The Legal Architecture

of Delphi’s Emergence

Edward R. Morrison Harvey R. Miller Professor of Law & Economics

Columbia Law School

Big Picture

• No surprise that Debtor-in-Possession (DIP) Lenders can exercise great influence during the reorganization process.

• But in Delphi’s case, the DIP Loan had an unusual structure, giving a majority of senior DIP Lenders power to override a dissenting minority and the entire junior tranche. The DIP Lenders were ultimately able to exercise their rights to effectively block a government-approved sale process.

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DIP Loan’s Structure Was a Product of the Credit Boom

• Boom of mid-2000s: Allowed Delphi to refinance both the original DIP financing ($2 billion) and prepetition secured debt ($2.5 billion) in January 2007.

• Result: A new DIP Loan with three tranches: – Tranche A: Original DIP Loan (revolver) – Tranche B: Original DIP Loan (term loan) – Tranche C: Refinanced Prepetition Secured Debt

• Not your ordinary rollup: Although it elevated the priority of the prepetition secured debt (gaining administrative expense priority), the refinancing: – Saved financing costs of $8 million per month. – Did not reserve the court’s right to unwind the rollup or refi under certain

conditions, as generally required by local rules. – Imposed important governance provisions on Tranche C, and gave important

rights and remedies to Tranches A and B. (See next slide.)

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Key Provisions: Inter-Creditor Governance and Default Remedies

• Inter-Creditor Governance: The DIP Loan included “Collective Action Clauses” (CACs), which are commonly seen in syndicated loans. Pursuant to these CACs, … – An Administrative Agent has exclusive authority to enforce remedies. – Unanimous lender approval is needed before the Agent can modify

core provisions (e.g., term, interest rate, balance). – But a majority of lenders (“Required Lenders”) can direct other Agent

decisions.

• Tranche C was disenfranchised: Delphi’s CACs excluded Tranche C from the definition of “Required Lenders.” – A majority of Tranche A and B could bind Tranche C.

• Key Remedy after Default: Required Lenders could direct the Agent to accelerate the loan and force sales of collateral – all without first seeking relief from the automatic stay.

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These Provisions Manage Inter-Creditor Conflict

• CACs can manage conflict among DIP lenders: New York caselaw (especially Beal Bank v. Sommer, 2007) makes clear that a CAC prevents syndicate members from exercising remedies unilaterally and that Required Lenders can direct an Agent to exercise particular remedies and when.

• Remedies, combined with CACs, can also manage conflict with the Debtor and other lenders: After an event of default, Required Lenders can credibly threaten to liquidate the debtor’s assets if they disapprove any proposed action.

• These contractual rights would prove extremely important during the years ahead.

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First Inter-Creditor Conflict Emerged after the Credit Bust

• As financial markets collapsed in late 2008, Delphi’s exit financing evaporated and its DIP loan matured. – Some DIP lenders (especially in Tranche C) rejected another extension

of loan maturity. Others (in Tranches A and B) favored extension.

• Strategic use of CACs: Required Lenders directed the Agent to forbear from exercising remedies after the DIP loan matured. – Under an “Accommodation Agreement,” Agent would forbear for six

months, provided that Delphi (i) paid fees to lenders, (ii) paid interest at a default rate, and (iii) achieved certain milestones, including an exit financing commitment in early 2009.

– Accommodation Agreement also elevated the priority of hedging debts owed to Tranche A lenders, effectively priming Tranche B and C lenders.

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Controversial Use of a CAC to Bind a Dissenting Minority

• Tranche C and other lenders complained: “What Debtors cannot do directly—obtain a duly authorized extension supported by all Lenders—they are trying to do through the back-door of forbearance.” (Tranche C Response p. 5, Nov. 18, 2008) – Tranche C Lenders also complained about the “surreptitious priming” of their

claims: In their view, Delphi was buying-off Tranche A Lenders by elevating the priority of these Lenders’ hedging claims. (Id., at 14)

• Judge Drain rejected these complaints because Required Lenders were exercising precisely the authority that the CACs gave them. – Forbearance is not the same as a maturity extension. For example, Delphi

would pay the default interest rate under the Accommodation Agreement. – There is no “surreptitious priming,” the judge said, because the dissenting

lenders “consented in advance” to being primed in this way. Under the DIP Loan, the Required Lenders can direct the Agent to elevate the priority of hedging claims. (Hearing Transcript p. 161, Dec. 1, 2008)

– Lesson: An inter-creditor agreement can waive many of the protections that lenders typically enjoy in Chapter 11.

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Second Inter-Creditor Conflict Emerged with the Auto Task Force

• With government approval, GM agreed to purchase assets from Delphi in mid-2009. After negotiation, the sale was broadened to include two buyers: GM and Platinum Capital.

– Delphi’s steering business and certain other assets would go to GM, most of remaining assets would go to Platinum.

– Proceeds from sale would cash out Tranches A and B, but leave Tranche C impaired.

• Delphi proposed implementing this sale through a modified plan:

– Step 1: Assets would be sold to GM and Platinum through a private sale, not an auction.

– Step 2: Required Lenders would direct the Agent to use remedies available in the DIP Agreement to take the proceeds, which would require a 51% vote of the senior tranches, rather than 2/3 in amount and 1/2 in number of the class.

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• Step 1: Tranche C and other dissenting lenders argued that this private sale process would allow Platinum to buy on the cheap. Delphi proposed a “no shop” sale process that would forbid it from considering competing bids, though Delphi’s board could take actions required by its fiduciary duties (a “fiduciary out”). – Delphi could not “solicit, initiate, respond to, continue, encourage or facilitate …

any inquiries or the making of any proposal with respect to … the possibility of a Competing Transaction.” (Master Disp. Agreement §9.40, June 1, 2009)

• Step 2: Under this step, Tranche C claims would not be paid in full in cash even though they had administrative expense priority. – Legal requirement: A plan must either cash out claims with administrative

expense priority or obtain lender consent to different treatment. §1129(a)(9). Delphi’s plan would use the CACs to obtain “implicit” consent from dissenting lenders despite their vocal opposition.

– This was highly controversial for two reasons: (1) Functionally equivalent to saying that the Agent’s consent to Delphi’s plan is binding on dissenting lenders. It’s unclear whether an Agent can do that. (2) Agent would use remedies in a way that looks like a “back door” release of liens on collateral and waiver of principal, which required unanimous consent under the DIP Agreement.

Each Step of the Proposed Sale Process was Highly Controversial

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• Tranche C Lenders immediately traded into Tranches A and B (buying the debt at a premium) because they believed the sale would allow Platinum to buy Delphi assets at a discount. Within days, they acquired over 75% of Tranche A/B debt.

• Now it was impossible to implement Step 2 of the sale process. Tranche C Lenders (and other dissenters) now controlled the Required Lenders and could direct the Agent’s actions.

• Tranche C inherited an important weapon: Delphi had repeatedly needed amendments to the DIP Loan Accommodation Agreement in order to avoid default (more than 35 times in 6 months). If Delphi needed yet another amendment, Tranche C could permit the Agreement to lapse and then direct the Agent to exercise remedies, including auctioning off Delphi’s assets.

• They used this weapon (and other protections under the DIP Order) to block the “no shop” provision in the proposed sale process: The Agent threatened to foreclose on collateral if the judge approved a closed sale process: “[T]he potentially chaotic and adversarial context of any such exercise of remedies could severely compromise Delphi’s business and also compromise GM’s ability to purchase assets from Delphi that are necessary to its business, which would in turn be severely disruptive of GM’s own restructuring and the U.S. automotive industry as a whole.” (Agent Objection p. 11, June 9, 2009)

Tranche C Fought Back By Putting Money Where Its Mouth Was

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Judge Drain Agreed

• The no-shop provisions were, in Judge Drain’s view, “broader than any language I’ve ever seen in a provision like this. …[I]n my view a process [that permits competing bids] makes it more certain, rather than less, that the right person or the right group ends up with these assets.” (Hearing Transcript pp. 82, 139, June 10, 2009)

– Although the judge opened the sale process, his order said that, if a DIP Lender submitted a bid other than a Pure Credit Bid, the lender would be deemed to have irrevocably consented to the outcome of the sale process.

– Judge Drain was avoiding the Westpoint-Stevens problem: There, first-lien lenders submitted bids but lost to second-lien lenders and subsequently complained that the winning bid violated their rights under an inter-creditor agreement. Reviewing courts agreed.

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This Led to an Unprecedented Successful Pure Credit Bid

• Agent submitted a “Pure Credit Bid” on DIP lenders’ behalf: Bid was equal to the value of the DIP loan. This is a “pure” credit bid because the Agent’s bid did not include consideration in addition to the DIP loan itself.

• The Delphi board accepted the bid … “based in part on the speed and certainty of execution of the Pure Credit Bid, which is supported by the Required DIP Lenders, as compared with the risks associated with the GM-Platinum transaction, which … the Required DIP Lenders do not support. Without the Required DIP Lenders approval, the Debtors could not move forward with modifications to the Confirmed Plan [to accept the GM-Platinum bid]. This would result in a number of negative consequences, including the elimination of the potential distributions to holders of General Unsecured Claims provided under the Modified Plan.” (Debtor’s Omnibus Reply p. 12, July 27, 2009)

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What Can We Take Away from the Story of Delphi’s Emergence?

• Administratively insolvent cases, like Delphi’s, have arisen more frequently in the current economic environment. – DIP lender power is at an apex in these cases. A properly designed DIP

loan can be used to resist proposals—including premature sales—that threaten lender recoveries in a relatively illiquid environment.

– Can we expect to see pure credit bids in cases going forward?

• Why did Judge Drain approve the DIP refinancing without reserving the right to unwind the refinancing under certain conditions?

– Would the case have turned out differently if the judge retained that right?

– How commonly do rollups or refis fail to give the judge that right?

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• Was Judge Drain overly aggressive in interpreting the CAC? – In prior cases, Required Lenders used a CAC to prevent

hold-up by a small minority holding less than, say, five percent of the affected debt. Here the dissenting minority was more sizeable, representing about one-third of the debt in Tranches A and B and most of Tranche C debt.

– Was the forbearance in this case too similar to a maturity extension? As several judges wrote in recent commentary, the “Accommodation Agreement had the indirect effect of extending the maturity of the DIP Credit Agreement by neutralizing any remedial exercises during the accommodation period.”

Additional Takeaways?

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Additional Takeaways?

• Can CACs be used to circumvent §1129(a)(9), as Delphi proposed in Step 2 of its proposed plan? – Can a debtor bypass the normal plan voting requirement

for a class of syndicated secured lenders by having 51% of Lenders direct the Agent to “exercise remedies”?

• How commonly do courts approve private sales? – Would Judge Drain have approved a “no-shop” sale to GM-

Platinum under §363 if DIP Lenders had not threatened to exercise remedies?

• If a “no-shop” sale were part of a reorganization plan, could a judge cram-down against prepetition secured creditors, even if they had no right to credit bid? – The Supreme Court just granted cert on this question.

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“[T]he condition that a plan be fair and equitable with respect to a [dissenting] class includes the following requirements: (A) With respect to a class of secured claims, the plan provides—

(i) (I) that the holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims; and (II) that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property;

(ii) for the sale, subject to section 363(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph; or

(iii) for the realization by such holders of the indubitable equivalent of such claims.”

Relevant Text of 1129(b)(2), with Key Phrases Highlighted

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• One view: Yes, as long as secured creditors receive the “indubitable equivalent” of their claims under Subsection (iii). See Philadelphia News (3rd Circuit, 2010) and Pacific Lumber (5th Circuit, 2009). – Subsections (i) and (ii) identify two types of plans that can be crammed down.

Subsection (iii) permits other types of plans, including plans with provisions that would be impermissible under Subsections (i) and (ii).

– For example, a plan violates Subsection (i) if it gives secured creditors a replacement lien on similar (not the original) collateral. But such a plan could satisfy the “indubitable equivalent” requirement, especially if it satisfies the other requirements of Subsection (i).

• Another view: No. See River Road (7th Circuit, 2011). – The statute does not have a plain meaning, but the better interpretation is

that Subsections (i) and (ii) set forth exclusive avenues for confirming nonconsensual plans that either retain or sell collateral subject to liens (Subsection i) or that sell collateral free of liens (Subsection ii).

– Subsection (iii) applies to plans that dispose collateral in different ways. Any other interpretation would render Subsections (i) and (ii) superfluous.

Does §1129(b)(2)(A) Permit No-Shop Sales That Preclude Credit Bids?

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