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Abstract

Aggressive liability management exercises have spilled over into bankruptcy court and exit financing is often the prize in the center of the arena. Debtors no longer rely upon gifting, the traditional strategy for buying plan support. Instead, they can replicate gifting’s benefits in a more defensible package by funneling discounted subscription rights to chosen constituencies as part of exit financing.

Recognizing exit financing’s distortive power, courts responded by evaluating the quality of negotiations and reviewing precedent transactions. Meanwhile, commentators suggest heightened monitoring and informal guardrails. All of these approaches ignore the shortcomings of judicial valuation. Market testing is the only way to disaggregate control of the bankruptcy case from the exit financing terms. This Article: (i) explains exit financing’s proliferation as a symptom of gifting’s demise and an outgrowth of liability management exercises, (ii) defines when exit financings violate the Bankruptcy Code and Supreme Court precedent, and (iii) crafts a framework for identifying forbidden exit financing gifts.

Exit financing is the new front in bankruptcy’s forever-war with gifting. Unlike gifting, however, exit financing often provides benefits beyond buying approval for the proposed plan. The proceeds can fund payments required for the debtor to emerge from bankruptcy, while consolidated equity ownership can improve corporate governance. Although proponents trumpet these attributes, exit financing also provides opportunities for gamesmanship akin to gifting. Sophisticated insiders and lender allies leverage their control of the plan process to obtain sweetheart exit financing deals. The Supreme Court’s assessments of new value contributions, a subspecies of exit financing, equip bankruptcy courts with the tools for unmasking exit financing giveaways. Pervasive control can only be separated from the exit financing terms through market testing. Fundamentally, exit financing should be conducted akin to whole-firm asset sales, through market-tested processes.

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