Lily Robertson: Can you start by giving us some background about Bracewell & Giuliani and your current role there?
Jennifer Feldsher: Bracewell & Giuliani is an international law firm with 470 lawyers around the world and major offices in Texas, New York, D.C., Seattle, Dubai and London. In the corporate group here in Bracewell’s New York office, we represent investors in financial transactions across a number of major sectors. I came to Bracewell in 2006 to focus on investments in the distressed space.
I began my career at Weil, Gotshal & Manges, where I worked for over six years representing troubled companies as they navigated through restructurings both in and out of court. While I was there I worked on restructurings in a variety of different industries including telecom, energy, airlines and automotive. Having started my career right as the tech bubble was bursting and the downturn in the financial markets took hold, I was called upon to work on some of the largest bankruptcies at the time, such as Enron, Global Crossing, Rhythms NetConnections and Adelphia. After I arrived at Bracewell my practice changed a little bit because I went from doing mostly debtor work to working predominately on the creditor side. Rather than representing companies in trouble, I now advise financial institutions on their investments in troubled companies. Such companies may be in or facing bankruptcy or they may just need to be restructured in another way outside of the bankruptcy process.
As far as my day-to-day practice, often clients will call me before they invest in a particular company with many different layers of debt and ask where in the cap structure is the best place to invest? “What rights do we have if we invest in one part of the cap structure versus another part of the cap structure?” Sometimes they call me after they’ve already invested and say, “Okay, now what are our rights? We’re already involved, here’s what we want to do. How do we get from point A to point B?” In addition to advising on these questions, if a company does file for Chapter 11, I’ll represent their interests in court proceedings if there are any.
Are you seeing any trends over the past year about where people are looking to make investments?
The number of distressed opportunities has certainly gone down, but most of my clients are opportunistic so they will pick across a variety of industries. Recently, there’s been a lot of interest in oil and gas assets, the assets larger banks are looking to sell off both domestically and internationally, and real estate, including homebuilders and land banks.
Are you seeing people making moves towards Europe, or are they holding off?
I think everybody is focused on Europe. They’ve been predicting a large sell-off in Europe as the banks there try to right themselves, but I don’t know that that has occurred yet. There have been isolated sales from the larger banks that have gone towards more private equity/hedge fund money, but it has not been the systematic sell-off that people have been predicting for the last couple of years. So people are still watching the situation.
What’s your sense of how the corporate bankruptcy process has changed over the last few years?
In 2005, Congress made limited but important changes in the Bankruptcy Code when it passed the Bankruptcy Abuse Prevention and Consumer Protection Act. That Act, among other things, limited the period in which the debtor has the exclusive right to propose a Chapter 11 plan and the time periods by which the debtor has to decide if it wants to assume or reject real property leases.
In addition, there were enhanced creditor rights with respect to reclamation and grounds for dismissal and conversion of Chapter 11 cases. So overall I would suggest the Act strengthened the hand of creditors in the bankruptcy process. But it also made the process more collaborative. By shortening the time periods, it forces debtors and creditors to have more agreement earlier in a case. Otherwise, if a debtor can’t propose a viable plan by the expiration of its exclusive period, then it’s open to creditors to superimpose their own plan. That’s a powerful right that creditors have today, because before 2005 bankruptcy cases could extend for long periods. That’s changed the practice dramatically, because when I started it was not uncommon to have a case that languished in bankruptcy for five or six years while people tried to restructure. Nowadays most cases are in and out well before the two-year mark.
Creditors too have an incentive to make a deal with the debtor early on in order to have a restructuring that is quick and timely, as well as cost-effective. So now there’s much more agreement going into bankruptcy, because the debtor doesn’t have the luxury of a long protracted period to sit in a bankruptcy proceeding, and creditors are less amenable to that because it’s an expensive process for them as well.
The other thing that has changed is the players. When I started, companies had what we call legacy banks, so if a company banked with a particular bank, it was that institution that usually served as its liquidity source through a restructuring. The legacy banks wanted to stick around because they wanted the continuing business on the back end. Nowadays legacy banks often sell out early in the process to private equity or hedge funds, who debtors then face in a bankruptcy process. And these new “lenders” have their own ideas on acceptable exit strategies. Therefore, the type of restructurings and solutions has changed.
What’s your perspective then on Chapter 11 versus Chapter 7, and is there a preference for one or the other?
One of the major differences between the two is around who controls the process. In a Chapter 11 case, management usually stays in control and has the ability to restructure on its own. In a Chapter 7 case, a trustee is appointed and is charged only with liquidating the company in the most efficient manner possible and maximizing recoveries. There’s no possibility to rehabilitate in Chapter 7 as there is in the Chapter 11.
I think among financial institutions there’s a large preference for Chapter 11 because people believe there is more predictability by keeping management in control, even in a liquidation scenario. People are afraid of an unknown party in the form of the trustee that gets appointed in Chapter 7. Creditors may feel that they don’t have an easy avenue to the trustee.
While most of my work relates to Chapter 11 cases, I recognize that sometimes Chapter 7 is the best alternative. For example, if a fund needs to liquidate a portfolio company – and there’s really no hope of rehabilitation – then Chapter 7 may be the most cost-effective way to go. A trustee overseeing liquidation doesn’t have to pay a lot of administrative expenses because he is not operating the business, he’s not proposing, soliciting or going out and getting votes on a Chapter 11 plan and accumulating the costs that are associated with that process. There is less leakage in that case.
So Chapter 7 can be a very effective tool to liquidate a non-performing asset over the Chapter 11 process. But it’s still used very sparingly by creditors. My clients will certainly go that route or threaten it, however, if they feel that management is not being responsive or has interests that differ from those of the creditor base.
Could you explain the idea of a cramdown situation, and what should investors be prepared for when it comes to that?
Cramdown refers to the ability – under section 1129 of the Bankruptcy Code – for the debtor to confirm a plan over dissenting classes of creditors. If the debtor is not able to get the support of all the classes of claims pending against it, the Bankruptcy Code provides the debtor with the ability to still confirm a Chapter 11 plan subject to certain requirements set out in section 1129(b). The requirements differ depending on whether you are seeking to confirm a plan over the objection of secured or unsecured classes of claims. Generally the debtor must get the support of at least one impaired accepting class, and the plan must be fair and equitable and not discriminate unfairly with respect to dissenting classes.
Debtors do not prefer to be in cramdown situations. Cramdown plans are usually expensive to confirm because you have armed and motivated at least one class to object to your plan and litigate. When that class is made up of secured creditors, confirmation is even more difficult because there are only three very specific avenues for cramming down secured creditors. First; you may provide secured creditors with an instrument that pays them the full present value of their claims (and stretch out repayment), but then they must retain their liens that they had going into the bankruptcy case. Second, you can sell assets, but the secured creditors’ liens must attach to the proceeds of the sale. Or third, you may give secured creditors the indubitable equivalent of their claim, but there are limitations on what qualifies there as well.
These types of issues have come up though in the last several years as the creditor markets have seized up and there’s been limited access to capital, causing debtors to be more creative in trying to reorganize. Sometimes when they try to be too creative with limited amounts of capital, however, we have seen debtors run afoul of the requirements of the Bankruptcy Code. And I believe these issues are going to continue so long as the credit markets remain skittish and options for companies trying to restructure remain limited. For instance, the law regarding the correct interest rate that you have to provide to creditors in order to do a cramdown plan remains pretty unsettled and is being challenged in more instances.
When it comes to the regulatory environment around bankruptcy, credit bidding was recently upheld by the Supreme Court. What are your thoughts on the use of that and what should investors be aware of?
In my opinion, credit bidding is one of the most formidable weapons that a financial player has in distressed situations. Section 363(k) of the Bankruptcy Code says that a secured creditor can credit bid up to the full face amount of its debt in an auction related to the collateral on which it has a lien. So even if the collateral is not worth as much as the claim, the secured lender can still bid up to the full face amount of the debt. What 363(k) preserves for the lender is the right to get the benefit of its bargain – the right to take its collateral in lieu of a reduced payment, along with any attendant upside. Obviously secured lenders don’t have to credit bid, but the right to block the debtor from selling assets at a discount is a powerful one.
As private equity and hedge funds have replaced traditional bank lenders in the capital structure, we’ve seen a shift from credit bidding being used defensively – to prevent the debtor from selling collateral and not paying the lender what it feels it should be paid from that collateral – to credit bidding being used strategically. It’s a way now for private equity, hedge funds and other creditors to take control of an asset for a fixed price (i.e., buying the secured debt and then getting the benefit of bidding that debt at higher amounts up to face value).
We saw a lot of this in 2009 and 2010 when the capital markets had really shut down and it was difficult for anybody to get financing in the distressed world for sales or takeovers. You saw private equity and hedge funds using credit bidding more and more as a way to take over with limited capital and with certainty on the amount you would pay. And I think it will continue to be an important tool.
How did the issue of credit bidding wind up in front of the Supreme Court?
The Philadelphia Newspaper’s decision, in which the Third Circuit upheld a debtor’s right to sell its assets under a Chapter 11 plan without providing its secured lenders with the right to credit bid in that sale, was surprising to the distressed community. Prior to the decision, most practitioners in the space would have read 1129(b)(2)(A) to mean if a debtor was selling assets free and clear of liens, it had to give its secured lenders the right under section 363(k) to credit bid. The court in Philadelphia Newspapers however said no, so long as the debtor could eventually satisfy the “indubitable equivalent” prong of 1129(b)(2)(A)(iii). That interpretation swallowed up the more specific provision of that section dealing with asset sales and provided a completely distinct avenue for the debtor to cramdown its secured lenders when it was doing a sale.
So I think that decision surprised a lot of people, and you saw subsequently in the River Road case that the Seventh Circuit declined to apply the Philadelphia Newspapers decision. Instead, the Seventh Circuit went back to a more natural reading of 1129(b)(2)(A), which says if you’re doing a “free and clear” sale you go under 1129(b)(2)(A)(ii), which deals with asset sales, and you have to provide the secured lender with the right to credit bid if you’re not paying the secured lender in full and no cause exists to curtail that right. The fact that the Supreme Court sided with the Seventh Circuit on this was a big decision favoring secured lenders.
Do you think people have realized those ramifications or are they still unaware of what a big deal it was?
Yes, it was a widely watched decision not just among the lawyers but in the financial community generally. When the Philadelphia Newspapers decision came out there was a real panic in the distressed community, and we were called upon to explain the decision to a lot of our clients. It was widely perceived as skewing the balance of power more in favor of the debtor. Our clients wanted to know what they should do both before a bankruptcy filing or at the beginning of bankruptcy cases to prevent a Philadelphia Newspaper situation, where the debtor could propose a plan and our client could be saddled with sale proceeds from a sale it did not support. Because the decision went to the predictability of the bankruptcy process for financial institutions, players in the stressed space knew about the decision. And we spent lots of time advising on its ramifications.
You work with clients from start to finish to avoid situations like this. What are some of the biggest red flags you look out for?
There are a few things I would want to know if a client comes to me and says they are thinking of investing in XYZ company. The first is figuring out what the fulcrum security’s going to be, which is particularly critical for my clients who often want control. They need to figure out what level of the cap structure is going to play the most critical role in a restructuring, because if they’re wrong about that, one of two things will happen. One, the company will do better than they expected, meaning they are in a higher level of the cap structure and likely going to be paid in full. In that case they will not drive the reorganization because they’ll just be taken out. In many cases, my clients view that as a failure of sorts, because they would rather take control, reorganize the company and get the benefit of the upside than just be paid out principal plus interest as part of a restructuring.
The flip side is that if things are worse than you expect them to be, then you could be in a situation where the class that you thought was the fulcrum class is actually one that isn’t getting any value. Obviously, that’s the worst of all worlds. So we work with our clients to help them understand the legal landscape so that they can put their financial models with the legal analysis, and make sure they are investing in the security that will best realize the returns for which they are looking.
The other thing that you need to be very careful of if you’re an investor in a distressed company is to understand what your rights are, and that your rights come from a variety of different places. The first place to look is obviously your debt documents. If it’s a loan, what does your loan agreement say? What are your rights? What are the rights of the debtor? What are the limitations that you have under the loan? Can you do whatever you want? Or have you ceded certain rights as an individual investor to an agent that acts at the direction of a majority? Those are the things that we look at when we advise our clients on their rights and limitations. If a particular investment goes south, what are they going to be able to do?
Another thing that we look at is intercreditor agreements. For example, when we represent second-lien lenders, there’s often an intercreditor agreement between them and the first-lien lenders that contains certain limitations on the rights of the junior creditor vis-a-vis the senior creditor. The courts have generally enforced intercreditor agreements. If the agreement doesn’t say that a right is curtailed, I think the courts will not curtail it. But if the agreement is unequivocal, most bankruptcy courts will enforce it, so you need to focus on that. Sometimes under these agreements the first-lien lender has the right to propose any plan it wants or sell the collateral, and the junior lender can’t object to it. Same with DIP financing. These are important limitations that can dramatically limit options for an investor.
Another thing to look out for is how much debt can the debtor layer into the cap structure? In “special situations,” the timeline to financial distress is critical. For a financial player to properly gauge the proverbial cliff, they need to understand what the debtor’s options are when debt is about to mature. Can it raise more debt? How much can it raise? What kind of debt? The answers to these questions are often critical.
One final thing I look for is what are the value drivers? What’s necessary for the company to reorganize? Is the problem a legal issue or is it a structural problem? Is it more process-driven? So we work with our clients to both understand those value drivers and keep them top-of-mind in connection with any restructuring discussions. That way we can make sure the company's able to reorganize in the best way possible.
What are some of the pitfalls of investing in the distressed space?
The Bankruptcy Code provides a framework for a Chapter 11 situation with a lot of predictability for all participants in the process. That’s why lenders choose to invest in this space, because there is predictability. But there is also the potential for pitfalls. One area to watch in recent years is DIP loans. Very often lenders will lend money in a bankruptcy scenario, but they tie down through their DIP loans a strict timeframe for a sale or a particular type of plan. Loans may even restrict the debtor from proposing a different type of plan or reorganizing instead of a sale. So if an investor doesn’t get in early, there can be a variety of pitfalls that were already created at the beginning of the case by the DIP lender and the terms of the DIP. Obviously as capital has become harder to come by, debtors have been forced to agree to a lot more conditions in their DIP financing, and those conditions have real ramifications on the debtor’s options later on to reorganize.
Another pitfall is the new Rule 2019, which requires heightened disclosure requirements when lenders band together – as they have done often in the last several years – to form ad hoc committees to represent their interests. The new rule requires additional disclosures about positions (including shorts) geared to parties knowing if a lender will do better if there is no reorganization. As trading information is almost always proprietary, lenders need to be careful so they either don’t trigger or are prepared to satisfy the heightened disclosure requirements.
In addition, litigation risks abound. For example, significant pitfalls have sprouted in the bankruptcies of single-asset real estate debtors, which have risen significantly in the last few years. In these situations, there is typically one lender with a lien on all of the collateral. When the lender does not agree to a particular restructuring, options for a debtor to go around the lender or cram them down are very limited. However, in these situations, some courts have interjected themselves as protectors for the debtor, and have held lenders at bay to give the debtor an opportunity to try to reorganize.
So that’s another pitfall, because there aren’t any guarantees in litigation. While we can advise our clients as to the state of the law and possible options, it’s never an all-or-nothing proposition, because the court has its own views. There are always risks when you litigate, and things don’t always work out the way you would expect them to. Appeals can take time and are expensive, so clients need to be prepared for that if they want to go the litigation route.
Finally, of late, lack of capital has injected significant stress into the system. This has not only curtailed the options of a debtor to reorganize but also exit opportunities for lenders in the distressed space. So even when lenders have come in, taken control of a company and been able to turn around its operations, current interest rates have created a bad environment for exits in certain situations. That has forced lenders to hold on to assets longer than they may want to before realizing the upside in their investment. The lack of capital and opportunities has also led more distressed investors who are looking at the same opportunities to buddy up on transactions. Some of the larger private equity and hedge funds would prefer to do a transaction alone, but these days that’s not always possible. Lots of people look at the same situations, and, if there’s value to be made, they want to be involved. “Doing it alone,” in those instances, can drive up the costs and lower returns.
So I’ve been seeing more groups of creditors getting together to work on an exit strategy, and that increase in collaboration has shifted our practice. Rather than representing one client, I am now frequently called upon to represent several funds and to understand their different goals and views. That has presented new issues and new problems, but also many new opportunities.
Jennifer Feldsher's primary area of practice is corporate restructuring and insolvency law. She represents interested parties in bankruptcy proceedings and complex corporate debt restructurings, as well as advising special situations investment firms on all aspects of their investments and acquisitions.
Ms. Feldsher has experience representing troubled corporate debtors, acquirers of troubled companies, creditors' committees and special creditors in a variety of in-court and out-of-court reorganizations, asset sales, loan restructurings and commercial loan transactions. She has directed all aspects of the bankruptcy process, including contested plan confirmation hearings, contested relief from stay and cash collateral hearings, DIP loan negotiations and related hearings and fraudulent conveyance and preference litigation. In addition, Ms. Feldsher routinely is called upon to advise directors, managers and creditors, as well as institutional investors, on zone of insolvency issues and fiduciary duties.
Ms. Feldsher has acted as counsel to companies involved in restructurings in the telecommunications, technology, healthcare, airline, automotive and financial services industries. She has worked on such matters as the chapter 11 proceedings of Boston Generating, Foamex, Greektown Holdings, Nortel, Asarco, Adelphia, Oneida, Global Crossing, G-I Holdings, Impath, Avianca, Rhythms NetConnections, EToys, Owens Corning, Victory Lake Nursing Center and RSL.
Lily Robertson is a senior content associate at Argyle Executive Forum overseeing content development and speaker recruitment for various cross-industry events. She is also the editor of Argyle Journal, the newly launched content and news platform for Argyle Executive Forum.
Lily has a B.A. in English and Anthropology from the University of Virginia.