Double-Dips: The Latest Restructuring TrendUpdated:
In the world of restructuring, no matter where you go, and no matter who you talk to, you’ll eventually end up talking about drop-downs and non-pro rata uptiers in some capacity. I think it’s inarguable that they’ve been the two dominate developments in the industry over the past five years – not so much because of their direct impact, since they’re still done relatively rarely, but because of their indirect impact.
In the case of both drop-downs (e.g., J. Crew, PetSmart, Neiman Marcus, Revlon, Envision, etc.) and non-pro rata uptiers (e.g., Serta, Boardriders, TriMark, Incora, Envision, etc.) this indirect impact comes through ushering in a reimagining of how permissible debt docs can really be, and how much the boundaries can really be bent before courts begin pushing back (this latter point still mostly being an unknown vis-à-vis non-pro rata uptiers and suddenly much more uncertain with the unfortunate downfall of our old friend Judge Jones who I spent so much time talking about in relation to Serta).
In all of my writing on Serta, Incora, etc. this is something that I’ve tried to get across: that these two types of solutions have caused a meaningful shift in the Overton window. Today, you’re invariably going to pay more attention to if pro-rata sharing provisions can be amended by a simple majority, how much value can be shifted to an unrestricted subsidiary, etc. in assessing the potential solutions available to a company – and, importantly if you’re on the buy-side, if you could be caught on the wrong end of a solution.
The new normal is thinking about these solutions in the back of your mind, and this leads to their impact being felt in situations where there’s just the possibility that they could be effectuated (e.g., leading to more cooperation agreements being signed as creditors eschew undergoing an arms race to offer companies the best non-pro rata solution in favor of working together on more vanilla out-of-court solutions, leading to companies more easily getting amend and extends done through being able to offer lenders valuable non-monetary consideration in the form of tightening up credit agreements to preclude drop-downs or uptiers from occurring in the future, etc.).
Additionally, it’s inarguable that the rise of drop-downs and non-pro rata uptiers has inspired the search for other creative solutions – ideally some that, at least superficially, look a little less abrasive to non-participating creditors and thus results in companies incurring less immediate litigation costs. And this search has only been accelerated by the current rates backdrop that has led to a proliferation of stressed companies that need an infusion of liquidity or the ability to refi existing debt coming due but also need to find ways to keep down their cash interest expense – since S + 800 feels a bit different when SOFR is north of 5% as opposed to south of 1%.
Anyway, a new solution has been found – one that, over the past few quarters, has been reproduced with a few tweaks multiple times just as Serta’s non-pro rata uptier was reproduced with a few tweaks by Boardriders and TriMark shortly after it was announced.
However, unlike drop-downs or non-pro rata uptiers the solution found isn’t really that novel. Rather, it’s a retrofitting of an old concept – initially popularized a few decades ago by distressed funds – that has been given a new lease on life and will join drop-downs and non-pro rata uptiers as being yet another tool in the toolbox (assuming that it holds up in court once tested, something that only time will tell but that most are bullish on as this “new” solution doesn’t hinge on a creative reading of the debt docs or harm non-participating creditors quite as much – at least initially).
Note: If you’re currently preparing for interviews it’s important to keep in mind the essentials: the accounting questions, the waterfall questions, the structural subordination questions, the bond math questions, etc. Those are the kinds of questions that will dominate your interviews. It’s certainly impressive to be able to explain (roughly) what drop-downs, non-pro rata uptiers, or this new solution are in an interview if the opportunity arises. However, as I've stressed before, knowing the granular specifics is far beyond any interviewer’s expectations and, more importantly, not something that'll organically crop up. So, focus on the important stuff first and don't become too lost in the sauce here for no reason.
Note: I’ve tried my best to create a nice little introduction here that covers the essentials and ventures down rabbit holes on an as-needed basis. To this end, there are some smaller details I've avoided discussing because I don’t think they're essential to telling the story of this solution and would just result in us getting dragged into debt doc deliberations over considerations that are of limited practical consequence (e.g., considerations surrounding the designation of an unrestricted subsidiary but designation isn't the real issue that can present itself with using an unsub here, considerations surrounding investment capacity vis-à-vis the new-money guarantees and the intercompany loan but if there’s sufficient debt and lien capacity then sufficient investment capacity is liable to be available, etc.).
The Traditional Double-Dip
In the real world, thanks to George Constanza’s chip dipping proclivities, the term double-dip has taken on a negative connotation. However, in the world of restructuring the term has anything but a negative connotation. In fact, it has been used for decades to refer to something that, at first blush, seems a little bit like alchemy.
The term “double-dip” refers to a situation where a creditor holding debt that’s been issued by a non-guarantor restricted subsidiary or unrestricted subsidiary can end up having a recovery upon the company filing that’s around double (or more) that of pari debt issued by some other entity (although the total recovery, in dollar terms, of a creditor benefiting from a double-dip is capped at payment in full – typically just meaning par although there could be a make whole, accrued interest, etc. nudging the total recovery above par).
Functionally, the way this potential doubling of recovery occurs is through the subsidiary-issued debt holders establishing two independent allowed claims against the company (ergo, the term double-dip). The first dip arising from an entity, or a series of entities, where value resides providing a guarantee of the subsidiary-issued debt. The second dip arising from the subsidiary upstreaming the proceeds from the subsidiary-issued debt, in the form of an intercompany loan, to an entity where value resides and often where some or all of the company’s existing debt has been issued out of in return for an intercompany loan receivable that’s then pledged to the double-dip creditors as security for their debt.
So, upon filing, there are two independent allowed claims that redound to the benefit of the subsidiary-issued debt holders: the direct claim arising from the guarantee(s) provided and the indirect claim arising from the subsidiary separately being able to enforce the intercompany loan against the debtor with any recovery then flowing to the subsidiary-issued debt holders.
Note: The above description is trying to retain as much generality as possible – something that’s impossible to do perfectly since double-dips have many permutations as we’ll soon discuss. If things seem a bit murky now, it’ll all (hopefully!) be cleared up as we move forward. For now, just keep in mind the basic principles: you could find yourself getting a recovery that’s around double that of pari creditors upon filing – although the dollar amount of your recovery will be capped at payment in full – and this arises through establishing two independent allowed claims against the debtor (each one of these allowed claims being a “dip”, ergo the double-dip name).
Anyway, to avoid ourselves getting too lost in caveats before we even get going, let’s put a bit of meat on the bones through a little example. Imagine that we have an entity called ParentCo. It holds all of the company’s assets and is the issuer of the company’s only debt: a $200mm 1L TL. Because of regulatory reasons or tax reasons or some reasons the company created a non-guarantor restricted subsidiary that we’ll call SubCo. SubCo then issued $200mm of Senior Secured Notes to some creditors and, as you might expect, the creditors demanded a secured (first-lien) guarantee from ParentCo to make the subsidiary-issued Senior Secured Notes pari with the ParentCo-issued 1L TL.
Now, SubCo was just a shell that was created for some reason, and it had no use for the $200mm raised there. In fact, the debt docs governing this $200mm in debt specifically precluded SubCo from engaging in any business activities other than more-or-less servicing its debt.
Therefore, SubCo immediately upstreamed the proceeds from its debt issuance to ParentCo through an intercompany loan that was also secured on a first-lien basis and thus resides pari with ParentCo’s 1L TL. In return, SubCo received an intercompany loan receivable to the tune of $200mm and this receivable was pledged to the Senior Secured Noteholders as security for their debt. Therefore, SubCo, the erstwhile shell company, now has $200mm in assets (the intercompany loan receivable) and $200mm in liabilities (the Senior Secured Notes).
So, to be clear, before filing ParentCo – the entity in this example that’s the issuer of the company’s pre-existing debt, has all of the company’s assets exclusive of the intercompany loan receivable, etc. – will be regularly paying the intercompany loan and those proceeds will be used by SubCo to pay the Senior Secured Notes. It all just flows through and the rate on the intercompany loan will be exactly the same as the rate on the Senior Secured Notes. (Remember: the only real reason this debt was incurred at SubCo to begin with was for some reason that precluded it being incurred as secured debt at ParentCo.)
However, if filing occurs down the road then things get a bit interesting because all of a sudden we’re looking at a double-dip situation...
Think about it from the Senior Secured Noteholders’ perspective: if filing occurs then the Senior Secured Notes, that have a secured guarantee from ParentCo, will reside pari to the 1L TL at ParentCo. However, the SubCo can separately enforce the intercompany loan against ParentCo that’s also been made pari to the 1L TL residing there and the recovery stemming from this will, obviously, flow to the creditors of the SubCo – and the only creditors residing there are the Senior Secured Noteholders.
Therefore, we have two independent allowed claims here that both redound to the benefit of Senior Secured Noteholders but one being direct and one being indirect. First, the direct claim arising from the secured guarantee of the Senior Secured Notes. Second, the indirect claim arising from SubCo’s intercompany loan receivable that’s been pledged to the Senior Secured Notes. So, effectively, the Senior Secured Noteholders have two bites at the ParentCo apple.
Put another way, if we were to do a little waterfall there would be $600mm of claims that are all residing pari to each other arising from the $200mm 1L TL, the $200mm Senior Secured Notes, and the $200mm Intercompany Loan. It just so happens that $400mm of these claims, in the end, benefit one group of creditors: the Senior Secured Noteholders.
Now, to turn this into more of an interview question, although it would never be asked, let’s imagine that the company files and that we apply a 6x multiple to their LTM Adj. EBITDA of $40mm (don’t worry about deficiency claim stuff). In other words, let’s pretend that there’s $240mm in distributable value for waterfall purposes. If there weren’t a double-dip, and instead the Senior Secured Notes had only the secured guarantee, then you’d say there are $400mm in total first-lien claims. So, there’d be a 60% recovery ($240mm / $400mm) for both the 1L TL and the Senior Secured Notes (in other words, $120mm of recovery for each).
However, as mentioned, with the double-dip there are really $600mm in first-lien claims. So, the 1L TL would receive a 40% ($240mm / $600mm) recovery or $80mm. However, the Senior Secured Noteholders would benefit from a 40% recovery on the Senior Secured Notes residing pari to the 1L TL and a 40% recovery on the Intercompany Loan residing pari to the 1L TL that’ll flow to them through SubCo. Since both of these are $200mm claims, the recovery from each will be $80mm and the total recovery, in the end, for the Senior Secured Noteholders will be $160mm or 80% of the amount initially lent. Therefore, even though the ParentCo-issued 1L TL and SubCo-issued Senior Secured Notes have identical face values and reside pari to each other, the Senior Secured Notes are getting double the recovery due to their multiple (two) allowed claims. Magic.
In the preamble I alluded to there really being two phases to the history of double-dips. The first phase, encompassing the better part of two decades, is one where the only double-dips that arose did so organically – they were merely a natural consequence of certain companies having cavernous capital structures borne, usually, out of a need to issue debt out of foreign subsidiaries for tax or regulatory reasons (e.g., Lehman, General Motors, etc.).
In other words, it wasn’t really the intention of these companies to create a double-dip when they were raising debt at some SubCo and most of the holders at the subsidiary level were entirely unaware that there was even the possibility of being able to multiply their allowed claims if the company were to file.
Given this, in the past twenty years many of the old guard of the distressed world (e.g., Appaloosa, Elliott, Redwood, etc.) have tried to find these relatively rare double-dip opportunities out in the wild and take advantage of them.
And there’s an obvious reason for doing so: if no one else recognizes that the debt issued by some SubCo could have around double the amount of claims and, by extension, could have around double the potential recovery it otherwise would have then the market is probably pricing the debt as if it has only a single-dip (e.g., pricing based on the assumption of a thirty-cent on the dollar recovery, not up to a sixty-cent on the dollar recovery, etc.). It’s been a good trade if you can find it and execute it in size – neither being easy to do.
Anyway, I’ve talked a bit before about how the announcement of Serta’s non-pro rata uptier, to the surprise of many within the industry, caused incredulous indignation outside the industry. It struck many outsiders as fundamentally unfair, on its face, that a simple majority could radically reorientate the priority of those in the minority. It was tantamount to bullying – even if those being bullied weren’t the most sympathetic cast of characters.
I can imagine that some reading this may look at double-dips the same way and are wondering how this has all stood up in court over the years. What were the arguments in favor? What were the arguments against? What are the rules of the road, the boundaries that can’t be broken? Surely, if there’s been a number double-dip situations over the past two decades, someone has litigated all of this and some precedence has been set. It’s not like these are benign situations where no one loses – we just saw in our little waterfall example that the gains in recovery of one party in-court (SubCo’s Senior Secured Notes) are per se the losses in recovery of another (ParentCo’s 1L TL). This is claim dilution and, just like with all kinds of dilution, if you’re the one being diluted you won’t be happy! Especially if you didn’t realize you would be diluted!
However, last month we discussed how many issues in restructuring that are controversial, contentious, and continually litigated tend to languish in a legal limbo – coming close to the brink of being ruled on, but never being so. And this is because, just as occurred with Apollo’s complaint surrounding Serta’s use and abuse of their DQ list, the issue gets settled before a court has the opportunity to weigh in one way or the other.
This has more-or-less been the case with direct double-dip litigation. There’s been a few decisions from courts around the margins but, in the end, settlements usually end up occurring at the eleventh hour. For example, the most famous double-dip involved Lehman Brothers. To reduce a mountain to a molehill here, Lehman Brothers Treasury Co. (LBT), a subsidiary domiciled in the Netherlands, issued around $35bn of Notes that were guaranteed by Lehman Brothers Holdings Inc. (LBHI). Immediately upon issuance, LBT upstreamed the proceeds to LBHI.
Upon filing the LBT Noteholders claimed they had a double-dip with a direct claim arising from the guarantee of the LBT Notes by LBHI and an indirect claim arising from the intercompany loan that was the result of LBT upstreaming the debt issuance proceeds to LBHI. This set off a fire storm and led to LBHI holders advocating for substantive consolidation to, in part, void the double-dip and it looked like this mess was going to be decided by the court.
However, before the final reckoning a settlement was reached. There would be no full double-dip, and there would be no substantive consolidation. Instead, both LBT claims were allowed in the Plan but a portion of the LBT Noteholders’ double-dip recovery would be allocated to LBHI holders.
So, when it was all said and done, those who timed their entry into LBT prior to the double-dip becoming well known, and those who timed their entry into LBHI before they regained leverage in the case through the substantive consolidation push, made historic windfalls (although in Lehman the biggest winners were arguably the advisors who risked nothing and gained nine figures – not bad work if you can get it).
Anyway, it’s unfair to say that these organically arising double-dips are entirely untested. There may be a paucity of precedence but there is a kind of tactic approval from bankruptcy courts stemming from PORs getting confirmed that contemplate certain creditors getting the benefit of a double-dip (even if, as in Lehman’s case, those creditors don’t get quite as much recovery as they were initially jockeying for due to a settlement occurring vis-à-vis the double-dip).
For example, in LatAm, a pandemic-era case, a number of distressed funds (e.g., Redwood) successfully argued that they had a double-dip that boosted the recovery of their holdings above pari creditors holding debt that didn’t benefit from a double-dip. It’s perhaps not surprising then that it would be Redwood that spearheaded the evolution of double-dips this year – sparking an onslaught of transactions with many of the big names in distressed rushing in to participate...
The Evolution of Double-Dips
In Northern Italy finding white truffles is done the old-fashioned way: you get a hound with a good nose, go marching through the forest for days on end, and, after many false positives, end up finding a few hunks that are worth their weight in gold. It’s laborious, inefficient work.
In the last few decades, finding double-dip opportunities has been roughly similar – just swap out the hound with a good nose for a distressed analyst with a masochistic relationship to their work, the old-growth forest of Northern Italy for a stressed company’s corporate structure, etc.
Given the relative rarity of double-dip opportunities and how tricky identifying them can be it seems natural to think that if the concept of double-dips has been at least tacitly supported by courts then why go through the rigmarole of finding them out in the wild to begin with? Why should it matter if they arose organically or not? Why not just, like, create them out of thin air?
This can seem to be an obvious thought in light of the drop-downs and non-pro rata uptiers that have occurred in recent years. But this is the rationale behind me going through my whole song and dance about the Overton window in the preamble. There is no reason the evolution of double-dips that we’re about to discuss couldn’t have happened earlier. It’s just that there’s been, for lack of a better turn of phrase, an attitudinal shift that’s allowed this evolution to occur now -- and, as with all things in finance, once one person does something then everyone piles on.
So, as you’ve guessed, the evolution of double-dips that began this summer involves companies manufacturing double-dips as part of a new-money transaction – something that participating creditors, obviously, love as it provides better downside protection if the company files in the future (through benefiting from a total claim size that’s around double, depending on the transaction structure, the face value of the debt that has the benefit of the double-dip).
The transaction that spurred this evolution was At Home, a sponsor-backed retailer of hokey home décor. They were acquired by Hellman & Friedman a few years ago and pre-transaction their capital structure consisted of a $425mm ABL with $321mm drawn, a $600mm 1L TL with $593mm outstanding, $300mm in Senior Secured Notes, and $500mm in Senior Notes (the 1L TL and SSNs were pari).
Sadly, it appears that the inflatable pumpkin, etc. market has seen better days. This year At Home had modestly negative EBITDA and, through the magic of addbacks, slightly positive Adj. EBITDA. But that’s a far cry from the $300mm of both that they did two years ago (although they’re expecting that both will rebound next year to over $100mm as freight-disruptions abate, cost reduction initiatives take hold, etc.).
Anyway, they needed some fresh liquidity and to dream up some ideas for doing so they brought in Kirkland & Ellis and PJT. In the end, they settled on a transaction that involved manufacturing a double-dip on a $200mm new-money investment – and it’s somewhat natural that they did considering that one of those providing the new liquidity, Redwood, was more than familiar with taking advantage of double-dip opportunities in the wild.
Similar to the first drop-downs and uptiers that occurred, this first manufactured double-dip was relatively straight-forward – not having the bells and whistles that double-dips that have come in the wake of At Home’s transaction (e.g., Tinseo and Wheel Pros) have had.
So, let’s work through the steps that At Home took to effectuate the transaction. As you go through these steps, keep in mind that we’re literally just trying to re-create a “traditional” double-dip that you’d find in the wild – therefore, we’re really just working backwards from the end goal of providing creditors participating in the transaction multiple allowed claims if filing occurs.
STEP 1: CREATING THE SUBSIDIARY
First, a subsidiary needs to be created. In At Home’s transaction, a non-guarantor restricted subsidiary was created, based in Cayman, that we’ll call SubCo. To be clear, it was a shell – having no assets and no liabilities. The “restricted” descriptor means that SubCo had to comply with the negative covenants underpinning At Home’s existing debt docs, whereas the “non-guarantor” descriptor means that SubCo wasn’t a guarantor of any of At Home’s existing debt.
You’ll recall that I’ve talked about unrestricted subsidiaries many times before – especially in relation to Serta’s transaction and the drop-down that was unsuccessfully pitched. Unlike a non-guarantor restricted subsidiary, an unrestricted subsidiary doesn’t need to comply with the negative covenants underpinning a company’s existing debt docs and doesn’t have to guarantee any of a company’s existing debt – it’s fully outside the restricted group thus the name.
Ideally, you’d rather be spinning up an unrestricted subsidiary to do one of these transactions instead of a non-guarantor restricted subsidiary – and in some cases like Sabre and Trinseo that’s been the case. However, the reason you’ll see non-guarantor restricted subsidiaries used is due to the underlying debt docs: more specifically, some debt docs precluding restricted group entities from guaranteeing the debt of an unrestricted subsidiary or, more generally, allowing unrestricted subsidiaries to incur debt that is recourse to assets residing within the restricted group (in most situations the restricted group entities are those that have issued most, or all, of the company’s existing debt and contain most, or all, of the company’s existing assets – so, if you’re looking to do a double-dip, you want access to those assets!).
STEP 2: ISSUING THE SUBSIDIARY DEBT
Second, with the subsidiary created it now needs to actually issue the debt. In At Home’s transaction this was $200mm of 11.5% Secured Private Placement Notes maturing in 2028. Redwood led the way in providing the funding along with a cohort of others that, like Redwood, were pre-existing Noteholders (we’ll circle back to this point in a few minutes).
Now, backing up for a second, all debt docs are heavily negotiated and try to strike a balance between restricting the company from taking actions that could diminish recoveries for holders while ensuring that the company has the flexibility to manage its affairs. This can most clearly be seen in the capacity that debt docs provide for a company to incur additional debt (e.g., the priority it can be incurred at, the purposes it can be incurred for, the type of entity that can incur it, etc).
Therefore, to effectuate a double-dip, the company’s existing debt docs must allow it to incur the new debt at the subsidiary level and guarantee that new debt at the subsidiary level (thereby providing the first dip) and permit the intercompany loan from the subsidiary to the operating company that’ll be using the funds (thereby providing the second dip). In other words, the existing docs must permit all three of these things to manufacture a double-dip.
So, getting back to our second step, we know there needs to be existing capacity under the existing debt docs to incur debt at the subsidiary level. If the subsidiary is an unrestricted subsidiary, then there’s no issue with this step as the subsidiary isn’t subject to the negative covenants of the existing debt docs. Practically this means you can raise as much debt at an unrestricted subsidiary as folks are willing to give you – the trick is figuring out how to provide sufficient value at the unrestricted subsidiary level such that people will actually want to put money there. (It’s not too enticing to lend to an empty shell that has no recourse to any value!).
This is how many drop-downs fail at the planning stage because the existing docs don’t allow enough value to be transferred down to an unrestricted subsidiary to make it worthwhile to pursue. Not to get too off track but this is, in the end, how Apollo, et al. got our maneuvered in Serta: there was only around $675mm in value that could be transferred to an unrestricted subsidiary, so there was a natural binding constraint on how much new-money could reasonably be lent to an unrestricted subsidiary and the amount of debt it’d make sense to exchange over.
Anyway, in At Home’s transaction the SubCo was a non-guarantor restricted sub. This means, as discussed, it is subject to the negative covenants under the existing debt docs. Therefore, to incur debt at the subsidiary there must be sufficient debt and lien capacity, and this capacity must be able to be tapped specifically for the purpose of incurring debt at a non-guarantor restricted subsidiary. The most common baskets that can be tapped are the general debt and lien baskets along with foreign or non-guarantor debt and lien baskets (although others can be available).
This is a huge rabbit hole that I’ll try to not go down too far. But think of baskets as being like little carveouts in the debt docs that allow additional debt to be incurred at some priority, at some type of entity, for some purpose. Some baskets will be a flat amount, some will expand or shrink as total assets or EBITDA or some other metric expands or shrinks, some will permit an amount of debt up until some ratio such as leverage or FCCR. The point is that in assessing the viability of most out-of-court solutions, you need to turn to the debt docs and figure out if there’s the capacity to do what you want. Some of the baskets won’t be applicable to the specific thing you’re trying to do, and some of baskets can be added together to get to the capacity desired.
So, if someone is asking, “How much additional debt can a company incur?” it’s far too general of a question to really answer. Is the debt going to be secured? Is it going to be structurally senior? Is it going to be used to repay existing debt? Depending on the answer, how much capacity the company has can be wildly different.
Knowing the ins and outs of tallying up capacity, or specific baskets that should be looked to in certain situations, is, to put it mildly, well beyond the scope of what you need to know in interviews. It’s just important to bring this all up to reinforce the point that most out-of-court solutions are going to be constrained by the debt docs, and this is true of double-dips too. Although, it should be noted that eventually you’ll learn the ins and outs and be putting together slides breaking down the capacity in the docs – albeit with “subject to review by counsel” emblazoned on them since it’s counsel that will have the final say, perhaps with some creative interpretation à la Envision.
Note: To maintain the integrity of the double-dip that’s being put in place, the debt docs governing the subsidiary-issued debt should ideally be heavily restrictive – precluding additional borrowing at the subsidiary, transferring its sole asset of the intercompany loan receivable, or otherwise doing any business beyond servicing the debt that resides there. The double-dip is predicated, obviously, on diluting the claims of other creditors through establishing multiple allowed claims – but double-dip creditors need to be mindful of the tables being turned on them and having value leak from their own subsidiary. You can’t just play offense; you need to play a little defense too.
STEP 3: GUARANTEEING THE SUBSIDIARY DEBT
In order to create the first “dip” a subsidiary’s newly issued debt needs to be guaranteed by entities where (obviously!) some actual value resides. In most situations this will mean a guarantee coming from one entity (or many entities) within the restricted group.
So, for example, in At Home the newly issued Private Placement Notes were guaranteed on a first-lien basis by the At Home ParentCo (At Home Group) and some of its domestic restricted operating subsidiaries thereby making them pari to the pre-existing 1L TL and SSNs.
Philosophically, if we think about what a guarantee really is, it’s functionally similar to regular-way debt being incurred by the entity providing the guarantee. This is the rationale behind nearly all debt docs treating guarantees as the assumption of additional debt – and, as we discussed above, when you’re trying to determine if debt can be incurred at some priority, at some type of entity, and for some purpose you need to turn to the debt docs and look for capacity.
Typically, the debt and lien capacity relied on will stem from the general debt and general lien baskets, guarantee-specific baskets (only if the guarantee is to the benefit of a restricted group entity, such as a non-guarantor restricted subsidiary), and the incremental debt basket (although, to be clear, all debt docs are unique snowflakes with a mix of baskets – these are just commonly used here).
Importantly, to create a secured guarantee you need both debt and lien capacity. The lien capacity being necessary to make the guarantee secured and, as you can imagine, in any double-dip transaction where the company is per se stressed you’re going to want a secured guarantee to make sure your new-money is pari to the company’s existing secured debt, as was the case in At Home and Wheel Pros.
(Alternatively, double-dip creditors can have secured guarantees from non-guarantor restricted subsidiaries where value resides, thereby giving themselves structurally senior claims on the value residing there relative to the company's pre-existing secured debt, as was the case in the Sabre and Trinseo double-dip transactions -- but I'll leave that discussion for the Double-Dip Guide to avoid muddying the waters here too much).
STEP 4: CREATING THE INTERCOMPANY LOAN
In order to create the second “dip” the funds raised at the subsidiary-level need to be upstreamed, in the form of an intercompany loan, to some entity (usually that has issued the company’s pre-existing secured debt) with the subsidiary then receiving an intercompany loan receivable that, in turn, is pledged to the subsidiary’s creditors as security for their debt.
Once again, this requires debt and lien capacity under the debt docs with the lien capacity being necessary insofar as you want the intercompany loan to be secured and thereby residing pari to the company’s existing secured debt (e.g., in At Home the Intercompany Loan was from At Home Cayman to At Home Group and was made pari to At Home Group’s existing first-lien debt).
Therefore, in determining if capacity exists, you’ll go back to the same well: looking at general debt and lien baskets, the incremental secured debt basket, etc. if there's remaining capacity there. However, in many double-dip transactions (e.g., Sabre and Trinseo) the intercompany loan proceeds are used specifically to repay existing debt – and, in this case, permitted refinancing baskets can be used that, to simplify, allow debt to be refinanced by similar debt (e.g., secured debt being refinanced by a secured intercompany loan à la Trinseo).
In the end, the lynchpin of making one of these Double-Dip 2.0 transactions work is making sure that the intercompany loan resides pari to the company’s pre-existing secured debt. Technically, if you wanted, both the double-dip debt guarantee and the intercompany loan could be unsecured and in that case you wouldn’t need the existing docs to provide lien capacity (they’d just need to provide debt capacity, and this is invariably more ample). But if you’re looking at a stressed company that’s desperate for liquidity or can’t do a regular-way refi of its existing debt then you’re not liable to get much recovery if your claims are behind a wall of pre-existing secured debt.
Remember: it’s fantastic to benefit from around double the claims of similarly situated creditors through having a double-dip – but if those similarly situated creditors are getting pennies on the dollar, or nothing, then all of those claims you have aren’t going to help you earn much of a return.
WRAPPING UP THE AT HOME TRANSACTION
So, we’ve briefly covered the mechanics of manufacturing double-dips and how, in the case of At Home, Redwood, et al. have turned a $200mm new-money investment at SubCo into $400mm of first-lien claims if filing occurs (although remember that the maximum recovery of the PPNs is capped at payment in full). Here’s how you can visualize things...
But let’s take a wider lens here and bring things full circle. You’ll recall that I mentioned some of the new-money participants were pre-existing Senior Noteholders – residing pre-transaction behind a wall consisting of the $321m ABL, $593mm 1L TL, and $300mm Senior Secured Notes. Now, if you’re providing new money to a struggling company, and you also happen to hold some lower part of the capital structure that’s inline for a de minimums recovery, then you’ll want to try to salvage some value – and one way you can do that is through trying to roll up your holdings as part of the transaction to a higher position in the capital structure.
So, that’s exactly what was done here. In conjunction with the $200mm new-money financing, $447mm of the pre-existing Senior Notes were exchanged into $413mm of new Senior Secured Notes that reside pari to the other At Home first-lien claims. The rate on the Senior Notes and these new Senior Secured Notes is the same (7.125%) but there is the ability to toggle the new Senior Secured Notes to PIK at 8.625%. Therefore, this little exchange created a bit of discount capture, since the exchange happened below par, and in the future At Home will be able to conserve some cash if they want to utilize the PIK toggle.
So, if we’re thinking about the waterfall, there’s the $321mm ABL; the pre-existing $300mm Senior Secured Notes, the $593mm 1L TL, the $200mm Private Placement Notes, the $200mm Intercompany Loan, and the new $413mm Senior Secured Notes that are all pari; and then there’s the lowly $53mm of left-behind Senior Notes that weren’t allowed to participate in the exchange.
Put another way: pre-transaction there were $893mm of first-lien claims and now there are $1,706mm – not something that the pre-existing 1L TL and SSNs are too happy about, even if the reason for the claim dilution is, in part, the new-money investment that was desperately needed.
The Benefits of Double-Dips
Similar to drop-downs and non-pro rata uptiers, double-dips won’t be able to be done by every company under stress. It all comes down to the docs: if there’s not sufficient basket capacity to incur the debt at the subsidiary and guarantee that debt on a secured basis and put in place the secured intercompany loan then the double-dip will be a non-starter (unless the transaction is being done by a majority of existing lenders, so the docs can just be amended to effectively add in the capacity as was done in Wheel Pros...).
Regardless, many will be able to do a double-dip, and there’s been a narrative develop over the summer that they’ll somehow replace drop-downs and non-pro rata uptiers. However, this is overstating the case for them. There will be times when a double-dip makes the most sense, and there will be times when a drop-down or non-pro rata uptier makes the most sense. Additionally, there will be times when a combination of these three solutions makes the most sense (e.g., Tinseo’s combined drop-down and double-dip, Envision’s combined drop-down and uptier, etc.).
But, to be clear, there are undoubtably benefits to double-dips, so let’s talk about a few of them...
First, there’s a certain innocuous quality to double-dips. Unlike in drop-downs or non-pro rata uptiers where the full weight of the transaction is immediately felt by non-participating creditors, in double-dips the impact is primarily felt by those “harmed” only upon filing – when suddenly they find themselves diluted down by the multiplicative claims arising from the double-dip.
The natural extension of double-dips appearing to be more innocuous when they’re executed is that there’s less immediate litigation costs. This stands in sharp contrast to drop-downs and non-pro rata uptiers where – as we’ve discussed ad nauseam in relation to Incora, Serta, etc. – there’s nearly always going to be some level of immediate litigation coming from those creditors who’ve been left out in the cold (although this isn’t always the case, Envision was a masterclass in doing follow-on transactions to diminish the amount of litigation that would eventuate).
Additionally, since most (not all!) doing these more “creative” transactions are sponsor-backed, this lack of litigation is valued not just from a cost-savings perspective but from a reputational perspective. This isn’t because sponsors are benevolent but because many creditors in one PortCo’s capital structure are going to be in other, or future, PortCo capital structures. So, all else equal, sponsors would rather not make creditors too mad as that could result in a slightly higher cost of debt in future buyouts (e.g., the so-called Apollo premium). Personally, I think this is all heavily overstated as a rationale for doing a double-dip as opposed to a more aggressive alternative but this is a narrative you’ll often hear, so now you’ve heard it too.
Second, in theory there’s no need for a new-money lender in a double-dip to be an existing creditor. The new-money at the subsidiary level could be funded by anyone so long as they liked the terms of the debt and felt comfortable with their enhanced downside protection (in other words, the enhanced level of recovery they’d get upon filing through having the double-dip).
This stands in contrast to non-pro rata uptiers where, by definition, you need a simple majority of the relevant existing creditors in order to amend the docs to effectuate the transaction. So, there’s not that much leverage for the company as the only ones who can do the uptier are some combination of existing creditors that can form a simple majority. In fact, the only real leverage of the company comes through threatening to try to do another type of transaction, instead of the uptier, if those pitching the non-pro rata uptier don’t agree to a lower exchange rate or better terms (from the company’s perspective) on the new super priority debt.
Third, the pricing of the double-dip debt (e.g., the subsidiary-issued debt that benefits from the double-dip upon filing) is usually pretty favorable considering the stressed nature of the company. For example, At Home’s Private Placement Notes have an interest rate of 11.5% and ended up pricing at around a 13% yield. Not exactly cheap. But considering that the pre-existing Senior Secured Notes had a yield well into the 20s pre-transaction (remember: they have a first-lien claim too) the pricing was about as good as could be hoped for from the company’s perspective.
The rationale behind the double-dip debt being relatively cheap for the company is pretty straight-forward: the downside risk to holders of this debt is significantly diminished due to having around double, give or take, the allowable claims relative to the amount lent if the company files.
Think about it this way: imagine you’re looking at a piece of debt and think the company could file in the next two or three years. Now let’s imagine that through your genius analysis you think the recovery you’ll get upon filing is around 30-40%. In this case, the size of the coupons you’re clipping over these two or three years pre-filing better be large or, alternatively, the entry point you’re getting into the debt at better be pretty low in order to make a reasonable return. But if there’s a double-dip then the recovery you’re assuming that you’ll get if filling occurs will be significantly higher (by virtue of the multiplicative claims) than it otherwise would be so you don’t need the coupons you’re clipping to be quite as large, or the entry point into the debt to be quite as low, to arrive at the same level of return or better.
Therefore, for a company struggling in the current rates environment, the double-dip is a valuable non-monetary form of compensation to give holders. In other words, the company doesn’t need to provide holders the same upside pre-filing (through high coupons or a low entry point) because the company is manufacturing a better downside for holders through a higher recovery than pari creditors post-filing.
Fourth, in the same way that drop-downs and non-pro rata uptiers can result in significant discount capture through having existing holders exchange their debt below par, so too can double-dips as part of the broader transaction (or as a direct part of it, à la Wheel Pros). In At Home this occurred, as we’ve already discussed, through $447mm of the Senior Notes rolling up into $413mm of the new Senior Secured Notes – thereby netting a nice little discount capture.
Additionally, it’s important to keep in mind that a company may look toward a more creative transaction not only to bring in new liquidity but to effectively refi or otherwise reconstitute debt through an exchange. For example, in Trinseo the blended double-dip and drop-down transaction was used to take out its remaining $660mm TLB due in 2024 and over three-quarters of its Senior Unsecured Notes due in 2025. Thereby pushing back maturity walls and giving itself some much needed breathing room (although it’ll still have to deal with those Unsecured Notes left behind but there's a plan for them...).
In At Home the challenge was less about maturity walls and more about the need to bring in liquidity and, if possible, keep cash interest expenses as low as possible. To this end, the Senior Notes exchanged into Senior Secured Notes had an identical cash rate. However, unlike the Senior Notes, the SSNs included a PIK toggle thereby providing more cash interest breathing room if needed in the future. So, this effective reconstituting of the Senior Notes into a PIK instrument as part of the broader transaction provides the company a bit more optionality moving forward.
The Expansion of Double-Dips
Whenever a new type of solution comes along a familiar script occurs: the first transaction is relatively vanilla and then, as the transaction is digested, a slew of similar transactions occur that are expanded and enlarged in increasingly novel (read: aggressive and/or complicated) ways.
If you’ve read all my writing on non-pro rata uptiers over the years, then this script will be familiar. Serta’s PTL Lenders exchanged their existing holdings well below par, thereby creating a huge discount capture for the company. But then, just three months later, Boardriders decided to push the envelope a bit more through announcing their own transaction that was similar in style but with participating holders exchanging their existing debt at par (a better deal for participating holders and causing much more indignation among non-participating holders given that the debt being exchanged was trading well below par).
More recently, if you’ve read my posts on Incora, you’ll recall that things were taken a step further with some of the Unsecured Notes rolling up above pre-transaction Senior Secured Notes at par – despite the Unsecured Notes trading way below par – to the direct benefit of the sponsor that had been buying up some Unsecured Notes themselves. Now that’s aggressive.
Anyway, the same script has played out vis-à-vis double-dips. Something that shouldn’t be too surprising given that double-dips, unlike drop-downs or non-pro rata uptiers, are a bit more flexible and can be more easily combined with other types of solutions.
Note: In the Double-Dip Guide that I’m putting the finishing touches on the below transactions are discussed in much more detail although, to be clear, the specifics of these are lightyears beyond what you need to know for interview purposes.
Immediately following At Home, we had Sabre that involved a larger new-money component and a bit more complicated of a structure (there was another proposal from existing lenders on the table, but the company opted to go the double-dip route after the double-dip proponents upped the size).
The transaction involved a group led by Centerbridge – with Oaktree, Oak Hill, and JPM tagging along in much smaller size – providing a $700mm Term Loan to an unrestricted subsidiary that the company had spun up. There’s still a recognizable double-dip here (e.g., the new-money creditors are going to have two independent allowed claims if the company files in the future). However, there are a number of things that make it distinct from At Home’s transaction including the secured guarantees coming from a smattering of non-guarantor restricted subsidiaries being capped at $400mm due to debt doc constraints and the terms of the Centerbridge, et al. Term Loan and the resulting intercompany loan that resides pari to Sabre's existing secured debt being, uh, a classic Centerbridge concoction (read: extremely aggressive, we’re talking a max rate of 17.50% for cash interest and 19% if PIK is elected).
In Trinseo the new-money became even bigger, and the transaction structure much more complicated. Ultimately, the transaction crafted was a blended double-dip and drop-down with a new lender group – consisting of Oaktree, Apollo, and Angelo Gordon – providing a $1,077mm Term Loan that benefits from a double-dip and that was used, net of fees, to take out the entire $660mm TLB coming due in September of 2024 (done at par) and $385mm of the Senior Unsecured Notes coming due in September of 2025 (also done at par).
Trinseo is a bit of a grab bag because, given the size of the Term Loan, the company didn’t have the basket capacity to do a “clean” double-dip (e.g., just have a non-guarantor restricted subsidiary or unrestricted subsidiary issue a $1,077mm term loan, have that debt guaranteed on a secured basis by restricted group entities, and then put in place a secured intercompany loan that would also reside pari to the company’s existing secured debt).
So, it was a bit of a mess with the intercompany loan being broken into multiple tranches and the proceeds being flung in different directions, the secured guarantees coming from a smattering of non-guarantor restricted subs at a capped amount, and the drop-down of the valuable Americas Styrenics business only being possible due to the elevator-style movement of the proceeds from one of the aforementioned intercompany loan tranches that opened up the necessary basket capacity to drop the business to an unrestricted sub to the benefit of double-dip creditors. (I’ll save all the gory details for the Double Dip Guide).
Finally, we have Wheel Pros where the double-dip isn’t to the benefit of the new-money component of the transaction (the $235mm FILO facility). Rather, the double-dip is to the benefit of those participating in the exchange component of the transaction – something that was open to all $1,154mm of 1L TL lenders and three-quarters, or $272mm, of Senior Noteholders to participate in. To complete the exchange and effectuate the double-dip, a new non-guarantor restricted subsidiary was spun up and a new $1,014mm 1L TL was created alongside a $272mm 2L TL. The first dip arises from these new term loans benefiting from secured guarantees from Wheel Pros Inc., the borrower of the company’s pre-existing secured debt, and all its wholly-owned subsidiaries. The second dip arises from the term loan proceeds, totaling around $1,286mm, being sent, through an intercompany loan, up to Wheel Pros Inc. and being secured and guaranteed by Wheel Pros Inc. and all its wholly-owned subsidiaries.
The proceeds of the $1,286mm intercompany loan were then used by Wheel Pros Inc. to execute open-market purchases on the participating holders’ existing 1L TL and Senior Notes positions (at 85% and 100% exchange rates, respectively). So, this just amounts to an exchange (at a discount) of the existing 1L TL at the ParentCo into a 1L TL at the SubCo with the benefit of a double-dip, and an exchange of the existing Senior Notes at the ParentCo into a 2L TL at the SubCo with the benefit of a double-dip.
In the end, Wheel Pros really demonstrates how existing creditors – staring down the barrel of a stressed company they don’t really want to put new money into – can structure a transaction with a double-dip component to buy the company more breathing room to implement a turnaround without it to being too risky and make sure that no third-party comes in to do a transaction that suddenly strips value from them (drop-down) or dilutes their existing claims (double-dip). So, of all the double-dips that have occurred, this is the most defensive-minded transaction.
It seems like my (extremely minimal) spare time is inversely correlated with the length of these posts. But there are a few housekeeping notes that are worth spending a few minutes on.
First, in last month’s post we talked about Serta’s use and, in my view, abuse of their disqualified lenders (DQ) list in relation to Apollo. This may have seemed like a relatively niche thing to focus on since, relative to the overall Serta case, it was a sideshow and was settled before Judge Jones had the opportunity to opine on it.
However, the reason I spent so much time talking about it – beyond the fact that I clearly have trouble keeping these posts short – is that Serta’s DQ list shenanigans are a harbinger of what’s to come. To this end, in recent months there’s been a number of distressed funds that have had their trades in certain stressed PortCo’s languishing in limbo – with some situations breaking out into public view like the battle brewing between Blackstone and Strategic Value Partners over SVP’s unsettled trades in a Blackstone PortCo (Packers Sanitation Services).
Just as there was an attitudinal shift that led to the evolution of double-dips suddenly occurring, there’s been an attitudinal shift that’s largely led to this DQ list mess suddenly occurring. And part of that attitudinal shift is a realization that even if the sponsor doesn’t have much of a legal leg to stand on (e.g., the distressed fund should have their trades settle) it’ll take time for it all to pan out. However, in the meantime tying up the trades of one distressed fund will have a chilling effect on all other distressed funds looking at building a position – so, insofar as a sponsor wants more control over who’s in the secured part of their capital structure and wants to send a warning shot, mission accomplished.
Note: The more worrying issue, as we discussed last month, that’ll rear its head in the future are the DQ provisions in some credit agreements becoming bewilderingly broad (some more-or-less stipulating that all funds of a certain ilk are persona non grata). Today, we're seeing (in my view) an abuse of still somewhat boiler-plate DQ provisions but, in the future, similar antics won't necessarily be an abuse as it'll align with the text of the credit agreement. Anyway, I won't belabor this point any further but moving forward there will be many breathless articles about how these expanded DQ provisions, and the DQ lists arising out of them, are gumming up secondary loan market liquidity – so, don’t be surprised when you see them.
Second, we need to talk about Judge Jones because, as mentioned in the preamble, he’s resigned due to, uh, an undisclosed living situation that really should’ve been disclosed. I’ve written about Judge Jones a fair amount in recent months because he’s had a truly outsized impact: turning the Southern District of Texas into the hottest venue in bankruptcy both literally and figuratively and tackling some of the most contentious cases. This includes current cases with far-reaching implications, like Incora, where the battle is still in full heat and that will now be reassigned. In fact, Judge Jones was actually hearing summary judgement arguments in Incora’s case after his living situation became public but resigned shortly thereafter – causing more than a few heart palpitations over at Platinum, I’m sure.
In my writing on Serta I think I made it pretty clear that Judge Jones is a divisive character – with the more uncharitable thinking that he’s an unserious self-promoter who is deferential to debtors to the detriment of case outcomes because to be known as debtor-friendly is to ensure that the largest and most controversial (read: consequential) cases continue coming to his court (and, like, he has handled over 10% of all cases with over $100mm in liabilities since 2016 and around 17% of all cases with over $1,000mm in liabilities since 2020 for a reason).
However, there are some – not just those at Kirkland! – who would defend Judge Jones as being someone whose eccentricities belied a seriousness of purpose, and who stood athwart those who would rather see cases shrouded in uncertainty because that may bear out organic compromises even if it prolongs the debtor’s time in-court. Judge Jones believed that in the most controversial and contentious cases, expediency is a form of equity, that cases must be dealt with as delivered, and that preserving business value should be sacrosanct even if this requires sometimes rubberstamping some dubious debtor behavior.
In the end, this is where much of the resentment toward Judge Jones comes from. For example, everyone knows that his real reason for upholding Serta’s non-pro rata uptier boils down to him more-or-less thinking, “If I unwind this transaction it’ll unleash chaos. There’s no doubt that it’ll be value destructive for Serta itself, since it’ll languish in-court longer, but it’ll also be value destructive for all the other companies that have done a non-pro rata uptier over the last three years. It’s not my issue that this wasn’t all decided by an Article III court in the three years prior to coming to me. So, it’s plausible to me that this transaction is permissible. Plus, it’s not like every credit agreement in the aftermath of Serta blocked these kinds of transactions from occurring. In other words, it’s not like Apollo, et al. are the unlucky few here who’ve been blindsided by this in a way that no one else ever will be. Therefore, on balance, it’s better to try not to put the toothpaste back in the tube – it would unquestionably be a negative for these businesses and their employees and could even end up being a Pyrrhic victory for non-participating creditors if unwinding these destroys enough business value.”
Note: I think it's fair to say that I view Judge Jones in a more sympathetic light than many although, I mean, that's really not saying much. However, there's no doubt in my mind, or in Apollo's, that he would have readily rubberstamped the DQ list issue we've talked about, likely making a few remarks along the way about how he doesn't see what the issue even is, and I would have vehemently disagreed with that.
Anyway, there’s no defense of the actions of Judge Jones that led to his resignation – it was as clear of a failure to disclose as there could be, and he knew it. However, the announcement of his living situation and his subsequent resignation was met with a certain level of triumphalism that, well, I don’t know if it was per se surprising but it was a bit much.
Remember that most in the industry are not in favor of these more creative transactions – and non-pro rata uptiers are especially loathed. So, the jubilation here is, in part, a reflection of the belief that non-pro rata uptiers now rest on a much shakier foundation with Incora still in-court and Serta's issue at the Fifth Circuit on appeal – and there’s no getting around that this is true.
Rest assured, Apollo and Angelo Gordon have continued making their arguments that non-pro rata uptiers are an afront to all that is decent in this world at the Fifth Circuit. Immediately following Judge Jones’ resignation they filed a reply brief stating that their appeal should be reversed, remanded, and moved to the Southern District of New York.
Meanwhile, both Apollo and Angelo Gordon last month led the combined drop-down and double-dip in Trinseo that saw them hack and saw at Trinseo’s debt docs to manufacture the ability to allow one of the most valuable parts of the business to be stripped away from existing creditors and simultaneously diluted down the first-lien claim pool at RemainCo (although, to be fair, the trading levels of Trinseo's secured and unsecured debt were slightly higher post-transaction, so it wasn't like the transaction had the immediate negative impact that Serta's transaction had on Apollo and AG's positions).
Now, Serta and Trinseo are two different kinds of transactions, etc. and it’s fine, or at least not inconsistent, to argue that non-pro rata uptiers are a blight on the industry and that drop-downs and double-dips are as wholesome as apple pie. But it's important to remember that the moralizations in these briefs aren't a reflection of what anyone at Apollo or Angelo Gordon truly believes – and Judge Jones, in his classily curt and cantankerous way, made it known that he at least understood this much. However, don’t be so sure that other judges will – especially if this does ends up back in the Southern District of New York. In the end, someone needs to decide what "open-market purchase" means (we can't just have judges say it's "ambiguous" forever!) and that decision will be one informed by the perceived fairness of the transaction even if it's wrapped up in a much longer dissertation on these six syllables than Judge Jones provided.
Note: In much of the financial press, as you can read in the above links, there’s very much a court-thrown-into-disarray narrative surround Judge Jones’ departure. But that’s all heavily overstated. It’ll all be fine. The current cases will be reassigned and the prior cases won’t be opened up unless there’s a clear and compelling reason for doing so. This is all a mess but it’s not that bad – well, I’ll reserve final judgement on that until we see how Serta and Incora do.