Advanced Distressed Debt Concept: The J Factor

When analyzing a distressed debt investment, it always helps to remember that the presiding judge on a case will be the final arbiter on a number of decisions that may sway the direction of a case and consequently, recovery and return to distressed debt investors. For example, today in Tribune's bankruptcy, the bankruptcy judge extended the exclusivity period of the debtor, shutting down the ad-hoc lenders plans of filing its own plan of reorganization.

The J Factor is the judge's role in a case. While lawyers pore over briefs and orders of past rulings of judges to get a sense where they may stand on a certain issue, one can never be quite sure which side of the fence the court may fall on. Take the example of Trump's bankruptcy.

Yesterday the court ruled, in a 121 page document (embedded below), that the Ad Hoc Committee/Debtor plan will be confirmed versus the Icahn/Beal Bank plan. The document is a fascinating read.

Trump Judge Ruling

The judge first lays out an overview of the case, presents the competing plans in plain language, and then methodically tests whether both plans are confirmable in relation to the bankruptcy code especially in light of the contested elements of each plan (i.e. Beal / Icahn contested that the Ad Hoc Plan may not meet XYZ requirement of the code). Significant legal discourse and case law is presented which is learning tool for all those interested in interpretations of the code.

After opining on each point and contention of each plan, the judge offers an opinion on the ability of the plan to be confirmed subject to modificatoins. For example, for the AHC/Debtor Plan:

I conclude that the AHC/Debtor Plan meets the requirements of section 1129(a) and (b), and is confirmable, subject to the following modifications:

(A) The plan provision releasing Trump from the Trump Personal Guaranty must be deleted from the plan.

(B) The plan provision releasing the Second Lien Noteholders from liability for any alleged violations of the Intercreditor Agreement must be deleted from the plan.

(C) The plan provision offering the Backstop Parties indemnification must be clarified and limited, per the discussion supra.

(D) The AHC, the Backstop Parties and the Indenture Trustee must apply under section 503(b) for reimbursement of fees and expenses as substantial contributors to the case.

(E) The New Term Loan must be modified to afford the First Lien Lenders a 12% rate of interest, and an 1111(b) premium.

(F) The plan is confirmable subject to approval of DIP financing.

and for the Icahn/Beal Bank Plan:

I conclude that the Beal/Icahn Plan meets the requirements of section 1129(a) and (b), and is confirmable, subject to the following modifications:

(A) The plan provision for exculpation must be modified to provide for acts or omissions constituting gross negligence, willful misconduct or fraud.

(B) The plan provision providing for a severance payment to certain employees must be stricken.

(C) The plan provision placing a cap on administrative and priority expenses, and requiring acceptance of post-confirmation claims determinations of the bankruptcy court by the proponents, must be stricken.

(D) The plan provision cancelling the Indenture dated May 20, 2005, applies only to the debtors’ obligations, and does not affect the relationship between the Indenture Trustee and the Noteholders and guarantors.

(E) The bar date for filing administrative claims must be extended to thirty (30) days after the date of confirmation.

So net/net, both plans are confirmable subject to the modifications listed above. Now, the judge must decide which plan will be confirmed. She does this by weighting the preference of creditors, the feasibility of the plan, and the treatment of creditors and equity security holders. For example, in regards to treatment of creditors:

As to the treatment of creditors, both plans provide for a full recovery to First Lien Lenders, one through conversion of the debt to equity, and the other through deferred cash payments at present value. But the two plans differ markedly otherwise, particularly as to the treatment of Second Lien Noteholders. Except for providing a pro rata share of $500,000 to the Convenience Class, the Beal/Icahn Plan provides no distribution to any other stakeholders in the case. In contrast, the AHC/Debtor Plan provides for a nominal recovery of cash, subscription rights and liquid stock to the Second Lien Noteholders and General Unsecured Creditors. More importantly, the plan provides, to a large number of the Second Lien Noteholders, (approximately 61% of the Noteholders), the opportunity to receive the only value that is left in the case after satisfaction of the First Lien Lenders’ claims. That value is the potential future benefit of the reorganization, if the reorganization succeeds. The Ad Hoc Committee is making a substantial payment of $225 million for the opportunity to participate in the future upside potential of the debtors, which would otherwise inure to the exclusive benefit of the First Lien Lenders. The treatment of creditors favors the AHC/Debtor Plan in this regard.

She states though in her ruling that the "most significant element in choosing between two confirmable plans is the statutory direction to the court to 'consider the preference of creditors and equity security holders in determining which plan to confirm'" - The preference is reflected in the voting results.

In the end: The largest creditor group in this case were the second lien note holders who voted overwhelming in favor of the AHC/Debtor Plan and against the Beal Bank/Icahn Plan:

The end result of the voting is that an overwhelmingly number of creditors voted in favor of the AHC/Debtor Plan and against the Beal/Icahn Plan. Of course, it must be recalled that both the AHC members and the Icahn parties obviously support their own plans. But the significant support for the AHC/Debtor Plan by the largest creditor constituency, coupled with the treatment of creditors and feasibility considerations noted above, compels the conclusion that the AHC/Debtor Plan, as modified, should be confirmed. Confirmation of the AHC/Debtor Plan will allow the debtor to shed approximately $1.4 billion in secured debt, to pay the First Lien Lenders in full, and to offer to creditors the opportunity to participate in the upside potential of the debtors.

So with that, and the revised changes above, it looks like the Ad Hoc Plan will go through. If a different judge had presided over the case, maybe a different outcome would have occurred. I have not yet heard what Icahn/Beal will try to again swing the needle in their favor (if anything). If the current plan gets approved, Avenue Capital, and a number of distressed hedge funds (holders of the second lien and participants in the rights offering), along with the Donald will be the new owners of Trump. We will be sure to follow the post-reorg equity (if its trade-able) upon emergence.