Franchise Group Final DIP Approval Hangs on Parties Addressing Outstanding Release Issue; Objecting Freedom Lenders Group Calls Issue ‘Fatal Flaw’

Relevant Document:
Agenda

Judge John T. Dorsey indicated at the conclusion of today’s contested Franchise Group hearing that he is “inclined to grant” the DIP financing motion “on a final basis,” but an “outstanding” dispute over releases must be addressed before he can rule. The judge provided his preliminary views after considering several hours of witness testimony and the parties’ DIP-related closing arguments this afternoon. Lenders in the first lien lender group are providing and backstopping the DIP, whereas the ad hoc group of Freedom lenders, which holds second lien and Holdco debt, opposes the DIP.

Judge Dorsey did find, however, that the evidence at today’s hearing demonstrates the DIP is an appropriate exercise of the debtors’ business judgment and that the 2:1 rollup is proper under the circumstances. At the debtors’ first day hearing, the judge approved a rollup of prepetition first lien claims on a 1:1 basis as part of the interim DIP order.

The final DIP hearing will resume tomorrow, Wednesday, Dec. 11, at 2 p.m. ET, at which point the judge said the parties can either report whether they have resolved the release issue or convince him “it’s not necessary.” The court will then decide whether to approve the DIP on a final basis and will also consider the debtors’ bid procedures motion. The Freedom lender group’s motion to terminate the Holdco debtors’ exclusivity will be heard at the hearing scheduled for Dec. 17 and not tomorrow, per the request of counsel to the Freedom lender group.

The debtors modified the DIP from their original proposal by scaling back the obligations that the two Holdco debtors – Freedom VCM Interco and Freedom VCM – would have under the DIP facility. Debra Sinclair of Willkie Farr, counsel to the debtors, explained that the two debtors, which are the sole obligors under the debtors’ prepetition Holdco facility would not be borrowers under the DIP. Instead, to the extent those debtors determine they need money to pay administrative expenses, DIP proceeds would be upstreamed to the Holdco debtors. The Holdco debtors would then be obligated to the DIP lenders solely for the principal on the upstreamed amounts without having any interest, fees or other obligations to the DIP lenders.

Sinclair argued that the Freedom lenders were trying to “manufacture confusion” on the simple concept. “If the Freedom lenders need money” for administrative expenses, Sinclair explained, the “DIP is there for them as and when they need it.”

Tom Lauria of White & Case, counsel to the Freedom lenders, highlighted that his clients hold approximately 93% of the 2L debt and Holdco debt and therefore represent the largest unsecured creditors in the cases. Lauria argued that the DIP funding mechanics as to the Holdco debtors are “clear as mud at this point” and would likely lead to disputes about how administrative expenses are allocated. In response, Sinclair said the final DIP order would reserve the Freedom lenders’ rights to challenge any allocation. The mechanics were not “nefarious,” Sinclair argued, but an “accommodation.”

Sinclair also argued that the debtors had no other viable DIP proposal. She said the Freedom lenders’ $7.5 million Holdco DIP budgets $6 million for the Freedom lenders’ professionals and contains worse economic terms. She further argued that the debtors met their burden in demonstrating that the DIP was a sound exercise of their business judgment, and even though the debtors have about $130 million to $140 million of cash on hand, denying final DIP approval would send a bad message to vendors and franchisees.

Jayme Goldstein of Paul Hastings, counsel to the first lien group, made similar points, arguing that the DIP is the “only realistic funding path.” Goldstein also argued that the applicable standard was whether the DIP represented a sound exercise of the debtors’ business judgment (and not the entire fairness standard as suggested by the Freedom lender group), that the DIP was not a sub rosa plan and that the “heavily negotiated” rollup feature was appropriate and should be approved.

Judge Dorsey questioned the parties regarding the releases and took issue with the fact that the DIP lenders could call a default if the Holdco debtors’ independent director uncovered potential causes of action against the operating debtors or against the 1L lenders. Although Sinclair argued that the lenders were not likely to create a “footfall” on the DIP, the judge said he was not “satisfied with that answer.”

In response to Judge Dorsey’s release-focused inquiry, Goldstein explained that the 1L lenders believe they have a right to have a say as to how potential causes of action are dealt with as part of the overall package they negotiated.

Lauria, speaking for the Freedom lenders group, said the release issue is “a huge problem” and “fatal flaw” that “needs to be remedied” before the DIP can be approved. Releasing potential claims that are assets of the Holdco estates for the benefit of the OpCo debtors and their creditors violates circuit-level precedent, and the separatedness of the Holdco and Opco estates must be respected, he argued.

Lauria also attacked the Holdco DIP as being “amorphous” on several levels, including what the amount and drawing mechanics would be. “It’s pretty much a blank check,” said Lauria before adding that he has “never seen” a similarly amorphous DIP approved in a chapter 11 case.

Lauria further argued that the Holdco debtors have no immediate need for DIP financing, and therefore, it “makes sense” to take a step back and figure out how to document the proposed DIP “in a way that everyone understands, including the court.” Taking aim at the rollup, Lauria argued that it “eliminates or restricts what may be important plan alternatives” and improperly gives the 1L lenders “more power” than they already have over the outcome of the chapter 11 cases.

Robert Feinstein of Pachulski Stang, counsel to the UCC, said that the committee came into the “very litigious, chaotic” cases “to restore order,” and the committee’s efforts led to “substantial” beneficial changes and concessions by the DIP lenders.

Feinstein asserted that the committee “has concerns too” and intends to conduct its own investigation. The facts “may lead wherever they lead,” but the release issue is ultimately a “plan issue” that can be dealt with “down the road,” he said. Feinstein also asserted on multiple occasions that the Freedom lenders are doing their best to “throw sand in the gears” in an attempt to be cut into a deal.

As previously noted, the final DIP and bid procedures hearing will continue tomorrow at 2 p.m. ET.