TDC debt buy-back stirs up controversy

Can a company owe itself money? According to most financial lawyers this is impossible, except in very unusual circumstances. So when a company buys back its debt, it forgives the loan, cancelling the debt immediately.

Because of the crisis sweeping through credit markets, bank debt is trading at big discounts in secondary markets, even for relatively healthy companies. For some, this has created a unique opportunity.

Using extra cash to buy back debt at a discount can be attractive to companies, as this allows them to cut their interest bill, boost earnings and reduce their leverage, all on the cheap.

This trend is particularly attractive for private equity-owned companies, which often have debt trading at more of a discount than other borrowers because of the high levels of leverage used in buy-out deals.

However, Denmark's TDC has set a worrying trend for banks as the first private equity-owned company to be identified as having completed a debt buy-back.

Lenders to the Danish telecoms group argue that its decision to appoint Deutsche Bank as its broker to mop up €200m ($320m) of its own debt at market rates of about 90-95 cents in the euro is a breach of its loan agreement.

The banks say the loan agreement places strict limits on who is allowed to buy the debt – limiting it to financial institutions regularly engaged in making or trading loans – as well as tightly defining how any excess cash should be used.

"It says in plain English that excess cash must be used to be buy back debt at par," said a person familiar with the lending agreement. "This shows real arrogance by the private equity groups behind TDC and has caused a lot of upset comment."

"It's just not cricket," said Stephen Gillespie and Neel Sachdev, lawyers at Kirkland & Ellis, in an article for The Lawyer, adding that there is doubt whether debt buy-backs "somehow go against the spirit and rule of syndicated lending".

People familiar with TDC, owned by Apax Partners, Blackstone, KKR, Permira and Providence Equity Partners, say the company was advised that its loan agreements did not forbid it from using spare cash flow this way. They say that TDC often makes inter-group loans, so qualifies as an authorised buyer of its debt, while its loan agreements allow extra cash to fund financial investments.

"It is a function of the loan agreements, so I'm surprised that the bank debt-holders have reacted this way," said a person close to TDC's private equity consortium. "The banks can't control this and they knew that from the outset."

Lawyers point out that discounted debt buy-backs may be less attractive than they first appear because companies could be taxed on the difference between the face value of the loan and the price they paid.

Clare Dawson, executive director of the Loan Market Association, said: "Banks are still thinking this through. Some say it is positive as it reduces overall leverage. Others say cash flows are meant to be used in certain ways [by borrowers] and this is not one of them."

Clifford Chance, the law firm working with the LMA on drafting its loan documentation, said: "There are considerable legal uncertainties under current market standard documentation in the purchase by a borrower of its own debt."

The LMA is preparing a "clarification" to its loan documentation guidelines that is expected to establish ground rules for discounted debt buy-backs in the future. But for many of the loans in existence, the debate may rage for some time.

© The Financial Times Limited 2008. All rights reserved.
FT and Financial Times are trademarks of the Financial Times Ltd.
Not to be redistributed, copied or modified in any way.
Euro2day.gr is solely responsible for providing this translation and the Financial Times Limited does not accept any liability for the accuracy or quality of the translation