Creditors Push on Chapter 11
Creditors Push on Chapter 11
Fast-Moving Cases Put Pressure on Unsecured Investors to Act Aggressively
More and more overleveraged, recession-battered companies are ending up in bankruptcy owing their creditors much more than they are worth, which is forcing unsecured creditors to make brash legal maneuvers to squeeze out even a small recovery in Chapter 11 cases.
Unsecured creditors, including bondholders, are near the bottom of the creditor-repayment scheme in bankruptcy, a reality that is hard to handle when over-leveraged companies that borrowed heavily during the credit boom end up in bankruptcy worth far less than they owe. But unsecured creditors and their attorneys aren’t just standing on the sidelines; they are pulling out all the stops to scratch out a recovery.
“The nature of the Chapter 11 process has changed,” said Francis A. Monaco Jr., an attorney with Womble Carlyle Sandridge & Rice PLLC. “Secured lenders are under water and, on paper, there is nothing left for unsecured creditors.”
Now, bankruptcy lawyers say, unsecured creditors, particularly bondholders often owed in the nine figures, must move quickly to wrest a recovery from secured lenders when a company files for bankruptcy protection with an exit plan that wipes out its investment.
That is a marked change from a few years ago, when unsecured creditors committees, which represent bondholders, vendors and pension-plan participants, among others, were content to negotiate recovery scenarios while a company remained under court protection. When financing was easy to obtain, lenders were often paid off, and unsecured creditors divided up the reorganized company’s equity or reaped the proceeds of a sale.
Today, companies are frequently entering Chapter 11 after negotiating a restructuring plan with secured lenders, but without the input of junior creditors. Also, lenders are frequently agreeing to finance the company only long enough to complete a sale of its assets.
Fast-track sales often generate just enough proceeds to repay lenders.
Mr. Monaco, a creditors’ attorney, calls such sales “liquidating 11s” because the company files for Chapter 11 but has no intention of pursuing stand-alone reorganization. Such fast-moving cases “put incredible pressure on committees to make quick decisions,” he said. “You’re almost forced into making objections just to slow things down.”
Creditors will object to the company’s bankruptcy financing, sale procedures and outline of a Chapter 11 plan, all in an effort to gain leverage.
Sometimes, the protests work.
For instance, the company may relent and bring creditors into reorganization talks. Or, even better from the creditors’ point of view, the objections could delay the case long enough to give creditors more time to muster substitute financing.
“Committees can object all they want, but the greatest leverage is being willing and able to provide alternative financing,” said Matt J. Williams, a bankruptcy attorney at Gibson, Dunn & Crutcher LLP.
That financing typically comes from bondholders, including hedge funds and other debt investors that have financing sources not available to rank-and-file trade creditors, he said.
That type of exit financing recently came into play in the bankruptcy case of Cooper-Standard Holdings Inc.
When the auto-parts maker filed for Chapter 11 in August 2009, it appeared that senior bondholders would get “a kiss,” or token recovery, and secured lenders would take control of the company, said Thomas Moers Mayer, whose firm, Kramer Levin Naftalis & Frankel LLP, represents Cooper-Standard’s unsecured creditors.
After seven months and substantial negotiations, Cooper-Standard’s bankruptcy-exit plan calls for investors, including certain bondholders, to pump $355 million into the company. That investment will allow lenders and senior bondholders to be paid in full while subordinated bondholders will recover more than a quarter of what they are owed.
“If you can extend the length of a Chapter 11 case, you have substantially more leverage,” Mr. Mayer said.
The success of such tactics, however, has prompted struggling companies and their lenders to take steps to fend off challenges even before a Chapter 11 filing, said Jeff Marwil, a partner in Proskauer Rose LLP’s bankruptcy practice.
For example, companies know creditors will challenge a quick sale to the lenders, so a business will shop its assets before it files. That way, it can tell a judge that it has been on the market for months.
Companies may also include small equity or cash “gifts” for unsecured creditors in their Chapter 11 plans to persuade creditors to support their deal rather than fight and risk walking away with nothing, Mr. Marwil said.
Companies and lenders “understand the game and come to court with an agenda,” he said. “You think about what the committee will do…and be prepared to respond, or litigate in court.”
If creditors fail in squeezing gains out of the Chapter 11 plan, they must look elsewhere for recoveries.