Debt Reinstatement Important Lessons for Plan Proponents and Lenders by Julie Schaeffer In the past few years, businesses have doing so, continue with the original terms In situations requiring a significant raised a significant amount of and maturities without obtaining the operational restructuring, however, at historically low rates, and, lender’s consent. debt reinstatement may be less likely to in many cases, with few restrictive succeed. “If lines of business will be sold covenants – making debt reinstatement To succeed, however, the debtor must or shut down, there may be an inability a potentially good restructuring strategy meet three criteria. First, it must cure to meet financial covenants based upon for overleveraged companies, says, Daniel any prepetition defaults. Second, it must the premise of a much larger operation, P. Winikka, a partner at Jones Day. ensure that the plan does not “otherwise and sale proceeds may not be available as alter the legal, equitable, or contractual a source of capital,” says Winikka. “Debt reinstatement involves the use of rights” of the lender. Third, it must the process to restructure a compensate the lender for any damages The viability of a reinstatement plan may company’s bad debt while simultaneously incurred as a result of reasonable reliance also be an issue if the debtor’s financial using the Bankruptcy Code’s on the acceleration of the obligation, and situation is precarious – specifically, if reinstatement provisions to retain for any actual loss arising from the failure the debtor projects little cushion in its valuable with below-market terms,” to perform a non-monetary obligation. ability to meet future financial covenants says Winikka. In other words, reinstatement requires or if it’s possible that the debtor may not a reorganized company to comply with be able to pay or refinance the reinstated “Reinstatement can be attractive to a all existing financial covenants, such as debt at maturity. reorganizing company if the are at a maintaining a certain level of earnings favorable (i.e., below the before interest, taxes, depreciation, Lenders may also be wary of rates that would be available to the and amortization (EBITDA) following reinstatement, says Winikka. Although company as part of its exit from Chapter consummation of its reorganization the lender receives the full benefit of its 11) and have some period left before plan. “Potentially problematic covenants original bargain, it may be hoping that maturity,” says Christopher Mirick, a may include restrictions on a change in a will provide an opportunity to partner at Pillsbury Winthrop Shaw control,” says Winikka. renegotiate to prevailing market terms. Pittman, LLP. “Because of the inability to renegotiate That said, Winikka continues, “if the to current market rates, lenders may “Such a strategy may be particularly reinstatement requirements are satisfied, view reinstatement of their debt as the appealing when the pricing of credit risk the lender’s claim will be deemed functional equivalent of a coerced .” increases substantially, as it did following unimpaired and the lender will be Indeed, according to Winikka, outcomes the financial crisis in late 2008,” adds deemed to have accepted the plan.” of debt reinstatement typically depend Winikka. upon whether the court is convinced the As a result of these requirements, lender is essentially receiving the benefit When a company defaults on its debt, the Winikka notes that reinstatement may of its original bargain. lender typically has the right to accelerate not be a viable strategy for all companies. the loan and collect any outstanding debt. Certainly, it can work with a financial Winikka points to two recent Debtors can reinstate debt as part of the restructuring designed solely to decisions by the Bankruptcy Court bankruptcy process, however – and in deleverage a company’s . for the Southern District of New York T&W Trends, November 2012 2

decisions – in Charter Communications the deal by arguing that the plan would that provided for, among other things, and Young Broadcasting – to illustrate violate the credit agreement’s change reinstatement of the senior secured debt. how courts perceive whether a lender of control provisions. Specifically, is receiving the benefit of its bargain. JPMorgan Chase Bank argued that the The credit agreement required Young “The contrasting outcomes in these two credit agreement required Allen to retain to retain control of at least 40 percent of cases, which involved very similar issues, an ongoing economic interest as well as voting stock. In the event of a triggering likewise provide valuable lessons on 35 percent voting interest, and that four default, the plan granted Young all Class issues associated with reinstatement,” bondholders constituted a “group” that B stock in the reorganized company, says Winikka. together had 38 percent voting rights, which shares would be entitled to cast more than Allen. over 40 percent of the total number of In the first case,Charter Communications votes for the directors, but only permitted prior to bankruptcy developed a The court found that the requirement Young to elect one of the seven directors. restructuring strategy premised on that Allen have 35 percent of the voting reinstating its senior debt to take power did not require that he have The lenders, in turn, argued primarily advantage of a favorable interest rate. a commensurate ongoing economic that reinstatement was not permitted However, a change-in-control provision interest. As to JPMorgan Chase Bank’s because the plan violated the credit in the credit agreement required second argument, the court ruled that agreement’s change-of control provision. Charter’s controlling shareholder, Paul the four bondholders did not constitute Allen, to retain at least 35 percent voting a “group” for purposes of the credit This time the court sided with the lenders power over Charter’s board of directors, agreement because there was no proof on the grounds that the benefit of the and to retain more voting power than any that they had reached any formal bargain and the plain meaning of the other person or group. agreement, or that any such agreement credit agreement required Young to have would matter. Charter was thus the power to influence 40 percent of the Thus, Charter’s prepackaged Chapter 11 successful in reinstating its debt. composition of the board – not simply plan proposed a settlement with Allen the power to cast 40 percent of the total wherein he would retain 35 percent of the After Charter Communications, another votes for directors. voting power and receive approximately Chapter 11 debtor, Young Broadcasting, $375 million, but retain no meaningful attempted to reinstate its senior debt in The next issue of Turnarounds ongoing economic interest in the a similar manner. & Workouts will offer advice for reorganized company. restructuring professionals wishing to In Young Broadcasting, the official formulate a restructuring transaction JPMorgan Chase Bank, agent for the committee of unsecured creditors around a reinstatement plan. senior lenders, attempted to prevent proposed a plan of reorganization