Distressed real estate – the ways out

March 2024 | SPOTLIGHT | BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

March 2024 Issue

All over Europe and beyond, real estate markets are in trouble. The rapid increase in interest rates in most jurisdictions after a long period of them remaining at low levels, has resulted in continuous high demand and, consequently, a price increase for virtually all real estate assets.

In this market, maturing real estate debt can rarely be refinanced as lenders are reluctant to take a risk on debt secured by decreasing real estate values. An exit via disposal of the asset is often not a solution, as buyers would only pay a low price that could be easily financed or does not require bank debt at all, which is unacceptable for sellers.

At higher price levels, lenders are often reluctant to finance real estate acquisitions. This is particularly the case for development projects. In addition to increased financing costs, construction costs have continued to rise. When project timelines cannot be met, because of supply chain constraints or if project finance has expired, extending or refinancing might be difficult.

We also see issues around listed real estate companies financed in the bond market, which cannot extend or reissue bonds in the current market at terms allowing them to continue their business. As a result, the markets have seen an increasingly high number of real estate company and fund insolvencies, especially where development is involved.

Insolvencies can be avoided if sponsors act early enough and actively manage the restructuring, but only when there is still time to react, not a few months before debt maturity.

A successful restructuring requires the sponsor to approach all stakeholders involved early. These stakeholders may include creditors or bondholders. In the case of regulated funds, they may include the alternative investment fund manager (AIFM) bearing the legal responsibilities. In the case of developments, they may include the general contractors, planners, project managers, municipalities, equity investors, shareholders and joint venture partners.

All parties should be aware of the changing economic landscape and its potential impact. The challenge for management is to thoroughly analyse all stakeholders’ interests and to tie all these loose ends together into a restructuring solution, which is better than a fire sale. A solution might include extending loans, refinancing or obtaining additional funding, considering mezzanine or debt fund capital when traditional banks are unwilling or unable to participate, selling at acceptable terms, further equity injections, or the participation of contractors, tenants and other stakeholders.

If these measures fail – and often there is at least one stubborn party whose contribution is a key piece of the puzzle – an insolvency filing cannot be avoided. This is particularly relevant because in Germany there is a strict deadline for filing as soon as the reason for insolvency has occurred. For illiquidity this period is up to three weeks, and for overindebtedness it is up to six weeks. However, German law allows a self-administered insolvency procedure where management can stay in charge for investments falling under its jurisdiction if the centre of main interest (COMI) is in Germany.

Since 2021, Germany has had a procedure similar to Chapter 11 bankruptcy in the US: the German Act on the Stabilisation and Restructuring Framework for Businesses (StaRUG). This procedure allows a company to pass a binding restructuring plan – which is eventually court approved for maximum reliability – in which creditors can be forced to reduce or extend debt or even agree to debt to equity swaps so that the consent of all creditors is not necessary.

This modular system includes, among other things and based on the choice of the company, judicial proceedings for voting on, and confirming, a restructuring plan with the possibility for a cross-class cram-down and a court-imposed ban on enforcement and realisation measures. A quorum of 75 percent of creditors of one class is required to pass such a restructuring plan, with the exception of a possible cross-class cram-down. However, these procedures are only possible if the company is not yet illiquid or overindebted.

Rather, the company must be facing imminent illiquidity in accordance with the German Insolvency Code, i.e., generally a liquidity shortfall is expected in the next 24 months. That is why it is so crucial for management to react early when crisis is visible on the horizon, as then the chances of a successful restructuring, without regular insolvency or forced administration, is so much better.

Another element for a successful restructuring outside regular insolvency or forced administration of real estate assets is the availability of complete, up to date and accurate accounting and due diligence data. Parties, especially creditors, that can contribute to a distressed scenario need to justify that contribution and therefore require accountable, reliable and sustainable solutions – no lender wants to grant additional funding to a project where debt or a financial gap is suddenly higher than expected, especially for construction and development costs, or where a contractor becomes insolvent.

Therefore, qualified auditors should be brought on board early to help collect and structure the data needed to deliver a suitable independent business review (IBR) or IDW S6 restructuring opinion – which is required by creditors but is also vital to protect management from personal liability risks.

Where sponsors are publicly listed and debt has been obtained via capital markets, restructuring bonds is often a key issue. German law allows a restructuring without the consent of all noteholders under the German Act on Notes. However, in many restructuring cases a representative is elected by the noteholders, who is authorised to cast their vote on behalf of all noteholders.

Tools similar to StaRUG are available in the UK, under the Corporate Insolvency and Governance Act 2020 (CIGA). In addition to certain short-term measures, CIGA introduced two new restructuring procedures: a standalone moratorium that leaves existing management in control of the business throughout, and a ‘supercharged’ scheme of arrangement much like the existing scheme of arrangement but with the ability to effect a cross-class cram-down of dissenting creditor classes and the ability to disenfranchise out-of-the-money creditors.

In Luxembourg, new Chapter 11-like restructuring laws have been implemented, coming into force on 1 November 2023. These laws allow, for example, the appointment of a conciliator by the state ministry who can conclude amicable reorganisation plans which can be ratified in court to make them legally binding and enforceable for all parties. Also, court recognised collective agreements with all creditors, a restructuring plan, stay of payments and court ordered transfers of assets are possible.

The need to act early, to thoroughly analyse and understand all stakeholders’ interests, and to have accounting, project, contract and due diligence data up to date, organised and available, applies no matter where a sponsor’s COMI might be.

Holger Wolf is a partner and Sylwia Bea-Pulverich is co-head of restructuring, EMEA at Norton Rose Fulbright. Dr Wolf can be contacted on +49 69 505096 340 or by email: holger.wolf@nortonrosefulbright.com. Dr Bea-Pulverich can be contacted on +49 69 505096 230 or by email: sylwia.bea@nortonrosefulbright.com.

Holger Wolf and Sylwia Bea-Pulverich

Norton Rose Fulbright