Challenges in European restructurings
January 2013 | SPECIAL REPORT: GLOBAL RESTRUCTURING & INSOLVENCY
Financier Worldwide Magazine
The corporate financial restructuring environment in Europe exhibits several challenges – legal, structural, and company specific. European restructurings are driven by: (i) the prevalent insolvency regime in the debtor’s jurisdiction of incorporation, where its financial liabilities exist, the local law in each of its operating bases, and governing law of the credit documentation; (ii) the size and layers of a debtor’s capital structure; (iii) the number and institutional nature of the company’s creditor base; and (iv) general factors such as macroeconomic volatility, the availability of alternative financing sources and the health of the capital markets and the banking system.
The insolvency and restructuring regimes in European jurisdictions tend to range from the very debtor-friendly to the very creditor-friendly. Over the past several years many jurisdictions have attempted to move away from regimes that were originally focused on liquidation towards environments that encourage business rehabilitation, where appropriate. However, while precedents are steadily growing, sufficient precedents do not exist to fully test the overall impact of these regimes. The vast differences in insolvency laws across Europe have led to an increase in jurisdiction shopping, where companies in distress relocate either their jurisdiction of incorporation or their ‘centre of main interests’ to more favourable jurisdictions solely to implement restructurings that may not be possible in their home jurisdictions.
The lack of a pan-European insolvency protocol is a detriment to achieving a European multi-jurisdictional restructuring within a formal coordinated legal framework. This inflexibility and inherent uncertainty mean that most European corporate financial restructurings are executed on an out-of-court or ‘consensual’ basis. ‘Consensual’ out-of-court restructurings add layers of complexity to the restructuring transaction. In general, they require unanimity from all stakeholders to be successfully implemented and even creditors with a small holding theoretically have the same power as creditors with much larger holdings.
Credit markets have seen increasing complexity of capital structures and new classes of lenders and investors. Historically, European companies were funded by loans from traditional commercial banks. Only large, well-established corporations had access to the public debt markets. Traditionally, corporate loans were syndicated to a limited number of commercial banks that held the debt until final maturity. Under the original model, the banks would monitor the borrower more intensively and the borrower would have had to negotiate with a limited number of banks in the event of stress on a relatively informal basis, which made it easier to execute the workout process while maintaining a modicum of confidentiality. This was generally known as the ‘London Approach’.
This ‘London Approach’ to the workout process has been made obsolete by the rise of loan trading and the number of non-bank institutions in the credit markets. Loan trading has made restructuring processes more complex as the number of debt holders has increased and alternative investors can have a more aggressive negotiating stance than traditional banks. The larger number of lenders means that confidentiality is much harder to maintain. As the news of financial distress becomes more widely known, the debtor faces increasing pressure from suppliers, customers and employees, which delays the recovery of the core operating business. Loan trading also has the potential to increase lender conflicts during negotiations as the incentives of par lenders are not the same as those of secondary market participants – a restructuring proposal may be acceptable to a lender that bought into the debt at below par, but unacceptable to a primary lender that provided the original loan at par.
Europe in recent years has seen innovative financing structures such as second lien and mezzanine debt structures and payment-in-kind loans. Second lien and mezzanine instruments may be structured as either loans or tradable notes, similar to bonds. These are junior instruments that are usually held by alternative investors such as hedge funds, dedicated mezzanine funds, CLO and CDO vehicles and other specialist investors. The number of layers in a company’s financial structure may make workouts particularly problematic, as it increases the number of stakeholders that need to consent to a restructuring.
The timing, form and nature of corporate financial restructurings are a function of the relative influence of the company, creditors and equity. Financings in the mid to late 2000s had weak covenant packages and a general softening of creditor rights. While this may have reversed somewhat recently, the appetite to use such creditor rights has been limited by a weak and volatile macroeconomic environment and financial market stresses.
In a number of situations, the operating environment continues to be volatile such that no credible medium to long-term operational business plan can form the basis of a financial restructuring. In many cases, creditors have been reluctant to force a transaction or enforce on their security so long as the company can afford to keep banks or bondholders current on interest payments and adopt a wait-and-watch approach.
The volatility in credit markets means that standard refinancing options are limited and the borrower may need to deal with existing stakeholders to provide a solution to maturity issues. This has resulted in a number of ‘amend and extend’ transactions, where the terms of the existing credit documentation are amended to extend the final maturity of the debt. While initial ‘amend and extend’ transactions were intended to be a bridge to a better day financing – with the expectation that refinancing would eventually be achieved through a new money bank or capital markets transaction – the continued malaise in capital markets has resulted in more long-term amend and extend transactions.
Europe has seen a number of financial restructurings of non-operating entities, such as securitisations.
The growth of very highly structured transactions as a financing tool, such as mortgage backed securities and opco-propco financing structures, and the subsequent closure of the securitisation markets, has resulted in a number of such vehicles having to be restructured on a standalone basis. These vehicles are complex, not widely understood, structured differently from corporate entities and are governed by documentation that did not contemplate a refinancing or restructuring involving existing investors and stakeholders.
The prevalence of financial restructurings in Europe has also been limited by the nature of financial borrowing in Europe. A significant number of companies, particularly small and medium sized enterprises, have borrowed from state-owned or state-backed banks and financial institutions, mainly local savings banks, which in some respects are not driven by the constraints of private finance providers. The inability of several national governments to continue to financially subsidise state owned financial institutions may result in an increasing number of restructurings.
In summary, financial restructurings in Europe are inherently complex given the number of jurisdictions, types of debt, variety of investor constituencies, and general uncertainty in the wider economy. Several recent developments have made restructurings more challenging and others have made the restructuring process more efficient and less value destructive. The associated execution risk requires higher levels of specialist analysis.
Martin R. Gudgeon is a senior managing director and Shirish A. Joshi is a vice president at The Blackstone Group International Partners LLP. Mr Gudgeon can be contacted on +44 (0)20 7451 4398 or by email: firstname.lastname@example.org. Mr Joshi can be contacted on +44 (0)20 7451 4067 or by email: email@example.com.
© Financier Worldwide
Martin R. Gudgeon and Shirish A. Joshi
The Blackstone Group International Partners LLP