Restructure This! Podcast Ep. 10
Challenges Facing Secured Creditors in Asset Sales
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Listen to the original podcast released May 4, 2022 here: https://www.sheppardmullin.com/multimedia-393
This episode of Sheppard Mullin’s Restructure THIS! podcast features a panel discussion held live April 29th at the American Bankruptcy Institute’s Annual Spring Meeting in Washington, D.C. and moderated by Justin Bernbrock. Guests Matthew Guill of Configure Partners, Maja Zerjal Fink of Arnold & Porter and Jeffery Dutson of King & Spalding discuss the challenges that secured creditors now face in bankruptcy asset sales, including imperfect information and potential caps to credit bidding post-Fisker. They also explore ways that a secured lender can maximize optionality in a sale process, the procedural or regulatory pitfalls that secured lenders may face post-filing, and how to placate other parties in the capital stack (e.g., an unsecured creditors’ committee) that oppose a proposed asset sale.
Guests:
Matthew Guill
As a Director with Configure Partners, Matt has advised companies, lenders, sponsors, and governments on an array of complex financing and restructuring issues, M&A activity, and general strategic advisory assignments. Matt came to Configure Partners from Greenhill & Co.'s Financing Advisory and Restructuring practice, where he most recently served as a Principal.
Maja Zerjal Fink
As a Partner at Arnold & Porter in New York City, Maja presents clients in distressed situations, corporate reorganizations, distressed investment litigation, and insolvency proceedings in the United States and across the globe. She has represented clients in numerous high-profile restructurings and some of the nation’s largest reorganization, including restructuring Puerto Rico's outstanding debt load of more than $74 billion.
Jeffery Dutson
As a Partner in King & Spalding's Leveraged Finance and Restructuring Group, Jeff represents banks and other investors in connection with their most complex financings, restructurings, and bankruptcy matters. He also frequently represents corporate debtors in Chapter 11 bankruptcy cases throughout the country, as well as buyers and sellers in distressed M&A transactions.
Transcript:
Justin Bernbrock:
This episode of Restructure This! features a live panel discussion that I was invited to moderate at the American Bankruptcy Institute's annual spring meeting in Washington, D.C. on April 29th. The panel included Jeff Dutson, Partner at King and Spalding, Maja Zerjal Fink, Partner at Arnold & Porter and Matt Guill, Director at Configure Partners. Each has a wealth of experience in advising parties in Chapter 11. In our panel discussion, they share their insights on in-court asset sales from the perspective of the secured lender. As always, stay tuned for after the interview for a quick rundown of current restructuring news and notable stories.
Justin Bernbrock:
Good morning.
Audience:
Good morning.
Justin Bernbrock:
For those that didn't hear it, I just played the theme music to the fastest growing and most popular restructuring podcast ever. I'm kidding. My name is Justin Bernbrock, and I'm a partner at Sheppard, Mullin, Richter & Hampton in Chicago. This morning, we're going to talk with you all for an hour about challenges facing secured creditors in the context of asset sales.
Justin Bernbrock:
I mentioned the podcast not only as a shameless plug, but to tell you all that this panel in particular is being recorded, and we will release it as a podcast episode after the conference. We can all listen to this multiple times. But I encourage you to still stay because there's value in being present, as we're all now able to be. Let me ask the other panelists to briefly introduce themselves, starting with Maja.
Maja Zerjal Fink:
Good morning, everybody, Maja Zerjal Fink. Arnold & Porter, New York city.
Matt Guill:
Matt Guill will Configure Partners in Atlanta, Georgia.
Jeff Dutson:
Hey everyone, I'm Jeff Dutson with King and Spalding. I'm a partner in our Atlanta office.
Justin Bernbrock:
All right. Well, thank you all. We're going to start with some learning objectives. Hopefully, the conference materials will be provided to all of you after the conference, or they may already be available. But we've included lots of material in the slides with the idea that you would review that on your own time or at your own leisure.
Justin Bernbrock:
Here are the things we do hope to accomplish as a product of the panel. The first is, recent trends and pre-bankruptcy tactics used by secured lenders and debtors to maximize optionality in a sales process. The second is post-filing procedures and pitfalls for secured lenders and asset sales, including regulatory issues and concerns, and finally, sale related disputes among secured creditors, purchasers and debtors in non-consensual asset sales. We will start with the first learning objective. Take us away, Matt.
Matt Guill:
Thanks, Justin. In the name of process efficiency and, frankly, selfishly to save your own time and from banging your head against a wall, it's always critical for you to play a little game of “what if” with your clients, to help them understand in a challenge situation where you're going into a sale process, what happens if value does not clear their claim? What are they going to do? Are they actually going to want to punch out and just be done with it, at whatever the market clearing price is, or might they have the flexibility and creativity within the confines of whatever investment vehicle they happen to sit in to do something more creative that might help create value for them over the longer term?
Matt Guill:
I've been in multiple situations where someone will say, "Yeah, I'm one of the creative guys. I want to do something cool and exciting. I'm on the right side of this spectrum." You begin to play the “what if” game and just help them walk through what actually would need to occur, and they start thinking about going back to the investment committee, they start thinking about their boss, they start thinking about the extra work that needs to be done from a documentation perspective, from a valuation perspective. You can start to see the wheels click a little bit and they understand, “well, maybe I don't have stripes, maybe I'm not actually the tiger that I would like to be.” Which for, whether you're counsel or a banker, an FA involved in the situation helps narrow scope of focus in a way that helps you really concentrate on the things that matter for what can be achieved within the limitations that a client or a group of clients might have.
Justin Bernbrock:
Matt, what strategies in particular have you and your partners employed when, as I'm sure we all have experienced, a client is not very flexible. How have you helped them see the light, so to speak?
Matt Guill:
Well, the first thing I always do is I pray that it's only one client, and it's not a big group, because it makes the job a heck of a lot easier. But, I think on the banker side, it really just comes down to a valuation that's hung on something, that's compelling, that's easy to understand, and oftentimes is messaged multiple times ahead of whatever the formal call is going to be.
Matt Guill:
So you have multiple opportunities, whether it's one client or several clients, to have their say, feel like their voice has been heard, their opinion has been expressed, they can privately ask you why a number is what it is without having to ask in front of the group, which oftentimes they are loathe to do. But building up consensus based on something that's compelling ahead of time is oftentimes the number one thing that I try to achieve.
Justin Bernbrock:
What about when you face a situation where there's almost an abundance, a flexibility, or a willingness on the part of a large group to defer heavily. What are some of the risks inherent there?
Matt Guill:
Well, that's when it gets to be a lot more fun, when the playbook is wide open. But again, the fundamentals are the same. It's multiple calls, multiple meetings ahead of time, ahead of whatever the official decision point is going to be. On the banker’s side, it's more fun, but certainly a lot more work to be able to walk through from a transactional perspective, from a valuation perspective, helping the clients to link whatever provisions are in the credit agreement or the bond indenture that are relevant to the valuation, to the actual transactional steps that need to occur to achieve whatever the flea flicker is, if you're going to be doing something more flexible.
Matt Guill:
There are always a few things, a few hurdles that you need to be able to get over. If you're advising a secured lender group, you're inherently at a disadvantage from an information perspective, because you don't have a seat on the inside, your clients aren't at the company on a day-to-day basis.
Matt Guill:
One of the things you're always concerned about is you hear the story that EBITDA was [$20 million] when you underwrote the credit, it was a very normal leverage point. Now, all of a sudden, EBITDA 10 or five or two or something significantly diminished, and you're at a point where something has to occur, whether there's a liquidity issue or there's a maturity coming and something has to be done.
Matt Guill:
This hot plate of you-know-what is effectively steamed up to you and you're presented with a decision that is really difficult and there's no way for you to know for sure whether or not the projections that you're seeing are real, are valid or something that you can bank on. Or, if you're going to turn around after potentially making a tough decision to punch out and get out of the situation, and all of a sudden, see EBITDA is back to 20, where it was when you underwrote it.
Matt Guill:
It's something that we're seeing a lot of right now, and I'm sure others are as well just by effect of the pandemic, and what's happened where there's been some really unnatural economic cycles, both to the upside and to the downside. You need to be able to get through that.
Justin Bernbrock:
Do you think that there are overlapping themes that are applicable, regardless of where the lender sits?
Matt Guill:
For sure, and at the risk of asking the barber if you need a haircut, you absolutely need to hire professionals. Whether it's counsel, an FA, or a banker, you need people on your side who are really pressing on the company to produce information that makes sense—to answer the tough questions. From a financial perspective, you really want to have someone in there working on your behalf, that's validating both the narrative that explains how EBITDA went from 20 to two or whatever it is, but moreover, validating and putting a stamp of approval on whether or not EBITDA is going to recover back to where it was, so that you, as a lender, have a lot more confidence that you're not being sold a bill of goods from folks on the inside who are looking to be opportunistic.
Justin Bernbrock:
Jeff, you want to take us into when the sale process is on the horizon and how you would advise in that context.
Jeff Dutson:
Yeah, absolutely. Imagine you’re an agent or a senior secured lender, the deal is going along fine. Borrower is making its payments, meeting its financial covenants. Hopefully, you have some window as things tend to trend downwards. You have some heads up that things are going bad. It gets transferred to your workout group. Workout banker gets involved and, hopefully, they hire the people in this room to start representing them in connection with this distressed borrower.
Jeff Dutson:
When we're advising clients, some of the first things that we're going to do, if we think a sale process is likely, if we're representing the senior secured lender, we want to know that they actually are secured. You're going to check your liens, you're going to make sure there were no mistakes made when the deal was closed.
Jeff Dutson:
But maybe more importantly, you're going to think about what collateral was skipped over when the deal was closed, and the sponsor and the company are negotiating with your client over what liens are going to be taken, what steps are going to be taken to perfect those liens. Oftentimes, as we all know, you don't get a full and complete collateral package. In restaurants, for example, you may have a restaurant chain with 150 locations, and yes, it may be great to get a leasehold mortgage on each of those locations, but no deal is going to get closed if that's the requirement for closing.
Jeff Dutson:
As a result, there's an agreement to not take those leasehold mortgages. But if you fast forward and you're in a distressed situation, you have an opportunity. If maybe they want a forbearance, maybe they want a waiver of a default, it's really an opportunity to revisit those issues. Did you get collateral access agreements when the deal was closed? Did you get those leasehold mortgages?
Jeff Dutson:
You still have the same dynamic, where the sponsor's going to be saying, “No, well, that's burdensome, we shouldn't be doing that. It's costly. This is a waste of time. Everything's going to be fine. This is just a blip.” But if you think a sale process may be on the horizon, it could be critical. You may not have to do every single thing; if there's 100 restaurant locations, maybe you pick the top 15 valuable spots with leases that are really valuable leases and get mortgages on those. But it's important to do that work.
Justin Bernbrock:
Let's test this theory. Let's ask you a tough question. You've just been hired by a money center bank agent. You're reviewing the diligence. You've seen the company's, the borrower's cash forecast, and it is not pretty. A filing is imminent. You discover a hole in the perfection. Do you advise your client to file? Let's say there's an expired financing statement, do you advise your client to file the UCC-1?
Jeff Dutson:
To take a step back, hopefully you're never in the position where the filing is imminent. That's why it's important to do this on step one, the second they're coming back for a waiver, the second they're coming back for forbearance. But yeah, if there's a flaw in perfection, I would have them file. Maja's getting ready to chime in because she might have better contrary advice.
Maja Zerjal Fink:
I was just going to challenge you a little bit, tag into something that you were saying earlier, which is, in a world where there's basically zero lender protections, and credit agreements, I don't know that you'll have the 90 days to do that.
Jeff Dutson:
Yeah. That's the problem in this brave new world where there are no real covenants. You may not have-
Justin Bernbrock:
But if you represent the lender group, you could make the 90 days happen, presumably.
Maja Zerjal Fink:
What if you ran out of cash before?
Jeff Dutson:
Well, you could file-
Justin Bernbrock:
Well, I hope these lender clients aren't running out of cash. Then we got a real problem in our hands.
Jeff Dutson:
That's one game that gets played—you discover a flaw. Well, not discover a flaw, but say there's just some asset that part of the deal at closing was—it wasn't going to get picked up. Now you realize, that's actually one of the most valuable assets of the company. Maybe it's intellectual property or maybe something else. Who knows what it is.
Jeff Dutson:
Now, you've done the file review and you're like, “Gosh, it would be great to have a lien on that.” Maybe you get the lien and then you soft pedal. If the borrower's running out of cash and that's the reason there's a filing that's imminent. That's the thing, whatever the circumstance is, that's the imminent filing, chances are the bank group could help with that.
Justin Bernbrock:
When is it time to push for a sale?
Jeff Dutson:
That's related to what we're just talking about, there's all sorts of factors that could dictate whether or not to push for a process immediately or not. A couple of things:
Obviously, market conditions. No one has a crystal ball, but I think my clients are constantly thinking, “Okay, do I sell now, or do I sell later?” The circumstances and the market conditions, whether it's through inflation, whether it's through labor issues, or just demand, commodity prices—there's all sorts of reasons that could dictate when you want to push for a sale process. And it's hard and it's complicated because, again, no one has a crystal ball. And as the lawyer, that's when I normally say, “I don't know, maybe we should ask Matt or one of these guys who's allegedly an expert on market conditions and get them in the room and for them to opine.” At the end of the day, the best you can do is ask the experts, get good counsel, good advice, and make a decision.
Regulatory concerns: If you're talking about a money centered bank that has capital requirements and maybe the loan has now been downgraded, they may just need to exit because of that. The exit that is most profitable would be a sale process.
We talked about liquidity constraints: If the borrower's running out of cash and the sponsor, the equity owner is not willing to fund. If you're going back to your bank group, and again, depending on whether they're on the flexible versus not flexible side of the spectrum. With some lenders, if you say, "Hey, we need you to increase the revolver by $20 million, because we're in a rough patch," they might say, "Okay, I'm happy to loan you more money, but you're starting a sale process right now. I'm not going to throw good money after bad and I'm worried this is going to get worse. So, you need to go out to the market and see what you can get for these assets."
Deal fatigue: If there's been multiple iterations of problems with this particular borrower that may cause lenders to want to exit and pursue a sale process.
Then management concerns: If you just constantly are having issues—they're not hitting their numbers, there's things blowing up at the company that are causing adjustments to their profitability, and they say, “Well, these are one-time adjustments,” but if you have a one-time adjustment, every three months, that may be a bad signal. It may necessitate pushing toward a sale.
Justin Bernbrock:
I want to push on this idea about a secured creditor dictating that a borrower commence a sale process immediately. If you assume that a Chapter 11 process is necessary, let's say, I don't know, there's mass tort liability, for example. You know there is going to be a process. Is it wiser to just insist that the process begin faster or does it make sense to commence a sale process pre-petition, and then you're in this weird process of trying to justify an accelerated bankruptcy process and potentially be forced to run the whole process again?
Jeff Dutson:
My view, which I hold pretty strongly, is you want to fight with everything you have to not file bankruptcy without a clear plan and a clear path. I've definitely been on the other side, representing borrowers where we ran out of money, and I thought the lenders were going to say, "Okay, we'll give you 10 million bucks to fund for the next month or so. We want you to start a sale process pre-petition, to get a stalking horse, do it smoothly, get lined up. But the feedback from them was actually, “We'll give you the $10 million in connection with the DIP loan, you need to get ready to file in two weeks,” which the circumstances of that particular case may have made that a good decision or may have made it a bad decision.
Jeff Dutson:
But I think, as a general matter, I would always want to do whatever I can, even if it means the banks or the lenders opening up their checkbooks outside of a bankruptcy, I would want to do whatever I can to lay the groundwork before the filing, so that you go in with a stalking horse, you have your investment banker retained, you have a clear message to the vendors, to the customers, to the employees that, “Yes, we have to file bankruptcy to consummate this transaction, but it's only going to last 90 to 120 days, whatever the timetable is, and here's our path to get out, and we're really excited about our new potential owners.”
Jeff Dutson:
There may be a higher bidder down the road if Matt's doing an excellent job marketing the asset, like he always does—there'll be more bidders at the table that could come in. But this is a lock, and this is definitely going to help this company survive. Did that answer your question?
Justin Bernbrock:
It's an answer.
Matt Guill:
Let me jump in on that for a second, too. Another thing to think about there is if your group has not decided whether or not they really want to punch out and be done with this credit, they're more interested in making sure that they're getting the best value, the best return given the state of play is you really want to make sure you have the FA, the banker onsite to tell you what is likely to happen if you go to market, because there can be lasting consequences if you go out and you market test the asset, the market tells you, EBITDA is not going to recover anywhere near where it used to be. Nobody wants to buy the company for an attractive valuation, nobody's willing to lend money at any terms, conditions that make sense for you. You then got to figure it out on your own. And by the way, if things actually do turn around, and two years down the line, you want to take this back to market, whoever's doing that marketing process is going to have a big hurdle to get over, because you're going to have to explain what happened in the last failed process.
Justin Bernbrock:
All right. Let's move on and, Jeff, still with you on this one. Let's talk about some strategies that a lender might employ in a consensual versus non-consensual type situation.
Jeff Dutson:
Yeah, I think the main point here is if you think you're going to have to sell the business in order to exit the deal, there's a lot of groundwork that needs to be laid, if you're going to try and do that on a consensual basis. So, if you imagine a family business that has exploded and done really well, and the principals are all now wealthy, and they’re the CEO of this business and the chairman of the board, the notion of that family giving up the business is going to be a hard pill to swallow.
That can be to the lender's advantage sometimes, too, and a good thing if they're truly committed, just like when you have a committed sponsor who really wants the business to succeed—that can be good. And so it's going to be iterative. A sale process is never Plan A. Laying the groundwork, sending the signals that, “Hey, we're going to give you relief from these financial covenants,” or “We're going to defer your amortization payments for six months, but you need to be hitting these EBITDA numbers or else, the bank group's going to get restless and we're going to need to actually start a process.”
So I think a lot of it is informal communications, but just setting the stage and laying that groundwork, knowing that, “Yes, you equity owner, we're going to give you a chance to fix this business, we're your partner, we want you to succeed, but we can't give you infinite chances.”
We've talked about having the right players in place, including independent directors and debtor or borrower professionals. I think getting them in early, even if a sale process may not be the way that you're going to go, having them on the ground and having them there, setting the chess table, as it were, to be ready.
Obviously, if the borrowers run out of money and the sponsor's not going to put any in, the easiest way to get people to cooperate is to say, “Okay, we'll provide you the funding that you need to run the business, but you have to cooperate with us, you have to hire the independent director, you have to start the sale process, get an investment banker.”
Lastly, working with management, because you might have a CEO or a CFO—they're not the owner of the business, it's just their day job—and now, all of a sudden you're talking about a scenario where they may get bought by a competitor and they may end up losing their jobs as a result—making sure they're incentivized to pursue the process and make sure it closes.
Justin Bernbrock:
Matt, I'm going to come back to you with this next one, if you want to talk briefly about some pre-filing strategies, again, to maximize optionality and economics.
Matt Guill:
Yeah. Completely reversing on my last comments, let's assume that EBITDA is somewhat steady, then a market test is actually prudent.
Justin Bernbrock:
That's the mark of a good advisor, being able to reverse yourself on the fly.
Matt Guill:
That's what they say. There is potentially a ton of value to testing the market, and that sticks, whether you're talking about a sale process or a refinancing process, your clients as the incumbent lender are always going to have a tremendous advantage in the fact that, for any third party to come into a potentially distressed or challenged or special situation, there's an awful lot of manpower or man hours that needs to be put in before you can turn around and go to your investment committee and present a compelling thesis.
Matt Guill:
And since you're already involved in the credit, obviously, you're going to have to do that, but you know the name already, you know the industry hopefully, you know the key business drivers, what's going to drive value, what might need to happen, what might need to change in order for this to be an attractive asset to buy or to finance.
Matt Guill:
So in going out to the market, and at least getting an initial view from folks in the capital markets, will allow you as the incumbent to understand at what price might this thing transact. Again, whether it's a sale or you're looking to finance the asset, what hurdles might be out there that may not be obvious to you, or you may think are a no-brainer and not a big deal, but the market thinks is really a big deal. So that you can turn around, and to the extent that you're advising someone that's more on the flexible side of the spectrum, you can be opportunistic, because you know, for a borrower to go back out to the market and get a third party to give you a piece of paper that they can transact on, you can always price at the same price, same terms, and it's always going to make sense for the borrower to stick with you. So it gives you an interesting opportunity to soak up some extra economics or terms you may not get, otherwise.
Justin Bernbrock:
Let's take the downside, and Jeff, I'm going to come back to you with this one, do I need rep and warranty insurance? Is this helpful, not helpful?
Jeff Dutson:
I wanted to flag this issue and I'll be brief. Rep and warranty insurance, for anyone that doesn't know, is basically a form of insurance that can provide a buyer of a company protection against breaches of the reps and warranties that the seller makes, in connection with closing. Over the past 10 years, 15 years, I guess, the market for rep and warranty insurance in healthy regular way deals has absolutely exploded.
Jeff Dutson:
It's gotten to the point now where you see it more often than not, that the seller's going to have rep and warranty coverage. The reason it's nice is because you can pay the premium to the insurer. So instead of having a gigantic holdback that would otherwise satisfy claims that the buyer has against the seller for those breaches, you can pay the premium and that holdback can go away to some measure, at least, and the seller can get more proceeds at closing and the seller can have more certainty that it's going to have that cash, and the buyer knows that it has protections.
Jeff Dutson:
So it's a great product; you see it more and more. You don't see it all that often in the context of distressed sales. Most 363 sales, the reps and warranties expire at closing. Once you close, the buyer can't go back and assert a claim against the seller for breaching a rep and warranty. Historically, it doesn't make sense even in a 363 sale that's structured like that. But if you have an out-of-court distressed asset sale, it could be useful for a lender who's saying, "Hey, I just want to take my chips and go home. I don't want to have a six month clawback period where this amount is sitting in an escrow."
Jeff Dutson:
And so there's brokers that are happy to sell you these products, and you can call them up and say, "Hey, can you look at this deal?" There are a lot of really good ones out there who know M&A and know these transactions and can help you place a policy that can give your client more certainty about the amount of funds that it's going to receive, and also just eliminate the post-closing hassle of dealing with those types of disputes.
Justin Bernbrock:
All right. Let's move on to after a filling has occurred and focus on the top concerns of secured creditors in that context, assuming an asset sale.
Jeff Dutson:
Obviously, when the borrower files, the secured lender wants to make sure there's a plan, there's a process to get out, that everyone's walking arm in arm to get to the closing of a sale that converts their liens in this business to actual cash, that they can then use to apply against their loan and be done with this business. So having control through the DIP credit agreement or a cash collateral order that sets the borrower on that process is key.
Jeff Dutson:
I think one thing we were talking about before that I'm curious for Matt's take is, it relates a little bit to Maja's topics on credit bidding, too, I think one thing that some lenders wring their hands over is, how transparent they should be about their reserve price. If the business is going to market, and they're holding in their back pocket this ability to credit bid, will that deter buyers? Will that help increase the price, if they play a game there? But I'm curious as to Matt's take: What would you advise?
Matt Guill:
It all goes back to whether you've got stripes or not, and being honest with yourself and understanding, what ultimately is your objective out of this sort of process, and what forms of consideration could you potentially take? There's also a wide range of outcomes. Whether you're dealing with multi-billion dollar processes, I think about Pacific Drill, for example, you sometimes might have first lien, second lien, and equity, there's plenty of liquidity, there's no imminent maturity. Maybe nothing has to happen, and the board of directors is going to bang on the table and say, "We've got to play out equity’s optionality here." Meanwhile, the second liens are trading for a penny and the first liens are trading for 20 cents. It's pretty clear from the market's perspective what needs to happen.
Oftentimes, more in the middle market, or lower into the middle market, you might have a single lender unitranche structure or small club deal where there's only two or three people who really have a say in what's going to happen. Of course, there's a wide range of which way you want to go, based on the way the chess table is set.
Jeff Dutson:
But in that club deal, would you want them to disclose their reserve price? Does that help you market?
Matt Guill:
Yeah, the code is really all about transparency, creating fairness for everybody. In that setup, I tend to think it does behoove the group to collectively get together, talk with the banker, figure out what your view of value is on an intrinsic basis, get the banker's view, based on market conditions, what the buyer universe might be—perhaps the most likely buyer is in process of integrating some other acquisition and they're unlikely to be able to transact, or at least at their maximum value—and set a reserve price and be upfront about it, which is also going to require your clients to go back to their IC and understand, what can I accept? How much of a haircut can I take?
Maja Zerjal Fink:
That's probably also informed by what you were saying before, which is that the pre-petition process to the extent that you can get management to do it, is important and is going to inform whether you should reserve or go for the full price, be the stalking horse bidder and so forth.
Matt Guill:
Absolutely.
Justin Bernbrock:
All right. We're going to move on to learning objective two, and this is post-filing procedures and pitfalls for secured lenders and asset sales. Maja, take us away. What is credit bidding?
Maja Zerjal Fink:
All right. I don't think I have to repeat for anybody in this room what credit bidding is, but I think it plays a lot into what we were just discussing. Part of the consideration, obviously, when you're a secured lender, is one, do I have a full collateral package, and two, what do I want to do with it? Am I somebody who wants to actually own these assets because I might have other companies in my portfolio that are capable of producing synergies, or do I really just want to be paid out? If I'm a CLO, I probably would prefer not to own this. Although, somehow they always find a way at the end of the day.
Maja Zerjal Fink:
So credit bidding really plays into that, and this goes to what we were discussing in the beginning, which is, from my perspective, again, credit protections are not great these days. You really don't have all that much reporting on a biweekly, monthly basis. To Matt's point, you might be in a situation where you don't know what EBITDA is doing right before filing, and you don't really know if this company is something that you might want to acquire.
Maja Zerjal Fink:
I think what you can do as a lender, and that is probably on an ongoing basis, frankly, is make sure your collateral package is as tight as it possibly can be. Once you determine that, credit bidding obviously is a great strategy. Now, some people might say that a credit bid in itself would chill bidding, and that could be true, or it actually could spark more bidders to come in if there is a market for these assets.
Maja Zerjal Fink:
Now, for a secured creditor, there's obviously two things, you have to have a secured claim—and you can bid the full amount of your claim, the face amount of your claim—and the claim has to be allowed. From both sides of the table, it's also a strategy for the data, perhaps, if this is a non-consensual deal where somebody can object to the claim or somebody can challenge the collateral package, which we didn't really talk about all that much yet. But if you can, as a secured creditor, getting acknowledgements about the validity of priority of your liens in a cash collateral order, the order is really significant. There will still be a challenge opportunity for usually committees, there is that opportunity, but the best you can do is, again, maximize your opportunity to credit a bid.
Now, again, going to whether credit bidding is really a defense or a strategy: If it's a strategy, I wanted to touch base on what we talked about before on opportunistic or strategic lenders that will acquire claims with the precise purpose to do that.
Maja Zerjal Fink:
Now, I've seen some borrowers being very creative about their disqualified lender lists in credit agreements, by really expanding them to institutions that perhaps are not necessarily deemed …hedge funds. That's something that people have to keep in mind.
Another thing that also plays into what we discussed is, as you're thinking about this, and as you're thinking about perhaps acquiring these assets and there is a syndicate or frankly, more than one lender is, how is this credit bid even exercised? What do my loan documents say? Does the agent own the right to credit bid? Who gets to direct the agent?
Maja Zerjal Fink:
It is really, really important, and again, this is something that lenders can do on their own, much like making sure the collateral package is good here will still be a challenge opportunity for usually committees: Do I actually understand how I make this credit bid, if I want to make it? Going on the other side, if this is a defense and you're dealing with a lender that really does not want to own the assets but just wants to recover as much as possible, you might do a pre-petition market test, and let's assume the company is cooperating, but it simply might be a business that is not all that great, and there is nobody that wants to buy it.
Maja Zerjal Fink:
So what you might decide is to say, you know what, or the price is too low and the price is not enough to cover your claim. What you might decide is to say, you know what, I will put in a credit bid that actually is not the full amount of my claim, or I will put something in just to spark additional bids at the auction in the hope that market will change or something else will change, and it will increase your recovery. Because if not, frankly, there might be liquidation, there could be administrative insolvency issues, and that's always something that lenders have to take into account.
Maja Zerjal Fink:
On lien coverage and priority, like I said, you have to ensure that the collateral package is right. You have to ensure there's no other lenders that are senior to you. If there are, of course, you have to look at the intercreditor agreements; you might still be allowed to bid, but you might have to cash out. What I think lenders don't always understand, or at least some of them, is that, even if you might have a fantastic opportunity to credit a bid, and it actually might be enough to acquire all the assets, you still might have to come up with cash.
Maja Zerjal Fink:
There's a number of reasons why you might do that. If your claim is challenged or your lien is challenged, you might be able to put aside some cash in an escrow to ultimately reserve for that dispute to be resolved. There might be the issue that, if the credit bid is consummated and the sale is consummated, there's no more cash in the estate. So, how are you going to close the bankruptcy case? You have to account for that.
Maja Zerjal Fink:
When you're doing the due diligence, and I'll talk about it in a second, you might actually find that there's senior secured liens. It could be statutory liens, or simply other things like we talked about that you don't have in your collateral package, but that might be really crucial to your business. And that's another piece where you might just have to account for the fact that there's going to have to be some cash on the side.
Justin Bernbrock:
I'm sitting here thinking that there's a really interesting squeeze play that I think borrowers and lenders can execute against an unsecured creditors committee by running a hyper accelerated sale process that is founded upon a credit bid and doing it in such a way that effectively renders the committee's investigation into priority extent, validity of liens, effectively nonexistent or worthless.
So how can there be a fair process that permits a committee to do its job and test liens, while at the same time promoting a sale of a going concern? Because I can imagine a scenario in which—I probably have designed a scenario where—you're running a very accelerated credit bid based sale process and you're putting the committee in the position of challenging, or filing a challenge to, liens and claims at the same time you're having a sale hearing where there are no backup bidders. So the court is faced with this, I think, conundrum of, do they allow the committee's challenge to go forward, or do they approve the sale and let the lenders take the company? It feels like a tough spot.
Maja Zerjal Fink:
Yeah, and this is where the balance comes in, because credit bids are generally allowed unless the court otherwise orders for cause. Here's where we get-
Justin Bernbrock:
Let's talk about that, let's talk about Fisker.
Maja Zerjal Fink:
Fisker is probably the best known case for that purpose, where a bidder was allowed to credit bid only the amount of the claim that it paid for the claim, as opposed to the face amount. The court in that particular case found that the credit bid froze the bidding. It didn't just chill the bidding, but it froze the bidding. Therefore, the credit bid was limited. It wasn't disallowed altogether, but it was limited.
Maja Zerjal Fink:
Usually, what does “cause” mean? It's obviously an open-ended question. What comes into consideration for the court is, is this claim an allowed claim? Are these liens valid perfected first liens or first or second liens? I think, in your example, in that case, the court would have to balance the speed of the sale: Is it really necessary for the sale to be consummated on such an expedited timeline? Perhaps it doesn't need to be a one or two day pre-back, or a pre-negotiated plan.
On the other hand, what are the challenges that committees bring? Does it even have the time to look at these liens? I would think that unless there is some compelling business reason for the sale to happen very quickly, the court would allow some time for the committee to do its investigation. Because at the end of the day, if that's not the case, the committee can't even discharge its duties under the Bankruptcy Code.
Jeff Dutson:
I think one thing, from the secured lender standpoint, when we're representing someone who wants a credit bid and we're worried about that dynamic, just being really straightforward as soon as the committee's appointed and saying, “Here are my docs, here are my loan documents, here's the lien searches we ran.” Also, to that end, if there's a hole in your collateral package, they're going to know about it.
Maja Zerjal Fink:
They're going to find it.
Jeff Dutson:
So throw the dead skunk on the table and say, “There it is, we have this issue. We've done this valuation analysis, we think it's worth $6 million and therefore our credit bid is going to look like this.” So I think, if you're really trying to have a fast process, just being as open and transparent and really cooperative with-
Maja Zerjal Fink:
Absolutely, and that's also going to be to blame, I think, the court's evaluation of what are just calls, and balancing the speed. I would say, practically speaking, if speed is really a problem, then to the extent you can limit the appointment of a committee or make sure the creditors are always happy, that's probably a good solution. If that cannot be the case, and you know you have holes, then I would advise my lenders to simply put aside some reserve for a settlement, if you really, really need to get this done.
Maja Zerjal Fink:
I just wanted to mention, after Fisker, there was, I think, a bit controversial of a decision. The court in Aeropostale in the Southern district of New York, took a bit of a different turn in distinguishing Fisker, because, again, the circumstances there were pointing to the fact that the credit bid froze the bidding, and said that if a bid is chilling the process, that in and of itself should not be enough to limit or disallow the credit bid. So I do think that courts are really careful, unless there is some egregious inequitable conduct, not to completely disallow credit bidding because it is a fundamental right of secured creditors under the Code.
Justin Bernbrock:
Let's just talk about, at a high level, the pros and cons of a standalone sale versus a plan sale, and how, from your perspective, Maja, that either lenders or borrowers ought to think about the two potential avenues.
Maja Zerjal Fink:
Yeah, absolutely. I guess, to your example earlier, if there's some need to consummate a sale quickly, and it could be for any number of reasons, then a 363 sale is the better route, especially if you don't have challenges of liens and the like, and everybody's on board. The main difference obviously is that if you're doing a sale under the plan, you will have to satisfy all the requirements of confirming a Chapter 11 plan.
Maja Zerjal Fink:
Now, there was some discussion before about whether a credit bid was applicable in Chapter 11 context, and the Supreme Court did confirm that it is. Unless, of course, you have all classes accepting and a cram down scenario does not occur.
Maja Zerjal Fink:
There is quite a bit of flexibility that you have under the plan that you might not have under the sale. There are fraudulent transfer protections in both. I think we basically summarized it all here. But again, I think, it really depends on the business itself and what you want to do with the business going forward. If it's not something that you need to consummate on an expedited basis, I think it will depend on the circumstances of the case.
Justin Bernbrock:
Why don't we just talk about, very briefly, some of the considerations for lender groups that will own the asset on the backend?
Maja Zerjal Fink:
Matt, I'm sure you're going to jump in, but this again goes to the group of people that really want to own the assets, as opposed to doing a defensive credit bid. One, when you have holes in your collateral package, either because there's permitted liens that you frankly allowed, or there's gaps, it's really important to actually understand the business. What does this business do? What are the key drivers? This goes to your point of getting enough information from the company to know what it is that runs this company.
Maja Zerjal Fink:
For example, there might be a license that the company really needs. Do I have a lien on this license? How do I extend the license? Do I have the appropriate permits? For instance, if you're trying to buy a casino, it is not that easy to get the gaming license transferred to you. Every single state has its own requirements as to how you do that. It's very similar to liquor licenses.
Maja Zerjal Fink:
So it's really more of an M&A process for you as a secured lender that I think can be undertaken way in advance of any restructuring, frankly, and can be done leisurely just for you with the appropriate advisors to understand, if I were ever to acquire this business, what does this actually mean to me? We were talking about earlier, there might be internal restrictions for bank CLOs and the like, I don't want to own this business. Okay, so do I perhaps want to put in a credit bid, own this business and then to sell it to somebody else?
Now, I'll talk about it in a second. There might be collusion issues there, but, again, it is important to understand how you're going to run this business. There was an interesting case in New York, not too long ago for IL Mulino Restaurant that a lot of you might know, where there was an issue with a person who was claiming to own the trademark. The sale happened, but then they still had to go back to court and ensure that they could actually use the IL Mulino trademark.
Maja Zerjal Fink:
One interesting case from the Fifth Circuit showed that you really need to know what you are buying. In that particular case, one of the patents was not in the schedules, and the sale was consummated. Later, the owner of the patent started a lawsuit, and the buyer said, "Well, wait a minute, these aren't really my assets." It turned out that was really not the case, because by operation of law, the patent was actually deemed rejected, and it was an important piece of the business. This just really goes back to doing your diligence in advance.
Justin Bernbrock:
The third learning objective for today's session is, sale related disputes among secured creditors, purchasers, and debtors in possession in the context of asset sales. Maja, you mentioned collusion. And at the risk of saying something in this town about collusion: Does it happen? Have you seen it? Is this all? I'm very tempted to say witch hunt, but I won't. Other than just, tell us about collusion. Is this really a big deal?
Maja Zerjal Fink:
Well, clearly the drafters of the bankruptcy court thought it might be a big deal, it's in there. I think the base of the concept is pretty simple: You are not supposed to entice somebody not to put in a bid, or you're not supposed to do something that is actually going to control the sale price. Now, in practice, the most simple example would be me sending a text to Justin to say, Justin, I know you're putting in a bid for 15. My bid is 10, do not bid.
Maja Zerjal Fink:
Now, what if Justin didn't see my text? Is that collusion? There's a lot of flavors to it. I just want to tell you about an interesting case in New York where I think it was a situation, Waypoint Leasing Holdings—it's in a slide that's further down—I think it was a situation where you could go either way.
The facts were as follows: There was a stocking horse bidder who was a strategic purchaser. It had a breakup fee and an expense reimbursement and a typical package. One of the ways in which the breakup fee would not be earned if it were outbid was if there was a successful credit bid, and it turned out that actually the face value of the secured credit was higher than the stalking horse's purchase price.
Ultimately, the credit bid was put in, and it was the winning bid, and the stalking horse screamed bloody murder because it turned out that the credit bidder was actually in discussions with another strategic party that had expressed some interest and, in fact, executed an NDA with a debtor' pre-petition.
Maja Zerjal Fink:
At the end of the day, the courts held that you, stalking horse bidder, could have raised your price, and you would've been the winning bid, and that was part of the bidding procedure. So, there really wasn't any collusion. You know what, the credit bidder disclosed to the court, which is key, that it was in discussions about offloading this business later on, because it simply was not in the business of operating the helicopters.
Maja Zerjal Fink:
So what was interesting there was that, in my mind, the stalking horse bidder did everything that it should have: it objected at the sale hearing, it requested discovery and whatnot. It did not seek a stay pending appeal of the sale order. And so when it later brought a claim against the ultimate purchaser, when the credit bidder actually then sold on the assets, the same arguments were revisited, and at that point, of course, it was res judicata. But it is an interesting dynamic, right, if I'm a credit bidder and I decide I'm not going to ultimately own this business, but I know because of my own diligence that there is actually a market out there for these assets, and it's actually way more than the stalking horse wants to put in. But I might know somebody that doesn't want to put in a credit bid for whatever reason—perhaps they don't want to do this transaction because there would be a tax issue for them, if they were acquiring this asset directly from the debtor—or some other issue where they just don't want to put in the bid. The question that becomes: If I, as a credit bidder, make a deal with this other entity, which effectively, they don't put in a bid, but they will pay more money for the assets, it's just not going to the estate, the balance is going to be kept by the secured creditor, is this collusion?
Maja Zerjal Fink:
I personally think it's not, because nobody can force a credit bid. If I have a legitimate reason not to put in a credit bid, you can't really force me. But these are the types of issues where it's not as simple as me sending a text to Justin saying, don't bid because I want to acquire this.
Justin Bernbrock:
Certainly, don't do it over the phone. Well, that is all-
Maja Zerjal Fink:
I usually use a pigeon.
Justin Bernbrock:
That is all the time that we have. I'm going to invite Evelyn Meltzer to come up and make an announcement. Evelyn's to chair the committee responsible for this panel. Let me pass this over. While we're passing this over, why don't we all thank our panel. Thank you very much.
Bryan Uelk:
Hello, again, everyone. This is Bryan Uelk of Sheppard Mullin for Restructure This! with this week's curated restructuring news. On Friday, April 29th, the US Court of Appeals for the Second Circuit held an oral argument on the appeals to the order confirming Purdue Pharma debtors' Chapter 11 plan. The matter has been taken under advisement. It's worth noting, though, that the Second Circuit panel expressed skepticism at the validity of the plan's non-consensual third party releases.
Bryan Uelk:
On the same day that the Second Circuit was wrestling with the appropriateness of the contents of Purdue's plan, the United States Trustee for region seven, which covers the Southern district of Texas, filed a motion to dismiss the InfoWars Chapter 11 cases as a bad faith file. As you may recall, InfoWars filed a Subchapter V case in the US Bankruptcy Court for the Southern district of Texas, on April 18th, after its founder, and then-owner, far-right conspiracy theorist, Alex Jones, transferred control of the debtors to a litigation trust with the express intention of funding the trust to pay holders of litigation claims.
Bryan Uelk:
The litigation claims stem from defamatory statements that Jones and others made following the Sandy Hook shootings in 2014. In its motion to dismiss, the US trustee asserts that the Infowars cases are merely skimmed by Jones to limit his own litigation liability and that of his larger business enterprise, without actually filing for personal bankruptcy or putting his larger enterprise in Chapter 11, in other words, reaping the benefits of Chapter 11 without any of its burdens.
Bryan Uelk:
The UST also alleges that the filing is an attempt to exploit Subchapter V by, among other things, taking advantage of certain plan confirmation rules, and the fact that a committee's not usually appointed. The UST also points out that the Infowars debtors filed their cases just before the damages phase of the Sandy Hook lawsuits in an apparent attempt to avoid filing with liquidated debts, so as to not exceed the maximum debt amount for Subchapter V.
I have to say, the UST makes some great points. If the case is not dismissed, one wonders whether this is exactly the sort of Subchapter V case in which a committee should be appointed.
Bryan Uelk:
In other news, President Joe Biden has said that he's working on a proposal to cancel $10,000 of student debt for each borrower. The president has stated, however, that he won't go so far as to forgive $50,000 per borrower. I suppose anything helps. Though, I do expect the president will hear from a lot of upset borrowers that have already paid back their loans in full prior to any such forgiveness going into effect.
Query, though, from which federal student loan debt tranches, some of which of different interest rates, will the forgiveness apply? And will this have any effect on the ability for borrowers to discharge their student debt and bankers?
Bryan Uelk:
Finally, Judge Isgur announced that he's stepping down from the complex case panel in the Southern district of Texas. Judge Chris Lopez will be his replacement. Judge Lopez has been a bankruptcy judge in Houston since 2019 and spent 16 years as a restructuring lawyer at Weil, Gotshal. From all of us at Restructure This!, Good luck, Judge Lopez.
Bryan Uelk:
Well, that's it for this dose of Restructuring News. This has been Bryan Uelk, for Sheppard Mullin for Restructure This!
Contact Information:
Matthew Guill: https://configurepartners.com/team/#matthewguill
Maja Zerjal Fink: https://www.arnoldporter.com/en/people/z/zerjal-fink-maja
Jeffrey Dutson: https://www.kslaw.com/people/jeffrey-dutson
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