Intercreditor agreement as a contractual solution to restructuring leveraged buyouts
Keywords: intercreditor agreement
contracting
game theory
corporate insolvency
financial law
strategic creditor actions
privatised insolvency
private equity
leveraged acquisitions
corporate restructuring
agency costs
private ordering

Leveraged buyout (LBO) transactions are corporate acquisitions financed with multiple layers of debt and equity and form a large subset of the leveraged finance markets. Intercreditor and debtor-creditor conflicts and conflicts within a larger debtor group arise in these transactions on many levels. The data suggests that a vast majority of distressed leveraged transactions are restructured without using statutory insolvency procedures and are governed by extensive contractual packages.
This thesis analyses how intercreditor agreements governed by English law (ICAs) and used in LBOs deal with the risk of the strategic creditor actions of distressed debtor groups, deal with the financial agency costs in multi-layered financing structures and create a controlled bargaining space for resolution of financial distress. The thesis addresses whether the ICA regime is theoretically and in practice able to deal with these concerns and to reduce the use of statutory insolvency law.
The thesis sets out some theoretical approaches and problems that are argued to restrict the use of privatised insolvency procedures. This analysis leads to four key propositions that are tested empirically to determine whether the contractual solutions can overcome these theoretical impediments to privatised solutions to distress. The empirical part consists of in-depth interviews with market participants and content analysis of Loan Market Association ICAs and market ICAs. The main themes addressed in the empirical section are creditor priorities, dealing with changes in the capital structure, creditor control ex ante and ex post distress and enforcement and distressed disposals clauses.
The thesis argues that contractual solutions for dealing with financial distress in corporate finance are both theoretically and practically feasible. ICAs are shown to deal with the most pressing risks for strategic actions by stakeholders and enable effective restructuring. Also, ICAs can operate without necessarily resorting to the statutory procedures. Therefore, the theoretical impediments to contractual solutions to financial distress are not pervasive in the financial markets and the theoretical literature on the parties’ ability to design financial contracts and capital structures to avoid strategic creditor actions is correct at least in the case of LBOs. Secondly, it is argued that LBO ICAs enhance creditor coordination by using contractual and capital structures that enable the stakeholders to achieve a reliable bargaining framework dealing with corporate insolvency. Creditors can, therefore, optimise the restructuring and creditor recoveries on the debtor group level, achieving a ‘Coasian bargain’, and offer an option of single or multi-entry point enforcement for the controlling creditor group. The employed capital structures and the ICA restructuring provisions also enable the parties to alleviate in some cases the so-called ‘debt overhang’ problem.
The thesis shows that the stakeholders of an LBO arrangement seek to achieve an optimal game-theoretical scenario to deal with distress scenarios. This means reducing the variables of a non-cooperative game to a level that is apt to provide the parties with a predictable ex post negotiation framework for distress.
However, the analysis shows that the effectiveness of the ICA and its solutions to distress scenarios relies on strong contract law protection, efficient enforcement of security interests and robust regulation of the fiduciary obligations of the security agents.