US DIP financing to the rescue for Australian retail insolvencies?

By Orla McCoy and Mikhail Glavac

Debtor in possession financing in the US has continued to rise, particularly in the context of retail insolvencies. In Australia, we have seen a number of high profile retail collapses in recent years. Can DIP financing solve the woes of struggling retailers in Australia?

The Australian financial press presaged the arrival of online retail behemoth Amazon in Australia in December 2017 as a significant challenge for the already embattled Australian retail sector. Parallels were invariably drawn with the disruption wrought upon the retail market by Amazon's exponential growth in the US, where more than 300 retailers filed for bankruptcy protection in 2017, including significant household names like Toys "R" Us, Gymboree and Payless ShoeSource.

Our US counterparts describe "ghost" retail shopping malls and tell us that retail, and its co-dependent industries (retail leasing, real estate investment trusts), represents a significant source of work for US restructuring and insolvency professionals. Likewise, in Australia, notwithstanding a relatively stable economy, 502 retail businesses entered external administration in 2017, including high-profile businesses Topshop Australia, Surfstitch, Marcs, David Lawrence, Oroton and Lover.

At the same time, funds with significant amounts of underutilised capital are looking for yield. These funds are prepared to put that capital to use in special situations opportunities, including by way of restructuring or "loan-to-own" strategies.

Lending to a company in bankruptcy protection or external administration may seem counterintuitive given that, by definition, it has insufficient means to pay its creditors. However, a vibrant market has become established in the US for "debtor-in-possession" (or "DIP") financing of companies in bankruptcy proceedings, with both traditional lenders and funds competing for their share. During the global financial crisis alone (2008-2009) almost US$100bn was raised through DIP finance.

The popularity of DIP finance products rests on favourable interest rates (usually at an uplift on prime lending rates), and the fact that the loans are generally fully funded, the lending periods can be lengthy, the fees lucrative and, depending on the nature of the DIP finance, can unlock loan-to-own opportunities. The sums advanced can be considerable ‒ in the Toys "R" Us bankruptcy, the US Bankruptcy Court approved a US$3.1bn bankruptcy financing package.

In the context of a retail insolvency or restructure, any self-financed rehabilitation, or sale of a business as a going concern, will require, at a minimum, the ability to quickly convert stock to cash (to pay the suppliers, employees and landlords critical to business continuity). Absent ready cashflow, any rehabilitation, restructure or sale will require access to new funding to finance the trade-on or restructuring measures.

This article considers the tools available to restructure struggling retail businesses in the US and Australia, in particular the availability of fresh funding which is crucial to facilitate turnarounds.

US Chapter 11 proceedings

While commonly invoked in response to financial distress, the United States Bankruptcy Code Title 11 procedure is available to facilitate both solvent and insolvent corporate restructures, making it one of the most flexible and commonly used (formal) restructuring tools in the US.

Bankruptcy protection is immediately granted upon the filing of a debtor's petition for relief under Chapter 11. That relief includes an immediate moratorium on any enforcement against the company and its property which has extraterritorial effect. The ultimate restructure under Chapter 11 is documented in a plan of reorganisation which must be voted on by parties "in interest" (creditors and shareholders), and approved by the Court.

In the conventional scenario, the debtor company's plan of reorganisation and related disclosure statement will be negotiated, prepared, and disseminated to stakeholders after the Chapter 11 petition is filed. The stakeholders thereafter vote on, and the Court must approve, the plan. Those steps may take many months (or even years), during which the company's future and market credibility are effectively in limbo. To avoid that bankruptcy free fall, it is also possible to file a "pre-packaged" or "pre-negotiated" (with voting to occur on the plan immediately post-filing) plan of reorganisation.

Bloomberg figures released by the American Bankruptcy Institute in November 2017 examine the confluence of US retail distress and the growing DIP loan market, charted below:

DIP Volume Continues to Climb in 2017 Amid Retail Industry Distress

DIP Chart

Tuesday, November 7, 2017

Australian voluntary administration proceedings

In Australia, voluntary administration via Part 5.3A of the Corporations Act 2001 (Cth) is a tool for debtor companies to restructure their affairs. It's also the closest analogous regime to Chapter 11.

An important distinction between the two regimes is that, under Chapter 11, a debtor company's existing management will remain in control of the debtor. Under voluntary administration, on the other hand, the administrator assumes exclusive control of the company's business, property and affairs (and the powers of the board of a debtor company are immediately suspended).

The two regimes are similar in that, as with Chapter 11:

  • administration is intended to be an interim or temporary regime - if a rescue plan isn't possible, the debtor company is placed in liquidation (which can continue for lengthy periods in complex administrations); and
  • administrators of a trading business in administration need cashflow, and often bridge financing, to continue trading and/or restructure the business.

DIP financing packages have been an important part of the success of Chapter 11. They are a feature of all large US retail bankruptcies, allowing the debtor company to continue trading while at the same time pursuing a plan of reorganisation which facilitates the restructure of the business, including, for example by rejecting or renegotiating onerous leases and executory contracts. As special situation finance, the terms of any DIP finance will be bespoke to the particular circumstances of the debtor company and a matter of negotiation between the parties. The same applies to loan agreements entered into by an administrator of an Australian debtor company.

Australia has the statutory and legal framework to facilitate funding of companies in administration, albeit without the full suite of protections afforded to DIP lenders in the US (and, to some extent, the flexibility offered by that regime). Even without those protections, however, recent examples like:

  • the CBS Networks' funding of Ten Network Holdings during its administration (to refinance existing secured creditors and to fund a DOCA as part of an ultimate (and successful) loan-to-own strategy); and
  • Gordon Brothers' financing of Surfstitch to enable it to trade during the peak retail (Christmas) period while a DOCA was explored,

demonstrate the (largely untapped) opportunities available under Part 5.3A of our Corporations Act for distressed entities and their financiers.

The tiles below outline some key considerations for rescue financing in the US under Chapter 11 and in Australia through the voluntary administration regime.

Comparison of rescue financing in Chapter 11 vs voluntary administration

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