By John Houghton and David Stewart

Liability management exercises (LMEs) are increasing in the bond and capital market and are often used in relatively benign situations. They are certainly not always a precursor to a full-scale restructuring or insolvency.

The increasing sophistication and flexibility of the European market means that companies have a number of options when looking to restructure their debt. In 2015, the Ukrainian energy business DTEK, advised by the Latham & Watkins restructuring team, restructured its high yield bonds through an advanced parallel-track exchange offer, consent solicitation and an English scheme of arrangement. It presented a pioneering instance of a liability management exercise being run in parallel with a scheme of arrangement. It also illustrated the English courts’ willingness to accept jurisdiction not only on the basis of the governing law of the bonds being English, for which there are ample precedents, but where that governing law had been purposively changed from New York to English law by way of consent solicitation.  

The English scheme has thereby become an even more powerful tool, particularly for debtors to force through their LMEs, with the fall-back of a scheme and its lower voting threshold as a “Plan B”.

While the DTEK case was a genuine success, the use of the English regime depended on a consensual agreement between the company and its investors. Investor constituencies will undoubtedly be seeking protection from such an impactful change of governing law. Centre of main interests (COMI) shift covenants are already a common feature of (recently issued) financial documentation; it may become less common to allow a simple majority of holders to amend the governing law.

Against this, however, is the fact that in many circumstances where the company is contemplating a wholesome restructuring, the bond covenants will already be breached (e.g. for non-payment of interest). In this case, an issuer may well take the view that breaching a COMI covenant, if it is in the best interests of creditors as a whole to do so, is the right thing to do.

LMEs can be hugely effective and the DTEK scheme was established in record time, but this doesn’t hide the fact that liability management and bond restructuring exercises can be hugely complex. Often high yield bonds in emerging markets attract a wide array of investors. It can be tough to identify them and to communicate with them. Issuers must socialise the proposal to the investor base and it is a real challenge to marry the needs of the issuer (whose shareholders may well have unrealistic expectations) with what the investors are prepared to accept. In addition, attention must be paid to the nuances of the legal contract and frequently, the demands of the regulators. It can be an incredibly fraught process.