Bankruptcy and Restructuring Considerations for Distressed De-SPACed Companies

As interest rates have risen and credit markets have tightened, many public companies formed via the de-SPAC process are trading far below their initial price. By some estimates, close to 100 of these companies lack sufficient liquidity to fund their current level of spending over the next year.

To date, at least a dozen of these companies have been forced to file for bankruptcy, with more likely to file in the near future. Chapter 11 of the U.S. Bankruptcy Code provides financially distressed companies with powerful tools that can be used to de-leverage balance sheets, reject unprofitable contracts and leases and preserve going-concern value.

Benefits of Bankruptcy for Distressed De-SPACed Companies
For distressed de-SPACed companies, a chapter 11 restructuring may provide the best option for recovery, but early evaluation of options is necessary to implement the smoothest path forward. The advantages of chapter 11 include: 

• Debtor’s Management Typically Remains in Control: In chapter 11, the debtor, under the direction of its existing management, typically retains possession of its property and continues to operate in the ordinary course of business. This stands in contrast to a liquidation under chapter 7 of the Bankruptcy Code where a trustee is appointed to take control of a debtor’s assets.
• Rejection of Unprofitable Contracts and Leases: Subject to limited exceptions, debtors can “reject” (i.e., jettison) unexpired leases and contracts with material obligations remaining to be performed and pay claims for breach in bankruptcy dollars. Debtors frequently use this powerful bankruptcy tool to get out of above-market leases and contracts that are unprofitable or that no longer align with the company’s business plan.
• Debtor-in-Possession Financing: Companies in bankruptcy often raise capital from private lenders via debtor-in-possession (DIP) financing. The Bankruptcy Code offers DIP lenders special rights and protections that are designed to reduce risk and thereby facilitate access to capital markets. For example, in appropriate circumstances, DIP lenders can prime existing loans with superpriority, senior liens on the company’s assets. DIP lenders also typically negotiate for other rights—such as a “roll up” of all or a portion of their outstanding pre-bankruptcy loans into superpriority DIP loans.
• Flexibility to Pursue Wide-Range of Restructuring Transactions: Chapter 11 provides debtors with flexibility to pursue a wide range of possible restructuring transactions. In some cases, the debtor sells its assets to a third party free and clear of all claims, liens and encumbrances, with the sale proceeds used to pay creditors and any remaining proceeds distributed to equity holders. Other cases entail a stand-alone restructuring where either (a) pre-bankruptcy equity interests are eliminated and pre-bankruptcy debt is converted into equity in the reorganized (i.e., post-bankruptcy) company or (b) a plan sponsor injects new capital into the debtor in exchange for equity in the reorganized company. 

A debtor can also reduce the time and costs of bankruptcy through a “prepackaged” chapter 11 case. In a prepackaged case, a distressed company negotiates and solicits support for a chapter 11 plan from its creditors and key stakeholders before the bankruptcy. Once the company has sufficient support, the company commences a chapter 11 case to obtain court approval of its chapter 11 plan knowing that it has the requisite creditor support to satisfy the Bankruptcy Code’s requirements. A prepackaged filing can drastically reduce the time that a debtor spends in bankruptcy and minimize chapter 11 costs. For example, Rockley Photonics Holdings Limited, one of the de-SPACed companies that recently sought chapter 11 relief, obtained court approval of a prepackaged plan just 46 days after commencement of the case. Rockley’s chapter 11 plan eliminated more than $120 million of debt and facilitated the raising of approximately $35 million in new funding from existing secured noteholders, permitting the company to exit chapter 11 as a going concern.

Considerations for Distressed de-SPACed Companies Contemplating Chapter 11
Although chapter 11 offers distressed companies many powerful tools, it is not a panacea. Many factors determine whether chapter 11 is a sensible option, including: 

• Liabilities: The principal objective of chapter 11 is to rehabilitate debtors burdened by unsustainable debt or other liabilities. Consequently, chapter 11 typically makes the most sense for companies whose problems are due to an overleveraged balance sheet or other liability-related issues (e.g., unprofitable contracts, above-market real estate leases or significant tort or litigation liabilities).
• Liquidity Needs: Liquidity needs may become more acute during a restructuring because bankruptcy typically imposes added costs (e.g., professional advisors’ fees). Thus, a company contemplating bankruptcy should consider whether it needs financing to satisfy its operating and bankruptcy expenses and if so, whether there are viable sources for that financing. As noted above, the Bankruptcy Code creates incentives for DIP lenders, but companies that need DIP financing benefit from identifying willing lenders and negotiating an appropriate financing package before filing for chapter 11.
• Business Plan Feasibility: Finally, a company must consider how it can use chapter 11 to emerge as a viable business. A chapter 11 plan of reorganization cannot be confirmed unless it is feasible—that is, the proposed restructuring has a reasonable likelihood of success and is not likely to be followed by liquidation or the need for further financial reorganization in the foreseeable future. Satisfying the Bankruptcy Code’s feasibility requirement can be challenging for pre-revenue businesses and startups that lack commercialized products, sales or a track record unless the debtor can prove that the capital raised under the plan will provide sufficient working capital to develop a commercially viable product and reach profitability.

Stakeholder Considerations
Stakeholders that take an active role in a bankruptcy may be able to minimize losses and capture upside value by investing in the reorganized business. For example, in some chapter 11 cases, a debtor raises the financing needed to emerge from bankruptcy by selling shares in the reorganized company (known as a rights offering). Stakeholders that believe in a company’s long-term prospects are often entitled to participate in rights offerings and sometimes negotiate the right to purchase new shares at a substantial discount. In one notable chapter 11 case, a stakeholder earned such a high return on new shares purchased in a bankruptcy that it has been referred to as “probably the single most lucrative trade for one man ever.”

Similarly, when a company files for bankruptcy to sell its assets, often there is a public bidding process. Bankruptcy sales create opportunities for existing or new investors to acquire the company’s most attractive assets without assuming the company’s pre-bankruptcy liabilities.

Conclusions
As a growing number of de-SPACed companies enter distress, bankruptcy filings are likely to rise. Bankruptcy provides powerful tools for companies that need to de-leverage their balance sheets and reconfigure their contractual or other operational relationships. Bankruptcy also creates opportunities for investors who believe in the long-term vision of a distressed business.