Chemico: Restructuring

Case Study

Jadek & Pensa / Allen & Overy LLP

Our task

1. Review a given set of facts, based on elements seen in some recent restructurings

2. Explore the issues affecting different stakeholders of the company

3. Compare the result – UK and Slovenia

4. Conclude – thoughts to take away

1

The facts:

• Chemico is a Slovenian petrochemicals company which manufactures plastic drink containers.

• It is an operating company with over 300 employees and sales income of just over €80 million, with subsidiaries in Poland and Germany.

• It has €50 million of bilateral loan facilities with multiple lenders which is secured over different assets. The debts have been guaranteed by Chemico’s subsidiaries.

• Chemico has also entered into a number of derivative transactions which provide foreign currency hedging.

• The group relies heavily on materials purchased from a number of key suppliers. Significant trade credit is in danger of becoming overdue to those creditors.

• Chemico’s Finance Director has concerns. There is an interest payment due next month under one of Chemico’s facilities and the company will be unable to pay it. He also believes the group will struggle to refinance some of its loan facilities which are due to mature within the next 12 months.

• Trade suppliers are becoming anxious and are threatening to cut off supply unless extra security (such as bank guarantees) is provided.

2

Further facts

• Chemico’s management has been taking advice from its financial advisers.

• The conclusions reached are that:

– In the short-term, forecast revenue is insufficient to meet interest payments and debt amortisation.

– Long-term,

• a restructuring of the company’s loan facilities is required; and

• further capital investment is needed for Chemico to develop its operations.

• What should management do?

3

Response: UK

4

• Management to initiate discussions with its key stakeholders to seek agreement to a contractual standstill (or ‘Go Naked’).

• No formal procedure to provide a stay on creditor action for large companies other than our rehabilitation procedure (administration) – unattractive to management and stigma risk for all stakeholders.

• Means discussions principally take place out of court and out of public eye. • Standstill for set period:

– No security enforcement , taking of legal proceedings or filing for insolvency by financial creditors

– Continued utilisation of revolving or overdraft lines or L/C facilities – Trade creditors / employees continue to be paid although cash ‘actively managed’ – Waiver of potential interest payment default to avoid cross-defaults – Allows time for information gathering and deal to be negotiated

• Once a deal is agreed, creditors sign up to a ‘lock-up agreement’.

Response: Slovenia

5

• Management could file for Preventative Restructuring Proceedings if it obtains the support of 30% of financial claims.

• Would provide: – A stay on enforcement or security proceedings by financial creditors

– Suspension of limitation period for claims

– No company default of payment of principal amounts

• Chemico would have 5 months (with possibility of 3 month extension) to conclude agreement with financial creditors on proposal.

• Excludes derivative contracts and business creditors (such as trade suppliers) – they would need to be paid.

To discuss

6

• Directors’ duties:

– What are the duties of the directors in these circumstances?

– Are the directors at risk of personal liability given the pending non-payment of interest?

– How is the position different between the UK and Slovenia?

• Publicity:

– A resolution to initiate Preventative Restructuring Proceedings will be publicised by the court, so that the commencement of proceedings will become public knowledge.

– In the UK, discussions can often take place out of the public eye.

– How will this publicity impact on management’s approach to stakeholders such as employees and suppliers ?

Further facts

• Chemico’s management has initiated discussions with its stakeholders and it’s clear that there are divergent views.

• The lenders are suspicious of management’s business plan and reluctant to discuss proposals involving an extension of loan maturity or reduction in margin (at least without proper information).

• What should the lenders do?

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Response: UK

8

Some of the information typically sought by lenders in restructuring includes:

Independent business review (IBR) - lenders may appoint financial advisers to carry out a review of a company’s forecasts and business plan to provide an unbiased view as to the financial condition of the company.

Valuation analysis – What is the company worth? Where does the value break in the debt structure? Do shareholders have equity in the business? Who carries out the valuation and will they owe a duty of care to lenders?

“Entity priority modelling” – individual entity and stakeholder view of outcome in insolvency.

Legal due diligence – Under key customer or supply contracts or leases, are there defaults in the event of insolvency or security enforcement or on a ‘change of control’? What is the potential impact on value return to stakeholders?

Response: Slovenia

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Independent business review (IBR) - lenders would negotiate with

Chemico to appoint financial advisers, acceptable to lenders, to carry

out a review of a company’s forecasts and business plan to provide an

unbiased view as to the financial condition of the company.

Typically there is no valuation analysis, no entity priority modelling, and

no legal due diligence.

Financial lenders would normally seek to force shareholders to inject

new capital into Chemico.

– What if shareholders only willing to provide capital for investment (not to repay financial lenders’ debt)?

– What if shareholders request investment takes form of super-priority debt?

To discuss

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• Appointment of committees of financial lenders

– Role of co-ordinating committees.

– Reimbursement by company of lenders’ fees and advisers’ costs incurred during restructuring.

– LMA appointment documentation – useful protections.

• Sharing of information concerning Chemico

– Sharing of company information across all lender groups?

– Would this include the amount of debt advanced under lender facilities? The value of lender’s secured assets?

• Require the replacement of some / all of management

• Demand the appointment of a Chief Restructuring Officer (CRO)

Further facts

• A deal has been reached.

• The majority of lenders are willing to extend the term of the loan facilities by 4 years and accept a reduction in interest margin. However, it is anticipated some lenders (some of whom have bought their debt at less than par) will not co-operate.

• In return, shareholders have agreed to invest €20 million of further capital to meet the capital expenditure required by Chemico in coming years.

• How could this deal be implemented?

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Response: UK

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• Management could implement the deal by a scheme of arrangement.

• Scheme requires approval by 75% by value and 50% in number of the voting class and sanction by the court as to matters of ‘fairness’.

• Only requires vote by those persons affected by the scheme.

• Key element is the determination of classes – grouping creditors and shareholders with sufficiently similar interests that they may vote together.

• Recent trends:

– Used to bind syndicate lenders where voting majorities in loan agreements cannot be satisfied

– Used for non-English companies with a ‘substantial connection’ with the UK (eg. English law loan documents). Could Chemico use an English scheme?

• New investment by shareholders would require 100% consent of shareholders.

Response: Slovenia

13

• Preventive restructuring proceeding may lead to confirmation of an agreement on financial restructuring (AFR).

• AFR requires approval by at least 75% in value of all ordinary financial claims included in the basic list of financial claims and 75% in value of secured claims if secured claims are being restructured.

• Lenders may agree on AFR and may at the same time provide in the AFR that an increase of Chemico‘s share capital by €20 million by existing shareholders is a condition precedent for the validity of the AFR. The competent court shall not approve the AFR unless Chemico‘s share capital is increased before the request for the AFR is submitted to the competent court (5 months from the initiation of the procedure, with the possibility of a 3 month extension)

Further facts

• Before the restructuring deal could be implemented, a major scandal concerning the contamination of soft drinks hits the news, causing sales of soft drinks to plummet across Europe and Chemico’s customers to scale back their orders for drink containers.

• Chemico’s forecasts are heavily revised and fresh valuations for the group value the company’s assets at less than the amount of its liabilities. Management determines that a more radical deleveraging is required than outlined in its original proposal.

• Instead management propose a debt for equity swap to its lenders, seeking a 25% conversion of their loans into equity and wiping out the interests of existing shareholders.

• Can these new company plans be implemented?

14

Response: UK

15

• The debt for equity swap could be implemented using a scheme if the requisite voting majorities of lenders and shareholders vote in favour of the proposal.

• However, if the requisite majority of shareholders refuse to support the proposal, the shareholders cannot be compromised, even though they are regarded as ‘out of the money’.

• One solution may be: • to offer existing shareholders a nominal shareholding (or a small

payment) in return for the requisite majority’s consent to the proposal; and

• if the shareholders refuse their consent, management could transfer the business to a new company, together with the secured debt, owned by secured lenders. The existing shareholders would be left behind as owner of an insolvent shell company.

Response: Slovenia

16

• A debt for equity swap may be proposed but if the existing shareholders do not vote for Chemico‘s capital increase, the swap could not be implemented in preventive restructuring proceedings.

• In this case lenders could stop the preventive restructuring proceedings (30% of all financial debt is needed) and start (50% of all financial debt is needed) a compulsory settlement procedure with only unsecured financial creditors , and all secured creditors, if needed, or they could file for bankruptcy.

• If Chemico‘s uncovered loss cannot be covered by a simplified decrease in share capital, or if the book value of Chemico‘s assets is higher than the liquidation value, the lenders committee (instead of Chemico‘s general assembly) may resolve that financial and all other Chemico‘s creditors (secured and unsecured) swap their debt for Chemico‘s equity.

• Trade debt and employees have to be paid in full.

•

Further facts

• Some of the secured lenders with security on Chemico‘s core assets do not want to swap.

• For discussion:

– What solutions are available to Chemico‘s management in such circumstances?

– What solutions are available to Chemico‘s management if only non-core Chemico‘s assets are pledged and such lenders do not want to swap?

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Further facts

– More bad news. It seems one of Chemico’s divisions may be subject to significant environmental liabilities. But management have identified an industry buyer who is willing to buy the profitable parts of the business, in an accelerated time period.

– As an alternative to a debt for equity proposal, management want to explore a ‘spin off’ of the profitable parts to the industry buyer.

– This raises questions:

– What debts are transferred across to the new company? Can you leave any secured debt behind?

– Are all the employees transferred to the new company?

– How are key customer and supply contracts to be dealt with?

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Questions?

These are presentation slides only. The information within these slides does not constitute definitive advice and should not be used as the basis for giving definitive advice without checking the primary sources.

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