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Unsecured need more security

The treatment of unsecured lenders in Europe may have severe repercussions for future liquidity, writes Andy Thomson.

In the US, some recent restructurings have resulted in cries of anguish from the unsecured creditors of the companies in question.

At bankrupt electronics retailer Circuit City, for example, it emerged that unsecured creditors were likely to get no more than 13.5 percent of the value of their claims. Meanwhile, at theme park operator Six Flags, unsecured creditors have submitted their own plan for the business after learning that Six Flags management some months ago proposed giving 92 percent of the business to secured lenders and only the remaining 8 percent to note-holders.  

From European unsecured creditors, the likely response to these developments in the US would not be sympathy but rather green-eyed envy.

While cases such as those above indicate that unsecured creditors in the US sometimes end up disappointed, in most cases Chapter 11 gives a level of protection that their equivalents in Europe can only dream of. For unsecured lenders in European processes to get their hands on even the tiniest slice of the business post-restructuring is a rare event. Contrast this with the recent case at Chrysler, where junior creditors were arguably favoured over their senior counterparts.  

In the UK, the recent High Court case of Carlyle Group-backed IMO Car Wash underscored the clear bias in favour of senior secured lenders. Here, junior lenders to IMO argued in favour of a way of valuing the business commonly used in Chapter 11 procedures and which would have entitled them to a portion of any post-restructuring upside. Not unexpectedly, the judge came down firmly on the side of the status quo by giving the senior lenders entitlement to 100 percent of the equity – possibly a shock to the junior lenders themselves, but not to students of historical precedent.   

As Bruce Bell, a partner at law firm Linklaters, said at the time: “The UK is often seen as creditor-friendly. What people don’t realise is that it’s senior creditor-friendly, whereas the US has a more expansive view of the creditor class.”

One point worth pondering is whether this “more expansive” view should be adopted in Europe too. An American distressed investment specialist based in London recently commented: “In the US there is a lot of protection around the unsecured lender – the view is taken that senior lenders can look after themselves. For Europe to end up with processes as efficient as those in the US, unsecured lenders need to be given more protection.”

This may sound counter-intuitive if you assume that the pricing of an unsecured loan is commensurate with the risk – i.e., unsecured lenders are not naïve innocents who need protecting from themselves.

There again, how much value do you place on maintaining Europe’s liquidity pool? Unsecured lenders in Europe, racking up massive losses, will no doubt be pondering that in many cases it turns out they have very little – maybe nothing – in the way of downside protection. And that could severely colour their future lending decisions.