By Marjorie Seeberan, Contributor
I HAVE always felt that the countries to the North, especially the United States (U.S.), have invested significant amounts of money, time and effort in understanding the rest of the world as markets for its goods and services, as hostile or friendly political regimes, as interesting cultures whose music, art, religion and philosophies may impact the cultural evolution of its people, or as neighbours whose migration patterns may affect their wealth and overall national interests.
It has been my experience that countries, like Jamaica, to the South, have not in a similar mode made the strategic leap towards the study of the U.S. and other industrialised nations to the North. We do not know enough about their markets, their legal and regulatory systems, their institutions, their history and the key drivers of their economic systems. This is so, despite the fact that globalisation is forcing us to operate in a world economy where wealthy nations set the rules of engagement as well as the penalties for flouting these rules.
My own perspective from living and working in the U.S. for three decades is that these nations represent a vast pool of research and development resources from which to craft our own institutions, develop new technologies and processes without the expense of our own R&D investment. Jamaica should seek to understand the 'best practices' of these major institutions, customise them to our purposes and avoid some of the costly 'learning curve' errors.
THE DEBT ARENA
Maybe the most challenging part of my banking experience in the U.S. was my work in the troubled debt arena. It is interesting that as specialists in corporate finance our mandate was to develop new market segments while still exploring all the opportunities of the current one. So it was that in the heyday of the leveraged buyouts, and the mergers and acquisition deals, we sensed that the debt burden of many of our companies, especially in real estate, retail, manufacturing and construction, had become onerous and without serious and timely intervention many other businesses and some banks would collapse. The idea of financing companies operating under Chapter 11 bankruptcy was born and was made possible only because of the 1978 Bankruptcy Reform Act.
CHAPTER 11 AND THE
BANKRUPTCY REFORM ACT
1) The 1978 Reform Act created the opportunity for a troubled company to file for bankruptcy under Chapter 11, and continue as a going concern under court protection until it could be reorganised back to health. In most cases, stakeholders' interests are better served by preserving the 'going concern' value of the company through an infusion of cash and proper management than by liquidating its assets through a 'fire sale'. A vast new industry sector has developed around this concept of 'convalescence' for ailing companies, and there is no shortage of practitioners with a vested interest in making the system work.
2) Why does Chapter 11 work?
It works because:
the Court is in charge so the process has credibility as well as being the institution of ultimate recourse
'going concern' value is preserved
stakeholders usually receive more from a distribution under re-organisation than a liquidation
the company has access to new capital, and
distributions to stakeholder are equitable under a court approved Plan.
3) This is a simplified version of how Chapter 11 works in the U.S.:
A company enters reorganisation under Chapter 11 by filing a petition with the bankruptcy court. This is an adjunct of the U.S. district courts.
The goal of the proceeding is to maximise the recovery by creditors and shareholders by maintaining its value as a going concern.
The company starts by preparing a plan of reorganisation that it hopes will be confirmed by the court since it has the exclusive right to do so only for the first 120 days. If the company manages to file a plan within that period the court may grant it additional time to gain plan acceptance from its creditors. However, once a trustee is appointed the debtor's exclusivity is terminated and any party in interest may file a plan.
The plan provides for the treatment of all the assets and liabilities of the debtor in the most equitable way. This might result in forgiveness of indebtedness since most creditor classes will not recover 100 per cent of the claim. Therefore, the critical question becomes whether the creditor is better off with an impaired claim or with the proceeds of a forced liquidation.
For the plan to be confirmed the Court's acid test must be met; that is, whether consideration given to the parties in interest under the plan has exceeded that which they would otherwise have received under a Chapter 7 liquidation.
Once the bankruptcy petition is filed, an Automatic Stay ('the Stay') goes into immediate effect. This means that the company or debtor is protected from its creditors until a final plan for its reorganisation is confirmed. All legal proceedings against the debtor are halted as well as payments of principal and interest to unsecured creditors.
NEGOTIATION AND REORGANISATION
Payments may be allowed to secured creditors by order of the court but often these are deferred until the plan is confirmed. The net result is that many bankrupt companies develop a large cash hoard during the stay and this makes them very attractive to new investors.
The debtor in possession of his company now begins to work with some very heavy players. The key player is the court-appointed trustee who provides oversight to the managers of the entity's operations and presides over the various creditor committees. At this time, the plan sponsor would have emerged and started negotiations with the various parties in interest. Each creditor class forms a committee and elects a chair who will represent it in its plan negotiations.
It is not difficult to imagine the acrimonious tone of these deliberations since each creditor class wants the highest percentage distribution. However, it is through this very transparent process that a final plan for reorganisation emerges.
Another important aspect of the filing is the amount that the Court awards for administrative expenses. This is the 'pot' from which professional fees for lawyers, accountants, advisers, etc. are paid on a current basis. New management will have been retained on an interim basis and their salaries typically run very high. At this juncture the old management will have experienced a drastic downward salary revision and are on their way out. The interim executives are not ne-cessarily the ones will head the re-organised company.
Simultaneously with the petition for Chapter 11 Bankruptcy, the court grants an order that allows the debtor to obtain bank financing to carry on its operations. This is a very critical element since the debtor is then able to obtain new money from regular banking sources that would have been impossible to obtain outside of the court's protection.
The ability to obtain financing for its operations without relying on the 'sitting' creditors or the taxpayers, is the first task of the debtor. This type of funding is called post-petition financing. The loan facility is referred to as Debtor-in Possession, or DIP, facility and has the following protection:
The lender is given a super-priority claim status over all other creditors on the basis that without such financing, irreparable harm will accrue to the debtor's estate.
This status allows the lender to be on a LIFO basis, that is, last in as a lender, but first out. Except for a 'carve out' for professional fees, no other claim (super-priority or parri-passu) is allowed until all of the DIP debt has been paid off.
The Automatic Stay mentioned earlier is vacated or modified to the extent necessary to allow the lender to exercise its rights and remedies permitted under the Agreement in the event of a default.
To the extent that the court has approved the loan agreement, the terms and conditions are binding. These terms usually include a security interest in the assets of the company on a formula that is reflected in a Borrowing Base Certificate. This ensures that the bank's loan to the debtor is never higher than that the liquidated value of the assets of the company.
This paper was made available through the auspices of the Wednesday Morning Seminar Series, presented by the Jamaica Conference Board and Myers Fletcher and Gordon. It is the first of a two part article dealing with this bankruptcy issue. The Jamaica Conference Board, a project of the Jamaica Chamber of Commerce, is a non-profit research and advisory body that provides a platform for the development and exchange of business knowledge. Myers Fletcher and Gordon is the largest law firm in Jamaica and the English-speaking Caribbean, with law offices in London, UK and Trust Offices in the British Virgin Islands.
Marjorie Seeberan is General Manager of the Corporate Banking Division at the National Commercial Bank of Jamaica