In re RadioShack Corp: Delaware Bankruptcy Court Implicitly Enforces Agreement Among Lenders in Unitranche Loan

Practical Law Legal Update 4-615-9765 (Approx. 8 pages)

In re RadioShack Corp: Delaware Bankruptcy Court Implicitly Enforces Agreement Among Lenders in Unitranche Loan

by Practical Law Finance

Background

On February 5, 2015, RadioShack Corporation (Debtor) filed a voluntary Chapter 11 petition. Following the petition date, the Debtor continued to manage its business as a debtor-in-possession (DIP) under sections 1107(a) and 1108 of the Bankruptcy Code.

Debtor's Secured Debt Structure

At the time the Debtor filed for bankruptcy, it was financed, in part, by two unitranche facilities with a split collateral structure:

A $250 million unitranche term loan (Term Loan) (under which a Cerberus Capital Management affiliate (Cerberus) was the first out lender and a Salus Capital Partners affiliate (Salus) was the last out lender), which was secured by the following liens on the Debtor's assets (the Term Loan collateral):
- a first lien on the Debtor's fixed assets (intellectual property (including the company name), subsidiary stock, real property, personal property and furniture, fixtures and equipment); and
- a second lien on the Debtor's liquid assets (receivables, inventory and deposit accounts).
A $585 million unitranche asset-based loan (under which a group of funds were the first out lenders and a Standard General L.P. affiliate (Standard General) was the last out lender), which was secured by the following liens on the Debtor's assets (the ABL collateral):
- a first lien on the Debtor's liquid assets; and
- a second lien on the Debtor's fixed assets.

Unitranche Term Loan

The issue involving the Term Loan arose in the context of a section 363 sale. In its bankruptcy case, the Debtor sought to sell as much of its business as a going concern as it could outside the ordinary course of its business. Section 14(c) of the Term Loan AAL provided that the first out lenders could direct the agent to consent or object to any sale or other disposition under section 363 and that no last out lender could object to or oppose the sale on any grounds that could only be asserted by a secured creditor if the first out lenders or the agent (on instruction from the first out lenders) consented to the sale or disposition. In other words, a last out lender was barred from raising any objections to a section 363 sale that a first out lender could raise. However, a last out lender could nevertheless raise any objections to a sale or disposition of assets that could be raised by an unsecured creditor, if those objections were not based on grounds that could only be asserted by a secured creditor.

Standard General, as the stalking horse bidder, offered to purchase one-half of the Debtor's stores by credit bidding its secured claim under the asset-based loan. Salus, as the last out Term Lender, objected to the sale, arguing that:

The sale process was unfair because it was confusing, not transparent, controlled by an insider, discouraged competitive bidding and unfairly discounted Salus's bid.
Standard General's bid undervalued the intellectual property that was Term Loan priority collateral.
A free and clear sale of Term Loan priority collateral without Salus's consent as the last out Term Loan lender violated section 363(f) of the Bankruptcy Code.
The proposed royalty-free license to use the Debtor's name (which was Term Loan priority collateral) violated Salus's right to adequate protection.
Section 14(c) of the Term Loan AAL did not prohibit Salus's objection, because Cerberus's initial objection to the sale, as the first out Term Loan lender, was irrevocable. (Cerberus had initially objected to the sale, but then changed its mind.)

Cerberus ultimately supported the sale and argued that the Court should overrule Salus's objection because:

Section 14(c) of the Term Loan AAL prohibited Salus from opposing a sale supported by Cerberus.
The subordination provision of an AAL is enforceable in bankruptcy in the same way that subordination provisions in intercreditor agreements are enforceable.

Unitranche Asset-based Loan

The issue involving the asset-based loan arose in the context of an AAL among the asset-based lenders and a subordinated participation agreement. The relevant provisions of the AAL were:

Section 4(d) ("Second Out Lender Purchase Option"), which stated that, on the occurrence of certain events (return of a cash deposit to the last out lender on termination of a letter of credit), the last out lender must "promptly apply an amount equal to the amount of such returned cash collateral to purchase from each of the First Out Lenders, on a pro rata basis at par, a 'last-out' participation interest . . . in each such First Out Lender's right, title and interest in outstanding [First Out Loans]."
Section 6(b)(vii) ("Bankruptcy and Insolvency"), which provided that "Lenders in any junior class do not waive any rights to credit bid in any sale or disposition in accordance with Section 363(k) of the Bankruptcy Code, so long as any such credit bid provides for the immediate discharge in cash of the Senior Claims of each Senior Class."
The waterfall provision of Section 3(a), which provided that the payment of "any attorney's fees or other costs and expenses of, and any indemnification obligations owing to, the First Out Lenders" was junior only to the obligation to pay the agent's fees.

The relevant provisions of the participation agreement were:

Section 3(a), under which the participant (last out lender) "acknowledges and agrees that no repayment to the Participant in respect of the Participated Obligation shall be made until all other Senior Claims (including . . . Indemnification obligations . . .) of the First Out Lenders in respect of the First Out Debt . . . have been paid in full in cash. . . ."
Section 13(h), which provided that: "Notwithstanding . . . Section 4(d) of the AAL, the Participant [last out lender] shall, at all times, have the right to direct the Existing First Out Lenders to credit bid the Participated Obligation in any sale of ABL Priority Collateral under Section 363 of the Bankruptcy Code . . . [a]nd the Existing First Out Lenders hereby agree to comply, or instruct the Agent to comply, with such direction; provided that, in each case, the terms of such sale . . . provide for immediate discharge in cash of the First Out Tranche. . . ."

Standard General, the last out lender in the asset-based loan, proposed to credit bid its secured claim and its participation interest to purchase ABL collateral which, in effect, is payment of its claim by way of setoff. Under this proposal, the first out asset-based lenders would be paid all principal and interest owing to them under the asset-based loan, which was now rolled up into the DIP financing agreement.

In response, the creditors' committee filed a motion for Rule 2004 discovery identifying potential causes of action for unspecified amounts against numerous parties, including the asset-based lenders. In addition, two weeks before the sale hearing, the Term Loan lenders filed an adversary proceeding against the asset-based lenders which:

Alleged violation of the AAL.
Sought disgorgement of $129 million paid to the asset-based lenders before the Debtor's bankruptcy.

The first out asset-based lenders argued that:

Under the asset-based loan agreement, the Debtor's indemnification obligations to the first out asset-based lenders constituted part of their secured claim that must be paid in full to allow Standard General, as the last out lender, to credit bid.
Since the Term Loan lenders commenced litigation and the creditors' committee threatened litigation against the asset-based lenders, the right to indemnification was not contingent.

In response, Standard General argued that only the first out asset-based lenders' claim then due and payable (principal and interest under the first out portion of the asset-based loan) must be paid in full and not the indemnification claims that were unliquidated, speculative and contingent.

Outcome

In its oral findings on March 30, 2015, the Court construed and enforced the Term Loan AAL and the asset-based loan AAL. On March 31, 2015, the Court approved the Debtor's sale of assets to Standard General through a credit bid of its last out debt.

The Court did not rule on the first out asset-based lenders' objections, but suggested that the potential indemnification claims were a part of their valid claims. However, it stated that withholding the full amount of the sale proceeds to secure these contingent claims would be unreasonable. The parties agreed that the sale order should provide for a $12 million indemnification reserve to satisfy these potential claims.

Unitranche Term Loan

The Court decided on two issues regarding the Term Loan:

The extent to which the last out lender could object to a bankruptcy sale that was supported by the first out lender.
Whether "paid in full" requires payment of the first out lenders' contingent indemnification claims as a condition to permitting the last out lender to credit bid.

As a threshold matter, the Court noted that the case involved "the application of certain prohibitions or provisions contained in Section 14(c) of the [Term Loan AAL]" and that the parties had acknowledged and consented to the bankruptcy court's jurisdiction to construe the AAL and related loan documents.

The Court next held that Cerberus's initial consent to Salus's objection was revocable. The plain language of Section 14(c) of the AAL did not restrict Cerberus, as the first out Term Loan lender, from settling or otherwise changing its position or its mind. The Court reasoned that construing the AAL otherwise would conflict with the first out lender's presumed contractual expectations and the common expectations of the parties.

Next, the Court determined the extent to which Salus, as the last out Term Loan lender, could object to a bankruptcy sale that was supported by Cerberus. The Court held that:

Objections based on a sale under section 363(f) of the Bankruptcy Code and a lack of adequate protection are "classic secured creditor objections" prohibited by Section 14(c) of the AAL.
Salus's other objections based on the fairness of the sale process and undervaluing the assets could proceed as they were the sort of "objections otherwise available to an unhappy, unsecured creditor. . . ."

Although Salus's objections based on the fairness of the process and the valuation of the assets were permitted, the Court overruled these objections after testimony and oral argument.

Unitranche ABL Loan

The Court did not rule whether "paid in full" required payment of the first out lenders' contingent indemnification claims as a condition to permitting the last out asset-based lender to credit bid. However, the Court commented that it would regard, at a minimum, "the indemnification rights as part of the collateral package and part of the rights the first out ABL lenders have" which it would respect by way of a reserve.

As a resolution, the parties agreed that the Debtor would pay the agent under its DIP loan two cash collateral reserves to withhold approximately $12 million from the sale proceeds to be available to satisfy the first out asset-based lenders' potential indemnification claims.

Practical Implications

Until now, the enforceability of AALs has been untested in bankruptcy. While the Court did not issue a ruling on the issue and based its jurisdiction on the parties' acknowledgment and consent rather than through statutory interpretation, the Court's statements provide guidance and should give secured lenders comfort that courts will enforce AALs in bankruptcy proceedings. Like intercreditor agreements, AALs should be carefully drafted to ensure that the protections they provide are not circumvented in a bankruptcy.

For more information on unitranche loans, see Practice Note, Unitranche Loan Financing.

In re RadioShack Corp: Delaware Bankruptcy Court Implicitly Enforces Agreement Among Lenders in Unitranche Loan | Practical Law