More about rights offering Rights Offerings in Bankruptcy:
More Than New Capital
Daniel P. Winikka
Jones Day
Paul M. Green
Jones Day
Over the past decade, rights offerings
have become a valuable and frequently
used source of exit financing for
chapter 11 debtors. The increased use of rights
offerings is, in part, a result of the increased
participation of non-traditional, sophisticated
lenders in the bankruptcy process. Rights
offerings are often beneficial to all parties
involved. The debtor can obtain access to new
capital without resorting to secured financing,
and creditors or pre-bankruptcy equity security
holders can preserve their investment in the
debtor and obtain enhanced recoveries by
investing at a discount to the perceived value
of the reorganized company. Moreover, a
successful rights offering can provide a signal to
the market that there is healthy optimism in the
success of the reorganized company.
In addition to providing reorganized debtors
with access to new capital, rights offerings are
increasingly being used as a tool to effectuate
other agendas in a bankruptcy case, including
the resolution of valuation disputes and
allocating control of the new company.
The Basics of Rights Offerings
In bankruptcy, a rights offering allows a debtor
to offer creditors or equity security holders the
right to purchase equity in the post-emergence
company, usually at a healthy discount to the
assumed value of the reorganized enterprise.
The class of creditors or equity security holders
solicited for participation is generally offered
the right to purchase their pro-rata share
(i.e., the same percentage that their current
holdings represent) of the equity available
under the offering. Rights offerings typically
involve a solicitation of the eligible creditors
or equity security holders either in connection
with solicitation of the reorganization plan or
following confirmation of a plan but prior to
consummation of the plan and emergence from
bankruptcy. Because the new equity typically
is sold at a discount to assumed value, parties
often have a strong incentive to participate in
the offering to avoid dilution, provided that they
believe the offering price does in fact represent
a discount to the value of the reorganized entity.
To guarantee the reorganized debtor’s
capital needs are met, rights offerings are
usually backstopped by a third party that
agrees to purchase any unsubscribed shares.
Because the debtor’s plan of reorganization is
normally premised upon raising the financing
contemplated by the rights offering, obtaining
a backstop commitment is typically critical
to establish the feasibility of the plan at
confirmation and to avoid the possibility of a
substantial loss of time and expense soliciting
and confirming a plan that is thereafter never
consummated because sufficient funds are not
raised. Because there is always the inherent risk
that the backstop party could be required to
purchase a much larger number of unsubscribed
shares than the party desires, backstop parties
typically require payment of a backstop fee, often
ranging from three to seven percent of the total
offering. The backstop party will also typically
want assurance, through an overallotment right
or otherwise, that it will have the opportunity
to purchase a certain minimum number of
shares. To ensure its protection, the backstop
party will require that, prior to proceeding with
any solicitation of the rights offering, the debtor
seek court approval of the backstop agreement,
including the backstop fee. The backstop party
can often end up with a controlling, or at least
very influential, equity block. To obtain the
most favorable terms, debtors often shop the
backstop right, sometimes through an informal
auction process.
One of the most heavily negotiated terms of the
backstop agreement will be any material adverse
change provision. There can often be months
between the time the backstop agreement is
signed and consummation of the rights offering,
and it can be challenging to define, and reach
agreement on, what unexpected adverse
developments might permit the backstop party
to terminate the backstop commitment.
A rights offering may include oversubscription
or overallotment rights. Oversubscription rights
allow existing creditors or equity holders to
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