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There has been an extraordinary growth in the number of issuances of high-yield (or “junk”) bonds in Europe until recently. Europe now has a full fledged high-yield market, and, of course, this growth has created a corresponding amount of defaults as well as the creation of a distressed high-yield debt secondary market. Although the European high-yield market differs from that in the United States in terms of volume of deals and the diversity of industries using high-yield debt as a financing mechanism, it is likely that American-style financing mechanisms for restructuring and selling distressed debt will grow in popularity in Europe. The European high-yield bond market is in a constant state of evolution and M&A practitioners should be aware of the evolution of U.S.-styled financing mechanisms for distressed assets. GROWTH IN EUROPE The growth of European high-yield bond issuances for European companies and European affiliates of U.S. companies that are denominated in euros or currencies other than the dollar has grown by leaps and bounds. The European high-yield bond market was virtually nonexistent prior to 1997. Before that year, only a small number of European companies issued any type of corporate debt at all. Since its infancy in 1997, the European high-yield bond market has experienced rapid expansion. That year, it generated approximately 40 debt issuances that raised approximately 5.5 billion euros. [FOOTNOTE 1]In 1998, European high-yield issuances more than doubled, raising approximately 13 billion euros. [FOOTNOTE 2]In 1999 and 2000 European high-yield issuances amounted to approximately 18 billion euros [FOOTNOTE 3]and 11 billion euros [FOOTNOTE 4], respectively. There have been approximately 38 new issues raising approximately $6.7 billion through the end of the third quarter of 2001. [FOOTNOTE 5]The European high-yield market, however, remains a fraction of the size of the high-yield market in the United States. High-yield issuances in this country totaled approximately $102 billion in 1999, [FOOTNOTE 6]approximately $47 billion in 2000, [FOOTNOTE 7]and approximately $59 billion during the first half of 2001. [FOOTNOTE 8] The European high-yield market differs substantively from the American version in certain respects. European high-yield is more illiquid than American high-yield debt. In addition, the European high-yield bond market is much less diversified than in this country. Issuers in the telecommunications and media industries have made up more than two-thirds of the European high-yield bond market although this is changing. [FOOTNOTE 9]In the United States these industries account for a little over one quarter of high-yield issuances. [FOOTNOTE 10]While there have been some issuances by industrial companies, European high-yield debt issuances by industrial and non-telecommunications companies remain a small portion of the overall high-yield debt market. EUROPEAN DEFAULTS INCREASE However, the European high-yield debt market has begun to catch up to the United States market in one important respect — the number of issues trading at distressed levels and the growing number of defaults. This downside of the European market is quickly becoming apparent. Approximately 50 percent of European high-yield issues are classified as distressed (defined by at least one source as debt that trades at spreads more than 1,000 basis points over the corresponding treasury notes or debt that is trading at 80 percent or less of its value). [FOOTNOTE 11] There has also been a marked increase in the number of defaults in the payment of interest from European high-yield debt issuers from the end of 2000 to the first half of 2001. There were 11 European high-yield defaults during the first half of 2001 [FOOTNOTE 12], compared with five during the entire year of 2000. [FOOTNOTE 13]There are also a number of European companies that have not yet defaulted on their high-yield debt but are dangerously close to doing so. [FOOTNOTE 14]Their bonds are trading at cents on the dollar in anticipation of a default. [FOOTNOTE 15]The European default rate increased from approximately 1.5 percent in 2000 [FOOTNOTE 16]to approximately 6 percent to date in 2001. [FOOTNOTE 17] The average time to default is less in Europe than in the United States. In Europe it is two years; in the U.S. the average time is three years, although this has more to do with market cycles than with the intrinsic credit risk of the assets. [FOOTNOTE 18]Because the European high-yield market is still in its early stages, there is little empirical data relating to recovery rates following a default. [FOOTNOTE 19] The European high-yield debt market has been hit particularly hard by the downturn in the telecommunications sector. A large percentage of defaults has been in the telecommunications industry — these defaults were the first major European high-yield defaults. [FOOTNOTE 20]Almost all of Europe’s telecommunications high-yield issues are currently trading at or near distressed debt levels. [FOOTNOTE 21]Defaults in the telecommunications industry account for over 90 percent of total European defaults, which amount to approximately $2.5 billion. [FOOTNOTE 22]There have, however, been high-yield defaults by industrial companies. In April 2001, Cammell Laird Holdings, a shipbuilding corporation, went into insolvency and defaulted on its high-yield bonds and Brunner Mond Group Limited is in the process of restructuring by default. [FOOTNOTE 23] INSOLVENCY PROCEDURES The distressed nature of the European high-yield market creates opportunities for practitioners with expertise in American restructuring financing mechanisms to participate in European financial restructurings and acquisitions, although practitioners should be aware of the substantive differences between the American bankruptcy mechanisms and European insolvency mechanisms. Because the European high-yield market is still nascent, there is virtually no precedent relating to the rights of high-yield debt holders in European insolvency proceedings. European bankruptcy procedures differ widely from Chapter 11; the U.K. insolvency mechanism is a prime example. In the U.K. there are three types of insolvency procedures: administration, administrative receivership and liquidation. An administration is created by court order and creates a moratorium, permitting the business and affairs of a company to be handled by an administrator for the duration of the order. The Insolvency Act of 1986 (Insolvency Act) provides that the court may make an administration order if a company is, or is likely to become, unable to pay its debts and there is a prospect of the survival of all or part of the company as a going concern, approval of a voluntary arrangement and a greater realization of the company’s assets than what would result from a liquidation. [FOOTNOTE 24]A petition for an administration order may be made by a company, its directors or one or more of its creditors. The administrator must be an insolvency practitioner. Administrative receivership is the most common insolvency proceeding used when there is secured bank debt, secured by floating charges over all or substantially the whole of a company’s undertaking. Practitioners in the United States may be surprised at how relatively unfettered the rights of secured lenders are in the U.K. There is comparably little restraint on the enforcement of defaults. Floating charge holders through administrative receivership are able to “pre-empt” the appointment of an administrator, allowing secured lenders, through their receivers, to take charge of the running and sale of a business. There are proposals being developed by the U.K. Department of Trade and Industry (DTI) to effectively abolish the process of administrative receivership. If implemented, these proposals will have a major impact on English insolvency law. The Insolvency Act also provides for liquidation or “winding up.” Liquidation is a distribution of a company’s assets with the intent of paying creditors and satisfying debt and can be one of two types, compulsory or voluntary. [FOOTNOTE 25]Compulsory liquidation is initiated through a court proceeding. [FOOTNOTE 26]A winding up order stays unsecured creditors from pursuing actions against the company. [FOOTNOTE 27]However, secured creditors may continue to exercise rights against collateral of the company, despite a winding up order. Voluntary liquidation is initiated by a shareholders’ resolution. [FOOTNOTE 28]A liquidator is charged with winding up the business and has the power to carry on the business as is necessary for the winding up. [FOOTNOTE 29]Once a liquidator assumes control of a company, the directors do not retain their powers. [FOOTNOTE 30] English insolvency law grants stronger rights to a secured creditor than is found in U.S. Chapter 11 proceedings. A secured creditor has the ability to initiate proceedings unilaterally and has the right to appoint an administrative receiver to act solely on its behalf to gain access to the secured asset. In acting on its rights to enforce its security interests, a secured creditor can enforce its rights to the exclusion of other creditors, particularly high-yield bondholders who are unsecured creditors. The Insolvency Act virtually allows a secured creditor to initiate a type of foreclosure procedure upon a company; this is not possible in the U.S. The Insolvency Act, like the Bankruptcy Code, provides for the sale of a business as a going concern. Once a company has filed for Chapter 11, there is a stay on all claims from creditors. Unlike the U.K., this stay encompasses claims by secured and unsecured creditors alike. The Bankruptcy Code expressly recognizes the right of contractual subordination, which allows one unsecured creditor to be made senior to another creditor by agreement, as does English law. In addition, under Chapter 11, the rights of holders of subordinated debt such as holders of high-yield bonds are junior to the rights of payment of the claims of senior creditors such as holders of bank debt. Moreover, under Chapter 11, consent to a plan of reorganization of a class of creditors is not required if that class is not impaired by the plan. The Bankruptcy Code also permits a “cram down” on an impaired class of dissenting creditors that has not accepted the plan under certain circumstances. RESTRUCTURING TECHNIQUES Given the growing number of defaults on high-yield issuances in Europe, and the increasing need to restructure and refinance European companies with large debt burdens, it is likely that financing mechanisms developed in the United States for restructuring distressed debt and assets prior to and in the context of bankruptcy proceedings will be adopted in Europe. These financing mechanisms include purchasing a company’s assets or divisions out of bankruptcy or insolvency, equitization and the use of pre-packaged bankruptcy plans. In the course of a restructuring or insolvency procedure, a company may sell assets. This could be a full-fledged asset sale, the sale of particular assets or the sale of a division. Acquisition of a company under Chapter 11 is effected through a plan of reorganization. Such an acquisition may take two forms: (1) purchasing all or a portion of the assets of a company, or (2) purchasing the debt or equity securities of a distressed company in order to effect control of the company once it emerges from bankruptcy. The auction process has been adopted in some European insolvency proceedings and is the basic method of security enforcement in the U.K. In April 2001, Cammell Laird, a shipbuilding concern, filed for liquidation in the U.K. [FOOTNOTE 31]PriceWaterhouseCoopers was brought in as a receiver to replace management and liquidate the assets. [FOOTNOTE 32]Approximately 30 companies expressed initial interest in bidding for the Cammell Laird assets [FOOTNOTE 33]and in August 2001 A&P Group purchased two Cammell shipyards, beating out two bids from groups composed of Cammell Laird management. [FOOTNOTE 34]A&P also obtained an option to take over the lease of a third shipyard. [FOOTNOTE 35]Similarly, in a recent liquidation proceeding in the U.K., a liquidator auctioned the technology and associated assets and intellectual property, brand, Web site and customer lists of Boo.com, an insolvent Internet company. [FOOTNOTE 36]These assets were purchased by two respective buyers. [FOOTNOTE 37] Acquisitions of distressed companies may also be effected by purchases of debt or equity securities. In the United States there is a significant liquid market in securities of distressed companies. In U.S. transactions potential buyers have acquired a stake in a troubled company prior to a bankruptcy when the company’s debt has begun trading at distressed levels. Once the company files for bankruptcy the potential buyer will make an offer for the assets of the company that consists of a combination of cash, equity and other financial instruments. The well-developed secondary market in distressed securities has made corporate reorganizations more viable than ever. Once a company has filed for bankruptcy, an investor with the intent to obtain control of the company may also purchase senior secured claims of the company in order to gain standing in the bankruptcy proceeding. If the acquiring company gains a substantial stake it can influence the bankruptcy negotiations and perhaps merge the bankrupt company into the acquiring company. Senior lenders sell their positions in distressed debt to investors who acquire large positions in distressed companies with the intent of acquiring the company or forcing the sale of core assets or a particular segment or division. Distressed companies are increasingly turning to equitization — which turns debt into equity — as a restructuring mechanism. In an equitization, bondholders swap the company debt for 100 percent ownership of the company in exchange for relinquishing their claims against it. Bondholders receive 100 percent of the common stock of the company and in some cases warrants to purchase additional shares of common stock pursuant to a bankruptcy proceeding or a pre-packaged bankruptcy. Equitization serves to greatly reduce or even eliminate the debt burden of the company involved in the bankruptcy proceeding and, in many instances, fully satisfies the claims of the bondholders. The existing stock of the company is converted into new stock that is then distributed to the bondholders. In some instances additional creditors are paid a nominal amount. An equitization serves to reduce or eliminate the debt burden of a company and eliminates the interest payments on the high-yield bonds. Equitizaton allows a company to emerge from bankruptcy with sufficient money to become cash-flow positive, along with a reduced debt burden. In some instances equitization may be the first step before a company is acquired. Esprit Telecom, the European long-distance reselling division of a U.S. company recently restructured its high-yield notes by completing the equitization of its high-yield bonds. [FOOTNOTE 38]Esprit defaulted in December 2000 when it failed to make interest payments on its high-yield bonds. [FOOTNOTE 39]Bondholders unanimously approved the exchange of notes representing $500 million in debt for a 90 percent ownership interest in GTS Business Services, a new company that will own Esprit Telecom. [FOOTNOTE 40] It is likely that the use of pre-packaged restructurings will increase in Europe. In a pre-packaged bankruptcy or restructuring a company negotiates with its banks, bondholders and vendors to agree on a strategy for preserving cash through a quick bankruptcy process. The parties agree to the reorganization plan prior to filing it with the bankruptcy court. A pre-packaged plan is fully negotiated and documented, with the debtor and the consenting creditors contractually agreeing to the terms of the plan and that they will vote in favor of it following the filing of a bankruptcy petition. In a pre-packaged bankruptcy the requisite acceptances are obtained prior to the filing of the bankruptcy petition and, in many ways, the bankruptcy proceeding is a formality. A pre-packaged bankruptcy in the United States, if approved, is binding on all creditors, even those who did not vote in favor of the pre-packaged plan. Pre-packaged bankruptcies reduce the length of bankruptcy proceedings and, in some instances, companies have emerged from bankruptcy in less than three months following the filing of a pre-packaged bankruptcy petition. Esprit Telecom obtained consents from its bondholders for the equitization discussed above prior to submitting the transaction for approval by the court. [FOOTNOTE 41]The transaction was effected through a scheme of arrangement under the U.K. Companies Act of 1985. [FOOTNOTE 42] LOOKING TO THE FUTURE The number of European distressed debt defaults and insolvencies will continue to increase in the coming weeks and months. U.S. models for financing and acquiring assets will increasingly be utilized in Europe. As a practical matter, the mechanics of restructuring a distressed company in any country are complex and difficult. However, the use of asset sales and auctions, equitization and pre-packaged bankruptcies will help practitioners navigate this difficult terrain. The principal challenges facing those practicing in the field of European high-yield are set out below. The first is jurisdictional diversity, and a sample of recent high-yield restructurings demonstrates the problem. Current restructurings involve the Netherlands, Norway, Poland, Spain, France, Germany, Italy, Greece and the U.K. All of these jurisdictions have their own separate insolvency regimes, and little, if any, relevant experience in high-yield restructuring. Instead, put mildly, there is almost no relevant case law or court expertise in restructuring high-yield. Second, much of insolvency law in Europe centers around security enforcement — there is no culture of “enterprise rehabilitation” — the concept of debtor-in-possession is foreign to much of Europe and even in those jurisdictions where it does exist (Germany) it is almost completely untested as of yet. Third, almost all European high-yield is governed by New York law and compliant with the U.S. Trust Indenture Act to enable securities to be offered in the U.S. Given that this requires unanimity from bondholders to vary the terms as to principal and interest, and given the absence in Europe of Chapter 11-style cram-down, the problems posed are enormous. Europe needs time to work through these issues, and until a European-wide Chapter 11-type procedure is developed, the prospects of recovery for high-yield investors in Europe is likely to be, and remain, significantly below the equivalent in the United States. Brian Hoffmann is a partner in the corporate department of Cadwalader, Wickersham & Taft. Andrew J.O. Wilkinson is a partner in the firm’s financial restructuring group and managing partner of the London office. Angelia M. Dickens is an associate in the firm’s New York office. ::::FOOTNOTES:::: FN1“European High Yield Stands Tall,” Euroweek, June 2000, at 4. FN2 Id. FN3 Id. FN4Moody’s Investors Service, Special Comment, “Ratings Migration in European High Yield: What’s Been Going On?”, June 2001, at 1. FN5Sarah Husband, “Deutsche Moves Up on European League Tables,” High Yield Report, Oct. 8, 2001. FN6The Bond Market Association, Research Quarterly, February 2000, at 5. FN7The Bond Market Association, Research Quarterly, February 2001, at 5. FN8The Bond Market Association, Research Quarterly, August 2001, at 5. FN9Sarah Husband, “Deutsche Moves Up on European League Tables,” High Yield Report, Oct. 8, 2001. FN10Ian Rowley, “Not Quite the Predator’s Ball,” Institutional Investor, August 2000, at 35. FN11 Independenton Sunday (London), Sept. 9, 2001, at 3; see alsoJason Nisse, David Lofts, “There’s Rich Pickings for the Vultures as High-Flying Telecoms Firms Fall to Earth,” Independenton Sunday (London), Sept. 9, 2001, at 3. FN12“Euro Junk Bond Defaults — CSFB Leads: Using Telecom Deals as an Entree Into a New Market Costs Wall Street Firms, Investment Dealers Digest, June 11, 2001, at 9-11. A default is broadly defined as a restructuring of debt, delay in making an interest payment or failing to make an interest payment. Id. FN13Suzanne Miller, “Growing Pains,” Institutional Investor, August 2001, at 26. FN14“Telecoms Junk Bonds Slump More than 50%,” Financial News, Aug. 6, 2001. FN15 Id. FN16Suzanne Miller, “Growing Pains,” Institutional Investor, Aug. 2001, at 26. FN17Sarah Husband, “More Defaults Coming in Europe,” Bank Loan Report, Oct. 8, 2001. FN18Sarah Husband, “More Defaults Coming in Europe,” Bank Loan Report, Oct. 8, 2001. FN19Sarah Husband, “Europe’s HY Market Learns Lesson from Cammell’s Default,” High Yield Report, April 23, 2001. FN20Including Ionica Plc, RSL, Esprit, Dolphin, and Atlantic Telecom. FN21“Junk Market Reaches New Distress Levels,” Financial News, July 2, 2001. FN22 Id. FN23Sarah Husband, “Deutsche Moves up on European League Tables,” High Yield Report, Oct. 8, 2001. FN24U.K. Insolvency Act of 1986 �8. FN25U.K. Insolvency Act of 1986 �73. FN26U.K. Insolvency Act of 1986 ��122-24. FN27U.K. Insolvency Act of 1986 �130. FN28U.K. Insolvency Act of 1986 �84. FN29U.K. Insolvency Act of 1986 �87. FN30U.K. Insolvency Act of 1986 ��91, 103. FN31Cammell Laird Attracts Interest From 30 Bidders-Receiver, AFX.com, available at www.lexis.com, April 30, 2001. FN32 Id. FN33 Id. FN34“Britain’s A&P Group Buys Cammell Laird Shipyards,” Defense Daily International, Aug. 24, 2001; see alsoJames Chapman, “Clock Ticking for Beleaguered Market Trio,” Investors Chronicle, Aug. 24, 2001. FN35James Chapman, “Clock Ticking for Beleaguered Market Trio,” Investors Chronicle, Aug. 24, 2001. FN36Clive Mathieson, “Wagner Snaps Up Boo.com’s Technology for Pounds 250,000,” Times Newspapers Limited, May 29, 2000; Dan Sabbagh, “Last Shout for Boo as US Net Firm Buys Brand,” The Daily Telegraph(London), June 2, 2000; see alsoMajorie Chertok and Warren E. Agin, “Restart.com: Identifying, Securing and Maximizing the Liquidation Value of Cyber-Assets in Bankruptcy Proceedings,” 8 Am. Bankr. Inst. L. Rev.255, 296-97, Winter, 2000. FN37 Id. FN38“GTS-Europe-Ltd. Bondholders Unanimously Approve Scheme of Arrangement,” Business Wire, July 13, 2001. FN39Rebecca Bream, Joia Shillingford, “Esprit Bond Default Turns The Spotlight on Telecoms Debt: The Company’s Non-Payment is Seen as a Clear Sign of Trouble to Come,” Financial Times(London), Dec. 18, 2000, at 19. FN40 Id.; see alsoPaul Durman, “GTS in $500m Bond Deal Saves Internet Carrier,” Times Newspapers Limited, April 8, 2001. FN41“Global TeleSystems Announces Consensual Agreement with Esprit Senior Noteholders,” M2 Presswire, March 28, 2001. FN42“Global TeleSystems-Europe-Limited Announces Commencement of Consent Solicitation; Consent Solicitation to Remain Open for 10 Business,” Business Wire, March 27, 2001.

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