Companies Are Using Covenants to Restructure Their Capital Structure and Prime Existing Debt
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By Michael Friedman, Simone Tatsch, and Nicholas Whitney (Chapman and Cutler LLP)

As more Companies face liquidity issues and near term debt maturities, they are looking closely to exceptions contained within their indenture/credit agreement covenants in order to achieve an overall or partial restructuring of their capital structure. Investments in “Unrestricted Subsidiaries” are an exception to investment covenants, which have been used in an attempt to provide flexibility in restructuring a Company’s capital structure. Before purchasing debt, distressed investors need to be mindful of what Unrestricted Subsidiaries are and how they impact the overall credit of a Company or debt recovery.

Companies may use Unrestricted Subsidiaries in order to transfer a valuable asset outside of the purview of a Financing Agreement’s covenants. A Company can use the Unrestricted Subsidiary to exchange near term maturing debt junior in the Company’s capital structure for debt issued by the Unrestricted Subsidiary – an exchange that would otherwise not be permitted by the covenants. The exchanged indebtedness could then be supported by the asset which has been transferred to the Unrestricted Subsidiary.

Two recent and well publicized examples of moving value into an Unrestricted Subsidiary are iHeartCommunications (“iHeart”) and J.Crew Group, Inc. (“J.Crew”). In iHeart, the stock of an iHeart subsidiary was moved to an Unrestricted Subsidiary in order to effect a debt exchange, while in J.Crew valuable intellectual property was moved into an Unrestricted Subsidiary for likely the same purpose. Investors must be prepared to determine if there is a way for a Company to utilize its covenants to transfer value to an Unrestricted Subsidiary.

The full client alert is available here.

Language Matters: Third Circuit Finds Make-Whole Provision Enforceable After Bankruptcy Filing
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates | 0

By Craig A. Barbarosh, Karen B. Dine, Jerry L. Hall, and Margaret J. McQuade (Katten Muchin Rosenman LLP)

In November 2016, the Third Circuit rendered a decision in Delaware Trust Co. v. Energy Future Intermediate Holding Co., LLC, finding that the defendants, who voluntarily filed for bankruptcy, were still obligated to pay over $800M in expected interest owed to lenders. The case stemmed from the defendants’ attempt to refinance, during bankruptcy, certain first lien and second lien notes in the wake of declining interest rates. The defendants filed for bankruptcy to render the notes immediately due and payable pursuant to the indentures’ acceleration provision. The defendants assumed acceleration would allow them to avoid the “make-whole” obligation to noteholders that otherwise would be due upon an optional redemption (i.e., the net present value of future payments not yet accrued at the time of prepayment).

In holding that the defendants’ actions effectively constituted an “optional redemption” triggering their obligation to pay future interest to noteholders under the make-whole provision, the Third Circuit clarified the often-muddy interplay between indenture acceleration provisions and “make-whole” redemption provisions. Specifically, the Third Circuit held that: (1) an acceleration provision that is silent as to “make-whole” does not annul a make-whole provision; (2) in order to sever “make-whole” obligations, acceleration provisions must specifically reference “make-whole” obligations; (3) “redemption” does not equal “prepayment;” and (4) issuers have the burden to insist on clear language if they intend to sever make-whole obligations through acceleration.

The full article is available here.

Recharacterization of Debt as Equity in the Fourth Circuit
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By Gabrielle Glemann (Hughes Hubbard & Reed)

In an unpublished opinion in August, In re Province Grande Old Liberty, LLC, Case No. 15-1669, 2016 WL 4254917 (4th Cir. Aug. 12, 2016), the Fourth Circuit Court of Appeals shed some light on the circumstances under which a court may recharacterize debt as an equity investment, effectively subordinating the claim.  The issue before the Fourth Circuit was not one of first impression — the Fourth Circuit had long recognized that a bankruptcy court’s equitable powers include “the ability to look beyond form to substance,” and had previously articulated the factors to consider in evaluating a request for recharacterization. See Fairchild Dornier GMBH v. Official Comm. of Unsecured Creditors (In re Official Committee of Unsecured Creditors for Dornier Aviation (North America), Inc.), 453 F.3d 225 (4th Cir. 2006). The Fourth Circuit decision is notable however, because the court looked beyond the facts giving rise to the underlying claim at issue and ultimately to the economic substance of the entire context of the transaction.  In Province, the creditor whose claim was at issue was a company owned by insiders of the debtor.  The creditors’ claim was based on a loan that was used by the debtor to settle other obligations.  The court held that the settlement agreement was the “substance of the transaction” and a basis for recharacterization, notwithstanding the fact that the creditor was not a party to the settlement agreement.

The full memo is available here.

FTI Roundup
by | posted in: Bankruptcy Roundtable Updates, Financial Firms and Safe Harbors | 0

The Seventh Circuit held last July in FTI Consulting, Inc. v. Merit Management Group, LP, 2016 BL 243677 (7th Cir. July 28, 2016), that § 546(e) of the Bankruptcy Code is not a safe harbor for “transfers that are simply conducted through financial institutions.” This decision deepens a circuit split on this issue. While the Second, Third, Sixth, Eighth, and Tenth Circuits have held that the plain language of § 546(e) protects transfers through financial institutions as settlement payments, the Seventh Circuit’s interpretation agrees with the Eleventh Circuit’s older decision in In re Munford, 98 F.3d 604, 610 (11th Cir. 1996). The legislative purpose of § 546(e) was to prevent the insolvency of one financial institution from causing systemic harm to the market as a whole. However, its text also has deep implications for leveraged buyouts that might render target corporations insolvent because payments to selling shareholders almost invariably pass through brokers and clearinghouses that are covered by the safe harbor.

Several law firms have now written memos on the FTI decision. Schiff Harden postulates that debtors will be more likely to forum shop when filing for bankruptcy when they have recently undergone a leveraged buyout. Jones Day makes clear that shareholders selling into a leveraged buyout face differing levels of risk depending on which forums the corporation could legally avail itself of in a bankruptcy proceeding. And Dechert argues that FTI Consulting will result in different treatment for parties selling identical securities in leveraged buyouts: financial institutions, stockbrokers, and the like will remain protected by the safe harbor when they are beneficial owners of stock, but other shareholders will be subject to avoidance action.

Tinkering with Ipso Facto Provisions Could Send Them Sailing out of Safe Harbors
by | posted in: Bankruptcy Roundtable Updates, Financial Firms and Safe Harbors | 0

By Maurice Horwitz (Weil, Gotshal & Manges)

Recently, the United States Bankruptcy Court for the Western District of Louisiana considered whether a bankruptcy termination provision in a forward contract continues to be safe harbored under section 556 if its enforcement is conditioned on other factors – in this case, the debtor’s failure to perform under the contract.  Consistent with prior case law, the court held that termination is only safe harbored if it is based solely on a condition specified in 365(e)(1) (i.e., the financial condition of the debtor, bankruptcy, or the appointment of a trustee).

The contract in Louisiana Pellets contained a standard ipso facto provision that permitted either party to terminate the agreement upon commencement of a bankruptcy case by the other party.  But the debtor’s counterparty could only invoke the provision if the debtor was also in breach of its obligations under the agreement.  The counterparty alleged that both requirements of the ipso facto provision – bankruptcy and breach – had been satisfied, and sought to terminate.

The court held that because the ipso facto provision contained an additional condition to enforcement (the debtor’s breach), it no longer fell within the 556 safe harbor.  Thus, even if both conditions were satisfied (bankruptcy and breach), the automatic stay applied and the termination clause could not be exercised absent relief from the automatic stay.

The lesson of Louisiana Pellets is that ipso facto provisions in financial contracts should be drafted carefully so that their enforcement depends solely on one of the conditions specified in Section 365(e)(1) of the Bankruptcy Code.

The full article is available here.

Strategies for Purchasing and Selling Assets in Chapter 11
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By Jacqueline Marcus (Weil, Gotshal & Manges) and Doron Kenter (Robins Kaplan)

Sales of a debtor’s assets pursuant to section 363 of the Bankruptcy Code carry significant benefits for buyers and sellers alike. But pursuing a sale process with the overlay of the Bankruptcy Code can also pose challenges and pitfalls, particularly for participants who are unfamiliar with the intricacies of the bankruptcy process and the applicable statutes, rules, and procedures inherent in 363 sales.

Jacqueline Marcus, a partner with Weil, Gotshal & Manges, LLP, and Doron Kenter, Counsel with Robins Kaplan LLP, recently authored an article for Practical Law Bankruptcy, in which they outline the relative advantages and disadvantages of sales in bankruptcy, from both the buyer’s and the seller’s perspective, and offer a practical guide to participating in section 363 sales. The article discusses the various types of section 363 sales, as well as the forms of sale processes that debtors may choose to employ in selling some or substantially all of their assets.  The article discusses the benefits and drawbacks of finding, or being, a stalking horse bidder, and provides guidance for the marketing process, credit bidding, conducting auctions, and choosing a winning bid. It then discusses the competing views regarding the circumstances under which the bankruptcy court may call the debtor’s decision into question or reopen an auction that has otherwise been closed. Finally, the article discusses the considerations that should be taken into account in determining an exit strategy after a debtor completes a sale of substantially all of its assets.

The full text of the article is available here.

Supreme Court to Resolve Circuit Split Over Structured Dismissals
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By Douglas Mintz, Robert Loeb and Monica Perrigino of Orrick, Herrington & Sutcliffe

The Supreme Court recently granted certiorari in Czyzewski v. Jevic Holding Corp. to decide whether a bankruptcy court may authorize the distribution of settlement proceeds through a “structured dismissal” in a way that violates the statutory priority scheme in the Bankruptcy Code.  Specifically, the Court must decide whether Section 507 of the Bankruptcy Code, which details the order of payment of certain priority claims, must be followed outside of a plan when distributing proceeds pursuant to a structured settlement of a bankruptcy case.

The Supreme Court’s decision should resolve an important circuit split.  There is a strong textual argument to permit such distributions and structured dismissals, given the lack of provisions in the Bankruptcy Code dictating that priorities apply to settlements (as opposed to plans).  A ruling in favor of structured dismissals would serve to channel cases away from chapter 11 plans and toward consensual settlements, thereby reducing administrative costs and facilitating quicker bankruptcy resolutions.  However, this could also lead to settlements that run counter to the expected results under the absolute priority rule.  The Supreme Court’s decision may also indirectly permit “gifting” payments outside the scope of a plan – as courts have generally limited gifts in the plan context.

The full article is available here.

Recent Developments in Bankruptcy Law
by | posted in: Bankruptcy Roundtable Updates | 0

By Richard Levin of Jenner & Block

The bankruptcy courts and their appellate courts continue to explore issues of interest to practitioners and academics. This quarterly summary of recent developments in bankruptcy law covers cases reported during the second quarter of 2016.

Cases of note include the Supreme Court’s invalidation of Puerto Rico’s homegrown restructuring statute and its surprising conclusion that an individual debtor’s debt to his corporation’s creditor might be nondischargeable for “obtain[ing] money or property” by “actual fraud” where the corporation transferred away property in an actual fraudulent transfer.

The Second Circuit upset GM’s 2009 bankruptcy sale by granting some ignition switch plaintiffs an exemption from the free and clear ruling because they didn’t have a chance to participate in sale process negotiations. The debate over whether the Code’s financial contracts safe harbor preempts creditors’ claims under state fraudulent transfer laws continues with a Delaware decision ruling against preemption.

A Delaware bankruptcy court (following a recent Illinois decision) invalidated an LLC agreement provision that allowed a creditor to veto a bankruptcy filing. In a boost for litigation funding, a Florida bankruptcy court found that communications with the funder might be subject to the common interest privilege.

And in a decision that should send shudders down the spine of every consumer bankruptcy lawyer, the Ninth Circuit BAP held that a chapter 7 trustee may reject a debtor’s prepaid retainer agreement with his lawyer to defend dischargeability litigation and recover “unused” fees.

The full memo is available here.

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We at the Bankruptcy Roundtable will take a break from posting for the next few weeks in August and hope that you too will be able to get away from your desk at work.  We’ll be back after Labor Day.

Bankruptcy Advisory: What Can Oil Pipelines Do As Shipper Bankruptcy Risk Increases?
by | posted in: Bankruptcy Administration and Jurisdiction | 0

By Filiberto Agusti, Caroline H.B. Gaudet, and Steven Reed, Steptoe & Johnson LLP

The expansion of North American petroleum production in the past 15 years triggered the construction of many pipelines. Construction was financed largely through long-term Transportation Services Agreements (TSAs) whereby shippers committed to transport minimum volumes on the pipelines at specified tariff rates or make shortfall payments. The recent sharp drop in the world price of crude oil has led to bankruptcies. This article reviews whether, in shipper reorganizations, bankruptcy courts have jurisdiction to approve the rejection of TSAs for which the Federal Energy Regulatory Commission (“FERC”) has approved the tariff rate structure.

No court has yet addressed this question, but there is guidance from cases addressing rejection of FERC-jurisdictional electric power agreements. The Fifth Circuit found that bankruptcy courts have jurisdiction to approve rejection where the reorganized debtor’s business purpose is to abandon the FERC-approved service altogether. In dicta, however, the Court noted that the bankruptcy court would have lacked jurisdiction to approve assumption of a modified contract without prior FERC approval of the modification. And in In re Calpine, the Bankruptcy Court for the Southern District of New York held that it lacked jurisdiction to approve rejection of a FERC-jurisdictional electric power agreement if the business purpose of the rejection was to obtain more favorable pricing for the estate. From a FERC standpoint, it is unclear whether a pipeline and a debtor shipper can modify a TSA to reduce pricing as a requirement for assumption.

The linchpin of FERC’s acceptance of specified TSA rates is that those rates must be offered through an “open season” to all potential shippers. A FERC proceeding may be necessary to clarify whether a pipeline has discretion to modify the TSA of a debtor shipper or if a post-open season modification reducing the shipper’s specified TSA rates would violate FERC’s non-discrimination requirements.

The full article is available here.

28 Law Firms Publish White Paper Addressing Trust Indenture Act Complications In Debt Restructurings
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By David A. Brittenham, Matthew E. Kaplan, M. Natasha Labovitz, Peter J. Loughran, Jeffrey E. Ross, and My Chi To of Debevoise & Plimpton LLP

On April 25, 2016, 28 leading U.S. law firms published a legal opinion white paper (the “Opinion White Paper”) addressing recent decisions of the United States District Court for the Southern District of New York interpreting Section 316(b) of the Trust Indenture Act of 1939 (the “TIA”) in the Marblegate and Caesars Entertainment cases. These decisions contain language that suggests a significant departure from the widely understood meaning of TIA § 316(b) that had prevailed for decades among practitioners. They have introduced interpretive issues that have disrupted established legal opinion practice and created new obstacles for out-of-court debt restructurings.

Section 316(b) of the TIA generally provides that the right of any holder of an indenture security to receive payment of principal and interest when due may not be impaired or affected without the consent of that holder. These recent decisions suggest that TIA § 316(b) protects more than the legal right to receive payment of principal and interest in the context of a debt restructuring.

The Opinion White Paper presents general principles that can guide opinion givers until the interpretive questions raised by these recent cases are resolved through future judicial opinions or legislative action.

The Opinion White Paper and further discussion of these cases are available here: Opinion White Paper.

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The Bankruptcy Roundtable has previously posted on the Trust Indenture Act as well as the Marblegate and Caesars Entertainment cases. Most recently, Mark Roe posted an article on the underlying policy behind 316(b) and suggested regulatory and legislative changes to address the problems of bondholder holdouts and coercive exit consents: The Trust Indenture Act of 1939 in Congress and the Courts in 2016: Bringing the SEC to the Table. Additionally, the Roundtable posted the National Bankruptcy Conference Proposed Amendments to Bankruptcy Code to Facilitate Restructuring of Bond and Credit Agreement Debt.

 

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