As LATAM went hunting for cash to see it through bankruptcy it leaned on old friends. Delta Air Lines led the efforts to define a $900 million tranche of debtor-in-possession financing, though it declined to contribute to that fund. Qatar Airways also stood up, offering significant amounts of cash, including the share Delta was theoretically going to provide. But the arrangement proved a bit too cozy and on Thursday a US Bankruptcy judge rejected the plan.
The court finds that the Modified Equity Subscription Election subverts the reorganization process because the discount is not market-tested, the Debtors can make this election without the approval or oversight of the Court, and that the election dictates key terms of an eventual plan of reorganization by prematurely allocating reorganization value to LATAM’s existing equity holders.
The financing plan anticipated $1.3 billion from Oaktree in Tranche A and another $900 million from existing owners in Tranche C. Tranche C is where the problems arose. Finding that much money from an outside investor proved challenging. The Court ultimately agreed that the deal from the insiders was not unduly priced on its face, despite objections from a group led by Knighthead representing other unsecured debtors. But the deal still came up short of the independence typically needed to meet the Court’s standards.
It included an option for the Tranche C investors to see their debt converted to ownership in new shares of LATAM, with a 20% discount from market rates. The discount was 32% when first proposed and Knighthead managed to convince the company that it should not be quite that sweet a deal. But 20% was still too much.
In its ruling the court notes:
If approved, the Tranche C DIP Facility locks into place the 20% discount to plan value on the stock to be issued to the Tranche C Lenders in satisfaction of the Tranche C DIP loan, if the Debtors elect to distribute stock, in lieu of cash, in satisfaction of that obligation. There is no way of knowing now whether that discount is appropriate. Yet, if the DIP is approved, neither the Debtors’ decision to make that election, nor the 20% discount, will be subject to creditor comment or Court review. The Court assumes that the Debtors will act in good faith in determining whether to exercise the election, but the fact remains that the Tranche C DIP Facility necessarily determines plan terms giving the Debtors the right to distribute equity in the reorganized Debtors to the Tranche C Lenders – at a 20% discount to plan value – that will not be subject to court review. That “short circuits” the chapter 11 plan review process under the Bankruptcy Code, by establishing plan terms sub rosa in the Tranche C DIP Facility. There is a domino effect to the Debtors’ exercise of the Modified Equity Subscription Election that exacerbates that problem.
The court also called attention to the fact that existing owners represent six of the nine members of LATAM’s Board of Directors. Those six recused themselves from the negotiations but the remaining three did not avail themselves of independent advisors. They were not required to, but the move raised suspicion of their independence in assessing the different offerings and a fair value discount for the deal.
For its part LATAM issued a statement noting “The Company, together with its legal and financial advisers, is analyzing the Court’s decision and its scope to define a course of action.”
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