Nicolas Laurent and Olivier Puech cover the evolution of capital structures in France’s active restructuring and insolvency market, amidst the economic crisis.
1. What trends, in terms of activity levels, affected industries or investor focus, have you seen in the restructuring and insolvency market in your jurisdiction over the last 12 months?
The first principal trend is that, over the last 12 months, the French restructuring and insolvency market has shown a steep increase in the number of judicial proceedings (i.e. safeguard, recovery and liquidation proceedings which are court-driven processes) opened in respect of medium and large size companies (Ascometal, EasyStudent, Fram, Pixmania, SNCM, etc.).
In terms of affected industries, whilst construction, transport, and real estate were the first to be affected by the financial crisis which started to hit France in 2008, in 2015 all sectors have been affected, including retail, real estate, textile, catering, oil and gas, travelling, media, etc., showing that the economic crisis was deeply established in the country.
As a second trend, the last 12 months have certainly marked the end of a distressed LBO cycle corresponding to over-leveraged LBO deals from the 2005-2007 “golden era”. The financial restructuring of such companies, which has been extensive since 2009, has been decreasing since 2014. Covenant resets, “amend and extend” and lenders-led restructurings have been booming over the last five years, some companies experiencing each of these three types of restructurings over a five-year period.
The investor profile has evolved too, with the higher involvement of Anglo-Saxon financial creditors (other than banks) who have significantly more appetite for lenders-led restructurings than French banks. French turnaround funds – there are less than 10 in total – have been less active than expected and tend to focus on small and medium size targets that they buy out in recovery proceedings.
Finally, refinancing has been quite active, especially on the high-yield market.
2 . What is the market view on prospects for the coming year?
We anticipate a steady level of restructuring/bankruptcy cases in France for the coming year.
This is because:
3. What are the key tools available in your jurisdiction to achieve a corporate restructuring – are they primarily formal, court-driven processes, or are informal out-of-court restructurings possible? Do you feel that the tools you have available are effective in terms of providing speedy, fair and predictable outcomes?
French law features both court-driven processes (safeguard, recovery, liquidation proceedings) and out-of court proceedings (mandat ad hoc and conciliation), thus offering quite a large “tool box” to practitioners depending on the level of the difficulties encountered by the debtor.
Among the formal court-driven restructuring proceedings, the safeguard and the recovery proceedings share the same purposes, i.e. preserving jobs, continuing the operation of the debtor or its business, and settling creditors’ claims, while liquidation proceedings are for companies with no chance of recovery.
Regarding out-of-court proceedings, French law provides for two confidential proceedings, the “mandat ad hoc” and the conciliation, for companies facing economic, financial, legal or employment difficulties.
The purpose of these proceedings is to provide a negotiation framework under the aegis of an independent Court-appointed third party (the mandataire ad hoc or the conciliateur) for the company to negotiate with its creditors and solve its financial difficulties. Typically, the measures discussed with the assistance of the mandataire ad hoc or a conciliateur relate to debt rescheduling/write-off. During the whole proceedings, the officers and directors remain in place and keep all their powers. Coupled with safeguard or recovery proceedings, conciliation allows to accelerate these proceedings and to pre-pack a financial restructuring or a sale of assets.
In the framework of a conciliation proceeding, creditors may intend to obtain a judgment of approval of the agreement reached with the debtor since this approval will strengthen the agreement and avoid claw back risks (nullification of some acts entered into between the date of cessation of payment and the date of the opening of recovery/liquidation proceedings).
All these tools have proven to be rather effective until now.
In terms of predictability, one may regret that given the political implications of some cases (e.g. when the debtor has a large number of employees), Courts are under strong pressure to accept offers from buyers offering to take over the largest possible amount of employees but not necessarily offering the strongest prospects for the business.
4. In terms of intercreditor dynamics, where does the balance of power lie as between shareholders and creditors, and as between senior lenders and junior/mezzanine lenders? In particular, how do valuation disputes between different stakeholders tend to play out?
Although French law has long been criticised for giving too much power to debtors to detriment the creditors, recent reforms have made it more balanced.
In safeguard and recovery proceedings, the creditors involved in a creditors’ committee are now allowed to propose their own restructuring plan, in competition with the plan proposed by the debtor.
Also, in recovery proceedings, shareholders can be forced by the Court to sell their shares to a third party or creditors (or to accept a dilution) when they refuse to participate in a capital increase which is required to save the company and that a third party/creditors offer to participate in such capital increase in their plan. The conditions for such an expropriation are, however, rather complicated to meet.
As regards the balance among creditors, a 2010 law had first decided that any restructuring plan had to “take into account” the subordination agreements, which was an initial step towards the application of contractual subordination in safeguard/recovery proceedings. Since 2014, the balance has also been adjusted to reflect better the fact that some creditors might be out of the money. The court-appointed receiver (“administrateur judiciaire”) must be notified with the existing inter-creditor agreements (notably subordination agreements) and will decide upon the voting rights of each category of creditor when voting on the proposed restructuring plan. Consequently, junior creditors who are out of the money may no longer be able to prevent the adoption of a plan. However, it is still unclear which factors are to be used to determine the voting rights of the creditors.
5. Have there been any changes in the capital structures of companies based in your jurisdiction over recent years caused by the retreat of banks from loan origination? In particular, have you found that capital structures now increasingly comprise debt governed by different laws (such as New York law governed high yield bonds)? If so, how do you expect these changes to impact on restructurings in the future?
In France, banks have long been the most important fund providers. As a consequence of recent funding restrictions, they are now less inclined to provide funds, in particular to small and medium corporates. Consequently, corporate borrowers have had to find other financing sources. In 2014, less than 25% of the annual net financing flow originated from banks, while more than 75% originated from the financial markets.
Debt funds have increased their involvement in the financing of French companies and have consequently offered more diverse products: for instance, companies issue mezzanine debt, unitranche debt and even high-yield bonds more frequently.
Some of these new products are specificities of the French market. For instance, the Euro Private Placement (Euro PP) is a medium or long-term financing transaction between a company and a limited number of institutional investors, based on deal-specific documentation negotiated between the borrower and the investors. It has been widely used recently.
We expect these capital structure evolutions to impact future restructurings in various ways.
In addition, we have noticed capital structures increasingly comprising debt governed by UK law or US law for high-yield bonds, offering the issuer the possibility, in distressed situations, to consider the UK Scheme of Arrangement or the US Chapter 11 for restructuring provided certain conditions are met. Safeguard is likely to compete with these proceedings and, in our view, offers significant opportunities.
6. Is there significant activity on the part of distressed debt funds in your jurisdiction? How successful have they been in entering the market, and how much has market practice (or law) evolved in response? If funds have not successfully entered the market, can you identify reasons why?
In 2015, we have noticed higher activity and higher involvement from distressed debt funds in France, as the legal environment has apparently been perceived as being more secure for creditors, and debt funds have large amounts of dry powder.
Distressed debt funds are now more inclined to lend money directly to companies, not only in the hope of obtaining control, but also of financing operations or acquisitions. Such funds have offered attractive conditions to companies (light covenants) usually with higher interest rates and more guarantees.
Also, as the French restructuring environment becomes more and more balanced in favour of the creditors, distressed funds have higher incentives to invest in French companies.
Recent cases seem to confirm this trend. For instance, the Courtepaille case was the first time a “Double LuxCo” structure was enforced: the unitranch creditor now owns the company after having triggered a clause to obtain the ownership of the shares (due to an event of default under the financing documentation). So far, the former shareholder has not obtained from French or Luxembourg Court a decision reversing the enforcement of the Double LuxCo mechanism.
7. Are there any unusual features of your insolvency or restructuring law that an external investor should be aware of (such as equitable subordination, or substantive consolidation)?
In terms of shareholder’s liability, the concept of co-employment has been widely and anxiously discussed recently. Provided certain conditions demonstrating interference in managing the company are met, a third party (frequently the shareholder of the distressed company) may be considered as “co-employer” of the distressed company’s workers. The co-employer then has to comply with all the obligations of an employer, including financing the dismissals and other social payments arising from a restructuring plan at the level of the distressed company. Although this may appear dangerous from a shareholder’s perspective, the Cour de cassation (French Supreme Court) has recently restricted the situations where the co-employment may be recognised.
Furthermore, an investor in France has to bear in mind the French concept of “extension de procédure”, which may lead to extending the judicial proceedings (safeguard, recovery or liquidation) of a company to another. Such extension is pronounced by a judge in two cases: false existence of a legal person; or intermingling of finances. As an investor in France, it is important to implement good practices in order to prevent any extension, it being noted that the purpose of the extension is generally to involve in the proceedings a “deep pocket” company in order to improve creditors’ repayments.
Finally, if the company ends up in liquidation proceedings, it may be possible to pierce the corporate veil and hold de jure or de facto managers (which may include a parent who is found to be a shadow director of a subsidiary) liable for the insufficiency of assets of the company. The shareholders held liable on such a ground are excluded from the distribution of the liquidation proceeds up to the amount of the damages they have been condemned to pay to the company as compensation for all or part of its insufficiency of assets.
8. Are there any proposals for reform of the legal framework that governs insolvency and restructurings in your jurisdiction?
The French insolvency and bankruptcy framework has been reformed on several occasions over the past years. Notably, and as explained above, the 12 March 2014 order created the accelerated safeguard procedure, the possibility for a creditor to propose a restructuring plan, or the ability to prepare a pre-pack sale. The Macron law (6 August 2015) also added new insolvency provisions, by allowing the forced sale of a shareholder’s stake in the debtor.
There are no pending insolvency or restructuring proposals for reform at the moment in France. Some practitioners are, however, pushing for the creation of stronger French turnaround funds, e.g. by having Bpi France, the French public investment bank, investing in such funds on a minority basis.
9. If it was up to you, what changes would you make?
It is of paramount importance for investors to have visibility over the “rules of engagements”, whether they relate to the tax environment, the employment rules or the bankruptcy proceedings themselves. The French legislator has been quite successful in offering a large “toolbox” to prevent and treat distressed situations. In bankruptcy proceedings, some rules could still be improved, such as a more automatic application of subordination, a framework allowing for more transparency in buy-out processes and the possibility to “bend” employment rules to expedite dismissals in order to save what can still be saved in distressed businesses.