Insights On Europe Restructuring

Tuesday, May 31, 2011 - 01:00

The Editor interviews Corinne Ball, U.S. restructuring lawyer tasked with spearheading Jones Day's bankruptcy and distressed M&A efforts in Europe.

 

Editor: Tell me about how you perceive your new role with Jones Day’s overseas offices.

Ball: I am very excited about it. Europe is facing challenges. Europe has the opportunity to diversify the range of capital investment available to its business community to include investors with a longer-term investment horizon as well as the currently dominant model, which depends upon short-term loans from traditional bank lenders. Our private-equity/value investor fund clients may have a unique opportunity to deploy their capital into Europe to assist in the transition for European banks to exit those loans that have become long term “embedded” capital. I am hopeful that we will craft an approach that is both sensitive to Europe’s bank regulators’ views as to what they would like to see unfold and sensitive to what they and the European banks are trying to achieve as they move forward into recovery from the financial crisis. 

Conceptually, the time is approaching when those loans and investments that have not performed as short-term bank loans should be recognized as longer-term or equity investments that are more suited to investors with a longer-term profile. Moving those financial assets to investors that want to turnaround and rescue what are now overly leveraged businesses should, if properly implemented, be good for employment and economic recovery and advance Europe’s recovery. Given our strong history in working with the world’s most successful operating businesses and our dedication to creative rescue- and value-oriented distress investment, we believe Jones Day is uniquely qualified to facilitate this transition and advance economic recovery in Europe.

When I came to Jones Day 10 years ago, my focus was on complex restructuring and rescue matters, whether it was on the company side or for sponsors with distressed portfolio companies. Frequently, those rescues meant a change of control; hence my second and most natural focus was distressed M&A. Jones Day with its global one-firm approach has been ideal for serving clients in need of a restructuring or those who are optimistically investing in such companies. 

Our clients should know that wherever our firm represents them, they are going to get the strength of the entire firm behind them to support their objectives. My four goals at Jones Day since I have been practicing in this area are constant: first, I want to have a strong and talented bench on the restructuring side, in the U.S., UK, Germany, Japan, Australia, India and Spain; second, our team is experienced at handling the urgent and pressing demands of a restructuring, as well as developing an approach to identifying and managing the multiple risks encountered in distressed M&A; third, our team has experienced professionals from other legal disciplines that have honed the allied skill sets to deal with all the attendant issues encountered in business rescue, e.g., pension and labor, litigation, tax, as well as competition issues; lastly, and perhaps, most importantly, serving the client – driving to achieve their objectives.

Editor: Please tell us about your background.

Ball: By way of background, I have been a restructuring professional for 30 years, the last ten of which have been at Jones Day. Immediately after law school the first rescue I worked on was the City of New York. I was mentored by Ira Millstein of Weil Gotshal. Ira’s retirement from practice and the determination of our managing partner, Steve Brogan, to enhance and invest in making Jones Day a leading global firm were the two key factors for my joining Jones Day. 

Chrysler was the culmination of a number of cases in which we pioneered a certain way of restructuring companies, such as with Dana Corporation and FGIC, and acquiring and rescuing troubled companies, such as International Steel Group, International Automotive Components and International Coal Company. 

Dana had operations throughout North America, Europe, Australia and Latin America. We restructured that business and ultimately transferred control of that business to Centerbridge Partners, a very large private equity fund with substantial experience as a rescue-oriented distressed investor. Rescuing the enterprise, preserving jobs and creating value while fully paying the senior secured banks were core objectives of Dana, Centerbridge, the unions and most of the bondholders. We and Centerbridge worked closely with Ron Bloom, a smart and creative investment banker dedicating his talents to serve the steelworkers and innovating new approaches as he did in working with our team and Wilbur Ross in building International Steel Group. One such example in Dana was our approach to the resolution of retiree pension and related legacy obligations in the U.S. and the UK. Our Dana team was responsible for the first joint negotiation and implementation of a VEBA solution for the auto and steel workers in North America and one of the first “Company Voluntary Arrangement” insolvency proceedings in the UK to implement a settlement with the UK pension regulator. Dana, like many companies facing financial distress had tried to outlast its business downturns and fund losses by embarking on an aggressive asset disposition program. Every time Dana sold a business line, it retained all pension and legacy retiree healthcare obligations attributable to the sold business. When we were introduced, Dana was working through a restatement of its financial statements and rapidly approaching a technical default on its secured credit facility which would create a cross-default throughout its capital structure. In addition Dana U.S. was carrying the retiree and legacy obligations of a company that had been three times larger, as well as providing the financing for all of Dana’s worldwide operations. It was an unsustainable model – Dana needed a resolution of its holdover pension and legacy obligations; it needed to de-leverage and redeploy its assets to meet the ever-increasing demands of its auto customers; and it had to preserve and protect its valuable European businesses throughout the restructuring process. Achieving these Dana objectives took groundbreaking labor negotiations where our labor insolvency team under the leadership of Andy Kramer reached a resolution with Ron Bloom, who would later represent the government in Chrysler, through a labor settlement with a VEBA to permanently address Dana’s legacy issues and achieve a competitive cost structure with the workforce. This aspect of the Dana restructuring would serve as a building block for other transactions, including Chrysler and GM.

Editor: Tell us about the Dana Corporation settlement with the UK pension regulator.

Ball: Dana’s asset disposition program had also created a pension deficit in the UK. Dana still had non-core business lines through North America, the UK and continental Europe that it wished to sell. Dana also had core operation in the UK and continental Europe that were central to its rescue and the Centerbridge investment. Achieving both of these Dana objectives presented many hurdles. Primary among them was the pension deficit in the UK. The Pension Regulator, the buyers of the non-core businesses and Centerbridge clearly had an interest in how Dana addressed the pension deficit. So we, with the guidance of Rosalind Connor from our UK benefits team, designed a solution relying upon a little-used UK insolvency proceeding, a “Company Voluntary Arrangement,” that included only the entities that were being sold and implemented a settlement with the UK Pension Regulator. To contain the risks and uncertainty of the U.S. chapter 11 and UK pension deficit we also had to take steps to preserve and protect the valuable European businesses. We needed to ensure that they could be self-sustaining and independently financed. To achieve this Dana objective, we capitalized on recent changes in German law that favored receivable financings, pioneering the first pan-European secured financing, which cleared the way for the Centerbridge investment. Our team reached similar achievements in Mexico and Australia. With the Centerbridge investment and these multiple successes we were able to launch Dana on its successful rescue – one that was built to survive even the auto crisis of 2008-09 which would send GM and Chrysler into bankruptcy. 

Like the VEBA solution, our positive approach to the Pension Regulator and perseverance to implement the pan-European financing would become important building blocks for other rescues and investments.

Following this success we assisted Wilbur Ross with his acquisitions in Europe. Through his company, International Auto Components, Ross bought the European operations of Collins & Aikman in seven different countries through one administration proceeding in the UK. Jones Day, including its London partner, Michael Rutstein, relied upon the relatively new EU Insolvency Regulation to preserve and pursue for Mr. Ross, as a rescue investor, the key auto operations of this multi-jurisdiction enterprise mired in insolvency. We were able to rely upon the UK, as the company’s center of main interest, to provide interim financing for the UK Administration proceedings and purchase the operations in seven different European jurisdictions. We would again, relying upon the leadership of Andy Rotenberg and Volker Kammel, strengthen IAC’s rescue of these auto operations with a pan-European financing relying upon the team and technique that we had pioneered in Dana.

Later, Mr. Ross took IAC into additional acquisitions, following Collins & Aikman, to buy operations from Lear, and once again, with Volker Kammel, used the same techniques that we had learned, including buying a German company, Stankiewicz GmbH, from a German insolvency administrator as well as its U.S. affiliate out of its chapter 11 case. Our team had previously done substantial investments through restructuring in the steel industry. International Steel Group, another Ross company, was created through rescue acquisitions across the distressed steel industry, launching one of the world’s most successful integrated steel companies, which Mr. Ross with our support would sell to Mittal. Once again we relied upon our multiple-discipline, multijurisdictional team that was experienced in rescuing a company with global operations, working with smart investors to build a successful company from various distressed situations. We would do the same in the North American coal industry, helping Mr. Ross build International Coal Group from Anchor, Horizon and other troubled coal companies, into a dominant player which, as recently announced, has just entered into a sale to Arch Coal for some $3.4 billion.

Editor: Tell our readers about your work with the Financial Guaranty Insurance Company (FGIC) and the extensive transactions with the UK’s Financial Services Authority.

Ball: We were early forerunners in the restructuring activities of the financial crisis. The subprime crisis first became apparent in the monoline insurance industry and later AIG, which had insured billions worth of complex financial structures involving residential mortgage-backed securities. As default rates escalated in these RMBS securities, and claims were being made with more expected, the AAA ratings of these insurers failed. That failure had a cascading effect on many financial institutions, especially the banking industry, whose accounting and investment strategies were premised upon the AAA rating, which effectively masked the risk and impact of the subprime crisis on many financial institutions. 

The big monoline insurers, such as Federal Guaranty Insurance Company, were among the first to fail. The monolines had broadened from their traditional business of insuring municipal debt and infrastructure projects into insuring structured financial instruments – the CDO-squared and synthetic derivatives related to the commercial and residential mortgage-backed securities. As insurers, the monolines were regulated in the U.S. by the various states and were not eligible for chapter 11 and in the UK by the FSA and subject to the insolvency laws. 

The traditional business was healthy and stable while the performance and future condition of the structured business was uncertain. We were asked to work with FGIC and its regulators to rescue the traditional business through a sale and stabilize and investigate the structured business. We designed a process for the rescue sale of the public finance business, which included a committee of financial institutions that were FGIC’s largest counterparties in its structured business, both here and in the UK. That process included a massive diligence effort involving prospective purchasers, the bank committee and its experts, and the regulators, culminating in a unique regulatory administrative hearing and approval process, at which the banks had the opportunity to be heard and submit evidence. We also coordinated that process and sale with the FSA.

Ultimately, FGIC’s municipal public finance business was sold to MBIA in less than 180 days from start to finish. In addition to the bank committee and regulatory process, we would also have to meet and defeat an expedited lawsuit brought by an equity holder seeking to enjoin the MBIA transaction. 

On the structured side we investigated very complex deals – some of which were subject to U.S. law while others were subject to English law, and many involved German banks. The investigation was motivated in large part by events in Europe. Just as the subprime crisis was breaking into the financial news, IKB, a large German bank that was heavily involved in structured products, failed, just weeks after IKB had sold large subprime-based complex synthetic derivatives deals onto the market. Our Financial Institutions Litigation and Regulatory (FILR) group under the leadership of Jay Tambe, with Stephen Pearson in the UK and Thomas Mahlich in Frankfurt, ran the investigation and assessment. 

In the wake of that failure, we designed a cross-border litigation and restructuring strategy for FGIC that saved FGIC from $1.6 billion in exposure, and we’re continuing to pursue a German bank for another $200 million. We were able through that means to relieve FGIC of its obligations to a French counterparty. 

While there were flaws in the original structuring of the deal, we were able to overcome them by involving UK and U.S. law and bring the matter to a successful conclusion. 

We then worked with more financial asset deals stemming from that experience with FGIC. Since FGIC, our restructuring/FILR team has helped MBIA assess its structured and infrastructure deals, in the U.S., the UK, Germany, and Australia. Again with that experience our restructuring/FILR team has also assisted major European banks in resolving their issues on complex structured products with Ambac and AIG. We are also working with Alvarez and Marsal on Lehman’s derivatives and complex financial instruments.

Editor: Could you briefly summarize your central role in the Chrysler reorganization? 

Ball: Chrysler was the first of the automobile companies to really admit that it was in dire straits after the fall of Lehman and the rescue of AIG, owing in large part to the foresight and judgment of its gifted general counsel Holly Leese. She urged us to help develop a contingency plan in view of the fact the company was running out of cash by the end of 2008, as Chrysler’s CEO would later tell Congress as part of the testimony by Detroit’s Big Three CEOs. 

I think that Hank Paulson made an absolutely critical decision in saving our economy and citizens from potentially devastating consequences when he determined that GM and Chrysler could borrow under TARP, a program that many critics would later argue was not intended for industrials, despite the magnitude of systemic risk presented by GM and Chrysler. 

As you know, Congress turned down a separate financing for the auto companies. In fact, that would be one of the arguments put forth by the Chrysler’s minority lenders in opposition to the Fiat transaction that was the centerpiece of Chrysler’s rescue in chapter 11. 

Significantly, although Chrysler and GM had asked for some $25 billion to get them through 2009, Hank Paulson agreed to loan the two companies a much lesser amount. In making the original TARP loans in December 2008, the U.S. Treasury lent enough to get the two auto companies through the first quarter of 2009 during which time each of Chrysler and GM would need to formulate a viability plan that would demonstrate that they had sufficiently restructured themselves to be cost competitive, including getting their labor obligations on a level with Toyota, rationalizing their dealer operations and reducing their leverage. Each had to submit a plan by February 17 at which time the government would consider whether additional loans were advisable. 

Bob Nardelli did a great job as a crisis CEO, knowing there was only enough money to get through 90 days and that Chrysler was going to have to apply to the government for a second installment based upon a viability plan. Yet, he, like Sergio Marchetti and other globally experienced auto executives, believed that no auto company could survive a chapter 11 filing. We finally were able to convince our client that given Chrysler’s diligent search for alternatives, if there were a rescue transaction such as the Fiat transaction, we could get Chrysler’s business out of chapter 11 quickly through a Section 363 sale. As you know, we would succeed in 42 days, including going to the U.S. Supreme Court.

Editor: There was a time when the government thought they would let Chrysler go, as I recall.

Ball: That is absolutely true. Instead of the “auto czar” contemplated by the Paulson loans, President Obama appointed an Auto Task force of experienced executives and Ron Bloom. Ron was the point person on Chrysler. The Auto Task Force hired some of the most brilliant, dedicated young professionals to analyze the viability plan and to help the Auto Task Force assess whether or not the taxpayers’ money should be used to do an auto bailout. The Chrysler viability plan, which was a public document, presented three alternatives: a stand alone plan, a joint venture with Fiat or, failing either, a liquidation plan. 

As you know, the government on March 30th would basically tell Chrysler that it was not viable on a standalone basis and that if, and only if, it could come to terms on a transaction with Fiat or another appropriate partner, the government would then loan Chrysler at least another $6 billion to complete the transaction. Chrysler had 30 days to determine whether it could close the deal with Fiat because we had already exhausted any other third party alternatives. The President actually mentioned the words “surgical bankruptcy.” We then convinced Nardelli that only the 363 strategy could save the company. Fiat, GMAC, the Task Force and Mr. Ron Gettelfinger and his autoworker team worked incredibly hard to come to a transaction that the U.S. Treasury would fund. Meanwhile the liquidation analysis of Chrysler clearly demonstrated that failure would be devastating to the creditors, the banks, the workforce and the many communities that depended on Chrysler, its dealers and its vendors. 

That analysis was totally transparent and available because we included the analysis in the publicly available viability plan and reviewed it at length with the union and the lenders, and their respective advisors. The lenders had ample opportunity to challenge and assess or find another alternative. The overwhelming majority of lenders finally concluded that the Fiat transaction was the only alternative to liquidation and provided a better recovery than the lenders would get in liquidation. 

The only “new money” lender was the U.S. Treasury. The only operating exit that lender would support was a Fiat or similar transaction, and – even then – only if it could be closed on an expedited basis as Chrysler was hemorrhaging some $100 million a day. 

Tim Cullen led the trial team, who would lay out for the court that the Fiat transaction was the highest and best deal available and after diligent, if not exhaustive search, there was no alternative other than liquidation, which would provide far less value. 

We moved at lightning speed, setting up the data room with discovery discs of all documents showing our efforts to find financing, our efforts to sell the company, our efforts with Fiat. The burden was clearly going to be on us since Chrysler wanted to move quickly and the lack of time and the magnitude of the situation required that we present an incredibly thorough case from the very first day. I think that made all the difference. 

We probably raised the evidentiary standard as to what it takes to do a 363 sale quickly. We had altogether about 17 trial dates with very active litigation following expedited extensive discovery. Three legal theories were argued unsuccessfully in an attempt to prevent the sale to Fiat: first was that the government’s actions were unlawful because TARP was never intended for auto companies; theory two was that the sale violated the absolute priority rule because Fiat, as purchaser, negotiated an equity deal with the unions while the banks only received 100 percent of the sale proceeds realized from their collateral; and third, the court should call the Government’s bluff and see if it would keep on lending Chrysler $100 million a day so that others could try to find a better deal. 

The first was a theory that was not appropriately challenged in the bankruptcy courts by hedge funds because the hedge funds were not injured by the loan and TARP had its own administrative and judicial review procedures. The evidence against the other two points was overwhelmingly in favor of going ahead.

Given the closing of the more than $7 billion financing to repay the government loans early, this rescue worked.

Editor: What opportunities does the current environment present for buyers interested in distressed assets in the U.S. and abroad?

Ball: There are fundamental differences right now in distressed investing in the U.S. and abroad. One is the capital characteristics of a U.S. company. In the U.S. the capital markets are clearly providing an alternative financing source. Banks are exiting over-leveraged companies via high-yield bond issues. So what we’re witnessing in the U.S is a great boon for the high-yield market in a low interest environment where the capital markets have replaced short-term bank loans with longer-term bond debt. As a consequence the maturities of the debts of these companies that are over-leveraged have been pushed out. In the U.S. those companies that could not refinance in this environment are either companies that are too small to access the high-yield market or they are in industries that we know are troubled, such as print media, book sellers, certain commodity dependent companies, and directories. In contrast in Europe 60 percent of the financing is bank based – by and large Europe doesn’t have the robust high-yield market present in the U.S. In the past amending and extending facilities rather than addressing the needs of the underlying business has been the dominant activity. It may come down to how creative investors and financial institutions approach credits that have become embedded capital rather performing commercial loans. Since Europe doesn’t yet have the capital markets availability, the opportunities lie with developing an investment approach to work with financial institutions to transition these financial assets to investors that are prepared to invest and rescue the underlying businesses. We may be a little ahead of ourselves in speculating as to how investors, the banks and their regulators will move toward this, but we are convinced that new investment dedicated to rescue turnaround would be a healthy outcome that would also move the banks out of long-term equity-like positions. 

There are similarities in the U.S. and Europe, however, that may provide the bridge for going forward. Commercial real estate ventures, hotels and similar multi-location ventures like pubs that are characterized by securitized and structured financing are now a focus for distress investors in both places. In Europe and the U.S., there are opportunities through NAMA, the regulatory entity in Ireland for the Irish banks. Similarly in Lehman Brothers there are substantial real-estate-related financial assets. We have already sold on behalf of Lehman a big CMBS deal based on German real estate. Not surprisingly, these are situations where market-value-based “marks” have already caused losses to be realized, or the lenders have already decided they’re going to move out of assets and take the loss.

In Europe we think that investors and their advisors have to be appropriately thoughtful about their objectives and approach. We hope to work with the Council on Global Financial Regulation to develop an approach so that financial institutions are more comfortable exiting these assets that once constituted short-term loans but have now become long-term or invested capital. 

Editor: With most large cases involving multiple jurisdictions these days, how does Jones Day coordinate restructurings across borders?

Ball: We have discussed the core hallmarks of our practice. The first is a deep bench of restructuring talent. Also we have the allied legal skill sets that are knowledgeable and experienced in the distressed investing arena. Whether litigation skills are needed in assessing and resolving financial assets or, as is the case with Wilbur Ross, much more M&A oriented teams are needed, we absolutely have the allied skill sets from multiple disciplines for operating in multiple jurisdictions. At Jones Day everything operates as one firm worldwide with truly efficient and effective cooperation to serve our clients.

Editor: Do these global cases present strategic opportunities for debtors in terms of the timing of filings or otherwise?

Ball: Yes, they do. I think if we return to some of our earlier discussions about Dana and Collins & Aikman, it was very important that Dana control and confine its insolvency proceedings to the U.S. and at the same time design and make cash and financing available so that its European operations that faced a much more difficult insolvency regime could be self-sustaining, operating outside insolvency, since the problems were largely, but not exclusively, the problems of the U.S. holding company. Clearly Dana involved a strategy as to where do we file and how do we keep our other properties stabilized and operating. In the case of Collins & Aikman, getting operations in seven countries operating through one administration in the UK was a strategic move. We could do the acquisition through one administration and that was very important, enabling us to stabilize the business through a loan to that one administration. Chrysler also operated in multiple jurisdictions and our strategy had to take account of that complexity too.

Editor: Do you see any recent or prospective developments that may change the playing field for restructurings in Europe or the U.S.?

Ball: There are legislative changes in Germany and proposed legislative changes in Spain. In Germany, in the case of an insolvency, the courts would formerly appoint the administrator or trustee-type figure. Creditors had no say in the matter. Now creditors will be allowed to pick the trustee, and that is a huge change. 

Spain, on the other hand, has been trying to deal with two problems making its insolvency regime unattractive to investors: one is its very complicated clawback rules, i.e., if you do a restructuring, which doesn’t work, you have a two-year look-back where the improvements made can be challenged and even voided. Spain has worked very hard to put something in place that would protect a well-conceived and widely supported restructuring plan from those challenges, and if the courts get it, that is a big development there. Spanish legislators also have a proposal right now that would deal with creditor holdouts. This is another development that would preserve value and make Spain more hospitable to new capital investing in distressed situations. Absent these developments as to clawbacks and holdouts, investors were very fearful about going into Spain.

The UK has been moving forward with distressed going-concern sales by using prepackaged insolvency administrations similar to our 363 sales in the U.S. The aim is to keep those assets in production and to stabilize them quickly. The benefit lies in a proceeding that allows you to know when you enter bankruptcy that at least there is a very good opportunity to exit in an orderly way so that customers, employees and others who are critical to the success of a restructuring do not desert the company when it’s in a proceeding. 

In addition, increasing reliance is placed upon a UK scheme of arrangement. Although it is a court-sanctioned proceeding, it is not an insolvency proceeding. Yet, it is being effectively used to restructure companies on a largely consensual basis – even with multiple jurisdictional enterprises. Recent developments suggest that if a foreign company has English law loan agreements providing for jurisdiction in England and the restructuring plan being proposed by the proposed scheme only affects those creditors that are subject to  English law loan documents, it can use the English scheme as a foreign company. These developments rely both upon the EU Regulation on Enforcement and the EU Insolvency Regulation with its Center of Main Interests (COMI) model and should enable us to have a more streamlined approach to implementing creditor-supported restructuring plans and dealing with hold-outs and unanimity requirements that are present in many funded debt instruments.

In the U.S. we’re seeing an interesting development. Distressed investors in smaller companies are buying what we would call a vertical strip – first lien debts, second lien debts, maybe even third lien debts. When such investors propose restructuring, the terms proposed for first liens may seem overly generous to more junior creditors and terms that normally a first priority lender would never consider. Yet, these investors are buying the senior and junior loans with a view to taking control of the company through the more junior loans and may be using their first and second lien positions to create a debt structure for a company they want to own through converting their third lien to equity. It seems counterintuitive until you realize that it actually is part of a strategy to return the company to health over the long term on the assumption that some investors that are buying the loans in the secondary market are going to be the equity owners of the future. This approach is not prevalent in Europe – perhaps because the secondary market for bank debt in Europe is in early stages.

Please email the interviewee at cball@jonesday.com with questions about this interview.