Adler RE noteholders with ‘significant holdings’ have formed a steering committee to further engage with the company and to ensure noteholders’ “interests will be adequately taken into account going forward”, according to a letter sent on 30 June from their legal counsel Kirkland & Ellis (K&E), and seen by 9fin.

The letter was addressed to Adler RE’s directors with White & Case, who has represented both Adler RE and Adler Group on various transactions in the past, copied in via email. This is the third letter sent by the group. The first two did not elicit a response.

Directors are reminded in the letter of their duties to Adler RE as their sole consideration, despite many having board roles elsewhere within the wider group. “Executing a dual mandate is a complex undertaking and not without liability pitfalls, especially when one or both institutions are in crisis,” K&E write, urging them to seek independent legal advice.

The letter also highlights potential event of defaults under the bond covenants. It reminds directors of their duty to “take appropriate restructuring measures when required,” and warns of their personal liability if they fail to do so.

Adler Group said to 9fin that it did not wish to comment on the letter or on whether it plans to respond to the noteholders.

In the piece below, we reveal the contents of the letter in detail, the series of events leading to it and examine some of the issues raised.

Adler RE springs a leak

Adler Group is the majority shareholder of Adler RE, with a share stake of 96.72%. But for over two years it has failed to consolidate it fully into its accounts, given its inability to execute a domination agreement. This limits the ability to move cash around the group and means that two boards remain in place. A squeeze-out of minority shareholders in Adler RE was launched in late June.

Adler RE is flush with cash in comparison to the rest of the group after two portfolio sales to LEG Immobilen and KKR respectively, announced in Q4 21 at a cumulative value of €2.485bn. Most of the valuable yielding assets sit at subsidiary level, with the riskier and more contentious development project assets (as outlined in a series of short seller reports by Viceroy Research) at parent level.

As a result many funds and advisors watching had believed Adler RE bonds were structurally senior to those at Adler Group, and in recent months Adler RE bonds traded at a significant price premium.

On 17 May, Adler Group Chairman Stefan Kirsten faced investor questions about the ability of Adler RE to transfer cash to Adler Group. In total, €265.2m was transferred to Adler Group from Adler RE as a short-term loan, subsequently converted into a long-term loan. A supplementary update on 10 May, included a statement on an ‘upstream loan’ which Adler says was a liquidity transfer, similar to a cash pooling system.

It said that “Upon notarization of the next portfolio sale, it became clear that Adler RE would continue to receive significant funds from asset disposals. Therefore, Adler RE’s management and supervisory board discussed the granting of one or more long term loans to Adler Group. The decision to grant such long term loan was taken on 30 March 2022 after Adler RE received the funds from the first closing of the so-called Luna Transaction which refers to the asset disposal to Velero/KKR.”

Berlin Portfolio Concerns

In the letter on June 30, the steering committee members said they were “dismayed to learn about the transaction announced” on 24 June that a subsidiary of Adler RE “has apparently agreed to acquire a real estate portfolio from Adler Group”.

The portfolio comprises around 1,400 residential properties in Berlin and is valued according to CBRE as of 31 March 2022 at €326m, according to the release. The consideration after taking into account minority interests, financial liabilities and deferred taxes is approximately €275m.

In their letter, the steering committee says it is “undertaking another attempt to illustrate to the board of Adler RE the significant risk of personal civil and criminal liability which can arise in a case where liquidity is drained from a company for the benefit of third parties and to point out certain concerns and requests regarding compliance with the terms of the Adler RE Notes,” states the letter.

“Adler RE’s current management does not seem to be safeguarding the interests of Adler RE and does not seem to appreciate the severity of the situation and its duty to act independently of its Parent,” the letter added. “It seems difficult to understand how a prudent and reasonable director of Adler RE could approve such a sale with due care if there were no firm third-party offers at significantly higher valuations.”

The steering committee is “highly concerned that the transaction may not be on arms’ length terms and may merely serve as an attempt to transfer liquidity from Adler RE to the Parent at a time when declaring a dividend is not an option in light of the disclaimer of audit opinion by KPMG and when there is significant uncertainty around the accounts of the Parent.”

“Even if pricing was adequate, Adler RE has exchanged current for non-current assets, thereby severely decreasing its liquidity position, despite the upcoming EUR 500 million April 2023 notes maturity in less than 12 months’ time and creating additional uncertainty around its repayment.”

Directors Duties

K&E in their letter issued a warning to the directors:

“Should the announced transaction prove to be detrimental to Adler RE’s and Adler RE Noteholders’ interests and in breach of the fiduciary duties of Adler RE’s management, Adler RE Noteholders will take all necessary steps to assert or help assert personal civil and/or criminal liability of management.”

K&E urged Adler RE’s board to obtain independent legal advice. The law firm also suggested that certain members of management should consider resigning from their positions at the Adler RE level and allow independent directors to be appointed.

Mindful of the bonds trading at distressed levels, K&E reminded the firm’s management of their obligation to ensure to take appropriate restructuring measures if needed.

“As transactions that require consent of noteholders need careful planning and implementation and can easily take more than six months, Adler RE and its board have no time to lose should there be any doubt about Adler RE’s ability to repay the Adler RE Notes upon maturity,” the letter said.

Bondholder questions

In order to allay their concerns K&E have asked the company to respond to the following in detail:

• What assets have been sold and to whom
• What information about the assets the board of Adler RE received from the parent ahead of entering into and approving the sale transaction
• Which advisers were involved on the side of Adler RE in conducting market standard due diligence of the assets, including a confirmation that the advisers owed duties only towards Adler RE and its subsidiaries and not the parent
• How long the due diligence process took
• What work product has been delivered to Adler RE during the course of, and to conclude, the diligence process
• How the acquisition by the subsidiary of Adler RE was financed
• What kind of evidence was provided that led the board to the conclusion that an asset sale on the same or - for the buyer - worse terms and same timeline with the same level of due diligence to a third party would have been successful
• Who instructed the valuation of the assets and who the valuation agent owed duties to. They also asked the company to disclose the valuation report in full
• How the company plans to address the maturity of the Adler RE notes due April 2023
• How and why the transaction has not decreased liquidity required at the level of Adler RE
• Which circumstances support your conviction that Adler RE has a positive going-concern prognosis for the next 12 months

Furthermore, K&E asked the company to confirm that the seller’s purchase price receivable was or will be set off against Adler RE’s repayment claim under the upstream loan. If not, K&E asked it to describe in detail on what basis the decision was taken not to set off such claims.

Upstream Guarantees

Adler RE provided a €265m unsecured loan to its parent in December 2021 and/or March 2022.

According to a disclosure from Adler RE, it has the right to demand collateral from Adler Group in the event of a significant deterioration in its parent’s financial circumstances. In addition, it may demand repayment of the amounts extended at any time in the event of non-performance by Adler Group of certain of its obligations. Adler Group, on the other hand, has the right to prepay all or part of the loan with five-days' notice.

To address potential liquidity issues, K&E has urged the company “to decrease Adler RE’s exposure to the Parent by either demanding adequate collateral or by terminating the loan. This is not a mere request, but a legal imperative.”

K&E highlighted that due to the “deteriorating level of creditworthiness and limited access to the capital markets that the market assigns to the Parent” there is “more than sufficient ground to conclude that Adler RE’s unsecured repayment claim under the Upstream Loan may not be fully recoverable.”

K&E cautioned Adler RE management that “ignoring these warning signs” means that they could be held personally liable.

Squeeze out

The group announced on June 23 a planned squeeze out of the 3.3% of Adler RE shares it doesn’t own. It has formally requested an EGM at Adler RE at which they “shall resolve to transfer the shares of the remaining shareholders (minority shareholders) to Adler Group for an appropriate cash settlement.” There was no mention of the price to be paid or whether an external valuation has been carried out.

Minority shareholders have opposed previous attempts to squeeze out. They were unhappy about a series of transactions, most notably when ADO properties acquired Adler RE in September 2019 for what they allege was a substantial premium to its share price, which lowered the combined group LTV by consolidation. An attempt to get BaFin to intervene failed, but in 2021 they did convince a German parliamentary committee to investigate.

K&E said in the letter that transferring value from Adler RE to the parent, even after a squeeze out, is not in the best interest of Adler RE. Therefore the board should take legal advice as to their obligations given any value transactions come with significant liability risk.

Covenant Compliance

In terms of the bond covenants, K&E would like the firm to elaborate on how Adler RE intends to ensure compliance with the Consolidated Coverage Ratio maintenance covenant going forward, in particular with regard to further asset sales.

Adler RE noteholders are “highly concerned about the path to bring the unencumbered assets ratio back to >125%, as described in the FY 2021 investor presentation of the Group”. To note, this is an incurrence-based covenant.

The presentation said that €490m of unencumbered assets are needed to increase the ratio to >125%. Adler Group expects to reach a comfortable position (>135%) later this year after the anticipated sale of BCP, a subsidiary of Adler RE.

In December 2021, fellow German real estate company LEG bought a 24.1% stake in BCP from minority shareholders and a 6.8% stake from Adler, as reported. As part of the transaction, LEG was granted an option on Adler’s remaining stake in BCP at a strike price of €157 per share (€765 million for the remaining Adler stake) with a 30 September 2022 expiry.

The K&E letter said that the presentation indicates that the group is considering repaying the Parent’s €400 million 1.5% notes due in 2024 and the Parent’s €24.5 million promissory notes due 2023 with proceeds from asset sales by Adler RE.

K&E said: “the directors of Adler RE have to act in the best interests of Adler RE, not the Parent or the Group, and should therefore partially repay the Adler RE Notes issued by itself instead of upstreaming cash to repay notes issued by its Parent.”

The bondholders’ lawyer questioned whether the planned asset sales and transfer of cash outside of Adler RE might constitute an event of default.

Below is a slide from Adler RE’s FY 2021 presentation, which shows its liquidity requirement until 2023. At the end of Q1 2022 Adler RE reported a cash balance of €569.8m, according to its report.

Asset Sales

The letter said that the steering committee observed that the aggregate number of property sales, that were announced by Adler RE over the last months, has far exceeded 50% of its consolidated total properties and assets.

Under New York law, which governs Adler RE’s €300m notes due 2024, crossing the 50% threshold means entering a “grey area” in which, depending on the circumstances at hand, it is possible to determine that “substantially all” properties or assets have been sold, the letter said. Under German law, which governs Adler RE’s €500m notes due 2023 and €300m notes due 2026, there does not seem to be clear guidance as to when such a threshold would be reached, but a “grey area” may also already have been reached.

If a court determined that these sales amounted to a transfer of “substantially all” of Adler RE’s properties or assets under New York and/or German law, Adler RE could be in breach of the Mergers covenant under the relevant notes, which generally prohibits transfers of “substantially all” assets unless the successor / transferee entity is organised in a permitted jurisdiction and assumes Adler RE’s obligations under the Notes. The transfer of “substantially all” properties or assets under New York law would also be a Change of Control under the 2024s, which would require Adler RE to offer to purchase the 2024s at 101% within 30 days of the Change of Control (such repurchases to be made within 60 days of the offer).

K&E asked management to explain how Adler RE intends to deal with this situation.

K&E also asked the company to confirm whether Adler RE or the Parent has received any termination notices or is aware of noteholders intending to terminate.

Adler RE has €500m 1.875% German law governed notes due April 2023, €300m 2.125% New York law governed notes due 2024, and €300m 3.0% German law governed notes due 2026.

The April 2023 notes are today indicated at 78-mid, according to ICE data, down from the low to mid-90s in late April. The February 2024 notes are 72.3-mid, down by around 10-points since mid-June, and the 2026 notes 65.4-mid, down from 77.8 in mid-June.

In contrast, Adler Group’s (including ADO Properties and development assets) 2024 bonds are at 56.6-mid, down by just over 10-points since mid-June, with the 2026s at 49.6 (from 61.7-mid).