This post consists of musings on the role of indenture trustees and bankruptcy. To lighten a heavy and technical subject, we’ve structured it as a musical in four short acts—each headlined by the title of a familiar song.
So, with both gratitude and apologies to Pete Seeger, the Beatles, the Clash and Lin-Manuel Miranda, let’s dive right in.
“Where Have All the Bankruptcies Gone?”
In the early days of pandemic, we anticipated increased distress and defaults in municipal and corporate debt markets. We were both right and wrong. There have been disruptions and strains making life difficult for many borrowers. But the massive wave of bankruptcies and workouts did not materialize as expected, in large part due to massive infusions of liquidity from the federal fisc.
Two years on, those strains on borrowers remain. The business cycle has not been repealed, and many enterprises that received financial support remain in need of restructuring. The day of reckoning has been postponed, not cancelled.
When bond issuers choose to restructure under the protection of a bankruptcy filing, the indenture trustee has several decisions to make. Those decisions will reverberate and make a material difference not just for the bond holders but for the entire enterprise.
“Should I Stay or Should I Go?”
Among the first decisions to make upon a bankruptcy filing (or earlier), the trustee must determine whether it can remain in that capacity. Under the Trust Indenture Act, a trustee must resign shortly after a default if it serves in conflicting capacities. That may include acting as indenture trustee for competing tranches of debt or being a lender in its corporate capacity. Deciding quickly whether it can and should remain as trustee is critical to ensuring the bondholders have adequate representation throughout the bankruptcy.
If the answer is for the trustee to go, the next question is who should step in? The incumbent trustee typically has some sway in selecting its successor. Investors and their advisors are increasingly making their preferences known as well. It is important that the chosen successor be qualified under the indenture, with the skills and resources to participate fully in the bankruptcy process.
The indenture trustee is charged to represent the interests of the bondholders. The best way to do that is to talk to them, help them assemble (if they haven’t already) and work closely with the holders to formulate and implement a strategy for maximizing recoveries.
The indenture typically gives holders the power to direct the trustee, assuming they have the requisite numbers and provide satisfactory indemnity. It is usually in the interests of both holders and trustee alike that most of the bonds coalesce around a strategy. For that to happen, the holders, trustee and their professionals should try to achieve a consensus on the best way forward. A good trustee will work hard to help build that consensus, while protecting the rights and interests of those holders not in the working group.
This is more complicated than it sounds. The trustee should both coordinate with the working group and keep non-participating holders informed of developments, all without piecemeal disclosure of material non-public information. There are many ways to step wrong; it is important the trust officer in charge has the expertise and judgment necessary for the challenge.
“What Else Can I Do?”
The indenture trustee’s work does not end once a plan is confirmed and goes into effect. The old bonds will usually be tendered and expunged, hopefully in exchange for good value. The trustee will be a necessary partner in effecting that exchange, coordinating with the debtor, claims agent, exchange agent, Depository Trust Company (DTC) and others. And the trustee will need to continue communicating with the holders through the effective date.
The trustee may often be approached with new roles, such as liquidation agent, trustee for new bonds, or distribution agent. The trustee is intimately familiar with the plan of reorganization and with the post-bankruptcy capital structure. It should therefore be a good candidate to take on resulting service roles for a seamless transition.
The UMB Distressed Debt team works to meet the broad needs of borrowers and bondholders, navigates trouble spots as they occur, and helps protect bondholder value. Learn how we can support your firm’s default and workout needs, or contact us to be connected with a distressed debt workout specialist.