Thu 09/10/2020 19:20 PM
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In a 142-page opinion issued this afternoon, Judge James Garrity Jr. declined to approve LATAM Airlines’ proposed DIP facility, concluding that the facility’s equity subscription election gives rise to improper sub rosa plan treatment of the tranche C DIP lenders and debtors’ equity holders.

The ruling comes despite findings by the court that (i) the price and terms of the revised DIP credit agreement, including the tranche A DIP facility and the tranche C DIP facility, were “entirely fair,” (ii) there were grounds under section 364(c) of the Bankruptcy Code to authorize the debtors to enter into the DIP credit agreement and (iii) the DIP lenders were entitled to a good faith finding under section 364(e) of the Bankruptcy Code.

The opinion states that the modified equity subscription election subverts the reorganization process because the discount that the subscription election provides to the tranche C lenders is not market-tested, the debtors have the discretion to make the election without court approval or oversight, and the election sets forth key terms of an eventual reorganization plan by “prematurely allocating reorganization value to LATAM’s existing equity holders.” Judge Garrity characterized that aspect of the tranche C DIP facility as problematic, saying that it bars approval of the revised DIP credit agreement.

Further, covenants under the revised credit agreement mandate that only a company approved reorganization plan may be confirmed in the chapter 11 cases, regardless of exclusivity, or an event of default will be triggered. These provisions “effectively lock up any future plan of reorganization to be only the Debtors’ plan providing for the equity conversion,” Judge Garrity states.

Judge Garrity finds that the absolute priority rule was not grounds to deny the debtors’ motions, concluding that the debtors satisfied the elements of the new value exception to the absolute priority rule since the proposed tranche C DIP facility represents “new, substantial money that is needed for a successful reorganization, and reasonably equivalent to the value of that which the tranche C lenders will be receiving.”

As part of his ruling, Judge Garrity also observed that with regard to short term cost savings, LATAM exceeded its recent cash flow forecast projections. Nevertheless, without available financing, the debtors’ cash could drop below the minimum level needed to run the business by August. Therefore, the court finds that the debtors established that they have an urgent need for financing, and that it was appropriate for the debtors to seek approval of the full $2.5 billion DIP facility.

“Entire Fairness” Test

A key component of the opinion is Judge Garrity’s analysis of whether to apply the entire fairness test in reviewing the tranche C DIP facility and tranche A DIP facility with the court ultimately concluding that “the Tranche C DIP Facility is an insider transaction that is subject to review under the entire fairness doctrine.” Judge Garrity also elected to apply the entire fairness standard to the tranche A facility to be provided by Oaktree. None of the parties contended that Oaktree was an insider, the opinion explains. However, the debtors contended that the court can approve the tranche A on a business judgment basis even if the court applies the heightened standard to tranche C. Judge Garrity said the debtors’ contention cuts against their earlier argument that the DIP loan transaction “needs to be assessed holistically.”

Regarding whether the transaction involved insiders of the debtor, the opinion notes the following:

  • Costa Verde and Qatar are the proposed DIP lenders. Costa Verde holds 11.2% of the company’s stock. Costa Verde is part of the Cueto Group which owns or controls about 21.5% of the stock and designates three of nine board members, including the board’s Chairman and Vice-Chairman;

  • Qatar holds 10% of stock and designates one director; and

  • Delta, though not a party to the tranche C DIP, was instrumental in negotiating transaction terms, remains interested in the transaction, holds 19.99% of the company’s common stock, and designates two board members.

In the aggregate, the motion remarks, the shareholders control or own more than 51% of the common stock and designate six of nine board members.

To satisfy the entire fairness test, the opinion explains, the debtors must show that the revised credit agreement resulted from fair dealing and reflects a fair price.

Fair Process

The court notes that the debtors and their advisors evaluated and considered the alternative Jefferies proposal in good faith and engaged Jefferies and its professionals. “Far from ignoring or turning away Jefferies,” Judge Garrity observes, the debtors communicated a variety of economic and non-economic concerns to Jefferies with regard to Jefferies’ proposal. Although the debtors did not choose to pursue the amended Jefferies commitment over the existing shareholders’ tranche C facility, the court finds that the debtors were able to demonstrate that the tranche C process undertaken vis-a-vis Jefferies’ competing bid was fair.

The court finds also that it was not unreasonable for the debtors to conclude that Jefferies’ proposal could not be executed given its terms and restrictions, and that the proposed tranche C DIP facility represented the only available option for the debtors for the postpetition financing.

Next, the court turns to the assertion that the debtors’ process was flawed because the debtors agreed to the tranche C term sheet without testing the market. The court reasons that the debtors demonstrated there were good reasons for their decision to not market the DIP before filing for chapter 11 protection. Specifically, the opinion says, the debtors reasonably reached the conclusions that (i) “a DIP underwritten by its major shareholders would enhance the potential for governmental support and send a strong signal to the market that their equity holders had confidence in the Debtors’ business” and (ii) “that it was impractical to go into the market because it did not have adequate collateral to fully secure a $2 billion loan.” Judge Garrity finds that under the circumstances, the debtors’ failure to market the tranche C DIP facility before executing the tranche C term sheet “does not support the Objectors’ contention that the process fails the entire fairness test.”

Next, Judge Garrity addresses the argument that the debtors cannot establish the entire fairness of the process because the independent directors allegedly failed to comply with Chilean law when, as members of the directors committee, they reviewed and thereafter, as board members, approved the tranche C DIP.

The opinion explains that Chile’s Corporations and Securities Acts govern the LATAM Parent. Expert witnesses put forth by the debtors and objecting parties disagree over whether the board’s approval of the transaction complied with applicable Chilean law. However, as the opinion explains, it is unnecessary for the court to attempt to resolve the dispute between the two Chilean law experts because the board and the independent directors treated the DIP loan as a “related party” transaction under Articles 146 and 147 of the Chilean Corporations Act. As a result, no party related to the tranche C DIP facility played a role in approving the transaction. However, in the ruling, Judge Garrity acknowledges that the court will consider the experts’ dispute over the independent directors’ actions in assessing the weight that the court will give to the independent directors’ role in the transaction in reviewing the transaction’s entire fairness.

Regarding whether the debtors marketed the tranche C DIP postpetition, the court finds that the evidence demonstrates that the debtors, through the board and management, assisted by legal and financial advisors, identified their financial needs, actively marketed the loans, reasonably evaluated other funding sources, engaged in arm’s length good faith negotiations with prospective lenders, adhered to corporate protocol, and fulfilled their fiduciary duties.

While the objectors contend that the debtors discouraged interested parties from bidding on the tranche C DIP loan by steering them to the tranche A or not being responsive to potential bidders, Judge Garrity finds that these contentions have no merit because, at trial, the objecting parties could not substantiate such claims.

Fair Price

Discussing fair price, the opinion explains that the court considers a number of factors:

  • The debtors negotiated the loan in the early days of the unprecedented global pandemic;

  • Government bans have shut down air travel and it is unclear when the debtors will be able to resume normal operations and when demand will return to pre-pandemic levels;

  • The debtors have limited hard-asset collateral available to secure the DIP facility, meaning a tranche C lender in the junior, first loss facility must rely heavily on the company’s survival as a going concern; and

  • LATAM is a Latin American airline that is not investment grade, and has not received government financial support, but is seeking over $2 billion of financing.

Judge Garrity finds that the debtors met their burden to satisfy the heightened entire fairness standard applicable to insider transactions.

In addition, the court finds that contrary to the objecting parties argument, the tranche C lenders are entitled to a finding of good faith under section 364(e) of the Bankruptcy Code because there is no evidence demonstrating that the tranche C lenders misused their status as shareholders. Further, there is no evidence that the tranche C lenders engaged in fraud or collusion, or attempted to take gross advantage of other bidders, “which is the typical misconduct giving rise to a finding of bad faith,” the opinion says. Rather, the court continues, the evidence supports the finding that the tranche C facility resulted from a robust and arm’s length process where the company’s management had the advice of outside counsel and a financial advisor in negotiating the tranche C terms, and all decisions were fully vetted and voted upon by LATAM Airlines’ directors’ committee.

Next, the opinion indicates that there is no merit to the contention that Oaktree, as tranche A lender, is not entitled to a good faith finding under section 364(e) of the Bankruptcy Code because Oaktree “signed up to participate in an insider transaction that on its face violates the absolute priority rule and constitutes an impermissible sub rosa plan.”

Sub Rosa Plan Analysis

Regarding whether the tranche C DIP facility is an improper sub rosa plan, Judge Garrity finds that the DIP includes provisions that will give the debtors a “leg up” in the confirmation process. Judge Garrity explains that the debtors are asking the court to approve a transaction that will “fix now, some of the terms of a plan yet to be filed.” The opinion points out that if the tranche C DIP facility is approved, it will lock into place a 20% discount to plan value on the equity to be issued to the tranche C lenders in satisfaction of the tranche C DIP loan, if lenders elect to distribute stock in lieu of cash.

According to Judge Garrity, “the Tranche C DIP Facility necessarily determines plan terms giving the Debtors the right to distribute equity in the reorganized Debtors to the Tranche C Lenders – at a 20% discount to plan value – that will not be subject to court review.”

The opinion finds that if the debtors exercise the modified equity subscription election, all the debtors’ shareholders are entitled to purchase stock in the reorganized company at plan value, which violates the absolute priority rule because the shareholders will be receiving the stock solely by reason of their status as shareholders, without the benefit of a market testing the transaction.

Absolute Priority Rule

Since payments to the tranche C lenders will be at least partly on account of their equity interests, that is enough to trigger analysis under the absolute priority rule, the opinion says. The court considered whether the debtors can invoke the new value exception to the absolute priority rule, which is the proposition that “the objection of an impaired senior class does not bar junior claim holders from receiving or retaining property interests in the debtor after reorganization, if they contribute new capital in money or money’s worth, reasonably equivalent to the property’s value, and necessary for successful reorganization of the restructured enterprise.”

“In this circuit,” Judge Garrity explained, to invoke the new value corollary, the “‘capital contribution by old equity must be: 1) new; 2) substantial; 3) money or money’s worth; 4) necessary for a successful reorganization, and 5) reasonably equivalent to the property that old equity is retaining or receiving.’”

The court finds that the tranche C DIP facility was negotiated at arm’s length, and underwent an extensive postpetition market test, stating that the $900 million provided by the tranche C DIP lenders was reasonably equivalent and necessary because the shareholders were the “last resort.”

Thus, application of the absolute priority rule is not grounds to deny the motions since the debtors have carried their burden to satisfy the elements of the new value exception given that the tranche C DIP facility represents new, substantial money that is needed for a successful reorganization, and reasonably equivalent to the value of that which the tranche C lenders will be receiving.
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