Even though the price and terms were “entirely fair,” Bankruptcy Judge James L. Garrity, Jr. refused to approve $2.45 billion in chapter 11 financing for Latin America’s largest airline because features of the credit amounted to a sub rosa plan.
LATAM Airlines filed a chapter 11 petition in New York when the pandemic curtailed flight operations. After tortuous negotiations stretching over weeks, the airline proffered approval of a financing package with two tranches.
Tranche A, from an unrelated third party, was a $1.3 billion senior secured loan. Tranche A was comparatively noncontroversial aside from the fact that it was inextricably tied to the approval of Tranche C.
Tranche C was to be a $900 million, undersecured, first-loss junior loan. The loan would have been made by senior executives and shareholders holding or controlling 32% of the airline’s existing stock.
Tranche C would have given the debtor the option of paying off the loan at confirmation in return for equity at a 20% discount to plan value. The stock payoff option was not the only feature that stuck in the craw of creditor groups objecting to the financing.
The loan contained a covenant preventing the proposal or confirmation of a plan that was not approved by the company. According to the objectors, the loan effectively barred the company from filing a plan that did not include the equity-conversion feature.
The loan had another covenant requiring the plan to have a rights offering where all existing shareholders could buy new stock at reorganized plan value.
Judge Garrity handed down a 138-page opinion on September 10 meticulously describing the negotiations and details of the loan. Despite a broad-based attack, most of the loan surmounted opposition.
Among other things, Judge Garrity determined that the loan satisfied the “entire fairness” test and was proposed in good faith. Negotiated at arm’s length, Tranche C underwent “extensive” market testing, he said. No one came forward with a competing proposal, and pricing, including the equity-conversion feature, reflected the lenders’ risk. The judge said there were no “viable” alternatives, making the shareholders’ offer the “last resort.”
Even though the “price and terms” were “entirely fair,” there were grounds under Section 364(c) to approve the loan, and the lenders were in good faith, Judge Garrity nonetheless disapproved the financing because the equity-conversion feature “gives rise to an improper sub rosa plan treatment” of the Tranche C lenders and the debtor’s other shareholders.
Judge Garrity comprehensively laid out the caselaw on sub rosa plans. He said that courts will reject financings that “include concessions to creditors or parties in interest that are unauthorized under, or in conflict with, provisions under the Bankruptcy Code.”
The debtor defended the equity-conversion feature, saying it paved the way for restructuring. Even though the debtor had shown a proper business justification for the financing, Judge Garrity still found three reasons to disapprove, because “it contains provisions that will give the Debtors a leg up in the plan confirmation process.”
First, Judge Garrity said that the financing “will fix now, some of the terms of the plan yet to be filed,” given that it “locks” in the 20% discount when there “is no way of knowing whether that discount is appropriate.”
Second, obliging the plan to contain a rights offering for existing shareholders “violates the absolute priority rule . . . without the benefit of market testing.”
Third, the financing was a sub rosa plan because it only allows confirmation of a plan proposed by the debtor. “Those provisions effectively lock up any future plan of reorganization to be only the Debtors’ plan providing for the equity conversion,” Judge Garrity said.
Summing up, Judge Garrity said that the financing “subverts the reorganization process because the discount is not market-tested, the Debtors can make this election without the approval or oversight of the Court, and … the election dictates key terms of an eventual plan of reorganization by prematurely allocating reorganization value to [the debtor’s] existing equity holders.”
Even though the price and terms were “entirely fair,” Bankruptcy Judge James L. Garrity, Jr. refused to approve $2.45 billion in chapter 11 financing for Latin America’s largest airline because features of the credit amounted to a sub rosa plan.
LATAM Airlines filed a chapter 11 petition in New York when the pandemic curtailed flight operations. After tortuous negotiations stretching over weeks, the airline proffered approval of a financing package with two tranches.
Tranche A, from an unrelated third party, was a $1.3 billion senior secured loan. Tranche A was comparatively noncontroversial aside from the fact that it was inextricably tied to the approval of Tranche C.
Tranche C was to be a $900 million, undersecured, first-loss junior loan. The loan would have been made by senior executives and shareholders holding or controlling 32% of the airline’s existing stock.
Tranche C would have given the debtor the option of paying off the loan at confirmation in return for equity at a 20% discount to plan value. The stock payoff option was not the only feature that stuck in the craw of creditor groups objecting to the financing.
The loan contained a covenant preventing the proposal or confirmation of a plan that was not approved by the company. According to the objectors, the loan effectively barred the company from filing a plan that did not include the equity-conversion feature.