In the fourth quarter of 2008, global credit markets were virtually frozen, leading many distressed businesses and their constituents to take measures to avoid bankruptcy filings at almost all costs. Without access to debtor-in-possession (DIP) financing, bankruptcy most often results in liquidation – and with lenders reluctant to provide new money, even in exchange for superpriority and/or priming liens, total collapse became an increasingly common result. This was especially true among companies in particular industries, such as retail and homebuilding, but no industry was unaffected by the lack of accessible liquidity.
Due to the effects of a deteriorating economy, many distressed businesses could no longer dodge bankruptcy by the first quarter of 2009. To avoid liquidation, companies desperately sought DIP financing from their prepetition lenders on whatever terms available.
The most notable example of this financing-at-any-cost mentality occurred in the Chapter 11 case of Lyondell Chemical Company (In re Lyondell Chemical Co., et al. (Bankr. S.D.N.Y., No. 09-10023)). After months of failed negotiations to restructure an enormous debt load, Lyondell filed for bankruptcy protection in January 2009. Following a contentious proceeding between the debtor and some of its creditors, the Bankruptcy Court approved Lyondell’s request to obtain $8 billion of DIP financing. The loans are priced at an astronomical spread of 1,000 basis points (10 percent) over the London Interbank Offered Rate (LIBOR) with a LIBOR floor of 3 percent. In addition, the loan carries fees of approximately 700 basis points (7 percent) and expires in December 2009, meaning that Lyondell will pay approximately 20 percent for money that it intends to borrow for less than one year. The Lyondell DIP lending group is primarily comprised of prepetition secured lenders who had “rolled up” $3.25 billion of their existing loans into the DIP facility.
So-called “defensive” lending is nothing new in bankruptcy. Prepetition lenders are routinely motivated to participate in DIP financing by a desire to avoid being primed by new lenders and in order to maintain a degree of control in the bankruptcy process. What made this loan somewhat unique was the disparate treatment given to prepetition lenders who participated in the DIP financing as compared to their counterparts who did not.
When credit cannot otherwise be obtained, section 364(c) of the Bankruptcy Code permits a bankruptcy court to authorize a debtor to borrow on an unsecured basis, with the loan having priority over administrative expenses of the bankruptcy estate. Because of their relative status ahead of administrative claims, unsecured loans of this kind are often referred to as “superpriority.” Section 364(c) also permits secured borrowing, with liens on unencumbered assets of the estate or with junior liens on assets already serving as collateral for a prepetition loan.
When a debtor still cannot obtain new money on a superpriority and/or junior secured basis, the court may allow it to borrow funds and grant liens that are senior to or pari passu with existing liens, pursuant to section 364(d). Such senior liens are referred to as “priming liens” because they rank in the priority structure ahead of existing liens. Besides demonstrating that credit cannot be obtained by other means, debtors seeking to grant priming liens to their DIP lenders must establish that the interests of existing lienholders will be “adequately protected.”
Secured superpriority financing is common, and priming liens (at least priming liens that “self-prime” the prepetition lenders’ liens in a “defensive DIP”) are also not unusual. In fact, the vast majority of lenders will agree to participate in DIP facilities only if promised these protections. What made Lyondell extraordinary was that lenders who participated in the DIP financing were granted priming liens for new money and for their prepetition loans. This arrangement obviously upset prepetition lenders who were unable or unwilling to lend new money and who therefore objected to the DIP financing.
In March 2009, the Bankruptcy Court overruled objections to Lyondell’s DIP loan, finding that Lyondell had complied with the Bankruptcy Code and demonstrated that not only was no alternate financing available, but also the interests of prepetition lenders were adequately protected. Faced with a debtor who very likely had no financing available on other terms, the court presumably had little choice but to approve the DIP financing and authorize the granting of priming liens. To rule otherwise would almost certainly have prompted a liquidation.
The unique circumstances facing would-be borrowers in early 2009 led to a stretching of the boundaries of sections 364(c) and (d) to encompass roll-ups by prepetition lenders. A Delaware court approved a roll-up DIP loan similar to Lyondell in In re Aleris International Inc., et al. (Bankr. Del., No. 09-10478; March 18, 2009) over objections of nonparticipating lenders. With credit markets having eased somewhat in the months since the Lyondell and Aleris rulings, debtors have easier access to capital and are not always being forced to roll up prepetition debts in order to obtain new money. However, much uncertainty remains in the credit markets and the broader economy. Given these prevailing conditions, the tendency of DIP lenders to seek maximum protections and the desperate condition of many debtors, it is likely that intercreditor disputes will continue to arise and that courts will continue to be confronted with difficult issues in the DIP financing arena.