Hold-Outs Beware: UK Schemes of Arrangement and Chapter 11 Lie in Wait
The recent Thomas Cook refinancing and Cortefiel scheme of arrangement offer contrasting examples to investors of the risks and rewards of adopting a hold-out position in complex multijurisdictional restructurings.
The rationale behind a hold-out strategy is simple enough: A prospective creditor will seek to acquire a portion of debt large enough to ensure that the debtor's restructuring, amend and extend or other objective cannot proceed. In larger situations, the blocking stake may be acquired by a group of like-minded funds acting in concert. Such a strategy is, however, beset on all sides by the risk of cram-down, jurisdiction shopping and specific industry pressures that may compromise the hold-out creditor's initial assessment of its position.
An early step in any prospective hold-out creditor's formulation of its strategy will be the calculation of a sufficiently large blocking stake. While this can be relatively high if buying into bonds (between 25 and 34, depending on the voting thresholds), it can drop to a far more attractive level in respect of bank debt, with the principal, interest and maturity provisions often requiring 90 percent or unanimous consent to amend.
However, as the English court's reach stretches further and further in claiming jurisdiction over restructurings with a peripheral connection, at best, to England, so does the risk of miscalculation of the blocking stake. While a hold-out creditor might buy on the basis that a small stake will be sufficient to obstruct amending and extending bank debt, it can quickly find itself subject to an English law scheme of arrangement, which allows the majority creditors to compromise its debt with 75 percent support. Such a pitfall has recently befallen the hold-out creditors in the Cortefiel restructuring, where the company, a Spanish clothing retailer, reacted to its failure to reach a 90 percent extension rate across creditors by pushing the company into a scheme of arrangement to utilise the 75 percent approval it did obtain.
Although assessing the availability and likelihood of a scheme of arrangement for a debtor is a difficult and constantly evolving analysis, it behooves a prospective hold-out creditor to consider the factual matrix surrounding the debtor.
Global operations may be a key complicating factor in limiting a debtor's (or its creditors') choice of restructuring paths. For example, although Cortefiel, Global Investment House KSC and Icopal demonstrate that the governing law of financing agreements is likely to be a sufficient connection to England, global operations are likely to present recognition problems. In structures where English law financing is guaranteed and secured by multiple subsidiaries across a range of jurisdictions, the availability of cram-down procedures will be severely restricted if some or all of those jurisdictions refuse to recognise such procedures. This situation will be exacerbated where the debtor has multiple classes of debt with differing governing laws. Take, for example, Norske Skog, which, in addition to English law banking facilities, has also issued Norwegian and New York law bonds. In highly complicated debt structures, the choice of restructuring tools will be far more limited.
Regulatory concerns have also previously impacted upon the strength of holdout creditors' positions to contrasting effect. In WIND Hellas in 2010, investors were successful in acquiring more than 10 percent of the super senior RCF, allowing them to block an amend and extend if the banks had been minded to roll their loan. In that case, the hold-out creditors relied on the company's reluctance to implement a scheme of arrangement at OpCo level, given its fear of losing its telecoms licence. Conversely, the time pressures imposed by industry regulation can influence a court in approving a scheme to the detriment of minority creditors, as witnessed in MyTravel. Similar considerations might have applied in Thomas Cook had the market not reacted positively to its turnaround plans.
Cortefiel also highlights the importance of a proper analysis of creditor composition. While the hold-out creditors were partially responsible for the company's failure to hit 90 percent, the presence of CLO lenders also handicapped the company's efforts to gain consent to extend. Even if supportive in principle, the investment policies of CLOs frequently prevent them from extending loans in their portfolios. Commercial lenders may also behave differently from fund creditors. In WIND Hellas, the blocking stake of the hold-out creditors proved to be unnecessary, as the bank lenders bucked the recent trend and sought a pay-out rather than extended debt. In many other situations, commercial/bank lender (who typically invest at par) may be reluctant to take a capital hit or may be more accustomed to local workout customs.
Not just schemes of arrangement threaten hold-out creditors' position. They are also faced with the prospect of a debtor engaging in jurisdiction shopping to take advantage of debtor-favourable insolvency regimes. The French sauvegarde (safeguard) procedure is not always viewed positively by non-French creditors. It features a DIP proceeding allowing the debtor, in certain circumstances, to restructure its debts over the course of 10 years, denying the hold-out creditors the immediate pay-off they seek and ruining the majority creditors' prospects of agreeing a less painful, more timely consensual restructuring. Similarly, and as seen in the Arcapita restructuring, a U.S. Chapter 11 filing may be forced upon a debtor by hold-out creditors where the debtor feels compelled to protect its assets from individual creditor action, leading to a lower return for creditors across the board.
This can be contrasted with situations where the debtor's willingness to enter into a formal insolvency procedure is heavily influenced by the nature of its business. Consumer-facing businesses, such as the travel industry, gambling or regulated businesses, are conscious of the value-destructive effect of entry into insolvency procedures, regulatory controls imposed upon them and their customers' need for perceived long-term stability when buying products or services from them.
A debtor's restructuring options may be heavily influenced by the availability of affordable refinancing. Thomas Cook's refinancing also demonstrates that the increasingly positive credit and equity markets may mean that complex restructurings are avoided completely. Unless the hold-out creditor is seeking a debt for equity swap, it may consider a repayment in full to be a good outcome.
The lesson from recent experience is that a creditor seeking repayment at a scheduled maturity (or seeking a restructuring outcome) should conduct a proper assessment of its prospects of being paid out. A far deeper analysis than calculating the blocking stake required under the transaction documents is required. The increasingly globalised menu of restructuring methods, the nature of the debtor's business, the composition of its creditors and its financing alternatives can all play a strong role in determining the debtor's response to hold-out creditor pressure, sometimes leading to unintended and painful results.
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Luke D. Johnson
This Commentary is a publication of Jones Day. The contents are for general information purposes only and are intended to raise your awareness of certain issues (as at August 2013) under the laws of England and Wales. This Commentary is not comprehensive or a substitute for proper advice, which should always be taken for particular queries. It may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at its discretion. The mailing of this publication is not intended to create, and receipt of it does not constitute, a solicitor-client relationship.