Magazine article Business Credit

NACM to Examine Creditors' Rights in LBO Financing

Magazine article Business Credit

NACM to Examine Creditors' Rights in LBO Financing

Article excerpt

NACM's Government Affairs Committee is currently reviewing the effects of a court decision regarding a leveraged buyout (LEO) case that could create the precedent for significant harm to the unsecured trade creditor community. Under the ruling of the Tenth Circuit Court of Appeals in Kaiser Steel vs. Pearl Brewing Company the court allowed assets acquired through the LEO to pay for the acquisition of the target company itself and its shareholders, essentially ignoring any unsecured creditor claims on the books of the target company prior to the LEO.

Specifically, the appellate court decided a takeover company (Pearl Brewing) could use $162 million of the target company's (Kaiser Steel) corporate assets to help finance the LEO despite the fact that at the time of the LEO, Kaiser Steel was insolvent (in Chapter 11) and holding up to $500 million in unsecured creditors' claims.

The court held that if the LEO includes the exchange of securities, it is not within the ability of the court to recover any of the monies paid to shareholders because security law and not bankruptcy law prevails. Consummation of an LEO is "settlement payment" exempted from the avoidance provisions of the bankruptcy code, thereby denying a trustee or debtor in possession the ability to avoid settlement payments.

Essentially, this ruling gives debtors (or investors) of a takeover firm a sophisticated technique by which unsecured creditor claims are subjugated to new debt incurred through the LEO transaction. The likelihood of unsecured trade creditors realizing any payments under such LEO transactions becomes quite remote as a result of this ruling.

In addition, this ruling appears to be a clear violation of the absolute priority rule. The court's ruling holds that once an LEO is completed, the interests of the shareholders are escalated over the rights of creditors.

NACM is examining the implications of this ruling as it appears to be a dramatic departure from the intent of the bankruptcy code. We have asked our Bankruptcy Task Force and Steering Committee to review whether this ruling compromises the protection of shareholders at the expense of trade creditors. Many of our members believe that the Kaiser ruling presents a clear departure from the preference provisions of section 546 (e) of the code and allows equity interest to be considered superior to debt interests. …

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