Recent Developments in DIP Financing for International and Domestic Debtors

In summary

This chapter discusses the ability of foreign-domiciled debtors who pursue Chapter 11 bankruptcies in the US to obtain debtor-in-possession (DIP) financing through analysing recent trends, including equity conversions, roll-ups and pre-packaged bankruptcies.

Discussion points

• The types of DIP lenders
• Considerations with respect to the recognition of the DIP order in foreign jurisdictions
• Trends in DIP loans including roll-ups and equity conversions
• DIP financing in pre-packaged bankruptcies

Referenced in this article

• In re Avianca Holdings SA, 20-11133 (MG) (Bankr. SDNY 2020)
• In re Grupo Aeroméxico, SAB de CV, No. 20-11563 (SCC) (Bankr. SDNY 2020)
• In re LATAM Airlines Group SA, No. 20-11254 (JLG) (Bankr. SDNY 2020)
• In re California Pizza Kitchen, Inc., et al., No. 20-33752 (MI) (Bankr. TXSB 2020)
• In re Automotores Gildemeister Spa, et al., 21-10685 (LGB) (Bankr. SDNY 2021)
• In re Fairway Group Holdings Corp., et al., No. 20-10161 (JLG) (Bankr. SDNY 2020)
• In re McDermott International, Inc., et al, No. 20-30336 (Bankr. TXSB 2020)
• In re FullBeauty Brands Holdings Corp., No. 19-22185 (RDD) (Bankr. SDNY 2019)
• In re Sungard Availability Services Captial, Inc., No. 19-22915 (RDD) (Bankr. SDNY 2019)
• In re Arsenal Energy Holdings LLC, No. 19-10226 (BLS) (Bankr. D. Del. 2019)
• In re Jason Industries, Inc. et al., No. 20-22766 (RDD) (Bankr. SDNY 2020)

Chapter 11 has gained a strong foothold as a pathway for foreign-domiciled companies to reorganise, whether or not such companies have substantial operations in the United States. A key component in such reorganisations is the access Chapter 11 debtors have to a broader base of funding sources to obtain financing through their bankruptcy case to achieve a successful reorganisation and exit. Known as debtor-in-possession^[1] (DIP) financing, potential debtors either obtain financing from their existing secured lenders or through other third-party lenders through well-established market processes in the United States. This chapter provides an overview of DIP financing with a focus on international Chapter 11 debtors and discusses recent developments in DIP financing, including roll-ups of a debtor’s prepetition debt into DIP financing, conversions of DIP financing into equity upon a debtor’s emergence from Chapter 11 and the use of DIP financing in pre-packaged and pre-negotiated bankruptcy plans.

DIP financing in Chapter 11 cases

DIP financing is routinely utilised in Chapter 11 cases, where the debtor seeking relief seeks to preserve its going concern operations and to emerge from bankruptcy or sell its business as a going concern. The US Bankruptcy Code (the Code) contains several provisions designed to encourage lenders to provide DIP financing in Chapter 11 cases. Due to protections provided under the Code, domestic and foreign debtors are often able to access liquidity that they would not be able to obtain outside of a US bankruptcy proceeding.^[2] Under the Code, post-petition lenders are provided automatic administrative expense priority for DIP loans and related obligations, and are routinely granted superpriority administrative claim status, wherein debt must be repaid upon the emergence of the debtor from Chapter 11 prior to nearly all administrative obligations incurred during the case. In addition, upon notice and a hearing, the bankruptcy court may authorise a debtor to enter into a DIP facility that is secured by a first priority lien on the unencumbered assets of its estate and by a second priority lien on collateral subject to prepetition liens.^[3] To obtain authorisation to grant such liens, the debtor must show that it is unable to obtain post-petition financing on unsecured terms, which is often relatively easy for a debtor to establish.

If the debtor is still unable to obtain financing on such terms, the Code provides that a debtor can be authorised to grant liens on its assets that are senior or equal to existing liens, provided that such priming is consensual or that the prepetition secured lender is otherwise adequately protected.^[4] When DIP financing is provided by prepetition secured lenders, this priming is generally consensual. However, when new lenders (ie, ‘offensive’ DIP lenders, as discussed below) are seeking priming liens in prepetition collateral, the debtor must show that it is unable to obtain such credit otherwise and that either the existing secured lenders have sufficient equity value in their collateral or that they will be ‘adequately protected’ against any possible diminution in the value of their security interests.^[5] Adequate protection is designed to ensure the existing lender will not be worse off if the DIP loan is approved and such protection can take on many forms, including periodic cash payments to the secured lender, payments of post-petition interest or granting of additional liens to the creditor on previously unencumbered assets or replacement liens on collateral that do not continue to attach to property post-petition. Additional protection is guaranteed under section 552 of the Bankruptcy Code as it cuts off certain prepetition security interests over after-acquired property under a security agreement upon commencement of the bankruptcy proceeding.^[6]

Once a debtor has lined up a lender to provide DIP financing, the debtor is required to obtain bankruptcy court approval for the proposed DIP financing.^[7] Although typically a debtor will seek such approval at the outset of the Chapter 11 case as part of its ‘first day’ motions, if the debtor’s liquidity needs are not as immediate, it may wait for some time after filing its bankruptcy petition to obtain such approval.^[8] Creditors and other parties of interest have a right to object to the terms of a proposed DIP financing and the bankruptcy court will ultimately decide whether to approve the financing after a review of the relevant pleadings and objections (if any) and after conducting an evidentiary hearing if required.^[9]

Types of DIP lenders

DIP financing can either be provided by a debtor’s existing lenders or by new third-party lenders. Prepetition secured lenders that provide DIP financing are termed ‘defensive’ DIP lenders because they are willing to make a DIP loan, in part, to mitigate the likelihood of a decline in the value of their collateral. The credit extended under the DIP facility will likely be subject to higher interest rates and fees than the prepetition credit and the loan documents will contain tighter covenants and more detailed reporting than is required under the pre­petition facility, as well as bankruptcy case milestones and events of default. Additionally, in their capacity as DIP lenders, such prepetition lenders will be able to exert more influence over the debtor and can help ensure that they will play a central role in the debtor’s restructuring negotiations. As discussed further below, in cases where existing lenders provide the DIP loan, it is not unusual for such facilities to contain a ‘roll-up’ of such lenders’ outstanding prepetition debt.

If the DIP financing is provided by third parties that do not have a prepetition relationship with the debtor, the lenders are termed ‘offensive’ or ‘new money’ lenders. New money DIP lenders are often attracted by the generous economics of DIP facilities and, in some cases, are interested in extending post-petition credit because they view DIP financing as a means to pursue a loan-to-own strategy (either through credit bidding their DIP claims or through a debt-to-equity conversion, as discussed below).^[10] These lenders are generally willing to finance DIP facilities where there exists sufficient unencumbered collateral to support the DIP obligations (or they believe there is little risk of a liquidation and they are willing to rely on the Code’s administrative expense priority that ensures they are repaid ahead of other parties upon the emergence of the debtor from Chapter 11), where prepetition lenders are over secured or where the prepetition lenders otherwise consent to having the debtor grant the DIP lender a priming lien.

Recognition of the DIP order in foreign jurisdictions

Upon the commencement of a Chapter 11 case, the debtor is protected by the Code’s statutory ‘automatic stay’, which goes into effect immediately upon a bankruptcy filing and has purported worldwide applicability.^[11] The stay operates to enjoin substantially all creditor enforcement actions during the pendency of the Chapter 11 case against the debtor and property of the debtor’s estate – both within the United States and within foreign jurisdictions. Despite the purported worldwide applicability of the automatic stay, in the absence of a parallel local recognition proceeding supporting the Chapter 11, a debtor, and its prospective DIP lender, will need to assess whether the stay will be honoured by non-US parties that may hold debtor assets or hold claims against the debtor and whether non-US courts will recognise and enforce the stay against such parties if required.

A debtor’s decision to seek local recognition of the DIP order involves an analysis of the particular situation including the jurisdictions involved, the composition and nature of the debtor’s creditors (including, most importantly, their jurisdictional and commercial nexus to the United States) and the location of the debtor’s assets. In certain jurisdictions and situations, the debtor may decide (or be required) to obtain formal recognition of the DIP order in a local proceeding to ensure that the DIP obligations and claims and liens on collateral are properly authorised under local law and will be enforced in the local jurisdiction. For example, the DIP facility in the LATAM Airlines Chapter 11 case included a closing condition that the debtors obtain local recognition of the DIP order by the Colombian Superintendence of Companies, authorising the incurrence of the debt and the pledge of collateral.^[12]

In other jurisdictions and situations, local approval of the DIP may not be feasible or it may entail additional risks that the lenders or the debtors do not want to take on. In these situations, the debtors may seek to obtain local law pledges of collateral and perfect such pledges through the requisite local law processes.^[13] The debtors and DIP lenders also may take some comfort in the power of the automatic stay – even in situations where a foreign Chapter 11 debtor does not commence a parallel local recognition proceeding, to the extent that the debtor’s major creditors are international financial institutions or have substantial business or other interests in the United States, such creditors may nonetheless be disincentivised from violating the stay in the United States given the potential that they may have repeat interactions with United States bankruptcy courts.

Roll-ups

In the context of defensive DIP loans, DIP lenders may seek to have their prepetition secured debt repaid with the proceeds of the new post-petition financing or otherwise ‘converted’ into DIP obligations. In this scenario, a certain amount of newly borrowed funds from the proposed DIP facility will be deemed to repay either all or part of the prepetition loans or such loans will be deemed converted into post-petition loans. This transformation is termed a ‘roll-up’ because the existing prepetition lender gets to roll-up its prepetition claims and liens into post-petition administrative claims and liens via the DIP facility. Roll-up features can be structured a number of different ways – some are effectuated by a single draw on the DIP facility and some provide for a ‘creeping’ roll-up over time on a dollar-for-dollar, or similar, basis. While the roll-up does not provide a debtor with additional liquidity, the debtor’s existing prepetition lenders, who may already have liens on substantially all of the assets of the debtor, can be encouraged to provide new money in exchange for the ability to transform the rolled-up portion of their prepetition debt into debt that will benefit from superpriority claims and liens, better economics and tighter controls.^[14] Indeed, in negotiations with prepetition secured lenders, it is often used as enticement to encourage all lenders to participate in post-petition financing, with debtors and the lead lenders offering the roll-up feature only to those lenders that agree to extend new money. For these same reasons, roll-ups of prepetition obligations can be subject to challenge by unsecured creditors. Bankruptcy courts pay careful attention to the percentage of new money provided in the roll-up and whether the roll-up benefits any prepetition lenders that are not providing DIP financing (measured most often by the ratio of new money to roll-up debt).

In more recent years, the roll-up has become a fairly standard feature of defensive DIP financings for both domestic and foreign-domiciled Chapter 11 debtors, although creditors and courts do still scrutinise the terms and structure of the roll-up feature, and it is typically not approved until the final DIP hearing. One such recent case involving foreign domiciled debtors is the Avianca Chapter 11, which was filed in the Bankruptcy Court for the Southern District of New York on 10 May 2020.^[15] The initial Avianca DIP facility includes approximately US$1.2 billion in new liquidity (Tranche A), along with a roll-up of about US$722 million of prepetition debt.^[16] The roll-up includes US$220 million of prepetition notes (the Existing Notes Roll-Up) and US$386 million under a certain prepetition convertible secured loan facility provided to certain of the debtors by United Airlines, Inc, an affiliate of Kingsland Holdings Limited, an affiliate of Citadel Advisors LLC, and certain other lenders (the Stakeholder Facility Roll-Up).^[17] The DIP facility also includes a junior tranche of DIP loans and notes (Tranche B), which the debtors could convert into equity upon consummation of the plan. The Tranche B agreement contemplates a minimum percentage of 72 per cent of the aggregate common equity if the company proceeds with the equity conversion.^[18] At the time of writing this chapter, the debtors owe approximately US$790 million under Tranche B before the applicable 10 per cent exit fees.^[19] The debtors’ pleadings in support of the DIP facility argue that Avianca would not have been able to enter into the DIP facility without the proposed roll-up.^[20] The debtors noted that, given the covid-induced economic environment for airlines, ‘the pool of potential lenders has been limited’ and the debtors have been ‘compelled to entertain “hard bargains” to obtain the full amount of funding’.^[21] In particular, the debtors noted that, without the roll-up, certain existing secured noteholder lenders would not have released their liens or consented to priming liens on their collateral, which were key to the proposed DIP facility.^[22] The debtors also argued that the roll-up would not prejudice the debtors’ estates because the amounts to be rolled up under both the Existing Notes Roll-Up and the Stakeholder Facility Roll-Up were less than the value of collateral securing the respective debt.^[23]

Following the initial DIP facility agreement, as part of its exit financing efforts, the Avianca debtors petitioned the Court to amend the agreements to include two new tranche loans or notes. The purpose of the new exit loans was to refinance the existing US$1.4 billion DIP obligations and provide additional liquidity amounting to US$220 million, which would become long-term debt at the closing of the Avianca Chapter 11 cases.^[24] The debtors also sought additional exit financing, which could primarily take the form of additional equity capital and replace the existing Tranche A. The two new tranches for US$1.05 billion and US$550 million would replace the existing Tranche A and convert to a seven-year exit financing at the close of the case.^[25]

Equity conversions

Traditionally, DIP facilities are required to be repaid in full and in cash at the end of a debtor’s Chapter 11 case, whether in connection with a plan of reorganisation, a 363 sale or a combination of the two. In certain situations – in particular, pre-packaged or prearranged bankruptcies – DIP facilities can be structured to provide that the outstanding DIP obligations convert into secured exit financing upon emergence from bankruptcy. Although less common, some DIP facilities provide for conversion of outstanding DIP obligations into equity of the reorganised debtor on emergence, most commonly at the debtor’s election. These conversion features can be of great benefit to debtors that are seeking a quick exit from bankruptcy (such as in the case of a prepack) or that are looking to mitigate the risks associated with obtaining the funding necessary to repay the DIP obligations at the end of the case. Especially in this covid-19 era, where the debtor’s projected revenues and its relative access to international debt or equity markets at the end of the case are extremely difficult to predict. Mitigating the risk of mistiming the debtor’s exit from Chapter 11 has become extremely important to certain businesses that want to avoid being in the situation where they are poised to emerge from Chapter 11 but cannot obtain attractive exit financing to do so.

Equity conversions are potentially attractive from the perspective of cash-strapped debtors and also for lenders that may recognise the underlying value of a business despite current exogenous factors from the pandemic. When presented with a DIP facility containing an equity conversion feature, the bankruptcy court will often scrutinise which parties are provided the ability to participate in the DIP financing, the economic terms of the conversion and other conversion features (such as which entity controls the conversion election). As with roll-ups, some practitioners believe equity conversions are a feature of weak credit markets and should be less prevalent when credit markets are robust.^[26] However, as described further below, equity conversions have featured prominently in certain recent bankruptcies in the airline industry.

The covid-19 pandemic has significantly factored into debtors’ structuring of their DIP facilities, given the additional pressures brought to bear on liquidity, especially in certain hard-hit industries, such as the airline industry. The ability to convert DIP obligations into reorganised equity at the end of a case provides meaningful flexibility for debtors in situations where liquidity may not be readily available on emergence. The approved DIP facility in Avianca, which contains a senior Tranche A of US$1.296 billion and a junior tranche B of US$722.3 million, contains an equity conversion option where the borrower can elect to pay the entire US$722.3 million junior Tranche B DIP facility (together with any fees) with equity of the reorganised debtors on exit.^[27] The approved conversion feature has proven valuable, where the debtors have not been able to identify any financing that would pay the DIP facility in full, and have filed a plan that contemplated such conversion would occur.^[28]

Similarly, the Aeroméxico DIP facility contains an equity conversion feature – although the conversion in Aeroméxico is at the lenders’ option.^[29] The lenders have the ability to elect to receive common stock of the reorganised debtors as repayment for their loan subject to satisfactory tax, legal and regulatory review.^[30] In support of the equity conversion aspect of the DIP facility, the debtors argued that the inclusion of the equity conversion:

substantially increases the odds of a successful reorganization as a going concern, as it provides a potential pathway to emergence from Chapter 11 without having to raise substantial exit financing.^[31]

The debtors subsequently revised the equity conversion feature to remove drag-along rights that would have enabled the DIP lender to drag the minority investors along as part of the restructuring if it chose to convert its holdings into equity.^[32] Under the revised election procedures, minority DIP lenders may choose whether to take stock or cash out after the majority DIP lender makes its own election.^[33] At the time of writing this chapter, the debtors are finalising their exit strategy.

Although the DIP facility that was ultimately approved in the LATAM Airlines Chapter 11 cases did not provide for equity conversion, the initial proposed DIP facility contained such a feature.^[34] The initial DIP facility provided that one of the three tranches of post-petition debt could be converted into equity on emergence (originally the conversion feature was at the DIP lenders’ option, but as part of a subsequent amendment, the debtors obtained control of the election). The proposed equity conversion feature was limited to a specific tranche of the DIP facility that was provided by certain LATAM shareholders in exchange for, among other things, a waiver of their pre-emptive rights as shareholders under local Chilean law to participate in any issuance of reorganised equity of the debtors on exit.^[35] The unsecured creditor’s committee and ad hoc bondholder groups objected to the DIP on a number of grounds, including that the limited equity conversion feature subverted the reorganisation process and gave rise to improper sub rosa plan treatment with respect to those shareholder DIP lenders. The bankruptcy court ultimately found that, although the terms of the DIP financing were reasonable and proposed in good faith, it could not approve the DIP facility as proposed because the equity conversion, which was limited to those lenders that were shareholders of the company and was connected to a waiver of the exercise of such shareholders’ pre-emptive rights, was a sub rosa plan.^[36] Following further negotiations between the debtors, the DIP lenders and the unsecured creditors’ committee, a revised DIP facility that did not include an equity conversion feature was approved by the bankruptcy court.^[37]

Pre-packaged bankruptcies

In the case of pre-packaged or prearranged bankruptcies, the provision and terms of DIP facilities, if any, may figure prominently in the negotiation and terms of the debtor’s Chapter 11 plan. Pre-packaged bankruptcies reduce uncertainty and risk in the plan confirmation process, which in turn offers the same benefits in the negotiation of a DIP. The posture of negotiating a DIP together with the terms of a plan with a debtor’s prepetition lenders can allow for greater certainty in the source of repayment of the DIP, for example, through conversion into exit financing or equity, or the repayment of the DIP from the proceeds of the sale of certain of the debtor’s assets.

Many recent pre-packaged bankruptcies make use of a DIP-to-exit financing model. For example, in the case of California Pizza Kitchen, which filed for Chapter 11 in the Southern District of Texas on 30 July 2020, a restructuring support agreement (RSA) provided for US$46.8 million in new DIP financing, which was funded through a new first lien exit facility.^[38] The DIP facility consisted of a roll-up of US$60.8 million in prepetition first lien loans in addition to the US$46.8 million in new money, totalling an aggregate amount of approximately US$107.7 million.^[39] Upon emergence from Chapter 11, the entirety of the DIP facility was converted into a new first lien term loan facility, which was supplemented by a second lien term facility.^[40] In Automotores Gildemeister, a Chilean vehicle importer and distributor which filed for Chapter 11 in April 2021 in the Southern District of New York, an ad hoc group of consenting noteholders, in connection with the negotiation of a restructuring support agreement, agreed to provide a US$23.6 million DIP.^[41] The plan provided that the DIP claims were to be paid, at the reorganised debtor’s election, (i) dollar for dollar with new senior secured notes, or (ii) in cash.^[42]

In other cases, pre-packaged bankruptcy plans negotiate a DIP to be repaid through asset sales. In Fairway Group Holdings Corp, the debtors a regional grocery retailer in the New York area, filed for Chapter 11 in the Southern District of New York in January 2020 in order to implement a strategic asset sale of substantially all of the debtor’s assets pursuant to an RSA with an ad hoc group of stakeholders holding over 91 per cent of the approximately US$227 million outstanding obligations under a prepetition credit agreement.^[43] The ad hoc group agreed to provide a US$25 million new money DIP, in addition to a roll-up of approximately US$42.8 million of prepetition letters of credit and term loans. Following multiple auctions and the sale of substantially all of the debtor’s assets, the debtor paid down substantially all of the DIP prior to commencement of solicitation of the debtor’s plan.^[44] Similarly, in the McDermott bankruptcy, an RSA with the debtor’s key secured and unsecured stakeholder groups contemplated an aggregate US$2.81 billion DIP provided by the debtor’s senior secured lenders, to be substantially repaid with the proceeds of the sale of the debtor’s Lummus Technology Business (pursuant to a prepetition stalking horse agreement which provided for the sale of the business for at least US$2.7 billion).^[45]

In such pre-packaged or prearranged bankruptcies, the promise of a roll-up of prepetition debt also may be a critical inducement for prepetition lenders to offer pre-filing ‘bridge’ financing, which is later rolled up in the DIP, in order to provide a compnay sufficient liquidity to engage in pre-filing negotiation over the terms of an RSA, when the debtor might otherwise file a free-fall bankruptcy. In McDermott, certain of the debtor’s prepetition lenders agreed to extend an addition US$1.7 billion superpriority senior secured financing, which permitted the company to continue to engage in discussions with its key secured and unsecured stakeholder groups regarding the terms of a potential restructuring, as well as to engage in a marketing process for the sale of its Lummus Technology Business.^[46] Similarly, in Ruby Tuesday, the debtor’s prepetition secured lenders agreed to extend US$2 million in bridge financing, giving the company sufficient liquidity to support the company’s operations until the petition date, including engaging in negotiations with said secured lenders about the terms of a restructuring support agreement.^[47] The US$2 million bridge loan was included as a roll-up of term loans in the DIP.^[48]

On the other hand, given the speed at which a debtor can emerge from bankruptcy under a pre-packaged plan, some pre-packs have avoided the need for DIPs altogether. In the FullBeauty Brands^[49] and Sungard^[50] cases, the debtors emerged from bankruptcy in 24 hours or less; given the short duration of their Chapter 11 cases, neither debtor required the use of a DIP. Similarly, in the case of Arsenal Energy Holdings LLC, which was confirmed within 10 days, no DIP was required.^[51] Although FullBeauty, Sungard and Arsenal are all exceptional in the speed at which each case proceeded to confirmation, Jason Industries, which was in bankruptcy for around two months,^[52] was able to reorganise in Chapter 11 without a DIP by funding the case through the consensual use of cash collateral.^[53]

Conclusion

International debtors filing for Chapter 11 in the United States are able to take advantage of an established market for DIP financing. Chapter 11 debtors are increasingly successful in including features in DIP facilities such as roll-ups and equity conversions that were previously subject to greater levels of scrutiny and that some practitioners thought were limited to times of illiquid financial markets. The recent cases discussed in this chapter suggest that these features may have gained a stronger foothold in the DIP financing toolkit.

Notes