As the European telecoms sector and its investors work through a painful restructuring, a few US law firms and boutique investment banks are being kept very busy. This is a source of irritation to the big City of London law firms that have eschewed the representation of bondholders in favour of their existing relationships with primary lenders.
As telecoms companies and other industrials grapple with the downturn, defaults have become increasingly common. Restructuring firms that can combine experience of high-yield litigation in the US with track records in Europe are finding themselves in great demand.
By the end of 2001 there was high-yield debt of around $60 billion in issue by companies with a material European presence. Martin Reeves, director of European credit research at Alliance Capital, says: “The resources needed to deal with this situation have not been required before. There was a 16% par default rate for 2001 and some predictions for 2002 are that this could rise to around 30%. However, even with these defaults, the market should continue to grow.”
European high-yield issuance took off four-and-a-half years ago, powering build-out in the telecoms sector but creating problems for investors. The key point is that, in contrast to the US, the preferred structure for European high-yield issues leaves bondholders in a weak position if the issuer defaults.
Uppermost amongst bondholder headaches in Europe is the fact that bankruptcy laws favour senior lenders. In mid-April last year, the collapse of UK shipbuilder Cammell Laird sounded warning bells, underlining how exposed they could be. The affair was played out under English law but it soon became clear that most European countries offered even less creditor protection. Over half the European high-yield deals have been structured in the UK, with most of the remainder being based in Germany. And while German bankruptcy law has recently been modified, it has yet to be significantly tested. Nor do the systems in France, Spain, Italy and the Netherlands do bondholders many favours.
Also, the lack of any harmonization in insolvency laws in Europe makes multi-jurisdictional workouts unpredictable. Bondholders are fighting back, however, and managing to exert some influence, notably in the cases of Brunner Mond, Polestar, Derby Cycle, Netia, Marconi and Versatel.
These victories owe much to the specialist law firms that have, so far, made this market their own, as well as to the predominantly US investment banks that have moved into Europe, exporting know-how gleaned from the highly leveraged US market. For bondholders, knowing how to push their claims, as well as identifying what these claims are, can be difficult.
Without a caucus representing at least 50% to 75% of the ownership of an issue, bondholders can find themselves without leverage to have impact on a restructuring. In the main, it will be the financial advisers and lawyers that pull together bondholder groups before deciding on a course of action. Joseph Swanson, senior vice-president of boutique investment bank Houlihan Lokey Howard&Zukin explains: “To get any kind of consensus it is essential to have complete transparency and it is the responsibility of financial and legal advisers to make sure that exists.”
Bernard Douton, a director in the restructuring group at NM Rothschild, adds: ‘”Bondholders are starting to get wary of the arrangers – who sold them the paper in the first place – organizing tenders for the issuer to buy those same bonds back at a fraction of par. The need for an adviser independent of the deal is now clearer than ever.”
Ultimately, however, the type of deal struck will depend on the health of the company. Swanson says: “At the outset of any restructuring, noteholders take a view on the prospects and value of the company. To the extent the business plan makes sense, noteholders are typically willing to exchange debt for some combination of new securities and cash. However, absent a viable business, noteholders will prefer the company to repurchase their debt or, in the absence of liquidity, enter into formal insolvency proceedings and liquidate the assets.” But, he says, with no clear framework for resolving differences among stakeholders, the outcome of deals in Europe remains uncertain and will depend on the capabilities of the parties managing the process.
Advising on these decisions under English law, New York law, and any number of other European insolvency regimes, has been keeping the two market leaders – Cadwalader, Wickersham&Taft and Bingham Dana – busy. These two US firms have shot to prominence in the European bondholder market over the past year, reaping the rewards of a forward planning process that involved Cadwalader’s London managing partner, Andrew Wilkinson, opening the firm’s London office in early 1998.
Wilkinson, had been convinced that law firms would need a convincing cross-border US/UK restructuring capability to cope with the inevitable surge of bond restructuring work that would flow from Europe’s growing infatuation with high yield. “We have been targeting this work from the outset and it has paid off, to the extent that we have now been involved in between two-thirds and four-fifths of all European high-yield defaults in the market,” he says.
At Bingham Dana, financial restructuring partner James Roome underlines the problems now facing the big City firms looking to target this work. “To an extent,” he says, “they have no natural client base in this area and because of their close client relationships with the debtors and the primary lenders they often find themselves conflicted out. This is not the sort of work that needs huge resources – we get hired because we have expertise and a track record, in Europe as well as the US.”
Both lawyers stress that bondholders are getting more of a fair say, especially investors in many of the newer entrants to the European telecoms market, which were highly leveraged from the outset. Wilkinson outlines the key issues: “Recovery rates for bondholders are significantly lower in Europe than in the US, generally because high yield ranks behind obligations to banks and subsidiary debt. Many insolvency laws in Europe are designed principally for the protection of secured creditors and appear to proceed on the assumption that in order to secure commercial lending, insolvency laws ought to be designed to protect the lenders’ interest.”
The consequences of this, says Wilkinson, are that bondholders will strive towards restructurings that avoid the insolvency process. There is also an increased awareness that structural subordination will lead to poor returns to bondholders in cases where there is secured bank debt.
Bryant Edwards, a partner at Latham&Watkins, stresses that although the balance is shifting in bondholders’ favour, in European debt they are still disadvantaged: “This is partly because of structural subordination, partly because of unfavourable, and fragmented, insolvency regimes and partly because they still need to get more organized.”
Last time Europe faced recession, in the early 1990s, the so-called London rules ameliorated the harshness of insolvency laws, at least in the UK. But this time around the hundreds of bondholders involved have complicated the situation enormously – as well as obviating the London approach. “That’s why the lawyers need to focus on pushing through alternative solutions,” concludes Edwards. There are no shortage of these on offer – from Dutch auctions, open market bond repurchase programmes and cash tender offers with exit consents, to pre-packaged Chapter 11 plans of reorganization and UK schemes of arrangement. For now, in the absence of any harmonized European approach to insolvency, the few specialist lawyers are going to be very busy indeed.
