Inside the Blood Sport of Creditor-on-Creditor Violence

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1:26Hello and welcome to another episode of the Odd Lots podcast. I'm Traci Alloway. And I'm Joe Weisenthal. Joe, what do you know about creditor on creditor violence? I don't know anything. Other than it's a very punchy term. It's a great, that's literally it. It's come up a few times in episodes we've done about credit. And I get the impression that, you know, lenders to a firm have different status and some are higher up in the rank than others. And that they would like to probably use the technicalities of the legal code to improve their rank in some sense when money gets paid out to lenders. Yes.

2:06So it has come up in a number of - It's not really violence, is it? Well, some of the fights get pretty nasty. Okay, well, so when I think about it, I think back to when I covered the leveraged loan market at the FT, and this was sort of like 2013, 2014. And I remember writing stories about how leveraged loans, more of them were becoming cov-light. So weaker covenants for lenders or investors. And what that means is companies basically had more leeway to restructure their assets if they were trying to raise new capital or stave off bankruptcy or whatever at the expense of those lenders slash investors.

2:50And back in 2014, I think the proportion of the leveraged loan market that was cov-light was something like 30%. And that was like a big deal. That was already higher than the the leverage buyout boom in 2007. Now, the vast majority of leveraged loans, I think something like 90 percent could be called Cove Light. So the entire market is basically Cove Light at this point, which fits into the creditor on creditor violence theme. So I feel like we need to we need to dive into this. What it is. I just my impression is that if I'm going to be a firm that buys leverage loans. I need a good lawyer to look over the contract.

3:33Well, I kind of wonder, I guess I wonder relatively how important like legal expertise is versus valuation expertise. This is what I am wondering as well. All right. So let's get into it. I am very pleased to say we have the perfect guest. We're going to be speaking with Sujit Indap. He is, of course, the Wall Street editor over at the FT, my former colleague. We used to double byline on at least one piece, I think. He is also the author of the excellent Caesar's Palace Coup book, which if you haven't read, I would highly recommend, especially on that point about distressed debt fights getting kind of nasty.

4:11Sajit, thank you so much for coming on All Thoughts. Hi, Tracy. How are you? It's great to be here. Thank you. So I guess my first question is, you know, we see these headlines about creditor-on-creditor violence or, you know, someone will be writing about the private credit market and there'll be an aside about creditor-on-creditor violence and how it's becoming more of a thing. Can you give us some context around whether or not this is becoming a bigger trend? I feel like it is, but it's not like there's a violence index that we can look at. Yeah. So the idea of violence in corporate restructuring and private equity deals is not a new idea.

4:50Imagine the business that's been bought by the private equity firm is just less valuable over time. The pie has shrunk. There's going to be a fight over who gets what piece and how big those pieces are. The creditor-on-creditor violence phenomena, though, is a little bit more nuanced and novel. And that's the idea that, imagine you, Joe, you, Tracy, and me, we are all holders of the first lien term loan. Let's say you own$500 million, Joe. You've got$300 million. Let's say I'm poor because I work with the FT and only have$15 million. But there would be the view that since we're all in the same security, governed by the same document, that our rights are the same.

5:31and we are all going to be treated equally in this fight with the private equity firm and maybe the junk bond holders below us. The creditor on creditor violence nuance now is that, in fact, we are not equal. And you two, as large holders, can do things to me, small holder, that are not equal in treatment, arguably unfair, arguably impermissible. Just to be clear, in this theoretical setting in which all of us are, quote, equal in the firm's liabilities, did we all have the exact same language? Did we all enter into the same contractual language when we purchased the debt or when we lent money to the company?

6:12And furthermore, if we did all have the same language, what are the tools that we use to change our priorities? Yeah. So we do. We all are governed by the first lien credit agreement. Maybe you bought in the original LBO and maybe your CLOs and I'm or you are a distressed debt hedge fund, which bought in later at a different price. But we're all governed by the same document and in concept have the same rights and protections. So then how do I do something to you guys? What are the basic tools at my disposal if I want to somehow gain an advantage for me that doesn't accrue to you? Yeah, so let's talk about why that scenario would first arise.

6:54And imagine the company is running into trouble. There's a maturity coming up or there's some liquidity challenge. As you said earlier, these documents now, since the financial crisis are covenant light or no covenant. So there's a lot of flexibility for the borrower, which is the company and the private equity firm that owns the company. And rather than just declaring bankruptcy and going to bankruptcy court and fighting out there, which is messy, it's time consuming, it has its own restrictions on what you can do. And the private equity firm will typically, if you're the equity holder, will get wiped out.

7:25Bankruptcy is not an attractive option for those reasons. And so what you can try to do is raise new capital. And you're going to raise new capital, often from the existing lenders. Those lenders, in exchange for giving you more money, are going to ask for some things. What are they going to ask you for? First, the company itself is probably going to want to reduce the principal balance. So they want people to take haircuts. So there's going to be some haircuts involved. And then there's going to be this new money brought in. That new money, however, if I'm giving you new money into this troubled company, I'm going to want some things to do that.

8:02Got it. And those things I'm going to want is the most senior priority, which is called super priority. Okay, that's all sort of standard. That's not new. The nuance is the company itself has some amount of value. It can pass out as cookies in this new financing process. and in the old world what they would do is let's say i've got a hundred million dollars and i'm making that number up a value to allocate in this new transaction that i'm going to raise new money in rather than splitting that up pro rata amongst the three of us i'm just going to give it to two of you and so why is that from the company's point of view it's a hundred million dollars how the three of us divide it up they don't really care about but you two care about getting as much as you can since you own the most well we all care about it but you guys have the the possibility of being, let's say, a 51 % group and saying, I can take all the cookies for me and leave Sajit behind.

8:53And that is the idea of creditor-on-creditor violence. We are theoretically party pursue. We are in the same place with the same document. But you, because you choose to and the sponsor wants to, doesn't really care, the sponsor will just go to you. It's easier to deal with cuts since there's two of you, not three of us to negotiate with. And that is the nuance of creditor-on-creditor violence. You two, theoretically, standing with me with the same document can impose pain on me simply because you're bigger. Super priority kind of reminds me of double secret probation, right? Like I wonder, can you have like super, super priority?

9:27I guess you could like keep doing it forever pretty much or at least until all the collateral is exhausted. Well, yeah, you see this kind of like 1.5 lean that's kind of put between first and second. And then there's been double creditor on creditor violence cases. So there is like this spiral and kind of like the looking gas. Violence squared. Yeah. So one thing I don't really get about the creditor on creditor violence is its connection with private credit. And I've seen people talk about private credit as a response to creditor on creditor violence in the sense that, you know, maybe it's easier to be a single lender to a company.

10:05You're higher up in the payment waterfall. all, you don't have to worry about getting into fights with a bunch of other investors. But then I also see headlines saying that creditor on creditor violence is becoming more of a thing in private credit, too. So basically, I'm confused. Yeah. So let's just take a step back and just think about that. I think there's two factors that are behind the generalized creditor on creditor violence concept. One is what we hit on before, which is just the technical aspect of these credit agreements, which is the legal contract that governs like a leveraged loan.

10:40And then, you know, what are the restrictions or covenants that are in that document that prevent this kind of creativity and like refinancing and exchange offers. And there is like a real legal dispute about whether these changes can be done with or without unanimity, whether you need 100 % of the group, all three of us to agree to a change in interest rate or principal maturity. Those are called the so-called sacred rights, if you will. And that's like a legal question that's been litigated. And we can talk about that more if you want. But then there's also the social aspect. And the social aspect is the idea that me, private equity firm X, they may have the legal ability for this mischief, but they ultimately wouldn't pursue that.

11:26And they wouldn't do that because they are a repeat player in the leveraged finance markets. and a big edit reputation as a firm that gets too cute, that will cause them to borrow at higher interest rates down the line. And the next deal, the deal after that, the different partners who are not in this deal are going to face the consequences. So there's a social aspect. And also within the deal itself, if you ultimately antagonize your creditors down the road, you may need to restructure again. And if they remember you as the person who was rough with them, they're not going to be so kind when you need their help.

11:58And yet Argentina exists. Exactly. Exactly. So that brings us to the private credit point. And you were obviously a leveraged finance reporter and a leveraged loan maven. And you know how that market works, which is it's really big. It involves banks who underwrite these deals and then they sell them on in the syndication process. And that's a whole kind of machine. And, you know, in a big leveraged loan credit, there's going to be dozens of CLOs and regular way mutual funds and then hedge funds. And it's like a wide, widely dispersed kind of group. And that dynamic affects how the document is negotiated and just, you know, all the kind of interactions down the line.

12:37In a private credit deal where you truly have like a club or maybe even a single lender, where there's, you know, four or five or three or two, maybe one firm that's providing a loan to a private equity backed company, that group is just much smaller. The negotiations around that document are much more intimate. And again, And for those social reasons, there was the idea that in a private credit deal, the private equity firm sponsor who owns the company is not going to declare war or go to DEFCON 5 or DEFCON 1, whichever the highest one is, to pursue their own ends. It's going to be much more of a collaborative and kind and gentle process.

13:17Friendly, kumbaya relationship. And so this, again, now we go to the examples of the creditor on credit violence that has arisen now in the private credit market. and the examples are relatively sparse so far because private credit is relatively new and two, I do think this kind of social dynamic actually is true. There's this case called Pluralsight, which Bloomberg has covered, the FTD has covered, where in fact there was one of these aggressive kind of refinancing transactions that happened using kind of a loose document and the private credit syndicate, which was four or five firms, was reportedly indignant that this had happened.

13:50In fact, this creditor and credit of violence situation was extremely mild. It was like one very small refinancing to make an interest payment. And then ultimately what happened was the sponsor handed the keys to the private credit firm to take ownership in a very bloodless way. And in fact, I wouldn't even link that. I wouldn't even put this even close to the real headline grabbing violence cases.

14:26Your best restaurant location gets five-star reviews. How do you make every location like your best location? Your best paper mill has been operating at peak productivity. How do you make every mill like your best mill? Your best data center has optimized every drop of water. How do you make every data center like your best data center? The answer is Ecolab. Better performance, better outcomes, better impact. Ecolab. Now every location is your best location. How many vendors does it take to meet all your organization's food needs? Just one. EasyCater, the workplace food platform that lets teams order from a huge variety of restaurants, over 100 ,000 nationwide, all through a single vendor.

15:11In addition to all that variety, EasyCater also gives you full visibility of your organization's food spend with invoicing, centralized reporting, and seamless integration with expense management systems, all on one platform. EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast. So let's say I am, I don't know, a small, there's some sort of club deal or there's some sort of deal and I am a small holder and I am aware of the existence of creditor on creditor violence as a risk. I perceive me as being the one who might get screwed, so to speak, at some point in the future.

15:50What am I doing along with my law firm to write that document in such a way so as to reduce my odds of finding myself in that position? If you're a small player in the leveraged finance market now and or a CLO, which is basically a passive instrument, as you guys know, these things that just accumulate loans and turn in securities, and you're not like a shark hedge fund. This leveraged loan market has changed quite a bit. And so if we just take a step back, leveraged loans are the most senior part of a capital structure, even on a levered company. And so what that means is even if things go south, the recovery rates in leveraged loans historically have been very high, like 80, 90, 100%.

16:34And so the people who hold these are relatively risk averse institutions. And so So two things have happened. One is this creditor-on-creditor-violence concept, but also, as you alluded to earlier, this market is huge now, leveraged loans. It's exploded in the last 10 years. And there are a lot of loan-only companies. There is nothing below the leveraged loan other than the equity. There's no high-yield bond. And so the recovery rates have become lower because there's less loss absorption below you. and this idea that a conservative buyer over leveraged loan have bought the safest security and you have the first lien, the first claim on the assets, that idea has been eroded.

17:16And that's actually very profound. And this market has become much riskier than it used to be for the technical reasons and the social reasons. So getting your question on what you should do about it. One, you have to ask yourself, do you want to be in this business? There's a lot of people who now, unless they're like one of the handful of really big players that can impact a distress situation and actually be in the negotiating room. They're thinking long and hard about being in this business. And two, you do hope that the documents themselves are being tightened over time. And there are ebbs and flows in the market.

17:50There's supply and demand, and there's waves of when the documents are tight and when they're loose. And now you hear these terms about there's a J.Crew blocker. Is there a pushback now? Yeah, there is. And there are these blockers, like the J.Crew blocker, the sort of blocker. And what does that mean? And that just means that in the document, the lawyers will negotiate tighter terms and restrictions that prevent the J.Crew transaction, the Serta transaction. And we can talk about this more in detail if you want. There is, again, this push and pull about the documents and how tighter or loose there are and how people push back.

18:21But the thing is, though, everyone tends to be a price taker in these markets. And you kind of take the document that is the market at the time. And if you are a firm that tries to push back in the negotiations, they can just pass you over. Right. There's plenty of others. Yeah. Someone else will take the bad document when you won't. And that is just that's a difficult dynamic right now. So there's this great bit in your book where the lawyers are arguing over the meaning of and in a contract. That's that's right. And or like whether and means a bunch of conditions have to be met. or maybe only some of them.

19:01You know, I've always thought in language, this is a weird term because it's exactly right. It's off. Anyway, yes, I didn't. I've always thought this is a weird term. Sorry, keep going. So personal aside, but my husband is a former corporate lawyer and it takes him ages to send a text message. Like he will spend 20 minutes writing a text message that's like two sentences and he blames it on his legal background and the fact that you really have to consider the meaning of every single word. The thing I don't get about covenants and indentures and things like that is I would have thought a lot of it nowadays is like standard boilerplate.

19:39But I mean, the fact that these like issues arise and that there can be arguments over them suggests that maybe it isn't. So I guess my question is like, how much of this is standardized versus customized for particular companies? Yeah, I mean, I think if we just take a step back and think about just like the industrial organization of these markets. And to your point, I think there was a sense that these documents are standardized and there's some kind of like template which you download and they're all kind of the same, more or less. What's happened is there has been now this arms race amongst the law firms and the investment banks to read these documents really carefully.

20:25And then in their laboratories in the basement come up with crazy transaction structures so the big creditor on creditor violence techniques there's something called the drop down there's something called the up to your exchange there's something more exotic called the double dip uh something called pari plus uh and these are like designed by these law firms and these investment banks and when you do one of these transactions you're not just checking a box and i want to do up to your exchange and something like it just happens there's like five crazy things you have to do which are kind of unnatural and combined together, create an uptier exchange or a dropdown.

21:00And the result is all the same, which is you, senior lender, suddenly in the left behind group, collateral that you owned now is somewhere else and is not reachable to you. And what I've described are different techniques to do those things. And so people realize not only are the documents sort of looser, but the creativity that lawyers and bankers try to exploit has been accelerated and ratcheted up. And there's this idea that we are going to ask for forgiveness, not permission. We'll do the transaction. If someone wants to sue, we'll see them in court. That'll go on forever. And what you're ultimately trying to do in all these cases is create negotiating leverage for the actual settlement where everyone will come into a room and sort it out.

21:44But in fact, who has the leverage is determined by who's in the group and who's not. So the actual transaction may or may not be important, but what it does is does set the parameters for the ultimate negotiation. So we've been talking a lot about behavior on the borrower and the lender side, but there is a sort of third party here, which is the court itself and the judges. And speaking of great books on credit, there's a great book on the Argentina restructuring that came out relatively recently called Default, the landmark court battle over Argentina's$100 billion debt restructuring. And one of the takeaways that I got from reading that book is so much depends on the judge that is put in charge of a particular case.

22:29And there are moments in that book where like, the judge is just really tired and fed up with everyone. And so he kind of like, does things kind of hastily, I guess. But what's been the response from the courts to more aggressive creditor-on-creditor infighting? So that's a great question. And not just the actual writing of the document the lawyers are doing is part of what the service they're offering. They're offering an entire kind of choreography on how this chess match is going to, each chess move is going to inflow. We're going to document to the actual creditor-on-creditor violence transaction and then ultimately the litigation and how can we game out each of these moves?

23:12So like we'll be in this jurisdiction, we can expect maybe to get like this particular judge and the company or the other lender will respond this way. Yeah, and so these documents are all now, almost all of them are written under New York state law. But that doesn't mean they always end up in New York state court. Sometimes they end up in New York state court. Sometimes they end up in federal court where the federal court is interpreting New York state law. And then sometimes they end up in bankruptcy court, which is a federal court as well and you know has its own like very kind of unique powers and they end up interpreting the document and there's a whole again art and science deciding you know how you think it's going to evolve the the state court and the federal courts are relatively slow bankruptcy courts are relatively fast so like one case that's really interesting and i followed closely is this case surda simmons from a couple of years ago uh which was which is one of the emblematic creditor on creditor balance cases.

24:08And so this is a mattress company. Obviously, we all heard of it, got into trouble during the pandemic. They, in an effort to raise more capital, essentially went to their existing lenders and said, we need more money. Who can give us a deal? And this is a fun case because there end up being two competing groups and they each propose their own deal. One is an up-tier exchange. One is a drop-down, essentially accomplishing the same things, which is new capital in the company, exchange debt for a discount. And the company essentially had an auction for new capital. They picked one. So one group won, one group lost.

24:46Wait, was it the uptier or the... So the uptier exchange group won. And there's a whole aside about this where the drop-down group, which is Apollo and Angela Gordon, very aggressive, smart firms that are in this market all the time, think the actual up-tier structure is something that actually is actually legally offensive in a way a drop-down is not. And that's a rabbit hole we can go down. But that point is actually very interesting. But they both essentially add a new layer of debt to the capital stack. Yeah, they both do the same thing. You end up in the same place. There's a whole question of whether the up-tier exchange is something that's actually contemplated in the original document, the drop-down kind of is or not.

25:24We can go down that rabbit hole if you want. But the point is, eventually, SIRTA had to file for bankruptcy. The Apollo-Angelo Gordon Group had sued in New York State Court. I can't recall if that ended up in federal court or not for jurisdiction reasons. But anyway, there was some lawsuit kind of going through the courts. There were multiple lawsuits about the transactions. Once the company went into bankruptcy, the company and the winning group sought to have the bankruptcy court declare the transaction permissible. And the bankruptcy court, which was very fast, the Houston court at the time, very, very fast, blessed the transaction, the deal, the bankruptcy deal got done and the people in the winning group ultimately kind of took control of the company.