Role and Interaction of Ad Hoc Committees with Security Trustees
The dynamics between an ad hoc committee and the security trustee can be nuanced, influenced by various factors, including the change in financial situation of the debt issuer, the composition of noteholders, and the specific trustee involved. The inherent risks to stakeholder value and to the trustees over their actions can deviate considerably from at the time of issuance.
Depending on the structure and jurisdiction involved, the trustee may be known as a security trustee, bond trustee or indenture trustee. Typically, a security trustee is a subsidiary of a financial institution, such as a trust company or a bank, or a fund administrator, and is appointed by the issuer of the notes and vested with fiduciary powers.
In certain circumstances, it may be appropriate to appoint independent trustees. Cork Gully is well-placed to act as trustee, given our independence and expertise. We act decisively and free from apparent or actual conflicts of interest.
Trustees
The trustee acts as the representative of noteholders, even though the issuer usually provides for its fees and expenses. A fundamental principle governing the relationship between an ad hoc committee and the trustee is that the trustee must consistently act in the best interests of all noteholders it represents. This includes members of the ad hoc committee, original noteholders, and those who acquired notes on the secondary market. The trustee should treat all noteholders equally, regardless of the price at which they acquired their notes, as long as they possess the voting and information rights attached to the notes.
The trust indenture, often used in English law, along with the offering memorandum, outlines the relevant procedures, such as convening noteholder meetings, and the conditions under which the trustee and noteholders can declare an event of default, triggering the immediate payment of principal and interest. The terms of the notes impose several restrictions on the issuer, including negative pledges (limiting the encumbrance of certain assets), restrictive covenants (restricting the disposal of specific assets or the incurrence of additional debt), and events of default (breaches of certain obligations). These conditions are designed to protect the creditworthiness of the issuer, safeguarding noteholders’ investments. The trustee is responsible for monitoring the issuer’s compliance with these conditions and ensuring relevant information is communicated to noteholders.
The trustee’s duties to noteholders, and by extension to the ad hoc committee, are fiduciary in nature, subject to common law and statutory duty of care. Importantly, this involves exercising reasonable care and skill, avoiding conflicts of interest, acting in the beneficiaries’ interests, and acting in good faith and with honesty and integrity.
In the normal course, before any pre-distress or default stage, the trustee’s role is primarily administrative, including distributing payments, maintaining noteholder lists, monitoring note terms, and potentially overseeing secured assets. The relationship between the trustee and noteholders at this stage is essentially mechanical, akin to that of an agent bank, albeit dictated by note terms.
Trustees do need to exercise discretion at various stages, with an implied duty to do so rationally. The case of Socimer International Bank v. Standard Bank [2008] EWCA Civ 116 underscored the trustee’s obligation to act with honesty, good faith, and rationality. How the trustee exercises this discretion can impact noteholders’ recovery during issuer restructuring or liquidation. Therefore, early communication and building a relationship with the trustee can be advantageous for the ad hoc committee.
Trustees are traditionally compensated with relatively modest fees. However, they must meticulously discharge their duties to protect noteholders and minimize personal liabilities and reputational risks. Due to these liability concerns, trustees seldom act independently and usually rely on instructions from the required percentage of noteholders, as outlined in note terms, or, when appropriate, seek guidance from a relevant court. In certain circumstances, the trustee may have the contractual right to revert to a time costs basis reflecting time properly charged to deal with those circumstances, such as litigation, enforcement, distressed asset realisation or insolvency.
Ad hoc committees
Ad hoc committees can be formed at various stages, such as when issues with the issuer’s debt arise or later in the workout process when it becomes evident that the issuer is distressed and value preservation is essential. The timing of committee formation depends on their nature and objectives, whether they are activist or have a specific strategy. Ad hoc committees offer a platform for relevant noteholders to communicate collectively with the trustee and develop a relationship that allows the trustee to consider their concerns and facilitate information exchange with the issuer.
During issuer distress, ad hoc committees may have concerns related to decisions regarding coupon payments or covenant waivers. While the trustee officially represents all noteholders, the formation of an ad hoc committee typically aims to give the group a voice and the ability to influence the trustee’s decisions. The committee members seek to avoid being adversely affected by the trustee’s actions influenced by other, potentially larger, creditors with different agendas.
One challenge noteholders may face is persuading the trustee to act on their instructions, especially when major institutional noteholders hold significant positions and can sway the trustee. Ad hoc committees can exert more influence on the trustee and issuer, particularly in shaping reorganisation plans or pushing for formal actions. The trustee is more likely to perceive an ad hoc committee as a credible threat compared to individual noteholders.
Ad hoc committees maintain regular communication with and rely heavily on the trustee, particularly concerning interactions with the issuer. Unified or assertive ad hoc committees can exert significant influence, especially if they collectively represent a substantial portion of the debt in a relevant tranche, which can allow them to block or delay certain issuer transactions. The trustee also pays attention to situations where the ad hoc committee’s representative value carries substantial weight.
The trustee communicates with ad hoc committees through its advisers, sends notifications, and facilitates communication with the issuer. However, trustee-noteholder communications are not always confidential, unlike attorney-client communications. In cases where default is likely, privileged information should be communicated carefully, often requiring a common interest privilege agreement between the ad hoc committee and the trustee and their respective legal counsel.
The information shared between trustees and ad hoc committees is essential for devising recovery strategies and determining the next course of action. In some cases, the trustee may cover expenses incurred by an ad hoc committee if those expenses benefit the trustee and a wider class of creditors under the trust deed.
Divergent interests and exercising discretion
When the issuer is distressed, the trustees typically possess wide discretion to determine if an event of default has occurred, if it is materially prejudicial to noteholders, and if acceleration is warranted. However, exercising this discretion is not always straightforward, and the trustee’s views may differ from those of an ad hoc committee. Ad hoc committees often form in distress or default scenarios to influence restructuring or enforcement actions. Upon issuer default, the trustee usually holds the exclusive right to accelerate the notes, subject to instruction from a certain percentage of noteholders. Noteholders cannot individually accelerate or take enforcement actions. Exceptions occur when the trustee fails to accelerate upon proper instruction from noteholders within a reasonable timeframe.
Relationships between noteholders and the security trustee face significant challenges during the issuer’s stress. Trustees, are independent parties but have relationships with the issuer and most noteholders, possess unique insights. Trustees are not obligated to inform noteholders of every event of default, and they may withhold information if they believe it’s in noteholders’ best interests, such as avoiding premature enforcement actions that could harm recovery. Trustees tend to take a cautious approach, seldom acting without noteholder ratification or court guidance but may feel constrained to make timely and necessary decisiveness due to pressures of their relationships with issuers.
The relationship between the trustee and the ad hoc committee depends on various factors, including noteholders’ approaches (proactive, passive, or aggressive) and the trustee’s stance (pro-issuer or pro-noteholder).
The relationship between an ad hoc committee and an agent bank is typically more mechanical, as the agent’s role is limited to administrative tasks. The agent acts upon instructions from majority lenders, and ad hoc committees can effectively influence the agent by assembling a consensus among lenders with sufficient firepower. Enforcing loans differs under an agency structure, where each lender or noteholder can accelerate their commitments individually. However, initiation of enforcement still requires a majority lender decision.
Unlike a trustee, a paying agent, often an entity of the bank, has no ability to enforce the bond payment obligations. If there were a paying agent but no bond trustee, there would be no independent party available to protect the rights of the bondholders if there were a default on the bonds.
Trustee liability and indemnity
Under a trust indenture, the trustee receives indemnities, but negotiations over the extent and scope of the indemnity can be challenging. Noteholders seek to limit their exposure and impose caps on their liability, while the trustee aims to cover various eventualities. In practice, the indemnity agreement often occurs during time-sensitive periods, potentially complicating negotiations. Furthermore, noteholders may sell their notes, leading to concerns over liability after transfer. The release from an indemnity often hinges on the purchaser of the notes providing a back-to-back indemnity, creating complexities for sellers.
Syndicated loan agreements usually include broad exclusion of liability provisions to protect the agent from liabilities beyond its agreed-upon duties. The agent enjoys indemnities, including those from the borrower’s parent company and lenders. Lenders are also required to indemnify the agent. Ad hoc committees must carefully review the facility agreement, as certain agents may assume more extensive roles.
However, in times of distress, inaction by trustees or the decisions they make with a view to conflicting interests may introduce risk that may not be covered by the indemnity, or being named in litigation and press coverage may otherwise be detrimental to the trustee’s reputation.
Conclusion
The relationship between an ad hoc committee and the trustee is complex, with benefits for both parties. Trustees play a critical role in safeguarding noteholders’ interests and acting as their spokesperson. However, the relationship can be influenced by ad hoc committees during times of issuer distress or disagreement among noteholders. The relationship’s effectiveness depends on various factors, and trustees must balance the interests of ad hoc committees with those of all noteholders. The interaction between an ad hoc committee and an agent bank is generally more straightforward, governed by the agent’s limited role as outlined in agreements.
The timely introduction of independent restructuring and asset recovery specialists, such as Cork Gully, will help to mitigate the risks of the trustees and noteholders. Value preservation by conflict-free experts will reduce or negate the risk of any adverse outcomes for trustees.
