Vol 4 (2007) - Issue 6

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More Litigation in the Next Downturn in Europe? – Part One

As the credit crunch intensifies and, as a result, the European debt market continues to see less liquidity, litigation may play an increased role in the next downturn. This twopart article explores the potential for investors to resort to
litigation to protect or improve their positions. Part One examines some of the insolvency/restructuring cases that have come before the English Courts in recent years. Based in part on those cases, Part Two, which will appear in Volume 5, Issue 1 of International Corporate Rescue, will address which other litigation angles may be considered by whom in the next downturn.

Introduction

Until the recent credit crunch in the late summer of 2007, the debt market in Europe and elsewhere featured an abundance of liquidity. Default rates were
at a historical low and had been substantially below average for a number of years. As a consequence,companies faced with liquidity issues had no problems
in finding parties in the market that were willing to refinance their existing debt and/or provide them with additional new debt. Maturities were pushed out and covenant packages became lighter. Capital structures of European companies have been enriched with second lien loans or notes, PIK (payment in kind) and/or hybrid instruments and have become more complex as a result. That has not only increased the number of stakeholders, but also the identity of stakeholders.

The historical picture of European debt capital needs being almost exclusively satisfied by the traditional relationship banks is changing and, to a certain extent, has already changed in recent years. New non-bank players have entered the market and are fast becoming a permanent feature in the European landscape. A secondary market in bank debt has developed in Europe and the mentality of the traditional banks has started to change. More often, traditional banks decide to sell their par position at a discount in the secondary market to the new non-bank players, instead of working out their original position. Generically referred to by some as ‘hedge funds’, these new non-bank players generally have been active in the US market, before they decided to become active in Europe as well. As hedge funds come in a great number of different sizes and shapes,employ
a range of different, usually alternative, strategies, they cannot easily be lumped together in one box. A subset of hedge funds focuses on investment opportunities in distressed credits. Although these distressed investors typically enter a situation by taking a position in the debt, some of them have also started to behave more as private equity funds, using a purchase of the equity as the way into a situation. Hence the references to an ongoing onvergence between hedge funds and private equity funds.