COVID-19: Debt restructuring and acquisition of distressed businesses and real estate assets

06 April 2020

A borrower who, without having the right to do so, would not pay a credit instalment due between 12 March 2020 and one month after the end of the state of health emergency (which is supposed to last two months as from 24 March 2020 but could be extended), could argue that the loan documents' acceleration clause and default interest clause (a liquidated damage clause) shall only take effect after that period pursuant to Ordinance No. 2020-306 of 25 March 2020, adopted further to the "emergency" Law No. 2020-290 of 23 March 2020.



This measure, together with the deferrals granted by banks, the exceptional credit facilities granted by BPIFrance Financement (cash credits, seven-year "rebound" loans, three to five year "advantage" loans and guarantees covering 90% of outstanding principal of certain bank loans, etc.) and certain other government subsidies, aims to protect businesses' cash.

Unfortunately, what is today a cash problem could turn into a solvency problem as the sanitary crisis morphs into an economic crisis.

Depending on the sensitivity of their business or real estate asset to the economic cycle, borrowing entities may become unable to pay their loan instalments or to comply with their financial covenants (interest coverage ratio, debt service coverage ratio, leverage ratio, LTV ratio), despite waiting until the last day permitted under the loan documents before submitting their financial statements and ratio certificates. Other events of default may occur sooner: a material adverse change, a cross-default in respect of debts to suppliers, a partial cessation of activity, etc.

In this context, negotiations will have to be undertaken in furtherance of either a) a restructuring of the debt or b) the disposal of the business or real estate asset, which could take place ideally with the assistance of an ad hoc administrator or a conciliator but possibly within the framework of an insolvency proceeding.

Debt restructurings

One solution, so-called "amend and extend", would consist of negotiating an amendment whereby the lenders waive outstanding event(s) of default and the debt is restructured (amortisation profile, margin, commission, new securities, milestone date for resale, fiducie).

In more complex situations, creditors may even be willing to grant additional facilities ("new money"), assuming the money invested will increase the value of the business or asset by a greater amount.

Disposal of the business or real estate asset

Another solution could be selling the distressed business or real estate asset so that the sale proceeds are distributed among the lenders and the borrower or, in case of a share deal, the borrower's shareholders (the "sponsors"). It should be noted that the purchaser could be:

  • a third party (where it would be a true sale, whether a negotiated sale or an auction sale, voluntarily agreed or further to the enforcement of security interests); or
  • the lenders themselves (where it would take the form of either a mutually-agreed share assignment, a payment in kind, an attribution further to the enforcement of security interests or a swap of debt and asset or equity); or
  • the sponsors themselves (it being noted that in this case the transaction would likely be structured rather as a debt forgiveness corresponding to the difference between the outstanding debt and the value of the business or real estate asset or, more likely, a debt buyback by the sponsors at a discounted price equal to the value of the business or real estate asset if lesser than the nominal amount of the outstanding debt).

Lenders may accept that the sponsors receive a small share of the proceeds of the sale of a business or (albeit more rarely) a real estate asset even if these proceeds would not be sufficient to fully repay the lenders. It may indeed be iappropriate to financially incentivise the sponsors to cooperate. Thsi would ensure that the sale is completed at the best price possible, such as by contributing to the data-room that will be available to potential buyers, and for continuing to operate the business or maintain the real estate asset pending its sale to avoid any operational loss of value.

In case of sale of a distressed business with LBO debt, potential buyers would therefore be invited to make a purchase offer for a priori, the shares in the holding company that issued the most junior debt, and to put forward an enterprise value which, when added to the business' cash and cash equivalents, will represent a total sum to disburse and allocate among:

  • the sponsors, as payment for the price of the shares and shareholder loans;
  • the mezzanine or even senior lenders who agreed to sell their loan/bond debt at a discount, as payment for the price of such loan/bond debt;
  • senior lenders, suppliers, the tax and social security administrations and the other creditors who it is agreed must be fully repaid, who will be reimbursed by the borrowing company with funds injected in the borrowing company by way of a new shareholder loan granted by the buyer.

Transfer taxes as well as fees and expenses of advisors and intermediaries (conciliator, lawyers, investment banks etc) shall also be budgeted for as transactions costs.

The offer may also provide for the injection of an additional amount – "new money" – through a shareholder loan, in order to enable the company to resume or increase its earnings (key investments, working capital requirements, etc.).

Following the completion of a purchase, the target group could be simplified and the acquired bonds and loans converted into capital.

Ad hoc administrator or (then) conciliator

A debtor may seek the appointment of a judicial administrator (administrateur judiciaire) as an ad hoc administrator (mandataire ad'hoc) or (then) as a conciliator (conciliateur) in order to facilitate negotiations among sponsors and creditors in furtherance of restructuring the debt or selling the business or real estate asset at the best price possible with sponsors being remunerated for cooperating with the sale process and maintaining the business or real estate asset in operation.

The main contribution of an ad hoc administrator or conciliator is to facilitate, by making it more transparent and efficient, the negotiations between creditors and sponsors. It is in the best interests of both creditors and sponsors that the business continues to be operated or that the real estate asset is maintained in a way that will maximise its value in case of sale in the short, medium, or long term. The ad hoc administrator or conciliator should:

  • have financial skills in order to understand the business model of the company (its working capital requirements, any seasonality factors etc.) or real estate asset (capex and opex budgets, etc), as well as its potential value given the possible value creation drivers versus its liquidation value;
  • have legal skills in order to assess the strengths of the security interests available to the various creditors and their effectiveness, should the negotiations fail and an insolvency proceeding be opened (guarantees, in rem security interests with a right of retention[1], "double luxco" share pledges, golden share, fiducie, etc.);
  • understand the stakes, limitations, costs and timetables for implementing solutions such as the sale of a business or real estate asset in order to be able to frame negotiations in respect of such solutions;
  • be proactive and lead the parties involved towards a realistic solution.

Furthermore, an advantage of opening a conciliation proceeding is that a debtor that is sued or receives a formal notice before action can ask for payment deferrals to the court pursuant to articles 1244-1 to 1244-3 of the Civil Code, which payment deferrals will also avail to its guarantors.

Additionally, in the event that the parties negotiate a debt restructuring, the lenders of "new money" will benefit from a lien in the event of a court-homologated conciliation agreement.

Insolvency proceedings

If the negotiations fail, the debtor who, without being in cessation of payments, "justifies difficulties which he is unable to overcome", may request the opening of a safeguard (sauvegarde) proceeding.

If the debtor is in a state of cessation of payments, he must within 45 days request the opening of a conciliation proceeding or make a declaration of cessation of payments to the clerk of the commercial court ("déposer bilan"), which will result in either:

  • the opening of judicial recovery (redressement judiciaire) proceeding or;
  • the opening of a judicial liquidation (liquidation judiciaire) proceeding (if recovery is clearly impossible because the situation is said to be irremediably compromised).

A cessation of payments occurs when the debtor is "unable to meet due and payable liabilities with available assets". Due and payable liabilities include debts immediately payable (even if the creditors did not claim them) but do not include debts that reached their maturity date but are subject to a moratorium. Available assets include liquid assets and assets that can be immediately sold as well as credit reserves, but do not include real estate assets, inventory and goodwill.

In the event of a safeguard or judicial recovery proceeding, an observation period will open during which all payments will be prohibited (unless offset against a related claim) and it will be possible to negotiate a debt restructuring with a view to adopting a safeguard or conciliation plan or to agree on a sale (although a total disposal plan cannot be included in a safeguard plan).

Such a proceeding is more cumbersome than an ad hoc administration or conciliation proceeding. Moreover, as this proceeding is not confidential (unlike an ad hoc administration or conciliation proceeding), its impact on customers, suppliers and potential buyers is often negative, at least in the early stages.

A safeguard or judicial recovery proceeding will however present an advantage with the forthcoming transposition (by way of ordinance further Law No. 2019-486 of 22 May 2019, known as the "Loi Pacte ") of European Directive 2019/1023 of 20 June 2019 on preventive restructuring frameworks, discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt - that of allowing senior creditors and sponsors to negotiate debt restructuring while protecting themselves against abuse by junior creditors.

Our restructuring team brings together specialists in, among others, finance, litigation, corporate, employment and real estate law. It regularly assists creditors (lenders, lessors, suppliers), purchasers and sponsors (particularly in the real estate sector) with the debt restructuring and contract negotiations and the acquisition of distressed businesses and real estate assets.

Footnotes

[1] Actually, a distinction must be made between so-called "real" and "fictitious" rights of retention, the latter being called as such because they are granted to beneficiaries of non-possessory pledges by Article 2286, 4°, of the Civil Code. The latter may exercise this right in the event of an isolated sale or disposal plan in the context of a judicial liquidation proceeding (Article L. 642-25 of the Commercial Code) but they may not exercise it in the event of a sale during the observation period or the safeguard or recovery plan in the event of a safeguard or judicial recovery proceeding unless there is a sale of the business (Article L. 622-7 of the Commercial Code).


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