The Role and Purpose of an Ad Hoc Committee from the Debtor’s Perspective
As credit conditions have recovered since the financial crisis of 2007–2008, there has been a proliferation of complex creditor structures with multiple stakeholder groups. Capital structures now frequently combine bank debt (with one or more tranches of senior, second lien or mezzanine loans) and bonds (both secured and unsecured tranches). In addition, one of the most impactful developments in the post-Lehman financial landscape is the retreat of traditional bank lenders (primarily as a result of additional regulatory pressure on their balance sheets) and the growth of alternative providers of credit. Although Europe still lags behind the more mature American market, it has been estimated that approximately 20 per cent of all financing comes from sources other than banks, with private debt providers raising in excess of US$98 billion in 2016 alone.
This fragmentation of the credit space, along both structural and participant lines, can make cooperation among stakeholders more difficult, particularly when the debtor faces a distress situation. It has long been well understood that participants in different sections of the capital structure may have different aims and risk appetites (taking an extreme example, providers of super-senior revolving credit facilities compared to mezzanine lenders) but the diversity in creditor type is a decidedly post-crisis development. Providers of alternative credit (whether stand-alone debt providers, hedge funds or divisions of larger investment management firms) may have very different investment theses compared with each other, let alone traditional bank lenders. When secondary investors are added to this mix, it is easy to see why coordination between a group of stakeholders with such diverging motivations can be challenging.
However, in order for there to be any successful restructuring of a debtor, cooperation between multiple creditors and creditor constituencies remains crucial. The rationales expressed in the INSOL Principles remain as relevant today as when they were first published at the turn of the century. As the fourth principle notes:
The interests of relevant creditors are best served by co-ordinating their response to a debtor in financial difficulty. Such co-ordination will be facilitated by the selection of one or more representative co-ordination committees and by the appointment of professional advisers . . . .
This need for coordination, despite increasingly fractured creditor constituencies, has resulted in an increasing prevalence of ad hoc committees in workout situations. This is in contrast to coordination committees or steering committees, which were more common in pre-crisis and immediately post-crisis restructurings. Coordination and steering committees were appointed by the company, with such appointment being confirmed by the lenders, usually based (with adjustment) on the standard form documents released by the Loan Market Association. As such, although the roles of such committees varied from situation to situation, these committees would usually be the principal conduit of information and discussion between the creditors and the debtor. In some, albeit limited, circumstances, certain powers of the creditors could even be delegated to the coordination or steering committee.
It is the multiplicity of creditor interests in today’s capital structures that has caused a decline in the prevalence of coordination and steering committees. The differing creditors and interests in a single facility (let alone across several tranches of debt) are frequently too diverse for there to be easy agreement on the representatives that might form a coordination or steering committee. Furthermore, even if it is theoretically possible that agreement could eventually be reached on the composition of such a committee, debtors have been discouraged by the amount of time required to agree their appointment, particularly as it distracts attention from the restructuring itself.
In contrast, ad hoc committees are self-formed groups of creditors that will coordinate among themselves and the debtor on the implementation of the workout. Although the size of an ad hoc committee can vary (from a minority ad hoc committee to one that holds substantially all the liabilities of a debtor), the crucial difference between an ad hoc committee and a more formal coordination or steering committee is that the ad hoc committee acts unilaterally, and is not representative of the wider stakeholder class. Any attempt to impose additional duties or responsibilities will be rejected. With this reduced scope, ad hoc committees can act more quickly and more flexibly than coordination and steering committees.
The purpose and role of ad hoc committees from a debtor’s perspective: the initial phase
From a debtor’s perspective, the benefits of an ad hoc committee over coordination and steering committees can be crucial. The appointment of a coordination or steering committee could take several weeks. In contrast, ad hoc committees can be established very quickly on bespoke documentation, as they have no obligation to represent a wider class than their own participants. In the initial phase of the restructuring of a debtor, where speed of execution can be critical, an ad hoc committee can play an invaluable role.
In the initial phase of a workout, one of the most important objectives is to create stability for the debtor business. The goal is to avoid any stakeholders, particularly creditors, taking precipitous action against the debtor, which could be value destructive. This need is particularly important if there are, or will imminently be, events of default that will permit creditors or creditor groups to take action against the debtor.
In European multi-creditor financings, the ability to take enforcement action against a debtor will usually require creditors holding at least a majority by value of the relevant piece of indebtedness to act in concert. In addition, if the capital structure is multi-layered, there is frequently an intercreditor agreement that will regulate when junior layers of debt are permitted to take enforcement action (which may vary depending on the type of event of default that has occurred).
If these existing contractual provisions are in place, a debtor may be able to achieve a standstill of its entire capital structure with the consent of a blocking proportion (potentially not even a majority) of, usually, its most senior creditors. An ad hoc group of senior creditors representing this blocking stake can usually organise much faster than a coordination or steering committee (for the reasons outlined above). The speed at which such an ad hoc group can organise and grant the necessary standstills is important because, at this stage, the taking of any precipitous action by a creditor group could permanently damage the prospects of the debtor. If suppliers, customers and employees become aware that a debtor is in financial distress, they may take defensive actions that could push the debtor even closer to insolvency. In contrast, a debtor that can project stability with the support of an ad hoc group sufficient to block any enforcement action from its financial creditors has a significantly improved chance of implementing a successful restructuring.
In some situations, the debtor will need some form of rescue financing to bridge the funding gap between its existing financial difficulties and a comprehensive restructuring solution. However, in a distressed scenario, investors (whether existing or new) will usually not be willing to advance new money without certain protections: particularly an element of priority over the existing debt. Outside of statutory processes (which are frequently undesirable as they usually involve some form of insolvency filing), the easiest way to do this would be to identify unencumbered assets and provide security over them.
However, this is frequently not possible as the debtor will often not have unencumbered assets available. In England, in particular, it is common for the debtor to have granted a floating charge as security over all or substantially all of its existing assets. Furthermore, the debt documents will usually contain a negative pledge forbidding the creation of additional security on already encumbered and, indeed, any unencumbered assets.
The other means by which priority for rescue financing can be achieved will be contractual. One contractual solution is an amendment of the ranking and priority provisions that already govern the existing debt. However, this invariably requires the consent of all lenders, many of whom will be resistant to having their existing priorities diluted. Even if the vast majority of lenders are in favour of permitting the existing security to be primed by the rescue financing, a single creditor, holding a nominal piece of the debt, could block such an attempt.
For debtors, this situation can be extremely frustrating. Once again, ad hoc committees can provide much-needed flexibility. On a basic level, ad hoc committees may be among the most likely providers of rescue financing, as existing investors are both more able to provide new money (since they will be more familiar with the debtor business than a new investor) and more willing (as they have the incentive to protect their existing investment). However, ad hoc committees can also help the rescue financing achieve priority status by means of a contractual turnover. This is where certain of the existing creditors agree to turn over any recoveries from the debtor to the provider of the new money, in priority to their existing indebtedness. As this arrangement is conducted outside the contractual provisions that already govern the existing debt, it will not require the consent of the existing creditors (albeit this will only bind the creditors that are willing to grant the priority).
In this case, again, the speed of execution offered by an ad hoc committee is significant. The availability of new money is frequently delayed because even those that are not providing the new money will need credit approval for diluting their priority. When this is required for every single creditor in a capital structure, the delay can be substantial. As the need for rescue financing is, almost by definition, time critical, the ability for a smaller ad hoc committee to approve such an arrangement is of significant benefit to the liquidity-constrained debtor. Furthermore, if the ad hoc committee holds a sufficiently senior or large position in the capital structure, the priority accorded to the rescue financing may not be significantly worse than an amendment to the existing ranking and subordination provisions.
When a debtor is distressed, one of the key focuses of the management team will often be disclosure of information. If a debtor is listed or has listed securities, its disclosure obligations will be determined by the regulations governing such listing. However, for a private company that does not have listed securities, management will usually resist as much as possible any public disclosure of the business’s financial difficulties, its fear being that such disclosure will increase the debtor’s financial distress (for example, customers and suppliers may impose harsher conditions, or even stop trading with the business altogether). However, at the same time, the initial phase of any restructuring is particularly concerned with gathering information to allow stakeholders to formulate the contours of a potential restructuring. It is during this period that the balance sheet of the debtor needs to be established, the group structure is confirmed, ranking of various creditor claims is determined, the strategy of the business is reassessed, cashflow forecasts are performed, discussions with management are engaged in, and so on.
However, unlike the debtor, creditors will not want to indefinitely retain information relating to the debtor that has not been disclosed to the wider creditor community indefinitely. This is one of the areas of most protracted negotiation when dealing with creditor committees, both coordination and steering committees or ad hoc committees, as having non-public information regarding the debtor usually restricts such creditors from being able to trade their debt. However, from the debtor’s perspective, dealing with an ad hoc committee can give slightly more flexibility with regard to information disclosure than when dealing with a coordination or steering committee. Coordination and steering committees will usually need to negotiate significant protections around disclosure of information. These relate not just to when information can be disclosed to the wider creditor community, but also to protection from any liability arising from the accuracy of information or from reliance by other creditors on the information disclosed. In contrast, ad hoc committees, since they are acting simply on their own accord without owing any duties to the other creditors, will usually be focused only on the timing of the information cleansing. Being able to concentrate on this single issue usually helps debtors shorten the time needed to negotiate a satisfactory information cleansing regime when negotiating with an ad hoc committee, rather than a coordination or steering committee.
The purpose and role of ad hoc committees from a debtor’s perspective: the main phase
Once the debtor business has been stabilised such that there is sufficient runway for a more comprehensive restructuring to be negotiated and implemented, the debtor can begin to engage with the ad hoc committee to determine the terms of such workout.
One of the main roles of an ad hoc committee from the debtor’s perspective is to facilitate the negotiation of the restructuring. The extent of the ad hoc committee’s role here will largely be determined by its size, constituents and the range of restructuring options that the ad hoc committee is able to implement without the consent of any third party. If, for instance, the ad hoc committee controls enough of the debtor’s capital structure such that, with its consent, a sufficiently wide-ranging restructuring of the debtor’s liabilities could be implemented to return the debtor to profitability, the debtor may not need to negotiate with any other creditor group. If the ad hoc group is particularly confident in its ability to deliver a meaningful restructuring, it is possible that it will develop its own restructuring proposals before engaging with the debtor.
The ad hoc committee’s ability, and thereby negotiating leverage, may be increased by resorting to some form of cramdown mechanism, which potentially allows an ad hoc committee to implement amendments to a debtor’s capital structure that would normally require unanimous creditor consent.
In contrast, if the ad hoc committee is insufficient to deliver the necessary restructuring on its own (whether or not employing a cramdown process), the role of the ad hoc committee shifts. Instead of being the sole focus of negotiation with the debtor, the ad hoc committee becomes more of a working group that, along with the debtor, will develop a restructuring proposal that it can support. In this role, both the debtor and the ad hoc committee will, in the process of developing the restructuring proposal, need to keep in mind whether or not the proposal will be acceptable to the rest of the creditor syndicate. Particular issues may arise depending on the make-up of the wider stakeholder group whose support is needed to implement the proposed workout. For instance, a workout that involves equitisation of debt may not be possible for CLO creditors.
Once a restructuring has been agreed between the debtor and the ad hoc committee, such agreement is frequently evidenced by entry into a lock-up agreement or restructuring support agreement. These documents are undertakings by the debtor and the ad hoc committee participants to take all reasonable and necessary actions to implement the terms of the agreed restructuring, with the principal terms of the proposal appended to the document in a term sheet. This support is crucial, as when the restructuring proposal is disseminated to the wider creditor syndicate, the debtor can announce that it already has the support of the ad hoc committee. If the ad hoc committee is sizeable, such support can generate enough momentum that the remaining stakeholders will regard the proposed restructuring as a fait accompli. Such support significantly dampens the prospect of any resistance to the restructuring. In contrast, without the anchor support of an ad hoc committee, a debtor would be forced to either negotiate the restructuring with every single creditor whose support it needs (impractical in most multi-creditor financing structures) or be forced to launch a restructuring proposal with a far more uncertain probability of success.
Engagement with the wider creditor group
Although ad hoc committees will resist any implication that they represent any constituency wider than their own members, they can nonetheless be useful to the debtor as a means of communicating with the wider creditor group. Although the debtor may be familiar with its relationship lenders, this may be of limited utility in a distress situation, given the original underwriters may have syndicated widely and that the debt is likely to have been traded to distressed investors (being the most likely buyers of such debt). Furthermore, most debtors and their management teams may not have experience of stressed or distressed situations, and, therefore, may not have relationships with common participants in such scenarios (such as the distressed debt investors, laws firms and financial advisers that operate in this space). In contrast, ad hoc committees will usually contain at least some participants who are familiar with market participants in this area, and may be willing to assist the lender in communicating and coordinating with the wider creditor group.
In this regard, ad hoc committees can also be useful in encouraging other creditors to engage with the debtor, rather than taking any form of unilateral action. If the ad hoc committee forms a blocking stake (as per the discussion regarding stability above), this will deter other lenders from opposing the committee and the debtor, as they will not be able to effectively take unilateral action. This will be further emphasised if the ad hoc committee constitutes a material proportion of the debtor’s financial creditors and such group has commenced discussions with the debtor to support their investment. Instead, it encourages other creditors to engage with the debtor or the ad hoc committee in seeking to have their views on an outcome taken into account.
As discussed above, a key role of an ad hoc committee in distressed and deteriorating businesses is the provision of rescue financing in the initial phase of the restructuring. However, the provision of new money is equally key as part of the post-restructuring capital structure. In fact, this is a critical role in most restructurings, and the existence of a functioning committee should make negotiations more efficient. We examined the considerations in more detail above, and at the risk of repetition, from a debtor perspective, ad hoc committees are among the most likely providers of new money financing. Even if the members of the ad hoc committee do not end up providing the new money financing as part of a restructuring, their consent will almost certainly be needed for any provider of rescue financing to achieve priority status (which they will almost certainly require).
A single coordinated committee can assist in reducing fees. It is a market custom, and often required in pre-existing facility documentation, that the debtor pays the costs of creditors in connection with an event of default or in connection with any realisation or enforcement of the transaction security. Obviously, the debtor is keen to minimise these fees, given its financial situation. An ad hoc committee will need to engage its own set of legal and financial advisers. However, the debtor can indicate to any small lenders that an ad hoc committee has been formed and is being advised. This obviates the need for the debtor to cover the cost of any additional advisers for smaller creditors, as the company can inform other creditors that any enquiries or requests should be made to the ad hoc committee.
Minority ad hoc committees
So far, we have focused our discussion on ad hoc committees that have formed and work alongside the debtor to achieve a successful restructuring. In general, though not always, these ad hoc committees will tend to represent at least a majority of a debtor’s most senior tranche of indebtedness, as they will have the greatest ability to deliver a workout. However, another use of ad hoc committees is to form frustrating ad hoc committees, which band together to protect themselves from adverse action. In contrast to those that we have already discussed, minority ad hoc committees usually consist of creditors that form less than a majority. As stated, their goal is usually to protect themselves from an attempt at what they perceive as coercive action by the debtor or the majority creditors. They attempt to do this in a number of ways.
Blocking group: debt documents
In a European context, the threshold needed to amend loan terms is most commonly lenders holding 66.66 per cent of total commitments for all amendments other than fundamental ones (principal or interest reduction, change in payment date, changes to the security, and so on), which will usually require the consent of all lenders. For bonds, these thresholds are most commonly 50 per cent and 90 per cent, respectively. As such, an ad hoc committee holding a relatively small percentage of the underlying debt can block fundamental amendments to debt documentation. As more comprehensive restructurings of highly leveraged debtors will typically require fundamental amendments to the debt documents, the existence of a blocking ad hoc group can severely hamper the ability of the majority creditors and debtor to effect a restructuring.
Blocking group: statutory processes
To address the hold-out problem outlined above, debtors and majority creditors have recourse to cramdown mechanisms. In the United States, this would, of course, be through Chapter 11 of the Bankruptcy Code. Increasingly in Europe, the preference is to use an English scheme of arrangement. Other cramdown proceedings include the Spanish homologación and French sauvegarde. What each of these procedures have in common is that they require the consent of a certain majority of creditors in support of a proposed restructuring. For example, a scheme of arrangement requires the support of a majority in number of creditors holding at least 75 per cent in value of the liabilities being compromised by the scheme. Similar thresholds apply to other procedures. If the necessary thresholds are achieved, the proposed restructuring will bind even creditors that did not vote in favour of the plan.
A debtor and its supporting creditors, therefore, need to be aware of the composition and views of the creditors it is trying to cramdown, in order to understand the potential leverage of a blocking ad hoc group.
One of the most significant ways a minority group with or without a blocking stake can seek to alter the course of an existing proposal is through the submission of an alternative restructuring proposal. In fact, in most jurisdictions, a creditor complaining about an existing proposal in the face of a debtor experiencing an unavoidable deterioration in performance and potential insolvency is unlikely to be sufficient to garner enough support (whether of other creditors, the court or court-appointed officers, or an insolvency practitioner) to challenge the proposed restructuring. What is usually more successful is an alternative proposal that may attract support from other stakeholders.
One example of this is that of Klöckner Pentaplast, the German plastic producer. In that situation, the first lien lender committee had agreed a restructuring where the first lien lenders would take control of the debtor, wipe out its junior lenders, and sell a piece of the equity back to the existing owner. However, an ad hoc committee of junior lenders proposed their own restructuring, where they would take control of the debtor, repay the senior lenders, and disenfranchise the existing owner. Ultimately, the junior ad hoc committee was successful over the first lien lender proposal.
If an opposing deal cannot be blocked and an alternative proposal does not gain traction, minority creditors may still form an ad hoc group and use the coalition to seek to challenge any proposal on grounds particular to their cause. Most jurisdictions will afford genuinely aggrieved stakeholders an opportunity to challenge a restructuring that overrides their existing contractual rights. This is an essential check to the power, under the relevant statutory process, for majorities to bind dissenting minorities against their will.
From a debtor’s perspective, the issue with such challenges is not just the substantive risk that the proposed restructuring will be derailed. A further complication is that, even if the litigation challenge is ultimately unsuccessful, the time it takes to dispose of the challenge could significantly extend the timetable needed to complete the restructuring. If the financial condition of the debtor continues to decline, this may be time the debtor does not have, forcing it and the majority creditors to compromise with the dissenting ad hoc minority.
As we have seen, the sheer diversity of today’s financing landscape has seen a decline in coordination and steering committees and an accompanying increase in ad hoc committees. The flexibility of ad hoc committees, both from a formation and role perspective, has meant that they are far more adapted to deal with the range of creditor interests prevalent in multi-creditor distress situations. Debtors will need to keep a close watch on ad hoc committees that form to address the emergence of a distress situation: ad hoc committees can be invaluable partners in the implementation of a successful restructuring, but can also pose a range of challenges.