distressed investing

Capital Structure Analysis and Debt Trading May 13, 2009

I. About the Speakers II.  Overview of Key Issues to Consider in Connection with a Capital Structure Analysis III.  Basic Issues for Distressed Bank Debt Market Participants IV. PowerPoint Presentation

Schulte Roth & Zabel LLP New York | Washington DC | London | www.srz.com
2009 Schulte Roth & Zabel LLP. All Rights Reserved.

I. About the Speakers

Kirby Chin 919 Third Avenue New York, NY 10022 212.756.2555 | kirby.chin@srz.com

Kirby Chin is a partner in the Finance Group at Schulte Roth & Zabel LLP. His practice focuses on secured financing transactions, including first-out/last-out and second lien and financings, term B financings, debtor-in-possession and exit financings, acquisition and leveraged buyout financings, hedge fund and fund of funds financings, capital call and liquidity facilities for private equity funds, asset-based and working-capital financings, factoring transactions, private placements and public offerings of senior and subordinated debt securities, and restructurings and workouts. Kirby recently represented private equity investors in connection with the senior credit facilities for the acquisition of Chrysler automotive and Chrysler financial services. Some of his other representative matters include: Representation of a financial institution in a $1.0 billion senior credit facility to a fund of funds secured by a pool of diversified portfolio fund investments. Representation of a media distributor in a $325 million senior financing facility, a $165 million secured bond offering and a $35 million holding company loan in connection with an acquisition by a private equity fund. Representation of a group of private equity investors in connection with financing their acquisition of LNR Property Corp. Representation of a lead agent in a syndicated $515 million debtor-inpossession financing facility to a chemicals and resins company. Representation of a private equity fund in a $190 million senior credit facility for working capital liquidity. Representation of a lead agent in a syndicated $125 million senior credit facility to an independent oil and gas company operating offshore and in the United Kingdom. Representation of a lead B agent in a syndicated $190 million senior credit facility to an automobile hauling and transportation company.

Kirby earned his J.D. from the New York University School of Law, in 1995, where he served on the Journal of International Law and Politics, and his B.A., cum laude, from New York University in 1992. He is a member of the American Bar Association and the New York City Bar Association.

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

David J. Karp 919 Third Avenue New York, NY 10022 212.756.2175 | david.karp@srz.com

David J. Karp is a special counsel in the Business Reorganization Group at Schulte Roth & Zabel LLP. His practice concentrates in corporate restructuring, special situations and distressed investments, distressed mergers and acquisitions, and bankruptcy aspects of structured finance. Representative transactions include: Represented owner and operator of hotel properties with respect to Ch. 11 bankruptcy reorganization and restructuring of approximately $1 billion of debt. Represented investment fund in providing debtor-in-possession financing to tier 1 automotive supplier. Represented investment bank in the sale of distressed CDO portfolio. Represented investment fund with respect to foreclosure upon natural gas leasehold interests in the Fayetteville Shale formation. Represented national retail propane distributor with respect to Ch. 11 bankruptcy reorganization and the restructuring of $550 million of debt. Represented retail center owner in connection with sale of real property under Section 363 of the Bankruptcy Code. Represented chemical manufacturer in refinancing $625 million of secured debt. Represented secured noteholders of pager company in connection with the company's debt restructuring. Represented numerous private equity firms and investment funds in top-tobottom review and analysis of capital and organizational structure for investment in distressed debt securities. Represented various parties in securitization and CMBS transactions, including providing advice in connection with bankruptcy-remote structures, and true sale and nonconsolidation issues. Represented various parties in structuring and addressing bankruptcy aspects of derivative contracts, including swap agreements, repurchase agreements and securities contracts.

David earned his J.D. from Fordham University School of Law and his B.S. from Cornell University. He is a member of the American Bankruptcy Institute and The Loan Syndications and Trading Association.
Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

Ronald B. Risdon 919 Third Avenue New York, NY 10022 212.756.2203 | ronald.risdon@srz.com

Ronald B. Risdon is a partner in the Finance Group at Schulte Roth & Zabel LLP. His practice concentrates in syndicated credit facilities, public and private offerings of debt securities, asset-based lending, and restructurings and bankruptcy, including debtor-inpossession financing. Representative transactions include: Represented agent lender in an exit term loan facility for a specialty printer. Represented automotive manufacturer and automotive financial services business in connection with financing from the U.S. Treasury under TARP. Represented term lender in exit financing for a wire manufacturer. Represented private equity investors with respect to a euro-denominated. credit facility in connection with the acquisition of an Austrian banking group. Represented agent bank in connection with a debtor-in-possession credit facility in a pre-arranged Chapter 11 case and the exit financing for the reorganized company. Represented borrowers in connection with the issuance of yen-denominated senior secured floating rate notes to finance investment in a Japanese bank. Represented private equity investors in connection with the senior credit facilities for the acquisition of Chryslers automotive and financial services businesses. Represented private equity fund in connection with senior secured credit facilities and high-yield notes to finance the acquisition of a provider of information management and business process outsourcing services. Represented major money-center bank in the Enron Corp. Chapter 11 cases, including representing the bank as agent in four structured transactions, and in connection with the sale of the Enron corporate headquarters. Represented agent lender in an asset-based facility for a nationwide school bus operator.

Ron is a graduate of University of Virginia School of Law and the College of William & Mary. He is a member of the American Bar Association and the New York City Bar Association.

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

II. O  verview of Key Issues to Consider in Connection with a Capital Structure Analysis

Overview of Key Issues to Consider in Connection with a Capital Structure Analysis

Kirby Chin
This article briefly summarizes some critical issues that an investor should consider before making an investment in the securities of a distressed company. I. Identification of a Potential Investment

Whether the potential investment is a bond, note, tranche of debt comprised of a senior secured loan, mezzanine loan, subordinated indebtedness or other debt investment in the capital structure, the essential starting point for an investor is determining whether the documents governing such debt security1 afford the investor sufficient protection and rights necessary to achieve the desired outcome (i.e., its investment realization or exit strategy). After an investor identifies the potential debt security, it is often necessary to engage legal counsel to review of the underlying documents governing the debt security to determine whether it has the essential characteristics to serve as the security in which to invest. The protections and rights of a debt security are typically set forth as covenants and other agreements in the applicable credit documentation and the primary credit document may take the form of a credit agreement, a note purchase agreement or an indenture. Because of the potential complexity of credit documents, it is important to set forth the proper scope of review.2 It is important to identify the investors exit strategy; the anticipated realization of value from the proposed investment will set the scope of the review. The exit strategy may be a loan-to-own, a debt restructuring, debtor-in-possession financing or a trade and quick realization of value. It may also entail offering the company an incremental loan facility with attractive fees or in exchange for an issuance of warrants or other equity securities. II. Analysis of a Potential Investment To determine whether a potential investment in a distressed company would serve to realize value, the investor should:
1

Examine the basic structural considerations related to the organization and business of the company. Determine the rights of the debt holder against the company.

While the term security usually refers to notes issued pursuant to 144A or private-for-life offerings, for purposes of this article, any investment in a debt instrument, regardless of whether it was issued pursuant to a securities offering, will be referred to simply as a security or a debt security. One challenge may be obtaining all the documentation relevant to the debt security. Even if the debt security is issued by a public company, there may be a limited number of documents publicly available. While the companys periodic filings may summarize the terms of the documents, such summaries often lack the level of detail necessary to conduct an appropriate review. It is important to examine the actual provisions of the agreements. If the company is not public, the investor will need to obtain the relevant documents by other means.
2

Review the rights of the debt holder against other investors.

A. Basic Structural Considerations Generally, there are two areas to consider in examining basic structural considerations: (i) the organization of the company and its subsidiaries, and (ii) the nature of the business and the type of assets of the company. 1. The Corporate Organization The corporate organization of a company and its subsidiaries is an important component of understanding, and potentially unlocking, the value of the debt security. An organizational chart will help identify where the issuer (and any guarantors) of the debt security are located in the corporate enterprise and the ownership of each such entity and its subsidiaries. To the extent there are other outstanding debt securities in the corporate enterprise, identifying entities that are the obligors under those other debt securities will help an investor to analyze potential competing claims that may have a priority over the claims of the debt security which an investor may purchase. Identification of the entities that own the assets and conduct the business operations is important in determining the value supporting the debt securities. Moreover, an investor should consider the location of assets and operations. Deriving value from foreign assets or operations or from guarantees by foreign entities might add a layer of complication to an investors attempt to realize value. Another important reason for inquiring into the corporate organization is to determine whether structural subordination exists. For example, structural subordination would exist where the issuer of the debt security is a parent holding company, with all of the assets and operations residing at the issuers subsidiaries. If the issuers subsidiaries have outstanding debt securities (or other creditor claims, secured or unsecured), then the holders of those subsidiary debt securities (or other subsidiary creditor claims) would have a priority claim to the assets of such subsidiaries, effectively subordinating the claims at the parent holding company level. The structural subordination concern may be moderated to the extent a debt security is guaranteed by the issuers subsidiaries that own the assets and conduct the operations. Separately, the investor should determine which entities are restricted or subject to the covenants in the applicable credit documentation. The greatest level of protection would be if the issuer were the top-level parent and the covenants restrict all of the subsidiaries in the corporate enterprise. However, if the corporate enterprise were organized into separate siloswith the issuer having a sister company with its own subsidiariesthe covenant coverage may not reach the assets and operations of the sister company and its subsidiaries. In that case, an investor needs to determine whether the assets or operations upon which it is relying are owned by the issuer and its subsidiaries (and not by entities in a separate silo). Alternatively, if the covenants are applicable only to a certain group of restricted subsidiaries, an investor needs to ensure that the credit documentation provides firewalls or ring-fencings to prevent the leakage of value from the issuer and its restricted subsidiaries on the one hand to the unrestricted subsidiaries on the other. 2. Nature of the Business and Assets The nature of a companys business is another factor in understanding the value of a debt security. Certain businesses or assets may require governmental consents in the event of a change in ownership (e.g., businesses licensed by the Federal Communications Commission, gaming authorities or state liquor authorities). To the extent the investor envisions an exit strategy entailing an own-to-loan scenario or a sale of the company, there may be significant waiting

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|2

periods to obtain the necessary consents from the appropriate governmental authorities to consummate the transaction. To the extent the debt security is secured, the potential investor should also carefully consider the scope of the collateral package and the type of assets owned by the company. Tangible, or brickand-mortar, assets may be more easily manageable than intangible assets, such as intellectual property rights. If the debt security is secured not by all assets but just certain specific assets (e.g., accounts receivables, a pledge of stock of the parent company, cash and bank accounts), an investor should determine whether the assets would provide sufficient value or would ensure that the investor can execute its exit strategy. For example, to the extent the investor purchases a debt security prior to a bankruptcy filing to better position itself to fund a debtor-in-possession financing facility in a bankruptcy, thereby exerting certain controls over the company during those proceedings, it may be essential to ensure that the pre-bankruptcy debt security is secured by liens on the companys bank accounts and to determine whether the company may maintain significant cash or other assets in foreign jurisdictions outside of the reach of any creditors lien. As a practical matter, identifying the assets that are not part of the collateral package is as important as identifying the assets that are part of the package. B. Rights Between the Investor and the Company The second area to focus on is the rights the investor would have under the proposed debt securitys documentation. 1. Restrictive Covenants and Events of Default Under Existing Documentation Below are brief descriptions of relevant covenants typically contained in credit documentation for loan instruments as well as bond securities. (a) Indebtedness. Indebtedness covenants limit the amount of indebtedness a company may incur that may be senior to, or pari passu with, the subject debt security. Any permitted indebtedness must be evaluated to determine whether it is senior or junior to, or pari passu with, the proposed debt security in terms of payment, lien priority or both. A popular feature in credit facilities during the past several years are accordion or incremental term loan facilities, which are essentially uncommitted lines of credit where a company may incur, to the extent it identifies willing lenders, more debt on substantially the same terms as any existing loan under the same credit facilities. An investor should be cognizant of any ability of the company to incur such additional indebtedness and understand fully the terms and pricing of such loans and the dilutive effect that such incurrence would have on the value of the debt security the potential investor may purchase. Typically, loans made under these accordion/incremental facilities share, pari passu, in the liens securing the outstanding loans, which would dilute the value of the loans to the extent the investor is considering an investment in an outstanding loan. (b) Liens. Credit documents usually include limitations on the incurrence of liens on the companys assets which are designed to protect the priority position of the investor regardless of whether the debt security is secured. Typical lien covenants prohibit all liens other than any applicable to the debt security and certain ordinary course carve-outs (e.g., for taxes and other governmental charges, non-material liens related to real property, capital leases or purchase money debt). The investor needs to identify additional negotiated exceptions to determine the amount of secured debt which may be dilutive to collateral available to the potential debt security, if secured, or which may be potentially senior in recoveries to the debt security if the debt security which is being considered for investment is not secured.

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|3

In certain bond indentures there are equal and ratable lien covenants, requiring a company to grant liens to the secure bonds that may initially be unsecured to the extent the company agrees to grant liens to secure other debt exceeding a certain dollar threshold. A restructuring of a debt security may trigger an equal or ratable lien provision diluting the collateral which may otherwise be available exclusively to secure the debt security. Many of these provisions are written as an affirmative requirement to provide an equal and ratable lien, and remain silent on whether such liens may be released to the extent the companys debt is restructured so that it is below the triggering dollar threshold. There has been at least one instance where the court has upheld the position that when outstanding debt no longer triggers the requirements to provide an equal and ratable lien to the bondholders, the liens securing the bonds may be decollateralized.3 (c) Anti-Cash Leakage Covenants. There are several covenants which usually govern the ability of the company to use its cash: investments, restricted payments, affiliate transactions and mandatory prepayments. (i) Investments. Investment covenants restrict the use of cash to purchase certain non-ordinary course assets. These covenants also usually limits the acquisition of the equity of a company or the purchase of all or substantially all of the assets of a division or business unit of a company or the entering into of a joint venture with a third party. (ii) Restricted Payments. Restricted payments typically refers to equity-based payments, such as dividends, distributions or repurchases or redemptions of equity. Other broader restricted payment covenants might restrict any payments to sponsors, including management/sponsor fees, transaction fees and expense reimbursements, and any payments on indebtedness subordinated to the applicable debt security or any optional or early repayment of pari passu indebtedness. In many indentures, the concept of restricted payments will include the investment prohibitions as well. (iii) Affiliate Transactions. Similar to restricted payments covenants, the principal concern addressed by an affiliate transaction covenant is the monitoring of a companys ability to excise money from the corporate enterprise by entering into preferential arrangements with its affiliatespayments that would be more than the affiliates would be entitled to receive in arms length transactions. Credit documents typically permit affiliate transactions only on an arms-length basis. Sometimes the covenant imposes further restrictions such as requiring that transactions be in the ordinary course of business or, to the extent exceeding a certain dollar threshold, be approved by the board of directors or considered fair by an investment bank. (iv) Prepayments upon Certain Events. While not strictly an anti-cash leakage covenant, debt documents commonly require prepayments of the outstanding debt securities in certain circumstances, such as asset sales, receipt of insurance or condemnation proceeds, issuances of indebtedness or equity, generation of excess cash flow or after a change of control. Some debt documents may require the company to make a mandatory prepayment of the debt securities and other debt documents may require the company to tender for the debt securitiesa put right. A company may have some relief from this provision in the form of reinvestment rights, where the company

The Indenture was drafted to take a look at a single benchmark. It states that when over 15 percent of the [Consolidated Net Tangible Assets] are liened, the Equal and Ratable Lien is automatically in place. It follows, therefore that when less than 15 percent of the CNTA are liened there is no right to an Equal and Ratable Lien. . . . The Indenture Trustees own representative . . . conceded that the release of the Equal and Ratable Liens was a routine event * * * anticipated by the terms of the [Indenture]. . . . [I]f the circumstances are right, [the Debtor] decollateralizes * * * the Company is entitled under the terms of its document, to do this, and they did. Wilmington Trust Co. v. Solutia Inc. (In re Solutia Inc.), 2007WL 1302609 (Bkrtcy S.D.N.Y.), 10 (2007).

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|4

would be permitted to avoid a mandatory prepayment or a tender by buying assets useful in the business. (d) Fundamental Changes. Other covenants govern the ability of the company to change its fundamental operations. These include restrictions on non-ordinary course asset sales, fundamental changes (such as mergers or consolidations) and change of control. (i) Non-Ordinary Course Asset Sales. Asset sale limitations aim to ensure that the assets of the company on which investors made their credit decisions and, in the case of secured investors, the assets on which their liens have attached, are not depleted without replacement of value during the term of the investment. Debt documents usually limit asset sales outside of the ordinary course of the companys business without the consent of investors. (ii) Fundamental Changes. Covenants prohibiting mergers, consolidations, sales of all or substantially all assets, or dispositions of a business unit or a division ensure that the company seeks advance consent of the investor before making significant changes to its corporate or capital structure. In indentures, the fundamental change provisions typically do not prohibit such transactions. Instead, the provisions require any new entity with which the issuer engages in a fundamental transaction to assume the obligations of the debt security and agree to be bound by the terms of the indenture. In some indentures, there may be an additional financial measure requirement (e.g., that the new entity has the same or better consolidated net worth). (iii) Change of Control. To make sure that the companys sponsor or management group remains in place, change of control provisions may be tied to the current equity holders control of the board of the company, a drop below a certain ownership percentage, or any other equity holders gaining ownership of more than a certain percentage. A change of control may also occur where the majority of directors are no longer the directors that were in place at the time the transaction originally closed, when the current directors were not appointed by the original board members at closing, or when a key management personnel no longer works with the company. In loan transactions, a change of control typically results in an event of default that allows all of the loans under the facility to be accelerated. In bond documents, on the other hand, a change of control often gives each bondholder an option to put the bonds to the companytypically at 101% of the principal amount of the bond. (e) Financial Covenants and Equity Cures. Most credit facilities have some financial covenants that set baseline financial levels to give lenders an early warning system to a potential problem company. Almost categorically, breaches of financial covenants result in an immediate event of default. In the past few years, many credit facilities contain no financial covenants (or one financial covenant which may not be tested until the occurrence of some event), commonly referred to as covenant-lite loans. In addition, in deals where financial covenants exist, some companies negotiated the right to cure financial covenants defaults with contributions of cash by the sponsor into the company (in the form of common equity or subordinated debt). The exercise of such cure rights, if permitted at all, are usually limited in frequency and by a maximum amount that may be injected on any single occasion or over the life of the loan. A cash infusion by the sponsor often increases the companys EBITDA or decreases its net indebtedness, which, in turn, provides the company relief on its financial covenants. Other indirect cures that may be in credit documentation may take the form of aggregating baskets over several covenants or increasing the size of certain baskets by

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|5

adding the portion of excess cash flow not subject to a mandatory repayment or adding the amount of an equity contribution. While none of these may have as direct an impact on the financial covenants on the company, the added flexibility could permit the company some ability to manage through a difficult financial situation which would have benefited the company beyond the financial covenants. It is important to understand the implications of covenant-lite loans and cure rights (whether direct or indirect). These mechanisms provide a measure of relief to a company and potentially delay or frustrate the ability of an investor to engage in meaningful dialogues with the company to restructure the credit or otherwise affect change. In most credit facilities, financial covenants are established as maintenance covenants, in effect, requiring the company to achieve a measure of financial success. On the other hand, in most bond indentures, there are no financial covenants with financial measures being used for incurrence based tests operative only to the extent the company desires to take certain actions. Incurrence-based tests provide much more flexibility to a company since the company does not need to maintain a benchmark, but would just be restricted from taking certain action. Maintenance covenants would require the company to perform at a certain financial level and a failure to do so would result in a default. (f) Loan Assignments and Participation Restrictions. Many credit facilities may restrict the holder of a debt security to entities meeting certain eligibility requirements, such as financial institutions with a certain amount of capital or investment funds that ordinarily invest in debt securities. Some credit facilities may even require consent from the company in order for a lender to assign its debt securities. These hurdles may hamper the liquidity of the debt security to the extent the investor intends to assign the debt to a third party. (g) Ability of the Company to Purchase its Own Debt. Loan assignments and participation provisions in credit facilities agreement should be carefully reviewed to determine if the company has the ability to purchase its own debt securities. Such an option may be attractive to a company if its loans are trading below par. An investment in its own loans could enable a borrower to avoid more expensive prepayments at par and could potentially permit the company access to privileged communication which would otherwise be reserved solely among the lender group. Additionally, a company could receive a benefit under its financial covenants by repurchasing its own debt below face value. Some credit facilities attempt to restrict the ability of the company or an affiliate from purchasing its own debt, limiting the ability to vote the debt it has acquired and control the dissemination of sensitive information about the company. In many bond indentures, the right to vote by affiliates of the issuer is limited as it relates to an affiliate by deeming such securities not to be outstanding for purposes of voting. C. Rights Between the Investor and Other Investors In expanding the scope of review, the other area of concern should be on the rights of the potential investor against other investorsboth within the same class of indebtedness and in separate classes of indebtedness. 1. Other Investors Within Potential Investors Class of Security (a) Lender Voting Rights and Required Lenders. Understanding the voting structures of debt securities is critical and an investor needs to examine the operation of these provisions carefully. Voting will be especially important in the context where an investor seeks to take a controlling position in a facility or purchases a stake sufficient to control any restructuring. Generally, amendments, waivers or other modifications require the consent

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|6

of the required lenders, which is a negotiated percentage based upon outstanding commitments and/or the outstanding principal amount of debt, usually set at holdings owning a majority of such interests but sometimes more. If a particular credit facility has two different tranches of debt (e.g., a revolver and a term loan), the voting arrangements of some of these credit facilities may be subject to class voting; that is, in order to amend, waive or modify a provision, a percentage of the revolver commitments and a percentage of the outstanding term loan must vote in favor of such change. There are a number of other variations to a required lender formulation. Certain characteristics of investments are considered fundamental and usually require unanimous consent to amend, waive or modify (or at least the consent of each lender being affected). These fundamental rights (sometimes referred to as sacred rights) often include: changes to the amount of the loan or commitments, to the extent unfunded, extensions of the maturity date and scheduled repayment dates, reductions in the interest rate and fees, and the release of liens (to the extent such debt is secured) or a release of guarantors comprising a substantial portion of the value of the guaranties. Investors should pay close attention to changes requiring the approval of all lenders. In particular, in a distressed investment, potential investors should review the percentage of lenders required to accelerate the debt and exercise remedies, impose the default rate of interest or exercise other enforcement rights and remedies. Often, bonds issued under indentures require less than a majority of note holders to accelerate the obligations after the occurrence and during the continuance of an event of default. In syndicated loan transactions, borrowers often negotiate rights to minimize the impact of holdout lenders, and thereby preventing such lenders with small interests from controlling credit decisions. The so called yank-a-bank provisions generally enable the borrower to force a holdout lender in unanimous consent situations to assign its loan to a new lender at par to the extent the borrower identifies a new lender that satisfies the criteria in the loan documents and operation to permit the borrower to lower the lender consent percentage required for modifications which require the unanimous vote of the lenders to a lesser percentage. (b) Forbearance in Troubled Loan Situations. At the time the potential investor considers making an investment in a distressed company, the company may be in default under its debt documents. As a result, the company may be negotiating accommodations from its lenders. In such situations, lenders and the company often enter into forbearance agreements under which the lenders, among other things, agree not to exercise remedies for a limited period to give the company some breathing room for negotiations with the lenders and other creditors, or others implementing other restructuring efforts. Prospective investors should be familiar with the terms of any such forbearance, including those during the forbearance period and events allowing the lenders to terminate the forbearance, such as the occurrence of other events of default or the failure of the company to achieve certain restructuring milestones. In cases where a company has several debt facilities, prospective investors should review the terms of the forbearance agreements under the other facilities to determine whether lenders under another facility have the right to exercise enforcement rights while the lenders in the other facility are under a forbearance. 2. Investors in Other Classes of Securities A potential investor must be aware of the rights of other investors in other classes of the companys securities which may ultimately impact the potential investors rights. This section briefly summarizes some of these rights, which may be documented in an agreement among the potential investor and the other investors, or which may be set forth in separate security documents to which the potential investor is not a party.

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|7

3. Intercreditor and Subordination Agreements. Investors in two or more classes may have an intercreditor/subordination arrangement to govern the rights between them. These arrangements may take the form of debt subordination, lien subordination or a combination of both. The terms of such arrangements vary considerably. In the absence of an agreement, the indebtedness would be pari passu and the liens would be governed by the lien priority rules at law. (a) Some examples of debt subordination provisions are as follows: (i) Application of Collateral Proceeds. The debt holders typically agree that the senior debt holders must be paid in full before any proceeds are to be paid to the junior debt holders. Sometimes these provisions require the junior debt holders to turn over any proceeds received by them in violation of this priority of payment. (ii) Payment Blockage. Senior debt holders may have rights to block payments to the junior debt holders upon a default or event of default under the senior debt documents or an acceleration of the senior debt. The length of a blockage period usually varies depending on the triggering event. If the triggering event is a payment default, the blockage period may be indefinite. On the other hand, if the triggering event is a covenant default (without an acceleration of the senior debt), the blockage period may be for a certain number of days, and the number of blockage periods may be limited. (iii) Waiver and Amendment Limitations. Senior and junior debt holders may agree to certain limitations in amending their respective debt documents without the consent of the other class. Junior debt holders often agree not to amend their debt documents in any material respect without the consent of the senior debt holders. Some restrictions that may be agreed to by the senior or junior debt holders are restrictions on increasing the amount of senior debt, changing the interest rate and fees above an agreed-to cushion, accelerating the amortization schedule and shortening the maturity date. (b) Some examples of lien subordination provisions are as follows: (i) Acknowledgment of Liens and Relative Priorities. Senior and junior lien holders provide mutual acknowledgements of their respective liens and their relative priorities (as to each other) and agree not to challenge those liens or priorities. (ii) Remedies Standstills. The senior lien holders may restrict the junior debt holders from exercising remedies for a certain period. The standstill typically continues beyond the expiration of the applicable period if the senior debt holders have commenced and are pursuing remedies against the company. (iii) Collateral Access Rights. Senior and junior lien holders typically agree to provide mutual access rights to any shared collateral. (iv) Asset Sales and Releases of Liens. Usually, senior lien holders have the right to make determinations regarding the release or disposition of shared collateral during the period when neither class is exercising remedies. (v) Buy-Out Rights. Intercreditor agreements may provide a junior lien holder with rights to buy out the senior lien holders debt typically exercisable after the occurrence of an event of default, an acceleration or other similar trigger. The purchase price for such debt is usually at par value. (vi) Senior Debt Cap. Junior lien holders may require the senior lien holders to agree to limit the total amount of outstanding senior lien debt, which often is limited to the

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|8

maximum permitted principal amount (sometimes based on a borrowing base formula) of the senior debt plus a cushion. The cushion may apply to a refinancing or to debtor-in-possession financing extended by the senior lien holders. (c) Some intercreditor arrangements include agreements if and when the company files for bankruptcy. Some typical bankruptcy provisions are as follows: (i) DIP Financing. Separate investor classes may agree that the senior debt holders may provide debtor-in-possession financing to the company within a certain dollar limit and agree not to object to such DIP financing or the priming liens granted in connection therewith. In exchange, the junior debt holders may negotiate protections such as receiving the same replacement liens as the senior debt holder receives or restricting a roll-up of the senior debt holders pre-petition indebtedness. (ii) Adequate Protection. In bankruptcy, secured creditors may be entitled to adequate protection against diminution in the value of their collateral during the case. Adequate protection may take many forms, including replacement liens or current cash interest payments on the outstanding principal amount of the pre-petition indebtedness. Senior debt holders may attempt to negotiate a waiver by the junior debt holders of their rights to receive adequate protection for their junior debt. (iii) Use of Cash Collateral. To run its business in bankruptcy, a company may need to use its own cash cash collateral of the existing secured lenders. Under the Bankruptcy Code, a company cannot use cash collateral unless the secured creditors consent or the company provides such creditors with adequate protection for such use. Oftentimes, junior debt holders waive their rights to object to the companys use of cash collateral in bankruptcy if such use is supported by the senior debt holders. (iv) Plan Voting. While atypical, some senior debt holders may be successful in requiring junior debt holders to waive certain voting rights on a plan of reorganization or to waive voting rights with respect to the appointment of a trustee. (v) Classification of Claims. The parties may agree that the senior lien holders and junior lien holders agree to support a motion to place each of them into separate classes of claims under a plan of reorganization for plan voting and distribution purposes which may make it easier for a senior debt holder to have its plan approved. (vi) Section 1111(b) Elections. In bankruptcy, if a secured creditor is under-secured, it has a two-part claim. The first part is a secured claim equal to the value of the collateral, and the deficiency is the unsecured second part. Under section 1111(b) of the Bankruptcy Code, a lien holder has the option of waiving the unsecured deficiency component of its allowed claim and electing to have its entire allowed claim treated as a secured claim. 4. Rights of Other Investors Not Set Forth in Intercreditor Agreements. A potential investor must also be aware of the rights of other investors set forth in documentation underlying the companys other securities which may impact the potential investors rights under its debt security. These rights may not be in the form of an intercreditor or subordination agreement, but may be set forth as a provision in the operative credit documentation. However, a practical effect of the operation of these provisions may serve to alter intercreditor rights. Cross-default and cross-acceleration provisions in debt securities other than the debt security in which an investor may purchase could undermine the leverage of the investor. If a separate class of debt securities cross-defaults or cross-accelerates upon an event of default or an acceleration of the debt security in which the investor holds, any negotiation or reorganization is complicated by the necessity of accommodating the cross-defaulted or cross-accelerated debt.

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|9

In addition, anti-layering provisions, which are usually in bond indentures and mezzanine loan documentation, could have an impact on restructuring the debt of a company. These provisions typically prohibit companies from incurring debt that is senior in right of payment to existing subordinated bond debt but junior to the companys senior secured debt. These provisions effectively eliminate the creation of a middle class of debt securities and may limit what the company may be permitted to issue to the extent, for example, the company is making a debt exchange as part of its reorganization. While rare, other investors may benefit from more restrictive covenants that were thought to be solely for the benefit of the one particular class of debt securities pursuant to the applicable most-favored nation clause. Most-favored nation clauses provide that if any other debt security enjoys more advantageous provisions, such as covenants which may limit more actions by the company or defaults with lower thresholds, that debt security is automatically amended to include such more advantageous provisions. In short, provisions such as those described in this section could provide rights to other classes of the companys security holders that may not be evident from a review of the credit documentation governing the debt security that the investor may purchase. III. Conclusion It is essential for an investor to understand the full scope of rights that a debt security may have at its disposal. It is also essential to understand the full scope of limitations. Equally important is an identification of rights and limitations that may be absent. Many of these rights and limitations are set forth in the governing credit documentation, as well as intercreditor and subordination arrangements. Some of these rights and limitations may be structural, arising as a function of a companys corporate organization or line of business. Conducting a thorough review of the credit documentation and the structural organization of a company will ultimately ensure the investor that the identified debt security is a worthwhile investment.

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

| 10

III.  Basic Issues for Distressed Bank Debt Market Participants

Basic Issues for Distressed Bank Debt Market Participants

David J. Karp
Bank debt trading is largely unregulated, but industry participants and trade associations such as the Loan Syndications and Trading Association (LSTA) have developed standards and guidelines to streamline the trading of bank debt.1 This alert highlights some important issues that debt trading market participants should consider as they trade. It is for general informational purposes only, and does not constitute, nor should it be relied upon as, formal legal advice or a formal legal opinion. For trade-specific advice, please consult with legal counsel regarding such trades particular circumstances. I. Determination of Proper Documentation (Par vs. Distressed)

There are two kinds of bank debt trades: par and distressed. Each requires different documentation and raises different issues. Par trades require less documentation than distressed trades, as they only require a Confirm, Assignment Agreement and a pricing letter, whereas distressed trades require a Purchase and Sale Agreement (PSA), which is a standard LSTA form, but includes trade-specific terms along with standard terms and conditions. In general, the distressed PSA provides for representations, warranties and indemnities relating to ownership, principal amount, funding requirements and the bad acts of prior holders. The choice of trade documentation is within the discretion of the parties. A potential for bankruptcy is the main reason credits will trade on distressed documents. When negotiating the transaction, the parties should consider a full range of factors regarding the borrower and the loan, including market price, current or anticipated defaults, ratings downgrades and negative earnings trends or a spike in CDS levels, to determine whether par or distressed documentation is appropriate.2 There is no bright-line test. Generally, once the parties have agreed, the type of trading documentation is binding regardless of subsequent changes in the financial condition of the borrower or its business environment. II. Upstream Review and Step-Up Provisions for Distressed Trades Often, the loan that is the subject of a trade has been traded previously, perhaps multiple times. Upstreams are the documents pursuant to which previous trades were completed. At some point, a credit may shift from par to distressed (the Shift Date). Once a credit shifts, trades should be completed on distressed documents. For many large credits, once a credit shifts, the LSTA conducts anonymous polls of dealers to assist in a determination of when certain credits began trading on distressed documentation. The results of these Shift Date polls are available to facilitate discussions between sellers and buyers and have no binding effect. Distressed trade buyers must review upstreams to confirm that previous trades were documented on distressed documents at any time after the credit

1 2

Additional information may be found on the LSTA website at www.lsta.org.

At the end of the fourth quarter of 2008, 57% of loans traded on the secondary market had a price of less than 70 cents on the dollar, while only 8% had a price greater than 90 cents on the dollar. See the 1Q09 LSTA Secondary Trading & Settlement Study. At the end of the first quarter of 2009, 39% of loans traded on the secondary market had a price of less than 70 cents on the dollar, while 28% had a price greater than 90 cents on the dollar. See the 1Q09 LSTA Secondary Trading & Settlement Study. Even though loan default volume slowed in April 2009, loan defaults still rose to their highest levels ever, with a default rate of 8.03% by principal amount. See S&P Leveraged Commentary & Data; May 1, 2009.

shifted from par to distressed. Trades on par documents after the Shift Date are defective and considered less marketable. A buyer may request the inclusion of Step-Up Provisions in the PSA to cure defective trades. Step-Up Provisions make a sellers representations, warranties, indemnities and other covered provisions apply to the current sale and to each previous sale after the Shift Date as of the date on which the closing conditions have been satisfied. Step-Up Provisions are designed to put the buyer in the same position it would have been in without the defective upstream. III. Timing and Delayed Compensation The Trade Date is the date on which the buyer and broker agree to the material terms of the trade. According to LSTA standards, par trades are supposed to close in T+7 (Trade Date plus 7 days), and distressed trades in T+20 (Trade Date plus 20 days) (each date, a Settlement Date). In practice, trades rarely close on the Settlement Date. For example, according to a recent LSTA report, the current mean time to close a distressed trade is T+48.3 Despite the prevalence of delays, the buyer must compensate the seller for a trade that does not settle by its Settlement Date, unless the trade confirmation provides otherwise. This compensation is intended to put the parties in the same economic position they would have been in had the trade closed by the Settlement Date, and is calculated pursuant to LSTA guidelines. IV. Assignment vs. Participation If the buyer meets the assignee eligibility requirements of the underlying credit agreement and obtains requisite consents, the trade may close as an assignment. As an assignment, the buyer becomes a party to the credit agreement as a lender with the same rights as the original lenders, and the seller transfers to the buyer all of its right, title and interest under the loan.4 If the buyer does not meet the eligibility requirements to take by assignment, the trade may close as a participation or other structure agreed upon by the parties. As a participation, the buyer receives a beneficial and economic interest in the loan but does not become a party to the credit agreement. The seller remains the lender of record and the agent continues to deal solely with the seller. Generally, an assignment is preferable to a participation because the seller is removed from the process. Because funds first flow through the seller, a participation subjects the buyer to greater risk, such as commingling of funds and payment delays, as well as uncertainty as to whether the participation would be characterized as a true participation by a court. If the participation is not a true participation, a court could find that the underlying asset is part of the bankruptcy estate of an insolvent seller, and the buyer would have the same status as other unsecured creditors of the seller. V. Taint of Claim by Prior Holder Investors in the distressed bank debt trading space should be aware that, over the past several years, there have been significant developments in the law related to investor risk exposure when purchasing distressed bank debt. In 2006, the U.S. Bankruptcy Court for the Southern District of New York ruled that good faith purchasers of bank debt were not protected from equitable subordination of their claims in a bankruptcy proceeding if a prior holder of the claims had acted fraudulently (i.e., the taint caused by the prior holder ran with the claim). The U.S. District Court for the Southern District of New York in Springfield Associates L.L.C. v. Enron Corp.5 reversed the bankruptcy courts ruling and reinstituted some protection against equitable subordination for good faith purchasers of distressed bank debt.

3 4

See the 2008 LSTA Secondary Trading & Settlement Year-in-Review.

The scope of the rights that are subject of a sale/assignment agreement and the Fabrikant case regarding this issue are discussed further below. In re Enron Corp., 379 B.R. 425 (S.D.N.Y. 2007).

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|2

The District Court ruled that even if a transferred claim would have been equitably subordinated in the hands of the prior holder, a subsequent purchaser of the claim who had no notice of the taint would be protected against equitable subordination in a bankruptcy proceeding. Although the District Courts ruling was seen as a win for traders in the distressed debt trading market in the wake of the worrisome bankruptcy court ruling, it was not a complete victory and investors should be aware of the rulings implications. The District Court made a distinction between a transfer by assignment and sale. An investor taking distressed bank debt by assignment would take the claim subject to the limitations it had in the hands of the assignor, namely subject to a taint caused by the assignors unlawful or fraudulent actions. In contrast, an investor who purchases a claim under a sale takes the claim free of the taint. Therefore, the claim assigned would be subject to, and the claim sold would be insulated from, equitable subordination. While the District Court did not give much guidance as to how investors can limit their exposure to equitable subordination by ensuring that their trades go forward as sales rather than assignments, investors should be careful to describe their trades as sales and notify their counterparties that their trades should be deemed such. More recent authority from the 7th U.S Circuit Court of Appeals has further helped to alleviate concerns about the threat of equitable subordination of distressed bank debt by creating a limited safe harbor for purchasers of distressed bank debt while sidestepping the question of sales versus assignments addressed by the District Court in Enron. In In re Kreisler, the 7th Circuit held that a creditor that acquired a secured claim against a debtor by assignment would not be subject to having its claim equitably subordinated to those of other creditors in the bankruptcy case, despite arguably inequitable conduct engaged in by the original holder of the claim, unless evidence of actual harm to other creditors arising from inequitable conduct was established in the case.6 The Kreisler court used the terms sale and assignment interchangeably, indicating that the court did not view the distinction as dispositive, but instead focused on whether the inequitable conduct by the original holder that tainted the claim actually harmed other creditors. If Kreisler ultimately receives positive treatment by other courts, purchasers of distressed bank debt can expect to receive protection from equitable subordination in the event that harm to other creditors cannot be shown. After Enron and Kreisler, the trend appears to be to provide greater protection from equitable subordination to purchasers of distressed bank debt. However, as these matters are far from settled, investors should continue to be mindful of the Enron rule and other developments in this area as they invest in distressed bank debt. VI. Counterparty Risk An entity that files for protection under Chapter 11 is permitted to assume (affirm) or reject (disaffirm) its executory contracts.7 There is a risk in maintaining open trades with a counterparty who may file for bankruptcy protection. The risk is that the counterparty will be able to renege on the open trade, and refuse to fund a purchase if prices have gone down (or refuse to sell if prices have gone up) since the Trade Date. The risk is magnified by the ability of a debtor to wait until the end of the bankruptcy case to decide how to proceed with executory contracts, such as open trades. VII. Information Access Considerations Bank debt trades presently fall outside the scope of federal securities laws, which prohibit securities transactions based on material non-public information (MNPI). Information may be considered MNPI if there is a substantial likelihood that a reasonable investor would consider the information important in making an investment decision, and such information has not been made available to general investors. Bank debt investors may gain access to MNPI and, therefore, need to take precautionary measures to
6 7

In re Kreisler, 546 F.3d 863 (7th Cir. 2008). See 11 U.S.C. 365.

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|3

limit the use of such information for other trades considered securities transactions. Bank debt investors should take appropriate measures to minimize potential exposure to MNPI. Some firms establish information walls to separate traders that have received MNPI from those parts of the firm that trade solely based upon public information. Bank debt investors may gain access to Syndicate Information, which is borrower information made available to lenders and potential lenders, subject to a confidentiality agreement. In addition to Syndicate Information, an investor may gain confidential borrower information that otherwise has not been made available to members or potential members of the syndicate (Borrower Information). An investor may gain access to such information in an advisory capacity or through participation on a steering committee or creditors committee. Engaging in a sale transaction with a counterparty lacking the same information (either Syndicate Information or Borrower Information) could potentially raise common law fraud and/or misrepresentation concerns. To resolve this issue, some parties have resorted to the use of big boy letters, in which both parties acknowledge that they are sophisticated investors who may not have access to the same information regarding the borrower, specifically disclaim any reliance on the others disclosures or omissions, and represent that they are entering into the transaction despite the information disparity and its potential effect on the value of the transaction. If drafted correctly a big boy letter may be useful in defending a fraud claim brought by a counterparty arising from the purchase and sale of distressed bank debt. To increase the likelihood of enforcement, the parties should clearly describe the type of information being withheld (i.e., business plans, earnings projections, financial statements) as well as the withholding partys relationship with the issuer (i.e., committee member, advisor, board member). VIII. Transferred Rights Under the standard LSTA documents for sale/assignment transactions, the seller transfers to the buyer all of its rights (the Transferred Rights)8 except those explicitly retained in the transfer documents. The standard documents provide for customary retained rights known as the Retained Interest.9 Recently, in In re M. Fabrikant & Sons, Inc.,10 the Bankruptcy Court for the Southern District of New York examined the standard LSTA documents to determine whether a sellers reimbursement rights were transferred along with the debt sold. In Fabrikant, the court authorized the debtors to use cash collateral pledged to its lenders as security for pre-petition loans, and granted the lenders, as adequate protection, an administrative priority claim for reimbursement of certain expenses, including attorneys fees (Reimbursement Rights). Soon thereafter, the lenders sold their loans on the secondary market pursuant to standard LSTA documents. The creditors committee later sued the lenders seeking to avoid the liens securing the pre-petition loans. The lenders incurred substantial legal fees in defending these actions. When the debtors plan of reorganization failed to provide for the payment of the lenders legal fees, the lenders objected. The lenders argued that the legal fees constituted Reimbursement Rights, that the Reimbursement Rights were a Retained Interest not transferred to the buyers, and that the failure to provide for the payment of such fees rendered the plan not confirmable. Rejecting the lenders arguments, the Bankruptcy Court held that the Reimbursement Rights did not need to be paid to the lenders under the plan because these

Transferred Rights is defined as any and all of [s]ellers right, title, and interest in, to and under the [l]oans and, to the extent related thereto, the following (excluding, however, the Retained Interest (if any)): (e) all claims (including claims as defined in the Bankruptcy Code 101(5)) and any other right of [s]eller against [b]orrower, any [o]bligor, or any of their respective [a]ffiliates See LSTA Purchase and Sale Agreement for Distressed Trades Standard Terms and Conditions. Retained Interest is defined as if Settled Without Accrued Interest is specified in the Transaction Specific Terms, the right retained by [s]eller to receive. . . . payments or other distributions, whether received by setoff or otherwise, of cash (including interest), notes, securities or other property (including Collateral) or proceeds paid or delivered in respect of the Pre-Settlement Date Accruals or the Adequate Protection Payments (if any); provided that the Retained Interest shall not include any PIK Interest. See LSTA Purchase and Sale Agreement for Distressed Trades Standard Terms and Conditions.
10 9

In re M. Fabrikant & Sons, Inc., 385 B.R. 87 (Bankr. S.D.N.Y. 2008).

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|4

rights fell squarely within the definition of Transferred Rights in the LSTA standard agreement and the Bankruptcy Codes definition of claim11 and, therefore, were assigned to the buyers of the loans. This decision confirms that the scope of rights assigned to a purchaser under LSTA documents is broad, and provides caution to sellers who may want to explicitly carve out certain rights aside from the Retained Interest as part of a trade. IX. Conclusion The world of bank debt trading contains a number of legal issues that require careful diligence as well as the assistance of counsel. Credit documents as well as trading documents need to be read and carefully analyzed in order to implement an effective investment strategy.

11

Claim is defined as (a) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or (b) right to an equitable remedy for breach of performance if such breach gives rise to a right of payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured. See 11 U.S.C. 101(5).

Distressed Investing Seminar: Capital Structure Analysis and Debt Trading 2009 Schulte Roth & Zabel LLP. All Rights Reserved.

|5

IV. PowerPoint Presentation

Disclaimer
This information has been prepared by Schulte Roth & Zabel LLP for general informational purposes only. It does not constitute legal advice, and is presented without any representation or warranty whatsoever as to the accuracy or completeness of the information. Distribution of this information is not intended to create, and its receipt does not constitute, an attorney-client relationship between SRZ and you or anyone else. Electronic mail or other communications to SRZ (or any of its attorneys, staff, employees, agents or representatives) resulting from your receipt of this information will not, and should not be construed to, create an attorney-client relationship. No one should, or is entitled to, rely in any manner on any of this information. Parties seeking advice should consult with legal counsel familiar with their particular circumstances.
2009 Schulte Roth & Zabel LLP. All Rights Reserved.

Capital Structure Analysis

Presented by Kirby Chin Ronald B. Risdon

Organizational Considerations Corporate organization Nature of a Companys Business Asset and Operations

Organizational Considerations Corporate organization Nature of a Companys Business Asset and Operations

Covenant Package to Review Indebtedness Liens Financial covenants Investments

Interlender and Intercreditor Rights Unanimous lender actions Required lender actions

Interlender and Intercreditor Rights (cont) Debt subordination Lien subordination Bankruptcy provisions Other rights

Distressed Investing: Trading Considerations

Presented by David J. Karp

Purchasing Distressed Bank Debt

Par vs. Distressed Trades

Par Trades:
- Still performing and paying

Distressed Trades:
- Loans which are in bankruptcy or otherwise considered to be in financial distress - Price is not a reliable indicator

What Makes a Credit Distressed Price is not a reliable indicator, so look at:
Bankruptcy Potential need for restructuring or bankruptcy Is there a default or anticipated default? Ratings downgrade Negatives trends: earnings, ratings, macro pressures on the industry (ex. newspapers, gaming, automotive) Spike in CDS levels Market convention Shift Date Polls

Documentation
Par
- Confirm, Assignment Agreement, Pricing - No upstream review

Distressed
- Confirm, Purchase and Sale Agreement, Assignment Agreement, Pricing - Upstream documents are reviewed - Seller provides reps and warranties

Time to Settlement
Par Timing
T+7

Distressed Timing
T+20

Bankruptcy Bankruptcy is the overriding concern and the main reason a credit trades with distressed documents When the music stops, creditors are at risk of equitable subordination, recharacterization or vote designation

Benefits of Distressed Documents Expanded and clarified description of what you are buying (litigation rights; rights against upstream parties) Representations, warranties, indemnities which include:
Ownership, principal amount, no further funding, no litigation, no bad acts, no set-offs, no consents required, no other documents

Rights against prior holders

No Protection on Distressed Documents Generic credit risk Deficient collateral or structure

Upstream Review Upstreams are the documents pursuant to which the debt was previously traded Par trades do not require upstream review Distressed trades require upstream review Are step-up reps needed?

10

Step-up Provisions
The Shift Date
The date on which a credit shifts from par to distressed If an upstream trade was done on par documents after the Shift Date, the trade is defective

Step-Up Provisions
Cure the defect Make Sellers representations, warranties, indemnities and other covered provisions speak to both the Seller and covered prior Seller Uninterrupted chain of distressed upstreams from the Shift Date onward Marketable to downstreams

Assignment vs. Participation

Assignment Participation

- If Buyer is eligible, the trade will close - If Buyer cannot meet the assignment as an assignment requirements - Buyer becomes a lender with the same rights as the original lenders - Agent, Borrower consent is generally needed - Buyer may fail to qualify as an eligible transferee by assignment for reasons unique to Buyer (e.g., it lacks a sufficient credit rating) or unique to the trade (e.g., does not meet minimum trade or posttrade holding requirements of the Credit Agreement would not be satisfied) - Buyer receives a beneficial and economic interest in the loan but does not become a party to the Credit Agreement

11

Loan Repayment Flow of Funds Risk

Assignment
Non Bankruptcy

Participation

Bankruptcy of Existing Lender

Transferred Rights

To Sell Is To Sell It All

12

Confidentiality and Ad Hoc Group Issues

Why Form an Ad Hoc Group? Common interests with a stronger unified voice Pool resources and expenses Shape or veto plan of reorganization Not appointed by U.S. Trustee

13

Treatment of Confidential Information Restricted or Unrestricted?

MNPI restricted from trading in securities Free trading vs. informed decisions Negotiated Access to Information Shielding/Forced Disclosure Sunset

Syndicate Confidential Information Available to lenders, potential lenders and brokers, pursuant to a confidentiality agreement May contain MNPI More limited exposure to a fraud claim or violating securities law when trading bank debt

14

Borrower Confidential Information Usually includes MNPI that has been made available to a lender because of its position on a steering committee or creditors committee of the Borrower If a party trades on the basis of MNPI gleaned from Borrower Confidential Information, it may be susceptible to allegations of
(i) breach of fiduciary duty to the borrower, to the bankruptcy estate or to other creditors or; (ii) fraud claims

Borrower Confidential Information Breach of Fiduciary Duty

Bankruptcy Courts may approve information blocking procedures and permit trading upon the establishment of screening walls

Fraud
A big boy letter may provide protection in certain instances

15

Big Boy Letters Keys to Enforceability

Clear description of type and quality of information being withheld
business plans earnings projections or financial statements

Non-disclosing partys relationships with the issuer

committee member advisor member of the Board of Directors

Counterparty acknowledges it has had the opportunity to conduct its own diligence

Bankruptcy Rule 2019 Verified statement setting forth:

Names and addresses of the creditors or equity security holders represented Nature and amount of the claims or interests Amounts paid for the claims and interests Any sales or other disposition of the claims or interests

16

Rule 2019 Disclosure of Trading Positions As of this date the application of Rule 2019 to ad hoc groups remains unsettled Does not explicitly require disclosure of short or hedging positions 2007 Scotia/Northwest 2009 and beyond?

17

This information has been prepared by Schulte Roth & Zabel LLP (SRZ) for general informational purposes only. It does not constitute legal advice, and is presented without any representation or warranty whatsoever as to the accuracy or completeness of the information. Distribution of this information is not intended to create, and its receipt does not constitute, an attorney-client relationship between SRZ and you or anyone else. Electronic mail or other communications to SRZ (or any of its attorneys, staff, employees, agents or representatives) resulting from your receipt of this information will not, and should not, be construed to create an attorney-client relationship. No one should, or is entitled to, rely in any manner on any of this information. Parties seeking advice should consult with legal counsel familiar with their particular circumstances. The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions. 2009 Schulte Roth & Zabel LLP. All Rights Reserved.