Parmalat's Restructuring: Implications for the Italian Corporate Bond Market

“Neither a borrower, nor a lender be… “. Although written four hundred years ago, the famous platitude declared by William Shakespeare’s character Polonius, in Hamlet, carries an unwelcome resonance for participants in the Italian corporate bond market today. Reeling from a series of crises over 2003/2004, with the failures of Cirio Finanziaria SpA (“Cirio”), Giacomelli Sport SpA (“Giacomelli”) and, most spectacularly, Parmalat Finanziaria SpA (“Parmalat”), much of the Italian corporate sector is in a profound state of introspection over the future of its many family controlled companies and their relationship to the debt markets.

Long the exclusive domain of Italy’s banking sector, corporate borrowing – particularly among medium-sized companies – took a dramatic turn towards bond issuance in 1999, when the introduction of the Euro combined with the desire by many of Italy’s leading commercial banks to expand their capital markets franchises. As Fitch Ratings has previously highlighted Italian corporate bond issuance grew rapidly from 1999 to 2002 until the high profile defaults started to occur. Many companies, once enamoured of the prospect of accessing inexpensive, medium-term fixed-rate debt capital from a willing market of domestic retail investors, are now facing considerable uncertainty as the retail market has closed in the aftermath of defaults and many bonds are scheduled to mature over the next two years.

Italian Corporate Bond Issuance by Year (1993-2004)

Source: Fitch from Bloomberg Data

In the absence of the retail market, many Italian companies attempting to refinance maturing bonds and unable to access international capital markets are facing demands by alternative capital providers for balance sheet restructurings, including asset disposals, restructured debt or additional equity. These borrowers are finding it difficult to coordinate complex restructurings with multiple bank lenders, diffuse bondholders and increasingly sceptical potential equity providers. Balance sheet restructurings, while considered standard for distressed companies in many international jurisdictions, are proving much more difficult in Italy.

Fitch examines the legacy of Italian corporate finance practices and their contribution to current crises from the perspective of bondholders. In particular, the rise and fall of Parmalat reflects the primacy of concentrated (or dominant) shareholders and bank lenders in Italian corporate finance. This is reflected in Italian insolvency law, which has translated into a corresponding lack of market influence and legal rights for bondholders:

• Despite protests by many of Parmalat’s domestic and international bondholders over their treatment in Parmalat’s restructuring, creditors have never enjoyed much influence over Italian insolvency procedures.
• Italian insolvency laws (concerning companies) have generally remained unchanged since 1942, and creditors, generally banks, are often considered part of the cause of insolvency as they may have failed to discipline the debtor company from taking inappropriate risks.
• In the effort to protect jobs and local communities, Italian insolvency frameworks, much like those in France, are court intensive and resolution of creditor claims occurs through lengthy administration and ultimately liquidation.
• In 1979 the government attempted to protect labour constituents and local communities by introducing Extraordinary Administration for Large Companies in Crisis, or the “Legge Prodi”, a framework that emphasised government guarantees to large insolvent companies.
• In 1999 Extraordinary Administration was amended in the New Insolvent Large Enterprises Act or the “Nuova Legge Prodi” law, as the Legge Prodi continued to result in liquidations and commitments to European Union (“EU”) prohibitions against state aid forced the Italian government to abandon government support to insolvent companies.
• The Nuova Leggi Prodi law amended procedures for large insolvent companies by granting government-appointed administrators additional powers to help insolvent companies reorganise and rehabilitate such that they could return to the commercial market place.
• The failure of the Nuova Legge Prodi framework to lead to meaningful rehabilitations, notably in the recent cases of Cirio and Giacomelli, may have been a fundamental factor in the Italian government’s response to the collapse of Parmalat.
• When unprecedented fraud was revealed in Parmalat’s accounts in December 2003, the government responded by amending the Extraordinary Administration framework by decree.
• Coined the “Marzano Law”, after minister of industry Antonio Marzano, the new Extraordinary Administration framework was intended to rehabilitate Parmalat while protecting Parmalat’s Italian constituent communities.
• The amendments essentially concentrated the power over Parmalat’s insolvency in the ministry of industry and its appointed administrator, noted turnaround specialist Mr. Enrico Bondi.
• With protections from Parmalat’s creditors and access to new priority ranking loans to support working capital needs, Mr. Bondi has developed a restructuring plan and a plan to exchange debtfor- equity in the “New Parmalat”.
• The role of Parmalat’s creditors, and particularly its bondholders, has been an awkward element for Mr. Bondi and the government given demands by separate creditor classes for inclusion in the restructuring process, and the rights of creditors to approve Mr. Bondi’s plan in a “concordato” (or composition with creditors).
• Citing Italian law and prohibitions against sharing private information, Mr. Bondi and Mr. Marzano have effectively avoided recognising or engaging separate creditor committees directly, even though such committees are widely considered part of accepted best practice in international restructurings.
• Given the Marzano Law requirement that Mr. Bondi achieve a “concordato” with a majority of creditors (implying a solution for creditors as a whole, rather than as among creditors), it appears as if Parmalat’s restructuring will move forward without adverse consequences to Italian constituents or to corporate Italy’s reputation in the international capital markets.
• While the Marzano Law framework may have helped streamline Mr. Bondi’s restructuring efforts at Parmalat, many other Italian companies in financial distress are finding similar restructuring efforts extremely difficult.
• Unlike Parmalat and the Marzano Law framework, distressed yet solvent corporate borrowers in Italy must achieve consensual solutions among their creditors, yet they have no effective procedures or mechanisms to coordinate with multiple creditor classes.
• Legal frameworks in Italy contrast sharply with the United States’ Chapter 11 framework, which emphasises the role of managements, rather than administrators, in developing consensual restructuring plans, and grants separate creditor and stakeholders the legal right to appeal and contest management-driven plans.
• Italian policymakers and market participants considering reform may find instructive precedents in France, where legislators are reviewing government proposals for “preinsolvency” procedures that emphasise Chapter 11 style consensual restructurings.
• Critically, the French pre-insolvency proposals (developed in the aftermath of the Alstom crisis) include similar Chapter 11-style protection from creditors enjoyed by Parmalat and Mr. Bondi under the Marzano Law, yet also grant creditors (through committees) direct influence over managements seeking consensual solutions.

Parmalat’s collapse helped illustrate fundamental breakdowns in Italian corporate governance and corporate finance, as a dominant shareholder (the Tanzi family) was able to avoid disciplinary constraints that incremental capital providers, such as minority shareholders and creditors, traditionally provide. Notwithstanding a clear shift in the composition of creditors to Italian companies over the last several years, the insolvency culture in Italy, even with the advent of the Marzano Law, continues to limit the ability of managements to orchestrate consensual restructurings with multiple and diffuse bank and bondholder creditors.

How Can Distressed Borrowers Avoid Insolvency with so Many Creditors to Co-ordinate?

Corporate lending in Italy has traditionally taken place on a bilateral basis, with the borrower arranging separate facilities from multiple relationship banks rather than a single facility syndicated to a group of banks as occurs in other markets. Separate bilateral lending relationships generally served the corporate borrower’s interest as it allowed greater access to loans from competing banks and provided borrowers with leverage in negotiations over terms.

However, corporate borrowers are finding the separate relationships now detrimental as bond maturities approach and they are compelled to discuss new loans with many lenders that may not have been involved with arranging any of the bonds. Managements attempting to refinance are learning that few banks are willing to renew loan exposure if the borrower does not have a credible plan to redeem, refinance or restructure bonds as they approach maturity.

Trustees Only Offer Access to Bondholders

Without immediate relief from shareholders or relationship bank lenders, many Italian companies are faced with similar predicaments in attempting to address approaching bond maturities. Compounding their situation is the fact that, in addition to multiple bilateral lenders, diffuse and anonymous bondholders now represent an important party to restructuring efforts yet the law does not offer effective mechanisms to co-ordinate with them.

Traditionally, and as evident in the case of Parmalat, professional distressed debt investors would build positions by buying bonds at discounted prices in secondary markets and quickly form creditor committees with original purchasers as bondholders recognise their common interest in participating in a restructuring process. However, as noted, Italian law does not recognise creditor committees and existing insider dealing rules create obstacles for companies with publicly traded securities from sharing private information. Consequently many professional international distressed debt investors – not to mention restructuring advisors and turnaround specialists – have been frustrated in attempts to orchestrate out-of-court restructurings in the Italian market.

Without recourse to creditor committees, distressed borrowers are almost entirely dependent on bond trustees to present restructuring plans – often prepared by management with input from shareholders and banks but not bondholders – and hold bondholder votes in the hope quorums can be achieved to win approvals. Because restructuring proposals are by definition “material and prejudicial” trustees do not have the discretion to act for all bondholders and must pass-on such borrower requests via publication in financial newspapers, inviting bondholders to attend a trustee meeting to vote on issuer proposals typically two to three weeks from initial notification. Approval of borrower proposals is dependent on achieving a majority of bondholder votes subject to quorum. Generally, 75% of bondholders must be represented at a trustee sponsored meeting in order for a quorum to be achieved. If a quorum at the initial meeting is not achieved then a set time period (typically another two weeks) must pass for a subsequent meeting at which a smaller percentage of bondholders (in recent Italian cases, at least 25%) represented may constitute a quorum.

Tension Mounting

For managements, coordinating multiple bank lenders and diffuse bondholders in an effective manner is proving difficult for several reasons. Not the least of these is the practical matter that dispersed and generally unsophisticated retail bondholders may fail to appreciate the urgency of their participation in the restructuring process. Moreover, many professional investors, excluded from the development of restructuring plans, remain suspicious of attempts to “cram-down” or force a unilateral solution on bondholders to the benefit of other stakeholder classes. Add the propensity of many banks to hold out for improved terms and many management-driven restructuring initiatives, even when led by professional turnaround specialists seeking consensual solutions, can not be developed with confidence that they will be approved.

Recent examples illustrate the predicament many distressed Italian corporate bond issuers face:

Fin.part

• In early July 2004, Fin.part SpA, the listed financial holding company of fashion house Cerruti and linens producer Frette, failed to establish quorums at its bondholder meetings and was unable to gain approval for its restructuring plan, even though new CEO and recent majority shareholder, entrepreneur Gianni Mazzola, pledged EUR41m to the plan and had appointed Italian and international restructuring specialists to advise the company. The company’s shares were suspended on 15 July 2004, and subsequent to the failed bondholder votes, the initial restructuring advisors resigned and two bonds matured on July 21 and July 26, 2004 without payment and in default. New advisors are now attempting to rally support for another restructuring proposal through separate discussions with banks and another bondholder meeting scheduled for mid-September.

Finmatica

• In early August 2004, listed software developer Finmatica SpA called an extraordinary shareholders meeting for October. The company announced it intends to raise up to EUR250m in an equity rights issue to avoid insolvency. Finmatica had its shares suspended on 28 July 2004, after it announced that it failed to agree a plan with its lending banks to defer maturities of its debt and arrange new financing. The company’s main banks were reportedly asked to lend EUR21m and did not respond in a “full and timely” manner “compromising the efficacy of its proposal”. ²⁵ In June 2004, the company’s auditors said the survival of the company depended on support from lenders and delaying the maturity of a EUR100m bond that is scheduled to mature in May 2005.

While some Italian companies have successfully avoided default on maturing bonds by arranging interim loans (Versace, Impregilo, Stefanel), delaying bond maturities (Italtractor), negotiating asset sales (Gruppo Frati) or an outright sale (Aprilia), these are frequently emergency measures taken under the duress of challenging business conditions, maturing debt and the lack of financial market confidence. The examples above illustrate that distressed corporate borrowers and their creditors lack a supportive legal framework to achieve consenual restructuring.

Advocates for the Marzano Law Cite Similarities with French Proposals

Advocates for the Marzano Law argue that despite its ad hoc development in response to the Parmalat collapse, the new Extraordinary Administration framework nevertheless represents the first substantive step towards rehabilitative insolvency solutions for distressed companies in Italy. After all, like the French proposals the Marzano Law employs the essential Chapter 11 style features of an automatic stay on creditor claims and access to new money to maintain the debtor company as a going concern. Moreover, the number of “commissioners” was reduced to one from three, with an emphasis on professional, full-time managers, rather than lawyers or academics, assuming the role of “extraordinary commissioner”.

Notwithstanding some similarities to formal debtor-in-possession, Chapter 11 style rehabilitations, however, the critical differences between the Marzano Law framework and the proposals under review in France (much less Chapter 11) are the respective role of managements and the potential power of all creditor classes to demand consensual restructurings. The Marzano Law’s Chapter 11 style features – protection from creditor claims and availability of new money – may have helped streamline Parmalat’s restructuring, yet without direct input from creditors it is difficult to argue that it will be considered consensual. Going forward, creditors to insolvent companies offered take-it-or-leave-it restructuring plans without any direct influence over the development of such plans may not have a high degree of confidence that the businesses they inherit from Extraordinary Administration are indeed restructured.

The Difference: The Rights and Powers of Management and Creditors

Moreover, in light of the out-of-court restructuring efforts currently underway among Italy’s distressed corporate bond issuers and the difficulties they face coordinating multiple creditor classes, the Marzano Law offers little comfort to either these borrowers or any management vulnerable to distress going forward. Despite numerous alterations in the course of its development, the Marzano Law remains a management-displacing and administration-driven framework where creditors are only consulted as a whole. Critically, creditors have not had any material improvement in their directive powers over debtors in distress, and therefore do not have the practical ability to influence or assist the development of management-driven rehabilitation efforts. Most if not all distressed borrowers prefer to avoid administration if they can help it and therefore must maintain payments on claims as they come due. Bondholders therefore find themselves passive bystanders and must await potential restructuring proposals from debtor companies via trustees that may or may not reflect their best interest.

The Marzano Law is Neither Available, Nor Appropriate for the Majority of Distressed Cases

In addition, most borrowers attempting to restructure under the Marzano Law would fail to qualify for a Parmalat style restructuring as the Marzano Law appears to be specific to only the largest companies (EUR1bn in debt and more than 1,000 employees). Smaller companies, representing the majority of companies in Italy, remain subject to the Nuova Legge Prodi law and the prospect of administration and liquidation.

Even large companies eligible for Marzano Law protections, such as distressed national airline Alitalia may find the Extraordinary Administration process under the Marzano Law of limited assistance. Alitalia faces a unique set of operational and competitive challenges as it attempts to restructure its business, yet the insolvency law to which it would be subject to in the event of default was developed in response to the financial fraud at Parmalat.

Indeed, Parmalat’s rehabilitation is mainly predicated on removing its massive debt burden. Any rehabilitation of Alitalia will rely less on a Parmalat style balance sheet restructuring and will depend instead on restructuring operations and access to new investment capital. Alitalia’s case is complicated further by the fact that the government is the largest shareholder and a large creditor (it owns 62% of the equity and 62% of a convertible bond issue). Under the Marzano Law, any restructuring plan for Alitalia will likely receive government approval as a matter of course from both the minister of industry and the ministry of finance (as a creditor) in a “concordato”. Given the separate set of circumstances and the inherent political sensitivities at Alitalia, many observers question whether Alitalia can be restructured as an independent enterprise or whether Italian law will be altered again if further large-scale defaults occur.

No Time Like the Present

Yet defaults are occurring, and much like the French have taken decisive action in the aftermath of Alstom perhaps Italian policymakers should take a similar approach in light of the lessons learned from Parmalat’s collapse and the rehabilitative emphasis of its restructuring. The challenge facing policymakers is that the desire for rehabilitative solutions for distressed or insolvent companies may be compromised by failure to include those with the most vested interest in market-driven rehabilitation as a solution, namely: management and creditors. Here, the French justice ministry’s reforms offer candid instruction that changes to insolvency law may need to be wholesale in nature.

Specifically, market and policy mechanisms must be developed to allow outsider creditors the powers to effectively screen and monitor the actions of the debtor company if a more effective corporate governance framework is to evolve. Central to achieving such a framework, however, both managements and outsider creditors will need reliable procedures to co-ordinate market-driven rehabilitations with meaningful legal protections and directive powers such that the restructured enterprise will have the consensual support of all stakeholders and therefore the strongest opportunity for success in the commercial marketplace.

Polonius Revised

orporate bonds are, after all, an increasingly necessary tool for financing the expansion of corporate activities, not only for large listed companies but for privately and closely held family companies as well. As Parmalat once demonstrated in its rapid expansion from a local business into a global enterprise, access to long-term, patient debt capital can be instrumental in creating value, jobs and economic growth and competitiveness. The relative cost and flexibility of bond debt compares favourably in many cases to traditional bank debt, a conclusion clearly reached by a growing number of Italian and European corporate borrowers as well as many of their relationship banks.

As Parmalat’s collapse and recent evidence among distressed Italian corporate borrowers illustrate, however, issuers and investors embracing corporate bonds without the necessary market and legal safeguards ensuring transparency and accountability can lead to distress and disappointment for all concerned. If William Shakespeare were observing the Italian corporate bond market today – where distressed managements lack effective procedures to coordinate restructurings and creditors do not have appropriate directive influence over managements in distress – he would likely have Polonius suggest that potential issuers and investors consider corporate bonds carefully; …’for bond oft loses both itself and friend.

²⁵ Finmatica distributed a statement on its refinancing discussions which was distributed by the Borsa Italiana on 29 July 2004. creditors lack a supportive legal framework to achieve consensual restructurings.

This is the abridged version of a Fitch Ratings special report titled “Parmalat’s Restructuring: Implications for the Italian Corporate Bond Market.”

Note: Co-authors of this report were Stefano Podesta, Giulio Lombardi and Elisabetta Zorzi. This report was first published by Fitch on 21 September 2004.

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