On 2 August Eurotunnel was granted protection from its creditors under a new chapter 11-like French law, procedure de sauveguarde. The ruling allows Eurotunnel to suspend interest payments on its £6.18 billion ($11.7 billion) debt pile, and allows the stricken company to rejoin negotiations with its creditors.

After 14 months of failed negotiations the waivers allowing Eurotunnel to negotiate directly with its creditors ran out on 12 July, leaving creditors to negotiate among themselves. A preliminary restructuring agreement (PRA) was agreed in May between senior creditors, the ad hoc committee, and Eurotunnel management – but that was as far as the agreement went.

The ad hoc committee comprise European Investment Bank, Franklin Mutual Advisers LLC, Ambac, MBIA and Oaktree Capital Management.

The PRA involved writing-off 54% of the debt to £2.9 billion, with a deal underwritten by Axa Private Equity, Barclays Capital, Goldman Sachs and Macquarie Bank. The original package consisted of £2.9 billion debt, comprising £2.55 billion senior debt and a £350 million mezzanine tranche, and a £1 billion convertible bond issue.

Two rival plans

However the junior bondholders, called the Arco group (creditors to the tune of £1.9 billion), were disgruntled by Eurotunnel's offer of £150 million cash. Deutsche Bank, the largest junior bondholder, put together a rival restructuring plan that would raise £2.56 of new debt and put in place £1.5 billion of convertible bonds paying a 4% annual coupon. Under the plan, the bondholders would underwrite Eu780 million of new Eurotunnel shares.

Also, earlier in the year a committee of tier 3, junior debt holders mostly comprising US hedge funds – senior to the bondholders (see table) – was in dialogue with Citigroup who came up with another restructuring plan. The plan involves a larger senior debt tranche of £3 billion, £500 million of junior debt, and payment-in-kind (PIK) notes.

No agreement could be made on any of the plans. The PRA seemed to undervalue the junior and subordinated creditors' claims and the shareholder Adacte group opposed the plan due to dilution. Eurotunnel said that Deutsche's plan saddled the company with too much debt and the ad hoc committee opposed Citi's plan because it undervalued the interests of tier 3 creditors.

Acrimony and mud-slinging

Central to the ongoing restructuring negotiations is Eurotunnel's chief executive Jacques Gounon. Gounon has achieved a status of notoriety particularly among junior and subordinated creditors for several truculent comments to the press. He said this of the sponsors of the alternative restructuring plans to Les Echos: "Their goal is to make the company as indebted as possible in order to get better interest." Gounon also reiterated that any alternative restructuring plan would need to wipe at least 53% of debt from its books to give the company the best chance going forward. If an agreement cannot be reached the company faces insolvency; before being granted protection under the procedure de sauveguarde, Gounon said that the company would run out of cash before January 2007.

Deutsche, leading the fight for the junior bondholders, urged Eurotunnel investors to consider their plan, arguing that its plan has lower financing costs and does not dilute the share capital as much as the original PRA. Eurotunnel countered that the plan offered junior bondholders better terms than the senior creditors and shareholders.

Send in the lawyers

The multi-layered complexity of the debt package, the inter-creditor agreements, and the appropriateness of particular creditors bargaining power has come under increasing pressure as the parties try to come to an agreement.

There have been some misgivings as to the role of MBIA – the monoline is believed to have been approached by Macquarie and Goldman Sachs to wrap a portion of the new debt that could throw up conflicts of interest as it is a creditor on the principal being taken out. The fear among other creditors is that MBIA is only interested in bettering its balance sheet rather than maximise the recovery of individual tranches.

Given the number of parties involved it is no surprise that a veritable army of law firms is acting on the restructuring.

On 12 July talks between the two camps broke down with Gounon accusing Deutsche and other junior bondholders of being 'unreasonable'. Accusations were flying from both sides – the US hedge funds were incensed at the short-notice given for meetings, sometimes as short as 24 hours, while Eurotunnel questioned the motives of the junior creditors' proposal, claiming it may have been a tactic to allow the trading of debt. This was strenuously denied by the head of the Arco bondholder consortium*, Jean-Pierre Mattei.

Fortunately when the talks were called off there was some convergence between the bondholders and Eurotunnel. One banker familiar deal says, "I think it's about 60-40 in favour of a compromise based on the original agreement." He added, "There was little hope of the other plans being implemented, but they gave junior and subordinated creditors a platform for negotiations."

On 2 August when Eurotunnel received protection from its creditors, Gounon said, "There is now a convergence of views amongst the principal creditors, including the ad-hoc committee and Deutsche Bank, who consider that this proposal constitutes the basis for pursuing negotiations that will lead to a reconciliation of their positions."

The current compromise involves adding £275 million of convertible bonds for subordinated creditors to the original PRA and removing £350 million of mezzanine debt. Perhaps too optimistically, a final agreement is being mooted as early as September, with a month or two for documentation.

The law is an ass?

Effectively, both sides are playing a game of high-stakes chicken. Both parties wish to avoid going through insolvency proceedings – it would be against the best interests of the shareholders, which Eurotunnel's board have a duty of care toward, and the junior bondholders would likely see little of the spoils.

Rating agency, Standard & Poor's, stated in a recent memo that the French insolvency law regime leaves capital-market lenders in a state of uncertainty. "France is not a good place to be a creditor, even a secured creditor, particularly with regard to rehabilitation."

Under the new proceedings there is a marked difference in standing between bank lenders and trade creditors – which have veto rights and a place at the credit committee meetings – compared with noteholders, who only have the right to be consulted and have little influence over the process to protect their interests.

The S&P report states further: "The importance of the creditors' committee is that it gives its members the opportunity to negotiate the final plan of reorganisation that determines who gets paid and how much." The proceedings do not offer noteholders a 'seat at the table' and although a general meeting will consider the plan of reorganisation with the noteholders, the new law does not consider a negative vote. It is therefore possible that the outcome might override any claims by the junior bondholders.

The rationale behind these proceedings seems to grant only those creditors with a meaningful interest in the company any rights in the restructuring and presumes that capital-market investors will be many and widely disbursed. However, there seems little difference between institutional investor noteholders and banks that have come in on the deal in syndication. Indeed, the law is surely wrong in its broad-brush approach where noteholders with large stakes such as Deutsche are precluded from creditor committees when, feasibly, holders of bank debt acquired on the secondary market are involved.

Gounon's dilemma

But the noteholders, having rejected £150 million cash under the original PRA for their £1.9 billion holding, are resigned to taking a large loss and having been backed into a corner are holding out for a piece in the restructured company. Deutsche's plan was cleverly engineered to drive a wedge between the interests of the shareholders and the senior creditors.

Deutsche's plan reduces the debt by 60%, opposed to the 54% of the PRA, with a larger convertible bond issue of £1.5 billion and a share issue of Eu780 million which bondholders would underwrite. The key metric is that shareholders would at worst retain 16% of the company but under the PRA dilution could leave shareholders holding only 13%.

The senior creditors are probably the biggest losers under the Deutsche proposal (as opposed to the PRA) as they would not receive as much equity via hybrid notes. Gounon must appease both the senior creditors who are first at the table in negotiations and the shareholders who must ratify the reorganisation. As part of the reorganisation a new French-listed umbrella company is also likely to need French shareholder support.

Although there are many moving parts the nub of the negotiations centre on the allotment of the debt-to-equity swap per debt tranche, shareholder dilution, and the capital value and leverage of a reorganised company – for instance, are shareholders interests best served by holding a smaller portion of a less leveraged company, or a larger portion of a more indebted company?

Gounon's preference is clearly the former, with a memo to shareholders warning them to be wary of the 'false dawn' of a reorganised company saddled with too many debts. Yet, the Adacte shareholder group is opposed to the original restructuring plan and has launched an appeal to Jacques Chirac to find a solution.

The scramble to get a piece of Eurotunnel is understandable: take out the crippling debt and therein lies a healthy business. The 2005 trading profit was £153 million, 19% higher than in 2004, with an operating margin of £299 million, 55% of revenues.

If the French and UK governments had helped subsidise the project to begin with, and if the traffic forecasts hadn't been anywhere near as bullish, the company could have worked from the word go.

*In the original version of the article, Project Finance referred to Mr. Mattei as also head of Deutsche's French operations. Deutsche Bank has pointed out that he is not an employee of the bank, and we have amended the article to reflect this information.