2015 Hon. Robert D. Drain United States Bankruptcy Court, Southern District of New York Professor Douglas G. Baird University of Chicago Law School Heather Lennox Jones Day Teri Stratton Piper Jaffray & Co. Un-Till Death Do Us Part? Fontainebleau Miami Beach

The Absolute Priority Rule is the central organizing principle of the Bankruptcy Code –A fully secured senior creditor is entitled to be paid in full –Or are they? Assessing the Rights of Secured Creditors in Chapter 11 2

U.S. Constitution Statute Case law Sources of Secured Creditors’ Rights 3

Adequate Protection Which is the correct baseline when a secured creditor requests adequate protection at the outset of a case: –The value of the collateral in Chapter 11 –The value of the collateral in a nonbankruptcy foreclosure sale (ABI Bankruptcy Commission) 4

Adequate Protection Example Senior Lender is owed $100 and has security interest in all assets, if Senior Lender exercised rights under nonbankruptcy law at the time of filing, Senior Lender would receive $50 Debtor’s assets include a Treasury bill for $50 By the end of Chapter 11, Debtor will end up being worth $60 or $140, with equal probability Does putting the Treasury bill in an escrow account provide adequate protection? 5

Reorganization Value Section 552(b) of the Bankruptcy Code contains a limitation on secured creditors’ liens on proceeds, products, offspring or profits of collateral “based on the equities of the case” What happens when the Debtor’s reorganization value is improved by use of some of the secured creditors’ collateral, as well as some assets which are not collateral? 6

Reorganization Value Example Senior Lender has security interest in all of Debtor’s assets except one piece of intellectual property –IP is useful but not critical, used in business and licensed to others Debtor files for BK amidst unfair publicity and threats of increased government regulation –Substantial chance firm would be liquidated CRO spends aggressively on clever advertising and adroit lobbying –Strategy is successful and Debtor is able to reorganize To what extent is the Secured Lender entitled to the increase in value attributable to the advertising and lobbying campaign? 7

Measuring the Cramdown Interest Rate Debtor proposes a plan of reorganization in which it proposes to pay Senior Lender the amount of its secured claim over five years Debtor could choose to use exit financing to pay Senior Lender in cash If Debtor proposes to give Senior Lender a note instead, must it bear the same interest rate as the exit financing and accrue interest at a contract rate of 10%? 8

Under § 1129(b)(2)(A), the secured creditor is entitled to the value of its claim Holder of secured claim must receive deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property Interest rate of exit financing is the best approximation of market 9 Measuring the Cramdown Interest Rate

However, the “market rate” includes profits and not just risk –Can attempt to disaggregate profits from risk on a case by case basis –Can use risk free rate plus an adjustment for risk 10 Measuring the Cramdown Interest Rate

Intercorporate Guarantees Case law suggests that a secured creditor has a claim for full amount of guarantee against the guarantor despite any recovery from borrower Another argument is that a secured creditor only has a claim for the amount of the deficiency against the guarantor 11

Intercorporate Guarantees Example Parent Debtor owns Subsidiary Bank lends $100 to Subsidiary and takes security interest in all assets Bank also gets unsecured guarantee from Parent Debtor Subsidiary defaults and Bank forecloses on its assets, realizing $50 Parent Debtor files for BK, owes other general creditors $200 and has assets of $100 12

Intercorporate Guarantees and Postpetition Interest Debtor has three subsidiaries: A, B, and C Bank makes a $30 loan to Debtor and each subsidiary guarantees and grants Bank security interest in all assets Entire corporate group files bankruptcy –A has assets of $20 –B has assets of $10 –C has assets of $5 Creditor is oversecured on a consolidated basis, but undersecured on an entity basis: entitled to postpetition interest? 13

Calculating Postpetition Interest At what point in a Bankruptcy proceeding do you value collateral to determine whether a secured creditor is oversecured –At time of filing –At point of collateral increase 14

Make-Whole Payments Courts have refused to enforce make-whole provisions on grounds they are not clear enough in the bankruptcy context to support payment –Become due upon pre-payment of the loan –Bankruptcy accelerates the payment, no longer making it a pre-payment 15

In the case that the make-whole provision is clear, should it be allowed? –Interest charged to a borrower is to compensate for the cost of finding a new borrower Make-whole is akin to liquidated damages, allowed in non- bankruptcy law –Make-whole compensates for the loss of an above market loan Claims based on unmatured interest are not ordinarily allowed 16 Make-Whole Payments