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Reorganization of Shipping Companies Under U.S. Bankruptcy Law
IIR Shipping Finance Conference, London
Shipping companies can be and have been successfully reorganized in U.S. bankruptcy cases. This article describes how the practices which have developed in the bankruptcies cases for other businesses have been applied to shipping companies which have used them to restructure their balance sheets.
The conventional wisdom has been that shipping companies could not be successfully reorganized in a U.S. bankruptcy because of the nature of their businesses. Their principal assets are highly mobile. The companies operate in and have creditors in many different jurisdictions with different legal systems. The creditors have rights to seize the assets for payment of their claims. U.S. bankruptcy courts may be powerless to prevent their seizure by local creditors in foreign ports. This view was borne out by the Hellenic Lines and U.S. Lines bankruptcy cases in the mid-1980's where U.S. chapter 11 filings did not prevent the ultimate liquidation of the businesses. Typically the restructuring and repayment of shipping company loans has involved the arrest and seizure of ships, as was the case in the recent Adriatic Shipping transaction.
Recent experience has demonstrated that shipping companies are not unique and can be reorganized in bankruptcy. Many U.S. companies operate in multiple jurisdictions and have creditors who are not subjection to the jurisdiction of the U.S. bankruptcy courts. Creditors other than maritime creditors also have lien rights, such as carriers and warehousemen, suppliers of perishable agricultural commodities and packers and stockyards. Persons who perform repairs on equipment have mechanics' liens similar to maritime liens.
In recent shipping cases, strategies which were developed in non-maritime bankruptcies in the U.S. have lead to successful reorganizations. Those strategies are the "pre-packaged" bankruptcy, co-opting management and distress merger and acquisition transactions involving the company in bankruptcy. These cases have shown that U.S. bondholders will wait for their recovery and take a recovery in a form other than cash, including debt or equity in the reorganized company.
Pre-Packs: Creditors and other parties in interest have been justifiably critical of the time and expense involved in many chapter 11 bankruptcy cases in the U.S. Eastern Airlines was an example of a business which was permitted to remain in bankruptcy for an extended period during which it suffered continuing operating losses until it was shut down and its assets sold for much less than the appraised values for at the commencement of the bankruptcy case. Almost all of the proceeds of the sale of the aircraft was consumed in the expense of the bankruptcy case, leaving less than 1% of outstanding indebtedness for the creditors after the professionals had been paid substantial fees.
A pre-packaged bankruptcy case involves the implementation of a balance sheet restructuring of the company on terms negotiated before the case is filed between the company and its institutional creditors, who are the only creditors affected in the bankruptcy case. The plan typically involves the exchange of the bonds held by investors for stock in a reorganized company. The secured creditors holding mortgages on the company's assets may be unaffected while the interests of the shareholders are substantially diluted or eliminated. In order to preserve the going concern value of the company, the claims of the trade creditors and customers of the company are not affected and they are paid in full in the ordinary course of business. In the case of a shipping company which has sold bonds in the U.S. markets, the bondholders will agree to exchange their bonds for stock while permitting the suppliers (who might otherwise have the right to arrest the vessels in foreign jurisdictions) to be paid in full as they perform services or supply goods. The real purpose of the bankruptcy case is to bind all bondholders to what might otherwise be implemented as a non-bankruptcy exchange offer of stock for the bonds. In bankruptcy, a bondholder who might be tempted to refuse to exchange his bond in the hope of enforcing it for full payment after other bondholders have cured the company's insolvency by their exchanges is bound to the exchange if the plan is accepted by the necessary majorities of the other bondholders. All trade creditors are paid in full, often without any interruption in payment. This group includes all foreign creditors and all creditors who may have lien rights against ships. Customers are unaffected since they would be able to take their business elsewhere. Customers' claims for credits which might be treated as claims subject to adjustment in the bankruptcy case are honored in full. Management is usually retained while the interests of the former shareholders are diluted or eliminated entirely by the stock issued to creditors.
Co-opting Management: Another key element in recent shipping bankruptcy cases is the incentives given to the managers to cooperate in proposing a plan which is acceptable to the bondholders. In the U.S., management continues in control of the company after a bankruptcy filing as the "debtor in possession." Management is displaced by a trustee only by court order upon a showing of cause such as fraud or mismanagement. Management is responsible for directing the activities of bankruptcy counsel and for proposing a plan or reorganization. The managers are frequently given "stay" and "success" bonuses to persuade them to continue to mange the company and implement a plan acceptable to the creditors. That plan may involve stock options and management contracts for the managers with the reorganized company. All of these steps permit the mangers to profit based on their services even if the shareholders receive no recovery on account of their pre-existing stock ownership.
Distress M&A: The third development is the use of bankruptcy as a forum for merger and acquisition transactions. It has always been true that assets can be purchased in bankruptcy free and clear of the claims of creditors in the same way that an admiralty sale frees a ship of all prior lien claims. Recently bankruptcy has been used as the context for the purchase of entire businesses as going concerns with the same protection against the claims of old creditors. In other cases, creditors have purchased claims in the bankruptcy proceeding to block confirmation of plans that they oppose and have purchased claims to obtain legal standing to propose and implement a reorganization plan transferring the business to the acquiror or to take over control of the company and propose a plan on terms preferred by the acquiror.
Recent examples of cases involving the implementation of these techniques include the Hvide Marine, TBS Shipping, Global Ocean and Golden Ocean bankruptcy cases, each of which involved the bankruptcy reorganization of a company which had sold high yield bonds in the U.S. markets.
Hvide Marine: Hvide is a U.S. company with its headquarters in Florida which operated 275 vessels all around the world primarily in the oil field serving business. Hvide sold $300 million in Senior Notes in February, 1998. When it was unable to make the second semi- annual coupon payment in February, 1999 and failed to attract sufficient interest for a complicated restructuring proposal, which was to be implemented through a non-bankruptcy exchange offer, it filed for bankruptcy in August, 1999 to implement a plan negotiated with its bondholders. That plan was approved and implemented in a little more than three months. It involved the issuance of 98% of the equity in the reorganized company to bondholders in exchange for their claims. Existing equity holders were given warrants to purchase 1.25% of the stock. All secured creditors and trade creditors, including all foreign creditors and those with lien rights were unaffected by the plan and retained their rights to full payment. Management received bonuses, employment contracts and stock options.
TBS Shipping: This Bermuda company whose ship owning subsidiaries were organized in the Marshall Islands and Panama operates a tramp and liner service with its tween decker vessels from an operational headquarters in a suburb of New York City. It sold $110 million in Notes secured by mortgages on the vessels owned by its subsidiaries in 1998. It was unable to make its second interest coupon payment in May, 1999 and, after more than one year of negotiations, filed a bankruptcy case to implement a restructuring negotiated with the Noteholders in August, 2000. The plan provided that the Noteholders' secured claims were reduced from $110 million to $50 million and the Noteholders received substantially all of the stock of the reorganized company and control of the board of directors. The managers, who were the principal shareholders of the company, retained minority equity interest in the company and remained as the officers. Perhaps more significantly, the management contracts with their affiliated companies were kept in place. Trade creditors and other secured creditors were unimpaired. The plan has been accepted by every creditor who voted and is expected to be approved by the court in October.
Golden Ocean: Golden Ocean is a Liberian corporation controlled by Fred Cheng which owned and operated VLCC and dry bulk carriers. In August, 1997 it issued $149 million in 10% Senior Notes and warrants to purchase $100 million in additional Notes and 200,000 shares of common stock. Those notes were exchanged for $291 million in Notes registered with the U.S. Securities and Exchange Commission in July, 1998. By September, 1999, the company was in restructuring negotiations with the Noteholders. The parties reached agreement on a term sheet in September, 1999 which was revised in January, 2000 due to "allegations of improprieties" by Mr. Cheng to provide that the Noteholders would receive 88% of the equity of the reorganized company and Mr. Cheng would surrender all management roles. The bankruptcy case was filed in January, 2000 and soon attracted the interests of groups who wished to capture control of the company through the bankruptcy case. In March, 2000 the Norwegian Frontline interests purchased Notes and offered financing for the bankruptcy case. A Greek group, Bentley purchased control of the equity of the company and offered a competing plan. In July, Frontline proposed a plan which was approved and implemented in August, 2000 after Frontline reached a settlement with Bentley. Under the plan the secured debt was unaffected while the creditors get Frontline stock valued at 20¢ on the dollar or 17¢ in cash plus a share of litigation recoveries.
Global Ocean: Global Ocean is a Liberian corporation operating from Greece which operated 10 feeder container vessels and 2 dry bulk carriers. It stock was traded on the American Stock Exchange but was more than 50% family controlled. It had one U.S. subsidiary and a few small bank accounts in the U.S. In June, 1997 it issued $126 million in Senior Notes due 2007. By the fall of 1999 it was in negotiations with a committee of Noteholders on the terms of a restructuring. In January, 2000 it reached an agreement in principle with the Noteholders for a recovery of 50¢ on the dollar plus interest from May, 2000. Implementation of its bankruptcy plan was opposed by one Noteholder who persuaded other small Noteholders to vote against the plan and moved to dismiss the bankruptcy case on the ground that there was an insufficient basis for the bankruptcy court to exercise jurisdiction over the company. The motion to dismiss was denied but confirmation of the plan was blocked by the negative votes of the small bondholders since U.S. law requires approve by a majority of both the members of a particular class as well as the principal amounts of their claims. The bankruptcy case remains unresolved.
U.S. Bankruptcy Court Jurisdiction: As a matter of U.S. bankruptcy law, a U.S. bankruptcy case can be filed in the U.S. if the company resides, has a place of business or has assets in the U.S. Hvide was a U.S. company; TBS had a base of operations in the U.S. The ability of Golden Ocean to file a U.S. bankruptcy case was litigated and the bankruptcy judge found that the bank accounts established by the companies in the U.S. was a sufficient basis for jurisdiction. In each of these cases the management cooperated and supported the bankruptcy filing, the main purpose of which was to bind all of the Noteholders (who were U.S. companies). Recognizing that foreign creditors could not be controlled and that their good will was required, all of the cases paid them in full.
The Downside: There are risks and costs to a U.S. bankruptcy filing. The U.S. bankruptcy system requires transparency and accountability. The company must file detailed schedules of its assets and liabilities and descriptions of its financial affairs. Its books and records are subject to inspection by the creditors' representatives. The managers must make themselves available for examination by the creditors in the bankruptcy case. Lawyers, accountants and investment bankers are retained by the creditors as well as the company which may be required pay the fees and expenses of all of them. All significant business decisions must be approved by the bankruptcy court after review by the creditors. Management may lose control of the process as happened in the Golden Ocean case where the business was acquired by Frontline. U.S. bankruptcy is always expensive in terms of fees of lawyers and investment bankers and may be subject to delays even in a case originally structured as a prepackaged plan.
Keys to Success: A number of factors affect the ability to restructure a company in a U.S. bankruptcy case. The first necessary element is a belief shared by the creditors and the management that the company is worth more as a going concern than in a sale of its assets. Restructuring may be easier with "vulture" investors who purchase the bonds after the company experiences difficulties than with the original purchasers. The original purchasers may have an emotional as well as a financial investment in the situation and may be seeking an unrealistically high recovery based on their original investments. The vultures may be happy with a quick return of 20¢ if they purchased a bond for 10¢. The managers must be willing to accept their recovery in the form of future compensation for services rather than equity and acquiesce in the dilution of the other shareholders.
Conclusion: The U.S. bankruptcy courts can provide a forum to reduce the debt burden of companies which are unable to service their bonds sold in the U.S. market while preserving the business if not the owners' equity stake.
James Gadsden is the head of the Bankruptcy Practice Group and a member of the Maritime Practice Group of the international law firm of Carter, Ledyard & Milburn located in New York City. This article is based on Mr. Gadsden's presentation at the September 27-28, 2000 IIR Shipping Finance Conference in London.