Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Restructuring & Insolvency, November 2010
Credit bids in relation to overleveraged businesses have become a hot topic following the economic crisis of 2008. Credit bidding is the process in which secured lenders (or their nominees) acquire assets of a business by applying their priority debt and security as a bid in kind instead of purchasing the assets by advancing funds which would flow through the estate and be distributed to the secured lenders and applied to reduce the indebtedness owed to them.
Capital structures of business have become much more complex and diverse over the last 10 years. Businesses may have numerous levels of secured debt allocated over various assets and, in some cases, there may also be assets which remain unsecured.
This fall, the Quebec Superior Court and Court of Appeal rendered judgments in the White Birch Paper proceeding under the Companies' Creditors Arrangement Act (CCAA) that reviewed a number of issues which had arisen in an auction process that compared a "winning" bid comprised of cash and a credit bid to an "inferior" or "bitter" bid that was all cash, but of slightly less value.
Both levels of courts reaffirmed the use of credit bids in insolvency proceedings in Canada and provided some helpful guidance in interpreting the new section 36 of the CCAA relating to court-sanctioned sales of assets in CCAA proceedings.
White Birch Paper (and related Canadian entities) obtained CCAA protection on February 24, 2010. On the same day, its affiliated U.S. entities, referred to as Bear Island Paper, filed for protection under Chapter 11 of the U.S. Bankruptcy Code. Approximately 80% of the business and assets are in Canada and approximately 20% are in the United States. The combined U.S. and Canadian enterprise (the White Birch Group) were indebted to first-lien lenders in the approximate amount of $480-million and to second-lien lenders in the approximate amount of $100-million.
The first liens and second liens covered the fixed assets of the White Birch Group, but not the current assets, that is, the accounts receivable and inventory. Both the Canadian and U.S. courts approved a first-ranking superpriority debtor-in-possession (DIP) financing over all of the assets (of which a total of approximately $85-million dollars was advanced). As the current assets were unsecured (after the DIP paid out a smaller ABL facility secured against the current assets), the payment of the DIP would first be made by recoveries over those assets.
A Sales and Investor Solicitation Process (SISP) for the sale of the assets of the White Birch Group was approved by both the Canadian and American courts. Pursuant to that process, a stalking horse bid was made by BD White Birch Investment LLC (BD White Birch) which had been formed by members of the firstlien lenders holding about 65% of the first-lien loan. Members of the first-lien lenders holding about 10% of the first-lien loan, submitted a qualifying offer through an entity named Sixth Ave. Investment Co., LLC (Sixth Ave). As a result of the delivery of the qualifying offer, Sixth Ave became a qualified bidder and an auction was held on September 21, 2010, in New York City between BD White Birch and Sixth Ave.
Court-approved bidding procedures also provided that a secured creditor could bid up to the full amount of its secured debt for the purchase of property secured in its favour, that is, the fixed assets. Therefore, as the current assets were only secured by the DIP, the monitor and the White Birch Group required that any bid contain a cash component that would need to be at least equal to the estimated liquidation value of the current assets.
At the end of the auction, BD White Birch was declared to have the winning bid. Its bid was for total consideration of approximately US$236-million. It contained a cash amount of US$94.5-million and a credit bid of US$78-million allocated to the fixed assets in Canada plus certain assumed liabilities and cure costs.
The alternative bid by Sixth Ave was for total consideration of approximately US$235.5-million ($500,000 less) and included a cash amount of US$175-million plus certain assumed liabilities and cure costs and payment of a break fee. White Birch sought approval of the BD White Birch bid by the Quebec Superior Court on September 24, 2010.
Sixth Ave objected and argued that the credit bid should not be accepted and the bids should not be compared by looking at the total consideration in each. Instead, they argued that the court should consider the benefits arising from each bid for each class of creditors, especially for the unsecured creditors, a class of which all lenders participate to the extent of their unsecured portion of the syndicated loans. The estimated value of the current assets was greater than the amount advanced under the DIP. Therefore, there was an issue about how much cash would ultimately be distributed to the unsecured creditors, as closing would occur at a later date, and the value of the current assets, the amount of the DIP and the resulting surplus for unsecured creditors would have to be crystallized. Sixth Ave argued that, under its bid, unsecured creditors would receive a dividend of approximately 5% instead of a de minimis dividend at best under the BD White Birch bid. These objections and characterizations were rejected and the BD White Birch bid was approved.
Sixth Ave sought leave to appeal the approval of the BD White Birch bid. They argued that Justice Mongeon of the Quebec Superior Court failed to properly apply the tests under the new section 36 of the CCAA, and erred in law by failing to take into account the fact that the fixed assets are worthless and the BD White Birch credit bid would, in effect, enable BD White Birch to acquire the current assets at a reduced price to the detriment of the unsecured creditors.
In addition, Sixth Ave argued that BD White Birch placed themselves in a position to prefer their interests over the interests of the other first-lien lenders by allocating the credit bid only to the Canadian fixed assets, thus allowing BD White Birch to keep the U.S. fixed assets for themselves. By keeping the U.S. fixed assets for their exclusive benefit and to the prejudice of the other first-lien lenders, Sixth Ave argued that BD White Birch breached their fiduciary duties as sub-agent for the agent of the other first-lien lenders.
The Honourable Pierre J. Dalphond, J.A. of the Quebec Court of Appeal, dismissed the motion for leave to appeal on October 25, 2010, and delivered reasons on November 1, 2010, in which he stated that Sixth Ave did not meet the test for the granting of leave to appeal as the appeal of Sixth Ave was not prima facie meritorious and would unduly hinder the progress of the reorganization of the debtors as a going concern.
Specifically, Mr. Justice Dalphond set out the following six reasons to support his dismissal of the motion for leave to appeal:
- The use of credit by a bidder was approved within the process approved by the court and therefore could not be determined to be unreasonable after the fact.
- The court did not accept Sixth Ave's contention that the fixed assets were worthless, especially considering that, even under the Sixth Ave offer, US$35.3-million in cash had been allocated for those assets and was not supported by the evidence presented to the court. Unless the credit allocation could be proven to be unreasonable and unfair, taking into account their market value as required under section 36 of the CCAA, the court ruled that it should not be disturbed, especially since the monitor's report stated that, in its opinion, the winning bid represents the highest and best offer when gauged against total overall value return to the debtors.
- Although Sixth Ave would have an unsecured deficiency claim, the court held that they were not the class of unsecured creditors which Parliament wanted to protect under section 36(3)(e) (which directs the court to consider the effects of the proposed sale on creditors and other interested parties) of the CCAA and that, had the winning credit bid been for the full amount of the credit, the first-lien lenders would not have qualified as unsecured creditors, and no ordinary unsecured creditor had opposed the proposed sale to BD White Birch.
- To refuse to approve the BD White Birch bid would mean that a new bid process or at least a new auction would have to be held since the court could not see how it could declare the Sixth Ave bid to be the winning bid. It was noted that this delay and uncertainty could compromise the reorganization of the White Birch Group.
- The court held that the allegation of a breach of fiduciary duty by BD White Birch, as sub-agent of the lenders, by bidding the claim against only the Canadian fixed assets, was not an insolvency matter to be dealt with under the CCAA, but should be determined by the forum designated under the terms of the agreement between the lenders participating in the syndicate of first-lien lenders.
- The court summarized Sixth Ave's opposition to the sale of the assets to BD White Birch as a desire to receive a bit more cash upfront, as unsecured creditors, rather than a minority equity interest (as the first-lien lenders would end up being equity holders). However, the court ruled that this was not a factor to be considered, as, according to the lenders' agreement, the majority shall prevail, that is, the members of the syndicate that form BD White Birch.
Overall, this case reaffirms that courts and their monitors will recognize credit bids against assets which are secured by such credit. In appropriate circumstances, a bid may also have to contain a cash component if there are unsecured assets or assets secured by other lenders. It is critical that the terms of the sale and bidding process be approved upfront by the applicable court.
Historically, courts have not been empathetic to losing or bitter bidders, unless there is a concern about the fairness in the application of the court-approved process.
Bitter bidders will likely continue to find it difficult to successfully challenge the approval of a winning bid for the assets of a company in CCAA proceedings that conforms to the court-sanctioned sale and bidding procedures. Process issues, such as the use of credit bids and the allocation of the purchase price to assets, plants or different jurisdictions, should not be raised at a late stage after the fact. Instead, prospective purchasers, which may include minority members of syndicates, should voice their concerns or objections early and throughout the court-approved sales process.
The rules of the game need to be clear and unequivocal from the start. The White Birch Paper case reinforces the commonly held view that those rules can't be changed at the end of the game. When the final whistle blows, it is over.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.