Introduction
It has been two years since our managing partner Natasha Harrison and New York partner Duane Loft spoke on developments in “lender–on–lender violence” which, at the time, had been an emerging trend in the US market which was just starting to move across the Atlantic to the UK.
In this Q&A, Natasha and Duane discuss some of the major developments in this space in the US and Europe since then and what this has meant for litigation over Liability Management Exercises (LMEs). They also examine the effect of past cases such as Serta, as well as some of the current cases that are currently working their way through the courts, and discuss where they see the market heading in the longer term.
Natasha: What have been some of the major developments in the market in the last two years?
Duane: Lender-on-lender transactions, or LMEs as they are more euphemistically known, are now a feature of the credit markets. For lenders in the same class, ratable treatment is no longer a bedrock norm of corporate finance.Gone are the days of “all for one, one for all”.
The market has also matured significantly. First, there has been a huge increase in volume. We used to see one or two LMEs a year, and they were controversial and headline-grabbing. Now it’s one or two a week.
Second, there has been a trend toward “gentler”, more inclusive LMEs. These deals give minority lenders the option of participating in the deal. The economics are worse, but minority lenders at least have the option of exchanging into the transaction. By contrast, in a lot of the older LMEs, minority lenders were completely cut out: they woke up one morning completely stripped, primed, or worse. Their only real option was to litigate.
Natasha: What has that meant for litigation over LMEs?
Duane: The newer, gentler form of deals has quieted a lot of the litigation. With the gentler deals, minority lenders may not like the economics, but now they have a choice: “Do you take the worse deal even though you’re unhappy, or do you try to bring a lawsuit and risk ending up with nothing.” With this shift in calculus, there has been less litigation. Now it’s only the more egregious deals that get challenged.
Natasha: Tell me about the recent Serta decision from the Fifth Circuit.
Duane: In one of the older LMEs, the Serta company attempted a non-pro rata debt exchange that took advantage of a provision in the loan agreement that allowed for “open market purchase” of existing debt.
The Fifth Circuit struck down the transaction. The Court held that it was not an “open market” transaction because Serta had privately negotiated the deal with a select group of its existing lenders.
Natasha: What has been the effect of Serta on the market for LMEs?
Duane: The Serta decision certainly calls into question a host of LMEs that relied on the same open-market exception. It remains to be seen whether those deals will be challenged. On a go-forward basis, many credit agreements still include the open-market exception, so borrowers will have to find other workarounds to avoid litigation risk.
But the game of cat and mouse will continue. Serta closed one door. Creative lawyers will find others. Then those will get challenged, and the cycle will repeat itself.
Natasha: What are some other cases still working their way through the courts?
Duane: Litigation over LMEs remains ongoing in Del Monte, AMC Entertainment, and SG Logistics, to name a few.
We are handling a case involving an up-tiering transaction involving the Hunkemöller company. Thiswill be an interesting test case for so-called “Payments for consent” clauses, which provide that if the borrower wants to pay a majority to amend a loan agreement, then it has to offer the same consideration to the minority. These were long thought to protect against non-pro rata deals like up-tiering. The Hunkemöller case may shed some light on that issue.
Natasha: Where do you see the market going from here?
Duane: LMEs are here to stay. At the same time, LMEs can be a temporary band aid for struggling companies. And coming out of LMEs, the debt documentation can be a lot tighter – given that no one wants to get “LME’d” a second time. So we should start to see full restructurings of post-LME companies that hit subsequent road bumps and eventually run out of liquidity.
Duane: Turning to the UK and Europe, how has the LME market been evolving there?
Natasha: LMEs have not been as common, but they are beginning to take hold. European debt markets have traditionally favoured more collaborative restructuring approaches.
However, with increasing economic pressures and the influence of major US advisors, we are starting to see heightened restructuring battles and liability management exercises.
Duane: What are some of the specific reasons for the slower uptake in Europe?
Natasha: Directors’ duties in Europe are a stronger deterrent against aggressive tactics due to potential personal, sometimes criminal liability.
Intercreditor agreements governed by English law also can provide for more robust protection against non-ratable treatment.
And in the EU/UK, there can be higher thresholds for amendments to bond indentures and credit agreements, especially for any changes to fundamental bond terms or sacred rights.
English common law protections against abuse of minority and collateral purpose voting, on top of the express contractual protections.
Duane: What are some examples of LMEs in the UK/European market?
Natasha: Altice France caused a lot of commotion when it announced a plan to designate Altice Media as an unrestricted subsidiary and conduct an LME at a 20% discount for secured creditors.
Oriflame was another company that raised eyebrows when it re-designated a number of subsidiaries as unrestricted, as a precursor to the Company raising new money against dropped-down assets.
Duane: What is the track record in the courts on LME deals?
Natasha: Very few have been tested, and the common law that we do have often comes from older and more extreme circumstances – for example, very oppressive exit consents. So whilst the law is there, it hasn’t been applied to the exact facts we are now seeing.
In terms of court-supervised restructurings, the use of the restructuring plan – for example, Adler andThames Water – and the cross-class cram down mechanism within it, has seen the English Courts become more used to majority-exercise of powers, albeit with the Court looking very carefully at how this is done.
In Casino, a large French retailer, the French courts approved the cross-class cramdown mechanism, forcing a group of dissenting creditors to accept the terms of the restructuring plan.
While not LMEs as such, these cases will tell us a lot about the law on disparate treatment of creditors. That may have the effect of either encouraging or discouraging future lender-on-lender violence.
It is to be confirmed how this will feed across into non-restructuring plan cases, where the protections are very different.
