The current economic situation predicts upcoming financial distress for certain economic sectors. Ukrainian corporate borrowers are not an exemption, and have to manage their liabilities in an unusual context. At the same time, despite the high level of non-performing loans in the portfolios of Ukrainian banks, there is a big question mark as to whether there are truly lucrative investment opportunities in the current market. Our speakers, Anton Korobeynikov and Igor Lozenko, partners at Sayenko Kharenko, suggest that upcoming challenges for both borrowers and lenders require a smooth and commercially balanced approach.
In the context of the combined topic of our discussion — distressed debt and liability management — how do you see them interplay in your practice?
Anton Korobeynikov: They may come together, but not necessarily. Liability management in the context of capital markets is an exercise of broader application. It is often driven by considerations that are not related to problems in the issuer’s financial condition, and is employed as a treasury management tool. When a company gets into a distressed situation and has both regular bank debt and capital markets instruments outstanding, that’s where liability management instruments become a part of the “bad debt” toolbox.
Igor Lozenko: If we look at capital market transactions in recent years by Ukrainian corporate issuers, liability management instruments, such as exchange offers and consent solicitations, have become an everyday business when they need to extend the maturity of their liabilities or take advantage of favorable market conditions or both. A distressed case scenario is different in its complexity, because we would usually need to ensure that the restructuring of the capital market instruments and loan debt work together smoothly.
Turning to the area of distressed debt, are there any particular trends that you have observed during the past year?
A.K.: In the sphere of our focus, which consists in the main of larger-size Ukrainian companies and business groups, last year may well have been “transitional” in a way, meaning that businesses recently completed dealing with the consequences of the latest crisis just to find themselves on the brink of the next downturn. We are yet to see how the situation unfolds, and this will depend on many factors, including the ability of the Ukrainian government to counteract the pandemic and avoid major political shocks and macroeconomic instability, as well as global market trends which are critical for Ukraine’s export-oriented industries.
I.L.: We have, indeed, not seen a surge in major restructurings that can be attributed specifically to the circumstances that emerged in 2020 — some, like Interpipe’s, were completed in late 2019, several others have been ongoing but originated in pre-pandemic times. One high-profile restructuring which is still pending since 2020 is that of DTEK Energo and, besides that, we are completing several private cross-border restructuring deals. Still, I agree that it may be too early to tell.
As your firm is regularly involved in cross-border restructuring deals, can you give a high-level overview of the approaches applied in these deals and legal instruments used?
I.L.: Generally, there are ways to restructure debt at pre-insolvency or post-insolvency stages. Almost all cross-border debt restructurings of Ukrainian businesses were carried out without recourse to insolvency procedures. In this regard, contractual workout could be viewed as the most common and reasonable restructuring mechanism as long as the debtor and all its creditors cooperate in the process. At the same time, dissenting or holdout creditors have not been a rare thing in the course of debt restructurings of Ukrainian businesses for the last 5-6 years. One of the effective solutions to deal with the issue remains use of the English law scheme of arrangement. This court-sanctioned tool has become popular given its ability to cram down dissenting creditors of the same class. It is also available for foreign companies (not just UK ones) and rather flexible. Currently, ongoing restructuring of DTEK Energo will likely employ the scheme of arrangement as a restructuring tool.
Notably, the UK expanded its restructuring regime by introducing a new restructuring plan procedure in 2020. This out-of-insolvency process is very much like a scheme of arrangement. However, in contrast to schemes, the new restructuring plan carries enhanced cramdown mechanics enabling the binding of creditors across different classes. A lack of this cross-class component in the past used to be one of the downsides of the UK regime compared to that of Chapter 11 in the USA. In the context of Ukrainian cross-border restructurings, this means that for particularly complex and difficult cases with dissenting creditors across different classes of debt the new procedure may be another option on top of the schemes.
A.K.: I would probably add several further points. Cross-border restructurings are generally well planned out and documented at all stages (although each deal can have its messy moments). We would usually expect creditors to form an informal creditors committee consisting of the most active and usually largest creditors. The parties would likely try to have as many creditors as possible to sign up to a standstill agreement establishing a consensual moratorium on enforcement by creditors for a certain period enabling everyone to focus on negotiating the restructuring. Then, depending on the number and complexity of the debt instruments involved, a restructuring agreement can be prepared setting out restructuring steps and their sequence. Finally, a set of documents would follow implementing the restructuring and governing post-restructuring relations between creditors and the debtor group, as well as between creditors themselves.
At the Ukrainian level, it is important for the legal teams to be skillful, solution-oriented, and able to work with Ukrainian legislation in an unusual context. International creditors who are used to working with more developed legal systems would often approach us with requests that do not have an obvious answer under Ukrainian law. If the debt is sold to two creditors in portions, how can you share the security? What can be added to a share pledge to create another layer of control over the collateral? A Ukrainian legal team needs to be able to solve this type of puzzle in a legally and commercially balanced way.
What would be the typical liability management techniques used in a restructuring context or otherwise?
I.L.: The toolkit available to Ukrainian issuers has generally not changed over the years. Depending on the particular needs of an issuer, this would ordinarily include a consent solicitation (essentially to amend the terms of notes) or a tender offer (to repurchase existing notes for cash or exchange existing notes for new ones) or a combination of both. These techniques would often come together with a new issue of notes, though occasionally they can also be pursued by way of a standalone transaction. For example, despite volatility on international capital markets against the backdrop of the coronavirus pandemic, 2020 saw several successful new issues of Eurobonds coupled with tender offers, including that of a sovereign one, Metinvest, and Kernel. At the same time, Ukreximbank carried out a cash tender offer without issuing any new notes. Similarly, without issuing new notes, at the end of last year state rail operator Ukzaliznitsya launched a consent solicitation and relaxed certain covenants under its existing notes.
When bonds are trading below par value, issuers may also take advantage of this and buy back their debt securities on the open market. Such buy-backs with a discount help to deleverage the balance sheet and ultimately reduce the total cost of servicing the debt. Repurchasing the bonds this way means the issuer should have extra cash and, hence, this option would not be sensible for those facing liquidity issues. Furthermore, for regulatory reasons, open market buy-backs would only be suitable for an insignificant portion of bonds as opposed to a formal tender offer procedure enabling the repurchase of the entire bond issue or a significant part of it. Finally, in order to benefit from this option the initial terms of the bonds should not restrict the issuer’s ability to do open market transactions. As such, this aspect should be well thought out by the issuers from the outset when negotiating the covenants for the prospective bond issuance.
It seems that cross-border restructurings are mostly done within foreign law frameworks as a primary legal platform. What is your view on Ukrainian law tools, like, for example, the Financial Restructuring Law? Why do some creditors view it as not providing fully adequate instruments for achieving its purpose?
A.K.: I suppose it depends on how you define the purpose. The Financial Restructuring Law, at the time of its drafting, had undergone a number of transformations. In the version that was adopted, the basic underlying principle is consensual participation by creditors. For a creditor’s claim to become subject to the process and limitations of the financial restructuring procedure, its consent is required. Therefore, on a conceptual level, the law establishes a consensual restructuring framework with additional procedural mechanics, certain regulatory and tax benefits for the parties. From this perspective, it generally achieves its purpose. Based on the publications of the Financial Restructuring Secretariat, the restructurings are launched regularly.
It is true that the Financial Restructuring Law may not be the solution for situations with a big number of different types of creditors with different strategies and agendas, especially if not all of them are prepared to consensually participate in the restructuring.
Another emerging tool is a revised pre-insolvency rehabilitation under Article 5 of the Bankruptcy Procedure Code. This is an out-of-court restructuring procedure, which now allows the debtor to structure the rehabilitation plan by dividing creditors into classes and passing the plan by a majority vote (with different thresholds) of creditors in each class with subsequent approval by the court. While pre-insolvency rehabilitation has, as such, been available under Ukrainian insolvency laws for about a decade, after its recent reform it may become a more adequate tool for multi-creditor restructuring.
The situation obviously provokes further opportunities for debt investors active in emerging markets, including Ukraine. What has been happening with the non-performing loans (NPL) market during this ongoing COVID pandemic?
A.K.: I don’t think that we are quite there yet in terms of the effects of the pandemic, which may show themselves in the next few years. While the distressed debt market remains active to a certain extent, the supply of assets that are of particular interest to investors has been drying up recently. The level of reported NPLs in the banking system remains high. At the same time, not all of the assets behind this number present a good case for investment. We have been working with most of the foreign investors active on Ukrainian distressed debt markets and, speaking of specific areas, investors are now expecting a more active sale of portfolios of state-owned banks, looking at individual cases elsewhere, including the DGF, which may present some investment opportunities.
What NPL investing strategies do you observe? What types of NPL portfolios are of particular interest?
A.K.: Most of the foreign investors we work with prefer to focus each case on a particular corporate borrower or group, which makes it easier to assess the viability of the business and the investment in its debt, as well as prospects of a potential turnaround. With regard to the strategy, it is usually based on the plan to reach an agreement with the debtor for consensual restructuring. Turning to aggressive actions is a last resort, which can usually be avoided because the parties appreciate that this may result in losing control over the situation, creating further deterioration in a business and diminishing the remaining value of the business.
I.L.: We have also been working on establishing some more long-term platforms for cooperation between foreign and local investors. These involve a higher initial cost, but assuming that a foreign investor has a proper Ukrainian partner, this type of platform enables the parties to take the benefit of more diverse investment opportunities (including mixed corporate and retail loan portfolios) and pre-established structures for making the investment and distributing the profits, which ultimately results in less time being needed to run each particular transaction.
What are the most challenging situations in your recent practice?
A.K.: The deals that we get involved in are all challenging. I cannot recall a single transaction, be it a distressed debt deal or restructuring exercise, which would not present a variety of challenges in the process. As a firm, we believe that this is where our value lies — where other lawyers might abandon the issue after initial attempts and leave the commercial parties struggling, we would usually try to get to know the issue inside out, both legally and commercially, and then find a way to solve the problem.