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Envirosource Inc., a hazardous waste recycler that relies on steel mills as customers, started the year laden with $270 million in debt, plummeting revenues and a bleak future. The problems at the Horsham, Pa.-based company made it ripe for a Chapter 11 bankruptcy filing, but Envirosource managed to complete an out-of-court restructuring in July in which it retired its existing stock for 20 cents a share and GSC Partners, a Citigroup affiliate and vulture investor, assumed control. While Envirosource was soliciting support for its restructuring, it was also preparing to file for a prepackaged bankruptcy in case the necessary 98 percent of the senior noteholders didn’t go along with the offer. As it turns out, it didn’t need to take that step. The now privately held Envirosource managed to reach consensus among 99.8 percent of its senior noteholders — many of whom were unknown to the company and its financial advisers a month earlier. While it seems as if there’s been at least one large corporate bankruptcy filing a day since the start of the year, Chapter 11 isn’t the preferred route to get a balance sheet in order, attorneys say. Bankruptcies are often ugly, expensive, lengthy and very public messes. TOUGH TO PULL OFF Out-of-court settlements that try to stave off a Chapter 11 filing are desirable for everyone involved, including the company, lenders and other creditors. “Companies always prefer out-of-court restructurings if they can do it,” said Alan Kornberg, the chairman of the bankruptcy department at New York law firm Paul, Weiss, Rifkind, Wharton & Garrison. “They are less expensive and less distracting. Chapter 11 can be very cumbersome with a lot of negative public relations.” But not every troubled company qualifies for an out-of-court solution. And such restructurings are more difficult to pull off. Witness the 98 percent consensus that Envirosource had to attain with its senior noteholders to get its restructuring through. “There were people who thought it would be impossible to get 95 percent consent,” says John Heenan, Envirosource’s chief financial officer. “And there were people who thought we would have to file for bankruptcy.” In fact, restructurings are nearly impossible to do if there are large amounts of non-bank debt or publicly traded equity. In a bankruptcy, consensus is easier to negotiate. Any creditor of a bankrupt company can be pushed into an agreement as long as half of the number of other creditors, and two-thirds of them in terms of volume of debt held, agree. But consent thresholds for an out-of-court restructuring are a lot higher. Agreement among creditors must be near unanimous. That’s why large companies usually can’t pull off a restructuring. MAKING IT STICK “Out-of-court restructurings are sometimes hard to do,” says George A. Davis, an attorney at Weil, Gotshal & Manges in New York who represented Envirosource. “In bankruptcy court, you can sometimes cram a plan down on a [creditor] class.” Moreover, out-of-court restructurings don’t have as high a profile as bankruptcies. Filings don’t have to be made in bankruptcy courts; instead, they often have to be made in easy-to-overlook Securities and Exchange Commission documents. Indeed, that’s why many restructuring and bankruptcy professionals are so eager to get good information on what out-of-court situations are afoot, how the negotiations are going and what creative solutions are being advanced. They also want to know what went wrong. To be sure, getting over the tough consensus hurdles are one thing, but having a restructuring that sticks is another. Edith Hotchkiss, a finance professor at the Boston College Carroll School of Management, says her research shows that nearly half of all out-of-court restructurings end up in bankruptcy within two years. Why? Because companies often try to restructure just the balance sheet when an operational overhaul is needed, she says. But getting a restructuring accomplished at all is often daunting. To William Derrough, a Jefferies & Co. managing director in Los Angeles and co-head of its restructuring and recapitalization department, there are two parts to a successful out-of-court solution. First, a company, based on its knowledge of the market, must first propose a deal that would be accepted by bondholders. “If you try jamming something down their throats that they find totally unacceptable, you won’t get that high ratio” of consensus, he says. Second, the company and its advisers must be able to contact all bondholders and convince them that the exchange offer makes sense, he says. SETTING A HIGH STANDARD Other financial restructuring advisers agree. Granted, to persuade, if not punish, a recalcitrant bondholder who refuses an exchange offer, a company can threaten to strip the covenants of the notes. In such a scenario, a company is required to pay a holdout 100 percent of the principal and payment, but then the bondholder would have no protection if the company defaulted. But such a disincentive only works when a very small number of bondholders won’t go along with the offer. If the bondholders decide to work together as a group to refuse an exchange offer, the company’s out-of-court restructuring is effectively dead. That’s why it’s so important to set a high standard on consensus that needs to be reached. “Any bozo can get a 90 percent offer done,” says Derrough, who helped Envirosource with its restructuring. “By setting an offer at 98 percent and above, we’re telling the world we are serious about getting the deal done.” Certainly the message got across at Russell-Stanley Holdings Inc., a maker of plastic and steel containers that also hired Derrough. Before soliciting for an exchange offer, Russell-Stanley’s consolidated financial statements showed liabilities exceeding assets by $39 million, rendering the company insolvent. It only had $59 million in current assets available to satisfy $278 million of debt coming due within the next year. In October, the Bridgewater, N.J.-based company commenced an offer to exchange $150 million of 10.875 percent senior subordinated notes due 2009 into substantially all of the equity of a reorganized Russell-Stanley and $20 million of new 9 percent senior subordinated notes due 2008. Interest on the new notes will be paid-in-kind until Aug. 31, 2003, and payable in cash thereafter if financial conditions are met. A stunning 100 percent of the senior noteholders consented to the exchange offer. CONVINCING BONDHOLDERS Was it just the financial package that got noteholders in line, or the fact that Derrough and the rest of the Russell-Stanley restructuring team also solicited their thoughts on a prepackaged bankruptcy? Perhaps a little of both. Part of convincing bondholders to accept an offer is to “convey to them that the company is prepared to go through with a Chapter 11, and that the bondholders will eventually get the same deal, but it’ll cost more money,” Derrough says. “A company has to convince — not try to fool — bondholders that they are not losing anything by avoiding Chapter 11.” Others agree, and also have attorneys draft papers for a Chapter 11 filing so they can simultaneously seek support for a restructuring and a prepackaged bankruptcy. Ken White, senior managing director at Ernst and Young Corporate Finance in New York, says he even threatened to file for bankruptcy as a tactic to get creditor approval for the recent restructuring of a large diversified industrial manufacturer with nearly $3 billion in revenue, which he declined to name. While White was soliciting approval for the restructuring, he was also raising debtor-in-possession financing — just in case. “Everyone would have been worse off if the company filed,” White says, noting that it still hasn’t. MOVING ON Sometimes it’s just better to settle and move on. Restructuring pros point to the diverse retooling at Danka Business Systems, a St. Petersburg, Fla.-based office equipment distributor, which completed its restructuring in June. The plan included exchanging $184 million of the company’s convertible subordinated notes; a new debt agreement from lenders and asset sales. At Focal Communications Corp., a Chicago-based CLEC, bondholders settled for 44 cents on the dollar. The company completed a debt-for-equity offer totaling about $280 million in principal amount of bonds for receipt of about 35 percent of the fully diluted shares of Focal common stock. Others are in progress. Loral CyberStar Inc., a subsidiary of Loral Space & Communications, announced an exchange offer for $927 million of its debt in October. Under the terms of the offer, noteholders would receive up to $675 million of new senior notes with five-year warrants to purchase up to 6.7 million shares of Loral Space. The offer must be accepted by 85 percent of the noteholders. The exchange offers and consent solicitations will expire Dec. 20. Another situation to watch is EasyLink Services Corp., an Edison, N.J.-based provider of outsourced messaging services, which announced an agreement to restructure $63.3 million of debt. Under the terms of the restructuring, the company will exchange about $63.3 million of debt and equipment lease obligations for about $19.1 million of restructured notes due in 2006, $4 million of other residual payments due in 2004, 19.4 million shares of common stock and warrants to purchase 18 million shares of common stock. In Envirosource’s case, the company offered a similar smorgasbord to its bondholders. It said it would exchange its $270 million 9.75 percent senior notes due 2003 for a combination of cash, new 14 percent subordinated notes due 2008, redeemable preferred stock and common stock. PROVIDING INFORMATION “Was it difficult? Yes, sure it was,” says the company’s Heenan. “The first 60 percent [owned by GSC Partners] was signed up before we started the solicitation process. Getting all of the [other] people to fall in line was somewhat difficult.” While master negotiating skills are always necessary in such transactions, Heenan says the success of the solicitation rested on providing as much information as possible to the noteholders. “It was a matter of finding people,” he says, “and then explaining to them [what needed to be done] and getting them to fill out the paperwork.” Jeffries’ Derrough says that creating a flexible capital structure via a restructuring is vital to getting a company more options down the road, yet “many times customers, vendors and employees are not willing to put their best foot forward and take any risk” when there are debt issues. In Envirosource’s situation, he, Heenan and others obviously did well to get this point across, given how warmly its out-of-court restructuring was embraced. Says Heenan: “People saw it as the best result.” Copyright (c)2001 TDD, LLC. All rights reserved.

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