Leveraged Finance Juniors: Your debt documentation primer is live!

It's been a while, but we're back just in time to earn a spot on your summer reading list. Understanding debt documentation is about far more than navigating legal language. It's about identifying where commercial terms are negotiated, how creditors are protected, and how much flexibility borrowers retain throughout the life of a financing. This primer provides a practical roadmap to reading leveraged finance debt documentation and unpacking the covenant package in detail.

Agenda

1. What’s Actually In a Debt Document
2. How to Read a Debt Document
3. Why This Matters
4. Reading a Covenant Package: The Basics
5. Limitation on Indebtedness
6. Limitation on Restricted Payments
7. Permitted Investments
8. Permitted Liens (and a Note on Collateral)
9. Limitation on Asset Sales and Related Transactions
10. Reclassification and Stacking
11. Why Baskets Are Now Central to Liability Management Exercises
12. The Rest of the Covenant Package
13. Optional Redemption: The Bond-Specific Layer
14. Key Definitions: Indebtedness, Consolidated Net Income, and Consolidated EBITDA
15. Credit Agreements vs. High-Yield Indentures: Where the Basket Logic Diverges

1. What’s Actually In a Debt Document?

A credit agreement or indenture is a long document, but it breaks down into a small number of functional pieces, once you know where to find them you would be surprised how “easy” it becomes to navigate them (Spoiler Alert: 500 pages drafted by lawyers can always only be “relatively easy”). But let’s take a look at what you find in there:

• Parties and mechanics, who the borrower/issuer, guarantors, agent/trustee, and lenders/noteholders are, and the administrative machinery (payment mechanics, notices, amendment and voting thresholds).
• Conditions precedent, what has to be true at closing (or at each draw, for a revolver) before money changes hands: security perfected, legal opinions delivered, no material adverse change, and so on. Almost entirely a closing-day concern, not something that gets revisited afterward.
• Representations and warranties, factual statements the borrower makes about itself (organisation, no conflicts, financial statements are accurate, no undisclosed litigation). These matter most at signing and at each future borrowing, and a false representation can itself be a default.
• Affirmative covenants, a shorter, less-negotiated list of things the borrower must do: deliver financial statements, maintain insurance, pay taxes, preserve corporate existence, comply with law. Largely uncontroversial boilerplate.
• Negative covenants, the long list of things the borrower must not do without qualifying for an exception: incur debt, grant liens, make restricted payments, make investments, sell assets, transact with affiliates, agree to dividend-blocking restrictions, merge or consolidate.
• Financial covenants, where applicable (typically pro rata bank tranches, not covenant-lite term loan Bs or bonds), an affirmative requirement to maintain a specified leverage or coverage ratio every quarter, tested regardless of whether the borrower has taken any action.
• Events of default and remedies, the list of triggers (payment default, covenant breach, bankruptcy, cross-default, change of control, and others) that let lenders accelerate or noteholders demand repayment, and the voting thresholds required to declare or waive a default.

Of all of this, the negative covenants, and specifically the baskets carved out of them, are what determine how much a company can actually do without coming back to its creditors, and how much cushion those creditors have already agreed to give up before a default occurs. Everything else in the document is either scene-setting (parties, conditions, reps) or a backstop (events of default) for the negative covenant package. The focus of this primer, accordingly, is squarely on the negative covenants and the baskets that qualify them, how each one is built, how to size real capacity under it, and how that same capacity is increasingly the tool used to execute liability management transactions in distress.

2. Why This Matters

Every leveraged credit agreement or high-yield indenture is built around a simple structural idea: the negative covenants say “no” to a long list of activities, no more debt, no more liens, no dividends, no asset sales, no dealings with insiders, and then baskets say “except for.” The prohibitions are largely interchangeable boilerplate from deal to deal. The baskets are not. They are where the commercial negotiation actually happens, and they determine three things that matter to almost everyone touching the credit:

• How much operating flexibility the borrower has, to make acquisitions, refinance opportunistically, return capital to sponsors, and run the business without going back to lenders for a waiver every time something happens.
• How much cushion existing creditors have lost before anyone breaches anything, because a covenant “breach” only happens once available basket capacity is exhausted, baskets are really a pre-negotiated map of how much the credit can deteriorate, structurally subordinate itself, or bleed cash before a default is triggered.
• How exposed the credit is to opportunistic use in distress. As the events of the last several years have shown, unused basket capacity is not just a governance issue for healthy companies, it is the primary tool sponsors and distressed borrowers use to execute liability management exercises (LMEs) without ever needing lender consent to amend the document (we look into this on a high level but I recommend RX focused resources like “Pari Passu Newsletter” if you want to learn more.

Understanding baskets, then, is not a drafting technicality. It’s the difference between reading a covenant package and understanding what a company can actually do with it.

It's worth pausing on why this dual reading matters so much in practice. The same basket language is drafted, negotiated, and later relied upon by two audiences with opposite interests: issuers and their sponsors, who view baskets as the flexibility that lets them run and grow the business without returning to creditors for consent, and creditors, who view the very same baskets as the rationed amount of cushion they have already agreed to give up before a default can occur. Neither reading is wrong, a basket is both things at once, which is precisely why basket capacity is negotiated so heavily at signing and monitored so closely afterward.

That negotiation, though, is rarely a fair fight between two equally matched sides sitting at the same table each time. It moves with the broader market. As of H1 2026, conditions remain issuer-friendly: new money supply is limited and debt investors are under real pressure to deploy capital, which pushes them to accept looser, more aggressive documentation than they otherwise would. That balance can, and does, shift. In a market where investors turn more cautious and new debt becomes harder to raise, issuers lose that leverage and have to give up more operating flexibility to get a deal done. Keep both dynamics in mind, the structural tension between issuers and creditors, and the cyclical one between them.

3. How to Read a Debt Document

Before diving into individual covenants or calculating basket capacity, it is worth taking a step back and understanding how a leveraged loan agreement or high-yield indenture is organised. Although these documents often run to several hundred pages, they generally follow the same structure. Approaching the document in a consistent order makes it much easier to identify the commercial terms, understand the lenders’ protections and, ultimately, analyse the covenant package.

1. Documentation & Parties. Begin by identifying the governing documents and the parties involved. For loans, this will usually be the “SFA”, Senior Facilities Agreement (or Common Terms Agreement), while bonds are governed by an Offering Memorandum and Indenture. If multiple debt classes exist, an Intercreditor Agreement (ICA) explains how different creditor groups interact. It is also important to identify the Facility Agent, Security Agent and, in bond transactions, the Trustee, as these parties administer the financing and exercise rights on behalf of creditors.
2. Economic Agreement. Once the documents are identified, review the commercial terms of the financing. Focus on interest margins, pricing grids, fees, repayment mechanics, prepayment provisions and mandatory prepayment events such as change of control or asset disposals. This section explains how lenders are compensated and how cash moves through the capital structure.
3. Security & Guarantees. Next, assess what supports the debt. Review the collateral package, guarantee structure, Agreed Security Principles and any guarantor coverage tests. This analysis provides a first indication of expected recoveries and whether any structural subordination exists within the group.
4. Signing, Funding & Conditions. Separate signing from funding. Signing makes the documentation legally effective, whereas funding only occurs once all Conditions Precedent (CPs) have been satisfied and, for loans, a utilisation request has been delivered. Conditions Subsequent identify items that can be completed after closing.
5. Commercial Provisions. Let’s go from the transaction mechanics to the borrower’s ongoing obligations. Review the representations and warranties, affirmative and negative undertakings, financial covenants (where applicable) and Events of Default (EoDs). Together, these provisions determine what the borrower must continue to do and when lenders obtain enforcement rights. As a Leveraged Finance Banker it matters mostly to negotiate them ahead of the deal, to make sure its in line with the market.
6. Amendments, Consents & Waivers. Debt documents also specify how terms may be amended. Understanding the relevant voting thresholds, particularly for economic terms such as margin, maturity, principal and collateral, is essential when analyzing refinancings, restructurings and liability management exercises.
7. Transfers. Transfer provisions determine who may become a lender or noteholder. Borrower consent rights, white- and blacklists, competitor restrictions and minimum rating requirements can all influence the secondary trading dynamics of a transaction.
8. Other Provisions. Finally, review the remaining commercial provisions, including use of proceeds, incremental facilities, delayed draw mechanics, confidentiality obligations and costs and expenses. While often overlooked, these provisions frequently provide meaningful operational flexibility.

4. Reading a Covenant Package: The Basics

Before getting into individual baskets, it helps to have a shared checklist for evaluating any basket you come across. Most of the negative covenants that carry baskets share the same broad structure, and in almost every document the same six covenants do the bulk of the work:

1. Limitation on Indebtedness: incurring additional debt beyond what is already permitted
2. Limitation on Restricted Payments: dividends, equity buybacks, and junior debt repurchase (and, in some documents, investments)
3. Permitted Investments: loans, guarantees, and equity stakes in anything outside the immediate credit group
4. Permitted Liens: granting security over company assets to other creditors.
5. Limitation on Asset Sales: disposing of company assets and what must happen to the proceeds (i.e., proceeds can repay debt in a way that favours creditors, or fund a dividend to the sponsor, which creditors would view as value leakage)
6. Limitation on Transactions with Affiliates: dealings with the sponsor and other insiders

Each of these is written the same way: a broad, sweeping prohibition, followed by a long numbered or lettered list of exceptions (the baskets). Nobody negotiates the prohibition, it’s standard. Everybody negotiates the exceptions.

A checklist for reading any basket. When you sit down with a specific basket, four questions tell you almost everything you need to know:

• How is it sized? Is it a flat dollar amount, a “grower” that scales with total assets or EBITDA (or Net Income) (often drafted as “the greater of $X and Y% of EBITDA/total assets,” so it only ever grows), or is it uncapped and instead governed by a financial ratio test (so-called “ratio capacity”)? Uncapped, ratio-tested baskets are usually the largest source of real capacity in a document, because they grow automatically as the business grows, sometimes faster than anyone modelled at signing
• What conditions gate its use? Common gates are: no default (or no payment/bankruptcy default) exists or would result, a financial ratio must be satisfied on a pro forma basis, or there are no conditions at all (a true “basket of right”). The fewer the conditions, the more useful, and more dangerous, the basket is in a stress scenario, because it remains available exactly when the company is least healthy
• Does using it reduce (or “ding”) anything else? Some baskets are freestanding, others quietly reduce the capacity of a different basket when drawn (most notably, certain restricted payment carve-outs reduce builder-basket capacity in bond deals but typically do not in loan deals - we compare bonds and loans later)
• Does it stack with other baskets, and can debt or a payment be reclassified later? As covered in Section 10, baskets generally stack (a company can use several simultaneously), and debt can often be reclassified into a different, newly available basket later on. This means the real headroom under a document is almost always larger than any single basket suggests, and it changes over time as EBITDA grows, debt is repaid, or ratios improve. And as mentioned we are in a strong market and lawyers on the deal side are thinking entrepreneurially, hence we are seeing more Omnibaskets (sometimes called a "combined basket" or "unified basket"), which is a single pool of capacity that can be drawn on for more than one type of covenant purpose, typically debt, restricted payments, and investments, rather than each of those having its own separate, siloed general basket. For creditors, it’s just another warning sign, and one that is not well liked in the market.

Sections 5 to 15 are on the blog and will be shared here in due course. Feel free to subscribe on the web page if you dont want to miss more like this in the future.