Working out of Financial Distress: Challenges and Opportunities

New York Los Angeles October 14, 2009 November 5, 2009

A Complimentary Roundtable

Working Out of Financial Distress: Challenges and Opportunities

Latham & Watkins operates as a limited liability partnership worldwide with affiliated limited liability partnerships conducting the practice in the United Kingdom, France and Italy and affiliated partnerships conducting the practice in Hong Kong and Japan. ©Copyright 2009 Latham & Watkins. All Rights Reserved. Where Have We Been?

A year of unprecedented developments

• 120 banks taken over by the FDIC since September 2008

2 Where Have We Been?

A year of unprecedented developments

• On Wall Street, Merrill and Lehman are no more

• On Main Street, Chrysler is part of Fiat, GM is a shadow, and small business lending has ground to a halt

• Unemployment has exceeded 9%, and expected to crest at over 10%

• Few politicians even bother to pay lip service to the idea of taming the deficit, and the dollar is under severe stress

3 Where Have We Been?

• The United States government is the largest shareholder in several major firms

4 Where Are We Going?

• Not here, we hope

5 Where Are We Going?

• According to the LSTA, absent refinancing or other leverage- reducing or extending events, leverage loan maturities will peak in 2011 for revolving facilities at over $100 billion and in 2014 for term facilities at almost $250 billion.

• At the same time, while secondary trading prices have seen significant improvement, new loan volume continues to be a fraction of what it was

6 What Can We Do?

You will hear from three panels today

• Panel 1 - Distressed M&A

• Panel 2 - Self Help Alternatives to Bankruptcy

• Panel 3 - Reports from the Front

7 New York Los Angeles October 14, 2009 November 5, 2009

A Complimentary Roundtable

Working Out of Financial Distress: Challenges and Opportunities

Panel 1: Distressed M&A

Peter Gilhuly Tony Richmond Finance Partner Corporate Partner Los Angeles Silicon Valley [email protected] [email protected] +1.213.891.8720 +1.650.463.2643

9 Discussion Topics

• Section 363 Asset Sales

• Credit Bidding

• “Loan to Own”

10 What M&A Activity is Occurring?

• Distressed-debt deals are running close to double the pace of last year

• Dealogic data shows that 140 distressed M&A deals valued at $84.4 billion have been struck through August 2009, as compared with 102 transactions worth $20 billion for all of 2008

Source:Source: WallWall Street Journal,, “Distressed“Distressed TakeoversTakeovers Soars,”Soars,” August August 11,11, 2009

11 Section 363 Asset Sale – Overview

Buying and selling businesses through Chapter 11 is becoming a routine process.

• Advantages • Buy “free and clear” of all prior liens, claims and interests, including administrative claims • Outside of bankruptcy, there are numerous exceptions to rule that buyer is not liable for obligations of seller • Bankruptcy adds protections for all but a handful of liabilities • Product, environmental and sometimes employee liabilities • Allows buyers to purchase assets or entire enterprises without requiring them to participate in a prolonged bankruptcy case • Eliminates fraudulent conveyance risk • Auction gives greater protection for the board of directors • Full transparency as to economics

12 Section 363 Disadvantages

• No exclusivity – full competition in auction

• Debtor is required to market and seek overbids from Sale Procedures hearing until Auction date

• Process and result is subject to Creditors Committee’s influence – Committee may not have been appointed when buyer enters into APA

13 Overview – Typical Section 363 Timeline

Day 1 File Sale Motion with Asset Purchase Agreement and Sale Procedure Motion

Day 15 Sale Procedures Motion hearing

Day 45 Competing Bids and bidder qualification deadline

Day 48 Auction

Day 50 Sale Hearing

Day 60 Closing

14 Strategic Issues at Every Step

Strategic DIP financing (“GRIP DIP”)

• To the extent debtor is in dire need of financing, purchaser can link financing to approval of satisfactory bid and auction procedures

• Immediate acceleration if another bid is accepted

15 Strategic Issues at Every Step

• Sale Motion • Advantage of being the stalking horse (often win auction) • Ability to control structure of the deal • First access to data room and due diligence • Control the timing and all key dates • Break-up fee available to fund investment in transaction costs and bid increments • Greater certainty of closure (HSR, financing, key consents in place)

• Sales Procedure Motion • Break-up fee and expense reimbursement as compensation for opportunity cost and as currency • Set initial overbid and subsequent overbid increments • Require qualification of bidders

16 363 Asset Sale Agreement

• Because seller is insolvent, asset purchase agreement in 363 Sale context differs from non-bankruptcy purchase agreement

• Reps and warranties generally do not survive closing, limited indemnification

• Holdbacks and escrows are more difficult to obtain

• Until the sale order is final, seller is not bound; buyer may be bound until termination

• Should include deadlines/timeline for filing motions, court hearing, final approval

• Break-up fee and expense reimbursement – sale procedure order must address priority and source of funds

• Provide express language about assumption and assignment of contracts and payment of cure costs

17 Bankruptcy – Specific Contract Issues

• Competing Bidder Requirements

• MACs (extremely limited and disfavored in bankruptcy)

• Very Limited “No-Shop” Rights

• Deals with Management

• “Back-up Bid” Commitment

18 Sales and Bidding Procedures

• Key requirement is that sales procedures not “chill” bidding

• “Pigs get fat, hogs get slaughtered”

• Minimum initial overbid will normally be the amount of stalking horse offer plus breakup fee plus expense reimbursement plus small increment

• Stalking horse normally gets credit for amount of breakup fee and expense reimbursement in subsequent bids

19 Sales Procedures Hearing

• Usually heard on 10-20 days notice

• Courts will approve shorter notice when: • There is evidence of substantial marketing prepetition • Delay will substantially hurt value

• Judges often want to wait until Committee is formed

20 The Auction

• Generally very fluid – can go on for hours or days

• Debtor and Committee have latitude to determine Auction process and “highest and best” bid

• Can be complicated “apples and oranges” issues

• Complex spreadsheets based on assumption and rejection of contracts, break-up fee credit, etc.

• Liquidation versus going concern

• Bankruptcy Court is ultimate arbiter of disputes

21 The Sale Hearing and Closing of the Sale

• Sale Hearing is usually within days of auction

• Approval of 363 Sale is based on four factors

• Sound business purpose

• Adequate and reasonable notice to interested parties

• Fair and reasonable sale price

• Purchaser acted in good faith – finding of good faith effectively moots appeal • Once order is entered, the winning bidder can close immediately or wait until the 10-day appeal period expires under Bankruptcy Rule 6004(g).

• With waiver, the Code permits a “good-faith” purchaser to close the sale during the 10-day appeal period and moot out appeal.

• The only exception is if the sale order is stayed pending appeal, which rarely happens.

• But there can be other closing conditions, such as HSR

22 Potential Blowups

• Inability to Assign IP contracts

• Diligence on Critical Executory Contracts

• Inadequate Notice

• Taxes/Sales Taxes

• ERISA Inability to sell free and clear

• Successor employer issue

• Credit Bid Rights

23 Credit Bidding Issues

• Section 363(k) allows a secured creditor to credit bid to the extent of its allowed secured claim in assets being sold

• Will not yet be determined judicially – often stipulated

• Can’t credit bid a disputed claim

• What about sale that involves mixed collateral and noncollateral?

• Not dependent on the amount paid for the claim

24 Credit Bidding (cont’d)

• Can also credit bid through a plan under Sections 1123(b)(3) and (b)(4) • Provide for 363 sale in the context of a plan • Given the credit crisis, First Lien or Second Lien Groups often faced with credit bidding situations

• Lender Syndicate credit bidding is a hot issue • Can agent credit bid for group with minority dissenters? Credit documents control • Drag along or cash out minority holders? • Courts have not yet ruled on the required treatment for nonconsenting minority holders

25 Credit Bidding – Greatwide

• Greatwide Case (Judge Walsh, Delaware)

• Court found that minority lender had previously delegated its right to credit bid to the collateral agent under the Credit documents

• Credit agreement provided for delegation to collateral agent “to exercise all rights and remedies of a secured party under the New York UCC and applicable law.”

• Court found that “applicable law included bankruptcy law and Section 363(k)

• Foamex case follows Greatwide

26 Rocking the Boat in Clear Channel

• Ninth Circuit BAP Decision in Clear Channel Outdoor upends well-established law on mootness and lien stripping in Section 363 Sales

• Holding: Retroactively invalidating “free and clear” provision in 363 authorized credit bid sale and reinstating junior lien

• Mootness: 363(m)/ mootness doctrine only protects sale, not lien stripping provisions

27 Clear Channel (cont’d)

• 363(f) does not authorize sale free and clear of lien of objecting “out of money” secured creditor

• 363(f)(3): Permits sale when sale price “greater than the aggregate value of all liens on such property”

¾ Face amount of claims secured by liens

¾ At worst, liens equal to, not greater than, value of property

28 Clear Channel (cont’d)

• Clear Channel Precautionary Measures (in 9th Circuit):

¾ Buyer and its lender should not close during appeal period unless (i) all secured creditors consent or (ii) purchase price exceeds aggregate secured debt

¾ Termination event (in APA and credit agreement) – filing of appeal challenging lien stripping provisions

29 “Loan to Own” – Alternative to 363 Sales How it Works • Accumulate large position in “fulcrum” security

• “Fulcrum” is located at the place in the capital structure where value is insufficient to repay the security in full in cash

– EX: A company has $200M of first lien bank debt, $100M of second lien bank debt and $150M of senior notes; if the company is valued at $400M, the senior notes are the fulcrum security

• Position should be at least one-third of the total amount of the security so as to have a “blocking position” with respect to any treatment of the class in a bankruptcy (still subject to cram-down) • Contact the company to discuss changes in capital structure and company’s willingness to explore out-of-court options, as well as in-court options

• Attempt to negotiate out-of-court exchange offer that converts fulcrum security to 100% of equity in reorganized company

30 “Loan to Own” (cont’d)

If bankruptcy is more attractive (for operational reasons or otherwise), negotiate treatment of the class via a plan of reorganization • Debt-for-equity exchange – Depending on where the fulcrum security stands, may require obtaining substantial exit financing to pay off senior secured debt • “Cram-up” – Junior class of debt receives 100% of equity in the reorganized debtor while senior debt remains in place – Requires that the senior debt receive “fair and equitable” treatment of its claim, which is usually a new cash pay note with the same priority and a market rate of interest – Challenging to execute in unsettled capital markets Negotiate corporate governance issues through Plan process – Exit bankruptcy with new board controlled by new owner – May require a stockholders’ agreement to protect interests of minority holders

31 “Loan to Own” (cont’d)

What can go wrong • Value erosion

• There is no guarantee that the “fulcrum” security remains the same

– Continued exposure to business risk, industry travails, economic downturns • If value erodes such that the fulcrum moves up in the capital structure, the acquired security’s return could be greatly reduced, if not eliminated • Access to information/management

• Access is usually limited, especially at the beginning of the process

– Management and/or equity sponsor may not want to engage with parties that they perceive as offering them little value • Buyer may have to accumulate a large position (as much as 2/3 of the security) before gaining access to material non-public information (“MNPI”)

• Any access granted may require trading restrictions that prevent unwinding the position if the information received counsels against taking ownership

32 “Loan to Own” (cont’d)

Risk Factors: Bankruptcy is a Litigation

• Failure to control the process, despite accumulation – Management can just say no Æ exclusivity period – Another class of claims may have an inside track with management or may have accumulated a large position first – Lack of control puts the buyer outside of the process and may result in tied-up capital while the company is in bankruptcy and the receipt of unattractive securities/consideration upon the company’s emergence from bankruptcy

• Minority holders are usually Part of the Picture – Very difficult to acquire 100% of the equity in a reorganized company • Even if buyer builds a massive position, it is often necessary to give up small equity stakes to junior creditors or equity holders to get a deal done – May allow minority holders to hold up the reorganization process or interfere with the operation of the business post-emergence • Imperfect information permeates this process—there are no guarantees in the “loan to own” context

33 “Loan to Own” (cont’d)

• Advantages compared to 363 Sale

• Control process (gain entry without debtor consent) and avoid auction

• Wipe out junior creditors/equity holders – cram down

• No shareholder approval/no need to show committed financing until plan process is underway

• Link to financing (even DIP financing that converts to exit financing) can block other bidders

• Obtain exclusivity via debtor to avoid competing plan of reorganization

• Issue stock without SEC registration

• Can use claim objection process to challenge claims

34 Prenegotiated Plans – Timing of Chapter 11 Case

Disclosure Statement hearing can occur approximately one month after commencement of the bankruptcy case

Shortly after court approval of the disclosure statement, plan is sent to parties in interest entitled to vote

Confirmation hearing typically occurs +/- 75 days after commencement of the bankruptcy case, although some cases last only 30 days (if court combines hearing to approve disclosure statement and to confirm the plan)

35 Case Studies – Loan to Own and Credit Bid

Greatwide Trucking

• Logistics and ground transportation supplier with $370M of first-lien bank debt and $117M of second-lien bank debt

• Filed for bankruptcy in October 2008

• The first-lien lender group credit bid its claims and purchased substantially all of Greatwide’s assets for an amount equal to 90% of the first-lien debt

• 2nd lien lenders and subordinated bondholders received almost no recovery

• Sale Motion was filed on October 21, 2008 and the sale was approved by the Bankruptcy Court on January 23, 2009

36 Case Studies (cont’d)

Key Plastics

• Automotive parts supplier with too much leverage and difficulty making interest payments

• Company had $115M of senior secured notes outstanding (notes were second in priority behind a $30M revolving credit facility)

• Majority holder approached the company early in the process to discuss an out-of-court debt-for-equity exchange

• Majority holder preferred to convert senior notes into equity through the bankruptcy process to “clean up” corporate structure and obligations

37 Case Studies (cont’d)

Key Plastics (cont’d)

• Reached agreement with management on a pre-packaged plan of reorganization

– Senior Notes converted into 65% of the equity in the reorganized company

– Rights offering of $20M for the remaining 35% (backstopped by majority holder) provided liquidity

– Left trade and other unsecured creditors unimpaired • Company began solicitation of the plan of reorganization on November 12, 2008

• Company filed for bankruptcy on December 15, 2008

• Bankruptcy Court confirmed the plan of reorganization on January 29, 2009

• Majority holder also provided pre-petition credit facility, DIP facility and exit facility

38 39 New York Los Angeles October 14, 2009 November 5, 2009

A Complimentary Roundtable

Working Out of Financial Distress: Challenges and Opportunities

Panel 2: Self Help Alternatives to Bankruptcy

Ana O’Brien John Mendez Tax Partner Finance Partner Los Angeles Los Angeles [email protected] [email protected] +1.213.891.8721 +213.891.8181

Stacey Rosenberg Mark Stegemoeller Finance Partner Corporate Partner Los Angeles Los Angeles [email protected] [email protected] +1.213.891.8554 +1.213.891.8948

41 Discussion Topics

• What Are the Alternatives?

• Debt Buybacks

• Amend and Extends

• Debt Exchanges

• Tax Consequences

42 Debt Buybacks

• Allows Borrower to repay debt at below par • Requires a source of cash to purchase • Key issues to structure around for loan buybacks • The exercise is very dependent on the wording of the document • Will the acquired debt be canceled? • Who is the purchaser • Available alternatives may include Sponsor, Holdco, Borrower and Subsidiary; “friend of the family” structures don’t usually work • Credit Agreement Provisions • Amendments – emphasis on avoiding affected lender votes • Assignments (including “Eligible Assignee” definition) • Pro Rata Payment • Sharing among Lenders • Affiliate Transactions Restrictions

43 Debt Buybacks (cont’d)

• Key issues (cont’d) • “Distressed” exchange categorization • Bankruptcy • Preference look-back for purchases by the Borrower • Considerations if Sponsor is the purchaser (and debt not canceled) • Where does sponsor get the money? • Access to Lender information and meetings • Ability of the Sponsor to vote its debt in a bankruptcy • Unintended consequences • Potential boost to EBITDA and Net Income as non-cash gain • Impact on baskets and mandatory prepays (excess cashflow) • Generally well received by the market, agreed Dutch auction provisions • Do not raise tender offer and other securities law issues that are raised by bond repurchases and tenders

44 Amend and Extends

• What it is:

• An extension of maturity, usually on a non-pro rata basis, of a revolving credit and/or term loan facility

• Accomplished by amendment to the existing credit facility

• Addresses concern of “refinancing cliff”

• May delay but not resolve issues

• Carrots for Lenders:

• Increased interest rate

• Change in other “off market” terms

45 Amend and Extends: Voting Requirements

• Voting requirements • Typically, majority plus each affected lender • Sometimes “all” lenders, sometimes “directly” or “directly and adversely” affected • Structures can involve exchanging or converting into additional tranches or simple extensions of final maturity payment for consenting lenders of existing tranche • Extension structure may be preferable depending on particular voting limitations • Review of exact provisions is key • Pricing and fee payments related to extended tranche • “Pro Rata” interpretation issues similar to debt buybacks • Agent and Borrower must have same interpretation

46 Amend and Extends: Concerns

• Concerns • If single tranche structure is maintained, amendment needs to provide for payment (or refinancing) of the non-extending lenders at maturity • Ability for non-extending lenders to extend (or for their assigns to extend) at a later date • Issues if additional collateral is provided solely to extending tranche • Ensuring non-impairment of collateral security • Material modification of the loan documents may raise issues particularly for real estate collateral • If a majority of lenders have extended their maturity, remedies and forbearance, including remedies with respect to payment at maturity for the non-extending lenders, may be controlled by the extended lenders with different economics at stake • Letter of credit and swing line mechanics • Covenant stripping and/or adding additional protections for extending lenders

47 Debt for Debt Exchanges

• Choices for Restructuring Bonds

• What are bond exchange offers:

• Offers to exchange all or a substantial portion of an issuer’s outstanding bonds for new securities or loans

• As with bank amendments, review of underlying documents is critical

• Types of bond exchange offers:

• SEC-registered exchange offers

• Section 3(a)(9) exempt exchange offers

• Private Section 4(2) exchange offers

• SEC registration requirements/exemptions therefrom do not apply if loans, not bonds, are being offered in the exchange

48 Registered Exchange Offers

Advantages Disadvantages

; New securities are freely : Timing – may be subject to SEC transferable by non-affiliates review and comment before offer of the issuer can be commenced (60 days +/-) ; Issuer may use solicitation : Section 11 securities law liability agent for consents and on content of registration tenders statement : More costly than unregistered deal : Holdout issue

49 Section 3(a)(9) Exchange Offers

Advantages Disadvantages ; Quick (no registration required) : May have restrictions on transfer of new securities if old securities ; Less expensive than registered were "restricted securities;” offering bondholders may require registration rights ; Exemption applies regardless of number of : Strict requirements for compliance holders with exemption, in particular inability to pay for solicitation services and “same issuer” requirement : Holdout issue

50 Section 4(2) Exchange Offers

Advantages Disadvantages

; Quick (no registration : Transfer of new securities is required) restricted; bondholders may require registration rights ; Issuer can use solicitation agent for consents and : Generally limit offer to QIBs tenders : S-1 quality disclosure requirements in most cases : Holdout issue, which may be exacerbated as it is more difficult to reach the minimum threshold when non-QIBs are excluded

51 Rule 14e-1 and Bond Exchange Offers

• All exchange offers to holders of bonds must be kept open for 20 business days

• If there is a change in price or amount sought (or amount to be spent in a Dutch auction or waterfall tender), the offer must remain open for 10 business days following such change

• If there is any waiver of a material condition, the offer must remain open for 5 business days following such waiver

• Additional rules apply if convertible bonds are sought (including requirement to file a Form TO with the SEC)

52 Carrots and Sticks in Bond Exchanges

• The Standard Carrots: • Better position in capital structure • Collateral or additional collateral • Increased amortization/earlier maturity • Cash compensation for consent or exchange • Better cash coupon • PIK interest or some other form of deferred compensation other than equity • Equity kicker

• The Standard Sticks: • Covenant strip through exit consents • End up behind those who cooperate

53 Timeline for Bond Exchange Offer with Exit Consent

Expiration of Closing: Consent T+3 Period—and Day 23 Withdrawal Rights: Day 10

Only those electing to Exchange by Day 10 Get Paid Consent Premium

Business Exchange Offer Days: 0 5 10 15 20Expires; Bonds 25 Accepted: Day 20 54 Tax Consequences

• Debt Buybacks • Issuer has income from debt cancellation if it (or a related person) buys debt for less than the adjusted issue price • Seller will generally recognize gain or loss equal to the difference between the cash received for the debt and its adjusted tax basis in the debt • Temporary legislation permits deferral of tax associated with debt cancellation income for debt cancellation in 2009 or 2010 • Potential application of AHYDO (Related Party Purchase)

55 Tax Consequences (cont’d)

• Debt Exchanges (Including Amendments Treated as Deemed Exchanges) • Note that “significant modification” of a debt instrument is treated as a deemed exchange of the old debt instrument for the modified (“new”) debt instrument • Holder and Issuer have distinct issues • Holder Treatment • Generally, taxable exchange in which gain or loss is recognized • Possible exception for “recapitalizations” where issuer is a corporation, both the original and the new debt are long-term (generally more than five years to maturity) and certain other requirements are satisfied

56 Tax Consequences (cont’d)

• Issuer Treatment • Income from debt cancellation if “issue price” of the new debt is less than the adjusted issue price of the old debt • Issue price may be fair market value or may be face amount depending on whether the new or old debt is “traded” within the meaning of the income tax regulations – Deferral of tax associated with debt cancellation income is available under temporary legislation for debt cancelled during 2009 and 2010 • Potential application of “AHYDO” rules for new debt – Temporary suspension of AHYDO from September 1, 2008 through December 31, 2009 except for certain contingent interest debt and for debt issued to a “related person”

57 New York Los Angeles October 14, 2009 November 5, 2009

A Complimentary Roundtable

Working Out of Financial Distress: Challenges and Opportunities

Panel 3: Reports from the Front

Don Berger Peter Gilhuly Finance Partner Finance Partner Los Angeles Los Angeles [email protected] [email protected] +1.213.891.8998 +1.213.891.8720

Gregory Lunt Finance Partner Los Angeles [email protected] +1.213.891.8792

59 Discussion Topics

1. Reinstatement: A New Battleground

2. Current State of CMBS

3. Chapter 11 after Chrysler and GM

4. DIP Loans: When Repayment in Full is Not Enough

60 Reinstatement: A New Battleground?

61 Reinstatement: Legal Issues

• Creditors that are not “impaired” by a Chapter 11 can “ride through” the case.

• This is sometimes called “reinstatement.”

• Impairment means any alteration of a legal, equitable or contractual right of a creditor.

• For a secured creditor, reinstatement means curing all the pre- petition defaults as of plan confirmation and thereafter honoring the terms of the loan exactly as written.

• Debtors motivated to seek reinstatement if original loan has favorable interest rate and/or borrower-friendly covenants.

62 Reinstatement: Legal Issues (cont’d)

• Lenders motivated to oppose reinstatement if original loan has below-market interest rate or is covenant-light.

• Reinstatement requires payment in full, as originally scheduled, but opportunity to reprice a loan will frequently cause lenders to oppose reinstatement.

63 Reinstatement: The Current Environment

• Current market conditions almost guarantee that debtors will seek to reinstate secured loans where the facts are favorable to doing so.

• Loans made 2003-2007 – at peak of the boom – typically have modest interest rates and minimal covenants.

• Borrowers with such a loan that go into Chapter 11 today will find it difficult in the current credit market to replace such loans on economically appealing terms.

• Pricing and covenants will both vary dramatically from terms of debtor’s original loan, assuming that a replacement can be found.

64 Reinstatement: The Current Environment (cont’d)

• Current credit terms naturally cause borrowers to consider whether their existing secured facility (but not a revolver) can be reinstated.

• Reinstatement has been litigated recently in the Spectrum Brands and Charter Communications cases.

65 Reinstatement: Spectrum Brands

• Consumer products company (Ray-O-Vac batteries; Remington shavers, etc.)

• $1.4 BB secured term loan; $1 BB in unsecured bonds.

• Term loan originally priced at LIBOR +200bps, no LIBOR floor, and was covenant-light.

• Bonds to be converted into equity of reorganized company.

• Spectrum unable to refinance term debt with new lenders on acceptable terms in early 2009, when it filed Chapter 11.

• Initial ask from term lenders was for 800-1000 bps increase in rate; LIBOR floor; tighter covenants.

66 Reinstatement: Spectrum Brands (cont’d)

• Lenders alleged a variety of fact-intensive incurable defaults.

• In particular, they argued that Harbinger, D.E. Shaw, and Avenue — which together would hold 80% of equity of reorganized debtor — were a “group” within the meaning of § 13(d) of the Securities Act.

• If they were, in fact, a group, then that would cause a change in control within the meaning of the credit agreement.

• A change of control would create an incurable default, which would preclude reinstatement.

• The three noteholders testified that they had not acted as a group and argued that there was no change of control.

• Noteholders denied any agreement between them to acquire, hold or dispose of Spectrum securities.

67 Reinstatement: Spectrum Brands — The Result

• Over 30 depositions taken and several million pages of documents produced prior to trial.

• Five days of trial.

• Settlement of reinstatement controversy announced the afternoon before the Judge was to issue his ruling.

• Debtor agreed to 250 bps increase in interest rate for term debt, with 150 bps LIBOR floor.

• Maturity shortened by nine months.

• Changes enhanced possibility that debt would trade at or near par, which was a primary concern of the holders.

• Increased Spectrum’s total annual financing costs, but by far less than if it had to refinance the entire $1.4BB term loan amount.

68 Reinstatement: Charter Communications

• Charter’s plan of reorganization proposes to reinstate $11.8 billion of senior secured debt.

• Largest contested reinstatement in American history.

• Loan made in March 2007: Debt is attractively priced with terms favorable to debtor.

• Charter has continued to pay principal and interest on this debt throughout its Chapter 11 case, which remains pending.

69 Reinstatement: Charter Communications (cont’d)

• Lenders assert a variety of fact-based incurable defaults.

• Any single default will preclude reinstatement.

• As in Spectrum, lenders argued that plan will result in a change of control under the credit agreement, creating an incurable default.

• Credit agreement requires that Paul Allen have 35% of total voting power.

• Also says that if any “group” acquires more than 35% of voting stock and exceeds amount of stock held by Paul Allen, then there has been a change of control.

70 Reinstatement: Charter Communications (cont’d)

• Lenders argue that Apollo, Oaktree, Crestview, and Franklin are a group and, as such, will control more than 35%.

• But representatives of such creditors testified that there was no agreement to acquire, hold, or dispose of Charter securities, and, hence, no group.

• Sixteen days of trial.

• Intense fact-based disputes, the resolution of which by the Bankruptcy Court determined that there were not incurable defaults.

• Judge Peck recently confirmed the Plan reinstating the bank debt. A formal ruling is expected soon.

71 Reinstatement: Conclusions

• Debtors will continue to try to reinstate attractively priced secured loans as long as there is a continuing liquidity squeeze.

• Reinstatement cases will continue to be very fact intensive and will involve extensive (and expensive) pre-trial discovery.

• The majority of reinstatement cases will settle, to avoid the uncertainty of a litigated outcome.

72 73 Current State of CMBS

74 Representative MBS Transaction

A Notes Borrowers Other Securitizations B Notes CDO or Re Remic Loans Cash

Monthly Originator P&I Participation Loans Cash

Depositor Cash Cash Primary (SPV) Underwriters Investors Servicer Certificates Certificates Loans Certificates Monthly Monthly Issuing Trust Rating P&I P&I Agencies Tranched Securities (from AAA-rated to the unrated Controlling Class (B Piece)) Master Special Trustee Servicer Servicer

Pooling and Servicing Agreement

75 Typical CMBS Mezzanine Financing Structure

Multi-purpose Parent/Sponsor

1st L ien Ple dge of E quity I nterests Junior Junior Junior Mezzanine Loan Mezzanine Mezzanine Borrower (SPE) Lender rests quity Inte ledge of E 1st Lien P

Senior Senior Mezzanine Loan Senior Inter- Mezzanine Mezzanine creditor Borrower (SPE) Lender Agreement rests ity Inte of Equ Pledge 1st Lien

Senior Senior Loan CMBS Borrower (SPE) Lender

ge rtga Participation Mo t ien 1s L A Note/B Note or Participations Co-Lender Property Agreement

76 Principal Challenges to MBS Market

• Dysfunctional Securitization Market

• Deteriorating Credit Conditions

• Inherent difficulties in implementing CMBS structure and protocols

• Servicer issues • Highly leveraged structure • Intercreditor relationships • Issues posed by recent bankruptcy cases • GGP • Extended Stay • Shifting Regulatory Response

77 CMBS Market

• State of the Market (since 2007 peak)

• Approximately $47 billion (6% of outstanding CMBS loans) are now in special servicing

• Expectations are that CMBS loan in special servicing will see explosive growth with $154 billion in CMBS loans maturing by 2012 (potential 30% default rate with 13% losses)

78 Servicer Issues: Who Is In Charge?

Two Servicers: Master and Special • Master Servicer: • performs all routine, ordinary-course servicing • Special Servicer:

• performs servicing of “specially serviced” mortgage loans • appointed by the majority holder of the most junior class of securities • The junior holder can generally terminate the Special Servicer and appoint a replacement, as long as that replacement is “qualified” • Operating Adviser: • Appointed by junior holder

79 Servicer Issues: Who Is In Charge? (cont’d)

• Who is in control of special servicing decisions (modifications, waivers, amendments)?

• The controlling holder, whoever that happens to be

• The controlling holder may change on account of appraisal reductions or realized losses

• B Note Holder may be controlling holder

80 Servicer Issues: Restrictions on Loan Modifications

• Under the REMIC rules: loans generally cannot be significantly modified unless they are in default or a default is reasonably foreseeable

• Chilling effect on restructurings

• Precipitation of Borrower defaults

• Recent REMIC changes

81 Servicer Issues: Decision Making Process Causes Delays and Inaction

• Servicing standard: act in the interests of all holders (A Note and B Note), taking into consideration relative priorities

• Multiple constituencies

• Broad approval rights over Major Decisions

• Lowest Common Denominator leads to consensus decision making or paralysis

82 Impact of Highly Structured Deals: Mezzanine Loan Issues

• Heavily structured transactions result in multiple decision makers

• Risks of bankruptcies at multiple levels

• Holes in form of Intercreditor Agreements

• Muddled cure rights

• Overlapping claims against common guarantors

• More challenging to negotiate deeds in lieu

83 Impact of Highly Structured Deals: B Note/Participant Issues

• Special Servicing Charges can include (i) special servicing fees (typically 0.25% per annum), (ii) liquidation fees (typically 1% of sale proceeds), (iii) workout fees (typically 1% of all principal and interest collections), and (iv) in certain transactions, net default interest and late charges

• Multiple Layers of “B Note” or Participants: appraisal reduction issues

• Servicing standard override to B Noteholder approval rights

84 Impact of Pending Real Estate Related Bankruptcies: GGP

• Efficacy of independent directors as means to avoid bankruptcy • Fiduciary duties • Replacing independent directors • Low threshold for bankruptcy filings (high threshold for dismissals) • Limitations of SPE structures and covenants • Cash management vs. cash collateral • Isolation of creditors and debt risk • Substantive consolidation • Added risks associated with parent bankruptcies

85 Impact of Pending Real Estate Related Bankruptcies: Extended Stay

• Impact of springing recourse provision upon filing of bankruptcy

• Who has right to act on behalf of the securitized lender: special servicer vs. certificateholders

• Real parties in interest: each class of certificateholder?

• Harsh effect of appraisal reduction in context of significant downturn in value: loss of controlling holder status for classes M through A-5

86 Regulatory Response

• Re-Remics (Regulatory capital relief, insurance against downgrades, tax, arbitrage)

• Government Efforts to revitalize the CMBS market

• TALF (legacy and new issue CMBS, single borrower deals, CMBS REITS)

• Covered bonds

• PPIP (legacy loans and legacy securities)

• Rating Agency Credibility

87 Chapter 11 after Chrysler and GM

88 The Structure of the Chrysler and GM Asset Purchase Agreements

Each Asset Purchase Agreement (APA) approved by the Bankruptcy Court under Section 363 of the Bankruptcy Code (the Code) looked like a typical out-of-court asset purchase agreement:

• The purchased assets constituted substantially all the assets of each entity with specifically enumerated exclusions.

• Among the common excluded assets were cash, certain plants and related personal property and equipment, certain insurance policies, permits and books and records related to other excluded assets, and contracts that were not assumed, such as dealer contracts.

89 The Structure of the Chrysler Asset Purchase Agreement (cont’d)

• The “Purchase Price” set forth in the Chrysler APA consisted of: • $2 billion cash (paid to lien holder); plus • assumption by the buyer only of certain specified liabilities.

• In addition, the Chrysler purchaser, which started out as a wholly-owned LLC subsidiary of Fiat: • Issued a promissory note for $4.571 billions plus 55% of its membership interests to a voluntary employee benefit association (VEBA) in connection with entry into a revised settlement agreement with the UAW respecting retiree medical benefits; and • Issued 8% of its membership interests to the US Treasury and 2% to a Canadian government entity in connection with new financing provided by those entities to the purchaser. • These transactions were disclosed to the Bankruptcy Court but determined by the court to be separate transactions between the purchaser and third parties that were outside its jurisdiction (except to approve the revised settlement agreement with the UAW relating to retiree benefits).

90 The Structure of the GM Asset Purchase Agreement

• The GM purchaser started out as an entity wholly-owned by the US Treasury, which is identified as the “Sponsor” in the APA. The “Purchase Price” set forth in the GM APA consisted of: • A credit bid by the US Treasury (UST) of all the pre-petition and debtor-in- possession (DIP) debt owed to the UST by GM except for approximately $7.66 billion of DIP debt, $6.7 billion of which was assumed by the purchaser.

• The warrant issued by GM to the UST in connection with the federal government’s pre-petition loans to GM;

• The issuance of 10% of the purchaser’s common stock to the DIP plus a warrant to purchase approximately an additional 15.25% of the common stock on a fully diluted basis; plus

• Assumption of only certain specified liabilities owed by the DIP and pre- petition GM, and no others.

91 The Structure of the GM Asset Purchase Agreement (cont’d)

• In separate but related transactions, the GM purchaser also issued common and Series A Preferred Stock to the Canadian government and a VEBA.

• The final capitalization of the purchaser was as follows: • Common Stock • UST - 60.8% • Canada - 11.7% • VEBA - 17.5% • DIP - 10% (plus warrants for an additional 15.25%)

• Series A Preferred Stock • UST - 23.3% • Canada - 4.47% • VEBA - 72.22%

92 The Structure of the Chrysler and GM Asset Purchase Agreements

• As part of the purchase, the DIP assumed certain executory contracts under Section 365 of the Code and then assigned them to the buyer:

• In some cases, such as the union contracts, the contracts were modified with the consent of the counterparty before they were assumed.

• The purchasers entered into a revised settlement of claims relating to retiree medical benefits as part of the package approved by the Bankruptcy Court.

93 The Structure of the Chrysler and GM Asset Purchase Agreements (cont’d)

• Other executory contracts were rejected by the debtor, such as dealer agreements, and were not assumed by the purchasers.

• When the sale was closed, the purchasers did not have a dealer network.

• Those wishing to be dealers were required to enter into a new dealer agreement with the purchasers on terms determined by the purchaser.

94 The Structure of the Chrysler and GM Asset Purchase Agreements (cont’d)

• Liabilities commonly assumed included:

• Cure amounts under assumed executory contracts;

• Express written warranties related to cars sold prior to closing (but liabilities under implied warranties were specifically excluded in GM);

• Environmental liabilities relating to purchased real estate resulting from post-closing ownership or operation of the real estate by the purchaser;

• Product liabilities for cars sold after closing;

• Wages and fringe benefits of retained employees;

• Liabilities under the modified assumed UAW union contracts;

• Most trade payables.

95 The Structure of the Chrysler and GM Asset Purchase Agreements (cont’d)

• Liabilities specifically listed in the APA as not assumed by the purchasers included:

• Product liability for cars sold pre-closing;

• Contracts not assumed, such as dealer agreements;

• Employee liabilities related to employees not hired by the purchasers;

• Most taxes;

• Most environmental liabilities;

• Pre-closing tort claims;

• Any liability not specifically assumed.

96 The Structure of the Chrysler and GM Asset Purchase Agreements (cont’d)

• The Bankruptcy Court orders approving the sales specifically found that each purchaser was not a successor to the debtors.

• The approval orders provided that the sales were free and clear of liens, claims, and encumbrances and further enjoined holders of liens and claims that were not assumed from asserting them against the purchaser or the purchased assets.

• In its opinion affirming the Chrysler sale, the 2nd Circuit held that it did not have to decide whether the order could properly extend to product liability claimants injured by cars sold pre-closing but who are injured in the future, because no such claims were before it. (Some prior cases have held that due process prevents a sale free of such “claims”.)

97 The Restructuring of Chrysler and GM was completed in a matter of weeks

• Within a matter of weeks, all the assets of both Chrysler and GM that the companies thought had any value had been transferred to new entities, free and clear of the claims of prior lien holders and creditors against such assets.

• The buyers agreed to pay those creditors that they thought were important to the ongoing operation of the business, or were politically favored by the governmental buyers. Other creditors got little or nothing.

• The companies left behind in the still-pending chapter 11 cases retained all non-assumed liabilities and claims, the total of which far exceeded the assets remaining in chapter 11.

98 The Restructuring of Chrysler and GM was completed in a matter of weeks (cont’d)

• In a word, both the operations and the capital structure of Chrysler and GM were completely restructured in approximately two months as part of the 363(b) sales.

• Chapter 11 cases remaining for GM and Chrysler (now called “Motors Liquidation Company” and “Old Carco LLC,” respectively) will continue for several more years, as assets are sold and claims are liquidated or settled.

99 The 2nd Circuit’s Opinion in Chrysler Includes 4 Key Holdings:

1. A sale of all the debtor’s assets can be approved under Section 363 if there is a valid business reason for such a sale.

• While an “emergency” is not required, the presence of one is an important ingredient in assessing whether a valid business reason exists.

• The court emphasized that an emergency existed, that there was no other alternative transaction available, and that the value realized in the sale exceeded the liquidation value of the assets. 2. A provision typically found in many secured credit agreements that authorizes a collateral trustee, with the consent of the “Required Lenders”, to dispose of collateral is authorization to consent to a Section 363 sale free and clear of such liens.

100 The 2nd Circuit’s Opinion in Chrysler Includes 4 Key Holdings: (cont’d)

3. Successor liability claims are an interest in property of which the buyer takes free under Section 363.

• In addition to common law product liability, statutes in some states typically impose successor liability for wages and certain taxes.

• In September 2009, the Chrysler buyer announced that it was voluntarily assuming product liability claims arising from cars sold pre-closing.

4. The requirements of the Code related to reorganization plans don’t apply to Section 363 sales. (The narrow holding was that the requirements of Section 524(g) regarding injunctions to supplement a Section 1129 discharge only apply to plans of reorganization.)

101 The 2nd Circuit’s Holdings in Chrysler

• The Indiana pension funds argued that the Chrysler APA violates the absolute priority rule by paying significant value to unsecured creditors in the form of selective debt assumption.

• The Chrysler and GM bankruptcy courts held that this value was paid by the purchaser outside of the case and hence did not violate the Code.

• Both courts – in effect – approved gifts from the buyers to particular creditors, outside the framework of a plan of reorganization.

102 DIP Loans: When Repayment in Full is Not Enough

103 Background

• Historically, DIP lending has been remarkably safe for lenders.

• Typically characterized by liens on good collateral (generally the best collateral), super-priority status, and payment of significant fees.

• Over the past 25 years, DIP loans have had a miniscule default rate.

• Until the credit contraction of the past year, lenders competed vigorously for the right to make DIP loans.

104 Background (cont’d)

• The security and profitability of these loans made them very appealing to lenders.

• Recent credit contraction has limited availability of DIP loans.

• Many of the chapter 11 cases filed by retailers have moved immediately to §363 sales or to liquidations because of lack of availability of DIP financing.

105 The Current DIP Market

• Liquidity is returning

• Lenders are somewhat more willing to consider DIP lending

• Protective DIP’s still exceed opportunistic DIP’s.

106 Payment In Full May Not Be Enough

• Various instances over past five years in which DIP lenders have traded repayment of some or all of their DIP loans for control of equity of reorganized debtor.

• More recently, and still infrequently, DIP lenders have asked for equity kickers, in addition to full repayment.

• In the Spectrum Brands case, three noteholders provided $45 MM of “last-out” DIP financing, in addition to DIP provided by existing lenders.

• Noteholders required 9.9 percent of the equity of the reorganized company upon emergence.

107 Payment In Full May Not Be Enough (cont’d)

• Bankruptcy Court approved this equity kicker at final DIP hearing, based on testimony that debtor needed the incremental liquidity and it was not otherwise available.

• Reports of similar requests in other distressed credits, but no actual filings since Spectrum with such a proposal.

• Remains to be seen whether this type of provision will become common in future cases.

108 Although this seminar presentation may provide information concerning potential legal issues, it is not a substitute for legal advice from qualified counsel. The presentation is not created or designed to address the unique facts or circumstances that may arise in any specific instance, and you should not and are not authorized to rely on this content as a source of legal advice and this seminar material does not create any attorney-client relationship between you and Latham & Watkins.

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