A FRESH PERSPECTIVE ON AMERICAN ROADS AND UNITRANCHE FINANCING IN BANKRUPTCY

In a recent decision in the American Roads Chapter 11 case, the Bankruptcy Court for the Southern District of New York enforced no action provisions in a unitranche financing deal, raising concerns for subordinate investors in other unitranche deals. This article explores the implications of the decision on future transactions.

As unitranche lending comes to join more traditional multi-tranche lending structures, courts will have occasion to demonstrate the legal differences between these structures in bankruptcy and other enforcement contexts. The recent decision in the American Roads Chapter 11 case, from the Bankruptcy Court for the Southern District of New York, may provide some guidance in this area since it enforced no-action provisions in a so-called insured unitranche deal in a way that has raised substantial concerns for lenders.

Nonetheless, while the American Roads decision is certainly troubling in some ways for subordinate lenders in unitranche financing deals, the decision is based on a very specific deal structure, which differs substantially from traditional unitranche financing deal structures. As a result of these differences, subordinate lenders in traditional unitranche financing deals should be able to avoid much, although certainly not all, of the harsh treatment that the subordinate creditors received in American Roads.

This article will provide an overview of the American Roads decision and, more importantly, will consider how the outcome in American Roads would have likely differed, given a traditional unitranche financing structure.

The American Roads Decision

In 2006, American Roads, LLC and certain of its affiliates issued two series of bonds and, for each series of bonds, also entered into corresponding swap agreements. Syncora Guarantee, Inc. insured the obligations underthebondsandthe swaps. All of American Roads' obligations under the bonds and the swaps and its obligation, if any, to reimburse Syncora as insurer were secured by a single lien on all of American Roads' assets. The rights of the bondholders and Syncora vis-à-vis American Roads and each other were governed by a set of financing documents that included a payment priority waterfall, which generally provided that Syncora had payment priority over the bondholders so long as Syncora was not in default as insurer.

In addition, the financing documents included multiple "no-action" provisions. Among other things, the no-action provisions provided that, so long as Syncora was not in default as insurer: (i) Syncora had "the power to control and direct all remedies in the Event of Default"; (ii) no bondholder had any right to institute any enforcement proceedings; and (iii) the bondholders irrevocably appointed Syncora as the "sole holder" for all purposes. In other words, the bondholders delegated to Syncora substantially all of their rights against American Roads.

Ultimately, American Roads was unable to meet its obligations under the bonds and swaps-generating only $14.2 million in EBITDA and paying $35 million in debt service in 2012-and defaulted on the swaps. Syncora, thereafter, performed its obligations under the swap insurance policies by paying a swap termination payment to the swap counterparties and, as a result, accrued a $334 million reimbursement claim against American Roads. Soon thereafter, Syncora and American Roads negotiated a prepackaged chapter 11 plan that would discharge Syncora's reimbursement claim in exchange for 100% of the equity in reorganized American Roads. The proposed plan would also separately classify the bondholders' claims and discharge them without making any distributions to the bondholders.

Because the bondholders were deemed to reject the proposed plan, only Syncora voted to approve the proposed plan, and immediately thereafter American Roads commenced a chapter 11 case in Manhattan, asking the Bankruptcy Court to confirm the proposed plan. Very quickly, litigation commenced between American Roads and Syncora on one side and an ad hoc group of bondholders on the other. The ad hoc group raised a number of objections to confirmation of the proposed plan, including an objection to the valuation underlyingthe proposed plan -i.e. American Roads could not distribute to Syncora new equity that was worth more than Syncora's reimbursement claim.

Before the Bankruptcy Court would consider the ad hoc group's confirmation objections, it considered the "threshold" issue of whether the ad hoc group even had standing to participate in any aspect of the Chapter 11 case. The Bankruptcy Court began its decision by recognizing that:

The Court confronts a unique financing structure known as an 'insured unitranche.'Typically, a debtor's creditors will fall into several tranches, each corresponding to different liens. Here, however, all of the secured creditors' claims are secured by the same lien, through the same trustee and collateral agent, on the terms set fort in the prepetition financing contracts. Those contracts, therefore, are the sole basis of these creditors' interests and rights, which the [bondholders] have curtailed as part of a quid pro quo with Syncora

Ultimately, the Bankruptcy Court, relying on the specific provisions in the financing documents, held that bondholders did not have standing to participate in American Roads' Chapter 11 case or to object to confirmation of the proposed plan. Thus, no party in interest with standing remained to object to confirmation or, in particular, the valuation of the new equity distributed to Syncora, and the Bankruptcy Court confirmed the proposed plan.

Implications of the American Roads Decision on Unitranche Financing Deals

At first glance, the American Roads decision seems a terrible outcome for the bondholders and an extremely bad precedent for junior lenders in unitranche financing deals. In particular, the Bankruptcy Court did not simply hold that the bondholders lacked standing to object as secured creditors; rather, it held that the bondholders did not have any standing whatsoever to appear in the cases. In addition, the Bankruptcy Court did not simply confirm a plan that made one distribution to Syncora and the bondholders collectively on account of their shared lien. Instead, the Bankruptcy Court actually applied the financing documents' waterfall provisions and determined that the bondholders were not entitled to any distributions, without, of course, giving the bondholders an opportunity to be heard on the matter.

However, the outcome may not be as harsh as it seems at first blush. From the bondholders' perspective, the decision did not actually mean they would receive nothing on account of their bonds because Syncora's guarantee persisted. Although the ad hoc group questioned Syncora's creditworthiness, the bondholders will certainly receive some distribution from Syncora and possibly payment in full.

More importantly, the American Roads decision actually has limited applicability to traditional unitranche financing deals due to substantial structural differences with the insured unitranche deal structure in American Roads. In the insured unitranche structure, Syncora and the bondholders actually had separate claims against American Roads and only shared a lien-in other words, the insured "unitranche" was not actually a true unitranche deal. In comparison, traditional unitranche financing structures, used as an alternative to a first-lien/ second-lien structure, typically involve only one claim against the borrower, often bearing a blended interest rate. Because traditional unitranche financing deals only involve one claim against the borrower, the rights and payment priority between junior and senior lenders is not determined simply by lien priority or a subordination agreement. Instead, those rights and payment priority are governed by a completely separate document, often called an agreement amongst lenders. The borrower is most often not a party to the agreement amongst lenders and may not even know the agreement exists.

Because the insured unitranche in American Roads actually involved two claims, American Roads was able to separately classify the claims and make disparate distributions to Syncora and the bondholders. And by so doing, Syncora was able to implement the financing documents' waterfall provisions and obtain judicial approval of that implementation, without giving the bondholders an opportunity to be heard. Although no court has considered the particular issue, a different outcome would likely result in a traditional unitranche financing deal because the junior and senior lenders do not have separate claims. As a result, a borrower could not separately classify the junior and senior lenders or confirm a plan that provides disparate treatment amongst the lenders.

Although junior lenders in traditional unitranche deals will likely fair better than the bondholders in American Roads, the American Roads decision still has some implications for junior lenders. Most saliently, the Bankruptcy Court in American Roads enforced the extremely broad no-action provisions in the financing documents. As a result, although junior lenders likely cannot be separately classified from senior lenders, the American Roads decision is a well-reasoned precedent for the enforceability of strong no-action provisions in an agreement amongst lenders, leaving junior lenders to rely on senior lenders to prosecute their collective unitranche claim against a borrower.

"This article will provide an overview of the American Roads decision and, more importantly, will consider how the outcome in American Roads would have likely differed, given a traditional unitranche financing structure."

Glenn Siegel is a partner in Morgan Lewis's Business and Finance Practice and co-head of the firm's Bankruptcy and Restructuring Group. He is resident in the firm's New York office.

Patrick Fleming is an associate in Morgan Lewis's Business and Finance Practice, resident in the firm's New York office.