Annex Aggregation in Corporate Restructuring Context
1. Corporate rehabilitation laws normally include robust features that are designed to address collective action and creditor coordination issues that arise from the existence of multiplicity of claims. At the same time, however, these provisions contain safeguards to ensure that aggregation does not give rise to discrimination among creditors with very different claims. Of course, one of the important factors that distinguishes the legal framework that restructures corporate debt from that which restructures sovereign debt is that corporate rehabilitation laws operate in the “shadow” of the corporate liquidation law. Specifically, if a rehabilitation plan fails to receive support from the specified majority of creditors, the corporation will normally be liquidated and assets will be distributed in accordance with the priority provisions set forth in the law. With respect to aggregation, these priority provisions play an important role in determining how different classes of creditors may be treated under a rehabilitation plan and, accordingly, provide important guidance on creditor classification issues.1
Communiqué of the International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund, Washington, D.C. April 12, 2003 (available at: http://www.imf.org/external/np/cm/2003/041203.htm).
In the preparation of this paper, staff benefited from extensive discussions with market participants, workout professionals, and academic economists.
The discussion of the potential use of aggregation in this paper is limited to the restructuring of debt; it does not include a discussion of voluntary debt swaps in the context of liability management operations for which the use of a collective framework would not be appropriate.
For purposes of this paper, aggregation of claims for voting purposes applies to both majority restructuring provision and majority enforcement provisions.
Factors that will have a bearing on the first point include the economic circumstances of the member; the extent to which nonparticipating claims may be small, rated as “selective default” by credit rating agencies (notwithstanding the fact that they continue to be paid); and the likely liquidity of the instrument.
Factors that will have a bearing on the second point include the appetite for litigation (including willingness to bear the financial costs and possible reputational damage), and the availability of assets or payment streams vulnerable to attachment.
In addition, a number of emerging market sovereigns have reopened old bond issues, and the Philippines has launched a new issue, all governed by New York Law, none of which include CACs.
A recent paper by Barry Eichengreen and Ashoka Mody (“Is Aggregation a Problem for Sovereign Debt Restructuring,” AEA Papers and Proceedings, May 2003, pp. 80–84), shows that—controlling for fundamentals—launch spreads are higher for debtor countries that have many bonds outstanding. This suggests that market prices may reflect the problems that could be encountered by a debtor seeking to restructure multiple bond issues.
For a detailed discussion of collective action clauses, see The Design and Effectiveness of Collective Action Clauses, SM/02/173 (06/07/02) and Collective Action Clauses—Recent Developments and Issues, SM/03/102 (3/25/03).
It is worth noting that Ukraine used a debt exchange in combination with the use of collective action clauses in order to ensure that the instruments issued in the restructuring would be fully fungible.
While the trustee may also initiate proceedings at its own discretion, it will not normally do so because of the risks and costs involved.
The Uruguay bonds issued in a recent exchange offer are governed by New York law and are issued under a trust indenture. The bonds require a 25 percent majority for acceleration and a 66⅔ percent majority for de-acceleration. Under the terms of the trust indenture, litigation can be initiated by the trustee either at its discretion, or if, among other things, the holders of not less than 25 percent of outstanding principal of a particular series shall have made a written request to the trustee to do so.
As discussed earlier, for bonds issued under a trust deed, the required majority of bondholders can also effectively block litigation after a default has occurred.
It is not, however, the approach advocated by a minority of market participants who are of the view that future interest should be taken into account so that the net present value of the original claim can be calculated.
See: Bartholomew, Ed. “Two Step Debt Restructuring” 2002, J.P. Morgan, New York. (available at http://www.emta.org/keyper/barthol.pdf).
The ability of investors to hold out under their original instruments, as opposed to being bound into a collective framework in an IDC, can be analyzed as an option. For creditworthy debtors, such an option would be out of the money, and would thus trade at a low price. As credit quality deteriorates, or in periods of extreme asset price volatility, the option would be in the money and have economic value. This is consistent with the recent experience with the inclusion of CACs in sovereign bonds issued in the New York market, which suggests that there is no premium for the inclusion of such clauses, and the expectation that in the context of an imminent restructuring, investors would require a financial incentive to exchange their claims for an IDC. It is also consistent with empirical work which has found a relationship between the market pricing of collective action clauses and the debtor’s credit rating. See: Eichengreen, B. and Moody, A., 2000, “Would Collective Action Clauses Raise Borrowing Costs?,” NBER Working Paper No. 7458 (available at http://papers.nber.org/papers/W7458).
If one assumes that Argentina will treat all similarly situated retail investors equally, one could argue that ABRA creates its own collective action problem: such investors may wish to stay out of ABRA to avoid paying the fee but will be able to benefit from the benefits of its negotiations with the sovereign debtor.
There was an early recognition that aggregating the claims of official bilateral creditors with those of private creditors would not be feasible, particularly if it meant that these two groups of creditors would be required to receive the same terms or menu of terms under a restructuring. Two different options have been considered. The first would exclude official claims, but would envisage the development of procedures to ensure that these claims were restructured in parallel with privates claims in a manner that addressed inter-creditor equity. The second approach would involve establishing a separate mandatory class for private and official creditors—a qualified majority in each class would be necessary for the overall restructuring agreement to become effective. By placing creditors in different classes, it would enable each group of creditors to receive different term from each other.
Multilateral development banks normally control the amount and type of security that is granted in collateralized borrowings through negative pledge clauses contained in loans extended by them. These clauses typically preclude borrowers from pledging or encumbering their present or future assets to secure other creditors, without equally and ratably securing those creditors whose contracts contain the negative pledge clause. For a detailed discussion of negative pledge clauses, see Assessing Public Sector Borrowing Collateralized on Future Flow Receivables, SM/03/210, 6/16/03.
The analysis set forth in this Attachment is drawn from Orderly and Effective Insolvency Procedures: Key Issues (IMF Legal Department, 1999).
Some countries also allow for the creation of different classes of secured creditors on the basis that, depending on the nature of their claims, they may have different economic interests from each other.
For this purpose, seniority is based on the ranking applicable in liquidation (secured creditors, priority creditors, general unsecured creditors, subordinated creditors).