Credit agreements entered into between corporate borrowers and bank lenders typically have a section outlining the conditions that would trigger a mandatory prepayment of outstanding loan amounts. Mandatory prepayment sweep provisions, such as the excess cash flow (ECF) sweep and the asset sale sweep, require the borrower to pay down outstanding loan amounts early using specific cash sources. The idea is to encourage the borrower to satisfy their obligations owed to the lenders when funds become available.

The excess cash flow sweep provision requires the borrower to prepay the loan amount based on a percentage of extra cash generated by the company. This ECF percentage may be subject to step-downs. The amount of excess cash flow available to prepay debt is often calculated by starting with Adjusted EBITDA, and then making further adjustments for items such as working capital, interest expense, and certain taxes. Alternatively, sometimes excess cash flow is calculated starting from net income.

An example ECF sweep provision is set forth below.

“In the event that for any fiscal year of the Company there shall be Excess Cash Flow, the Company shall, on the relevant Excess Cash Flow Application Date, prepay the term loans in an aggregate amount equal to the ECF Percentage of such Excess Cash Flow less (i) the aggregate amount of voluntary prepayments and (ii) the aggregate amount of any capital expenditures made prior to the time such Excess Cash Flow prepayment is due.”

Another common prepayment provision in credit agreements is the asset sale sweep provision, which requires the borrower to prepay the loan amount using proceeds from an asset sale outside of the ordinary course of business. The asset sale covenant in the credit agreement will set parameters with respect to the sale, such as requiring the assets to be sold for fair market value and mostly for cash consideration.

The asset sale sweep provision may be subject to a reinvestment right. As an alternative to immediately prepaying the loan, a reinvestment right will enable the borrower to reinvest the net proceeds from an asset sale within a specified timeframe after the asset sale.

An example asset sale sweep provision is set forth below. An “Asset Sale” may be defined in the credit agreement to mean any permitted disposition of assets of the borrower or any of its subsidiaries. In some credit agreements, additional specificity is provided to exclude certain assets from the definition. It usually excludes asset sales made in the ordinary course of business and asset sales below a certain threshold amount.

“If on any date the Company or any of its subsidiaries shall receive net cash proceeds for any Asset Sale, then the Applicable Prepayment Percentage of such net cash proceeds shall be applied on such date toward the prepayment of the term loans.”

The definition of the “Applicable Prepayment Percentage” will be negotiated between the borrower and lenders. An example definition may state that the Applicable Prepayment Percentage means (i) 100% or (ii) 50%, if the senior secured leverage ratio is less than 2.50 to 1.0.