Will US lender-on-lender violence gain traction in Europe?

October 2023  |  FEATURE | BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

October 2023 Issue

The US accounts for more than half the revenue of the global legal services market – an industry domination that can lead to established US practices eventually landing in Europe, which itself accounts for more than a quarter of the world’s legal market revenue.

One US practice many believe has the potential to cross the Atlantic is that of ‘lender-on-lender violence’. This aggressive strategy involving lenders taking as much value as possible out of a distressed company.

“Lender-on-lender violence refers to a type of liability management transaction through which a company gives an advantage to a subset of its creditors at the expense of another subset,” says Natalie Blanc, an associate at Ropes & Gray. “These transactions are often referred to as ‘priming’ deals, whereby a participating subset of creditors will, post-execution, have some form of priority ranking in relation to the non-participating creditors.”

In the US, the past few years have seen several high profile examples of the phenomenon. These include J. Crew, Travelport, Cirque du Soliel, Revlon, Trimark, Murray Energy, Serta Simmons and Boardriders.

Lenders holding the majority of a syndicated credit facility’s debt (often in collaboration with the borrower or its financial sponsors) leverage their majority position to structure transactions that benefit themselves to the detriment of the other lenders.

As outlined by Vinson & Elkins in its 2023 ‘Navigating lender-on-lender violence: An Overview of Liability Management Transactions and Market Trends’ report, there are two types of these transaction structures attracting the most attention in the US market in recent years.

First, uptier transactions. This type involves a company enhancing its liquidity by issuing super senior secured debt to the participating lenders (and possibly a sponsor) – which may be partially in exchange for new money and partially in exchange of existing secured indebtedness – after lifting any restrictions on such new super senior secured debt by majority vote of the existing secured lenders.

Second, dropdown transactions. In this scenario, a company enhances its liquidity by moving assets into an ‘unrestricted subsidiary’ (i.e., a subsidiary that is not subject to the liens and claims of existing secured lenders) and then raising a new financing secured by those assets.

“While these structures operate differently in the mechanical sense, they all include a ‘priming’ component and share a common theme: upon consummation of a transaction, a group of lenders that are believed to have the first priority over certain collateral are subordinated to other lenders with respect to that collateral,” adds Jennifer Selendy, a partner at Selendy Gay Elsberg.

A European perspective

While lender-on-lender violence transactions are certainly commonplace in the US market, they are yet to be widely used in Europe, where such deals would be a much more challenging endeavour due to differences in market standards for documentary terms and the legal frameworks. That said, although more complex, they should not be considered impossible.

Many of the challenges involved in introducing lender-on-lender violence into the European arena are outlined by Ropes & Gray in its ‘Lender-on-lender violence: a European perspective’ analysis, which notes the following as likely to impact the ability of debtors in Europe to implement dropdown and uptiering transactions. First, there is less flexibility regarding credit documentation, and second, for uptier transactions, unfavourable case law may cast doubt on the ability to make use of aggressive exit consents in law credit documents.

“The ability to implement a dropdown transaction in Europe will depend on the permissions in the relevant credit documents in each case,” states the analysis. “A dropdown transaction can be structured based on the relevant permitted investment baskets, restricted payment baskets or asset disposal baskets and, if the basket capacity is sufficient, then no additional consent is required to implement the dropdown transaction.”

In terms of uptier transactions, the closest alternative in the European context would be a bilateral facility. To allow for such a transaction, existing credit documents would need to include: (i) the ability to carry out open market repurchases on a non-pro rata basis; and (ii) appropriate debt and security capacity (or ability to extract value into a joint venture or an unrestricted subsidiary) under the existing credit documentation.

Possible but improbable

Despite some commentators suggesting that Europe may be too ‘polite’ to adopt lender-on-lender tactics wholesale, the chances of such transactions gaining traction in Europe remain, for the moment, in the realm of possible but improbable.

“We expect to see an increase in the number of distressed European companies seeking more bespoke refinancing techniques,” concludes Ms Blanc. “With increasing global macroeconomic pressures due to, among other things, supply chain disruption, high levels of inflation, increasing interest rates and geopolitical instability, European companies without easy access to vanilla refinancing options may consider the viability of these techniques over the coming months.”

Essentially a classic divide-and-conquer strategy, despite the challenges need to be overcome, the lender-on-lender violence phenomenon may, in time, cross the Atlantic to Europe and no longer be considered the exclusive jurisdiction of the US.

© Financier Worldwide

BY

Fraser Tennant