August/September 2003

Robert J. Figurski
Manager of Restructure and DIP loans
Senior Vice President

Typically, we see companies filing for Chapter 11 and taking the “easy” route by only seeking debtor-in-financing from the debtor’s pre-petition lender. The debtor’s professional advisors infrequently recommend possible alternate DIP lenders, and for a variety of reasons. One of the reasons advisors don’t recommend alternate lenders stems from their operating under the mis-conception that the present lender is already “up to speed” on the debtor’s business and financial affairs, and only that lender can move quickly enough to close the DIP facility. Another reason professional advisors fail to recommend alternatives is because they don’t always know what banks to contact for the DIP deal size that is required.

In addition to doing their clients a disservice by not recommending alternative DIP lenders, these professionals are exposing themselves to criticism, or perhaps even legal action. Better financing translates into more working capital, a necessity to reorganize effectively. A debtor may ultimately determine its reorganization efforts were impeded by a lack of sufficient working capital, if the professional advisors did not recommend competing financing offers the debtor may blame the professional for not getting a better deal.

It is imperative for a professional advisor to search all financing avenues before deciding on one particular lender, because many lenders see chapter 11 merely as an opportunity to enhance their interest rate spread, to charge substantial fees and inject into the DIP facility additional protections, such as tighter covenants and, in some instances, even poison pills. Higher interest costs, excessive fees and tighter operating restrictions cannot be defended, unless alternative lenders are not available. A Debtor and its advisors need to test the market and determine if that is a correct assumption.

With lender consolidation, the lending industry has changed drastically in recent years, which has resulted in the creation of three distinctive types of lenders. At one end of the spectrum are the very large credit facilities, starting generally at $20 million, and then climbing to lofty nine and ten figure credit facilities. Only a handful of banks entertain loans at those levels. For these facilities, the largest banks either fully fund the credit themselves, or partner up with one or maybe two other large banks. And where these larger credit facilities are not done by the largest banks, they are now provided by large syndications of sometimes twenty or thirty or more lenders. Finding alternative DIP lenders for these credits is most difficult, because few banks (participating in one of these large credits) will bid against the transaction lead or agent for fear of being locked out of future credits by those agent lenders.

At the other end of the spectrum, we have the credit facilities which generally fall between $2 and $3 million. Since a much higher proportion of these companies are ultimately unable to survive, interest rates and fees charged for these companies are quite high.

Finally, there does exist a group of lenders within the middle area of credit facilities (from $3 million to $20 million) that understands the chapter process as a legitimate tool. Most significantly, these lenders have developed an industry in lending to debtors in possession. For these middle market companies, there are almost more suitors chasing deals than available financing opportunities. Consequently, it is likely that the debtor will find a new lender where the terms and pricing are competitive.

Certainly, an added amount of time and cost will be expended, both for the debtor and its professional advisors to educate a new lender, and for the lender to complete its due diligence and be prepared to close on, or shortly after commencement of the case. However, obtaining cash collateral order on the date of the filing to allow the company to continue to operate until alternate DIP financing sources can be implemented generally provides the necessary breathing spell. For that matter, it is often the case that even when the pre-DIP lender agrees to finance the DIP, the pre-DIP lender’s attorneys suggest a cash collateral order until their lender is ready to close the DIP facility. Lenders who are accustomed to providing DIP facilities to companies other than their existing clients are aware of the time constraints imposed by Chapter 11 and are prepared to process a DIP facility on a much faster track than is traditionally the case.

Two additional issues that often mitigate in favor of a new DIP lender are: (1) “lender fatigue,” and (2) management of the credit facility in the lender’s organization. Lender fatigue generally occurs after years of broken promises, missed projections and breached covenants. Thus, the pre-DIP lender’s management has lost all confidence that the debtor ever will perform as projected. They simply agree to finance the DIP as a defensive measure to enhance their interest spread and fees, and to strengthen loan documentation.

Whether a management of a credit facility is by a “line” officer or the “work- out” people, it is often impossible for the credit facility to be returned to the line officers and certainly in the latter case. In most banks, once a loan has had its “risk rating” downgraded by its pre-DIP lender to “Unsatisfactory”, or some other negative rating, it is difficult, if not impossible, to earn an upgrade to a satisfactory risk rating within that lending institution. On the other hand, new lenders for DIPs desire DIP loans as a means of having the opportunity to finance a company’s exit facility from Chapter 11. They may better understand that the causes of the bankruptcy are temporary and that there is light at the end of the tunnel.

Companies filing Chapter 11 generally fall into two classes. The first class consists of those debtors who continue to experience unstoppable negative cash flow. Thus, not only is it less likely for the company to obtain exit financing, but there is a high probability that the reorganization case will be converted to a liquidation. This case is oft referred to as a “defensive” DIP. In these cases, it is difficult, if not impossible, to obtain a replacement DIP lender. Thus, the debtor’s only choice, if he can get one at all, falls to its pre-chapter lender.

The second type of DIP is often referred to as a “strategic” DIP. These debtors can demonstrate a sound management plan realistic cash flow projections, and sufficient collateral to cover the amount of the facility to pay off the pre-DIP lender and provide additional working capital. Strategic DIPs exhibit higher likelihood of successful emergence from Chapter 11. For such debtors, a new DIP lender is a realistic prospect and the failure to consider a new lender (or the assumption that no other lender besides the pre-petition lender may have an interest in financing the debtor) is a dis-service to the client.

Many sophisticated financial institutions now recognize that not all Chapter 11s are the result of problems that cannot be remedied. For some debtors, Chapter 11 greatly enhances cash flow and the likelihood of a successful restructuring. They view Chapter 11 as if the debtor is a newborn and they understand how to analyze creditworthiness without the taint of the past. They can get “comfortable” with a business plan that demonstrates the likelihood of success in Chapter 11, and also the likelihood of having a solid client upon exit from Chapter 11.

Office 212-806-4543
Fax 212-806-4530
Cell 917-224-4448

rfigurski@whitehallbcc.com