French restructurings: Could a 'high yield' noteholder block a safeguard procedure?

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The issuance of international bond debt, aka high yield notes, has been a very popular financing option for French companies for the last few years, whether it was to finance their industrial investments or to fund an LBO transaction. However, a bond crisis seems to start playing out in Europe[1], which is attested for example by a worrying liquidity decrease for these securities observed in the first half of 2016[2]. A critical question is how this debt will be treated in the event of a safeguard procedure (sauvegarde) opened in France (this analysis being also applicable to a redressement judiciaire).

High yield and safeguard mechanisms

The complex workings of a high yield borrowing is characterised by its international nature. Essentially, a borrowing French company (issuer) will enter into an issuance agreement (indenture) governed by a foreign law, usually the law of the State of New York, providing for the issue of bonds which represent the loan (notes).

This transaction involves mainly four participants: the issuer, the trustee (who schematically manages the loan and is the issuer's contact point in this respect), the custodian (who physically holds the notes) and the beneficial owners (who funded the proceeds of the loan and are those who are the ultimate recipients of the repayment of the notes). It is important to clarify that the beneficial owners, who are often a combination of pension funds, hedge funds and other debt funds, only have an indirect stake in the loan (called book-entry interests, which are bought and sold on the market) and therefore only have a direct contractual relation with the trustee and the custodian, but not with the issuer to which they often remain anonymous.

The opening of a safeguard procedure allows a company in financial difficulty to restructure its indebtedness through diverse measures (debt rescheduling, write-offs, debt-to-equity swap, etc.) which are set out in a draft safeguard plan, subject to the approval of creditors and the court.

When a safeguard procedure is opened in favour of a company of significant size which has issued bonds, French insolvency laws provide that there is a general assembly made up of the entirety of the bondholders (including the high yield noteholders)[3]. This assembly has to vote for or against the draft safeguard plan, at a two thirds majority "notwithstanding any contractual provisions to the contrary and notwithstanding the law applicable to the issuance agreement". This rule of majority aims at preventing a minority creditor from blocking a recovery plan which may be approved by the vast majority of other creditors.

Identifying the right creditor

Should a person want to vote in this assembly, said person should first be qualified as a creditor. In a high yield borrowing, one must ask who is the actual creditor between the trustee, the custodian and the beneficial owners, since each one has its own rights deriving from the indenture.

In connection with the lengthy judicial battle we fought in the Belvedere case a few years ago, the French Supreme court, in what we believe is the only French case law existing on this issue, answered very clearly to this question by ruling in favour of the trustee, or more precisely in favour of the law applicable to the debt obligation[4]. The Court stated that it is "the law of the source of [the debt] that shall define who is the creditor". In other words, since New York law entitles the trustee with the quality of creditor, then the trustee must benefit from all rights that French law grants to creditors. Therefore, the trustee of the notes shall be entitled to file a proof of claim and to vote in the assembly of bondholders, in each case for the total amount of the notes.

Consequences and implications

This satisfactory solution allows the issuer, the court and all of the procedure bodies to benefit from a single interlocutor for the notes during the whole of the safeguard procedure, speaking as a single voice, regardless of the number of beneficial owners and even when the notes keep being exchanged on the market during said procedure.

However, an indirect consequence of this decision is to confer, de facto, a significant amount of power, even a power of obstruction, to potentially each beneficial owner. The restructuring measures which are contemplated in the safeguard plan are indeed deemed to be amendments to the indenture, which amendments the trustee shall not accept without having obtained the approval of the beneficial owners in accordance with the majority rules provided by the indenture. These majority rules can also vary depending on the envisaged modification. In this respect, certain minor modifications only require a simple majority approval, whereas an extension of maturity, a debt-to-equity swap, or a write-off, may require a majority of 90% or even in certain indentures a unanimous decision.

Thus, if the consultation of the beneficial owners results in an endorsement of the safeguard plan with the required majority, then the trustee can express his complete and total agreement of the above mentioned plan at the general assembly of bondholders. On the contrary, if the majority contractually required is not reached, then the trustee has no other option than to reject the plan.

Therefore, the combination of the safeguard mechanism with that of the high yield notes largely neutralises the majority rules provided by French law for the adoption of a safeguard plan, or even an accelerated financial safeguard plan. This indeed leaves the precision of article L.626-32 of the French Commercial code, pursuant to which the two thirds majority rule should apply "notwithstanding any contractual provisions to the contrary and notwithstanding the law applicable to the issuance agreement", ineffective. A beneficial owner who holds less than the third required by law but the minimum required by the indenture (which could even represent a single high yield bond when a unanimous decision is required) would benefit from a potential indirect power of blocking the procedure, and therefore a real negotiation power.

This confers these bonds with a maximum legal protection, which is reassuring for the investors. However it is very likely that, in the face of a blocking situation, an issuer and his judicial administrator would be tempted to explore certain legal options we can think of in order to circumvent this situation and facilitate the adoption of a safeguard plan. Nevertheless, it is clear that none of these legal options have yet been tested in French courts. Consequently, near future restructuring projects should be watched closely, certain players already showing some desire to be a meaningful counterparty in the forthcoming operations.

[1] Les Echos, 17 septembre 2015, "Un mur de dette spéculative à rembourser en 2016"
[2] Les Echos, 24 mai 2016, "La stratégie des gérants face à la dégradation de la liquidité"
[3] Article L. 626-32 du Code de commerce.
[4] Com., 13/09/2011.