It has been estimated that there are between 1,500 to 2,000 French companies under leveraged buyout (LBO) financing, of which some 25% have not been able to respect one or more of their financial covenants to lenders. The breach of financial covenants by a company under LBO is often the first warning sign to lenders that all is not well. This may indicate a temporary problem resulting from a downturn in current market conditions or, when linked to an immediate or pending liquidity problem, a more serious structural problem requiring a restructuring of the capital and debt financing structure of the company and its subsidiaries.
Typical French LBO structure
A typical French LBO debt financing will involve senior secured debt financing and mezzanine debt financing. The senior debt financing will usually comprise a senior acquisition facility for the acquisition vehicle – a holding company (holdco) – a capex facility, a refinancing facility and a revolving facility for its subsidiaries and interest rate swap protection arrangements. The mezzanine financing was until recently often made available in France as a bond and not as a loan for a number of reasons.
The mezzanine finance is often provided in France directly at the holdco level at the same level as the senior acquisition debt. The mezzanine debt financing is typically not therefore structurally subordinated to the senior acquisition debt but will be contractually subordinated pursuant to an inter-creditor agreement and where there is common security, pursuant to a security sharing agreement.
Typically, the senior financing would be secured on the shares of the target company and – subject to legal restrictions in France – will include security over subsidiary shares, bank accounts, possibly real estate, intercompany loans and IP rights. Typically, the mezzanine financing would usually be secured on the shares of the target company also. Where the target company has non-French subsidiaries it would not be unusual for the mezzanine debt to have the benefit of second ranking security or guarantees from those subsidiaries, again to the extent legally permitted by the laws of the jurisdiction of the relevant subsidiary.
In many of the French LBOs, particularly those involving a French sponsor, there will be no share pledge over the holdco shares. The sponsors may have provided finance to the holdco for the purposes of the acquisition by way of capital contribution and under subordinated debt instruments, again often taking the form of a bond instrument. Finally, management may have a small direct or indirect stake and interest through an intermediary company above the holdco.
The structure of the senior and mezzanine debt financing and the absence of a share pledge over the shares in the holdco has significant implications for the ability of the sponsor, the company and its lenders to find a rapid solution to difficulties encountered by a company under LBO in France.
Traditional framework for French LBO restructuring
Where an LBO encounters difficulties, a prompt analysis of whether the problem is of a temporary or more permanent nature, is essential if proper remedial action is to be taken to preserve value for stakeholders and inject new money as required to restructure the business and provide a more sound capital and debt financing structure. In practice, this is usually undertaken by an external audit firm which will undertake an independent business review of the group. The sponsor and management will usually have a much better picture of the extent to which there is a fundamental problem and the need for a major restructuring and therefore have a tactical advantage over other stakeholders as to the type of action which they may wish to take.
Framework for a consensual restructuring
The traditional framework for seeking to achieve a consensual restructuring in French LBOs has been the appointment of a special mediator (mandataire ad hoc) or a conciliator.
Mandataire ad hoc
A special mediator can only be made if the company is solvent, i.e. if it can meet its payments as they fall due for payment with its available assets, taking into account any grace periods granted by its creditors. The appointment of a special mediator will usually be for a period of three to six months and can be extended by the court without limit. During the special mediation period, creditors will usually be requested to acknowledge that they will not make a formal request for payment of any debt claims so as to ensure that the company remains solvent throughout this period.
Conciliation
A conciliator may be appointed in circumstances where the company is encountering financial difficulties or has been insolvent for less than 45 days. Unlike special mediation, the conciliation proceedings are limited in time to 4 months with a possible extension of one further month. In practice, conciliation proceedings are likely to be opened either if the company has serious liquidity problems and there are concerns about whether or not it is actually insolvent at that time or to obtain a special new money privilege.
The special mediator and the conciliator effectively act as a facilitator for the purposes of seeking to persuade stakeholders to agree to a consensual deal. Many of the practical difficulties in seeking agreement amongst stakeholders arise from the documentary requirements for unanimous decisions or super-majority decisions involving more than two-thirds of the votes of a particular class of creditors. The senior debt documentation would typically require unanimous decisions to extend the final maturity date of the loans for example. The terms of the mezzanine documentation typically are more flexible on these issues but it would not be uncommon to see a requirement for an 80%-85% vote of mezzanine lenders to release security and guarantees in favour of the mezzanine debt. We have seen a number of cases recently where much time is spent by the special mediator and the conciliator in seeking to obtain the agreement of individual lenders as the last hurdle to a consensual restructuring agreement.
'Pre-pack' safeguard proceedings
There have been two recent high-profile examples in France of a 'pre-pack' safeguard, Auto Distribution and Thomson/Technicolor.
In the absence of a consensual agreement or agreement from a small number of creditors to a restructuring proposal which is acceptable to the majority of stakeholders, recourse has been had to a 'pre-pack' safeguard procedure. The object of the 'pre-pack' safeguard plan is to implement a restructuring proposal which is acceptable to the majority of stakeholders, in circumstances where the proposal cannot be implemented under the terms of the finance documentation because the required voting majority cannot be obtained.
In practice, this means that the company will request the opening of safeguard proceedings, which it can do if it is solvent and facing financial difficulties. The restructuring arrangement agreed to by the majority stakeholders prior to the opening of the safeguard proceedings will be put to the creditors as the company's safeguard plan. If it is agreed to by the financial creditors' committee, the trade creditors' committee and the bondholders' committee – in each case by creditors voting two-thirds of the relevant debt – and provided that the court concludes that the interests of all the creditors are not prejudiced, the safeguard plan will be adopted by the commercial court.
Implementation of the 'pre-pack' safeguard plan is not without uncertainty or possible legal challenge. However, the success of these cases has added leverage to the ability of the special mediator and the conciliator to obtain the agreement of minority lenders seeking to hold out on a consensual restructuring agreement among stakeholders. It has also helped overcome technical legal difficulties with the original finance documentation, for example, where the documentation does not contain release mechanisms by mezzanine lenders in favour of senior lenders in respect of the mezzanine debt, security or guarantees on enforcement and which therefore meant that, absent a 'pre-pack', the consent of those lenders was required for a consensual restructuring.
New money
Where the sponsor is willing to inject new money there will be a negotiation as to the ranking of the new money in the payment waterfall. In practice this will depend on the amount of new money and the anticipated value of the company following implementation of the restructuring. But it is becoming more common for the stakeholders to spend more time negotiating the new payment waterfall between the new money and the old money post-restructuring rather than the security or guarantee package. In a number of cases mezzanine lenders have agreed to restructure the mezzanine debt instrument and to release security and guarantees in return for significant sponsor new money injection, maintenance of the mezzanine debt and a possible upside return on a future sale of the company.
Within the framework of conciliation proceedings, new money providers which make available new money within the terms of, and after, a court approved (homologation) order for the purposes of ensuring the continuation of the company's business can benefit from a new money privilege. For example, in the case of liquidation of the company, the new money is granted a super-priority ranking vis-à-vis other creditors of the company (other than certain salary claims and court fees and expenses) .
This requires the formal approval (homologation) by the commercial court of a conciliation agreement reached between the company's main creditors. Formal court approval will only be given if the company is not insolvent (or the arrangements with creditors put an end to its insolvency), the arrangements agreed are such as to ensure that the company will continue as a long term viable business and that the arrangements do not prejudice other parties who are not parties to the conciliation agreement.
Debt buy-backs
Another feature which has been encountered over the last year, is the willingness of certain sponsors to enter into discounted debt buy-backs. This is not without legal difficulty and needs to be properly structured if it is not to infringe finance documentation covenants and transfer restrictions. However, this is becoming an increasing feature of sponsor proposals in France where the sponsor is prepared to inject new money and can be a useful tool for reducing second lien or mezzanine debt.
Security and enforcement
As mentioned above, many of the French LBO financings are not secured by a share pledge over the holdco shares. In practice, this means that the lenders have little leverage against the sponsor in circumstances where an LBO goes into difficulty. The lenders cannot take over the holdco other than on a consensual basis with the sponsor because they have no share pledge to enforce. Even where the sponsor has granted a share pledge over the shares in the holdco, the ability of the lenders to enforce their share pledge privately may be thwarted by action taken to place the holdco and its parent company in safeguard proceedings in France. Once safeguard proceedings have been opened there is a freeze on enforcement action against the assets of the company subject to the safeguard proceedings.
The Coeur Défense case
Although not an LBO, but a structured property finance transaction, a good example of the inability to enforce security by lenders is the Coeur Défense transaction.
This case involved the financing of a property situated in the La Défense business area outside Paris. The borrower under the financing (Heart of La Défense SAS), acquired in 2007 the property Cœur Défense for approximately €2.1 billion ($2.67 billion) of which €1.6 billion ($2.03 billion) was financed by way of loans and securitised through a French securitisation vehicle. The security package for the financings included a limited recourse share pledge over 100 per cent of the shares of the borrower by its Luxembourg single purpose parent company, Dame Luxembourg Sarl (Dame). The ultimate shareholders of the borrower included Lehman Brothers affiliates. Neither the borrower nor its Luxembourg parent have any employees.
As part of the financing arrangements, the borrower entered into interest rate swap arrangements with Lehman Brothers affiliates which became insolvent in September 2008. As a result of Lehman's insolvency, the borrower was requested to replace Lehman Brothers in accordance with its contractual obligations.
The Paris Commercial Court opened safeguard proceedings in favour of the borrower and its parent. The basis of the application by Heart of La Défense SAS was that it could not replace a swap agreement entered into with Lehman Bros which it was required to replace following the insolvency of Lehman. The Paris Commercial Court mentioned that Heart of La Défense SAS faced difficulties of a nature likely to lead to its insolvency which it was not able to overcome without recourse to safeguard proceedings. As regards Dame, the Commercial Court of Paris indicated that there was a tissue of verifiable factors demonstrating that the centre of main interest (COMI) of Dame was in Paris and that it too was encountering difficulties which it was not able to overcome without recourse to safeguard proceedings.
The effect of the safeguard order was to prevent the Fonds Commun de Titrisation (FCT) from enforcing a share pledge granted by Dame over the shares in Heart of La Défense SAS.
Fourteen months after the opening of the safeguard proceedings, on 25 February 2010, the Paris Court of Appeal ordered that the safeguard proceedings opened in November 2008 be withdrawn. The Court decided that there was no ground for justifying the opening of safeguard proceedings either against Heart of La Défense SAS or Dame. In its decision, the Paris Court of Appeal stated that Heart of La Défense SAS had not claimed that it was undergoing any real difficulties preventing it from continuing its business as a lessor of the property, but only that unforeseen circumstances had made it more onerous for Heart of La Défense SAS to comply with its contractual obligations to replace the hedging contracts as required by the finance documentation; this was not sufficient reason to open safeguard proceedings.
The Paris Court of Appeal further stated that the re-negotiation of the interest rate swap arrangements did not really affect the leasing business of the Cœur Défense building which could continue whoever was owner of the building and whatever the composition of its shareholder. The court confirmed that Heart of La Défense SAS had not demonstrated its assertion that the sale of the building would have a materially negative impact on the Paris property market, in particular because the FCT had indicated that it did not wish to sell the building but wished to preserve value. The court did not reach its decision on the grounds of COMI. An appeal to the French Supreme Court (Cour de cassation) has been lodged against these decisions.
Alternative structure to improve the security position of lenders
In the light of the uncertainty raised by this case, a number of alternative structures have been examined by practitioners with a view to seeking to improve the effective security position for lenders in France. These include: the interposition of two Luxembourg holding companies between the sponsor and the holdco with a view to enforcing security in Luxembourg; the establishment of a Luxembourg fiducie or a French fiducie; the granting of a golden share, giving the right to vote certain decisions and also réméré. Another potential alternative would be to take security closer to the sponsors' equity investment. Each of these alternatives has its advantages and disadvantages from a legal, tax or accounting perspective but none appears to be water-tight from a lender perspective.
In our experience a negotiated and consensual restructuring in relation to LBOs in distress has proved to be much more beneficial in relation to the maintenance and creation of value for all stakeholders rather than a formal court driven insolvency procedure. We believe that sponsors which, in the past, have had recourse to a court driven procedure will give serious second thoughts to this approach in the future.
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About the author
Rod Cork is a banking partner at Allen & Overy LLP based in the Paris office.
Rod has advised commercial lenders, banks, CLOs and funds in the public and private sector and has recently been involved in many major French restructurings, refinancings and numerous cross-border restructurings. He has recently acted on transactions including mandataire, ad hoc, conciliation and safeguard proceedings involving public companies, LBOs and structured transactions.
Rod is a solicitor of England and Wales and a member of the Paris Bar. |
Contact information
Rod Cork
Allen & Overy LLP
Edouard VII 26, boulevard des Capucines 75009 Paris France
Tel: +33 (0)1 40 06 54 00
Fax: +33 (0)1 40 06 54 54
Web:www.allenovery.com |
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About the author
Having founded of the law firm SCP Santoni & Associés 20 years ago, Marc's activity has since then been devoted to the management of French businesses in difficulty and investment funds advisory.
He advises buyers interested in company turnaround, as well as companies under special mediation (mandat ad hoc) or safeguard-rehabilitation-liquidation proceedings (sauvegarde-redressement-liquidation judiciaire).
Marc intervenes in the treatment of underperforming LBOs on behalf of many investment funds. At present, the firm is in charge of 19 underperforming LBOs.
Marc is a member of the Association pour le Retournement des Entreprises (Association dedicated to companies' survival and turnaround) and of the Turnaround Management Association (TMA) and takes part in the investment boards of many investment funds. |
Contact information
Marc Santoni
Santoni & Associés
Edouard VII 26, boulevard des Capucines 75009 Paris France
Tel: +33 (0)1 40 06 54 00
Fax: +33 (0)1 40 06 54 54
Web:www.allenovery.com |