Q&A with Elizabeth Majers, Partner with Loeb & Loeb in Chicago
April 20, 2009
Elizabeth Majers has 27 years of experience in the private placement market, practicing mostly as a special counsel representing institutional lenders. She also has done extensive work representing lenders in workouts and distressed financings, working with such credits as C-BASS LLC, U-Haul International Inc., Wabash National Corp., Illinois Vehicle Premium Finance, Union Square Credit Tenant Loan, and many others.
Prior to joining Loeb & Loeb in early 2008, Majers was a partner with McDermott Will & Emery and served as head of the firm’s global corporate finance group, and partner in charge of client service. Majers received her J.D. from the Indiana University School of Law, and did her undergraduate work at the University of Illinois at Urbana-Champaign. Majers is also a Certified Public Account, a current member and former president of the American College of Investment Counsel, and is a frequent speaker at industry events related to the private placement market and credit tenant loan financings.
Recently, Majers sat down with PPL Managing Editor Grant Catton to discuss the role of borrower pre-designated counsel (PDC) in private placement transactions, and the increased use of independent lender counsel in modification or distressed scenarios…
Elizabeth Majers
GC: Can you explain a little bit about the history of borrower PDC and its use in private placement transactions?
EM: Prior to the mid-90s, a prospective borrower would select an agent or an intermediary to raise private debt and a private placement memorandum and term sheet was prepared by the agent in consultation with the borrower. The agent went to the market to solicit bids, and the lenders were allocated their commitments based on price quotes and size interest and a review of the offering materials. The agent would then ask one or two of the largest investors to select counsel for all the noteholders. Counsel would be selected and such noteholder counsel would begin to prepare the note agreement and related documents.
In 1994 to 1996, model documentation was created by an industry group to provide more consistency and efficiency in the documentation process. During the mid- to late-1990s liquidity began to expand in the global market, and the private placement market faced more competition for deals, so intermediaries and others looked for ways to make this market more competitive, easier to access, and more predictable. One solution, in addition to model documentation, was to control the selection of lender counsel and to switch the selection process from the noteholders to the borrower and the borrower’s agent.
An outgrowth of that shift of the selection privilege was the preparation and negotiation of the note agreement in advance of the marketing of the deal, and the inclusion of not only price but also the content of the note agreement in the distribution phase. So noteholders were asked to bid on deals with not only price indication and size indication, but also with any documentation comments they might have. So the agent or borrower pre-designated counsel became a very viable role, in connection with new debt issuance, particularly in times of excess global liquidity.
This protocol remains in place today. In fact all 2009 new deals have all contained agent or borrower designated counsel.
What typically happens to the borrower PDC in distressed situations? Do they stay involved in the transactions?
Even during the late 1970s, and all the way through the 1990s and today, many insurance companies and institutional investors maintained internal policies against using original deal counsel for distressed situations, even if they had picked that counsel themselves.
The rationale for that policy really was two-fold. Number one, the noteholders wanted to avoid a compromised representation, where an original deal counsel who is now working in a distressed situation might be put in a position to defend deficiencies in their own documents. The representation there might not be as vibrant as it would be if a new independent counsel had been brought in. And that policy, like I said, has been around with these sophisticated institutions for over 30 years, even in situations where they themselves selected that counsel.
And the second rationale for that policy is there are some institutions that internally will move a distressed credit from their private placement desk to a whole different desk, their workout and restructuring group, which typically uses different professionals than the original deal counsel that underwrote the original credit. Many times when you shift a credit from a private placement desk to a workout desk, those professionals have their own law firm relationships and they select different kinds of counsel, workout counsel.
What’s interesting is while the counsel shift in times of either amendment, modification, distress, or bankruptcy has been the long-standing protocol at many institutions, it has become more widespread in the last six to 12 months during the credit crunch. That is due to a third reason; because the original deal counsel in so many of these transactions was never selected by the lenders. Those firms, particularly in all private placement debt issued since the late nineties, have been borrower or borrower agent designated.
So in addition to the two long-standing reasons I discussed, compromised representation together with the relationships with workout counsel, noteholders are telling me they are concerned that the level of advocacy they would receive from borrower designated counsel in these kind of amendment/modification/distress circumstances might be compromised – possibly the level of advocacy might be lower – than might be the case if they were able to select their own independent counsel.
What percentage of buyside institutions have internal policies to shift to independent counsel in distressed deals?
If you looked at the whole market of institutional investors — you’d see some of them always had the shift requirement — but now you’re seeing a vast majority that have it. Before you would see maybe a third having these policies, now its probably north of two-thirds.
Now, you’re also seeing independent lender counsel being brought in much earlier in the process. A lot of times when you just have a little amendment, a hiccup, you would feel comfortable going back to the pre-designated counsel, but now amendment requests may turn very rapidly into seriously deteriorating financial situations.
And, frankly, the deals that were done 2002 through 2007 were generally done with lighter covenant packages. So any amendments to those “covenant lite” transactions probably indicates some advanced financial stress of the borrower.
Does this shift have any effect on the tenor of the amendment process or the negotiation, in general?
Well, you do see that the selection of independent counsel sends the borrower a message that the noteholders are looking for a fresh pair of eyes, they are looking for representation of their own selection. So I think that indicates that noteholders are taking the situation seriously. That doesn’t mean they are being bullies or overly aggressive, but it does mean they want an independent look. And that of course, as you would imagine, is a function of loyalty and relationships it is someone they are more comfortable dealing with in a situation that has become somewhat of a challenge, possibly more complex, possibly more contentious, depending on the financial condition, rather than remaining with representation by a counsel that was designated by the very entity who is having some financial stress.
It is materially that much more advantageous for lenders to do this?
Oh I think so. Way back when, somebody told me that it’s easy to put the dollars out the door, but the real skill comes in getting them back in the door. Recovery of these distressed loans is going to become very significant, particularly to these financial institutions and insurance companies who themselves are facing asset valuation issues in their own portfolios. Not to say that it was less important before, but it’s certainly going to become more important in times where these institutions themselves also have to keep a sharp eye on their capital levels and their financial health.
So after the market gets better, and liquidity improves, will this tendency continue?
Well, control of the debt placement process is a function of leverage. In times of excess liquidity the borrowers will have leverage during that type of environment. Restructuring or distress situations are not environments where your borrower is in control and has leverage. Therefore distressed counsel selection will likely permanently remain with the lenders. As long as they continue to see the borrower designated counsel as possibly compromised, they will continue to look for independent counsel.
That’s not to say though that the debt issuance market will change – I believe that PDC plays a very viable role for debt issuance – but that role is designed to enhance execution of issuance so that we could become more competitive as a market. Since PDC is selected by the borrower or the borrowers’ agents, they often conduct substantial negotiation and make compromises in the context of the pre-circle documentation process before the lenders were even identified in the deal. But it was never designed to handle more serious discussions with the entity that put them in the deal. Distressed situations frequently become contentious, they’re challenging, they’re complex, and unfortunately in some situations they will result in litigation or bankruptcy filings. Generally that role is just not designed for someone that already has relationships with the entities that appointed them in the first place.
What are the long range effects of lenders bringing in their own counsel earlier?
Some firms are very well known and very well respected for their roles as PDC, and that will continue. There are other firms that are known for their non-borrower designated, non-PDC representation. And I think the distinctions between these roles will become more apparent.
Are there any deals where the PDC stays in the entire time?
During 2007 I was doing sub-prime workouts. There were some workouts in other industries at that time, but it was mainly in the mortgage backed security, mortgage backed servicer area in 2007, which is what of course signaled the tsunami of the credit crunch. So in 2008 other industries started getting impacted by the global economic situation, and amendments increased during that time. In some of those amendments, PDC began to work on those issues, and some of those situations were more of the non-distressed type. However, lately a number of amendments I’ve been involved with in 2008 have tended to start out pretty optimistically and then in Dec. and Jan 2009 and later, the borrowers’ financial condition has deteriorated at a pace I had not seen before.
The negotiations start to deteriorate?
No, the borrowers’ financial condition deteriorates. Sometimes they deteriorated so rapidly that the discussions became much more serious. It no longer was, ‘Give me a waiver for a quarter,’ on a covenant, it was ‘I’m not going to come close to complying with my covenants.’ And that has really deteriorated over just the last couple of months.
So the lenders who probably in mid-2008 said, ‘Okay, it’s a one-quarter amendment let’s just let PDC do it,’ are now sitting with a bunch of situations on their desk, where the financial conditions have rapidly deteriorated. This idea of just a quarter waiver now has a much different tenor, much different tone, and is much more serious, implicating other huge debt instruments of these borrowers. So the lenders are now saying, ‘We need our own independent counsel at this juncture, this has gotten or could get too serious,’ and transitions are being made.
Some transitions are going smoothly, some are not going as smoothly, and so the lenders are saying, ‘Look what’s happened so quickly, so negatively’ in some of our other credits. Furthermore, they’re saying, ‘At the first sign of any modification, we’re just switching. We’re not going to go through the transition process.’ And the number of situations that are arising with this rapid deterioration are increasing. You can see it in the market itself; you’ve got the auto industry, which in the Third and Fourth Quarter of 2008 said, ‘I need a little bit of money,’ now they’re back in 09 saying, ‘I need a lot more money.’ And now they’re saying, ‘We’re getting bankruptcy counsel.’
That’s a pretty dramatic and sudden shift for a very large global industry. And that experience is being felt by the noteholders. The rapid deterioration in the market means these noteholders are having to become much more assertive and aggressive in managing those situations.
What are the main questions lenders are asking themselves now, in these new, more rapidly deteriorating situations?
First it’s, ‘Do we switch counsel?’ And while many institutions already had that policy in place, it is becoming increasingly prevalent now.
The second question is, ‘When do we switch?’ And in the current economic conditions, they are switching sooner and sooner.
Obviously, the overlay to this is the original borrower or agent selection or designation; questions of loyalty, questions of who did the original deal, whose documents are you defending? So that undertone is really driving the acceleration of how many people say, ‘Yes we’re going to switch,’ and really driving the speed in which they are bringing independent counsel into a situation.
And frankly, when you look at the PDC role, it was designed to push money out the door efficiently. And it did a very good job. PDC law firms have always understood that they were designated by the borrower or the agents, but they were representing the lender. At the American College of Investment Counsel we’ve spent years studying that hybrid ethical situation, and the ACIC has hired ethics counsel to look at that. By and large, I think the firms that have been in that role have done a very good job acknowledging the ethics of the hybrid situation. They’ve done a good job of disclosure; they have followed many of the ACIC best practices recommendations. And that functioned as it was intended to function, which was to get the money out the door efficiently, so our market could compete with bank loans, with private equity loans, and all sorts of other capital sources. It was never, never designed, with all of its complexities and challenges, to get the money back in the door.—PPL
For more information on related topics, visit the following:
