Trade Alert: United States of America

UNITED STATES OF AMERICA

On 1 February 2022, data compiled by Bloomberg found that the total amount of traded distressed bonds and loans in the Americas totalled USD65.5bn, increasing by 6.5 per cent week-on-week. The U.S. accounts for the greatest share of the distressed debt market, USD54.1bn, with the Media and Telecommunications sectors having USD8.42bn and USD8.04bn respectively. In January 2022, only three companies with liabilities of over USD50m filed for bankruptcies in the U.S., the lowest figure for January since 2008, reflecting the wide-ranging stimulus programs enacted by the government due to the pandemic.

U.S. national debt stands at around USD 29.6tn and the Federal Reserve confirmed on 26 January 2022 that it will begin tapering and stop adding to its balance sheet in March 2022. The Federal Reserve further indicated that inflation remains well above its long-term goal of 2 per cent and observed that bottlenecks and supply chain constraints are a major driver of price increases and that now, price increases have extended beyond these areas.

However, recent data illustrates that the Federal Reserve will need to act soon to restrain the growing inflation. On 25 February 2022, the Federal Reserve announced that the core personal consumption expenditures price index increased by 0.5 per cent in January, leaving the annual increase at 5.2 per cent, which is the fastest increase in four decades. Additionally, the PCE index increased by 6.1 per cent from February 2021 and there has been a 2.1 per cent rise in household spending since the start of 2022.

KEY POINTS FOR TRADERS

CHAPTER 11 CLAIMS

Issues that creditors should consider when trading Chapter 11 claims include: (1) the secured status of the claim and the value of the underlying collateral; (2) whether the claim is subject to attack, subordination or disallowance; and (3) the priority of the claim and the potential waterfall allocations (including what these claims may receive – cash, take-back debt, equity interests, and/or interests in a litigation trust).

The Bankruptcy Code does not allow for unmatured post-petition interest to be claimed for unless: (1) the creditor is claiming the interest as a secured creditor and the value of its security exceeds its claims; or (2) the estate of the debtor-in-possession is solvent, and it is able to pay its unsecured debts in full. Thus, unless a claim is "over-secured" or the debtor-in-possession is solvent, no claim will accrue post-petition interest. For this reason, in the vast majority of cases involving the purchase of claims, the transferee should understand that it will likely not be entitled to post-petition interest on the claim.

There are a variety of ways that the debtor-in-possession or, more usually other creditors, may seek to attack, subordinate, or disallow claims in order to increase their own entitlements. Transferees must be cognisant of whether the debtor-in-possession’s case may be substantively consolidated (i.e., the debtor-in- possession’s entire corporate structure is combined such that claims of every debtor entity receive distributions at the same "structural" priority level). This could negatively (or positively) impact the distribution a transferee receives on account of the purchased claim depending on the priority and which debtor the claim originally stood against. Other creditors may seek to recharacterise the claim in question from a debt claim to an equity interest (equity interests are subordinate to all claims for distribution purposes) based on the true character of the monies advanced in support of the claim. Moreover, other parties in interest may seek to subordinate claims based on the inequitable conduct vis-a-vis other creditors conducted by the original claim holder (or transferee). In these instances, the subordinated claim will not receive distributions unless senior claims are paid in full. Some courts have held that even innocent transferees of claims that are to be subordinated are not insulated from subordination. Finally, claims may be disallowed if the underlying debt is proved not to be owed after an objection to the claim is filed.

To protect against these risks, it is common for transferees to receive all of the relevant information from the transferor including the proof of claim and associated documentation relating to the underlying asset. The transferee would then familiarise itself with the history of the claim and the transferor as well as arguments in the Chapter 11 case to understand if the claim may be subject to attack. The claims trade contract can be drafted in a way that shifts the risk of any subordination, disallowance, recharacterisation or the like back on to the transferor.

Furthermore, the transferee can determine if a bar date has been set in a Chapter 11 case and whether the claim has been properly filed before the bar date and is correctly identified by the debtor-in-possession on the case’s publicly available claims register.

OVERVIEW OF CHAPTER 11 BANKRUPTCY

Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") governs reorganisations in the U.S. with Chapter 11 bankruptcy cases usually the most complex and costly forms of US bankruptcy proceedings. During Chapter 11 proceedings, the courts will assist the debtor (known during this process as the "debtor-in- possession") to restructure its debts and obligations with the business generally continuing to operate. The debtor is required to obtain court permission for certain actions including asset sales (other than in the ordinary course of business), payment of pre-petition claims (i.e., claims that arose prior to the filing date), termination or assumption of executory contracts and unexpired leases, or obtaining post-petition credit to run or expand business operations. When a company files for Chapter 11 proceedings, it immediately triggers an automatic stay which is broad in scope and applies to almost all types of creditor action against the debtor-in-possession and the assets in its estate.

The debtor-in-possession initially has the exclusive right to propose a Chapter 11 plan. If it is determined at a hearing that, among other things, this plan is feasible and fair, treats similar creditors equally and is deemed to be in the best interest of the debtor-in-possession’s estate, then the Bankruptcy Court will approve the plan. The confirmation of the Chapter 11 reorganisation plan will generally discharge a business debtor-in-possession of all of its pre-petition debts to creditors.

WHAT ARE CHAPTER 11 CLAIMS?

Shortly after a debtor’s Chapter 11 petition, the debtor-in- possession will list all known claims in its schedule of assets and liabilities. Generally, for creditors with claims that are not listed in these schedules (or which are listed as "disputed", "unliquidated" or "contingent"), such creditors must file a proof of claim by a bar date set by the Bankruptcy Court. Creditors with listed claims may object to the debtor-in-possession's description of their claim. The Bankruptcy Court will set a deadline by which the debtor-in-possession and other interested parties may object to the creditors' proofs of claim.

TRADING CHAPTER 11 CLAIMS

Unlike the Loan Market Association (the "LMA"), the Loan Syndications and Trading Association (the "LSTA") does not have a prescribed form of transaction documents for claims trading. As seen with MF Global, Madoff and Lehman claims, bespoke documentation is produced for each claim depending on the basis of the claim (be it debt, bonds or of a derivative nature).

There is an active and well-developed market for trading Chapter 11 claims and, in the absence of a court order, parties may freely transfer bankruptcy claims. Partial claims can be transferred, though the documentation (both the underlying contract and notice filed with the bankruptcy docket) for such claims must be meticulously constructed to ensure ultimate enforcement.

Claims involving publicly traded securities may often be traded through customary market channels without the need to provide any notice to the Bankruptcy Court. However, claims traders should be wary of court orders such as those: (1) limiting the transfer of significant percentages of equity interests or controlling interests; or (2) imposing additional notice and information requirements in respect of those trades. The Bankruptcy Court will generally set a record date for claims trades prior to distributions, and trades that occur after such date may not be recognised for distribution purposes. If a proof of claim in respect of a claim that is not based on publicly traded securities has already been filed, then the buyer of the claim must file evidence (in the form of a standardised claim form available on the applicable court's website) of the transfer of the claim with the Bankruptcy Court. Any objection to the transfer must be filed with the Bankruptcy Court within 21 days of the mailing of the notice (meaning the form filed with the Bankruptcy Court) to the seller. In the absence of any objection, the transfer is deemed valid.

Claims that are acquired for an amount lower than face value are enforced at their full face value if the claim is otherwise valid. One exception to this general rule is for claims based on bonds issued with original issue discount. In this instance, it is (again) the general rule that original issued discount is treated by the courts as if it is unmatured post-petition interest.

Unless the acquired claim is secured, and the value of the collateral exceeds the value of the claim, interest will not accrue on the claim (assuming the solvent debtor exception, discussed above, does not apply).

LMA UPDATE

On 18 February 2022, the LMA published revised Bank Debt, Claims and Risk Participation Trade Confirmations. The revisions focus on the wording of the ‘Other Terms of Trade’ tick-boxes, with the credit adjustment spread (CAS) excluded and zero-floor options included, where Delayed Settlement Compensation applies. These amendments to the Trade Confirmations have not changed the position on these commercial issues. Whether or not they apply to a respective trade, this must continue be agreed by the parties at the time of trade. The revised Trade Confirmations are effective from 18 February 2022.

On 24 February 2022, Louisa Watt spoke at the LMA Training Day on the revised terms and “Completing a trade confirmation – difference between par and distressed.” The slides and presentation will be published on the LMA website soon.

NOTABLE TRANSACTIONS

NORWEGIAN CRUISE LINE HOLDINGS LTD (“Norwegian Cruise”)

Norwegian Cruise, the third largest cruise line operator in the world by revenue, sold USD1.6bn of notes on 10 February 2022 to refinance the debt it sought during the pandemic.

Norwegian Cruise sold USD1bn of secured 5.875 per cent notes due 2027 and USD600m of unsecured 7.75 per cent notes due 2029. The liner also announced that it is proposing to sell USD435m of its exchangeable senior notes due 2027 in a private offering that is exempt from the registration requirements of the Securities Act. Norwegian Cruise will use the proceeds of the refinancing to redeem all of its outstanding USD675m 12.25 per cent secured notes due 2024 and USD750m 10.25 per cent secured notes due 2026 and to service any short-term debt that is maturing. Three vessels of the Norwegian Cruise group are being used as security for the secured notes and the related guarantees.

Jody Lurie, Bloomberg Intelligence credit analyst reflected: “We’re seeing the same story on repeat for the big three of the seas: refinancing high coupon debt and pushing out maturities, while at the same time bolstering liquidity to fill cash gaps until they become cash flow positive.”

In 2020, Norwegian Cruise suffered dramatically, losing 80 per cent of its market value by May 2020. In response, the cruise liner sought to shore up cash to withstand extended voyage suspensions due to the pandemic and on 6 May 2020, Norwegian Cruise raised an additional USD2.4Bn providing the company USD3.5bn in liquidity.

EXXONMOBIL CORPORATION (“Exxon”)

On 1 February 2022, Exxon announced that it had registered its highest profits since 2014, earning USD23bn in 2021 and in 4Q21, the oil giant earned USD8.9bn, which beat Wall Street expectations. Recently, Exxon has sought to decrease its debt and streamline its corporate structure with the Exxon board of directors approving a company plan for 2022 with capital spending expected to be between USD21bn to USD24bn. As such, Exxon is going to buyback shares of up to USD10bn over the next 12 to 24 months. Accompanying the financial results, Exxon reflected: “Our new streamlined business structure is another example of the actions we are taking to further strengthen our competitive advantages and grow shareholder value. We have made great progress in 2021 and our forward plans position us to lead in cash flow and earnings growth, operating performance and the energy transition.”

On 11 January 2022,  Exxon bought a 49.9 per cent stake in the Norwegian biofuels company Biojet AS, continuing its focus on low-carbon businesses. The Biojet AS acquisition will allow Exxon to purchase up to 3 million barrels of biofuel each year, based on the potential capacity of 5 Biojet AS facilities. The fuel can be used by passenger vehicles and heavy trucks with additional opportunities for marine transportation and aviation in the future. Biojet AS expects commercial production to begin in 2025 and its biofuel will meet the advanced fuel requirements under the Norwegian, United Kingdom and European Union Regulations.

This acquisition continues Exxon’s trend towards energy transition with the oil giant establishing  its energy transition business Low Carbon Solutions in 2021. Low Carbon Solutions seeks to commercialise biofuels and carbon storage around the world.

LOGAN GROUP COMPANY (“Logan”)

As discussed in our last Trade Alert, Chinese property developers are suffering from increasing debt maturities with little opportunity to refinance. Another property developer which has suffered of late is Logan Group Company, China’s 20^th largest property developer by contracted sales.

On 8 February 2022, Logan’s long term foreign and local currency issuer default ratings (IDRs) was downgraded to BB- from BB by Fitch Ratings. This decrease is due to Logan’s recent off-balance sheet disclosure of a private debt arrangement. Only last month, Logan denied it had any privately placed debt only to disclose that its guarantees on privately placed debt did not exceed USD1bn. Additionally, there are reports that the group is considering a change in auditor amidst Logan declaring that “the current productions and operations of the company are normal”. As such, Fitch has downgraded Logan’s ESG – Financial Transparency rating from 3 to 5. Furthermore, Moody’s Investor Service has downgraded Logan’s corporate family rating to Ba3 from Ba2 and its senior unsecured ratings to B1 from Ba3. Reasons for the downgrade are due to “Logan’s weakened funding access and its inadequate control over its contingent liabilities, which raises concerns regarding the company’s governance practices”.

Logan has been seen as one of the strongest Chinese property developers, focusing on residential property development in Guangdong, Hong Kong and Macau. As of mid-2021, Logan’s borrowings have kept below the “three red lines” however, the 98 per cent decrease in land purchases in 2H21 compared to 1H21 has raised fears on the group’s liquidity. Furthermore, Logan’s contracted sales decreased by 44 per cent year-on-year in January 2022.

CINEWORLD GROUP (“Cineworld”)

Cineworld, the world’s second largest cinema operator, is expected to avoid insolvency as it is thought that a deal has been agreed with Cineplex Inc over the failed merger in 2020. In June 2020, Cineworld retracted from a proposed deal to purchase Cineplex for USD2.3bn due to Cineplex’s breaches in the merger agreement between the two parties. Cineworld announced in a statement: “As a consequence of Cineplex’s unwillingness to cure the breaches, Cineworld has notified Cineplex that it has terminated the Arrangement Agreement with immediate effect”.

The two parties have sued each other in the courts, alleging breaches of contract and in December 2021, the Ontario Superior Court of Justice ruled in Cineplex’s favour awarding USD950mn in damages, which is more than Cineworld’s current market value. Cineworld has appealed against this decision which has, in turn, led Cineplex to file a cross-appeal against Cineworld’s challenge. Cineplex has instructed the court to consider a list of claims between CAD714m for liabilities had the deal been completed to CAD1.3bn for lost compensation to Cineplex’s security holders.

However, it is thought that Cineworld’s overall debt, USD4.6bn as of June 2021 including the emergency USD750m financing it sought in 2020, is too large and if the damages were to be pursued, Cineworld will become bankrupt, and Cineplex’s damages will rank below the secured lenders. Therefore, Cineplex is expected to agree to lower damages even if Cineworld’s appeal is unsuccessful.

Overall, cinema groups have all suffered during the pandemic and therefore, as Abigail Klimovich, an analyst at S&P Global Ratings, reflected: “[Cineworld and Cineplex] need to resolve their acute liquidity problems and their capital structure then there is the litigation issue, but it is not the main problem at the moment”.

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CONTACT

Please contact Steven Wasserman, Linda Marcus, Louisa Watt or Iden Asl with any queries regarding this Trade Alert.