Bankruptcy, restructuring, and leveraged finance expert
Robert Grien, Managing Director and Head of the Finance and Restructuring Advisory Group of TM Capital Corp. and an affiliate with Analysis Group.
Since the onset of the credit crisis, bankruptcy filings have skyrocketed as large, leveraged loans come due and available financing remains scarce. In May 2009 alone, U.S. business bankruptcy filings jumped 40 percent from the previous year. Further complicating bankruptcy and restructuring proceedings, the complex issue of loan reinstatement has emerged as a significant topic in reorganization negotiations. As debtors and creditors jockey for position on this issue, the first few Chapter 11 reinstatement cases are setting critical precedents.
Here, Mr. Grien and Dr. Chakraborty answer pressing questions about the increasingly prominent role of reinstatement in bankruptcy litigation and negotiation.
Dr. Chakraborty: Bankruptcy and restructuring proceedings are complex matters that have developed their own lingo. Two terms, ‘reinstatement’ and ‘cram-up,’ have recently emerged as particularly important. Reinstatement, or renewal, of debt is a specific action that can occur if the only default on a particular creditor is the act of filing for bankruptcy. In other words, for that particular creditor, the debtor is current on the loan’s principal and interest and not in breach of other loan covenants. It is possible, in this circumstance, for the loan simply to be reinstated under all of the original terms as long as the junior lenders demonstrate that the senior lenders are receiving the full value for their secured claim.
Maureen Chakraborty, a Managing Principal who specializes in bankruptcy-related matters and solvency analysis.
Mr. Grien: A cram-up is a new wrinkle on the more familiar ‘cram-down,’ in which the more senior creditors impose their plan, or ‘cram it down’ on dissenting junior creditors. This is possible because bankruptcy law allows for a plan to be confirmed over the objections of a dissenting class of creditors if one impaired class has voted in favor of the plan. We say a class is impaired if it is receiving less than 100 percent of its claim in the plan. A cram-up is the opposite phenomenon, and occurs when junior creditors try to force a plan on more senior creditors by reinstating their debt. Many of the loans put in place in the few years leading up to the credit collapse are very attractive to the borrowers, so we expect more of them to attempt to utilize this strategy going forward as a means of preserving that debt in their capital structures.
Dr. Chakraborty: In this economy, companies filing for bankruptcy are not always in technical default on their senior loans. They often preemptively declare bankruptcy as a means to reorganize and achieve favorable financing terms. Reinstatement has not, historically, been battled out in bankruptcy court, and there is no formal case law on this topic. We expect to see a lot more of this type of contentious litigation because, as Rob just explained, reinstatement of debt has become particularly favorable for debtors and unpopular with senior creditors.
Mr. Grien: There are a few factors. The credit boom allowed companies to borrow too much money at historically low interest rates. Many of these loans were put in place with loose restrictions, or covenants, and ambiguously written loan agreements. As the economy has weakened, many of these over-leveraged companies are running into liquidity problems. Due to the loose covenants, however, they may not be in default under their senior loan agreements. Because these loans are so attractive, debtors are willing to fight hard to keep them in place. This explains the uptick in reinstatement battles that Maureen mentioned.
Mr. Grien: Money. Lenders at the peak of the credit market assumed that borrowers would default before filing for bankruptcy, thereby giving them an opportunity to renegotiate these loans. As we have discussed, this does not always occur. When reinstatement is suggested, the outcome is even worse for the senior lenders than traditional bankruptcy proceedings. Those lenders are, in effect, stuck in a below-market loan. Senior lenders have significant reason to want to fight back. As we have seen in both the Spectrum and Charter bankruptcy litigations, senior creditors had strong views that the proposed reorganization of the junior debt would lead to a change in control of the company, an event of default under the existing terms of the Senior Creditor Agreements. Furthermore, under certain circumstances, senior lenders might view a restructuring of the junior creditors’ debt as a violation of the traditional senior–junior subordinated structure, where senior lenders should be paid before junior lenders. ■
This feature was published in July 2009.