OF NOTE BANKRUPTCY

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Expert Q&A on Out-of-Court
Restructurings
An out-of-court restructuring of a financially distressed company can be a simpler and more efficient way
to modify a company’s capital structure than a bankruptcy proceeding. Determining whether an out-of-
court restructuring is appropriate depends on the circumstances and requires consideration of various
factors. Practical Law asked My Chi To of Debevoise & Plimpton LLP to discuss her views on out-of-court
restructurings and how they may be used as an alternative to a Chapter 11 proceeding.

MY CHI TO What is an out-of-court restructuring?

PARTNER
DEBEVOISE & PLIMPTON LLP An out-of-court restructuring is a transaction that modifies a
company’s capital structure outside of bankruptcy. In an out-of-
My Chi is a corporate partner and a member of the
firm’s Business Restructuring & Workouts Group.
court restructuring, the company cannot bind non-consenting
She represents companies, creditors, and investors in parties on many important issues, as it can in Chapter 11.
restructurings and bankruptcies, and regularly advises Therefore, the company has to obtain the support of affected
clients in connection with distressed acquisitions and stakeholders or find a way to implement the transaction in
complex financing arrangements. compliance with their legal rights. A critical mass of creditors
must be willing to engage with the company because they
believe that an out-of-court restructuring is preferable to
bankruptcy.
Out-of-court restructurings are always negotiated against the
backdrop of what would happen in a bankruptcy proceeding.
Apart from the impact a bankruptcy proceeding might have on
the value of the business, as well as the added costs and delay
generally associated with a bankruptcy proceeding, a creditor

18 July/August 2017 | Practical Law © 2017 Thomson Reuters. All rights reserved.
assesses its own leverage to object to unfavorable treatment in „„Key stakeholders must be willing to negotiate with the
Chapter 11 and the risk of challenges that might be brought to company. Constructive discussions generally require that
its claim. creditors have confidence in the company’s business plan and
its capacity to execute on it.
Companies often negotiate out-of-court restructurings in
„„The number of parties at the negotiating table must be
parallel with prepackaged bankruptcy plans. This discourages
creditors from holding out by refusing to provide their consent, manageable. While there are examples of successful out-of-
and allows the company to be adequately prepared in case it court restructurings of large companies with complex capital
does not obtain the required creditor support. If the restructuring structures, consensus is easier to achieve with fewer parties.
cannot be consummated out of court, the company can instead Negotiating with holders of public debt presents unique
quickly pivot to an orderly bankruptcy filing to implement the challenges because they can be difficult to identify, they might
transaction negotiated with key stakeholders notwithstanding change over time, and they are often not willing to become
the existence of holdout creditors. restricted (limiting their ability to trade) for long periods,
which complicates negotiation dynamics and information
sharing. Even with a small number of creditors, there is always
Search The Prepackaged Bankruptcy Strategy for more on the
prepackaged bankruptcy process, including how “prepacks” are
a risk that one party holds out to extract additional value from
implemented, when they are most useful, and their advantages and the company or other creditors.
disadvantages.
„„The company’s problems must be addressable without
resorting to bankruptcy. An out-of-court restructuring is
There are no blueprints for out-of-court restructurings because generally a more effective tool to delever a balance sheet than
each transaction depends on the particular challenges a to remove burdensome contract obligations or resolve other
company faces. Out-of-court restructurings run the gamut operational issues.
from surgical covenant amendments and targeted maturity „„The advantages of an out-of-court restructuring must
extensions to extensive recapitalizations involving debt outweigh the unique advantages of a bankruptcy filing.
exchanges, new debt issuances, debt-for-equity conversions, The Bankruptcy Code provides a company with a variety of
friendly foreclosures, and other highly negotiated transactions. tools that can facilitate the formulation and implementation
In any given transaction, a company might also need to obtain of an operational reorganization, including, most notably, the
concessions from stakeholders other than its financial creditors, time and respite offered by the protection of the automatic
such as equity holders, key trade creditors, landlords, and stay. The Bankruptcy Code also empowers debtors to reject
litigation claimants. uneconomical leases and executory contracts. Moreover, in
A company may employ a combination of carrots and sticks to some instances, there can be material tax advantages if a
induce creditors to support an out-of-court restructuring. For proposed restructuring is implemented in bankruptcy.
example, it may offer fees, increased interest rates, additional
collateral, enhanced covenants, enhanced priority, or other What are the main advantages for companies
consideration. More coercive tactics, such as “exit consents,” are
proceeding with an out-of-court restructuring?
also often used in bond exchanges as a disincentive for creditors The main advantages of an out-of-court restructuring include:
to hold out. In particular, exchanging bondholders are often „„Potential time- and cost-savings opportunities compared
asked to consent to indenture amendments removing material to a bankruptcy proceeding. Preparing a Chapter 11 filing,
covenants or permitting transactions that significantly impair the even a prepackaged one, can be disruptive to the business and
value of non-exchanging bonds. Holdout creditors are effectively involves substantial work and distraction for management.
forced to either exchange their bonds or lose any meaningful Certain types of businesses can experience substantial value
covenant protection. erosion as a result of a bankruptcy proceeding.
„„Less publicity than a bankruptcy proceeding. A bankruptcy
What factors should companies consider when deciding proceeding is conducted in an open courtroom and requires
whether to conduct a restructuring in or out of court? broad disclosures from the company. Moreover, parties in
Companies often use their best efforts to restructure out of interest may request discovery and generally be heard on any
court because it is generally quicker and less expensive than issue in front of the court.
bankruptcy and less disruptive to the company’s business. „„More certainty regarding the outcome. An out-of-court
However, an out-of-court restructuring may not always be restructuring involves fewer parties and allows the company
possible. For an out-of-court restructuring to be successful: more control. Unlike a bankruptcy proceeding, there is no
„„The company must have enough liquidity to operate unsecured creditors’ committee, judge, or US Trustee second-
while it negotiates with its creditors. If it does not, the guessing the result negotiated among key stakeholders in an
company might be forced into bankruptcy to access debtor-in- out-of-court restructuring.
possession (DIP) financing using inducements such as priming
liens and priorities available under the Bankruptcy Code.

© 2017 Thomson Reuters. All rights reserved. The Journal | Transactions & Business | July/August 2017 19
 OF NOTE BANKRUPTCY

What are the main disadvantages for companies PRACTICE NOTES

proceeding with an out-of-court restructuring?
By restructuring out of court, companies forgo the considerable The following related Practice Notes are available on Practical Law.
powers granted to debtors under the Bankruptcy Code. >> S
 imply search the resource title
Bankruptcy offers various advantages, including:
Out-of-Court Restructurings: Overview
„„Improvement in a distressed company’s liquidity because Methods of Restructuring Outstanding Debt Securities
the debtor: Debt Exchange Offers: Purpose and Process
zz is prohibited from paying claims arising before the Intersection of the Trust Indenture Act and the Bankruptcy Code
bankruptcy filing, thereby freeing up more cash; and Restructuring Outstanding Debt Securities: Cancellation
of Indebtedness Income for Issuers
zz may seek court approval to obtain DIP financing or use
secured creditors' cash collateral (for more information,
search DIP Financing: Overview and Cash Collateral: the decision-making process, all serve to protect the board and
Overview). minimize litigation risk.
„„The ability to impose a plan of reorganization on non-
Another important legal development is the ruling of the
consenting creditors (for more information on confirmation
US Court of Appeals for the Second Circuit in Marblegate Asset
of a plan of reorganization and cramdown plans, search
Management, LLC v. Education Management Corp. This ruling
Chapter 11 Plan Process: Overview).
overturned a lower court’s decision that had created significant
„„The automatic stay, which is triggered by the filing of the uncertainty about the legality of distressed exchange offers,
bankruptcy petition and stops substantially all creditor acts particularly those with coercive features. The Second Circuit
and proceedings against the debtor and its property (for more held that Section 316(b) of the Trust Indenture Act of 1939 does
information, search Automatic Stay: Lenders’ Perspective). not prohibit exchange offers that arguably impair the practical
„„The power to assume, assign, or reject burdensome and ability of non-consenting bondholders to be paid, but not their
unfavorable executory contracts and unexpired leases (for legal right to payment. While the Second Circuit reaffirmed the
more information, search Executory Contracts and Leases: viability of exchange offers as an out-of-court restructuring tool,
Overview). it also noted that dissenting bondholders can still challenge
„„Authorization for the debtor to sell assets free and clear of those transactions under various state laws, including fraudulent
most liens and claims, including fraudulent conveyance claims conveyance and successor liability theories. (846 F.3d 1, 6-17
(by contrast, if an out-of-court restructuring requires asset (2d Cir. 2017).)
sales, fraudulent conveyance concerns might deter potential Like the examiner’s report, the Marblegate ruling serves as a
purchasers). reminder that companies and other parties engaged in an
out-of-court restructuring must consider its impact on all
How will recent legal decisions impact out-of-court stakeholders, including potential holdout creditors actively
restructurings? seeking creative avenues to attack the transaction.
While not a court-issued opinion, the examiner’s report in the
bankruptcy proceeding of Caesars Entertainment Operating Search Marblegate Asset Management v. Education Management:
Co., Inc. and certain affiliates highlights many mistakes that Second Circuit Reverses SDNY and Clarifies Right to Payment Under
Section 316(b) of the Trust Indenture Act for more on the Marblegate
distressed companies and their advisors should avoid in decision.
formulating and implementing an out-of-court restructuring.
For example, the examiner found that material transactions
consummated by Caesars prior to its bankruptcy gave rise to
Looking ahead, do you expect an increase in out-of-
billion dollar claims against the debtors, their directors and
court restructurings?
officers, and the parent company for actual or constructive
fraudulent transfers and breaches of fiduciary duty, and against Distressed companies have been restructuring out of court for
the sponsors of Caesars’ leveraged buyout and directors of the decades and are incentivized to do so when feasible and where
parent for aiding and abetting breaches of fiduciary duty (In re the potential benefits of bankruptcy do not clearly outweigh
Caesars Entm’t Operating Co., Inc., No. 15-01145 (Bankr. N.D. Ill. the significant associated costs and risks. More companies are
Mar. 15, 2016)). proactively addressing challenging capital structures well in
advance of a default through debt exchanges and other creative
The examiner’s report reinforces for distressed companies, transactions. This might signal an increasing appreciation of
as well as their boards, sponsors, and advisors, the critical the flexibility and efficiency of out-of-court restructurings. By
importance of observing corporate governance best practices tackling a fragile capital structure early, companies might be
when contemplating an out-of-court restructuring. Taking able to buy time and potentially avoid the need for a more
steps such as exploring alternative transactions, evaluating comprehensive restructuring down the road when they have
all options while keeping fiduciary duties in mind, negotiating fewer options available or run out of time to negotiate with
affiliated transactions at arm’s length, and fully documenting their creditors.

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