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An effort to overhaul commercial bankruptcy laws is in its early stages, and creditors in the syndicated loan market sense a threat to some of their most important tools for guarding collateral.
November 16 -
Dealmakers have been pushing bankruptcy recapitalizations for a few years. The time may now be ripe with credit quality improving while debt loads linger.
August 21
Banks and other lenders are taking heat for the strict conditions they attach to advances to distressed companies.
So-called debtor-in-possession financing allows a troubled company to continue operating (typically by paying its employees and suppliers) while it negotiates with creditors, either in or outside of the Chapter 11 bankruptcy process. Since this kind of lending is highly risky, borrowers usually have to agree to repay the debt ahead of any other outstanding debt.
DIP financing is coming under fire as part of a broader rethinking of the U.S. Bankruptcy Code by the American Bankruptcy Institute, an association of attorneys, auctioneers, bankers, judges and other professionals. One of the things an ABI commission is examining is whether the strings attached to DIP financings have led to unnecessary liquidations and untimely asset sales.
Critics complain about practices such as roll-ups, or the use of DIP loans to repay debt incurred before a bankruptcy filing; milestones, which are provisions that trigger a default unless debtors meet certain requirements; and cross-collateralization, or securing pre-petition debt with post-petition collateral. Lenders say these provisions are necessary because it gives them some comfort in providing credit while allowing debtors to access financing at reasonable costs.
Mark Shapiro, head of the global restructuring and finance group at Barclays, has defended these practices at two separate ABI hearings. Every DIP provision "has a purpose and underlying value to the lender, and becomes part of the lender's overall risk-benefit analysis concerning the potential DIP loan," he said May 20.
Prohibitions of practices that some view as "too favorable" to DIP lenders will prompt them to raise prices or enhance other terms, Shapiro said. In the worst case, changes to the current system might stop borrowers from getting a DIP loan in the amount and time needed for its reorganization.
Pricing of DIP loans is said to have remained steady throughout the years. "This is so different from other markets such as high yield and leveraged loans," says James Hadfield, a director at the investment bank Morgan Joseph TriArtisan, who has studied data on DIP spreads versus Libor.
The DIP providers also remain constant, with most of the loans coming from secured creditors, he says. Morgan Joseph represents both creditors and debtors, but historically more of its practice has been debtor focused.
Two commission members, University of California law professor Kenneth Klee, and Richard Levin, a partner in Cravath, Swaine & Moore's corporate department, recently made proposals to limit or even ban certain DIP provisions. These include prohibiting certain kinds of roll-ups; eliminating prepayment penalties in DIP agreements; and barring restrictions on debtors' ability to refinance.
Klee and Levin perceive a roll-up as an undue exercise of lender control, hindering the debtors' reorganization alternatives. Klee and Levin are proposing that roll-ups should be prohibited except for three instances: when the collateral is receivables or inventory; when the roll-ups offer incremental liquidity to the debtor and benefits the debtor's estate; and when the rolled-up debt amount is limited to the pre-petition collateral value.
Both members also think that milestones have resulted in many quick asset sales and preclude the debtor from finding other business plans, thus potentially causing lower asset valuations. They also want to prohibit other common DIP provisions such as cross-collateralization.
But "all of these proposals and the commission's focus on these types of DIP provisions miss the point," Shapiro testified.
There are no data to support anecdotal evidence that the increase of DIP loans with roll-ups of pre-petition debt and control provisions that have tighter milestones have resulted in many quick sales or liquidations during Chapter 11, he said.
The banker cited a recent study by the Loan Syndications and Trading Association of 157 cases since 2006, in which all but a few had such provisions, but only roughly 25% of the cases had either converted to Chapter 7 liquidations; involved bargain asset sales or
Additionally, of this subset of companies, only 38% (which is equivalent to less than 10% of the total sample) had DIP financings that rolled up pre-petition debt, a fact that Shapiro says disproves the idea that roll-ups are fundamentally bridges to sales.
"The proposals to address this anecdotal problem fail to apprehend the role that such provisions play and the effects of prohibiting or restricting them," Shapiro said.
Though some of the DIP provisions favor secured lenders, many of the borrowers need DIP for working capital, bankruptcy costs and payroll, and they might have additional costs to support a declining business, Hadfield says.
In the end, a delicate balance is important to ensure that secured lenders can have a level of certainty and control in bankruptcy while debtors can access less expensive financing, he says.
"There should be a balance" that prevents secured lenders from garnering "excessive amounts of control and to enrich themselves through fees and DIP terms to the detriment of other company constituents, owners, employees and unsecured creditors."
This story originally appeared on leveragedfinancenews.com
