Restructuring Support Agreements: What You Need to KnowUpdated:
Throughout the early 2000s, it was increasingly recognized that the Chapter 11 process was not operating as it was intended to. Instead of the process being an efficient and effective way for debtors to work with their creditors on reconfiguring their capital structure, some cases were taking years to come to any kind of resolution.
One of the more famous examples used during the early aughts to illustrate the perceived brokenness of the Chapter 11 system involved PG&E, who took three years to emerge from bankruptcy protection after filing Chapter 11 in 2001.
The problem with sustained Chapter 11 proceedings is the immense business disruption and value destruction that occurs. When a company enters into a prolonged Chapter 11 process, it’s not only highly disruptive to the ordinary operations of the debtor – due to suppliers becoming reticent to extend credit and key employees leaving the company – but also value destructive due to the general financial and reputational harm of being in the bankruptcy process (along with the exorbitant fees that need to be paid to lawyers, consultants, and bankers).
Given this, over the past few decades efforts have been made to try to incentive both debtors and large creditors to come to an agreement pre-filing, or just after filing, regarding how the debtor will be reorganized upon emergence from the bankruptcy process (thereby limiting the amount of time the debtor has to spend in the actual Chapter 11 process negotiating with creditors).
The primary way in which these agreements are codified is through the creation of a Restructuring Support Agreement (RSA) or Plan Support Agreement (PSA), both of which are terms that can be used interchangeably.
An RSA can be thought of as a preliminary Plan of Reorganization (PoR) formed between the debtor and key institutional creditors – who often have commanding positions in the capital structure – that details how the company will ideally be reorganized. As a consequence of agreeing to this RSA, the debtor and these key institutional creditors agree to support a future PoR, which will be voted on by all relevant creditors, so long as it significantly adheres to what was laid out in the RSA.
Therefore, if an RSA has been signed off by a sufficient number of creditors to actually approve a PoR in-court, then the ultimate PoR that will be consummated in-court will be the same as the RSA (with potentially some slight modifications).
However, if the RSA has been signed off by a significant number of institutional creditors, but not enough to approve a PoR without the support of other creditors not involved in the RSA creation process, then the RSA will really act as a kind of initial offer to the rest of the creditors to try to get them on board with the Plan. So, in the end, the RSA may end up being more or less the same as the PoR or there may need to be further significant negotiations and changes to get a PoR ultimately approved by a sufficient number of creditors.
The Benefit of Restructuring Support Agreements to the Debtor
From a debtor’s perspective, there are significant benefits to getting an RSA in place (either pre-petition or shortly after filing) and limited downsides.
First, getting an RSA in place early will enhance the confidence of everyone directly or indirectly involved with the debtor. It’ll demonstrate to suppliers, employees, and potential new customers that while it’s never ideal to be going through the Chapter 11 process, there’s a clear plan in place for what’s being done and by following it the debtor will quickly emerge as a leaner, healthier company.
Second, part of every RSA is a requirement that existing creditors who support the RSA must vote for any PoR that is consistent with the RSA and must not undertake any activity that could delay confirmation of a PoR. In other words, once a creditor signs off on an RSA, they can’t change their mind and try to extract better terms if the debtor suddenly ends up looking a bit healthier than they did a few weeks or months beforehand.
Third, part of every RSA is a requirement that existing creditors who support the RSA must not assign (meaning sell) their claims to third parties unless those third parties agree to be bound by the RSA as well. So, in other words, you don’t need to worry about some distressed debt fund coming in and accumulating claims that previously supported the RSA, reneging on that support, and thus throwing a wrench into the Chapter 11 proceedings.
Fourth, contained within every RSA will be some verbiage surrounding a so-called “fiduciary out” for the debtor. All this means, practically, is that if at some point the debtor believes that the RSA is no longer in the best interests of the estate, then it can terminate the RSA.
So, the debtor can strike the best deal possible with some creditors, but if it believes later that a better deal could be had, it can terminate it and try to renegotiate anew.
Note: This is very rare to see as it creates a great deal of consternation among the key creditors that the RSA was initially entered into with (as you can imagine!). In reality, given the value destruction that can occur through a Chapter 11 process, terminating an existing RSA must always be counterbalanced with the potential for value destruction in the advent that a new RSA cannot be readily entered into with better terms for the debtor.
The Benefit of Restructuring Support Agreements to Creditors
For the creditor’s who participate in the crafting of the RSA with the debtor – which, to be clear, will usually be a small number of large holders – there are a number of benefits to participating in the process.
First, credit investing – whether you’re buying new issuance or you’re a distressed debt fund buying at a discount – always revolves around downside protection. It suits neither the debtor nor the vast majority of creditors to see a prolonged Chapter 11 process that deteriorates the underlying value of the debtor. So, the first benefit of having a prepetition or post-petition RSA in place is simply creating some level of certainty (assuming the Plan ultimately looks more or less like the RSA) as to how the debtor will be reorganized.
Second, when a debtor reorganizes that will almost invariably come along with some level of new money issuance that existing creditors can participate in (such as a post-petition DIP, which often has great economics). For large institutional creditors, most will be open to participating or rolling up their preexisting secured debt into the new DIP facility. By having a seat at the table to negotiate the RSA, a creditor can try to push for favorable terms for new money issuance that they would like to participate in.
Note: I'm trying to keep this all reasonably high level, so I'm glazing over quite a bit of nuance on the mechanics of how creditors participate in new money issuance and how sophisticated credit investors will think about participation in DIP facilities or the eventual exit facility (and the linkage between these two, and what you had prepetition, in terms of rolling your consideration). Maybe I'll try to tackle this a bit in a post later on, but rest assured this is all lightyears outside of what is talked about in restructuring interviews.
Third, another benefit conferred from having a seat at the table is that debtor’s will often throw little incentives at creditors to try to get them to partcipate in the process given that there are some downsides to participating. These incentives can include having their advisory or legal fees paid for if they agree to support the RSA, along with also providing liability releases.
To be clear, there are downsides for the creditor associated with participating in putting together the RSA. Most notable among these are that by agreeing to support the RSA the creditor will be restricted in their trading (if they do sell their claims, the buyer will need to agree to support the RSA fully) and will need to support a PoR so long as it’s substantially similar to the RSA.
Prepetition and Post-Petition RSAs
Thus far I’ve tried to skirt around some of the more technical nuances to RSAs in an attempt to give you the bigger picture.
However, there are a few things you should be aware of:
- RSAs can be entered into either prepetition or post-petition (post-petition meaning after the debtor is already in the Chapter 11 process).
- RSAs are treated as contracts (between the debtor and whichever creditors have signed onto the RSA) and as such the Court will need to review and approve the contract.
For RSAs that are created pre-filing, a debtor would file a motion with the court seeking for this contract to be assumed under Section 365 of the Bankruptcy Code (which is the provision that allows for a debtor to seek to assign, assume, or reject leases and contracts within Chapter 11).
This is incredibly routine, and the court will show a great amount of deference to the debtor that is seeking to assume an RSA that was created pre-filing. Generally, a business judgement standard will be utilized by the court which more or less means the court will ask itself, “Is it reasonable to assume that the debtor wishes to assume this contract in order to maximize the value of the estate?”.
For RSAs that are created post-filing, things get a bit trickier. The debtor will seek for the court to review the RSA under Section 363. However, section 1125(b) of the Bankruptcy Code prohibits soliciting votes on a plan prior to the court approving the disclosure statement.
As we’ve discussed, the RSA is not a plan per se, but is a precursor to a plan reached by key creditors along with the debtor so this raises the question of whether or not an RSA is really a solicitation of votes in all but name. For this reason, at the very top of every post-petition RSA you’ll have the following bold disclaimer making it clear that the RSA is not soliciting votes:
Example Restructuring Support Agreements
Below are a few examples of RSAs, one done pre-petition (as part of a prepack) and one done post-petition.
Guitar Center Inc.
Guitar Center is one of my favorite debtors to talk about. For years they did relatively small out-of-court restructurings to try to buy themselves enough time to turn things around as they progressively became more and more distressed.
By late November of 2020 the writing was on the wall so they did a prepack in order to gain the benefits of the Chapter 11 process, while having all the details of what they wanted to do already ironed out beforehand with their primary creditors so they could get in and out of court quickly.
Here's a breakdown of the support Guitar Center had for their plan pre-filing:
Guitar Center, after putting together an RSA and supporting prepack documents (the RSA is Exhibit B, page 66 of the PDF), entered Chapter 11 on November 17th, had its final plan confirmed on December 17th, and then officially emerged from Chapter 11 with ~$800m less debt and an equity injection of $165m before the start of the new year.
Today Guitar Center is preparing to do an IPO. Thus illustrating how a well managed restructuring process can lead to distressed companies turning things around and being set on a sound financial foundation for the future.
Note: Houlihan Lokey advised the debtor on the transaction. Part of the reason why the process was so clean-cut was due to Guitar Center being owned by Ares (who is obviously a very sophisticated player and who was actively looking to inject new equity into the company as part of a comprehensive restructuring). Further, Guitar Center had a supermajority of their noteholders (most of whom were sophisticated credit funds) on board with the RSA.
Restructurings are always trickiest when you have lots of small, relatively unsophisticated credit investors. With Guitar Center a critical mass of creditors (enough to push the Plan through) were sophisticated credit investors and the owner of Guitar Center was obviously a large PE fund, so everything ran as smoothly as you could have hoped.
Of course, one of the more notable and widely discussed Chapter 11 filings of 2020 was Hertz. Hertz gained notoriety primarily because after it had filed, it became a bit of a meme stock and had its equity bid up.
As you likely already know, while almost everyone in the restructuring and distressed debt world thought meme stock investors were literally throwing away their money, they turned out to be right for all the wrong reasons as equity holders ended up getting non-trivial compensation in the end due to a turnaround in Hertz while they were in Chapter 11.
Note: It’s relatively rare – but not abnormal – for equity investors to receive some form of compensation in a Chapter 11. Normally this is in the form of warrants and normally what equity investors are getting is worth nowhere near what the equity was trading at just before the company filed. But I’ve lost the desire to try to explain the machinations of equity markets in 2020/2021, so I won’t elaborate further here.
Anyway, Hertz filed a post-petition Plan Support Agreement that was agreed to by the debtor (obviously) and a series of key creditors, along with the “PE Sponsors”, who include Centerbridge (who incidentally has done incredibly well over the past year in their credit funds and who love doing hairier buyout deals out of their PE funds), Warburg Pincus, and Dundon.
Note: The Plan Support Agreement above is not the ultimate Plan approved. I'm just linking this as an example of a post-petition RSA. As you may know, part of the reason why equity holders received non-trivial compensation is due to the bidding war that broke out over Hertz. While Hertz was initially going with the Centerbridge, Warburg, Dundon offer (which the PSA above notes), in the end a group lead by Knighthead, Certares, and Apollo ultimately won. If you're curious, here's a reasonably good Bloomberg piece quickly going over the bidding war.
As with nearly everything in the world of restructuring, there’s quite a bit of nuance I’m glazing over in order to try to cram this all down into a few thousand words.
But to be crystal clear, all an RSA really represents is an agreement between the debtor and some, but not all, creditors as to what the final Plan (that all eligible creditors will vote on) should look like. Although if the RSA doesn’t have a critical mass of creditors across the capital structure agreeing to it, then there will likely be fights in court that will lead to the final Plan potentially looking quite a bit different than the initial RSA.
Since most of the people who come across this site are preparing for restructuring investment banking interviews, I should probably note that details surrounding RSAs will never come up in any meaningful way in an interview.
What will come up in an interview are the classic restructuring interview questions or perhaps tricker ones on structural subordination, so you focus on those and not be spending hours poring through the minutiae of Guitar Center’s prepetition RSA.
With that being said, RSAs are a great way to get a feel for how debtors plan on restructuring themselves in-court, what consideration (read: compensation) various classes of creditors will receive, and what their exit capital structure will look. So, if you're curious, feel free to check out the RSAs discussed above.