Introduction

In view of the current unprecedented economic situations, a well organised structure of debt restructuring could clear a path for both debtors and creditors through an increasingly complex creditor landscope.  Debt restructuring is a process to modify the terms of existing debt obligations. It involves negotiating with creditors or lenders to adjust repayment terms, interest rates, or obligations to accommodate the borrower’s financial situation. Debt restructuring aims to provide relief to borrowers facing financial difficulties or insolvency by making their debt load more manageable.

In this article, we intend to explain a some issues that may arise in corporate debt restructuring – in particular, when it involves high yield bonds (also commonly known as junk bonds).

Over the years, alas high yield bonds are unsecured and subordinated to all senior debt, it has become a mainstream source of financing for large corporation.  High yield bondholders often take a proactive role (for instances, by way of organising steering committee or creditors’ committee) in the debt restructuring of a financially distressed issuer – especially when they are likely to be paid a return as a result of the restructuring.  The two main recovery strategies for holders of high yield bonds can be categories into (1) selling the bonds at a discount, with an aim of converting the debts into shares; and (2) seeking payments from investors or creditors to block restructuring arrangement proposed by the issuer or other creditors.

Bond documentations

In order to allow a bond holder to understand its position, one must review the terms of bonds to ascertain its legal position, and to strategise its restructuring position.  It is paramount to ascertain whether the bond is formed by a trust deed (English law) or an indenture (US law). 

Trust deed

Under a trust deed, the issuer enters into covenants with the trustee, which will hold the benefit of these covenants on trust for the bondholders.  Generally speaking, the trustee is given certain discretion in determining whether an event of default has occurred and bondholders cannot initial action against the issuer unless the trustee unreasonably fails to do so.

Some bondholders may have a perception that if the bond is a bearer bond, the bond holder would have a direct legal relationship with the issuer, and hence the bondholder could initiate action against the issuer directly. However, in certain circumstances, the bearerby. bonds may be issued in the form of a single global bond that is held by a depositary or in a global form.  In such circumstances, the holder of such bearer bond does not have direct legal relationship with the issuer.

Indenture

If the terms of the bond are governed by an indenture, the issuer has a direct legal relationship with the trustee.  The trustee would represent the bondholders and owes fiduciary and statutory duties to the bondholders.

Generally speaking, the issuer’s obligations to repay the bondholders are to make payments to a paying agent, and that these payments would be held on trust by the paying agent for the benefit of the bondholders. 

Similar to a trust deed, an indenture will limit the rights of a bondholder to take legal action against the issuer, unless the trustee unreasonably fails to do so.

Subordination

In addition to structural subordination, the priority of the high yield bonds may also be regulated through an inter-creditor agreement, whereby it would be limited to protective provisions that are in favour of senior creditors, such as payment blockage provisions, standstill provisions and non-compete provisions. 

Regulatory issues

In addition to considering the terms of the high yield bonds, one should also identify and consider the relevant regulatory issues.  In particular, whether the bonds are listed on a recognised stock exchange. 

Restructuring methods

The most commonly seen debt restructuring methods involving high yields (for those debt restructuring can be have been achieved) are (1) debt for equity swaps; (2) exchange offers; (3) cash tender offers; and (4) buy-backs.

Whichever method one chooses, one should need to consider the possible implications under the applicable insolvency laws both locally and those in other jurisdictions.

If you would like to find out more about the contents in this note or other issues pertaining to debt restructuring, please contact us.

Alfred Leung, Partner 

(E: alfredleung@hkytl.com; T: +852 3468 7202)

YTL LLP is a law firm headquartered in Hong Kong, China.  This article is general in nature is not intended to constitute legal advice.