Distressed Debt Concessions

When investing in distressed debt, one has to be aware that negotiations can affect a creditor's ultimate recovery - for the good or the bad.

Why does this dynamic occur? More appropriately, what influences a creditor's decision to negotiate in a bankruptcy proceeding? As noted quite often in this blog, the bankruptcy process is expensive. Lawyers are billing upwards of $1000/hour. If a certain creditor class wants to expedite the bankruptcy approval process, they may give up some "nuisance value" to junior creditors to get their support.

In addition, in the wake of fraudulent conveyance rulings, senior creditors, specifically at the bank debt level, do not want to see their liens extinguished by a litigation from subordinated creditors. So they have even more incentive to offer up a little value to get junior creditors to play ball with a confirming bankruptcy plan.

The bankruptcy case of Idearc, which we spoke about quite a long time ago (Idearc Bankruptcy), is an example of negotiations among various creditor classes. Here is the new proposed Idearc bankruptcy plan.

As you can see on page 22 of 50 of the file, the plan outlines the treatment of Class 4 Claims, which in this case represents, the unsecured bond holders. Furthermore, we can see the edits on this document:
  1. Bondholders were to get 5% of the new common stock - They are now getting 15%
  2. Bondholders were to receive no cash - They are now getting $120M
Why did this happen? If you have been following the Idearc bankruptcy, you would have known that MatlinPatterson and the unsecured creditors, via the Unsecured Creditor Committee, was challenging the bank debt lenders and the bank debt agent on possible unencumbered assets at Idearc (from the docket):
The Creditors’ Committee commenced this adversary proceeding in order to challenge certain of the Agent’s liens and the valuation and allocation of the Debtors’ unencumbered property, if any, pursuant to the Debtors’ proposed plan of reorganization. The Creditors’ Committee contended that there are significant unencumbered assets, including the Debtors’ copyrights and related revenue streams, and rights to use the Verizon brand, as well as post-petition revenue streams, and that the value of such assets should be distributed to unsecured creditors. The Agent rejected the Creditors’ Committee’s contentions, maintaining that (a) the Agent held a perfected pre-petition lien, for the benefit of the Lenders, on substantially all of the Debtors’ assets, (b) the Creditors’ Committee’s challenges to the Agent’s liens on the Verizon brand and the revenues associated with the Debtors’ copyrights were without any merit, (c) the value of the Debtors’ copyrights were de minimis, and (d) the challenge to the Agent’s lien on post-petition revenues was defeated, among other things, by the diminution in value of the Debtors’ estates since the bankruptcy filing, and the Agent’s right to be adequately protected by receiving a post-petition replacement lien on whatever unencumbered property existed. This litigation ensued, extensive discovery was taken, and trial commenced and was conducted on November 9th and 10th.
Now, I have no opinion one way or the other on the validity of these claims. I do know, though, that these claims brought the various creditor parties to the table to work out an "amicable" solution. A lengthy litigation may have dragged the bankruptcy process on substantially longer, thereby accruing more lawyer fees, and possibly harming the underlying business of Idearc

The docket continues:
Now, following the commencement of trial on the myriad legal and factual issues implicated in this dispute, the Parties have reached a global resolution of all issues. The Settlement described herein preserves a significant recovery to the Lenders on account of their secured claims, while significantly increasing the consideration to be paid to Class 4 unsecured creditors under the Debtors’ plan of reorganization, and paves the way for the Debtors’ prompt emergence from Chapter 11.
So, to drop their dispute, the Class 4 creditors (the bond holders), got the aforementioned benefits: $120M in cash and a large percentage of the post-re org equity. In addition, the new bankruptcy plan has the support of a large creditor class thereby bringing the confirmation of the case that much closer.

Who won out in this exchange? In all honesty, probably everyone won out - except the bankruptcy lawyers. Note holders get a bump in recovery (the bonds have been gradually trading up over the last 3 months), bank debt holders do not have to worry about losing massive value, and the company will emerge from bankruptcy faster. Win/Win for all.

Happy Thanksgiving from Distressed Debt Investing!


Anonymous,  11/25/2009  

Another dynamic at play here is that not only do parties want to reach a resolution, but judges have begun forcing mediation, with heavy pressure to settle. The resources at DE and SDNY courts are stretched, and often a marathon mediation is the only way to timely solve these things. Otherwise the estate is whittled away by adminsitrative costs and the company craters.

Anonymous,  11/25/2009  

With decent lawyering, junior creditors can often get hold up or nuisance value in excess of what they are entitled to under a straight waterfall.

To me, the more interesting development is the ability of senior creditors to "gift" value to junior creditors to get them to support a plan while skipping an intermediate class of creditors. Meaning a very junior class of creditors gets value while an intermediate class of creditor is not paid in full.

financespot 11/30/2009  
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hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.