A recent decision of the Delaware bankruptcy court serves as a reminder of a key risk for lenders who finance leveraged transactions—namely, that a bankruptcy court may “collapse” the components of a leveraged transaction in order to avoid the lender’s liens and the debtor’s loan obligations as fraudulent transfers.
In Official Committee of Unsecured Creditors v. The CIT Group/Business Credit, Inc. (In re Jevic Holding Corp.), 2011 Bankr. LEXIS 3553 (Bankr. D. Del. Sept. 15, 2011), the equity sponsor (the “Sponsor”) financed the acquisition of a target company (the “Debtor”) with an acquisition loan, which was secured by the Debtor’s assets. Within one month after the acquisition closing, the loan was repaid with the proceeds of a refinancing facility, which was also secured by the Debtor’s assets. The Debtor defaulted under the refinancing facility shortly after closing. The Debtor and the refinancing lender (the “Lender”) operated under a forbearance arrangement for approximately 2 years before the Debtor filed for bankruptcy. The creditors’ committee (the “Committee”) objected to the Lender’s claims in the bankruptcy and sued the Lender and the Sponsor under several theories—the primary one being that the court should collapse the refinancing with the prior acquisition and acquisition loan in order to avoid the Lender’s liens on the Debtor’s assets, together with the Debtor’s loan obligations, as fraudulent transfers. The Lender filed a motion to dismiss.
Importantly, from a procedural standpoint, in ruling on a motion to dismiss, the court was required to assume the truth of the Committee’s factual allegations and construe them in the light most favorable to the Committee. The ruling on the motion to dismiss was not a decision on the merits of the parties’ legal arguments, but rather it was a decision on whether the Committee should be entitled to proceed to the next phase of the litigation. Generally speaking, it can be difficult for a lender to win at the motion-to-dismiss phase in this type of litigation.
The court ruled that, for purposes of overcoming the motion to dismiss, the Committee sufficiently alleged facts that could support a collapsing of the refinancing with the prior acquisition and acquisition loan into a single transaction. While it would not be unusual for a court to collapse the components of a leveraged transaction (e.g., the acquisition and acquisition loan) into a single transaction in a fraudulent transfer case, it would be unusual for a court to collapse a refinancing with a prior acquisition and acquisition loan. In Jevic, the refinancing occurred within one month of the acquisition closing and the Committee alleged that the Lender had been involved from the outset of the transaction, e.g., the Committee alleged that the reason the Sponsor obtained the acquisition loan was because the Lender needed additional time to complete its approval and syndication processes. While the Jevic facts are distinguishable from a typical refinancing (e.g., a refinancing that occurs long after the acquisition closing), the ruling in Jevic may invite a creditors’ committee to “test the waters” on a weaker set of facts. From a strategic standpoint, the opportunity for a creditors’ committee to move beyond the motion-to-dismiss phase of litigation (e.g., in an attempt to create leverage for a settlement) is significant. Lenders will want to see future decisions limit Jevic to its facts.