DDJ Capital Management, LLC (“DDJ”) has thrown its money in front of the Grede Foundries fast track, 363 sale bankruptcy strategy. Grede Foundries planned a “fast-paced” section 363 sale to a new venture backed by the private equity fund Wayzata Opportunity Fund II, L.P. (“Wayzata”). DDJ has achieved a critical fist step in keeping the 363 sale from gaining momentum. DDJ has stepped in with DIP financing.
DIP Financier a/k/a Stalking Horse Bidder Gambit
When Grede Foundries filed bankruptcy, its plan was to obtain debtor in possession (“DIP”) financing from a Wayzata affiliate. Another Wayzata affiliate would be the “stalking horse” bidder for a 363 sale. Having essentially the same entity be both the DIP financier and the stalking horse bidder is a proven acquisition tactic that renders the sale to the stalking horse bidder a near certainty as soon as the interim DIP financing order is approved. The essential elements of the DIP financing in this gambit are:
- a requirement that a sale be accomplished in a very short time frame;
- only enough DIP financing to give time for a sale to the stalking horse bidder – sale to any other bidder would result in the debtor running out of money before the sale could be closed;
- the existence of triggers in the DIP financing that increase debtor’s costs or increase purchase price if a sale goes forward with an entity other than the “stalking horse” bidder; and
- provisions allowing for a credit bid – the amount of the DIP financing can be used to “pay” all or part of the stalking horse bidder’s bid
A classic illustration of the effective use of the strategy was the bankruptcy of Fluid Routing Solutions, where the 363 sale to the affiliate of an insider was a foregone conclusion before the creditors committee was even formed. Once the creditors committee was formed, its strenuous efforts to block the sale were totally ineffective. The terms of the DIP financing already approved by the court precluded any effective challenge. The result was a 363 sale to an insider affiliate that effectively rendered the debtor unable to pay administrative expense claims, much less make distributions to the suppliers and other unsecured trade creditors.
DDJ’s Forceful Objection to Wayzata DIP Financing
DDJ was well aware of the effectiveness of the DIP Financing/Stalking Horse Bidder gambit. When Grede Foundries moved in its first day motions for interim and final orders approving DIP financing from a Wayzata affiliate, DDJ prepared and filed a forceful objection in less than 24 hours. DDJ knew that only by stopping the Wayzata DIP Financing could it hope to stop the 363 sale process. As DDJ stated in its objection:
in granting the [Wayzata] DIP Motion, the Court would do more than just approve postpetition financing; it would seal Grede’s fate by limiting the rights of its creditors (and of any alternative funding sources) to propose options less drastic than a wholesale liquidation of the Debtor’s assets at a bargain basement price.
DDJ essentially objected to the Wayzata DIP Financing on 3 grounds:
The proposed DIP Financing should not be approved because, as more fully set forth herein, (i) its terms and conditions confer an unwarranted degree of control over this chapter 11 case on the DIP Lenders and Wayzata’s apparent strategic partners; (ii) as currently proposed, the DIP Financing chiefly benefits. first. the First Lien Lenders. second. Wayzata, and lastly—if at all—the Debtor and its estate; and (iii) other options exist to address the financing of the Debtor’s chapter 11 case on terms that are more beneficial to the Debtor’s estate and creditors.
DDJ first argued that the Wayzata DIP Financing achieved an unwarranted degree of control and leverage. DDJ’s argument is summarized in the following quote from its objection:
The ways in which the [Wayzata] DIP Financing achieves this unwarranted degree of control and leverage are several, but the most significant is the fact that a sale of substantially all of Grede’s assets must be noticed, conducted, and consummated in a mere 80 days. So truncated a timetable, together with certain other asset sale-related rights conferred on Wayzata’s affiliate that is to be the stalking horse at such sale (the “Wayzata Purchaser”) by the proposed DIP Financing, ensure that Grede’s assets would be sold at a price that would yield a recovery only to the First Lien Lenders, thereby depriving the Debtor of any ability to formulate a chapter 11 plan that would benefit its estate as a whole. The chapter 11 process would, in other words, be concluded even before it had ever commenced. Affording to the DIP Lenders such unilateral control over this chapter 11 case would improperly usurp the Debtor’s mandated role in the chapter 11 process, and should not be countenanced by this Court.
DDJ’s second argument was that the Wayzata DIP Financing solely benefited Wayzata and its affiliates and the first lien prepetition lenders. DDJ stated:
Approval of the DIP Financing should also be denied because its benefits to the DIP Lenders far outweigh its benefits to the Debtor and its estate. Indeed, the DIP Financing appears to have two primary objectives: (i) to enable the Wayzata Purchaser, together with its strategic partner Citation Corp. (“Citation”), to obtain Grede’s most valuable assets at bargain-basement prices; and (ii) to ensure that the First Lien Lenders, and only the First Lien Lenders, extract whatever value is to be recovered from the estate in today’s depressed market conditions.
Finally, and most importantly, DDJ argued that there was other DIP financing available to Grede Foundries. Absent this element, the other arguments made by DDJ would have been meaningless. DDJ stated to the court that:
approval of the DIP Financing should be denied because other options exist to finance the Debtor’s operations during the pendency of this chapter 11 case that provide significant benefits to the Debtor’s estate as a whole, including its unsecured creditors. While the DIP Financing mandates a fire sale of the Debtor’s assets at a price that would provide a recovery almost exclusively to the First Lien Lenders, the Debtor rejected an alternative proposal from the Second Lien Lenders (the “Second Lien Proposal”) that provided for financing, secured on a basis junior to the existing and post-petition liens of the First Lien Lenders, for a term, and in the amount, sufficient to finance a chapter 11 plan process that would have inured to the benefit of the Debtor’s estate as a whole.
DDJ’ Offer to Provide DIP Financing is Accepted
DDJ followed up its objection with a term sheet for providing DIP financing to Grede Foundries. By interim order entered July 2, 2009, DIP financing under this term sheet was approved by the Bankruptcy Court on an interim basis. DDJ stopped the dominos from falling and gave it time to present an alternative strategy for a Grede Foundries reorganization.
DDJ’s Motivation and the Corresponding Message for Suppliers and other Unsecured Bankruptcy Creditors
DDJ was highly motivated to stop the 363 sale to Waysata’s new venture. Accordingly to DDJ, that 363 sale would have meant that Grede Foundries’ repayment of the $20.6 million second priority secured loan administered by DDJ was doubtful. In front of DDJ’s secured loans were first priority secured loans held by a syndication having GE Business Financial Services Inc., as administrative agent (the “First Lien Lender”). These loans total $36.7 million.
The message to suppliers and unsecured bankruptcy creditors is clear. If DDJ’s secured loan repayment in fact was jeopardized by the Waysata orchestrated 363 sale, that sale provided no chance for any payments to the unsecured creditors.
So should suppliers and other unsecured creditors be pulling for DDJ? We have serious concerns that the 363 sale as originally contemplated by Grede Foundries would have “burned off” the supplier and other unsecured trade creditor claims with no distributions. These concerns are based on: the lack of any supplier favorable first day motions; the little bit of financial information that can be drawn from the documents filed to date; the position of DDJ; and the results in other automotive supplier bankruptcies where similar stalking horse bidder tactics were employed. The one caveat is the possibility that some supplier contracts could be assumed as part of the 363 sale and for those suppliers the news would have been good – full payment of all prepetition claims and immunity from preference claims.
Whatever DDJ’s alternative reorganization proposal is, there are some fundamental, major problems that DDJ is going to have to deal with. A 363 sale certainly would have dealt with those problems. All that is certain is that, for now, DDJ has stopped the Waysata train from leaving the station.