Distressed property deals in Central and Eastern Europe: structures and legal implications
January 2014 | SPECIAL REPORT: DISTRESSED M&A AND INVESTING
Financier Worldwide Magazine
Distressed property transactions are still increasing in Central & Eastern Europe. There are several reasons for this but one of the main drivers is that the enforcement and insolvency regulations do not favour creditors’ right in an enforcement procedure or an insolvency scenario. For example, in Hungary, borrowers have ample legal tools to obstruct enforcement. Insolvency procedures are also detrimental to creditors due to the lack of transparency in liquidation and bankruptcy processes. Both enforcement and insolvency processes may drag on for several years, while creditors remain unsatisfied. It is also worth noting that due to the lack of liquidity and financing, even in the event of a successful enforcement or insolvent liquidation, the price that can be achieved in a tender process is often disappointing to creditors.
Banks have realised all of these uncertainties and problems and have chosen to follow alternative routes with the aim of striking an agreement with borrowers and sponsors, creating incentives for them and trying to keep projects out of enforcement or insolvency.
The success of these alternative routes is mixed. Some projects may be saved and start to create value, including cash for the repayment of bank debt. In these projects, the underlying economics tend to be in order but for some reason they are overleveraged and unable to service the heavy debt burden.
Some projects are doomed to fail, even after restructuring. The majority of these tend to be mid-sized and smaller projects.
Three typical structures are outlined below.
The bank forces the sponsors to sell property to a recommended buyer. This is typical where equity is lost and therefore the sponsors are not interested in finding a buyer for the project. Also, the banks uses this structure when it believes it can find a willing buyer on the market who is prepared to put additional equity into the project. In these cases, banks take a proactive role in finding a buyer for the distressed assets. This structure is bank driven and often involves a sale of the underlying asset and refinancing that asset in a new SPV. The structure is complex since the sale and the refinancing have to occur simultaneously.
In these projects, the treatment of creditors’ claims is essential as they may challenge the deal on several grounds. The main concern with third party creditors is that the SPV holding the asset pre-restructuring may have several creditors (the tax authority and various suppliers) which will become creditors to an empty shell after the restructuring takes place and the asset is transferred from the SPV into the buyer’s own SPV. These creditors may claim that they have been intentionally deprived of collateral for the satisfaction of their claim, entirely or in part, if the other party acted in bad faith or had a gratuitous advantage originating from the contract, and therefore the satisfaction of their claims became impossible. The challenge on deprivation of collateral could be successful even if the price paid was a fair amount, if the buyer knew that as a result of the transaction other creditors would lose their basis to satisfy claims. In a subsequent liquidation of the seller, the liquidator may also challenge the purchase price and claim that the asset was sold below value. If the court finds this reasoning acceptable, the payment of an additional purchase price could be ordered, in the case of an undervalued sale, or the original status quo has to be reinstated and the asset has to be transferred back to the old owner.
This is a significant risk not only for the buyer of the asset but also for the financing bank. The financing bank’s securities have ‘followed’ the transfer of the asset and terminated in the old SPV. It is questionable how these terminated SPVs may be reinstated.
The bank itself acquires the distressed asset and gives it back to the sponsor in the form of a financial lease or appoints the sponsor as an agent for the project. Alternatively, the bank acquires the assets from liquidation. This is a simpler structure by which the bank gains title to the collateral in a peaceful manner and either continues the financing in a more secure financial lease structure or puts the assets on the market with the assistance of the borrower.
Besides improving the security position of the bank in a quick and peaceful manner, these structures keep the borrower motivated in the disposal or operation of the assets. Also, the bank often does not have all the information about what it acquires, which underlines the necessity to maintain some cooperation with the former borrower, if possible. In our experience, these structures are difficult to use with bank syndicates as they tend to fail when it comes to agreeing on who should acquire and hold the assets for the benefit of the syndicate.
The bank enters into a joint venture with an experienced sponsor to operate the asset portfolio owned by the bank. This structure is not often seen in Central & Eastern Europe but there are attempts to develop such a structure, given the banks’ lack of experience operating assets over a long term. One weak point of these structures is that banks are also not experienced in maintaining and operating joint ventures; therefore, the exercise of shareholders rights and dealing with deadlock situations creates a new problem for banks.
Dr Erika Papp and Dr Gábor Czike are partners at Ormai és Társai CMS Cameron McKenna LLP. Dr Papp can be contacted on +36 1 483 4813 or by email: email@example.com. Dr Czike can be contacted on +36 1 483 4819 or by email: firstname.lastname@example.org.
© Financier Worldwide
Dr Erika Papp and Dr Gábor Czike
Ormai és Társai CMS Cameron McKenna LLP