Handling the Non-Profit Workout/Bankruptcy

The National Benevolent Association of the Christian Church (Disciples of Christ) (NBA) was founded in 1887 as a Missouri-based nonprofit corporation. The laudable mission of the NBA was to provide social and health services to children, youth, disadvantaged families and others. Prior to bankruptcy, the NBA was the parent company of approximately 25 affiliated nonprofit entities that owned and operated 11 senior care facilities, four children's care centers and three special care facilities in 12 states. In addition, the NBA managed 76 HUD-financed, low-income residential housing projects serving thousands of residents.

In the early 1990s, the NBA embarked on a plan to augment its cash flow that could be used to broaden its charitable mission. The NBA commenced the construction and purchase of high-end senior care facilities (including so-called “congregate care retirement communities”) and financed the resulting capital costs primarily with unsecured variable rate and fixed rate tax-exempt and taxable bonds. In a marked change from the previous 100 years of its existence, the ownership and operation of senior care facilities (including independent living and assisted living units, as well as skilled nursing beds) became the NBA's most financially significant line of business and one that it hoped would be a cash cow.

Knowing that its senior care facilities would not be cash-flow positive for a number of years, the NBA settled upon a financial model to service its debt. The model relied upon investment income from a substantial portfolio of restricted and unrestricted funds acquired through charitable donations and other sources to supplement operating revenues derived from resident entrance fees, monthly occupancy fees, ancillary service fees, and payments from Medicare, Medicaid and other government payors.

Instead of augmenting the cash flow necessary for the NBA to continue and expand its charitable mission, the senior care facilities became an enormous cash drain which, in combination with reductions in federal and state government program payments, stock market losses and increased insurance costs, resulted in the NBA's loss of more than 50% of the cash and investments devoted to its charitable mission. In its calendar year 2003 financial statements, following years of operating and investment losses, the NBA reported consolidated total revenue of approximately $151 million and consolidated total operating expenses of approximately $165 million; it also reported long-term debt of approximately $220 million; land, building and equipment with a book value of approximately $215 million; and cash and investment assets with a market value of approximately $90 million. The NBA projected that its cash drain, if left unchecked, could result in a cessation of the charity's operations within 2 years.

Pre-Petition Workout Negotiations

The NBA's response to the cash drain resulting from its decision to enter into the senior care living industry was to demand that its creditors, principally its bondholders, accept a significant write-down of principal. The NBA retained Huron Consulting Group and Cain Brothers as its financial consultants and Weil, Gotshal and Manges, LLP as its counsel. The charity and its consultants asserted that as a result of structural issues, including reduced reimbursement rates from governmental payors, reduced investment income and increased expenses, the NBA was now overleveraged, and that there was no realistic alternative for the creditors except a debt restructuring and/or write-down of approximately 40% (with some potential additional future payments from a portion of any surplus cash flow generated after the restructuring).

The indenture trustee for the bondholders, UMB Bank, N.A. (UMB), was represented by Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., which, among other functions, served as UMB's liaison for communication with, and input from, the hundreds of NBA bondholders throughout the country. UMB, which also served as master trustee for all of the NBA's principal debt obligations, was also represented by its long-standing outside counsel, Spencer, Fane, Britt & Browne, LLP.

UMB retained its own financial consultant, Herbert J. Sims & Co., to review the NBA's projections, conduct site visits and make an independent assessment of the NBA's ability to properly operate and manage its senior care living facilities. Sims' report concluded that the NBA's self-managed senior care facilities were not being operated to their full economic potential, that it was not evident that the NBA's facilities were structurally incapable of carrying its existing debt, and that better management could produce substantially better results than those projected by the NBA.

Beginning in the fall of 2003 and over the course of months of negotiations, UMB and certain of the NBA's bank creditors made a number of proposals whereby outside managers with proven track records in the CCRC industry would be hired to operate all or some of the NBA's senior care facilities, and some short-term debt relief would be provided while the impact of external management on cash flow was assessed. Each proposal was rejected in whole or in part.

As the negotiations dragged on with little discernible progress, the renewal deadline for the letters of credit supporting the NBA's variable rate bond issues passed, the NBA's working capital line of credit expired, and the NBA elected not to pay debt service on its bonds in order to “get some movement” in the negotiations. Faced with a deliberate payment default, UMB accelerated and sued, requesting, among other things, the appointment of a receiver for the NBA's senior care facilities, which request was scheduled for a hearing on Feb. 18, 2005. On Feb. 16, 2005, the NBA and 25 of its affiliates filed for bankruptcy under Chapter 11.

Unlike many workout situations, the NBA's bondholders generally did not fear a bankruptcy filing and, in fact, firmly believed that, given the NBA's resistance to external management, bankruptcy court supervision would provide the best prospect of achieving a favorable resolution. In addition, it was very likely that the bondholders would be able to control the case and block any unacceptable plan of reorganization. The total liabilities of the NBA were approximately $250 million, with virtually no secured debt. The unsecured bond-related debt comprised approximately $230 million of the total. If the bondholders were to vote consistently with one another, the NBA could never achieve an acceptance of a plan by the requisite one-half in number and two-thirds in amount of the debt.

The only method by which the NBA might be able to confirm a plan would be to cram-down the bondholders by obtaining the affirmative vote of at least one impaired class and also satisfying the so-called Chapter 7 test by proving that, notwithstanding the debt write-down sought by the NBA, the bondholders would be receiving at least as much as they would receive in a liquidation.

The bondholders were, of course, aware of the risk that the NBA might attempt to gerrymander a class of creditors having a higher priority than the bondholders, convince that class to vote affirmatively for a plan that paid the creditors in that class less than the full amount owed, and then claim that the lower priority unsecured class, which would include the bondholders, could be crammed down, thereby effectuating the NBA's desired debt reduction through a plan of reorganization without the consent of the bondholders. The probability of success of such a tactic would be dependent on the NBA's ability to legitimately identify a class of higher-ranking creditors and demonstrate that the liquidation value of the NBA assets available for payment to bondholders was equal to or less than the amount to be paid to the bondholders under the crammed-down plan.

Low Risk to Bondholders

For two reasons, it was determined that the risk to the bondholders was low. First, as a result of the drawn-out negotiations, it was known that the NBA had no secured debt (other than some immaterial mortgages on a few peripheral buildings that could, if necessary, easily be paid in full) and no priority unsecured debt. Prior to bankruptcy, the NBA had been very careful to pay all of its trade debt, taxes, PILOTs and similar obligations on a current basis. Given the NBA's debt structure, the claims of the general unsecured creditors, including the bondholders, would effectively be the highest-ranking, non-administrative claims in the case. Although debtors are sometimes known for “discovering” secured or priority claimants, it was believed that the bondholders had a good chance to defeat any attempts at gerrymandering a higher-ranking class.

Second, it was very unlikely that the NBA could satisfy the Chapter 7 liquidation test because the Debtors had $90 million in cash and investments and, based on the Sims report, the senior care facilities, if properly managed, were themselves worth close to the bond-related debt. In fact, the only real concern about a bankruptcy filing by NBA had been a fear that the bondholders would lose, at least temporarily, their periodic bond payments. When the NBA elected pre-petition to cease making bond payments, the principal downside to the bondholders of a bankruptcy filing was essentially removed.

Next month, we discuss the bankruptcy case in depth.

Part One of a Two-Part Article

On April 15, 2005, one of the largest not-for-profit bankruptcy cases ever filed, In re: The National Benevolent Association of the Christian Church (Disciples of Christ) et al., (Bankr. W.D. Texas), Case No. 04-50948 (RBK), came to an extraordinary conclusion when the joint plan of reorganization of the Debtors and the Unsecured Creditors' Committee became effective. Under the Plan, all of the Debtors' creditors were paid the full amount of their pre-petition principal and interest, plus a stipulated amount of post-petition interest, together with reimbursement of the full amount of their pre- and post-petition legal fees. After paying their creditors in full on the effective date, the Debtors, a separately constituted arm of the Disciples of Christ Church, retained certain of their assets and will continue their charitable mission. This unusual outcome, in which creditors were paid in full and the Debtors continued certain of their operations, marked the end of a process that began with the Debtors' unsuccessful attempts to negotiate a substantial write-down of their debts outside bankruptcy, was followed by a year-long bankruptcy case in which the Debtors argued that their charitable status and mission should take priority over their bankruptcy law duty to maximize creditor recovery, and was finally resolved when the Debtors were compelled to sell the bulk of their real estate assets in order to fund full payment to creditors.

Background

The National Benevolent Association of the Christian Church (Disciples of Christ) (NBA) was founded in 1887 as a Missouri-based nonprofit corporation. The laudable mission of the NBA was to provide social and health services to children, youth, disadvantaged families and others. Prior to bankruptcy, the NBA was the parent company of approximately 25 affiliated nonprofit entities that owned and operated 11 senior care facilities, four children's care centers and three special care facilities in 12 states. In addition, the NBA managed 76 HUD-financed, low-income residential housing projects serving thousands of residents.

In the early 1990s, the NBA embarked on a plan to augment its cash flow that could be used to broaden its charitable mission. The NBA commenced the construction and purchase of high-end senior care facilities (including so-called “congregate care retirement communities”) and financed the resulting capital costs primarily with unsecured variable rate and fixed rate tax-exempt and taxable bonds. In a marked change from the previous 100 years of its existence, the ownership and operation of senior care facilities (including independent living and assisted living units, as well as skilled nursing beds) became the NBA's most financially significant line of business and one that it hoped would be a cash cow.

Knowing that its senior care facilities would not be cash-flow positive for a number of years, the NBA settled upon a financial model to service its debt. The model relied upon investment income from a substantial portfolio of restricted and unrestricted funds acquired through charitable donations and other sources to supplement operating revenues derived from resident entrance fees, monthly occupancy fees, ancillary service fees, and payments from Medicare, Medicaid and other government payors.

Instead of augmenting the cash flow necessary for the NBA to continue and expand its charitable mission, the senior care facilities became an enormous cash drain which, in combination with reductions in federal and state government program payments, stock market losses and increased insurance costs, resulted in the NBA's loss of more than 50% of the cash and investments devoted to its charitable mission. In its calendar year 2003 financial statements, following years of operating and investment losses, the NBA reported consolidated total revenue of approximately $151 million and consolidated total operating expenses of approximately $165 million; it also reported long-term debt of approximately $220 million; land, building and equipment with a book value of approximately $215 million; and cash and investment assets with a market value of approximately $90 million. The NBA projected that its cash drain, if left unchecked, could result in a cessation of the charity's operations within 2 years.

Pre-Petition Workout Negotiations

The NBA's response to the cash drain resulting from its decision to enter into the senior care living industry was to demand that its creditors, principally its bondholders, accept a significant write-down of principal. The NBA retained Huron Consulting Group and Cain Brothers as its financial consultants and Weil, Gotshal and Manges, LLP as its counsel. The charity and its consultants asserted that as a result of structural issues, including reduced reimbursement rates from governmental payors, reduced investment income and increased expenses, the NBA was now overleveraged, and that there was no realistic alternative for the creditors except a debt restructuring and/or write-down of approximately 40% (with some potential additional future payments from a portion of any surplus cash flow generated after the restructuring).

The indenture trustee for the bondholders, UMB Bank, N.A. (UMB), was represented by Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., which, among other functions, served as UMB's liaison for communication with, and input from, the hundreds of NBA bondholders throughout the country. UMB, which also served as master trustee for all of the NBA's principal debt obligations, was also represented by its long-standing outside counsel, Spencer, Fane, Britt & Browne, LLP.

UMB retained its own financial consultant, Herbert J. Sims & Co., to review the NBA's projections, conduct site visits and make an independent assessment of the NBA's ability to properly operate and manage its senior care living facilities. Sims' report concluded that the NBA's self-managed senior care facilities were not being operated to their full economic potential, that it was not evident that the NBA's facilities were structurally incapable of carrying its existing debt, and that better management could produce substantially better results than those projected by the NBA.

Beginning in the fall of 2003 and over the course of months of negotiations, UMB and certain of the NBA's bank creditors made a number of proposals whereby outside managers with proven track records in the CCRC industry would be hired to operate all or some of the NBA's senior care facilities, and some short-term debt relief would be provided while the impact of external management on cash flow was assessed. Each proposal was rejected in whole or in part.

As the negotiations dragged on with little discernible progress, the renewal deadline for the letters of credit supporting the NBA's variable rate bond issues passed, the NBA's working capital line of credit expired, and the NBA elected not to pay debt service on its bonds in order to “get some movement” in the negotiations. Faced with a deliberate payment default, UMB accelerated and sued, requesting, among other things, the appointment of a receiver for the NBA's senior care facilities, which request was scheduled for a hearing on Feb. 18, 2005. On Feb. 16, 2005, the NBA and 25 of its affiliates filed for bankruptcy under Chapter 11.

Unlike many workout situations, the NBA's bondholders generally did not fear a bankruptcy filing and, in fact, firmly believed that, given the NBA's resistance to external management, bankruptcy court supervision would provide the best prospect of achieving a favorable resolution. In addition, it was very likely that the bondholders would be able to control the case and block any unacceptable plan of reorganization. The total liabilities of the NBA were approximately $250 million, with virtually no secured debt. The unsecured bond-related debt comprised approximately $230 million of the total. If the bondholders were to vote consistently with one another, the NBA could never achieve an acceptance of a plan by the requisite one-half in number and two-thirds in amount of the debt.

The only method by which the NBA might be able to confirm a plan would be to cram-down the bondholders by obtaining the affirmative vote of at least one impaired class and also satisfying the so-called Chapter 7 test by proving that, notwithstanding the debt write-down sought by the NBA, the bondholders would be receiving at least as much as they would receive in a liquidation.

The bondholders were, of course, aware of the risk that the NBA might attempt to gerrymander a class of creditors having a higher priority than the bondholders, convince that class to vote affirmatively for a plan that paid the creditors in that class less than the full amount owed, and then claim that the lower priority unsecured class, which would include the bondholders, could be crammed down, thereby effectuating the NBA's desired debt reduction through a plan of reorganization without the consent of the bondholders. The probability of success of such a tactic would be dependent on the NBA's ability to legitimately identify a class of higher-ranking creditors and demonstrate that the liquidation value of the NBA assets available for payment to bondholders was equal to or less than the amount to be paid to the bondholders under the crammed-down plan.

Low Risk to Bondholders

For two reasons, it was determined that the risk to the bondholders was low. First, as a result of the drawn-out negotiations, it was known that the NBA had no secured debt (other than some immaterial mortgages on a few peripheral buildings that could, if necessary, easily be paid in full) and no priority unsecured debt. Prior to bankruptcy, the NBA had been very careful to pay all of its trade debt, taxes, PILOTs and similar obligations on a current basis. Given the NBA's debt structure, the claims of the general unsecured creditors, including the bondholders, would effectively be the highest-ranking, non-administrative claims in the case. Although debtors are sometimes known for “discovering” secured or priority claimants, it was believed that the bondholders had a good chance to defeat any attempts at gerrymandering a higher-ranking class.

Second, it was very unlikely that the NBA could satisfy the Chapter 7 liquidation test because the Debtors had $90 million in cash and investments and, based on the Sims report, the senior care facilities, if properly managed, were themselves worth close to the bond-related debt. In fact, the only real concern about a bankruptcy filing by NBA had been a fear that the bondholders would lose, at least temporarily, their periodic bond payments. When the NBA elected pre-petition to cease making bond payments, the principal downside to the bondholders of a bankruptcy filing was essentially removed.

Next month, we discuss the bankruptcy case in depth.