22.1.2 Developments in the financing practice: increase of debt financing and complex financing structures

The PCM and Tribune cases are certainly not isolated cases, but they are prime examples of how many companies were funded in the years before the financial crisis. The ample availability of credit meant that enterprises increasingly funded their activities using loan capital.1 Particularly in takeovers by private equity investors, equity on the target’s balance sheet was replaced by secured debt. Due to the leverage created, shareholders realized high returns in a prosperous economy; on the other hand, the financial resilience of some companies proved to be too limited when the economic tide turned. Not only did listed, financial institutions have inadequate capital in 2008, but unlisted, non-financial businesses also heavily suffered from the capital structure they had chosen.

The PCM and Tribune cases also illustrate that in the past few decades, financing structures have become increasingly complex. In each case, the takeover was structured as a leveraged buyout (LBO), an acquisition structure whose popularity reached a record level in the run-up to the credit crisis. An LBO is a takeover that is mostly funded by loan capital, with financing for the takeover coming at the target company’s expense. As a rule, an LBO is comprised of a large number of closely related (legal) transactions involving the takeover target, the old and the new shareholders, as well as the financing banks. The manner in which the law should stipulate limits for LBOs is the subject of discussion in many jurisdictions. The special, composite nature of the transaction structure gives rise to questions regarding the application of the existing system of legal standards. What stands out is that wide- ranging approaches are chosen in the various jurisdictions. For example, until recently, in many European Member States, LBOs primarily gave rise to difficult questions regarding the application of the formal capital rules; on the other hand, since the 1980s the prevailing opinion in the United States has been that in principle, LBOs comprise legitimate transactions, that nonetheless may give rise to liability on the part of the parties involved if the target company’s creditors have been exposed to unreasonable risks.