BDCs As Creditors of Distressed Companies: What You Need to Know. September 9, 2015

Transcription

1 BDCs As Creditors of Distressed Companies: What You Need to Know September 9, 2015

2 Introduction Historical Background BDC Distress Exposure 2

3 Today s Presenters Daniel M. Dunn Partner, New York Dechert LLP daniel.dunn@dechert.com Thomas J. Friedmann Partner, Boston Dechert LLP thomas.friedmann@dechert.com Michael J. Sage Partner, New York Dechert LLP michael.sage@dechert.com Jeffrey S. Sion Partner, New York Dechert LLP jeffrey.sion@dechert.com Eric M. Winthrop Managing Director Houlihan Lokey ewinthrop@hl.com Scott M. Zimmerman Partner, New York Dechert LLP scott.zimmerman@dechert.com

4 Issues Peculiar to BDCs Tax Issues: the Basic Ground Rules BDC: a corporation with some asset, income and distribution requirements, and generally subject to tax like a pass-through entity if properly managed Distribution Requirement: At least 90% of income must be distributed each year Qualifying or Good Income Test: At least 90% of gross income to be interest, dividends, gains from securities, currencies, etc. trade or business income NOT okay. Thus: o Common stock, preferred stock, loans, warrants of corporate issuers are all okay o Units in a flow-through LLC or partnership that is engaged in business is NOT okay; Warrants can be but care must be exercised o Fee income merits scrutiny Asset Diversification: o Each quarter, at least 50% (75% for a diversified investment act company) must be invested cash/securities in which (i) any one issuer does not represent more than 5% of the BDC s assets, and (ii) the BDC does not have more than 10% of the vote of any one issuer o Securities of no single issuer can exceed 25% of the BDC s assets 4

5 Issues Peculiar to BDCs (cont d) Accounting; General Sensitivity to Optics, e.g. Material changes to blend of capital gain and ordinary income Yield Cash distribution rate Other Issues Portfolio Eligibility Valuation Issues MIP Implications Performing / Non-performing Criteria--Preferred v. Debt Thin Equity Rules Impact on Valuation and Company Deductions 5

6 Case Study 1 Five BDCs hold 20% each of second lien debt (fulcrum security) of a corporate borrower. The debt is restructured, and each of the BDCs take 20% of the common, 20% of a new junior security, and agree to provide funding on a revolver. A fee is paid to the group at closing. Distressed debt: should the holders stop accruing interest? Exchange taxable? Gain/loss--COD? o Private debt no gain or loss to the extent par is preserved o COD consequences may be modest Junior security debt or equity? o OID? Clear income accrual desired despite cash distribution need to maintain yield o Borrowing base? Voting stock: asset diversification implicated Revolver? Fee? 6

7 Case Study 2 Four creditors (a BDC, a CLO, a fund and a bank) hold 25% each of second lien debt (fulcrum security) of a corporate borrower. The debt is restructured, and each of the creditors take 25% of the common, 25% of a new junior security, and agree to provide funding on a revolver. A fee is paid to the group at closing. The BDC: as discussed previously The CLO: o Aversion to equity (and certainly for flow-through entities) o No fee income if payment for services o No revolver participation The Fund: o May prefer to trigger losses o Flow-through entities probably a problem o Same fee concern o Aversion to phantom income (paper gains, OID income, etc.) The Bank: Probably the most flexibility, although will typically want a taxable loss and no phantom income 7

8 Bankruptcy and Restructuring Issues That Remain Common to BDCs and Other Entities Effect of Exclusivity on the Process Impact of Leveraged Lending Guidelines on Distressed Companies Pre-reorganization issues Impact on exit financing 8

9 Q&A Session 9

10 Thank You For further information, visit our website at dechert.com or contact any of today s presenters. Dechert practices as a limited liability partnership or limited liability company other than in Dublin and Hong Kong.