Eurobond and High Yield Distress – Consent Mechanics and Recent Case Law Impacting European Bond Issuers
By Stephen Phillips, FreiLibertas Law, November 2022
Introduction
On both sides of the Atlantic we are seeing a rise in stress of companies which have issued bonds to finance their corporate activities. Some companies will need a full-scale restructuring perhaps involving formal procedures such as schemes of arrangement or restructurings under formal procedures (in Europe) or Chapter 11 in the US. However, many will look to liability management exercises implemented under the consent procedures embedded in the bonds implemented outside of formal procedures. This article focuses on the nature of the consent mechanics for European issuers of High Yield or Eurobonds and addresses how such consent or exchange requests will be impacted by the case law generated after the global financial crisis.
Bond Consents – a summary
· Distress and cost of capital is rising and so expect to see a wave of liability management exercise for European bond issuers
· English law governed bonds tend to be far easier to amend than NY law governed bonds which have far high consent thresholds for changes to the ‘Money Terms’
· US case law is far more permissive and supportive of coercive techniques such as covenant stripping than English law so expect to see more coercive requests in the US with more of a ‘carrot’ approach in the Eurobond market.
· The case law is not entirely clear and so expect to see corporates pushing the envelope and consequent litigation as we go into the next distress cycle
The Rise of Distress
The law firm Weil Gotshal in an interesting on-going research project tracks defaults of speculative grade companies and rises in distress of European corporates (see table below). As would be expected defaults lag stress indicators. Issuers have proactively raised long term debt when market conditions were exceptionally benign and interest rates were low, so it is expected that even if the business environment is deteriorating and following interest rate increase it will take some time for any distress to show in default rates[1].
Issuers will use a variety of tools before they reach a point of non-payment. Issuers often request to extend the term of the bond, lower the interest rate to avoid an outright default or swap old debt into new debt. The implementation of amendments varies between New York Law bonds and English law governed bonds. Corporates have tended to push the envelope to pressurize bondholders to accept commercial changes, offering both a ‘carrot and stick approach’ and we discuss the developing case law in England and in the US. Before we discuss consent requests a short detour on the development of the European bond market will provide helpful context.
The Rise (and reasons for the Eurobond Market)
A Eurobond is a debt instrument that's denominated in a currency other than the home currency of the country or market in which it is issued. Famously, the Eurobond market began with the Autostrade issue for the Italian motorway network in July 1963[2]. It was for US$15m with a 15 year final maturity and an annual coupon of 5½%. S G Warburg was the lead manager of the issue while the co-managers were Banque de Bruxelles, Deutsche Bank, and Rotterdamsche Bank. A key factor to issue the bonds in London rather than the US was to avoid the US Interest Equalization Tax which raised the cost of capital in the US market.
Eurobonds benefit from certain withholding tax deductions often referred to as the quoted Eurobond exemption. Where a debt is owed by a UK entity to any entity or person who is not resident in the UK and interest is payable on that debt, then the UK entity is obliged to deduct UK withholding tax in respect of the interest amount payable. If a debt meets certain requirements to be classified as a ‘Quoted Eurobond’ then tax does not need to be withheld on interest payments in respect of that debt.
The above pioneering bond issue spawned a vast market for European corporates to issue debt from a highly liquid market which continues to operate post BREXIT. A key characteristic of such bonds is that they tend to have few covenants (as they tend to be issued by large credit worthy companies) and they are often governed by English law.
High Yield Bonds – Some Background
High-yield (formerly called junk) bonds are debt securities issued by companies rated below investment grade which are usually governed by New York law. Although US low grade US corporates were issuing bonds throughout the 20th Century, and before, so called Junk Bonds came to prominence during the takeover mania of the 1980s – a book and subsequent film about the takeover of RJR Nabisco Inc in the late 1980s (Barbarians at the Gates) gave such bonds and the leveraged finance model a degree of notoriety which hasn’t entirely gone away.
High yield bond issuers historically have had to issue high coupons to compensate for risk associated with these issuers[3], and investors are also provided with a package of customary covenants[4]. These covenants tend to be engaged when the issuer wishes to take certain actions where value is taken from the estate in some way– so called incurrence tests – which contrasts with bank debt where covenants always apply or apply on periodic basis – so called maintenance covenants. The usual HY covenants (which are often highly negotiated) are:
· Incurring additional debt
· Granting liens on assets
· Making certain investments
· Making Dividends, distributions and purchases of equity or junior debt (otherwise known as ‘restricted payments’)
· Selling assets.
· Entering into transactions with affiliates.
HY gives the borrower considerable flexibility but if it wishes to undertake certain transactions such as paying a dividend or taking on extra debt it may be constrained from doing so and may need to seek permission from the bondholders through a so-called consent solicitation. In the past few years the exceptions and various baskets negotiated have tended to be very debtor friendly and so in practice whilst the documentation is lengthy I would argue the comfort they might give is largely illusory.
It's likely that many issuers are simply going to find it hard to refinance their debt burden and that consent processes are not likely to be triggered by covenants but more because the total debt burden at market interest rates are not sustainable. Looming maturities are likely to be the driver of exchange and consent offers.
NY Law Bonds Versus English Law Bonds – Amendment Provisions
Trust deeds
Under an English law trust deed which typically govern Eurobonds, the issuer enters into covenants directly with the trustee. Accordingly individual bondholder action is constrained.
Indentures
An indenture is the US equivalent to a trust deed and Bondholders retain some albeit very limited rights against the issuer.
Modifications
Trust Deeds
The issuer will be able to modify the terms of the bonds, including the key terms relating to the maturity date of the bonds, the interest payable and the price at which the bonds can be redeemed or sold, if it obtains an extraordinary resolution often two-thirds or, in some cases, a three-quarters majority in value of those voting at the meeting. The trust deed will usually provide that a higher quorum applies to meetings to approve amendments to the bonds' payment or so called ‘money terms’. The size of the quorum tends to fall if the initial meeting is inquorate. The result is that unless there is organised opposition it is often the case that key terms can be changed having obtained the positive votes of a small number of bondholders. The flip side is that to block a consent dissenters will typically need to hold 25% of any issue.
These modification provisions are often called collective action clauses (or CACs).
Accordingly, a restructuring may be achieved without resorting to a court-based procedure such as a scheme of arrangement or insolvency measures.
Indentures
Indentures generally prevent bondholders taking action directly against the issuer unless the trustee unreasonably fails to act on their behalf or there is an outstanding payment due.
Trust Indenture Act 1939 (TIA)[5]
The TIA provides that certain mandatory provisions will be deemed to be part of the indenture. One mandatory provision is the need for unanimous bondholder consent to a change in the fundamental payment terms of the bonds. Whilst many European HY Bonds are not covered by the TIA, bonds are often drafted consistent with TIA provisions or require a very high threshold to implement a key ‘money terms’ amendment. The ‘Money term’ amendment clause in European High Yield often only permits changes with the consent of noteholders holding 90% or more of the notes making the obtaining of consent at challenging or impractical[6].
Commercial importance of the Voting Thresholds
Where bonds include CACs issuers are often able to push through substantial changes with a low threshold of consent but on occasion where bondholders actively object to a consent they may seek to form a so called ‘blocking group’ to reject any proposed changes. In Eurobonds this blocking group would typically be noteholders representing 25% of the principal amount of the bonds depending on the drafting. In these cases, the presence or absence of a CAC, and the applicable percentage required to achieve a modification can have a huge commercial impact. We saw this starkly for example in 2012 when the government of Greece sought to change the terms of its debt where several bondholders sought to adopt a hold out strategy for an exchange offer proposed by Greece. Bonds with the same pari passu ranking often traded at different prices depending on the absence or presence of a CAC.
Another interesting example (where I, for full disclosure, acted for the bondholders) occurred in 2011. Bank of Ireland bondholders were asked to consent to a highly aggressive exchange offer which had coercive features, which would have written off 80% of the Bond’s value. A group of subordinated holders bought a tranche of debt which included a CAC and rejected the offer. The BoI’s efforts to buy back this tranche on a discounted basis proved unsuccessful although other holders accepted the offer. [7] The Argentinian attempts to restructure its public debt and the fight back by Elliott Management became a long drawn out litigation.[8] In the Argentine example much of the debt was governed by NY law governed bonds which did not include CACs and so in effect under NY law unanimity was required to change the terms of the bond debt and Elliott had a strong hand to play in the US courts.
UK Case Law on Consent Requests
In summer 2012, two important judgments were handed down on cases relating to bond consent solicitations. Although the consent solicitation techniques proposed by the debtor companies in each case were markedly different, at issue in both cases was how companies, which are seeking to amend their bond terms, can lawfully incentivise their bondholders to vote in favour of proposed amendments to the relevant bonds.
On 22 April 2013 the Court of Appeal upheld the judgment of Hamblen J in Azevedo and Another v Importacao, Exportaacao E Industria De Oleos Ltda and others [2012] EWHC 1849 (Comm)[9]. The decision also confirmed that an appeal against the High Court’s judgment in the second consent solicitation case, Assenagon Asset Management S.A. v Irish Bank Resolution Corporation (formerly Anglo Irish Bank Corporation Ltd) [2012] EWHC 2090 (Ch), was not going to be pursued.
The High Court judgment in Assenagon therefore remains good law. In Azevedo, Hamblen J found that it is lawful for a company to offer the ‘carrot’ of an additional payment to bondholders who vote in favour of an amendment where that additional payment is not made to those that do not vote or vote against the proposal. The claimants’ arguments that (i) a class of noteholders must be treated on a pari passu basis; and (ii) consent payments made only to those Noteholders who vote in favour of an amendment should be characterised as an unlawful “bribe”, were each dismissed at first instance and on appeal to the Court of Appeal.
Bond Consent Solicitation Payments - Pari Passu Treatment
Lloyd LJ acknowledged that the requirement for pari passu treatment of all members of a class (in this case, the noteholders) is a basic principle of English insolvency law. However, given that the present case did not involve insolvency law, Lloyd LJ considered that the principle could only be invoked by reference to the terms of the relevant note documents. He noted that the underlying trust deed required that any moneys received by the Trustee be held on trust in payment of amounts owing in respect of the notes pari passu and rateably. However, on the facts, the terms of the consent solicitation were such that the funds required to make the consent payments were not at any stage held by the Trustee and so Lloyd LJ held that there was “no other valid basis … for the argument that the relevant funds had to be applied pari passu as between all the noteholders”.
Validity of Consent Payments
Lloyd LJ also considered the argument that the consent payments in question, which were only made to those noteholders who voted in favour of the resolution, were invalid under English law. However, after an analysis of the relevant authorities, Lloyd LJ confirmed that there was nothing which prevented the making of the consent payments to those that voted in favour of the amendments to the bonds: “I would hold that it is not inconsistent with English company law, or with the documents governing the Notes in the present case, for the Issuer to offer a consent payment to Noteholders who vote in favour of a resolution proposed for their consideration as a class, where the payment is available for all members of that class, and provided that the basis of the payment is made clear in the documents related to the resolution, the meeting and the vote, as was the case here.”
Assenagon
The consents sought by Anglo Irish Bank in 2009 and 2010 in connection with a number of distressed exchange offers, were successfully challenged in the High Court by Assenagon. These exchange offers differed from the Azevedo consent solicitations in that Anglo Irish Bank’s bondholders were invited to exchange their bonds for cash and/or new securities, and bondholders who accepted the exchange were required to vote in favour of a resolution which would have allowed Anglo Irish Bank to call the bonds of investors who did not participate in the exchange, for a nominal consideration. In Assenagon, Briggs J held that “this form of coercion is in my judgement entirely at variance with the purpose for which majorities in a class are given power to bind minorities” and added that “oppression of a minority is of the essence of exit consent of this kind, and it is precisely that at which the principles restraining the abusive exercise of powers to bind minorities are aimed”.
In contrast, the Noteholders in Azevedo were asked to consent to certain amendments to their bonds and the claimants’ case did not include any allegation of oppressiveness, unfairness or bad faith in relation to the consent solicitation. While the differences between Assenagon and Azevedo are acknowledged, it is a shame that the Court of Appeal was not able to hear the two cases side by side, as two key factors in Assenagon were also present in the amendment proposed by Imcopa, namely: (i) the offer was available to the entire class of bondholders; and (ii) the adverse treatment of those who did not accept the offer was transparent. In Assenagon, Briggs J reported that counsel for Anglo Irish Bank had argued there was no principled basis distinguishing Assenagon from Azevedo. The solicitations in each case had, however, markedly different economic effects: in Azevedo a non-consenting holder would lose the benefit of an inducement to vote in favour of the proposal, whilst in Assenagon the non-consenting holder stood to lose everything and hence the Anglo Irish Bank consent solicitation technique was considerably more coercive in nature.
Technical Differences
Apart from the key commercial differences between Assenagon and Azevedo, there were a number of technical differences. In particular, the exchange offer in the Assenagon case was structured such that Anglo Irish Bank acquired a specifically enforceable promise to acquire the relevant bonds before the vote. As a consequence, Anglo Irish Bank had a beneficial interest in those bonds. The trust deed which bound Anglo Irish Bank specifically prohibited the Bank from voting any bonds which it held for itself, and it was held that votes cast in respect of bonds which had been tendered for exchange were therefore invalid. This was sufficient for the judge to side with Assenagon.
Briggs J also distinguished the Assenagon case from the Azevedo case on the following grounds: (i) the resolutions to postpone the interest payments in Azevedo were the substance of that which the Issuer wished to achieve, whereas in Assenagon the substance of the Bank’s plan was to substitute new notes for existing notes; (ii) the Issuer in Azevedo proferred the inducement whereas in Assenagon it is the noteholders which wield the negative inducement (i.e. the call option resolution); (iii) the Azevedo proposal was “plainly capable of being beneficial to noteholders”. Mr Justice Briggs went on to explain “[in the Assenagon case] the Resolution was designed in substance to destroy rather than enhance the value of the notes and was, on its own of no conceivable benefit to the Noteholders”; and (iv) the claimants in Azevedo did not claim minority oppression but only bribery.
Given that any future exchange offer processes will no doubt be structured to avoid falling foul of any such voting restriction in bond documentation, of more likely relevance for future cases was Briggs J’s conclusion that the solicitation would have, in any case, failed owing to the actual and/or threatened oppression of the minority of bondholders who did not participate in the exchange.
Conclusion for English Case Law on Consents
A small inducement to vote in favour of consent solicitations or so called ‘early bird’ fees are relatively common practice in the UK capital markets and the Azevedo case, now confirmed by the Court of Appeal, may well be seen by market participants as nothing more than endorsing a practice which is fairly widespread. The Assenagon judgment showed there were limits to how much ‘stick’ an issuer could use in pursuing consent solicitations and we are unlikely to see an issuer try something similar.
Exit Consents – the US Practice
Typically, a bond issuer will issue a conditional offer to bondholders to exchange their bonds for new bonds or other types of securities or offer to buy the existing bonds back at a discounted price. The conditions might typically be: (a) the exchange offer is accepted by a majority of the bondholders; and (b) each tendering bondholder must give consent to a resolution which may release a group guarantee, strip off the protective covenants, or approve the issuer to transfer its substantial assets to another entity, thereby reducing or even destroying the value of the existing bonds. This is different to the Assenagon exit consent where the consent embedded a call option allowing the issuer to buy the bond for a de minimis payment. Regardless it is highly coercive approach which was supported by a series of US cases including Katz v Oak Industries Inc. (1986) 508 A 2d 873[10], which rejected a challenge to a exit consent. I am not aware of a challenge in the English courts to this form of exit consent.
In a case known as Marblegate[11] and in relation to Caesars[12] the market expectation that exit consents were lawful was thrown into disarray as the district court held that arrangements of an exit consent which stripped off restrictive covenants violated Section 316(b) of the TIA on the basis that such arrangements impaired the bondholders’ ‘practical right’ to receive payment, even though the bondholders’ legal rights were left formally intact[13].
In Marblegate the exit consent would have left dissenting bondholders with a claim against an empty shell company as the exit consent stripped the holder’s claim against a parent guarantor. A similar attempt to guarantee strip occurred in the Caesars case and the judge followed the Marblegate approach. In January 2017, the Second Circuit Court of Appeal issued a ruling in the Marblegate appeal overturning the District Court’s original decision[14][15]. Whilst there remains some uncertainty as to the exact scope of the TIA as regards exit consents (particularly as the judgement was not unanimous)in practice exit consents have been used extensively since the overturning of the Second Circuit Court of Appeal judgement.
Overall Summary
A wall of debt has been issued in a low interest rate environment and as this debt matures there will be a need to engage with bondholders as a considerable portion of the debt may not be sustainable at new interest rate levels. Some of this debt will need to go into a deep restructuring process involving Chapter 11 in the US, or UK equivalent procedures such as schemes or restructuring plans or possibly insolvency processes in EU member states. However these processes can be value destructive and costly often leaving the original shareholders with nothing. Expect directors and PE Houses who own Bond issuers to seek to launch a wave of exchange offers and consent requests with a ‘carrots and sticks’ to push bondholders to accept an offer in the coming years. Bondholders in return should start to get organised to make their views known in a coherent way otherwise they risk losing value and being picked off by well organised issuers. The modification and voting provisions and the case law will set the rules of the game for this process to take place.
M. +44 7811 113 895
T. +44(0)3330509715
For more information: FreiLibertas
About the author:
Stephen Phillips founded FreiLibertas Law, a SRA regulated law firm in 2022. Stephen qualified as a solicitor in 1997 with Linklaters, in London, and spent five years in Singapore advising on project finance and corporate distressed mandates during the Asian Currency Crisis. Having moved back to London in the early 2000s he advised bondholders during the High Yield telecoms and energy market turbulence often using UK schemes of arrangement to implement a restructuring. During the Global Financial Crisis, he assisted funds, banks and corporates mainly in respect of their exposure to stressed leveraged finance / private equity structures. Stephen also advised on bank restructurings, and structured finance vehicles such as SIVs and CMBS. In the past few years, his focus has been energy-related matters, hospitality, construction and retail-related stress. He has also had a great deal of experience advising technology-related companies in prepacked administration sales. Stephen frequently advises investment funds, particularly in relation to special situations and creditor rights. More recently he has helped a number of founder directors who have faced personal claims arising from difficulties in the businesses they have founded.
Stephen was a partner at White & Case, for 8 years and more recently headed the European Restructuring team at Orrick, Herrington & Sutcliffe. He established Freilibertas Law in 2022. Stephen has been described by the Legal 500 as being “commercial” and as having “a deep understanding of cross-border matters”. He has won a number of industry awards for deals executed during his career and he writes for leading restructuring journals and newspapers.
DISCLAIMER:
This presentation is given by Stephen Phillips for FreiLibertas Law Limited (both of whom are together referred to hereafter as “we”, “us” and “our”). It is not intended to provide tax, legal or investment advice. You should seek independent tax, legal and/or investment advice before acting on information obtained from this presentation. We shall not be liable for any mistakes, errors, inaccuracies or omissions in, or incompleteness of, any information contained in this presentation, nor for any delay in updating or omission to update the information as we have not undertaken to do so.
• We make no representations or warranties regarding the contents of and materials provided in this presentation and exclude all representations, conditions and warranties, express or implied arising by operation of law or otherwise, to the fullest extent permitted by law. We shall not be liable under any circumstances for any trading, investment, or other losses which may be incurred as a result of use of or reliance on information in this presentation. All such liability is excluded to the fullest extent permitted by law
• Any opinion expressed herein is a statement of our judgement at the date of presentation and is subject to change without notice
• Reproduction without prior written permission of Stephen Phillips of FreiLibertas Law Limited is prohibited
[1] As an example of the change in cost of capital Northumbrian Water is now paying 6.585% yield on its £400m 12 year bond in contrast to 2.375% paid on its 10 year bond issued in 2017.
[2] The History of the Eurobond Market | About Us | ICMA » ICMA (icmagroup.org)
[3] Although during the low interest rates period since the Lehman bankruptcy some market wags would refer to them as the ‘bonds formerly known as high yield’ – this joke can no longer be made in the current rising interest rate environment
[4] For a good primer on HY Covenant Packages see here - HYB-Milbank-digi.pdf
[5] Section 316(b) of the TIA provides that “[n]otwithstanding any other provision of the indenture to be qualified, the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security, on or after the respective due dates expressed in such indenture security, or to institute suit for the enforcement of any such payment on or after such respective dates, shall not be impaired or affected without the consent of such holder”
[6] For reasons obscure to this author Italian corporates which issue HY bonds have a lower threshold for consent for ‘Money term’ amendments – often 75% of the principal amount.
[7] US hedge funds threaten action on bond losses | Financial Times (ft.com)
[8] Recent Financial Restructuring Developments in the Region: Argentina - Lexology
[9] Azevedo & Anor v Imcopa Importacao, Exportacao E Industria De Oleos Ltd & Ors | [2014] 3 WLR 1124 | England and Wales Court of Appeal (Civil Division) | Judgment | Law | CaseMine
[10] Katz v. Oak Industries Inc., 508 A.2d 873 | Casetext Search + Citator
[11] Marblegate Asset Management v. Education Management Corp., 2014 WL 7399041, 75 F.Supp. 3d 592 (S.D.N.Y. 2014); Marblegate Asset Management v. Education Management Corp., 2015 WL 3867643 (S.D.N.Y. 2015)
[12] MeehanCombs Global Credit Opportunities Fund, LP v Caesars Entm’t Corp 80 F Supp 3d 507 (SDNY 2015) (Caesars I); BOKF, NA v Caesars Entertainment Corp 144 F Supp 3d 459 (SDNY 2015)
[13]For a good review of Exit Consents and a full discussion see Benjamin Liu, law lecturer at the University of Auckland here - Exit Consents in Debt Restructurings – Harvard Law School Bankruptcy Roundtable
[14] Marblegate Asset Mgmt, LLC v Educ Mgmt Fin Corp (15-2124-cv(L), 17 January 2017
[15] For a review of the Second District Court Appeal decision see - Out-Of-Court-Restructuring-After-Marblegate.pdf