European High Yield Bond Market: Restructuring and Workout Considerations 

HY Bonds – Restructuring and Workout Considerations

Given the sheer volume of high yield deals in the market recently¹ and the fact that the bonds are increasingly becoming a permanent fixture in European capital structures, it is inevitable that a greater number of restructurings going forward will contain a high yield bond component.  Restructuring high yield bonds poses a range of challenges not otherwise found when dealing with loan-driven structures.  Some of the unique problems faced include:

Restructuring triggers (covenants and events of default)

As a rule of thumb, loans have more extensive covenants and events of default, which will likely trigger earlier than those in high yield bonds once the company enters into distress.  Covenants in the bonds are incurrence-based, which means there are no financial metrics to maintain, and the ratios are tested only if the issuer is considering a major voluntary corporate transaction such as new debt incurrence, a dividend payment or an asset disposition².  Events of default in the bonds are generally limited to non-payment of principal or interest, cross-payment default and cross-acceleration to material indebtedness, non-payment of material final judgments and a bankruptcy/insolvency process event of default.  In addition, a common formulation in the bonds is that a default is not an "event of default" until the trustee or the holders of at least 25% in principal amount of the then outstanding bonds notify the issuer of the default, and the issuer does not cure such default within the applicable grace periods specified after receipt of such notice.  In practice this means that a group of bondholders first must get organized (or an anchor bondholder holding more than 25% of the bonds needs to decide to take action) before an event of default is actually called – at times potentially leading to a "hung default"³.  Therefore, restructuring discussions typically start much later for bonds than for loans, which may give bank lenders a head start over the bonds in terms of preparation of a restructuring proposal.

Capital structures and their effect on the enforcement process

One of the more common capital structures involving high yield bonds in Europe consists of a super senior revolving credit facility (the SSRCF) (providing liquidity) plus senior secured high yield notes (the SSNs) (providing long-term non-amortizing capital).  In a SSRCF/SSN structure, the SSNs share the security and guarantees on a pari passu basis with the SSRCF lenders in right of payment; however, in an enforcement scenario, the SSRCF lenders receive priority in receipt of such proceeds.  In this structure, if the secured parties disagree on the means of enforcement (after an obligatory consultation period), the intercreditor agreement commonly provides that the noteholders control enforcement instructions for a set period of time (typically ranging from 3 to 6 months), with the SSRCF lenders or the security agent taking charge of the enforcement instruction process after the end of such period, unless the SSRCF lenders have been repaid before that.

One recent example of the restructuring dynamics in a bond structure is the EnQuest restructuring, which involved the amendment and restatement of the US$1.7bn super senior revolving credit facility, the exchange of US$650m senior (unsecured) high yield notes for new notes, the amendment of the terms governing £155m retail notes, an equity raise and the approval for renewal of surety bonds relating to decommissioning liabilities.  The scheme of arrangement implementing the restructuring itself was also novel, in that it treated holders of the high yield notes and holders of the retail notes as a single class of creditor, despite differences in the terms of, and nature of investors in, these instruments.⁴

Dealing with the bondholders

Since high yield bonds are freely tradable on the secondary market and are often widely held, identifying anchor bondholders can be challenging, and the composition of any group of key bondholder decision-makers may change frequently.  This can be made even more difficult by complex custody chains (see graph 1) which mean that the ultimate beneficial holders of the notes are not easy to establish, and often an information or identification agent needs to be retained in order to identify (or clarify chain of ownership) and establish communication with bondholders.  The next step in progressing restructuring discussions is organizing the bondholders.  Here, an important role is played by the advisors, in particular with respect to pulling together an ad hoc committee to represent the group, the managing and dissemination of material non-public information (MNPI) and public-to-private wall-crossing procedures, and the execution of non-disclosure agreements (NDAs) (with cleansing provisions) and lock-up/standstill agreements.  All of this must take place while ensuring the issuer is in compliance with its disclosure obligations under the applicable securities laws, market abuse regulations, insider dealing, anti-fraud and other rules and regulations.

Graph 1 - How bonds are held

Legal framework

The structure of any proposed restructuring transaction will need to be scrubbed for compliance with the U.S. securities laws.  It is likely that any restructuring proposal will involve amendments to the high yield bonds, the repurchases of the existing bonds and/or issuance of new bonds or other securities in exchange for the existing bonds.  Any such exchange offer/tender offer/material consent solicitation will require compliance with the U.S. securities laws (the “new securities doctrine”), the primary practical implications of which are:

• Timing.  The 20 business days tender offer rule likely applies, which means that any tender offer/exchange offer likely needs to be kept open for at least 20 U.S. business days, with each material amendment of the terms of the offer requiring another 10 U.S. business days.  Note that the issuer has some limited ways to structure around this requirement, but in any event a tender offer/exchange offer should be kept open for no less than 5 U.S. business days to give the bondholders a meaningful opportunity to consider and react to the offer or consent solicitation.
• 10b-5 liability for material misstatements/omissions attaches to both the issuer and the underwriters.  Broadly, the U.S. Rule 10b-5 makes it illegal for anybody to directly or indirectly use any measure to defraud, make false statements, omit relevant information or otherwise deceive another person in relation to transactions involving securities.
• Extensive disclosure requirements.  10b-5 liability considerations in turn lead to the extensive disclosure drafting and due diligence associated with any such exchange offer/tender offer/material consent solicitation (which means an extended timeline and additional legal expense, plus it may raise confidentiality concerns as the terms of any offer/proposal will need to be made public).  There are ways to structure around the need for extensive disclosure in a private placement context, if parties agree that no 10b-5 letters will be given by the legal counsel.
• Exemption from registration.  U.S. securities counsel needs to advise on the structure of the transaction to make sure an issuance or deemed issuance of new securities is exempt from the SEC registration requirements under the U.S. Securities Act. The commonly used Reg S and Rule 144A routes may be available; in addition, the so-called 3(a)(10) and 3(a)(9) exemptions are also possibly available in a restructuring scenario if consideration for the new/amended notes is primarily non-cash.⁵ Structuring the transaction as a Section 4(a)2 private exchange offer is also a possibility. 

Implementation options

Bond restructurings make use of different tools than loan structures: while loans get amended or repaid and refinanced with new money, in the bond world, restructuring is most commonly achieved via the exchange offers, tender offers and consent solicitations.⁶ See the illustrative timeline for these processes on graph 2 below.  Other potential bond liability management techniques include open market repurchases and redemptions, but their use is typically limited in the restructuring scenario, unless there is a material source of liquidity to finance such exercises.  Sometimes several of these techniques are employed simultaneously or sequentially, for example, an exchange offer whereby the old notes are being exchanged for the new notes, plus a repurchase and redemption of the remaining old notes that did not roll into the exchanged notes with the proceeds of a simultaneous new notes issuance, the size of which depends on the amount of the old notes tendered in the exchange offer (PT MNC Investama).  There is even a possibility of exchanging the notes into a wholly different type of instrument (as was done in the 2015 CGG restructuring, whereby several separate classes of notes issued within the CGG group, with different terms, maturities and event different issuers, were rolled into a new TLB via a single exchange offering memorandum).

Graph 2 - Consent Solicitation / Exchange Offer / Tender Offer - Illustrative Timeline

Voting thresholds and mechanics. 

A list of the common voting thresholds in the indenture key voting can be found in the table below:

As part of the exchange offer/tender offers/consent solicitation process, the parties may make use of techniques not available in the loan context, for example coercive exchange offers where parties use "covenant stripping" as a stick to encourage holders to accept and discourage holdouts from remaining on the side-lines.  "Covenant stripping" is a tactic whereby an exchange offer for new bonds (which typically requires consent of 90% of the bondholders) is coupled with a consent solicitation to remove negative covenants (which requires consent of only 50% of the bondholders): if the 90% voting threshold for the exchange of the existing bonds into the new bonds on the terms requested by the issuer is not achieved, but the 50% threshold is met, the remaining bondholders will be left with the notes that are significantly less marketable (if not worthless) because they contain no restrictive covenants.

1. For example, European high-yield issuance volume for 2017 alone totalled EUR 110 billion (which was comprised of 339 deals with an average size of EUR 466 million).

2. Much can be written on the variety of ways in which high yield covenants can be exploited by an issuer in a distressed scenario to provide it with a runway/flexibility to restructure (or, from the standpoint of the investors, to "prime" the bondholders by incurring additional debt or making dividends/taking the assets out of the system). One of the most talked-about examples as of recently is the so-called "J.Crew trapdoor": A US retailer J.Crew had a high-yield-like covenant package which (as drafted) did not prevent it from transferring valuable intellectual property assets to non-Guarantors and subsequently out of the Restricted Group and collateralizing those assets for additional secured and structurally senior debt. The high-yield covenant package may vary a great deal (depending on the issuer's credit rating, industry and geography, and whether it has a financial sponsor), and careful analysis of the covenants is required on a case-by-case basis to determine the scope of permissible actions in each scenario.

3. A recent example of this is the current Four Seasons situation, where an "anchor" investor, holding more than 50% of the bonds, is unwilling to act upon a payment event of default, while several significant minority investors holding more than 10% but less than 25% of the bonds individually have been unable to enforce the default.

4. Ashurst received the Restructuring Team of the Year Award in 2017 for advising EnQuest plc on its US$2.5 billion financial restructuring, which was reported as being the largest and most complex European upstream oil company restructuring in recent years.

5. For example, the 3(a)(10) exemption was used in the Towergate restructuring, which took a form of a mostly non-cash exchange offer of the existing senior notes and senior secured notes into new notes with an equity kicker, implemented via a scheme of arrangement.

6. A whole section could be written on the pricing of tender offers, e.g. via the processes of a Dutch auction, modified Dutch auction or a fixed spread offer. The preferred strategy will vary on a case by case basis depending on the investor pool.

7.  The fact that an individual holder's right to payment cannot be amended or waived without its consent becomes problematic if restructuring discussions start in earnest only after there is a missed coupon payment: this means that 100% of the holders need to waive their right to claim the missed coupon payment; otherwise the "non-consenters" in any consent solicitation process will always have a residual right to demand such payment, and technically they will always constitute a separate class of holders from the "consenters" because of such residual right. This issue came up in the Seven Energy restructuring.