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Developments in Distressed Lending
Most participants in the distressed debt market for secured loans are familiar with the concept of adequate protection in bankruptcy. Typically, as part of a cash collateral order or an order approving a priming DIP loan, adequate protection is provided to secured lenders to protect against diminution in value of their security during a bankruptcy case. Although adequate protection often takes the form of replacement liens, superpriority claims, and payment of interest, fees, and expenses, the bankruptcy code allows it to take any form that results in the realization by secured lenders of the “indubitable equivalent” of their interest in collateral. 11 U.S.C. ' 361(3). Recently, in In re TOUSA Inc. (“TOUSA“) and In re Capmark Fin. Group Inc. (“Capmark“), secured lenders have received, as part of their adequate protection package, the right to obtain principal paydowns during a bankruptcy case.
Principal paydowns during a Chapter 11 case not only provide lenders with obvious benefit, but also could benefit debtors' estates by reducing interest expense in cases where secured creditors are oversecured. In such cases, pursuant to ' 506(b) of the bankruptcy code, the oversecured creditor would be entitled to receive postpetition interest at the applicable rate provided in the loan document through the effective date of the plan of reorganization, while debtors typically are required to hold their cash in bank accounts at approved financial institutions that have minimal risk and corresponding loan interest rates. 11 U.S.C. ' 345. The resulting negative interest spread, therefore, could be significant.
As illustrated by TOUSA and Capmark, when principal payments are made during a Chapter 11 case, the payments can be tailored to account for single or multiple payments of fixed or floating amounts under circumstances involving single or multiple liens. They can even be used when there is a threat of an avoidance action which could ultimately result in disgorgement of the payments.
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