Any colour, as long as it's austere

Thursday, 12 December 2019 08:48 pm

This piece was written for the corporate and financial sector clients of Clifford Chance, summarising the content of a webinar given by the firm on restructuring.

Restructuring – what's next?

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Restructuring – what's next?

Clifford Chance partners reflect on recent developments and look ahead to the next wave of work-outs
by Brian Thompson

During 2011, the restructuring boom of the recent past gave way to a period of relative calm, but the early indications are that restructuring will dominate 2012 and the question of how to refinance debt from the last decade remains unanswered.

Despite the difficult economic environment, ‘burning platform’ insolvencies remain relatively rare. Most work remains focused on ‘long tail’ cases. Default rates stand at 2.5% against a long-term average of 4.75%. Governments appear to be committed to addressing SME lending constraints and the ‘amend and extend’ culture is helping even relatively fragile companies to remain on life support.

This situation, however, may be about to change. As Philip Hertz, partner in Clifford Chance’s Restructuring and Insolvency practice, puts it, “sticking plaster solutions applied in the last couple of years are getting curly around the edges and, in one or two cases already, dropping off.” Moody’s estimates that within EMEA alone more than USD $325bn of speculative grade non-financial corporate refinancing will be required between 2012 and 2015. Lenders will therefore have to make hard choices and it is unlikely there will be enough money to go around. “Audit going concern issues will come to the fore, and we expect a tightening of bank lender credit conditions. We are already seeing an uptick in cases and we expect this trend to continue,” adds Philip.

The challenge posed by the oncoming wave of work-outs and understanding the  way in which techniques will evolve to deal with them is of crucial importance. Philip believes future solutions “will be informed by the current crop of restructurings, those in the recent past and the changes in law which have resulted from them”. Recent developments in both consensual and so-called ‘Plan B’ restructurings are, therefore, set to play an important role in future restructurings.

As creditor groups become more fragmented and investment objectives more diverse, finding consensus is becoming more challenging. However, Clifford Chance partner Iain White believes consensus can still be achieved, particularly if co-ordinating committees and standstill arrangements are used effectively.

Iain speaks from first-hand experience having put both of these tools to work for Southern Cross, the UK’s largest provider of care home for the elderly where, together with fellow restructuring partner, Nicholas Frome, he led a consensual restructuring which is now nearing a successful conclusion.

With the need to provide uninterrupted care to the elderly a matter of national importance, a complete solution that kept all creditors (especially the 80 different landlords who leased the care homes to Southern Cross) on board was essential. Achieving this consensus was helped by the fact that a group-wide administration was not commercially viable, as someone would still have to fully fund post-administration rents. “The final factor driving parties towards a consensual deal was that the spread of landlords and leases across more than 100 group companies meant that cram-down processes were unavailable,” adds Iain.

“What Southern Cross reminded us was that the committee concept can, within reason, be flexed according to whatever the situation requires,” explains Iain. In fact, Southern Cross involved two committees. The first, which comprised landlords, developed its own rules, appointed advisers and acted as the ‘postbox’ for communication with the wider landlord group.

The second was an over-arching restructuring committee, whose membership included representatives of the landlord committee, the banks and the company. This second committee was the forum to thrash out key terms and resolve inter-creditor differences. “But its role went beyond that, as members took on additional responsibilities, such as monitoring professional spend, liaising with care regulators and bringing collective pressure to bear on trade creditors in order to give the company breathing space,” Iain adds.

The Southern Cross case demonstrates just how flexible and effective the committee process can be. In Iain’s view “it is important that as we move forward into the next phase of restructuring, creditors and companies recognise that flexibility and maximise its potential”.

Nowadays it is rare for any larger restructurings to move from initial engagement to implementation without some form of “standstill” on creditor enforcement. This is firstly because restructuring solutions are becoming more complex and therefore taking longer than ever to implement. In addition, as debtors are waiting longer before they approach their stakeholders, the situation is often well past the stressed stage and deep into default territory before work can begin.

More recently, Clifford Chance is seeing an increase in the number of debtors operating under a so-called “de facto standstill”. This is, in effect, an informal, non-legally binding understanding that enforcement action will be suspended as long as the status quo among stakeholders continues.

From the borrower’s perspective, the tendency toward de facto standstills may be driven by the time and financial costs of negotiating a formal standstill as well as by a desire to avoid the undertakings demanded by creditors in return for their signing up to such an agreement.

However, standstills are not just about calling a ceasefire between a company and its creditors. They were originally conceived as a means of protecting creditors from each other, as well as protecting debtors. In this sense, “de facto standstills certainly provide less stability,” adds Iain.

Southern Cross used a de facto standstill. Although this was not always an easy ‘truce’, it proved to be an essential tool in achieving a restructuring. “But that is not to say it will work in every case – in particular, we expect it to be a challenging concept for directors of obligors in certain overseas jurisdictions in which insolvency filings are obligatory,” explains Iain.

The first area to focus on here is prepacks, whose popularity has been driven by several factors. Pre-packs can often be implemented without the need for unanimity among senior secured lenders and without the need to reach agreement with the junior lenders, the equity sponsor or the company itself. In addition, they can also be executed quickly and without notice, which means that “good” operating companies or businesses can be sold before the parent company is known to be insolvent or subject to insolvency proceedings. This helps to maximise value for all creditors as can the fact that operating companies are deleveraged before sale, which puts them on a sounder footing for the future.

The advantages of pre-packs place the UK at the centre of the ‘creditor friendly’ restructuring world and attract companies that wish to use this method. The easiest and most obvious way to do this is by shifting the centre of main interests – or COMI – of a holding company to the UK. But in many cases a COMI shift is simply not possible and other options need to be explored.

In such instances, Clifford Chance has been working across its European network to find ways of implementing similar “prepack” solutions in foreign jurisdictions. As restructuring partner John MacLennan explains, “we have pushed boundaries to establish workable templates for prepacks through security enforcement in a number of key jurisdictions.”

Although these ‘euro-packs’ might not bear all the hallmarks of an English prepack, they are, nonetheless, a real option to be considered, particularly in the following jurisdictions:

  • Luxembourg – a law introduced in 2005 has simplified the security enforcement process and means that secured creditors can now enforce share pledges quickly and ‘out of court’. “In fact the firm led for the senior lenders in what we believe is the first known example of restructuring being implemented through a Luxembourg share pledge enforcement,” explains John.
  • The Netherlands – in the Netherlands, which is another key holding company jurisdiction, enforcement of security is through a court process (which can sometimes lead to delay and uncertainty). But, because of a case which Clifford Chance led, court guidance now exists that provides a usable template and gives some certainty of outcome for stakeholders.
  • Germany – although it is commonly believed in Germany that security cannot be enforced, it has been demonstrated that the share pledge enforcement process, which is run through an auction, can be used to great effect. In fact, in the recent case of Tele Columbus, a share pledge enforcement was used (although stopped only hours before the auction commenced) helping reaching an agreement with the sponsor in the context of the wider restructuring. With such progress being made in these countries, it will be interesting to see if it is replicated elsewhere in the coming round of restructurings.

Despite these developments in Europe, it seems the UK may be heading in the opposite direction. Negative media coverage has led the Government to propose reforms to “improve transparency and confidence in pre-pack sales”. It now appears that these reforms may be implemented as soon as April 2012, although October 2012 is seen by many to be a more likely date.

The key proposed change is that where an administrator intends to sell all or a substantial part of a company’s business and assets to a person connected or associated with the selling company, he must first give three business days’ notice to every creditor of the selling company.

However, there are a number of uncertainties. It is not entirely clear, for example, what the giving of notice achieves for the creditors. For example, could they stop the sale by seeking an injunction? Would they want to expend time and money challenging the prepack? In addition, the notice and subsequent delay to the sale could result in significant damage to the business and increased losses for all creditors. During the hiatus, for example, in the context of a holding company administration where it is intended to sell the “good operating” companies, there may be a tightening of credit terms, removal of credit insurance and a loss of customers and goodwill.

The definition of a person connected or associated with the selling company isalso not completely clear. In this case, itis thought that secured creditors will notbe considered to be ‘connected’ byreason of their security alone. If other stakeholders, such as equity sponsorsand existing management, are to formpart of the solution, would they beregarded as connected?

Schemes of arrangement, which date back to the 19th century, are enjoying a comeback among the current crop of restructurings. Essentially, a scheme of arrangement provides a technique to ‘cram down’ within creditor classes where 100% consent is required. By the use of a scheme, changes such as margin or haircut that would require 100% agreement can, in effect, be made by a majority in number and 75% in value.

The evolution of these schemes has enabled them to be used recently by foreign companies without the need for a COMI shift. Such a use can be possible, even if there are very few other (or any) UK connections, as long as the debt documentation is governed by English law. In three recent cases on which Clifford Chance has advised, the English court has accepted jurisdiction to sanction a scheme on this basis – Metrovacesa (Spain), Tele Columbus (Germany) and Rodenstock (GmbH) – the last of which cases produced a precedent setting judgment on this very issue by the English court.

Indeed, this whole area might be seen in the wider context as part of a trend toward foreign jurisdictions accepting creditor friendly English techniques. And some jurisdictions are going further and creating their own legislation with, for example, Spain developing a process similar to a scheme.

Another important area is the raft of regulations relating to the way in which failing financial institutions are administered. These regulations are so far untested, but MF Global offers the first example of the special administration regulations for investment banks being used in the real world.

The collision between pensions and insolvency legislation provides another intriguing area. While the so- called section 75 debt (i.e. the debt owing by an employer company to a pension scheme in respect of a pension fund deficit) is normally classified as unsecured debt, the Nortel/Lehman ruling has decided differently, making it an expense of the administration and therefore affording it almost super priority. Given the huge sums involved (£2.1 billion in Nortel alone), it seems highly likely that new legislation will be needed to address this issue, given this remains a Sword of Damocles hanging over and paralyzing trading administrations.

Even in the relatively narrow area covered in this article, it is clear that much is changing. In the foreseeable future, the oncoming crop of restructurings look set to follow the same basic principles as in the past but practices and procedures will continue to develop. The best solutions are likely to combine lessons from the past and an ability to respond effectively to the present. And, although the possibility of consensual restructuring should not be underestimated, it is worth bearing in mind Philip Hertz’s adage that “if you do not have a fall back plan B, you do not have a consensual plan A”.