The Backstop Rights Offerings: Securing Capital During Your Restructuring Process

• Jurisdiction: United States,Federal
• Law Firm: Mayer Brown
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Financial Restructuring, Corporate and Company Law, Directors and Officers, Insolvency/Bankruptcy
• Author: Mr Adam C. Paul, Lucy F. Kweskin and Tyler R. Ferguson
• Published date: 16 February 2023

When a Chapter 11 debtor seeks to emerge from bankruptcy through a plan of reorganization¹ it must demonstrate feasibility by, among other things, showing sufficient funding for its go-forward, reorganized operations. Some or all of this funding can come through a rights offering ' in which the reorganized debtor issues debt or equity instruments to raise funds. Backstop agreements have become a frequent companion to bankruptcy rights offerings and commonly involve existing creditors or equity holders guaranteeing that the rights offering will be fully subscribed by agreeing to purchase any unsubscribed rights in exchange for a fee.

This chapter provides an overview of how backstop agreements are utilized in Chapter 11 bankruptcy cases, addresses common critiques of backstop agreements and analyzes recent trends in backstop agreements through the lenses of both case law and key terms in the underlying backstop agreements.

Overview of backstop agreements

The rights offering

If a debtor elects to obtain exit funding in full or in part through the issuance of new equity² or debt instruments, it will seek bankruptcy court authorization to conduct a rights offering in which a select group of creditors or existing equity holders may purchase the instrument being issued.³ Participation in a rights offering is typically offered to all eligible claimants (typically those that meet certain accreditation requirements) in a particular class of claims on a pro rata basis. Participation is also usually solicited concurrently with (and as an inducement for a class of creditors to vote in favor of) plan confirmation. For this reason, court approval is most commonly sought in conjunction with the filing of the debtor's disclosure statement so that the debtor may work toward getting the rights agreement subscribed concurrently with obtaining the necessary votes for plan confirmation.

In order to incentivize participation in the rights offering, it is very common for the debt or equity instrument involved to be issued at a discount ' sometimes a very steep discount ' to the estimated enterprise value of the reorganized debtor. A debtor may subject its proposed rights offering to market testing, but this is not especially common and is not a legal requirement to obtain court approval of the backstop agreement.

Purpose, logistics and importance of backstop agreements

To ensure the necessary capital is raised via the rights offering, it is common for a debtor to enter into an agreement with either a third party or, much more commonly, a group of existing creditors or equity holders (who, many times, are also taking part in the initial rights offering). This is done to "backstop" the initial rights offering by agreeing to purchase any unsubscribed portion of the initial rights offering after the offering period expires. Backstop parties are compensated for undertaking the financial risk incumbent with backstopping a rights offering through fees that may be paid in cash, in kind with the instrument being offered, or a combination of both.

Backstop agreements can provide a myriad of benefits to the debtor's bankruptcy estate, principally that the reorganized debtor can meet its post-bankruptcy capital requirements. To confirm a Chapter 11 plan, the debtor must establish plan...