Friday Workout

Hard Brexit for UK Restructuring; Oil be Back; Collateral Damage

By Chris Haffenden | Editor | chris@9fin.com

The implications of the hastily agreed and skinny Brexit agreement are now coming into sharp relief for market participants. Financial services were excluded from the deal, but despite this, many UK-based restructuring professionals were blissfully unaware of the consequences, until it was too late. 

Nowhere in the 1276-pages of the EU-UK Trade and cooperation agreement is there a reference to the recognition of UK Insolvency processes, said one prominent lawyer. The lack of failsafe to replace the EU Recast Insolvency Regulation (RIR) at the end of December was arguably a big wake-up call for lawyers and financial advisors which had grown fat on foreign deals coming to the UK since the global financial crisis. 

9fin subscribers had a sneak peak of the main issues in our piece in early January - RIR restructuring recognition rescindment rankles post Brexit, UK practitioners rush to repair damage.

Without a recognition process, there is an urgent need to find alternatives, but there appears to be little movement and appetite at government level, say experts. The recent appointment of Brexit negotiator David Frost to handle relations with the EU has caused dismay in some circles, given prior neglect in dealing with insolvency issues during his negotiations with the EU.

As we flagged last weekgategroup’s convening hearing for its UK Restructuring Plan raised a number of important issues, most notably whether the new UK Restructuring Plan, which came into effect last summer is an insolvency process. It would qualify under a bankruptcy exclusion and the Lugano convention swiss-law jurisdiction clause under the notes would therefore not apply. 

The release of Justice Zacaroli’s convening judgment has provided further angst for legal advisors, most notably Kirkland & Ellis, who took the unusual step of writing to the court following the convening hearing to intervene in the debate. Kirkland & Ellis said it is “firmly of the view that the restructuring plan procedure is not an insolvency proceeding” and that they consider it would be “extremely unhelpful for the court to decide that a restructuring plan is an insolvency proceeding for the purposes of the Lugano Convention.” 

Zacaroli in a lengthy judgment, however, sided with the company. Paragraphs 171-173 are arguably the most important part, noted one lawyer. Zacaroli has acknowledged “that there may be cases where the attempt to compromise plan creditors’ rights against third parties was bound to fail, because that compromise would not be recognised in any of the foreign jurisdictions where it mattered.”

Our initial take on the judgment is available here.

A more detailed version of the issues is available here - a health warning, it may be headache inducing and one for the lawyers only. 

This is a bad day for the recognition of future restructurings in Europe, said a second lawyer. Lugano and the Hague conventions were potential routes to recognition, but had carve outs for insolvency matters, “which means that future UK Restructuring plans cannot benefit from their recognition.”

But the first lawyer believed that Zacaroli’s analysis was correct. Many restructuring professionals were asleep at the wheel over Brexit, the likelihood is that upcoming deals will now require more costly parallel or inter-conditional proceedings, he added. 

Flowering Dutch process

Dummen Orange is likely to be the first example of parallel processes post Brexit. The Netherlands-based flower producer is set to implement a restructuring plan using a UK Scheme of arrangement. 

Sponsor BC Partners and lenders are putting in €50m of new money at a super senior level, in return for a debt/equity swap with lenders taking a haircut at 40, said one lender.

A BC Partners vehicle owns the entire €70m RCF and around 25% of the €425m Term Loan B. The sponsor will retain 51% of the equity and 49% to the lenders, led by ICG and JPMorgan Asset Management. But there is a twist, BC is converting at Par, with the lenders converting at a discount, and not all lenders are signed up to the plan. This leaves it open to a potential challenge, despite more than 75% onboard to pass the Scheme voting threshold.  

Lenders are advised by Latham & Watkins, and the company by Kirkland & Ellis and Rothschild.

In conjunction with the English Scheme, there is a Dutch scheme to enforce on the security and execute the debt/equity swap, said the lender. “We could have gone Dutch only, but as it’s a new process and there are no precedents, the parallel process was chosen.” The English process is quick and tried and tested, Chapter 11 was another alternative, but was seen as too expensive, he added.

This may be the best chance for the UK to retain its dominance. 

The commercialism of the courts and the expertise of judges remains a big draw. Yesterday, panelists on a webinar – Brexit: Aspects on Insolvency & Restructurings from a European view featuring Justice Snowden as moderator and Mark Phillips QC as keynote with legal experts from the UK, Spain and Germany - suggested that the onus is on the UK to find a solution. The current situation is a lose/lose with the US the only likely winner, they noted. 

There are some other options to consider, such as using local agreements – but most governments will defer to the EU regulations first – said one. Potentially a blended approach using UK processes to deal with financial debt and local processes for other matters could be used. But European courts may require the UK to move on the controversial Rule in Gibbs which gives English courts exclusive jurisdiction to vary English Law contracts as a price for cooperation. 

But the most favoured option amongst experts appears to be a solution which involves the UNCITRAL model law on cross-border insolvency. The UK and the US are already signed up – pressure should be applied on governments to join, and for the EU to take part under a global insolvency recognition solution, they suggest. In the meantime, greater cooperation from the judiciary and practitioners will be needed, as the recognition options diminish. 

Oil be Back

Sometimes it is easier to workout businesses as value returns and there is more outlook certainty. The Oil & Gas sector has already seen a number of casualties over the past year, with the worst sufferers from the severe slowdown in Exploration and Production spending being the Rig companies. 

Last week oil hit $60 on recovery and supply hopes, with research houses talking about another commodities super-cycle and the potential for prices to rise further. This is positive news for some of the E&P companies such as Tullow Oil, but this will take some time to feed through into exploration investment, with shale the new swing factor for supply in the meantime. The rig sector suffers from significant oversupply and a number of high-profile operators have undergone or about to undergo restructurings, capacity reductions and consolidation are needed.

After months of forbearance agreements and talks with lenders, one of the largest rig operators is entering into a workout process with Seadrill Limited filing for Chapter 11 in early February.

Seadrill Limited has around $6.1bn of secured debt with another $1.5bn of payment and lease obligations and is around 50x levered on an LTM basis. Unlike most Chapter 11 deals where a plan of reorganisation is submitted and pre-agreed with creditors prior to filing, court documents reveal there are two competing lender groups. A CoCom holding $2bn of debt in six of the 12 secured credit facility silos – wants to leave more debt in the group – whereas an ad hoc group for the remaining six silos disagrees. A restructuring support agreement was dropped by the company on the weekend prior to the filing on objections from the ad hoc group to the $1.7bn post debt load. 

Seadrill Partners filed a couple of months earlier, to protect itself from claims from Seadrill Limited which owns 46% of the equity. It is planning to equitise the entire $2.7bn of debt and will seek “value-maximising” service providers to operate its offshore drilling rigs. 

Largest rig operator Transocean has sought to avoid insolvency via a series of exchange offers and debt buybacks at a discount. 

It is in a legal battle with Whitebox Value Partners who sought an injunction to block an exchange offer swapping a whopping 11 unsecured note tranches totalling $4.95bn into new USD 750m (max size) senior guaranteed notes. The exchange attracted $1.5bn in orders

The fund said it was “fraudulent and coercive” and violated provisions under the $2.25bn 8% senior notes due 2027. The company won in December, but an appeal was lodged in mid-January. This Cleary Gottlieb explainer shows the implications “This is an important decision for bondholders with respect to the ability of corporate issuers to move assets within a corporate group to structurally subordinate investors who elect not to participate in an exchange transaction without violating the terms of the indenture.” 

According to Moody’s, Transocean’s $8.2bn order backlog is the strongest in the sector but suffers from unsustainable leverage and a heavy debt maturity schedule. 

Many smaller operators are now gearing up for workout processes. Dubai-based jack-up rig operator Shelf Drilling has mandated Moelis as financial advisor with bondholder appointments to be confirmed soon. Floatel the rig accommodation operator announced a proposed restructuring in December, with first lien and second lien bonds partially equitized, with the first lien owning 31.1% of the equity on completion, and the second lien into warrants. 

We will take a closer look into the oil services sector in the coming weeks. 

Collateral Damage

One of the hot topics at 9fin, is the amount of collateral coverage for secured creditors and the ability under documents for asset and value leakage. We have had plenty of subscriber enquiries on sponsors' ability to do a “J Crew” to transfer assets out of the restricted group and use them for their benefit, either to issue more debt or leak value via dividends.

While we haven’t seen a Neiman Marcus, My Theresa, event yet in Europe, there have been some warning signs, with Olympic Entertainment’s much criticised land and online business transfer and attempts by McLaren to monetise assets that led to a legal challenge from bondholders.

Financial and legal advisors privately admit that the first things that they look at as company- side advisors are baskets capacity and the asset-sale covenant. Ambiguities in drafting and looseness in event of default language mean that companies are often able to strip value and assets at a time of distress, the very point that creditors require protection. The limiting factor on using these baskets and provisions aggressively is a lack of precedent in the European Market and conservative boards. But conversations are going on, caution advisors. 

Plans by Intralot to grant security to their 2021 SUNs at the expense of the pari passu 2024s could be a sign of changing attitudes. Our known unknowns piece looks at how this could be achieved. 

As covenants loosen, the amount and quality of security is being eroded. This allows plenty of room for security to be pledged for fresh funding using ready availability under baskets. It also creates tension between existing lenders and third-party providers seeking to muscle in with priority funds.

This week, we did a deep dive into Carnival’s debt instruments and were amazed by the latitude under the documents to sweep collateral overboard. 

Our TLDR section below gives a flavour of our report (key points underlined for emphasis):

  • Carnival’s COVID-era debt instruments (as well as the 2027 First-Priority Secured Notes and the EIB Facility, both pre-existing debt instruments granted equal and ratable security with the COVID-era first lien debt instruments) are guaranteed by guarantors representing substantially all cruise-related revenues, EBITDA and total assets. 

  • The Collateral for Carnival’s secured debt instruments generally consists of Guarantor share pledges, 77 vessels (as compared to 88 ships expected to return to service as of November 30, 2020), certain other assets associated with the mortgaged vessels and material IP. The net book value of vessels and IP constituting Collateral was $27.8 billion as of November 30, 2020.

  • Due to the flexibility under the debt documents to transfer value from the Issuer/Guarantors to non-Guarantor Restricted Subsidiaries combined with an overbroad Release of Liens provision, Carnival may be able to transfer Collateral assets to non-Guarantor Restricted Subsidiaries and thereby release those assets from the Collateral package. There appear to be minimal documentary restraints on such a maneuver, as long as it would not constitute a sale of substantially all assets of a subsidiary Guarantor or of the Restricted Group as a whole.

  • Non-Guarantor Restricted Subsidiaries could then use available Debt capacity to raise structurally senior debt.

  • Our analysis also covers Carnival’s ability to make Asset Sales, undertake Sale/Leasebacks and make Restricted Payments and Permitted Investments under its COVID-era debt instruments.

For a copy, please contact team@9fin.com

What we are reading this week