LSQ’s preeminent DIP financing team provides valuable insight on how to better approach and facilitate the acquisition of capital for your clients prior to and following a Chapter 11 petition. Improve your understanding regarding challenges frequently associated with DIP financing transactions— including those involving multiple stakeholders, reorganization, and 363 sales.
Highlights from this webinar include:
- Our 90-day outlook for DIP transactions.
- Disruptive events that may occur and influence the use of DIP financing.
- Case studies reflective of what we’re seeing in 2021 vs. the last financial crisis.
- Ideal scenarios where LSQ excels as a DIP partner.
Watch the Webinar
Renee Jackson, National Sales Director
Tom Fevola, Director of Underwriting
Doug Goldin, General Counsel
About LSQ / Speaker Intro
Renee Jackson: Thank you for joining us today. As we approach the latter part of the first quarter and an uptick in debtor-in-possession transactions, we decided as a team that a prudent topic for our quarterly webinar today would be today’s market landscape in DIP financing. Joining us today from the LSQ team is Tom Fevola, our director of underwriting, and Doug Goldin, our general counsel. My name is Renee Jackson. I lead the sales team here at LSQ.
Prior to handing the floor over to Tom and Doug, I’m going to give you a brief overview of who we are and what we do here at LSQ. LSQ is based in Orlando, Florida, and was founded 25 years ago by a gentleman by the name of Max Eliscu. Currently, we’re one of the largest privately held working capital finance companies here in the US. Within our national footprint, we have funded over 25 billion to small to medium-sized businesses.
Over the past 25 years, we formalized over 40 bank partnerships in an effort to act as an incubation tool, primarily by bridging the gap to companies in a transition period, and or high growth mode, allowing for them to return to a bankable status. During today’s webinar, we’ll be reviewing the current market landscape, bankruptcy trends, and we’ll discuss some of our recently funded DIP transactions. Tom has been in the industry for over 25 years and has a wide array in experience in the sector.
Doug Goldin, prior to representing LSQ, spent numerous years in commercial litigation, bankruptcy, insolvency, and the reorganization space. Doug will speak to his experience and the events that may occur and disrupt projections. At the end of the presentation, we welcome you to ask questions by using the webinar control panel to submit, and feel free to ask questions at any time. With that said, I will hand it over to you, Tom.
First, Let’s Level Set
Total U.S. BK Filings
Tom Fevola: Thank you, Renee. Welcome, everyone. My name is Tom Fevola, I’m the director of underwriting here at LSQ Funding. We thought it would be good to start off the webinar by level setting and taking a look back at 2020 as it relates to bankruptcy filings. The first graphical representation that we have here represents the total US bankruptcy filings in 2020. You’ll know right away that there was a significant downtick in total filings across all chapters in 2020, compared year over year to 2019, by approximately 35%.
That, firstly, is the lowest that it’s ever been in the last 35 years as far as measurement of bankruptcy statistics go, and a little bit surprising, I think, on two levels. As I think back to about 12 lifetimes ago at the end of 2019, myself and some internal peers, as well as some external peers, were opining about what we thought might happen in this very space in 2020. The general consensus I recall at the time was that there was an expectation that bankruptcies as a whole were going to rise in 2020. Wasn’t sure exactly when.
There were a lot of driving factors for that. One of the primary factors at the time was the amount of US debt on corporate balance sheet. It was at that time the highest it had ever been. There was a prevailing consensus that at some point throughout 2020, the Piper needed to be paid. There was going to be some atonement for this amount of balance sheet debt that was being carried. It had been increasing year over year for the past several years.
That’s actually indicated here in the graph. If you take a look at 2015 to 2019, you see a downward trend before that of decreasing bankruptcies and then a leveling off. That’s because corporate debt, to some extent, was increasing, and there were other options besides filing of bankruptcy for a lot of organizations. We’re going to take a look at some of those things that drove that today, as well as provide some projections.
Ch. 11 U.S. BK Filings
If we take a closer look at bankruptcy filing, specifically as it relates to our next graphical image, Chapter 11 filings in the US for 2020, an interesting part is that while total bankruptcies were down across all chapters, Chapter 11 commercial filings were up by approximately 29%, which is, I think, pretty material. Interestingly enough that this cohort of the total bankruptcies was up and indicates a little bit of what I was just talking about, or at least I think so, that two factors played a large role in 2020 of driving these commercial bankruptcies up.
One was the debt that was already being carried in, and the pandemic being a very specific event that also, by itself, could have likely caused some increasing in Chapter 11 filings. That’s what we want to focus on today. We’re here to focus specifically on what we believe is going to happen with Chapter 11 commercial US filings. That’s what the bulk of our presentation represents.
As we start to think ahead for 2021, and we believe we can project what’s going to happen over the course of the year as it relates to Chapter 11 filings, our projections for 2021 are as follows.
We believe there’s going to be a notable increase in Chapter 11 filings. There’s a lot of reasons for that. We’re only going to address a few of them here that I think might be a little bit more interesting to talk through. Overall, we believe Chapter 11 filings are going to notably increase prior to the end of 2021. Same prediction that was in 2020, and hopefully, we’re not wrong, three times in a row. One of the things that is certainly going to increase filings across 2021 is going to be the completion of PPP 2.0.
We’re right now currently in the midst of issuing PPP to a lot of small businesses, 2.0. If there’s any indication of how it operated the first time, at some point within the next 60 to 180 days, we would expect this to end. When that ends, there’s going to be choices that need to be made by several organizations. We believe that’s going to create an environment where there’s going to be the opportunity for significant more filings. The other thing that is probably well known is currently in institutions and banks, there’s a lot of forbearance and moratoriums that have been issued and continually are extended.
Well, at some point, these are going to stop as well as there is more certainty in what the marketplace is going to shape up to look like, and there’ll be a little bit firmer projection that’s likely going to expose the fact that there’s going to be several institutions that are going to stop the continuation of these moratoriums and these forbearances that they’re issuing currently to a lot of their portfolios. That will certainly create an environment whereby Chapter 11 is likely to be a more viable option for several of these organizations.
Something that might not be as mainstream that may not be thought about is increased personal or consumer filings. Right now, very similar to PPP 2.0, there’s been a lot of government stimulus to consumers. That’s certainly propping up several families and or households as unemployment is at a much higher level than it was pre-pandemic. At some point, that’s just not sustainable to continue. We believe that there are going to be increased personal filings in 2021.
Well, with that, over the course of time, it’s pretty consistent that commercial filings follow in tandem with an increase of personal filings. With that, given that we’ve already seen that commercial filings were up in 2020, an additional increase in personal funds are likely to pull those commercial filings even higher. Lastly, something else that is not as mainstream today, usually talked about, is Subchapter V. What Subchapter V is, is a specific subchapter to the US Bankruptcy Code. It was enacted back in February of 2020.
Its purpose and design was to allow smaller businesses to be able to file Chapter 11 with more ease and the ability to move through the process a little quicker. The original intent was in lieu of Chapter 7. This is an area that Doug Goldin, LSQ’s general counsel, is going to focus on specifically a little later on in our presentation, but needless to say, Subchapter V grows in both popularity and knowledge increase because it’s a newer program.
We believe this will also promote an additional wave of Chapter 11 filings throughout 2021. It could probably go either way, but I’m coming down on the side that this is going to help promote that.
Now, speaking of the wave for 2021, waves come in all different sizes. Not really sure if this is a two-foot wave or a 22-foot wave, but certainly believe that prior to year-end, we’re going to see a notable increase in Chapter 11s. If we break 2021 down into a smaller trunk and we just focus on the next 90 days, the prediction here is generally that we’re probably going to remain in a status quo environment.
What does that mean? Perhaps some elevated filings. However, mostly it’s probably going to continue along with a wait and see type of approach. As I was doing a lot of research regarding Chapter 11 and just bankruptcy filings in general, I was reading not that long ago, maybe two, three weeks, the end of February, some information put out by Epiq, which by the way for anyone who isn’t aware, Epiq is a first-class resource for bankruptcy information in the United States.
If you’re ever looking for additional information, it’s good of a place as any to go to find statistical information. If there’s any folks from Epiq on the line, that was your unsolicited free plug. As I was reading, there was a specific article as it related to the projection of Chapter 11 commercial filings in 2021. Deidre O’Connor, who is the senior managing director of corporate restructuring at Epiq, in direct response to that question said, “We appear to be suspended in an air bubble at the moment.”
I think that’s a fabulous representation of what is going on currently. As it relates to Chapter 11 bankruptcy filings, we are suspended in an air bubble. One of the reasons for that is because there continues to be uncertainty in the marketplace, or uncertainty in general. As long as there’s uncertainty, that breeds hesitation, and when there’s hesitation, there’s the wait and see. That’s what drives some of the elements that we see that’s allowing organizations to have other alternatives other than Chapter 11 filings.
One of the other reasons why we expect it to remain status quo, again, the inversion of what I was just talking about why we expect before the end of 2021, Chapter 11 filings to increase as a whole. Over the next quarter, we projected it’ll remain flat or generally performing the way they have been performing the last few months. A large reason for that is PPP 2.0 in the process of distributing it now, and that’s going to provide these companies an extra 60, 90, 180 days worth of lifeline to where they won’t have to look for an alternative solution.
They can use these funds to continue to operate their business. Also at the institutional level, forbearance and covenants forgiveness is expected to continue through Q2, and why wouldn’t it? While there’s other options for a lot of organizations through PPP, and perhaps even some other alternative options, why wouldn’t they continue? In 2020, we saw the largest reserve, loan loss reserves by US banks, for at least the last decade, if not more.
They’re likely well-positioned when the time comes to be able to absorb some of these losses, but if they’re able to trade space for time in the interim, some of these firms might be able to pull themselves out of the trouble that they’re into by using PPP, and maybe some return later on to normalcy. It might actually lessen their losses. As long as there’s an outlet, it makes sense that some of these institutions for a variety of reasons, outside of the scope of this webinar, but reputational risk is certainly something that I’ve heard quite a bit of as to why these forbearances and covenant forgiveness is in the first place.
They’re going to likely continue on at least to the next quarter. Something that’s a little bit more anecdotal and much less documented is business owner resiliency. There’s at least been some information as businesses that have made it this far through the pandemic continue to fight and struggle to survive. Small business owners have always had the label of being resilient and being tough operators generally as a whole in the backbone of a lot of the economy.
For example, I spoke with two local business owners, both restaurant owners in the past few weeks. One of them that I had two very interesting that I think takeaways came from. The first part was he firmly believe that we’re near the end than we are at the beginning, and the fact that he’s been able to fight his way through this long, there’s no reason to give up now when there’s light at the end of the tunnel. I think that certainly can’t be the only business owner that might be thinking that way.
I think that’s going to continue to maintain the status quo with some of these folks continue to fight on. The second element to that was the ability that he believes that there’s also some help behind it and that there’s going to be continued help while we navigate through whatever this is till we get to the natural end of it.
When you combine those four, again, lots of other factors to help maintain the status quo.When you combine those with the other factors, we believe that it’s going to stay generally flat and we’re likely not to see any type of a material increase or even necessarily decrease over the next quarter.
Potentially Disruptive Events
Some disruptors to these projections, and on this particular slide that you’re viewing now, we’re going to break it down into two segments. The bottom left is a table which shows a couple of elements that might disrupt both to increase or accelerate filings or decrease or decelerate filings.
Then a graph on the right, which we’ll visit at the end after I’ve walked through the table in the bottom left. A couple of items that I think are worth note here to talk about that might disrupt these types of projections are, especially in the increase or accelerant side is, the first thing you have to look at I think is sector or industry performance. There were a number of industries that were in trouble pre-pandemic, retail, energy as it relates to oil and gas, that were already struggling when the pandemic hit.
Then there were several industries that were hit quite hard just directly from the pandemic. Restaurants, entertainment industry, real estate, for example, are some of these. I’ve also included healthcare. That’s going to be more of a 2021 focus, and I’ll touch on that in a moment. There’s a lot of fissures in these current industries right now due to the trouble they were experiencing pre-pandemic and the stress that has been added with the pandemic.
If these industries cannot hold out for whatever time is required to emerge on the other side to provide a little bit more certainty on who is going to fail and who might succeed, these can create a very significant tailwind for Chapter 11 filings. If these industries start to crumble at a much faster pace than anticipated, it can really increase the amount of filings that we’ll see. Something else that will provide an accelerant to Chapter 11 filings we believe is an increase in interest rates.
I mentioned earlier that one of the reasons why Chapter 11 or commercial filings were down in the first place, because the large amount of corporate debt that was being carried pre-pandemic. The pandemic has just served to push that to even further acute levels. If there’s an increase in interest rates, that’s going to push some of these companies who are- some companies are termed as zombie companies today. A zombie company being company that has a greater interest expense than their current revenue stream, to shorten it down in a single sense.
If these interest rates increase, that’s certainly going to push some of these entities over the edge. They’re not going to be able to- they’re already struggling to service- it’s going to create even additional struggles for not only the current lenders to these organizations, but the organizations themselves, and can really serve to increase the amount of filings that you might see. Again, many other factors that can increase or accelerate Chapter 11 filings, but these two seem noteworthy to me and of interest to discuss it in more detail here today.
From a decrease or decelerating aspect, the first thing that might serve to help suppress or keep down some of the filings is access to capital, both in the market or whether it comes from the market or come from the US government itself. The fact of the matter is, here we are, we sit, we’re issuing PPP 2.0. There could be a PPP 3.0 or 4.0, depending on the length of time that this pandemic is considered to continue. Also, that will certainly continue to suppress filings.
Something else is that, let’s think for a moment if institutions actually start to clean up their balance sheet a little bit and say, “Hey, we’ve got reserves, let’s start transitioning some of these, some of these tougher transactions out.” Well, if the market is ready, willing, and able to absorb these transactions, whether it be from an alternative lending perspective, or there’ll be some froth in the M&A market, there’s going to be better choices than Chapter 11 or filing for the protection of bankruptcy because they can, again, kick the can down the road further with another source.
That will serve to certainly decrease the amount of filings. Again, something more along the lines of a little bit more anecdotal is out of court solutions. It’s certainly not undocumented totally that there’s been organizations that have settled some of their challenges out of court, where they could have used the protection of bankruptcy, but they decided to work it out. That probably happens more at the very smaller business level where there aren’t as many creditors and more local businesses.
I would imagine that there’ll be national type businesses. Certainly, that can serve to help reduce the amount of filings. The fact of the matter is, throughout the pandemic, from the start even up to now, businesses have been shuttering. These are smaller businesses where they just simply stop operating. If and when the time comes to come back to some sense of normalcy, what might happen with some of these business, they may never even file.
They may just cease to exist and matters are taken into some creditors hands and they go and take care of what they need to take care of. This can also serve to decrease the amount of filings as well. Something that can work in either direction is going to be the US vaccination program. If the efficacy of the vaccine or the efficiency in which it is distributed is done very well, that’s likely to increase the amount of filings.
What that will probably do is create some level of certainty in the market, which means then that there’s going to be the ability for more solid projections to be made and there be a tally system as to which firms may or may not make it based on whatever the new normal is or return to the old normal or something in between. With that, I believe that it will increase the amount of fines because certainty will then show whether or not companies can survive.
However, if there is not very wide adoption of the vaccine as intended or there’s a botched, something occurs with the rollout, that delays it to some significant amount of time, then we talk about that uncertainty again. When there’s uncertainty, that’s where it’s likely to slow down because then other factors or forces might step in place to fill the void of the uncertainty in the interim. Similar to institutions implementing forbearance government, issuing stimulus to both consumers and to businesses and so forth.
That’s something that can go either way. We’re in the process of seeing how that’s going to work right now. I think the jury’s still out on that. Let’s focus and go back to the sector performance. If you take a look at the graph on the right side of the slide, what you’ll notice is in 2020 some of those industries and sectors that I mentioned initially that if they continue to slide at an increased pace can really accelerate the amount of filings. It’s noticeable here when you just look at some of these.
For example, there’s 300% to 400% increases in some of these industries in the filing 2020 versus 2019 year over year. Entertainment is one up by several 100 percentage point. Oil and gas 300% increase there. Not necessarily unexpected. The pandemic certainly pushed a lot of those over the top, they were already struggling to begin with. I would expect that these be the leading industries in 2021 as well that are likely going to lead the charge for commercial filings.
One that I mentioned earlier, healthcare, you don’t see here for 2020. Healthcare also was in trouble in 2020 as it started due to rising costs, lower reimbursements. There was even talent issues, a lack of talent to be spread around to a lot of locations. The government really stepped in and helped some of these facilities in a lot of these healthcare organizations survive out of necessity, especially during the pandemic, with their ability to pump some stimulus into these. In 2021, there’s some sense of normalcy that comes about this.
These weaknesses that were present going into 2020 will resurface in 2021, and they’ll have to be some tough decisions to make. These are going to really have to figure out how they’re going to continue to survive or do they seek the protection of bankruptcy in Chapter 11. With that, what I’m going to do next, we’re going to move to the Subchapter V element analysis of our part of the presentation. Doug Goldin, LSQ’s general counsel, will explain to us why it’s an important program, and some of the observations we can make with it. With that, Doug, I turn it over to you.
Legal Breakout: Subchapter V
Doug Goldin: Thanks, Tom, and thanks, everyone. There’s lots happening right now in real-time with Subchapter V. It’s an exciting time, I’m excited to share the key information with you today. Subchapter V of Chapter 11 went into effect in February of 2020. The goal primarily was to decrease costs for debtors and create more opportunities for small businesses to seek Chapter 11 relief.
There was a lot of changes to Subchapter V, but some of the key highlights include that fact that there is no unsecured creditors committee, unless one is appointed by the court, and there’s no US trustees fees paid by the debtor. That saves a lot of money for potential businesses looking to do a Subchapter V, particularly not having to worry about the unsecured creditor’s committee and paying for those attorneys. Additionally, there’s no requirement for the debtor to file a disclosure statement.
Again, something that’s very laborious and a time-consuming process. It eliminates the absolute priority rule. Owners now can retain their equity in the business over the objection of a claim of unsecured creditors without having to pay those creditors in full, so it gets more options to successfully emerge from Chapter 11. There are shortened timeframes to file and complete a plan. A plan or reorganization must now be filed within 90 days of the commencement of the case. All really good changes saves a lot of money. I think potentially, it’s all great opportunities.
Almost immediately after Subchapter V went into effect, COVID hit. As a result of all the stay-at-home orders, Congress passed the CARES Act. The CARES Act, in addition to creating the payment protection program and providing additional financial assistance for businesses and individuals, also amended Subchapter V by increasing the eligible debt limit for debtors from $2.7 million to $7.5 million. Now, businesses that have up to $7.5 million in debt can look at and potentially file a Subchapter V plan, which is great.
Unfortunately, the increase in the eligible debt of a Subchapter V debtor has a sunset provision, and at which time the debt limit will revert back to $2.7 million, and that happens in a couple of weeks on March 27. It remains at this point to be seen whether or not it will be extended. That being said, a couple of weeks ago on February 25th, a Democrat and a Republican senator introduced the COVID-19 Bankruptcy Relief Extension Act.
It’s a bipartisan legislation to temporarily extend COVID-19 bankruptcy relief provisions enacted in the CARES Act. As it relates to Subchapter V, the bill would extend the maximum debt limit of $7.5 million for another year. I think this is really promising because it has bipartisan support, which we have not really been seeing very much of in Congress lately. It also has the support of the American Bankruptcy Institute, or the ABI, which is the largest association of bankruptcy professionals.
In fact, last week on March 5th, the ABI sent a letter to the senators who introduced this bipartisan legislation and raised some I think great points. The first being that nearly 30% of all Subchapter V cases are filed by debtors whose debt exceed the original $2.7 million debt limit. According to the Executive Office of the United States trustees, cases filed under Subchapter V are experiencing higher plan confirmation rates, speedier plan confirmation, more consensual plans, and improved cost-effectiveness than if those cases had been filed in Chapter 11.
As a result of the increased debt limit, more small businesses are being successfully reorganized during the pandemic. I think that’s a good thing, and hopefully Congress will do its job, do the right thing, and keep the debt limit of $7.5 million in place for the next year. Moving to the next slide. The issue of PPP loan eligibility for bankrupt businesses. The courts are currently split on this issue as to whether the government can deny PPP assistance to bankrupt debtors. Back in December when Congress passed an additional round of COVID relief legislation, the issue was addressed, but it was not really resolved.
The new legislation allows, but it doesn’t require, and that’s key, debtors-in-possessions and trustees to obtain PPP funds, but it’s subject to the SBA’s determination that the debtor is otherwise eligible for the loan. Congress has an effect gave the SBA, who is the administrator of the program, the ultimate power to decide whether to approve PPP funds to companies currently in bankruptcy. On the most recent PPP borrower application form, which was updated last week on March 3rd, it inquires whether the business and its owners are currently in bankruptcy.
If you check yes, then the form states that the loan will not be approved. It appears the SBA plans to deny PPP loans to bankrupt debtors, despite the fact that Congress has expressly allowed businesses in bankruptcy to receive PPP funds. I think we’re going to see more litigation on this issue in the coming months, as I said, the courts are currently split, but I am also consciously optimistic that the SBA may come around on this issue and hopefully resolve that ongoing litigation.
In terms of the numbers of Subchapter V and the possible effect that COVID-19 is having on Subchapter V. There’s been 1,595 Subchapter V elections as of March 4th, 2021, according to the American Bankruptcy Institute. The top five States for Subchapter V cases are Florida, Texas, California, New York and Illinois. Sort of what you would expect. Small business centers I think need to be aware that the– As it relates to the amount of debt that they’ve incurred, again, the sunset provision that reverts to the debt limit from $7.5 million down to $2.7 million is coming up on March 27th.
Unless, of course, it’s extended. Maybe we see a short uptick of Subchapter V filings in the coming weeks, but hopefully, that limit is increased. Additionally, I think small business debtors should be cautious about PPP loans because although they have forgiveness provisions, the terms may be confusing. If the funds are not utilized according to the program, they may not be forgiven. If that happens, it’s definitely possible once the PPP funds dry up, we may see more of a surge of bankruptcy at that point.
Once that happens, if the PPP funds are not forgiven, then that would affect what the total debt- that could affect a decision to file, and of course, what the debt limitation is over Subchapter V at that point, and whether it’s 2.7 or 7.5. If it’s 2.7 at that point, that could force a lot of businesses into a traditional Chapter 11 bankruptcy or liquidation. We’ll have to see what happens there.
The graph on this slide is information from the ABI. You could see that the amount of filings for Subchapter V has been pretty steady over the past year. We’ll have to see again what happens with the debt limit. If that goes down, and hopefully as more people catch on as to the benefits of Subchapter V, we’ll see more filings. With that, I’ll turn it back to Tom.
What We’ve Encountered
Case Study 1
Tom: Thank you, Doug. For the final portion of our presentation, we’re going to spend a few minutes on a couple of DIP debtor-in-possession transactions that we’ve been a party directly to, and that we’ve done. We’ve selected two case studies today. Our first case study involves a 98-year-old catalog printer firm in the upper Midwest, about 100 million in annual revenue to give an idea of the size. In mid to late mid-2020, the company elected to file for Chapter 11 bankruptcy protection.
What ultimately drove them there was that at the end of 2019, they had projected significant growth across their customer base for 2020. They went out and purchased some additional real estate to gear up for this anticipated growth. Of course, pandemic hits at the end of Q1 2020. Company is unable to service its debt, and LSQ was asked by their current senior lender, which was at the time a regional commercial bank, to partner up with them to navigate through the Chapter 11 process.
The bank didn’t want to take full exposure. One of the reasons why was because LSQ was involved and engaged. By the time we actually funded, it was August of 2020, but they were entering into their very busy season. You can imagine a catalog printer, the holiday season is very big. A lot of their client base was in the retail sector. Some are industrial, and so the bank didn’t want to continue that exposure. We structured something with the bank. We were able to do it very rapidly. I think we negotiated the structure within four or five business days of being contacted.
Took a little longer than that, obviously, with all the parties to come to agreement on the structure. By the time that the company was ready to petition the court, we had a united front with current lender, us, LSQ, being the lion’s share lender for working capital on a day-to-day basis. We were able to show up with a solution ready for the court. That was the business case made for this. I’ll hand it over to Doug very quickly, who will talk about some of the legal solutions that we put in place.
Doug: On this case, it was a situation where- because we were retained and able to negotiate with the pre-petition lender ahead of time, it was really great because everyone was sort of able to get on the same page. You can’t predict every possibility of what’s going to happen in a bankruptcy. Being able to work if the DIP factor is different than the pre-petition lender, being able to work ahead of time and get on the same page and get the debtor on the same page, really is helpful and streamlines the case.
The difficulty in terms of the negotiation was basically determining who would get what between the pre-petition lender and the DIP financing company, LSQ, in a catastrophic event. Luckily in that case, we were able to come up with a really creative solution that made everyone feel comfortable enough to proceed.
Additionally, just in terms of the DIP financing order that was entered with the court, we were able to agree that there would be an escrow that would be put in place in which the administrative claimants, the attorney’s fees, the attorneys accountants, the turnaround folks, would all be able to obtain their fees from that escrow account.
That escrow account was tied to the DIP budget, and that would be the funds, and the only funds that the administrative claimants would look to for their fees. Having that tied to the budget and just getting that result on the front end, really, I think just made everyone worked together in a way that was really productive because there was no surprises.
I think the professionals were able to budget their time accordingly, and in a bankruptcy situation, the biggest problem is there’s not always enough money for everyone to go around. Getting that resolved on the front end, I think, was really helpful. Additionally, we put in benchmarks or milestones in the DIP order as far as deadlines that the debtor had to meet.
That helped move the case along as well. I think that was really a beneficial thing that was done. We tried to have releases. Everything that we could negotiate on the front end in the order, we put in. Again, it just went very smoothly. One little hiccup, in that case, was a landlord that was contesting where one lease was assigned and one lease was rejected. They made the argument that they were cross defaulted, and they both need to be assumed.
Again, you can’t anticipate every aspect of a bankruptcy. One thing I would recommend for anyone that’s considering providing to financing, or filing for bankruptcy is just have a due diligence checklist to make sure that the debtor has some feasible plan to deal with any angry landlords and creative arguments that they could make.
Tom: Thanks, Doug. The outcome on this one, again, LSQ funded in August of 2020. The company emerged after about six months in Chapter 11 to the completion of a successful 363 sale. They’re currently, they exited us, and the pre-petition lender, NewCo, was able to recapitalize and refinance the facility. Since then, they’ve been operating successfully for the last several months through 2021, and likely to continue on.
Case Study 2
Moving along to our second case and final case study. This was a 35-year-old solar panel and roofing business. The draw here was that a lot of their contracts were with major national building companies. They also did some residential work. This was about an $85 million a year annual revenue company. From a business perspective, the solution that we were able to provide, we came in actually after they filed Chapter 11.
They had filed Chapter 11, current senior secured lender had sufficient amount of fatigue. Gauged LSQ, we came in, and funded in July of 2020. We were the sole working capital provider. We were able to structure a solution that provided working capital to emerge as a company from Chapter 11 throughout the remainder of its case. One of the interesting facts here was we knew they had strong contracts with national builders.
Obviously, national builders are a little skeptical with firms that are in Chapter 11, are they or aren’t they going to emerge. One of our business challenges was as these contracts were being serviced, it was dependent upon the type of work that was being thrown our client’s way from these national builders. That significantly created variable costs in those amounts of payroll, based on the number of employees they had working, it would go up, it would go down over a week-to-week basis.
Obviously, their insurance costs would also go up and down. One of the most important needs was their material needs, to be able to complete the installation of the solar panels and or roofs. We were able to structure a unique solution and show our flexibility by changing our advance rate. Sometimes even over-advancing, past our comfort zone, but based on the underlying credit, we felt comfortable doing that.
LSQ today continues as a large portion after they’ve emerged from Chapter 11, as we continue to provide a source of financing for them in a fairly sizable amount. Doug, if you want to touch on the legal side here.
Doug: Sure. From the legal perspective, the issue really on this particular case was coming into the bankruptcy after it had already been filed, which as in case study one, it was great that we can negotiate ahead of time. With case study two, we didn’t have that luxury. It’s not to say that you can’t do it this way, but it does present different challenges, I think.
One of the bigger issues that I saw was by the time LSQ came into the bankruptcy, and after negotiating with the senior secure pre-petition lender, we had to deal with a significant amount of vendors, in this case, since this was a construction bankruptcy. Through the bankruptcy, a critical vendor motion was entered, which allowed certain vendors to receive payments on pre-petition transactions in order to complete those deals and move forward within the Chapter 11 debtor-in-possession.
When LSQ came in, there was a significant amount of negotiating and horse-trading, and create a solution that we had to look into in terms of how to make the critical vendor or work alongside a debtor-in-possession order, where funds were ultimately being sent to LSQ, but we were able to fund those critical vendors pursuant to the critical vendor order.
Through some creative negotiations and concepts, we were able to ultimately get that to the finish line. In this particular bankruptcy, there was a 363 sale, and we were able to work and negotiate with the buyer for that bankruptcy sale. It was another layer of complexity, another new party that came in, but ultimately, we were able to assign and assume our facility to the buyer and the 363 sale, who since now emerged from bankruptcy.
Tom: Thanks, Doug. The final outcome on this one, again, with LSQ funded in July 2020. For about eight months, they emerged from Chapter 11. As I mentioned, we continued to play a large role in their continued financing on the other side with NewCo. With that, that concludes our case studies. I will turn it over to Renee, who I believe has some closing remarks, and we move into our Q&A session.
Renee: Great. Thanks, Doug and Tom. One last question here. I think Doug, this question is for you. What are the biggest red flags that a DIP funder considers before seeking court approval to fund?
Doug: I think in addition to make sure that the collateral is good, but assuming the lender is comfortable with the collateral, I think being able to work with the pre-petition lender is key because it’s just a lot of time and expense to move forward and seek DIP financing if all parties aren’t on board.
If a global resolution cannot be reached between the debtor, the pre-petition lender, and the DIP factor, or the DIP lender, I think that it’s probably going to be tough and expensive and potentially not something that you’d want to get yourself into.
Renee: Thanks, Doug. I’m just looking here. Anymore questions in the queue, we’ll give it a moment, here and then we’ll wrap up. [silence] We just had another question come in. This is for you, Doug. How much legal expense is involved in an LSQ DIP facility?
Doug: I think it also depends. If you’re able to negotiate on the front end, it’s significantly cheaper, and depending if there’s in-house council involvement or if you’re solely relying on outside council. The fees can certainly add up quickly.
Another reason why if you’re able to negotiate or try to foresee any possible issues that may arise in the bankruptcy on the front end, it just saves so much time and so much attorneys’ fees in fighting those issues when you can try to resolve them on the front end. You don’t end up in a bankruptcy case that’s just languishing with all the attorneys fighting. That’s kind of when fees really rack up.
Renee: Absolutely. Agree. Thank you so much. I think those are all of the questions that we have. Just wanted to thank everyone again for joining our team today. We also will be sending out a recording of the webinar within the next 48 hours, so look for that in the queue. With that said, we appreciate everyone for joining. Have a wonderful day. Thanks so much.