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Reinstatement: How Valuable Is Below-Market Secured Debt?
A closer look at 'In Re: Charter Communications'
Special to Law.com
November 05, 2009
Perkins Coie's Steven M. Hedberg
This is a story as old as borrowers, lenders and the Bankruptcy Code, but with a new twist.
On Oct. 15, Southern District of New York Bankruptcy Judge James Peck stated that he would confirm the joint plan of reorganization of Charter Communications Inc. over the hard-fought objection of a group of its secured lenders lead by JP Morgan Chase Bank as administrative agent. Charter holds itself out as the fourth largest cable operator in the United States, providing high-speed Internet, telephone and video service to approximately 5.5 million customers[FOOTNOTE 1], maintaining a 27-state footprint and employing more than 16,000 people.[FOOTNOTE 2]
More impressive than the size of its operations was Charter's ability to lose money. Even one of the wealthiest people on earth found Charter's losses unsustainable. "After investing and losing more than $8 billion in the Charter enterprise," Paul Allen said "enough."[FOOTNOTE 3]
What Charter lost in equity, however, it more than held onto in debt. Charter's secured creditors were owed an aggregate of approximately $11.8 billion in the case. Even worse, from their perspective, the interest rate on those billions of dollars of debt was substantially below the current market rate. As a result, rather than seek to modify its loans through a cramdown and thereby reset the lenders' interest rates at a higher market rate, Charter sought to "reinstate" the loans and retain the benefit of below-market rates. To reinstate the loans, Charter would have to convince the court that the lenders' legal and equitable rights would be unaffected after the bankruptcy case and that all defaults would be cured by the plan's effective date, i.e., the lenders would have the full benefit of their prepetition bargain notwithstanding the intervening bankruptcy.
Reinstatement is specifically contemplated by the Bankruptcy Code.[FOOTNOTE 4] It has been recognized by courts as a viable treatment of secured creditors for purposes of confirmation for more than 25 years.[FOOTNOTE 5] During a 16-day trial, Charter and its lenders did battle the way most debtors and secured creditors do: Charter argued economic substance and what results are "right," while the lenders responded with technical arguments under the loan documents and process rights under the Bankruptcy Code. Charter, for example, in framing the arguments that it anticipated at confirmation, spoke of lenders receiving "the complete benefit of their bargain with Charter."[FOOTNOTE 6]
It also stated that reinstatement is "globally intended" to put debt "back on track and effect a reorganization "[FOOTNOTE 7] and that lenders should not be allowed to "extract improper windfalls at the expense of the debtors' estates."[FOOTNOTE 8]
In response, the lenders identified numerous "incurable" defaults that Charter had tripped (e.g., change of control, breaches of past and future representations and Charter's inability to reinstate due to acceleration)[FOOTNOTE 9] thereby making reinstatement impossible. Further, the lenders pointed out that Charter had the burden of proving the elements of reinstatement, and, they argued, Charter's proof fell short.[FOOTNOTE 10]
At the end of the day, however, the Court sided with Charter, concluding that the lenders' $11.8 billion of debt could be reinstated by Charter, resulting in an interest savings to Charter of more than $500 million per year. The actual ruling and order have not yet been issued, but the court indicated it would enter a written ruling in the near future.
So if reinstatement has been available to debtors for over a quarter century, what is the new twist? The twist is current-day economics. Although reinstatement as a theory has been around for years, the economic incentive to utilize the practice has not been as compelling as it is today. In the frothy liquidity days earlier in this decade, capital was readily available. Banks, private equity funds, CMBS facilities and others were pumping hundreds of billions of dollars of fresh cash into the economy annually. Companies were expanding, revenues were increasing year after year and everyone in the capital markets wanted to be a part of it. Both competition and broad-based access to funds pushed debt pricing down. Debtors even utilized the Chapter 11 process to take advantage of these lower market rates.
That has changed. In the current economic climate, debt is more expensive, if it is even available. New debt pricing at the market rate would have cost Charter approximately $500 million per year in increased interest costs. That created a powerful incentive for Charter to seek reinstatement of its existing indebtedness. While debtors historically have utilized bankruptcy to get a better deal, Charter utilized the process to hold onto what it had.
Will the same economic incentives drive additional bankruptcy filings, or at least cause companies to file sooner?
More than ever before, debtors in the current capital-constrained market have a powerful incentive to place their debt-strapped companies in bankruptcy before there is a default on secured indebtedness and lenders can effectively accelerate their debt. The interest rate pricing differential, as in the case of Charter, may be a significant corporate asset that boards of directors will have to carefully evaluate in determining whether and when to file bankruptcy cases.
Only time will tell whether there are enough other debt-strapped debtors living in the perfect storm of: (1) huge amounts of secured indebtedness (enough to justify the transactional costs and market risks of a significant Chapter 11 war), (2) borrowed at significantly below current market rates, (3) whose boards and advisers can see far enough ahead to know that a "sooner than normal" bankruptcy filing is essential.
It is hard to tell how often these three elements will converge, or whether companies realistically can be expected to assess when all the reasons for a pre-default filing are aligned. A decision to file before a secured debt facility is even in default would be counterintuitive to most directors. One thing is certain, however: sophisticated boards and management of large companies will now have to consider the "Charter Reinstatement Scenario" should their companies approach the zone of insolvency.
Steven M. Hedberg is a partner in the Bankruptcy & Workouts practice group at Perkins Coie. He has more than two decades of experience working with clients to solve complex commercial and economic issues related to insolvent companies. A member of the firm's Management and Executive Committees, he is based in the Portland office. He can be contacted at SHedberg@perkinscoie.com.
:::::FOOTNOTES:::::
FN1 See http://www.charter.com/Visitors/AboutCharter.aspx?NonProductItem=20
FN2 Id.
FN3 Post-Trial Brief of Paul G. Allen at 1.
FN4 See U.S.C. §1124.
FN5 See, e.g., In Re: Madison Hotel Associates, 749 F.2d 410, 419-420 (7th Cir., 1984)
FN6 Debtors' Memorandum on Reinstatement in Support of Approval of Disclosure Statement at 4
FN7 Id. at 5.
FN8 Id.
FN9See generally Post-Trial Brief in Support of Objections to Confirmation and of Entry of Judgment in the Adversary Proceeding Filed by JP Morgan Chase Bank, NA, as Administrative Agent.
FN10 Id.
