Reed Smith Client Alerts

The Loan Syndications and Trading Association, Inc. (the “LSTA”) recently published an updated suite of trading documents for all secondary market loan trades entered into on or after May 17, 2019.  The changes to most of the trading documents are technical clarifications and/or intended to capture recent changes in law.  One exception is the LSTA Chapter 11 Plan Proceeds Letter Agreement for Post-Effective Date Settlement of Distressed Trades (the “Proceeds Letter”), which underwent both technical as well as a more substantive change to account for a unique scenario arising from a recent bankruptcy case that is ongoing.

To better understand the reason behind the changes to the Proceeds Letter some background may be helpful.

  1. What does the Proceeds Letter do?  The Proceeds Letter is a bilateral agreement between two parties to a secondary market loan trade where the loan has been converted in connection with a chapter 11 restructuring plan of the applicable borrower.  The Proceeds Letter provides for certain representations, warranties and other provisions relating to the loan proceeds as well as mechanics for the transfer of the proceeds from the seller to the buyer.
  2. When is the Proceeds Letter used?  The Proceeds Letter is used only if (a) the trade was confirmed using an LSTA Distressed Trade Confirmation and (b) (i) the applicable borrower is a debtor under chapter 11 of the Bankruptcy Code, (ii) the class in which the loan is placed is impaired (pursuant to section 1124 of the Bankruptcy Code), (iii) the plan of reorganization has been confirmed and (iv) the effective date of the plan has occurred.  The LSTA further recommends using the form only after the record date for distributions under the plan has occurred and distributions have been made.
  3. Why is a form Proceeds Letter necessary?  The need for a form Proceeds Letter is premised on the widely accepted principle in secondary market loan trading that a “trade is a trade”.  As set forth in Section 2 of the LSTA Standard Terms and Conditions for Distressed Trade Confirmations (as well as the LSTA par trade confirmation standard terms and conditions), a buyer in a loan trade assumes the obligation to purchase the debt as it may be “reorganized, restructured, converted or otherwise modified.”  Often debt is reorganized in connection with a chapter 11 plan and the Proceeds Letter is intended to document the transfer of such reorganized debt.

Perhaps the most significant revision to the updated form Proceeds Letter is the change to how disgorgement risk is allocated between buyer and seller.  It is a generally accepted trading principle that any payments or other distributions made in respect of a loan or loan proceeds (as the case may be) from and after the settlement date of the transaction are for the benefit of the buyer.  If agreed to at the time of trade, payments and distributions from and after the trade date may be for the benefit of the buyer as well.  If the seller receives a payment or distribution due to buyer, seller is required to pass along such distribution or payment to Buyer in accordance with the terms of the Proceeds Letter.  Since the seller is merely acting as a conduit by passing along such payments or distributions, it is not expected to take on the payment risk and merely passes along what it receives (if anything).  Similarly, if any such payment or distribution is required to be disgorged, it should ultimately be buyer’s (and not seller’s) risk absent egregious actions by the seller or a prior seller.   

Until this recent change to the form Proceeds Letter, buyer was obligated to return any payments or distributions in case of disgorgement only if such payment or distribution was “made by mistake or in error by the entity charged with making the distribution…”  The premise of that language was based on the assumption that a debtor is unlikely to make any payment or distribution to creditors in connection with a plan of reorganization unless the decision to do so was final and un-appealable.  Accordingly, payments and distributions should only be subject to disgorgement if such payments or distributions were made by mistake or in error.  That premise was challenged in connection with the 2016 bankruptcy filing of Ultra Petroleum Corp. (“Ultra”) and its related debtors (In Re: Ultra Petroleum Corp., et al.,  U.S. Bankruptcy Court, S.D. Texas, Houston Div., jointly administered under Case No. 16-32202 (MI) (Jointly Administered)).