Bankruptcy Court Actions Show Debt Priority Is Not Guaranteed

Last April, we reported on the February 2009 loan commitments extended to satellite radio broadcaster Sirius XM Radio by Liberty Media, which controls satellite television broadcaster DirecTV. Liberty Media functioned as a “white knight” to stave off an apparent “loan-to-own” takeover of Sirius XM by EchoStar, parent of DirecTV competitor Dish Network, which had purchased $375 million of Sirius XM’s debt.

Some of that debt matured in February and would have given EchoStar the ability to force and accept an event of default, which would almost certainly have provoked a Sirius XM bankruptcy filing. The event of default and bankruptcy prospect gave EchoStar leverage in its reported offer to restructure the debt into equity and inject new capital in exchange for a controlling interest in Sirius XM. Among other commitments, Liberty Media agreed to a standstill on acquiring majority control of Sirius XM and to leave its management in place.

The deal is worth remembering in the context of the October decision by a U.S. bankruptcy judge in New York to approve the Chapter 11 reorganization plan of ICO Global Communications subsidiary DBSD North America — over objections by Dish, the holder of $51 million of DBSD’s first lien debt.

The bankruptcy court went a step beyond the common cram-down procedure of approving a reorganization plan over the objections of unsecured creditors; the overruling of Dish’s objections represented a far less common cram-up approval of a plan over the objections of senior debt holders. The court imposed a four-year term loan facility at the same 12.5 percent interest rate at which Dish bought DBSD’s debt at par in July after its voluntary Chapter 11 bankruptcy petition had been filed. The four-year term is intended to allow DBSD to obtain new financing. In particular, the judge, in calling the plan “fair and equitable,” said: “Although the developmental nature of the debtors’ business and absence of present revenue would at first blush suggest uncertainty as to repayment under the amended facility. I find that the risk is not new.”

In cramming up Dish, the court seemed motivated by the facts that Dish bought DBSD’s debt with its eyes open, knowing that the company was in bankruptcy, had no revenues and uncertain prospects, and, therefore, that the debt acquisition could fairly be inferred to have been strategic. This contrasts with the bankruptcy concern to protect the ordinary case of a lender to a going concern enterprise that subsequently falls on hard times, in which the lender’s motivation was interest payments. What this means for the debt markets, restructurings and financial engineering in the satellite sector and beyond going forward is an interesting question.

At first blush, the bankruptcy court’s decision would seem to be good news for debtors, against whom senior lenders may have less leverage in a bankruptcy context. The second blush is less clear. Although cram ups are rare, there is nothing in the decision that suggests that it is limited to strategic purchasers of distressed debt, as opposed to ordinary lenders.

Even if that limitation is assumed, a cram-up precedent may chill the secondary debt market for distressed companies and create unforeseeable supply and demand effects. On the one hand, senior debt is devalued and its priority and leverage diminished. Parties who purchase distressed senior debt strategically may be less sure of the traditional bankruptcy protection of their claims versus unsecured debt and equity. The supply-demand ratio of such debt should increase, and its price should decline towards that of unsecured debt and equity.

However, buyers who would be incentivized by lower price and not dissuaded by increased risk may realize that the potential return on this debt probably has not changed in proportion to the lower price paid for it. In other words, the risk-reward ratio has increased. Also, under the “next fool” theory of markets underlying so much restructuring, financial engineering and debt flips, demand also may decrease as the next fools become less foolish. The net result may make it harder for distressed companies to find white knights even in an environment of cheaper debt. Moreover, even ordinary lenders may be disincentived to lend if their risk is increased by the unavailability of secondary debt markets. If that happens, the music may stop in the game of musical chairs that underlies so much restructuring activity.

Owen D. Kurtin is a founder and principal of private investment firm The Vinland Group LLC and a practising attorney in New York City. He may be reached by e-mail at [email protected].