High yield bond issues

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					High yield bond

Raising the stakes

                                                                                                                                               PLC December 2003
                                                                                                                  Illustration: Getty Images

Andrew Wilkinson
and Andrew Lucas of

Wickersham & Taft
LLP look at European
high yield bond
structures and
consider recent trends.

The European high yield bond (see Glos-
sary) market experienced rapid growth
in the mid-1990s. This growth has, how-
ever, been followed by a significant num-
ber of bond defaults, perhaps most no-
tably in the telecommunications, media
and technology sectors. The promi-
nence of high yield bonds in the debt pro-
file of many defaulting companies and
the increased representation of bond-
holder groups through organised steer-
ing committees has resulted in the hold-
ers of high yield bonds playing an impor-
tant part in the negotiation of a number
of recent high-profile European restruc-     Inevitably, as the European high yield      bondholders with enhanced features
turings (see News brief “Negotiating         market has matured, lessons have been       such as guarantees from the issuer’s sub-
with bondholders: The changing face          learned by both issuers and investors. As   sidiaries and, in some cases, security over
of restructurings”, www.practicallaw.        a result, the “traditional” European high   the issuer’s assets (see box “A new ap-
com/A28649).                                 yield bond model is evolving, providing     proach?).                                             15
                       This article will examine:

                                                                        Capital structure
                       • The key features of European high
                         yield bonds.                                   The capital structure of a company or group that is the subject of a restructuring will
                                                                        typically include some or all of the following elements:
                       • Some ways in which restructurings of
                         European companies involving high              • Senior debt. Often referred to as senior credit facilities, senior debt comprises
                         yield bonds have recently been imple-             loans made available by one or more banks that will usually rank in priority of repay-
                         mented.                                           ment before other types of debt on any liquidation of the debtor company (see
                                                                           “Subordination” in the main text). The senior banks will usually take the benefit of
                       • The influence of the US Chapter 11 re-            first ranking security over the assets of the debtor company and its group. Senior
                         structuring model and recent Euro-                debt is typically structured in two tranches: a term loan facility, with a fixed
PLC December 2003

                         pean insolvency law reform on these               amount, specified rate of interest and fixed repayment schedule; and a revolving
                         restructuring mechanisms.                         credit facility, with a fixed maximum amount, to be used for the ongoing working
                                                                           capital purposes of the debtor company and its group.
                       EUROPEAN HIGH YIELD BONDS
                       High yield bond issues have been used in         • Mezzanine debt. Mezzanine debt generally comprises a term loan on substantially
                       Europe for two main purposes:                       similar terms to the senior debt with the necessary amendments to reflect that the

                                                                           mezzanine debt will rank in right of repayment at all times behind the senior debt
                       • To complement the senior debt and                 but before equity and trade creditors. Mezzanine debt will often have a second
                         mezzanine debt financing of larger                ranking interest in the security package taken out in respect of the senior debt. In
                         European leveraged buyouts (LBOs)                 addition, there will be a higher rate of return on mezzanine debt than senior debt
                         where the level of the acquiring com-             which will be made up of a higher rate of interest than on the senior debt and an
                         pany’s indebtedness makes its junior              “equity kicker”, namely, warrants issued by the debtor company (a type of security
                         debt “speculative” (see box “Capital              that allows the holder to subscribe for shares in the issuing company at a specified
                         structure”).                                      date or period in the future and at a specified price).

                       • To provide start-up capital for the            • High yield debt. This is debt that is rated as sub-investment grade by the credit rat-
                         growth of businesses which do not                 ing agencies. High yield bonds (see Glossary) are either bonds that were initially is-
                         have the financial stability, earnings            sued as high yield or bonds that were initially issued as investment grade but have
                         and sales track record or assets neces-           been subsequently downgraded (the latter often referred to as “fallen angels”).
                         sary to issue investment grade bonds              The claims of high yield bondholders will rank behind those of the holders of the se-
                         or raise significant amounts of bank              nior debt and mezzanine debt. Typically, the holders of bonds will include individ-
                         debt.                                             ual investors, mutual funds, insurance companies, pension funds and investment
                                                                           managers. In the context of high yield bond restructurings, bondholders that are
                       Pros and cons of high yield bonds                   the original subscribers to a bond issue are referred to as the “par investors” and
                       For an issuer, high yield bond issuance             those that have purchased the bonds in the secondary market (often at a price sub-
                       has certain advantages over other meth-             stantially below the par value of the bond) are referred to as the “distressed debt”
                       ods of debt financing (see box “Capital             investors.
                       structure”) including relatively long ma-
                       turity periods (terms of between eight           • Shareholder equity. There are two principal types of shareholder equity: ordinary
                       and 12 years are common) and flexible               shares, which represent ownership in a company; and preference shares, which en-
                       warranty and covenant provisions (and,              joy preferential rights over other shares in the company such as the right to repay-
                       often, the absence of the financial                 ment on a liquidation or the right to receive dividends.
                       covenants found in senior debt docu-
                       ments) (see box “Key features”). There           • Trade creditors. A broad range of creditors of the company will fall within this cate-
                       are also certain advantages over equity             gory including the various suppliers of goods and services to the company and its
                       financing including, in particular, the             group.
                       fact that the issue of high yield bonds will
                       not in itself have a dilutive effect on the
                       issuer’s existing shareholders.                higher initial transaction costs of a high       Regulatory considerations
                                                                      yield bond issuance (due, in large part, to      A UK issuer may need to consider the fol-
                       The principal disadvantages of high            the need for the issuer to make detailed         lowing:
                       yield bond debt for an issuer include a        disclosure in the offer documents to give
                       typically higher interest expense than on      investors the ability to fully assess the in-    US. Many European high yield bond is-
                       other forms of debt financing (including       vestment in light of the increased credit        sues have been offered in the US as well
   16                  senior and mezzanine debt) and the             risk they are being asked to assume).            as in Europe principally to take advan-
tage of a large US investor base familiar                                                     represents the bondholders and owes

                                              KEY ISSUES
with high yield bonds. These issues have      The following issues are frequently en-         various fiduciary duties to them. The
not, for the most part, been registered       countered when advising on European             1939 Act, which, in broad terms, is ap-
initially with the US Securities and Ex-      high yield bond offerings:                      plicable to all non-sovereign bond issues
change Commission (SEC) but have                                                              offered to the public in the US and regis-
been made using the exemptions from           Indentures vs trust deeds                       tered under the 1933 Act, imposes cer-
the application of US securities reg-                  European high yield bond issues        tain powers and duties on the trustee and
ulations in Regulation S                                  that attract, or are intended to    states that certain provisions are deemed
and Rule 144A of the US                                     attract, significant US in-       to be part of the indenture.
Securities Act of 1933                                         vestor interest are usu-
(1933 Act) (see box                                              ally issued under a US-      Two principal areas of difference be-
“Key features”).                                                    style indenture be-       tween trust deeds and indentures relate

                                                                                                                                           PLC December 2003
                                                                     tween the issuer and     to:
An issuer offering                                                 the bond trustee
high yield bonds into                                             (who acts on behalf of      Modification of the trust deed or inden-
the US will also need to                                        the bondholders). If the      ture. Under a trust deed, modification is
consider certain issues in                                    intended investors are          usually dealt with in the section on bond-
relation to the US Trust In-                                predominantly English or          holder meetings and resolutions. A trust

denture Act of 1939 (1939                                  European, then an English          deed will typically provide that payment
Act). Although the 1939 Act will              law trust deed will be used. This choice is     terms (including the maturity date of the
not apply to an initial offering of high      significant, as certain standard provi-         bonds, the coupon payable on the bonds
yield bonds under Rule 144A and/or            sions of an English law trust deed (such        and the price at which the bonds can be
Regulation S, it will apply if and when a     as the ability to vary economic terms of        redeemed or sold) can be amended so as
subsequent SEC-registered exchange of-        the bonds with less than unanimous              to bind all bondholders by an extraordi-
fer has been made (see box “Key fea-          bondholder approval) would conflict             nary resolution of a two-thirds or
tures”). In particular, section 318(c) of     with mandatory provisions of the 1939           three-quarters majority in value of those
the 1939 Act provides that certain            Act. It is therefore common for Euro-           voting at the meeting which has a (usu-
mandatory provisions will be deemed to        pean issuers to establish multiple bond         ally enhanced) quorum present and
be part of an indenture whether or not        tranches with dollar denominated bonds          which has been otherwise properly con-
expressly set out in the indenture (see       sold into the US under a 1939 Act inden-        vened.
“Indentures vs trust deeds” below).           ture and sterling or euro denominated
                                              bonds sold outside the US under                                  Any modification to
UK. Relevant English law considera-           an English law trust deed.                                          the     fundamental
tions for a UK issuer include the applica-                                                                         payment terms of
tion of the financial assistance regime in    Under a trust deed, the                                              an indenture must
sections 151 to 158 of the Companies Act      bond issuer enters into                                               be approved by
1985 (1985 Act) if high yield debt is being   covenants directly with                                               each bondholder
issued in an LBO transaction (and where       the trustee, the most im-                                              to be bound by
guarantees are being given by the rele-       portant       being      the                                           the modification
vant target company and/or the target         covenant to repay princi-                                              and cannot be im-
group operating companies in respect of       pal and interest on the                                            posed by a majority
the high yield bonds). A UK issuer would      bonds (see box “Key                                          (section 316(b), 1939 Act).
also seek to ensure that the bonds are        features”). The trustee holds the bene-                 Other non-payment terms (for
listed on a recognised investment ex-         fit of these covenants on trust for the            example, authorisation for the in-
change (RIE) to take advantage of the         bondholders. The trustee will usually be        denture trustee to waive a default under
“quoted eurobond” UK withholding tax          a corporate entity (for example, The            the indenture or to enter into a supple-
exemption (section 349(3)(c), Income          Law Debenture Corporation p.l.c.) ap-           mental indenture on terms permitted by
and Corporation Taxes Act 1988). For          pointed by the bond issuer to represent         the indenture) can often be amended,
this reason, UK issuers that are either       the bondholders’ interests on the terms         however, by an absolute majority vote.
newly incorporated companies or un-           set out in the trust deed. In carrying out      Unlike trust deeds, indentures rarely
able to obtain the requisite guarantees       its duties, the trustee will need to have re-   provide for meetings of bondholders.
for a listing of the bonds on the London      gard not just to the relevant trust deed        Amendments or waivers are instead
Stock Exchange have commonly sought           but also to the Trustee Act 2000.               typically made by written consent (so
to list the bonds on the Luxembourg                                                           that all votes in effect require an ab-
Stock Exchange which, despite its rela-       Although usually governed by New                solute majority), and are then made
tively less stringent listing requirements,   York law, indentures are structured in a        binding by an amending supplemental
is an RIE.                                    similar way to a trust deed. The trustee        indenture.                                   17
                                                                                                                       often call for the consent of “creditors” or

                         Key features                                                                                  “holders” (see “European restructuring
                                                                                                                       models” below). On a strict legal inter-
                         • Rule 144A. Rule 144A of the US Securities Act of 1933 (1933 Act) will exempt of-            pretation in each case this may be consid-
                            fers and sales of qualifying securities by persons (other than the issuer) to “quali-      ered to apply to a holder of the global
                            fied institutional buyers” from the registration requirements of the 1933 Act.             note, a trustee or somebody else in a di-
                            Many European high yield bond (see Glossary) issues have initially been offered in         rect contractual relationship with the is-
                            the US using the Rule 144A exemption. These Rule 144A offers have usually been             suer, to the exclusion of the beneficial
                            followed by a US Securities and Exchange Commission (SEC) registered exchange              holders. However, in the US, particularly
                            offer (commonly referred to as an “AB exchange offer” or an “Exxon Capital ex-             in the Bankruptcy Court, courts follow-
                            change offer”) under which the issuer will offer to exchange the existing (non SEC-        ing the US Bankruptcy Code have taken a
                            registered) Rule 144A bonds for substantially similar SEC-registered bonds that            practical view of the relevant relation-
PLC December 2003

                            are freely transferable by holders. In this way, the Rule 144A exemption provides          ships, effectively allowing direct partici-
                            issuers with the ability to issue high yield bonds to US investors (and receive the        pation in proceedings by beneficial hold-
                            proceeds of the issue) without having to go through an often lengthy SEC clearance         ers who are not necessarily in a direct
                            process in advance of the initial issue.                                                   contractual relationship with the issuer.

                         • Covenants. High yield bonds have a “standard” covenant package intended to                  In many European proceedings, how-

                            maintain the credit quality of the issuer and its group and the unencumbered move-         ever, the courts have not fully adopted
                            ment of cash up the issuer’s group and ensure that the issuer deals on an arm’s            this practice. For example, in the UK, a
                            length basis with its group companies. The covenants will include limitations on           number of high yield bond restructurings
                            the ability of the issuer and other group companies from incurring further indebted-       have been implemented through a
                            ness, making certain “restricted payments” (such as dividends and other distribu-          scheme of arrangement under section 425
                            tions to shareholders, intra-group loan repayments and investments) and asset              of the 1985 Act (section 425 scheme) (see
                            transfers, granting liens over its property and assets and entering into non-arm’s         “Equitisation” below). Under a section
                            length transactions with group companies. The exact form of the covenants will             425 scheme, only a creditor of a company
                            vary from issue to issue and specific exemptions to these limitations will also be in-     is entitled to vote at a creditor’s scheme
                            cluded.                                                                                    meeting. There have been different opin-
                                                                                                                       ions expressed as to who in a bond struc-
                         • Financial statements. The financial statements included in high yield bond offer            ture is a “creditor” for this purpose. The
                            documents are often extensive. The statements will reflect the issuer’s current fi-        legal creditor is arguably only the regis-
                            nancial position and the results of operations in recent periods.                          tered holder of the global note, rather
                                                                                                                       than the numerous ultimate beneficial
                         • Events of default. High yield bond documents will include a series of issuer events         holders. For this reason, the approach
                            of default including any default in the payment of principal or interest (usually fol-     that is increasingly being taken is to
                            lowing a specified grace period), any breach of covenant and the instigation of in-        “split” the global note before the scheme
                            solvency or other related proceedings against the issuer or the group.                     meeting and issue individual bondhold-
                                                                                                                       ers with definitive notes, entitling them
                         • Risk factors. High yield bond documents will include a series of “risk factors”             to vote individually at the scheme meet-
                            which are intended to disclose particular areas of risk to investors. The precise na-      ing (for an example of this in practice, see
                            ture of the risk factors will vary from issue to issue but usually include risks associ-   feature article “Marconi restructuring: A
                            ated with the leverage of the issuer and its group; the ongoing ability of the issuer to   blueprint for the future?”, www.practi-
                            service its debt; the relationship of the high yield debt to the issuer’s other debt and   callaw.com/A32774).
                            the general operating and other risks associated with the issuer’s business.
                                                                                                                       The way in which high yield debt is sub-
                       Relationship between issuers and hold-           holder of a global note. Ultimate benefi-      ordinated to bank and other senior debt
                       ers. Under both trust deeds and inden-           cial holders of the bonds will, in effect,     in the traditional European high yield
                       tures, the binding relationship exists be-       own participations in that single global       bond model differs in certain respects
                       tween the issuer and the trustee for the         note. Generally, an indenture will limit       from the way high yield debt is subordi-
                       benefit of the bondholders. There may            the rights of a beneficial holder against      nated in the US high yield bond model.
                       well be specific exceptions to this general      the issuer and this limitation would be
                       principle, which will be expressly set out       interpreted as a matter of contract in a       US position. In the US model, the main
                       in the trust deed or indenture. Modern           similar way in both UK and US courts.          group holding company (Holdco) will
                       book-entry transfer systems, such as                                                            typically issue the high yield bonds and
                       DTC, Euroclear and Cedel, have led to            In a restructuring context, amendments         the group’s main operating companies
   18                  there often being just one registered            to the terms of trust deeds and indentures     (Opcos) will be the borrowers under the
senior credit facility (see box “US high

yield bond model”). In some cases,               US high yield bond model
Holdco will also be a borrower under the
senior credit facility. The Opcos will give
a financial support package to the senior               Main group
                                                     holding company                                                 Bondholders
lenders, which will usually include secu-                (Holdco)
rity over the assets of the Opcos and guar-
antees from the Opcos. However, al-
though bondholders will commonly be
given guarantees from the Opcos with re-
spect to the high yield debt, they will
rarely be granted security over the assets              Operating

                                                                                                                                          PLC December 2003
of the Opcos (like the senior creditors).               companies                                                   Senior lenders
                                                         (Opcos)            Support package including
                                                                             guarantees and security
European position. In the European
model, the high yield bonds will typically
be issued by a financing vehicle (often in-
corporated for the sole purpose of issu-          payment blockage notice on the issuer      Standstill provisions

ing the high yield debt) and Holdco               and for so long as the default remains     Where there is an event of default under a
and/or the Opcos will be borrowers un-            unremedied.                                high yield bond indenture or trust deed,
der the senior credit facility (see box “Eu-                                                 standstill provisions are intended to pre-
ropean high yield bond model”). The            In the US high yield bond model, the pay-     vent bondholders from pursuing guaran-
proceeds from the high yield debt issue        ment blockage provisions are usually          tee claims (and, where relevant, from en-
will either be loaned to Holdco or con-        found in the indenture together with the      forcing their security) and to prevent the
tributed as equity. As in the US model,        express subordination provisions in           issuer from pursuing any inter-company
the Opcos will give a financial support        favour of the senior lenders. In the Euro-    claims, in each case for an agreed period
package (including security and guaran-        pean high yield bond model, these provi-      of time, usually 120 to 180 days. Where a
tees) to the senior lenders and any mezza-     sions are normally found in the               guarantee is provided to bondholders,
nine lenders. In recent years, it has be-      intra-group loan documents between the        the standstill is effected by providing in
come increasingly common for bond-             issuer and Holdco and, where Holdco           the guarantee that it does not become
holders to be given guarantees from            has provided a subordinated guarantee         payable until 120 to 180 days (as the case
Holdco with respect to the high yield          to bondholders, in the Holdco guarantee       may be) after the bonds become due for
debt, although these guarantees are no-        and in the indenture or trust deed.           payment.
tably absent from earlier European high
yield bond issues. In some recent issues,
bondholders have also been given secu-
rity over the issuer’s assets.
                                                 European high yield bond model

The “contractual” subordination of                       High yield                                 Bondholders
high yield debt to senior debt is further               bond issuer
achieved by the inclusion of “payment
blockage” and “standstill” provisions in
the relevant documents (see below).                               Intra-group loan

Payment blockage provisions
A payment blockage provision will pre-                                                             Senior lenders
                                                         Main group
vent the issuer from making payments to               holding company
bondholders:                                              (Holdco)                               Mezzanine lenders

• On any payment default under the se-
  nior credit facility, until the default is

• On any non-payment default under                       Operating           Support package including guarantees and security
  the senior credit facility, for a period                (Opcos)
  of 179 days from the date on which
  the senior lender serves the relevant                                                                                                   19
                       Although common in European high              Equitisation                                  ing convened with the leave of the court.

                       yield bond structures, standstill provi-      There are many recent examples of Eu-         If the court then sanctions the scheme, it
                       sions are rarely seen in US high yield        ropean companies using an equitisation        will become effective and binding on all
                       bond structures as they are not consid-       (also known as a debt-for-equity swap)        creditors of the relevant class that had
                       ered legally enforceable. This is because     as the principal means of implementing        voted in favour of the scheme.
                       there is a widely held view that bond-        a restructuring involving high yield
                       holders cannot contract out of the re-        bonds (for further information, see fea-      Section 425 schemes to effect an equitisa-
                       quirements of section 316(b) of the 1939      ture article “Debt equity swaps: A grow-      tion involving bondholders have typi-
                       Act. This section provides for the right of   ing trend”, www.practicallaw.com/             cally been accompanied by an ancillary
                       bondholders to take individual action to      A26041). An equitisation takes place              proceeding under section 304 of the
                       obtain recovery following any payment         where bondholders (and possi-                               US Bankruptcy Code to en-
                       default by the issuer under the bonds.        bly other creditors) ex-                                        sure that the adopted
PLC December 2003

                                                                     change bonds (or                                                 scheme is recognised
                       EUROPEAN RESTRUCTURING                        other debt, as the case                                           in the US and not
                       MODELS                                        may be) and any other                                              re-adjudicated.
                       Before the development of the European        claims they have
                       high yield market, the Bank of England        against the issuer for                                              In addition, the
                       developed a set of principles to govern       new shares of the issuer.                                           successful imple-

                       the way in which a company’s banks and        Equitisations have also                                             mentation of an eq-
                       other creditors should react to a situa-      included the payment of                                          uitisation by a section
                       tion where a company was facing serious       cash or the issue of a new                                  425 scheme will usually re-
                       liquidity problems (the London Ap-            debt instrument (such as a con-                        quire the consent of existing
                       proach). These principles were devel-         vertible bond or warrant instrument) or           shareholders to the issue of the new
                       oped on the basis that a debt restructur-     a combination of these.                       shares and any other securities to bond-
                       ing outside the statutory insolvency                                                        holders (and any other creditors) and a
                       regime would benefit all interested par-      The percentage of the post-restructuring      waiver of their rights of pre-emption
                       ties and, in particular, would offer credi-   share capital (and the amount of any          with respect to the issue of such securi-
                       tors higher returns (for further informa-     cash or nature of any debt instrument)        ties.
                       tion, see feature article “Corporate debt     that bondholders will be entitled to re-
                       restructuring: Preliminary issues”.           ceive following a successful restructur-      Trust deed. Where bonds have been con-
                       www.practicallaw.com/A22493).                           ing will depend on the particu-     stituted by an English law trust deed, it
                                                                                 lar circumstances but will be     may be possible to effect an equitisation
                       Although the London Ap-                                     influenced by such factors      of the bonds by using provisions in the
                       proach continues to be ap-                                     as the level and nature of   trust deed itself rather than a section 425
                       plicable to debt restruc-                                         the company’s finan-      scheme. Trust deeds will often allow for
                       turing involving UK do-                                             cial distress and the   the passing of a bondholder resolution
                       mestic bank debt only,                                                need to involve       (binding on all bondholders) by a two-
                       it has not provided a                                                existing      share-   thirds or three-quarters majority. The
                       suitable framework                                                  holders in the re-      terms of the resolutions put to bond-
                       for implementing re-                                              structuring approval      holders could include, for example, the
                       structurings     involving                                      process.                    issue of shares in the issuing company to
                       bond debt as well as bank                                                                   bondholders in exchange for their exist-
                       debt. This is mainly because a                               Section 425 scheme. In the     ing bonds. This method has potential
                       bond issue is typically held by a               UK, it has become common for an eq-         cost and timing advantages over a sec-
                       large, varied and international group of      uitisation involving high yield bonds to      tion 425 scheme court process. In con-
                       investors making it difficult, and often      be implemented by way of a section 425        trast, a US style indenture governed by
                       impossible, to obtain the unanimous           scheme. A section 425 scheme is a com-        the 1939 Act would require the consent
                       creditor approval that is required for a      promise or other arrangement between a        of all the relevant bondholders to effect
                       London Approach restructuring.                company and its creditors (which will in-     such an equitisation (see “Indentures vs
                                                                     clude bondholders) (see, for example,         trust deeds” above).
                       Consequently, alternative mechanisms          feature article “Marconi restructuring:
                       have been developed over the last few         A blueprint for the future?”, www.prac-       Market bond buybacks
                       years to restructure European compa-          ticallaw.com/A32774). The scheme will         In a market bond buyback programme,
                       nies with high yield bond debt in finan-      be approved if a majority in number rep-      the issuer (or an affiliated company) will
                       cial difficulties, many of which are based    resenting 75% in value of such creditors,     repurchase all or a portion of its out-
                       on US restructuring models and use US         present and voting in person or by proxy,     standing bonds in one or more open mar-
   20                  legal processes.                              vote in favour of the scheme at the meet-     ket transactions, often over an extended
period of time. Bond buybacks will be

particularly attractive where bonds are         A new approach?
trading at distressed levels, that is, at a
(usually significant) discount to their         At the end of 2002, a letter was sent by ten UK investment funds to their stakeholders
face value.                                     calling for changes to the structure of the existing European high yield debt model.
                                                The particular concerns raised by these institutions were:
The ability of a company to effect a bond
repurchase will depend on its having the        • The need for high yield bonds (see Glossary) to have a security package that was
necessary cash resources, or, at least, the        broadly similar to that for mezzanine debt (see box “Capital structure”).
ability to obtain better financing to fund
the programme. In the context of a possi-       • The position of the issuer in the capital structure and the level of seniority of the
ble restructuring, a company will be seek-         subordinated high yield bond (see “Subordination”, in the main text).

                                                                                                                                           PLC December 2003
ing to reduce its gearing ratios suffi-
ciently through repurchase to avoid the         • The inclusion of covenants in high yield bond documents to protect against certain
                                                   perceived “abuses” such as the payment of dividends to equity when the issuer is
need to implement a full restructuring. In
                                                   close to insolvency.
addition to any interest payment savings
that a company may make following a
                                                • The establishment of reporting standards for issuers of European high yield bonds
bond buyback, a company may also be
                                                   that are at least equal to the reporting standards for US Rule 144A offers (for exam-

able to recoup a proportionate amount of
                                                   ple, quarterly reporting) (see “Regulatory issues” in the main text).
any sums held in escrow in respect of
these bonds pursuant to the terms of the
                                                This letter has been followed by a paper delivered in early October 2003 by 26 UK in-
bond indenture or trust deed.
                                                vestment funds stating that an industry working group has been established to “con-
                                                sider ways of promoting better standards in the European credit markets” (“Improving
However, market repurchases of high
                                                market standards in the Sterling and Euro Fixed Income Credit Markets”). The paper
yield bonds by distressed companies are
                                                considers that a perceived lack of pan-European regulation in the European credit
usually only an interim measure until a
                                                markets has led to “poor market practices” in relation to bond issues, including the
full restructuring is implemented.
                                                lack of availability of relevant documents to make informed investment decisions and
                                                of adequate protections in high yield bond indentures and trust deeds for bondhold-
In any event, a company intending to ef-
                                                ers. The paper recommends, among other things, the inclusion of certain key
fect a market repurchase of its bonds
                                                covenants in the bond instruments of investment grade bond issuers and that disclo-
should take the necessary precautions to
                                                sure and document standards generally should be improved to allow investors to make
ensure that the repurchase does not in it-
                                                more informed investment decisions.
self or in conjunction with any other re-
purchase constitute a “tender offer”
                                                This drive for change in the European bond market has been illustrated in recent prac-
obliging the issuer to comply with US se-
                                                tice. In the LBO of Legrand SA, for example, before the refinancing of a bridging loan
curities laws (see “Cash tender offers”
                                                with structurally subordinated high yield debt, the senior bank lenders were asked to
                                                approve (which they refused to do, in the event) the inclusion of upstream guarantees
                                                and second security in the high yield debt on broadly similar terms to the package that
Cash tender offers
                                                had been in place on the bridging loan. In the buyout of Brake Bros. Ltd, a similar re-
Cash tender offers are often used in re-
                                                quest was made of the senior lenders, which, in this case, they agreed to.
structurings involving bonds held by US
investors to repurchase substantially all       In addition to changes to the European high yield debt model, other forms of debt se-
bonds of one or more series that are trad-      curity are being used in situations that would traditionally have supported a high yield
ing at distressed levels. If repurchases of     debt structure, for example, the recent issue by Focus-Wickes (Finance) PLC of mez-
bonds amount to a tender offer, the pur-        zanine notes to refinance a bridging loan. Like high yield bonds, these mezzanine
chaser will be required to comply with          notes have a debt rating and are listed on the Luxembourg Stock Exchange. However,
the anti-fraud rules of Regulation 14E          unlike the position of many European high yield bondholders, holders of the notes
under the Securities Exchange Act of            rank second to senior lenders pursuant to a mezzanine style guarantee and security
1934 (1934 Act) which, among other              package (see box “Capital structure”).
things, requires that a tender offer be
held open for a minimum of 20 business
days.                                         der offer can be structured, the most              indenture amendment. A fixed price
                                              common in a restructuring context be-              or formula-derived spread price (as
In order to make the tender offer attrac-     ing:                                               the case may be) per bond is offered
tive to investors, the offer is often made                                                       and consents are solicited to an inden-
at a premium to the trading price. There      • A fixed price or fixed spread cash ten-          ture amendment eliminating all re-
are a number of ways in which a cash ten-       der offer with consent solicitation to           strictive covenants (thereby creating     21
                          an incentive to tender so as to avoid      indenture or trust deed so that most, if     pany. A Chapter 11 proceeding will

                          being left with a modified instrument,     not all, restrictive covenants are re-       therefore involve the formulation, nego-
                          further subordinated, without issuer       moved from the indenture or trust deed.      tiation and implementation of a plan of
                          restrictive covenants).                                                                 reorganisation. The plan will typically
                                                                     Where an exchange offer is made to Eu-       reorganise a debtor’s pre-petition finan-
                       • A “Dutch auction” tender offer. The         ropean high yield bondholders largely or     cial obligations and establish a new capi-
                         issuer offers to repurchase a specific      solely outside the US, there may be a        tal structure often by the issue of new
                         number of bonds within a given price        1933 Act exemption available, often un-      debt or equity in exchange for existing
                         range. Bondholders are invited to ten-      der SEC Regulation S (see “Regulatory        obligations and interests. It will also pro-
                         der bonds (usually over a 20 day pe-        issues” above). As with a tender offer, an   vide for the post-reorganisation man-
                         riod) and do so by indicating the low-      exchange offer may be subject to the ten-    agement structure of the debtor. Once a
                         est price within the range that they        der offer rules in Regulation 14E of the     plan has been confirmed, the debtor will
PLC December 2003

                         will accept. The issuer aggregates          1934 Act.                                    be released from its pre-petition obliga-
                         bondholder offers and buys the ten-                                                      tions.
                         dered bonds up to the specified bond
                         limit at the lowest price possible. All                                                  A plan can be confirmed if:
                         bondholders who tendered bonds at
                         the accepted price or lower will have                                                    • It is accepted by every impaired class

                         their tender offers accepted. If the is-                                                   of creditor (the consent to a plan by an
                         suer receives more offers at the ac-                                                       unimpaired class of creditors is not re-
                         cepted price than the specified bond                                                       quired);
                         number, all bondholders will receive
                         a pro rata allocation. The logic be-                                                     • The creditors of each class holding at
                         hind a “Dutch auction” is to encour-                                                       least two-thirds in principal amount
                         age bondholders to underbid each                                                           and at least one-half in number of the
                         other to ensure their bonds are repur-                                                     allowed claims in that class have
                         chased.                                                                                    voted for the plan; and

                       Exchange offers                                                                            • At least two-thirds in principal
                       An exchange offer is effectively a tender                                                    amount of shareholders have voted
                       offer (see above) where the considera-                                                       for the plan.
                       tion includes new securities as well as, or
                       instead of, cash. An exchange offer may                                                    Importantly, the US Bankruptcy Court
                       be used in a restructuring involving                                                       may confirm a plan even if these voting
                       bonds held by US investors to effectively                                                  thresholds have not been achieved in any
                       amend the payment terms of a com-             CHAPTER 11                                   class (including shareholders) if the plan
                       pany’s bonds by exchanging the existing       In addition to the restructuring mecha-      does not “discriminate unfairly” and is
                       bonds for new bonds which contain the         nisms set out above, there have been a       “fair and equitable” in respect of each
                       revised payment terms.                        number of well-publicised recent exam-       impaired class.
                                                                     ples of large multinational companies
                       As is the case with a cash tender offer, an   using the bankruptcy procedure under         These so-called “cram-down” provi-
                       exchange offer will not bind non-con-         Chapter 11 of the US Bankruptcy Code.        sions would allow, for example, a debtor
                       senting bondholders to the exchange.          Some of these companies have been non-       and its creditors to agree a plan that pro-
                       For this reason, it is usual for exchange     US companies (for example, Global            vides for the issue of new equity shares in
                       offers to be made conditional on high         Crossing Ltd and Regus Group plc) that       exchange for debt claims despite the ob-
                       minimum acceptance levels, often 90%          have chosen to file a Chapter 11 petition    jections, or in certain circumstances
                       or 95%. This will mean that some exist-       either with or without commencing a lo-      without obtaining the consent, of certain
                       ing bonds are likely to remain outstand-      cal restructuring process or proceeding      junior creditors, such as pre-petition
                       ing following the exchange offer and          (see “Non-US companies” below).              shareholders. This contrasts with the
                       holders of such bonds will continue to be                                                  position under an equitisation pursuant
                       paid on the terms of the existing bonds       Conventional Chapter 11                      to a section 425 scheme (see “Equitisa-
                       and not the new bonds. To incentivise         The basic principle behind a “conven-        tion” above) where, although a dissent-
                       all bondholders to participate in the ex-     tional” bankruptcy proceeding under          ing minority of creditors (including
                       change offer, an exchange offer is usu-       Chapter 11 is that it is generally prefer-   bondholders) will be bound by a court-
                       ally accompanied by a consent solicita-       able for a corporate debtor to continue      sanctioned scheme, shareholders will
                       tion to make amendments to the non-           to operate while reorganising its busi-      not be bound by the scheme and will be
   22                  payment covenants set out in the              ness, rather than liquidating the com-       able to vote down any shareholder reso-
lutions necessary for the implementation

of the scheme.                                    Glossary
Pre-packaged Chapter 11                           Debtor in possession. In a Chapter 11 proceeding, the debtor will usually retain pos-
In a “pre-packaged” Chapter 11, the               session and control of its assets allowing it to operate its business during the Chapter
debtor will reach agreement with its              11 process (see “Chapter 11” in the main text).
creditors on the terms of the plan and
will solicit votes to accept or reject that       Global note. A certificate usually issued in bearer form representing the whole of the
plan before the commencement of Chap-             high yield bond issue.
ter 11 proceedings. As with a conven-
tional Chapter 11 proceeding (see                 High yield bond. A bond rated by commercial credit rating agencies as sub-invest-
above), once the plan has been con-               ment grade (see below), for example, lower than BBB by Standard & Poor’s and lower

                                                                                                                                               PLC December 2003
firmed, all creditors affected by the plan        than Ba by Moody’s Investor Services (see also boxes “Capital structure” and “Key
will be bound in. There are two princi-           features”).
pal advantages of a pre-packaged Chap-
ter 11 proceeding over a conventional             Impaired. In the context of a Chapter 11 proceeding, a creditor will be impaired if its
Chapter 11 proceeding:                            contractual rights are to be modified or it is to be paid less than the full claim under a
                                                  plan of reorganisation (see “Conventional Chapter 11” in the main text).

• By going into a Chapter 11 proceed-
  ing only after creditors have accepted          Investment grade bond. A bond rated by commercial credit rating agencies as invest-
                                                  ment grade, for example, BBB or higher by Standard & Poor’s and Ba or higher by
  the plan, the company’s management
                                                  Moody’s Investor Services.
  minimises the risk of losing control of
  the Chapter 11 proceeding to a credi-
                                                  LBO. A leveraged buyout commonly involving the acquisition of a company by the
  tors’ committee or potential pur-
                                                  management team supported by a high proportion of debt.

                                                  Regulation S. A US Securities and Exchange Commission rule that provides guide-
• A pre-packaged Chapter 11 proceed-
                                                  lines under which offerings of securities (including high yield bonds) can be made
  ing will often be shorter than a con-
                                                  outside the US without registration under the US Securities Act of 1933.
  ventional Chapter 11 proceeding re-
  ducing the administrative expenses of
                                                  Subordination. An arrangement where one creditor agrees with another creditor (the
  the process and the scope and cost of
                                                  senior creditor) that it will not receive repayment of its debt unless and until the se-
  any necessary debtor in possession fi-
                                                  nior creditor has been repaid in full.

Pre-negotiated bankruptcy
In a pre-negotiated Chapter 11 process,
the debtor will reach agreement with its        the US Bankruptcy Code, a company                mestic insolvency proceedings and
major creditors before commencing               need only have a place of business or            where there is a connection with the US)
bankruptcy proceedings but will not so-         property in the US. US courts have previ-        (Cenargo Navigation Limited www.
licit acceptances of a plan (as in a “pre-      ously found that the presence in the US of       practicallaw.com/A29867).
packaged” Chapter 11 process (see               assets as minimal as a few hundred dol-
above)). The plan is prepared before fil-       lars in a bank account may be sufficient         EC INSOLVENCY REGULATION
ing the bankruptcy petition and then filed      to provide a jurisdictional link for a US        At present, there is no pan-European
with the petition or shortly after. It is of-   bankruptcy case. For example, the                bankruptcy regime with a consistent set
ten the case that the debtor seeks “lock-       Delaware Bankruptcy Court confirmed              of procedures and priority rules and,
up” agreements from creditors to vote in        the Chapter 11 plan of Golden Ocean              consequently, the way in which creditors
favour of the plan. The principal advan-        Group Ltd, a Channel Islands based               are treated vis-à-vis other creditors on
tages of a pre-negotiated bankruptcy            shipping company, even though the                insolvency differs between the various
over a conventional Chapter 11 proceed-         company’s US connections mainly con-             EU member states. The EC Insolvency
ing are much the same as those for a pre-       sisted of three bank accounts in                 Regulation (1346/2000) (the Regulation)
packaged Chapter 11 proceeding.                 Delaware. More recently however, the             came into force on 31 May 2002 and is in-
                                                US courts have been prepared to recog-           tended to address the conduct of insol-
Non-US companies                                nise the predominance of domestic (that          vency proceedings within the EU (other
A company does not have to be incorpo-          is, non-US) proceedings where, on the            than Denmark) rather than harmonise
rated in the US to take advantage of the        facts, this has been more appropriate            the various insolvency laws that exist in
powers and remedies in a Chapter 11             (even where Chapter 11 proceedings               the various member states (www.
proceeding. To qualify as a debtor under        have been commenced prior to the do-             practicallaw.com/A24144).                     23
                       In broad terms, the Regulation provides

                       that main insolvency proceedings can            Related information
                       only be initiated in the country in which
                       a debtor’s “centre of main interest” is lo-     Links from www.practicallaw.com and the web
                       cated (being the country in which the           These links can be found from this article which is at www.practicallaw.com/A34206
                       debtor conducts the “administration of
                       its interests on a regular basis” which, as     Know-how topics
                       set out below, may or may not be the            Bonds                                                    www.practicallaw.com/T876
                       country of its incorporation). Once the         Corporate recovery and rescue mechanisms               www.practicallaw.com/T1080
                       main insolvency proceedings have been           Loans and debt financing                                  www.practicallaw.com/T78
                       initiated, they are automatically recog-
                       nised across all member states. Al-             Practice note
PLC December 2003

                       though the Regulation applies to admin-         Schemes of arrangement and companies
                       istrations and other types of formal in-        in financial difficulty                               www.practicallaw.com/A20559
                       solvency proceedings, it does not apply,
                       for example, to administrative receiver-        Previous articles
                       ships. (For information on the current          Marconi restructuring:
                       UK position on these proceedings, see           A blueprint for the future? (2003)                    www.practicallaw.com/A32774

                       feature article “Enterprise Act: Corpo-         Negotiating with bondholders:
                       rate insolvency aspects”, www.practi-           The changing face of restructurings (2003)            www.practicallaw.com/A28649
                       callaw.com/A29513.)                             Enterprise Act:
                                                                       Corporate insolvency aspects (2003)                   www.practicallaw.com/A29513
                       It is perhaps too early to tell whether the     Coping with vulture funds (2003)                      www.practicallaw.com/A29427
                       Regulation will have any significant im-        Cross-border bond restructurings (2003)               www.practicallaw.com/A29284
                       pact on the European high yield bond re-        Debt equity swaps: A growing trend (2002)             www.practicallaw.com/A26041
                       structuring model. Clearly, as the Regu-        Falling apart?
                       lation is limited to insolvency proceed-        Rescue mechanisms and insolvency (2002)               www.practicallaw.com/A21397
                       ings, restructurings involving an               Insolvency Act 2000:
                       out-of-court process will not be affected.      A taste of things to come? (2001)                     www.practicallaw.com/A18322
                       But the Regulation may well be relevant         High yield debt finance:
                       to bond restructurings involving struc-         Fledgling market taking off (1999)                    www.practicallaw.com/A11321
                       tures where a special purpose vehicle has
                       been incorporated (to raise finance, for        For enquiries about subscribing to PLC web materials please call +44 207 202 1200
                       example) and has its centre of main inter-
                       est in one member state and the issuer of
                       the high yield bonds has its centre of main   BRAC, a company incorporated in the              that wish to make parallel filings in an
                       interest in another. The Regulation may       US, on the basis that BRAC’s centre of           EU member state.
                       also restrict any choice as to the member     main interest was located in England
                       state in which the main insolvency pro-       (www.practicallaw.com/A28628). As a
                       ceeding is commenced.                         result of this decision, it is clear that com-   Andrew Wilkinson is a partner and An-
                                                                     panies incorporated in non-EU member             drew Lucas is a special counsel at Cad-
                       In addition, in In re BRAC Rent-a-Car         states are able to take advantage of Euro-       walader, Wickersham & Taft LLP. The
                       Int’l Inc., the High Court decided that it    pean insolvency proceedings. This may            authors would like to thank Richard
                       had jurisdiction to make an administra-       well benefit multinational groups filing         Nevins, a partner in the firm, for his as-
                       tion order in England in relation to          bankruptcy petitions under Chapter 11            sistance in writing this article.

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