Check out one of the latest pieces published by Max Frumes, Global Head of LFI Special Situations:
The recent At Home Group financing and exchange is among the first transactions — if not the first — where financing has been structured in order to intentionally create a so-called double dip. Parties to the At Home deal that closed two weeks ago touted it as a more creditor-friendly pro rata alternative to the various creditor-on-creditor violence options available to the company because of its permissive credit docs, as LFI reported. What it also represents is a true innovation born out of a confluence of distressed debt investors’ history of investing in “double dip” opportunities, and creative advisors recognizing an opportunity to raise cheaper capital without resorting to the typical non-pro rata uptier or drop down transactions en vogue among sponsor-backed distressed credits, according to more than a dozen interviews with liability management experts and veteran investors, including sources directly involved in this and other such transactions.
All of the other known double dip examples — where two or more bankruptcy claims against a common debtor arise from one transaction — were post-hoc interpretations of structures created for other reasons, mainly tax reasons. The idea behind a single piece of debt getting multiple “dips” (not to be confused with “debtor-in-possession” financings or DIP loans) can be traced back to distressed debt investors taking advantage of a structural advantage — largely untested in court — that debt issued by foreign subsidiaries and/or fincos has in restructurings.
For years, a small cadre of distressed investors has been looking for just this type of opportunity when a company goes distressed, buying the discounted debt issued by the foreign sub or finco in the secondary market, then pointing out why they should get double or even triple the claims that would get them back to par, plus any make whole (though a double dip does not mean 200 cents on the dollar), even when debt that is pari passu at the same parent company would only get one claim and thus a fraction of the recovery. And, regardless of few precedents where a court has issued a decision clearly supporting the theory, it has been a highly lucrative investment strategy as the claims usually settle near where the claimants argue they would be covered.
One of those investors was Redwood Capital Management, who led the innovative At Home financing as one of its existing noteholders. Redwood was advised by Dechert, including professionals with ties to the Kramer Levin practice that advised on multiple double dip situations in the distressed world over a span of more than a decade. Meanwhile, the innovative leveraged finance teams at Kirkland & Ellis and PJT Partners known for a slew of recent, precedent-setting LMEs, including for Envision, Boardriders, Trimark, and Incora, were advising the Hellman & Friedman-backed At Home. Together, the parties ultimately created an empty shell non-guarantor Cayman Subsidiary and a subset of existing At Home noteholders led by Redwood lent $200 million to the Cayman sub that was guaranteed by the At Home parent on a first lien basis. The Cayman sub then lent the $200 million to At Home using more At Home incremental secured capacity, giving creditors to Cayman sub the double dip claim on the same collateral; that is to say, lenders to the Cayman sub have a guarantee from At Home that they can enforce directly against At Home, while the Cayman sub can separately enforce the $200 million proceeds loan against At Home, with any recovery on that proceeds loan ultimately going to the Cayman sub’s creditors as well.
Buy the (double) dip
Distressed debt investors have been making money on the prospect of a double dip opportunity for the better part of two decades. They bought into the distressed bonds of foreign subsidiaries of General Motors, Lehman Brothers, AbitibiBowater, and Latam Airlines, and made out well in settlements after those companies filed for bankruptcy. Sometimes, it was only a matter of getting comfortable with an uncertain investment bolstered by the potential for a double dip even though a company did not restructure, such as in BP Oil’s UK fincos in 2010 after the Deepwater Horizon spill, and Sprint Capital, an affiliate of Sprint at the time it was in distress prior to its 2020 acquisition by T-Mobile.
In the General Motors bankruptcy in 2009, GM had earlier issued nearly $1 billion in debt in the Canadian province of Nova Scotia in an unlimited liability company, a ULC, which provides certain tax advantages. Starting in 2005, distressed investors led by funds of Fortress Investment Group, then later Elliott Management, Appaloosa Management and Aurelius Capital Management, snapped up those bonds at distressed prices with the thesis that the law governing the notes would allow multiple claims on the same debt. Ultimately, in a 2013 settlement agreement, funds received a $1.55 billion bankruptcy claim on $1.07 billion in debt along with a $50 million payment, in addition to $367 million in cash they’d received earlier – still a profitable investment for those involved with recoveries well above other bonds not issued by GM Nova Scotia.
In the 2008 Lehman Brothers bankruptcy, Lehman Brothers Holdings Inc., the main debtor, had raised more than $36 billion through indirect Dutch and Netherlands subsidiaries. Holders of those claims at those foreign subs said this structure created a “double dip” via a direct claim against LBHI on LBHI’s guarantees and, through their claim against the applicable Lehman subsidiary. While Lehman’s senior bondholders were ready to fight and threatened to seek substantive consolidation to eliminate the potential double dip, creditors and Lehman ultimately landed on a consensual plan giving the creditors most of the double dip claim they were asking for (See Oxford Library’s discussion).
In the Latam Airlines bankruptcy in 2020, a least a dozen distressed investing firms — including Redwood — jumped on the disclosure of an intercompany receivable as proof that dollar-denominated bonds were entitled to an additional claim, making them essentially senior to Chilean bonds that could not avail themselves of the interco claim — creating diverging recoveries for the two sets of bondholders.
Mark Kronfeld, a managing director at boutique advisory firm Province, spent 16 years on the buyside, and for much of that time, kept watch for potential double dip structures, which he says was a very profitable strategy that a lot of investors overlook.
“People incorrectly look at a finco issuer as being a shell, when it really holds a valuable asset in the form of an intercompany receivable,” Kronfeld told LFI in an interview. “That’s one of the key components of the double dip.”
He started looking at them in CIT Group’s Canadian entities in 2007, and invested in several of the major examples subsequently. In 2012, Kronfeld penned one of the only articles — the main one cited by most professionals interviewed for this story being “The Anatomy of a Double-Dip” — detailing the various examples and legal basis for the double dip thesis.
Kronfeld says when looking to identify “double dip” investment opportunities he looked for a finco issuer entity that’s often a foreign subsidiary of the distressed company, and if he finds one, “there’s a material probability that there will be a double dip and it’s worth investigating further to confirm that where there is smoke, there is indeed fire.”
Kronfeld has deeply researched justifications for why investing in double dips works and would stand up in court: Corporate separateness; joint and several liability; the 1935 Supreme Court case Ivanhoe; Bankruptcy Code sections 502(b), on the allowance of claims; and 509, regarding the claims of co-debtors. He says asserting simultaneous full face value claims against separate co-debtor entities on account if a single loan or bond issuance is nothing new or controversial, and the nature of joint and several liability by guarantors is a routine feature in nearly all credit documents.
“The bondholders are not the same as the corporate issuer entity, and people often improperly conflate the two perhaps because of a visceral reaction where the bondholders are the only creditors at that issuer entity, and thus receive the direct benefit of the guarantee and indirect benefit of the interco receivable,” Kronfeld says. “There’s nothing nefarious or sneaky about it… Just because we have a visceral reaction doesn’t mean it’s a legitimate reaction,” he adds.
Delta and the caveats
Despite this lucrative practice of seeking out and capitalizing on double dip opportunities having been built into the restructuring ecosystem, and even significant litigation in these precedents, all of these above cases settled before a judge was forced to make a decision. And that may mean that a court looks at it differently than even other cases.
“To our knowledge, this kind of structure has never been tested,” according to Covenant Review, in a Q&A after the At Home transaction. “We note, however, that a bankruptcy court is a court of equity—which means, among other things, that it is supposed to decide what is fair for all parties. It is possible that a bankruptcy court could decide that the New Money Notes, the guarantees of the New Money Notes, and the Intercompany Note are all part and parcel of one transaction, that they all represent the same debt, and that it would not be fair to permit holders of the New Money Notes to recover twice (i.e., ‘double dip’) on the same debt.”
Covenant Review’s Head of Special Situation Research Scott Josefsberg further commented to LFI, “GM Nova Scotia is the closest precedent but it was a quirk of Nova Scotia law that they had to give an inter company note. At Home was designed for the purpose of creating some kind of double dip security like At Home was. GM Nova Scotia was not designed that way. And the inter company note there was Nova Scotia law, giving the holders a different jurisdiction to go try to enforce.”
Another liability management expert describes it as a “form” over “substance” dilemma.
“With Lehman, the Dutch sub allowed them to tap into the European market in a way that gave them substantive tax benefits that went on for a long time. With GM Canada, again, the company was doing this for tax and other reasons for some meaningful period of time,” according to this professional. “In At Home, it’s more like ‘here let’s give those lenders a double dip.’ Is the court going to give you the same treatment?”
In fact, the only “double dip”-relevant case law where a decision has been issued arose from the Delta Airlines bankruptcy in 2009. In Northwestern Mut. Life Ins. Co. v. Delta Air Lines Inc., at issue were leveraged leases structured where Northwestern and other parties were owner participants in leveraged leases on several aircraft who held tax indemnity agreements in the case of foreclosure, where lenders on those leases got a security interest assigned to an indenture trustee. When Delta filed for bankruptcy, Delta rejected leases on those aircraft and repossessed them. Subsequently, both the owner participant and the indenture trustees asserted claims arising from those foreclosures. The owner participants claims came to nearly $1 billion under those tax indemnity agreements. After the bankruptcy court only permitted one claim. On appeal, the Second Circuit held that the owner participants were permitted to bring their claims for tax losses under the tax indemnity agreement, reasoning that’s what the TIA’s were for.
Mark Lightner, Head of Special Situations Legal Research at CreditSights, notes how different these facts are when compared to At Home.
“The Second Circuit’s decision in Delta can certainly be read for the proposition that two claims asserted by separate legal entities against a common debtor arising from one common transaction should both be allowed in bankruptcy,” according to Lightner. “However, the facts of Delta are different than At Home. At Home involved a financing subsidiary, and Delta involved lease transactions with two distinct investor groups that held different kinds of interests in the financing structure, invested in that structure for different reasons, and arguably had different investment expectations with respect of their bankruptcy claims. Lower courts may find ways to distinguish the Second Circuit’s decision in Delta if they believe the facts and circumstances warrant it.”
Lightner also notes that the Second Circuit’s decision in Delta was mostly about contract interpretation than the double dip claim issue,
“Moreover, the Second Circuit’s decision in Delta was primarily about contract interpretation and was not principally focused on bankruptcy claim allowance. No court has cited the Second Circuit’s decision in Delta for the proposition that double dips are per se allowed; however, we note that the only case that has cited the decision for double-dips was Latam, but the citation was in passing, and the Judge noted that any attempt to disallow/recharacterize a double-dip claim would be hotly contested,” Lightner comments.
Potential for more double dip LMEs
Regardless of some of these caveats, advisors are absolutely looking at At Home as yet another option in the liability management playbook, according to sources. Provided a company has sufficient secured debt capacity and no limitations on it uses how it uses pari debt, then this structure could be used by a number of companies, they say. One such transaction may have even been executed but has not yet become public, according to one source.
Everything innovative, any LME could be challenged, advocates of this structure say. At Home used the capacity that it negotiated for and paid for when it issued its existing debt, the argument goes, and in this recent deal complied with debt docs, allowing the company to raise new money on the cheapest terms possible.