Prior to the economic downturn – when sales were rising and debt was cheap – many businesses found it convenient to spur further growth by taking on “second-tier” secured financing, or engaging in aggressive leveraged buy-outs (LBO’s). With the recession and resulting steep drop-off in firm revenues worldwide, many of the same businesses (and LBO targets) found themselves over-leveraged and struggling to service their debt. First priority lenders have responded to this distress by negotiating exclusively with their debtors for pre-arranged “restructuring” plans that, in effect, provide for the transfer of assets and repayment of the first-priority debt – but provide little, if anything, to “second-tier” lenders and other creditors.
A recent piece from Reuters discusses what junior creditors are doing about it.
As illustrated in recent Chapter 11 cases such as Six Flags Inc., Pliant Corp., and Trump Entertainment Resorts, Inc., junior creditors are attempting to fight back with competing restructuring plans of their own – proposed plans that provide them with better returns, or with a meaningful equity stake in the reorganized debtor.
A review of the dockets in each of those cases indicates that these efforts have met with varying degrees of success. The Reuters piece suggests three variables that can impact the success of this strategy:
- Valuation. Arguably the most critical factor in supporting a plan that competes with one pre-negotiated with the first-priority creditors is evidence demonstrating that the debtor is, in fact, worth more than the first-priority creditors claim. That demonstration can be challenging, particularly in light of today’s uncertain economy and pricier debt. Even so, junior creditors are likely to argue credibly that a company whose revenues were historically strong should not be under-valued purely on the basis of weaker performance in a generally weaker economy. Still other junior creditors seeking to preserve their original position may be willing to advance additional funds, thereby opening up a possible source of financing otherwise unavailable to the debtor.
- The Court. Concerns such as docket management and the court’s philosophical disposition to maximize enterprise value or protect the position of junior creditors – or not – are factors that have real effect on the success of junior creditors’ bid to present a competing plan.
- Cost-Benefit. Finally, the presence – or absence – of effective negotiation between the parties can impact the perceived benefit of a competing plan. When everyone is talking and a plan can be effectively built, a successful outcome is more likely than a full-blown “plan fight” which weighs down the estate with administrative expense and can, if sufficiently large, even jeopardize the debtor’s successful post-confirmation operations.