Editor: Please describe your practice in Proskauer's Chicago office.
Marwil: Our bankruptcy practice in Chicago is part of our firm's national practice. We participate in cases and restructurings across the country. We coordinate on cases, pitches and marketing events with our colleagues in the firm's New York, Boston and Los Angeles offices.
Editor: Much of your work is with middle market companies that are experiencing distress. What is the state of that market?
Marwil: A lot of companies in distress are coming up against maturities on their senior debt with little runway to refinance that debt in the current market. That is really a result of more conservative lending practices, and lower overall values as a result of declining revenue and EBITDA. It amounts to a double whammy hitting these companies. In 2006 and 2007 they had borrowed money based on high valuations and very loose credit standards. These companies will need to restructure perhaps multiple tranches of debt, and due to declining revenues and cash flow, also may need operational restructurings as well. There will be the need to dispose of unprofitable divisions, sales of valuable divisions in order to raise capital and efforts made out of court and in court to reduce debt.
Editor: How willing are the financial institutions that lent to these companies to restructure, even with tighter loan terms?
Marwil: Much depends on where a lender sits in the capital structure. Senior lenders often think that in a sale of the business or even in a liquidation that they get most, if not all, of their debt repaid. They have no obligation to watch out for junior creditors. Senior lenders are starting to react in the current marketplace by not expecting their investment to lose value. Lending standards are not going to drastically change from their current conservative nature. The senior lenders are more interested in simply recovering their capital investment, which is what they've really been doing for the last six to twelve months.
Editor: Many corporations will soon be facing the maturity of debt they obtained on favorable terms back in 2006 and 2007. What is going to be the fallout from that and how can boards and managers prepare themselves?
Marwil: The first thing that management and the boards need to recognize is that unlike prior business downturns, the existing lender base is very diverse and may not have the flexibility to extend additional credit in the event a borrower runs out of cash and does not have availability under its credit lines to meet expenses. Therefore, management and the board, now more than ever, need to be forward-looking in projecting future cash flows. If the company hits a point where it cannot satisfy current expenses at some time in the future, it should start restructuring talks with both its senior and junior lenders, making sure it doesn't find itself in a scenario where it has no restructuring in place, has not negotiated new terms with its lenders and can't meet payroll tomorrow. That is an untenable position for management and for the board - one that could subject them to liability for breach of fiduciary duty. It is incumbent on boards and general counsels to be proactive in planning future cash flows if there is a hint the company will not have the support of its lender base should it run out of cash.
Editor: Shouldn't covenants be a trigger-point for boards to start seeing when they should take some action?
Marwil: The problem is that so many of the loans that were made in 2006, 2007 and even into 2008 were covenant-light loans, i.e., no covenants. That's how competitive the lending landscape was then. In these loans, there are no indicators to tip off a lender or to tip off management or the board that there is a problem or crisis. I like to refer to those loans as free money loans. The purpose of covenants historically has been to provide the lender an opportunity, through either forbearance or through a restructuring once a default occurs, to take legal control or at least legal leadership of the situation in order to make sure the company does not have to resort to a painful liquidation. The kind of early warning that covenants provided in prior downturns doesn't exist in many of the loans that are out there today.
Editor: Why is Section 363 of the Bankruptcy Code so prevalent in bankruptcy cases today?
Marwil: Section 363 is a provision that authorizes the sale of assets free and clear of lien claims and conflicts of interest from a bankrupt estate. In other words you can buy assets, and typically a business through an asset purchase transaction, leaving all of the debt and other obligations behind in a shell or deeply distressed company. Coupled with Section 365, which allows for the assumption and assignment of executory contracts, a purchaser can take the assets and essential contracts for running the business, leaving everything else behind, thus cleansing the going concern of the old capital structure and taking on a capital structure that is beneficial to the buyer. In the current marketplace because there is a lack of liquidity and because lenders are reluctant to make credit available even in bankruptcy, Section 363 allows for a transfer of the business as a going concern very quickly to a new owner or sometimes even to a lender through a credit bid.
We have seen instances where a business is sold 45 to 60 days from the time a case is filed through a 363 sale process. Lenders are using this as a way to monetize their first lien debt (and sometimes even the second lien debt). Section 363 sales wipe out the old capital structure unless the secured creditor is bidding for the business, at which point the secured creditor will control what the capital structure will be. The purpose of 363 is to sell assets to generate cash in the bankruptcy estate in order to pay the parties according to their ranking in the capital structure.
Editor: Is a liquidation of assets more beneficial to the junior creditors, if the assets are there?
Marwil: That's the key. Many times the unsecured creditors' committee, a group of unsecured creditors appointed by the trustee in bankruptcy, has standing as a party in interest. Their professional fees and expenses are funded by the debtor's estate. Many times the unsecured creditors' committee will argue that liquidation is preferable since they obtain more value from a liquidation. There are a host of arguments that committees will make in connection with 363 sales to disrupt the sale in order to create an opportunity to recover a portion of the estate, slowing down the process so that the secured creditors will share some of the proceeds with them even though the secured creditors might not be paid in full.
Editor: What are the benefits of Section 363? What are some alternatives to it?
Marwil: In situations where there is value beyond that needed to repay senior secured debt or there's a willingness by junior creditors, whether secured or mezzanine creditors, to convert debt to equity, there's sometimes a great benefit in doing a plan of reorganization in Chapter 11. Chapter 11 plans typically delever the debtor's balance sheet by providing for distribution of equity or junior debt to creditors in order to allow the company to emerge from bankruptcy to reassert itself in the marketplace. The hope is that the company may improve sufficiently that the out-of-the-money creditors on the petition date get into the money within a reasonable time in the future. In situations where you have creditors who are willing to convert debt to equity or convert current debt into long-term debt, it provides an opportunity for them to stay in the game and realize upside in the future. Given the low valuations of companies today, I think we're going to see junior creditors assert themselves and try to negotiate with senior creditors for restructurings (rather than quick sales) in order to live to fight another day.
Editor: You played a key role in several hedge fund restructurings and bankruptcies. Could you tell us about your role as a sole managing member of the Bayou group of hedge funds and how you came to this position?
Marwil: In 2006 I was contacted by one of the investors who had been defrauded by Bayou. I was asked to interview to become the receiver and the sole managing member of the funds with the goal of ultimately pursuing recoveries from redeemed investors in order to equalize the harm of the fraud among redeemed and unredeemed investors. I think they contacted me because I had been a receiver in another securities fraud case, and I had more than 20 years of experience as a corporate restructuring and bankruptcy lawyer. We filed Chapter 11 cases for all of the Bayou funds and pursued fraudulent conveyance recoveries or "clawback litigation." We settled 150 out of 158 cases. The eight cases that we didn't settle we won on summary judgment, which are currently on appeal right now.
Editor: You also played an important role in the Sage Crest hedge fund bankruptcy case. What were the issues and outcomes there?
Marwil: Sage Crest is still a pending case. In that case I represent the provisional liquidator who was appointed under Bermuda law for two non-debtor Bermuda funds that together own a third Bermuda fund that is one of the hedge fund Chapter 11 debtors in Connecticut. The sister on-shore fund is also a Chapter 11 debtor in Connecticut. The hedge fund bankruptcies are different from corporate bankruptcies in that typically, and in Sage Crest, the on-shore fund and the off-shore funds do not share common ownership. The ownership of the off-shore funds is held by off-shore non-U.S. investors and the ownership of the on-shore fund is held by U.S. investors. Unlike a typical Chapter 11 case with multiple debtors but with a parent that has common ownership, here we don't have that. We have inter-fund issues that we are litigating and now trying to resolve. It is a unique case in that regard. Sage Crest will be a road map for future funds on how to deal with the conflicts that come up between an on-shore fund and an off-shore fund managed by the same people and, in fact, invested in the same assets but ultimately owned by very separate and distinct investors.
Editor: What can and should investors do if they suspect a fund manager fraud?
Marwil: There are probably a series of things that they can do. The first thing is to try to withdraw their funds, which may or may not become subject to clawback litigation. Typically, if you think that there is fraud, it has probably been announced and you can't get your money out. At this point the thing to do is to get as much information as you can to find out who the other investors are and to work with those other investors in order to negotiate a change in management. If that fails, then you might have to resort to litigation either in the U.S. or abroad if the fund is offshore. You can go to the attorney general's office in the state in which the fund is formed. You can also turn to the SEC. Although the SEC has limited authority, it has been very active in cases of suspected fraud in filing a civil action and seeking the appointment of a receiver to displace the management that committed the fraud. Obviously one of the impediments is having to spend your own money as an investor for the benefit of all investors in order to get a change in management or a receiver.
Editor: What kinds of bankruptcy deals do you anticipate in the future, and are there new issues or developments to expect?
Marwil: We have touched on one of the areas - corporate defaults; we are going to see a rise in enforcement remedies by lenders (foreclosures, cash sweeps, forced bankruptcy filings), as the banks get more aggressive in trying to collect on loan defaults. You are going to see a lot of activity in the commercial real estate market where there has been a huge market downturn in values. There is going to be pain to be suffered by developers and owners of properties.
Editor: Are there any new issues or developments that we can expect?
Marwil: Lawyers and other professionals will continue to be creative in solving the problems emanating from distressed covenant light loans, deteriorated valuations from the time that some of these loans were made, depressed revenues and negative cash flow. There is a lot of room for creativity and negotiation. The key to success is patience. If the various parties in the capital structure can exhibit some patience and take on some risk in negotiating a resolution to the problem, there may be an opportunity for enhanced value down the road for everybody.
Published October 4, 2009.
