Exit consents, UK law, and common sense
The wonkier edge of the blogosphere (Joseph Cotterill at Alphaville, Anna Gelpern at Credit Slips, Matt Levine at Dealbreaker) has been paying a lot more attention than any non-blogger journalists I can find when it comes to a very significant recent decision, in the English courts, on the subject of exit consents. (The decision can also be found here, in PDF form.)
There’s a bit of a tinge of panic to some of the coverage: Gelpern, for instance, calls the decision “a really big deal”, while Cotterill calls it “a depth charge”. And on the surface, it’s easy to see why they might think that way. Exit consents are a standard weapon in the debt-restructuring arsenal, a clever way for bond issuers to get their bondholders to agree to a restructuring. And now an English judge seems to have ruled that they’re illegal.
In order to understand the real problem here, it’s helpful to understand a key difference between bonds and loans. One upon a time, when companies wanted to borrow money, they would go to the bank — and then, if they ran into trouble, they would negotiate new terms with their lender. That didn’t change when simple bank loans became syndicated loans: borrowers then just had to negotiate with a consortium of banks, rather than with just one. But when banks became just intermediaries, and companies borrowed in the bond market, things did change. You can’t negotiate directly with your lenders when you don’t even know who your lenders are, and when there might well be many thousands of them.
So, how do you restructure a bond? One option is that you simply don’t: you go bankrupt instead, and let your creditors fight it out in court for whatever pickings they can find on your carcass. That’s unpleasant: there are serious costs of filing for bankruptcy, and often a nice bond restructuring can be a lot cheaper and result in a better outcome for all concerned. If you can manage to pull it off.
So, how can you restructure bonds, if you need unanimous consent from thousands of different and often anonymous bondholders? Isn’t that akin to herding cats? Well, yes. But exit consents offer a clever solution: you ask bondholders to voluntarily tender their bonds into a bond exchange, taking some kind of a haircut in the process. Lots of bondholders will be willing to do that, if the alternative is bankruptcy. But they also worry about free riders: what will happen to the bondholders who don’t tender into the exchange? Will they continue to get paid out in full? Not if all the bondholders who do tender into the exchange vote, while tendering their old bonds, to cripple the old bonds at the same time. They might not be able to change the payment terms — that normally requires unanimity — but they can change other terms, and would-be holdouts end up holding highly illiquid, crippled instruments of very little value.
Exit consents come in various different flavors, from the polite to the extremely coercive. But the general idea behind them is the same. Whether or not you think the offer is a good one, bondholders are incentivized to vote for it, rather than just sitting on the sidelines, because sitting on the sidelines can be dangerous. But in one particular case, according to Mr Justice Briggs, the exit consent was so coercive that it became downright illegal.
I can see why he said that. The debtor in question was Anglo Irish Bank, and the exit consent in this case was particularly evil: exiting bondholders gave the bank (which at that point had already been nationalized) the right to buy back all of its old bonds at a price of €0.01 per €1000 in principal amount. Assenagon Asset Management owned just over €17 million of bonds, and didn’t participate in the bond exchange; shortly thereafter, it found all of its bonds redeemed in return for a payment of just €170.
The exchange was a success, with some 92% of bondholders participating; at that point, the bank could easily have reopened the offer and given the holdouts a second chance to say yes. Instead, it got vindictive — and got sued. The result: the entire exchange was found to be illegal. Which has some lawyers, like those at Davis Polk, rather alarmed:
The Anglo Irish decision casts doubt on the legality under English law of any form of exit consent that imposes less favourable consequences upon those who decline to participate in any associated exchange offer, even if such exit consent does not lead to a complete expropriation of the relevant securities as occurred in the Anglo Irish case.
Brown Rudnick, too, thinks this is a Very Big Deal:
The repercussions of this judgment are potentially huge, and could affect all bond restructurings carried out by the Irish banks in the period 2009 to 2011, as well as restructurings in other jurisdictions.
But I think that Clifford Chance is closer to the realities of this case. In a note entitled “Liability Management: Exit Consents and Oppression of the Minority”, they conclude that the English courts merely “provided a timely reminder that the English courts will not uphold structures that seek to impose unfair or punitive outcomes on dissenting or non-participating Noteholders”. Or, to put it another way: go ahead and use exit consents, if you must. But don’t be evil about it.
This is actually one of the things I like about UK law: judges are perfectly free to use common sense, instead of taking everything to its logical conclusion. To use the language of regulation, there are principles involved as well as rules. So while investors are now being urged to buy English-law bonds, and issuers are being urged to issue in New York, the fact is that the difference between the two is not as great as the headlines about the ruling might make it seem. Unless, and until, the issuer decides to be incredibly, and quite unjustifiably, vindictive towards holdouts.