Exit Consents in Restructurings – Still a Viable Option?

Exit consents are often used as a restructuring tool by issuers of bonds. Issuers invite bondholders to exchange their existing bonds for new bonds (usually with a lower principal amount). In order to participate in the exchange, bondholders must agree to vote in favour of a resolution that amends the terms of the existing bonds so as to negatively affect (or, in Assénagon, [1] substantially destroy) their value. This is referred to as ‘covenant-stripping’. If the issuer does not achieve the majority needed to pass the resolution, the covenant-strip and the exchange do not happen. But if the resolution is passed, each participating holder’s bonds are exchanged for the new bonds, and the terms of the old bonds are amended to remove most of the protective covenants. This incentivises bondholders to participate in the exchange: accepting the new bonds (even though they will usually have a lower face amount than the existing bonds) may be preferable to being ‘left behind’ in the old bonds, which will cease to have any meaningful covenant protection.

Facts of the case

Anglo Irish Bank Corporation Limited (the “Bank”) suffered severe financial difficulties as a result of the financial crisis, and was nationalised in January 2009. As part of its restructuring, the Bank proposed an exchange offer whereby:

• bondholders would receive €0.20 of new bonds for every €1 of their existing bonds (the “Existing Bonds”) exchanged; and
• participating bondholders would have to vote in favour of a resolution amending the terms of the Existing Bonds. One of those amendments was the inclusion of a provision allowing the Bank to redeem the Existing Bonds at a rate of €0.01 per €1,000 of face amount.

The exchange and amendments went ahead. One of the bondholders that did not accept the offer was a hedge fund called Assénagon Asset Management SA. Its €17 million of Existing Bonds were redeemed for €170.

High Court decision

Assénagon challenged the validity of the exit consent on a number of grounds, the two most important of which were as follows:

Ground 1: At the time of the bondholders’ meeting, bondholders who voted in favour of the resolution held their bonds beneficially for, or for the account of, the Bank

Bond documentation generally includes disenfranchisement provisions, which prevent bonds beneficially held by the issuer from counting in a vote. In Assénagon, a quirk in the timing of the exchange meant that the Bank had notified acceptance of the Existing Bonds offered for exchange the day before the bondholders’ meeting. Because the issuer had agreed to buy these Existing Bonds (and the holders had agreed to sell), the issuer had entered into a specifically enforceable contract to acquire the Existing Bonds, meaning that it had acquired a beneficial interest in the Existing Bonds. So the disenfranchisement provisions prevented them from voting at the meeting. [2]

Ground 2: The resolution constituted an abuse of the power of the majority

Although the judge’s conclusion on the first ground was sufficient to determine the case, he addressed the second given its importance to the bond market. There are some relatively old general principles of English law that limit the power of majorities to bind minorities. In short, they require the power of a majority to bind a minority to be exercised in good faith and in the best interests of the group as a whole. Many of the cases establishing those principles concerned shareholders (i.e., where the majority shareholders are seeking to prejudice the minority). But they are broad enough to apply to bondholder decisions as well.

The application of these principles to debt products was significantly watered down by the High Court in the 2002 case of Redwood Master Fund Ltd and others v TD Bank Europe Ltd and others, [3] which concerned a syndicated loan. The judge in that case decided that the power to bind a minority must be exercised in good faith, but that does not mean that the majority is prevented from approving any change to the agreement that might be prejudicial to other lenders.

In Assénagon, the judge decided that the proposed resolution was designed in substance to destroy rather than enhance the value of the Existing Bonds and was, on its own, of no possible benefit to the bondholders as a class. This could be contrasted with a resolution postponing interest payments, [4] which was capable of being beneficial to the bondholders as a class since it aimed to facilitate a restructuring of the issuer for the benefit of all its stakeholders.

Towards the end of the judgment, it looked like the Court was going to draw a distinction between exit consents that seek to expropriate rights and those that seek to amend them (with only the latter being acceptable). But the judge ended up making statements that cast doubt on whether any form of exit consent could be valid. In doing so, he observed that:

“…oppression of a minority is of the essence of exit consents of this kind, and it is precisely that at which the principles restraining the abusive exercise of powers to bind minorities are aimed…”.

Implications

As English law currently stands, in a collective contract like a bond or syndicated credit agreement, the majority creditors must exercise their power to amend the terms of that contract:

• in good faith; and
• for the benefit of the group as a whole.

It is unclear what level of ‘coercion’ (if any) is permissible before an exit consent will be held unenforceable by virtue of being an abuse of an amendment power. However, some comfort is to be derived from apparent approval in Assénagon of both:

• “drag along” schemes, where dissenting holders receive the same consideration as those participating in the exchange; and
• arrangements where holders are given a second chance to participate in the exchange after the meeting date.

The overall effect of the decision is to increase the risk that a disgruntled creditor could disrupt a restructuring being implemented by way of an exchange offer and exit consent, or use the uncertainty around the process as leverage to negotiate a better deal.

Endnotes:

[1] Assénagon Asset Management SA v Irish Bank Resolution Corporation Limited (formerly Anglo Irish Bank Corporation Limited) [2012] EWHC 2090 (Ch).
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[2] The standard approach in such exchanges (where the acceptance of bonds for exchange is conditional on the passing of the resolutions, with results only announced after the relevant meeting is complete) would prevent any such issues arising in the future.
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[3] [2002] EWHC 2703 (Ch).
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[4] See, for example, Azevedo v Imcopa Importação and others [2013] EWCA Civ 364, which involved the postponement of a payment of interest.
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