As corporate restructuring evolves and becomes increasingly complex, the different requirements of the stakeholders involved can create issues without precedent that require legal resolution. This was the case in late 2004, when following legal intervention and a groundbreaking court judgment, holders of convertible bonds in MyTravel Group, a leading UK leisure travel operator, took a last-minute decision to submit to the terms set out in the company’s restructuring process.
This case, and the final submission of the bondholders to the settlement, raises significant questions about the rights of bondholders and has wider implications for future negotiations between creditors and companies in financial difficulty.
MyTravel, formerly known as Airtours, had an enviable track record until 2002. It reported sustained growth over a number of years and nearly doubled in size between 1997 and 2002. Unfortunately, this growth had a high cost and 2002 represented a watershed for the group. Following a downturn in bookings in the aftermath of 9/11, the group issued three profit warnings, which culminated in record losses before tax of £78m in 2002 and the departures of the chief executive, the chief financial officer and, in 2003, the chairman. Owing to these difficulties, PricewaterhouseCoopers (PwC) was appointed by the lenders in October 2002 and subsequently worked closely with all parties to restructure the business, eventually reaching resolution in late 2004.
At the outset of the restructuring in 2002, it became clear that the MyTravel case would be very different to other recent large company restructurings, such as those of Marconi, NTL or Drax. This was due to the number and mix of the lenders involved.
As a sign of the increasing complexity of corporate restructuring, the MyTravel deal involved more than 75 lenders at completion. A large number of hedge funds and distressed credit investors bought into the debt between initial difficulties in 2002 and completion in late 2004, as illustrated by the fact that, of the 75 institutions in the lender group at completion, only 25 were lenders in 2002. This mix of lenders had very different risk exposures, and therefore very different attitudes to recovery based on their financial positions. However, the legal structure of MyTravel, involving complex structured aircraft operating leases and proprietary financial instruments, added further complications for lenders buying into the credit.
The issue of the legal rights of bondholders was key to establishing the terms of the final settlement. Initially, the bondholders laid claim to approximately 25 per cent of equity on the basis that their debt claim was around a quarter of the aggregate converting debt claim. However, MyTravel and other creditors, working with PwC, argued that, as the bondholders were subordinated to other financial creditors in a liquidation (the alternative to a successful restructuring), their claim was therefore invalid.
The bondholders went to court to challenge the company proposal, claiming that a liquidation analysis was irrelevant given that MyTravel proposed to remain a going concern. The court rejected the bondholders’ claims and concluded that: companies instituting schemes of arrangement do not need to consult creditors (or shareholders) who have no economic interest in the company; and determining the existence or absence of an economic interest by reference to a liquidation analysis is a valid approach if liquidation is the only alternative to the scheme.
Faced with this outcome, the bondholders accepted MyTravel’s equity offer. This was calculated by modelling a liquidation to determine the relative level of ‘pain’ suffered by each creditor – the PwC Entity Priority Model. For those creditors who were converting to equity, the model’s calculation of their dividend in a hypothetical liquidation then formed the basis of the amount of equity into which their debt would convert.
The company’s action is regarded as groundbreaking, as MyTravel proposed to disenfranchise a creditor group. The court was sympathetic to MyTravel’s situation, as it recognised that the bondholders were trying to leverage their legal status, thereby obstructing final resolution and the recovery of the company. This judgment resulted in the bondholders agreeing, albeit reluctantly, to the proposal.
Aside from the bondholder rights issue, another highly unusual feature of the MyTravel case was the role of the Civil Aviation Authority (CAA), which played a major part in the restructuring. As the CAA licenses tour operators, it fulfils a statutory role to protect consumers, and it would not agree to renew MyTravel’s licence if it felt that the business was likely to fail. Failure to renew its licence would mean the group having to cease trading and, in this situation, the CAA acted as a competing creditor.
PwC and MyTravel adopted an open and honest approach with the CAA, keeping it abreast of what was happening with the restructuring at all times. The CAA acted as a key driver to the restructuring, as the debt-to-equity conversion improved significantly the company’s ‘free asset’ position – one of the tests required by the CAA to assess the financial strength of the company.
A further complication was the fact that the CAA had to implement European Economic Community regulations that require majority ownership and control of airlines to be in the hands of European Economic Area (EEA) nationals (the EEA states consist of the members of the EU – Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden and the UK – together with Iceland, Liechtenstein, Norway and Switzerland). As many of the bondholders were from the US, there was a risk that a controlling share of the equity would fall outside of EEA hands, which could have resulted in the airline’s loss of an operator’s licence – and therefore not be allowed to fly. This issue was resolved by creating two classes of share, an ‘A share’ (ordinary share), to be held by EEA nationals, and a ‘B share’ (preference share), with very similar rights for those who did not qualify for A shares.
The fact that bondholders in MyTravel decided to drop their legal challenge following an unfavourable decision by the court means that there has been, to date, no definitive legal decision on the issue of bondholder rights. Until the legal issues raised in the MyTravel case are tested by a company that is determined to implement its proposed scheme of arrangement, the implied threat of legal challenge by disadvantaged subordinated creditors will continue to encourage compromise. However, the case should provide serious food for thought for potential bondholders, as well as for debtor companies and their advisers.
Zubin Randeria is a partner at PricewaterhouseCoopers Business Recovery Services.