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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
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we are witnessing the crack-up of western
civilization. this represent economic immorality...
we should also note that forced bankruptcy or
loan calls (credit events) makes cds more
valuable providing incentives for parties to
such instruments to force credit events.....
which is one reason why jpm called a
loan on a major bank in a former ussr republic
a month or so ago....
both acts point to the financial terrorism and
immorality of the bankster universe.
mammon is an evil god.
My fear is that an implosion will not be gradual. It will be sudden and dramatic. The politicians know it, the bankers know it, the media knows it. Everyone seems to be acting like everything is so normal these days and behind that facade there is massive trouble brewing that nobody wants to talk about and inform the public.
We are waiting for the critical mass.
is there no end to the insanity?!?!?
So basically lawyers are now advising issuers the same way they're advising debt-laden households, "The first step is to stop paying your mortgage... " There's nothing good about this. We can expect the usual number of corporate defaults as the economy spirals into depression *plus* the deliberate defaults to facilitate reinstatement under this rule. If I'm not mistaken, this might be bad for corporate fixed-income.
i was thinking the same. a big a-bomb to anyone needing to roll paper forward.
...good thing that there's no large chunks of CMBS coming due this year or next.
Is this the big set up for C, BofA? Eventually test some new lows?
Tyler,
It shoud be renamed....
1124 Refinancing cramdown with an unlimited interest rate put option to the bond holder (while market rates are zero) while bondholders have no legal means of recourse on any of their secured claims in perpetuity.
THIS IS EQUITY IN DRAG!
R.I.P. Corporate Bondmarket 2009
Absolute storm in a tea cup - ask any corporate treasurer what is most important to them at the moment, either term of debt or credit margin. This refinancing "cramdown" tactic only resets to original terms - big deal they save a litle on the spread (versus current market) at the COST of pissing off a bank enough to ensure that they don't refi at the ORIGINAL maturity date when we get there.
If you give a banker a chance to get his keys on your business at cost (i.e. zero equity value, but 100% debt) he will take it. Just look at the embedded option value.
Perhaps you didn't read the full document...they changed the maturity and rate. Also if your "new plan" is anything like Chrysler where is your say with regard to increase risk? Yes by the face of it there is very little by way of actual financial impact but it is the precedent that is set that makes those of us who have actually have done this process take notice.....
Also the idea is to restructure the debt and take out management and give the company to the bondholders because the management is screwed up (those who fail should go!) you can't blame credit markets for bad business decisions! Ask anyone who has to make payroll and real decisions on a daily basis not a numbers cruncher in a office somewhere...
ys, I did read it. The maturity was actually shortened, sounds like a traditional negotiated deal to me. If the debtor had power why would they shorten the maturity? Nothing to see here.
Will Kimco be the first major REIT to go this route, or will they just keep doing equity secondaries?
At the pace of their stock death-spiral, we should know by the end of the month.