According to Thomson Reuters' Distressed Debt & Bankruptcy Restructuring Q1 Round-up issued in April 2012, EMEA distressed debt restructuring deal volume amounted to €11.45bn in the first quarter of 2012, marking a 57.3% decrease in activity compared to the first quarter of 2011. Financials was the leading sector with approximately 53% of total completed EMEA distressed debt restructuring deal volume.

Nevertheless, European debtors are now forced to find a more substantive cure for their capital structures than the 'extend and pretend' stopgaps that have been so prevalent in the market in the past two years. The deleveraging is present everywhere and the sole question is how deep will it be.

Creditors, therefore, are now ready to accept to replace part or all of their debt in exchange for equity ('debt equity swap'). It could be seen as the last antidote to avoid death!

Although bondholders are usually unsecured and must deal with the company and its senior lenders, they are commonly and actively involved in the discussions and negotiations of restructuring transactions. Given that bonds are considered company debts, whereas shares, although company liabilities, are equity and represent ownership in the company, bondholders cannot be considered as 'normal' company creditors as their debt is part of a collective debt and is represented by a negotiable instrument. Bondholders are linked to the fate of their debtor, usually for a long period of time, and if the company faces financial difficulties, it is unlikely that they will be reimbursed for the interests or even for the principal in the worst case scenario.

However, in distressed situations, bondholders, despite being unsecured, are not totally left without any means and their rights are quite well protected under Luxembourg law. The current wording of articles 79 to 98 of the law of August 10, 1915 on commercial companies, as amended (the 'Law') dealing with bond issuance has been designed to organise and protect the bondholders' body. Obviously, as the interests of bondholders and shareholders differ, the Law granted a wider protection to bondholders, and both the company that issued the bonds (the 'Issuer') and the general meeting of bondholders are allowed to appoint, during the term of the loan, a representative (the 'Representative') with specific powers. In case of multi bond issuance, each bondholders' body may be represented by a Representative.

The crucial role of the Representative

The Law provides that either at the time of the bond issuance by the Issuer or, at any time during the term of the loan's note, one or several Representatives may be appointed by the general meeting of bondholders.

The Law further provides for some exceptions with respect to the appointment of the Representative, i.e. neither the Issuer, nor (i) the companies holding one-tenth or more of the capital of the Issuer or in which the Issuer has a holding of one-tenth or more; (ii) the companies guaranteeing all or part of the obligations of the Issuer; or (iii) the members of the board of directors, of the management board (directoire), of the supervisory board, statutory auditors, external auditors, and representatives of the aforementioned companies can be appointed to this role.

These exceptions reinforce the independent status and the powers granted to the Representative.

The Law has clearly stated the powers of the Representative in case the Issuer appoints it at the time of the bond issuance, in order to protect the bondholders and maintain a certain balance between the rights and duties of the bondholders meeting and those of the Representative. In this context, the Issuer can neither limit these powers, nor extend them while appointing the Representative at the time of the bond issuance.

The main missions of the Representative will be to implement the resolutions adopted by the general meeting of bondholders, to accept on behalf of the bondholders the collateral intended to secure the Issuer's debt, and to take conservatory measures to protect the bondholders' rights.

More importantly, the Representative may be a party to legal proceedings as plaintiff or defendant acting in the name and in the interest of all the bondholders, without it being necessary for the latter to be joined to the proceedings. In this context, once a Representative is appointed, bondholders are deprived from exercising their rights individually and individual actions that have already commenced shall terminate unless the Representative continues such actions within six months after its appointment.

In a distressed situation, an Issuer, facing an action of a bondholder, may be tempted to convene a general meeting of bondholders to have a Representative appointed in order to block such action. In practice, this can be a huge miscalculation for the Issuer, as the bondholders may agree to appoint a 'friendly' Representative who will continue the action, if such action can be useful to all bondholders. In such situation, the Issuer will still have to face the action and deal with a more organised group of bondholders and a Representative.

When a Representative is appointed by the general meeting of bondholders or after a period of six months if it has been appointed by the Issuer at the time of the bond issuance, its powers are freely determined by the general meeting of bondholders, that can either restrict or extend such powers in order to enhance the protection of the bondholders' rights.

In pre-insolvency situations, the role of the Representative is even more essential. As a matter of fact, it shall represent the bondholders in any bankruptcy, suspension of payments, composition with creditors to prevent bankruptcy, controlled management and all similar procedures, and shall declare all the claims in the name and in the interest of the bondholders and prove their existence and amount by all legal means.

The above clearly highlights that the choice of the Representative is the key stone. The general meeting of bondholders may appoint one of the bondholders as Representative, however, a third party, specialised in distressed situations and restructuring, with a good knowledge of the market in which the Issuer is active, may generally be privileged; especially in order to avoid any conflict of interest between bondholders.

Finally, it is also worthwhile to mention that the general meeting of bondholders may dismiss the Representative. The Representative may also be removed for just cause by the judge presiding over the chamber of the district court dealing with commercial matters, at the application of the company or of any bondholder. This seems like a useful crash barrier in order to protect the rights of the bondholders. In a case concerning a company's request to remove the Representative, a court decision dated February 29, 2012 ruled that as bondholders may have diverging interests from the interests of the company, the Representative should be obliged to act independently and without any conflict of interest and the existence of a just cause or not should be assessed carefully.

Despite the fact that the Representative is appointed by the bondholders meeting, the Issuer is obliged by the Law to pay its fees and to reimburse its expenses. This shall also guarantee its independency towards minority bondholders.

Powers of the bondholders meeting

The Law implemented dual powers between the Representative and the bondholders meeting (two separate organs), equivalent in certain aspects to the ones of a sole manager and the shareholders meeting in a private limited liability company.

Actually, the rules applicable to the conducting of the meetings are similar to the ones applicable to shareholders meetings and are determined by the articles of association of the Issuer, the terms and conditions of the bond issuance and the provisions of article 67 of the Law.

The Law provides that the meeting may appoint or remove the Representative and particularly resolve on the conservatory measures to be taken in the common interest, modify or waive the specific collateral granted to bondholders, but also amend the conditions of the issuance.

Notably, the general meeting of bondholders can postpone one or more interest payment dates, agree to a reduction of the interest rate or change the conditions of payment thereof, extend the amortisation period suspend the same and consent to changes in the conditions thereof, agree to the substitution of bonds by shares of the Issuer, and agree to the substitution of bonds by shares or bonds of other companies.

However, the Law provides that decisions concerning the amendments to the interest rate, the postponement of the interest payment date, the extension of the amortisation period and the substitution of bonds by shares of the Issuer or by bonds or shares of other companies, may only be taken if the capital of the Issuer has been fully called. Finally, where the substitution of shares for bonds implies a share capital increase of the company, it may only be executed if the capital increase is resolved upon by the general meeting of shareholders no later than three months after the decision of the meeting of bondholders.

With regards to the securities, the Law provides that the meeting can, in the interest of the bondholders, amend or wave the specific collateral granted to the bondholders. The Law has reserved this power to the meeting of bondholders and not to the Representative. This provision was adopted in order to secure the rights of the bondholders towards the Issuer and the Representative, who will only have the power to accept new collateral, but will be powerless with regards to existing collateral at the time of its appointment.

To summarise the roles of each organ: all measures that could affect the financial rights of the bondholders are resolved upon by the bondholders meetings, whereas the Representative executes its decisions or is only allowed to take conservative measures.

Active role of bondholders in debt Restructuring

In practice, the Representative lacks adequate power to check the Issuer's moves, as it only has the right to attend the shareholders meetings, to read the minutes of debates and to view the shareholders' register, whereas it is denied a direct access to the most important account books. These limitations reduce the Representative's capacity to perceive the company's financial distress and, consequently, to propose a preventive debt renegotiation, which must be approved by the majority of bondholders.

Nevertheless, the bondholders frequently use the sword of Damocles of suing for bankruptcy in order to bring the Issuer to the negotiating table.

Therefore, bondholders, amongst other stakeholders such as shareholders, senior lenders and creditors, are usually deeply involved in debt restructuring negotiations. As a matter of fact, in the negotiations debt equity swaps are commonly chosen as a potential solution. Consequently, although bondholders will partially lose their investment (sometimes a substantial part of this investment), they will receive equity instead of entirely losing their investment should the Issuer go bankrupt.

In practice, such debt equity swap operations are not so easily carried out and the fact that the various stakeholders in the negotiations have divergent interests clearly does not help to find a solution.

Debt equity swaps imply that all stakeholders should agree on the valuation of the Issuer, assess the amount of debt to be converted into equity, agree on the terms of this conversion and the type of equity to be issued, quantify the allocation of new equity between converting bondholders or other creditors and chose a proper mechanism to convert it, while taking into account tax and regulatory aspects. In any case, a report from an independent auditor is necessary to allow such conversion and thus guarantee the stakeholders' protection.

Meanwhile, the consent of existing shareholders will usually be required with regards to the issuance of new shares as they will face a risk of dilution which might lead them to consider carefully and reluctantly a debt equity swap. In case of a capital increase through authorised capital and in view of 'converting bonds into shares', Luxembourg legal authors have controversial points of view regarding the fact whether it could be done only by the board of directors or not.

For listed companies, regulatory requirements will have to be met, as well as disclosure requirements. Relevant thresholds might be reached while implementing the debt equity swap and clearance on regulatory obligations may be required (such as takeover bid, concerted actions, etc.).

Needless to say, this kind of restructuring is time consuming, costly, difficult to implement and in half of the cases it only reaches a deadlock.

However, the advantage of this solution consists in simultaneously reducing the Issuer's debt (and interest payments) and increasing its equity, which may boost its credibility and confidence to seek new financing in order to continue its operations.

Evidence has proven that the stumbling block of this solution has often been the lack of coordination between the bondholders, which may reduce its efficiency due to the high amount of expected negotiation costs further to breach of covenants. Lenders from the banking sectors are usually more organised as from the beginning (acting through facility agents) and therefore costs of negotiations are usually lower and the use of covenants is more efficient.

Facing the worst: do the bondholders have any rights in case of bankruptcy?

It is deemed crucial that in case of bankruptcy or of any similar proceedings, the general meeting of bondholders shall still have the right to appoint a Representative, as it has the power to represent the bondholders in the insolvency proceedings and to lodge their claims. The bondholders have more weight and powers by being represented as a bondholders' body by their Representative rather than by acting individually.

This seems to be a straight forward route as the provisions of the Law in this respect are crystal clear.

Cross-border insolvency and recognition of a Luxembourg Representative

In practice, the Issuer is rarely declared bankrupt or placed under another insolvency proceeding in Luxembourg. In fact, in Luxembourg there is no real efficient in-court restructuring tool. The procedures of suspension of payments (sursis de paiement) and composition with creditors (concordat préventif de faillite), which are used to remedy the situation of the debtor, seem to have fallen into disuse. In the past 10 years there have been no reported cases of suspension of payments or composition with creditors and only one or two controlled management proceedings (gestion contrôlée) are opened every year.

Under such circumstances, the Issuer commonly uses the provisions of the EU Regulation 1346/2000, and, in order to benefit from a friendlier location for restructuring, states that its Center Of Main Interests is not located in Luxembourg. Should the latter occur, it might be more difficult to have the provisions of the Law enforced. Local courts or insolvency practitioners might be reluctant to accept claims lodged by the Representative and not by the bondholders individually.

In conclusion

Despite the fact that bondholders are legally protected and well organised under Luxembourg law, compared to other types of lenders, they quite often fail to achieve a successful restructuring, as most of the time the bondholders individually have divergent interests from the bondholders' body. Nevertheless, Luxembourg with its large amount of Euro bonds continues to be a welcoming and secure country for bondholders.

This article originally appeared in the Global Insolvency & Restructuring Review 2012/13

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