Liability management transactions which may favour a subset of creditors over another are increasingly common in the US leveraged finance markets. 2024 may be seen as the year in which these US imports began to make a real impact in Europe. Which strategies could creditors employ to protect themselves from unfavourable treatment where such transactions are attempted?
The appeal of liability management transactions to stressed debtors is that they can facilitate a refinancing or incremental borrowing where this would not otherwise be possible. The participating creditors will often see economic benefits with respect to both new instruments and their existing investments. Two key types of such transactions are:
- 'Uptiering', where a borrower incurs new debt secured by super senior security over the existing collateral and a subset of the existing lenders is typically tapped to provide the financing and to consent to the necessary amendments to the debt documents to introduce it on a priority basis. This may be coupled with a roll-up of existing creditor debt into a facility senior to the remaining debt but junior to the newly financed tranche; and
- 'Drop-downs', where a borrower avails of flexibility to move assets outside of the restricted group, enabling the group to offer such assets as collateral to support new borrowing which will be structurally senior to the original financing.
More recently, we have seen 'drop-down' transactions which enhance the credit support offered to the new lenders by giving them a receivables pledge over an intercompany loan from the unrestricted subsidiary borrower to the existing credit group as well as guarantees of the new debt by the existing credit group (a 'double-dip') or by entities outside of the existing credit group (a 'pari-plus' financing).
We have started to see either preparatory work, or in some instances, financing structures incorporating these types of transactions, show up on this side of the Atlantic. In this Alert, we outline some strategies which creditors may be able to employ to protect themselves from unfavourable treatment where such transactions are attempted.
1. Be prepared: forewarned is forearmed
Creditors should be fully apprised of the flexibility under the finance documents for each borrower on their 'stressed watchlist' so they can understand the options available. Specifically, creditors should be aware of debt and lien baskets, restricted payments capacity, intercreditor agreement protections, amendment and waiver provisions, and voting thresholds. The analysis of the finance documents should be coupled with a commercial assessment of the possible risks, which may including evaluating the value of unencumbered collateral and which assets, business lines or subsidiaries might be capable of disposal (including to an unrestricted subsidiary) and/or offered as collateral for a new financing. Creditors will then want to take every opportunity to tighten documentary flexibility when asked for amendments, waivers or forbearance.
2. Relationship maintenance
Creditors should look to maintain strong relationships with debtors' management teams and sponsors. The larger the debt holding of the relevant creditor and the more senior the position they occupy in the capital structure, the easier this will be. Maintaining an open and constructive dialogue with key decision-makers, other creditors and advisors will allow creditors to anticipate what is coming down the line and position themselves favourably ahead of any liability management transaction. Creditors would also be wise to consider the basis and terms on which they would be willing to provide 'new money' should the need arise.
3. Blocking stakes
One of the only concrete ways of preserving a creditor position is to hold a blocking stake in the debt. This also involves considerations from the first two points above regarding amendment and waiver provisions and voting thresholds as well as the overall relationship of the creditor with the debtor. Although acquiring further debt will not always be feasible and obviously requires a creditor to increase its economic exposure to the debtor, it does put the creditor's destiny in its own hands. Nor should the term 'blocking stake' imply that a creditor will necessarily act or be perceived to have positioned itself in opposition to the debtor – a creditor which has accumulated a significant holding may in fact be viewed as a favoured partner in any liability management transaction.
4. Work together: co-operation agreements
Creditors in the US have shown an increasing willingness to work together in the face of prospective liability management transactions by signing co-operation agreements, and recent months have seen several co-operation agreements proposed and agreed in the context of stressed European capital markets issuers. Whilst European investors have been slower to embrace co-operation agreements for various reasons, including the relatively consensual restructuring market, the recent uptick in liability management transactions in Europe may be a turning point as creditors look to protect themselves in large restructurings.
By signing up to these agreements, creditors agree not to support specified transactions unless certain criteria are met with a view to preventing deals being consummated with some creditors at the expense of others. A simple concept in theory, creditors should note that 'co-op' agreements take time to put in place, especially where there are large and disparate creditor groups. Further, hostile debtors may take steps to pre-empt their signing, to impede groups from forming or to work around existing agreements (including issuing additional debt to achieve consent thresholds or 'weaponising' NDAs to prevent lenders from holding private discussions).
When used effectively, co-op agreements can serve to protect creditors against the 'divide and conquer' strategy often employed in the context of coercive liability management transactions, allowing lenders to present a united front and negotiate with debtors from a position of strength. In particular, a co-op agreement may work well in circumstances where the debt holdings are concentrated amongst a small group of creditors which has already appointed legal advisors. However, the practical obstacles to installing co-op agreements can be significant and their mere existence does not guarantee that creditors will not ultimately be played off against each other.
5. Applying pressure: directors' duties
In several key European jurisdictions, the duties of company directors (and, in some circumstances, their obligations to consider the interests of creditors) are perceived to be more robust and extensive than in the US. Creditors in Europe may be able to leverage this by reminding directors of their potential personal liability and emphasising their willingness to hold directors to account for any breach of their responsibilities. Directors' duties considerations are likely to be more acute where assets are being transferred away from a company of dubious solvency.
6. The last resort: pursuing litigation
Where creditors have an argument that an aggressive liability management transaction was not permitted by the finance documents, they may seek to challenge the transaction in court. The initial step will often be a claim that a breach of contract has occurred or is threatened and an application for an interim injunction to prevent it. Challenges of this nature are common in the US market and several high-profile transactions have been the subject of litigation by minority or excluded creditors. Whilst differences in jurisprudence (and a smaller body of precedents) make it difficult to anticipate how the English courts will view these transactions, the relevant case law suggests that the level of coercion against minority creditors will be a key factor in determining whether a transaction is abusive and impermissible.1 They may also consider the motivations behind liability management transactions (e.g. the extent to which a transaction is driven by cash flow requirements and benefits even non-participating creditors) when determining whether they are abusive or permissible.2
Closing remarks
Whilst the recent rise in potential liability management transactions in Europe can, in part, be attributed to a higher interest rate environment, it looks like the trend will continue. Credit investors would be wise to ensure they are fully apprised of the flexibility for such transactions under their finance documents and to consider the defensive strategies which may be appropriate to protect their interests.
1 Assénagon Asset Management SA v Irish Bank Resolution Corp Ltd (formerly Anglo Irish Bank Corp Ltd) [2012] EWHC 2090 (Ch).
2 Redwood Master Funds Ltd v TD Bank Europe Ltd [2002] EWCH 2703 (Ch).
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This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.
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