In Part I of this three part series we noted the likelihood that credit bidding will be more prevalent in today’s unpredictable economic environment and discussed some of the statutory backdrop. Here, in Part II, we will discuss certain mechanics that are associated with making, and later consummating, a credit bid.
Rather than risk holding assets in an entity that was not organized with that in mind (e.g., a bank), lenders will often organize a new “acquisition vehicle” (e.g., a limited liability company) for purposes of consummating, if not making, a credit bid. The form of the entity may depend on the assets to be acquired. For example, lenders in a recent transaction formed a trust, rather than LLC, to acquire their helicopter collateral. Recognizing that there may be an acceptable third-party cash bid, a lender itself will often submit a bid, reserving the right to assign that bid to a newly created entity should its bid be successful. In the context of a syndicated loan, if successful, each lender will typically contribute its pro rata portion of the debt to the acquisition vehicle in exchange for a pro rata ownership interest, ensuring appropriate ownership of the collateral upon consummation of the credit bid. Of course, the dynamics of every group are different and negotiations with regard to the organizational documents for the acquisition vehicle may take different paths. With respect to voting rights, the parties may agree that those “sacred rights” — decisions that required a 100% vote under the credit facility — require unanimity under the organizational documents. Alternatively, they may agree that a “bankruptcy majority” of two-thirds in amount and one-half in number should control. Many subjects of negotiation, including those regarding “drag-along” and “tag-along” rights, may be new to many lenders and require careful consideration, particularly in an environment where lenders themselves have differing structures and motivations (e.g., traditional lenders v. private credit providers).
Given the size of many financing facilities and the activity in the secondary markets for such debt, it is infrequent that all lenders in a syndicate agree to pursue a common path in a workout and reorganization. When a large syndicate of lenders participate in a single facility, it should be expected that they may have different expectations for the means and timelines of their recoveries. This includes their willingness to propose and participate in a credit bid for the group’s collateral in the first instance. The protections afforded by Section 363(k) of the Bankruptcy Code would be upended in a syndicated facility if a single lender held veto power. If that were the case, an interested competitor of the borrower could theoretically acquire debt and prevent a group of lenders from topping its third party bid. When faced with this issue, courts have pointed to the remedy provisions common in syndicated facilities and found that “required lenders” are able to direct the agent to exercise certain remedies on behalf of the group following the occurrence of an event of default — it is now generally accepted that those remedies include, even if not expressly stated, the submission of a credit bid on behalf of the group consistent with a collective action approach. While this protects against a disgruntled minority lender, it does not protect against a third party accumulating a blocking position in the secured debt (e.g., acquiring 35% of a facility in which the “required lender” threshold is 66%).
Many issues, however, remain unaddressed by the courts. For example, where the majority lenders direct the agent to submit a credit bid on their behalf, must the contributed debt be that of all of the lenders on a pro rata basis? Instead, can those lenders direct the agent to bid only the debt held by lenders that are willing participants? If the latter is permissible, those lenders that do not, or cannot, contribute their debt will be forced to rely on the “sharing provisions” of the underlying credit facility that require that any lender that receives greater than its pro rata share of recovery on account of the loan to share such amounts with the other lenders. In such a case, nonparticipating lenders will not own interests in the holding company and will therefore have no control over the operation and management of the assets, including the timing of any dividends in which it would presumably share. While some clarity has been provided by the courts, there is much left to address on a case-by-case basis.
In Part III, we will address some additional considerations that a lender must take into account when deciding to credit bid its debt.