Bond Workouts, Distressed Equity Offerings and State Interventionism - The Inefficiency of French Law Concerning the Restructuring of Large Distressed Companies

In my most recent paper, ‘Bond workouts, distressed equity offerings and State interventionism - Analysis of the Consequences of the Inefficiency of French Law Concerning the Restructuring of Large Size Companies’, I try to show that there is a link between several phenomena which were viewed, until now, separately.

Studies in finance have shown that there are a greater number of distressed equity offerings, ie capital increases carried out by companies in difficulty, despite the obvious risk of transfer of undue wealth to the benefit of creditors and to the detriment of shareholders. These studies were confirmed by an empirical analysis of the 82 share issues carried out by distressed companies listed on the Paris Euronext market between 2009 and 2017 which is provided in my paper.

Out of these 82 transactions, 30 were carried out by companies seeking to raise more than 50 million euro. The French State played a role in more than one-third of these major transactions. An analysis of the stock market performance of the shares issued in connection with the 30 most significant transactions confirms that this type of transaction often constitutes a risky gamble for their subscribers and sometimes unnecessarily delays in-depth restructuring of the company’s debt. This empirical study is completed by a detailed analysis of the restructuring of Bull, Technicolor, CGG, the Solocal Group, Eurotunnel, Alcatel, Alstom, PSA Peugeot Citroën, Areva, and General Motors.

At the same time, while in the US we see a high number of debt for equity swaps in the form of public exchange offers, it is notable that in France no similar offer was launched, despite that: 1) a relatively large number of companies of significant size were seriously distressed; and 2) bond markets in France are well developed.

The interest of my study in relation to previous studies in finance and law lies in establishing a causal link between: 1) the deficiencies of French law which is, in my view, the cause of the absence of debt for equity swaps in France in the form of public exchange offer, and 2) the abnormally high number of distressed equity offerings, which are ruinous for shareholders and contrary to the teachings of economic theory, which tells us that shareholders should refrain from subscribing to new shares under these circumstances (‘debt overhang’).

Indeed, I show in this paper that:

1) it is impossible for a large French company to use debt-for-equity swaps in the form of public exchange of public exchange offer to obtain significant concessions from their creditors since it cannot credibly threaten to enter insolvency proceedings;

2) the rules relating to corporate governance inadequately protect creditors, as well as minority shareholders, from the risky choices of their managers, who are often in a state of denial with regard to the magnitude of the company’s distress; and

3) the obligations of transparency and information of financial markets incumbent upon companies are inadequate to enable investors to truly assess the risks of distressed equity offerings.

The intervention of the State, again acting too often as shareholder of last resort, serves as a stop gap measure for the inefficiency of French law.

Whenever government intervention takes the form of State aid, the European Commission is obliged to force companies to make painful concessions in order to avoid distortion of competition on the Internal Market.

For all these reasons, France has everything to gain from a major reform of its law, in particular insolvency law. For that purpose, it must rely on the initiative of the European Commission initiative on minimum standards concerning insolvency law for growth in Europe, made public on November 22, 2016.

Such reform would allow a market to develop for the acquisition of control of large distressed companies via the purchase of their debt on the secondary market and promote the intervention of private investors capable of becoming majority shareholders of distressed companies, irrespective of their size.

Ultimately, only the creation of such a market for corporate control of large distressed companies will allow the fatality of certain distressed equity offerings to be avoided, thereby reducing the losses incurred by poorly informed minority shareholders, as well as the unnecessary risks that the State is often forced to take by acting as a shareholder of last resort.

Sophie Vermeille is the President of the Droit & Croissance (Rules for Growth) Institute (‘Droit & Croissance’).