The restructuring and workout environment in Europe

Martin Gudgeon Shirish Joshi PJT Partners

1. Introduction

The current restructuring and workout environment in Europe is characterised by diversity and complexity, and has witnessed several transformative trends. Steps continue to be taken to make workouts easier and to limit value destruction from financial distress, particularly in the form of revisions to local insolvency laws to make them more reorganisation-friendly within each jurisdiction, and attempts to coordinate and harmonise laws and processes across various jurisdictions. Several characteristics of corporate and financing structures and innovation in financing markets mean that financial restructurings in Europe continue to be complex.

These characteristics include:

• increased complexity in debt instruments, security packages and corporate capital structures;

• a secondary market in loans and other credit instruments that continues to grow;

• credit markets willing to refinance stressed credits with limited levers that creditors can rely on in a downside scenario;

• continued uncertainty and challenged prospects on a macro-economic level in several industries, particularly in terms of timing of recovery on an industry-wide level; and

• an increasing number and variety of credit investors.

In general, the course and outcome of any restructuring process will principally depend on:

• the prevalent insolvency regime, not just in the debtor's jurisdiction of incorporation or where its financial liabilities exist, but also in every jurisdiction where the debtor has material business operations;

• the size and complexity of a debtor's capital structure;

• the number of stakeholders in the company;

• the composition of the company's creditor/lender base;

• the degree of effectiveness of the contractual rights that creditors have against the company, as negotiated in the credit documentation; and

• the availability of alternative financing sources and general health of capital markets and, in particular, the banking system in the relevant jurisdiction.

The European markets have seen a transformation in each of these factors that will have a long-lasting impact on the restructuring environment going forward.

2. Legal environment

Relative to the United States, where Chapter 11 of the Bankruptcy Code is more debtor-friendly, European jurisdictions tend to be creditor-focused, with the exception of certain jurisdictions such as France and Italy. Often, control is ceded to creditors or the courts, either directly or through an appointee. Over the past several years many jurisdictions have made tangible efforts to move away from regimes that almost seemed to encourage liquidation in any bankruptcy and towards regimes that encourage business rehabilitation (where justified), which may be viewed as an attempt to emulate the Chapter 11 framework that has prevailed in the United States. The intent has been to make restructurings and workouts easier to execute by facilitating elements such as super-priority new money financings, binding/cram-down mechanisms and debt-for-equity swaps via legal, rather than solely contractual, means.

Germany was one of the first European countries to implement a new insolvency regime, the Insolvenzordung, in January 1999. Italy has had the Prodi Bis since 1999 and the Marzano Decree, which was highlighted during the Parmalat restructuring, since December 2003. The United Kingdom reformed its insolvency law with the Enterprise Act that came into effect in September 2004. Incremental revisions to local insolvency and restructuring laws continue to take place, including the German Bondholder Act of 2009 (Schuldverschreibungsgesetz) and modifications to the Italian regime in 2010 and the German regime in 2012. France has implemented the procedure de sauvegarde. French restructuring and insolvency law remains debtor-friendly; however, certain amendments (which came into force in 2012 and 2014) and the CGG transaction precedent (where, relative to previous French-based company restructurings, pre-restructuring shareholders were provided a much smaller percentage of the post-transaction equity and more limited new money participation rights, and the vast majority of the post-restructured company was owned by creditors) may suggest a change, slightly rebalancing the bargaining power in favour of creditors. While many of these new regimes have been used on an ad hoc basis, few of them have been tested to the extent where they are sufficiently well understood to cater to the wide range of specific situations and outcomes that are typically seen in restructurings. The European Union in 2015 implemented a new regulation which made amendments to the existing 2002 EU Insolvency Regulation and which was aimed at making the pan-European restructuring and insolvency environment more coordinated and transparent (the 'Recast Regulation').

In contrast to the implied extraterritoriality of the US Chapter 11 process, individual jurisdictional analysis is an important part of European restructurings. For instance, a company may be headquartered in one jurisdiction, with the parent company incorporated in another; conduct business operations, own key assets and owe financial debt in a further half-dozen jurisdictions; and have its primary credit documentation governed by English law. While the overall relationship between the company and its creditors and among creditors themselves will be governed by English law, the efficacy and economic rationality of any enforcement of security or court procedure will be a function of each individual jurisdiction in which the company operates. For instance, certain jurisdictions allow a lender to take security and derive benefit from guarantees granted by other members of the corporate group, but the quantum of any such guarantee is limited to the amount of direct corporate benefit derived by that particular entity as a result of the provision of credit by the lenders.

Further, the test of insolvency or prospective insolvency differs from jurisdiction to jurisdiction, ranging from solely a mechanical balance sheet test to a cash flow test, either in isolation or in conjunction with a balance sheet test. Further, the cost and speed of enforcement action in certain European jurisdictions are quite high, making the threat of enforcement less effective in forcing a borrower or other creditors to negotiate a consensual transaction.

The approach and mindset of the relevant...