United States: Delaware Bankruptcy Court Rules That Lenders Are Free To Enforce Contract Rights And "Negotiate Hard" Against Distressed Borrowers At Arm's Length

Last Updated: February 2 2017
Article by Mark G. Douglas

When lenders take an aggressive approach to a financially troubled borrower that ultimately files for bankruptcy protection, stakeholders in the case, including chapter 11 debtors, trustees, committees, and even individual creditors or shareholders, frequently pursue causes of action against the lenders in an effort to augment or create recoveries. The incidence of lender-liability type claims in bankruptcy in the guise of litigation seeking, among other things, to equitably subordinate lender claims or to recharacterize such claims as equity has led some lenders to second-guess how aggressively they can enforce their rights under a loan agreement, including the extent to which they can take an active role in the affairs of a borrower.

For this reason, a ruling recently handed down by the U.S. Bankruptcy Court for the District of Delaware has been welcomed by lenders. In In re Hercules Offshore, Inc., 2016 BL 366002 (Bankr. D. Del. Nov. 1, 2016), the court overruled the objections of a committee of equity security holders to a chapter 11 plan that included releases of prepetition lenders, including a hedge fund which acquired 40 percent of secured debt refinanced as part of a previous chapter 11 filing. In rejecting the committee's argument that the releases were inappropriate due to colorable claims against the lenders for misconduct in enforcing their rights under a prepetition credit agreement, the court summarized the dispute as follows:

"Will you walk into my parlor?" said the spider to the fly;

" 'Tis the prettiest little parlor that ever you did spy.

The way into my parlor is up a winding stair,

And I have many pretty things to show when you are there."

"O no, no," said the little fly, "To ask me is in vain,

For who goes up your winding stair can ne'er come down again"

[quoting The Spider and The Fly: A Fable, Mary Howitt].

To put it into terms employed by the Equity Committee, the central dispute for determination by the Court is whether the lender (spider) here "conjured up immaterial defaults," catching the (sufficiently unwary) Debtor "completely off guard" to "impose their will on" the Debtor, undermine its "recently confirmed plan and raid the Company's coffers to force an expedited repayment" . . . (and a premature liquidation).

Hercules Offshore

Hercules Offshore, Inc., and its affiliates (collectively, "Hercules") perform offshore drilling services, both domestically in the Gulf of Mexico and internationally. In August 2015, Hercules filed a pre-packaged chapter 11 case in the District of Delaware. The bankruptcy court confirmed a chapter 11 plan for Hercules in September 2015, pursuant to which $1.2 billion in debt was exchanged for 20 million shares of new common stock. Among other things, the plan provided Hercules with access to new liquidity in the form of $450 million in exit financing under a November 6, 2015, first-lien credit agreement. The first-lien lenders included Luminus Energy Partners Master Fund, Ltd. ("Luminus"), a Bermuda-based hedge fund. At the time Hercules emerged from its 2015 chapter 11 case, Luminus held approximately 1.2 percent of the debt outstanding under the first-lien credit agreement.

Due to a significant post-confirmation decrease in oil prices and revenue, a special committee of Hercules' board was created in January 2016 to pursue strategic alternatives available to the company, including a sale of assets, a sale of the company as a whole, and the issuance of additional equity or debt securities. The special committee initiated a marketing process and solicited bids for Hercules' assets or the company as a whole.

From December 2015 through April 2016, Luminus expressed concerns to the special committee that Hercules was experiencing unsustainable cash burn, would likely default on various covenants under the first-lien credit agreement in 2017, and should take steps to de-risk various projects by seeking project financing or a joint venture relationship. Luminus also proposed to purchase Hercules' assets in an out-of-court sale transaction due to the "disappointing" results of the special committee's efforts to market the assets to other buyers.

On April 15, 2016, Luminus provided a proposal to the special committee for a controlled chapter 11 bankruptcy in which Hercules' various assets could be sold off individually and holders of the company's common stock would receive $27.5 million in "cash or highly certain value." However, the committee viewed this proposal not as final, but as subject to due diligence.

Hercules allegedly defaulted on certain covenants in the first-lien credit agreement in April 2016. Nevertheless, the first-lien lenders agreed not to accelerate the debt in accordance with the terms of a series of forbearance agreements.

During the forbearance period, the special committee proposed to sell various Hercules assets, including rights in a North Sea jack-up rig that Hercules had intended to purchase outright as a new source of revenue. The first-lien lenders claimed that the transfer of such rights constituted an event of default under the first-lien credit agreement and accelerated the debt. Pursuant to the terms of the forbearance agreements, escrowed funds in the amount of $200 million that had been earmarked for the jack-up rig purchase were then released to the first-lien lenders to reduce their claims under the credit agreement.

On May 26, 2016, holders of 99 percent of the first-lien debt entered into a restructuring support agreement that was unanimously approved by Hercules' board of directors. The agreement contemplated that Hercules' operations would be wound down in a second pre-packaged chapter 11 case.

Hercules filed for chapter 11 protection in the District of Delaware for the second time on June 5, 2016. Luminus then (or shortly afterward) held approximately 40 percent of the debt outstanding under the first-lien credit agreement as well as 914,992 shares (4.5 percent) of Hercules' common stock.

Hercules' pre-packaged chapter 11 plan provided for the liquidation of its assets pursuant to a series of sales. The sale proceeds were to be used to pay unsecured claims in full ($35 million) and, at the low end of the estimated proceeds, $388 million of the $579 million in allowed first-lien lender claims. In addition, if the holders of Hercules' common stock voted in favor of the plan, they would receive $12.5 million in cash on the effective date and certain additional amounts depending on the aggregate proceeds of the asset sales. The first-lien lender and unsecured creditor classes voted to accept the plan. The class containing holders of common stock voted to reject it.

After mediation requested by Hercules failed to produce a global settlement, Hercules proposed an amended plan providing for, among other things, an increased guaranteed recovery to consenting common stock holders. An official committee of Hercules' equity holders objected to the amended plan. The committee argued, among other things, that releases of the estate's claims against the first-lien lenders were impermissible.

According to the equity committee, the plan releases were invalid because the estate had colorable claims and causes of action against the first-lien lenders, including claims for equitable subordination, equitable disallowance, and breach of the implied covenant of good faith and fair dealing.

The Bankruptcy Court's Ruling

Bankruptcy judge Kevin J. Carey ruled that a claim for equitable subordination of the first-lien lenders' claims to Hercules' common stock failed as a matter of law because the U.S. Court of Appeals for the Third Circuit "has held that Bankruptcy Code section 510(c) does not permit creditors' claims to be equitably subordinated to equity interests" (citing In re Winstar Commc'ns, Inc., 554 F.3d 382, 414 (3d Cir. 2009)).

Moreover, Judge Carey ruled that "equitable disallowance . . . is not typically recognized by bankruptcy courts" (citing Sher v. JP Morgan Chase Funding Inc. (In re TMST, Inc.), 518 B.R. 329, 357 (Bankr. D. Md. 2014), vacated in part on other grounds, 2014 BL 324561 (Bankr. D. Md. Nov. 13, 2014); In re LightSquared Inc., 504 B.R. 321, 339 (Bankr. S.D.N.Y. 2013)). He explained that the exceptions to the allowance of a claim are specifically delineated in section 502(b) of the Bankruptcy Code, "and a creditors' conduct—whether or not it was in good faith—is not within this list of exceptions." In addition, Judge Carey noted that "the record here does not support such a claim."

The equity committee claimed that the first-lien lenders had breached the implied covenant of good faith and fair dealing by asserting "baseless" events of default under the first-lien credit agreement, by declining to extend the deadline for compliance with certain covenants in the credit agreement, and by forcing Hercules to enter into the forbearance agreements.

Judge Carey rejected these arguments. He explained that Hercules did not dispute that it had breached covenants under the first-lien credit agreement. The judge wrote that although the equity committee characterized such defaults as "immaterial, . . . there is no 'materiality' requirement in the [credit agreement] . . . [, which states] that any failure to satisfy the [relevant requirements] is grounds for acceleration of the loan" (emphasis added).

Similarly, the judge emphasized, withholding consent to an extension of time for Hercules to comply with covenants "was arguably unfortunate, but not inappropriate."

The equity committee also argued that, by claiming Hercules was in default, the first-lien lenders had forced Hercules to enter into the forbearance agreements, thereby preventing the company from accessing escrowed funds which would have allowed it to purchase the North Sea jack-up rig—an important additional source of revenue that might have kept the company out of bankruptcy.

Judge Carey rejected this argument as well. According to him, although the first-lien lenders "were strategic in their actions, lenders are free to enforce contract rights and negotiate hard against borrowers at [arm's length], particularly those that are in distress, as here."

Judge Carey noted that Hercules characterized the first-lien lenders, "sardonically, as 'aggressive,' 'vocal,' 'persistent,' and at times 'annoying.' " However, he wrote that "there is no evidence that they acted unlawfully and no evidence that [Hercules was] damaged by any alleged lender misconduct." Evidence was lacking, he explained, that the first-lien lenders had interfered with Hercules' business or had somehow been implicitly bound to grant extensions of time to satisfy covenants. Nor was any evidence introduced to establish that the lenders had caused or contributed to Hercules' inability to timely satisfy covenants. Instead, the record showed that the first-lien lenders "acted within the boundaries of their contractual rights."

Finally, Judge Carey noted that the first-lien lenders had agreed to provide substantial consideration in exchange for the plan releases, including guaranteed payments to unsecured creditors and equity holders from the proceeds of their collateral. He therefore approved the releases, observing that they "bring needed certainty to [Hercules'] exit from chapter 11."

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Mark G. Douglas
Similar Articles
Relevancy Powered by MondaqAI
McDermott Will & Emery
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
McDermott Will & Emery
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions