Bond workouts - Distressed equity offering - State Interventionism

BOND WORKOUTS
DISTRESSED EQUITY OFFERINGS AND
STATE INTERVENTIONISM
An analysis of the real costs of the inefficiencies of French corporate insolvency
law for large public corporations
Sophie VERMEILLE
• Lawyer in Corporate and Restructuring Law
• Researcher at the Law and Economics Research Laboratory
of the University of Paris Law School (Paris II, Panthéon Assas),
• President of the Rules for Growth (Droit & Croissance) Think Tank in Paris
16/11/2017
LABEX REFI PARIS I-ESCP-CNAM-ENA

Introduction Context – Empirical Studies Page 3
Part I Nine findings Page 16
Case Study
Bull, Technicolor, Alcatel, CGG, Solocal, Alstom, Areva
and General Motors
Part II Conclusion and five recommendations Page 62
2
SUMMARY

3
INTRODUCTION
Context – Empirical Studies

Introduction: large distressed firms in France over the last years
• Over the past five years, France has seen a number of major
restructuring/recapitalization of public companies (including several
relapses)
• Major restructurings and recapitalizations have made headlines in the
past (Eurotunnel, Bull, Alstom, Rhodia, Technicolor, France Telecom and
Air France)
4
Dexia
CGG
Sequana
Technicolor
PSA
Alcatel,
Soitec
PSA, Solocal
Gascogne
Sequana
Eurodisney
OL-Groupe
Latécoère
CGG,
Vallourec,
Solocal
Soitec
CGG
EDF, Air
France,
Areva
2012 2013 20162014 20172015

Introduction: large distressed firms in France rarely file for formal insolvency
proceedings under French law
• 101 recapitalizations during 2009 and may 2017 on the Euronext Market
• 82 gave rise to the issuance of new common shares, with maintenance of
preferential subscription rights (PSR)
• These 82 transactions concern 62 companies amongst which only 21
involved transactions, the amount of which exceeded 50 million euros
• Furthermore, these 21 large companies were at the origin of 30
recapitalization transactions with PSR (out of our sample of 82
companies), a certain number of them having made several public offers
in order to resolve their financial difficulties.
5

Introduction: Instead of insolvency proceedings, French listed companies
have historically preferred to launch distressed equity offerings
• 25 out of the 30 recapitaizations above the 50M euros threshold can be classified
as distressed equity offerings, i.e. a capital increase carried out by means of
contributions in cash, to the exclusion of any conversion of debt into shares,
implemented for the benefit of a company, complying with at least three of the
five following criteria:
6
 (i) the transaction is presented on the market as being essential to the
immediate survival of the company,
 (ii) the company has a high level of indebtedness leading to a speculative rating
or close to being so,
 (iii) the company has interrupted the payment of dividends or has not
distributed dividends in the course of the last three years,
 (iv) the subscription price of the new shares has a greater than 30% discount in
relation to the face value of the market price immediately before the
announcement of the transaction,
 (v) the issuance of shares leads to a significant dilution (greater than 25%) of the
rights of those shareholders not having taken part therein.

Introduction: empirical studies have shown that these recapitalization
operations remain, in fact, very risky for shareholders
• 25 distressed equity offerings, concerning only 18 different companies, highlights
a « failure » rate of approximately 30% (bearing in mind that four issuances were
carried out between 2016 and 2017).
• There is a failure if the distressed equity offering is followed, within less than four
years, by a new distressed equity offering or an in- depth restructuring of the
balance sheet, entailing a massive conversion of debt into shares, itself leading to
a dilution of more than 80% of shareholders’ rights.
• In half of the cases (12 out of 24), the stock market performance of the shares
remains less than 1.5 times than that of the CAC 40, which may be considered as a
reference
7

Introduction: Instead of insolvency proceedings, French listed companies
have historically preferred to launch distressed equity offerings
• A capital increase essential to the survival of the company and earmarked for: 1)
the repayment of past debt and/or 2) the financing of a restructuring plan and/or
3) the financing of essential investments
8
• This is a risky financial gamble for
shareholders who must be convinced
that the recapitalization can generate
enough net positive value for them.
• Absent such increase in value, the
recapitalization merely amounts to a
massive transfer of shareholder wealth
to the creditors
• This is also a risky gamble for creditors when proceeds of the recapitalization are
used to make unprofitable investments wasting the company's time and
resources.

Introduction: empirical studies have shown that these recapitalization
operations remain, in fact, very risky for shareholders
• Yet, there is a positive correlation between the level of distress of a firm and the
chance of a distressed equity offering (Ph. Jostarndt, 2009)
• In addition, concessions from creditors remain very moderate (26%-30%), (N.
Keifer, 2003 and J. Franks, S. Sanzhar, 2006)
9
• The stock price usually drops significantly after such a
recapitalization (10%) (J. Franks, S Sanzhar, 2006)
• A transfer of wealth between old and new shareholders?
Not really, the average yield of the shares of distressed
firms remains lower than that of healthy firms in the same
business. The "Distressed puzzle" phenomenon (J.
Campbell, J. Hilscher and J. Szillagyi 2008)

Introduction: findings and questions
• An omnipresent French State in the restructuring of large French companies.
• The State played a role in 12 out of the 30 transactions in the sample, either as an
existing shareholder at the time of their recapitalization or, most often, as
«shareholder of last resort», contributing its financial support at the time of
recapitalization.
• Regardless of size, the State shareholder was led to play a role, between 2009 and
mid-May 2017, in 16 out of the 82 transactions giving rise to the issuance of new
shares with preferential subscription rights. This is not surprising considering the
State’s level of intervention and commitment in the economy, which, according to
the Cour des Comptes (French court of auditors) has no equivalent in the OECD.
10

• Theses findings show massive transfers of wealth from shareholders to creditors.
This is a problem because the French State often supports this type of operation.
 Why are large French listed companies so prompt to launch themselves into risky
distressed recapitalizations without previously requiring significant concessions on
the part of their creditors, as is the custom in numerous countries?
 For what reasons do creditors of such large companies not impose greater
requirements on managers to carry out in-depth restructuring of the company’s
debt, as in done in numerous countries, in order to avoid the failure of the
company in which they shall bear the losses?
 For what reasons do minority shareholders of such companies agree to take part
in distressed recapitalizations that are so risky for the shareholders?
11

 What is the liability of the managers of French companies who cause their
shareholders and their companies to incur such risks?
 What are the reasons compelling the State to assume, in France, the role of
shareholder of last resort in both public and private companies?
 Why does the State not systematically compel creditors to make concessions in
order to reduce its risk and limit the cost for public finances of this type of
recapitalization?
12

• We shall seek to highlight the connection existing between legal deficiencies and:
 the difficulties encountered by large French companies, whose bond debt is
dispersed over French markets, in restructuring their debt in-depth, other than by
means of any insolvency proceeding; this
 the difficulties encountered by creditors in exercising control over company
managers allowing them to compel them to give priority to in-depth debt
restructurings;
 the inadequacy of the protection afforded minority shareholders in connection
with distressed recapitalizations;
13

Introduction: we will seek to show the link between the inefficiencies of
French corporate insolvency law and:
 the ease with which the managers of French companies put their minority
shareholders at very high risk by requesting them to subscribe to distressed
recapitalizations without incurring their own liability;
 the frequency of the intervention of the French State in distressed
recapitalizations is explained by the absence of a market enabling opportunistic
investment funds to play the role that is theirs in other countries;
 the terms and conditions of the intervention of the French State which often
accepts the risk of a shareholder of last resort, rather than the lower risk of lender,
thereby causing considerable public financial losses to be incurred, sometimes in
violation of European rules concerning State aid.
14

First
Finding
The bargaining power of the CEO against bondholders depends on the
credibility of a threat to file for insolvency proceedings
Slide 20
Second
Finding
French corporate insolvency law does not grant the CEO the right to
compel bondholders to participate in an exchange offer Slide 25
Third
Finding
French corporate insolvency law does not give the CEO any leverage to
convince bondholders to participate in an exchange offer Slide 28
Fourth
Finding
French corporate insolvency law has failed to foster the creation of a
market for the control of large distressed company – Consequently the
management of French companies are rarely under any pressure from
their own creditors to conduct a thorough restructuring of their balance
sheet.
Slide 41
Fifth
Finding
Failing any pressure to restructure their balance sheet, French CEOs
prefer to launch distressed equity offerings which are riskier for
shareholders; and which shareholders should, at least in principle, turn
down
Slide 44
15
Introduction: demonstration in nine findings

Sixth
Finding
However, because shareholders suffer from information asymmetry
relative to the management, it is very difficult for them to distinguish their
own interest, as well as to admit that their judgment can be significantly
impaired by cognitive biases
Slide 45
Seventh
Finding
The management is subject to similar cognitive biases as well as to conflicts
of interests
Slide 48
Eight
Finding
Finally, because France has no alternative market or specialized investors
actively bidding for the control of distressed companies, the significant
investments made by the French State send a misleading signal of
confidence to minority shareholders,
Slide 54
Ninth
Finding
Under US law (Chapter 11) the management can force bondholders to
make significant concessions. This leads to a significant number of
exchange offers extended to bondholders to convert their bonds into
shares; the US Treasury is not expected to assume the role of shareholder
of last resort
Slide 64
16
Introduction: demonstration in nine findings

Micro economic Analysis Macro-economic Analysis
• Financial difficulties, operational
difficulties, or both
• In an extremely competitive
environment, when operational
difficulties are not merely temporary,
it takes more than an extension of
the maturity of the debt to secure
the survival of the company => rapid
deleveraging becomes a priority
• The high leverage of companies
dating from the pre-2008 credit
bubble as well as the bond bubble
which followed the quantitative
easing policy of the ECB
• Long recession or stagnation period
in Europe
• Other major transformations of the
global economy (energy, digital)
17
Preamble: it has never been more necessary to deleverage
 More and more companies will need
to exensively restructure their balance sheet

Preamble: ways of restructuring a balance sheet
18
LiabilitiesAssets LiabilitiesAssets LiabilitiesAssets
Disposal of assets
and allocation of the
proceeds to the
repayment of the
debt. However, high
risk of fire sales and
obligation to obtain
the approval of the
creditors
Repurchase of the
bonds by the
company on the
open market, at a
discount. Not always
practicable and
obligation to obtain
the approval of
creditors
Write off of the debt
by creditors, usually
in consideration for
the issuance of new
shares

Finding n°1
• The bargaining power of the CEO against bondholders
depends on the credibility of a threat to file for insolvency
proceedings
• The unavailability of a public offer option to convert bonds
into shares illustrates the inefficiency of French corporate
insolvency law
• The CEO can only offer a limited bond workout; knowing that
he has no leverage to convince or compel bondholders to
make significant concessions
20

The difficulties of restructuring bond debt out of court
• Prior to filing for bankruptcy, any restructuring of the company's bonds requires
the prior agreement of each creditor when the bonds are subject to French law (or
the law of the State of NY)
▫ Bondholders, as a class, have no right to either reduce the nominal value of the
bonds, or convert them into shares
▫ Prohibition of collective action clauses
• When the number of bondholders is important, the company must launch a public
exchange offer to convert bonds into shares
▫ In order to be attractive to shareholders, the public offer must be more
interesting than the status quo
▫ Those who fail to subscribe to the offer should be left with a bond that has
become less liquid, sometimes stripped of its covenants and guarantees or the
maturity of which has been extended
21

• There are two identified risks of rejection of the offer, leading to a holdout
situation:
▫ The holdout of a minority of bondholders holding the same class of bonds
▫ The holdout of the holders of a whole class of bond
• This creates a high risk of rejection because then other creditors (i.e. the banks)
are forced to bear the cost of the concessions necessary to reorganize the
company
• Finding: THERE ARE NO exchange offers of bonds into equity in France, when
compared with the situation in the United States
• Potential abuses of the mandatory rules applicable to bondholders in order to
allow extensive bond workouts to be approved by a special majority of
bondholders (Bull)
22
The difficulties of restructuring bond debt out of court

Preamble: ILLUSTRATION CASE – Bull
 A French group specialized in computer hardware and software
 2004: Bull raises 44 million euros from institutional investors, subject to the
amendment of the terms and conditions of its convertible bonds (OCEANES)
 A special meeting of bondholders is scheduled to extend the term of the
convertible bonds (OCEANES) to 1 January 2033 with an annual interest rate of
0.1%
 In order to encourage convertible bond holders to convert their debt into shares,
Bull extended an exchange offer of 10 shares for 1 convertible bond, which
remained open for a period of 15 days. Beyond that date, the exchange ratio fell to
1 share for 1 convertible bond.
 Conclusion: the restructuring of Bull convertible bonds amounted to a reduction
of their face value, which is prohibited under French Law.
23

No public offer, who is responsible ….?
24
French corporate law French securities law
French corporate insolvency
law
Shareholders must approve all
capital increases, this power
may also be delegated by the
shareholders to the Board of
Directors
≠
United States (Delaware).
Nevertheless, US market rules
(NYSE and NASDAQ) require
shareholder approval if the new
shares amount for more than
20% of the share capital or in
the event of a change of control
(with some exceptions)
Obligation to extend
an exchange offer
when certain
thresholds are met,
such as 30%, 50%
or 1% over
a 12-month period
(with some exceptions
which apply easily
when the company is
in distress)
The cost of filing for insolvency
proceedings is so high under
French law that a French CEO
can rarely afford to make a
credible threat of filing for
insolvency proceedings
French law governing the rights
of bondholders are complex
and unclear making it
extremely difficult for a
bondholder to determine
whether it is in his long term
interest to tender his bonds in
the exchange offer
NO NO YES

Finding n°2
• French corporate insolvency law does not grant the CEO the
right to compel bondholders to accept meaningful
concessions = to participate in the exchange offer
• The CEO's bargaining power is weakened by two factors:
▫ The cost/benefit analysis of filing for insolvency proceedings
weighs against it
▫ No debtor-in possession financing (DIP financing) in France
25

Cost/benefit analysis of filing for insolvency proceedings
from the perspective of the CEO
26
The company becomes
protected from its creditors,
immediately after a public
offer has been rejected
The power to
unilaterally force a
creditor cram down
The cost of filing for
is lower than the
expected benefit
Condition met
in a "safeguard"
procedure with
automatic stay
Condition not met
because creditor consent
is always required for a
debt equity swap
Condition not met
considering the negative impact on
clients and suppliers,
especially considering
the notoriously high rate of relapse+
–
 Small number of insolvency procedures among large public companies
II

Regarding the insufficient expected benefits,
the absence of a debtor in possession
financing market is due to:
27
The legal privilege
of wage claims
Court Costs
"Conciliation"
privilege
Secured claims,
(in Court ordered
liquidations)
« Procedure «
privilege
“Conciliation”
privilege
“Procedure”
privilege
The legal privilege of
wage claims
Court Costs
The legal privilege for
money provided
during a conciliation
proceedings
(“Conciliaiton
Privilege)
• The weakness of the legal privilege
for funds invested during a formal
(“Procedure” privilege)
• The unpredictability of the
outcome of the insolvency
proceedings, which is at the
discretion of the debtor
=> no guarantee to be reimbursed

Finding n°3
• French corporate insolvency law does not grant the CEO of a
French company any leverage to convince bondholders of
their interest to participate in the exchange offer and to
accept significant concessions
• French corporate insolvency law does not allow bondholders
to measure their potential loss in the event of a insolvency
proceedings, or, conversely, how much they have to gain (and
to share among bondholders) from avoiding insolvency
• French corporate insolvency law fails to provide a fair,
transparent and predictable assessment of the risks assumed
by each party
28

In order for bondholders to properly evaluate their interest in participating in
the public offer, the law must provide for a risk distribution that is:
29
PREDICTABLE
The rights of investors must be
limited based only on the level
of financial stress of the
company and their order of
priority =>
Investors must be divided into
distinct classes before
approving a restructuring plan
FAIR
Bondholders must be
certain that no single or
group of bondholder can
unduly reject a
restructuring plan
(either within the same
class of bonds or within
a whole class of bonds)
Condition not met
Violation of the absolute priority
rule => no guarantee that priority
rights will be respected + senior
creditors’ rights can be affected by
a restructuring plan even if the
rights of junior creditors are
maintained
Condition not met
because everything
depends on the ability of
dissenting bondholders
to form a blocking
minority during the
bondholder meeting in
which ALL bondholders
may vote
Condition not met
Creditors have very little
leverage during French
TRANSPARENT
The level of information
available to investors about the
debtor is sufficient +
transparency of the due
diligences carried out by the
various parties + right of third
parties to contest any decision
affecting their own rights

30
Focus on the risk allocation which must be predictable and fair >
determination of the conditions under which it is possible to override a
holdout
• The rights of investors may not be modified depending on the outcome of the
insolvency proceedings (i.e. whether the debtor has already implemented a
reorganization or a sale plan)
=> Condition not met
• Investors must be divided into distinct classes prior to the approval of the plan
• The assembly of creditors must be certain that the bankruptcy procedure will allow the
company to override dissenting creditors who may attempt to UNDULY holdout the
plan
• When a majority of bondholders having the same rights as one or several of the
dissenting bondholders approves the plan > No “worse off principle”
• When a whole class of bondholders, or even all of the bondholders reject the
plan while other, more senior, creditors have accepted it > it all depends on
"where the value breaks"

Focus on the predictable and fair allocation of risk > determination of the
conditions under which it is possible to override a holdout
31
Liquidation value Ongoing concern value
Liquidation of the business
(when the company
is not viable)
Continuation of the business
with a restructuring
(when the company is viable)
Continuation of the business
without restructuring
(normal procedure)
Value of the
company
Rights of creditors
Liquidation Value: possibility to override the vote of dissenting bondholders, if 1) a two-
thirds majority of bondholders of the SAME class have approved the plan, and if 2) the
dissenting bondholders are not left worse off than in the event of a liquidation ( the "No
worse-off" principle)
Ongoing concern value: the possibility to override the dissenting bondholders of an
ENTIRE class of bonds, if the bondholders of the class are not left "worse off" than in the
event of a sale of the business to a third party at the ongoing concern value

32
Focus on the predictable and fair allocation of risk > determination of the
conditions under which it is possible to override a holdout
• The Court must resolve the conflicts of interests
• The Court must also have the power to force the consent of
shareholders based on the ongoing concern value of the company
• Failing this right, the debtor may be tempted to seek
concessions from bondholders which go beyond what is
necessary in light of the financial problems of the debtor

ILLUSTRATION CASE - Technicolor
 A French group of companies specialized in the manufacture of video
systems and digital imaging for media professionals
 Debts consisting of bank loans, a senior bond issue and super
subordinated securities (TSS)
 The Conciliation procedure failed due to a failure to reach an agreement
between bondholders and banks as well as the presence of numerous
Credit Default Swaps (CDS)
 The interests of CDS holders were more closely aligned with those of the
company which disrupted the negotiations. This disruption was
exacerbated by the inability of the insolvency proceedings to lead to a
predictable, fair and transparent allocation of risks.
33

ILLUSTRATION CASE - Technicolor (2)
 2009: opening a French "safeguard" proceedings
 2010: first recapitalization, followed by other restructuring operations
 Outcome of the restructuring
 The debt was reduced from 2.8 to 1.55 billion euros
 Technicolor shareholders managed to retain 16% of the share capital
 A significant portion of the debt (loans and bonds) was converted into shares
 The TSS holders were able to maintain their right to the payment of the face value of
their bonds (but a refund remains hypothetical). The TSS holders were offered 25 million
euros in a settlement of all claims, or approximately 6% of the face value of their
securities > this lead to numerous litigation cases
 Conclusion: The Technicolor case illustrates the difficulties of successfully
restructuring bond debt when corporate insolvency law allows junior creditors to
exercise their holdout powers
34

Consequences of the difficulty to compel and convince
• Circumvention attempts and their impact: the structural
subordination of bondholders and the "Double LuxCo"
• Abandoning the unanimity rule? On a theoretical level, the transition to
the majority rule requires that:
▫ 1) creditors are sufficiently well-informed
▫ 2) creditors seek the outcome that maximizes the value of their investment
(=> limited risk of conflict of interests)
▫ 3) the mandatory rules governing bond indentures amended
(= > The French "Sapin II" Law)
35

Finding n°4
• French corporate insolvency law does not foster the
emergence of a market for control of distressed firms in
France where large investments funds could invest
• This kind of market facilitates the consolidation of corporate
debt in fewer hands
• Market discipline can effectively compel executives to better
anticipate financial difficulties and more actively restructure
the balance sheet of their company
36

The recapitalization by shareholders,
a good deal for the creditors?
• While it may look like a good
deal at first, especially when
the recapitalization proceeds
are allocated to the repayment
of the debts, which is rare
• It, is, in practice, often a
dangerous option, because it
merely postpones the
resolution of problems
37
In practice,
financial covenants often
prohibit en equity cure
without the agreement
of creditors

A good deal for creditors ?
"loan to own" strategies in France – Definition
• Investors lend funds to a distressed company (or purchase its debt
on the secondary market) in order to gain control of the company
• Unlike banks, these investor make a profit as a shareholder of the
distressed companies in which they invest, therefore, their priority
is to:
▫ Deleverage the company as much as possible
▫ Close down all unprofitable operations
38

The absence of "loan to own" in France - The reasons
39
• Concentrates the power to approve a
reorganization plan among a limited
number of creditors
• Allow the identification of the debt
structure and the fulcrum security
allowing this strategy (according to
the order of priority of payment and
the financial situation of the
company)
• Does not allow holdouts from other
classes of creditors and shareholders
to block the procedure
This strategy requires that the procedure:
In France, the plan
must be approved by
the creditors'
committee. Creditors
are ranked according
to the nature of their
claim rather than their
order of priority. The
plan must be
approved by the
creditors' committee
as well as by each of
the individual
committee of
creditors

The absence of "loan to own" in France - The reasons
40
• Under current French law, investment funds can only
invest in companies which are relatively small or have
a relatively simple debt structure, for example:
• Apollo Management investing in Latécoère
• Oaktree Capital Management investing in Vivarte
• The creditors of large distressed companies don’t have
enough leverage to impose financial discipline to their
management

COMPARISON: Sovereign debt crisis – Can we achieve debt restructuring
absent an insolvency proceedings ?
The sovereign debt crisis has highlighted the limits of a purely consensual
approach to the resolution of financial difficulties. Negotiations have
reached a deadlock
The Greek crisis has created a renewed interest for a legitimate
international Court
The IMF sought to limit holdout situations and the amendment of
collective action clauses in bond indentures in order to compel:
▫ Minority creditors holding the same series of obligation
▫ Holders of a whole class of bonds, when a majority of bondholders (in value)
agree with the State
This approach has some downsides due to the incomplete nature of
contracts by essence
41

COMPARISON: The LBO debt crisis
 Negotiations were characterized by 1) the presence of a majority shareholder, (the
private equity fund), 2) a greater (theoretical) concentration of debt than among
large public companies
 It is thus relatively easier to organize the collective action of creditors and
overcome the deficiencies of French corporate insolvency law
 However, very few companies were able to reach a long-standing agreement
during out-of-court negotiations or an agreement leading to a significant
deleveraging due to the obligation, under French law, to reach an agreement with
each of the creditors and shareholders.
 The "relapse" rate remains high during French consensual procedures ("ad hoc
mandate" and "conciliation") (Vivarte)
42

Preliminary Conclusion
• The inability of the CEO to effectively restructure its bond
debt leads to three types of consequences:
 A greater propensity of French companies to engage in fire sales of their assets
at a heavy discount with a high risk of dismantling their business (Belvedere,
Alstom)
 A greater propensity to launch distressed equity offerings which are very risky
for shareholders (Solocal, CGG, Alcatel)
 A greater risk of a forced sale to a third party, absent a viable restructuring
alternative (Alcatel, Rhodia)
43

Finding n°5
• Absent a comprehensive restructuring of the balance sheet,
the CEO is encouraged by French law to prefer a "last chance"
capital increase even though he has neither sought nor
received any significant concessions from creditors
• In theory, shareholders should be reluctant to participate in
such capital increases, as it leads to a massive transfer of
shareholder wealth to the creditors: this is known as the
theory of "debt overhang"
• In France (as well as in Europe) the facts contradict this theory
44

45
Principle Reasons In practice
Reluctance of
shareholders to reduce
the level of the already
high level of debt of a
company
Shareholderq subscribe
to a share capital
increase only if it
creates enough value
for him, regardless of
whether the capital
increase already
creates value for the
company
Shareholders are in a situation
of conflict of interests with the
company because the reduction
of their shareholding that they
have accepted primarily
benefits the creditors, unless
creditors have made enough
concessions themselves
This transfer of value is
acknowledged by the market.
The share value always drops
when a recapitalization is
announced
There is a positive
relationship between
the level of financial
distress and the
occurrence of a capital
increase, even where
creditors have granted
no significant
concessions
In some cases, the full
proceeds of the capital
increase is allocated to
the sole repayment of
the debt!
The debt overhang theory

ILLUSTRATION CASE - Solocal – restructuring of 2014
 The holding company of the French historic "Yellow Pages" operator is active today
in the online search, local advertising and connection business
 2011: 1st restructuring includes an extension of the maturity of the debt and 350
million euro bond issue to refinance the existing debt
 2013: 2nd restructuring conducted under a French "ad hoc mandate" to obtain
another extension of the maturity of the bank debt
 2014: 3rd restructuring conducted under a French "accelerated safeguard"
proceedings leading to the approval of a restructuring plan providing :
 A share capital increase of 440 million euros, at a price of 0.5 cents per share, the
equivalent of 15 euros, after the consolidation of existing shares
 91% of the proceeds of the capital increase allocated to the repayment of the existing
debt
 The share capital increase was oversubscribed by a ratio of 254,83%
46

ILLUSTRATION CASE - Solocal (2)
 2015: new share capital increase reserved to
employees and former employees at 16.80
euros per share
 2016: opening of an "ad hoc mandate" which
led to:
 A 400 million euro share capital increase entirely
allocated to the repayment of the existing debt.
Subscription price: 1 euro
 The conversion of part of the existing debt into
shares under less favorable terms than those of the
share capital increase payable in cash. This time,
creditors agree to make significant concessions
 Conclusion: the restructuring of Solocal in
2014 illustrates the irrationality of the
decision of shareholders
47

ILLUSTRATION CASE - CGG
 A French group specialized in ground exploration and geological sciences
active in the energy industry (mainly oil and gas)
 By the end of 2015 the debt had reached 2.8 billion euros and the
company could not meet its financial covenant obligations
 In early 2016 a 350 million euro share capital increase was offered,
maintaining the shareholders' preferential right of subscription (DPS) to
fund a 200 million restructuring plan and 150 million in working capital.
The operation was highly dilutive. It was underwritten in full
 November 2016 a new restructuring plan is tabled, following an "ad hoc
mandate" contemplating a shareholder cram-down and the conversion of
all of the existing debt into shares.
48

ILLUSTRATION CASE - Alcatel
 A technology leader of the 1980s in the fixed and mobile phone business. Alcatel
missed the boat on the internet and globalization. Its problems were compounded
when it merged with Lucent, a company that was also experiencing difficulties.
 Historically, the company had always been under capitalized. The company grew
out of former water utility conglomerate Compagnie Générale des Eaux (CGE), a
private company which was heavily dependent on its main client, the French State,
and had always operated with very little share capital and a huge debt
 2013: Alcatel successfully raises 995 million euros in a "last chance"
recapitalization, 750 million euros in high yield bonds and 500 million euros
through a syndicated loan
 Alcatel was never able to reduce its debt significantly and was eventually absorbed
by Nokia in 2015, on the brink of bankruptcy
49

Finding n°6
• The gap between the debt overhang theory and practice can
be largely explained by the difficulty for shareholders to
evaluate the value of their share, when faced with significant
information asymmetry,
• The gap can also be explained by the existence of strong
cognitive biases among shareholders
50

Shareholders rarely have access to enough information
about their company
• Information asymmetry between the management and shareholders =>
rules of corporate governance encouraging the CEO to disclose
information to shareholders. Sometimes the CEO himself does not have
the information (ex: chances of success of a reorganization plan)
• Need to strengthen the disclosure obligations of the company and of the
liability of underwriters of the new shares as guarantors
• Difficulties to assess the value of distressed companies (ex: no Discounted
Cash Flows are available when, as is often the case in distressed
companies, cash flows are negative)
• Need to encourage Private Investment in Public Equity (PIPE) in distressed
companies
51

Shareholders suffer from cognitive biases and are at
risk of making their decision based on:
• The difference between the market price
of the shares, at the time of the
announcement of the operation and the
subscription price offered, in spite of the
fact that market price is a poor reflection
of value for a distressed company.
• The difference between the (high)
historical price of the share at the time of
its acquisition and the (lower) price
offered for the subscription, fuels his
inclination to gamble further in the foolish
hope to recover from his loss rather than
accept it
52

Finding n°7
• The gap between the debt
overhang theory and practice
can also be explained by the
conflicts of interests and the
cognitive biases of the
company's management and,
more generally, by the lack of
strong rules of corporate
governance in France
53

Conflict of interests
of the management
• Hubris and an excess of confidence
• Attribution bias: the natural
tendency of any individual to
underestimate the weight of
external factors in his analysis of
the factors influencing his
professional performance
54
• Loss of their job
• Decrease of their
compensation, if they find a
new job
Cognitive bias
of the management
Need to establish checks and balances

ILLUSTRATION CASE - Eurotunnel
 A construction group awarded the contract to build the tunnel between
France and the United Kingdom
 1995: suspension of the payment of a 8.56 billion pound sterling debt due
to errors in evaluating the financial needs of the project, its insufficient
capital and lack of a main sponsor (the share capital was held exclusively
by minority shareholders)
 This capital structure gave too much power to the management of
Eurotunnel which had accepted far too onerous terms
 For several years, the group was forced to restructure itself. The
restructuring included a distressed equity offering followed by a
"safeguard" proceedings, in 2016
55

ILLUSTRATION CASE - Eurotunnel (2)
 In 2006, the management, facing another “debt wall”, requested a
moratorium and, before the end of the moratorium, filed for a
"safeguard" conciliation procedure, without the consent of creditors
 In the Eurotunnel case, the debt was mainly made of listed financial
instruments which were not held by credit institutions. This made
conciliation negotiations very difficult.
 Eurotunnel filed for safeguard proceedings in 2006
56

The shortcomings of French law
with respect to corporate governance
57
Under French law,
the duty of the chief executive is to act
"in the best interest of the company",
not
those of its shareholders
French law does not provide
efficient civil and criminal penalties
to enforce market rules and improve
the efficiency of financial markets
The maganement of a French company
owes no fiduciary duties
to the shareholders or creditors,
they cannot be held liable
for a violation of such duties,
as they would in the United States
Limited scope of
shareholder derivative suits
and liability for deepening
insolvency under French Law
Absence of class actions
Lack of internal checks and balances Lack of external checks and balances

The shortcomings of French law
with respect to corporate governance
58
There is extensive French case law
attaching civil liability to shareholders
for the mismanagement of companies,
known, under French law, as
management "in fact" (undue interference)
l l
This creates a chilling effect on creditors
who are reluctant to confer with the
management even though their interests
are aligned with those of the company
Creditors may not take control of
a distressed company
without the consent of its CEO
as long as the company has not
reached a formal liquidity crisis
(a "cessation of payments")
l l
No leverage is available to
creditors until the company has
reached this liquidity crisis
Inefficiencies of French corporate insolvency law
= no market discipline holding the management accountable to shareholders

Finding n°8
• The gap between the debt overhang theory and practice can
be explained by the participation of the French State in
distressed equity offering due to the absence of market for
control of distressed firms
• The French State is often forced to serve as a "shareholder of
last resort"
• This State participation is likely to mislead individual
shareholders into participating in the operation
59

• The announcement of the participation of a significant shareholder is
always an important factor in the success of a share capital increase
• The significant shareholder is under no obligation to recapitalize, nuance:
▫ A shareholder may decide not to use his veto rights in order to protect
its reputation (for example, a private equity fund having invested in the
wrong target or favor an aggressive dividend distribution policy)
▫ The mere failure of adequately supervising the management cannot
justify making shareholders liable for the recapitalization of the
company
60

State intervention is often dictated by a proactive policy of anticipating and
avoiding job losses
• The interests of the French State as a shareholder are not necessarily aligned with those of
other shareholders. The French State may be pursuing objectives conflicting with those of the
company leading it to assume the role of a shareholder of last resort, even when its
responsibility was limited to a failure to properly supervise the management:
61
When acting
as a shareholder:
It would be politically very costly for
the French government to withhold
the support of the French Treasury,
whether it is a minority shareholder
(CGG, Vallourec) or a majority
shareholder (Areva)
When the French State
is not a shareholder:
the French government is quick to bail
out French companies (Alstom) in
order to pursue a proactive policy
aimed at limiting job losses.
Problem: there is no consistent public
policy guiding state intervention (for
example: ruling out a bail out a when
financial difficulties cannot be
attributed to exceptional
circumstances)

ILLUSTRATION CASE - PSA
 The financial crisis of 2008 hit PSA’s sales hard. Rating agencies decide to
downgrade the stock of PSA and of its captive bank, PSA finance.
 The company’s cost of credit is significantly increased and destabilizes
PSA.
 The European Commission approves a state aid in the form of a French
State guarantee for new bonds issued by PSA Finance in order to keep the
company running and let it refinance of the group’s debt
 The European Commission imposed a drastic restructuring program of
PSA, the French State’s bail out is conditioned upon the arrival of a third
party investor.
62

ILLUSTRATION CASE – PSA (2)
 2014: PSA launches a 3 billion euro capital increases during which Chinese
automobile manufacturer Dongfeng and the French State become
shareholders (each holding 14% of the share capital). The share of the
Peugeot founding family is diluted down to 14%.
 2017: PSA has spectacularly recovered and announces the 1,3 billion
euros purchase of the loss making units of GM in Europe, Opel and
Vauxhall. The French State transfers to BPIFrance its shareholding in PSA
for an amount equal to 1.92 billion of euros (capital gain equal to 1.12 B)
 Conclusion: The early intervention of the French State, ahead of financial
difficulties caused by a sudden and external hit to PSA Finance, allowed
the French State to reduce the risk that the bailout becomes costful for
taxpayers
63

ILLUSTRATION CASE - Alstom
 Born out of a spin off of Alcatel-Alstom in 1989, Alstom was under capitalized from
its inception to the benefit of Alcatel. A bad acquisition a company which
triggered an industrial accident after the delivery of defective power turbines
 2003: 1.4 billion euro losses and 5.3 billion euro debt (with no bonds issued).
Banks refuse to convert their debt into equity
 Absent an active market for the control of large distressed firms, Alstom had to
turn to the French State for a bailout. The State sought the approval of the
European Commission to invest 720 million euros for 30% of the company's share
capital, with the condition that the French State would sell its participation within
a 4-year period
 However, the European Commission imposed a drastic program of asset disposals,
which could have been avoided had the investor been private
64

ILLUSTRATION CASE - Alstom
 The French State makes a 2 billion euro profit from the sale of its Alstom
participation to construction conglomerate Bouygues
 Conclusion: The early State intervention ahead of financial difficulties,
caused by an external event, the turbine incident, at a time when the
company’s industrial assets were still competitive, has reduced the cost of
the bail out to taxpayers.
 Today, after having experienced financial difficulties again, Alstom has
been dismantled and can no longer be saved by an investment fund.
65

The terms of the bailout by the French State
• The French State does not seek to limit the cost of the bailout to
taxpayers. The French State rarely requires that creditors absorb any
of the losses, prior to bailing out a distressed company
• To circumvent the inefficiencies of French corporate insolvency law,
the French State could resort to a defeasance entity akin to the
good bank/ bad bank model used to bail out banking institutions,
and force creditors to absorb some of the losses
• This is not the practice of the French State, even where there is no
risk of a systemic impact to the economy (Areva)
• The State is thus guilty of sending a falsely positive signal to
minority shareholders
66

ILLUSTRATION CASE - Areva
 A French energy utility producing goods and services along the entire
production cycle of the nuclear industry
 Majority (86.82%) held by the French State (directly or indirectly through
the Public Investment Bank (BPI) or the Atomic Energy Commission (CEA))
 2015: accumulated losses of 9 billion euros over 4 years which the French
State was unable to prevent
 2016: restructuring plan including two capital injections totaling 4.5 billion
euros by the French State in the holding company (Areva) and in a new
company created to host Areva's combustible business (New Areva).
67

ILLUSTRATION CASE - Areva (2)
 The European Commission ruled that
these capital injections amounted to
state aid which required a program of
asset disposals to be compatible with
the internal market
 There was no restructuring of the
debt prior to the injection of capital
68
 Conclusion: without any obligation to do so, the French State regularly bails out to
large distressed companies under terms which are not necessarily favorable to
taxpayers. The French State sends the wrong message by granting an implicit
financial guarantee to companies which it deems too big to fail

The French State - questions
69
To comply with EU rules governing state
aid, the State must make its investment
conditional upon that of private investors
However, in most cases, these private
investors are also competitors of the
distressed company (ex: PSA/ Dongfeng,
Vallourec/ NSSMC)=> this creates a risk of
"tunneling", the extraction of significant
shareholder value through the payment
of large dividends at the expense of
minority shareholders, in order to
compensate for the loss otherwise
sustained by the partner when asked to
invest in the distressed company

COMPARISON WITH THE BANKING CRISIS - Contingent
convertible bonds (CoCos), a solution to the problem?
70
⎕CoCos are hybrid securities structured to absorb the
company's debt - the issuance contract sets the terms of the
conversion of the debt into shares The conversion is often
triggered by the violation of a capital ratio set by prudential
regulations
⎕Initially used in the financial sector, CoCos could also be
helpful to circumvent some of the hurdles created by
corporate insolvency law. However, it won’t be easy to
determine the triggering event

Finding n°9
• US corporate insolvency law (Chapter 11) confers
leverage to the management to force bondholders to
accept significant concessions => this leads to a high
number of successful exchange offers to convert
bonds into shares
• There is a thriving debate about the interest of
reintroducing collective action clauses in bond
indentures
71

What are the incentives provided under US corporate
insolvency law to help the management of the debtor
to compel or convince creditors?
• Chapter 11 regulations allow the reorganization of a company
if it can generate an increase in shareholder value when
compared to a liquidation
• The rules governing the approval of the plan are based on
the premise that the control of the company belongs to those
creditors whose interests are most aligned with the survival of
the company (otherwise known as the holders of the
"fulcrum" security)
72

How does US law help management to compel
creditors to accept losses?
• The judge does not rule on the fate of the company but rather
on the equitable treatment of investors with respect to
several valuations of the company:
▫ The liquidation value is used when overriding the consent of a
minority of creditors within the same class of creditors
▫ The ongoing value is used when overriding the consent of a
whole class of creditors
73

Pros and cons of the US system
Pros
• Avoids the unnecessary destruction of
shareholder value by a fire sale of the
company's assets (if the company
emerges from bankruptcy)
• Encourages the consolidation of the
debt into the hands of investment
funds who will pay the highest price
for the control of the company. This:
▫ changes the bargaining position of
the company from the outset of the
negotiations (ex ante)
▫ facilitates the restructuring
▫ improves corporate governance
74
Cons
• High cost and length of the negotiation
period. The absence of a Court
appointed receiver requires the
approval of the Court for most
decisions
• There is important litigation regarding
both valuation issues and in relation to
dispute over the control of the
company
• The quick and wholesale disposal of
the company's assets to satisfy the
claims of senior creditors can lead to a
loss of value for the company

Impact of the US system
75
On right issues
Share capital increases are conducted, if necessary,
only AFTER the balance sheet has been deeply
restructured
Policy regarding
the intervention of
the US Treasury
The US Treasury has not bailed out many companies
except during the apex of the financial crisis
The US Treasury managed to bail out those
companies while limiting their cost for taxpayers

ILLUSTRATION CASE - General Motors
 The group is a major automobile manufacturer
 During the financial crisis, the group was hardly hit by the credit crunch
The US Treasury decided to bail out GM only after its creditors and
shareholders had declined to take their losses
 The Treasury initially extended direct loans and loan guarantees worth 20
billion euros, then another 30 billion euros after the opening of a
bankruptcy procedure which enjoyed the privilege granted to Debtor In
Possession (DIP) financing
76

ILLUSTRATION CASE - General Motors (2)
 The US Treasury, together with the government of Canada, subsequently
took control of New GM, a new entity created to host the viable assets of
GM, leaving the "bad" assets into the old GM, which was eventually
liquidated
 The Treasury took advantage of the 2010 public offering of New GM to sell
its shares, recording a limited 9 billion euro loss from the sale
 Conclusion: The Treasury never sought to take control of the company. It
was exclusively focused on minimizing the cost of the bailout to taxpayers
77

78
PART II
CONCLUSION AND RECOMMENDATIONS

• The negative micro economic impact of the inefficiencies of French
corporate insolvency law is still relatively unknown or misunderstood
• The negative macro economic impact of the inefficiencies of French
corporate insolvency law is still insufficiently studied. This is in spite of a
high relapse rate, 5 years after filing for insolvency proceedings:
▫ In France, the relapse rate reaches 85% for companies filing for formal
insolvency proceedings and 50% for those filing for a "safeguard"
conciliatory procedure => this shows that French Courts often grant
insolvency proceedings to companies which are either 1) not viable or 2)
over leveraged
Conclusion
79

• Second obstacle:
the importance of the culture and
history of the country. The State is
prone to what economists call "path
dependence"
▫ The State must realize the urgency of
the need to reform French law
▫ The latest ordinances issued in 2014
and 2015 under the "Macron" law
have reintroduced a preference for
consensual pre-insolvency
procedures
The slow evolution of French corporate insolvency law
- obstacles to quick and ambitious reforms:
80
• First obstacle:
corporate insolvency law sits at
the crossroads of various branches
of the law

 The mistaken notion that consensual agreements are always preferable
to formal bankruptcy proceedings is still highly prevalent among legal and
business circles (this is not true when the debtor has a multitude of
individual and uncoordinated creditors)
 Multiplying exceptions to the rule of automatic stay (ex: through the use
of trusts - fiducie)
 Multiplying exemptions to the collective nature of insolvency
proceedings (the "accelerated safeguard" procedure or the "accelerated
financial safeguard" procedure)
The piecemeal approach adopted by French lawmakers
to reform French corporate insolvency law has
introduced much complexity and many pitfalls
81

 Introduce safeguards, granting a minority of creditors the power to
unduly block the adoption of a plan, including, in violation of the order of
priority (ex: violating the principle of 1 euro = 1 vote, without
transparency)
 Introduce a shareholder cram-down to avoid holdouts by shareholders
who are allowed to veto debt equity swaps in violation of the absolute
priority rule, however such cram-down is not transparent
 Implement measures to restore the duty of the management to
maximize the value of the debtor's assets however without full judicial
review (pre-pack cessions)
The piecemeal approach adopted by French lawmakers
to reform French corporate insolvency law has created
many pitfalls
82

• The European Commission has put
forward two main objectives:
▫ The treatment of non performing loans in
the balance sheet of banks
▫ The development of bond markets in the
context of the Capital Markets Union
▫ Other concerns include the anticipated
bond market crisis, the change of economic
environment (industrial revolution, energy
revolution, digital economy)
The developments of European law
83

• The proposal of the Directive of 22 November 2016 offers a
clear path towards the improvement of the early resolution
of the financial difficulties of large companies
• France would be its first beneficiary because:
▫ of the complete lack of any predictable, transparent and fair
allocation of risks under French corporate insolvency law
▫ of the size of its economy and the depth of its financial markets
▫ of a large number of companies of significant global size
The developments of European law
84

Recommendation n°1
• Make the allocation of risks more predictable, fair and
transparent when a company files for insolvency
proceedings
• It is important to understand that there can be no efficient
way to help a company solve its financial problems before it
becomes distressed without the availability of an efficient,
swift and predictable insolvency proceedings
85

To achieve this end, it is necessary to build on the proposals of
the Directive:
86
Respecting the order of priority
of payments
(the "absolute priority rule")
Respecting the principle of
consensual settlement
(obtaining the approval of a
plan by at least one class of
creditors)
Respecting the "no worse off
principle » or »creditor best
interest" test
Availability of a cram down
mechanism for shareholders
as well as those creditors
who are entitled to none of
the going concern value (out
of the money creditors)
Equitable and fair treatment
of investors

Recommendation n°2
• Authorize parties contract out the rules requiring the approval
of the entire class of bondholders under French law, in order to
let a 2/3 majority of the same class of bondholders approve the
conversion of their bonds (subject to French law) into equity,
outside and ahead of a bankruptcy or conciliatory procedure.
87

Recommendation n°3 and n°4
To improve the transparency of the information:
88
• Create an obligation, for issuers of any equity rated non
investment grade to obtain a certificate of solvency prepared
by an independent expert before the issuance of any new
shares and to publish management forecasts supporting the
company's confidence in a successful recapitalization
• Increase the liability of underwriters offering their guarantee
on the sale of shares of issuers rated "speculative" or below,
on the model of rule 10(b)(5) in the U.S.

Recommendation n°5 and n°6
• Forcing the underwriters to disclose their shareholding in the
company as well as their equity derivative positions
• Encourage a modification of the doctrine of the French
market regulator (AMF) regarding the equal treatment of
shareholders in order to encourage private investment in
public equity (PIPE) for distressed companies and allow
turnaround professionals to play their role in providing funds
for this type of risky investment
89

For the future
• Other recommendations are necessary to improve rules of
corporate governance and will be covered in a separate study
• Improved conditions for independent institutions conducting
multi-disciplinary legal research in France will also be
essential to improve the effectiveness of the French legal
framework
90

References
 Ph. Jostarndt, "Equity Offerings in Financial Distress - Evidence from
German Restructurings", 2009
 N. Keifer, "Essays in corporate finance", 2003
 J. Franks, S. Sanzhar, "Evidence on Debt Overhang from Distressed Equity
Issues", 2006
 J. Campbell, J. Hilscher and J. Szillagyi,"In Search of Distress Risk", 2008
 W. Adam, A. Levitin, "The New Bond Workouts", 2017
 Wachtell, Lipton, Rosen & Katz, "Distressed Mergers and Acquisitions",
2013
91

92
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CONTACT
Sophie VERMEILLE
President
Droit & Croissance
Rules for Growth
+ 33 (0) 6 73 04 89 90
svermeille@droitetcroissance.fr
www.droitetcroissance.fr
LinkedIn: http://fr.linkedin.com/in/sophievermeille

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