Advanced Distressed Debt Lesson #2

In our first edition of Advanced Distressed Debt learning / knowledge base, we discussed negative pledges. In this post, we will discuss the issue of exclusivity.

The exclusivity period is the period after the bankruptcy petition date in which only the debtor can file its Chapter 11 plan. This is advantageous in that the company can work out its own version of how it sees fit in financing itself going forward - without creditors pressing for actions / solutions that may peril the debtor, but also peril the debtor's management team.

Section 1121 of the bankruptcy code gives exclusivity to the debt for the first 120 days after the bankruptcy petition is filed. If a plan is filed in this period, the debtor is given another 60 days (i.e. a total of 180 days), where no other plan may be filed. The judge of the case, as usual in most bankruptcy cases, can make this period longer if the debtor so requests, or can shorten it if creditors move against the debtor's exclusivity.

Before the new 2005 bankruptcy rules, exclusivity could of lasted for a very very long time. Companies that filed prior to the new bankruptcy rules are still able to drag out the bankruptcy process many times to the chagrin of creditors. Very few of those cases remain (W.R. Grace is one as an example). Any filings after the 2005 rule changes, the exclusivity period (i.e. 120 and 180 days respectively) may not be extended past 18 months and 20 months respectively.

If the debtor fails to file a plan AND get creditors on board within these aforementioned periods, Wild West sets on the bankruptcy court, and anyone may file a plan.

Why is this all important? Given that the window of time for a debtor to file a plan has been maxed out to the 18-20 month period, management many times has to really reach out and deal with creditors if they want to keep their jobs. Further, 363 sales, because of the swiftness in which they can be accomplished, are being pursued a lot more frequently than prior to the new 2005 bankruptcy law changes. But most importantly: It creates an avenue for distressed debt investors to position themselves better than being handcuffed by obstinate management teams intent of keeping their positions.

We have discussed Six Flags' bankruptcy at length on this blog. The company has proposed a plan (within their exclusivity rights) to give over 90% of the new equity to bank debt lenders. Unfortunately, the subordinated OpCo notes do not like this plan and have laid out its own ideas what the restructuring should look like. And the market has concurred: Six Flags' OpCo notes have marched to the high 80s (from 50s earlier in the summer), as the market anticipated that the currently filed plan will not be accepted and more than likely amended to give some juice to the OpCo notes.

It turns out that the company has been working on a new plan. But at the same time, it has asked for an extension of exclusivity, which everyone and their mother has objected to (I very much enjoyed and suggest you read this entire document: Six Flags' Exclusivity Objection)

I do not know who will win the battle here. I have been invested in the Six Flags' bank debt since I first posted about it in April when it was trading in the low 70s. The return is significantly lower, but the downside risk is also quite muted. If management's plan is confirmed, you are creating the company at a ridiculously low valuation, and if the OpCo note holders plan is confirmed you get taken out at par (make some carry and a few points here). To me, that is still the best place to play in the capital structure, from a risk/return, especially given the run-up of the OpCo notes.

Later in the weak, I am going to do a two part series on fraudulent conveyance - an issue ripe for a Distressed Debt Investing post given the recent ruling at Tousa.