Indignation Over Incora: An Update on Their UptierUpdated:
The last time we talked about Incora, a complaint had recently dropped from some aggrieved Secured Noteholders that were left behind when Incora’s non-pro rata uptier layered over $1.7b of new debt in front of them and rendered them unsecured (without them, by definition, having a say in the matter).
There were a few reasons why I wanted to talk about Incora back then...
First, there was inherently some novelty to the Incora transaction relative to the other non-pro rata uptiers we’ve discussed in the past since it involved notes, not loans, so the transaction dealt with a fundamentally different set of constraints (e.g., no open-market purchase provisions like we talked about with Serta!).
Second, it really involved two non-pro rata uptiers: one involving some Secured Notes flipping up into newly created 1L Notes and one involving some Unsecured Notes flipping up into newly created 1.25L Notes. With the sponsor holding a non-trivial amount of the Unsecured Notes, and them trading well below par but exchanging slightly above par into a 1.25L position thereby layering over even the Non-Participating Secured Notes, it was a bold move.
Third, the original complaint from the Non-Participating Secured Noteholders was just a hilarious read: full of lawyerly angst and fiery rhetoric surrounding the “Sham Transaction” that was “violently detrimental” to non-participating holders. But it did a great job laying out the transaction, so I thought it’d be a fun read for you and, in conjunction with my explanation, would make for great interview talking points – and I’m glad to hear many did end up talking about Incora with PJT and EVR this past cycle.
Anyway, the gears of justice grind slowly and no amount of angst and fiery rhetoric within a complaint changes that reality. But there have been a few interesting developments with Incora – including a new (separate) complaint dropping from the Non-Participating Unsecured Noteholders – so let’s do a little update…
Note: I haven’t had much free time lately, so I’m not going to spend a few thousand words recapping the transaction – therefore, if you haven’t yet, be sure to read my original post or flip through the original complaint that does an excellent (albeit slightly one-sided!) job recapping the transaction.
Note: Keep in mind that in an interview you're never going to be asked (unprompted) about your thoughts on the merits of various non-pro rata uptier arguments being flung around in court. So, if you're preparing for interviews, make sure to prepare for what will actually come up not deciding whether you're in favor of the integrated transaction argument put forward by the Non-Participating Secured Noteholders (although, needless to say, if you're talking with PJT or EVR about Incora, it's best not to say you agree with the arguments of those suing over the transaction!).
Revisiting the Secured Notes Litigation
As a quick refresher, the pre-reorg capital structure of Incora – which is an entity formed after Platinum took Wesco private and merged it with Pattonair - contained $650m of 2024 Senior Secured Notes, $900m of 2026 Senior Secured Notes, and $525m of 2027 Unsecured Notes.
Due to the pandemic, supply chain issues, etc. Incora quickly began to find itself stretched thin. And with interest payments on its Notes coming up in May 2022 it needed to devise some plan to raise fresh cash and some (e.g., PIMCO and Silver Point) were more than happy to oblige.
The obvious solution was doing a non-pro rata uptier. But, as was discussed at length in the initial Incora post, the so-called Favored Noteholders (e.g., those allowed to participate in the eventual uptier) didn’t hold the supermajority required in both the 2024 and 2026 Secured Notes to strip their liens. This was a necessary precondition to doing the transaction as the Favored Noteholders wanted to exchange their Secured Notes into new (higher priority) debt that had liens on substantially all the company’s assets (in other words, the liens just stripped from the Secured Notes prior to the exchange).
In the end, the necessary supermajority in the 2026 Secured Notes was manufactured through the issuance of $250m of new 2026 Secured Notes exclusively to the Favored Noteholders. These Favored Noteholders, with their newly minted supermajority, then immediately stripped the liens of the Secured Notes and exchanged their holdings into the newly created (higher priority) 1L Notes.
Those Secured Notes that weren’t allowed to participate were rendered unsecured after having their liens stripped – and, to add insult to injury, were also primed by the majority of Unsecured Notes (some held by the sponsor!) who flipped up into new 1.25L Notes despite not putting in any new money.
This is a (very) quick-and-dirty overview of what happened with the Secured Notes but here’s a nice illustration of the overall transaction...
When I wrote the initial post on Incora there wasn’t much to talk about beyond the initial complaint. It’s still early days but we’ve had a bit of traction – most notably with the Participating (Secured) Noteholders, Wesco, Platinum, and Carlyle providing their side of the story and trying to get the complaint dismissed.
Here’s the overarching perspective of the Participating (Secured) Noteholders (PIMCO and Silver Point) that, for what it's worth, I’m in agreement with. They start by arguing that the Non-Participating Noteholder’s complaint amounts to sour grapes – similar to how Apollo and Angelo Gordon feigned indignation and incredulity in the wake of Serta’s decision to do a non-pro rata uptier pitched by Invesco, Eaton Vance, et al. instead of a dropdown (unrestricted sub transfer) pitched by Apollo and Angelo Gordon.
The Participating Noteholders then go on to say basically, “Look, we’re all big boys and girls here and these Original Indentures use highly specific, and highly bargained for, language. It’s absolutely clear that you just need a simple majority of the Secured Notes to consent to increasing the amount of debt that can be issued under the Original Indentures, and that a supermajority can, if they so choose, remove liens. And that’s exactly what happened here: a majority consented to the additional $250m issuance, and a supermajority then voted to remove the liens. That's all that really matters here.”
This is a bit of clever maneuvering (or, if you prefer not to use a euphemism, obfuscation) as what’s said above isn’t something the Non-Participating Noteholders would necessarily disagree with. This is why they made the argument (that, in my view, is a stretch) that this transaction should be viewed as one big integrated transaction.
In other words, the original complaint argued you can’t divorce the step of additional issuance from the step of removing liens. So, there was never really a supermajority for removing the liens as the additional issuance, used purely to facilitate the stripping of liens, should be impermissible.
To partially support this theory, the Non-Participating Noteholders point to how much the 2026 Secured Notes traded up above the 2024 Secured Notes after the idea of the potential for a non-pro rata uptier first leaked on Debtwire. To their mind, this is proof that the Participating Noteholders, caught off guard by the leak, scrambled to get a supermajority (66.67%) that they hadn't yet locked in while, simultaneously, the Non-Participating Noteholders scrambled to get a blocking position (33.34%).
And then, only when a blocking position was achieved by the Non-Participating Noteholders, did the Participating Noteholders then come up with the plan to use their simple majority to allow for the issuance of $250m additional 2026 Secured Notes.
By these newly issued Secured Notes being invested in exclusively by the Participating Noteholders, this then gave them the supermajority necessary to strip the liens and commence the exchange. But if the Participating Noteholders really believed all along that they could manufacture a supermajority this way, and that it wasn't legally dubious whatsoever, then why the mad scramble to buy up the 2026 Secured Notes?
In other words, the argument goes, the Participating Noteholders knew they couldn't manufacture a supermajority through additional issuance -- that's why they were buying up the 2026 Notes initially! But, when they failed to get their supermajority the "right" way, that's when they pivoted to trying to manufacture a supermajority through additional issuance to avoid having their Sham Transaction fall apart before it even got started. And they just hoped, presumably, that despite how legally dubious the transaction was that any litigation could be quickly settled (a settlement basket, providing for additional 1.25L issuance to settle claims from those left behind, was included for a reason!).
Here's what the Participating Noteholders have to say about that...
There is an undercurrent of exasperation (or, depending on your reading, bemused dismissiveness) from the Participating Noteholders throughout – coming back continually to a plain text reading of the indentures: the majority can issue additional notes, a supermajority can strip liens, and the indentures allowed for “privately negotiated transactions”. That’s what happened, end of story. Every step of the process toward this uptier was expressly allowed and there’s no language in the Original Indentures surrounding judging each step differently if they just so happen to be taken in quick succession.
Further, even if the Participating Noteholders purchasing the newly issued Secured Notes seemed irrational if there weren’t an underlying agreement to immediately vote, as a new supermajority, to strip the liens and exchange their Secured Notes into new (higher priority) notes, the Participating Noteholders argue that’s not proof of any kind of wrongdoing.
Finally, because lawyers can’t resist, there are a few jabs throughout around the fact that the Non-Participating Noteholders were crafting their own transaction, that Participating Noteholders were allegedly unaware of, and that the company simply opted for the transaction that was the best deal for them.
This is a touch unfair as the alleged alternative proposal - that an ad hoc group of minority secured noteholders scrambled to put together after they realized they were about to be left behind - was going to be pro-rata (e.g., open to all secured noteholders, including PIMCO and Silver Point). So, it's not like both proposals were going to inevitably leave some behind in the same way or to the same degree.
In the Wesco and Guarantor Defendants reply in support of their motion to dismiss the complaint (linked above) front and center is their core argument: outside of the more ephemeral issue of whether the transaction breaches the implied covenant of good faith and fair dealing, this all boils down to whether you view this transaction as being an integrated one or whether it involved distinct and permissible steps (e.g., using the simple majority to create additional issuance, using the newly created supermajority to strip the liens, etc.).
The logic of their argument here is more-or-less: the Non-Participating Noteholders want you to believe that the Original Indentures permanently bar holders of newly issued Secured Notes from voting (or at least voting the “wrong” way) to strip the liens of all Secured Notes. But this is per se nonsensical, as the Original Indentures make clear that all newly issued Secured Notes are to be equivalent to those originally issued (e.g., with the same rights to provide consent).
So, the argument continues, if you agree with the Non-Participating Noteholders, then what you’re really agreeing with is the notion that these newly issued Secured Notes have different rights relative to the original Secured Notes – which has no basis in the Original Indentures and would be an idea made out of whole cloth.
Note: In the original complaint there are claims that the transaction represents a preferential transfer to an insider (Platinum) and is a fraudulent transfer. This is something that’s more central to the Non-Participating Unsecured Noteholders complaint discussed below, and it’s why the Non-Participating Unsecured Noteholder’s complaint refers to the transaction an “Insider Exchange” whereas the Non-Participating Secured Noteholder’s complaint calls it a “Sham Transaction”. This past week Platinum did try to take down the preferential and fraudulent transfer claims (linked above) and it’ll likely be the same line of argument relied on when addressing the Non-Participating Unsecured Noteholder’s complaint.
The Unsecured Noteholders Take Issue
Just a few weeks ago a new complaint dropped from non-participating holders of the 2027 Unsecured Notes against Platinum (the sponsor), Wilmington Savings Fund Society (the indenture trustee), Carlyle (the majority holder of the Unsecured Notes pre-reorg), and Senator (a minority holder of the Unsecured Notes who also participated in the transaction).
In my original post on Incora, it was probably self-evident that I wasn’t overly moved by the “integrated transaction” line of argument at the core of the complaint. It struck me then, and it still does today, that it’ll be very hard to get a court to move away from a plain-text reading of the Original Indentures and adopt something that’ll per se be more handwavy.
But when thinking about just the Unsecured Notes things get a bit more interesting because, as mentioned in the original post, this aspect of the overall transaction really pushed the envelope...
First, there’s clearly, at a minimum, the appearance of a tawdry insider element to what occurred as the sponsor, Platinum, had been buying up Unsecured Notes prior to the transaction and participated in the roll-up into the 1.25L Notes.
Further, Carlyle, who was the former majority owner of Wesco before Platinum took it private, had owned over 50% of the Unsecured Notes since Platinum took Wesco private and their consent was strictly necessary to effectuate the roll-up. This was true not only because Platinum didn’t hold a majority of the Unsecured Notes, but also because they’re an affiliate of the company so their notes aren’t included in any consent calculation to begin with.
So, even though Carlyle is a former insider they did have a prior relationship with Platinum and this transaction per se put Platinum in a better position than they’d otherwise be in – indeed, in the event that Incora files, as it appears inevitable that they will this year, the sponsor’s return will be driven almost exclusively by their 1.25L Note holdings as their equity will almost certainly be zeroed.
Second, the Unsecured Notes exchange didn’t occur at a discount, despite the Unsecured Notes trading at around sixty cents prior to the transaction, but rather at 101.125 plus fees and accrued interest. But unlike the Participating Secured Noteholders, who also exchanged their debt slightly above par, there was no meaningful additional consideration given by the Participating Unsecured Notes (e.g., the Participating Unsecured Notes didn’t kick in $250m of new cash as the Participating Secured Noteholders did!).
Third, the Participating Unsecured Noteholders (Carlyle, Platinum, and Senator) didn’t jump over just the Non-Participating Unsecured Noteholders, they also jumped over the Non-Participating Secured Noteholders (who, you’ll recall, are now unsecured due to having their liens stripped – so they’re just secured in name only). This, as it just so happens, puts the Participating Unsecured Noteholders in the part of the capital structure where value is likely to break (in other words, where they’ll likely get some significant recovery!).
Coincidently, this is similar to what has played out with Serta after they did their non-pro rata uptier in 2020 but subsequently had to file earlier this year. Those that were allowed to participate in the transaction are in line for a significant recovery, including the vast majority of the post-reorg equity, while those who weren’t given the opportunity to participate (e.g., Apollo, Angelo Gordon, et al.) are getting a pittance.
Anyway, here’s how the complaint starts off...
The complaint goes on (as any complaint will) to give a litany of reasons why the transaction shouldn’t be permissible. This includes a series of arguments, many of which resemble those in the Secured Noteholders complaint, that fall a bit flat: the indenture trustee not carrying out the transaction in a “fair and appropriate manner”, the deletions made to the Original Indenture just prior to the exchange occurring being improper, the transaction violating sacred rights, etc.
When reading the complaint you can almost tell that some of these arguments are made a bit meekly. Because, when you don’t know what will stick, you throw out everything in the hopes that something does. Especially since you don’t know what decisions will be made, after the complaint, in other non-pro rata cases winding their way through courts.
But to my mind the most interesting aspect of the complaint given Platinum's involvement – more as a thought experiment, as it’s unlikely that it’ll end up being persuasive – surrounds whether this all constitutes a preferential transfer given the unique factors in play.
Here’s how the Non-Participating Unsecured Noteholders partly lay it out...
The obvious retort to this is that the Unsecured Notes weren’t trading at pennies on the dollar prior to the transaction: they were around sixty cents and it’s simply a statement of fact that the transaction did buy the company a bit of breathing room (although likely to no avail). Plus, as part of the transaction, a $25m promissory note from Wolverine (the HoldCo through which Platinum owns Incora) was rolled up into the 1.25L Note and thereby had its maturity deferred.
In other words, it may have been true that the company would have had to file if this transaction did not occur, but that’s the whole point of most out-of-court transactions: to buy the company time to turn things around. Sometimes it works, sometimes it doesn’t. And, unfortunately in this case, it appears not to have worked based on how much the Unsecured Notes have traded down over the past year.
But the real argument from the Unsecured Notes is that this transaction was done despite insiders knowing that the fate of Incora was sealed. They knew the transaction wouldn't move the needle. They just wanted to make sure, when the inevitable filing did occur, that they held a more senior part of the capital structure that would ensure them some level of recovery (as opposed to being more passive and just holding their equity that’ll inevitably be worthless upon filing).
In support of the contention that this transaction was done not so much to buy time, as it was inevitable the company would have to file, but rather just to get Participating Unsecured Noteholders into a better position prior to filing there are a few indirect factors one could point to...
First, the Unsecured Notes traded down significantly to around 40 cents after the transaction and continually traded down thereafter (e.g., there was never a bump in pricing reflecting optimism that this transaction could turn things around). Further, today, just a year later, the Unsecured Notes are trading under ten cents – making it clear that not only is the market pricing in that a default is in the offing, but that the value of Incora will break above the Unsecured Notes (in other words, they’re unlikely to get any recovery).
Second, the overall transaction was done a year ago due to interest expense coming due in May. Well, it’s almost May once again and the position of Incora isn’t ideal: as of last quarter, they had around $140m in liquidity and will need to shell out around $100m in interest expense next month. So, unless there’s a significant new infusion of cash or a sudden turnaround in the business, then filing is likely in Q3 or Q4 of 2023. Perhaps, if you want to be generous to the Non-Participating Unsecured Notes, this indirectly illustrates that insider(s) knew the transaction was just going to stall things out for a year, but was never going to remedy the situation.
Third, the 2024 and 2026 Senior Secured Notes are also trading more-or-less around ten cents on the dollar. Meaning that the market thinks the value of Incora breaks more at the 1.25L Notes level – conveniently the level that Platinum, Carlyle, and Senator exchanged into (in other words, above the Non-Participating Unsecured and Secured Notes). This, once again, being an indirect signal that the Participating Unsecured Notes possibly knew where in the capital structure they roughly needed to land to secure some recovery in the evitable filing.
As part of the complaint, the Non-Participating Unsecured Noteholders talked through a little illustrative waterfall...
The Non-Participating Unsecured Noteholders are really trying to suggest that this transaction was done under false pretenses. That ostensibly it was done to provide the company with additional time to try to turn things around through an aggressive transaction that, unfortunately, did come at the expense of the Non-Participating Unsecured Noteholders.
But, in reality, the Non-Participating Noteholders believe the company was insolvent at the time of the transaction, and that the insider(s) knew this and also knew the transaction wasn’t going to change the trajectory of the company. Instead, the transaction was done merely to enhance the recovery of Platinum, Carlyle, and Senator by bumping them up in the capital structure – along with buying them just enough time (a year or so) so that it doesn't look too on the nose when they end up filing.
If this theory sounds like a heavy lift – as it’s predicated partly on imputing motives through a series of indirect factors or signals over the span of a year – then I'm inclined to agree. It’s unlikely that this line of argument will go far even though, optically, there's no getting around that the Unsecured Notes element of this transaction does look particularly aggressive.
But it does raise the question of just how much any sponsor, who’s staring down the barrel of their PortCo equity being wiped out in a seemingly inevitable future filing, should be thinking about aggressively rejiggering the capital structure to potentially end up with a non-trivial amount of post-reorg equity if filing does occur – a circuitous reward for driving the pre-reorg equity value down to zero. It sure beats pumping fresh cash in pre-filing themselves.
When it comes to non-pro rata uptiers, there haven’t just been developments with Incora since my last post. There was also a fresh complaint dropped regarding Mitel’s transaction last month, which is a transaction I briefly mentioned in my post on the next restructuring cycle.
Additionally, with Serta having filed after buying a few years of breathing room with their non-pro rata uptier several years ago, the question quickly became whether the new priorities set by the uptier would be respected in court. If they were, then those that participated would end up getting a fantastic recovery, including the vast majority of post-reorg equity, with those left behind getting a sliver of recovery (something akin to what is most likely to happen if and when Incora files, assuming this transaction stands).
The answer, coming down from Judge Jones a few weeks ago, was that the open-market purchase provisions in the docs made the transaction unambiguously permissible. In fact, in some ways he seemed offended this was even a question he had to resolve, “I sit with these matters everyday… Sophisticated parties know what words they want to choose… this is very easy for me”.
Note: Judge Jones did leave the door ever-so-slightly ajar on the implied covenant of good faith and fair dealing line of argument (something you’ll notice is an almost boilerplate part of every complaint regarding non-pro rata uptiers now). And it was made clear that this ruling didn't speak to whether the transaction complied with all aspects of the credit docs -- just the open market provision aspect.
Anyway, it goes without saying that in an interview you’re never going to be expected to know all the arguments being flung around in court or provide some cogent analysis of them. But it was really fantastic to see how many enjoyed my original Incora post and put it to good use in interviews, so I just wanted to do a little follow-up on where we are today (hopefully discussing so many disparate threads so quickly hasn't been too confusing!).
If you want to keep track of the Secured Notes litigation, go here and search by index number 654068/2022. If you want to keep track of the Unsecured Notes litigation, search by index number 651548/2023.