Corporate restructuring report: McCann FitzGerald
Stephen FitzSimons looks at debt for equity transactions as a form of financial restructuring.
There has been much media speculation in recent times regarding potential debt for equity swaps involving distressed companies and their lenders. Put simply, a debt for equity swap involves a creditor of a company (typically a bank or bondholder) agreeing to reduce the amount of debt due to it by converting all or part of the outstanding debt into shares in the company.
To date, there have been a few high-profile debt/equity swaps involving Irish public companies. We have also seen a small number of debt/equity swaps involving Irish private companies.
However, these transactions can give rise to a number of issues which, for the reasons outlined below, can make them difficult propositions for the parties concerned.
Recent debt/equity transactions have tended to share some common characteristics such as: the debtor company has large debts which it is unable to service in the short-to-medium term; the company's long-term business model is viable if debt levels are reduced to more realistic levels (rather than simply being restructured); a restructuring of the company is more likely to realise value for creditors than an insolvency; and new or existing investors are prepared to inject new money into the company.
There is no pre-ordained structure for these transactions. That will be largely determined by the existing debt and equity profile of the company and the requirements of lenders.
From a lender's perspective, debt for equity swaps give rise to two main issues. Firstly, banks prefer not to take significant or controlling stakes in businesses. After all, their role generally is to lend to businesses, not control and manage them.
More importantly, a lender will be keen to avoid consolidating the debtor company in its annual financial statements. Lenders will also be wary of potential HR issues (for example, where there are significant differences between the terms and conditions of its employees and the employees of the borrower).
From a regulatory point of view, a bank will need to consider whether the size of the proposed stake gives rise to capital adequacy issues or requires consent from the Financial Regulator or (for those banks that are subject to the State Guarantee Scheme) the Minister for Finance.
Secondly, the banks have their own financial positions to consider. This means that many banks will be sensitive to the loss of priority on any subsequent liquidation in respect of the sums converted into equity. More importantly, they will be extremely reluctant to approve any restructuring proposal which involves any significant debt write-off, since that write-off will have a direct impact on the bank's own capital position. This reality can be a real stumbling block, particularly where a distressed company is worth substantially less than its debts.
In private companies, new shares issued as part of any restructuring will dilute existing shareholders and, depending on the rights attached to those new shares, may effectively eliminate any value for the existing holders. Typically, the articles of association of a private company and/or any shareholders' agreement will require that existing shareholders must consent to the restructuring before it may be implemented. In the case of listed companies, any new shares will typically rank alongside existing listed ordinary shares. However, shareholder approval may also be required for any share issue. Obtaining consent in either case may prove difficult.
Two of the most high-profile debt for equity swaps in the last year involved Independent News & Media (INM) and Payzone. The complex restructuring of INM comprised a number of elements, including a debt/equity swap with bondholders, asset disposals and new senior debt bank facilities. The equitisation of the company's €200m bond was accomplished by an issue of shares to bondholders in satisfaction of €123m of principal and accrued interest, with the balance of the amount owing under the bond being satisfied from the proceeds of a rights issue. Following completion of the restructuring, bondholders held over 40% of the company's equity.
Whilst the INM restructuring involved a substantial dilution of existing shareholders, the Payzone restructuring saw most shareholders in the formerly AIM-listed company ceasing to have any interest in the restructured business. As part of the restructuring, Payzone's seven bank lenders agreed to a debt for equity swap which saw them becoming shareholders in a new holding company, together with Duke Street Capital (which made a total equity investment of €45m) and management. The transaction saw the restructured group's level of senior secured debt reduced from approximately €300m to €77m.
Given the above issues, debt for equity swaps have not been as common as might be expected from the level of media coverage they generally attract. However, it is interesting to note that we have seen quite a few instances where banks have agreed to waive breaches of financial covenants in loan documents in return for small equity stakes or warrants to subscribe for small equity stakes. This is attractive to banks since it generally does not involve a write-off of any amounts owing (although it is of course not a proper debt for equity swap).
As this article goes to print, there is speculation regarding a number of further debt for equity transactions and it will be interesting to see whether the improving economic situation allows banks to take a different approach in the months ahead.
Stephen FitzSimons is a solicitor in the Corporate Finance Group at McCann FitzGerald. For more information, log on to www.mccannfitzgerald.ie
