How to Navigate Bankruptcy and Restructuring in M&A

How to Navigate Bankruptcy and Restructuring in M&A

Benjamin Beller: Graduated law school in 2013. I went right into bankruptcy and restructuring work at my old law firm.
[00:05:00] I came over to Sullivan and Cromwell in 2020, right in the middle of the height of the pandemic, which was a really interesting time to change law firms. But of course, to be in the bankruptcy and restructuring space, there was a lot going on and it's been a great run here for going on five years at S&C.
I had the opportunity to work with just an amazing roster of clients — debtor representations, which we'll get into, creditor side representations, really everything in between, the full gamut. We have a great practice here and I'm honored to be
[00:05:30] part of it.
Kison: This is great. I get your perspective from all sides of bankruptcies. I know you worked on some like really high profile deals.
Benjamin Beller: Yeah.
Kison: Can you mention some of them?
Benjamin Beller: Sure. Lots of people know that we represent the FTX debtors in their bankruptcy case, which filed in November of 2022, and that's been all over the news for two and a half years. That case confirmed a bankruptcy plan late last year and emerged from bankruptcy just this month, earlier this month, which has been a great accomplishment for the team and for the company and for
[00:06:00] everybody involved. And it's a great outcome we think for creditors and for stakeholders. So that's probably the highest profile in the last few years. We've also worked on, as debtor counsel, in the Silicon Valley Bank bankruptcy, which filed shortly after the crypto wave. That had a successful emergence from bankruptcy last year.

On the creditor side, which is an important part of our business — important and growing — we've been involved in the Mallinckrodt bankruptcy, both bankruptcies, another one that had a lot of attention on it, given
[00:06:30] the opioid exposure there. We represented one of our great private credit clients, and we have a roster of private credit clients that we've been doing work for over the years in a lot of bankruptcies that we can get into.

And of course there are representations that aren't in Chapter 11 bankruptcy and are out-of-court restructurings, which don't always get as much attention — for good reason — and that's part of the point. And those are also very challenging and rewarding cases to work on. Of course, you're trying to keep the company out of bankruptcy for a reason. Those don't hit the
[00:07:00] headlines. Those hit the headlines when we want 'em to. As some of my partners like to say, the best deals leave no fingerprints. The Chapter 11 always does. That's a fully public process. You're always in the spotlight on those, but it's a mixed bag for us. Since we do everything, we have a generalist model here. We do in-court, out-of-court, all across the capital structure.
‍
Kison: We get the full picture. Let's start with the basics. When I think of bankruptcy, there's a lot of chapters. There's Chapter 7, Chapter 13. Your primary focus is Chapter 11, yeah?
[00:07:30]
‍
Benjamin Beller: Chapter 11 is our primary focus. It's the primary focus of all law firms like ours. Chapter 11 is the most fundamental reorganization chapter or type of bankruptcy for companies. So a company that has a viable business and is looking to restructure and reorganize through a bankruptcy is gonna file for Chapter 11.

Chapter 11 can also be used for sales and liquidations of a type. But in Chapter 11, the company stays in control. Chapter 11
[00:08:00] is run to preserve value and maximize value through some sort of process. Chapter 7, on the other hand, is a straight liquidation type of bankruptcy. That one is also for companies, but that's when the company has no viable operations to continue and what's called a Chapter 7 trustee gets appointed and basically liquidates the business — buyer sale type asset sales, brings some litigation if there is any to be brought — and tries to just eke some dollars out for
[00:08:30] creditors.

Chapter 7 in some ways is always a specter when you're talking about Chapter 11 because a Chapter 11 done wrong or a Chapter 11 that goes wrong can turn into a Chapter 7. But Chapter 7 should never be the goal. And Chapter 13 is really for individuals. That's for individuals who typically have income and can use the bankruptcy process to pause all of the — maybe litigation, maybe collection actions — that are from people that they owe money to, and pause all of that, come together, figure [00:09:00] out payment plans, and get their finances back on track.

‍Kison: Okay, so 13's personal. Between 7 and 11, most of it's 11. 7 is if the company's total FUBAR, you just do like a pure liquidation — that's what the Chapter 7 is. But most of it's on a Chapter 11 where you're trying to get the most value for it, where the company can come out restructuring, come out of Chapter 11, perform again, or figure out the best solution to get the top dollar. Our focus is on—
‍
Benjamin Beller: Chapter 11 tends to be the most complex,[00:09:30] multiple stakeholders negotiating with organized groups across the capital structure, and that's when large firms like ours will get involved and can help figure out—
‍
Kison: Solutions. What are the scenario differences between the reason why a company would go into Chapter 7 opposed to 11?
‍
Benjamin Beller: Chapter 7 is when the company basically can't — has no operations to continue. Either they've lost all of their customer contracts, or all of their employees are gone, or there's really no future for the company. So
[00:10:00] there's not gonna be a going concern sale. There's not gonna be anything to reorganize around. You need value really to use Chapter 11. Chapter 7 is when you're just stripping it for parts. There’s no real value to be left.
‍
Kison: Okay.
‍
Benjamin Beller: You can think about Chapter 7 in a little bit of a different context than we usually work in, but if you have some sort of construction general contractor — terribly capitalized business — really has no inherent value other than the contracts that they have to do the work and get paid for it. And this happens all the time, is that general contractors
[00:10:30] file for Chapter 7 bankruptcy. They're selling the van, they're selling the tools. Maybe there's a little bit of litigation to be brought, but that's just an organized way to wind up and liquidate the company without paying creditors in full.

In Chapter 11, the company is typically relatively strong and it just needs to deal with its capital structure. Now, there are exceptions to those where the company, despite seeming like it has value, really can't sustain a Chapter 11 process. And that often is the case, for example, with service providers — accounting firms, those kinds of companies can't really survive a Chapter 11 because their customers aren’t gonna be around sticking it out through the bankruptcy.

But most companies can — if they've done proper planning and if they have, frankly, engaged advisors who can help navigate these things early and figure out strategies, figure out what's the best value-maximizing type of transaction, engage with creditors in a constructive way rather than a destructive way. There’s a path through Chapter 11 that can
[00:11:30] really preserve the company, preserve jobs — very importantly — and preserve value for stakeholders.
‍
Kison: Tell me more. ’Cause I notice that Chapter 11 — some go in and come back out, and some don’t come back out. What makes it a successful process for a company to continue?
‍
Benjamin Beller: Well, often it's about planning. Because what ends up happening is a company that doesn’t plan in advance loses optionality. The more planning, the earlier you do it, the more you’re strategizing with advisors, the more you can engage with stakeholders — [00:12:00] and that’s the name of the game. Chapter 11 is all about gathering as much stakeholder consensus as you possibly can while preserving the value play for those stakeholders who are either investing new money or compromising their claims, exchanging their debt for equity.

A company that waits until they’re basically out of money — you've lost a lot, all of your optionality. You're desperate for money. You don't have the ability to negotiate. You're just kind of dead in the water. But a company that says, look, we're gonna have [00:12:30] this upcoming maturity in 18 months, or we're gonna have a liquidity issue in 18 months or 24 months — you can start planning even that early about how are we gonna deal with this?

Are we gonna do some sort of liability management transaction? We can talk about that. That’s a hot topic in the bankruptcy and restructuring space these days. But are we gonna do some sort of liability management transaction out of court? See whether that can solve some of our problems. Are we gonna look for new money? Are we gonna do debt financing? Is there an opportunity for equity financing?

How are we gonna use the toolbox? That’s what it’s [00:13:00] all about — to preserve the company and maximize value. And sometimes those things don’t work. And then you say, okay, what’s our plan B? We call it contingency planning. The contingency planning is: what happens if all of our plan A doesn’t work out?

We can’t raise financing, we don’t get to a deal with our existing creditors to do some sort of out-of-court restructuring. Then you start talking about Chapter 11. And Chapter 11, again, there are options. Do we have an option for a pre-packaged bankruptcy? Pre-packaged bankruptcies are short. They [00:13:30] cost less money, which is a huge problem in bankruptcy these days — the exorbitant cost of going through a bankruptcy process. Chapter 11 process. Can we do a pre-pack?

Pre-packaged is when you don’t impair any unsecured creditors, meaning all of the unsecured creditors ride through the bankruptcy. It’s as if the bankruptcy never happened for them. That’s when you have a relatively simple capital structure. You have a cooperative lender or set of lenders in your secured debt and you’re doing some sort of transaction — usually
[00:14:00] equitizing their debt through the pre-packaged bankruptcy — and the company can just continue on. That can often be a great outcome for all of the stakeholders.

Benjamin Beller: But not all the cases are as easy as that. You have different types of bankruptcies where you can file with a lot of consensus — still not quite a pre-packaged level of consensus — but a lot of consensus, and you're running some three or four month process to impair unsecured creditors, likely do some sort of exchange with your secured creditors. Maybe you have some [00:14:30] fights along the way and then you emerge. So all of these are the options and you have to be thoughtful early about what the best route is, and you have to be able to toggle.

That's the other big thing — the earlier you start, the better situated you are to toggle when one route doesn't pan out. So the ones that end up in real trouble? Poor planning. Overly aggressive to start out with in some way. And not working well with your stakeholders to garner consensus.

At the end of the day, some of these [00:15:00] companies, when you say "don't come out," they might have to toggle into a Chapter 7. That was the SmileDirectClub, for example — a case that had to turn into a Chapter 7 even though it was filed as a Chapter 11. And there were issues with that case that might be interesting to some of your listeners.

But most of the time, you see a Chapter 11 filed by some of the typical players in this space — there's gonna be a route out. It's not always the success that they hoped it would be when they filed. Sometimes it takes longer, sometimes it goes a different direction. [00:15:30] But one of the most important things when a company is thinking about a Chapter 11 bankruptcy is: how are we going to get out?
‍
Kison: Okay. We got a lot of things to talk about. You know, we have the planning process itself — I want to get more specifics there. You mentioned liability management transaction, doing some kind of debt or equity to raise, and then a pre-packaged bankruptcy is also another one.

Let’s make up a scenario here. Let’s say I raised money, took on about $10 million of debt. We throw in like another secondary on there to make it… you want to [00:16:00] see how complicated — you wanna make this a tough case? Maybe that’s it. We got a little secondary on there. Let’s say $10 million of primary capital that we borrowed from a good institution, and then we had some secondary line of credit. Is that like a common secondary?
‍
Benjamin Beller: Yep, sure.
‍
Kison: Or let’s say a couple million dollars.
‍
Benjamin Beller: Frankly, usually the numbers have another zero or two zeros on them from 10 and 2, but we’ll work with it. 10 and 2 is easier for my lawyer math anyway.

Kison: Exactly. It’s easier for me, what I’m being encountered. So okay, simple math here. So what is our
[00:16:30] payments on something like that? $10 million loan — it’s not that high. It’s gonna be maybe, let’s say, 150 a year or something.

‍Benjamin Beller: I believe you.
‍
Kison: Simple math — made-up math. And then we’re breaking even. Like we don’t have money — we’re losing money. We don’t have money to pay off the debt, we don’t have money to pay off the secondary. We just had a bad year. Missed our growth targets, lost a key customer — it was a really rough year.

I wanna click into the planning part, because I’m trying to get a sense of that line of sight. Because you say “planning,” but a lot of this stuff I realize in the real [00:17:00] world tends to be easier said than done. So like what are these things that you start sensing? When should we start planning — is it as early as, “Hey, this looks like it’s gonna be a rough year”? Where does the planning process start?
‍
Benjamin Beller: Well, the company’s planning process should be, from my perspective, an ongoing thing. Most of the management and the CFOs out there are constantly staying up at night because they’re worried about liquidity, and they’re wondering about the next raise and all of that.

So for those folks, they’re probably always in planning and contingency planning[00:17:30] mode. The more fundamental question is when do you start engaging with others outside of the C-suite about these issues — about what’s going on at your company?

From my perspective, as someone who often does a lot of creditor — secured creditor — work, we represent a lot of private credit lenders in mid-size, mid-market companies. Knowing your lenders, having a relationship with your lenders, so that you can then go to them and say, “Look, here’s the situation. Here’s why the situation is what it is. And here’s how we want to[00:18:00] solve it.”

That goes a long way in getting your lenders to buy into then what you want to do — showing that you are thoughtful about it, that you have a good reason for why this company’s in the situation that it’s in, and that you’re looking to work cooperatively with them to solve the collective problems.

That goes a long way, and it’s gonna smooth the road — because you’re gonna need those secured lenders on board one way or the other For the most part, from my perspective, once you see the writing's on the wall, you shouldn’t wait. Get ahead of it. You should [00:18:30] be getting your advisors — whoever the advisors are — up to speed and you should be proactively managing the situation.

‍

Benjamin Beller: The other thing that has a huge impact on all of that is your employees and your customers. You’ll lose one key customer — that happens. But you start having more fundamental issues. You start having employees worry about what’s going on, you can have employees start leaving. Other customers can hear that there’s serious problems. They can start pulling their contracts. Vendors can start saying, “Okay, instead of having you on 30 days or 60 days payment, I’m gonna make you put up cash on delivery.” All of those little things are straws, and the straws can break the camel’s back, and it can be a cascade. You gotta get ahead of that cascade.
‍
Kison: Lenders can be different.
‍
Benjamin Beller: Yes.
Kison: You know, when you borrow money, some could be like coldhearted loan sharks and they want their money. Might not send somebody to break your knees, but they sort of are pretty tough on where they stand. And then others may be more relaxed and flexible. Where do you see that? Like what types of lenders
[00:19:30] fall in what category?
‍
Benjamin Beller: This is the point. You have to know your lenders, and you gotta know your lenders when you're taking their money to begin with.
‍
Kison: How do I know that? Like right when — right now I’m shopping for some debt, and I’m not even thinking about this. I’m just thinking about pure interest number, getting the best terms possible. But this is a good point — hey, when you need the help, do you have a friend in your corner or are you gonna sort of have somebody else that’s gonna be after you? How do you get a sense of that early?
‍
Benjamin Beller: It depends on where you are in [00:20:00] the market. If you’re a huge company, the lenders that are able to write significant checks — they’re pretty much known in the industry. And any debt finance lawyer — my debt finance lawyer partners can tell you left, right, and center about how all of the lenders in the market behave.

And if you're talking about — are you talking about banks? Are you talking about private credit? The rise of private credit over the last 10 years has changed the face of this a little bit. Private credit lenders, on the one hand, can —
Kison: When you say private credit, we’re just talking about like these actual structured funds that are essentially doing these type [00:20:30] of debt, placing debt and they're cash-based?
‍
Benjamin Beller: Oh, yeah. Yeah, yeah. It's just as a comparison to large syndicated bank loans, basically, and where the regulation is a little bit different and the underwriting standards are different, and how they deal with their investments are different. But of course, there's differentiation between the private credit lenders.

You gotta know your lenders. That’s why engagement with them, even in non-distressed times, is an important step for any company — that you know that when push comes to shove, you have a sense of where they're gonna be.

At the end of the day, all these[00:21:00] lenders are economic animals. They have made an investment, they have underwritten that investment with diligence, and they want to see that investment play out the way that they intended it to. Different lenders may take a different approach to achieving that goal, but for the most part, lenders are not in the business of foreclosing on assets.

That’s not what they want to do. That’s their remedy at the end of the day. And one of the things that we counsel our lender clients about is: you gotta remember, at the end of the day,
[00:21:30] that is your remedy — is taking the assets. And it can be very difficult in certain kinds of industries — regulated industries like pharmaceuticals. We’ve had a number of cases here.

You can’t just go take someone’s pharmaceutical inventory and put it in your garage and then sell it. There’s a ton of regulation about how it has to be stored. So that’s a difficult position for a lender to be in — facing foreclosing on pharmaceutical drugs. That’s not a great position to be in.

Most of the time, lenders don’t want to foreclose. That’s the [00:22:00] total nuclear option. Now, different lenders will take different approaches in how they engage in the negotiations about how to avoid that foreclosure. Some will be more aggressive. Some will be willing to take equity. Some won’t be. You gotta know whether your debt is held by CLOs, who really can’t hold equity. Equitization for them is not that great an option.

And that’s why debt trades — debt trades from banks, trades from CLOs, trades to people who are a little bit more agile and able to come up with creative[00:22:30] solutions — that can take equity, that can take warrants, and are happy to do that if the value is right. But at the end of the day, all of these lenders are economic animals who want to get paid back.

And the earlier you are engaging with them about ways to do that —
‍
Kison: Again, optionality.
‍
Benjamin Beller: Exactly.
‍
Kison: And you’ll get a sense of their appetite and how they want to negotiate.
Benjamin Beller: Exactly. So many first conversations that we are involved in — whether we're on the company side or on the lender side — is saying to the other side, “What are you looking for here? [00:23:00] What do you want?” Because maybe you want something that I want too. Maybe we can figure out how to get to yes.

That’s the element of a restructuring — is getting to yes. Can’t always do it. If you're the company and your lender wants to take your company for cheap so it can merge your company into some other portfolio company of theirs to benefit that company — maybe there’s no deal to be made there.

But for the most part, if the lender says, “Look, I want to figure out a way to get my money back,” the company is saying, “Well, let's do [00:23:30] that — and I'm not gonna give up the ghost to do that for you. I'm not gonna give you all the value. I'm not gonna give you $200 million worth of equity when your loan is only $100 million. But maybe I need to give you something that really could have a lot of upside if all things go well.”

We align our incentives and we can move forward into a different kind of chapter. So everybody has to be a little bit more open-minded. They have to be willing to accept outcomes that maybe they didn’t foresee two years ago, five years ago. If you're dealing with a founder of a company, that can be very challenging.
[00:24:00] But the name of the game in restructuring is figuring out how to benefit everybody in a way that works.

Kison: You know, is there a strategy of kinda dragging things out so it can be more aggressive to negotiate, where the bank lender doesn't want to go through a bankruptcy process because it's a headache for everybody? Wait till it's sort of, "Hey, like I need you to cut down this debt," or sort of use that as leverage to reduce the debt?
‍
Benjamin Beller: Definitely. Timing is a huge element [00:24:30] of this. Again, this is part of planning — is when do we go.

Kison: Yeah.
‍
Benjamin Beller: It's not just, "I'll go as early as possible." It's, "When do we go and approach them, and what is the situation that—what is the proposal that we approach them with?"

Companies tend to wait too, because they are usually unfamiliar with bankruptcy, are concerned about the impact to the business. Often the people — the decision makers, frankly — have equity at stake and want to preserve equity, which is sometimes a challenge to do in bankruptcy. They’re often waiting. They want to drag things out as long as possible.

But what we see is sometimes lenders jump the gun [00:25:00] and lenders will go too early. And they will put the company into a— The company doesn’t have to do a transaction. Maybe they would in 6, 12, 18 months. But going too early can actually harm the process and make it more difficult if the company says, “You don’t have any leverage over me right now, there’s no default.”
‍
Kison: No— They can’t initiate the Chapter 13?
‍
Benjamin Beller: The lender?
‍
Kison: Yeah.
‍
Benjamin Beller: They can’t initiate—no. Well, I don’t mean to initiate the Chapter 11 case, but to initiate restructuring discussions.

‍Kison: Okay? Timing's gonna be a big thing — early planning, but even with that, there's still an element of timing. Going back to our private debt case over here, example. We still try to get a sense of early what we can do. We probably strategize, even get some outside perspectives, and what are different things that we could propose. Hopefully try to clear things off early. But if that doesn't happen... one of the elements too that you mentioned — maturity. So here's a debt that sort of has an end date that needs to pay out basically.
‍
Benjamin Beller: Yeah.
‍
Kison: And then that sort of — you can get a sense of planning then that hey, here's something that's gonna come up and we need to act on it. It's like, not natural just to try to refinance that debt?
‍
Benjamin Beller: It is.
‍
Kison: The problem becomes when you can't refinance it because your overall picture doesn't look as good.
‍
Benjamin Beller: Exactly.
‍
Kison: So they said, hey, nobody wants to refinance this debt. We got a [00:28:30] problem.
‍
Benjamin Beller: Either nobody wants to refinance it, or the price is not right. And for whatever reason you can't refinance it. Then you have to say, okay, what are we gonna do now?

Kison: When you said liability management transaction, tell me more about that.
‍
Benjamin Beller: This is something that has become a phenomenon a little bit in this business and in the restructuring tabloids or whatever you want to call them. There's a ton of focus on all of this, and it started to make its way into the more other financial press.

I don’t know if it’s familiar to you and your listeners from the M&A side, but basically it’s when typically a private equity sponsor — although it's not only for private companies, it's also for public companies — but the owners of the business engage in some sort of transaction to manage their liabilities, as the name suggests.

And you can have liability management transactions that are plain vanilla — you would just call restructurings or exchanges of debt. What people really mean when they talk about liability management transactions is some sort of either coercive transaction with a subset of your lenders that favors those lenders over other lenders, involves amendments to the debt documents, involves super senior issuances, dropdown transactions, uptier transactions, double dip transactions.

These are all the words that have come into the vernacular in the restructuring space over the last 10 years, which you can probably have a whole other podcast on, frankly.
‍
Kison: Can you tell me what some of those mean? I never heard any of them.
‍
Benjamin Beller: Yeah.

Kison: Dropdown—
‍
Benjamin Beller: People love catchphrases, and that’s what these are.
‍
Kison: I love learning these catchphrases.
‍
Benjamin Beller: Yeah. Under a typical debt document, there’s all these negative covenants about what you can and can’t do as a company and your company group. And it’s—you can’t just go dividend all the money we give you up to your equity owner, and you can’t go out and raise a billion dollars of debt senior to us, or even pari passu with us, or maybe even junior to us.
‍
Kison: What’s pari passu?
‍
Benjamin Beller: Equal in ranking.
‍
Kison: Equal rank, okay.

Benjamin Beller: This is a whole negotiation that happens when you’re entering into this debt. And the negotiations are different — again, whether you’re in the private credit market, whether you’re in the syndicated loan market. These are all the S&C capital markets, finance, leveraged finance folks — like my partner Ari Lao and Neil McKnight — they’re the ones that are typically negotiating all of these things when the debt is issued.

And it’s a whole negotiation between the lenders and the company about what you can do.

Years go by, and the company is maybe facing some distress or stress. And people start thinking, “My debt — even though it’s senior secured — is trading at 60 cents on the dollar. If I exchange my debt and somehow get senior on some assets that get moved, and even if I exchange that into a smaller amount of principal, I can turn my 60 cents on 100 million dollars into 80 cents on 90 million dollars.”

The question is, how do I do that within the restrictions of the debt[00:31:30] documents?

What often happens in these kinds of situations, the company’s doing fine. The debt is [00:25:30] trading publicly at a fine price — not distressed, not stressed — and then something happens. The prices come down. The debt trades. It trades to people who are practiced in the world of distressed investing.

They buy the debt up at a relatively cheap price, and then they’re ready to act. They’re ready to engage with the company to then turn their 50 cent paper into 75 cent paper.
‍
Kison: That's a whole other element. Somebody
[00:26:00] can actually sell this debt for cents on the dollar. Now you gotta deal with somebody that's more ROI driven.
‍
Benjamin Beller: Right. And debt trading is a whole topic that is very important. That’s been a really interesting—and it's been pretty well covered in the FTX case, where this wasn’t financial debt that was trading, but there’s just regular claims trade.

Customers are able to sell their customer claims in the open market. And there’s a lot of funds that, very early on in the case, went and bought up a ton of customer claims on the public market — on the open market — and have turned that into a very successful [00:26:30] return on investment.

But yeah, all of the publicly traded debt for these large companies gets bought and sold and traded. And it usually makes its way into the hands of people who are familiar with restructuring, familiar with the bankruptcy process — not necessarily vultures, not necessarily lenders who want to do wrong by the company, but people who know their way around the system and can use the system to their advantage.

They might come in and say, “Okay, I’m ready to engage with the company about what a restructuring looks like because debt is trading low. The company has serious problems. The company needs to face these problems, and we’re here to help —[00:27:00] but we’re not going to be here to help forever.”

So the company needs to engage with us now. And then the company has to say, “Okay, what are we gonna do? What are our options? What kind of leverage do we have? Are we willing to engage with them right now? Do we feel like we need to wait until something that’s on the horizon has happened, and then we’re ready to engage?”

So again, this is all the strategy. And each case is different. And each situation is
[00:27:30] different. You gotta know who you're dealing with. You gotta know how you're gonna do it. And you gotta start thinking about it early.

Benjamin Beller: Dropdown transaction is moving assets in the collateral package for your existing debt into typically a newly formed subsidiary. That itself then issues debt to a subset of your current lenders, where the lenders are exchanging their current debt — they’re getting the new debt. Usually there’s a new money component, which makes it worthwhile for the company ’cause they’re getting some incremental financing that they probably wouldn’t otherwise have been able to get in the public market.

And the lenders themselves have benefited because they’ve just, on paper, increased the value of their debt. And there’s all these different iterations.

That’s a dropdown.

Uptier is—let’s say you have unsecured debt, unsecured convertible debt, and let’s say there’s $500 million of it, and I own $100 million. I take my $100 million of unsecured debt, I exchange it for secured debt in a lower amount — $75 million, $65 million. I give some new financing that’s also in that secured debt piece, and all of a sudden I’ve gone from unsecured to secured. So I’ve uptiered my debt.

The company, again, has gotten some liquidity. And those parties maybe are perfectly happy. Of course, the people who are left behind might say, “What’s this all about?”

These liability management transactions — when they’re super aggressive — have brought a lot of litigation. So the Serta Simmons case, which was a liability management transaction, went into bankruptcy — as often the aggressive liability management transactions do, by the way. And then there was litigation in the bankruptcy case. It went up to the Fifth Circuit. This was a case that got a lot of attention in the industry because the Fifth Circuit basically said that the transaction was not permitted. And that’s just contract law. This is just interpreting the terms of the debt documents and whether what was done was permitted or not.

And so this is, again, why having leveraged finance and restructuring lawyers — at S&C we have a generalist model both at the firm but also in the finance and restructuring group. The finance and restructuring lawyers are doing both the liability management transactions and the out-of-court restructurings and the in-court restructurings. We’re a one-stop shop.

Being able to navigate the debt documents in creative ways, but in ways that are gonna work — this goes to your point about a Chapter 11 — can’t just do a transaction and say, “Well, maybe it works.” It’s gotta work. Being able to structure these transactions has become very[00:34:00] important to companies who are looking for ways to avoid Chapter 11, bring in some liquidity. But of course, there’s always a risk of litigation. And that has its own—you gotta make the cost-benefit analysis.

Kison: You get quite creative between this example of a dropdown and uptier.
‍
Benjamin Beller: Well, I wish I had invented all of this. People have been doing these transactions for quite some time. Another famous—you know, you hear the names—J. Crew was a very famous one of these that had a litigation over it. A lot of retail cases, frankly. But it’s not just retail.

This has become part of the industry. And frankly, it’s become a huge part of the industry. And one of the reasons that people say bankruptcies over the last couple years have actually not been as high as historically they tend to be, is because of the rise of the frequency of liability management transactions — and those largely deferring bankruptcies.

Because as I said, the aggressive liability management transactions almost always end up in bankruptcy anyway, even though they’re intended to avoid it. Those cases still file for bankruptcy. But it’s smoothed
[00:35:00] out the waves that we were used to seeing post-financial crisis in 2000 — call it 2014 to 2019 — with oil and gas wave, retail waves.

Those have kind of in some ways been smoothed out by these liability management transactions.

Benjamin Beller: You mentioned earlier prepackaged bankruptcy. The way we think about a Chapter 11 is you have three types. You have a prepackaged bankruptcy — again, we love jargon — prearranged bankruptcy, and a free fall bankruptcy.

Free fall bankruptcy is, in some ways, the easiest to understand. That’s when you basically have none of your stakeholders on board with what you’re using the Chapter 11 for. Often those are filed in an emergency situation. Lehman is a classic free fall bankruptcy. FTX — classic free fall bankruptcy. Because those were filed under circumstances where the most important thing was to get the company into Chapter 11, and then you figure things out from there.

Prepackaged bankruptcy is something that everybody should be thinking about — both on the company side and the lender side — when you're evaluating restructuring options. Because the prepackaged bankruptcy is the least expensive Chapter 11. And as I said earlier, bankruptcy has become very expensive. And we can talk about why. But part of it is that the company is paying not only for its advisors — lawyers, bankers, often financial consultants, independent directors and all of that — it’s also paying the fees of the official committee of unsecured creditors, which is a statutory body that gets formed usually early in the case to represent unsecured creditors.

They have lawyers. They have bankers. They have financial advisors, typically. The company’s secured creditors are also having their lawyers — and sometimes a banker’s — fees paid. The company is taking on a huge professional fee cost to do the bankruptcy.

So the juice has to be worth the squeeze. It has to be worthwhile to pay $20 million, $30 million — at least in our world — Chapter 11 professional fees to do the transaction. And that’s a question for the stakeholders.

The creditors, the lenders who might be equitizing their debt through the bankruptcy, may say, “It’s not worth all of that.” And maybe they just do some sort of out-of-court transaction. Or maybe they say, “We want to do a Chapter 11 because we can’t get everybody’s consent.” The secured debt is too widely held. It’s going to be too hard to get 100% lender consent, but we have to exchange all this debt, so we want to do a prepackaged bankruptcy.

In a prepackaged bankruptcy, there’s no unsecured creditors committee formed, because unsecured creditors are just totally unaffected — unimpaired, 100% recovery — where either they’re getting paid in cash in the ordinary course, or they’re being reinstated and assumed on the back end of the case. And all that’s happening is up top at the financial debt — what we call a balance sheet restructure.

Those cases — there was a time when I was a younger lawyer, when people were filing one-day prepackaged bankruptcies. That meant you were in bankruptcy for less than one day. You’d file the bankruptcy, you would then go to court later that day, the court would approve the plan of reorganization, and you would have a moment in time of bankruptcy.
[00:38:30]

That’s great when you can do that. And when you're—you know, because there's minimizing disruption to the business. Again, worried about employees, worried about customers, worried about all of that. That trend — one-day bankruptcy, seven-day bankruptcy — that trend has gone away for a variety of reasons.

But now we think about prepackaged bankruptcies as taking somewhere between 20 and 30 days at best, which is a relatively short amount of time for a company to be in bankruptcy. And it gives the most certainty to the market. It gives the most certainty to the vendors, to customers, to employees.

But at the end of the day, it has to make sense economically — because you’re not impairing any of the unsecured
[00:39:00] debt.

Kison: Can’t be a terrible situation. It’s one that you’re likely gonna be the business from there.
‍
Benjamin Beller: The business has to be strong. Otherwise, it just has to be that there’s too much financial debt on the company. The interest cost is too high. And the lenders have to agree with that. And they have to say, “Look, we’re willing to give unsecured creditors 100% recovery, even though we — secured creditors who are senior on the assets — are taking less than 100% recovery because we’re turning our debt into equity.”

They have to be willing to say, “This is the best way path forward. This is the best way to preserve value. This is the best way to return investment on our investment. This is the best way to pursue the interest of our investors and our LPs.” Because at the end of the day, the lenders — they have their own obligations to their investors that they have to pursue.

That’s a prepackaged bankruptcy. We try to get in and out as quickly as possible, do the least amount of time in to minimize disruption to the business. Not always viable.
[00:40:00]

Benjamin Beller: Not always viable. Prearranged is — I would say — the vast majority of bankruptcies. That’s when the company has done adequate planning, has engaged with their — typically — secured creditors, but doesn’t have to be secured creditors, about a transaction in bankruptcy, and you come into the bankruptcy with that support, typically through a restructuring support agreement that lays out the basic terms and timeline of the case.

Is it going to be a sale? Or is the company going to run a sale process in bankruptcy? Are the creditors going to credit bid? That’s when you use your debt as consideration for buying the assets. Maybe you have to throw in some cash too, but it’s mainly going to be debt.
‍
[00:40:30Is it going to instead be a plan case where there’s an equitization of some sort? Is there going to be a rights offering? Is there going to be new money coming in? What’s the exit financing going to look like?

Those are the negotiations with the supporting creditors — and often your equity owner too — about what that bankruptcy is going to look like. And the idea there is, if you can, you try to make it a three- or four-month case, which gives sufficient time to go through the due process considerations that are required to get the benefit of bankruptcy. Usually sufficient to market the transaction.

Because one of the important things in bankruptcy is to make sure that there is an adequate process to make sure that the transaction the company is trying to do is value-maximizing. Can’t just come in and say, “Don’t worry judge, don’t worry everyone, we’ve decided.” There’s still business judgment — there’s a huge amount of business judgment deference — but you have to be able to prove that as a matter of evidence in court.
[00:41:30]

Kison: Will there be somebody to come in, just an offer to buy the company?

Benjamin Beller: Oh yeah.

Kison: Because this is in bankruptcy?

Benjamin Beller: Oh yeah. Usually what happens — if there’s going to be a sale process — there’s an organized process. People have to sign NDAs. People get access to the data room. Will put in bids by a certain date. Maybe there’s an auction.

One of the interesting things for your listeners who are more in the M&A space is a little bit of unfamiliarity with the M&A process in bankruptcy. And we represent a number of potential bidders, we’ll say, who don’t know the process as well. And it’s actually one of the things I really like — is educating them about it.

Because it’s not that different. Bankruptcy is really a tool for implementing a transaction, whether it’s in M&A…
[00:42:00]

Kison: I have a competitor that I know is in bankruptcy. I call you. I say, “Ben, I think there’s an opportunity here.”
‍
Benjamin Beller: Yeah.
‍
Kison: “I don’t know anything about how we can, you know, leverage it, but teach me. What are we going to do here to seize the opportunity?”

Benjamin Beller: No, exactly right. And one of the hugely important roles that a bankruptcy lawyer plays is educating the business folks about process. Because the process is a little opaque. It’s complicated. There’s a lot of jargon, again, being used. It does take some investment to learn the process, to learn the leverage points in the process.

And it can take longer time, sometimes, than buyers or bidders are interested in taking. And it’s all public. That’s another thing. But at the end of the day, Chapter 11 is a tool for implementing a transaction — whether it’s M&A,
[00:43:00]
debt financing, equity financing, or a combination of these things.

In any event, these prearranged cases, whether it’s going sale route or plan route, take strategy, take discussions with your lenders. There’s pros and cons to each. And it’s all dependent on the status of the business.

And one of the things that — again — is hugely important for our clients is S&C’s ability — our group’s ability — to bring in our elite M&A colleagues, to bring in our elite capital markets colleagues, whoever it is. The restructuring folks sit at the center of it, to do all of those transactions regardless of what it is.

And we are there to be Swiss Army knife–type lawyers. We’re there to implement a transaction at the end of the day.

Kison: Hey, do you want to give the example of like how you brief — like this — the example of the competitor: “Hey, I found out that they’re going to bankruptcy. How do I get in there and actually buy that company?”
[00:44:00]
‍
Kison: Is it just — it’s going bankrupt, there’s definitely a chance we can go buy it? Or is it sort of waiting for a certain flag to get lifted to say, “Okay, now they’re taking bids on it?”

Benjamin Beller: Yeah, there’s a process. So the company files for bankruptcy. Usually, right away, there’s a sense of whether they’re going to run some sort of organized M&A process, or whether they’re going a different route — like just filing a plan of reorganization to hand the keys over to the lenders.

Kison: So they can have a plan and they could do that. Or there is an alternative — like it goes for sale. So an insider, like you, could figure that out?

Benjamin Beller: Oh yeah. The great thing about bankruptcy — for someone who is looking to be involved in buying or providing financing — is almost everything is public. Maybe it’s not public today, but it will be public soon enough. You can’t hide in bankruptcy no matter what. The transaction has to be public. The terms have to be public. It has to be explained to the court why this is in the best interest of the company and the company’s stakeholders.

Part of it is diving into the process and saying, yeah, let’s see what we can do. And knowing that maybe it’s not going to work out — especially a competitor. There can be issues about selling to a competitor.
[00:45:00]
The company might say, if I have a bid from a competitor worth $100 million, and I have a bid from a non-competitor worth $95 million, I might prefer to sell for 95, even though the number is less, because it’s not a competitor.

But at the end of the day, the company — the debtor’s advisors — are obligated to find the highest or otherwise best (is the phrase) transaction. Usually, money talks. If you’re a competitor and you see an opportunity, you gotta deal with regulatory issues and whatever else is going to come from that.

But corporates in particular have great opportunity in the distressed M&A space to do relatively below-market purchases. We’ve seen a lot of companies do that in the life sciences space, and the life sciences industry has some particularities that make more sense for corporates to do it than for strategic financials.

Being able to look for purchasing opportunities in a Chapter 11 context is something that is worth looking at for companies — and buying them. Because again, it’s a great opportunity. You’re going to buy the assets free and clear of all liens and interests and all of that.
[00:46:00]
You got a clean slate, clean assets. And companies often have very strong assets — even if it’s just the IP that’s being sold.

Kison: Have you seen it where the company’s still — you can still operate it and turn it around?

Benjamin Beller: Oh yeah.

Kison: Better example: either in bankruptcy, put an offer there — what is it? Is it the stalking horse? You can be. We can talk about stalking horse versus not stalking horse. That’s an interesting area. Does that make sense? Am I just — talk…

Benjamin Beller: Yeah, let’s break that down.

Kison: So I’m just trying to throw the buzzwords out there.

Benjamin Beller: Yeah, yeah, no, I like it. You’re picking up from the jargon.

Kison: Yeah, you gotta teach it to me.

Benjamin Beller: Yeah. The thing about the jargon is, usually it’s not that creative. It’s not cool jargon, but it’s jargon nonetheless.

Stalking horse is: the company says, I’m going to designate this buyer — this bidder — as the lead. They’re going to set the floor for this sale process. And it can be a third-party buyer. Sometimes stalking horses are actually the lenders credit bidding.
[00:47:00]
But it’s: this is the floor for the sale. Anybody who wants to come in and bid, you should know that, absent something significant, we’re not taking less than this.

Usually the bidding procedures that get filed and approved by the court — that say, here’s how this whole process is going to run — they’ll say: when you get to an auction, you’re only going to be a qualified bid if you are determined to be higher than the stalking horse bid, or if the company otherwise determines. And then you get to an auction and — before the auction starts — maybe the stalking horse bidder is the lead bid for the auction, maybe not.

But there’s then a lead bid for the auction, and every bid after that has to increase over that lead bid by some determined increment, depending on the case.

But the stalking horse bidder, if it’s a third party, usually is going to be given court-approved stalking horse protections. And that can come in the form of a breakup fee. So you’re doing a service to the company by creating a floor for the auction. You gotta get paid for that.
[00:48:00]
‍
So: 3% breakup fee of the purchase price. You’re going to maybe have your advisor’s fees paid by the company — by the way, adding to the cost of a Chapter 11. Usually there’s a cap, but stalking horse legal fees are paid for. And that’s designed — again — to give structure to the sale process, set a floor, and give certainty to your customers, to your vendors, to your employees, that there is some path forward.

Kison: How often do you see the stalking horse bid be the winning bid? Is it a situation where there’s no competition when that typically happens, or does it turn into a real auction that’s competitive?
[00:48:30]

Benjamin Beller: It varies, and things have changed over time. In the slightly previous generation, the stalking horse bid was often going to be the winner. And that was either because it almost chilled the bidding—because nobody wanted to compete—or because the stalking horse really wanted the asset and was willing to come into an auction, increase its bid, keep bidding up until it got what it wanted.

These days, the trends probably are a little bit different. The likelihood of the stalking horse winning the bid has gone down. Part of that is because sometimes the stalking horse bidder are lenders and the lenders are credit bidding, and the credit bid can have a lot of hair on it and have challenges to the debt because there’s not cash coming in. You can have objections. Someone—a third party—who really wants the asset can come in and put cash on the table, sometimes even less than the amount of the credit bid, and still get the asset.
[00:49:30]

When there is a stalking horse bid, it can sometimes create a more lively bidding dynamic. But I also think the frequency of stalking horse bidders has gone down. Something we’ve seen a lot over the last 18 months in our cases has been companies deciding that the stalking horse just isn’t worthwhile. It’s not worth paying the bidding protections, and it’s not worth the risk that having the stalking horse actually chills the bidding.

As I mentioned, sometimes the company says, if you came up $50 million or whatever it is, maybe we would make you the stalking horse. But when your bid is at this price level, it’s just not worth it. We’d rather have a naked 363, as we call it—go into an auction and see what kind of bidding dynamic we can have.
[00:50:00]

And that’s also when it’s really important to have good advisors on all sides, including good bankers who can really have a finger on the pulse of the market and to say, “Look, this bid is okay, but I think if we go out, there’s going to be enough bidding interest to have a bidding environment at auction without it.”

Kison: Interesting. Do you see it like nowadays there’s more visibility and that’s why you see more likeliness of quite a bit of third parties getting involved?

Benjamin Beller: Yeah, I think that’s an interesting idea—that there’s more visibility and more sophistication, more willingness to come into the process and participate in a Chapter 11 sale process.

I also think that the dynamics of being a stalking horse—people have psychologically changed a little bit about it, where they’re worried about overpaying. That bidders are less willing to put forward their best price as stalking horse because they’re worried that best price, they’re not actually going to have to pay it. They’re saying, “Okay, I’d rather put my best price forward at auction than when the company is filing.”
[00:51:00]

There’s that disconnect between what the company is looking for in a stalking horse and what maybe the best bidder is actually willing to do at that time.

Kison: When these auction processes happen, how do you assure that you’re getting the most value on these deals? Because like I’d expect this to be a great opportunity, but then you’re mentioning it’s auction process. I know how things can get competitive and it sounds like a big variable if it’s competitive versus not. How is that going to get played out in terms of maximizing value?
[00:51:30]

Benjamin Beller: In some ways it’s no different in bankruptcy than it is outside of the bankruptcy context. There’s a lot of uncertainty about how the market is going to respond to buying some assets. And so really important to have good advisors, really good bankers, marketing the asset who understand the dynamics in Chapter 11. And there are a lot of great bankers out there who specialize in this kind of thing and who know the assets and know the buyers.

But at the end of the day, I think the best way to create a dynamic auction is as much as possible, start pitting people’s pride and arrogance and emotions against themselves and against each other. The best way to do that is you get two—maybe more—but really two people in the auction and get both of them feeling like they have to have that asset.
[00:52:00]

Kison: They’re in the same room.

Benjamin Beller: So yes, different auctions are structured different ways. You usually have breakout rooms so that parties have spaces where they can discuss by themselves. And usually what happens is there’s a lot of back channeling where the company and the company’s advisors are going room to room, having side conversations. And then there’s an auction room that’s just a conference room. But everybody comes into that and that’s where everything happens. That’s on the record, ’cause all these auctions are public record.

You get two people in the auction and you can say, “Look, you better buy this. If you’re not going to buy it, then they’re going to get it and you don’t want to let them get it.” You start to play up those psychological elements. That’s a big part of it.
[00:53:00]

And being thoughtful and strategic in how the company responds to bids. ’Cause bids can take different forms. That’s the other thing about bankruptcy is that these bids aren’t always just dollar increasing dollar by X amount. There’s different ways to structure these things. You can structure it by assuming more liabilities that can give more value. You can structure it by giving different forms of consideration.

So being strategic and agile in meeting the bidders where they are and then creating that psychological element, I think is the way to do it. And we saw that happen exactly in the NanoString bankruptcy from last year, where you had two bidders in the room. Both really wanted the asset. The auction went on for just about 18 hours, and the bidding price doubled from something like $200 million to $400 million over the course of those 18 hours.
[00:54:00]

Kison: So it was a little bit dribs. They had a stalking horse bid, so there was like a floor set and then, and then we had an auction.