Being A Bondholder In A Distressed Situation: The Debt Equity Swap Route - A Vessel Fraught With Pitfalls?

According to Thomson Reuters' Distressed Debt & Bankruptcy Restructuring Q1 Round-up issued in April 2012, EMEA distressed debt restructuring deal volume amounted to €11.45bn in the first quarter of 2012, marking a 57.3% decrease in activity compared to the first quarter of 2011. Financials was the leading sector with approximately 53% of total completed EMEA distressed debt restructuring deal volume.

Nevertheless, European debtors are now forced to find a more substantive cure for their capital structures than the 'extend and pretend' stopgaps that have been so prevalent in the market in the past two years. The deleveraging is present everywhere and the sole question is how deep will it be.

Creditors, therefore, are now ready to accept to replace part or all of their debt in exchange for equity ('debt equity swap'). It could be seen as the last antidote to avoid death!

Although bondholders are usually unsecured and must deal with the company and its senior lenders, they are commonly and actively involved in the discussions and negotiations of restructuring transactions. Given that bonds are considered company debts, whereas shares, although company liabilities, are equity and represent ownership in the company, bondholders cannot be considered as 'normal' company creditors as their debt is part of a collective debt and is represented by a negotiable instrument. Bondholders are linked to the fate of their debtor, usually for a long period of time, and if the company faces financial difficulties, it is unlikely that they will be reimbursed for the interests or even for the principal in the worst case scenario.

However, in distressed situations, bondholders, despite being unsecured, are not totally left without any means and their rights are quite well protected under Luxembourg law. The current wording of articles 79 to 98 of the law of August 10, 1915 on commercial companies, as amended (the 'Law') dealing with bond issuance has been designed to organise and protect the bondholders' body. Obviously, as the interests of bondholders and shareholders differ, the Law granted a wider protection to bondholders, and both the company that issued the bonds (the 'Issuer') and the general meeting of bondholders are allowed to appoint, during the term of the loan, a representative (the 'Representative') with specific powers. In case of multi bond issuance, each bondholders' body may be represented by a Representative.

The crucial role of the Representative

The Law provides that either at the time of the bond issuance by the Issuer or, at any time during the term of the loan's note, one or several Representatives may be appointed by the general meeting of bondholders.

The Law further provides for some exceptions with respect to the appointment of the Representative, i.e. neither the Issuer, nor (i) the companies holding one-tenth or more of the capital of the Issuer or in which the Issuer has a holding of one-tenth or more; (ii) the companies guaranteeing all or part of the obligations of the Issuer; or (iii) the members of the board of directors, of the management board (directoire), of the supervisory board, statutory auditors, external auditors, and representatives of the aforementioned companies can be appointed to this role.

These exceptions reinforce the independent status and the powers granted to the Representative.

The Law has clearly stated the powers of the...