Distressed Company Lenders Look to Cooperate to Avoid ‘Violence’

Efforts by struggling companies to shore up liquidity by pitting their lenders against one another have spawned a wave of controversial restructuring deals, but in many cases also pushed Wall Street firms to band together to thwart financial gamesmanship.

Cooperation agreements among lenders of private equity-backed companies are on the rise in what attorneys say is the most effective defense to a surge of liability management transactions by struggling portfolio companies trying to avoid bankruptcy by raising fresh cash from select creditors.

From one distressed situation to the next, financial creditors are left with a prisoner’s dilemma of either trying to join the in-group that negotiates a deal—typically to pare their losses—or banding together to stymie a borrower’s negotiating leverage and avoid the short end of a new agreement.

The fear of missing out on the more favorable side of a debt exchange has become a behavioral driver, said Kramer Levin Naftalis & Frankel LLP litigator Ariel Lavinbuk, but fund managers are getting “tired of looking over their shoulders” and worrying about “chit chat” over deals at cocktail parties they didn’t attend, he said.

So-called co-op agreements have been inked this year by holders of debt in companies like telecom Altice, satellite television provider Dish Network Corp., and pharmaceutical firm Bausch Health Cos.

The arrangements help debt holders “get together on the front end and set the terms of debate,” said Lavinbuk, whose firm is advising the Bausch creditor group. “It’s not a panacea, but it’s a tool for lenders to take back some of the power.”

Countering Aggression

Liability management transactions, in which companies exploit loose language in existing loan agreements without unanimous backing from affected lenders, come in a variety of iterations that have evolved in recent years.

The more aggressive version of financial creditors trying to better their positions to the detriment of some of their peers has been familiarly dubbed “lender-on-lender violence.” Canned fruit distributor Del Monte Foods Inc. and tool supplier Apex Tool Group are among several companies this year that have engineered such transactions requiring just a slim majority of lender support.

The trend began because “there was running room” in the lending documents and covenants, said attorney Jonathan Young, co-chair of Locke Lord LLP’s bankruptcy practice group. “Liability management exercises have worked in many cases because the credit documents permit them,” he said.

Joining forces under a co-op agreement is a way of preempting adversarial scenarios that private equity sponsors may try to employ, Young said.

“It’s just a strong and effective response to that sort of strategic behavior,” he said. “It really does as a matter of strategy force things onto a collective footing, very effectively and perhaps earlier in the process.”

Lenders now know that if there’s room in a credit agreement for additional financing and re-positioning of priorities, it could very well happen, said restructuring partner Brian Resnick, head of Davis Polk & Wardwell LLP’s liability management and special opportunities practice.

Resnick said when his firm gets hired on the lender side, defensive action is “the first thing that gets talked about.”

“The signing of a co-op is the way to solidify your group,” he said.

‘Strength in Numbers’

When liability management options are on the table, the only way to reliably counter a borrower’s ability to dictate negotiations is through a binding agreement. Without one, there is nothing that prevents hedge funds or other investors from privately discussing a potential transaction with the borrower separate from others holding the same debt.

“There’s definitely a lot of game theory that goes into this and it is very strategic,” said Young.

But the draw of joining forces with other creditors is to create order and ground rules among the group while taking away a borrower’s asymmetrical leverage, he said.

A co-op group of Altice France creditors in September sent a debt restructuring offer seeking bonds that could be converted to equity and a smaller haircut on the value of their debt than the company had previously proposed, Bloomberg reported. The move followed the formation of a separate group of Altice USA creditors concerned about restructuring scenarios.

Putting a group in place is important because it keeps creditors on the same page, spreads around the cost of advisory assistance, and prevents “spies in your group,” said distressed debt attorney Stacy Tecklin of Glenn Agre Bergman & Fuentes LLP.

“You’re seeing them form because a small holder can’t do anything on their own but a large group can do something,” said Tecklin. “There’s strength in numbers.”

Proactive Thinking

Getting a jump on potential trouble brewing at a company is usually key, as cooperation agreements can prevent private equity sponsors from making significant strides toward building a borrower-friendly coalition or picking off certain members to do a side deal.

The advent of co-ops has made the process of dealing with distress “less about chasing ambulances and more about finding busy intersections,” said restructuring attorney Alexander Woolverton, who works with Lavinbuk on Kramer Levin’s special situations team. “You have to look earlier and earlier for signs of distress.”

Sponsors have no say over lenders teaming up and oftentimes aren’t privy to the terms of an agreement, unless the details are made public, attorneys said.

Getting a threshold of support can also change from one situation to the next depending on the positions and attitudes of the parties involved.

There are lenders who tend to be more aggressive and try to form a group with just 51%, while in other cases nearly all of the debt holders have agreed to work together, said Resnick.

“You have opportunistic funds and you have defensive funds,” he said. “There’s a lot of money for investors to make if they play these right, and a lot to lose if they don’t.”