Fountain Powerboat Industries, Inc. and its 3 co-debtor affiliates (collectively the –Debtors ) have moved Bankruptcy Court for the Eastern District of North Carolina (the “Court”) to authorize the Debtors to postpone the pre-ordained section 363 sale. This is a U-turn for the Debtors who had pushed for a rapid 363 sale citing fears that a delay could result in the Debtors running out of money to fund operations. The two fold reason for the turnaround – a probable credit bid by a recent acquirer of the pre-petition secured lender’s position and a potential white knight offer to provide debtor in possession (“DIP”) and exit financing. This may be good news for the suppliers and vendors who have nearly $1.8 million in pre-petition trade claims.
The Initial High Level of Interest by Potential Bidders
On August 24, 2009, the Debtors filed a “Sale Motion” for authority to sell substantially all the Debtors’ tangible and intangible assets on an expedited basis, free and clear of all claims. On September 10, 2009, the Court entered the “Sale Procedures Order”– approving the requested sale procedures. The timing of the planned sale was to be very tight with an auction date of October 4, an objections deadline of October 5 and a hearing to approve the sale to the proposed bidder on October 9.
Prior to filing bankruptcy, the Debtor had worked up a lot of interest from potential bidders. At the September 1 hearing, the Debtors reported that there were 8 to 12 potential bidders. By September 30, however, many of the bidders had packed there bags and gone home. The reason was the likely a “credit bid” by one of the bidders.
The Fountain Powerboat Secured Loans get Sold to a Potential Bidder
Fountain Powerboats entered bankruptcy with about $20 million in secured debt. The secured debt was owed to Regions Bank. The security for the Regions Bank loans essentially was all of the Debtors’ assets. At the September 1 Court hearing, it was clear that Regions Bank would be selling the secured loans.
Due to the economy, banks and other institutional lenders frequently are selling their portfolio loans at substantial “discounts”. A discount is a sale price at less than the amount outstanding under the loan. For example, if a $20 million loan gets sold for $12 million, the discount is 40 percent. In this economy, some banks and institutional investors have reportedly sold loans that are not even in default at discounts as high as 60 and 70 percent. These discounts occur for a number of reasons but the most frequent reason is a fear of future default.
In the case of Fountain Boats, a substantial discount could be justified on a number of grounds. The loans are in default. The loans are “under collateralized” – meaning that the value of the collateral securing the loans is less than the outstanding loan amounts. The borrower is in bankruptcy.
On September 17, 2009. Regions Bank sold the Fountain Powerboats secured loans to a company newly formed by Oxford Financial Group (“Oxford”). This sale was likely at a substantial discount. We stress, however, that we have no idea what Oxford paid Regions for the loans.
The Chilling Effect of Credit Bids on the Auction Process
The purpose of the Oxford acquisition of the Regions Bank loan is clear. Oxford acquired the secured loans to give Oxford the ability to “credit bid”. “Credit bid” simply means that instead of giving the Debtors cash, the secured lender can say “I bid “X” dollars of my secured loan.” If the credit bidder wins, the secured loan is reduced by the amount of the credit bid. The debtor receives no new cash.
In seeking an extension of the sale process, the Debtor advised the Court that “one effect of the assignment of the Regions Bank Indebtedness to a potential bidder has been to chill the bidding process and discourage other potential bidders from participating in the auction.” This observation illustrates one of the biggest problems with credit bids in 363 sales in this highly distress economic environment.
Oxford likely acquired the Regions Bank loan at a discount. However, what Oxford paid for the loans has nothing to do with the amount that Fountain Powerboats owes. That amount remained the same. This allows Oxford to credit bid up to $20 million even though it paid something less for the loans.
For example, if a loan is acquired at a 40 percent discount, every dollar of credit bid will only cost the credit bidder 60 cents. From the perspective of the other potential bidders, a credit bidder gets to use 60 cent dollars in the bid process while the other bidders are bidding with 100 cent dollars. This allows a credit bidder to bid more than all the other bidders while actually having a lower out of pocket cost.
At the time of the September 22, 2009 bankruptcy court hearing, it looked like Oxford would almost certainly be the future owner of Fountain Powerboats. By acquiring the Regions Bank loan, Oxford had put itself in the driver’s seat. But in the following few days the situation changed dramatically.
Fountain Powerboats has a Potential White Knight Investor
After the September 22, 2009 hearing, the Debtors have received an alternative proposal from Liberty Associates. L.C. (–Liberty”). Liberty also was a potential bidder that wished to acquire the Fountain Powerboat Assets. After Oxford acquired the Regions Bank loan, Liberty took the only step possible to block the 363 sale to Oxford. As the Debtors advised the Court in their motion to postpone the sale, Liberty stepped in with an offer “(i) to provide post-petition financing to allow the Debtors to continue operations, and (ii) to fund a proposed plan of reorganization.”
This development potentially is good news for the suppliers and vendors of Fountain Powerboats. As the Debtors told the Court:
the alternative proposal from Liberty would appear to offer other creditors in this proceeding at least some opportunity to receive a distribution on allowed claims and thus may be in the best interest of the Debtors’ estate as compared to the proposed sale.
Suppliers Should Hope for Something but Not Expect a Lot
The suppliers and vendors of the Debtors should not anticipate getting anywhere near 100 cents on the dollar for there pre-petition claims. Any possible payout will be at a very low percentage. One reason for only a low distribution percentage is that Oxford is going to adding a potentially large claim to the unsecured claim bucket.
Under the Bankruptcy Code, a secured loan becomes unsecured to the extent the collateral value is less than amount of the loan. For example, if a $20 million loan is secured by collateral having a value of only $13 million, as part of the reorganization process the secured portion of the loan will be reduced to $13 million. The remaining $7 million loan amount will be put in the pot with the unsecured creditors.
The effect of this re-characterization is to dilute the share of the other unsecured creditors. The claim that was in front of the unsecured creditors becomes a claim that shares pro rata with the unsecured creditors. Although there is a dilution, at least some dollars may make it to the unsecured creditor pot.
Expect Oxford to Fight
Oxford is not likely to stand still. Oxford can be expected to fight this development tooth and nail. The Court has tremendous flexibility to deal with the situation. The Court has broad equitable powers. The Court also has express authority under section 363 of the Bankruptcy Code to level the playing field as regards the potential credit bid.
The story is still unfolding. We will have to wait to see what the Court decides. A hearing on the postponement motion is scheduled for Monday, October 5, 2009.