Riding out the storm
7 July 2008
Up until last year, the Spanish economy had been growing above the European Union average. This economic bonanza was fuelled by, among other things, a booming real estate market that was supported by historically low interest rates and cheap financing.
Although covenant-lite loans were not popular in Spain, borrowers took advantage of the market situation and negotiated and closed their financing documents with favourable terms when an almost irrational liquidity fled the financial markets and banks had fierce competition to close deals.
Since September 2007 a ‘perfect storm’ caused by the global credit crunch and the bursting of the real estate bubble has been taking shape in Spain. The situation is particularly gloomy for some real estate developers who have used financing mechanisms to purchase land at expensive prices. They can neither sell the land, unless they do so at a big loss, nor develop it, because there are no final buyers able to obtain financing that could be used for this.
Although insolvency has not yet affected major players in the Spanish economy, except for some specific real estate companies, borrowers and banks are analysing the options available to agree a rescue plan in order to avoid an insolvency situation.
Even before initiating a negotiation for the extension of the maturity or dealing with a refinancing, the banks have to look back and revisit old financing agreements to check what support they can provide to the bank’s position in future negotiations or in the event of the acceleration of the financing and enforcement of the security interests.
This article looks at the provisions that may not work in a pre-insolvency scenario. Of course, insolvency would have other side-effects on the facility documents – suspension of accrual of interests except those secured, clawback, etc – but the analysis of such effects would go beyond the intended scope of this article.
Obstacles to acceleration
Banks may face difficulties with the acceleration of the facility. Some examples are:
• In the course of negotiations, banks have often waived their right to individually accelerate their participation in the facility (even in the case of payment defaults) and a blocking majority may reject the acceleration. The acceleration and termination of the facility prior to insolvency would be important because once insolvency is declared, agreements can only be terminated by the judge for breaches that occurred after the declaration of insolvency (and not because the borrower is insolvent).
• Some warnings of an imminent insolvency, such as breach of financial covenants, can be remedied by means of equity cures (that is, by occasional contribution of equity by the shareholders) or even not taken into account with the so-called ‘Mulligan’ clauses. High thresholds or baskets agreed for events of default in the syndicated facilities may prevent the acceleration, even if certain attachments or seizures have been levied on the borrower’s assets, or other indebtedness with third parties are unpaid.
• Even if an event of default can be called, inter-creditor agreements may slow down or even prevent the acceleration of a syndicated facility or the solicitation of the bankruptcy of the borrower. Standstill periods, blocks on payment provisions or super-majorities required to apply for the insolvency of the borrower may require the involvement of other creditors, such as second lien or mezzanine lenders, who may have other interests.
Certain issues should be taken into account in pre-insolvency scenarios regarding security. Given the material cost of stamp duty for the creation of certain security interests (mainly mortgages and chattel mortgages), it has become market practice that borrowers should only undertake to create such security interests in the future if an event of default or other agreed circumstance occurs.
Such promissory security would be ineffective during insolvency because the capacity of the borrower to dispose of its assets is materially limited. If the security interests were created under such an undertaking within two years prior to the insolvency, they could be subject to clawback and be rescinded, as the Spanish insolvency law considers securing an obligation that was initially unsecured to be detrimental to the debtor’s estate.
The Spanish insolvency law provides a stay period of one year from the declaration of the insolvency to enforce security of the borrower’s business assets. This works as another argument for trying to agree a rescue plan with the borrower prior to the insolvency. If the banks enforce their security, the borrower will react by applying for insolvency to stay the enforcement.
In conclusion, hard times are still to come and banks with exposure to borrowers who are suffering the consequences of the credit crunch must prepare and see what resources they have in their agreements. If certain banks want to walk out and sell their credits to distressed investors at a discount, they should be reminded not to forget to sell the credits prior to the declaration of insolvency. If they are sold afterwards, the purchaser will lose the right to vote in a creditors’ agreement and consequently the price that would be paid for the credit would be substantially lower.
Ángel Alonso Hernández is co-head of the restructuring and insolvency department and Ángel Pérez López senior associate at Uría Menéndez