A View From the Bench… U.S. Bankruptcy Judge Shares His Perspectives on the Post-Crisis Environment
In an exclusive Q&A with ABF Journal publisher Jerry Parrotto and New York Institute of Credit managing director Harvey S. Gross, U.S. Bankruptcy Judge Michael B. Kaplan shares his thoughts on corporate restructuring in the post-credit crisis environment.
ABFJ/NYIC: According to a new Fitch Ratings report, U.S. ABL facilities present in a defaulted issuer’s capital structure demonstrated complete recoveries in a bankruptcy scenario. This of course is good news for the ABL industry. Would you care to comment on these findings?
MBK: In a general sense, ABL facilities provide very high recovery for lenders in the event of a default. This is partly because of the structural features of ABLs, such as the over-collateralized status of the pre-petition ABL’s and the liquidity of the collateral. Given this relatively high prospect for recovery for ABL lenders, it is not surprising that the recent Fitch Ratings report found complete recoveries in a bankruptcy scenario. However, each bankruptcy case is unique and the structure of the ABL facility, coupled with the structure of the DIP facility, will ultimately dictate the amount of recovery. Needless to say, ABL lenders should also be cautious in bankruptcy cases where there is no DIP facility.
ABFJ/NYIC: In the Hostess case, GE Capital as agent for the prepetition lenders objected to a court order authorizing the debtors to retain and employ a liquidation company saying it believes the debtors are not entitled to any proceeds with respect to any term loan priority collateral as such phrase is used in a wind-down order. Instead, GE said the debtors should be required to apply the proceeds from the agreement to pay-down the prepetition indebtedness. Can you comment on this aspect of the Hostess bankruptcy case?
MBK: In the early days of “baby Judge school,” I and my new colleagues were admonished not to comment upon pending cases (especially cases being handled by other Judges). As a result, I will limit my views to how I address similar issues in cases coming before me. Courts need to recognize the need for a debtor to move quickly through the bankruptcy process in order to best realize the value of that debtor’s assets. In balancing that notion with a lender’s request for prompt payment, the Court is constrained to follow an approach supportive of a debtor’s efforts to enhance recovery to all creditors, including the use of liquidity agents and the application of proceeds to address immediate liquidity needs.
ABFJ/NYIC: It’s hard not to bring up — finally the Tribune Company has emerged from bankruptcy. In hindsight, would it be possible for you to provide our readers with a few notable takeaways from this case?
MBK: From an outside perspective, and from what I have gleaned from reading a number of articles, what Tribune lacked in the days leading up to the bankruptcy was a vision of the company’s future that took into account the impact of digital media and the new age of how people get their news. Once in bankruptcy, the Debtor (like many retail debtors) needed to focus on improving its capital structure and strengthening its brand. With a new management team, Tribune was able to emerge from the bankruptcy process as much leaner, yet focused entity. An important takeaway from the Tribune case is the significance of having competent management — a team that is both knowledgeable and has a proven track record in the industry — at the helm both during and upon exit from bankruptcy.
ABFJ/NYIC: Now that we seem to be in a post-credit crisis mode, can you please comment on your sense of the “healing” that has shown up or manifested itself in more recent cases on the debtor side?
MBK: From what I have seen and read, the data seems to indicate that the number of out-of-court workouts and deals have increased during the post credit-crisis. More recently, however, DIP lending has been on the rise as lenders appear to be re-entering the market. It seems that this upward trend in DIP lending is continuing, which would foster the ability of Chapter 11 debtors to emerge from bankruptcy and potentially increase the number of §363 sales. However, as discussed below, increased DIP lending now comes with a heavier price tag, with a debtor forced to abide by higher benchmarks and stricter timeframes. So while there appears to be an upward trend, we are not yet seeing pre-credit-crisis lending, as DIP lenders are more selective and cautious when extending credit.
ABFJ/NYIC: We sense from the tone of some of the articles we’ve featured that banks are growing impatient with some of their borrowers and seem to be less inclined to amend/extend or otherwise be supportive during a difficult period. Does this posture reflect itself in a proceeding as being more indicative of a recent change in attitude toward a borrower?
MBK: From the Court’s perspective, it seems that the impatience of some banks is due to the lack of confidence in borrowers making good on their commitments, as well as failing to meet certain consensual trigger points. In the bankruptcy context, this impatience can be seen in §363 sales whereby banks are requiring higher benchmarks, expedited timeframes and more control over the sale process. Requiring these higher standards may not be due to a lack of patience on the part of the lenders, however, but rather a desire to confront the debtor’s operational weakness and distress head on instead of letting the situation worsen. In order to rebuild confidence in borrowers, creditors need to see management teams that meet expectations and deliver on promises.
ABFJ/NYIC: As a follow-up, from where you sit, is bankruptcy still a viable restructuring solution for borrowers? And if “yes,” what one factor usually turns out to be critical to a successful outcome?
MBK: Given a debtor’s potential ability to restructure its business by righting its balance sheet and streamlining its operations in bankruptcy, restructuring certainly continues to be a viable option. Whether reducing debt, selling the business as a going concern, replacing management or renegotiating its contracts, bankruptcy provides a debtor with alternatives that may not be possible without Court assistance.
ABFJ/NYIC: With debtor-in-possession financing, do you see the trend continuing with respect to DIP financing being most prevalent in situations where a §363 sale is indicated?
MBK: The extended liquidity crisis has changed dramatically the post-petition lending landscape. Many lenders have opted to leave the DIP market, and those who remain are offering DIP loans at such higher rates and shorter maturities, so as to make traditional restructuring infeasible. DIP loans are now employed as vehicles to facilitate a sale under §363, rather than support for restructuring and eventual emergence from Chapter 11. Indeed, we have seen marked decreases in DIP loan durations over the past three years, often mandating repayment in as little as three to six months. Debtors have substantially less time to accomplish meaningful turnaround initiatives, leading to §363 sales as the only viable route. I have seen nothing to suggest that changes in this approach are likely in the near-term. The change in lender mix also points to continued use of DIP financing as a pathway to an asset sale. Traditional institutional lenders have been replaced by third-party private investment funders, who view DIP financing as a means to acquire assets, and thus place harsher restraints on the loans in order to influence the outcome and timeline of the Chapter 11.
ABFJ/NYIC: With the turmoil in the European liquidity markets continuing, can you comment on cases you’ve seen where a U.S. debtor and affiliate of a foreign based parent was unable to achieve a restructuring in a bankruptcy proceeding because of the parent’s inability to access the capital markets?
MBK: Admittedly, here in Trenton, NJ we have few cross-border cases in which foreign corporate parents with U.S. affiliates are engaged in foreign insolvency proceedings. I regard the opportunity to handle a meaningful Chapter 15 case akin to playing a round of golf at Augusta National. I am confident I wouldn’t embarrass myself, but no one is sending me an invitation. From what I have seen in our sister courts, the European liquidity crisis has changed the direction of reorganization cases in a fashion similar to what we see here in domestic Chapter 11 cases— a momentum toward asset sales rather than emergence. Chapter 15 has been used successfully to permit a foreign representative, in recognized foreign main proceedings, to undertake a §363 sale of U.S. based assets. The advantages of a §363 sale, when combined with the often more favorable (as far as timing and noticing) liquidation processes permitted under foreign insolvency schemes, continue to make Chapter 15 cases attractive and productive. The WellPoint Systems Inc. Chapter 15 proceeding filed in Delaware in 2011 is an excellent example of a coordinated approach to structure a stream-lined asset sale.
ABFJ/NYIC: BankruptcyData.com noted recently that there were 86 publicly traded companies that filed for bankruptcy protection in 2012 — the exact same number that filed in 2011. Perhaps a coincidence, but would you venture a guess on what you expect will occur in 2013 and why? Would you please comment on which sectors are most likely to feel the pain of only modest growth in the economy?
MBK: I recently had an opportunity to walk the frighteningly empty hallways and casino floor of the new Revel Resort and Casino in Atlantic City, and came to the conclusion that there are very few good economic prognosticators. I am certainly not among them. However, from what I see and read, I would not be surprised by a small increase in the interest rates, which may give rise to a default rate increase this year. I foresee companies, which for the past several years benefited from lower rates and loan extensions, being compelled finally to address balance sheet concerns and operational problem areas. The debt “maturity wall,” which has been kicked forward consistently since 2009, may start this year to hold strong. Given the current administration’s inclination to enhance regulatory oversight, I would regard the health and energy sectors as likely to face more financial distress this year. Finally, given my recent stroll by the lonely slot machines in Atlantic City, I would not feel overly confident in a swift recovery in the gaming/entertainment sector.
Judge Michael B. Kaplan was appointed as a Bankruptcy Judge on October 2, 2006, for the District of New Jersey, Trenton Vicinage. Prior to taking the bench, Judge Kaplan served as a Standing Chapter 13 bankruptcy Trustee, as well as a member of the Chapter 7 panel of bankruptcy Trustees, where he received case appointments as both a Chapter 11 and Chapter 12 trustee. Judge Kaplan received his A.B. degree from Georgetown University (1984) and his J.D. degree from Fordham University School of Law (1987).