Realogy's Failed Exchange Could Provide Road Map

Members of the global private equity practice at international law firm Paul Hastings believe Realogy's failed bond-for-loan exchange could provide guidance on future cases. Specifically, it could offer guidance on how strictly courts will interpret covenants in each tranche of outstanding indebtedness in the context of contested exchange offers.

Jonathan Temps, a lawyer in the global private equity business, and William Kirsch, who chairs the same division, spoke with about Realogy's case and what it means for similar lawsuits. The two, along with Thomas Kent, a partner in the same department, penned a paper that analyzed the case and its implications for the company's debt holders. The law firm had no involvement with the case.

Last fall, a Delaware court denied Realogy its debt exchange, siding with the company's toggle note holders. The company had four levels of debt-a senior secured credit facility, senior cash notes, senior toggle notes and senior subordinated notes. The company wanted to exchange the senior subordinated notes for a new loan agreement, but that would have leapfrogged the bonds lowest in the capital structure over the more senior bondholders. Billionaire Carl Icahn and Bank of New York Mellon were among those who called for a stop to the exchange. The court said that without an amendment or waiver to the existing credit facility, the transaction could not be consummated.

"Courts are going to narrowly construe the terms of existing financing agreements when it comes to permitting sandwich debt or new debt that would disadvantage any class of existing debt holders. This decision provides a roadmap as to how courts are likely to proceed in similar debt exchange transactions," said Kirsch.

Like so many other companies, Realogy was looking to do the buyback-exchange, one-two punch. It planned to take advantage of an accordion feature in its credit facility to enter into a new $500 million term loan agreement. The proceeds from this new second-lien term loan would have gone to buyback the senior subordinated notes, which were trading at distressed levels.

"In many instances, unsecured debt holders will not want to have a situation where they become disadvantaged as a result of the company granting a security interest to other existing unsecured debt holders," said Kirsch. "Existing lenders will protect themselves against companies taking Realogy's approach to refinancing because their debt is trading at a discount."

Oddly enough, Realogy could have amended its credit facility without the permission of the toggle note holders who brought the case. The facility could have been amended with the permission of the bank group that provided the senior financing. However, the toggle note holders found provisions in the credit agreement that worked in their favor.

"I think there are going to be a lot of things companies can do with the permission of their lenders, but the question is how motivated will those lenders be to make the necessary accommodations," said Temps. "As an investor, one thing you want to make sure you're aware of is being displaced in the capital structure. That is what the toggle note holders were afraid of with Realogy. The lesson of the case is that you will see companies struggling with debt attempt an unsecured for secured swap at a big discount. And the debt holders who are excluded from participation in, or disadvantaged by, these transactions will fight to prevent them."

Realogy is a Parsippany, N.J.-based real-estate broker that operates the Century 21 and Coldwell Banker brands. It reported $209 million in losses in the first three quarters of 2008. As of Sept. 30, it had about $6.5 billion of long-term debt.

Kirsch added that as companies face troubles in this downturn, it is important to realize that the ability to obtain modifications to existing credit agreements is "highly dependent on the agreements and relationship between the impacted parties."

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