Score is 60 and the current portfolio Diversity Score is 58, the Collateral Manager could only acquire an obligation that brings the Diversity Score to 59 or above — not one that maintains it at 58.
(b) Minimum Floating Rate Coupon Floor: Fontaine proposes adding a new Collateral Quality Test in the form of a Minimum Floating Rate Coupon Floor of SOFR + 250 basis points. Under this test, no loan with a floating rate spread below 250 basis points over SOFR may be acquired as a collateral obligation.
(c) CCC Bucket Reduction: Fontaine argues that the current CCC Bucket of 7.5% of aggregate collateral par is generous by current market standards and proposes reducing it to 7.0% of aggregate collateral par ($28,000,000).
3.3 A&P Position (Trustee's Counsel). Marchetti notes that the Trustee's compliance reporting obligations under the Collateral Administration Agreement will reference the Collateral Quality Test definitions set forth in the Indenture. Marchetti requests that the calculation methodology for the Weighted Average Rating Factor and the Diversity Score be set out explicitly in the Indenture itself, rather than solely by reference to the applicable rating agency model. Marchetti's concern is that the Trustee needs sufficient clarity to perform its compliance calculations without having to interpret or apply the rating agency models independently.
3.4 C&H Recommendation. "Maintain or Improve" Standard. C&H strongly recommends resisting the "must improve" standard proposed by BLH. The "maintain or improve" formulation is market standard for broadly syndicated CLO transactions and was specifically presented to and accepted by both Brindoval (Anita Delgado and Brian Whitford) and Ridgeline (Kenji Matsuda) during the rating agency presentations conducted on June 12 and June 19, 2023, respectively. The rating agency model review was completed on July 28, 2023, on the basis of the "maintain or improve" standard. Changing to a "must improve" standard at this stage could require re-engagement with both rating agencies and could potentially jeopardize the preliminary ratings received on August 4, 2023. Moreover, the "must improve" standard is operationally impractical in a stressed credit environment, where it may be difficult for the Collateral Manager to find obligations that affirmatively improve a failing test.
Minimum Floating Rate Coupon Floor. C&H recommends resisting the proposed Minimum Floating Rate Coupon Floor. This is a non-market addition that is not included in either rating agency's model and would unnecessarily constrain the Collateral Manager's ability to acquire obligations at the lower end of the credit spread spectrum. While such obligations are less common in the broadly syndicated leveraged loan market, they do exist (particularly among higher-quality investment-grade crossover credits), and the Collateral Manager should retain the flexibility to include them in the portfolio where doing so is consistent with the overall portfolio construction strategy.
CCC Bucket. The CCC Bucket at 7.5% of aggregate collateral par ($30,000,000) is consistent with the rating agency models and the preliminary ratings received on August 4, 2023. C&H recommends resisting the proposed reduction to 7.0%. A review of recent CLO transactions shows that 7.5% is within the market range (typically 7.0%–7.5%), and the preliminary ratings were issued on this basis. Additionally, the 7.5% threshold provides the Collateral Manager with meaningful flexibility to hold CCC-rated obligations without triggering excess CCC haircut adjustments in the O/C Test calculations.
Calculation Methodology. C&H recommends accepting Marchetti's request for explicit calculation methodology language. We propose adding a new definitional schedule to the Indenture (Schedule 1 — Calculation Methodology) that sets forth the methodology for calculating the WARF and the Diversity Score, in each case referencing the Brindoval methodology (the Brindoval corporate credit rating scale is the basis for the 2,850 WARF minimum). This addition is helpful for operational clarity and should not be controversial with BLH. Patrick Gallagher should prepare the initial draft of this schedule based on the Brindoval methodology document provided during the rating process.
Issue 4: Overcollateralization Test Cure Mechanics
This is a high-priority issue that directly implicates the balance of control between the Collateral Manager and the senior noteholders. The O/C test cure mechanics determine what happens when the portfolio's credit quality deteriorates to the point that the O/C Tests fail, and the extent to which the Collateral Manager may be compelled to take affirmative action to restore compliance.
4.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, if an O/C Test fails on any Determination Date (the date on which the Trustee calculates the Coverage Tests for each payment period), the cure mechanism operates automatically through the waterfall. Specifically, interest proceeds and, if necessary, principal proceeds are diverted from junior classes to redeem senior notes until the applicable O/C Test is restored. This waterfall diversion mechanism is the standard cure mechanic in CLO indentures and does not require any affirmative action by the Collateral Manager. There is no requirement for the Collateral Manager to sell collateral obligations in order to cure an O/C Test failure.
The O/C Test levels, as set forth in the C&H draft, are as follows:
4.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes a more aggressive cure framework with the following elements:
(a) Forced Sale Mechanism: If an O/C Test remains in breach for two consecutive payment dates (i.e., approximately six months), the Collateral Manager must sell collateral obligations at the direction of the Trustee, acting at the request of a majority of the controlling class (Class A-1 noteholders), in order to restore compliance. The Collateral Manager would not have discretion to select the obligations to be sold; instead, the Trustee (acting at the direction of the controlling class) would have the authority to direct the sale of specific obligations.
(b) Event of Default Trigger: If any O/C Test remains breached for three consecutive payment dates (i.e., approximately nine months), such breach would constitute an Event of Default under the Indenture, entitling the controlling class to direct the Trustee to accelerate the notes and liquidate the collateral.
Fontaine argues that these provisions are necessary to protect senior noteholders, particularly the anchor investor Marlowe Asset Management Peak Institutional Credit Fund LP, which has committed to an $80,000,000 allocation in the Class A-1 Notes (Robert Calloway, Portfolio Manager). Fontaine has indicated informally that Marlowe Asset Management Peak's investment committee has expressed a preference for enhanced noteholder protections in the event of O/C Test failures.
4.3 A&P Position (Trustee's Counsel). Marchetti supports the forced sale mechanism as a protective tool for the Trustee's fiduciary obligations. However, Marchetti requests the following modifications to the BLH proposal:
(a) Any forced sale must be conducted at market price (i.e., the Trustee should not be required to accept below-market bids), with a 10-business-day cure period before the forced sale is executed, during which the Collateral Manager may restore compliance through other means (e.g., voluntary sales, receipt of principal proceeds).
(b) The Trustee must receive explicit indemnification for any losses arising from forced sales, including any claims by the Collateral Manager, the Issuer, or any noteholder that the forced sale resulted in a loss to the portfolio.
4.4 C&H Recommendation. Forced Sale Mechanism. C&H recommends resisting the forced sale mechanism as overly aggressive and not consistent with market practice. The waterfall diversion is the standard cure mechanic in CLO indentures, and forced sales at the direction of the controlling class introduce a number of significant risks:
(i) Market Timing Risk: Forced sales in a distressed market environment may require the Collateral Manager to sell obligations at depressed prices, which would further erode the portfolio's par value and potentially exacerbate the O/C Test failure rather than curing it.
(ii) Conflict of Interest: The controlling class (Class A-1 noteholders) may have incentives that diverge from the interests of the junior noteholders and the equity holders. A forced sale directed by the Class A-1 noteholders could result in the crystallization of losses that disproportionately harm the junior tranches.
(iii) Operational Impracticality: The Collateral Manager, not the Trustee or the noteholders, has the expertise and market access to execute trades in the leveraged loan market. Allowing the controlling class to direct sales of specific obligations is operationally impractical and could result in suboptimal execution.
Recommended Compromise. If the O/C Test remains in breach for three consecutive payment dates (not two, as proposed by BLH), the Collateral Manager shall present a remediation plan to the Trustee setting forth the Collateral Manager's proposed steps to restore compliance. The Collateral Manager shall not, however, be required to sell collateral obligations at the direction of the Trustee or the controlling class. The controlling class may direct the Trustee to declare an Event of Default only after four consecutive payment dates of O/C Test breach (i.e., approximately twelve months), which provides a meaningful period for the waterfall diversion and the Collateral Manager's remediation efforts to take effect.
The three-consecutive-payment-date trigger for an O/C-related Event of Default, as proposed by BLH, is too aggressive. The standard in CLO indentures is for the existing Events of Default provisions (failure to pay, insolvency, etc.) to serve as the acceleration triggers, rather than a standalone O/C trigger. An O/C failure is a credit quality issue, not a payment default, and should be addressed through the waterfall mechanics rather than through acceleration.
Action Item: Discuss with David Hwan (Driftwood) whether any compromise on this issue should be linked to the specific O/C Test levels (e.g., the forced sale or remediation plan trigger could apply only if the Class A O/C Test is breached, as the most senior test, rather than if any O/C Test is breached) or should apply equally to all four tests. This may be a point of flexibility in the negotiation.
Issue 5: Interest Coverage Test Cure Mechanics
This issue is closely related to Issue 4 and concerns the cure mechanics for Interest Coverage Test failures. The I/C Tests measure whether the portfolio's interest income is sufficient to cover the interest obligations on the rated notes, and a failure indicates that the portfolio's income-generating capacity has deteriorated.
5.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the I/C Tests operate as waterfall diversion triggers, similar to the O/C Tests. If an I/C Test fails on a Determination Date, interest proceeds are diverted from junior classes to senior note principal redemption until the I/C Test is restored. The I/C Test levels are as follows:
As with the O/C Tests, the cure mechanic is automatic through the waterfall diversion, and there is no requirement for the Collateral Manager to take any affirmative action (such as selling collateral obligations) in order to cure an I/C Test failure.
5.2 BLH Markup (Placement Agent's Counsel). Fontaine's position on I/C Test cure mechanics mirrors his position on the O/C Tests discussed in Issue 4 — specifically, he proposes a forced sale mechanism after two consecutive payment dates of I/C Test breach. The same concerns and considerations discussed in Issue 4 apply here.
In addition, Fontaine proposes that an I/C Test failure would automatically suspend the Subordinate Collateral Management Fee (currently 0.35% per annum, or $1,400,000 per year) until the I/C Test is restored. Fontaine frames this as an alignment-of-interest mechanism, arguing that the Collateral Manager should not be compensated at the subordinate fee level when the portfolio is not generating sufficient income to cover the rated noteholders' interest obligations.
5.3 C&H Recommendation. Forced Sale Mechanism. C&H recommends resisting the forced sale mechanism for I/C Test breaches for the same reasons set forth in Issue 4. The waterfall diversion is the appropriate cure mechanic, and forced sales in a distressed market could exacerbate rather than cure the problem.
Subordinate Collateral Management Fee Suspension. This proposal is partially acceptable but requires careful drafting. The Subordinate CMA Fee is already junior in the priority of payments waterfall (payable only after Class D Note interest and senior expenses), so in practice, the fee would naturally be diverted during an I/C Test breach as the waterfall mechanics redirect cash to senior note principal redemption. However, there is an important distinction between a deferral and a suspension (which implies forfeiture):
• A deferral means that the unpaid Subordinate CMA Fee accrues as an obligation of the Issuer and is paid when the I/C Test is restored, at which point the deferred amounts become payable as a senior claim in the waterfall.
• A suspension or forfeiture means that the Collateral Manager permanently loses the right to receive the Subordinate CMA Fee for any period during which the I/C Test is in breach.
C&H recommends counter-proposing that the Subordinate CMA Fee is deferred (not forfeited) during an I/C Test breach, and that deferred amounts accrue and become payable as a senior claim once the I/C Test is restored. This approach preserves the alignment-of-interest principle (the Collateral Manager does not receive cash compensation during a period of I/C Test failure) while protecting the Collateral Manager from permanent forfeiture of earned compensation.
Issue 6: Discretionary Sale Rights — Categories and Limitations
This issue concerns the definition and scope of the Collateral Manager's discretionary sale rights. It is closely related to Issue 1 (Trading Flexibility During the Reinvestment Period) but focuses on the specific categories of permitted sales rather than overall volume limits.
6.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the Collateral Manager has the right to sell any collateral obligation during the Reinvestment Period for any of the following reasons:
(a) Credit Risk. The obligation is a Credit Risk Obligation, defined as an obligation that is rated CCC or below by any applicable rating agency, is in default or payment default, or is subject to credit deterioration in the Collateral Manager's reasonable judgment. The Collateral Manager's judgment as to credit deterioration is not subject to review by the Trustee or the noteholders.
(b) Credit Improved. The obligation has materially improved in credit quality, as evidenced by either (i) an upgrade of at least one full rating notch by any applicable rating agency or (ii) a bid price at or above 102% of par value. The Collateral Manager may sell credit-improved obligations in order to capture gains and reinvest the proceeds in higher-yielding obligations.
(c) Tax Reasons. The sale is necessary to comply with the tax structuring of the Issuer and the Co-Issuer, including the avoidance of a U.S. trade or business characterization for the Cayman Issuer and the maintenance of the disregarded entity treatment of the Delaware Co-Issuer. Sales for tax reasons are coordinated with Sylvia Hartwell's ongoing tax analysis.
(d) Other Discretionary. Any other reason determined by the Collateral Manager in its sole discretion, subject to the requirement that all Collateral Quality Tests and Coverage Tests are satisfied on a pro forma basis after giving effect to the sale and any reinvestment of sale proceeds.
6.2 BLH Markup (Placement Agent's Counsel). Fontaine's markup addresses each of the four categories as follows:
Categories (a) and (c): Accepted without objection. Fontaine agrees that credit-risk and tax-driven sales are necessary and appropriate.
Category (b) (Credit Improved): Fontaine proposes narrowing the definition of "Credit Improved Obligation" to require both an upgrade of at least one full rating notch and a price above par value (not either/or as in the C&H draft). Additionally, Fontaine proposes that credit-improved sales may not exceed 20% of aggregate collateral par per annum during the Reinvestment Period.
Category (d) (Other Discretionary): Fontaine proposes eliminating this category entirely, arguing that it effectively gives the Collateral Manager unlimited discretion to sell any collateral obligation for any reason, which is inconsistent with the noteholders' expectation of a managed portfolio with limited turnover. Fontaine argues that the first three categories (credit risk, credit improved, and tax) are sufficient to cover all legitimate sale scenarios.
Fontaine further argues that investors in the transaction — including Blackpine Insurance Holdings Ltd. ($45,000,000 combined allocation across the Class A-2 and Class B Notes; Sarah Liang, Chief Investment Officer) and Stonehill Public Employees' Retirement System ($22,000,000 combined allocation across the Class C and Class D Notes; James Whitaker, Director of Fixed Income) — expect limited Collateral Manager discretion to sell performing assets and that the "Other Discretionary" category is inconsistent with these expectations.
6.3 C&H Recommendation. Credit Improved (Category (b)). C&H recommends the following compromise: the definition of "Credit Improved Obligation" should require an upgrade of at least one full rating notch or a bid price above 101% of par (splitting the difference on the price threshold between C&H's 102% and BLH's par). The disjunctive "or" formulation is important because there are situations in which an obligation's credit quality has clearly improved (as reflected in price appreciation) but the rating agencies have not yet acted to upgrade the rating. Requiring both an upgrade and a price above par would be too restrictive. C&H recommends resisting the 20% annual volume cap on credit-improved sales as excessive, but acknowledges that some limitation may need to be conceded in the overall negotiation context.
Other Discretionary (Category (d)). This is a critical provision for the Collateral Manager and should not be eliminated. The "Other Discretionary" category provides the Collateral Manager with the flexibility to sell obligations for legitimate reasons that do not fall neatly into the credit-risk, credit-improved, or tax categories — for example, to reduce industry concentration, to manage maturity profile, or to respond to market developments that do not yet constitute "credit deterioration" but that warrant proactive portfolio management.
C&H's counter-proposal: Other Discretionary sales should be limited to 15% of aggregate collateral par per annum during the Reinvestment Period ($60,000,000), with the requirement that all Collateral Quality Tests and Coverage Tests are satisfied on a pro forma basis after giving effect to the sale and any reinvestment of sale proceeds. This cap provides a meaningful constraint on the Collateral Manager's discretion while preserving the category as a tool for active portfolio management.
Action Item: Discuss with Marcus Sorensen and David Hwan at DCM. DCM's investment philosophy requires broad trading flexibility, and the retention of the Other Discretionary category is a key business point. The deal team should understand DCM's priorities as between the various trading-related issues (Issues 1, 2, and 6) in order to develop an integrated negotiation strategy that preserves flexibility where it matters most.
Issue 7: Workout and Restructured Obligation Buckets
This issue concerns the Collateral Manager's ability to acquire and hold obligations received in connection with the restructuring of existing collateral obligations. Workout situations are an inevitable feature of leveraged loan portfolios, and the Indenture must provide a framework for the Collateral Manager to participate in restructurings and hold the resulting obligations.
7.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the Collateral Manager may acquire or retain "Workout Obligations" (defined as obligations received in connection with a restructuring, workout, or bankruptcy of an existing collateral obligation) and "Restructured Obligations" (defined as obligations that have been modified or amended in connection with a restructuring) without such obligations being required to satisfy all of the Eligibility Criteria that apply to the acquisition of new collateral obligations. This is necessary because workout obligations often do not satisfy standard eligibility criteria (e.g., they may be unrated, may not be first-lien, or may have non-standard terms).
The C&H draft provides a Workout Obligation bucket of 5.0% of aggregate collateral par ($20,000,000). Workout Obligations are required to satisfy the O/C Test requirements (i.e., they must be valued at their market value or recovery rate for purposes of the O/C Test calculations), but are otherwise exempt from the Collateral Quality Test requirements.
The C&H draft does not impose any specific limitation on the Collateral Manager's ability to participate in the restructuring process on behalf of the CLO, including voting on restructuring plans, serving on ad hoc creditor committees, and directing the Trustee to take or refrain from taking action in connection with a restructuring.
7.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes the following modifications:
(a) Reduced Bucket Size: Reduce the Workout Obligation bucket from 5.0% to 3.0% of aggregate collateral par ($12,000,000).
(b) Trustee Consent for Workout Participation: The Collateral Manager must obtain the prior written consent of the Trustee before participating in any workout or restructuring negotiation on behalf of the CLO. This would include voting on restructuring plans, serving on creditor committees, and providing direction to the Trustee in connection with restructuring proceedings.
(c) Combined Bucket: Fontaine proposes defining "Restructured Obligations" as a separate defined term but treating them as a sub-bucket within the Workout Obligation bucket (i.e., 3.0% total for both Workout Obligations and Restructured Obligations, not 3.0% plus a separate Restructured Obligation bucket).
7.3 A&P Position (Trustee's Counsel). Marchetti requests that the Trustee receive notice (rather than consent) of any workout participation by the Collateral Manager, and that the Trustee be indemnified against any claims, losses, liabilities, or expenses arising from the Collateral Manager's workout activities. Marchetti's position is more moderate than Fontaine's — the Trustee does not seek a veto right over workout participation but wants to be informed and protected.
7.4 C&H Recommendation. Bucket Size. C&H recommends resisting the reduction to 3.0%. A Workout Obligation bucket of 5.0% ($20,000,000) is within the market range for broadly syndicated CLO transactions (typically 5.0%–10.0% depending on portfolio size and credit quality). A 3.0% bucket ($12,000,000) would constrain the Collateral Manager's ability to hold workout obligations in a scenario where multiple portfolio credits experience restructurings simultaneously — a not-implausible scenario in a stressed market environment.
Combined Bucket. C&H accepts the concept of a combined Workout Obligation / Restructured Obligation bucket of 5.0% (i.e., the two categories are not additive). This is effectively consistent with the C&H initial position, since the C&H draft did not establish a separate, additional bucket for Restructured Obligations.
Trustee Consent for Workout Participation. C&H strongly recommends resisting the requirement of Trustee consent for workout participation. Such a consent requirement would be operationally impractical — restructuring negotiations often move quickly, and requiring the Trustee to evaluate and approve each instance of workout participation would create unacceptable delays. Moreover, the Trustee does not have the credit expertise to evaluate whether participation in a particular restructuring is in the best interests of the CLO and its noteholders; that judgment belongs to the Collateral Manager.
C&H recommends accepting A&P's more moderate proposal: the Collateral Manager shall provide notice to the Trustee within five (5) business days of the Collateral Manager's decision to participate in a workout or restructuring negotiation on behalf of the CLO. Notice, rather than consent, is the appropriate standard.
Trustee Indemnification. C&H recommends accepting the Trustee's request for indemnification against claims arising from the Collateral Manager's workout activities, subject to standard exceptions for the Trustee's own gross negligence and willful misconduct. This is consistent with the general Trustee indemnification framework discussed in Issue 8 and is a reasonable request.
Issue 8: Trustee Indemnification Scope
This issue concerns the scope of the Trustee's indemnification under the Indenture. Trustee indemnification is a standard feature of CLO indentures, but the specific scope of the indemnification, the exceptions to indemnification, and the Trustee's standard of care are frequently negotiated.
8.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the Trustee (Ironclad Trust Company, N.A.) is indemnified by the Issuer out of the collateral for all losses, liabilities, damages, costs, and expenses (including reasonable attorneys' fees) arising from or in connection with the Trustee's acceptance or administration of its duties under the Indenture, except where such losses result from the Trustee's own negligence, bad faith, or willful misconduct.
The indemnification obligation is payable as a senior administrative expense in the priority of payments waterfall, ahead of all note interest and principal payments. This senior positioning ensures that the Trustee can fulfill its duties without concern that its indemnification claims will be subordinated to noteholder payments.
The Trustee fee is set at $25,000 per annum (flat), and the Trustee expense cap is $50,000 per payment date (i.e., $200,000 per annum, assuming quarterly payment dates). Expenses in excess of the cap are subordinated in the waterfall and payable only after all rated note obligations have been satisfied.
8.2 A&P Markup (Trustee's Counsel). Marchetti proposes the following modifications to the Trustee indemnification provisions:
(a) Direction of Controlling Class. The Trustee should be indemnified for any action taken at the direction of the controlling class (or any action taken or omitted in reliance on such direction), even if such direction later proves to have been erroneous or results in loss to the Issuer or the noteholders. This provision protects the Trustee from liability when it acts as a "directed trustee" carrying out instructions from the noteholders, which is a significant portion of the Trustee's role in a CLO structure.
(b) Reliance on Certificates and Notices. The Trustee should be indemnified for actions taken in reliance on officer's certificates, opinions of counsel, notices, and other documents provided to the Trustee by the Issuer, the Collateral Manager, or any other party. The Trustee should not be required to independently verify the accuracy or completeness of any such document.
(c) Environmental Liabilities. The Trustee should be indemnified against any environmental liabilities arising from any collateral held by the Issuer. Marchetti acknowledges that this provision is drawn from A&P's standard form trust indenture and may not be directly applicable to a CLO backed by broadly syndicated loan participations (as opposed to a trust holding real property or other tangible assets), but includes it for the avoidance of doubt.
(d) Trustee Expense Cap. Marchetti proposes either (i) removing the $50,000 per payment date expense cap entirely, or (ii) in the alternative, increasing the cap to $100,000 per payment date ($400,000 per annum). Marchetti argues that the current $50,000 cap is inadequate to cover the Trustee's out-of-pocket expenses in a distressed scenario (e.g., an Event of Default, a collateral liquidation, or litigation involving the CLO).
Additionally, Marchetti proposes that the Trustee's standard of care be elevated from simple negligence to gross negligence or willful misconduct. Under this formulation, the Trustee would be indemnified for actions that constitute simple negligence, and the indemnification carve-out would apply only in cases of gross negligence or willful misconduct. This effectively raises the bar for noteholders or the Issuer to hold the Trustee liable for errors in the performance of its duties.
8.3 C&H Recommendation.
(a) Direction of Controlling Class Indemnification — ACCEPT. This is a market-standard provision and is present in virtually all CLO indentures. The Trustee should not bear liability for following the instructions of the controlling class. C&H recommends accepting this provision without modification.
(b) Reliance Indemnification — ACCEPT. This is also a market-standard provision. The Trustee is an administrative fiduciary, not a credit analyst, and should be entitled to rely on the accuracy of officer's certificates and opinions of counsel provided by the Issuer and the Collateral Manager. C&H recommends accepting this provision without modification.
(c) Environmental Liabilities — REJECT. This provision is drawn from A&P's standard form trust indenture and is inapplicable to a CLO backed by broadly syndicated loan participations. The collateral held by the Issuer consists of participations in senior secured and second-lien loans, not real property or other tangible assets that give rise to environmental liabilities. C&H recommends suggesting deletion of this provision as inapplicable boilerplate and providing a brief explanation to Marchetti.
(d) Trustee Expense Cap — COMPROMISE. C&H recommends compromising at $75,000 per payment date ($300,000 per annum), which represents the midpoint between the C&H position of $50,000 and the A&P position of $100,000. C&H recommends rejecting the outright removal of the expense cap, as an uncapped expense reimbursement obligation could, in a distressed scenario, consume a significant portion of the collateral proceeds that would otherwise be available for distribution to noteholders.
Standard of Care. C&H strongly recommends resisting the elevation of the Trustee's standard of care from simple negligence to gross negligence. Simple negligence is the standard set forth in C&H's form CLO indenture and provides appropriate protection for noteholders and the Issuer. Under a gross negligence standard, the Trustee could engage in careless or unreasonable conduct without facing liability, so long as such conduct did not rise to the level of "gross" negligence — a standard that is difficult to establish and provides minimal deterrent effect. This is a point on which BLH (Gregory Fontaine) is likely to support the C&H position, as the placement agent's counsel generally prefers the lower negligence threshold to maximize investor protection. C&H recommends coordinating with BLH on this issue to present a unified front against A&P.
Issue 9: Events of Default — Definitions and Remedies
This issue concerns the definition of Events of Default and the remedies available to the Trustee and the controlling class upon the occurrence of an Event of Default. The Events of Default provisions are among the most consequential provisions in the Indenture, as they define the circumstances under which the notes may be accelerated and the collateral liquidated.
9.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the following constitute Events of Default:
(a) Failure to pay interest on the Class A-1 or Class A-2 Notes when due (no cure period);
(b) Failure to pay interest on the Class B, Class C, or Class D Notes when due, subject to a five (5) business day cure period;
(c) Failure to pay principal on any rated notes at stated maturity (October 15, 2036);
(d) Breach of any representation, warranty, or covenant contained in the Indenture, subject to a thirty (30) day cure period after written notice from the Trustee or holders of at least 25% in aggregate principal amount of the controlling class;
(e) Insolvency, bankruptcy, receivership, or liquidation of the Issuer or the Co-Issuer; and
(f) Acceleration or termination of the Collateral Management Agreement (other than in connection with the replacement of the Collateral Manager in accordance with the terms thereof).
Upon the occurrence of an Event of Default, the controlling class (holders of the Class A-1 Notes) may direct the Trustee to accelerate all notes, liquidate the collateral, and distribute the liquidation proceeds in accordance with the priority of payments.
9.2 BLH Markup (Placement Agent's Counsel). Fontaine proposes the following additional Events of Default:
(g) O/C Test Breach. Any O/C Test remaining in breach for three consecutive payment dates, as discussed in Issue 4 above.
(h) Collateral Manager Removal or Resignation. Removal of the Collateral Manager for cause or resignation of the Collateral Manager without appointment of a successor Collateral Manager within sixty (60) days.
(i) Loss of SEC Registration. Loss of the Collateral Manager's SEC investment adviser registration (DCM's CRD #182447), whether through revocation, withdrawal, or lapse.
In addition to the standard acceleration and liquidation remedies, Fontaine proposes that the remedies available upon an Event of Default include a forced sale of the Collateral Manager's interest in the CLO and appointment of a substitute collateral manager at the direction of the controlling class. Fontaine frames this as a mechanism to ensure continuity of portfolio management in the event that the existing Collateral Manager is removed, resigns, or loses its regulatory status.
9.3 C&H Recommendation.
(g) O/C Test Breach. C&H recommends resisting this as a standalone Event of Default trigger. As discussed in Issue 4, the appropriate mechanism for addressing O/C Test failures is the waterfall diversion, supplemented by the compromise proposal of a remediation plan after three consecutive payment dates of breach and a controlling-class-directed Event of Default trigger only after four consecutive payment dates of breach. Adding a standalone O/C-related Event of Default at three consecutive payment dates would effectively give the controlling class the ability to accelerate and liquidate the collateral after only nine months of O/C Test failure, which is too aggressive.
(h) Collateral Manager Removal or Resignation. This is acceptable in principle. However, C&H recommends proposing a ninety (90) day period (rather than BLH's proposed sixty (60) days) for the appointment of a successor Collateral Manager. Identifying, vetting, and engaging a qualified successor CLO manager is a complex process that requires regulatory approvals, board consents, and negotiation of new management agreements. Sixty days is insufficient in practice. A ninety-day period provides adequate time while still ensuring that the CLO does not operate without a Collateral Manager for an extended period.
(i) Loss of SEC Registration. This is acceptable, subject to a ninety (90) day cure period to allow DCM to re-register with the SEC or cure any regulatory deficiency that led to the loss of registration. Loss of registration may occur due to administrative errors or regulatory disputes that can be resolved within a reasonable period; an immediate Event of Default trigger is disproportionate.
Forced Sale of Collateral Manager's Interest. C&H recommends rejecting this proposal. The Collateral Management Agreement already contains removal-for-cause provisions, including specified grounds for removal and a process for appointment of a successor. A forced sale of the equity interest in DCM is beyond the scope of the Indenture and would raise significant corporate governance issues for Driftwood Absolute Return Fund Ltd. and its subsidiaries. The Indenture governs the relationship among the Issuer, the Trustee, and the noteholders — it does not govern the corporate ownership structure of the Collateral Manager. A provision requiring the forced sale of a Collateral Manager's equity interest would be unprecedented in a CLO indenture and would raise serious questions about the enforceability and the scope of the Indenture's contractual authority.
Issue 10: Priority of Payments Waterfall — Subordinate CMA Fee Placement
This issue concerns the placement of the Subordinate Collateral Management Fee in the priority of payments waterfall. This is a high-priority economic issue for DCM, as the Subordinate CMA Fee represents approximately 70% of DCM's annual fixed compensation from the CLO.
10.1 C&H Initial Position (Issuer/Collateral Manager). Under the C&H draft, the priority of payments waterfall positions the various fees and obligations as follows:
1. Trustee fees and expenses (senior administrative expenses)
2. Senior Collateral Management Fee (0.15% per annum / $600,000 per year)
3. Class A-1 Note interest
4. Class A-2 Note interest
5. Class B Note interest
6. O/C and I/C Test waterfall diversion (if applicable)
7. Class C Note interest
8. Class D Note interest
9. Subordinate Collateral Management Fee (0.35% per annum / $1,400,000 per year)
10. Subordinated Note distributions
11. Incentive Management Fee (20% of excess above 12% IRR hurdle to subordinated noteholders)
12. Residual distributions to subordinated noteholders
Under this structure, the Subordinate CMA Fee is positioned after Class D Note interest but before Subordinated Note distributions, which ensures that DCM receives its subordinate fee before equity returns are distributed.
10.2 BLH Markup (Placement Agent's Counsel). Fontaine accepts the placement of the Senior CMA Fee as a senior administrative expense and does not contest its position in the waterfall.
However, Fontaine proposes that the Subordinate CMA Fee be positioned after Subordinated Note distributions — effectively making it the last obligation in the waterfall (other than the Incentive Management Fee). Fontaine's rationale is that the Subordinate CMA Fee should be paid only after the equity holders have received their distributions, on the theory that alignment of interest between the Collateral Manager and the equity holders is maximized when the Collateral Manager's subordinate compensation is junior to equity returns.
As an alternative, Fontaine proposes a hybrid structure: 50% of the Subordinate CMA Fee ($700,000 per year) payable before Subordinated Note distributions and 50% ($700,000 per year) payable after Subordinated Note distributions.
10.3 C&H Recommendation. C&H recommends resisting the full subordination of the Subordinate CMA Fee below equity distributions. This is below market and would effectively make $1,400,000 per year of annual collateral management compensation contingent on the CLO generating sufficient equity returns. In a stressed scenario — where the portfolio experiences credit deterioration, defaults, or market dislocation — the equity tranche may receive reduced or no distributions, and full subordination of the Subordinate CMA Fee would mean that DCM's compensation is cut by approximately 70% even though the Collateral Manager is performing its duties and managing the portfolio through a difficult period. This would create perverse incentives: the Collateral Manager would have reduced motivation to dedicate resources to a CLO from which it is receiving minimal compensation.
The hybrid proposal (50/50 split) is potentially workable as a last-resort compromise, but the C&H recommendation is to maintain the Subordinate CMA Fee above equity distributions in its entirety. The 50/50 split should be reserved for use in the negotiation only if BLH is unwilling to accept the current placement and the alternative is full subordination.
Action Item: Discuss with Marcus Sorensen and Elena Voss at Driftwood. This is a key economic point for DCM's economics on the platform and will directly affect DCM's profitability from the CLO. The client's instructions on acceptable compromise positions should be obtained before the August 15 negotiation call.
Rating Agency Impact. The current waterfall placement was presented to both rating agencies (Brindoval and Ridgeline) and was modeled accordingly. Changing the placement of the Subordinate CMA Fee could require re-engagement with both rating agencies to confirm that the modified waterfall does not affect the preliminary ratings. This is a point that should be raised with BLH as a practical obstacle to any change in fee placement.
Issue 11: Minimum Denomination and Transfer Restrictions
This issue concerns the minimum denomi

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INDENTURE NEGOTIATION ISSUES LIST AND REDLINE SUMMARY

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III. ISSUE-BY-ISSUE ANALYSIS

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