The phenomenon of “lender-on-lender violence” has become increasingly frequent in the US in the last decade and is showing signs of spreading to Europe.
In recent years, various liability management transactions have occurred in the US in which one or more classes of lenders (typically invoking a collective action clause to act as a majority) seek to change the capital structure to the detriment of the minority lenders. Creditors have attempted this in certain ways in US financings, such as:
- Dropdown transactions making use of unrestricted subsidiaries and transferring material assets (J Crew, Neiman Marcus);
- Effecting the automatic release of guarantees and potentially liens when a subsidiary ceases to be wholly owned (Chewy); and
- Priming/uptiering transactions, which may also involve lien and/or payment subordination despite pro rata sharing voting protections (eg, the “open market purchases” exception in Serta).
The propensity for UK lender-on-lender violence turns on several factors, including: (i) the economic environment; (ii) transaction documentation and the wider legal framework; and (iii) the risk appetite of lenders/sponsors. While there are some inherent protections in the UK market and legal landscape that should reduce the risk of lender-on-lender violence, there is a growing prospect that it will be attempted (although whether it succeeds is another matter).
The current UK landscape
Intercreditor disputes are nothing new in the UK. Lenders will often find themselves in contentious situations – sometimes with no option but to litigate a dispute – in which they seek to uphold or improve their position in a distressed capital structure. Historically, it has been uncommon in the UK and elsewhere for banks to sue one another, unless there is a point of principle or market precedent worth fighting for or there are truly large sums at stake (ie, hundreds of millions of pounds, if not more).
Yet today’s deal landscape involves a greater range of characters with differing roles: private equity sponsors and distressed/opportunistic funds may sit alongside banks in any given capital structure. Indeed, private credit has gained a more prominent role in recent times by buying up loan portfolios from banks’ books or providing financing to corporates where traditional banks have been reluctant.
The macroeconomic picture in the UK is not so rosy. Interest rates are at a 15-year high and, while further increases appear unlikely for now, they are set to remain at these historically elevated levels for some time. With increased financial distress comes defaults and restructurings, and/or liability management transactions to ward off such scenarios, creating situations where the interests of different lenders can clash. Complex capital structures that may have worked well at the time that deals were originated or amended can suddenly turn problematic, especially when it becomes clear that certain groups of creditors may be at a disadvantage.
Lender-on-lender violence often arises when there is ambiguity or deficiency in finance documents. Lenders in UK financings (ie, governed by English law) have learned from recent cautionary examples in the US and have endeavoured to tighten up credit documents for new originations and recent restructurings to reduce the risk of similar scenarios arising on their deals.
Even where majority lenders have a contractual ability to take certain decisions or actions, the exercise of this power is subject to certain restraints under English law. In situations where a creditor is intent on invoking lender-on-lender violence in any given structure, assuming there are no ostensible restrictions in the financing documents, they may nevertheless be prevented from doing so by legal doctrines that dictate how creditor rights must be exercised.
It is recognised by the English courts that majority creditors owe no duty of care to the minority and that the majority is free to pursue its own legitimate commercial interests. Only an improper exercise of voting rights will offend this basic principle. For example, doing so not in good faith and not for the purpose for which the power was conferred, as was the case in a 2012 decision known as Assenagon Asset Management.
However, the law is far from settled in this area, with a paucity of cases over the last two decades. This certainly leaves room for an opportunistic and creative creditor to test the boundaries under English law.
Lenders’ various strategies in 2024
In practice, lenders (and borrowers) may seek to restructure corporate liabilities in the courts through a scheme of arrangement or restructuring plan under the Companies Act 2006. These tools have gained popularity since the covid pandemic and have mostly been used with great effect, particularly the restructuring plan, which includes the ability to cram down across classes.
In summary, nothing is off the table for creditors in English law financings, particularly if economic conditions remain testing in 2024 and beyond. Ultimately, if a creditor is facing a write-down of their investment and has no choice but to attempt an aggressive manoeuvre, they may be willing to take whatever action necessary to protect or enhance their position at the expense of other creditors. However, there would be various hurdles (and hotly contested legal challenges) to any lender-on-lender violence attempted in the UK.
Michael Jacobs is a partner at New York-based law firm Boies Schiller Flexner.