For better or worse, deregulation is now a factor in the electric utility industry. As a general proposition, deregulation makes for increased competition, which in turn will trim costs for consumers. Deregulation of the electric industry means that utilities face the prospect of freezing or reducing rates to retain market share. Stranded investments and the burdens of above-market supply contracts and construction and development contracts (especially nuclear-related contracts) will place additional pressure on these utilities and further reduce their revenue. Ultimately, these problems could hinder a utility's ability to service its debt, invest for the future, and provide a reasonable rate of return to investors.
Certain companies will be able to adapt to the changes and challenges of deregulation more quickly and adeptly than others. Weaker participants may restructure and emerge as powerful industry players, while others will fail and disappear. Some may succeed through simple expense reduction programs; others may require significant operational and/or balance-sheet restructuring (such as asset, debt, and equity writedowns).
Utility companies that are being smothered by their existing debt-service and dividend obligations are less likely to be able to meet the challenges of deregulation. Short-term solutions to liquidity problems, such as eliminating stock dividends or selling assets, may not solve the problem if revenues remain flat or fall. On the other hand, potential long-term solutions, such as attracting new equity or selling a division or business section, may not be feasible.
For at least some utilities, dramatic financial restructuring will be needed to reduce debt and preferred stock obligations. Traditionally, this has meant out-of-court workouts/exchange offers or Chapter 11. A third option that has emerged in the past few years (em the "prepackaged"
reorganization (em combines the best features of both alternatives.
Workouts/Exchange Offers
The first choice for debt and preferred stock reduction, if feasible, is a fully consensual exchange outside of court. This type of restructuring, at first blush, appears particularly applicable to the electric utility industry, where ownership structures customarily involve bonds and preferred-stock capital. In a workout, the parties can achieve anything they can agree upon. This may include forgiving debt, in whole or in part; extending debt maturity dates; reducing interest rates; releasing liens; selling assets; converting debt to equity; and much more. In a bond exchange offer, bondholders may consensually exchange their existing bonds for others with new terms the company can satisfy and new values in conformity with the writedown of stranded investment or whatever else.
Workouts/exchange offers avoid the enormous expense, time, and diversion of management energies that often accompany a traditional Chapter 11 case. Additionally, they generally enable management to stay in place and in control of the restructuring process, an important factor when one considers the value that management continuity brings to a successful franchise in this industry. Finally, they avoid the stigma and related business deterioration that may occur in Chapter 11.
Workouts/exchange offers, however, are difficult to implement because they are binding only on bondholders that voluntarily exchange bonds and creditors that consent. Bondholders that choose not to exchange will retain their existing bonds unchanged and can enforce their terms. Creditors that elect not to accept the out-of-court restructuring agreement cannot be bound by its terms. Thus, even if an overwhelming majority of all creditors and bondholders agree to restructure their respective debts, the dissenters (and abstainers) can still enforce all their legal rights as if the restructuring did not occur.
The consensual nature of exchange offers becomes an almost insurmountable obstacle in the electric industry, where utilities commonly use multiple issues of publicly held, widely distributed bonds to finance operations, and the number of constituencies involved in a financial restructuring is enormous. Moreover, traditional exchange offers, even if successful, would not impact the onerous contracts that often burden utilities. Thus, workouts/exchange offers may not be an effective restructuring tool in this industry.
Traditional Bankruptcy
Chapter 11 of the Bankruptcy Code is the other extreme: a company attempts to reorganize its affairs while under court protection from its creditors. The company's existing management continues in place and operates in the ordinary course of business. Examples of utilities that have been involved in Chapter 11 proceedings include Public Service Company of New Hampshire, El Paso Electric, Colorado-Ute, and Cajun Electric.
The most immediate impact of a Chapter 11 filing involves the "automatic stay," an injunction that comes into effect upon the filing of a bankruptcy petition and suspends most creditor actions against the company. This stay prevents, among other things, debt collection; property foreclosure; the setoff of claims against bank or other accounts, whether involving secured or unsecured debt; and general harassment by creditors seeking payment. Generally, the automatic stay does not enjoin regulatory action, although any rate changes in a bankruptcy plan must be approved by the regulatory authority that customarily sets that company's rates. Nevertheless, in the Cajun Electric case, the parties are litigating whether the automatic stay prevents the imposition of a rate reduction order issued by the Louisiana Public Service Commission. (The bankruptcy court enjoined a rate case for interfering with the reorganization process.)
The purpose of the automatic stay "breathing spell" is to provide the debtor with the time, free of creditor collection efforts, to reorganize its business and negotiate a restructuring plan that will be satisfactory to its creditor and equity constituencies.
Chapter 11 also gives the debtor the power to:
s assume, assign, or reject nearly any executory contract (that is, one with performance remaining on both sides) or unexpired lease, despite express terms in the contract or lease that prohibit such actions.
s treat any claim arising from rejection of an executory contract or unexpired lease as a prepetition general unsecured claim, which may be limited in amount under the Bankruptcy Code and paid less than in full under a plan of reorganization.
s borrow new money with superpriority status that can prime existing lienholders (provided that "adequate protection" can be demonstrated).
The first two powers may prove valuable to utility companies in connection with above-market, long-term power-supply contracts as well as construction and development contracts. For instance, a utility may be able to reject its contract to continue funding the construction and development of a troubled facility that is far from being online. Similarly, a utility burdened with an above-market independent power producer supply contract may be able to reject the contract. The third power can provide a company with sufficient cash to maintain its business while negotiating a restructuring. Such new funds are only available because of the protections that Chapter 11 affords lenders.
The ultimate objective of Chapter 11 is to confirm a plan that establishes the structure of the reorganized company and how its obligations to creditors and equity security holders will be treated. The debtor has tremendous control in this all-important task. First, only the debtor may file a plan for at least the first 120 days. (Usually this period is extended by the court, often for years, although it can be shortened in rare cases.) Thus, management generally stays in control. Second, even though a plan is developed through negotiations with creditor and equity constituencies, and voted on by these parties, the debtor, as the plan proponent, establishes the "classes" of claims and equity interests (within reason). This is key because of the unique voting and binding provisions of Chapter 11.
Chapter 11 creditors and equity holders vote on a plan of reorganization by class. For a class of claims to accept a plan, more than one half in number of the holders in a such class must vote to accept the plan, and these holders must represent at least two-thirds of the amount of claims in such class. For equity classes, only two-thirds in amount is required (count only those holders who actually vote in making the calculations). If such percentages accept, the plan is binding on dissenters and abstainers (as long as certain basic tests are made). These voting and binding features are critical advantages for a restructuring company, when compared to a workout/
exchange offer where virtually unanimous individual consent is required. Moreover, in Chapter 11, even if one or more classes reject the plan, it is possible to "cramdown" the plan on such classes if certain other tests are met.
Chapter 11 is not without its serious shortcomings, however:
1) It can be exorbitantly expensive (see Chart 1 for a list of the professional expenses associated with certain well-known Chapter 11 cases).
2) Mere filing can cause business deterioration as customers, suppliers, employees, and others become concerned about the company's long-term prospects.
3) The administrative burdens are enormous and may divert management's attention from the primary goals of running the business and reorganizing the company.
4) Cases can take inordinate amounts of time, often lasting for years.
5) Management might be replaced, or third parties might propose a plan not to management's liking.
Despite these pitfalls, Chapter 11 can provide a mechanism for reorganizing companies when other possibilities are not available.
Prepackaged
Chapter 11 Plans
"Prepackaged" restructurings are a relatively recent innovation that combines the best elements of workout/exchange offers with the best elements of traditional Chapter 11 cases. In "Prepacks," the entire restructuring is negotiated, documented, and voted on by creditors and equity holders, prior to the commencement of a Chapter 11 case. Only after the company has received sufficient votes to confirm the plan (and bind all dissenters and abstainers) does it file Chapter 11 petitions. Normally, orders are entered by the bankruptcy court on the first day of the case, enabling the company to operate almost as if the filing had not occurred. The sole objective of the case is to confirm the plan. That usually occurs in approximately 30 days, but was effected in only 16 days in the recent Harvest Foods case.
A Prepack's benefits to the restructuring company are extraordinary. The debtor avoids the enormous costs, business deterioration, administrative burdens, diversion of management attention, and risk normally associated with a traditional Chapter 11 case (Chart 2 compares the time and cost of Prepacks and traditional Chapter 11 cases).
At the same time, the company may take advantage of the voting, binding, and cramdown features of Chapter 11, as well as the ability to assume, assign, or reject contracts; limit certain damage claims; borrow money with superpriority; and prevent creditors from pursuing legal remedies.
Prepacks are thus quickly becoming the restructuring vehicle of choice in the 1990s. Numerous companies have already successfully used this technique, including Memorex Telex, Harvest Foods, In-Store Advertising, LaSalle Energy, Trump Taj-Mahal, Cherokee, Kendall, Charter Medical, and JPS Textiles.
Nevertheless, the Prepack route is still a relatively new technique, and the law on Prepacks is still evolving. Moreover, despite the foregoing simple overview, Prepacks are complex undertakings that require legal expertise in various areas (em securities, tax, corporate, government regulations, and litigation as well as restructuring/ bankruptcy. Managing trade credit, customer relations, and employee confidence during Prepacks is also crucial. In the utilities industry, Prepack negotiations will need to include the appropriate regulatory authorities. If creditor and other required approvals are not obtained in a timely manner, an attempted Prepack can devolve into a traditional Chapter 11 case. Thus, proper planning and execution of Prepacks can mean the difference between a relatively quick, inexpensive, and seamless restructuring and a failed attempt resulting in a long, drawn-out, and costly Chapter 11 reorganization (em or possibly a liquidation. t
Jay M. Goffman is chairman of the Business Reorganization Group at
O'Sullivan, Graev & Karabell, a law firm headquartered in New York and specializing in corporate finance. He has been involved in workouts, traditional Chapter 11 filings, and increasingly popular "prepackaged" restructurings. John R. Ashmead, an associate with OG&K, who assisted in preparing this article, is also experienced in all aspects of restructuring.
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