Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Restructuring & Insolvency, November 2010
In the last couple of years, we have seen an increased use of out-of-court restructurings or "workouts" as an alternative to a formal insolvency proceeding under the Companies' Creditors Arrangement Act (Canada) (CCAA) or its equivalent in the United States, Chapter 11 of the U.S. Bankruptcy Code. There appears to be two principal reasons for this.
First, the global economic recession and uncertain valuations have raised significant concerns about collateral realization values, resulting in lenders being more reluctant to "pull the trigger" on troubled investments, particularly where there is a risk of a net negative recovery. In these market conditions, lenders are demonstrating a willingness to "kick the can down the road" and take a "wait and see" strategy in hopes of better recovery prospects in the future when market conditions are expected to improve and valuations are expected to stabilize.
Second, there has been heightened sensitivity to the costs and stigma associated with a formal insolvency filing. In tight credit markets, companies seeking to restructure have faced significant challenges in being able to access debtor-in-possession (DIP) financing that may be required to fund increased liquidity needs during a formal restructuring process. As access to credit markets have improved significantly in the last six months, this issue appears to have largely dissipated. Companies and their stakeholders are also extremely concerned about the risks that an insolvency filing would further erode value and put an increasing strain on already fragile relationships with key customers and suppliers, both already having been significantly and negatively impacted by the global recession.
Increasingly, even when restructurings are being implemented under formal insolvency processes, most or all of the negotiations occur prior to the filing, with an increased number of pre-packaged insolvency filings designed to minimize the time that a company is under court protection. This approach minimizes ongoing court and administrative costs and the stigma associated with traditional insolvency filings. In these cases, the required stakeholder support is lined up prior to the filing, usually in the form of support or lock-up agreements.
Similar forms of support or lock-up agreements can be used for out-of-court restructurings. These support or lock-up agreements are entered into by the company with certain of its creditors, usually with holders of at least two-thirds of the amount of the affected debt, to ensure that sufficient statutory majorities are met if a formal process is necessary to implement the restructuring.
The agreements can also contain an agreement on the terms, conditions and circumstances pursuant to which the consenting creditors and other affected stakeholders will support a formal process if the desired level of support to implement the restructuring out-of-court is not obtained by a specified deadline. This technique commits these parties to the implementation of the proposed restructuring through a formal process if an out-of-court solution cannot be achieved. As discussed later in this article, this technique also serves to motivate affected parties who have not consented to co-operate as it demonstrates to them that the proposed restructuring can and will be implemented through a formal process even if the dissenting creditors continue to refuse to consent to the restructuring.
"Amend and extend" or "amend and pretend" arrangements – which reflect the "wait and see" approach referenced earlier – have become an increasingly popular mechanism to restructure a company's balance sheet out-of-court. These amend and extend arrangements are generally considered to have contributed to pushing out the start of the so-called "maturity wall" – the trillion plus dollars of corporate debt that will need to be repaid in the next five years. Even with today's improved access to credit markets, these arrangements continue to be popular because of the limited supply of good credits and because many over-leveraged companies still have difficulty accessing credit for refinancing.
Amend and extend arrangements can be implemented through a variety of structures and often contain some kind of de-leveraging mechanism, either by way of a lump sum principal repayment, increased amortization and/or a partial debt to equity conversion, by direct conversion or convertible instrument.
The biggest challenge in implementing a restructuring out-of-court is trying to obtain a consensus among creditors and other affected parties without thediscipline of a court-supervised process or the ability to cram down dissenting members within an affected creditor class. This process involves a delicate exercise of balancing very different and often conflicting stakeholder interests and has become increasingly challenging given the complex capital structures that exist today. The ability to successfully navigate a consensual out-of-court restructuring will largely be dictated by the dynamics between and within the relevant creditor constituencies.
Given the complex financial and legal issues and creditor dynamics involved in a consensual restructuring, successfully implementing a restructuring out-ofcourt can be a challenging undertaking. However, there are techniques and tools available to assist in overcoming some of those challenges towards achieving a consensual solution and avoiding an insolvency proceeding.
Where unanimous participation is not required by the proposed restructuring, exchange offers can be used by issuers of debt securities to reduce outstanding debt and/or to extend the maturity of outstanding debt obligations, subject to compliance with applicable securities law requirements and subject to restrictions contained in existing debt documents. In an exchange offer, a company makes an offer to holders of certain outstanding securities to exchange the existing debt securities for new debt securities or equity securities or for a combination of debt and equity securities. Holdouts who choose not to participate in the exchange offer will continue to hold existing notes on the same existing economic terms. However, they may lose some or all of their covenant protections if these are stripped from the debt securities because the company also obtains, in conjunction with the exchange offer, the required level of consents under the applicable trust indentures to effect such amendments. Debt exchange offers may also be conditional on a minimum tender percentage which is quite high to ensure that only a limited number of holdouts or freeloaders are able to obtain the benefits of the restructured balance sheet which results from the implementation of the exchange offer.
An example of this structure is found in the recently announced debt-for-equity exchange offer by Angiotech Pharmaceuticals where holders of $250‑million of senior subordinated notes are being offered approximately 90% of the new shares in the company in exchange for their existing notes. As a result of the proposed recapitalization, existing shareholders will see their equity significantly diluted to 2.5% of the equity, plus warrants to acquire additional equity, subject to shareholder approval or an exemption order. In addition, holders of $325-million floating rate notes are being offered new floating rate notes in exchange for their existing notes. The Angiotech exchange offer also provides for the removal of all restrictive covenants and events of default from the senior subordinated notes and from the floating rate notes, as may be permitted under the terms of the applicable trust indentures with the noteholders' consents.
The threat of an insolvency filing forms the backdrop of every out-of-court restructuring because creditors, shareholders and other stakeholders are forced to evaluate whether an out-of-court restructuring gives them a more favourable result than an insolvency filing. In a consensual process, these parties hold significant negotiating leverage to negotiate better terms for themselves. In an insolvency proceeding, these parties will generally lose some of their bargaining leverage since a court-supervised process such as the CCAA can impose the restructuring on them regardless of their dissent, provided that the minimum statutory approval thresholds are met. Therefore, the threat of an insolvency filing by the company is a common strategy used in out-of-court negotiations to motivate parties towards a consensual solution.
In the Angiotech exchange offering, if the desired minimum exchange offer threshold (98% of the principal amount of senior subordinated notes) is not, or cannot be reasonably expected to be, met by the prescribed deadline, the support agreement entered into by the company with more than two-thirds in value of its senior subordinated notes provides for the recapitalization to be effected pursuant to a plan of arrangement under the Canada Business Corporations Act (CBCA), a corporate statute governing federally incorporated companies, or, alternatively, pursuant to a plan of compromise or arrangement under the CCAA, if shareholder approval proved to be an issue. As the Angiotech exchange offering illustrates, where the CBCA arrangement mechanism is available to a company, the company can now replace the threat of a CCAA filing with the threat of a CBCA arrangement process to implement a restructuringwhere the required or desired consensus (unanimity or otherwise) cannot be achieved out-of-court without a process that can bind dissenting parties. This is an important development because the threat of the CBCA arrangement mechanism can be a more effective tool than the threat of a CCAA filing to motivate dissenting holders to co-operate with an out-of-court restructuring. This is because the CBCA arrangement process is generally a quicker and less expensive mechanism to bind dissenting lenders than the CCAA process, management remains in control throughout the CBCA arrangement process and existing equity is more likely to able to preserve some value in a CBCA arrangement, albeit in significantly diluted form, than in an insolvency proceeding where existing equity is at risk of being wiped out entirely. Perhaps more importantly, the CBCA arrangement process generally carries with it less stigma than a CCAA filing because the restructuring under the CBCA process is being effected under a corporate statute and the CBCA arrangement process itself contains a solvency requirement. For these reasons, from a debtor company's standpoint, the CBCA arrangement process can be a more palatable alternative than a CCAA filing and therefore may be viewed as a more credible threat by dissenting creditors who are seeking to leverage their co-operation in an out-of-court restructuring.
It is important to note that there are limitations on the use of the CBCA arrangement process, both in terms of jurisdiction, the types of liabilities that it can be used to restructure and the scope of the stay of proceedings that the court may be prepared to order under the CBCA. Consequently, the CBCA arrangement process may not be available in every case as a viable alternative to the threat of a CCAA filing where an out-of-court restructuring is not achievable.
We have also seen – in connection with exchange offers and also in a number of CBCA arrangements – the use of cash and/or equity sweeteners available to those who tender or consent early as a technique to incentivize affected creditors to support the proposed restructuring or to participate in the new money financing as part of the proposed restructuring. For example, in the Angiotech exchange offer, senior subordinated noteholders are being offered an additional 3.5% equity sweetener if they consent to the terms of the support agreement by the earlier deadline.
Market conditions will continue to cause distressed and over-leveraged companies, their stakeholders and their respective advisors to look to out-of-court solutions to restructure their balance sheets. As such, these parties will be motivated to continue to develop innovative structures, techniques and tools to make the out-ofcourt restructuring mechanism an even more desirable alternative to a formal insolvency proceeding.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.