Document Type
Article
Publication Date
2024
Disciplines
Law
Abstract
Convertible debtor-in-possession ("DIP") financing is symptomatic of a paradigm shift in the control of large bankruptcy cases. During the prior era of lender control, distressed investors used DIP financing to shape the trajectory of bankruptcy cases and extract monopolistic rents at the expense of other constituencies. Enter the original loan-to-own: a common strategy commenced with a DIP loan, continued with a stalking-horse bid, and culminated in an acquisition of the debtor's assets. More recently, private equity sponsors ("Sponsors") and other sophisticated insiders are usurping control of bankruptcy cases. Convertible DIP financing (Loan-to-Own 2.0) is a byproduct. This Article situates convertible DIP financing within the new era of Sponsor control, examines how it distorts valuation, and identifies why it violates the Supreme Court's teachings in Consolidated Rock Products Company v. Du Bois and its progeny.
Loan-to-Own 2.0 reflects Sponsors' prowess. When Sponsors propose DIP financing, they can exceed lenders' gains by leveraging their command over management, an influence unavailable to third-party lenders. Convertible DIP financing locks up a discounted stake in reorganized equity early in the case when the Sponsors' leverage as the proposed DIP lender is at its zenith. This precludes a subsequent fair and equitable allocation under a Chapter 11 plan. Meanwhile, Sponsors' control over management means they can be confident the bankruptcy case will be orchestrated to maximize their returns.
The Bankruptcy Code incorporates the Supreme Court common law requirement for an informed valuation prior to the grant of reorganized equity. However, convertible DIP financing is authorized at the outset of a bankruptcy case, which is too early for an informed valuation of the debtor. The result is a lowball guesstimate designed to augment the Sponsor's returns at the expense of other stakeholders. Absent an informed valuation, convertible DIP financing should be prohibited.
Publication Title
Drexel Law Review
Volume
17
First Page
1
Recommended Citation
Robert Miller, Loan to Own, 17 Drexel L. Rev. 1 (2024)