In the News Bankruptcy Court Decisions

Negotiating a Deal in a Falling Market

By all appearances, Masonite wasn't going to buck the trend. After all, during the worst housing market since the Great Depression, door manufacturer Masonite was racked with $2.2 million in debt. With housing starts declining precipitously from more than 2 million in 2005, to just over 500,000 today, the company effectively lost 75 percent of its customers.

Great success seemed unlikely. Nevertheless, after a 75-day stint in bankruptcy, culminating in the approval of its prearranged plan, Masonite emerged earlier this month. While that in itself was a great accomplishment, Masonite didn't just skirt by on some short-term restructuring of its balance sheet, likely to expose it to a Chapter 22 when the housing market sank even lower than projected.

Rather, Masonite emerged debt free and with $150 million in cash. One hundred percent of its secured lenders — holding more than $1.4 billion in debt — voted for the plan. The lenders could have voted to require Masonite to take up to $300 million in debt, but instead elected that the company take only $11 million, which it paid off one day after it emerged. As for the bondholders, 99.99 percent voted for the plan. Just $36,000 of the $750 million in bonds voted no.

Judge Peter J. Walsh (Bankr. D. Del.), in applauding the deleveraging of Masonite's balance sheet and the absence of serious disputes over the plan, said he hadn't seen a case like Masonite in 10 years. He also noted that it was only the second reorganization he presided over in the past year — the rest were liquidations.

"The success of this restructuring was due to three things — leadership from management, an incredible team effort, and a myopic focus on what was best for the company," said Masonite lead restructuring counsel, and Kirkland & Ellis partner Jon Henes.

Masonite's management team and advisors weren't content to reach a short-term deal and be left to pray that the market didn't decline below projections.

Through the coordinated efforts of its management and advisors, constant communication with their stakeholders, and a refusal to bite at any deal that wasn't in the company's best interests, in the end, Masonite did buck the trend, in a big way.

Before it even hired advisors, Masonite began the painful process of shoring up its business for the housing market storm, by reducing its head count from 15,000 to 8,000, and shutting down more than 30 percent of its manufacturing facilities. It was an important first step, said CEO Fred Lynch, to show lenders that Masonite was an operationally strong company whose potential value was hindered only by an unworkable capital structure. Those early efforts paved the way for the parties to work cooperatively toward a consensual deal. "It allowed us to keep hammering home the same mantra to our lenders: 'This is a valuable asset, and if we get it right, we will create long-term value for the investment base. So, let's not screw it up.'"

In June 2008, in the midst of a financial market maelstrom, Lynch, Henes, and Perella Weinberg's Derron Slonecker, set out to negotiate that deal.

Initial negotiations involved leaving a decent amount of the debt on Masonite's balance sheet. But with every consecutive housing report revealing an increasingly dismal reality, the team wasn't biting.

"We would be in negotiating sessions when the housing numbers would come out and they would be even lower than our projections," said Henes.

"And we already thought we were projecting them as low as we thought we reasonably could." Over the course of the negotiations, new, unworkable housing numbers forced management to rework its operating report three times, but it was a worthwhile effort.

"In mid-2008, we didn't know where the housing market was going to go," Lynch said. "Those initial deals may have worked if the market stayed at 1 million housing starts, but here we are one year later, and housing starts are at 480,000. Those deals clearly would not have worked. The company would be back at the table again, and my feeling was if we ever had to come back, we would destroy the value in the company."

By November, housing numbers were so abysmal that Masonite halted negotiations. The advisors urged the lenders to be patient, and ultimately, the lenders agreed to give the debtor more time, in large part, Lynch said, because throughout the process, the team and advisors made it a priority to constantly communicate with the lenders, and to provide them with as much information as they could. "At the end of the day, we reached the best possible deal, and since everything was communicated, everyone realized it. Reasonably well-informed people will often act reasonably, and that's just what happened here."

The market's continued decline also helped negotiations, Henes observed. "Whenever you make a conservative pick on where the industry is going, your stakeholders think you're low-balling them. In Masonite, when we would go to the table projecting 790,000 housing starts, and the numbers would come in at, say, 650,000, the lenders couldn't tell us we were being overly-conservative.

That helped build credibility and showed them that we weren't being self-interested."

Source: Bankruptcy Court Decisions. Copyright 2009 by LRP Publications, P.O. Box 24668, West Palm Beach, FL 33416-4668. All rights reserved. For more information on this or other products published by LRP Publications, please call 1-800-341-7874 or visit our website at: