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RESTRUCTURING in COURT: Chapter 11 Overview WHAT IS CHAPTER 11?

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RESTRUCTURING IN COURT: Chapter 11 Overview WHAT IS CHAPTER 11? • A chapter contained in title 11 of the United States Code (the "Bankruptcy Code") which provides for the reorganization, rather than immediate liquidation, of a debtor • Primarily intended for the rehabilitation of business enterprises (the "fresh start policy") • Goals ‒ To provide equitable treatment for creditors ‒ To preserve incremental value attributable to the ongoing operations 2 WHY DO COMPANIES UTILIZE CHAPTER 11? • Cases for filing ‒ Over-levered ‒ Litigation liabilities ‒ Operational restructuring • Easier to identify and negotiate with parties ‒ Creation of a single national forum to deal with groups with competing interests ‒ Statutory committees • Ability to bind all parties to a solution ‒ Class approval of at least two-thirds in amount and majorly in number in those voting binds entire class • Discharge of Debts 3 CHAPTER 11 RESTRUCTURING TOOLS • Chapter 11 provides a debtor with certain tools to restructure • their liabilities ‒ Automatic stay (the breathing spell) ‒ Rejection of contracts ‒ Compromise claims and equity o Class approval binds all creditors in class o Ability to "cramdown" junior creditor classes ‒ Proposal of a Plan of Reorganization 4 THE PLAYERS IN A CHAPTER 11 CASE THE PLAYERS • Debtor and its existing management ordinarily continue to operate the business as a "debtor in possession" ‒ Trustee can be appointed to take over management of the debtor's affairs only for "cause"; such appointments are rare • Official Committee of Unsecured Creditors ‒ Usually the seven largest unsecured creditors willing to serve • Equity Committee – rare • "Ad Hoc Groups" of creditors ‒ All creditors, shareholders, interested governmental entities are "parties in interest" and can be heard on any matter 6 WHO CAN BE A DEBTOR? • Bankruptcy Code § 109(a): Eligibility for Chapter 11 relief requires the entity to have a domicile, a place of business, or property in the US • Eligibility is determined as of the date the Chapter 11 petition is filed. • A foreign debtor with property in the US meets the eligibility requirement and the court would have proper jurisdiction. • US bankruptcy courts will maintain jurisdiction over a foreign debtor if the Chapter 11 filing was made in good faith and with the intention to reorganize the business. 7 AUTOMATIC STAY AUTOMATIC STAY • Prohibits substantially all legal actions affecting the debtor or its property ‒ On account of a prepetition claim or debt • Stops all actions by individual creditors to obtain satisfaction of their claims using remedies available under state law ‒ Stops creditor collection efforts ‒ Prevents lien foreclosures or lien creation ‒ Generally prevents termination of contracts with the Debtor • Limited exceptions for governmental regulatory actions, termination/netting of swaps, commodities contracts or forward of contracts 9 CLAIMS AND CLAIM PRIORITY ORDER OF CLAIMS (THE "WATERFALL") • DIP Loan secured claims • Secured claims (up to value of collateral) • Administrative claims (claims for post-petition salaries, vendor claims, estate professionals, etc.) • Priority claims • Unsecured claims • Equity 11 ADMINISTRATION OF THE CHAPTER 11 CASE USE, SALE OR LEASE OF PROPERTY OF THE ESTATE WHILE IN BANKRUPTCY • Debtor may use, sell or lease most of its property in the ordinary course of business without court authorization • Debtor can incur unsecured debt in the ordinary course of business and use noncash collateral • Certain items require special review and approval of the bankruptcy court: ‒ Use of cash collateral ‒ Use, sale or disposition of property outside of the ordinary course 13 USE OF CASH COLLATERAL • Cash collateral includes: cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents, including cash proceeds from other collateral, which serve as collateral for a claim • No use of cash collateral without court authorization, unless the secured party consents • If the secured party does not consent, the use of cash collateral is prohibited unless adequate protection is provided • Gives secured party considerable leverage at outset of case 14 DIP FINANCING • If the debtor does not have sufficient cash on hand or is unable to obtain sufficient unsecured credit, the court may ‒ Authorize debt with a "super-super priority" over all administrative expenses ‒ Grant the new lender a priming 1st lien on all property of the estate ‒ Grant the new lender a lien on unencumbered property of the estate ‒ Grant a junior lien upon property that is already subject to a lien • Pre-petition unsecured lender can insist that the DIP be a "roll-up" of the pre- petition loan ‒ A DIP financing order often grants to a lender additional protections that were not available to the lender under its existing loan documents • DIP financing lenders typically allow use of cash collateral, including to pay the professionals of the debtor and the creditors' committee • DIP loans are typically due and payable on the date the Plan becomes effective and are typically refinanced with exit financing 15 ADDITIONAL DIP FINANCING ISSUES • Loan to own DIP Lenders may seek to include covenant or repayment of terms that provide ability to control bankruptcy/plan process, i.e. ‒ Information covenants ‒ Strict budget/use of proceeds controls ‒ Failure to meet certain milestones in bankruptcy case are often events of default under the DIP 16 ADEQUATE PROTECTION FOR SECURED CREDITORS • Granted to secured creditors to protect against a decline in the value of their collateral ‒ If a debtor opposes a secured creditor's motion for relief from stay, the debtor carries the burden of showing that adequate protection exists ‒ Arises in connection with super-priority priming DIPs • Provided by: ‒ Offering periodic cash payments (typically post-petition interest) ‒ An additional or replacement lien ‒ Other relief resulting in realization of the "indubitable equivalent" of the value of the collateral 17 ADEQUATE PROTECTION FOR SECURED CREDITORS (CONTINUED) • In lieu of providing adequate protection, the debtor can seek to demonstrate that the value of the collateral greatly exceeds the amount of the secured creditors' debt • If the debtor is unable to provide adequate protection, then a secured party is entitled to obtain relief from the automatic stay and enforce its collateral rights • If a grant of adequate protection ultimately proves to be "inadequate," the secured creditor's claim for its lost collateral value will be treated as a "super priority" claim and administrative expense of the case 18 ASSET SALES ("363 SALES") • Court approval for property use/sale/lease outside ordinary course of business (§363(b)(1)) • No Court approval for normal/daily transactions (§363(c)(1)) • Most courts allow 363 sales of substantially all assets • Benefits of 363 Sales ‒ Speed ‒ Free of liens, claims and encumbrances ‒ Insulation from fraudulent transfer claims ‒ Potential insulation from successor liability claims ‒ For directors and officers, eliminates exposure for the sale ‒ Limits exposure for breaches of reps and warranties 19 TYPICAL SALE PROCESS • Marketing of Assets • Negotiations with "stalking horse" • Filing sale/bidding procedures motion • Executory contract cure process • Receipt of bids • Auction • Sale Hearing • Consummation 20 EXECUTORY CONTRACTS • Debtor has the right to assume or reject executory contracts • Ipso facto clauses are not enforceable • Contracts are "executory" where there are obligations remaining to be performed by both parties ‒ A long term supply contract or lease is an "executory" ‒ A loan is not executory • If a debtor assumes a contract, it must cure all non-bankruptcy defaults and continue to perform all obligations • If a debtor rejects a contract, the counter-party has a claim for damages caused by the breach 21 PREFERENCE ACTIONS • The debtor may avoid any transfer of an interest in property: ‒ To or for the benefit of a creditor; ‒ For or on account of antecedent debt owed by the debtor before such transfer was made; ‒ Made while the debtor was insolvent; ‒ Made o Within 90 days before the filing of the petition; or o Within one year if the creditor was an insider; and ‒ That enables such creditor to receive more than such creditor would receive if (i) the case were a case under Chapter 7 of the Code, (ii) the transfer had not been made, and (iii) the creditor received payment as provided by the code • Note that non-cash transfers are also subject to preference challenge ‒ I.e. if a pledge has not been perfected within 30 days of such transfer, it may constitute a preference 22 FRAUDULENT TRANSFERS • Under Section 548 of the Code, a transfer by a debtor occurring within 2 years prior to the debtor's bankruptcy filing may be avoided if the debtor: ‒ Made such transfer with the actual intent to hinder, delay, or defraud any creditor; or ‒ Received less than "reasonably equivalent value" and (i) was balance sheet insolvent prior to or as a result of the transfer, (ii) was left with unreasonable small capital for engaging in its business, or (iii) intended to incur, or believed it would incur, debts beyond its ability to pay as such debts became due. • Examples: non-judicial foreclosures on real estate, many (but not all) up-stream and cross-stream guaranties 23 FRAUDULENT TRANSFERS (CONTINUED) • In addition, Section 544 of the Code gives the debtor the status of a hypothetical lien creditor, which allows the debtor to utilize applicable state laws (namely,
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