Welcome back to our blog post series on those distressed financing pitfalls that may seem like little bumps in the road but can cause meaningful delays and issues in the midst of restructuring transactions (see Part 1 for our introductory discussion and coverage of agency resignations). Below we discuss a couple of operational topics that may cause serious interference.
Letters of Credit
While companies relying heavily on use of letters of credit and bank guarantees (whether structured as a sub-facility of a revolving facility or a standalone letter of credit facility) tend to give attention to treatment of letters of credit from the outset of restructuring negotiations, companies less reliant on letters of credit may neglect such considerations. However, failure to address even a single outstanding letter of credit under a secured credit facility can lead to delays.
Frequently, first lien obligations are negotiated based on the assumption that all creditors of the same class will receive similar consideration (with some differences based on whether or not such creditors are participating in a transaction, are sponsors of the transaction or elect to receive a different type of consideration). While related calculations are easy with respect to outstanding principal obligations, a company’s reimbursement obligations with respect to undrawn letters of credit are contingent and, therefore, not suited for direct comparison to outstanding principal obligations despite both sets of obligations having equal lien and payment priority. Even though there are mechanisms in bankruptcy proceedings to reduce contingent claims to a dollar value, such estimates are subject to objections and litigation, and such processes are not a realistic option if the company is looking to emerge from bankruptcy with efficiency.
Below we note a number of letter of credit related issues that need to be addressed prior to a restructuring in order to avoid delays and last minute renegotiations.
- Does the company have ongoing letter of credit needs that will require outstanding letters of credit to “ride through” a restructuring process unaffected? Will other creditors consent to such treatment? Alternatively, can the company work with the beneficiaries to obtain the return of such letters of credit undrawn and potentially replace them with other letters of credit?
- Do the letters of credit provide backstops for other letters of credit, bank guarantees or bonding obligations, including at foreign subsidiaries that are not intended to be affected by a predominantly domestic-focused restructuring?
- If the company has filed for bankruptcy, does the plan specifically address treatment for letters of credit within the applicable class?
- If the agreed upon treatment for letters of credit in a restructuring is to provide cash (whether for full face value or a percentage thereof) to letter of credit issuers/letter of credit participating lenders when they are drawn in the future, what type of arrangements will be made? What entity will hold the cash? How will the cash be returned to other creditors that might be entitled to such cash if the letters of credit are returned undrawn?
Rebalancing of Facilities; Facility Exchanges
Since non-participating lenders in an out-of-court restructuring transaction will not be consenting to modifications requiring all lender (or all adversely affected lender) votes, such transactions frequently require the creation of additional facilities and instruments with characteristics different than those in the capital structure prior to a company’s restructuring.
Prepayments of the participating lenders’ overall exposure and/or aggregate commitment reductions for participating lenders are frequent benefits exchanged for a participating lender’s consent to a transaction. When only term loans or notes are implicated, the mechanics for paydowns and reductions are typically more manageable; however, when dealing with revolving facilities, such paydowns and reductions can be more complicated and more involved rebalancing maneuvers may be necessary. Below are some items that would be helpful to think about when rebalancing facilities and/or exchanging facilities:
- In the existing loan documentation, are there fully flushed out mechanics for amend and extend or similar transactions, or are there more general provisions allowing the agent to effect modifications as necessary?
- Will letter of credit exposure be reallocated between the existing and new facilities? Will the borrower be permitted to make any of the following as between the existing and new facilities:
- Non-pro rata prepayments;
- Non-pro rata borrowings; or
- Non-pro rata commitment reductions?
- Note that failing to treat all aspects as pro rata may require additional mechanics for when availability as a percentage under each facility is out of sync.
- Will interest and fees on the obligations being exchanged into another facility be paid on the effective date of the restructuring or in the ordinary course?
See Part 3 where we discuss when compliance with internal institutional policies can delay an otherwise well implemented distressed transaction.