Chapter 11 Fees: The Cost of Bankruptcy Isn’t CheapUpdated:
There’s a certain irony that a company filing – with some exceptions, as we discussed with LTL last summer – is usually not going to be flush with cash but yet the amount of professional fees that can be racked up can stretch comfortably into eight-figure, or even nine-figure, territory.
This reality occasionally leads to slightly unsavory headlines in the financial press – as you can imagine, it tends to rile up the general public when they hear that hundreds of millions are spent on professional fees, especially in cases like Purdue or Boy Scouts of America where the money spent on bankers and lawyers is per se money that can’t be spent compensating victims. It seems that the general public sadly doesn’t appreciate that bankers are doing God’s work.
Anyway, the eye-watering costs of filing haven’t been lost on creditors, and this is partly why pre-packs have been steadily on the rise over the past decade. Because even if a creditor thinks they could potentially squeeze out a higher recovery in a free-fall, the possibility of a case stretching on for a year or two, and professional fees steadily churning higher, could make winning an argument for a higher valuation or a more advantageous mix of consideration a pyrrhic victory.
In the upcoming restructuring cycle, you’ll likely notice a continued bifurcation whereby sponsor-backed companies with sophisticated creditors holding majorities across the capital structure are much more likely to come together, pre-filing, and try to work out at least the contours of a Plan to avoid the uncertainty of filing with no Plan in place. This will continue to give sponsors quite a bit of leverage to push the bounds, without much to lose, in trying to achieve some level of recovery on their buyout.
For example, back in the dog days of the pandemic Chisholm Oil and Gas (sponsor backed: 58% Ares, 42% Apollo) filed with an RSA in place with holders of 99.6% of their prepetition RBL. The proposed Plan contemplated prepetition equity holders (read: the sponsors) getting back 1% of post-reorg equity and warrants for an additional 11% of the post-reorg equity despite holders of the term loan and general unsecured claims getting just pennies on the dollar in recovery.
This, understandably, wasn’t initially received well by the term loan and general unsecured holders and they objected. But the Plan contained death trap provisions and the impacted creditors – understanding that their recovery would only decline the longer the case dragged on and that Apollo isn’t exactly known for their equanimity – came to a settlement in a few months that provided holders modest concessions while still providing the sponsors with their post-reorg equity.
The Plan was then subsequently approved, and the debtor exited bankruptcy just four months after filing. For their efforts, Evercore, who were debtor-side, would earn around $4m, as laid out in their fee (retention) application, primarily stemming from a $3.25m “completion fee” (in the ninety-days prior to filing, covering most of the timeframe between when EVR was retained and when the debtor filed, they accrued fees of ~$550k).
Additionally, showing that bankers are nothing if not generous, after filing EVR was nice enough to revise its fees down from the original engagement letter thereby saving the debtor probably around $1-1.5m in fees.
Joking aside, the total fees contemplated by the fee application – at around 0.8% of the total pre-reorg debt – is in the ballpark of similarly sized cases as you can see in the excellent little analysis Reorg did breaking down the fees paid to investment bankers across different types of cases...
As you can imagine, there’s quite a bit of dispersion when it comes to the total amount of fees in a given case based not only on the size of the case, but also on whether it was a pre-pack or pre-negotiated case, whether significant asset sales occurred while in court, and other complicating factors (e.g., tort claim issues, a complex capital structure with many disparate creditors dragging the case out, etc.).
In the end, the larger and more complicated the case is, the more refined the fee structure in the fee (retention) application will generally be to account for the uncertainty over how exactly the case will unfold – if you’re a banker, you don’t want to be missing out on any potential fees!
So, you can end up with a situation where you have a dizzying number of different fees: a flat monthly fee, a flat overall restructuring (success) fee, an asset sale fee based on a percentage of any potential asset sales that occur, and a wide assortment of financing fees that’ll be struck at various percentages (e.g., a relatively low fee for advising on exit secured debt, a relatively high fee for advising on exit unsecured debt).
This can lead to situations where creditors object to retention fees, a number of hearings take place, and the fee structure is (potentially) rejiggered. For example, after a number of hearings Judge Drain told Evercore in the Frontier case that, among other things, their restructuring fee should be 14bps, not 16bps, of the total dollar amount of debt restructured – a number divined not through some deep analytical model, but rather loosely based on precedence and his view in the moment.
Like everything in finance, precedence generally wins the day so that’s why you (curiously) tend to see cases of like-kind having roughly the same overall level of fees as a percent of prepetition debt outstanding despite the fee structures potentially being quite different.
It’s also why in more complex cases, where different fees can begin to add up on top of each other quickly, a “fee cap” will be put in place to avoid raising the ire of either creditors or the court as they begin to contemplate just how high the fees could go depending on how the case unfolds.
Anyway, it’s been a crazy past few months, so I haven’t had too much time to dedicate to posts. But I figured this would be a fun little post – albeit not overly relevant to actual interviews – and I’ll drop plenty of links so you can poke through some final fee applications that you may find interesting.
As mentioned earlier, pre-packs come along with many benefits – if, and it’s a big if, you can get enough creditors to agree on what to do pre-filing – including lowering the total amount of fees that’ll be incurred or at least providing more cost certainty.
Carestream Health, that had HL debtor-side, was a great little pre-pack done last year. It didn’t set any records for speed – like the CWT pre-pack, that also had HL advising, getting done in just a day – but its Plan was confirmed in around a month. You can read the Plan / Disclosure Statement here if you want.
Given that smallish pre-packs are typically pretty straight-forward, the fee structure matches with the vast majority of fees comprising a flat amount for successfully completing the restructuring. Here’s HL’s final fee application – for $6.89m – that breaks down what they were retained to do, what they did, and includes the original engagement letter (as you can see, HL was engaged far before filing to explore a potential sale, but this then got amended to include a potential restructuring).
Anyway, here’s an overview of all the (potential) fees...
And here’s HL’s calculation of the actual fees owed...
Note: In any final fee application you’ll notice there are fees, as we’ve discussed above, and then expenses (e.g., travel, meals, access to certain tools or research, etc.). However, the true expenses are often systemically understated – optically it’s never ideal when you’re claiming thousands in small meal expenses, etc. So, even though you’ll use a certain deal code when ordering $35 of lukewarm sushi at 11pm sitting at your desk that may not ultimately be reflected in the final fee application to keep expenses relatively low.
It’s seldom that a company files in a vacuum (e.g., without significant work having been done prior to the ultimate filing). So, whenever you're looking at the fees paid while in-court, it’s important to remember that those engaged would’ve typically been racking up at least some fees pre-filing either to prepare for filing, explore alternatives, or possibly to effectuate an alternative solution (e.g., an out-of-court restructuring) that didn’t end up preventing the need to more comprehensively restructure in-court.
By way of example, McDermott International engaged Evercore in May of 2017 to explore options and eventually filed in January of 2020 with a pre-pack that was confirmed a few months later. Given the complexity of McDermott, a significant amount of groundwork was done in the year prior to filing. This included raising ~$1.7b of prepetition debt with the plan to roll most of it into the DIP facilities upon filing, along with preparing for the sale of their Lummus Technology business with a stalking horse bid of ~$2.73b.
Further, given the relatively weighty capital structure of McDermott – totalling nearly $5b – along with the complexity in what was planned to be done, the in-court fee structure, as outlined in the initial fee (retention) application, was significantly more complex with a flat monthly fee, flat restructuring fee, sale fee for the Lummus unit, financing advisory fees that fluctuated based on the type of security raised, financing placement fees that fluctuated based on the type of security raised, DIP financing fee, flat amendment fee, and an exchange fee.
In the end, since so many of the fees were triggered while in-court, the total fees, as outlined in the final fee application, totaled $51.7m. However, there was a fee cap that lowered the amount down to a healthy $27.5m.
But the above just covers the fees from what was done while in-court. Prior to filing, as mentioned earlier, a significant amount of groundwork was laid to allow for the pre-pack to go relatively seamlessly.
In total, McDermott paid $59.9m in total fees to Evercore in the year prior to filing – with $43.1m of that coming in the three months prior to filing for arranging the prepetition financing, preparing the sale process, etc.
The fact that EVR earned over double the fees pre-filing vs. post-filing may strike you as being a bit counterintuitive – but in more complex cases splitting fees like this isn’t abnormal to see given the desire to not raise the ire of creditors or the court too much with eye-watering fee applications. And, when it was all said and done, the total fees brought in by EVR, as a percent of total prepetition debt, isn’t overly out of line with cases of similar size and complexity.
It’s understandable that from the outside looking in restructuring fees can seem untenably high – and this perspective is likely why there are a few articles a year talking about fees or expenses that fan the flames and undoubtably generate a lot of clicks (it’s low hanging fruit to talk about expenses related to staying at the Ritz).
In an out-of-court context, restructuring fees are, obviously, dictated by what a company is willing to pay – if they don’t like PJT’s terms, they can shop around. And it’s not like the barrier to entry for starting an advisory shop is overly high – the majority of top shops today started more or less from scratch from those departing elsewhere.
In an in-court context, where one could argue the debtor isn’t as incentivized to scrutinize professional fees as in an out-of-court context, creditors can and do object to fees and courts aren’t shy about weighing in. So, there’s a reasonable check on fees running amuck and draining the estate of value.
With all that said, in this post we’ve just covered the banking side of things. In any case where bankers are involved (e.g., a relatively sizeable case) you’re also going to have financial advisors (e.g., FTI, A&M, etc.) and lawyers involved too.
Reorg did a nice little analysis of financial advisor fees – and, as you’d expect, the results are directionally analogous to the banking side of things...
Reorg also did a nice little analysis of legal fees and, as you’d also expect, if a restructuring support agreement is in place, then the overall level of fees, as a percentage of prepetition debt, are significantly less than if there’s none in place (in the latter scenario the cases are not only longer as consensus needs to be built in-court, but they’ll per se involve at least a bit more contention occurring in-court).
When taking all the banking, financial advisory, and legal fees together in a typical case, there’s no getting around that filing isn’t cheap. But costs can be significantly reduced when creditors are willing to be a bit more amicable pre-filing and, as mentioned in the preamble to this post, that can be one of those hidden points of leverage that sponsors are likely to continue pressing down more firmly on moving forward.
In my post last month discussing Incora, I mentioned that they were very likely to file this quarter or next and, when they do file, the sponsor (Platinum) is likely to get some level of meaningful recovery through their pre-filing maneuvering. Well, this week it became public knowledge that they’re currently talking to creditors in anticipation of filing in the next few weeks with (hopefully!) an RSA in place with a non-trivial number of creditors.
The other company that did the most creative (read: aggressive) out-of-court restructuring last year, that I've briefly referenced in a number of past posts, was Envision. Envision represented a grab bag of trends: involving both an unrestricted sub transfer and a non-pro rata uptier to completely rejigger their capital structure and bring in significant new liquidity (PJT was debtor-side, KKR was the sponsor).
Well, this week they decided to preemptively bite the bullet and file - with $655m of cash still on hand, making a DIP unnecessary - in Houston which has become an increasingly popular (read: debtor friendly!) place to file among those that have done more creative transactions (as evidenced by Serta’s success last month – including the Judge Jones decision that I also briefly mentioned last month).
Note: Envision was able to cobble together an RSA that you can read if you’re curious – attached is a declaration from the Chief Restructuring Officer that lays out its path toward filing, what their 2022 out-of-court transaction involved, and why they decided to file now.
In the coming weeks there will be arguments proliferating that these more aggressive maneuvers out-of-court are spurious – only benefiting a certain set of creditors that were allowed to participate and, of course, those advising on the transaction but not really moving the needle on the company’s probability of having to file in the future. In other words, there’s no real value-add to these transactions – they just represent a shifting of value prior to the still predestined filing.
This line of argument has always struck me as being a simplistic reading. It’s exceptionally rare that any out-of-court transaction can be anywhere near as comprehensive as what’s done in-court (e.g., Envision’s RSA would delever the debtor by ~$5.6b!).
Instead, out-of-court transactions are just about doing something that simply forestalls filing and provides for the enhanced possibility, but not the certainty, of being able to turn things around – and in recent years, due to the continual loosening of credit docs over the past decade, it’s been found that often the maximally viable solution out-of-court, the one that provides the biggest reduction in debt or the largest infusion of liquidity, involves a more creative transaction like we’ve seen with Serta, Boardriders, TriMark, Envision, Incora, etc.
For those pursuing an out-of-court solution, sometimes, oftentimes, it doesn’t work out. But that doesn’t make it wrong or, as an increasing number in the financial press insinuate, somehow underhanded or nefarious to pursue just because filing occurs subsequently.
Additionally, insofar as any out-of-court solution greases the wheels of subsequently filing (e.g., through the pre-filing rejiggering making it easier to get an RSA in place with those now most senior in the capital structure) then the out-of-court solution isn't really a failure as it makes the in-court process quicker, cheaper, and likely will result in a post-reorg capital structure that’s better suited to the company upon emergence.
This is a point that really riles people up but it's a reality that almost any comprehensive out-of-court transaction will fundamentally change the inter- and intra-class dynamics (for better or for worse) if filing occurs relative to what these dynamics would've been pre-transaction. So, proactively thinking about a transaction and how it will potentially inform these dynamics, even though you hope the transaction obviates the need to file in the future, is sensible not scandalous.
Anyway, the real point here is that many (read: most outside the industry and some within) have a Straussian reading of transactions like Incora and Envision: believing they were never really about buying time to hopefully turn things around but were just designed to put more favored creditors, or potentially the sponsors themselves, in the driving seat when the inevitable filing occurs (thereby enhancing their returns relative to non-favored creditors and making the filing process easier).
In other words, these transactions are distinct from out-of-court transactions of the past as they're just a glorified prelude to the inevitable filing not an earnest attempt to obviate having to file.
There’s a grain of truth to some of this but it’s far too absolutist. It’s certainty true that one could envision (no pun intended) an out-of-court solution that provides no real enhanced breathing room to the company (e.g., doesn’t move the needle on the probability of them subsequently filing) but does benefit a certain favored group of creditors upon filing, and makes reorganizing in-court easier, through the pre-filing rejiggering done.
But this, in my view, quite clearly doesn’t describe the full intent behind the Serta, Incora, Envision, et al. transactions. In all these transactions significant new liquidity injections occurred and the companies were put in a better position than they otherwise would have been – although non-participating creditors have obvious, and understandable, gripes with the nature of the transactions.
And if the secondary, but not primary, intent of these transactions is that they make for a more seamless filing through likely being able to cobble together an agreement with some creditors pre-filing – as Serta and Envision were able to, and as Incora is likely to – then that strikes me as reasonable.
However, the fact that Envision and Incora are likely to have an easier time in-court, relative to if they had never done their out-of-court work, is viewed by many as proof positive that these transactions were never about forestalling filing – but were rather done with a single-minded focus on making sure a favored set of creditors reaped the highest recovery upon filing (thus why those who participated in these transactions are more than happy to sign onto RSAs and try to jam the cases quickly and relatively cheaply through court).
Anyway, with Envision filing, and Incora likely filing within the next few weeks, you’ll be reading lots about how these sponsor-backed companies aggressively stripped a minority of creditors of the recovery they’d otherwise be due through these transactions despite the supposed inevitability of their filing. It certainly makes for a better story. However, like many things in life, it’s not quite so clearcut and I very much doubt these cases will get clogged up by courts entertaining this line of thinking.
But there’s no getting around there are some bad optics to Incora and Envision filing so quickly after doing transactions that are so aggressive. And, as discussed at length regarding Incora, there is only so much the bounds can be pushed before the bounds become more clearly defined by the whims of the courts – and that should make everyone a bit wary as no one knows exactly where those bounds would be set.
Note: In a redux of the pre-reorg maneuvering that took place with Incora, Platinum (allegedly) began buying up significant amounts of the senior unsecured notes of their PortCo Cision a few weeks ago. So, they aren't overly fazed by the ongoing Incora litigation we've discussed before.