Acts of God Meet Acts of AI in Private Equity’s New Debt Play
(Bloomberg) -- Force majeure has long protected companies from acts of God. Now some borrowers want protection from acts of AI.
Private equity firms are adding force majeure-style clauses to new buyouts that could let companies stop the clock on addressing defaults they determine were caused by AI disruption.
H.I.G. Capital managed to get the language included in the €470 million ($524 million) loan backing its majority stake in Terras Group, a German-headquartered provider of infrastructure engineering and construction services, according to people familiar with the deal who didn’t want to be identified discussing private details.
Years of strong demand have allowed private equity firms to chip away at lender protections. But several creditors said the new language goes further than usual and has appeared in at least two leveraged buyout financings since September.
“Lenders and investors are closely reviewing language proposed by sponsors that seeks to permit event of default flexibility in connection with AI,” said Jeremy Duffy, a partner and chair of European leveraged finance at Cahill Gordon & Reindel LLP. “It’s a fast-moving piece of the leveraged finance documentation pie.”
Artificial intelligence is threatening to upend every business model, and the debt structures built around them. Buyout firms are particularly exposed after amassing a big bet on software-as-a-service firms now vulnerable to AI disruption.
A force majeure clause is typically invoked by companies to waive contractual obligations in a catastrophe — usually reserved for so-called acts of God like hurricanes and earthquakes, the Covid pandemic or the 9/11 terror attacks.
In this case, H.I.G. Capital is adapting force majeure language to stop the clock on a default if Terras Group is disrupted by the impact of AI, and an array of other situations. These include Covid-19 or any other pandemic, a substantial increase of energy or resource pricing, war and terrorism, according to people familiar with the documentation.
Some creditors argue that the proposed provisions undermine a basic premise of lending: even when things go wrong, you still expect to get your money back.
When companies miss an interest payment, they are usually allowed a grace period, typically 30 days, to make the payment before a default is called. After that, lenders can demand their money back.
Officially, the new provisions seek to extend grace periods. But in practice, AI disruption, unlike a pandemic, has no clear end date.
H.I.G.’s clause would allow Terras to defer the consequences of not paying back interest for as long as it feels the impact of AI, said a person familiar with the deal. The company still owes interest, but lenders’ remedies are suspended.
Lenders succeeded in having similar language struck from Bain Capital’s €4.7 billion-equivalent ($5.3 billion) leveraged-loan deal for its acquisition of a controlling stake in Volkswagen AG’s heavy diesel-engine unit Everllence, said the people.
The market’s approach to investor protections has become increasingly split. Private equity sponsors are being aggressive in cases where the credit deals they expect will perform well, but are re-inserting covenants to deals in troubled sectors like software.
H.I.G. Capital was advised by a group of partners from law firm Paul, Weiss including Neel Sachdev, a powerful private equity lawyer who has played a big part in encouraging buyout firms to slash creditor protections in financing.
Representatives at H.I.G. and Bain declined to comment while Sachdev didn’t reply to a request for comment.
More stories like this are available on bloomberg.com
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