C. Edward Dobbs, Business Bankruptcy Panel: the Brave New World of Finance

• Publication year: 2011

BUSINESS BANKRUPTCY PANEL: THE BRAVE NEW WORLD OF FINANCE

Moderated by C. Edward Dobbs^*

MR. KURZWEIL: I'd like to welcome everybody to the business part of the Symposium today, entitled "The Brave New World of Finance." I would like to thank the panel members who magnanimously donated their time in preparing and presenting today and to introduce each one to the audience.

Mack McNair is a managing director of CIT Corporate Finance. With offices in New York and Atlanta, Mack manages a team of business development professionals and CIT's alternative investment channel. His team is responsible for developing and maintaining relationships with hedge funds, distressed private equity groups, special situation investors, and second lien lenders. He and his group are responsible for originating, structuring, and closing creative financing solutions including senior secured asset-based, enterprise value, cash flow, and second lien transactions. Mack is a graduate of Florida State University and has over sixteen years of corporate lending experience.

Joel Piassick is Executive Vice President of Harbert Management Corporation, a sponsor of diversified alternative asset investment funds based in Birmingham, Alabama. Joel is a principal of Harbert Private Equity Fund. Harbert has more than $8 billion of assets under management and ten asset classes including private equity, early stage venture capital, mezzanine debt, domestic real estate, and distressed debt. Prior to joining Harbert, Joel was a partner and co-manager of the Financial Restructuring practice at Kilpatrick Stockton, where he remains of counsel to the Firm. He is also a member of the Board of Directors of the American College of Bankruptcy.

Andrew Hettinger is a Managing Director of Cerberus Georgia and a Vice President of Ableco Finance Georgia. Prior to joining Cerberus and Ableco, Andrew was a director at Houlihan Lokey Howard & Zukin, where he was responsible for managing advisory assignments for private debt and equity placements, mergers, acquisitions, and special situations. Andrew previously worked at Deutsche Bank and Bank of America where he originated senior and subordinated debt.

William Runge, a Managing Director with Alvarez & Marsal, serves as co- head for the firm's North American Commercial Restructuring practice for the Southern Region. Based in Atlanta, Bill specializes in business diagnostics, business plan development, and financial strategies for corporate turnarounds and restructuring. Bill has more than thirty-one years of combined experience in industry operations, financial executive management, and turnaround consulting. Prior to joining A&M, he spent more than ten years with the Corporate Restructuring Group of a "big five" accounting firm in Atlanta where he served as Partner-in-Charge. He has served as a Chief Financial Officer, Chief Operating Officer, Chief Executive Officer, and Controller for companies in the manufacturing, distribution, and service industries.

Our moderator for today is Ed Dobbs. Ed is a named partner in the law firm Parker, Hudson, Rainer & Dobbs and is head of the firm's Commercial Lending & Bankruptcy practice group which includes commercial lending, bankruptcy, and workouts. Ed is widely known as one of the premiere lending lawyers in the United States. He writes and speaks extensively on commercial law topics. Ed has been listed in the Best Lawyers in America each year since

1989 and Chambers USA since 2003 and is one of the top 100 "Super

Lawyers" in Georgia in Super Lawyers Magazine and Atlanta Magazine.

Also, a special thanks to Ed's firm who worked very hard in putting together the materials today, including the hypothetical.

HYPOTHETICAL^*

Debtor Co. is a manufacturer of widgets, which it distributes throughout the United States, Canada, and Western Europe. Part of its manufacturing operations are in China. Debtor Co. is owned by Private Equity Co. (ninety percent) resulting from an equity investment of $5 million, and management (ten percent). Debtor Co. obtained a working capital line of credit in the amount of $70 million from Senior Lender, which has a lien upon substantially all of the assets of Debtor Co. other than Debtor Co.'s assets in China. Debtor Co. has raised $125 million in the public debt markets by issuing its ten percent senior subordinated notes due 2015. The notes are subordinated only to debt for borrowed money under the Senior Lender facility and other debt for borrowed money, up to an aggregate senior debt amount of $75 million.

Private Equity Co. is disappointed with this investment and has approached Senior Lender about financing a $5 million special dividend to Debtor Co.'s shareholders. Senior Lender has declined due to tightness of availability that would result under the borrowing base formulas. Second Lien Lender, however, has agreed to provide a $10 million term loan ($5 million of which will be used to fund the dividend) to be secured by second priority liens on the same collateral that is subject to the liens of Senior Lender. Second Lien Lender's valuation expert has opined that Debtor Co.'s patent technology and trademarks (which are registered throughout North America, Western Europe, and China) are fairly valued, on a going concern basis, at $10 million. Such assets are not included in the borrowing base under the working capital facility provided by Senior Lender.

At the time Second Lien Lender funds its $10 million term loan, the total amount outstanding under the working capital line of credit from Senior Lender is $60 million. Senior Lender and Second Lien Lender enter into a standard intercreditor agreement by which Second Lien Lender subordinates its liens to those of Senior Lender, agrees to a ninety-day standstill on lien enforcement actions,¹agrees to yield to Senior Lender's cash collateral arrangements in a bankruptcy case, and agrees to release its liens in connection with foreclosure sales and specific asset dispositions (excluding sales involving the sale of intellectual property) up to an annual basket of $1 million. In the intercreditor agreement, Second Lien Lender is granted an option to purchase Senior Lender's claims after certain standard triggering events, including the bankruptcy of Debtor Co.

Eighteen months after the closing of Second Lien Lender's loan and the funding of the dividends to Debtor Co.'s shareholders, Debtor Co. is unable to make an interest payment on its senior subordinated notes and, as a result, Indenture Trustee issues to Debtor Co. a notice of default. The lack of liquidity is attributable in part to the dividend, a recent quarterly interest payment made to the senior subordinated noteholders, manufacturing problems in China, and unanticipated increases in raw material prices.

With prompting from Second Lien Lender and Senior Lender, Debtor Co. hires Turnaround Consultant to conduct a viability analysis and to make recommendations regarding a reorganization or recapitalization of Debtor Co. After a thirty-day study, Turnaround Consultant concludes that Debtor Co. is insolvent (and was insolvent at the time of the special dividend); an effective reorganization of Debtor Co. will require a capital infusion of at least $15 million; on an orderly liquidation basis, the loans of Senior Lender are only marginally secured (Senior Lender failed to perfect its security interest with respect to Debtor Co.'s assets in China and did not perfect its liens on intellectual property registered outside of the United States); a going concern sale of Debtor Co., properly marketed over a period of ninety days, should yield proceeds in an aggregate amount, on a conservative basis, sufficient to satisfy substantially all of the secured indebtedness (leaving Second Lien Lender with a small deficiency) and, on a best case basis, return ten cents on the dollar to unsecured creditors;²and the collateral position of the secured lenders will erode, through ongoing losses, by up to $5 million during the period that would be required to market and sell Debtor Co. as a going concern.

In an effort to conserve cash, Debtor Co. elects to forego making monthly principal payments on Second Lien Lender's term loan. As a result, Second Lien Lender gives notice of its intent to exercise remedies at the end of the ninety-day standby period. Unable to convince Second Lien Lender to withdraw its foreclosure notice, Debtor Co. files for chapter 11 relief in the United States Bankruptcy Court for the Northern District of Georgia, Atlanta Division, some twenty-one months after the special dividend.

At the time of the filing of bankruptcy petition, Debtor Co.'s indebtedness to Senior Lender totals $68 million, to Second Lien Lender totals $9.5 million, and to unsecured creditors totals $150 million (of which $120 million is owed to the senior subordinated noteholders).

Chart 1: Debtor Co. Balance Sheet

Company Balance Sheet as of Time of Bankruptcy Filing

($ in millions) 31-Dec

Total assets $ 74.0^*

Liabilities:

Total current trade liabilities $ 30.0

Senior lender's debt 68.0

Second lien lender's debt 9.5 Total secured debt $ 77.5^**

Sub note debt 120.0 Total liabilities $227.5

Shareholders equity (153.5)

Total liabilities $ 74.0

^*Approximate amount based on valuation of Turnaround

Consultant; assumes sale of Debtor Co. as a going concern in

90 days.

^**Does not take into account that a certain amount of the secured debt may be bifurcated into secured and unsecured pieces pursuant to 11 U.S.C. Sec. 506(a) (2000).

Chart 2: Status of Liens on Debtor Co. Assets as of Bankruptcy Filing

China Assets

International Intellectual

Property

All Other As s ets

China Assets: Unencumbered

Int'l I.P.: Subject to the liens of Second Lien Lender only

All Other Assets: Subject to the liens of Senior Lender and Second Lien Lender

DISCUSSION POINTS

1. What is the general state of the second lien, private equity, and senior loan markets today?³How has the abundance of liquidity...