There are few restructuring lawyers today who have not yet experienced the involvement of a hedge fund in a restructuring. Over recent years there has been a proliferation of such funds, which are now active in London and Europe. Additionally, many banks have built distressed debt teams in London to take advantage of the growing corporate bond market in London and Europe, which itself has grown out of the increasing use by European companies of international capital markets to provide finance.
Although funds are increasingly looking to other types of investment, the most visible area of investment over the past few years has been in the distressed corporate bonds market. Very often, funds will identify some unidentified value in the company’s balance sheet or enterprise and will invest in the bonds or bank debt (at a distressed or highly discounted level) for the purposes of either benefiting from some future restructuring of the company or out of an insolvency proceeding.
Funds will often take a majority or blocking position in either bonds or bank debt to influence either the board or the insolvency practitioner. Alternatively, funds will form ad hoc bondholder committees, which themselves may represent a majority in value of the bond or bank debt or represent a blocking position. The bondholders or the committee will then instruct counsel and, if a restructuring is imminent, their own financial advisers and will seek to have advisers’ fees met by the debtor.
Once the bondholder or committee has taken a position in bond or bank debts there are various tactics that may be employed to increase the ‘leverage’ of the bondholders. Given the usual structure of a European high-yield issue – where the bondholders are usually structurally and/or contractually subordinated to senior and/or mezzanine lenders – the tactics will often involve an attempt to overcome or mitigate the effects of either structural or contractual subordination and to create leverage via legal proceedings.
An example of this tactic is the Colt Telecom litigation. In this case, Highberry, an affiliate of US hedge fund Elliot Associates, attempted to place Colt into administration. This attempt was an extraordinary use of the administration jurisdiction and was ultimately unsuccessful. Although this action was widely criticised, the company was forced to engage the bondholder in legal proceedings and in the coverage in the press, and so to some extent the tactics of the bondholder were successful.
The failure of the Colt action may have tempered bondholder activism. It might also be that the eventual outcome of the costs issue in a case involving Barings might have a similar effect on bondholders’ willingness to resort to the English courts. Nevertheless, the use of litigation is likely to remain one of the tactical tools used by bondholders.
In conjunction with the increase in hedge funds and distressed debt desks, what has emerged in the past few years is a body of lawyers that has become very closely identified with these entities. These firms have restructuring practices that have grown up with the hedge funds in London. They arrived in London around the same time and have no loyalty to the traditional insolvency trinity of magic circle lawyers, accountants and clearing banks. At the same time, the bondholders had not heard of, and were even less interested in, the London approach.
Bondholder lawyers have become well versed in the psychology and tactics of the hedge funds and in many instances facilitate and encourage the creation of the ad hoc bondholder committees. The law firm very often plays a critical role in guiding and formulating the approach and tactics of the ad hoc committee. This ‘team’ approach of law firm and bondholder committee (and where necessary financial adviser) has become an effective tool in the restructuring market and should not be ignored by companies that have issued bonds or have bank debt when contemplating a restructuring or refinancing.
The new restructuring tools
We have seen some critical changes in English and European insolvency law that have provided restructuring lawyers with new tools and have blunted the tools of senior lenders.
In May 2002, the European Regulation on Insolvency Proceedings came into force within the EU (not including Denmark). The regulation, which was initially considered irrelevant by many, has brought about a major revolution in cross-border restructurings. The regulation is intended to regulate which members states’ courts have insolvency jurisdiction over bankrupt individuals and companies.
The legal test under the regulation to determine whether a member state court has jurisdiction to open a primary or ‘main’ insolvency proceeding is whether the debtor has the centre of their main interests (Comi) within the relevant court’s jurisdiction. The recitals to the regulation provide that the Comi should correspond to the place where the debtor conducts the administration of their interests on a regular basis and is therefore ascertainable by third parties. In the case of a company, there is a rebuttable presumption that its Comi is the jurisdiction of its registered address.
Initial indifference towards the regulation arose from the fact that it made no provision for the restructuring of a corporate group – it focused on the Comi of each individual company and provided no mechanism to open a single bankruptcy proceeding in respect of a pan-international group. Given the prevalence of corporate groups in cross-border restructurings, this was indeed a significant criticism.
However, it has not taken long for the regulation, largely with the English court system’s assistance, to address this criticism. Cases such as BRAC Rent-a-car and Crisscross have demonstrated that the regulation will have a huge role in future cross-border restructurings. In BRAC, the English court found that the regulation could apply to non-EU companies and duly found that it had jurisdiction to place Brac Rent-A-Car International, a US Delaware-incorporated company, into administration on the grounds that the company had its Comi within the UK. In Crisscross matters went a stage further. The English court made administration orders over the entire Crisscross corporate group, despite the fact that it consisted of eight companies with their own assets and creditors in their respective jurisdictions which were registered in various EU jurisdictions and Switzerland. The group order was apparently made on the basis that each of the companies had its Comi within the UK. The rationale for this decision appears to be that the companies effectively formed one business and that the management of this business was directed from the UK.
These cases demonstrate clearly that a major step towards a real pan- European restructuring process has been made.
The Enterprise Act 2002 – administration orders
The corporate insolvency provisions of the Enterprise Act 2000 came into force on 15 September this year. The underlying rationale of the act is to promote and encourage the use of administration as a restructuring tool, in particular by heavily circumscribing the possibility of recourse to the administrative receivership procedure.
The act posits a general prohibition on the ability to appoint an administrative receiver, even for a secured creditor holding a full security package, including a floating charge. An administrative receiver may only be appointed in certain limited and narrowly defined cases. Even if a secured creditor manages to appoint an administrative receiver, the act makes provision for a “prescribed percentage” of net floating charge realisations to be set aside for the benefit of unsecured creditors.
It is too early to discern what effect the act will have on secured creditors. By being obliged to use the administration process, such creditors lose their favourable position in insolvency, as the administrator owes a duty to all the creditors, and are made the subject of the cross-border provisions of the regulation.
These new players and new tools will no doubt lead to interesting new developments in the restructuring market over the next few years. As hedge funds and their legal advisers utilise the new tools, corporates will increasingly need specialist restructuring lawyers well versed in bondholder tactics, rather than their usual corporate counsel.
Lyndon Norley is a partner at Kirkland & Ellis. He was assisted in this article by associates Richard East and Graham Lane