The § 1124 Debt Reinstatement Trap
An interesting development in some recent bankruptcies has been § 1124 of the Bankruptcy Code, also known as the Debt Reinstatement provision. Recently used in the Spectrum Brands chapter 11, and presumably soon to be attempted in the Charter case, this approach allows "financially distressed companies seeking to use Chapter 11 to substantially delever their balance sheets by equitizing junior debt while “reinstating” existing senior debt on original terms that are more favorable to the borrower than those available in today’s financing market." In other words, this allows the best of all worlds for a bankrupt company: deleveraging due to unsecured debt equitization, while the secured debt continues paying interest at a 2005 Libor rate. With Libor soon to hit negative thanks to the US backstopping all the toxic assets in the universe, and some bufoonery by the ABA, you can bet your bottom dollar that bankruptcy lawyers and financial advisors are pitching default after default even to healthy companies, so they have screw all sorts of creditors.
A recent letter by Wachtell Lipton had this to say on the subject:
Section 1124 of the Bankruptcy Code provides that if, pursuant to its Chapter 11 plan, a debtor cures all nonbankruptcy defaults under a debt instrument and does not alter the rights of the debtholders, the reorganized company can “reinstate” the debt on its original terms, without the consent of the debtholders. Thus, the success of a “reinstatement” strategy depends on the debtor’s ability to craft a feasible plan that does not violate the terms of the relevant loan documents and allows the debtor to remain in compliance with the loan’s terms post-bankruptcy. Because many secured credit agreements negotiated over the last several years have favorable interest rates and contain so-called “covenant lite” provisions (few or no financial covenants and permissive negative covenants), such companies have a strong incentive to try to take advantage of reinstatement.
More great news for secured lenders everywhere - First, after the D-3 debacle, all unionized companies are just waiting for the moment to lube bankholders up, and now this will make life for "secured" lenders even more of a living hell, as, if nothing else, most will be forced to spend hundreds of thousands of dollars on litigation defense from overzealous debtors who attempt to emerge from bankruptcy with a 0% cost of debt.
hat tip Ed