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July 15, 2009

RESTRUCTURING AND FINANCE DEVELOPMENTS

Attempted Reinstatement of Bank Debt in Bankruptcy

Litigation in the bankruptcies of Spectrum Brands (settled three weeks ago at the
close of trial) and Charter Communications (scheduled for trial starting July 20) offers a preview
of what will be a recurring theme during this economic downturn and tight credit environment:
financially distressed companies seeking to use Chapter 11 to substantially de-lever their balance
sheets by equitizing junior debt while “reinstating” existing senior debt on original terms that are
more favorable to the borrower than those available in today’s financing market.

This unusual scenario is the product of an unprecedented credit boom followed


quickly by a market collapse, leaving a number of financially distressed, overleveraged compa-
nies in its wake. Many of these companies find themselves unable to sell or refinance in the cur-
rent market, and are looking to a little-used provision of Chapter 11 for a solution. Section 1124
of the Bankruptcy Code provides that if, pursuant to its Chapter 11 plan, a debtor cures all non-
bankruptcy defaults under a debt instrument and does not alter the rights of the debtholders, the
reorganized company can “reinstate” the debt on its original terms, without the consent of the
debtholders. Thus, the success of a “reinstatement” strategy depends on the debtor’s ability to
craft a feasible plan that does not violate the terms of the relevant loan documents and allows the
debtor to remain in compliance with the loan’s terms post-bankruptcy. Because many secured
credit agreements negotiated over the last several years have favorable interest rates and contain
so-called “covenant lite” provisions (few or no financial covenants and permissive negative
covenants), such companies have a strong incentive to try to take advantage of reinstatement.

In Spectrum Brands, the debtors tried to reinstate their $1.4 billion senior secured
term loan. The senior lenders mounted a two-pronged challenge to the plan, arguing that (1) the
equitization of the subordinated debt created non-curable defaults under the credit agreement
provisions concerning permitted refinancings and changes of control, and (2) the plan was not
feasible because the debtors would be unable to comply prospectively with the loan’s senior lev-
erage ratio covenant. As part of a settlement following a five-day contested confirmation hear-
ing, the debtors and lenders agreed to leave the term loan in place but with significantly en-
hanced economic terms for the lenders: a 2.50% increase in the interest rate spreads, the addition
of a 1.50% LIBOR floor, and a shortening of the maturity by 9 months.

The outcome of the Spectrum trial, as well as future cases such as Charter, dem-
onstrate that debtors and creditors confronted with a potential reinstatement must carefully ana-
lyze the debt documents and scrutinize the debtor’s projections to identify, or defend against, po-
tential default and feasibility issues.

Richard G. Mason
David C. Bryan
Elaine P. Golin
Joshua A. Naftalis
Gregory E. Pessin

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