Kirkland partners Patrick J. Nash, Jr., and Alexandra Schwarzman spoke with LevFin Insights regarding Chesapeake Energy’s Chapter 11 cases, the issues they faced and how the company was able to overcome those challenges.
Chesapeake Energy’s chapter 11 plan of reorganization went effective on Feb. 9 following a challenging, roughly seven-month in-court restructuring process in Houston and completion of a two-week confirmation trial pitting the debtors and their plan support parties against the unsecured creditors committee, which opposed plan confirmation on various grounds.
The debtors ultimately prevailed at trial, with the company emerging shortly thereafter under majority control of its Class 4 prepetition first-lien last-out term loan lenders, with prepetition funded debt reduced its over $7 billion, employee jobs preserved and well-positioned for future success.
Chicago-based Kirkland & Ellis restructuring partners Patrick J. Nash, Jr. and Alexandra Schwarzman led the engagement, first representing Chesapeake beginning in March 2020 prior to the bankruptcy filings, ultimately reaching agreement with the FLLO term loan lender group and Franklin Advisers on the framework of a restructuring transaction that included a $600 million fully backstopped rights offering, while under the shadow of potential future preference litigation related to certain liens granted in connection with the company’s December 2019 refinancing transactions.
The duo then led the company to a subsequent agreement with Chesapeake’s RCF lenders on a $925 million new-money DIP financing facility, through the chapter 11 filings in June at the peak of the Covid-19 pandemic, and subsequent case turbulence involving the unsecured creditors committee, all the way through the successful confirmation hearing and emergence.
In this wide-ranging conversion, Pat and Alex candidly discuss Chesapeake’s chapter 11 cases, the issues they faced and how the company was able to overcome those challenges with the help of the Kirkland team of attorneys, other company professionals and Chesapeake’s plan support parties.
They also take a look back and reflect on what was a difficult year for the country and the capital markets, look ahead to what is in store for 2021 and hit on other hot topics in the restructuring space.
JCD: Pat and Alex, thanks so much for joining me today. Pat, Chesapeake Energy emerged from chapter 11 earlier this month after a long confirmation trial in which you and the Kirkland team represented the company. The cases were filed at the height of the Covid-19 pandemic and were contested virtually every step of the way by the unsecured creditors committee. Please tell me how you and your team were able to achieve that great result for the company and its stakeholders.
PN: Well, as you know Jason, we filed the cases with a restructuring support agreement. At the first-day hearing, I remember articulating to the court how hard-fought were the negotiations around that restructuring support agreement and the deal contained therein. And I think that I'm remembering correctly when I say that, at that first-day hearing, I told the court that of course, there would be an official creditors committee that would be looking over our shoulders as to the deal that we cut, but I also told the judge that we were frankly pretty proud of the deal that we reached.
We felt like it was a great framework to maximize value and we felt like the company, frankly, not to strain our elbows patting ourselves on the back, but we thought that we did a pretty good job for all stakeholders in those prepetition negotiations.
We just moved forward and stuck to that deal and stuck to the timeline and thankfully, ultimately got that plan confirmed.
JCD: You certainly did. This next question is for Alexandra. And it follows up on some of the things that Pat just touched on. Alex, Chesapeake’s prepetition liability management initiatives, I would say, came under fire in the chapter 11 cases from the UCC. So without getting into all the specifics of the UCC’s well-documented allegations, could you please talk about those challenges, how the team responded to those challenges and how the firm was ultimately able to successfully shepherd the company through bankruptcy in the face of those gusty headwinds?
AS: Of course. First off, I think that the term “liability management” or “liability management transactions” has become a bit of a dirty word in recent years. What I mean is, people use it as code for transactions on the eve of a bankruptcy designed to take value and move it away from certain creditors, or take an action with respect to the company’s balance sheet that could be disadvantageous to certain parties. But in truth, liability management transactions are a company’s attempt, and in this case Chesapeake’s multiyear attempt, to right-size its balance sheet.
These actions were liability management transactions in the true sense of the word, not with any sort of nefarious connotations, despite the UCC’s unsuccessful attempt to spin it otherwise. And so the way we were able to shepherd the company through this process, notwithstanding those liability management transactions, is we were able to show the court that these were true liability management transactions. We had a management team focused on right-sizing the balance sheet and focused on moving the company toward full financial health. And when the facts of those transactions were brought to light, those facts clearly supported the conclusion that management was just trying to get this company fully stabilized with a balance sheet that it could support going forward.
JCD: Question for both of you, what lessons did you learn from the Chesapeake chapter 11 cases that you will take with you going into your future restructuring transactions?
AS: I think that the work we did between mid-March 2020, when we and the other professionals got retained, and the end of June, when the cases were filed, was incredibly instrumental in allowing for a smooth case. I mean, there was a lot of litigation but it was smooth in the sense that we really never got knocked off our true north. We knew where we wanted these cases to go. We were able to do that.
We had an incredibly sophisticated, organized, hardworking management team that allowed the professionals to get in and quickly understand the business, get a business plan together and get a path forward. The company also had a lot of leverage over its creditors, and we used that leverage to the maximum advantage possible.
And by doing those two things, being highly organized and exerting our leverage, we were able to come up with a restructuring support agreement that would carry us through to a very successful result.
JCD: Anything to add to that, Pat?
PN: Yeah, look, I agree with all that. I’d say that my biggest takeaway is probably, a great bankruptcy judge once told me that sometimes you have to be prepared to just try your case. And without question, most restructurings end in some sort of compromise. That is always the goal and more often than not, it’s the right outcome. But one takeaway I have from the Chesapeake case is don’t be afraid to try your case and put on your evidence if you believe in the restructuring that you put in front of the court.
JCD: All right, switching topics off Chesapeake for a minute, Pat, as you know, 2020 was a year of extraordinary chapter 11 activity as a result of the pandemic and other factors, with Kirkland representing debtors in cases like Neiman Marcus, Akorn Pharma, J.C. Penney, Covia, Frontier Communications, Intelsat, Denbury Resources, Ascena Retail Group and many, many others. Frankly, the list of Kirkland debtor engagements in 2020 is astonishing. How was the firm able to successfully handle such an immense list of complex matters, both currently in bankruptcy and in the pipeline, all at once and without blowing a gasket, so to speak?
PN: Good question, though with a pretty straightforward answer. The firm has made a big investment in the restructuring group and the size of the group, the depth of the group, the number of partners in the group. There are 20 or so Kirkland bankruptcy partners who have run big cases and can run big cases. And if you want to have as much market share as we have and you want to be able to file as many cases as we file and work on as many restructurings as we work on, you’ve got to have a big and experienced team. And thankfully, the firm has supported that effort and so we have a large and experienced restructuring group, bottom line.
JCD: Alex, with two months of 2021 now in the books, there has been a noticeable tick down in major new filings, certainly compared to last year with many of those companies that filed in March through the end of last year already emerging from chapter 11. What are your thoughts on the outlook for volume of restructurings in 2021, and what are the sectors you’re keeping your eye on?
AS: It definitely feels slower right now. I think it is slower right now, but it’s so hard to know where the year is going to go. If we were having this conversation a year ago today, would any of us have predicted what was about to come? Of course not. We’ve already seen natural disaster activity this year, recently down in Texas with the cold snap and the energy crisis that’s going on down there. So I think a lot of people are predicting a slower year, but the only thing I’ve learned in this job is to predict the unpredictable. And to Pat’s point, we have a large and experienced bench and so we’re here and able to serve our clients, regardless of the industry.
It will be really interesting to see what happens with energy. I think we had a huge wave last year. Obviously, any company that’s been operating near the border right now has been having some short-term issues, and we’ll see if any of those turn into long-term issues. But the country and the world is marching towards alternative energy sources, so I think there will continue to be some sort of steady stream of energy restructurings. I also think healthcare will be an interesting space with the industry changing so much.
JCD: Pat, what effect if any do you think President Biden’s $1.9 trillion proposed stimulus package will have on the economy and potential 2021 restructurings?
PN: When you think about the government’s fiscal policy and when you think about generally putting more money in consumer’s pockets, those things are consistent with economic growth. It’s going to be a good thing for restaurants and businesses that are dependent upon discretionary consumer dollars. Putting more money in people's pockets helps them in the near and intermediate term. It does seem, though, that we may be entering into somewhat of a rising-interest-rate environment, which could ultimately put some pressure on companies’ balance sheets and the ability to refinance. So, we’ll see.
JCD: Pat, I am glad you hit that last point because I want to ask Alex, what is your view on the current state of the capital markets vis a vis the availability of DIP and exit financing in chapter 11 cases that you’re working on now and in upcoming matters?
AS: I think it’s safe to say the capital markets are much more open now than when we filed the Chesapeake cases. It’s a very different world. Our capital markets team is on fire. There’s just a ton of activity in that space. That said, I think there is probably a little bit of a hangover from this last year and perhaps there’s some hesitation about lending in certain industries, but that might be more on an institution-by-institution basis.
JCD: So back when the pandemic hit, you said that the availability of financing was a lot worse.
AS: I’d say it was close to nonexistent at some points.
PN: It was clearly nonexistent in the E&P space.
JCD: Right, which makes the result you got to in Chesapeake all the more impressive.
AR: Thanks. Also as to DIP financing, it’s usually coming from within your capital structure, which gives you a captive audience from the debtors’ perspective, which is always a good thing. Lenders need to make a determination to let a company potentially go under and lose their investment, or to put in some more money to salvage what’s already gone in. So there is a little bit of a different calculus versus that third-party financing source that is evaluating the situation in the context of a completely new investment. Of course, when you can have competition between incumbent investors and third-party investors for a DIP loan, you potentially can get much better terms, but overall we are seeing more DIP loans made by existing lenders and that trend will probably continue.
JCD: Pat, along the same lines of existing creditors making a further investment in a company in chapter 11, I think credit bidding for the purchase of debtor assets has become more and more en vogue the past couple of years. I know you were involved in one such matter last year, the Akorn Pharma matter in Delaware matter where there was $1 billion-plus credit bid by an existing lender group, which sale was ultimately consummated.
PN: Yes, I was. We are very proud of that result.
JCD: Do you see the trend of credit bidding continuing on an upward arc and if so, why?
PN: I do. I’ve been doing this for about 25 years, and when I first got started, credit bidding from a syndicated lending facility was maybe a little bit more bespoke. It was rarer and less common than it is today. It’s easy if you have one lender and that lender has a lien on one facility and the company can’t pay that lender back and the lender has the right to take possession of its collateral. That scenario is very straightforward, so this notion of a secured lender credit bidding for its collateral in the context of a single lender is not at all complicated.
But what started out as being a bit unusual, which gave rise to a lot of issues, is syndicated lending facilities, so anywhere from three, four, five, to 30 secured lenders who have a lien on substantially all the company’s assets, but not literally all assets, and what they want to do through the credit bid is effectively take ownership of the company. It’s not a secured lender who’s repossessing collateral. It’s a syndicated facility taking ownership of a business and that gives rise to issues. Those issues include a situation where not all the lenders want to be new owners, and what about the aspects of the business that the lenders do not have a lien on?
Over time, restructuring professionals started to develop a road map for how you get these deals done. Your credit bidding lenders also provide a DIP loan and through the DIP financing, those lenders get a lien on things they don’t already have a lien on, which improves their position immensely. Also, credit-bidding lenders often enhance their bid with at least some amount of cash, for example, to assure administrative solvency and/or to fund the wind down of the estates.
One other thing that I think is interesting about credit bidding is to me, there’s a real distinction between loan to own lenders who take a position in the company’s capital structure and/or provide a loan initially with the thought and understanding that they may in fact get to own the assets of the company on the back end. That's one flavor of credit bid.
The other flavor of credit bid, which is clearly what Akorn was, is secured lenders who are reluctant credit bidders. The Akorn lenders certainly did not take the position in the company’s capital structure intending to own the company, but they found themselves in the position of having almost no choice but to provide a floor credit bid while remaining hopeful that a third party is going to show up and overbid them, which did not happen in Akorn.
JCD: Alex, I would say that many of the fights in large reorganization cases last year seemed to focus on valuation disputes, especially the energy sector cases, given the volatility in commodity prices and how that volatility ultimately affected valuation and creditor recoveries. What are your thoughts on how to attack valuation dispute issues from a debtor’s perspective?
AS: I think you have to start with forming your own view of value. In Chesapeake, the professionals performed a comprehensive valuation for the company, and we stuck by it. There is no magic per se. You do the work and you have evidence to back up your conclusions.
I think one of the reasons there was so much litigation around valuation this past year is so many company valuations decreased so dramatically during the onset of Covid as a result of market conditions. I think people were just stunned. And then, there is the other dynamic of if that’s where the company is saying value is, parties have nothing to lose by fighting because recoveries are getting cut so dramatically and if you don’t fight, you’re going to get nothing or close to nothing? I think those two dynamics were very much at play. But like anything else in this industry, if you do your work and you’re thorough and thoughtful, then you have a good chance of success.
PN: Adding to the valuation discussion, I think one of the most important initial determinations that company-side restructuring professionals, anybody in the capital structure for that matter, need to make, is whether the company needs new equity capital? Does the company need additional dollars in order to get a restructuring done? If the answer to that question is yes like it was in Chesapeake, at what value are the providers of those new equity dollars prepared to invest money? That is a big factor when it comes to valuation in my experience.
JCD: Pat, as a senior restructuring partner at Kirkland, when a distressed company comes to you in 2021 seeking advice about a potential restructuring, what’s the first thing you ask them, and what is your game plan going forward?
PN: You first have to listen and understand what the company’s issues are. In the process of listening and trying to figure out what the company's issues are, the first order of business is the company’s liquidity runway and making sure that there is alignment on how much time we have to figure this out before the company needs new money, and we then act accordingly.
JCD: For either of you, as we were talking about before, once the pandemic hit, everybody went remote, including court hearings. How did that affect your ability really to get the job done in such a time of need for your clients? And how did it affect your ability to interact with other parties in the cases, as well as the judge?
PN: Amazingly, neither Alex nor I had met a member of the Chesapeake management team or board in person. Still haven't, which is pretty-
PN: It is incredible. When we first started talking to them in March of last year, Alex and I would say things like, “Well, not next week, but in April after this gets cleared up, we look forward to coming down and meeting you all in person,” and we just never did for reasons that are obvious. Look, we made it work and frankly, surprisingly, seamlessly.
In terms of the court hearings, the various courts really bent over backwards to make it work and it does work. You can’t say enough, frankly, about the lengths to which the courts have gone to make this work. I don't know that it could have gone any better to be honest.
JCD: Are you both looking forward to getting back into the live courtroom?
AS: Yes, once it’s safe, of course. There’s some magic to everyone being in the room for those moments.
JCD: Thanks so much to both of you for your time, that was outstanding.