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Today, we will learn more about:

1. Cram Downs

2. Weaponization of the Dollar

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Cramdowns

Two weeks ago, we learned about cram-ups, which are when poor terms are imposed on objecting senior creditors as part of the Chapter 11 process. In contrast, a cramdown is when a court ignores the objection of junior creditors and approves a debtor's plan of reorganization (POR). As a reminder, in a Chapter 11 bankruptcy, a POR classifies the claims against the debtor, describes how each class of creditor will be treated under the plan, and how the plan will be carried out. The bankruptcy plan must be approved by a majority of the creditors and the bankruptcy court. For a plan to be accepted by a class of creditors, it must be approved by a majority in number and two-thirds in dollar amount of claims. Therefore, any investor (or group of investors) that accumulates a 33.4% position in the claims of a class can prevent approval by voting no. Alternatively, a majority of claims within a class can come together to vote no and also block the plan.

However, according to Section 1129(b) of the Bankruptcy Code, a bankruptcy court has the right to disregard the objections of a class of creditors and approve a borrower's restructuring plan if certain conditions are met. Essentially, the plan is, in effect, forced upon impaired creditors who voted against plan approval. This is called a "cramdown."

Why Do Creditors Oppose Plans?

If a creditor opposes a proposed POR, it can delay or even halt the restructuring process. When a creditor or class chooses to oppose a POR, it can either be because they believe there is a genuine problem with the plan or to use their established leverage to attempt to negotiate for greater recovery. A few reasons why creditors may oppose a plan of reorganization include:

Feasibility: A class or a single creditor may oppose a POR if it is likely to result in a subsequent liquidation or further restructuring. Different creditors in different positions may argue a lack of feasibility to achieve different ends. For example, one class may argue that the value of a reorganized company will be too small to compete in the market adequately, and, therefore, it should be sold in an auction process. This can delay the bankruptcy process, and the threat of this delay may allow for a better recovery to be achieved through negotiation. A different class of creditors (particularly those who expect to receive debt or equity in the reorganized debtor) may argue that the reorganized company will have an unsustainable amount of debt on its balance sheet. This could lead to issues if the company cannot make its interest payments or refinance its debt in the future. As outlined above, a class of creditors does not need to believe that a plan is genuinely not feasible; by simply arguing that it is, it may be able to gain a greater recovery by threatening to hold up the process.

Insufficient Recovery: Creditors may reject a plan of reorganization if they believe it does not offer them a satisfactory recovery on their claims. Suppose the proposed plan provides lower payments or a lower value for their debt than their expectations or the value they think they could receive in alternative scenarios (it is rare to know with certainty). In that case, creditors may opt to reject it. This argument may be particularly liable to a cramdown from a bankruptcy court if, as explained below, it is not inherently unfair or discriminatory to the objecting class. However, a class of creditors choosing to block a plan for this reason may still be able to gain leverage in negotiations.

Lack of Communication or Negotiation: Open and effective communication between the debtor and its creditors is crucial in the Chapter 11 process. Suppose creditors feel that the debtor has not adequately engaged with them or considered their input during the plan formulation. In that case, they may reject it as a way to express their dissatisfaction. Additionally, creditors require comprehensive and accurate information about the debtor's financial condition, assets, liabilities, and future prospects to evaluate a plan effectively. Suppose they believe the plan lacks sufficient supporting information or the debtor has not provided transparency. In that case, creditors may reject it due to concerns about the accuracy or completeness of the information presented.

Requirements for a Cramdown

In cases where creditors continue to oppose a POR, a debtor will likely try to pursue a cramdown before giving additional value to the opposing class. Three main requirements must be met for a bankruptcy court judge to cram down a class of creditors. These include:

1. At least one impaired class must vote in favor of the plan. To review, an impaired creditor is any creditor who, under a plan, will be paid less than the full value of their claims.

2. The plan may not discriminate unfairly against the objecting class of creditors. Within a plan of reorganization, all claims within a single class must be treated equally. However, there is no requirement that all similar claims be placed in the same class. The only requirement is that all members of a class hold substantially similar claims or interests. Different treatment of separate classes of similar claims becomes important in cramdown scenarios but is not required as long as a plan has the acceptance of all impaired classes.

3. The plan must be fair and equitable with respect to the objecting class. For a plan to be fair and equitable, the primary condition is that it must follow the absolute priority rule. This ensures that every claim junior to the objecting class can only receive recovery if the objecting class's claims are paid in full. In practice, when the objecting class holds unsecured claims, this requirement prevents a debtor from offering recovery to a class below the objecting class (for example, equity holders) to get their support for a POR. If a POR provides even a slight recovery for the equity class (who will likely get nothing in Chapter 11), the equity class will likely approve the plan. This would satisfy requirement #1: that an impaired class must vote in favor of the POR. This "tipping" an impaired class strategy is common in Chapter 11 processes to prevent litigation or other actions that could hold up the resolution process. However, it cannot be used in conjunction with a cramdown.

Unsecured Institutional Debt & Unsecured Trade Debt

Both types of unsecured claims are likely pari passu, or equal to each other in terms of priority. Thus, they could be consolidated within a single class to simplify and expedite the restructuring process. However, if the two groups had differing goals for the restructuring process, it might make more sense to keep the two claims within separate classes.

A POR could classify both types of claims separately, providing the institutional debt holders with a longer-term payout or giving one class an equity position while the other receives cash. To justify such a differentiation, it may be argued that banks and insurance companies are accustomed to, and may be more receptive to, a longer-term repayment (both during a Chapter 11 process and in out-of-court negotiations) than ordinary trade debt, which operates generally on thirty-day or sixty-day terms. There might be logical reasons, accepted by both trade debt and unsecured bank debt, for the differing treatment accorded by different classes.

Where does a Cramdown Come into Effect?

Let’s say the debtor’s proposed plan of reorganization provides the institutional debt with new debt and equity in the reorganized debtor and provides the trade claims cash. The institutional debt agrees to the plan, but the trade claims oppose it. The debtor proceeds to push for a cramdown of the trade claims’ objection. In that case, the trade claims can argue that the plan unfairly discriminates against them, as they did not receive any equity, but the institutional debt, which was pari passu to them, did.

Unsecured Claims With and Without a Guarantee

This is a bit of a niche scenario, but it is helpful to highlight how many factors can affect negotiations in a restructuring. Let’s assume that a corporate debtor has two types of unsecured claims: claims with a guarantee of payment and claims without a guarantee. A guarantee of payment is an absolute and unconditional promise to pay the debt at maturity if not paid by the principal debtor. In this instance, the unsecured claims are guaranteed by corporate insiders.

The claims with a guarantee might be placed in a separate class and offered better treatment than the non-guaranteed, unsecured claims. Even though some unsecured creditors would be treated better than others, the disfavored unsecured creditor might consent to such treatment because they were interested in keeping in place old management, which had guaranteed the debts, and not forcing the guarantors into their own personal bankruptcies. With the consent of both parties, this discrimination among separate classes of similar claims is acceptable.

Source: [1], [2], [3], [4]

Weaponization of the Dollar

In Episode 109 of Clauses and Controversies, sovereign debt and restructuring are discussed with long-time debt journalist Felix Salmon, who has his own podcast called Slate Money. Felix talks about the weaponization of the dollar and how it has impacted countries affiliated with it. He also points out the problems that can arise from China taking advantage of lending opportunities in distressed countries in which their relationships will strengthen against those with the United States.

Weaponization of the Dollar

The Dollar’s International Impact

To begin, it is important to gauge how the US dollar affects other countries in several ways. A strong dollar can buy more goods when converted to the local currency, giving Americans greater buying power overseas. However, a strong dollar can make American-made goods more expensive and less attractive to international shoppers. Emerging economies with big dollar-denominated debt balances can be hit particularly hard by the strengthening dollar. The Federal Reserve’s determination to crush inflation at home by raising interest rates can push prices up, increase the size of debt payments, and increase the risk of a deep recession in other countries. In addition, when the US dollar is strong, American-made goods become more expensive — and less attractive to shoppers — in other countries. People living in many other countries where the currency is now weaker than the dollar may think twice about traveling to the US or buying US goods. As the dollar gets stronger, their visits and purchases will become more expensive.

Weaponization

The "weaponization" of the dollar refers to the US government's use of the currency's global dominance to extend the extraterritorial reach of US law and policy. This includes the enforcement of economic sanctions against countries like Russia or Iran in an attempt to shut them out of the international banking system. The US government can use the dollar as both a carrot and a stick, showering foreign aid to "friends" and locking out "enemies" from the global financial system.

The matter of talk is how the US has large amounts of power in affecting foreign economies such as Venezuela and Russia. Felix then mentions how the dollar has been drastically impacting countries like Afghanistan and Cuba as well, and states how it is worrying because it is indicative of the “playing field” in which the US can easily change the rules. Therefore, these fears from other countries will affect how much they save and borrow in US dollars.

Splitting Off

Several countries have already displayed interest in moving away from the dollar such as Brazil and Argentina having discussed the creation of a common currency for the two largest economies in South America. The UAE and India are in talks to use rupees to trade non-oil commodities in a shift away from the dollar, and President Macron of France has recently displayed some fondness for being part of BRICS- a grouping of developing countries of Brazil, Russia, India, China, and South Africa.

Syndicated Loans

Belt and Road Initiative

The Belt and Road Initiative is a global infrastructure development strategy adopted by the Chinese government in 2013 to invest in more than 150 countries and international organizations. The initiative aims to improve connectivity and cooperation on a transcontinental scale by linking East Asia, Europe, and Africa through physical infrastructure such as roads, railways, ports, airports, pipelines, and telecommunications networks. With the initiative including roughly one-third of the world’s trade and over 60% of the world’s population, the “belt” refers to railroads that will connect China with participating countries via the same historical Silk Road trading routes that connected China and central Asia to Europe and the Middle East. China has been heavily investing in Africa particularly due to several reasons:

1) Secure natural resources such as oil, copper, and cobalt.

2) Gain access to new markets for Chinese goods.

3) Garner interest in Africa’s potential as a manufacturing hub.

4) Exploit Africa’s strategic location along key shipping routes.

China’s Lending Strategy

Most recently, syndicated loans have been booming around the world. A syndicated loan is financing offered by a group of lenders — called a syndicate— who work together to provide funds for a borrower. Syndicated loans arise when a project requires too large a loan for a single lender. Syndicating the loan allows lenders to spread risk and take part in financial opportunities that may be too large for their individual capital base.

With China notably providing more syndicated loans to distressed countries in the past decade, China will be in the mix of major creditors and will have a much bigger role in international restructuring. According to a study published by researchers from the World Bank and Harvard Kennedy School, between 2008 and 2021, China spent $240bn bailing out 22 countries that are “almost exclusively” debtors in Xi Jinping’s signature Belt and Road infrastructure project, including Argentina, Pakistan, Kenya, and Turkey. The study also found that China’s overseas lending portfolio supported countries in debt distress. In 2010, less than 5% of China’s overseas lending portfolio consisted of such countries. By 2022, that figure had soared to 60%, reflecting Beijing’s new focus on rescue operations and movement away from the infrastructure investments that had characterized this campaign in the early 2010s. Felix believes this will be a huge problem as China will be more reluctant to grant necessary loans among major creditors for a lot of countries suffering from the rise of interest rates.

China’s Impact

In smaller countries such as those in Africa, China is appreciated well because they are there for long-term funding, and they are helping with local infrastructure projects while Western countries have been leaving with their post-imperialist projects. The loans funded projects including railway lines, ports, stadiums, hospitals, governmental palaces, and digital migration programs. In recent years, there has been growing concern about debt distress in nations across the continent, including Zambia, Ethiopia, Kenya, and Djibouti. This allows China to pose as a new debt creditor in which they are offering more money, which then leads to China having a real negotiating advantage for more financing purposes in the future.

Felix mentions how the old sovereign debt regime does not really work anymore and that there will eventually have to be a new status quo. He thinks that when it comes to some countries like Zambia and Sri Lanka, the United States should essentially leave China as a “big question mark.” He recommends the US to restructure all non-Chinese debt and leave these countries in default, forming a new regime in which the Chinese debt then gets restructured.

Going Forward

Within the next five years, Felix is most worried about the implosion of the dollar which the entire global economy rests on, as he notes there is starting to be a loss of global faith in it. He mentions how the US has taken significant actions that have eroded the trust in the dollar with countries like Russia and Argentina. Lastly, he signs off with his approval for the trillion-dollar coin, which would allow the US to reduce the national debt in order to eliminate the need to raise the debt ceiling.

If the world economy de-dollarized, it may lead to a recession in the United States. As the world’s largest currency issuer, the US’ position in the international trade and financial system would be weakened, which could have a negative impact on the American economy. The long-term consequences of de-dollarization will translate to less demand for dollars and a fall in the value of dollars in forex markets. This will mean increased costs for imports, and this will result in the further impoverishment of American workers already burdened with the impact of inflation. An increasingly de-dollarized world would weaken America’s ability to influence the behavior of its adversaries and could consequently magnify national security threats.

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