European bond restructurings
January 2015 | SPECIAL REPORT: DISTRESSED M&A AND INVESTING
Financier Worldwide Magazine
Since 2010, European borrowers have issued over €250bn in high yield bonds, according to S&P Capital IQ. One of the most typical European high yield capital structures that has emerged includes: (i) a super senior secured RCF accompanying the issuance to provide working capital: (ii) senior secured notes that are governed by New York law; and (iii) issuers based in low tax jurisdictions (Luxembourg and the Netherlands are favourites).
Currently, it remains relatively untested how the restructuring of these bonds will play out. Given borrowers’ ability to issue notes with extremely attractive pricing and covenants, defaults remain low. However, the maturity profile of notes issued in the last few years suggest that the time is coming soon when a number of issuers will need to review their capital structure (almost 160 issuances are scheduled to mature in each of 2018 and 2019), according to Bloomberg.
Typically in European high yield deals, the valuable operating guarantor subsidiaries and assets will be spread across a number of European jurisdictions. The associated intercreditor and security documents will be governed by English and local European laws. This makes choosing an insolvency jurisdiction complex, and there has been debate over whether US Chapter 11 proceedings will be used to restructure a number of these groups.
Some groups have attempted to restructure their debt burden not through a formal workout process but through a consensual tender offer. Ideal Standard’s 2014 tender offer is one such example. The group offered each noteholder the option to exchange existing notes for new notes that had a PIK interest option to relieve the company’s immediate liquidity shortfall. Noteholders could select among three different options, with one of these options featuring straight PIK notes and the other two providing for PIK notes that could be converted into equity. However, the issue with restructurings through a tender offer process is the high consent threshold. In the majority of European high yield issuances, substantial amendments to economic terms such as principal, interest and maturity will require at least 90 percent consent, reducing the flexibility of any proposed restructuring.
What is beginning to emerge, however, is that for more formalised workouts or in cases where the 90 percent consent threshold cannot be achieved, English law is a potential forum – in particular, by using a Scheme of Arrangement, which requires a majority in number representing 75 percent in value of each class. In the last few years a number of groups have turned to the English jurisdiction and used Schemes to help facilitate restructurings of New York law governed bonds, such as Mobile-8 Telecom (2011), Magyar (2013) and New World Resources (2014).
There are a number of benefits English law can offer, as illustrated by these examples. One major attraction is the relative receptivity of the English court to exercising its jurisdiction when, at first glance, the business has relatively little connection to the UK. In both Magyar and Mobile-8, there were no English operations; the operating companies were located in Hungary and Indonesia respectively. In the case of New World Resources, although the group was listed in London, its operations were located in Poland and the Czech Republic. In each case, various steps were undertaken to shift the group’s ‘centre of main interest’ (COMI) to England (such as appointing UK resident directors, renting office space, making management decisions in the UK) to enable the English court to exercise its jurisdiction. In the cases of Magyar and NWR, Chapter 15 recognition of the English insolvency proceedings were successfully sought from the US courts to provide additional comfort.
However, what if it is not possible or practical (whether for tax, operational or other reasons) to move a non-English group’s COMI to the UK? The case of Auto-Teile-Unger (ATU) is an example of a successful restructuring of New York law governed bonds by a European (in this case, German) issuer taking advantage of the flexibility offered by English insolvency law.
Germany’s largest independent chain of automotive repair shops, ATU suffered a significant decline in EBITDA over 2012-13 as a result of the mild winter weather reducing tyre sales and repairs. This resulted in an unsustainable debt burden, made obvious by unsuccessful attempts at a refinancing or sale throughout 2012-13. Further complicating the situation were obligations on its directors under German law that required them to file for insolvency in a very short timeframe if they considered it was not possible for the business to continue trading, or risk personal liability.
The idea of a ‘flip-up’ was devised so the group could take advantage of an English administration and immediate pre-pack sale. An English SPV was incorporated and became an obligor under the finance documents. This newco was then sold to a Luxembourg holding company of ATU, and in turn the group was sold to the newco, inserting it into ATU’s holding structure. The newco was then placed into administration and sold to an SPV controlled by the noteholders.
The ‘flip-up’ mechanism allows a non-English group to take advantage of the flexible solutions offered by English law (such as administration or a scheme of arrangement) without having to shift its COMI. In its judgment, the English court noted that although the flip-up was “in some senses artificial”, it served “the very real commercial purpose of maximising recovery for the group”. ATU demonstrates the willingness of the English courts to exercise its jurisdiction over what was, essentially, a foreign restructuring provided the relevant tests are met for bringing it into the English jurisdiction. The court was willing to give comfort to the other stakeholders, including the creditors but also the administrative parties, like the security agent and the notes trustee, by approving the flip-up structure, thereby minimising the risk of any challenge to those parties after the event.
We are bound to see more European issuers make use of the English legal system to affect high yield bond restructurings in the future.
Elaine Nolan is a partner at Kirkland & Ellis International LLP. She can be contacted on +44 (0)20 7469 2130 or by email: email@example.com.
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Kirkland & Ellis International LLP