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      Insolvency News and Analysis - Week Ending September 12, 2014
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    Posts Tagged ‘“DIP financing”’

    DIP Lending in Transition

    Monday, August 9th, 2010

    As the economy lurches forward into an uncertain back half of 2010, the DIP lending market remains in flux.  In a short piece appearing in the Journal of Corporate Renewal last Wednesday, Imran Choudhury and Frank Merola – both of Jeffries & Co., Inc. – offer a concise overview of the factors affecting credit availability and expense over the last two years.

    After a sharp contraction in 2008, Choudry and Merola show how DIP funding has increased – both in terms of deal size and in terms of new money . . .

    and likewise, how spreads have eased during the same period . . . .

    Their walk-away, in light of this data:

    “The overall state of the DIP financing market has changed over the last couple of years as the broader credit markets have changed. Lower yields due to improvements in the overall credit markets have resulted in lower rates in the DIP loan market as well.

    While it is difficult to say precisely what DIP yields will be over the next year or so, it seems very likely that the worst part of the credit cycle is over and DIP yields are not going to reach the same levels as they did in late 2008 and early 2009. Even though yields on DIP loans are not at their peak levels, the loans will still likely be used for . . . strategic reasons—protecting existing debt positions or controlling restructuring processes or acquiring assets through credit bids.”

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    Chicken.

    Monday, November 30th, 2009

    The purchase of debt on the cheap and subsequent use of activist litigation to seize control of a troubled company, or obtain other economic concessions from the debtor, is a common tactic in Chapter 11 practice.  But it is not without risk – especially when the purchased debt comes with possible strings attached.

    From New York’s Southern District last week, a cautionary tale of what can happen when an agressive distressed debt investor presses its luck despite ambiguous lending documents:

    ION Media Networks’ Pre-Petition Credit Arrangements and Pre-Arranged Chapter 11.

    ION Media Networks Ltd. and its affiliates (“ION”) entered into a series of security agreements with its first- and second-priority lenders during the “go-go” days of 2005.  The documents included an intercreditor agreement setting forth the respective parties’ rights to ION’s assets.

    By early 2009, ION was involved in restructuring discussions with the first-priority lien holders.  Those discussions resulted in a Restructuring Support Agreement (“RSA”) by which ION conveyed 100% of ION’s reorganized stock to the first-priority lien holders upon confirmation of a Chapter 11 plan.  In furtherance of the RSA, the ION companies filed jointly administered Chapter 11 cases in May 2009.

    Enter Stage Right: Cyrus.

    In the meantime, Cyrus Select Opportunities Master Fund Ltd. (“Cyrus”) purchased some of ION’s second-lien debt for pennies on the dollar.  Using its newly acquired stake, Cyrus systematically attempted to interpose itself into ION’s pre-arranged reorganzation:  It objected to DIP financing proposed by the first-priority lien holders, requested reconsideration of the DIP financing order so it could offer alternative financing on better terms, objected to ION’s disclosure statement, commenced its own adversary proceeding for a declaratory judgment, prosecuted a motion to withdraw the reference with respect to two adversary proceedings concerning ION’s FCC broadcast licenses, objected to confirmation, proposed amendments to the Plan to enable it more effectively to appeal adverse rulings of the Bankruptcy Court, and even filed supplemental papers in opposition to confirmation on the morning of the confirmation hearing.

    Cyrus’ basic objective in this campaign was quite straightforward.  It sought to challenge the rights of ION’s first lien holders (and DIP lenders) to recover any of the enterprise value attributable to ION’s FCC broadcast licenses.  Its ultimate objective was to leverage itself into economic concessions from ION and the first lien holders – and a hefty profit on its debt acquisition.

    Cyrus picked its fight (i) while its position was “out of the money”; and (ii) in the face of an Intercreditor Agreement prohibiting Cyrus from “tak[ing] any action or vot[ing] [on a Chapter 11 plan] in any way . . . so as to contest (1) the validity or enforcement of any of the [first lien holders'] Security Documents … (2) the validity, priority, or enforceability of the [first lien holders'] Liens, mortgages, assignments, and security interests granted pursuant to the Security Documents … or (3) the relative rights and duties of the holders of the [first lien holders'] Secured Obligations . . .”).

    Cyrus apparently decided to go forward because, in its view, ION’s valuable FCC broadcast licenses were not encumbered by the first-priority liens that were the subject of the Intercreditor Agreement.  As a result, Cyrus claimed a right to pro rata distribution, along with the first-priority lien holders (who were themselves undersecured), in the proceeds of the purportedly unencumbered FCC licenses.  Therefore, its objections, based on Cyrus’ position as an unsecured creditor, were appropriate.  By the time the cases moved to confirmation, the ION debtors had commenced their own adversary proceeding to determine whether or not Cyrus’ objections were so justified.

    Second-Guessing Cyrus’ Strategy.

    Cyrus’ game of legal “chicken” was, in the words of New York Bankruptcy Judge James Peck, a “high risk strategy” designed to “gain negotiating leverage or obtain judicial rulings that will enable it to earn outsize returns on its bargain basement debt purchases at the expense of the [first lien holders].”

    Unfortunately for Cyrus, its “high risk strategy” was not a winning one.

    In a 30-page decision overruling Cyrus’ objections to ION’s Chapter 11 plan, Judge Peck appeared to have little quarrel with Cyrus’ economic objectives or with its activitst approach.  But he was sharply critical of Cyrus’ apparent willingness to jump into the ION case without first obtaining a determination of its rights (or lack thereof) under the Intercreditor Agreement:

    Cyrus has chosen . . . to object to confirmation and thereby assume the consequence of being found liable for a breach of the Intercreditor Agreement.  Cyrus’ reasoning is based on the asserted correctness of its own legal position regarding the definition of collateral and the proper interpretation of the Intercreditor Agreement.  To avoid potential liability for breach of the agreement, Cyrus must prevail in showing that objections to confirmation are not prohibited because those objections are grounded in the proposition that the FCC Licenses are not collateral and so are not covered by the agreement.  But that argument is hopelessly circular. Cyrus is free to object only if it can convince this Court or an appellate court that it has correctly analyzed a disputed legal issue. It is objecting as if it has the right to do so without regard to the incremental administrative expenses that are being incurred in the process.

    In contrast to Cyrus’ reading of the Intercreditor Agreement, Judge Peck read it to “expressly prohibit[] Cyrus from arguing that the FCC Licenses are unencumbered and that the [first lien holders'] claims . . . are therefore unsecured . . . .  At bottom, the language of the Intercreditor Agreement demonstrates that [Cyrus' predecessors] agreed to be ‘silent’ as to any dispute regarding the validity of liens granted by the Debtors in favor of the [first lien holders] and conclusively accepted their relative priorities regardless of whether a lien ever was properly granted in the FCC Licenses.”

    Judge Peck further found that because Cyrus’ second-priority predecessor had agreed to an indisputable first-priority interest in favor of the first lien holders regarding any “Collateral,” this agreement also included any purported “Collateral” – and, therefore, prohibited Cyrus’ dispute of liens in the FCC broadcast licenses . . . even if such licenses couldn’t be directly encumbered:

    The objective was to prevent or render moot the very sort of technical argument that is being made here by Cyrus regarding the validity of liens on the FCC [l]icenses. By virtue of the Intercreditor Agreement, the parties have allocated among themselves the economic value of the FCC [l]icenses as “Collateral” (regardless of the actual validity of liens in these licenses).  The claims of the First Lien Lenders are, therefore, entitled to higher priority . . . .  Affirming the legal efficacy of unambiguous intercreditor agreements leads to more predictable and efficient commercial outcomes and minimizes the potential for wasteful and vexatious litigation . . . .  Moreover, plainly worded contracts establishing priorities and limiting obstructionist, destabilizing and wasteful behavior should be enforced and creditor expectations should be appropriately fulfilled.

    Judge Peck acknowledged case law from outside New York’s Southern District that disfavors pre-petition intercreditor agreements which prohibit junior creditor voting on a Chapter 11 plan or a junior creditor’s appearance in the case as an unsecured creditor.  But these features were not the ones at issue here: Cyrus was permitted to vote, and it could (presumably) make a general appearance as an unsecured creditor.  However, it could not, in this capacity, object to the ION Chapter 11 plan.

    Finally, Judge Peck noted that his own prior DIP Order acknowledged the first lien holders’ senior liens on “substantially all the [ION] Debtors’ assets.”  As a result, Cyrus was independently prohibited from re-litigating this issue before him – and couldn’t have done so in any event because it had no standing to raise a proper objection.

    Food for Thought.

    The ION decision raises a number of questions – about the activist litigation tactics often used to extract the perceived value inherent in distressed debt acquisitions, and about the debt itself.

    Was Cyrus overly aggressive in enforcing its purchased position?  Judge Peck suggests, in a footnote, that Cyrus would have been free to raise objections to a settlement between the ION debtors and unsecured creditors by which the unsecured creditors were provided consideration sufficient to meet the “best interests of creditors” test required for confirmation.  But wouldn’t any objection ultimately have raised the same issues as those put forward by Cyrus independently – i.e., the claimed lack of any direct encumbrance on ION’s FCC licenses, and the extra value available to unsecured creditors?

    Or perhaps Cyrus wasn’t agressive enough?  For all the paper it filed in the ION cases, shouldn’t Cyrus have concurrently given appropriate notice under its second-priority debt Indenture and commenced an adversary proceeding to determine its rights under the Intercreditor Agreement?

    Finally, what of Cyrus’ purchased position?  Was the Intercreditor Agreement truly “unambiguous” regarding Cyrus’ rights?  Didn’t the “Collateral” described and the difficulty of directly encumbering FCC licenses create sufficient ambiguity to trigger an objection of the sort Cyrus offered?  Are “purported liens” the same as “purported collateral“?  And is a distinction between the two merely “technical”?

    For distressed debt investors (and for lenders negotiating pre-petition intercreditor agreements), ION Media offers provoking food for thought.

    But while you’re thinking . . . be sure to check your loan documents.

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    Chapter 15 Round-Up: July-September 2009

    Monday, October 5th, 2009

    After a blazing start during the first half of 2009, it was a longer, slower summer for newsworthy Chapter 15 filings.  The last 3 months have produced a handful of new cases, including:

    Stomp Pork – The Saskatoon, Saskatchewan-based pig-farm operator sought Chapter 15 protection in Iowa’s Northern District on May 29 after being placed into receivership the same day under the Bankruptcy and Insolvency Act in the Court of the Queen’s Bench, Judicial Centre of Saskatoon.  It was the company’s second trip to bankruptcy court after a prior, 2008 reorganization under the Companies’ Creditors Arrangement Act.

    The company’s Candian receiver, Ernst & Young Inc., planned to liquidate the company’s assets and distribute the proceeds to its creditors.  Prior to seeking protection in the US, the company received approval from the Candian court to sell its 130,000 pigs to Sheldon, Ohio-based G&D Pork LLC for $2.8 million.  Of these proceeds, creditor National Bank reportedly received $2.7 million.

    The filing was made in an abundance of caution, but ultimately proved unnecessary: Following the sale and the distribution of proceeds, the debtor obtained a dismissal of the recognition petition on the grounds that no further assets remained for the Iowa Bankruptcy Court to protect.

    Sky Power Corp. – The Toronto-based developer of solar and wind-powered energy projects in Canada, the US, India and Panama (and portfolio company of bankrupt Lehman Brothers) sought protection in Delaware in August, seven days after seeking protection under Canada’s Companies’ Creditors Arrangement Act in the Ontario Superior Court of Justice.

    The company characterized its bankruptcy as part of a “domino effect” created by Lehman’s bankruptcy (Lehman was the major shareholder), as well as on reduced liquidity and on defaults triggered with respect to its senior debt by Lehman’s filing.

    At the time of the filing, the company was reportedly relying on a $15 million DIP financing commitment from CIM Group Inc. for liquidity.  The facility was priced at prime plus 875 basis points (prime is given a 3.5% floor), matures November 30, and permits CIM Group to credit bid the DIP obligation toward a purchase of SkyPower.

    Judge Peter Walsh entered a recognition order on September 15.

    Daewoo Logistics Corp. – The Seoul, Korea-based shipping company sought protection in New York in mid-September to protect US-based assets from the immediate effects of an adverse arbitration ruling.

    In addition to the award – obtained by Saga Forest Carriers International for $609,638 in New York’s Southern District – the company also faced 12 other actions, including five others pending in New York.

    The company had previously sought creditors’ protection under the Republic of Korea’s Debtor Rehabilitation and Bankruptcy Act with the 8th Bankruptcy Division of the Seoul Central District Court.  The Korean filing was allegedly a result of plummeting profits stemming from a decline in the market value of dry bulk shipping contracts.  The company also identified a failed land purchase in Madagascar, which was disrupted by a military coup in that country, as a source of financial stress.

    Bankruptcy Judge Burton Lifland granted a preliminary injunction on September 24.

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    Is The Shortest Way Up . . . Straight Down?

    Sunday, August 16th, 2009

    “There’s a cement slab on Ridge Lane, topped with a few pipes, an electrical box and a porta-john.  Nearby, an empty house, a large sign in the driveway declaring ‘inventory home.’  Around the corner, a few muddy lots, rimmed with construction fences … ‘If [the developer] is gone,’ [Kathy] Koss [a resident in the neighborhood] said, ‘what is going to happen to these houses?'”

    This quote from a story in March 15’s Charlotte Observer opens an extensive and intriguing study assembled by Sarah P. Woo, entitled “A Blighted Land: An Empirical Study of Residential Developer Bankruptcies in the United States – 2007-2008.”  Woo is an independent risk management consultant and doctoral scholar at Stanford University with prior experience as a research manager at Moody’s KMV London and a background in corporate finance at White & Case LLP.  She offers a simple premise as the basis for her 194-page work, which also serves as her dissertation:

    Until the housing sector is stabilized, there will simply be no recovery in America.  And as financially distressed residential developers and home builders are forced into liquidation or foreclosure, the unfinished projects they leave behind affect not only the immediate community, but area housing prices as well.

    Woo is not alone in her assessment of the persistent weakness of the US residential housing sector.  A Deutsche Bank study released in early August and briefly summarized in a CNN-Money article last Wednesday indicates that home prices may fall another 14% before hitting a bottom, leaving as many as 48% of mortgage holders “underwater” by 2011.

    Ouch.

    Among Woo’s findings on developers who have filed Chapter 11 cases over the last 2 years:

    – Only 5.3% were able to successfully reorganize.  In fact, the majority of cases were actually dismissed or converted to Chapter 7 – leaving real estate to be foreclosed or liquidated in forced sales.

    – 72% of the cases sampled involved at least one request by a secured lender to lift the stay for purposes of foreclosure.  In such instances, relief was granted approximately 90% of the time.  However, foreclosure may not always have been the best outcome for the bank.  According to Ms. Woo, “[i]n one case, the bank which repossessed the property not only had trouble with the remaining development process but also found itself in a position where it could not necessarily sell the property as a going concern . . . .  In [another] case, the bank which repossessed the property was seized by regulators 2 months later for being insufficiently capitalized, raising the issue of the extent to which a bank’s own financial problems might have contributed to its preference for liquidation during bankruptcy proceedings.”

    – Where properties were disposed of through “363 sales,” Woo “uncovered a pattern of winning credit bids where secured lenders acquired the properties . . . at low prices.”

    – Access to DIP financing appears to have been severely impaired for developers (as it has been for many Chapter 11 debtors this cycle, regardless of industry).  Even where DIP financing has been available, such financing often occurred in cases where the debtor was ultimately liquidated or packaged for sale (again, a common scenario this cycle regardless of the debtor’s industry).

    Is the near-certain prospect of liquidation or sale facing struggling residential home developers a good one for the sector?

    On the one hand, Woo’s study appears to suggest that the control available to lenders through mechanisms such as DIP financing and stay relief litigation, employed by highly regulated and troubled US banks desperate to raise capital by seizing and liquidating collateral, puts housing developers who might reorganize in Chapter 11 on a very slippery slope with little prospect of survival.  On the other, it suggests that the industry may be ridding itself of weak performers very quickly, leaving only the strongest to survive as the residential housing sector struggles back to prior levels.

    Where real estate development and the residential housing sector are concerned, is the shortest way up . . . straight down?

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