Prepackaged bankruptcies, prearranged bankruptcies, and expedited sales are available options for businesses in need of accelerated restructurings during the coronavirus (COVID-19) pandemic.
While the full extent of COVID-19’s impact on the economy remains to be seen, it will likely create significant restructuring activity for companies already experiencing financial distress and otherwise healthy companies that experience distress caused by the pandemic. We have already seen an increase in Chapter 11 filings, and more will follow.
Prior restructuring cycles typically resulted from specific negative industry trends, commodity prices, or financial market irregularities. The COVID-19 pandemic, by contrast, will indiscriminately cause the broadest and deepest need to address financial distress in modern history. Government and private sector financing may help some troubled companies avoid bankruptcy. Others, however, will need to implement out-of-court restructurings or seek bankruptcy relief in response to financial and operational challenges during this period.
The pandemic has caused revenues for affected companies to drop so dramatically that they may lack sufficient funding for operations notwithstanding the benefit of the automatic stay in a Chapter 11 proceeding. In the retail and hospitality industries, revenues have often ceased entirely and investors are reluctant to invest new capital or financing into an unprecedented and unknown business environment. As a result, Chapter 11 proceedings in this early stage of the credit cycle will be laser-focused on expediency and efficiency, and on controlling costs and avoiding administrative insolvencies.
In light of such concerns, certain bankruptcy courts have granted motions to “mothball” cases to allow the debtor a respite until it might reopen shuttered businesses and generate sufficient revenues to continue prosecuting an orderly liquidation or restructuring. For more information, please read our LawFlash on mothballing and other bankruptcy court measures during the pandemic. However, suspending a case only offers a short-term solution to preserve liquidity; parties will need a focused exit strategy to restructure in the most efficient manner. Below we discuss some of these strategies, which will be key to restructuring during the pandemic and its aftermath.
A prepackaged bankruptcy (commonly referred to as a “prepack”) is an expedited restructuring where the debtor negotiates and obtains the supporting votes of its relevant creditor constituencies before actually filing for bankruptcy (or soliciting some but not all votes prior to filing in a “partial” prepack). These highly consensual restructurings largely limit the scope of judicial activity in the bankruptcy case to approval of the disclosure statement solicitation process and confirmation of the plan of reorganization. Prepack cases can be completed in a fraction of the time required to resolve a typical Chapter 11 case; instead of a year or more, prepacks are ordinarily approved in one or two months and, in certain circumstances, a matter of days.
When Is a Prepack Optimal?
Prepacks are not feasible in all circumstances, but many distressed companies will be good candidates for prepacks in the current environment. Prepacks are most successful in capital structures without significant intercreditor disputes (e.g., first lien vs. second lien or secured vs. unsecured) or other major litigation—and where the ordinary course trade creditors can be unimpaired (i.e., paid in full).
Prepacks are often used to implement the following restructuring transactions:
- Debt-for-Equity Swaps: Change-of-control transactions whereby a creditor class exchanges its claims against the debtor for equity in the reorganized company.
- Supermajority Debt Adjustment: To adjust debt obligations with less than unanimous consent of an impacted class of creditors.
- Capital Raises: To raise additional capital to cover the transaction costs of the process and to capitalize the reorganized business going forward. Capital raises take numerous forms and often involve a “rights offering” where existing creditors who will continue as stakeholders in the reorganized company are given the opportunity to participate in the new financing by purchasing equity of the reorganized business or funding a credit facility. Often the capital raise is “backstopped” by a group of creditors who guarantee (for a fee) that the total capital will be contributed to the restructuring even if some creditors decide not to participate in the rights offering.
Prepack use has increased in recent years—a trend we expect to continue in the current crisis where debtors may be forced to seek the benefits of Chapter 11, but they and their stakeholders prefer a streamlined, low-cost solution.
A prearranged bankruptcy occurs where parties achieve substantial consensus in prebankruptcy negotiations regarding the terms of a plan of reorganization but, unlike the prepack, no creditor voting occurs before the bankruptcy filing. Typically, the debtor and its major creditors negotiate restructuring terms or plan and memorialize the arrangement in a plan support agreement (PSA) or restructuring support agreement (RSA).
The PSA/RSA provides that the debtor will file for bankruptcy and promptly seek to implement the restructuring by filing a plan of reorganization and disclosure statement in accordance with the agreed terms. The creditor support parties commit to vote in favor of the plan once solicited in accordance with a court-approved disclosure statement—provided the terms of the plan remain consistent with those agreed in the PSA/RSA. The debtor usually files its plan and disclosure statement with its petition for Chapter 11 relief, although the plan may be delayed slightly to provide additional time for drafting.
The level of consensus among stakeholders generally determines the time needed to confirm a prearranged plan of reorganization. Prearranged plans with broad support may be confirmed in about 60 days, depending upon the court’s availability. Courts may shorten the process further by combining the disclosure statement and confirmation hearings. Cases with less consensus may take longer, and active plan opponents sometimes cause significant delays.
Prearranged versus Prepack
Prearranged cases may be the best alternative in circumstances where prepacks are not viable because of intercreditor disputes or litigation. It is common for senior creditors to enter into a PSA/RSA and support a prearranged case even if junior creditors oppose the plan due to valuation or other objections. Such disputes give rise to litigation rights and a discovery process that can delay the confirmation process. With time and discovery, these disputes are often settled, but many proceed to a contested confirmation hearing.
Even where there is broad consensus, a debtor may need to pursue a prearranged bankruptcy rather than a prepack if the debtor has insufficient time to fully document and solicit a prepack before filing for Chapter 11 relief. This is common where the debtor lacks adequate liquidity to fund operations during the prepack solicitation period.
Parties willing to financially support the restructuring are usually unwilling to extend prepetition financing; instead, they prefer debtor-in-possession (DIP) financing approved by the court, which provides significant lender protections, including super-priority status. As a result, many prearranged bankruptcy filings include a request for approval of a small DIP financing—along with a plan and disclosure statement—to cover costs through confirmation.
We are also seeing (and will see more) cases during the pandemic that involve immediate efforts to sell significant portions, or substantially all, of the debtor’s business/assets. Such sales are particularly common among retail companies that were already under financial pressure before the pandemic response forced closures and eliminated their revenues.
Without revenues or stakeholders willing to fund the business during the pandemic (even via DIP loans), some companies cannot afford a reorganization in bankruptcy and need to sell the business as quickly and efficiently as possible. Even where limited DIP financing is available, it may be predicated upon the debtor pursuing an expedited sale and only provide sufficient funding for that process.
Chapter 11 sales are subject to bankruptcy court approval under Section 363 of the Bankruptcy Code. Traditionally, courts and creditors expect and require a robust sale process to obtain the best purchase price and maximize the value of the debtor’s assets in the sale. This involves two stages.
First, the debtor’s professionals conduct an out-of-court sale process (either before or after commencement of bankruptcy) designed to solicit multiple bids from a large universe of interested parties. Although any interested parties are welcome to bid, the process focuses on two targets: (1) investment funds known to invest in businesses like the debtor’s, and (2) competitors of the debtor. Potential buyers perform diligence to assess the assets for sale before submitting bids that are reviewed by the debtor and its professionals.
The debtor typically selects the best bid to serve as a “stalking horse bid” and then files a motion with the bankruptcy court seeking approval of (1) a subsequent auction with court-sanctioned bid procedures in which other interested buyers can bid against the stalking horse bidder, and (2) a hearing to approve the sale to the winning bidder.
Under ordinary circumstances, the sale process is time consuming. The prebankruptcy marketing process alone takes several months, and the bankruptcy process of obtaining court approval and conducting the auction can add at least another month, if not several more.
COVID-19 Expedited Timing
Under current circumstances, many companies will not have time to accommodate the full traditional process. We expect debtors to seek expedited sale processes during the pandemic in the following ways:
- Asking courts to shorten the ordinary deadlines for the sale process.
- Proposing a stalking horse bidder after limited prebankruptcy marketing with the expectation that a quick auction will create competition for the assets.
- Eliminating the initial stage of the sale process—opting instead to file “naked” 363 sale motions without a stalking horse bidder and proceeding directly to an open auction.
- Conducting “private sales” whereby the debtor seeks court approval under Section 363 of an asset sale to a buyer without any auction process in bankruptcy. Private sales are uncommon in Chapter 11, but exigent circumstances may warrant their approval during the pandemic. Especially where a company suddenly has no revenues and no available financing, a quick private sale with creditor support may be the only viable alternative to administrative insolvency and liquidation under Chapter 7, which may reduce recoveries for all stakeholders.
During the pandemic, these three expedited options will be most effective where debtors and creditors can achieve consensus on a plan to maximize value for all stakeholders. Even where collaboration may be difficult—or impossible—debtors, lenders, and other stakeholders will benefit from becoming familiar with the restructuring and bankruptcy tools available to withstand the economic fallout of COVID-19.
How We Can Help
The Morgan Lewis bankruptcy and restructuring team has experience in all of the options described above. We are available to discuss these strategies with any business presented with the need during these unprecedented times.
Coronavirus COVID-19 Task Force
For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold.
 In “partial” prepacks, the voting continues after commencement of the bankruptcy case and the plan and disclosure statement are considered by the bankruptcy court on a combined basis.