This article considers the emergence of loan-to-own as an acquisition strategy in Europe.
Despite recent signs of economic recovery, highly geared (www.practicallaw.com/0-107-6640) companies acquired during the leveraged buyout (LBO) frenzy of 2005 to 2007 are struggling to service their debt, even when their underlying business models are sound. A recent industry survey found that eight out of ten British private equity bosses expect some of their portfolio companies to default on their debt over the coming months (see Grant Thornton, Private Equity Barometer, October 2009). Also, according to Standard & Poor’s:
As of September 2009, 20% of European speculative-grade companies acquired through an LBO had defaulted on their debt, breached loan covenants or negotiated waivers or amendments.
45% of these companies were at least 10% behind their Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) forecasts at the end of 2008, compared with 31% at the end of 2007 (see Standard & Poor’s, Report, Leveraged Finance: LBO Performance In Europe Falls Behind Expectations As Recession Bites, 9 September 2009).
An overleveraged but otherwise sound company is the ideal target for “loan-to-own”, a strategy involving the acquisition by investors of the company’s (generally secured) “distressed debt” (that is, debt which is, or is perceived to be, unlikely to be repaid in full and on time), with a view to potentially converting this debt into an equity stake (which can often involve taking control of the borrower). The acquisition of the debt gives the investors an advantage in any eventual insolvency proceedings or during the negotiation of a consensual debt for equity conversion before the company, or its creditors, initiate those proceedings.
In the US, the conversion usually takes place through a plan of reorganisation (www.practicallaw.com/9-382-3694). In Europe, the conversion can take place through a number of procedures depending on the relevant jurisdiction’s corporate restructuring (if the loan-to-own involves a distressed but solvent company) or insolvency regime (if the company is insolvent) (see below, Impact of European insolvency laws and procedures on loan-to-own).
Once the investor's debt is exchanged for equity, existing shareholders and certain creditors, such as unsecured and mezzanine creditors, usually get wiped out.
In addition to loan-to-own, lenders and specialist investors have pursued several other strategies during the downturn to realise value from distressed corporate debt, including:
A “trading strategy”, where investors buy distressed debt and then sell it at a higher price within a short time frame.
“Buy and hold”, which involves buying distressed debt to influence the restructuring process and then selling the investment at a higher value (see PLC Magazine, Article, Distressed debt investing: UK and US markets compared (www.practicallaw.com/5-383-6325)).
Most loan-to-own activity has traditionally taken place in the US, where an established culture of corporate rescue, reflected in Chapter 11 of the Bankruptcy Code (Chapter 11), supports lender-led acquisitions (see box, Chapter 11 and loan-to-own transactions in the US). US-based financial sponsors specialising in distressed debt, turnaround and special situations have been very active in the US during the current crisis and have attracted large commitments from institutional investors.
Compared to the US, loan-to-own strategies remain relatively infrequent in Europe, partly due to:
The lack of a single Europe-wide restructuring procedure.
The relative inflexibility of some jurisdictions’ insolvency regimes.
Despite these difficulties, loan-to-own investors have attempted to buy several European companies during 2009, with varying degrees of success. Examples include Countrywide in the UK; Monier, Bavaria Yachtbau and Almatis in Germany; and Belvédère in France.
Against this background, this article considers the emergence of loan-to-own as an acquisition strategy in Europe, in particular:
The impact of European insolvency laws and procedures on loan-to-own strategies.
Recent loan-to-own transactions involving European companies, notably Countrywide and Monier.
The advantages and disadvantages of using an English law scheme of arrangement for executing a loan-to-own transaction.
Council regulation (EC) No 1346/2000 on insolvency proceedings (EU Regulation) brought some uniformity to conflict of laws rules for insolvency proceedings and related judgments in the EU. However, “Investors envisaging a loan-to-own strategy in Europe must accept that every jurisdiction has a different insolvency regime, each with its own peculiarities”, explains Johannes Tieves, an R&I specialist at Hengeler Mueller and one of the lead advisers to Monier in its recent restructuring (see below, Recent loan-to-own transactions involving European companies). (For background information on the international aspects of insolvency, see PLC Finance, Practice Note, Cross-Border Insolvencies (www.practicallaw.com/2-107-3985).)
Yushan Ng, a restructuring and insolvency partner at Linklaters and one of the lead advisers to Oaktree in its recent acquisition of Countrywide (see below, Recent loan-to-own transactions involving European companies), believes that investors should draw a distinction between the insolvency regime in the UK and those in continental European jurisdictions when assessing the legal and commercial viability of loan-to-own strategies. He identifies three key differences relating to the:
Influence of senior lenders in the relevant restructuring procedures.
The availability of cram-down procedures (where a minority group of creditors or shareholders becomes bound by a restructuring which they have rejected but which the majority of creditors or shareholders have approved), and pre-pack administrations.
Varying cultural perceptions of insolvency.
In continental European jurisdictions, creditors often have limited rights in court-led insolvency proceedings and can therefore exert little influence over the actions of the court and/or court-appointed insolvency practitioners. This factor alone can make a loan-to-own transaction extremely difficult to execute if the incumbent owner is unwilling to cede control and the court adopts a debtor-friendly approach at the expense of creditors’ claims.
The recent restructuring of French drinks manufacturer Belvédère illustrates the obstacles facing loan-to-own investors in these circumstances (see box, The French safeguard procedure and the restructuring of Belvédère (www.practicallaw.com/2-500-7203)).
The position of senior creditors in the UK is stronger than in other European jurisdictions, partly due to the availability of cram-down procedures, such as those under a scheme of arrangement under Part 26 of the Companies Act 2006 (Part 26 scheme) (see below, Executing a loan-to-own strategy via a UK scheme of arrangement (www.practicallaw.com/2-500-7203)).
Part 26 schemes sit outside the English insolvency legal framework and are used for a wide range of general corporate transactions. However, they can also be used to restructure a company in a way that prevents classes of creditors whose claims rank below ‘where value breaks’ from influencing the restructuring and/or being allocated any interest in the restructured entity.
During the first half of 2009, a number of UK companies, including Countrywide (see below), McCarthy & Stone (Developments) Ltd, British Vita (UK) Ltd and Crest Nicholson Ltd, used schemes of arrangement to reduce their leverage, wiping out certain junior lenders’ claims in the process.
Although the insolvency regimes in other European jurisdictions also provide for ways to cram down dissenting creditors in certain circumstances, this is usually subject to:
Approval of the proposed cram-down by a certain number of members of the affected creditor class.
A finding by the court that the proposed cram-down is likely to produce a more favourable outcome towards the dissenting creditor(s) than any other viable alternative.
The ability to carry out a pre-pack sale (pre-pack) is another flexible characteristic of the UK insolvency regime that is generally not available in other European jurisdictions. In a pre-pack, a company is put into administration and its business/assets are then sold to a newly formed company under a sale that was arranged before the administrator’s appointment. (For more information on pre-packs, see PLC Finance, Practice Note, Pre-packs in administration: a quick guide (www.practicallaw.com/7-385-0829).)
Pre-packs, which made up at least 29% of UK administrations during the first two quarters of 2009, are often negotiated without the involvement of junior creditors. In contrast, the sale of a company undergoing insolvency proceedings in other European jurisdictions often requires court approval and/or consent of minority creditors, which is why pre-packs are rarely seen outside of the UK.
However, a recent forward-thinking court decision has made it technically possible for senior lenders to Dutch companies to achieve a virtually identical outcome to that of a UK pre-pack.
Security over registered shares in The Netherlands usually takes the form of a pledge. The most common way for a pledgee to enforce (foreclose) this form of security, which does not require formal insolvency proceedings, is the sale of the shares to a third party with the pledgor’s consent. This consent can only be validly given after the pledgee has become entitled to enforce the pledge. A share pledge can also be foreclosed by a court-approved private sale under Article 3:251(1) of the Dutch Civil Code.
The district Court of Amsterdam’s ruling in the Schoeller Arca Systems case, delivered on 23 September 2009, was the first time that a Dutch court has approved the foreclosure of a share pledge by a private sale, which the buyer and senior lender had previously agreed, despite a challenge from junior lenders.
This court ruling opens up the possibility for pre-pack-type transactions to become more prevalent (in The Netherlands at least) and could prove useful for senior secured lenders wishing to carry out loan-to-own strategies there (see PLC Cross-Border, Secured lending Q&A: The Netherlands (www.practicallaw.com/0-384-7454)).
Similarly, as Latham & Watkins partner Frank Grell notes, German rules on share pledge (Pfandrechte) enforcement and credit bidding (a right enjoyed by secured creditors in some jurisdictions to use their secured claims against a debtor as currency in an auction of the debtor’s collateral) are relatively straightforward (without the need to file for insolvency), and enable loan-to-own transactions to take place in Germany in broadly the same manner as they do in the UK or the US. Even if filing for insolvency becomes necessary, German insolvency plan proceedings or sales out of insolvency have also been proven to work. Latham & Watkins has represented the lenders on major German restructurings, such as Honsel and Neumayer Tekfor, and is currently advising Bavaria Yachtbau in its ongoing restructuring, one of the latest examples of a loan-to-own in Europe. (For a quick guide to German restructuring and insolvency law, see PLC Cross-Border, Restructuring & Insolvency Q&A (www.practicallaw.com/0-385-3893).)
Varying cultural perceptions of insolvency is the other key difference between the US, the UK and continental European markets. In recent years, the UK has moved towards a rescue culture closer to that of the US, as reflected in the corporate insolvency provisions of the Enterprise Act 2002. However, the key aim of insolvency procedures in many continental European countries remains the realisation of a company’s assets for the benefit of its creditors, as opposed to the survival of the business as a going concern (see PLC Magazine, Article, Distressed debt investing: UK and US markets compared (www.practicallaw.com/5-383-6325)).
The idea of filing for insolvency is also surrounded by stigma in some European countries. This stigma can make lenders hostile to the idea of a negotiated rescue plan and discourage distressed borrowers from starting a debt restructuring until liquidation becomes virtually inevitable. (For an overview of UK corporate insolvency law and links to US and other jurisdictional insolvency content, see PLC Corporate and PLC Finance, Practice Note, Corporate insolvency: a guide (www.practicallaw.com/8-107-3973).)
The acquisition of Countrywide by Oaktree, Alchemy Partners (Alchemy), Polygon Investment Partners (Polygon) and the company’s previous private equity owner, Apollo Management (Apollo), was the first significant loan-to-own transaction involving a UK company during the current downturn.
Background. Apollo acquired Countrywide, the UK’s largest real estate services provider, on 9 May 2007 (see PLC What’s Market, Apollo Funds offer for Countrywide plc). Although Apollo financed the £1.054 billion acquisition with a complex combination of cash, securities and stub equity (see PLC Magazine, Article, Stub equity: eat your cake and have it (www.practicallaw.com/0-313-0999) and PLC Magazine, Article, Acquisition of Countrywide: safe as houses? (www.practicallaw.com/5-378-8843)), the deal left Countrywide with a substantial debt package comprising:
A £100 million super-senior revolving credit facility (RCF).
£370 million in senior secured floating rate notes (FRNs).
£100 million in secured toggle (www.practicallaw.com/5-382-3115) notes.
£170 million in senior unsecured notes.
Countrywide's loans and notes contained several borrower-friendly provisions including:
No maintenance covenants requiring regular leverage or coverage tests.
A payment in kind (PIK) option allowing the company to choose whether to pay the coupon (www.practicallaw.com/6-107-6005) on the toggle notes in cash or by issuing additional securities until 2011. Critics of PIK notes have recently renamed them "pacman" notes, due to their tendency to eat away the value left in highly leveraged companies.
A sizeable RCF with super-priority (a right of first payment over all creditors, including other secured creditors in the event of an insolvent liquidation) (see PLC Finance, Legal Update, Leveraged lending terms: a less brave new world? (www.practicallaw.com/1-378-8784)).
The downturn in the housing market had a substantial impact on Countrywide’s cash flow. However, the flexibility of the company’s capital structure allowed it to delay defaulting on its debt by drawing down on its RCF and exercising the PIK option when paying coupon on the toggle notes. These measures impacted on the value of Countrywide’s debt. As of March 2008, the company’s loan debt and notes were trading at 67% and 51% below face value respectively (see Standard & Poor’s Ratings Direct, Leveraged Finance: Case Study: Countrywide PLC's Borrower-Friendly Capital Structure Wards Off Default Risk, But Weakens Secured Debt Recovery Prospects, 1 September 2008).
Loan-to-own restructuring. On 17 February 2009, Castle HoldCo4 Ltd, the company Apollo used as Countrywide’s acquisition vehicle, announced its financial restructuring plan, proposed by a bondholder syndicate led by Oaktree and comprising Alchemy, Polygon and Apollo.
The restructuring, carried out through a Part 26 scheme of arrangement in May 2009:
Created a new holding company for Castle Holdco 4.
Reduced Countrywide’s £640 million secured debt to £175 million in 10% secured notes with flexibility over the timing of interest payments.
Cut annual interest payments from £60 million to £17.5 million.
Converted the bonds held by Oaktree into a 35% stake in the new holding company’s ordinary share capital (OSC).
Gave the four-lender syndicate a 60% stake in the new company’s OSC in exchange for a £75 million cash injection.
Wiped out the unsecured creditors’ debt, but offered them a 5% stake in the new company’s OSC.
Repaid the £100 million and associated hedging rights of the RCF.
Although Apollo was both a majority shareholder and minority lender before Countrywide’s 2009 restructuring (having previously bought part of the company’s debt), the transaction illustrates the potential for collaboration between incumbent sponsors and loan-to-own investors.
As Richard Youle, a Linklaters private equity partner and one of the lead advisers to Oaktree in this transaction points out, “Collaborating with loan-to-own investors is a sensible step when the incumbent owner of a distressed company is a private equity sponsor”. He continues, “When a private equity owner faces a cash flow problem in one of its portfolio companies, the key question is whether it is prepared to inject more money into it. If the answer is no, the sponsor’s efforts must then inevitably shift towards avoiding the potentially adverse reputational impact of its decision, which can in turn affect future fundraising. In this situation, ceding total or partial control to loan-to-own lenders can be a suitable alternative”.
Commentators have pointed to the acquisition of Monier by a lender syndicate headed by Apollo, Towerbrook Capital Partners and York Capital Management (ATY) as a possible blueprint for future continental European loan-to-own transactions.
Background. Paris-based private equity house PAI Partners (PAI) acquired Monier (then called Lafarge Roofing) on 29 February 2007 for a €2.4 billion enterprise value, including €420 million in existing debt and pension liabilities. Lafarge co-invested €215 million in return for a 35% stake in the new company.
PAI financed the buyout with €2.07 billion of debt. After two reverse flex requests (a mechanism giving borrowers the right to negotiate a reduction in the price of debt in an oversubscribed syndicated loan), the transaction was finally structured as follows:
a €125 million seven-year revolving credit facility (RCF) at 2% over Euribor;
a €175 million seven-year capital expenditures (CAPEX) facility at 2%;
a € 200 million seven-year term loan A at 2%; and
a €622.5 million eight-year term loan B at 2.125 % over Euribor.
A junior debt €325 million nine-and-a-half year second lien.
Monier’s debt package was typical of the covenant-lite facilities that were common during the LBO-boom (see PLC Finance, Practice Note, Covenant-lite facilities: overview (www.practicallaw.com/0-374-9991)).
In March 2008, PAI became an early example of the emerging trend towards sponsor-led debt buybacks when it bought some of Monier’s second-lien debt at 55% face value (see PLC Magazine, Article, Debt buy-backs: from chaos to opportunity (www.practicallaw.com/5-382-7420)).
In October 2008, Monier drew down on its €125 million RCF to boost its cash cushion, prompting speculation about its financial position.
Loan-to-own restructuring. On 6 November 2008, PAI sought advice on a full restructuring of Monier’s debt amid concerns that the company risked breaching its 31 December 2008 leverage covenant. This allowed PAI to delay filing Monier’s covenant compliance certificate (www.practicallaw.com/1-382-4305), while it worked to devise a rescue plan for the company.
On 30 April 2009, ATY, which had acquired Monier loan participations in the secondary market over the previous months, urged the company to engage in debt-restructuring talks with its lenders.
On 11 May 2009, PAI submitted its first restructuring proposal for Monier, under which:
PAI would inject €125 million of (underwritten) new money into Monier in return for a 73% stake.
Lenders would write-off two thirds of their debt in return for a 22% stake.
Monier’s management would hold the remaining 4%.
The proposal would reduce Monier’s total debt to €600 million.
Monier’s senior lenders rejected the proposal reportedly on the basis that it would have caused too many debt-holders to lose out, while giving PAI too large a stake in the restructured business.
On 18 May 2009, ATY met a steering committee of five lenders, representing 30 banks, which collectively, held 75% of Monier’s senior debt, to discuss an alternative restructuring proposal.
At this stage, ATY held approximately 40% of Monier's total debt, including two thirds of its senior debt. Monier’s term loans were reportedly trading at around 32-33.5% of face value as of May 2009.
ATY's proposal, submitted in late May, consisted of:
A €150 million super senior, committed, underwritten RCF.
€50 million available on a non-committed basis, to finance asset sale and leasebacks.
A lender-led acquisition with a new capital structure including €700 million in senior debt and a €300 million PIK tranche, to be paid on the sale of the company.
Although ATY's proposal was technically less efficient in terms of reducing Monier’s balance sheet liabilities, the wider lender group believed that it was preferable to PAI’s solution, as it offered continued debt servicing and higher repayments.
In an attempt to retain control of Monier, PAI unveiled a final restructuring plan consisting of:
A €100 million injection of new equity in return for 40% of Monier's share capital (part of a €200 million new capital raising).
A reduction of debt leaving total liabilities at € 800 million; €500 million cash-pay debt and up to €300 million in PIK notes, depending on EBITDA.
The majority lenders also rejected PAI’s final rescue plan and, on 6 July 2009, Monier announced that the requisite majorities in the lender group, two-thirds of first and second lien lenders and more than 75% of first lien lenders, had approved the ATY rescue proposal.
Although Monier’s main borrowing entity is a German entity, some of the involved parties considered shifting its centre of main interest (COMI) to the UK. This was to make use of a Part 26 scheme of arrangement to adjust by majority vote certain of the existing loans which were to survive the restructuring (which were currently not capable of being amended by majority decision). However, as Johannes Tieves from Hengeler Mueller explains, the proposed COMI-shift became unnecessary after Monier managed to secure near unanimous lender approval for ATY’s rescue plan. Moreover, had Monier migrated the COMI to the UK, there was still the possibility that the creditors whose debts were restructured would have been able to enforce their claims in Germany, as the scheme of arrangement is not a procedure acknowledged in all EU member states in accordance with the EU Regulation (see below, Executing a loan-to-own strategy via a UK scheme of arrangement).
Monier announced completion of its debt restructuring, which cut its interest payments by 80%, in October 2009. PAI’s €256 million equity write-off as a result of the Monier transaction was the second largest loss sustained by a private equity fund with respect to a European portfolio company in the last two years.
Since the onset of the credit crunch, several troubled European companies have changed, or at least considered changing, their place of incorporation or shifting their COMI to the UK due to its relatively versatile insolvency regime. For instance, Greek telecoms company Wind Hellas recently relocated its parent company Hellas Telecommunications to the UK in order to restructure its debt (see PLC Magazine, Article, Insolvency proceedings: shopping for the best forum, 26 November 2009 (www.practicallaw.com/8-500-7219))
Lenders to European companies could also begin using the UK to implement loan-to-own strategies via a Part 26 scheme; particularly when their rescue plan is likely to encounter opposition from minority creditors (see PLC Corporate, Practice note, Schemes of arrangement: overview (www.practicallaw.com/2-107-4433); PLC Finance, Practice note, Schemes of arrangement and companies in financial difficulty (www.practicallaw.com/6-107-3988) and PLC Finance, Legal update, Schemes of arrangement and debt restructuring (www.practicallaw.com/0-422-2064)).
Part 26 schemes have several advantages from a loan-to-own investor’s perspective:
They are governed by the Companies Act 2006 rather than the Insolvency Act 1986. This means that a company can use them to pre-empt the start of formal insolvency proceedings. Unlike CVAs, administrations and administrative receiverships, they are not subject to the supervision of an insolvency practitioner, unless carried out in conjunction with one of these procedures. As Yushan Ng of Linklaters notes, “When deciding whether it has jurisdiction to put a non-UK company into administration, an English court is likely to apply a higher threshold than when deciding whether it has jurisdiction to sanction a Part 26 scheme of arrangement involving a non-UK company. In the second case, the existence of UK debt documents or UK-based creditors may suffice”.
They are binding on all creditors subject to the appropriate approvals being obtained (75% in value and 50% in number in each class of creditor) and the court sanctioning the scheme. Yushan Ng identifies the ability to cram-down minority pari-passu lenders as the main appeal of Part 26 schemes from the point of view of loan-to-own investors.
The recent High Court decision in the IMO Car Wash case (In the matter of Bluebrook Ltd and others  EWHC 2114 (Ch)) has made it even harder for junior lenders to challenge a restructuring plan that wipes out their interests, provided the valuation method used in the plan was reasonable (see PLC Magazine, Article, Scheme challenge: working at the Car Wash debt (www.practicallaw.com/5-422-4268) and PLC Finance, Legal Update, High Court approves present market value as basis for restructuring (www.practicallaw.com/0-422-1677)).
Part 26 schemes do, however, have disadvantages. For instance,
Getting the classes of creditors right. As Yushan Ng and Richard Youle of Linklaters point out "The case-law with regards to forming creditor classes for the purposes of a Part 26 Scheme is not entirely clear-cut, which can create risk of separate classes being formed in certain circumstances, which in turn could have an impact on the deliverability of the scheme" (see PLC Finance, Practice Note, Schemes of arrangement and companies in financial difficulty (www.practicallaw.com/6-107-3988)).
Potential court challenges to the scheme outside the UK. Also, Part 26 schemes fall outside the scope of proceedings listed in Annex A to the EU Regulation, since they are governed by company, and not insolvency, legislation. As Johannes Tieves highlights, this means that creditors enforcing their claims against an entity outside the UK could in principle challenge the scheme’s validity in a foreign court.
Cost and timing considerations. Ng and Youle identify the time and large financial cost involved in completing a scheme of arrangement as additional difficulties. As Ng points out, “A company facing liquidity problems is always extremely time-sensitive. Completing a Part 26 scheme is an invariably lengthy process which leaves the company vulnerable to enforcement action by creditors in the intervening period, particularly when those creditors are located outside the UK.”
Loan-to-own strategies are, by their very nature, opportunistic and often difficult to execute; they are therefore likely to remain confined to specific distressed situations. However, as the shockwaves of the debt crisis continue to be felt across corporate Europe, loan-to-own will remain a valuable weapon in the hands of certain investors.
Johannes Tieves from Hengeler Mueller envisages a similar, possibly slightly higher level of loan-to-own activity in 2010. He explains, “What triggers a loan-to-own is ultimately a liquidity need and throughout 2010, we will continue to encounter more distressed private equity portfolio companies, which make the most suitable targets for loan-to-own investors”.
Meanwhile, Frank Grell from Latham & Watkins predicts that while covenant resets will feature heavily on the agenda over the next months, debt to equity swaps and loan-to-owns will come back after this, particularly in cases where a need for new money arises.
Yushan Ng and Richard Youle from Linklaters also see loan-to-own as a viable acquisition strategy provided that investors can buy the company at a value they are happy with. “Like all M&A activity, loan-to-own gravitates around value”, Youle notes. Ng also highlights the importance of acquiring control of the company, “Ultimately, loan-to-own is private equity by another name; you therefore need to ensure that the client can buy a sufficient level of debt cheaply enough to take control of the company at an attractive price”.
The 2005 creditor-friendly amendments to the US Bankruptcy Code, combined with the scarcity of DIP financing, make the US the prime market for loan-to-own strategies (see PLC Magazine, Article, Distressed debt investing: UK and US markets compared (www.practicallaw.com/5-383-6325), November 2008 and PLC US, Article, Distressed Debt Investing: A High Risk Game (www.practicallaw.com/9-386-1346)).
Some of the aspects of the Bankruptcy Code which support loan-to-own include:
Chapter 11 proceedings, which provide for a court-sanctioned mechanism allowing businesses to continue operating, while devising a plan of reorganisation or liquidation. “Pre-pack” Chapter 11s can be particularly useful for facilitating a consensual, seamless change of ownership (see PLC US Corporate & Securities and PLC US Finance, Practice Note, Bankruptcy: the Chapter 11 Process (www.practicallaw.com/4-380-9186)).
The opportunity to provide Debtor-in-Possession (DIP) financing, combined with the superpriority enjoyed by DIP lenders. The influence of DIP lenders over any potential plan of reorganisation and/or asset sale and their ability to credit bid (see below) also facilitate potential loan-to-own restructurings (see PLC US Finance, DIP Financing: Overview (www.practicallaw.com/1-383-4700)).
Section 363(b) of the Bankruptcy code, which allows a creditor to acquire a bankrupt corporate debtor’s assets outside the ordinary course of business (see PLC US Corporate & Securities, Practice Note, Buying Assets in a Section 363 Bankruptcy Sale: Overview (www.practicallaw.com/1-385-0115)). Additionally, investors who buy or provide pre-petition secured debt or provide the DIP financing, can use this to execute a credit bidding strategy in a sale of the assets of the company (offensive credit bidding) (see, PLC US Corporate & Securities and PLC US Finance, Practice note, Credit Bidding in Section 363 Bankruptcy Sales (www.practicallaw.com/7-500-4339)).
Investors can also participate in a rights offering to buy new equity in the company, either during the Chapter 11 case or before, in the context of a prepackaged bankruptcy. Alternatively, an investor can be a “plan sponsor”, which involves making a cash investment to enable the company to make distributions under its chapter 11 plan to certain creditors holding the “fulcrum security” in exchange for their votes on the plan (see, Article, Loan-to-Own Strategies and the Private Equity Investor (www.practicallaw.com/1-384-0471)).
Although it appears that sales of businesses and assets, rather than reorganisations, have been the preferred exit strategy from Chapter 11 during the current crisis, it is worth highlighting that bankruptcy procedures in the US are supported by a culture that favours company rescue.
France’s procédure de sauvegarde (safeguard procedure) provides a means for solvent, distressed companies to restructure their debts under court supervision.
Creditors’committees. Under the safeguard procedure, creditors of large companies (meeting minimum turnover and number of employee thresholds) are divided into two committees:
A credit institutions committee.
A major suppliers committee, made up of trade creditors holding more than 3% of the total of the suppliers' claims.
A two-third majority in value of each class of creditor must vote in favour of any rescue plan proposed by the company for it to be binding on all creditors. The plan can include a debt-equity swap (among other proposals).
Creditors that do not qualify for committee membership are consulted individually. Bondholders are excluded from the credit institutions committee, but must be consulted separately as a group.
Court supervision. The court has the ultimate power to approve (or reject) the rescue plan. Once the relevant committees give their approval, the court, after ensuring that the interests of all creditors are sufficiently protected, approves the plan. At this point, it becomes enforceable against all creditors.
If any committee fails to approve the company’s restructuring plan, the court can impose a ten-year maximum term-out on dissenting creditors (without prejudice to any longer maturity date that may have been initially agreed). This means that the creditors will not only have failed to execute their proposed loan-to-own strategy, but could have to wait up to ten years to recover the debt owed to them. This is exactly the situation facing a group of senior noteholders caught up in the ongoing Belvédère restructuring (see below).
Belvédère restructuring. Distressed investors Oaktree and Farallon Capital Management LLC (Farallon) acquired €375 million of 2013 floating-rate notes (www.practicallaw.com/8-107-5774) (FRN) in French alcoholic drinks manufacturer Belvédère in 2008, after a covenant breach caused the notes to plummet in value. They then sought early repayment of the notes in an attempt to force Belvédère into a debt to equity conversion, but the company instead opted to start the safeguard procedure in July 2008.
Belvédère’s rescue plan, filed in April 2009, proposed to repay creditors over a ten-year period. The Court approved Belvédère’s plan on 10 November 2009. A further court hearing to determine whether the FRN holders are bound by the rescue plan is scheduled for 15 December 2009.
Several commentators have identified the Belvédère restructuring as an example of distressed debtors using the safeguard procedure to delay debt repayments for as long as they can with the complicity of some judges, who are allowing companies to shelter from creditors rather than engaging in debt talks (see PLC Cross-Border, Restructuring and Insolvency Q&A: France (www.practicallaw.com/0-385-1530))
Loan-to-own investors are generally specialised distressed funds or traditional private equity sponsors seeking to diversify their investment strategy. However, the contractual arrangement between Heineken and UK company Globe Pub Company (Globe), announced on 29 October 2009, shows how trade buyers can benefit from loan-to-own strategies, albeit in very specific circumstances.
Following a series of debt purchases during April and May 2009 (prompted by Globe breaching a covenant and defaulting on its loan repayments) Heineken acquired control of almost 50% of Globe’s debt, divided into:
93% of Globe’s Class A1 notes.
33% of its junior bond notes.
24% of its bank debt.
Following an independent review commissioned by the trustee to Globe’s noteholders, an administrative receiver was appointed on 29 October 2009.
Globe’s estate, comprising over 400 pubs across the UK, was sold to a new acquisition vehicle (EPB Pub Company Limited (EBP)), controlled by FEOH investments, for £180 million. Almost immediately EPB announced an agreement with Heineken, under which:
Heineken would provide £180 million for the acquisition of Globe’s estate.
Heineken and FEOH would then enter into a conditional share purchase agreement giving Heineken the right to acquire full ownership of EBP in the third quarter of 2010.
Heineken would continue to supply beer and corporate and management services to the estate through S&N Pub Enterprises.
It is this last point that appears to have motivated Heineken’s unconventional use of a loan-to-own strategy. Following Heineken’s acquisition of the UK operations of Scottish & Newcastle in 2008, the company was locked into a supply and management contract with Globe. Under the terms of the contract, if Globe ever encountered financial difficulties, payments to bondholders and lenders would take priority over payments to S&N; but S&N would remain contractually bound to provide Globe with beer and management services, potentially for the duration of the (30 year) agreement.
Although it is unlikely that there will be an upsurge in trade buyers executing loan-to-own strategies in the future, this example suggests that they can be used by a supplier in a strong financial position and facing onerous contractual obligations in relation to a distressed customer.