| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
— Bankruptcy —
Then came General Motors Corp. When the giant automaker made history on June 1 with its bankruptcy filing, it was hardly a revelation that the billions of dollars the federal government had already loaned GM, as well as the $35 billion in debtor-in-possession financing that the U.S. and Canadian governments provided, wasn't going to be paid back. Instead, those debts would eventually be folded into a credit bid that effectively put control of the company into taxpayers' hands. In other words, loan-to-own had become legit. But it didn't take the $48.7 billion GM deal to validate the use of so-called credit bids. Simply put, creditors apply what they are owed to bids to buy bankrupt companies beholden to them. These credit bids have become staples in auctions conducted under Section 363 of the Bankruptcy Code during this relentless Chapter 11 up cycle. Through Sept. 11, 45 credit bids worth $54.7 billion have prevailed in the $88 billion worth of Section 363 sales this year (see table), according to pipeline.thedeal.com. Before GM, Credit Suisse Group and Carl Icahn successfully made a credit bid of $200 million on their $1.38 billion prepetition debt for the bankrupt Tropicana Casino & Resort in Atlantic City, N.J. AgStar Financial Services ACA, WestLB AG and Dougherty Funding LLC did the same with the $516 million they were owed by VeraSun Energy Corp. After GM came Elliott Management Corp. and Silver Point Capital LP's $3.4 billion credit bid for Delphi Corp.
"In the last 12 to 18 months, we have seen more credit bidding, and that will continue in this restructuring cycle," says bankruptcy attorney Paul Leake of Jones Day. There are a few reasons why Leake and other bankruptcy professionals feel that way, but the biggest one has to do with how credit bidding enables secured creditors to protect themselves against falling asset values. With acquisition financing still scarce, a secured creditor may not realize the full value of his claim unless he does something about it. Clearly, credit bidding these days also lets bottom feeders get assets on the cheap, especially since they can buy debt at deep discounts and become creditors postpetition. But credit bidding isn't as easy as it sounds. Legal twists and turns must be negotiated. Various strategies abound, some proven, some still hypothetical. And credit bidders aren't a pat group of players. The usual loan-to-own suspects -- private equity firms, hedge funds, distressed debt buyers -- are participants, of course. But so now are company insiders and strategic acquirers. Only banks, often secured creditors, have generally avoided credit bidding, since they really don't want to own companies they lend to. The plain-vanilla credit bid occurs when a suitor makes, say, a $7 million offer for a bankrupt company and then a secured lender, which holds a $10 million claim against the debtor, bids the amount of its claim instead of taking a haircut, says investment banker William Welnhofer of Robert W. Baird & Co. That provides value preservation. Adds Jones Day's Leake: "[Secured creditors] can defensively credit-bid to take the assets to avoid having them sold for less than they are worth." When Boca Raton, Fla., private equity firm Sun Capital Partners Inc. is deciding whether it will credit-bid during a bankruptcy sale, it looks to see whether it makes sense on a valuation perspective, says Anthony Polazzi, a Sun principal. The PE fund wants to know whether its investors would be better off if it were to purchase the company out of bankruptcy or take whatever proceeds there are from a sale to someone else, Polazzi says. But credit bidding can stifle auctions, too. Bidders who aren't also creditors often steer away from making an offer because they fear having to overpay if a creditor credit-bids what he's owed. Another deterrent: unpredictability. A secured creditor can credit-bid either the entire amount of the debt, a portion or whatever he thinks will win the auction. "It is a very valuable tool to have in an auction," Leake says. "A credit bidder can bid up to the face amount [of their debt], no matter what the value of the collateral is." Meanwhile, after a sale is completed, the credit bidder still must decide who will run the company and how long to hold on to it. There also seems to be confusion over what happens to the debt that the credit bidder doesn't use when making his bid. Jean Robertson, a bankruptcy attorney at Calfee Halter & Griswold LLP, says that what isn't credit-bid will remain secured and will usually stay with the company. Polazzi agrees that the debt would stay secured but said that it would likely remain in the bankruptcy estate. If a creditor wants to own the assets, however, it will likely bid the full amount of its claim as a stalking horse, hoping to set a floor to start the bidding. But here is where creditors could theoretically get more tactical. According to James Nollsch, an investment banker at General Capital Partners LLC, if a lender believes the market can fetch $2.5 million for the assets, it can start the bidding with a $2 million credit bid in the hopes that someone will come in with a higher offer. There may be a reason this hasn't happened yet, Nollsch warns -- and the lender risks having to actually own the assets. Other strategies are more common. One involves debtor-in-possession financing to make a credit bid, along the lines of what the federal government did in GM. Sun Capital provided a $16 million DIP to bankrupt stationery supplier Lang Holdings Inc. and will now credit-bid the DIP under a proposed sales transaction with PE firm Catterton Partners, which became a claimholder by buying prepetition debt from Bank of America Corp. (Affiliates of Catterton also owned 90% of Lang.) The PE firms will start the bidding at Lang's Sept. 29 auction. Sun Capital had an opening after Lang's prepetition lender decided not to provide a DIP. Sun stepped in with a DIP to save the company from liquidation and allow it time to conduct a more orderly sale process, in which Sun could participate, Polazzi says. Historically, Sun Capital hasn't provided DIP financing, but the credit crunch changed that, he says. To be sure, providing a DIP loan gets a lender face-to-face talks with the company and its other lenders, says Kevin Nystrom, a managing director at crisis management firm Zolfo Cooper. It also gives a lender access to information that will help it evaluate whether it wants to buy the company. Still, despite the Lang example, lenders haven't typically engaged in defensive credit bidding. In other words, they aren't offering DIPs to credit-bid -- yet. But they can credit-bid the DIP if they don't see another way of being paid back. "It would be unusual for a sale to go forward where a DIP lender would take a loss," Welnhofer says. More common is offensive credit bidding, in which hedge funds, PE firms and other distressed investors go into the secondary market to buy discounted debt that banks are only too eager to sell and become creditors, Leake says. Hedge funds such as Avenue Capital Group, DDJ Capital Management LLC, Silver Point Capital, Laurus Master Fund Ltd. and Angelo, Gordon & Co. have all credit-bid in auctions this year. In April, Avenue Capital and DDJ Capital bought bankrupt Milacron Inc. for $175 million through the assumption of liabilities, with $6.1 million a credit bid of what the debtor owed them. Conversely, principals and insiders of a debtor will sometimes acquire discounted debt to get the company back, says Nollsch's colleague at General Capital Partners, Peter Hartheimer. Witness what happened in 2005, when Datatec Systems Inc.'s former CEO, Raul Pupo, bought $32.1 million of the company's secured debt through an investment vehicle, Eagle Acquisition Partners Inc., just days before its Dec. 14, 2004, bankruptcy filing. Eagle then credit-bid the amount of the debt it was owed. Sometimes even strategic buyers will acquire debt and launch a credit bid. Kosher meatpacker Agriprocessors Inc. was sold to SHF Industries LLC in June for roughly $8.5 million plus the assumption of liabilities after the buyer, controlled by Hershey Friedman, president of Montreal-based Polystar Packaging Inc., bought First Bank Business Capital Inc.'s $10 million secured claim and the $11 million secured claim of MLIC Asset Holdings LLC. SHF isn't alone. Other strategics have done the same thing. Sinclair Oil & Gas Co. bought bankrupt Provident Royalties LLC for $150 million through a credit bid after it acquired the debt from the debtor's previous senior lenders J.P. Morgan Chase Bank NA, Frost National Bank and Amegy Bank NA. Premier Exteriors Holdings LP bought bankrupt Nailite International Inc.'s $32 million in senior debt earlier this year, and by April 13, its bid for Nailite, consisting of an $8 million credit bid plus $650,000 in cash, had been approved. That strategics have tapped into a world -- the secondary debt market -- over which hedge funds once lorded is no surprise. Instead of spending, say, $100 million in cash in a transaction, a strategic can spend a fraction of that by becoming a credit bidder. The company simply buys a $100 million secured claim from a bank for much less than that and then gains the rights to credit that amount in an auction. Some PE funds, such as Tennenbaum Capital Partners LLC, have also become renowned for doing just that. Tennenbaum bought the debt of bankrupt Radnor Holdings Corp. at an unknown discount and then later made a credit bid part of its $223 million offer for Radnor in 2006. Sometimes prospective suitors don't want or can't afford to buy the entire company but are interested in owning a block of it. They'll buy 20% or 30% of the debt at a discount and then try to persuade the rest of the creditor group to credit-bid, with the suitors leading the transaction, says Zolfo Cooper's Nystrom. But this is where confusion can sometimes reign. Buying pieces of debt at a discount can often create a mix of players with different objectives within a syndicated loan -- some interested in credit bidding, others not, Leake says. Bankruptcy courts now have to look at individual loan documents to see whether the agent for the loan has the authority to credit-bid. While all loan contracts are different, most allow the agent to credit-bid if a certain percentage of debtholders agree to it. The consent of holders of more than 50% of the value of the debt is commonly needed to agree to credit-bid, Nollsch says. One case that tested this premise involved bankrupt GWLS Holdings Inc., or Greatwide Logistics, which was sold free of a $1 million lien held by Grace Bay Holdings LLC and Grace Bay Holdings II LLC. All first-lien lenders, except Grace Bay, consented to the credit bid. Grace Bay argued against the sale, claiming the credit agreement required unanimous written consent of first-lien lenders for the credit bid to proceed and that, because Grace Bay, as a first-lien lender, had not consented in writing, the sale could not proceed. Judge Peter Walsh of the U.S. Bankruptcy Court for the District of Delaware in Wilmington ruled Feb. 23, when he approved the sale, that it was "abundantly clear" that the first-lien lender had the right to credit-bid under the debt agreement. One key to credit bidding is that the holder of the claim needs a valid and perfected lien on the debtor's assets. Since a credit bid generally leaves unsecured creditors with no recovery on what they are owed, unsecured creditors often challenge the validity of the claim or the perfection of the lien held by the secured creditor. Perfecting a lien is very bureaucratic -- a lender must file a financing statement listing the type of collateral securing its loan in a designated filing place, such as the office of the secretary of the state or a county recorder's office, for its lien to be considered perfected. If the unsecured creditors can find a defect in the loan documents, they have leverage, which they can then use to get a return for unsecured creditors, Calfee Halter's Robertson says. One remedy for this situation is to have a credit bidder backstop its bid with cash or ask the court to make a determination. "We will be seeing more challenges on credit bids of this nature because of the trading of debt," Leake predicts. Unsecured creditors can also attempt to fight a credit bid by seeking to have the debt, or a portion of it, subordinated. If secured creditors are insiders, unsecured creditors can argue that the insiders aren't really debtholders and should be considered equity holders instead. Or if an insider is willing to lend a company $10 million when an outside lender would have lent only $2 million, then the unsecureds may try to get the secured claim reduced to $2 million and the rest equitably subordinated, says Frederick Holden Jr. of Orrick, Herrington & Sutcliffe LLP, who represents both unsecured and secured creditors. The fundamental question when it comes to equitable subordination, Holden says, is "Would an arm's-length lender have lent this money?" In the GM case, a special committee of bondholders, which held 0.01% of the bonds, objected to the sale for various reasons, primarily that a normal lender would not have lent the money that the Treasury did to GM. Thus, Treasury should not be allowed to credit-bid the debt, and it should be treated as equity instead. Judge Robert Gerber of the U.S. Bankruptcy Court for the Southern District of New York in Manhattan disagreed, approving the credit bid on July 5. Other courts, however, take a dimmer view of credit bids. On May 30, 2008, the 9th Circuit Court of Appeals bankruptcy appellate panel ruled against credit bids in the case of PW LLC. Secured creditor DB Burbank LLC credit-bid its entire $41.4 million secured claim. However, there was a $2.5 million lien that junior creditor Clear Channel Outdoor Inc. held. The sale was set to close June 5, 2007, but Clear Channel received no payment because the credit bid meant there were no proceeds to which its lien could attach. Clear Channel appealed the sale on May 1, 2007. The BAP court ruled more than a year later that Section 363(f) of the Bankruptcy Code does not permit a secured creditor to credit-bid its debt and purchase estate property, taking title free and clear of valid, nonconsenting junior liens. The ruling said that Section 363(f)(3) permits a sale free and clear of junior liens only if the price paid is equal or greater than the aggregate amount of all liens held against the property. The BAP added that a nonconsenting lien holder could be required by a legal proceeding to accept a payment in exchange for its lien, even if that is less than the full amount owed. "In the future, if you need to consider the ruling, [the secured creditor] would at least need an agreement with a junior lien lender, or it would need to assume the junior lien," Nystrom says. "Assuming the junior lien is not practical." Second-lien or junior lenders can also credit-bid their debt, as long as they pay the lenders in full in front of them first, Welnhofer says. Some lawyers don't see that as very likely. According to Robertson, junior and senior lenders would have an intercreditor agreement, which would outline whether the junior creditor had the right to credit-bid. Junior creditors, however, usually waive that right in the agreement. There are other court tests, too, such as one for solvency. If a credit bid is successful, then no money is coming into the bankrupt estate, making it hard for administrative expenses to be paid. "If a sale will leave the debtor administratively insolvent, then in most cases the court will not approve the sale," Robertson says. Some buyers must be mindful of the legal minefield they enter because of the multiple roles in which credit bidding can entangle them. This is especially true regarding a recent trend in which PE firms are trying to use credit bids and 363 sales to buy back bankrupt portfolio companies, gaining the assets while leaving the liabilities with bankrupt estates.
Patriarch Partners LLC, for example, bought back Zohar Waterworks LLC by credit-bidding $76.3 million in prepetition and postpetition debt in a deal approved on May 29. Sun Capital has become particularly adept at the maneuver. It bought back Big 10 Tire Stores Inc. through a $27.89 million credit bid of its prepetition and postpetition debt. The PE firm also bought back Fluid Routing Solutions Inc.'s fuel systems division through an $11 million credit bid. In both cases, Sun Capital provided a DIP loan that refinanced prepetition debt and gave the company new money, with a plan to credit-bid that debt toward a repurchase. Being an equity holder, DIP lender and ultimately a buyer, attracts questions from unsecured creditors' committees and the U.S. trustee, who is concerned with interests of all creditors and not just a few, Sun Capital's Polazzi says. While Robertson calls this credit-bidding strategy "twisted," she says the way to circumvent the conflict of being both an owner and a lender is to hire separate attorneys and financial advisers for each function. "[It's] schizophrenic and expensive, and you have to really want it," she says. Still, credit bidders have an edge in auctions because if a rival wants to bid less than the face amount of the debt, it needs approval from senior lenders, Nystrom says. Credit bidders need only an OK from a bankruptcy judge. Nollsch recalls a lender who bought a $2.5 million note of a bankrupt company at an unknown discount and credit-bid all of it, setting a hurdle that deterred competing bids. While some grouse about creditors being able to credit-bid the full amount of debt that they bought at a discount, others defend the practice. "[Credit bidders] paid for the advantage," says John Jerome of Saul Ewing LLP. "If the lender bought the loan, it bought the advantage." Bankrupt companies acquired through credit bids, however, aren't usually quick flips or fixes, especially if the offers at auction were low. When bankrupt professional engineering firm STS Consultants Ltd. was looking for a buyer, it attracted bidders. But they didn't offer more than the company's secured debt. STS lender Northern Trust Co. didn't want to own the company, but it felt compelled to credit-bid after other offers were received, Welnhofer says. Northern Trust owned the company for a short while, but it eventually sold it to the company's employees. "When the smoke cleared, the bank sold the company to the employees at a price which was greater than the auction results but less than the value of the debt," he says. Alas, as long as acquisition finance is scarce and secured debt trades at large discounts in the secondary market, Section 363 auctions will be fertile ground for credit bids. That will especially be the case if there's a wave of commercial real estate bankruptcies over the next two years, says Orrick Herrington's Holden. Even bank lenders may actually join the credit-bidding fray because it isn't difficult to own an office building, he says. They'll have competition, of course, from folks grown accustomed to feasting on the discounted debt for sale. "A lot of debt was bought up by hedge funds and the like, which represents raw material for credit bidding," Welnhofer says. "I wouldn't be surprised if we saw an uptick in credit bids." That'll probably be the only thing that won't be a surprise.
Also see: Lehman, Chrysler, GM: The fallout | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Not long ago, the idea of loaning money to a company in need with an eye toward eventually owning it was seen as a sinister plot hatched by private equity firms, hedge funds and rapacious individuals, eager to take advantage of the corporate downtrodden.
|
|
|
|
|
