A tangled tale
Lone Star’s acquisition of Europe’s largest commercialproperty earlier this year brought to an end a saga that began with Lehman’sbankruptcy in late 2008 and had a major impact on the French legal system.
When Lone Star Funds acquired Coeur Défense in March, it brought the curtain down on a troubled period for the trophy asset that has seen its valuation, not to mention its occupancy rates, collapse. The property, which shares with the notorious Palace of Parliament in Bucharest the distinction of having more floor space than any other building in Europe, is appropriately situated in the heart of Paris’ business district, La Défense.
The property’s troubles began with its acquisition by Lehman Brothers seven years ago at the height of the buyout boom and escalated following the investment bank’s collapse. Since then, the building’s owners have been fighting a lengthy campaign against creditors in the French courts. That four-year legal battle – featuring no less than 16 judicial decisions and three separate courts of escalating seniority – has had farreaching consequences for investors in real estate in France, as well as the creditors who supply finance to such deals.
How the Texas fund manager managed to acquire the asset amid that feud is worth exploring as it demonstrates how a canny manager with knowledge not only of real estate, but more pertinently of financial engineering and structuring, can acquire a trophy asset and leave creditors broadly satisfied. To understand the Lone Star deal, however, it’s worth revisiting the property’s acquisition by Lehman.
In March 2007, Lehman paid a top-of-the-market price to owners Rodamco and Goldman Sachs’ Whitehall Funds for the asset: €2.1 billion. At the time, it was the largest single-asset property deal in Europe, and the bank is understood to have outbid other investors by around €150 million. As one ex-Lehman banker told sister publication Private Debt Investor: “When you’re distributing risk and skimming fees at each stage, you can afford to pay €2.1 billion for a building.”
Equity of around €500 million came from Lehman’s balance sheet and French group Atemi. The bank originally had planned to transfer ownership of the asset to one of its real estate funds, but it ended up keeping it on its balance sheet.
Lehman used an acquisition vehicle called Heart of La Défense (HOLD), the shares of which were held by a Luxembourg-domiciled special-purpose vehicle called Dame Luxembourg. That, in turn, was held by another holding company called LB Dame, whose equity was held by two Lehman units and General Electric’s pension plan. Lehman financed the deal with two bullet loans: a B1 loan of €1.297 billion and a B2 loan of €342 million (giving a total term loan debt package of €1.639 billion). This loan package, which initially matured in July 2012, was issued by Lehman’s German unit and subsequently acquired by Windermere XII, a CMBS structured as a fond commun de creances. The CMBS was managed by EuroTitrisation, a vehicle owned by several French lenders understood to include Crédit Agricole, Natixis, Banque Populaires-Caisses d’Epargnes and BNP Paribas, which financed the deal by issuing notes listed in Dublin. These notes were secured against rental income on the property, with interest rate fluctuations hedged via Lehman Brothers International Europe (LBIE).
A legal legacy
When Lehman collapsed in late 2008, LBIE lost its credit rating and therefore became unable to act as counterparty to the hedges, triggering a default. In such a scenario, the loan documentation required that the hedges be replaced at current market rates. At that time, with the financial markets in meltdown, that proved impossible to achieve.
Windermere’s only recourse in that scenario was to invite noteholders to vote on a proposal to accelerate the term loan and enforce redemption. That would have led to the insolvency of HOLD and Dame Luxembourg and a distressed sale of Coeur Défense itself. With property values plummeting, that was an unedifying prospect.
In late 2008, Jean-Philippe Robé, a Paris-based partner at law firm Gibson Dunn, successfully argued in the Paris Tribunal of Commerce that Dame Luxembourg and HOLD should be placed into the French
sauvegarde (safeguard) system, a French creditor protection regime similar to the US Chapter 11 debtor inpossession procedure. It effectively stayed any proceedings against the two parties by creditors.
In September 2009, the same tribunal adopted the safeguard plan, enabling a restructuring of the term loan.
Five months later, however, the Court of Appeal in Paris overturned the decision on the basis that HOLD And Dame Luxembourg had failed to prove they were in sufficient operational difficulties.
That ruling was itself overturned in March 2011 by France’s highest court (the Cour de cassation), which ruled the procedure was open to any debtor confronted with insurmountable difficulties regardless of their nature and regardless of the nature of the debtor (be it an operational owner, holding company or specialpurpose vehicle).
As Gibson Dunn pointed out at the time, the decision had far-reaching consequences in France, extending the range of debtors entitled to call on the safeguard process.
“The safeguard procedures are all about preserving the possibility to recoup equity over time,” said Francesca Galante, co-founder of European real estate specialist First Growth. “Safeguard is effectively similar to Chapter 11, but a debt write-down cannot be imposed on creditors, even if junior debt tranches are wiped out. An extension of term of up to 10 years can be imposed on creditors. It’s a more European way of delaying the pain and hoping things sort themselves out.”
Enter Lone Star
Lone Star began work on the deal in late 2013, according to sources close to the transaction, and its acquisition of Coeur Défense progressed very quickly, with the firm’s deal team working through the Christmas break to get the transaction finalized. The Texas investment group declined to comment further on the deal beyond a statement released in March confirming the transaction.
Time was of the essence – the safeguard procedure would have expired this July, meaning the asset would have had to be put up for sale or further court proceedings instigated. Lone Star, which previously had dealt
with the executors of the Lehman estate successfully, began buying up the Windermere notes, which had traded in some volume on the secondary market.
Earlier, Lone Star had acquired Excalibur, one of Lehman’s legacy collateralized debt obligations (CDO), in two tranches in early 2012. That CDO had aggregated some of Coeur Défense’s junior debt, sources noted. Perella Weinberg, meanwhile, also had been buying up notes, including Goldman’s exposure to the deal, and had amassed a sizeable position as a result. Reports have suggested that Perella had been eyeing its own bid for Coeur Défense, having held a large portion of its debt for several years.
In the end, Lone Star’s approach to acquiring Coeur Défense was straightforward. It bought the equity in the holding company and then hoovered up all the junior notes on the
Lone Star paid €1.35 billion to acquire LB Dame (the parent company of Dame Luxembourg, which owns HOLD). As part of the deal, HOLD was removed from the safeguard system with a view to its debt being repaid at a negotiated discount.
Without the deal, Coeur Défense would have been obliged to leave creditor protection this July, triggering a likely liquidation or sale of the property. This would have been complex, given the different positions of the various classes of noteholders, and a sale of the asset likely would have triggered a transfer tax that would have hurt the most junior noteholders. So, for all parties, the outcome is a largely positive one.
Lone Star funded the acquisition with equity from Lone Star Real Estate Fund III, its latest commercial real estate vehicle, and a five-year term loan package provided by Bank of America Merrill Lynch. BoAML provided €805 million of senior debt and €130 million of mezzanine debt.
The sale price represented a 40 percent discount to the property’s 2007 valuation, a remarkable reflection of how much the asset has depreciated in just seven years. This also reflected the uncertainty over ownership of the property, as well as declining occupancy.
Indeed, the property’s current vacancy rate hovers around 24 percent and the lease profile is just 5.3 years on a full lease expiry basis, according to reports. Lone Star will be keen to improve those numbers and create value.
Cyril de Romance, a partner and co-founder of First Growth alongside Galante, said Lone Star had a major advantage when it approached the asset. “Real estate investors who understand financial engineering and structuring have a tremendous advantage over those who take the narrower, property-only approach. Both approaches are key in this market.”
This article originally appeared in the May edition of sister publication Private Debt Investor. Visit www.privatedebtinvestor.com for more details.