Shifting Sands: Creditor Alignment, Cohesion and Committees in Large Value Insolvencies Doug McIntosh Janis Sarra Edward Sellers Derrick Tay Insolvency Institute of Canada Annual Conference & General Meeting September 8-11, 2011 1
INTRODUCTION There are fundamental differences in circumstances, characteristics, conduct, roles and expectations among creditor interests in any restructuring. In large value restructurings, those differences are becoming more pronounced and having a greater impact on how matters are resolved. 2
INTRODUCTION (cont d) Outline: Primary characteristics of creditors Nature of their interests and expectations Material impacts from how they operate Discuss: Challenges /conflicts created by varied characteristics, interests and expectations Appropriateness of legislative amendment 3
THE PLAYERS AND THEIR INTERESTS Single Source/Club Deals Syndicated Senior Credits Initial Lenders Secondary Holders Indenture Debt CDS Counterparties 4
Single Source/Club Deals Traditional relationship model typically with one primary borrower and multiple facilities Mostly Canadian chartered banks, credit unions Interests: Keep issuer leveraged Provide ancillary services and products Loss avoidance or minimization Avoid converting debt to equity Thin secondary market 5
Syndicated Senior Credits Single Agent with multiple borrowers, multiple facilites and a mix of lenders under one set of credit documents Large number of lenders (can exceed 200) Non-traditional lenders Different participants in separate tranches with differing maturities First lien/second lien interests OID, multiple currencies Significant growth in secondary market trading 6
Syndicated Senior Credits (cont d) Initial Canadian lenders typically Have or want a relationship with issuer for ancillary services Avoid or minimize loss, keep issuer leveraged and avoid converting debt to equity Concerned about collateral impacts of insolvency More likely to waive default or amend credits 7
Syndicated Senior Credits (cont d) Other initial lenders typically Have no relationship with issuer and do not provide ancillary services Avoid or minimize loss, keep issuer leveraged and avoid converting debt to equity Less concerned about collateral impacts of insolvency May waive default or amend credits 8
Syndicated Senior Credits (cont d) Secondary holders typically Have no relationship with issuer and do not provide ancillary services Hold at a substantial discount to face value and look to negotiate a return Many are prepared to convert debt to equity Far less concerned about collateral impacts of insolvency May not waive default or amend credits 9
Indenture Debt Initial institutional and retail holders typically Have no relationship with issuer and do not provide ancillary services Avoid or minimize loss, keep issuer leveraged and avoid converting debt to equity May hold at a discount to face value as OID Less concerned about collateral impacts of insolvency May waive default or amend credits 10
Indenture Debt (cont d) Secondary holders: Similar characteristics as syndicated senior credit in secondary market Retail: rarely participate in negotiations/proceedings May require solicitation 11
CDS Counterparties Syndicated senior credit and indenture debt holders frequently hedge their large value credit risks with credit default swaps ( CDS ) Lack of transparency in CDS market Lack of public record and cascading swaps make claim holders invisible Challenging for solicitation of support for waivers, amendments, other collective action and plan support 12
CDS Counterparties (cont d) Economic interests become bifurcated Extreme case sees holder of credit protection on un-owned loans buy loans to force default Decreased incentive to engage in oversight Collection risk is against CDS seller not borrower May stand to benefit from bankruptcy of issuer Higher collection on swap than on credit Abitibi holders pushed for CCAA and then exited via ISDA auction 13
HOW THEY OPERATE Amendments to Credits Exit and Workout Options Restructuring Influence 14
Amendments to Credits Club Deals Bi-lateral discussion requiring agreement of a few lenders Syndicated Senior Credits Agent effects all administration and changes May have a Steering Committee Voting thresholds matter Unanimity provisions are a veto outside proceedings 15
Amendments to Credits (cont d) Indenture Debt Trustee effects formal administration and changes May have an Ad Hoc Committee of holders Voting thresholds matter Unanimity provisions are a veto outside proceedings 16
Exit and Workout Options Options for lenders have increased due to active secondary market Attempt to extend or restructure with view to increasing revenue and recovery at later date Sell debt and security at discount Enforce CDS Compensation not limited to actual loss Cash vs. physical settlement Enforce rights and liquidate collateral 17
Restructuring Influence Committees Club Deals Just lenders and their credit officers Syndicated Senior Creditors Agent and/or Steering Committee of lenders Asymmetrical information flow Indenture Debt Ad Hoc Committees, with holders trading in and out Professionals get restricted information holders allegedly get no material non-public information 18
Restructuring Influence (cont d) Secondary holders Buying debt/equity across classes and entities Buying single class debt through several entities Focus on short term ROI Foreign based claimants Jurisdiction to bind depends on Debtor(s) COMI Foreign main vs. foreign non-main proceeding Attornment Ancillary proceedings (i.e. Chapter 15) 19
CHALLENGES AND CONFLICTS Conflicts created by Economics Control Capacity Process Residency 20
Economic Interest Conflicts Initial and secondary holders vary on priorities, value and what is needed to avoid a loss/receive a return Agent motivated by Fees for creating, closing, selling and administering sustainable credit Provision of ancillary products and services to issuer 21
Economic Interest Conflicts (cont d) Initial holders concerned with Credit-worthiness Initial rate of return Provision of ancillary products and services to issuer Loss avoidance or minimization Secondary holders Concerned with generating a substantial return Arbitrage holders vs. enterprise holders Widely divergent acquisition pricing 22
Control Conflicts Covenant compliance DIP facilities; support agreements; plan sponsor agreements Voting thresholds Classification and vetoes 23
Capacity Conflicts Holders of multiple positions in capital structure ( cross dressers ) Not generally required to disclose information Are subject to compliance with securities laws and orders of the supervising court Uniforet Stelco 24
Capacity Conflicts (cont d) Can hold and vote an interest in one capital pool without regard for their other interests or hedge them Buy unsecured debt quietly and then buy equity publically Buy unsecured debt to control the class and confer benefits on another class (Uniforet) No majority of the minority test in debt securities 25
Process Conflicts Sales/Credit Bids Secondary market for debt = value decisions in hands of market participants Bias in favour of maintaining debtor as going concern regardless of value conflicts with that authority 26
Process Conflicts (cont d) Creditors Committees Assumes homogeneity Ignores CDS, collateral interests or desire to remain unrestricted in trading Assumes fully instructed professionals Ignores lack of restricted principals Anonymity and low direct transaction costs to creditors can make it tactically advantageous to block agreements 27
Residency Conflicts Secondary market participants primarily in US Limited regard for societal or collateral impact of insolvency Jurisdiction to bind depends on Debtor s COMI Foreign main vs. foreign non-main proceeding Attornment Ancillary proceedings not readily available outside North America 28
Legislative Reforms? Status disclosure Creditor registries Record dates Automatic stay Limited first day impact Voting alignment Classification Majority of minority 29
Conclusion Questions and Discussion 30