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Oliva Mantock

In this 9fin Educational piece, we discuss cooperation agreements, what they are, how they came about, what they aim to achieve and potential pitfalls in the European market.

We’ve seen a number of cooperation agreements proposed in recent weeks in the context of distressed European businesses: namely, Altice and reportedly Ardagh too. They have a history of use in the US, and have been used a couple of times in Europe before, but this is their first material foray into the Europe market. Their use may signal a new tool for stakeholder management and restructuring strategies in Europe and so it seems like an appropriate time to drill down into its use.

In broad terms, the aim is to get a creditor group to form a united front against an aggressive sponsor/borrower, with a view to preventing side deals being consummated with some creditors but not others (i.e. up-tiering transactions, drop-down financing transactions and other liability management exercises).

We’ll go into the history of these agreements shortly, but first it’s perhaps useful to explain what a cooperation agreement is not.

It is not a lock-up agreement. In broad terms, a lock-up agreement is an agreement which is usually signed — or at least becomes effective — once a restructuring transaction has actually been negotiated and agreed with sufficient creditors to implement it (either consensually or using a cram-down process, such as a UK Restructuring Plan or English Scheme of Arrangement). It will schedule the terms which have been agreed, and the creditors who sign it will agree to take all steps necessary to vote in favour of, and implement, the transaction.

Conversely, cooperation agreements have historically been used as more of a defensive tool: the signatories will usually agree not to take certain actions (e.g. splinter off and pursue drop-down financings or up-tier transactions with the company).

It is possible that these lines may blur over time; for instance, there is scope for cooperation agreements to be used offensively as well as defensively, but we have not really seen this yet and so a discussion of offensive cooperation strategies is beyond the scope of this piece.

See below for more detail on some of the terms we have seen in cooperation agreements.

A cooperation creditor group (we’ll call it a cooperation group) is not an ad hoc group — albeit they can overlap. Ad hoc groups are also called AHGs, coordination committees, co-comms and steercos: but they’re all effectively the same thing.

The difference between an AHG and a cooperation group is two-fold:

AHGs are multilateral, but the aim is to engage with the company. The idea is that the AHG corrals creditors towards a co-ordinated proposal and then acts as the interface/conduit of information with the company and other stakeholders (e.g. shareholders) in negotiating and implementing a restructuring transaction. Some of that information will be material non-public information (or MNPI), which will go to the group’s advisers and/or directly to the group (provided there are appropriate cleansing mechanics in place — see below for further details on this)

A cooperation group forms a shield against coercive action by the borrower. They are not designed to facilitate active interaction with the company, indeed we understand that they can include provisions which actively prohibit communications with the borrower

Historically, debt documentation included covenants which allowed creditors to monitor the performance of the underlying business, enabling them to spot signs of distress at an earlier stage.

The trend since the financial crisis has been towards looser debt documentation, with maintenance covenants removed in favour of a handful of incurrence covenants instead. This was driven, at least in part, by low interest rates and a smaller pool of assets for banks and funds to invest in, and generally by the high yield bond market.

The end result here was information asymmetry between creditors and borrowers in relation to the underlying business. Some borrowers have exploited this ‘first mover advantage’, with the helpful assistance of loose documentation, by moving assets outside of the restricted group, subordinating creditors via drop-down financings and otherwise implementing priming / up-tier transactions (which can collectively be referred to as liability management exercises). These will usually be implemented with a subset of creditors, and so playing creditors off against one another and splintering creditor groups is a strategic imperative for borrowers in successfully implementing these transactions.

But taking a step back — what are these liability management exercises?

We talk about priming transactions in this 9fin Educational9fin Educational, but in broad terms, they involve distressed companies actively managing near-term maturities and/or leverage levels by raising additional liquidity, often in circumstances where the traditional capital markets are otherwise closed to them.

Again, these have primarily been seen in the US market — although they do remain controversial (and are by no means litigation risk free) there. At present, they are not market standard in Europe, but we have now seen a couple, and while there may be some further complexities to implementing them over here (particularly in relation to up-tiering transactions, as noted below), it seems likely that there will be more of them going forward. See 9fin’s coverage here on Apollo’s recent priming transaction in relation to Ardagh.

There are two key types of liability management exercise. We’ve written about them extensively, but here’s a recap.

In a drop-down financing transaction, generally speaking the company:

uses restricted payment and/or permitted investment capacity under the debt documents to move valuable assets to an unrestricted subsidiary, or designates a restricted subsidiary as unrestricted, as has recently been achieved by Patrick Drahi in the Altice situation; and

then raises new, secured debt on those now unencumbered assets

The unrestricted subsidiary is not bound by the original covenants, so there is no limitation on how much debt it can raise. Any debt secured on these assets will be structurally and effectively senior to the existing debt. The most notable example of this sort of transaction was the J.Crew drop-down (see our 9fin Educational). In Europe, examples of this include Intralot and Olympic Entertainment.

The US market is no stranger to amendment and exchange processes that seek to strip non-participating creditors of most of their covenant protections. In bonds, there is much more of an established practice of combining a consent solicitation with a tender or exchange offer, where the point of the consent solicitation is to make the original bonds less attractive, and therefore to drive participations.

However, there are also a number of leveraged loan deals in the US market that have gained attention, particularly in the wake of the Serta Simmons up-tiering transactions.

Covenant stripping and releases of guarantees and security are also generally possible under European SFAs if the requisite lender consents are obtained. However, even if an A&E process could be structured to effect a covenant and security strip in the context of a European SFA, there are numerous practical and commercial considerations which will need to be taken into account for any particular set of facts and circumstances, in addition to the relevant consent thresholds that will also need to be considered (which we cover in this 9fin Educational). A qualitative discussion of the implementability of up-tier transactions in the European market is beyond the scope of this piece, but do read our 9fin Educational for further details.

Cooperation agreements emerged in the US with creditors militating against these liability management exercises. The main objective is to form a blocking stake — at a minimum, a simple majority with a view to dissuading (or even prohibiting) coercive action being taken by the company and subsets of creditors.

The theory is that a simple majority (at a minimum) can prevent borrowers from seeking to implement liability management exercises in both formal and informal ways, therefore allowing creditors to negotiate from a position of strength — or at least, from less of a position of weakness.

Informally, it acts as a credible threat to the borrower. The simple fact that a majority has formed may prevent a borrower from seeking to deal with one creditor group but not another. It just makes side-deals harder from the borrower’s perspective.

a simple majority might prevent the borrower from looking to implement an up-tier, as it will not be able to implement a covenant strip with a simple majority voting against; and

(with company consent) a simple majority may implement changes to the documentation with a view to prohibiting coercive action from being taken (e.g. by tightening covenants/voting provisions/inclusion of a J.Crew blocker, etc). In an HYB context, it might be used to amend voting thresholds too

As far as we know there’s no ‘market standard’ cooperation agreement yet; accordingly each will have its own bespoke terms depending on the facts and nature of the capital structure in question. Here’s a general outline of what we’ve seen — publicly — so far (alongside some informed assumptions).

Effectiveness: we understand that most cooperation agreements will only become effective once a minimum of 50% of the relevant creditor group has signed up. This is the minimum needed to prohibit a coercive exchange (with covenant strip)

Covenants: we assume that the central covenant in the agreement will be a prohibition on entering into side-deals with the borrower (i.e. priming transactions), as well as transfer restrictions (see below)

Transfer restrictions: as with lock-up agreements, we assume the creditor group will be prohibited from transferring participations unless to another cooperation group party, or where the transferee signs up/adheres to the agreement

Termination: we understand that many cooperation agreements are limited to six months — with three-month or six-month extension options. This is pretty short in the context of a restructuring negotiation, and again extensions will hinge on continued creditor unity. We also note that to the extent a cooperation agreement contains individual termination rights, the efficacy of the agreement is seriously diminished

Remedies: we understand that a number of agreements have provided for specific performance and injunctive relief. In other words, if a creditor breaches the agreement and (for instance) an up-tier transaction is subsequently implemented, money damages would likely not be adequate for the other creditors, and the ask will be that the court makes an order for the transaction to be unwound

Governing law: historically, New York. Our assumption is this will continue, even in the context of European situations such as Altice and Ardagh

What are the problems with cooperation agreements?

There are a few areas to look out for, which can broadly be split up into two buckets.

The first, overarching point is that the success of a cooperation agreement will turn on continued creditor unity.

The borrower may seek to splinter a unified group by offering up side-deals to some creditors but not others. In that context, maintaining a unified front may become tricky. The extent to which this poses an actual issue will turn on a couple of things.

First, the makeup of the capital structure and creditor constituencies in question. A cooperation agreement may be a bit of a blunt instrument where, for instance, one has a large corporate group, with significant outstanding debt (some secured, some unsecured), staggered maturity dates, and creditors with significant cross-holdings across the capital structure

A creditor with unsecured debt maturing in the near-term and later-dated secured debt will have different, competing interests and strategies in relation to its respective holdings. It will be keen to maintain temporal seniority in respect of its unsecured debt, but will be concerned that its later-dated secured debt may be primed.

One can see why a cross-holder may be reticent to sign up in these circumstances. The broader point is that the maintenance of unity in a complicated capital structure becomes harder to sustain

Second, termination rights. If there are individual termination rights which can be exercised on notice then that would make the cooperation agreement rather otiose; but it might be that a set majority (likely by value) of those who have signed must agree to terminate, which would make the agreement more robust

Third, how long (absent termination) the agreement lasts. If it has a relatively short tenor, then its utility may be in doubt, particularly given restructurings can roll on for significant time

Fourth, and relatedly, is when the agreement becomes effective. In relation to the two big European situations where cooperation agreements have been discussed and/or signed, the horse had already ‘bolted’ in a sense, prior to effectiveness. In relation to Altice, assets had already been transferred out of the restricted group (which could then be used to implement a drop-down financing in the future). In relation to Ardagh, the borrower had already agreed to a priming transaction with Apollo. So the timing of the cooperation agreement is crucial to the leverage achieved

The second area of concern is a collection of more technical potential pitfalls.

First, cooperation agreements are much more effective at prohibiting action taken within the existing contractual framework than outside it. In that sense, a 50%+ group of creditors can effectively block a successful up-tier transaction using a coercive exchange. A cooperation agreement is far less effective against drop-down financings, though. In a drop-down context, if a borrower has capacity, it can unilaterally transfer assets out of the group. Any debt then raised against those assets (whether provided by existing creditors or third party providers) is, by definition, outside the scope of the existing contractual framework. This goes to the ‘formal’ vs ‘informal’ threat point we raised above. Further, as mentioned, the implementability of up-tier transactions where the underlying debt is under a European SFA may be in doubt, as noted above

Second, as we’ve said, we assume these documents will continue to be governed by New York law, even where they relate to European situations. In those circumstances, even though the correct forum for dispute resolution will be the New York courts, creditors will want to ensure that the agreement is enforceable in jurisdictions where assets are located and operations are carried out. There is a question mark over whether these documents will be recognised and enforceable in Europe. There are two points here:

In England, for instance, agreements to agree have traditionally been held to be void for uncertainty (and are therefore found to be unenforceable)

Cooperation agreements arguably lack certainty as to subject matter to be enforceable. All the creditors are covenanting is that they won’t do a series of things for a period of time (contrast this with a lock-up agreement, which is probably at the outer edge of what is acceptable in this context, but which at least schedules a specific deal to be implemented)

It might be that, if the remit of what those things are is well defined (i.e. the priming transactions which cooperation agreements seek to prohibit), then it is sufficiently certain, but that analysis will turn on the specific drafting in question

We also understand the remedies provisions will include specific performance/injunctive relief. We query the likelihood of an English court recognising and enforcing that (money damages would need to be deemed inadequate). We understand there are question marks around enforceability of specific performance for these purposes in New York, too. Again, this will turn on the factual matrix

Third, there is a potential information flow issue. Creditors’ possession of material non-public information (MNPI) under the Market Abuse Regulation (Regulation 596/2014) will preclude those creditors from trading their debt holdings

In a restructuring, AHGs may (if they elect to) receive MNPI — as we noted above. When they receive it, they will be ‘private’, and so prohibited from trading. The relevant MNPI will periodically be cleansed in accordance with the AHG contractual framework (as a result of the company putting that information in the public domain) or only the advisers will receive the information

In cooperation agreements, given the company will not be party, the question is what happens in circumstances where the creditors receive MNPI — namely, how the creditors can ensure the relevant information is cleansed and they don’t remain private. Practically, in those circumstances they would probably ‘self-cleanse’ (i.e. make the information public themselves), although that would in turn give rise to another set of issues

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