đŸ’„Student Loans in America = a Hot MessđŸ’„

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Will bankruptcy courts solve a national crisis?

America’s student loan crisis shows no signs of abating.

A plot of loan debt growth over the past twenty-odd years shows a healthy upward trajectory, with the current number at a whopping $1.7t dollars, 90% of which is held by the U.S. government. For context, Americans owe more in student loans than they do in either credit card or auto loan debt.

Over 40% of outstanding debt was for graduate school students, as masters students end up taking on more than twice the debt of their undergraduate counterparts without the corresponding incomes needed to justify the degrees. Though some colleges have pledged to adopt “need-blind” admission policies to ensure their programs are affordable, these policies are only feasible for the most elite institutions with the largest endowments. Moreover, the recent pandemic-induced financial crisis — however short-lived it may have been for some segments of the economy — has had a disproportionate impact on low income, first generation, women, and minority students. Those saddled with prohibitive loan debt are less likely to start small businesses and spend on goods and services, foreclosing them from the activities that keep the gears of our economy running. Not to mention the psychological burden of carrying around a load of debt that never seems to get smaller. M.H. Miller writes for The Baffler:

After ten years of living with the fallout of my own decisions about my education, I have come to think of my debt as like an alcoholic relative from whom I am estranged, but who shows up to ruin happy occasions. But when I first got out of school and the reality of how much money I owed finally struck me, the debt was more of a constant and explicit preoccupation, a matter of life and death.

Politicians are finally chipping away at the problem, albeit in small chunks. Congress recently agreed to cancel around $6b in student loans for borrowers that have a total and permanent disability. Recognizing the live nature of the issue, progressive democrats have called for cancellations of up to $50k in loan debt as a starting point.

Though the Biden administration campaigned in support of cancelling up to $10k in loan debt (one of the more moderate positions among the ‘20 Democratic presidential candidates), it has so far settled for just rolling a loan repayment freeze through May 1, ’22 (and that came at the 11th hour). It’s questionable whether President Biden has the legal authority to cancel student loans without explicit Congressional authorization, and well, we know there hasn’t been any love lost between the President and the moderate Senators he’d need to corral for any cancellation bill to make it through Congress.  

Student Loans in Bankruptcy

Millions of debtors unable to pay back their loans, without any government relief in sight? Seems like yet another scenario where the bankruptcy courts can fill a void left by Congress.

But not so fast.

Since 1976, federal student loan debts have faced barriers to the traditional bankruptcy discharge available to other debtors, purportedly to protect taxpayers from footing the bill for savvy Americans who earned their degrees and then quickly used the discharging powers of the bankruptcy court to cleanse themselves of their student loans. Debtors were forced to wait at least five years after their loans were due to apply for a discharge. The law became progressively more prohibitive, as the waiting period was first extended to seven years before being eliminated altogether in 1990. Private loans were given the same treatment in 2005. Of course, the situation in 2005 was not nearly as dire: back then, student loans accounted for just 15% of a household’s non-housing debt. Now? It is 40% â€” it turns out that skyrocketing tuition inflation



and predatory loan servicers that made it as difficult as possible to repay loans are a killer combination. Indeed, the latter issue is/was so big that last week DE-based Navient Corp. ($NAVI), one of the nation’s largest private student loan servicers, entered into a $1.85b settlement with a coalition of (39) state AGs for steering borrowers into interest-accruing forbearance plans rather than enrolling them in low-cost repayment plans. As part of the settlement (which is still subject to court approval), Navient will cancel the loans of 66k borrowers — totaling $1.7b of loan forgiveness — and make another $95mm in payouts to the states. The loans impacted by the proposed settlement were all issued between 2002 and 2010 and have all since defaulted (PETITION Note: this seems like a nice move by Navient: it will cancel defaulted debt it likely would struggle to get paid back anyway and remove a meaningful litigation overhang in the process. This company is publicly-traded: the stock moved down just a tick on the news. Interestingly, the stock is up 37.3% over the past five years and 94.5% over the past year. It even pays a pretty good dividend which, considering the allegations, is a bit of a perplexing wealth transfer.).

The Undue Burden Exception

As anyone even remotely acquainted with the American legal system knows, however, every rule has its exception. In the case of student loans though, the exception is especially difficult to satisfy. Debtors seeking to discharge their student loans must first initiate an adversary court proceeding in bankruptcy court against the loan holder (the U.S. Department of Education if the loan is publicly held, or whatever deep pocketed student loan servicer if the loan is private). Debtors must then follow Bankruptcy Code § 523(a)(8) and meet the Brunner test — that is, prove an “undue hardship” amounting to what courts have called a “certainty of hopelessness.” Considering a majority of circuit courts have adopted this standard, it’s unsurprising that bankruptcy courts haven’t been able to provide much relief to debtors, worthy or not. As a result, just 0.1% of debtors with educational loans who filed for bankruptcy even attempted to discharge them. Successful discharges are newsworthy events — an aspiring lawyer who took out tens of thousands of dollars before failing multiple attempts at the bar was eventually granted a discharge (after a ten year long legal battle), but only after getting chewed out by a displeased district court that cited his wife’s lack of full employment as a reason not to discharge his loans. Considering the paucity of discharge attempts, success stories are few and far between.

Recognizing the need to unburden debtors from the yoke of their loans, a few courts have split from this test. Rather than requiring the misery-inducing “certainty of hopelessness” quoted above, the Eighth Circuit and some courts in the First Circuit evaluate the “totality of circumstances” in evaluating a debtor’s hardship. These types of balancing tests are more debtor friendly than the rigid, inflexible, conjunctive test used by most courts. Indeed, one study found that debtors in a circuit using the totality standard were more than twice as likely to secure a discharge. However, recent efforts by bankruptcy judges to shift to this more forgiving standard have been rebuffed, setting the stage for a circuit split.

So, what gives? What happens when two courts of equal stature disagree on something of such immense consequence? Well, first, an enterprising law student will probably write a law review note on it.

Then, hopefully, the all-powerful Supreme Court of the United States will weigh in to set a unifying standard. SCOTUS had a perfect chance to do just that in McCoy vs. United States, a 2021 case where a 62 year-old woman requested the discharge of over $300k of student loan debt incurred while pursuing her doctorate degrees. The case was closely watched by the bankruptcy bar, with various luminaries of the bar submitting amicus briefs and pushing the court to resolve the split. As it tends to do, the SCOTUS denied certiorari, dooming Ms. McCoy to her unfavorable circuit court ruling and keeping student loan debtors in the dark about the dischargeability of their loans.

The “Educational Benefits” Distinction

Student loan debtors and their industrious attorneys developed a new method to attack the dischargeability of their loans; they have recently argued that some loans issued by private lenders aren’t the type of loans that ought to be guarded by the Bankruptcy Code. At the risk of oversimplification, Bankruptcy Code § 523(a)(8) exempts three types of student loans from discharge: (i) federally backed loans, (ii) loans received as “educational benefits”, and (iii) “qualified educational loans” that fund only higher education expenses. Some debtors have taken the tack of arguing that their private loans don’t fit into the “educational benefits” bucket and so, are prone to discharge. The policy reasons for such a distinction hold water – after all, there’s no reason to coddle for-profit lenders who ended up making non-credit worthy loans. Last year’s Homaidan case lent credence to these theories. The Second Circuit ruled that the private loans a student incurred to attend undergraduate school were not “educational benefits” protected from discharge. Instead, loans would only qualify as “educational benefits” when they bore resemblance to conditional grants, such as when a football player receives a scholarship contingent on their continued play on the football team, or an ROTC student receives a stipend for remaining in the program for at least two years. Unfortunately, the court didn’t actually qualify the scope of the discharge exception, making it difficult for future debtors to model their case after this one. Other circuits have adopted a similar approach to private loans, including the Fifth Circuit and the Tenth Circuit. We have yet another circuit split, as, again, most other circuits hold that both public and private loans are non-dischargeable without the undue hardship exception.

SCOTUS again had a chance to resolve which (if any) private loans qualify for discharge in Conti v. Arrowhead Indemnity Co. and again, it left loanees in the lurch by denying certiorari. As a result, it’ll remain unclear to debtors whether they have a strong discharge case, though courts that have considered the issue evaluate the purpose for which the loan was taken (i.e. a loan that was taken out for living expenses may be eligible for discharge, while one that was taken out for textbooks may not be). Considering that this line of cases would impact only private loans, which constitute only 10% of the total student loan market, it’s debatable whether a favorable ruling is the relief that’s needed, anyway. Hello, Congress, anybody home?

Useless Congress: Want to Do Something for Once?

Has SCOTUS declined to weigh in because it sees Congress weighing the issue? Legislation to amend bankruptcy discharges has gotten as far as the “FRESH START through Bankruptcy Act” introduced, on a (surprisingly and rare) bi-partisan basis, by Senators Durbin and Cornyn in August of 2021. The bill would make federal student loans eligible for discharge ten years after the first payment is due. The Code could benefit from an update in this area, considering the current law was written when student loans were not nearly the issue they are today. In addition, the inflexible Brunner case was decided when courts allowed some discharges of student loans taken out 7 years after filing, implying it may need an update. The quiet legislative front since the introduction of the bill, however, portends that an amendment is not in the cards anytime soon.

As an alternative, the Biden administration has pledged to alter its enforcement against student loan debtors seeking to discharge their loan debts. As the creditor to most student loanees, the Department of Education is tasked with contesting bankruptcy discharges. It has traditionally used the rigid “certainty of hopelessness” standard to do so. As recent as October of 2021, Department officials testified before a House education subcommittee to acknowledge a need to reform the standard it uses. These changes have been backed in part by organizations including the American Bar Association, whose constituent lawyers leave school with an average of $138,500 in educational loan debt. For now, the department has agreed to any stay of proceedings requested by debtor plaintiffs until at least the student loan payment pause ends – once that expires in May though, it’s anyone’s guess as to what’ll happen. đŸ€”

It’s unclear whether bankruptcy courts retain a role in solving the student loan crisis. Chief Judge Morris’ attempt to do so in the Rosenberg case was rebuffed, and future attempts seem destined for the same fate. Until then, and barring a congressional solution, will we see opportunistic student loan debtors traveling across the country to file in slightly more favorable circuit courts? Any model plaintiffs out there?  

😎The Professionals Weigh In. Part II.😎

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Pros opine on the big restructuring themes for 2022.

Source: Getty Images

Last Wednesday — after publishing thousands and thousands of words over the course of 2021 — we finally took a step back and shut the hell up (though we still had plenty to say in Sunday’s a$$-kicking paying subscribers’-only briefing).

Instead, we reached out to a variety of restructuring professionals* and asked:

✅ What would be your selection for the chapter 11 bankruptcy case of the year and why (don't shamelessly list your own)?
✅ What are 2-3 of the biggest restructuring themes to emerge out of 2021?
✅ Given all of the excitement around mass tort cases like Boy Scouts of America, Purdue Pharma and J&J, what do you think Congress will do about venue and third-party releases, if anything? What should be done?

You can see their answers here.

This week we return to our panel with questions about the future. One important note: answers were, for the most part, submitted on December 13th. Enjoy.

PETITION: Put your prediction cap on: what do you think the 2-3 big restructuring themes of 2022 will be?

Pilar Tarry: “Overall, 2022 will be in like a lamb, out like a lion. If we keep clawing back from this pandemic slowly, and all signs are it will continue to be slow, companies in the hospitality and tourism space will start to crumble. The pace of change in monetary policy will be interesting to watch. It’s like a giant game of Jenga once all the obvious pieces are out.” 

David Meyer: “Rising interest rates will not have an immediate impact on restructuring activity.  But inflation will play a larger role in the latter half of the year coupled with easing of federal assistance together with supply-chain challenges and a decrease in consumer spending. 2022 will largely mirror 2021 with acute and unforeseen situations emerging as the most likely restructuring candidates. Accelerated prepacks will become the norm, and the public announcements about the fastest in-court restructuring ever will cease.”

Brian Resnick: “First, real estate. The pandemic abruptly altered many existing real estate trends.  Nobody is really sure where things will go next but investors are placing different bets— return to work vs. hybrid work; whether remote work leads to less office space or the pandemic leads to the need for more space so employees can be sufficiently distanced; finance and tech moving to Florida and Austin; business travel as usual or zoom meetings here to stay; demand for additional workspace in suburbs and warmer remote work destinations; continued growth of residential housing prices; rising interest rates cooling that growth.  Real estate bets are usually highly-levered and not all of these predictions can turn out to be right. Next, China. The restructuring world is obviously watching Evergrande and Kaisa closely, given the more than $5 trillion in debt that Chinese developers took on during the country’s recent building boom.  Total sales among China’s largest developers have plummeted over 35% year over year.  Any restructuring of the country’s major developers could have cascading effects throughout a very large industry and national economy.  If the Chinese government allows for restructuring of these distressed businesses or does not successfully manage these economic pressures, the global reverberations can be massive. Lastly, opportunistic recapitalizations. Last year, companies with medium-term debt maturities amended and extended loans to take advantage of favorable rates and market conditions.  That trend will probably continue this coming year as companies with 2023-2024 maturities opportunistically look to recapitalize and get additional runway while the getting is good.” 

Natasha Labovitz: “I don’t think we’ve seen the end of targeted mass-tort restructurings, or the related focus on third-party releases.  As more people understand what the so-called “Texas two-step” really is (hint, it’s really no more or less than a spin-off using 21st century deal technology) I predict some of the furor will die down, but the litigation will remain.  Speaking of litigation, we’re also likely to continue to see cases that sharpen the line between what borrowers and majority groups of lenders can – and cannot – do to minority and holdout lender groups in the context of liability management.  And, I’ll go way out on a limb and say that 2022 will be a year when some checks come due for businesses whose pandemic-era borrowing dwarfs their post-pandemic business prospects.  Lenders’ patience and the era of easy money will not last forever.”

Rachel Albanese: “(1) Will there be large restructurings in 2022? When will the bubble burst? (2) More mass tort action. (3) Your guess is as good as mine!”

Matthew Dundon: “Impact of higher rates, including return of a key credit metric only analysts over 40 remember – EBITDA to interest expense; recency bias luring people into low-priced 2L and unsecured bonds and loans shortly after filings because that was the money-making trade for the past couple of years.”

George Klidonas: “Third party releases, unless the Supreme Court or Congress weigh in sooner rather than later to determine the issue. Out of court restructurings, creditor on creditor violence, and liability management litigation will likely continue, particularly if certain market conditions continue.”

Damian Schaible: “Bootstrap A&Es â€“ As many have discussed, we have added tremendous leverage to the market and capital structures over the past couple of years, and financing documents have gotten looser and looser.  As a result, there are often no traditional triggers, so capital structures can more easily persist through poor performance with liquidity issues or maturities being the only practical limitations.  With investors currently interested in keeping money to work wherever possible and obvious uncertainty in the future with respect to how long this remains the case, sponsor portfolio companies and public companies alike are looking for ways to extend maturity runways by multiple years.  Wherever traditional refinancings can be used, they will be.  Where leverage or performance issues mean that’s not on the table, companies are engaging with existing creditors to seek maturity extensions in exchange for new junior capital and/or better documents and/or terms.  We will see this dynamic accelerate until rising rates begin to bring people to the table more naturally.

Liability Management - As you’ve often reported, docs are now looser than ever before, and when you add to that investors looking desperately for things to do, you get lots of liability management opportunities for companies that would be distressed in normal times.  We will see lots of liability management exercises in 2022 as a result.

Inflation and rising rates - It’s no longer “transient” and it’s the only thing likely to stop the music at this current all-night market rager
. Inflation is the one thing the Fed can’t really manage away, and it would lead to rising interest rates that would stop the party for a lot of severely over-levered balance sheets.  (How is that for mixing metaphors?!) Who knows if it will happen in 2022 or later, but rising rates could change the game.”

Chris Ward: “First, I could have used this as a 2021 theme as well, but the continued downturn in the restructuring industry.  It will undoubtedly change, but the start of 2022 will continue with the entire industry continuing its sabbatical.  I believe my ’21 prediction was when is the wave coming?  Unfortunately, the answer may once again be – next year. Second, scrutiny.  Whether its third-party releases, independent directors, conflicted professionals, the enhanced scrutiny on the legal profession will again be a prominent part of our practices. And, third, out of court alternatives. Given the state of the economy and liquidity available to PE firms, the biggest trend may be what happens outside of bankruptcy courts.  There are still plenty of distressed companies and there are still many deals being done.  We have seen an uptick in Article 9 sales, distressed M&A deals being done out of court, and state law alternatives like ABCs and Receiverships.  When times are tight, people want to do the deal and not have to pay the costs of a full chapter 11 process.  I think this trend will continue into ’22.”

Navin Nagrani: “First, just technically speaking  - interest rates rising in 2022 coupled with the Fed plans for tapering will generally cause market and asset valuations to come down and the cost of indecision and inaction to increase (as it relates to loans in workout). Second, I think we will see more private equity sponsor backed loans in workout amongst traditional banks and non-bank lenders (BDCs, private credit groups, SBICs, etc.). Lastly, real estate in general is a slow moving asset compared to other assets like inventory or receivables..  There are some fundamental issues going on with certain types of real estate right now like office that will eventually make its way onto the restructuring scene as rents roll over and/or debt comes due.”

Steven Korf: “Third-party releases and venue shopping will continue to be hot topics into 2022. As a healthcare advisor, I would be remiss if I didn't mention the themes we are predicting in the healthcare industry in 2022. With temporary stimulus funding drying up from the CARES Act, the financial strain on hospitals and health systems will no longer be masked. While we expect hospitals may receive limited funding from the various federal infrastructure and support packages going forward, it will only provide a short-term solution to long-term operational problems and extend the timeline for entities that would otherwise be absorbed by larger systems, file for bankruptcy, or close.”

PETITION: What is the disruptive innovation trend that you’re most curious about and why?

Natasha Labovitz: “I’m interested to see what happens next in the so-called “Great Resignation”. Is this a short-term pandemic-driven phenomenon, fueled by media hype and a very catchy name, or is it in fact a societal shift that has been long in coming, which ultimately will rebalance the economic power between employers and employees and reshape the definition of career success?”

Chris Ward: “Hybrid court hearings.  Rightfully so, much ado is made about the cost of bankruptcy. However, virtual court hearings can drastically reduce the cost of professional fees for cash strapped debtors. Hybrid hearings would allow the soccer team that some firms send to the first day hearing to stay home and virtually participate.  We are approaching two years of virtual hearings and the courts and the entire restructuring industry have not missed a beat. This trend should continue, with the caveat that some evidentiary hearings and case events must be in person to delve into the veracity of the witnesses, but this is a positive trend that benefits everyone.”

David Meyer: “Zoom and 5G/increased high-speed connectivity.  Will facilitate work-from-home trends, change the way we do business (all in favor of Zoom first-day hearings raise your hand), how we shop, how we interact with each other, and how we manage our teams and optimize our culture at our respective firms.  It is inescapable that all restructuring professionals have a different work experience than they did just a few years ago, and this is arguably most impacted at the more junior levels.  The impact is at its earliest stages and will have long-lasting consequences.”

Brian Resnick: “In recent years, particularly in 2021, direct lending has increased precipitously in number of funds (to over 700), capital (to over $300 billion) and deal size (some recent ones exceeding $2 billion).  A common direct lending unitranche structure, where a single lender (or small group) holds the debt (sometimes a single lien, first out / second out structure) without syndication, has been a major selling point for direct lenders to act more like partners invested in the borrower’s success.  This structure allows a borrower that becomes distressed to negotiate with one or a small group of lenders.  The large-scale direct lending market did not exist prior to the 2008 crash, and it will be interesting to see how direct lenders manage the next downturn.  In the current borrower’s market, lenders competing hard for deals often try to market themselves as having a collaborative and flexible client-service reputation.  If defaults start to increase, direct lending funds will have to make tough calls to balance their drive to compete for new loan origination (to deploy significant accumulated capital) with the need to minimize losses from existing portfolios.  Direct lending transactions typically (though not always) still include leverage ratio-based financial maintenance covenants, so those lenders have more ability to push for restructuring than under the “covenant-lite” term loans that have become the norm across the broadly syndicated market. Direct lending structures also often include additional powerful lender protections, like pledge rights allowing lenders to replace boards.  The documentation used in direct lending transactions has not yet been tested as extensively as for more traditional loan market structures.”

Rachel Albanese: “Activist “stonk” investors.  For example, will Macy’s cave to the recent demand to create a Tesla showroom in its flagship stores and start accepting crypto? How will AMC’s new popcorn business fare? Will any CEO of a public company actually show up at an investor conference sans pants and, more importantly, how would it affect the company’s stock?🚀 🚀 “

Damian Schaible: “SPACs
. In 2021, we saw tremendous numbers of both early stage and potentially distressed companies go public through SPACs.  I am interested to see how these companies perform longer term and what the market implications will be.  Traditionally, for companies to go public, the companies and their governance, financial reporting and other systems had to be much more mature than many SPAC companies are – the traditional IPO underwriters would want to see late stage, seasoned companies looking to go through a traditional IPO process.  There obviously isn’t a lot of debt on these companies, so it is unlikely to lead to large numbers of traditional restructurings, but I am interested to see how they operate longer term and what regulatory and litigation impacts may develop.”

Navin Nagrani: “WFH has created massive ripples in the way people work and interact with others.  What is our new normal? Decentralized finance is happening - what are the downstream implications and opportunities for restructuring professionals?”  

George Klidonas: “Although I am not necessarily certain if, how and when cryptocurrency will completely disrupt the system it was intended to, i.e., replacing fiat or government-issued currency.  But one thing is for sure.  Cryptocurrency is infiltrating our everyday life more and more, e.g., Overstock, PayPal, Etsy, Starbucks, Dallas Mavericks, and the more mainstream it becomes, the more likely we are to see disruption in both the industries it is accepted in, as well as the financial institution sector as a whole.”

Ryan Preston Dahl: “No idea what “disruptive” even means anymore.  I’m not a millennial.”

Steven Korf: “I am interested to see how Artificial Intelligence (AI) and machine learning, as well as new entrants to traditional healthcare delivery, will continue to disrupt the industry.

AI and machine learning are future disruptors that cryptocurrency analysts and Elon Musk, Disrupter-In-Chief, are suggesting will reframe life over the next decade.  Both will be backbones to support predictive modeling for global health trends, climate change, and geographic displacements, which could contribute to economic upheaval.

Large commercial corporations and private equity firms have entered the healthcare market and are providing new channels of care and disrupting current providers. While this may be painful for many existing traditional organizations, I predict that we will see improvements to the delivery of care at more cost-effective rates with the new entrants.”

Pilar Tarry: “Well if you must know, crypto.  Because I just don’t get it.  Now that Gwyneth is officially in the game though, maybe I should circle back on that.”

Matthew Dundon: “Restructuring professionals and distressed investors have no idea of the informality of – or absolute absence of – corporate organizational structures and financial records in even quite large blockchain / crypto / defi companies (or “companies” in some cases).  Failures of those entities will be extremely challenging in every sense (conceptual, execution, etc.).”

Dan Dooley: “Back to the Future Supply Chains. It’s already started but you will see significant resourcing back to North America from the Pacific Rim and especially China as the labor cost differential is not nearly as great as it was 10 years ago, the pandemic has exposed the logistics risks of over-the-ocean sourcing and the relatively new political risks with sourcing specifically in China and perhaps in Taiwan as well.”

PETITION: What are you “short” going in to 2022 and what are you “long”? 

Steven Korf: “In 2022, I’m "short" China based on the evolving but unresolved Evergrande situation (multiple defaults and the Chinese government’s recent lowering of capital ratio requirements for its banks which seems to hint at something more serious) and recent IPOs for overvalued tech and direct to consumer retail companies.

LONG: ??? I am a restructuring professional.”

Natasha Labovitz: “Short the ski season in my Southern Vermont homeland, where the lack of snow makes it feel anything like Christmas-time as I type this.  Long party dresses, airplane tickets and Broadway, as pent-up demand seems to be overcoming all fear of COVID variants.  Omicron who??”

Chris Ward: “Long – Restructuring professionals.  Conservatively, $4 TRILLION was pumped into the U.S. economy during the pandemic.  Not to mention the recent $500 MILLION infrastructure bill.  Inflation is already running rampart.  Omicron (and whatever the next variant will be) are threatening closures again.  The supply chain may never recover.  This economy will crumble faster than Kevin Spacey in House of Cards.  Like dragons in Game of Thrones, restructuring professionals will resurface and rule Westeros once again! Short your 401(k). See the foregoing.”

Brian Resnick: “Short predictability.  Major freefall chapter 11’s have become fewer and farther between, but market conditions have put pressure on the usual tools that lenders and potential acquirers use to try to keep prearranged and prepackaged cases streamlined.  Stalking horse protections are less likely to deter competing bidders when valuations can rise rapidly.   Lenders looking to use a fulcrum security to acquire a debtor will continue to face the high-class problem of payment in full as more junior creditors or even shareholders take a large share of exit ownership.  A growing number of sophisticated players are under intense pressure to find strategic advantages in a smaller number of cases, leading to increasingly creative and aggressive strategies.  Out-of-court lender-on-lender violence in liability management transactions (uptierings and drop-down financings) has become increasingly common. A “first lien” piece of paper doesn’t assure a lasting first lien position the way it used to.  More than ever, stakeholders need to look carefully around every corner to anticipate non-obvious arguments and angles that could weaken their position and leverage in a restructuring.

Long volatility and major disruption.  The world feels like it is going through the most rapid rate of change in my lifetime, in both positive and negative ways.  We’ve seen a surge in development of new potentially-transformative industries based on technologies like artificial intelligence, the metaverse, blockchain and cryptocurrencies, electric (and maybe self-driving) cars. At the same time, there is increased focus on growing wealth-disparity, social polarization, climate-based risk, inflation and other collective challenges.  Aggressive fiscal policy has so far allowed the US economy to dodge the economic shocks of the pandemic, and it is hard to predict what will disrupt the current equilibrium or when that will happen.  Upcoming efforts to tighten today’s easy money fiscal policies during a credit-fueled market boom will require the federal reserve to walk across a shaky tightrope with lots of risk for a misstep.”

Rachel Albanese: “I’m “short” low orbit “space” travel (it’s like going to The Four Corners and saying you’ve been to each state). I’m “long” DTC – not necessarily the existing brands (Allbirds!) but the concept – and malls too.”

Damian Schaible: “Short Traditional Restructurings - Until inflation and rising rates call the police on the party, there won’t be a lot of traditional restructurings.  As discussed above, sponsors and public companies will use market refis, SPACs, additional leverage, liability management and bootstrap A&Es to delay the inevitable as long as possible, and traditional equitizations will be fewer and further between.

Long Liability Management and Bootstrap A&Es — Loose docs and free flowing money will lead to more liability management and “bootstrap” amend and extend transactions to buy runway for sponsors, equity and junior debt.”

Ryan Preston Dahl: “My views on “short” remain completely unchanged since I last had the chance to chat with you fine fellas—although I do wish Mr. Springsteen a happy holiday.  In terms of 2022, I’m very long Amazon’s new “Second Age” series derived from the Lord of the Rings legendarium.  My fellow nerds in the PETITION readership know exactly what I’m talking about.”

Dan Dooley: “Short technology and the internet companies who are struggling to be cash flow positive. This bubble will burst just like the technology sector did in the year 2000 for Y2K. Long anything Mexico, which will be a big winner from the pandemic.”

David Meyer: “I am “short” on returning to the office (and business travel) returning to pre-pandemic practices.  The world has changed and there is no such thing as “a return to normal”. I am “long“ that 2022 will present further opportunities to balance the best in-person aspects of our work with the lessons learned over the last 20+ months to create a better, more enjoyable, and more efficient working environment – firms that do this well will be able to create stronger cultures that will generate sizable benefits over the long term compared to those who get left behind.”

Navin Nagrani: “‘Short’: I generally think the “metaverse” and most cryptocurrencies are in somewhat of a hype bubble - too many get rich stories/schemes.  There is no easy money over long periods of time and I think this principle will play out here as well. â€˜Long’: I continue to believe that relationships and health compound with energy, intention and time just as much as money does.  I am “long” on focusing on what’s really important in 2022.”  

George Klidonas: “Short Auto Sector.  The auto sector is likely to see short term stress particularly at a time when high demand for semiconductors and global bottlenecks throw supply chains into disarray.  These supply chain constraints could lead to decreased revenues, which in turn, challenge the ability for companies to deal with funded debt (especially at a time when the industry has taken on more debt).  And it is unclear whether higher car prices can fully offset reduced sales volumes.  Beyond 2022?  The industry’s migration toward autonomous vehicles could lead to long term distress for certain players in the auto industry.  But time will tell.

Long Financial Institutions. With the Federal Reserve signaling that they are going to raise interest rates in 2022, banks and financial institutions are likely to see an increase in revenues.  And with banks sitting on a ton of cash, they are likely redeploy capital back into the system.  I believe financial institutions (e.g., retail, commercial and investment banks, as well as brokerages) and FinTech are going to be big winners in 2022 if raise start to go up.”

Pilar Tarry: “Long: Cybersecurity firms/technologies as privacy and security concerns increase with higher use of technology and living more of life online. Short: Hospitality, tourism and urban mobility. Long: E-logistics companies. Short: the ultra-short case, except where the business consequences are truly disastrous. Long: Anyone who can successfully navigate the growing divide between high and middle income countries and poor countries, and similar divisions in families here at home. Short: 2nd years, after almost two years of trying to learn how to do this work in a WFH environment, it’s not surprising they’re looking at their options.”   

đŸ€”

* Pilar Tarry is a Managing Director at AlixPartners. Damian Schaible is a Partner at Davis Polk & Wardwell LLP. Rachael Albanese is the Vice-Chair of the Restructuring Group and a Partner at DLA Piper. Dan Dooley is a Principal and CEO at MorrisAnderson. Ryan Preston Dahl is a Partner at Ropes & Gray LLP. Chris Ward is a Partner and Practice Chair at Polsinelli. Brian Resnick is a Parter at Davis Polk & Wardwell LLP. Navin Nagrani is an Executive Vice President at Hilco Real Estate. Natasha Labovitz is a Partner and the Co-Chair of Debevoise & Plimpton’s restructuring group. Steven Korf is a Senior Managing Director at and Co-Founder of ToneyKorf Partners. Matthew Dundon is a Founder and Principal of Dundon Advisers LLC. David Meyer is a Partner and Co-Head of Vinson & Elkins’ Restructuring and Reorganization group. George Klidonas is a Partner at Latham & Watkins LLP.

đŸ’„A Bomb Just Dropped in Purdue PharmađŸ’„

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District Court Judge Vacates Bankruptcy Court Approval of Sackler Releases

Let’s get this out of the way: yes, clearly, Purdue Pharma is UNEQUIVOCALLY the biggest loser of the week. This is literally the easiest call we’ve ever had to make.

In a 142-page opinion, Judge McMahon of the United States District Court for the Southern District of New York dropped a bombshell of a decision and order on appeal vacating Judge Drain’s bankruptcy plan confirmation order — an order that, among other things, blessed non-consensual non-debtor-third-party liability releases of the Sackler f*ckfaces. We’ll spare you the lengthy read (though we do recommend it): the Judge concluded that the USDC had both legal and factual de novo review; that there was zero statutory predicate for Judge Drain to approve the releases (effectively neutering the catch-all power of Bankruptcy Code section 105 in the process); that, in the absence of statutory authority, there is no such thing as “residual authority”; and that the Sacklers are just generally sacks of sh*t. Ok, ok, Judge McMahon didn’t expressly say that last bit but it is implied: after all, as the Judge takes pains to note, it’s clear from the factual record that the Sacklers consulted with bankruptcy attorneys immediately after entering into a ‘07 plea deal and then, over a period of many years, siphoned off assets (~$10b) into impregnable legal structures in far flung places to shield themselves in the event of an eventual bankruptcy they knew was well within the realm of possibility. These people truly are something else.

These people will also most certainly appeal — something Judge McMahon
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😎2021: Restructuring Professionals Weigh In. Part I.😎

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Experts Cite Purdue Pharma and Hertz as Bankruptcy Cases of the Year

Not to state the obvious, but it’s been a wild year. We’ve covered it like crazy, twice a week, every week with barely a break.

So now it’s time for us to shut the hell up and give others an opportunity to share their perspectives. We reached out to a variety of restructuring professionals* for their thoughts on a few things. Without giving anyone much lead-time whatsoever, we only had one bit of real guidance: “[t]he best answers are succinct with personality.”

In this edition you get to see what our panel had to say âŹ‡ïž.** You can be the judge as to who can follow instructions and who cannot. 😜

* Damian Schaible is a Partner at Davis Polk & Wardwell LLP. Rachael Albanese is the Vice-Chair of the Restructuring Group and a Partner at DLA Piper. Dan Dooley is a Principal and CEO at MorrisAnderson. Ryan Preston Dahl is a Partner at Ropes & Gray LLP. Chris Ward is a Partner and Practice Chair at Polsinelli. Brian Resnick is a Parter at Davis Polk & Wardwell LLP. Navin Nagrani is an Executive Vice President at Hilco Real Estate. Natasha Labovitz is a Partner and the Co-Chair of Debevoise & Plimpton’s restructuring group. Steven Korf is a Senior Managing Director at and Co-Founder of ToneyKorf Partners. Matthew Dundon is a Founder and Principal of Dundon Advisers LLC. David Meyer is a Partner and Co-Head of Vinson & Elkins’ Restructuring and Reorganization group. Pilar Tarry is a Managing Director at AlixPartners.

** You can see last year’s entries here and here.

PETITION: What would be your selection for the chapter 11 bankruptcy case of the year and why (don't shamelessly list your own)?

Source: Getty Images

First, here is Damian — in true lawyerly fashion — threading the needle with a generous interpretation of our “don’t shamelessly list your own” instruction 😂
.

Damian Schaible: “Purdue [Pharma] is likely the most complex Chapter 11 case in United States history. It had more than $40 trillion of filed claims, more than 614,000 claimants and more than 120,000 creditors voting on the plan, each of which is without precedent. The more than 15 interlocking settlements embodied in the plan include the federal government, 38 attorneys general and 11 ad hoc groups representing every conceivable category of claimant against the company and the Sackler family. The plan received virtually universal support, with more than 95% of creditors voting to accept. It contemplates turning the debtors into a public benefit company for the benefit of the American people and also embodies a $4.325 billion settlement with the shareholders.”  

I know you said not list my own case.  Davis Polk leads Purdue as you know, but I have nothing to do with it, and it’s really hard not to list it in my mind
.”

Natasha Labovitz: “Purdue [Pharma] has to be the case of the year. It’s significant in dollar value, but much more importantly, it will have a meaningful impact in big cities and hometowns across the country.  The company is on the verge of obtaining approval for a $4.35 billion settlement payment and leveraging that to provide critically important opioid abatement and treatment options in the local communities where help is needed.  Hulu dramatizations and Elizabeth Warren criticism notwithstanding, the settlement in Purdue represents a faster, better and more evenhandedly positive outcome for claimants than endless years of litigation that would delay recoveries, reward some litigants at the expense of others, and divert available funding to the lawyers representing both sides instead of to the communities where it can be most helpful. I’m not saying paying lawyers is intrinsically a bad thing – but in this case, I think there’s a higher and better use for the Sacklers’ settlement funds.”

Dan Dooley: “Purdue Pharma. We will soon find out whether 3rd Party Releases in a Chapter 11 Plan are what Congress intended or not. I think they are not!”

Ryan Preston Dahl: “Purdue [Pharma], without question.  Purdue has crystallized so many legislative, social, and public health issues beyond the scope of this particular article or any article for that matter—separate and apart from Purdue “just” being a massively complex chapter 11.  And, for me, the most interesting part is the extent to which at least some members of Congress seem to have Purdue squarely in mind when they speak to, or about, legislating the Bankruptcy Code.  But this legislative discourse seems to be occurring without at least some sense of irony or self-awareness.  One might say that it’s largely a result of Congressional inaction in the face of a massive public health challenge that has caused the bankruptcy courts to become, it seems, the only forum available to address these challenges in a collective way.”

But there are others who thought Hertz stole the show


Source: Getty Images

Rachel Albanese: “Hertz, because of the headlines and the positive outcome for stakeholders.”

Matthew Dundon: “Hertz. Rough start and then solid run to a par+ outcome.  Broader economy helped, but still saw textbook executions of many different value creation strategies by different stakeholders.”

Chris Ward: “Hertz.  Plain and simple.  Kudos to the professionals that shepherded Hertz through chapter 11.  Taking a floundering car rental company through a process that turned a zero cent recovery into a 100% return for creditors and a distribution to equity.  That is what chapter 11 is all about. The Hertz debtors used every play in the playbook to maximize value and were not afraid to take chances to get to the appropriate end game.”

Brian Resnick: “My vote for case of the year is Hertz.  In summer 2020, many in the industry (maybe even me) chuckled when Hertz shares popped above $5. The company had just filed for chapter 11, the pandemic had shut down travel, and the restructuring community debated whether Judge Walrath should even let the bankruptcy estate exploit naĂŻve speculators by selling $1 billion of shares that that debtors’ own lawyer admitted in open court “might be worthless.”

The story of 2021 is how equity investors got the last laugh.  It wasn’t just frothy equity markets, the “meme stock” phenomenon, and masses of individual investors helping boost struggling companies like AMC and Gamestop.  Large, sophisticated distressed funds that had raised significant war chests found themselves in competitive auctions for chapter 11 debtors like Hertz, putting shareholders in the money by billions of dollars.  Equity committees also became important players in major 2021 bankruptcy exits of Latam and Garrett Motion.  Economic logic says this trend cannot become the norm – companies generally will not file for chapter 11 when they can raise equity instead.  But in the topsy-turvy world of 2021, betting on equity recoveries had a nice run.”      

Steven Korf: “The Hertz bankruptcy. The case looked a lot more like the old school, successful, balance sheet restructurings we used to see in Chapter 11, versus the 363 liquidation sales that have become the standard more recently. Secondly, Belk deserves a notable mention for emerging from bankruptcy with record speed, though some think the jury is still out on whether the restructuring will ultimately be successful.”

David Meyer: “Hertz.  A symbol of all that 2020 and 2021 have to offer including a freefall into chapter 11 near the height of the pandemic, an unprecedented (and successful!) effort to raise equity inside a chapter 11 process that was subsequently halted, the Company gathers itself and seeks to utilize the tools of chapter 11 to right-size its balance sheet while exploring alternatives, the company then becomes propped by and leverages the open capital markets, a robust auction ensues behind the scenes and then publicly involving significant competition among sophisticated financial investors fighting over more limited opportunities, an equity committee organizes and emerges with a voice while the company simultaneously operates in chapter 11 but yet traveling remains behind its pre-pandemic heights, and a multi-day in-person gathering in Florida to decide the Company’s fate (and the winning bidder).  Normal?”

And then there is a offbeat choice which, we should point out, is rather interesting:

Navin Nagrani: “Rather than being micro and picking a specific case - will just zoom out and select "Subchapter V” and its second year of being in place as my selection here.   More small to medium sized businesses are going to end up going thru some sort of formal restructuring via this route.  It is important for restructuring players to understand not only the specific technical aspects of these new provisions but also some of the nuances and pitfalls associated with actually working within this relatively new framework. There is now enough case material to review and learn from.”

PETITION: What are 2-3 of the biggest restructuring themes to emerge out of 2021?

Source: Getty Images

Damian Schaible: “Junior capital coming into situations to buy runway – Unprecedented money raised and looking for homes has led to a number of situations where equity or junior creditors have been eager to put in additional junior capital quickly and flexibly in situations that in normal times would be restructurings.  I have been involved in a number of situations in the past year where the presumptive fulcrum creditors have headed toward a traditional restructuring and equitization only to have junior capital come in behind them to prop up the companies.  We will see how these work out in the coming year!

Third party releases – Purdue and the Boy Scouts cases have brought the somewhat arcane world of third party releases in bankruptcy cases under a real public microscope. There are a lot of social discussions underway about the propriety of non-debtors being released in cases, but the reality is that this type of release is completely de rigueur and more importantly often absolutely required to get settlements and restructurings done.  Congress is now involved and some cases can become much tougher if the rules are monkeyed with extensively.

Super short prepacks – We are seeing more and more “one day prepacks” used to effectuate consensual restructurings.  Once the very hard work of devising and achieving full consensus is done, we have traditionally had to wait (and pay for) about two months of process and delay.  Courts like the Southern District of Texas have been leaders in designing “due process orders” to make sure that everyone gets notice and an opportunity to come to court in the event of any impact on their rights.  So long as this important protection is provided, in the right case, it is just more efficient and significantly cheaper not to have to wait around in court to have a couple of extra hearings.”

Natasha Labovitz: “Well, the effects of the pandemic stimulus and easily available liquidity mean that we’ve all seen our kids and other loved ones a lot more.  Let’s not lose sight of that being a really good thing.  That said, it seems the restructuring professionals who have been re-deploying in the M&A, finance and mass tort arenas throughout 2021 are ready to return to more mainstream restructuring activity in the coming year.  As the M&A and financing markets become increasingly more frothy at the same time the pandemic stimulus begins to recede and the US and global political environments begin to appear less stable, it looks increasingly like the kind of late-stage credit cycle that puts our industry on high alert.  (Maybe a little like the way my dog perks up and trots to the kitchen when she hears the refrigerator door open 
 but surely we are more dignified than that.)”

Rachel Albanese: “(1) Where’s the Beef? Lots of money in the market led to dramatically less restructuring work in 2021. (2) The “toggle” plan – it was showing up everywhere for a while.”

Steven Korf: “The future of third-party releases (Purdue [Pharma]). The future of venue shopping (Johnson & Johnson and NRA).”

David Meyer: “Creditor on creditor tactics will continue with a dearth of restructuring opportunities. Continued shift from distressed for control funds to shareholder activist strategies and direct lending. Companies with scale that can tap capital markets do so and refinance or address near-term maturities; smaller companies are left behind for consolidation where available.”

Matthew Dundon: “Limits to third party releases, importance of fundamentals (e.g. EV:EBITDA relative value), and he who fights Fed is dead.” 

Navin Nagrani: “First, in periods of market dislocation, the perception of value is sometimes more important than actual value (Wall Street Bets mania, etc.). Second, industry practitioners have continued to accomplish things remotely that would have historically only have happened in person (court appearances, pitches, internal meetings, etc.). And, third, no one that I know of was able to predict the general nature the markets inverted in 2021 (in a mostly positive way) from the depths of the chaos COVID created in 2020.”      

Brian Resnick: “First, equity committees.  Equity committees played major roles in several of the biggest cases of the year.  From Hertz to Latam, bidding wars between sophisticated distressed investors put shareholders in the “fulcrum” position and gave them an important seat at the table negotiating bankruptcy exits.  It took an unlikely set of circumstances (and singular pandemic), but with stock market exuberance continuing, equity committees may become a more regular feature in cases with unpredictable market upside potential. Second, the Texas Two-Step. J&J made the Texas-Two Step famous enough to get Congress’s (negative) attention, following attempts by a number of other companies (Georgia Pacific, CertainTeed, Trane Technologies) to try to cabin massive tort liabilities by running these types of divisive mergers through bankruptcy in the Western District of North Carolina.  It is unclear whether any of these efforts will succeed or the tactic will be shut down legislatively or by the courts, but this novel maneuver may mark the high-water mark of restructuring aggressiveness and creativity.  Until the next one. And third, remote hearings.  Bankruptcy megacases in SDNY, Delaware, SD Texas and elsewhere continue to be conducted virtually even after many of their sister district courts and state courts are back in-person.  There are good practical reasons that bankruptcy may be more conducive to Zoom. And it appears that a larger share of bankruptcy court business may stay online even after the pandemic ends.  Aside from the obvious pros and cons, this development could also impact ongoing venue reform discussions.  For better and worse, videoconferencing makes every jurisdiction “local” enough that any employee or creditor can easily and cheaply participate in proceedings.  On the flip side, it also makes it less expensive for sophisticated bankruptcy professionals in the major restructuring markets to efficiently run megacases in faraway jurisdictions.”

Ryan Preston Dahl: “Just one:  inflation.  This isn’t so much a 2021 theme as it is a precursor of things in the “Ghost of Christmas Yet to Come” sort of way.  After all, inflation was “transitory” in 2021 until somebody told us it wasn’t.  But inflation certainly feels real for every company I’m working with.  And we have a generation of operational managers, financial professionals, and legal advisors that have never seen, let alone experienced, inflation in any real (pardon the pun) way.  But now it’s here and we’re all going to figure out what to do with it.”

Dan Dooley: “Third Party Releases: will they survive? I doubt it. The Texas 2-Step. How is it possible to fraudulently convey assets under Texas law with legal insulation? I don’t believe the Texas 2-Step will survive federal legislation. Bankruptcy venue reform. Given the backdrop of 3rd party release abuse, the absurdity of the Texas 2-Step and some ridiculous bankruptcy venue abuses, I think venue reform is likely to be part of a Bankruptcy Reform Act which will significantly reduce the importance of NYC, Wilmington and Houston Bankruptcy Courts. This legislation will likely not happen until 2023.”

Chris Ward: “The three themes I took note of in 2021 were (i) the attack on the independent director (whether this is fact or fiction still needs to play out), (ii) the mass tort dump and run (unfortunately, we probably have not seen the last of these), and (iii) more chapter 11 filings in the “home” jurisdiction of the debtor (will Houston continue to dominate Delaware and New York in chapter 11 filings? Who knew so many companies had their primary place of business in Houston?).”

Source: Getty Images

PETITION: Given all of the excitement around mass tort cases like Boy Scouts of America, Purdue Pharma and J&J, what do you think Congress will do about venue and third-party releases, if anything? What should be done?

Natasha Labovitz: “It’s hard to see Congress accomplishing much of ANYTHING in 2022, and my best guess is that an amendment to the Bankruptcy Code isn’t going to be the “unicorn” type legislation that Democrats and Republicans are actually able to agree upon and get passed.  But honestly, I’ve long given up being able to predict what is going to happen in Washington, and I haven’t forgotten the early 2000s, when bankruptcy reform legislation that had first been introduced in 1997 -- and had been tried, and failed, in just about every subsequent year – suddenly attracted bipartisan support (including from Joe Biden) and surprised us all by passing in 2005 in the form of BAPCPA.  So, the pending legislation bears watching.”

Chris Ward: “Venue is not broken, so it doesn’t have to be fixed.  The jurisdictions that have historically challenged venue have “fixed” their concerns via their local rules.  The pandemic also mooted most venue concerns and now anyone can appear virtually at hearing.  That phantom creditor from Enron from 20 years ago, could now participate – regardless of where the case was filed. Fortunately, Congress cannot get out of its own way and I do not see any momentum building to legislatively change third party releases, the “Texas Two-Step” or anything else.”

Pilar Tarry: “If Congress gets somewhere on this topic, I’ll be shocked.  And not because they don’t seem to get there on anything else.  That’s totally not it..(yes it is).”

Rachel Albanese: “I expect there will be more House hearings and more political posturing about taking action, but, particularly with this Congress, I’d be surprised if any game-changing legislation actually gets passed.  That’s not to say there isn’t room for improvement on some of these issues, though. I guess I’d fall somewhere on the spectrum between Senator Warren and Professors LoPucki and Levitin, on the one hand, and Andy “Confessions of a Forum Shopper” Dieterich, on the other. The SDNY and EDVA bankruptcy courts have taken steps to ameliorate related concerns and recently entered orders requiring random assignments for mega cases filed in the districts.”

Damian Schaible: “I have long ago given up trying to predict what Congress will do on any topic!  But venue and third-party releases are both extremely important topics and each currently works just the way it should.  Choice of venue, including based on the experience of certain courts and the predictability that this experience provides, is extremely important to companies in need of restructuring and the capital providers that support them.  And third-party releases permit deals to get done, without having to go to the lowest common denominator – the Code provides sufficient protections and the courts are good at making judgment calls in accordance with the law.  For both, to “throw the baby out with the bathwater” would lead to unsatisfactory economic and practical limitations and loss.”

Ryan Preston Dahl: “I think the focus around mass tort cases and third party releases is asking at the wrong question.  The real question is why have bankruptcy courts become the venue to deal with what are truly profound issues that can and do go well beyond the ‘traditional’ restructuring context?  It’s also worth asking why there are so many soundbites from Congress around ‘bankruptcy reform’ and so little action taken on the underlying causes. In my own view, bankruptcy courts are dealing with fundamental questions of public health and safety (like Purdue) or the profoundly difficult case of something like Boy Scouts because the other two branches of government have simply failed to do so—for whatever reason.”

Brian Resnick: “I’ve long since stopped guessing what Congress will actually do, but clear, uniform nationwide legislation describing strict requirements for nonconsensual nondebtor releases would be the best way forward.  There are situations where nondebtor releases are not just critical to a successful bankruptcy and a major source of value to bankruptcy creditors, but the most effective way to maximizing recoveries to creditors of nondebtors too.  Congress should consider building in safeguards to prevent abuse—like approval by a super-majority of claimants, specific findings that the releases are truly necessary to the reorganization, financial disclosure by released nondebtors, and court findings of fairness.  That type of nuanced law that limits releases to appropriate situations would preserve valuable flexibility and even encourage value-maximizing negotiations.  In contrast, a blunt prohibition on any releases in all cases just encourages undemocratic holdup by minorities of claimants, less room for negotiation, and ultimately smaller creditor recoveries. 

Venue reform feels like a political overkill for a problem that’s largely already been solved, if it ever existed. In recent years many of the largest cases have been filed in numerous jurisdictions outside of New York and Delaware. Abuses are few to start with, and when they exist, courts do not hesitate to use the existing statutory framework to transfer cases when they determine that venue was initially chosen in an improper manner or that the initial forum is unduly inconvenient for the relevant parties. Both the Southern District of New York and the Eastern District of Virginia have eliminated the assignment procedures that sparked much of the backlash by removing the ability to choose one or a few specific Judges, and other jurisdictions may follow. Ultimately, the system works best when debtors select an appropriate jurisdiction that will maximize the efficiency of the case and creditor recoveries.  Also, while it sounds simple to just require a company to file where it is located, experience with COMI manipulation in international insolvencies shows just how tighter venue rules can introduce new gamesmanship and litigation, especially in an age of large multinational companies, where operations, assets and employees are often spread across different geographies.”

David Meyer: “The beauty of the American free enterprise system is the adaptation and creativity to find solutions to seemingly intractable problems.  We think large and complex chapter 11 cases are generally best served by judges who routinely deal with such cases and provide a level of efficiency and predictability to all parties involved and this generally maximizes stakeholder recovery.  Likewise, third party releases (and particularly non-consensual third party releases) have developed as a way to address mass tort liabilities in a way that can deliver substantial value to victims far quicker than years of drawn out litigation in trial-courts around the country.  Perhaps neither is perfect in their current form, but wholesale prohibition through legislation doesn’t strike us as the right solution either.  It falls on all restructuring professionals to develop and nurture the best features of the current system, while working to educate lawmakers on the opportunities and challenges.”

đŸ”„Johnson & Johnson Doesn’t Get a Southern Welcome in Bankruptcy CourtđŸ”„

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Last week we listed “Talc Claimants” in our “Losers” section since Johnson & Johnson Inc. ($JNJ) had gone ahead with its cynical maneuver to dump its talc liabilities in bankruptcy court while leaving the rest of the enterprise a presumed beneficiary of the automatic stay. Supporting the view that the automatic stay would apply not just to the bankrupt entity, LTL Management, but also to non-debtor JNJ, generally, is the choice of forum, a bankruptcy court in North Carolina, which falls under the Fourth Circuit. We’ll spare you a lot of boring legal jabber, but there’s precedent in the Fourth Circuit for


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đŸ’„It's Over: Hertz is Already Deal of the YearđŸ’„

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âšĄïžUpdate: Hertz Global Holdings Inc., LOL.âšĄïž

It all comes back to Hertz Global Holdings Inc. ($HTZGQ), the unofficial poster child for COVID-19 era markets.

Let’s recap the bona fides:

The company filed for bankruptcy in May 2020 after the pandemic sparked governments around the world to shut down air travel. No business trips and vacations quickly destroyed the rental car market as revenue fell off a cliff. The precipitous decline in sales triggered a margin call on debt backing the Hertz Debtors’ car fleet — a margin call that they could not satisfy. In other words, the chapter 11 bankruptcy filing was in no way tied to near-term structural business reasons that merely got uber-accelerated (word choice purposeful) by the pandemic (like many other bankruptcy filings at the time); it was as pure a COVID-19 filing as they came at the time.

The entire capital structure capitulated but a month later the stock mysteriously rose to over $6/share. The markets were incredulous and lots of really smart people using decades of historical precedent cast shade on Robinhood bros and memers for being dumb enough to buy shares in a bankrupt company with loans trading at levels (30 cents) that reflected significant impairment higher up in the capital structure. In other words, Hertz became sort of like an analog meme stock before more-digitally oriented meme stocks (e.g., GameStop Inc.) became a thing.

Needing additional funding, the Hertz Debtors sought to capitalize on the good fortune conferred upon them by WallStreetBets and partake in an at-the-market equity offering, a strategy viewed by most as a cynical maneuver to take advantage of willing fools. This sent the Twittersphere into a tizzy but ultimately (and predictably) got approved by the Delaware Bankruptcy Court. Shortly thereafter, however, the SEC put the kibosh on this plan which probably had something to do with the Hertz Debtors acknowledging that they were knowingly and intentionally feeding pigs what they reasonably thought to be sh*t. The Hertz Debtors did squeak out a small allocation of shares, though (at just over $2/share).

Hertz then flooded the market with used cars as it sought to raise cash in a depressed travel environment; from June 1, 2020 through December 31, 2020, Hertz disposed of more than 199,000 vehicles.

During that time, there was a torrent of car purchases as people were wary of air travel. Meanwhile, auto OEMs had to curtail production — first because of COVID-19 and then due to semiconductor shortages (PETITION Note: production cuts of new cars now total a reported 1.2mm vehicles). Large customers like Hertz also ceased volume orders. Used car prices quickly recovered. As just one way of illustrating the “torrent” point, take a look at Carvana Co’s ($CVNA) revenue:

Fast forward to a miraculous economic recovery (Jay POW-ell!) and as borne out by Avis Budget Group Inc. ($CAR), car rentals came back. Consequently, the Hertz Debtors decided to put the pedal to the metal and get the hell out of bankruptcy. Who knew whether this would all last? Better to take advantage of this momentum now, the thinking went.

You know about the back-and-forth by this point. First there were one group of plan sponsors (Knighthead Capital Management LLC and Certares Opportunities LLC) and then there was a “pivot” (a group consisting of Centerbridge Partners L.P., Warburg Pincus LLC, Dundon Capital Partners LLC and an ad hoc group of the Hertz Debtors’ unsecured noteholders) and then another “pivot” and then another “pivot” and then a 36-hour auction and, ultimately, the initial sponsors, supported by reinforcements (Apollo Management Group), ended up back on top. Each time the outlook for general unsecured creditors and, more importantly, shareholders improved. Some noteholders absolutely crushed it.

Now — NOW! — shareholders are the big winners too! The mainstream media tripped all over itself to declare the memers the victors and the shadecasters as pessimistic boomers who didn’t understand the recovery potential (though some also pointed out the luck involved). And there’s probably some truth to the latter though we highly doubt that 99% of the former were running complex recovery analyses enough to know whether the equity had value.

But some well-known public market money managers were! And they combined with Knighthead and Certares to push through with the winning bid. The media celebrated $8 a share.

But is it really $8 a share? Or even “near $8/shr?” Bloomberg’s Matt Levine pays this point short shrift though at least, to his credit, he does note that there’s more there there:

“That $8 number isn’t quite real — you have to decide how much you value the warrants and reorganized equity — but certainly the equity is getting something. And if you believe, or partly believe, the $8 post-bankruptcy valuation, then $6.25 a year ago was a bargain. If you bought Hertz stock at $6.25 last June, that was a reasonable bet. Not necessarily a great bet — you’re down about 20% over the last year, and of course you’d have been better off buying Dogecoin â€” but a reasonable one, and if a few more things break your way you’ll have a nice little profit. And if you paid under $3 for Hertz — which is where it traded for most of last June — you did great.”

But that’s the thing. The entry point matters. And the details matter. Shareholders will get (a) $239mm in cash, (b) common stock representing 3% of the shares of the reorganized Company (subject to dilution from warrants and equity issued under a new management incentive plan); and (c) 30-year warrants for 18% of the common stock of the reorganized Company (subject to dilution by a new management incentive plan) with a strike price based on a total equity value of $6.5 billion, or the opportunity, for eligible shareholders, to subscribe for shares of common stock in the $1.635 billion rights offering at Plan equity value. As if that doesn’t sound complicated enough, shareholders could also elect to participate in the rights offering but, kinda sorta not. Instead, they could sell their rights pursuant to an auction and receive their pro rata share of proceeds of the rights sale instead of warrants. Thoughts and prayers to the retail investor trying to figure what the bloody hell that actually means for them.

So what does it mean? It means — NOT INVESTMENT ADVICE, DO YOUR OWN WORK! — $1.53 in cash per share. It means, with the 3% piece, another $1 per share. So, ~$2.53 is a guaranteed recovery. Beyond that, it depends upon what the shareholder opts to do and how they might value the warrants. And on that point we say, “good luck with that.” Why are we so flippant? Because this entire analysis depends on how you run your — 😳gulp 😳— Black-Scholes model (lol), which, among other inputs, requires an assessment of volatility (LOL). This volatility assessment could get you anywhere between $2/share to $5.50/share (LOL!!) and so going shorthand with $8/share isn’t exactly telling the whole story (despite making a good story). The Hertz Debtors note a volatility range of 50-65%. At its midpoint, the warrant value comes to ~$769mm or $4.92/share. Applying additional inputs might get you to $5.47/share. You could be forgiven for thinking that some Managing Director was spinning around in his chair ordering an analyst to somehow “land around $8/share” and then some excel monkey made some magic happen (adding an extra penny at the end to make things look more optically kosher). The bottom line is that along with entry points and details, the inputs matter too. And so there must be a whole lot of people running some B/S models this week (LOL!!!):

Screen Shot 2021-05-26 at 2.21.38 AM.png

Of course, that’s a whole bunch of nuance that today’s equity market doesn’t exactly have time for. But đŸ€·â€â™€ïž.

*****

On Wednesday, Consumer Price Index data pushed the market into a swoon with CNBC coming about an inch away from this:

Headline year-over-year inflation came in around 4.2%, a somewhat misleading number since it factored in oil prices that, on a relative basis, were over $100/barrel higher than the year before.

Drilling down further into core CPI (excludes volatile food and energy) and the clear outlier is used car prices. Per the U.S. Bureau of Labor Statistics:

Screen Shot 2021-05-26 at 2.24.34 AM.png

In other words, while other indices also increased, used cars/trucks were the largest contributor to the CPI number that freaked everyone the hell out.

Which brings us back to Hertz. The company is out in the market trying to stock back up on cars pushing prices up in a supply-constrained auto environment. It would be the greatest irony of all time if inflation fears decimated the personal trading accounts of all of the new retail entrants into the market on the same day that they experienced a win on their Hertz stock. The Lord giveth and the Lord taketh away.

Taking this a step farther, it would be amazing if the Fed felt compelled by inflation or perceived inflation to tighten monetary policy (read: raise rates) in part because Hertz vomited nearly 200,000 cars into the market and then, months later, had to go back to that market and buy its sh*t back. (PETITION Note: the inflation argument sure didn’t spook markets for long as momentum swung back fast and furious to the upside on Thursday and Friday. Markets today are fickle AF.).

Regardless of what happens with the Fed and inflation later, Hertz has already established itself as a founding member of a lot of special clubs all at the same time:

✅the pandemic-induced bankruptcy club;
✅the meme stock club; and
✅the inflation club.

Which makes us wonder: what’s next for Hertz? Is it going to NFT something? Or will it announce that it plans to carry Bitcoin on balance sheet? How long until it issues new debt into the market for the sole purpose of paying Knighthead and Certares a big fat dividend?

Nothing would surprise us at this point.

đŸ”„Greensill Capital = DRAMA!đŸ”„

in

The Auction for Finacity Heats Up

Back on March 25, 2021, Greensill Capital Inc. (the “Debtor”) filed for chapter 11 bankruptcy in the Southern District of New York. The company is the direct subsidiary of Greensill Capital Management company (UK) Limited(“GCUK”) and the indirect subsidiary of ultimate parent, Greensill Capital Pty Limited; it is the direct parent of Finacity Corporation (which we’ll come back to in a moment). All together, the Greensill situation is a complete clusterf*ck — as you likely know from extensive Financial Times coverage of everything Greensill


Whatever it is, the way you tell your story online can make all the difference.


wait
let’s take a moment to just revel in the sheer bounty of FT coverage on the matter
seriously, look at that âŹ†ïž, they’re cranking out a new story, like, every 9 hours on the subject!

Greensill was in the business of arranging factoring and reverse factoring programs around the world. Here is a company-provided description of the business:

The Debtor constituted Greensill’s US presence and sold these âŹ†ïžfinancial products to clients and investors in the Americas, with revenue therefrom flowing up the corporate org chart to GCUK.

Unfortunately for Greensill, however — and, by extension, the Debtor — a lot of company-wide funding arrangements went sour, triggering a domino effect that first sparked a UK administration filing, a company-wide liquidation and, by extension, the US-based bankruptcy filing. Per The Financial Times:

Greensill Capital, a SoftBank-backed company that says it is “making finance fairer”, has had a string of its clients default on their debts in high-profile corporate collapses and accounting scandals.

The London-based finance group, which employs former British prime minister David Cameron as an adviser, arranged funding for scandal-plagued hospital operator NMC Health and controversial “rent-to-own” retailer BrightHouse, which have both fallen into administration in recent weeks.

Greensill, which received $1.5bn of investment from Japanese conglomerate SoftBank’s Vision Fund last year, also provided financing to Agritrade, the Singaporean commodities trader that collapsed earlier this year amid accusations of fraud from its lenders.

These corporate collapses mean Greensill and a group of insurers are having to cover losses in funds managed by Credit Suisse.

Things unraveled quickly. Per Reuters:

Greensill Capital filed for insolvency on Monday after losing insurance coverage for its debt repackaging business and said in its court filing that its largest client, GFG Alliance, had started to default on its debts.

Cause âŹ†ïž. Effect âŹ‡ïž.

The Debtor is a much smaller piece of the overall Greensill puzzle: it listed 50-99 creditors, $10mm-$50mm in assets, and $50mm-$100mm in liabilities on its petition. It has no revenue and no secured debt. Prior to the leadup to bankruptcy, it had just one director, Alexander Greensill, and its top 20 list of creditors is comprised of employees. It is fully redacted though we know at least two of the names from the UST’s appointment of a 2-member official committee of unsecured creditors. To effectuate the filing, the Debtor added an independent director, Jill Frizzley, to its board (PETITION Note: she effectuated the filing of the petition) and hired Togut Segal & Segal LLP as legal and, after the filing, GLC Advisors & Co. LLC as investment banker. The purpose of its filing is insulate the Debtor from the general Greensill global sh*t show, minimize liabilities (PETITION Note: the Debtor filed a rejection motion on day one which encompasses both its lease in NYC, a WeWork location Chicago, and other contracts) and sell its valuable assets (read: Finacity) for the benefit of its creditors and shareholder. It secured $2mm of DIP financing from The Peter Greensill Family Trust to pursue this course.

Within days of filing, the Debtor filed a motion seeking approval of bidding procedures and approval of stalking horse protections on behalf of a stalking horse purchaser, the Katz Parties, which includes Finacity’s original founder and CEO. The bid is for $24mm which includes $3mm of cash, and the release of some $21+mm of earn-out payments still owed to the Katz Parties from the 2019 sale of Finacity to the Debtor. That last bit is interesting because, if ultimately successful, it will eliminate a massive general unsecured claim that dwarfs the rest of the unsecured claim pool and, consequently, will enhance general unsecured creditor recoveries. The Debtor initially sought a April 20th bid deadline with an auction on April 23 and a sale hearing on April 27. The bankruptcy court entered an order approving the procedures and stalking horse protections on April 6.

The next day the UST’s office appointed a three-person creditors’ committee. The committee then chose Arent Fox LLP as its counsel and Cohn Reznick LLP as its financial advisor.

On April 15, the Debtor filed a notice of revised dates and deadlines relating to the sale of Finacity, making the bid deadline May 5, the auction May 7, and the sale hearing May 12. Meanwhile, the composition of the UCC kept changing: it turned over for a third time on April 19. That must have been fun for everyone.

But the fun merely followed! Things got weird. On April 30, the UCC filed a motion to extend the sale process and push the bid deadlines, auction date, and sale hearing date. They wrote:


it has come to the Committee’s attention that wrongful conduct and flaws in the sale process are chilling bidding. The Committee requests a reset of the sale timeline and remedial measures to bring bidders back to the process. Without these curative steps, the Debtor’s ability to maximize value will be compromised and general unsecured creditors, consisting largely of former employees, will feel the brunt of the wrongful conduct and irregularities in the sale process.

Irregularities? In a case that kicked off due to irregularities?! Stop the insanity!!

The UCC continued:

Most troubling – and the immediate cause for expedited relief – is that the Committee has learned of specific wrongful conduct by Finacity management this week alone that has tainted the sales process. At this point, the question is not whether damage has been done. The question is whether the damage can be repaired
.

The UCC went on to cite (i) correspondence from a Finacity senior executive to a prospective bidder that informed said bidder that it was “not a good fit,” (ii) aggressive, adversarial and. unprofessional behavior towards a second potential bidder, (iii) slow processing of NDAs to the detriment of the expedited sale process, (iv) poor messaging that appears to be “artificially inflat[ing]” any required entry bid, and (v) some inside baseball shenanigans — including special discounts (in exchange for IP transfers) — that favor the Katz Parties to the detriment of other prospective bidders (without consideration for whether the Katz Parties are subject to additional scrutiny on account of, among other things, potential preference exposure related to earn-out payments paid in conjunction with the sale). They write:

The totality of the circumstances have created an environment that is chilling bidding and positioning the Stalking Horse to re-acquire Finacity for a mere $3 million cash, despite the fact that Finacity is performing better than when the Debtor acquired it for a price tag exponentially higher less than two years ago.

The UCC proposed pushing everything to mid-June. The Debtor did not agree to those dates but they did push the bid deadline to May 10, rendering the UCC’s objection moot. A member of the UCC subsequently said “f*ck this sh*t” and quit, leaving just a two-person committee. Ok, maybe it wasn’t that dramatic but you get the idea. This UCC has had more change than J.Lo has had long-term relationships that go nowhere.

Sh*t. We’ll take this drama over that drama any day of the week.

Anyway, yesterday the Debtor filed a notice indicating that “
the Debtor has received more than one ‘Qualified Bid,’” and therefore pushed the auction date — yet again! — to May 14 with a proposed sale hearing on May 21.

Stay tuned.

đŸ”„NRA Gets Whipped in Bankruptcy CourtđŸ”„

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TX Judge Hale Dismissed the NRA’s Bankruptcy Case

When the National Rifle Association of America and its affiliate Sea Girt LLC (lol) first filed chapter 11 bankruptcy cases in the Southern District of Texas back in January, we titled our initial coverage of it, â€œđŸ”„NRA. LOL.đŸ”„,” which 
 let’s be honest 
 basically sums things up. Because, seriously, folks, it was a f*cking stupid filing premised on a f*cking stupid affiliate spun up out of thin air for the dubious purpose of filing in Texas. Contemporaneous with the f*cking stupid filing came a f*cking stupid press release where the NRA flicked off the New York State Attorney General Letitia James, a f*cking stupid poke-the-bear tactic that she saw right through and is now primed to throw right in the NRA’s face. It was, as we said previously, an epic “own the libs” moment that was 
 well 
 f*cking stupid. Of course, Texas Governor Greg Abbott celebrated the theatrics at the time, exhibiting f*cking stupid ignorance about bankruptcy law and the concept of “bad faith filings.” Yesterday, he was curiously silent on the subject. When you compound f*cking stupid with f*cking stupid you just end up with a whole lot of f*cking stupid. And since the integrity of the bankruptcy system is the flavor of the year, we’re not very surprised that, after some f*cking stupid testimony in court and some even more f*cking stupid leaked video of Wayne LaPierre being a stupid bad shot out of court, Judge Hale booted this f*cking stupid ploy to the curb.

Back in January we wrote:

All of this leaves us with some questions.

First, what’s the deal with the affiliate debtor? It’s a f*cking mockery, that’s what. The entity mysteriously appeared less than two months ago and appears to be a shell with little to no assets or liabilities. It’s questionable whether anyone actually works there but we suspect not. We’d expect, therefore, a challenge to venue. That said, we’ve seen so much venue-related BS over the years (looking at you SDTX and White Plains) that “venue shopping” is something that’s fun to talk about in academic circles but often has no real world ramifications. Moreover, Texas — judging by the Governor’s response — seems more than happy to welcome the NRA there. Query whether the judge will be as welcoming. Will anyone care that the NRA has virtually zero pre-existing connection to the state whatsoever? Probably not. đŸ€·â€â™€ïž

Indeed the action remained in Texas.

But:

Then there’s the issue of “good faith.”

Here’s where the press release is particularly fascinating. In the same breath, the NRA says it is “dumping New York,” “there will be no immediate changes to the NRA’s operations or workforce,” “[t]he move [to Texas] comes at a time when the NRA is in its strongest financial condition in years,” and there’ll be “a plan that provides for payment in full of all valid creditors’ claims” with the organization “uphold[ing] commitments to employees, vendors, members, and other community stakeholders.” Soooooo, the bankruptcy is foooooor what exactly? Oh, right. Dumping New York. They told us that. The NRA might as well blast in flashy neon lights that it’s operating in bad faith, filing solely to circumvent a governmental authority’s power. Will it matter? Probably not. (emphasis in original)

But it did!! We were too cynical for our own good.

Yesterday in an “Order Granting Motions to Dismiss,” Judge Hale noted that “
it has become apparent that the NRA was suffering from inadequate governance and internal controls.” This goes to the heart of the NY AG’s effort to enforce the law against the NRA and its leadership! And if successful, the end result (and stated goal) of the NY AG’s efforts would be the dissolution of the NRA. And so the Court underscored:

The question the Court is faced with is whether the existential threat facing the NRA is the type of threat that the Bankruptcy Code is meant to protect against. The Court believes it is not. For the reasons stated herein, the Court finds there is cause to dismiss this bankruptcy case as not having been filed in good faith both because it was filed to gain an unfair litigation advantage and because it was filed to avoid a state regulatory scheme. The Court further finds the appointment of a trustee or examiner would, at this time, not be in the best interests of creditors and the estate.

đŸ’„BOOM!đŸ’„

The NRA apparently offered testimony that was all over the place. They offered a variety of reasons for the bankruptcy filing — from (a) controlling the cost of ongoing litigation (not just the NY AG action) to (b) dealing with banking and insurance issues to (c) effectuating a move from Texas to New York to (d) streamlining operations with the benefit of the bankruptcy “breathing spell.” Judge Hale didn’t bite. Why not? So what were the reasons the Court relied upon?

First, it appears that Mr. LaPierre unilaterally decided to file for bankruptcy without the knowledge of the rest of management or the board of directors. Second, testifying witnesses were in consensus that “the NRA is in its strongest financial condition in years and intends to pay creditors all allowed claims in full.” The NRA’s former CFO and current acting CFO testified that the NRA is capitalized enough to fund all litigation. Moreover, the NRA’s general counsel apparently failed to establish that there was any immediate threat of dissolution or other litigation which might reasonably place a financial strain on the company. There was also no near-term existential threat: Mr. LaPierre testified that the NRA had not been put on notice that the NY AG intended to seek a receiver. All of which, in the aggregate, indicated that there was no imminent financial distress and only speculative near-term legal risk that my impact the financials. Here’s some testimony taken from the Order:

Whatever it is, the way you tell your story online can make all the difference.

That’s pretty damn clear. And so the Judge concluded:

The evidence does not support a finding that the purpose of the NRA’s bankruptcy filing was to reduce operating costs, to address burdensome executory contracts and unexpired leases, to modernize the NRA’s charter and organization structure, or to obtain a breathing spell. While some of these could be added benefits of going through a bankruptcy process, they do not appear to have been significant considerations for the NRA.

Rather:

Based on the statements of counsel and the evidence in the record, the Court finds that the primary purpose of the bankruptcy filing was to avoid potential dissolution in the NYAG Enforcement Action.

So then, thanks to late 20th century case law that stands for the proposition that “a Chapter 11 petition is not filed in good faith unless it serves a valid bankruptcy purpose,” Judge Hale had to consider whether there was such a valid bankruptcy purpose, keeping in mind whether “the petition [was] filed merely to obtain a tactical litigation advantage.” Thanks to Mr. LaPierre, it wasn’t hard to conclude that it was.

Interestingly, Judge Hale highlights the high burden the NY AG must fulfill to achieve the dissolution of the NRA. A successful pursuit by the NY AG is no fait accompli (though this filing may have actually made the case easier!). The court noted:

A dissolution that requires this showing is not the type of dissolution that the Bankruptcy Code is meant to protect against. The Court is not in any way saying it believes the NYAG can or cannot make the required showing to obtain dissolution of the NRA, but the Court is saying that the Bankruptcy Code does not provide sanctuary from this kind of a threat.

And continued:

For this reason, the Court believes the NRA’s purpose in filing bankruptcy is less like a traditional bankruptcy case in which a debtor is faced with financial difficulties or a judgment that it cannot satisfy and more like cases in which courts have found bankruptcy was filed to gain an unfair advantage in litigation or to avoid a regulatory scheme. The purpose of this bankruptcy filing may not have been to end the NYAG Enforcement Action immediately, but it was to deprive the NYAG of the remedy of dissolution, which is a distinct litigation advantage. This differs materially from the prescribed parallel proceedings structure for regulatory actions where regulators can obtain monetary judgments in one forum and then are required to have any claims treated through a bankruptcy process in that it is the NRA’s goal to avoid dissolution and subvert the remedy provided for under New York law entirely through this Chapter 11 case. The Court does not know what specific mechanism the NRA plans to use, but its intention is clearly to “take dissolution off the table.”

The NY AG wasted no time taking a victory lap:

Big picture? Lots of people have been messing with the bankruptcy process lately, doing all kinds of f*cking stupid stuff.

The “process” is finally fighting back.

âšĄïž"Love Really Hertz Without You" - Billy OceanâšĄïž

in

When we last discussed Hertz Global Holdings Inc. ($HTZGQ) ten days ago, the Hertz debtors were trying to push forward with approval of their proposed (i) disclosure statement and (ii) break-up fee and expense reimbursement accommodations for their “PE Sponsors,” Centerbridge Partners LP, Warburg Pincus LLC and Dundon Capital Partners LLC. But much like the “pesky kids” in Scooby-Doo, the debtors’ initial plan sponsors, Knighthead Capital Management LLC and Certares Management LLC, just had to — with the help of Apollo Global Management Inc. and active equityholders Glenview Capital Management LLC and Hein Park Capital Management LP â€” step in and f*ck everything up. At the 11th hour — on April 15, 2021, the night before a hearing to consider the above-noted relief — they came forward with an alternative proposal that threw the Hertz debtors’ plans for that hearing way off the tracks. And they found a sympathetic ear.

Judge Walrath was willing to play ball. Though she never heard the details of the new proposal (in fact specifically advising all parties not to delve into them), she agreed to kick the hearing — despite opposition from the Hertz debtors’ counsel — to April 21, 2021, to allow the Hertz debtors an earnest opportunity to weigh the two proposals against one another and ascertain whether the relief requested made sense under the new circumstances.

This, ladies and gentlemen, is the funny thing about bankruptcy. There are federal rules of bankruptcy; there are local rules of bankruptcy; there are judicial guidelines; there are Office of the United States Trustee guidelines; there are case procedures orders, etc. The process is chock full of rules and procedures. Sh*t. Putting aside that old federalism thing, the highest and best use case for a “local counsel” is simply having a safeguard against tripping up local jurisdictional rules. In other words, people make a lot of money just dancing around all these frikken rules.

And, yet, despite all of that — ALL 
 OF 
 THAT — if someone marches into a bankruptcy court with a massive trunk overflowing with green paper that’s backed by the full faith and credit of the United States of America, well, sh*t, all of those rules and procedures will fly out the window quicker than you can say “capitalism!” Ultimately, a debtor has an obligation — a fiduciary duty — to maximize value for the estate. Period.

And so that’s what the Hertz debtors did. In those five days, the Knighthead-Initial-Plan-Sponsor group further revised their proposal, compelling the boards of the Hertz debtors to conclude that they were for real. Indeed, they initially concluded, in furtherance of their requisite fiduciary duties, that the new proposal, maaaaaay very well constitute a superior offer.

đŸ€‘An "Active Auction" Breaks Out for HertzđŸ€‘

in

Early Friday morning, The Wall Street Journal broke news* that the sponsors of Hertz Global Holdings Inc.’s ($HTZGQ) initial plan of reorganization — Knighthead Capital Management LLC and Certares Management LLC â€” had re-emerged with a fresh proposal for the company that would value the company at $6.2b, creating a dramatic delta between their valuation and the $5.3b valuation upon which the Hertz debtors had predicated their previous agreement with selected plan sponsors, Centerbridge Partners LP, Warburg Pincus LLC and Dundon Capital Partners LLC (the “PE Sponsors”). Adding credence to the proposal was the fact that it was backed by $2.5b in preferred equity financing from Apollo Global Management Inc. and joined by the ad hoc committee of equityholders led by Glenview Capital Management LLC and Hein Park Capital Management LP.

TO READ MORE OF THIS ARTICLE, YOU MUST BE A PAYING SUBSCRIBER.

âšĄïžUpdate: Washington Prime Group ($WPG)âšĄïž

in ,

As new retail looks out onto the horizon, old retail struggles to survive.

We’ve been following the beleaguered Washington Prime Group Inc. ($WPG) for years (see here and here). Our last update indicated that WPG’s tenants are struggling to pay rent, which is making it tough on the mall operator to manage its ~$4b of debt. WPG reported Q4 and FY 2020 earnings on March 16, and they were NOT good. For a high level recap:

WPG 1.png

  • Revenue down 12% for the quarter and 21% annually, YoY;

  • Adj. EBITDA (EBITDAre) down 22% for the quarter and 33% annually, YoY; margins absolutely CRUSHED; and

  • Comparable NOI down 14% for the quarter and 24% annually, YoY.

Exactly one month earlier, WPG announced it wouldn’t be making its $23.2mm interest payment on its Senior Notes due 2024 and entered into a 30-day grace period. With the grace period set to expire on March 17th and ripen into a full-blown Event of Default, WPG and its lenders needed to get back to the table.

Included in its earnings release was an announcement by WPG that it had entered into a forbearance agreements with “certain beneficial owners of more than 67% of the aggregate principal amount” of the 2024 Senior Notes and with respect to its Credit Agreements. The forbearance period expires “on the earlier of March 31, 2021 and “the occurrence of any of the specified early termination events” including “negotiations of the terms and conditions of a financial restructuring
of the existing debt of, existing equity interests in, and certain other obligations of the Company and certain of its direct and indirect subsidiaries.” WPG warns that a restructuring “may need to be implemented
under chapter 11 of the United States Bankruptcy Code.”

Management provided neither 2021 guidance nor a conference call. And on March 17 S&P downgraded WPG’s issuer credit rating to 'D' from 'CC'. Can’t say we’re surprised.

None of that fundamental weakness stopped the retail speculators from getting into the action.

“Blow up,” sure, but not in the way @ersindemirtas expected. On the day of the âŹ†ïž prognostication, the stock was trading at $3.39/share. After the earnings report, the stock dipped below $3/share only to pop back 10% and close slightly over $3/share. Maybe because, as this guy âŹ‡ïž astutely points out, things are kinda backwards these days:

On Monday, however, Bloomberg reported that WPG is in the market for a DIP loan:

Guggenheim, the company’s investment bank, has asked prospective lenders to indicate their interest in providing a potential $150 million debtor-in-possession loan, according to one of the people, who asked not to be identified discussing confidential talks. The negotiations are ongoing and the terms could change, the people said.

Which is where the WPG story is these days. It’s not a question of ‘if’ or ‘when.’ It’s a question of ‘how much.’

The stock initially dropped over 12% on the news, regained some ground to end Monday down 7.6% before rallying slightly after the market closed. Because, like, đŸ€·â€â™€ïž.

Source: Yahoo! Finance

Source: Yahoo! Finance

Of course, that small rally didn’t hold. The company got smoked by over 10% in trading on Tuesday:

Source: Yahoo! Finance

Source: Yahoo! Finance

While — âšĄïžshockerâšĄïž — the market appears to be acting rationally for once, there are, of course, certain participants who appear unfazed.

There’s not much suspense left in this story beyond just how wrong @MaxValue1 will be.

đŸ”„The "Weil Bankruptcy Blog Index," CMBS and how Nine West is the Gift that Keeps on GivingđŸ”„

in ,

We’re still clearing through some year-end stuff here at PETITION. This edition will conclude our review of 2020 (parts I and II here and here). Before we get there, this was obviously a momentous week. The Democrats took Georgia and by extension the Senate, the Capitol fell to a siege, unemployment figures underwhelmed (140k job losses with leisure and hospitality getting f*cking napalmed), Saudi Arabia unexpectedly cut oil output, and a new virulent COVID strain is now apparently running wild within our borders. Good times. It’s almost enough, all in, to make us nostalgic for 2020.

Oddly, the stock market took in all of the above and be like đŸ€·â€â™€ïž: it had an up week! Mania is sweeping the markets to the point of Elon Musk becoming the richest man on the planet, Bitcoin breaching $40k, sponsors issuing SPACS called Queen’s Gambit Growth Capital (sounds fake: it’s not), and corporates
well


Maybe. Probably not. More likely? They’re seeing the market swallow up ridiculously low rates. This week US high yield rates hit a fresh all-time low. Spreads are back near pre-crisis levels:

Screen Shot 2021-01-10 at 2.05.05 PM.png

Demand is insatiable.

Back in October the PETITION team took a look at (but ultimately opted not to write about) Urban One Inc. ($UONE), a Maryland-based media operator focused on the African-American community. Our interest derived from an 8-K indicating that UONE (a) anticipated COVID-19-induced revenue decreases might trip financial covenants, (b) initiated wholesale cost-cutting initiatives, and (c) drew down $27.5mm on its ABL facility. Thereafter, the company commenced an exchange offer and consent solicitation pursuant to which it exchanged $347mm 7.375% senior secured notes due 2022 for new 8.75% senior secured notes due 2022. The company also pulled off a $25mm at-the-market equity offering. In other words, both the debt and equity markets were willing to play ball and play for some sort of social justice-driven pull-through of demand that would improve business fundamentals.

And as it turns out, the company did pull forward demand â€” more election related than anything:

"The radio segment benefited from unprecedented levels of political advertising spending targeting African American voters.  Bolstered by this revenue, we expect our radio segment fourth quarter revenue to be down a low single-digits percentage year over year, a material improvement from second quarter's decline of -58.4% and third quarter's decline of -31.9%," says CEO Alfred C. Liggins III.

In a pre-market announcement on Thursday, the company indicated that consolidated net revenues for FY20 would be down roughly 13.7-14.6%. But Q420? They reported a net revenue increase of between 3.9-7.7% and adjusted EBITDA up 49-56.2%. That’s all the capital markets needed to see.

On Thursday the company also announced a private offering of $825mm 2028 notes to pay off the relatively new 8.75% ‘22s, the stub 7.375% 22s, and loans outstanding under two separate credit agreements. The issuance priced inside of initial 7.5% talk and got done at 7.375%. Notably, the 8.75% ‘22s were trading below par as long ago as, uh, *checks calendar*, Tuesday (they’re now above 100). This is not the most, uh, optimistic issuance we’ve seen of late — we’ll leave that to the airlines and movie theater chains — but it does highlight the forgiving nature of capital markets: that’s quite a dramatic drop in rate mere months after a previous issuance. And let’s be clear: we’re talking about a company that is, in part, a radio station operator coming off a significant uptick due to election-related ads. But đŸ€·â€â™€ïž. That really is the best way to describe all markets these days.

How about the bankruptcy market? Epiq Systems Inc. released its 2020 bankruptcy filing statistics this week and “2020 had the lowest number in bankruptcy filings since 1986 with a total of 529,068 filings across all chapters.” Commercial chapter 11 filings were up 29% YOY but chapter 13 and chapter 7 filings decreased by 46% and 22%, respectively.

TO READ THE REST OF THIS ANALYSIS, YOU MUST BE A PETITION MEMBER. BECOME ONE HERE.

đŸ’ȘCan You Spot Me, Bro? Part III. (Long Competition)đŸ’Ș

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Town Sports International LLC Reaches Agreement

The drama foreshadowed in a response to Town Sports International LLC’s cash collateral motion fizzled in court on Wednesday as Kennedy Lewis Investment Management LLC stood down, the court entered an interim cash collateral order, and the debtors moved forward with negotiations with an ad hoc group of lenders comprised of Abry Partners, Apex Credit Partners LLC, CIFC Asset Management LLC, Ellington Management Group LLC and Trimaran Advisors Management LLC and private equity firm Tacit Capital LLC on the terms of both a DIP credit facility and a credit-bid-based asset sale in bankruptcy (of no more than $85m). The company hopes to run a quick marketing process and


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🎟Disruption Hits CEC’s Supply Chain (Short Arcade Tix)🎟

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Chuck E Cheese Wants to Incinerate Prize Tickets

Back in February 2018, when Cenveo Inc. filed for chapter 11 bankruptcy, we wrote the following:

Founded in 1919, Cenveo is a 100 year-old, publicly-traded ($CVO), Connecticut-based large envelope and label manufacturer. You may not realize it, but you probably regularly interact with Cenveo’s products in your day-to-day life. How? Well, among other things, Cenveo (i) prints comic books you can buy at the bookstore, (ii) produces specialized envelopes used by the likes of JPMorgan Chase Bank ($JPM) and American Express ($AMEX) to deliver credit card statements, (iii) manufactures point of sale roll receipts used in cash registers, (iv) makes prescription labels found on medication at national pharmacies, (v) produces retail and grocery store shelf labels, and (vi) prints (direct) mailers that companies use to market to potential customers. Apropos to its vintage, this is an old school business selling old school products in the new digital age.

As an old school business, we noted that it was ripe for new school disruption. We wrote then:

Per the company,

“In addition to Cenveo’s leverage issues, macroeconomic factors, including the introduction of new e-commerce, digital substitution for products, and other technologies, are transforming the industry. Consumers increasingly use the internet and other electronic media to purchase goods and services, pay bills, and obtain electronic versions of printed materials. Moreover, advertisers increasingly use the internet and other electronic media for targeted campaigns directed at specific consumer segments rather than mail campaigns.”

Ouch. To put it simply, every single time you opt-in for an electronic bank statement or purchase a comic book on your Kindle rather than from the local bookstore (if you even have a local bookstore), you’re effing Cenveo.

We were reminded of Cenveo when we read a September 14th motion filed by CEC Entertainment (Chuck E. Cheese) seeking entry of an order authorizing CEC to enter into settlement agreements with three large suppliers.

Here’s the situation


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đŸ’ȘCan You Spot Me, Bro? Part II.đŸ’Ș

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đŸ‹ïžâ€â™‚ïžNew Chapter 11 Bankruptcy Filing - Town Sports International LLCđŸ‹ïžâ€â™‚ïž

In Sunday’s Members’-only briefing, we discussed the plight of brick-and-mortar gyms. As anticipated, on Monday, Town Sports International LLC, the company behind, among other brands, Johnny’s beloved New York Sports Club, filed for bankruptcy in the District of Delaware (along with 161 affiliates, the “debtors”). Pre-COVID, the debtors employed 9,200 people and serviced over 605,000 members across 183 locations primarily in the Northeast and Mid-Atlantic regions — proof-positive, given the disturbing lack of cleanliness Johnny experienced at those hell holes, of why this country is so susceptible to a pandemic.

Jokes (“jokes”) aside, this is, no doubt, in large part a COVID story. COVID shut down gyms, COVID spikes delayed re-openings, COVID has customers skittish about returning, and COVID is causing a complete re-evaluation of what it means to provide fitness services to customers while keeping them safe. The latter part has culminated in the debtors’ “COVID Plan,” which, in turn, translates into “
significant costs related to increased training, more comprehensive cleaning, disinfecting, and health screening protocols, and enhanced facilities maintenance.” It also means “
modifying activities, restricting programs, adjusting hours of operation, travel restrictions, telecommuting opportunities and virtual communication platforms.” And so it’s a pretty rudimentary calculus: customer revenues (and satisfaction) âŹ‡ïž + operating expenses âŹ†ïž. With no options for revenue generation and few reasons for optimism, the debtors spent the last few months trying to navigate its expenses and carve a path forward: they fired thousands of people; they negotiated with their landlords; they engaged their lenders and third parties on strategic alternatives. None of it could stave off bankruptcy.

Bankruptcy avails the debtors of two very powerful tools. First, in light of failed negotiations with landlords over lease concessions, they can use section 365 of the bankruptcy code as a hammer and reject those leases and free themselves from ongoing obligations thereunder (relegating the landlords to general unsecured creditors which, per an absolute priority waterfall, puts them behind senior lenders but in front of the equity for any recovery coming out of the bankrupt “estate”). The debtors already have a motion on file seeking to reject 35 leases.

Second, bankruptcy code section 364 can confer certain benefits upon lenders willing to provide new financing — including, among other things, “priming” of pre-petition debt and super-priority lien and claim status. The debtors go into the bankruptcy with approximately $167.5mm of funded secured debt, inclusive of accrued and unpaid interest: $12.5mm under a revolver that matured on August 14, 2020 and $155mm under a term loan facility that matures on November 15, 2020. Behind that, they have approximately $74mm in outstanding trade and other unsecured liability. Given its liquidity challenges, the debtors have spent the last several months trying to find new financing alternatives while parallel-pathing a potential sale of substantially all of their assets.

Two options emerged. Pre-petition lender Kennedy Lewis Investment Management LLC, a middle-market focused opportunistic credit investor,* owns over 45% of the total amount of pre-petition secured debt and offered a $80mm DIP credit facility and expressed a desire to credit bid its debt for the debtors’ assets. The other lenders, however, said “thanks but no thanks,” blocking this proposal purportedly because the credit bid component wouldn’t lead to a suitable recover for them to (PETITION Note: at the time of this writing, the loan is quoted at or around 16.5 cents on the dollar). Rather, those other lenders — which, significantly, account for the majority needed to consent to priming liens â€” currently support a third-party proposal from private equity firm, Tacit Capital.** That proposal involves a (i) $17.5mm DIP, (ii) commitment for an additional $47.5mm in exit financing and (iii) credit bidding their debt.

And so you have a lender game of chicken.

Or so they say. But they’re not exactly staying neutral here. They also say they believe the KLIM proposal is the better one. It provides more liquidity; it provides for the potential assumption and assignment of 94 of the debtors’ leases — a greater number than that contemplated by Tacit Capital and the other lenders. That would, obviously, preserve more jobs, tax revenue, yada yada yada. So they need KLIM and the other lenders to come together and kumbaya around a go-forward plan. The debtors indicate that discussions are ongoing and the debtors have established a special committee of independent directors to help facilitate.

Wait. Hold on. This is bankruptcy so of course there have to be allegations of shady-a$$ sh*t transpiring. In fact, an ad hoc group of “other” lenders allege that attempts to discuss and negotiate have been rejected by the debtors; they allege that this is an inside job by KLIM (which also happens to be a large shareholder) and board member Kennedy Lewis himself; and they assert that this is all supported by the debtors. In a response to the cash collateral motion, they wrote:


after months of the Ad Hoc Term Lender Group trying to bring the Debtors to the table, this filing makes clear what we suspected all along—the Debtors never had any real intention of providing access to information, running a marketing process, or reaching out to third parties. Instead, the Debtors have been solely focused on pursuing a deal with Kennedy Lewis Investment Management, LLC (“Kennedy Lewis”), the second largest shareholder of the Debtors’ parent entity (“Parent”) at 14.1%, which contemplates a priming debtor in possession (“DIP”) financing facility and a sale transaction pursuant to a credit bid. Based on currently available information, the Kennedy Lewis deal would then provide the shareholders of the Parent with a material recovery by virtue of a post-sale merger whereby certain non-Debtor entities (the “Unrestricted Group”) owned by the Parent would be merged with the reorganized Debtors in exchange for providing the Parent shareholders with a material percentage of the overall reorganized Debtor equity, all while the existing lenders would receive little or no recovery.

They continue:

The largest shareholder of the Parent is Patrick Walsh, the Debtors’ Chief Executive Officer and Chairman of the Parent board of directors (the “Board”). The second largest shareholder of the Parent is Kennedy Lewis itself. The conflict of interest here is clear and explains the Debtors’ insistence on preventing third parties from accessing information, failing to run any kind of sales or marketing process, and continuing to insist that the non-consensual Kennedy Lewis transaction is in the best interests of the Debtors and their estates.

Which explains the appointment of the independent directors. This potential “conflict of interest” wasn’t entirely clear from the debtors’ papers.

So the upshot is that the debtors do not have a definitive DIP, do not have a stalking horse purchaser and, for now, don’t even have consent to use the lenders’ cash collateral. Good times. To make matters worse, the ad hoc group foreshadows dark times ahead if these issues aren’t resolved pronto:

While the Ad Hoc Term Lender Group is working with the Debtors on the terms of a limited duration, consensual cash collateral order, this is a short-term bandage for a much larger problem—the Debtors need a new source of capital. The Debtors’ budget demonstrates that they cannot run these chapter 11 cases on the use of cash collateral only.

While all of that fun stuff is happening behind the scenes, gym-goers are looking at all of this and wondering “WTF.” They were outraged to see charges in March and April for their gym fees while clubs were closed. The subsequent social media backlash caught the attention of New York Attorney General Letitia James, who forced the gym operator to temporarily stop charging members and introduce flexible cancellation policies. Recently, Bloomberg reported that the debtors billed their members for full September dues despite the gyms’ limited operating hours and reduced capacity. 

Members are pissed; they’re staring down the barrel of paying effectively the same amount going forward for fewer fitness services and more administrative hassle to get through the door; they’re requesting credits and refunds. Clearly this is credit negative for the business.

As part of their motion seeking the ability to continue various customer programs, the debtors indirectly acknowledge these challenges:

The Debtors do not issue any cash payments on account of the Member Satisfaction Credits, and estimate that approximately $1.9 million worth of Member Satisfaction Credits have accrued, but not been applied, as of the Petition Date.

Particularly following the onset of COVID-19, certain customers may hold contingent claims against the Debtors for refunds and other credit balances (collectively, the “Refunds”). In addition, certain customers may dispute certain charges with their credit card issuer, and the Debtors may be obligated to refund to such issuer the disputed amounts, subject to certain adjustments (the “Chargebacks”). As of the Petition Date, the Debtors estimate that approximately $225,000 is owed and outstanding on account of the Refunds and Chargebacks, respectively. This estimate does not include additional Refunds or Chargebacks that relate to the prepetition period, but which have not yet been requested. The Debtors believe that the increase in customer loyalty generated by the Refunds and Chargebacks far outweighs the costs thereof. Accordingly, the Debtors seek authority to continue to issue Refunds and Chargebacks, in their discretion, in the ordinary course of business, whether related to payments made before or after the Petition Date.

If the above doesn’t make this clear, members ought to be sure to affirmatively request a refund. Even better to request the refund from the debtors while also initiating a process with credit card companies.

Finally, there’s the employees. As of the petition date, the employee ranks are down to 2,169 people. That’s a 7,000 employee reduction! What was once a $5.6mm bi-weekly payroll dropped down to $1.2mm over the last three months and is expected to recover less than halfway to $2.5mm. This demonstrates in real quantifiable terms the impact of COVID.

So we are left with two big questions.

Will the parties come to an agreement such that Town Sports will be able to avoid liquidation?

And given the wave of gyms that have capitulated into bankruptcy to this point, are there any gyms that can avoid chapter 11?

*KLIM is also the largest creditor of Flywheel Sports Inc., a spin boutique that was once wildly popular. Earlier this year, Town Sports, likely at the behest of KLIM, explored an acquisition of Flywheel. On Monday Flywheel filed a chapter 7 bankruptcy proceeding in NY.

**If this name rings a bell, it may be because Tacit Capital was also in the mix to buy Rudy’s Barbershop Holdings, which filed for bankruptcy back in April.

đŸ’„PETITION's Hot Take And Potentially Regrettable Statement on Hertz' ShenanigansđŸ’„

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On May 26, 2020, Hertz Global Holdings Inc. ($HTZ) and a number of affiliates filed massive chapter 11 bankruptcy cases. The company’s publicly-traded stock dropped to $0.56/share. Thereafter, the stock inexplicably started to rise. On Thursday June 4, HTZ stock experienced a sudden and mysterious surge that had everyone who knows anything about chapter 11, the absolute priority rule, and the typical bankruptcy treatment of equity (read: it typically gets wiped out) a bit befuddled. The surge continued through the beginning of this week — reaching as high as $5.53/share on Monday, June 8th. The Twitterverse, in particular, went apesh*t as Dave Portnoy and other gamblers 
 uh, investors 
 took aim at HTZ and several other cheap stocks on the (un)sound (un)fundamental basis of their 
 well, cheapness.

Most folks could predict that it wouldn’t end well. After all, HTZ is, to state the obvious, BANKRUPT!, its debt trades like dogsh*t and its equity is currently the subject of a delisting notice. Still, folks like Jim Cramer and Josh Brown all but encouraged the behavior, back-handedly claiming that it’s a good “learning opportunity” for these (predominantly new) market participants. As of market close on June 11, the stock has fallen back down to earth, trading at $2.06/share leaving many a now-learned investor in its wake.

Still, one’s foolishness is another’s opportunity.

In a motion filed June 11 (along with a complementary motion seeking shortened notice and an emergency hearing), the HTZ debtors seek authority to enter into a sale agreement with Jefferies LLC to issue up to and including 246,775,008 shares of common stock through at-the-market transactions under HTZ’s existing shelf-registration — a move designed “to capture the potential value of unissued Hertz shares for the benefit of the Debtors’ estates.” The debtors opportunistically note:

The recent market prices of and the trading volumes in Hertz’s common stock potentially present a unique opportunity for the Debtors to raise capital on terms that are far superior to any debtor-in-possession financing. If successful, Hertz could potentially offer up to and including an aggregate of $1.0 billion of common stock, the net proceeds of which would be available for general working capital purposes. Unlike typical debtor-in-possession financing, the common stock issuance would not impose restrictive covenants on the Debtors and would not impair any of the creditors of the Debtors. Moreover, the stock issuance would carry no repayment obligations, and the Debtors would not pay any interest or fees to those who provide the funding by buying shares at the market. Hertz would include disclosure in any prospectus used to offer common stock highlighting that an investment in Hertz’s common stock entails significant risks, including the risk that the common stock could ultimately be worthless. (emphasis added).

Congratulations people. The very folks that Cramer and Brown talked about have been marked as fools. And people erupted:

Our inbox immediately flooded with messages reflecting incredulousness and lost faith in humanity. We get it. This is next level sh*t right here. Dumb motherf*ckers are about to get taken advantage of.*

But you know what? Maybe we just want to be contrarian, but we are impressed with this move.** Look, for the last week the market has been awash with commentary about how nothing makes sense anymore and how “the Fed put” has introduced all kinds of bubble-like behavior. Idiots off of Robinhood have been (maybe) getting rich off of $HTZ stock and $CHK stock and $WLL stock while legends like Ray Dalio, Stanley Druckenmiller and Warren Buffett are eating sh*t. Like
this actually happened:

Proponents of efficient markets have been apoplectic. None of this makes any sense to them. For good reason.

But you know what does make sense? Basic supply and demand. And if there is enough demand for something as asinine as acquiring a portfolio of HTZ stock and HTZ alone can quench that demand, why wouldn’t and shouldn’t it issue those shares? Isn’t that efficient markets playing out in their harshest and most savage form? Isn’t it more efficient for the debtors to issue more stock than pay some usurious coupon on a DIP credit facility? Why get ripped off by lenders when you can rip off aspirational equityholders?

The HTZ debtors have a duty to maximize the value of their estates.*** To use or sell property of the estate, the debtors merely need to show that the use/sale is an exercise of sound business judgment. They write:

Here, the decision to enter into the Sale Agreement and to sell unissued shares of Hertz’s common stock is an exercise of the Debtors’ sound business judgment. The rise in the trading price of Hertz’s shares indicates that the market believes that the shares have significant value. The proposed sale of Hertz’s unissued shares would allow the Company to raise up to and including $1.0 billion in gross proceeds, the net proceeds of which the Debtors could use general working capital purposes. The sale would also allow the Debtors to raise capital on terms superior to any debtor-in-possession financing. The stock issuance would not impose restrictive covenants on the Debtors and would be junior to claims of the Debtors’ creditors. Moreover, other than the 3.0% fee that would be owed to Jefferies and related transactional costs, the issuance of the shares would impose no payment or repayment obligations on the Debtors. (emphasis added).

Do the debtors have some sort of duty to those prospective shareholders that are about to get dragged over the tracks? Do the debtors need to be concerned about the business judgment of the morons on the other side of the transaction?**** Does a prospectus describing the dangers eliminate any and all responsibility here? The debtors are clearly of the view that the answers are ‘no’ and ‘yes,’ respectively.

Notably, Jefferies ain’t no fool. In addition to getting 3% of the gross proceeds of any shares that are sold through the proposed ATM program, they’ll get a crucial indemnity from HTZ “
based upon or otherwise related to or arising out of or in connection with Jefferies’ participation, services or performance under the Sale Agreement or the sale of shares or the offering contemplated hereby, provided that the Company shall not be liable to the extent a court determines a claim resulted directly from Jefferies’ gross negligence or willful misconduct.” Moreover:

The Company will also agree to reimburse Jefferies for any and all expenses reasonably incurred by Jefferies in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action.

Jefferies saw the equity price action this week and be like


Michael Jordan GIF.gif


and immediately dusted off that same ATM pitch they’ve used in plenty of other situations. In the process, they make no mistake about it: they know they’re about to get dragged in some mud.

And so where does this leave us? It’s not a bankruptcy court’s jurisdiction to protect the Robinhood bros. They’re not parties in interest in the cases. The debtors will likely get authority pursuant to their motion and Jefferies will try and push shares into the market and, in turn, the market will prove whether there’s continued demand. If there’s more demand, the debtors will then have an option to sell more shares on the basis of that demand.*****

As to whether there is some mysterious way that the equity ultimately has value in the future? Not to cop out on the question but we simply don’t have enough information to opine on that. Likely, neither do the debtors. Nor the Robinhood traders. Will travel recover? Will the used car market sh*t the bed? In a pandemic, anything goes. And that’s the point of the debtors’ motion and precisely why, all the furor notwithstanding, it actually makes sound business sense for them to move forward with it.

A hearing on the motion is scheduled for tomorrow, June 12th, at 3pm ET. Pop your popcorn.

*Meanwhile, some HTZ directors are laughing their asses off after hitting the top right on the head:

**We fully acknowledge that we may regret this hot take at a later time.

***The debtors actually argue that, pursuant to certain case law, unissued shares may note even constitute property of the estate. They seek approval pursuant to this motion “out of an abundance of caution.”

****This assumes the debtors are actually insolvent. Remember: this case basically came out of nowhere thanks to COVID and what, in form, was a margin call.

*****The process leaves a lot of latitude:

From time to time, the Company may submit orders to Jefferies relating to the shares of common stock to be sold through Jefferies, which orders may specify any price, time or size limitations relating to any particular sale. The Company may instruct Jefferies not to sell shares of common stock if the sales cannot be effected at or above a price designated by the Company in any such instruction. The Company or Jefferies may suspend the offering of shares of common stock by notifying the other party.

✈ Airlines, Airlines, Airlines ✈

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The Airline Bailout Debate Will Rage On

Over the last several weeks there has been a significant amount of discussion across the United States about the financial condition of the major airlines post-COVID-19 and whether and when air travel will resume in earnest. In parallel, there has also been fervent debate as to whether government assistance ought to be available to the airlines and, if so, what conditions ought to be attached (if any). One view against — that of Chamath Palihapitiya â€” went viral and sparked widespread debate that placed people firmly in one of two camps. That camp — the “f+ck the airlines and f+ck bailouts” camp, urged the federal government to let free markets be free markets, regardless of whether that might mean a wave of bankruptcies. On the other side, there are folks who think that, given the extraordinary externalities at play — including, significantly, worldwide government-mandated shutdowns — fairness dictates that the airlines ought to be given a lifeline to avoid costly and drawn out bankruptcy processes that will ultimately destroy a lot of value and potentially result in meaningful job losses. After all, a deal around a plan of reorganization and eventual emergence from bankruptcy requires some ability to determine a “fulcrum security.” Good luck doing doing that in this unprecedented environment.

For now the debate is moot. The United States government agreed to provide assistance with the understanding that jobs would be preserved. Much of this money has no strings attached:

Similarly, United Airlines Inc. ($UAL) obtained $5b through the CARES Act split between $3.5b of direct grants and $1.5b of low interest loans. United noted at the time:

These funds secured from the U.S. Treasury Department will be used to pay for the salaries and benefits of tens of thousands of United Airlines employees. In connection with the Payroll Support Program, the airline's parent company also expects to issue warrants to purchase approximately 4.6 million shares of UAL common stock to the federal government.

Airlines are cash burning machines. No doubt, these funds are critical. To help matters further, certain airlines tapped the capital markets — some, like Delta Airlines Inc. ($DAL), successfully and others, like United, unsuccessfully. Per Bloomberg:

United Airlines Holdings Inc. abandoned a $2.25 billion sale of junk bonds because it wasn’t satisfied with the terms, said people familiar with the transaction.

The airline ultimately reached a deal but decided to pull it to seek more favorable terms and potentially a different structure later, said one of the people, who asked not to be named discussing a private transaction. The offering fell flat with investors on concerns about the planes backing the debt.

Enticed by the hot market for junk bonds, United had been planning to use the new debt to refinance a $2 billion one-year term loan that the company signed with a group of four banks on March 9. At a yield of 11% based on unofficial price discussions, the potential interest rate was significantly higher than that on the loan, which pays a rate of as much as 2.5 percentage points above the London interbank offered rate over the course of the year.

Whoops.

But that wasn’t the only news that United made last week. Per Barron’s:

United said Monday that it expected to cut its management staff by at least 30%, starting in October, according to a memo sent to employees. The cuts amount to about 3,450 workers. United is receiving $5 billion in payroll support under the government’s Cares Act program, which includes restrictions on compensation and layoffs. But the money doesn’t cover payrolls entirely and it will run out in September, giving United more flexibility to reduce its workforce.

Even with government support, “we anticipate spending billions of dollars more than we take in for the next several months, while continuing to employ 100% of our workforce,” United’s chief operating officer, Greg Hart, said in a memo to workers. “That’s not sustainable for any company.”

Moreover, news surfaced that United was effectively downgrading the status of its employees, circumventing the spirit of the CARES Act. This set a bunch of people off:

Here is crypto enthusiast Anthony Pompliano bemoaning this series of events (which, coming from a crypto fanboy, implies a certain level of government distrust to begin with):

At the end of the day, we are now seeing the downsides to bailing out corporations. A bailout is really the government trying to prevent a natural market correction. If they didn’t intervene, United Airlines would file for bankruptcy protection and the assets / equity would be bought by new ownership. That transition would hopefully land the company in better hands that would be better prepared in the future. This is the risk that equity holders take. By not allowing this natural market function to occur though, the government is changing the risk-reward framework for equity owners and actually incentivizing bad behavior.

We should have let the airlines fail, rather than bail them out and now force me to write this letter today about all the dumb and nefarious things that the companies are doing. The US government has a “God-complex” when it comes to the markets. They think they can do no wrong and they believe that they can solve any problem by interfering. The issue is that they are actually making the situation worse. They are preventing a free market from going through the natural cycle. The allure of a short term bandaid actually drives a much larger, long-term problem.

United Airlines should be forced to give the money back if they cut workers hours.

What Mr. Pompliano says should have happened in the US is EXACTLY what is happening in many other parts of the world.

*****

Like Colombia for instance. Per its recently filed bankruptcy papers, Avianca Holdings S.A. is “
the second largest airline group in Latin America and the most important carrier in the Republic of Colombia and in the Republic of El Salvador.” It is the largest airline in Colombia and is one of 26 members in the Star Alliance (along with United), the world’s largest global airline alliance. Its history goes back 100 years; it generates $3.9b of annual revenues and employs 21.5k people; and it, like many of the US-based airlines, was perfectly healthy prior to COVID-19 halting worldwide air travel. Despite “
Avianca’s importance to the Colombian domestic air transportation market
” and while “
the Debtors anticipate that the Republic of Colombia may be one of the key stakeholders in the Debtors’ restructuring efforts
,” no government stepped up to bail Avianca out. Hence the chapter 11 bankruptcy petition it (and its debtor affiliates, the “debtors”) filed on Sunday. No government. Not Colombia. Nor the Republics of El Salvador, Ecuador or Peru.

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The debtors required the chapter 11 filing to preserve its cash in a non-operating environment; they have $275mm of unsecured trade payables and a boat load of debt secured up by all kinds of stuff — from credit card receivables to aircraft. The debtors incurred the debt in an effort to expand capacity in an increasingly competitive space beset by low cost carriers nibbling away at market share. One of the lenders? United Airlines. How poetic!

Back to the aircraft. Given what travel trends are likely to be and new aircrafts that the debtors are contractually on the hook for, it stands to reason that the debtors will use the bankruptcy to reject a number of aircraft lease agreements in addition to addressing their balance sheet. The market is about to be flush with planes for sale. Query what new airline may rise from the ashes.

Luckily, the debtors have a meaningful amount of unrestricted cash to fund their cases and so, at least for now, they’re not seeking a DIP credit facility. That may change, however, if the travel environment doesn’t improve and the cases drag on. Which they very well may given the uncertainty in the markets and the very real possibility that air travel doesn’t recover. Notably, tourism is a major driver of Avianca’s traffic. Something tells us that there aren’t a whole lot of people planning extensive getaways to Bogota at the moment. đŸ€”

This will be an interesting test case for a lot of other airlines that, unlike the US-based airlines, aren’t lucky enough to receive governmental intervention.

*****

Which “other airlines”? For starters, we know that Virgin Australia entered voluntary administration in Australia two weeks ago after the Australian government declined Virgin’s entreaties for a $888mm loan.

There will be others. Here is Bloomberg suggesting that, due to sovereign issues throughout Latin America, other Latin American airlines are in trouble. In the piece published before Avianca’s chapter 11 filing, they noted:

But while just about everyone agrees it will be up to governments to help save the industry, there’s a disconnect between what’s needed and what nations can -- or even want to -- do. Brazil and Colombia seem willing to step up; Mexico and Chile don’t. Latin America was already the lowest-growth major region in the world and budgets were stretched thin even before oil collapsed and the coronavirus crippled the global economy.

As we now know, Colombia didn’t step up. Which leaves Latin America’s other air carriers in a bad spot, including Latam Airlines Group SA (the finance unit of which has debt bid in the 30s and 40s), Gol Linhas Aereas Inteligentes SA ($GOL)(the finance unit of which has debt bid in the low 40s), and AerovĂ­as de MĂ©xico SA de CV (Aeromexico)(which has debt bid in the 30s). Will one of these be one of the next airlines in bankruptcy court?

*****

The US isn’t the only country to entertain bailouts of airlines. In mid-March, Norway offered 6 billion Norwegian crown ($537mm) credit guarantees to Norwegian Air Shuttle SA ($NWARF). There are strings attached, though. Reuters noted:

To receive the full 3 billion, the company must first persuade creditors to postpone installment payments for loans and forego interest payments for three months.

DNB Markets analyst Ole Martin Westgaard said in a note the package was likely too small, calculating that it would only cover the total cost of grounding all Norwegian Air aircraft for one-and-a-half months.

“We are doubtful the company will be able to attract any interest from a commercial bank at interest rates that would make sense,” Westgaard said.

It is struggling to get it done. In late April, Bloomberg reported:

Norwegian Air Shuttle ASA, the low-cost carrier fighting to qualify for a bailout, presented a plan to relieve part of its heavy debt burden that would largely wipe out existing shareholders and warned most flights would stay grounded until next year.

The airline is racing against the clock to meet terms set by Norway to access the bulk of a 3 billion-krone ($283 million) package in loan guarantees. With most of its fleet grounded, the company has proposed a debt restructuring and capital increase by mid-May that would unlocking [sic] the cash it needs to survive the coronavirus crisis.

The company has debt bid in the low 20s as it attempts to address its conundrum.

*****

On Tuesday, Boeing Corporation ($BA) CEO Dave Calhoun came out blazing. Per Bloomberg:

Boeing Co.’s top executive sees a rocky road ahead for U.S. airlines, saying it’s probable that a major carrier will go out of business as the Covid-19 pandemic keeps passengers off planes.

The recovery is going to be slow, with air traffic languishing at depressed levels for months, Boeing Chief Executive Officer Dave Calhoun said in an interview to be aired Tuesday on NBC. Asked by ‘Today’ show host Savannah Guthrie if a major airline might have to fold, Calhoun replied, “Yes, most likely.” (emphasis added)

Take cover y’all. He continued:

“Something will happen when September comes around,” Calhoun added, referring to the month when the U.S. government’s payroll aid to the airline industry expires. “Traffic levels will not be back to 100%. They won’t even be back to 25%. Maybe by the end of the year we approach 50%. So there will definitely be adjustments that have to be made on the part of the airlines.”

If this happens, the sh*t storm that will be sure to unfurl from those who were anti-bailout will be hard to contend with (though there is something to be said for buying time to make a bankruptcy more “orderly”). The warrants the government received in exchange for the billions of dollars will become worthless exposing them for the mere window dressing they obviously were. Why didn’t the government take a more aggressive approach that both assisted the airlines and shunned moral hazard? Why didn’t it pursue a General Motors-style transaction and serve as effective DIP lender to the airlines in bankruptcy? These are questions that are sure to re-emerge.

*****

When all is said and done, we’re going to have a number of different data points to determine which approach was best. For the next several months, however, the question will remain salient all over the world: to bailout or not to bailout?

🌧April Suffers No Fools🌧

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April was a busy bankruptcy month but something tells us it won’t hold a candle to what’s coming for the industry in May. There were smatterings of small retail filings and a pair of massive oil and gas bankruptcies (Whiting Petroleum Corporation, Diamond Offshore Drilling Inc.). TMT as a category continues to hold steady with telecom set to fill a lot of restructuring firm’s coffers (Frontier Communications Corporation, Speedcast International Limited). The big winners of the month: the District of Delaware, Kirkland & Ellis LLP, A&M and FTI Consulting Inc. (tough call as they both handled mega deals), Evercore Group LLC and Moelis & Company (same), and Prime Clerk LLC which continues to monopolize the biggest deals.

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đŸ”„F.E.A.R. Part Two.đŸ”„

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âšĄïžWhat. The. Hell. Part. Two.âšĄïž

Pardon us: it’s a little hard to write with a neck brace on. This week’s whiplash has us all sorts of flummoxed.

On Monday, the stock market surged 1000 points because 
 well 
 who the hell knows? Was President Trump correct last week when he suggested that some of last week’s negative market price action had to deal with the rise of Bernie Sanders? Maybe. On Monday, while the mainstream media simultaneously reported on the consolidation of the moderate democrat lane and new coronavirus-related deaths, the stock market somewhat-inexplicably rocketed higher. Apparently the thought of 2% of the US population succumbing to a painful pneumonia-like death was no longer so frightening now that “the establishment” was rallying against good ol’ Bernie. We know, we know, you’re wondering: is this really the reason? The answer: we have no f*cking idea. But whatevs đŸ€·â€â™€ïž. The market was green!

Enter the FED. The market was looking mighty volatile again yesterday when the FED came out of nowhere and lowered its benchmark FED Funds rate by 50 bps — acting between meetings for the first time since 2008. We all know what happened that year. Why couldn’t the FED wait two weeks? Chairman Powell said:

“The committee judged that the risks to the U.S. outlook have changed materially. In response, we have eased the stance of monetary policy to provide some more support to the economy.”

In other words, the FED must be seeing some disturbing-AF data that we aren’t privy to yet. Less likely though equally plausible: Jerome Powell continues to be Reek to President Trump’s Ramsey Bolton.

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The result? Well, the market rallied for about 1.2 hot seconds and then puked all over itself. It subsequently tumbled 2.8%. The energy sector is now down 23% YTD. The Ten-year treasury yield dipped below 1% for the first time in history.

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FOR THE FIRST TIME IN HISTORY. Yes, folks, sh*t is getting real. We’d opine as to “how real” but, again, this is THE FIRST TIME IN HISTORY that this has happened. So, literally nobody knows.

To the extent this extraordinary measure was meant to calm markets, well


Time to extract that gold tooth: it’s going up in value.

You know what else is going up in value? Food. As coronavirus reports spread to multiple cases in NYC, North Carolina and other places, people are stocking up like crazy with an eye towards a potential quarantine situation. Lots of marriage about to get tested, y’all. Netflix and
KILL?!? 😬 Long divorce lawyers.

*****

What does all of this coronavirus disruption mean for restructuring professionals? It’s still far too early to tell. But this doesn’t bode well:

This shows that supplier delivery times are slowing due to China-related issues.

This doesn’t help either:

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Ooof. No bueno. Like 2009-level no bueno. Stating the obvious, JPMorgan noted that “
demand, international trade and supply chains were severely disrupted by the COVID-19 outbreak.”

Bottom line: it’s hard to generate revenue (and service debt or comply with covenants) when you don’t have product.

đŸ”„F.E.A.R.đŸ”„

in , ,

âšĄïžWhat. The. Hell.âšĄïž

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This week was a complete and utter sh*tshow. There’s no sugar-coating it. As fears about coronavirus rose, the stock market got absolutely annihilated — the S&P dipped over 11% for the week (one of the most severe declines in history) and the Dow dropped approximately 4000 points — precipitating a rabid shift to safety in the markets: the 10-year treasury hit a record low, dipping below 1.2%. Leveraged loans, meanwhile, got napalmed.

Majors like Apple Inc. ($AAPL), Mastercard Inc. ($MA) and Microsoft Inc. ($MSFT) lowered guidance and Goldman Sachs Inc. ($GS) issued a report indicating lowered growth expectations for the year — to zero. Yep, zero. The VIX “fear index” jumped into the 40s after being virtually catatonic for years. Now there’s widespread speculation that the FED will lower rates to stimulate the market — a controversial strategy given (a) the sheer volume of money already flushing through the system and (b) the fear that the FED will be ill-equipped to then address any subsequent recession.

There are a lot of restructuring implications — on both sides of the fence. On one hand, lower interest rates ought to help a number of companies with floating-rate loans. It’s clear that the rising interest rate catalyst that many expected — and the FED quickly shot down last year — is nowhere near becoming reality. Secondly, oil and gas prices are getting smoked and given that those commodities constitute huge input costs, companies will see some savings there. Theoretically, lower oil and gas prices should also help stimulate the consumer which, we all know, had been carrying both the economy and stock prices to recent (clearly inflated) highs.

That is, unless they stay home and do nothing other than watch Netflix ($NFLX) and Disney+ ($DIS) and order bottled water and canned goods from Amazon ($AMZN) and Walmart ($WMT) â€” assuming, of course, that third-party fulfillment isn’t affected by supply chain disruption. Interestingly, both the consumer staples and discretionary spending ETFs are down over 10%. And the former more than the latter, which, when there’s a flight to safety pushing treasury rates down, doesn’t make much sense. So đŸ€·â€â™€ïž. Corporations are, one by one, curtailing business travel, cancelling conferences, and encouraging stay-home work as advisories abound about congregating in mass group settings. This is impacting the airlines and movie theaters, naturally. The MTA ought to see a decline in ridership which ought to dig a bigger budget deficit hole (PETITION Note: Is NYC f*cked?).

Transports are getting smoked too. SupplyChainDive writes:

The COVID-19 outbreak and resulting quarantines have led to a record number of blank sailings, according to the latest figures from Alphaliner. Inactive fleet size has swelled to 2.04 million TEUs or 8.8% of global capacity. The decline is greater than the 1.52 million TEUs of canceled capacity during the 2009 financial crisis, the previous record, 11.7% of the total fleet at the time.

The Ports of Los Angeles and Long Beach are facing 56 canceled sailings over the first three months of the year, the ports told Supply Chain Dive.

Note that we had previously asked “Short the Ports?” in “🚛Dump Trucks🚛” here.

Here is The Washington Post highlighting a world of hurt at the ports:


shipping container traffic both coming and going from the ports of Los Angeles and Long Beach has been sliding at an average rate of 5.7 percent a month since the beginning of last year
.

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Pour one out for the shippers.

Of course, none of this is positive for sectors that are already massively struggling, i.e., restaurants. Nor retail. Per CNBC:

If the coronavirus spreads in the U.S., that could mean really bad news for U.S. mall owners, according to a survey taken this week.

The survey by Coresight Research found that 58% of people say they are likely to avoid public areas such as shopping centers and entertainment venues if the virus’ outbreak worsens in the United States. The group surveyed 1,934 U.S. consumers 18 and older.

The survey was taken Tuesday and Wednesday — before California said it was monitoring 8,400 people for COVID-19.

Back to energy. Energy bonds are getting smoked as massive outflows flee the sector.

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OPEC meets next week to discuss a massive production cut. From a restructuring perspective, it’s likely irrelevant at this point.

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We’re heading into redetermination season for oil and gas explorers and producers and, given the rapid decline in oil and gas prices, banks are likely to take a stern stance vis-a-vis borrowing base levels. That ought to help usher in another wave of oil and gas restructuring.

Hold on to your hats, folks.