Rallye Converts - Legal view

All,

We’ve received legal advice on the value of the conversion option embedded in the 2022 Rallye bonds.

In summary, the news is not as positive as we had hoped, but there appears to be some value nonetheless. Specifically:

- As per investment thesis, Sauvegarde does not have a legal ground for dealing with a conversion option. So there are two scenarios for “true” convertibles under French Law: 1) a Sauvegarde plan specifically addresses the option and is voted on favourably and 2) in a term out the plan may simply remain silent on the option, so as to strip the converts of it. Conversion of debt securities into equity amounts to repayment of the debt and precisely that is being termed out. So the expectation of exercising the conversion rights during the term-out period (immediately following exit from Sauvegarde) appears unrealistic.

- Moreover, the Rallye convertible bonds are not “true” convertible bonds under French law, but are rather “convertible-like debt securities”. Specifically, the bonds only give rise to a cash settlement in lieu of shares in Casino. Thus the bonds are more similar to classic bonds with some exotic side-language. There is no precedent for the treatment of these bonds, but odds are they will be considered debt securities.

- The most likely way of capitalising on the options is at initial filing of the proof of claim by the trustee, where amounts should include par + accrued for the bonds and a calculated option value for the embedded conversion rights. We understand that this has happened, but do not yet have the amount claimed. Converts should however be prepared for Rallye to dispute and try to reduce whatever claim has been filed. Also, of course, given the option was out-of-the-money at the time of filing, the value would not be nearly as great as it would if it gave rise to a conversion right following the end of Sauvegarde.

Below is the full email.

Wolfgang

_____________________

Wolfgang,

Please see below some additional thoughts from our Paris colleagues, on the converts treatment in a term out scenario.

The issue of the treatment of convertible bonds in a term out scenario remains largely uncertain as there are no precedents for this. We set out in (1) below our thoughts on the two tranches of convertible bonds issued by Rallye (the 2020 CB and the 2022 CB) and how these are relatively complex and “exotic” debt securities which are not exactly the same as French law convertible bonds and might accordingly not be governed by the few rules relating to convertibles in a safeguard process. The possible treatment of the 2020 CB and the 2022 CB in a term out scenario - which we have described separately in (2) below, is therefore uncertain.

1. Treatment of “true” Convertible bonds under French law

Convertible bonds are primarily debts of the debtor which are treated as such under safeguard and in a safeguard plan similarly to other prepetition debts. Indeed, safeguard generally does not distinguish between the various types of debt to be restructured. Only limited provisions and case law actually deal with the particular nature of convertible debt securities. The exact treatment of converts in a term out plan remains largely unclear and, to the best of our knowledge, largely unsettled either by case law or academic literature.

As a general principle, the repayment conditions of pre-petition convertible bonds (in cash) - which are debts – will be dealt with under the safeguard plan (and possibility termed out thereunder).
Additionally, specific provisions relating to convertible securities (article L. 228-106 of the Code de commerce) opens a statutory conversion period (i.e. notwithstanding the terms of the indenture) starting from the date of the judgement approving the safeguard plan. This statutory conversion right may be exercised at the discretion of each bondholder but only in accordance with the terms of the safeguard plan. These provisions are primarily designed to enable a debt-to-equity conversion which would assist in deleveraging the issuer (notwithstanding the terms of the indenture and the conversion criteria set out therein), if the plan provides for such conversion.

However, the application of these provisions raises uncertainty.
It is possible the safeguard plan simply does not provide for any particular provisions regarding the conversion of convertible bonds, in which case the statutory conversion right would not be exercised “in accordance with the safeguard plan”. In particular, in a term out scenario, the court only has the possibility to extend the maturity of the debt and there are no specific powers allowing the court to decide on specific provisions relating to the conversion of convertible bonds.

Accordingly, there is a good chance in practice that the term out plan is simply silent in respect of the exercise of conversion rights in which case it is arguable that the converts could be stripped of their conversion option. Conversion of debt securities into equity indeed amounts to a payment of the convertible bond and such payment needs to abide with the conditions set out in the plan. In other words, in our view, the conversion cannot enable bondholders to benefit from an early repayment (vs. the rescheduling imposed under the term out plan) and somehow “pass through” the safeguard plan by receiving equity rather than cash. Another approach might be to consider that the convertible securities could only be progressively converted into equity in accordance with the % set in the term out plan but which would be potentially only be of limited interest.

2. “Convertible-like” debt securities

Further uncertainty arises regarding Rallye’s convertible bonds, because these are not directly compatible with traditional convertible bonds. We understand that the optionality embedded in:

i. the 2022 CBs is purely contractual and only gives rise to a cash settlement (in an amount derived from the value of Casino’s shares) and not actual shares issued by Casino upon conversion of the bond. In this respect, the 2022 CBs would be similar to a classic bond (rather than a convertible bond) which provides for some contractual mechanism replicating the optionality of a convertible bond;

ii. the 2020 CBs can be cash settled or physically settled in exchange for shares in Casino. A thorough analysis of the bond documentation would be required to assess the nature of the 2020 CBs. Our current understanding is the 2020 CBs are not properly speaking convertible bonds (implying a share capital increase of Casino to issue new shares upon conversion of the bonds) but rather “exchangeable bonds” under which the bonds are paid either in cash or “in kind” with existing shares of Casino that Rallye already owns (or could acquire) and which were not issued for the purpose of (and linked to) the 2020 CBs. According to academic commentary, these type of bonds would not amount to real “exchangeable bonds” and should be considered as traditional bonds providing for some additional “exotic” contractual rights enabling a payment in kind (i.e. in shares in another company owned by the issuer).

To the best of our knowledge, such “exotic” debt securities and their treatment in a potential term out scenario have not been considered by the French Courts.

As a general principle, the statutory treatment of prepetition debts under a term out scenario relies on the rescheduling of the outstanding debts as at the date of the opening judgement. Outstanding debts are crystallized on such date subject to limited exceptions (e.g. accrual of interest if the tenor is more than 1 year). For instance, debts in a currency other than Euro are converted into Euro based on the exchange rate on the date of the opening judgement and the creditors would then lose their exposure to foreign currency exchange upside/downside.

Accordingly, unless the conversion trigger was met prior to the opening judgement only the amount of debt outstanding on such date is taken into consideration under safeguard. The creditor would accordingly lose its ability to potentially increase the amount of its prepetition debt given such optionality is not one of the statutory exemptions to the crystallization of the prepetition debt on the opening of proceedings (since this optionality is cash settled, only the amount of the claim would vary).

At this stage, our view is that the converts issued by Rallye could be treated as traditional bonds and simply termed out with only a cash repayment (in accordance with the repayment schedule of the safeguard plan).
From a practical standpoint, one route to attempt to hedge against such risk would be to increase the amount of the convertible bond debt in the proof of claim filed with the creditors representative so as to reflect not only the outstanding principal + interests but also the value of the embedded conversion option.
Indeed, the amount that a creditor can receive under a safeguard plan is limited to the amount specified in its proof of claim. The inclusion of a premium on the convertibles in the proof of claim could therefore provide some protection.

Our understanding is that the proof of claim filed by the bondholders’ representative in respect of each tranche of convertible bonds included in the same manner a total amount significantly beyond the amount of principal and accrued interest on the convertible bonds in order to reflect such optionality.

Such an approach may, however, result in lengthy discussions and disputes with Rallye and its advisors as part of the verification process of claims (especially given it would imply a prospective valuation of Casino’s shares) in an attempt to reduce the total amount of debts that would need to be taken into consideration and repaid in a term out scenario.

We’re of course happy to discuss the above over the phone if helpful.

Best regards, The Willkie Team