Recently a number of businesses that were acquired in the relatively heady pre-GFC days have needed to take action to restructure their equity and debt. Often the businesses have been carrying a significant debt burden from the acquisition. Compounding this, the value of the business may have been eroded to a level that is less than the value of the debt, possibly because of operating results having deteriorated and/or the valuation multiples attributed to the business having shortened.
These factors may have resulted in breaches of bank covenants, together with a realisation that debt levels are unsustainable and that continuing with the existing capital structure is not a practical option. Negotiating a restructured capital structure can be a complex undertaking, with the company, senior lenders, subordinated lenders and equity holders all having differing interests.
A number of recent restructurings have been undertaken by way of a “hive down”. A hive down generally involves three key steps:
- establishing a new corporate group with a lower level of debt funding;
- selling the operating group or assets to that new corporate group for an agreed purchase price; and
- the old group using the proceeds of the sale to part-pay down its debt and then being struck off.
A hive down process can make it easier to bring in a new equity investor who doesn’t want to be exposed to the old corporate structure and debt levels. Also, it can often be achieved with less than unanimous lender approval (as discussed below).
Establishing a new corporate group
The new corporate group will own the business going forward. Establishing the capital structure for the new group, including the respective proportions of equity and debt the parties will be entitled to can be contentious. It will be particularly difficult where the old group has multiple layers of debt as well as equity holders or where there is a disagreement about valuation that means that it is not clear where in the old group’s capital structure the “value breaks” and losses arise.
There will often be a natural tension when setting the debt level for the new group. Lenders may want the debt relatively high to reduce the difference between the old level of debt and the new level of debt. On the other hand, the directors of the new borrower may require debt levels to be lower as they have a statutory duty to have reasonable grounds to believe that the new borrower will be able to repay that debt at the end of its term.
Selling the operating companies
There are a number of different ways that the old group can sell the operating companies or assets to the new group. Recent hive downs in New Zealand have tended to involve the security trustee enforcing its security interest over the operating companies and then exercising its power of sale to immediately transfer those assets to the new corporate group. Financing documents often permit the security trustee to take this sort of enforcement action on the instructions of a specified proportion of the syndicate (e.g., 66.7%), so the transaction can be implemented without requiring unanimous lender support. This can be very important to the efficacy of any restructuring proposal and go a long way to preventing a minority lender blocking the progress of the restructuring, possibly in the hope of being taken out at a better price than it might otherwise have achieved.
Establishing the purchase price for the transfer can be relatively difficult for a number of reasons, including:
- often restructurings do not involve testing the market to establish the market value for the business and, as a result, the various parties to the restructuring need to settle on a value between themselves;
- valuation can have an impact on the parties’ respective bargaining power, so interests are not aligned;
- the directors of the new group will have fiduciary duties and will want to be comfortable that the new group is not over-paying;
- the security; and
- trustee will not want the transaction to be under-value as it will want to be seen to be achieving an appropriate level of recovery for the existing lender group.
The old group
After a hive down restructuring is completed, the old group is generally left without assets, with residual debt and in default under the original finance documents. Also, the directors are likely to have all resigned. The companies will be in breach of the Companies Act 1993 for failing to have a director and are therefore likely to be struck off the register by the Registrar at some point for this breach or for failing to file returns.
The sale of the operating companies from the old group to the new group may require approval under the Overseas Investment Act 2005 if more than 25% of the new group’s shareholders are overseas persons and either the purchase price exceeds NZ$100 million or the operating companies have an interest in ‘sensitive land’.
Change of control
A hive down restructuring may trigger ‘change of control’ termination rights in the operating companies’ trading agreements. A pre-restructure due diligence exercise can identify potential change of control issues which may allow key commercial partners to be approached early. Generally, a restructuring will be good news for commercial partners, who may otherwise have been concerned about their ongoing commercial relationship with a business in default.