AMERICAN INSTITUTE JOURNAL Issues and Information for Today’s Busy Insolvency Professional Second- Financings Part III: Anecdotes—the Good, the Bad and the Ugly: Atkins—the Good

Contributing Editor: About the Author and administrative agent for Jo Ann J. Brighton two levels of secured . The first level Kennedy Covington Lobdell & Hickman Jo Ann Brighton is special counsel with was granted a first lien on substantially Charlotte, N.C. Kennedy Covington Lobdell & Hickman all assets of Atkins Nutritionals and its [email protected] in Charlotte, N.C. She is on the Advisory affiliates, while the second level was Board of the ABI Law Review and is granted a second lien on those same Also Written by: assets. Each level was widely syndicated. Mark N. Berman Board Certified in Business Bankruptcy Law by the American Board of However, the low-carb diet revealed Nixon Peabody LLP; Boston itself as a fad, and the growth of demand [email protected] Certification. Mark Berman is a partner at Nixon Peabody LLP in Boston. for Atkins Nutritionals cooled in 2004 as his is the third installment in a the company’s performance was further series of articles that focus on the contained in the intercreditor agreement. hit by competitive products from Tactual experiences realized when established food manufacturers. Later in second-lien financings hit the bankruptcy Background and Workout 2004, Atkins Nutritionals defaulted on its courts. In the second installment printed The Atkins story has its roots in 1972, pre-petition agreement. A workout in the March Journal, we explored the when Dr. Atkins published his first book ensued. American Remanufacturers case.1 This about low carbohydrate (low-carb) During the workout, several things third installment dieting. A second book on the same topic became apparent. First, the first-lien explores the Atkins was published in the ’90s and became a lenders could “control” the process by Nutritionals Inc., et al, chapter 11 cases. As a reminder, this News at 11 report is purely anecdotal.2 However, outvoting the second- best-seller. Paralleling the publishing of it is readily apparent lien lenders on those second book, Dr. Atkins established a that the comparisons corporation that introduced a low-carb matters governed by Jo Ann J. Brighton with the first food product in 1997. More products the pre-petition credit installment could not followed, and as the low-carb diet became agreement. As a be more striking. Atkins resulted in a a significant force in American society, result, declaring a confirmed chapter 11 reorganization plan, the company grew to meet a growing or taking a continuing business operation, and both demand. In 2003, the company, Atkins enforcement actions first- and second-lien lenders participating Nutritionals, was acquired by Parthenon that might be the in the reorganized company. By contrast, Capital Inc. and its affiliates along with subject of an American Remanufacturers cratered at the Goldman Sachs Capital Partners and its Mark N. Berman intercreditor very start—unable to resolve differences affiliates. While the acquisition included agreement and a resultant standstill period between the first- and second-lien lenders a significant amount of put into the for the second-lien lenders were all in the on the terms of the DIP credit facility. The company by its new owners, it also control of the first-lien lenders, who case was converted to a chapter 7 included a significant credit facility in dominated due to the size of the first-lien liquidation and the assets sold by the which UBS served as the agent for a credit when compared to the second-lien chapter 7 trustee. In our view, nobody syndicate of secured lenders. The credit credit.4 gained a thing by the battle over rights facility involved a single credit 4 The authors believe that most current second-lien financings documented between the first- and second-lien holders agreement,3 and UBS served as the single today involve separate credit agreements for the first- and second-lien lenders. This approach enhances the likelihood that a bankruptcy court will view the two sets of lenders as holding separate rather than as 3 1 (Delaware-Case no. 05-200022) (filed 11/7/05) (Judge Walsh). It has become more common for second-lien lenders to insist upon participants in a single . This issue has ramifications for classification separate credit agreements with separate agreements and UCC 2 The authors reviewed some, but not all, of the pleadings and spoke to in chapter 11 plans as well as the right to accrue post-petition interest and financing statements to document their secured loans with an inter- some, but not all, of the parties involved in the case discussed in this adequate protection. As can be seen from the Atkins Nutritionals agreement being negotiated between the two. See Kerr and article. Our sincere apologies if any information we report in this article experience, it also has ramifications for the ability of the second-lien Rovito, “Second Lien Evolution Creates Higher Recovery Prospects—At is incorrect or if the motivations we speculate about are inaccurate. lenders to impact the workout and chapter 11 process. See In re First Lien Lenders’ Expense,” Ratings Direct, Aug. 5, 2005. Ionosphere Clubs Inc., et al, 134 B.R. 528 (S.D.N.Y. 1991). 44 Canal Center Plaza, Suite 404 • Alexandria, VA 22314 • (703) 739-0800 • Fax (703) 739-1060 • www.abiworld.org Second, there was a significant amount of the chapter 11 process and a plan that would percent. cross-ownership of the first- and second- either allow the company to be reorganized The future fate of the reorganized lien positions, so much so that it became with both first- and second-lien lenders company will bear out whether Atkins works difficult to find lenders who participated sharing in the reorganized company, or a sale out for the first- and second-lien lenders. Can in only one of the positions and who would of the business should a reasonable good it sustain a profitable operation? Will a sale be willing to serve on a steering committee prospect appear. of the business as a going concern be realized (a group often formed when a syndicated at greater than the $115 million price? It secured loan goes into default in order to The Chapter 11 Case would appear at first blush that the second- make the process of negotiation and Atkins Nutritionals filed its chapter 11 lien lenders recovered more than they would decision-making more streamlined). As a case in the Southern District of New York on have had the assets been liquidated in a result, most lenders looked at the credit July 31, 2005. At that time, there was chapter 7 case or even sold as a going facility from a total-return standpoint rather approximately $300 million in secured debt concern in a §363 sale during the chapter 11 than exclusively from the standpoint of the with $216 million held by the first-lien case. Ostensibly, any recovery for second- first- or second-lien position. This probably lenders and $84 million held by the second- lien lenders must have been at the expense reduced the amount of friction between the lien lenders. Unsecured trade payables of the first-lien lenders.5 However, it is fair two positions. amounted to about $36 million. Of course, to say that the chapter 11 process worked Third, many of the lenders who had the had the benefit of the pre- smoothly. Employee jobs were saved. The acquired their positions via trading had a negotiated plan represented in the lock-up first-lien lenders continue to earn interest on perception that their rights were different than agreements between the first- and second- a reduced first-lien credit facility, both first- the documentation revealed was true. Several lien lenders. What remained was what would and second-lien lenders have a piece of the first-lien lenders believed they enjoyed the happen to general unsecured who equity in the reorganized company, and benefits of debt subordination rather than stood to get nothing based on the pre-nego- unsecured creditors got an immediate cash only lien subordination. The “waterfall” tiated deal. dividend. provisions of the credit agreement addressed A series of first-day motions produced The more difficult question to answer only distributions from collateral and not the expected result, and the DIP credit facility is this: Why did Atkins work out this way payments that the first- or second-lien lenders was approved by the bankruptcy court and (i.e., with a confirmed chapter 11 plan), when might obtain outside of collateral liquidation. put in place. No sale materialized, and the American Remanufacturers, having Fourth, the first-lien lenders generally deal represented by the lock-up agreement converted to chapter 7, did not? Were the favored a quick sale of the company where was made the subject of the reorganization polar opposite results a function of the Atkins they could realize what they believed to be plan. As a result of the creditors’ committee credit facility utilizing a single credit the current value of the company. The first- raising issues arising out of the 2004 agreement, a single security agreement and lien lenders believed that the liquidation of acquisition and threatening litigation against a single agent? Or was the negotiated-for the company would result in less than the family of Dr. Atkins, a deal was reached result a function of Atkins having significant payment in full of their first-lien position. that involved the Atkins family funding a 15 cross-ownership in the pools of first- and Fifth, the second-lien lenders generally percent cash dividend for unsecured creditors second-lien lenders so that the bank group as wanted a chance to realize the value that in exchange for a release of all claims. First- a whole was oriented to finding the best might be created over and above the first-lien lien lenders received the right to participate possible return on their investment in both position if the company could be reorganized in a new $110 million post-petition credit pools rather than pushing one to the and proceed profitably into the future. While facility secured by a first lien on all assets. disadvantage of the other? In the end, one the second-lien lenders feared that a sale of The remainder of the first-lien debt, and all thing seems clear: In any bankruptcy, dealing the company would leave them with nothing, of the second-lien debt, was converted into with limited assets expeditiously will they also believed that with the benefit of the equity in the reorganized debtor. Equity always be more beneficial than standing on new management team and other operational provided to second-lien lenders and supposed contractual rights and litigating changes, there was a realistic chance for a management included special rights that while the assets continue to decline in value. greater return down the road. Accordingly, acted like warrants if the value that could be Stay tuned. Next month we will discuss the second-lien lenders believed that their derived from the business on a sale exceeded two other recent bankruptcy cases that collateral had real value if the business could $115 million. A management-incentive plan involved second-lien financing and the continue as a going concern. was put in place providing not only for equity resultant inter-creditor issues—the New World Pasta, Ronzoni, Maxim Sixth, none of the parties, or their ownership, but also for bonuses upon the a.k.a. and the Crane bankruptcy cases. ■ advisors, were sure of how reorganization happening of certain events. securities would be dealt with in a chapter 11 All told, assuming there is value in the of the reorganized company, the first- Reprinted with permission from the ABI case (i.e., whether the equity to be issued in Journal, Vol. XXV, No. 4, May 2006. a chapter 11 reorganization would be lien lenders received value equal to 100 considered the proceeds of the first- and percent of their claim plus the benefit of the The American Bankruptcy Institute is a second-lien lenders’ collateral). pricing and participation in the DIP facility. multi-disciplinary, nonpartisan orga- These forces resulted in the negotiation They also secured the collateral to nization devoted to bankruptcy issues. ABI of a pre-bankruptcy lock-up agreement being themselves alone should the post-chapter 11 has more than 11,500 members, entered into by the first- and second-lien operations falter and only liquidation value representing all facets of the insolvency lenders. The lock-up agreement be realized. The second-lien position field. For more information, visit ABI World contemplated a chapter 11 filing, a DIP credit assuming an $18 million value on the at www.abiworld.org. reorganized company stock provided to them facility geared to providing the debtor with 5 See Kerr and Rovito, “Second Lien Evolution Creates Higher Recovery sufficient funds to ensure operations during recovered value of approximately 20-25 Prospects—At First-Lien Lenders’ Expense,” Ratings Direct, Aug. 5, 2005. 44 Canal Center Plaza, Suite 404 • Alexandria, VA 22314 • (703) 739-0800 • Fax (703) 739-1060 • www.abiworld.org