Executive Summary
A distressed disposal (Distressed Disposal) under an LMA-based intercreditor agreement1 (ICA) is a powerful restructuring tool. It has the potential to significantly de-lever a business for the benefit of the "in the money" class of lenders (which, for ease of terminology, we will refer to as the "Senior Lenders").
Yet, unlike similar tools (such as company voluntary arrangements (CVAs), schemes of arrangement and restructuring plans), it receives little press attention. This is for two reasons, each of which should make the process even more appealing for Senior Lenders. The first is that it is a contractual right, requiring no court involvement or recourse to statutory tools. The second is that, based on the limited case law on the process, it has rarely been challenged.
We would expect, however, that with the economic tide turning, the process may well be put to the test more regularly and produce a greater body of case law considering the issues.2
This article suggests some tips for best practices to facilitate a challenge-free process. For ease, the discussion assumes the following:
-
that the security package permits a single point of enforcement by way of an English share pledge in respect of an entity that holds the operating companies (which, together, we will refer to as the "
- that value breaks in the Senior Lenders' debt.
- Diligence: lawyers will need to be engaged to review the transaction documents as well as the
Target Group's key commercial contracts; - Valuation: a specialist accountant will need to be engaged to advise on the value of the
Target Group and inform where value breaks; and - Planning an Accelerated Merger and Acquisition: if the circumstances dictate, the
Instructing Group will need to facilitate an accelerated marketing process. - negotiate any incremental powers and protections (such as additional indemnities, cash cover for a fighting fund and additional contractual protections).
- conducting a competitive sales process;
- obtaining a court order; or
- conducting the process at the direction of an administrator, liquidator, receiver or administrative receiver.
- sufficient time for interested parties to consider the opportunity and conduct diligence; and
- a management team on hand to provide assistance (i.e., prepare an information memorandum and answer questions).
- In the context of the common law duty of mortgagees, the case law should be persuasive, since the ICA drafting has borrowed from it. A mortgagee is permitted a margin of error when assessing market value, and it has been held that it will only be liable if the conduct is "plainly on the wrong side of the line." Further, it has been held that, where commercial parties have negotiated, in complex documents, the duties that the security agent owes to lenders on enforcement, the court will give effect to the parties' intentions (and not impose more onerous duties) in delineating the scope of the trustee's duties.8
- In the context of appropriation of financial collateral under the Financial Collateral Arrangements (No. 2) Regulations 2003 (FCAR), the
UK High Court has held that the collateral taker's obligation is limited to complying with the FCAR in establishing that the method of valuation is reasonable.9
ICAs and Distressed Disposals - A Brief Introduction
For those unfamiliar with Distressed Disposals and ICAs, below is a brief introduction.
Deleveraging Tool: At its heart, a Distressed Disposal is a deleveraging tool. Senior Lenders may invoke it following an enforcement event to effect a transfer of the
Other creditors of the seller entity (including the mezzanine lenders and intra-group lenders (which, together, we will refer to as the "
Parties to an ICA: An ICA governs the relationship amongst the various classes of principal financial creditors to a corporate group (e.g., the Senior Lenders and
The Senior Lenders and
Instructing Group: A so-called "Instructing Group" (being the majority Senior Lenders while senior indebtedness is outstanding) has the right to instruct the security agent to protect and enforce its rights once an enforcement event occurs. The Junior Lenders are prohibited for the duration from exercising contractual or enforcement rights.3
It is worth noting the obvious: since the ICA is binding only on those creditor classes that have agreed to it, a Distressed Disposal only affects the rights of those creditor classes. Thus, if a broader balance sheet restructuring is required (e.g., lessors, employees, pension deficits or trade creditors), then a CVA, scheme or restructuring plan will be necessary, either in the alternative or in coordination with the Distressed Disposal.
Tips for a Smooth Execution
Distressed Disposals require planning. This is not welcome news when, invariably, the circumstances giving rise to a right to exercise a Distressed Disposal mean that the time period available to avoid an insolvency filing is short. This is particularly so with the prevalence of "cov-lite" financings, where the enforcement event being relied on may be a payment default, as opposed to an early warning breach of financial covenant.
Nevertheless, at a minimum, the following matters will need to be attended to:
-
Security Agent: the incumbent security agent should be replaced with a specialist;
Each of these is discussed briefly below.
Appoint a Successor Security Agent
The security agent is the lynchpin in the process. Its role in executing the transfer of the
For this reason, it is advisable to resign the incumbent security agent and appoint a successor who is a specialist with experience in enforcement and restructuring processes. This should be done as soon as possible because the security agent will need time to do the following:
-
engage its own counsel and review the documentation to understand the steps required to execute on the
Diligence
A full diligence on the
Valuation
The ICA requires, at a minimum, the security agent to take reasonable care to obtain fair value on a Distressed Disposal. Whilst there might be evidence as to the price at which the debt of the Senior Lenders and
The ICA is not prescriptive as to the steps that the security agent is required to take to "obtain fair value", though the following are typical:
-
procuring a fairness opinion and/or valuation opinion provided by a duly qualified financial advisor;
If circumstances permit the luxury of a court order or an officer appointment, the security agent's role will be simplified. However, in most circumstances, there will not be such an option. Below, we consider some issues arising in relation to fairness opinions and competitive sales processes, and look at some English law principles on valuation.
Fairness Opinions: The ICA provides that a fairness opinion should provide that the proceeds received or recovered in connection with the Distressed Disposal are "fair from a financial point of view taking into account all relevant circumstances."
An important point of reference is likely to be the recovery on the counter-factual, which may be a sale in administration or an asset break-up on an accelerated basis, so the valuation may need to consider that scenario. A financial advisor engaged to provide its opinion may or may not require some market testing. In appropriate circumstances, it may rely on desktop valuations.4
Competitive Sales Process: Undertaking an accelerated marketing process may be an alternative option. To stand up to scrutiny, the process should, to the extent practicable, include the following:
-
a sensible universe of parties to invite to bid (preferably including industry specialists);
Non-cash consideration (if permitted by the ICA) should be subject to valuation by a financial advisor. Although there is no statutory basis in English law for credit bidding, it is routinely done, and Senior Lenders are likely to provide consideration in the form of their senior debt.5 Recent case law has also permitted unsecured creditors to credit bid their unsecured claim.6
English Case Law on Valuation: Although the case law specifically on Distressed Disposals is limited, there is case law on valuation in other contexts:
-
In the context of restructuring plans, the
Conclusion
With the era of cheap credit apparently at an end, it is expected that lenders will be looking for avenues to preserve value. Distressed Disposals under an ICA should be included in the mix of options available. It is a powerful tool, but early preparation is required.
Footnotes
1. The English law
2.The Distressed Disposal provisions were first introduced in the ICA in 2012. It is likely to be utilised more in the coming era of high interest rates than in the benign economic era since 2012.
3. This is in contrast to a typical US-style ICA, where the right to instruct enforcement lies with the Junior Lenders. The US philosophy is that the Junior Lenders, who suffer the "first loss," have the greatest motivation to maximise recovery, whereas the Senior Lenders are motivated only to protect their own investment.
4.
5. The costs and expenses of the security agent and other service providers to the transaction will, however, need to be paid in cash.
6. Re
7. Re
8.
9.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Old Jewry
EC2R 8AE
Tel: 3125778469
Fax: 3125774678
E-mail: brook.radford@katten.com
URL: www.kattenlaw.com
© Mondaq Ltd, 2023 - Tel. +44 (0)20 8544 8300 - http://www.mondaq.com, source