On a code to nowhere

In an attempt to ease tensions between stakeholders during restructuring negotiations, the British Private Equity and Venture Capital Association (BVCA) is to produce a code of conduct aimed at private equity firms and banks.

The idea of the code is to develop a long-term framework or protocol by which both banks and private equity firms can "come to an understanding of the issues at hand", according to BVCA spokesperson Nathan Williams. The approach to be taken is from the point of view of "what's best for the portfolio company" and will focus on process issues, while avoiding commercial issues such as pricing.

"Some of our members have become increasingly frustrated with aggressive banking practices. The point of the code is to focus on helping those companies that are trading well in this market, but are breaching leverage covenants that were set during the boom years, therefore not accurately reflecting the health of these businesses," he said.

"Banks are coming down hard and taking advantage of what are sometimes purely technical breaches to demand new equity or charge sharply increased fees for covenant resets. This can do serious damage to the health of a portfolio company."

Williams continues: "We appreciate it's not a one-way process and that the industry needs to give something back in return." Possible suggestions include a requirement for a private equity house to flag up a potential covenant breach to banks three to four months in advance, rather than surprising lenders.

But this doesn't seem to be giving anything to banks, nor is it a solution to the actual problem. Banks' complaints are centred on the fact that buyout houses are too often delaying debt-for-equity swaps. This can be boiled down to sponsors wanting to have control of their companies for as long as possible in case markets recover. This doesn't seem likely to change anytime soon, as businesses that are suffering as a direct result of the downturn could emerge robust once markets pick up again. Adding to this, companies with leveraged loans are obliged to report quarterly earnings to their existing lenders. There are therefore no secrets in the loan world, as banks have continually indicated they are already on top of their game.

Says one banker: "The only way this code would be helpful is if it obliged private equity firms to actually start negotiations early, and not just flag up potential problems that banks are most likely already aware of. This way, management teams could spend more time on the operations of their business, giving them a greater chance to turn the companies around, rather than being bogged down."

At a time when banks are hardening their fists, it is unlikely that they would agree or adhere to guidelines that are not necessarily in their best interest, especially when there is little or no incentive for them to do so.

An imperfect solution

In an economy bustling with corporate insolvencies and companies just barely managing to keep afloat, it has become apparent that some course of action needs to be taken. But is this it? One private equity professional has expressed that the task is perhaps too ambitious and that banks would be reluctant to agree to such terms.

But all this does not take away from the need for some kind of defining protocol regarding restructuring companies. The question is whether a code would be better directed at resolving disputes between different lenders.

The last issue of unquote" reported six cases of restructuring, one that was even taken to court after lenders could not agree to proposals put forth by senior creditors. This type of case is becoming more frequent in the UK, and could be extremely damaging not only to the relationships between various banks, but to the companies that are wrestling with heavy debt burdens as lenders attempt to get it together.

All of this ignores the public relations disaster it will be - one must realise that today's entrepreneurs reading about buyouts-gone-wrong are the potential targets for private equity tomorrow.

Loaning, moaning, owning

In a landmark ruling on 11 August, Lord Justice Mann approved an arrangement that would see senior lenders, including Lloyds Banking Group, take ownership of Carlyle-backed IMO Car Wash, a scheme incidentally opposed by the business' lower-ranked mezzanine creditors. Lenders in the UK were following this case closely, as the fear was that its outcome would weaken the influence mezzanine creditors would have in future restructuring cases. After a three-day trial, mezzanine lenders failed to convince the judge that the senior creditors' valuation of IMO was too low and that the company would be better off without the proposed restructuring. The heavily indebted company was put up for sale earlier this year after lenders could not agree to restructuring proposals suggested by Carlyle.

Yet another case that had a similar dispute between lenders is that of Qatar Investment Authority-backed Four Seasons Health Care. The company has been in talks with lenders for more than a year, but negotiations have been made difficult by the business' complex debt structure, which is split between 11 tranches and 35 different lenders. Junior creditors are reportedly now on board with a restructuring proposal that would see senior lender RBS take a 40% stake in the company, having previously blocked the deal from completing.

Bankers are now calling for a new London panel to help prevent ugly fights. The group, to be modeled on the Takeover Panel, would be used primarily when a minority of lenders is unreasonably holding out on other creditors. The panel would see the Bank of England make a call and take a reasonable position. Perhaps if there was some sort of legal code established to define standards between lenders, there would be no need for such a panel.

Whatever the code or protocol may be, one thing is certain: restructuring cases are on the rise, as the downturn and all its subsequent effects have yet to hit company earnings worldwide.

The BVCA code, which is to list acceptable behaviour, is due by early next year. Discussions will be led by Tom Lamb, investment committee chairman at Barclays Private Equity, and could include banks like RBS, Lloyds, Barclays and HSBC.

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• Regulation
• UK / Ireland