Backstop commitments have become commonplace in large corporate bankruptcy cases – they provide certainty to the debtor that it will have the funds needed to satisfy its obligations to creditors under its plan of reorganization and that it will have liquidity to operate post-bankruptcy as the reorganized entity. Backstop commitments are also a way for certain creditors to generate some additional return in the form of commitment fees and expense reimbursements in exchange for their agreement to backstop all or a material portion of a proposed rights offering or other financing arrangement. Typically, the opportunity to participate as a backstop provider is not offered to all creditors in a class but is rather limited to those having large claims – often members of an ad hoc group that have the leverage to negotiate for such treatment, and most importantly, the financial wherewithal to perform. For that reason, the fees associated with backstop commitments are sometimes controversial, criticized by those not participating as an unnecessary expense paid by a debtor to a preferred group of creditors in exchange for their support and/or violative of Section 1124(a)(4) of the Bankruptcy Code which requires generally that similarly situated creditors receives the same treatment.
Recently, the Bankruptcy Court in In re LATAM Airlines Group S.A., et al., Case No. 20-11254 (Bankr. SDNY 2020) (ECF 4667) authorized the debtors in that case (the “Debtors”) the enter into a “Commitment Creditors Backstop Agreement” and a “Backstop Shareholders Backstop Agreement,” pay related fees and expenses, and incur certain indemnification obligations. The Debtors proposed exit from bankruptcy is proposed to be financed through the issuance of notes and equity in connection with certain “New Capital Notes Offerings” and an “ERO Rights Offering” in Chile, raising approximately $8 billion in new money. Generally, the offerings will be backstopped by (i) certain creditors holding more than 70% of the general unsecured claims asserted against the parent Debtor (the “Commitment Creditors”) and (ii) certain of the Debtors’ shareholders (the “Commitment Shareholders”). Specifically, the Commitment Creditors committed to purchase $400 million of Unsubscribed ERO New Common Stock (i.e., shares not purchased by existing shareholders pursuant to Chilean law) and approximately $3.27 billion of Unsubscribed New Convertible Notes Class C (i.e., notes not purchased by existing shareholders pursuant to Chilean law). As consideration for their commitment, the Debtors agreed to pay the Commitment Creditors a fee equal to 20% of their commitment amount (the “Commitment Fee”). They are also entitled to a certain expense reimbursement and indemnification. The Commitment Creditors Backstop Agreement included a termination fee ranging from 10% to 50% of the Commitment Fee (the “Termination Fee”), depending on the nature of the termination event, and includes a “holdback” of 50% of the New Convertible Notes Class C for purchase by the Commitment Creditors. The Commitment Shareholders will commit to purchase $400 million of Unsubscribed ERO New Common Stock and approximately $1.37 billion of the New Convertible Notes Class B Notes. Although they will receive no fee, they will be entitled to expense reimbursement and indemnification. There is no backstop with respect to New Convertible Notes Class A Notes. The Debtors contended that it could take up to 8 months to satisfy the conditions to effectiveness for its plan of reorganization.
Among the questions before the Court was (i) whether the Debtors could incur the costs, outside of the ordinary course of business, pursuant to Section 363 of the Bankruptcy Code and (ii) whether the fees are the “actual, necessary costs and expenses of preserving the estates” required by section 503(b)(1)(A) of the Bankruptcy Code. The Unsecured Creditors’ Committee and a number of other creditors objected, arguing that the Commitment Fee and Termination Fee were unreasonable and above-market for similar transactions. They also argued that reimbursement of fees and indemnification provisions were unnecessary. After an evidentiary hearing, the Court conducted a thorough analysis of the facts and law, and found that the backstops ensure “necessary funding to the Debtors on terms that are fair and reasonable in the particular circumstances of these cases” and that “the Backstop Agreements [are] integral to the Debtors’ pursuit of the Plan.” In considering the reasonableness of the Commitment Fee, the Court applied an “All-In Backstop Fee at Plan Value” analysis which purports to measure the true benefits to the backstop provider (because it accounts for the value of any holdback and the new money discount available to all creditors that participate in the proposed offering). Using this standard, the Court determined that the fees were reasonable under the circumstances and in line with those in comparable transactions (although among the highest in the representative sample). Among other things, in reaching its decision the Court recognized that the backstop agreements (and related restructuring support agreement) were negotiated as a part of an extensive mediation and that certain levels of creditor support are needed to access the Chilean markets. Moreover, the Court placed little weight to evidence of a competing proposal with a lower fee due to deficiencies in the proposal, including the fact that it could not assure approval of the plan due to the lack of necessary creditor support.
Any backstop agreement must be considered in the context of the transaction in which it arises. In In re LATAM, the Court placed much weight on (i) the global nature of the settlement, (ii) the length of the commitment, (iii) the risk of fluctuation in the value of the Debtors’ equity during the interim period between confirmation and effectiveness, and (iv) the likelihood that the Debtors could satisfy their obligations under the agreements and therefore satisfy conditions to closing. However, this will not be the last that we hear on the backstop agreements in LATAM. The Unsecured Creditors Committee has filed a notice of appeal of the Court’s decision. Moreover, regardless of the outcome of the appeal, the Court expressly preserved the objecting parties’ rights to raise certain arguments regarding the confirmability of the plan (including under sections 1124(a)(4) and 1129(a)(11) of the Bankruptcy Code) at the confirmation hearing currently scheduled for May 17, 2022.