The Chapter 11 case of First Brands, the struggling Ohio-based auto parts debtor, is off to an immensely contested start as the company has been bombarded by opposition to its request for DIP financing and use of cash collateral. In light of the staggering number of objections from various parties-in-interest – more than the Debtwire legal analyst team has seen in recent history – we discuss the tensions in the case of First Brands, which needs the DIP financing to continue to navigate its Chapter 11 case, but is in a position of having to agree to arguably onerous provisions that are not common in the majority of DIP loans, as discussed below. Although we often see tension between overly aggressive DIP terms and a debtor’s need for the financing, First Brands’ case presents its own unique set of troublesome circumstances.

As further discussed below, we believe that the debtors have presented strong arguments for agreeing to the economic terms of the DIP facility (including the provision of the roll-up, fees, and interest rates), but the factoring parties and unsecured creditors committee (UCC) has made arguments with respect to other provisions of the DIP financing that present valid points.

Off-market DIP financing package for an unusual debtor

As summarized in the table below, First Brands’ USD 4.4bn DIP facility includes USD 1.1bn in new money and a creeping roll-up of USD 3.3bn of prepetition term loans. The USD 1.1bn new-money tranche is fully backstopped by members of First Brands’ ad hoc first lien lender group, which has 81 members including Antares Capital, Arena Capital Advisors, Black Diamond Capital Management, Eaton Vance, and Pacific Investment Management Company. The substantial roll-up occurs at a drastic 3:1 ratio alongside new-money funding: USD 1.5bn of prepetition first lien term loans are rolled up at the interim draw, followed by USD 1.8bn at final funding. This creeping structure functions as a participation premium, locking in lender leverage as commitments increase. Additionally, the debtors’ USD 24.5m bridge loan was to be repaid in full in cash upon entry of the bankruptcy court’s 1 October interim DIP financing order.

As if the ratio of new money DIP loans to rolled-up DIP loans were not enough, the DIP lenders also seek a lien on all of the company’s unencumbered assets – including all possible causes of action. Moreover, as the Debtwire legal analyst team previously discussed, the DIP credit agreement contains milestones that are more compressed than those contained in the average DIP credit agreement, including most notably that the debtors agreed to sign a transaction support agreement (TSA) with their lenders within 30 days of the bankruptcy filing – a milestone the debtors have already missed.

On 1 October, Judge Christopher Lopez of the US Bankruptcy Court for the Southern District of Texas approved the financing on an interim basis during at the debtor’s first day hearing. A hearing on final approval of the DIP financing has been set for 6 November, and the objections to final approval are stacking up, as discuss below.

Significant opposition to key DIP financing terms

Over 20 parties-in-interest have filed objections with respect to approval of the DIP financing on a final basis. Some of the more salient objections are summarized in the following table.

Objecting parties can largely be grouped into categories including (i) counterparties to factoring agreements, (ii) landlords, (iii) lenders, and (iv) the unsecured creditors committee (UCC) and, as discussed below, the objections can be further grouped based on substantive points raised.

Nearly all objecting parties point out that the debtors have already conceded that an unpaid balance of approximately USD 2.3bn has accrued under various third-party factoring arrangements as of the petition date and that the debtors received roughly USD 1.9bn in proceeds of factored receivables but failed to turn them over to the applicable (and still unspecified) factors. The objectors also point out that debtors’ counsel has stated on the record that those funds are no longer in the debtors’ possession. Although the debtors have appointed a special committee to investigate what happened with respect to these missing receivables, additional details on the investigation have not been made available.

Factoring related objections

Katsumi Servicing, a buyer representative under a receivables facility, noted in its objection that the debtors’ “prepetition third-party factoring practices present extraordinary and unresolved issues” that directly implicate the rights and interests purchasers of receivables factored under the receivables facilities prior to the petition date, as well as any funds and collections received by the debtors in respect thereto both pre- and post-petition. They, like other objectors that are parties to factoring agreements, have requested that any final DIP financing order (i) provides for the immediate turnover to buyer of any and all funds received by the debtors in respect of receivables factored under the receivables facility, or (ii) to the extent turnover is deferred, is conditioned on more concrete and durable protections to safeguard the value of such receivables (and any related funds and proceeds). They have also requested an extension of the challenge period until the investigation is complete (with a requirement of a 25 February completion date), various other forms of adequate protection and other concessions[1].

Section 364(c) of the Bankruptcy Code provides that if a debtor is unable to obtain unsecured DIP financing as an administrative expense, a bankruptcy court, after notice and a hearing, may authorize the obtaining of credit or the incurring of debt (i) with priority over any or all administrative expenses; (ii) secured by a lien on unencumbered property of the estate; or (iii) secured by a junior lien on encumbered property of the estate. If a debtor is unable to obtain DIP financing on those terms, section 364 of the Code provides that, if the debtor provides adequate protection of the interests of the holder of the lien on the property of the estate, the debtor may grant senior or equal liens to DIP lenders.

As many opposing parties point out, nothing in section 364 authorizes a debtor to grant liens on property that is not property of the estate, and the factors argue that the DIP lenders are therefore not entitled to liens on property that, under the factoring agreements, belong to them – and not the debtors. The bankruptcy court will not have time to assess property rights with respect to various receivables under all of the factoring agreements before approving, or refusing to approve, the DIP financing on a final basis. As such, the most prudent course of action would be for the bankruptcy court to provide that the DIP lenders will not have liens on property that is not property of the estate, thereby tabling the fight for a later date. While this may not be acceptable to the DIP lenders, it appears to be the only reasonable resolution at this stage of the case. The Debtwire legal analyst team previously discussed the arguments concerning whether factored receivables can be found to be property of a debtor’s estate.

The next issue to be addressed in connection with these objections is that of adequate protection. Section 363 of the Bankruptcy Code provides that a debtor may not use cash collateral unless either the entity that has an interest in such cash collateral consents or the court authorizes such use. Section 363 further provides that, on request of an entity that has an interest in property to be used, the court must prohibit or condition such use as is necessary to provide adequate protection of such interest. Accordingly, if it is ultimately determined that the receivables are First Brands’ property and that the factors have an interest in those receivables, given that they do not consent to the use of their property, the bankruptcy court would be required to find that their interests are adequately protected. While replacement liens often serve as an acceptable form of adequate protection, that may not be the case with First Brands, whose financial state is unclear at this point in light of allegations of the missing funds. More to the point, the UCC contends that the debtors “lack reliable financial information” and note “disturbing allegations regarding their historical business practices, including allegedly missing cash, fabricated invoices, inflated sales figures, tainted books and records, double (perhaps triple or more) pledged collateral, commingled assets, improperly accounted for receivables, labyrinthine ‘off-balance sheet’ financings, and myriad and complex insider and related-party transactions.” The UCC goes on to note that “[c]riminal inquiries are pending, as are multiple requests for the appointment of an examiner” and that [t]he “fog” currently enveloping the company is thick.” For these reasons, replacement liens may prove inadequate.

However, we note that we have never seen a bankruptcy court grant standing to pursue certain causes of action on a debtor’s behalf as part of an adequate protection package, and we think it would be unlikely to see such relief granted here, particularly at this stage of the case. Post-petition payments and administrative expense priority claims, on the other hand, are more typically granted as adequate protection and would seem to be equitable under the circumstances. Granting such rights to payments and administrative expense claims, however, likely would receive significant pushback from the debtors and the DIP lenders, and a bankruptcy judge often is in the position of walking a fine line between requiring creditor concessions and making a DIP financing no longer attractive to DIP lenders. Lastly, we note that requests for information with respect to the special committee’s investigation would seem warranted under the circumstances.

Liens on avoidance actions and other estate causes of actions

Raistone Purchasing, a receivables purchaser, and the UCC (as well as other objecting parties) argue that the DIP lenders should not be granted liens on avoidance actions and their proceeds, as well as nearly all other causes of actions and their proceeds belonging to the debtors. According to Raistone, the DIP Facility “should not hinder the ability to recover the potentially misappropriated proceeds of the Purchased Receivables.” Such recoveries are often preserved for general unsecured creditors and, as the objectors argue, are of particular importance here given the missing fund, for which there are potentially billions of dollars that could be recovered in actions held by the estates on account of these factored receivables. These claims, according to Raistone, should be preserved for the benefit of the factors and general unsecured creditors and to fund recoveries to the parties that were harmed by the debtors’ potential misconduct.

The UCC also contends that the DIP lenders should not be granted liens on every potential cause of action available to the debtors, arguing that granting all such proceeds to the DIP lenders “effectively amounts to a federal foreclosure – with secured creditors receiving all of the benefits, and unsecured creditors receiving little or nothing” in which case the “Chapter 11 [case] has no real purpose, and the case should be either dismissed or converted.”

While bankruptcy court judges often grant DIP lenders a lien on the proceeds of avoidance actions, they are often reluctant to also grant liens on the actions themselves, much less all other causes of action available to the debtors and the proceeds of those actions. This is a big, and unusual ask, of the DIP lenders, and we would expect the bankruptcy court to push back as much as possible, particularly when there are potentially billions of dollars to be recovered in causes of actions in light of the missing funds and other allegations discussed by the committee, above. Moreover, giving a DIP lender a lien on a cause of action essentially gives that lender power to decide whether to bring the action. This is particularly troubling with potential causes of action against the DIP lenders and typically should not be granted until after the period within which the UCC may investigate such claims has expired (i.e., the challenge period).

To this point, the UCC also argues that granting such liens essentially “shields the [l]enders and their affiliates from scrutiny respecting the extent, validity, and priority of their prepetition claims and liens – through broad stipulations, full estate releases, and stifling ‘Challenge’ restrictions.” The UCC further argues that the challenge limitations contained in the proposed DIP financing (i.e., the 8 December challenge” deadline and USD 50,000 investigation budget) “would function to preclude the Committee from conducting a reasonable investigation, given the enormous complexity and murkiness surrounding the Debtors’ corporate and capital structures, business and operations, and prepetition transactions.” Similarly, the UCC argues that the DIP lenders’ credit bidding rights must be subject to UCC’s challenge rights. The Debtwire legal analyst team agrees that this is a compelling argument, and as discussed below, the debtors and DIP lenders have made concessions on these points. Had they not, we would have expected the bankruptcy court would attempt to get the DIP lenders to agree to revise the provisions of the DIP financing agreement governing the challenge deadline, investigation budget, and liens on all causes of action – most notably causes of action against the DIP lenders.

Above-market cost of DIP financing that is indisputably a risky investment

Another major category of opposition to the DIP financing is one that was raised by the UCC and goes to the economic terms of the facility, including the roll-up, fees, and interest rate. This category of opposition is more difficult for a bankruptcy court judge to push back against the DIP lenders on due to fear that they will walk away from the deal. That concern is even more prominent here, where the debtors have already defaulted under the DIP financing agreement by failing to meet two milestones, giving the DIP lenders the ability to call a default.

According to the UCC:

• the roll-up is egregious as it materially deviates from accepted bankruptcy norms, both in aggregate dollar amount and in the 3:1 ratio of prepetition debt to new money DIP financing;
• it is doubtful that the DIP facility will provide adequate funding to bridge these cases to plan confirmation, as the DIP budget shows that funds likely will be exhausted at the end of  December and it is likely that this case will take much longer than that. As such, as the DIP is currently proposed, the cases will likely be administratively insolvent by the end of December;
• the DIP facility carries an excessive cost, including off-market premiums, interest, and other protections, (which the Debtwire legal analyst team discussed  earlier) – the “lavish” fees and overall cost of the DIP facility are excessive, and charging fees on the “roll-up” obligations (potentially exceeding USD 200m) is “aberrant;”
• the DIP Facility effectively forecloses any possibility of a value-maximizing reorganization because it requires the debtors to raise over USD 5bn in cash at exit to repay the DIP facility “despite the [d]ebtors lacking any practical ability to access the capital markets and the absence of reliable information respecting the [d]ebtors’ potential debt capacity;” and
• as proposed, the DIP facility would assuredly result in “low-ball (if any) bids” for the debtors’ assets, enabling the DIP lenders to: “(i) swipe the operating businesses at severely depressed prices via credit bid and assert (likely) massive superpriority deficiency claims (secured by DIP Liens) to snatch up all residual value in the cases.”

As the Debtwire legal analyst team previously discussed, the roll-up in First Brands’ case is not in line with the majority of the other roll-ups we have seen, but the debtors argue that they need the financing to proceed with the Chapter 11 cases, and are unable to obtain financing on any less onerous terms.

Courts construing these provisions of a proposed DIP financing typically look to whether (i) the DIP financing is necessary to preserve the assets of the estate, and (ii) the terms of the transaction are fair, reasonable, and adequate, given the circumstances of the debtor-borrower and proposed lender. In short, the court will consider whether agreeing to the terms of the DIP financing was a sound exercise of the debtors’ business judgment, and given the state of the debtors’ finances, there is a strong argument that any other lender would be willing to provide First Brands with any less restrictive – or expensive – DIP financing. In any event, the reasonableness of the terms under the circumstances discussed above will be a difficult call for the bankruptcy court to make.

The difficulty of dealing with competing DIP financing tensions

As discussed above, the objecting parties raise serious concerns, including most notably that a debtor cannot grant liens on assets it does not own. For this reason, until a determination as to ownership of receivables is made, we would be surprised to see the bankruptcy court allow First Brands to grant liens to the DIP lenders on these assets. We also believe that UCC presents a valid argument that the challenge period and investigation budget should be enlarged which, as discussed below, the debtor and DIP lenders have agreed to revise. Disputes over the extent to which First Brands should be permitted to grant the DIP lenders liens on all causes of action, and challenges to economic terms of the DIP financing, including the provision of the roll-up, the fees and the interest rate, are much thornier issues.

As the ad hoc lender group points out in its reply, “[t]his DIP Financing is arguably among the riskiest in recent history” – noting documented allegations of rampant fraud against the debtors’ owner and CEO, Patrick James. Moreover, in its defense, the lenders in the ad hoc group contend that they “had less than two weeks to negotiate and backstop this DIP Facility.” The lenders contend that funding into this structure is incredibly risky, and these contested provisions are necessary to address that unique risk. The lenders also note that they agreed to increase the investigation budget to USD 250,000 and extend the challenge period to 31 January 2026. We agree that these concessions would satisfy the bankruptcy court with respect to the objections concerning these points.

In their reply to the objections, the debtors paint a bleak picture, arguing that without the DIP facility, their businesses “will immediately collapse with trustees and liquidators appointed in multiple jurisdictions to fight over the scraps.” The debtors also argue that in if the bankruptcy court does not approve the DIP facility, such a ruling would “destroy any chance of recoveries for most of the Debtors’[d]ebtors’ stakeholders” and “cause approximately 26,000 employees world-wide (including approximately 6,000 in the United States) to be unemployed overnight.” The debtors also argue that the UCC has not presented any evidence that the DIP facility will cause the debtors to become administratively insovlent and that, as a concession in this regard, the DIP Lenders have agreed to carve out a basket of USD 200m for administrative expense claimants that will be senior to the roll-up obligations in the event the debtors become administratively insolvent. Any determinations in this regard likely will largely depend on witness testimony to be provided at the hearing.

As for the economic terms of the facility, the debtors make a strong argument as to its reasonableness. They note that the DIP lenders are providing USD 1.1bn to a debtor with limited unencumbered assets to offer as security and that the existing ABL lenders hold a first-priority lien over the debtors’ inventory and accounts receivable (which the DIP lenders are not seeking to prime). Thus, without any priming liens and limited unencumbered property, the DIP facility is mostly secured by the debtors’ enterprise value. They also note the uncertainty and risk to the DIP lenders, who are awaiting the results of the quality of earnings report that will be performed over the next few months. These factors weigh in favor of approving the economic terms of the DIP financing.

As for the objections raised by the factoring parties, the debtors argue that such objections should be overruled because, to the extent the factoring parties can prove that any funds held by the debtors are not property of the estate, there are no liens or claims being granted against those funds, and that very little of the debtors’ cash on hand related to invoices that were actually factored with the factoring parties. To this point, we would note that the proposed DIP financing order should be clarified to make this provision explicitly clear so that no fights may arise later in the case.

Related Links:

UCC Objection
Raistone Objection
Katsumi Servicing Objection
Debtors’ Reply to Objections
Ad Hoc Lender Group’s Reply to Objections
Case Profile
Debtwire Dockets: First Brands Group
Debtwire Restructuring Database: First Brands Group

Prior to joining Debtwire, Sara was a law clerk to two judges in the United States Bankruptcy Court, S.D.N.Y. and practiced in the Financial Restructuring Group at Clifford Chance, where she represented financial institutions (as secured and unsecured creditors, defendants in adversary proceedings, and participants in DIP financings) in high-profile restructurings. She also represented foreign representatives in Chapter 15 cross-border cases.

This report should not be relied upon to make investment decisions. Furthermore, this report is not intended and should not be construed as legal advice. ION Analytics does not provide any legal advice, and clients should consult with their own legal counsel for matters requiring legal advice. All information is sourced from either the public domain, ION Analytics data or intelligence, and ION Analytics cannot and does not verify or guarantee the adequacy, accuracy or completeness of any source document. No representation is made that it is current, complete or accurate. The information herein is not intended to be used as a basis for investing and does not constitute an offer to buy or sell any securities or investment strategy. The information herein is for informational purposes only and ION Analytics accepts no liability whatsoever for any direct or consequential loss arising from any use of the information contained herein.

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[1] They have also sought (i) adequate protection in the form of monthly cash payments of interest at the contract rate; (ii) that the final DIP financing order requires that the debtors must deliver to all factoring parties (and their advisors) interim and final written findings and discoveries resulting from the investigation, together with any and all back-up documentation on which such findings and discoveries are based and participate in bi-weekly calls with the factoring parties, (iii) standing to assert a challenge or timely file an adversary proceeding or contested matter in respect of claims and causes of action in favor or belonging to the buyer, the debtors and their estates with respect to claims or cause of action relating to receivables factored before, on or after the petition date modification of the automatic stay to allow them to pursue such actions and a tolling of deadlines to bring any and all such claims and causes of action, and (iv) language in the final DIP financing order providing that nothing, including the final order, grants liens in favor of the DIP lenders or in connection with any adequate protection liens, on funds, accounts or receivables (or the proceeds thereof) that have been purported to be sold to the buyers, unless and until such funds, accounts or receivables (or the proceeds thereof) have been determined by the court, pursuant to a final, non-appealable order, to have not been sold to the buyer and instead to constitute property of the debtors’ estates.