RESTRUCTURING IN COURT:

Chapter 11 Overview

2

WHAT IS CHAPTER 11?

• A chapter contained in title 11 of the United States Code (the "Bankruptcy Code") which provides for the reorganization, rather than immediate liquidation, of a debtor

• Primarily intended for the rehabilitation of business enterprises (the "fresh start policy")

• Goals ‒ To provide equitable treatment for creditors

‒ To preserve incremental value attributable to the ongoing operations

3

WHY DO COMPANIES UTILIZE CHAPTER 11?

• Cases for filing ‒ Over-levered

‒ Litigation liabilities

‒ Operational restructuring

• Easier to identify and negotiate with parties ‒ Creation of a single national forum to deal with groups with competing interests

‒ Statutory committees

• Ability to bind all parties to a solution ‒ Class approval of at least two-thirds in amount and majorly in number in those

voting binds entire class

• Discharge of Debts

4

CHAPTER 11 RESTRUCTURING TOOLS

• Chapter 11 provides a debtor with certain tools to restructure

• their liabilities ‒ Automatic stay (the breathing spell)

‒ Rejection of contracts

‒ Compromise claims and equity o Class approval binds all creditors in class

o Ability to "cramdown" junior creditor classes

‒ Proposal of a Plan of Reorganization

THE PLAYERS IN A CHAPTER 11 CASE

6

THE PLAYERS

• Debtor and its existing management ordinarily continue to operate the business as a "debtor in possession" ‒ Trustee can be appointed to take over management of the debtor's affairs only

for "cause"; such appointments are rare

• Official Committee of Unsecured Creditors ‒ Usually the seven largest unsecured creditors willing to serve

• Equity Committee – rare

• "Ad Hoc Groups" of creditors ‒ All creditors, shareholders, interested governmental entities are "parties in

interest" and can be heard on any matter

7

WHO CAN BE A DEBTOR?

• Bankruptcy Code § 109(a): Eligibility for Chapter 11 relief requires the entity to have a domicile, a place of business, or property in the US

• Eligibility is determined as of the date the Chapter 11 petition is filed.

• A foreign debtor with property in the US meets the eligibility requirement and the court would have proper jurisdiction.

• US bankruptcy courts will maintain jurisdiction over a foreign debtor if the Chapter 11 filing was made in good faith and with the intention to reorganize the business.

AUTOMATIC STAY

9

AUTOMATIC STAY

• Prohibits substantially all legal actions affecting the debtor or its property ‒ On account of a prepetition claim or debt

• Stops all actions by individual creditors to obtain satisfaction of their claims using remedies available under state law ‒ Stops creditor collection efforts ‒ Prevents lien foreclosures or lien creation ‒ Generally prevents termination of contracts with the Debtor

• Limited exceptions for governmental regulatory actions, termination/netting of swaps, commodities contracts or forward of contracts

CLAIMS AND CLAIM PRIORITY

11

ORDER OF CLAIMS (THE "WATERFALL")

• DIP Loan secured claims

• Secured claims (up to value of collateral)

• Administrative claims (claims for post-petition salaries, vendor claims, estate professionals, etc.)

• Priority claims

• Unsecured claims

• Equity

ADMINISTRATION OF THE CHAPTER 11 CASE

13

USE, SALE OR LEASE OF PROPERTY OF THE ESTATE WHILE IN BANKRUPTCY

• Debtor may use, sell or lease most of its property in the ordinary course of business without court authorization

• Debtor can incur unsecured debt in the ordinary course of business and use noncash collateral

• Certain items require special review and approval of the bankruptcy court: ‒ Use of cash collateral

‒ Use, sale or disposition of property outside of the ordinary course

14

USE OF CASH COLLATERAL

• Cash collateral includes: cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents, including cash proceeds from other collateral, which serve as collateral for a claim

• No use of cash collateral without court authorization, unless the secured party consents

• If the secured party does not consent, the use of cash collateral is prohibited unless adequate protection is provided

• Gives secured party considerable leverage at outset of case

15

DIP FINANCING

• If the debtor does not have sufficient cash on hand or is unable to obtain sufficient unsecured credit, the court may ‒ Authorize debt with a "super-super priority" over all administrative expenses ‒ Grant the new lender a priming 1st lien on all property of the estate ‒ Grant the new lender a lien on unencumbered property of the estate ‒ Grant a junior lien upon property that is already subject to a lien

• Pre-petition unsecured lender can insist that the DIP be a "roll-up" of the pre-petition loan ‒ A DIP financing order often grants to a lender additional protections that were not

available to the lender under its existing loan documents • DIP financing lenders typically allow use of cash collateral, including to pay

the professionals of the debtor and the creditors' committee • DIP loans are typically due and payable on the date the Plan becomes

effective and are typically refinanced with exit financing

16

ADDITIONAL DIP FINANCING ISSUES

• Loan to own DIP Lenders may seek to include covenant or repayment of terms that provide ability to control bankruptcy/plan process, i.e. ‒ Information covenants

‒ Strict budget/use of proceeds controls

‒ Failure to meet certain milestones in bankruptcy case are often events of default under the DIP

17

ADEQUATE PROTECTION FOR SECURED CREDITORS

• Granted to secured creditors to protect against a decline in the value of their collateral ‒ If a debtor opposes a secured creditor's motion for relief from stay, the debtor

carries the burden of showing that adequate protection exists

‒ Arises in connection with super-priority priming DIPs

• Provided by: ‒ Offering periodic cash payments (typically post-petition interest)

‒ An additional or replacement lien

‒ Other relief resulting in realization of the "indubitable equivalent" of the value of the collateral

18

ADEQUATE PROTECTION FOR SECURED CREDITORS (CONTINUED)

• In lieu of providing adequate protection, the debtor can seek to demonstrate that the value of the collateral greatly exceeds the amount of the secured creditors' debt

• If the debtor is unable to provide adequate protection, then a secured party is entitled to obtain relief from the automatic stay and enforce its collateral rights

• If a grant of adequate protection ultimately proves to be "inadequate," the secured creditor's claim for its lost collateral value will be treated as a "super priority" claim and administrative expense of the case

19

ASSET SALES ("363 SALES")

• Court approval for property use/sale/lease outside ordinary course of business (§363(b)(1))

• No Court approval for normal/daily transactions (§363(c)(1)) • Most courts allow 363 sales of substantially all assets • Benefits of 363 Sales

‒ Speed ‒ Free of liens, claims and encumbrances ‒ Insulation from fraudulent transfer claims ‒ Potential insulation from successor liability claims ‒ For directors and officers, eliminates exposure for the sale ‒ Limits exposure for breaches of reps and warranties

20

TYPICAL SALE PROCESS

• Marketing of Assets

• Negotiations with "stalking horse"

• Filing sale/bidding procedures motion

• Executory contract cure process

• Receipt of bids

• Auction

• Sale Hearing

• Consummation

21

EXECUTORY CONTRACTS

• Debtor has the right to assume or reject executory contracts • Ipso facto clauses are not enforceable • Contracts are "executory" where there are obligations remaining to

be performed by both parties ‒ A long term supply contract or lease is an "executory" ‒ A loan is not executory

• If a debtor assumes a contract, it must cure all non-bankruptcy defaults and continue to perform all obligations

• If a debtor rejects a contract, the counter-party has a claim for damages caused by the breach

22

PREFERENCE ACTIONS

• The debtor may avoid any transfer of an interest in property: ‒ To or for the benefit of a creditor; ‒ For or on account of antecedent debt owed by the debtor before such transfer was

made; ‒ Made while the debtor was insolvent; ‒ Made

o Within 90 days before the filing of the petition; or o Within one year if the creditor was an insider; and

‒ That enables such creditor to receive more than such creditor would receive if (i) the case were a case under Chapter 7 of the Code, (ii) the transfer had not been made, and (iii) the creditor received payment as provided by the code

• Note that non-cash transfers are also subject to preference challenge ‒ I.e. if a pledge has not been perfected within 30 days of such transfer, it may

constitute a preference

23

FRAUDULENT TRANSFERS

• Under Section 548 of the Code, a transfer by a debtor occurring within 2 years prior to the debtor's bankruptcy filing may be avoided if the debtor: ‒ Made such transfer with the actual intent to hinder, delay, or defraud any

creditor; or ‒ Received less than "reasonably equivalent value" and (i) was balance sheet

insolvent prior to or as a result of the transfer, (ii) was left with unreasonable small capital for engaging in its business, or (iii) intended to incur, or believed it would incur, debts beyond its ability to pay as such debts became due.

• Examples: non-judicial foreclosures on real estate, many (but not all) up-stream and cross-stream guaranties

24

FRAUDULENT TRANSFERS (CONTINUED)

• In addition, Section 544 of the Code gives the debtor the status of a hypothetical lien creditor, which allows the debtor to utilize applicable state laws (namely, the UFCA and UFTA) to avoid fraudulent transfers that a creditor could have avoided, but for the intervening bankruptcy case.

• Section 544 significantly expands the debtor's avoiding powers by allowing the debtor to utilize longer statutory reach-back periods than the two year time frame permitted under Section 548.

• Example: The reach- back period under New York State law is six years.

THE CHAPTER 11 PLAN

26

THE PLAN

• Principal method of effectuating a reorganization in Chapter 11 is through a Chapter 11 plan (a "Plan") ‒ Under Chapter 11, can be a plan of reorganization or a plan of liquidation

• A Plan can provide for a number of changes to pre-petition rights ‒ Amounts, interest rates or maturities of outstanding debts ‒ Reinstatement of favorable existing contracts notwithstanding defaults ‒ Satisfaction or modification of liens ‒ Rejection or assumption of contracts and leases ‒ Amendment of the debtor's corporate charter ‒ Issuance of new debt or equity securities for cash, property, existing

securities, or in exchange for old debt or equity interests

27

THE PLAN (CONT’D)

• Existing creditors' debt claims are usually reduced or modified ‒ Creditors of one or more classes often become shareholders of the

reorganized entity (an "equitizing" Plan; a/k/a debt-forequity swap)

• The debtor has the exclusive right to propose and file a Plan during the first 120 days

• Classification of Claims and Equity Interests ‒ Claims and equity interests are grouped into one or more "classes," depending

on their nature ‒ Claims of a particular class must be "substantially similar" ‒ Plan must provide the same treatment for each claim or equity interest in a

particular class

28

VOTING ON A PLAN

• Only impaired classes of creditors or shareholders are entitled to vote on the Plan

• Each holder of a claim or equity interest votes on the Plan with other members of the applicable class

• Acceptance by a class requires consent by holders of claims equaling at least two-thirds in amount and a majority in number of claims

• Classes recovering no distribution under the Plan are deemed to reject the Plan, and are not even solicited

• A "cramdown" on junior classes of creditors can be imposed if a consensual Plan cannot be achieved

29

EFFECT OF PLAN CONFIRMATION

• Distribution of plan value (cash, new notes or equity) in accordance with claims Waterfall

• Discharge of all prepetition debts; no claims against debtor for "unpaid portion"

• Debtor company emerges as a new entity and conducts business

RESTRUCTURING IN CHAPTER 11

31

RESTRUCTURING HYPOTHETICAL: BANK DEBT & PUBLIC NOTES—FAILED EXCHANGE OFFER

Facts • Publicly Traded Company

‒ Oil and natural gas exploration and development company ‒ Borrowed extensively 5 years ago to expand operations

o $200 million senior secured revolving credit facility maturing in May 2016 o $250 million unsecured public notes due May 2017

• Company, Banks and Ad Hoc Group of Public Noteholders agree to certain restructuring terms, but the requisite 90-95% of Noteholders did not agree to exchange their notes

• Company filed Chapter 11 to stop Banks from exercising on their collateral and to "force" a restructuring on the Noteholders

32

IMPLEMENTATION OF RESTRUCTURING IN CHAPTER 11

• Automatic stay prevents Banks from exercising on their collateral

• Company proposes a Plan of Reorganization (in consultation with "majority" of Banks and Notes)

• Debtor classifies creditors into different classes under the Plan; creditors vote by class ‒ Two-thirds in amount and a majority in number of creditors voting in a class

can bind the entire class

33

IMPLEMENTATION OF RESTRUCTURING IN CHAPTER 11 (CONT’D)

• Classes of Claims under Plan ‒ Class 1: Administrative Expense Claims—Unimpaired (paid in full)—deemed to

accept ‒ Class 2: Secured Claims—Impaired—entitled to vote

o Extend $200 million Bank debt to May 2017, with "market interest“ and "market" covenant package; maintain senior lien status

‒ Class 3: Unsecured Note Claims—Impaired—entitled to vote o For every $100 in existing Notes, distribute $50 in new notes and 75 shares of new company

(cumulative 100% of equity of Company post-reorganization)

‒ Class 4: General Unsecured Claims (miscellaneous vendors)—Impaired—entitled to vote o Distribution of 50 cents on the dollar

‒ Class 5: Equity—Impaired—Deemed to reject o No recovery

34

POST-RESTRUCTURING CAPITAL AND ORGANIZATIONAL STRUCTURE

Noteholder (100% equity)

Company

Operating Subsidiary A

Operating Subsidiary B

Operating Subsidiary C

$200 Million Secured Bank Debt

$125 Million Unsecured Public Note Debt

Secured Guarantees

35

RESTRUCTURING FLOW CHART

Banks and Private Notes

Restructure by Exchange Offer

re: Notes

Exchange Offer threshold achieved

Out of Court

Exchange Offer thresholds not met

Chapter 11

66 2/3 | 50% Noteholders

consent to Plan Plan Confirmed

66 2/3 | 50% Noteholders don’t

consent to Plan Cramdown

Banks and Private Notes

Restructure by Contract

Failure to Agree Chapter 11

36

T:

E:

Evan Flaschen Partner

+1.860.256.8537

evan.flaschen@bracewell.com

This presentation is provided for informational purposes only and should not be considered specific legal advice on any subject matter. You should contact your attorney to obtain advice with respect to any particular issue or problem. The content of this presentation contains general information and may not reflect current legal developments, verdicts or settlements. Use of and access to this presentation does not create an attorney-client relationship between you and Bracewell.