Relevant Documents:Notes Offering Memorandum8-K - Indenture8-K - Earnings
During an earnings call on May 20, Royal Caribbean CFO Jason Liberty said that the cruise operator is “really happy” with the “additionally liquidity” provided by the $3.32 billion secured 2023 and 2025 notes issuance that
closed May 19, in part because “by raising that bond, it really provides a lot of flexibility for us to raise additional capital, especially debt.” According to Liberty, “there's a pretty significant basket and flexibility on our ability to raise additional debt” under the notes indenture, and if “circumstances change,” “we would certainly need to consider all alternatives that would be available to us.”
Putting aside the indebtedness baskets provided for in the indenture itself, an additional flexibility afforded by the notes is that they preserve the company’s ability to use most of the value of the collateral for the notes - the assets of vessel-owning subsidiaries - to secure a priming DIP facility in a chapter 11 bankruptcy. The new notes are secured by a first lien on IP, other intangible assets and vessels with a net book value of approximately $12 billion as of March 31 (measured before the depths of the Covid-19 pandemic),
but these liens are subject to a collateral cap designed “not to exceed permitted capacity under the Company’s existing indebtedness.” The notes indenture sets this collateral cap at $1.662 billion.
So long as the company abides by covenants in the new notes’ indenture and other credit agreements limiting the vessel-owning guarantor subsidiaries from incurring additional secured or unsecured debt, this cap may not materially affect noteholders’ recovery. If the noteholders are the guarantors’ only sizable unsecured creditor after using up the collateral cap, they could be paid in full through
pari passu unsecured distributions of the remaining $10 billion in vessel value (subject of course to any dramatic declines in collateral value).
If, however, the company were to file a chapter 11 case, it could use that $10 billion in asset value to secure a new DIP financing facility. Of course, this would run afoul of covenants in the debtors’ existing facilities and the new notes, but covenant protections and true secured liens result in starkly different bankruptcy outcomes. A bankruptcy filing would, in and of itself, default and accelerate all of the company’s debt. With acceleration already a
fait accompli and the automatic stay limiting any creditor actions outside the bankruptcy process,
the protection of prepetition covenants mean little. Secured liens are, of course, treated as creditors’ property rights in bankruptcy, but here such protection is limited by the collateral cap to approximately 50% of the notes’ principal amount.
The new notes indenture does include a “liquidated damages” provision that could disincentivize the debtors from filing for bankruptcy and accelerating the notes. The careful legal wording of the provision - which specifically provides that “[a]ny premium payable pursuant to this paragraph shall be presumed to be the liquidated damages (and not unmatured interest under Bankruptcy Laws)” - appears to reflect the latest lines of cases addressing the possible
unenforceability of this premium as “unmatured interest” in any bankruptcy case, akin to a “make whole” provision. Nevertheless, the tide of make whole cases appears to have
turned against their enforceability in bankruptcy, making the bankruptcy utility of such a provision to noteholders dependent on litigating the difference between “liquidated damages” and a typical “make whole.” And even if the provision holds up, it might - in light of the collateral cap - only increase the noteholders’ unsecured claim.
Of course, in his comments on the May 20 call, Liberty was referencing “flexibility” in the context of the indenture’s limitations on further indebtedness outside bankruptcy. However, the collateral cap on security for the notes may also offer significant “flexibility” in bankruptcy. With the secured property interest of the noteholders capped at no more than half their outstanding amount, the remaining value of the “collateral” pool could secure new DIP financing, leaving the notes substantially undersecured. At the very least, this possibility could enhance the debtors’ negotiating leverage in seeking an amendment allowing for financing beyond the baskets mentioned by Liberty.
New Note Terms
The offering memorandum for the 2023 and 2025 notes makes clear the limitations of the noteholders’ secured status. The offering memorandum specifies that the notes would be secured by first-priority security interests in “certain of the Issuer’s material intellectual property, including rights in certain of the Issuer’s marketing databases, customer data and customer lists, a pledge of 100% of the equity interests of certain of the Issuer’s wholly-owned vessel-owning subsidiaries, the collateral account established pursuant to the indenture governing the notes, mortgages on each of the vessels owned by such subsidiaries and an assignment of insurance and earnings in respect of such vessels.” According to the offering memorandum, “[t]he 28 vessels owned by the Guarantors as of the Issue Date included in the collateral collectively have a net book value of approximately $12 billion as of March 31” - which would leave the $3.3 billion in new notes dramatically oversecured, before even considering the uncertain value of IP and other intangibles.
However, only a portion of that value would be available to noteholders in the event of default. Specifically, the offering memorandum warns investors that “in no event shall the amount of obligations under the notes and the related guarantees secured by the collateral exceed the Collateral Cap,” which is defined by the indenture as $1.662 billion. This limitation, the company’s 8-K indicates, corresponds to “permitted capacity under the Company’s existing indebtedness.”
As the offering memorandum makes clear, “[a]s a result of the Collateral Cap, any value of the collateral or collateral proceeds realized from the enforcement or sale of collateral in excess of the Collateral Cap will not be available to holders of the notes,” and “any remaining unsatisfied obligations under the indenture or the notes will be unsecured and will not have priority with respect to any collateral assets over the claims of other unsecured claimholders of the Issuer or any Guarantor, as applicable.” “If the proceeds realized from the enforcement or sale of collateral exceeds the amount of the Collateral Cap,” the offering memorandum continues, “any excess amount of such proceeds will be paid for the benefit of the holders with respect to the remaining unsecured obligations under the notes and the indenture, but will be shared pro rata with any other unsecured obligations (including trade payables and other unsecured indebtedness) that are
pari passu in right of payment with the notes, or related guarantees, as the case may be.”
So long as the company desires (or has the ability) to avoid default under the notes and its other existing indebtedness, the indebtedness covenants in the indenture should provide comfort to the noteholders that they might be the dominant unsecured creditors of the issuer or the vessel-owning guarantors, and thus entitled to the lion’s share of distributions from the value of the guarantors’ vessels notwithstanding the collateral cap - in effect, that they hold a “synthetic first lien” in all of the guarantors’ assets.
The “liquidated damages” provision of the indenture could also, in theory, deter a default or bankruptcy filing. Section 6.02(iii) of the indenture provides that if the notes are accelerated upon default, an “Applicable Premium” would also be due and payable “as though the Notes were optionally redeemed on the date of such acceleration.” The indenture defines “Applicable Premium” as the greater of (i) 1% of the outstanding principal amount of the notes and (ii) the excess of (a) “the present value at such redemption date” of (i) the redemption price of the notes as of a set date (March 1, 2023, for the 2023 notes and June 1, 2022, for the 2025 notes) plus “all required interest payments due on the Note through that date (excluding accrued but unpaid interest to the redemption date, if any), computed using a discount rate equal to the Adjusted Treasury Rate as of such redemption date”; over (b) the outstanding principal amount of the note.
The indenture takes great pains to emphasize that this is not a “make whole” for lost future interest but a “liquidated damages” provision, presumably in order to circumvent case law disallowing make whole premiums as unmatured interest under section 502(b)(2) of the Bankruptcy Code. The indenture specifically indicates that the “Applicable Premium” applies in the event of default because of “the impracticability and extreme difficulty of ascertaining actual damages and by mutual agreement of the parties as to a reasonable calculation of each holder's lost profits as a result thereof.” “Any premium payable pursuant to this paragraph shall be presumed to be the liquidated damages (and not unmatured interest under Bankruptcy Laws),” the indenture continues.
The Notes in an RCL Bankruptcy
The offering memorandum for the notes exhaustively details the financial challenges facing the company due to the Covid-19 crisis, which has resulted in a suspension of most passenger sailings until
Aug. 1 at the earliest, with the exception of sailings from China, which could start July 1. According to the offering memorandum, the pandemic’s “effect on the economy and consumer demand for cruising and travel is still rapidly fluctuating and difficult to predict,” and “these impacts may persist for an extended period of time or even become more pronounced, even after we are permitted to and/or begin to resume operations.”
The company
estimates its “cash burn” during “ a prolonged suspension of operations” as “on average, in the range of approximately $250 million to $275 million per month.” This range includes, the company says, “ongoing ship operating expenses, administrative expenses, debt service expense, hedging costs, expected necessary capital expenditures (net of committed financings in the case of newbuilds) and excludes cash refunds of customer deposits as well as cash inflows from new and existing bookings.” Within the company’s cash burn estimate, Royal Caribbean estimates that “during a prolonged suspension of operations” its operating expenses and administrative expenses would be approximately $150 million to $170 million per month.
The company’s financials, however, may suggest a need for further cash infusions. The company’s stated liquidity declined approximately $1.3 billion between March 31 and April 30, from $3.6 billion to $2.3 billion. This could indicate that the company’s cash burn during other months of the “prolonged suspension” could be considerably higher than estimated. For instance, cash deposit refunds are not included in the company’s cash burn estimate. As of March 31, Royal Caribbean had $2.4 billion in deposits and said that as of April 30, approximately 45% of guests requested cash refunds. That percentage
increased slightly subsequent to April 30. The company’s
disclosure of negotiations with credit card processors over the provision of new collateral also hints at continuing concern over the company’s cash position. According to the company, the processors are allowed under existing agreements to require that it maintain a reserve under certain circumstances, including the existence of a material adverse change, excessive chargebacks and other triggering events, which the company estimates could be a maximum of $300 million over the next 12 months.
It is possible that, with revolving availability fully drawn, the company could run out of the liquidity provided by the new notes and the revolver draw before a significant recovery in the cruise industry, depending on the length of the economic drag from the pandemic and the effect of the pandemic on the cruise industry in particular.
The company could, of course, seek additional financing without filing a chapter 11 case, as allowed under the notes indenture and other credit facilities. Should sufficient financing not materialize on those terms, however, a chapter 11 would likely be under serious consideration.
Of course bankruptcy in an industry that relies heavily on consumer perception and trust would not be undertaken lightly. But assuming the company made that decision, a primary risk to holders of the new notes is that the debtors could lien up the vessels and other collateral “securing” the notes with DIP financing, at least to the extent the vessels were being encumbered for only the value in excess of the $1.662 billion collateral cap - so long as the noteholders’ limited security interest is “adequately protected.”
The noteholders might not even be entitled to “adequate protection” for being primed in that scenario, since their secured claim is limited to the value of their collateral - $1.662 billion. If the lien is being preserved at that level, the noteholders would be entitled to adequate protection only to the extent the vessels’ value is less than that amount and getting lower. And the “liquidated damages” premium would be unavailable if a bankruptcy judge determines that it is the equivalent of “unmatured interest” under the Code.
The offering memorandum appears to hint at this outcome. Upon a bankruptcy filing, the company warns, the company “would be stayed from making any ongoing payments on the notes, and the holders of the notes would not be entitled to receive post-petition interest or applicable fees, costs or charges to the extent the amount of the obligations due under the notes exceeded the value of the collateral available for the notes (after taking into account all other senior debt that was also secured by the collateral
and the fact that our secured obligations under the notes and related guarantees are subject to the Collateral Cap), or any ‘adequate protection’ on account of any undersecured portion of the notes” (emphasis added).
As noted above, the new notes have protections that provide credit support outside of the bankruptcy context. However, if the company’s cash burn during its limited operations period is greater than estimated, or if the cruise industry is slow to recover from the pandemic, a chapter 11 filing might become an option for the company. Among myriad other considerations of pursuing a bankruptcy path, it would give the company considerable “flexibility” to render the new notes dramatically undersecured.
--Kevin Eckhardt