(Bloomberg) -- The end of rock-bottom interest rates has made it harder for struggling companies to access new funds. So they’ve been seeking out new ways to deal with their debts. Often, this means exploiting loopholes in their bond or loan documentation to favor one set of creditors over another. The company survives, but lenders left out in the cold can end up with heavy losses.
Alarmed at this turn of events, debt investors are circling the wagons. Many have been signing cooperation agreements that force them to act in concert and negotiate better terms as a whole, rather than go off and make a side-deal with the company and its owners.
But there are downsides to such arrangements, which bind together credit funds that often have different interests and objectives.
What’s been happening?
For years, interest rates near zero meant that junk-rated companies looking to raise debt could dictate terms to potential buyers of those securities. As a result, debt documents became increasingly permissive from the point of view of the borrowers, and investor protections eroded. That wasn’t much of an issue when firms had almost guaranteed access to capital markets and defaults were at near-zero.
But when markets turned and lending conditions tightened two years ago, companies started to get more creative. Testing the array of loopholes in the documents threw up a range of options, from raising new debt backed by assets that weren’t subject to creditor claims, to giving one group of creditors a stronger claim on the company’s assets in exchange for concessions, while leaving the rest behind. This series of practices, called liability management exercises, have become an increasing worry for debt investors.
How did cooperation agreements appear?
They’ve existed for some time, but came to the fore more recently during the high-profile restructuring of US used-car dealer Carvana in late 2022. The company’s largest creditors, including Apollo Global Management, Ares Management Corp. and Pacific Investment Management Co., signed a pact binding them together in debt talks, and months later struck a coordinated deal with Carvana entailing a partial debt write-down and an extension of the remaining maturities.
They’ve since been used in a number of large US corporate debt restructurings, from Bausch Health Cos. to WW International Inc., the parent company of Weight Watchers. This year, they made their way into Europe, notably in cross-border deals involving packaging firms Ardagh and Klockner Pentaplast, and with telecommunications giant Altice France, whose capital structures contain debt denominated in both euros and US dollars.
Cooperation agreements are introduced — and pushed — by advisers to the creditors, especially the lawyers who are eventually the ones drafting the legal documents outlining the pacts. Some US law firms have grown a reputation for championing cooperation agreements, especially the restructuring practice at Gibson Dunn & Crutcher LLP.
How do cooperation agreements work?
In a typical debt restructuring, creditors come together and organize with legal and financial advisers to coordinate negotiations with the company. A steering committee of debt investors — usually representing the holders with the largest positions — is selected to represent the wider group. Signing a cooperation agreement is a step beyond this: It signals even more strongly to the company and its owners that debt investors have formed a united front, but also comes with additional restrictions.
For instance, you cannot leave whenever you want, whereas without an agreement there is usually no formal hurdle preventing one investor from breaking off to arrange a side deal with the borrower. Furthermore, the duration of these agreements — which were originally designed to last three or six months — is getting longer. In the case of US cable provider Radiate Holdco, also known as Astound Broadband, it lasts through to the maturity of its term loans due in 2026.
While this ensures no creditor will be left behind, for some funds with deep pockets and the flexibility to provide capital, it might also limit their range of options and hinder potentially lucrative deals for their own investors.
This tension emerges when long-term investors, who had bought the debt when originally issued and at par, are bound together with funds which bought at a discount. The entry point, the nature of the creditors and the returns they target are different.
This has recently tested the cooperation pact among creditors to Altice France. When they had to vote on an extension of the agreement through to 2026, some in the group considered rejecting the proposal. Eventually, however, 93% of the creditors that signed the first agreement supported the extension, including all the members of the steering committee.
Trading out of the debt is also not as straightforward: Once you’ve signed a cooperation agreement, usually you can only sell your holdings to someone who is willing to sign the pact — or might have already done so. However, there are exceptions. Many cooperation pacts include provisions which allow market-makers to buy the debt from an investor without actually signing the agreement.
What if someone breaks the pact?
It’s not clear what the legal implications would be if a creditor were to break a cooperation agreement. In fact, the pacts are so new that there’s no legal precedent. In Europe, funds can sign up under different legal jurisdictions, creating room for further complications.
Most cooperation agreements include a specific performance provision, which means a court can force those who sign one to uphold their commitment, rather than just pay damages.
Joseph Goldschmid, a managing director at Oak Hill Advisors in New York, argues that the threat of reputational damage should be enough of a deterrent to ensure cooperation agreements remain intact.
“It’s a repeat-player game,” Goldschmid said. “Being a bad actor and getting that reputation can come back to haunt you.”
How are cooperation agreements working in practice?
Cooperation agreements are usually signed as a precautionary measure, but have sometimes been used to block off a specific move by a borrower or its sponsor, which is usually a private equity fund.
When French company Worldwide Flight Services in 2023 offered to buy back its bonds below the threshold price outlined in its documents, a group of its bondholders banded together in a cooperation pact, and managed to negotiate a better price.
With Altice France, on the other hand, cooperation agreements were signed after management took a particularly aggressive stance in a call with investors, claiming they were going to have to participate in “discounted transactions” to help the company slash some of its debt.
The dynamics of game theory often play a part in whether a cooperation agreement is signed. In order to get the other creditors into a transaction, you need to get at least 50% them to sign up. Because of the limits on trading imposed by the cooperation agreement, a creditor won’t want to tie their hands unless they’re sure there’s the critical mass to force the borrower to comply.
And it’s not as if the agreements are always designed with the interests of all creditors in mind. In some transactions, creditors holding just 51% of the debt can team up in order to extract better terms than the remaining 49% of creditors that are not part of the group.
Can borrowers still find ways around them?
Cooperation agreements can’t guarantee full protection against alternative maneuvers from a distressed company. And there’s nothing to stop borrowers moving some assets away from creditors who signed a cooperation agreement and using them as collateral to raise financing from new lenders, in a deal known as a “drop-down” transaction.
For instance, Altice approached funds that aren’t existing creditors to discuss raising new debt to repay looming maturities. The new debt would be backed by assets in so-called unrestricted subsidiaries, meaning that they are out of reach of existing creditors.
“If there’s a provision in the credit agreement that allows the borrower to raise money from a third party or an existing lender and the latter hasn’t signed up to the cooperation agreement, the lenders that have signed are not protected from that happening,” said Tuck Hardie, a managing director at Houlihan Lokey in New York.
--With assistance from Reshmi Basu and Jill R. Shah.
(Adds detail on creditor motivation at end of penultimate section. A previous version of this story was corrected, changing “borrower” to “lender” in the final quote)
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