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Consensual "give-ups" in Chapter 11

Senior lenders may fare better in bankruptcy proceedings when they do not demand every benefit to which they are contractually entitled. The best-drawn loan documents and intercreditor agreements may not fully protect a senior lender when holders of junior debt and unsecured creditors assert the leverage accorded them in a borrower’s bankruptcy case.

In today’s economic climate, the value of a borrower’s assets may deteriorate rapidly. By the time the borrower arrives at the bankruptcy courthouse door, a number of hungry constituencies may be seeking to recover from substantially depleted assets. Creditors’ committees may attempt to improve their position by opposing a senior lender’s “lift stay” motion, refusing to approve a Chapter 11 plan endorsed by senior debt-holders, or even commencing legal proceedings against perceived “deep pockets”. Some bankruptcy courts have proved unwilling to enforce intercreditor agreements according to their terms, and the law in this area is unsettled.

Rather than demanding their rights, senior lenders may be well advised in some cases to negotiate a quick and reasonably acceptable accommodation with other parties in interest, including junior creditors. This paradox was illustrated in the Maxim Crane case, In re ACR Management, LLC, Case No. 04-27848-MBM (Bankr. W.D. Pa.). The debtors confirmed a plan that involved what is commonly termed a “gift” or “give-up” by the senior lenders.  Before the bankruptcy filing, the debtors and senior lenders negotiated an agreement including a “Lock-Up Agreement” and pre-negotiated plan of reorganization. After the bankruptcy filing, holders of unsecured debt – who had played no role in the prepetition negotiations – formed an official committee of unsecured creditors, which refused to support the plan. To resolve the committee’s objections, all parties negotiated a global agreement whereby the committee’s constituents would receive value, in the form of a cash pool of up to $3 million, and a series of warrants, voluntarily contributed by the senior lenders out of the recovery to which they would otherwise have been entitled (in accordance with the “absolute priority rule”).There was nothing wrong with the loan documents, but the seniors were driven by their desire to move the case along (and obtain payment) quickly, to participate in the “debtor in possession” loan, and to eliminate risk associated with any possible challenge by the junior creditors.

See the Practice Profiles of our Financings, Structured Finance and Bankruptcy & Creditors Rights Groups and our Credit Crisis Task Force for more information on Sullivan & Worcester’s expertise and broad experience in restructurings, workouts and all other aspects of debt financing.