Should the Borrower plan to pursue a Chapter 11 strategy, Lenders should be aware of the following considerations:

• Bankruptcy planning -- A Borrower filing for bankruptcy without giving thought to certain strategic considerations may find itself in a liquidation (i.e., a Borrower should plan the outcome). During negotiation sessions prior to filing, the Borrower should present the Lender a proposed timeline and milestones for the proceeding, packaged with expected funding to achieve the goals. In addition to “buying into” the timeline and providing funding, the Lender should assess its ability to “pull the plug” (i.e., potentially convert the bankruptcy case into a liquidation) – should the situation continue to deteriorate.
• Debtor-in-possession (“DIP”) financing -- DIP financing is a credit facility provided to fund expenditures during the Chapter 11 case. Often, a Lender will attempt to “roll-over” the pre-bankruptcy existing credit facility into a DIP facility with similar structure; by doing so, the Lender can protect its first lien position (known as “priming the lien”). In some situations, there may be a sufficient collateral base for an existing Lender to allow another Lender to provide the DIP facility if the existing Lender is adequately protected.
• The absolute priority rule in Chapter 11 cases -- Absolute priority order is the order in which the creditors of a bankrupt entity receive payments against claims (highest level to lowest). While Lenders typically reside towards the top of the absolute priority order, under certain circumstances statutory claims can trump a Lender’s claim in a Chapter 11.

As stated above, there are three potential outcomes of a Chapter 11 filing:

• Sale of substantially all of the debtor’s assets -- Sales of assets in Chapter 11 is administered under §363 of the Bankruptcy Code (a “363 sale”). One primary concept of a 363 sale is the ability to sell assets “free and clear” of liens (i.e., detaching assets from liabilities/encumbrances). Such a structure may entice more buyers. A 363 sale is structured as an auction. Ideally the Borrower would identify a potential buyer, designated as a stalking horse, before the auction is conducted to serve as an opening bid – creating a “floor” sale price for the assets.  An alternative way for a secured Lender to participate in a 363 sale is to reserve its right to “credit bid” on the assets. By credit-bidding, the Lenders can bid on the Borrower’s assets, setting their bid amount at the Lenders’ debt value, providing protection to the Lenders by setting their debt value as the “floor” value of the 363 sale auction.
• Reorganize through a Plan of Reorganization (“POR”) -- A POR typically takes longer than a 363 sale because of the solicitation process required and the threshold of creditors, by class of claimant, necessary for POR approval. A 363 sale process typically takes four to six months to execute, while a POR may take nine months to one year. A POR process typically involves a plan sponsor (a new equity capital provider) and restructuring of the company’s capital structure. Lenders can participate in a POR process as an exit financing provider (post-bankruptcy Lenders), in which their debt facility will be converted into a post-petition debt facility with revised terms and conditions that support the POR. Alternatively, a plan sponsor can bring its own exit financing provider, taking out the existing Lenders’ position.
• Liquidation -- In-court liquidation can be accomplished under Chapter 11 or Chapter 7 of the Bankruptcy Code. A Chapter 11 liquidation can be accomplished by the Borrower itself as a debtor-in-possession while a Chapter 7 liquidation is administered by a Chapter 7 trustee. A Chapter 7 liquidation is often associated with a “fire sale” of the estate’s remaining assets. For a number of reasons, both administrative and procedural, Chapter 7 liquidations may take considerably longer than Chapter 11 liquidations. Accordingly, Lenders typically prefer a Chapter 11 liquidation.

Lenders have a number of factors to consider when dealing with a distressed credit. While the variety of options may at first seem daunting to a Lender unfamiliar with the process, with the right guidance from restructuring professionals, Lenders can successfully navigate their way through troublesome loans.

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