Debt Restructuring Tools in International Capital Market Transactions

Olena V. Polyakova

In 2013 several new Eurobond offerings by Ukrainian issuers were coupled with restructuring of their liabilities under existing Eurobonds from the previous issues. By way of an example, a new issue of USD 600 million 7.875% high yield notes by DTEK Group was coupled with a tender offer transaction in respect of the outstanding USD 500 million 9.50% notes. In the agricultural sector, a new issue of USD 750 million 8.25% high yield notes by MHP was coupled with a tender offer transaction in respect of the outstanding USD 584,767,000 10.25% notes.

What is liability management in international capital market transactions?

Liability management is a term used to describe the restructuring of liabilities typically under debt securities issued in international capital markets. In particular, it is used to describe transactions to better manage, modify, or eliminate liabilities of an issuer of debt securities, including, (i) payment obligations and/or (ii) covenant liabilities under the instrument governing such debt securities.

To put it simply, liability management is an essential tool to keep an entity with debt on its balance sheet from issue of debt securities running smoothly. The financial crisis and the ongoing debt turmoil in the EU serve as good examples of importance of proper and timely debt restructuring. Those who exercised prudence with their balance sheets were more likely to weather the storm; others went bankrupt or had to be liquidated.  However, liability management is not something that comes in handy only during the times of crisis, it is an ongoing process that can either help a company grow or, if ignored, can cause a business to close its doors.

The objectives of liability management vary but in many instances are similar, and include, among other things:

— Reduction of the principal amount of debt at a reasonable price. For instance, by way of cash tender offer an issuer may benefit from buying back debt securities at a significant discount to the nominal value. If a cash tender offer transaction is coupled with the new issue of debt securities, the repurchase may be structured so that the issuer would use the proceeds generated from the new issue to repurchase the “old” debt securities without the need to advance cash from own reserves for purposes of such repurchase.

— Easing of interest expense and extension of maturity of debt securities for purposes of having a cheaper debt with longer maturity profile. For instance, as a result of new Eurobond offerings and cash tender offer transac- tions in spring of 2013, DTEK and MHP could raise cheaper financing with yield of 7.875% and 8.25%, respectively, and substitute more expensive debt from the issue of Eurobonds in 2010 with a yield of 9.50% in the case of DTEK and 10.25% in the case of MHP.

— Waiver of restrictive covenants. In the ordinary course of business and changing economic environment companies may pursue new investment opportunities, seek to raise new financing, grant security, improve baskets for carve-outs for certain event of defaults in the instruments governing the debt securities. Such changes are commonly subject to the consent of the investors.

What are the different types of liability management transactions?

So, what are the options to restructure liabilities under the debt securities issued in international capital markets? An issuer of debt securities in international capital markets may consider the following options:

— Redemption. Redemption is a transaction for purchase of outstanding debt securities for cash. While redemption has advantages in timing, it requires cash from the issuer and may be expensive (debt securities are redeemed usually with a premium as a compensation for yield to maturity).

— Repurchase. Repurchase transaction allows the issuer to repurchase debt securities at a significant discount and save money on continuing interest payments. Similar to redemption, repurchase requires cash from the issuer and is not suitable if the issuer intends to repurchase a substantial percentage of the outstanding debt securities. Repurchase is typically made to a limited number of investors and for a limited amount of notes due to the risk of application of tender offer rules and in this case the need to structure the transaction as a cash tender offer.

— Cash tender offer. Cash tender offer is a transaction for an offering to repurchase existing debt securities for cash, which is made to all existing investors. The tender offer may be the most appropriate tool to restructure indebtedness if the issuer (i) wishes to repurchase all or a significant portion of outstanding debt securities, (ii) debt securities are held widely by the investors, and (iii) simultaneously with the repurchase of debt securities, the issuer considers obtaining consents from the investors to waive or amend certain covenants in the indenture. US courts provided a set of factors to determine if tender offer rules apply to the liability management transaction, including: active and widespread solicitation, solicitation is made for a substantial percentage of the issuer’s securities, offer to purchase is made at a premium over the prevailing market price, terms of the offer are firm rather than negotiable, offer is contingent on the tender of a fixed number of securities, often subject to a fixed maximum number to be purchased, and offer is open only for a limited period of time. Issuers must carefully consider the characteristics of the tender offer when structuring a liability management transaction. If the transaction satisfies the conditions for the tender offer, its timing, documentation, and costs would be significantly affected.

— Exchange offer. If an issuer does not have available cash or does not want to use it, an alternative to redemption, repurchase and tender offer may be an exchange offer, which permits the issuer restructuring its indebtedness without the use of cash. In the exchange offer transaction, the issuer offers to exchange newly issued securities for the outstanding “old” ones. Similar to the cash liability management transactions, exchange offers enable the issuer to reduce interest payments (by exchanging debt securities with a higher interest rate for debt securities with a lower interest rate), manage maturity dates (by exchanging for securities with an extended maturity), reduce or eliminate onerous covenants in the indenture.

— Consent solicitation. Often restructuring of liabilities under foreign debt securities involves the need for the issuer to modify certain covenants in the indenture. For instance, the issuer may seek to conform the covenants in the indenture for the “old” securities with the covenants in the indenture for the new securities (if the restructuring is coupled with the issue and offering of the new securities) or the issuer improved the financials and seeks entering into new transactions to develop the business, etc.  In such cases, the issuer must undertake a close review of the indenture for the existing securities to determine the consent requirements for amendments or waivers.

There is an array of factors that must first be explored to decide whether to restructure indebtedness under foreign debt securities and which arrangement would be most appropriate, time and cost wise. Some of these factors include market conditions, cash availability, tax and legal implications. While taking advantage of declining interest rates might be enticing, restructuring the indebtedness may have adverse legal and tax implications for the issuer. To ensure that a decision to restructure would not adversely affect the issuer and achieves its desired goal, all of the factors need to be considered and weighted in their entirety in a structuring phase of the transaction with the involvement of financial, tax, legal, and accounting specialists for purposes of finding a solution, which would best satisfy the business needs of the issuer and be appealing for the investors.