This article was originally published on Law360 on May 19 ...€¦ · management fees or shared...
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pillsburylaw.com Many power generation companies (PGCs) are experiencing difficulties under current market conditions. In addition to being exposed to the industrywide difficulties resulting from depressed energy prices and unexpectedly warm weather, many PGCs have been reliant on easy access to the capital markets to develop or acquire generation capacity, or to meet other capital needs, and now face upcoming debt maturities and skepticism regarding their ability to refinance. As restructuring discussions commence across the capital structure, creditors seeking to improve their recoveries should bear in mind lessons learned from recent PGC restructurings such as Dynegy and Edison Mission Energy. Background PGCs face significant capital needs and potentially significant exposures to environmental or other liabilities while operating in an industry that periodically experiences disruption from technological, economic or regulatory forces. Generally, PGCs have tended to operate with intricate corporate and capital structures designed to efficiently raise capital and to appropriately manage these risks. In particular, one common financing mechanism is the use of “ring-fenced” or “yieldco” entities, which are operating subsidiaries formed by the PGC to acquire and/ or hold specific capital assets such as power generation facilities. Because such capital assets tend to have long-term predictable cash flows, a yieldco structure allows long-term debt at favorable rates to be raised by the yieldco to finance the acquisition or development of such assets, which are then leased to the parent company or to third parties. These facilities and a yieldco’s rights under the related leases can be used to secure the yieldco’s debt obligations. While it is common for the parent and/or intermediate holding or operating companies to also raise capital by issuing debt, such debt will be structurally subordinated to the yieldco debt as to the yieldco assets. In addition, yieldcos often have favorable tax attributes as a result of operating cash flow and significant depreciation characteristics of the power plants and other assets held. In most cases, yieldcos send a significant portion of their cash flow to their direct or indirect parents or affiliates through dividends, management fees or shared services agreements. The yieldco cash flow is then further upstreamed through the corporate structure with similar arrangements. While the governing debt documents will contain various restrictions on such distributions, such restrictions rarely prove Deryck A. Palmer Insolvency and Restructuring +1.212.858.1100 [email protected] Richard L. Epling Insolvency and Restructuring +1.212.858.1649 [email protected] David S. Forsh Insolvency and Restructuring +1.212.858.1884 [email protected] Matthew J. Oliver Insolvency and Restructuring +1.212.858.1395 [email protected] Pillsbury Winthrop Shaw Pittman LLP Insolvency and Restructuring Considerations for Power Generation Co. Restructuring This article was originally published on Law360 on May 19, 2016. by Deryck Palmer, Richard Epling, David Forsh and Matt Oliver
Transcript of This article was originally published on Law360 on May 19 ...€¦ · management fees or shared...
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Many power generation companies (PGCs) are experiencing difficulties under current market conditions. In addition to being exposed to the industrywide difficulties resulting from depressed energy prices and unexpectedly warm weather, many PGCs have been reliant on easy access to the capital markets to develop or acquire generation capacity, or to meet other capital needs, and now face upcoming debt maturities and skepticism regarding their ability to refinance. As restructuring discussions commence across the capital structure, creditors seeking to improve their recoveries should bear in mind lessons learned from recent PGC restructurings such as Dynegy and Edison Mission Energy.
BackgroundPGCs face significant capital needs and potentially significant exposures to environmental or other liabilities while operating in an industry that periodically experiences disruption from technological, economic or regulatory forces. Generally, PGCs have tended to operate with intricate corporate and capital structures designed to efficiently raise capital and to appropriately manage these risks. In particular, one common financing mechanism is the use of
“ring-fenced” or “yieldco” entities, which are operating subsidiaries formed by the PGC to acquire and/
or hold specific capital assets such as power generation facilities.
Because such capital assets tend to have long-term predictable cash flows, a yieldco structure allows long-term debt at favorable rates to be raised by the yieldco to finance the acquisition or development of such assets, which are then leased to the parent company or to third parties. These facilities and a yieldco’s rights under the related leases can be used to secure the yieldco’s debt obligations. While it is common for the parent and/or intermediate holding or operating companies to also raise capital by issuing debt, such debt will be structurally subordinated to the yieldco debt as to the yieldco assets. In addition, yieldcos often have favorable tax attributes as a result of operating cash flow and significant depreciation characteristics of the power plants and other assets held.
In most cases, yieldcos send a significant portion of their cash flow to their direct or indirect parents or affiliates through dividends, management fees or shared services agreements. The yieldco cash flow is then further upstreamed through the corporate structure with similar arrangements. While the governing debt documents will contain various restrictions on such distributions, such restrictions rarely prove
Deryck A. PalmerInsolvency and Restructuring+1.212.858.1100 [email protected]
Richard L. EplingInsolvency and Restructuring+1.212.858.1649 [email protected]
David S. Forsh Insolvency and Restructuring+1.212.858.1884 [email protected]
Matthew J. OliverInsolvency and Restructuring+1.212.858.1395 [email protected]
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Insolvency and Restructuring
Considerations for Power Generation Co. RestructuringThis article was originally published on Law360 on May 19, 2016.by Deryck Palmer, Richard Epling, David Forsh and Matt Oliver
insurmountable for a determined parent or shareholder and may not protect against future decreases in value. Accordingly, debtholders at the yieldco or especially at the interme-diate levels may find insufficient value remaining at their respective obligors for full recoveries in a distressed situation, for example where power prices have unexpectedly dropped and the timing and extent of any rebound is uncertain.
In such circumstances, creditors of operating subsidiaries or intermediate holdcos in a PGC restructuring may seek to recover value from upstream parents or shareholders by reviewing the asset transfers underlying the formation and subsequent operation of the yieldco. For example, creditors in the Dynegy and Edison Mission Energy bankruptcies were able to significantly improve their recoveries in this manner.
The Dynegy TransfersThe Dynegy prepetition restructuring illustrates how PGCs may seek to use ring-fenced entities to transfer value between constituencies. In the three months before bankruptcy, Dynegy Holdings LLC (DLLC), the indirect owner of all Dynegy operations, engaged in a restructuring that transferred billions of dollars of stock and ownership interests in its operating subsidiaries among the Dynegy entities through a series of transactions that complied with the terms of Dynegy’s indebtedness. Among other things, this restruc-turing concentrated the company’s coal assets in certain subsidiaries (CoalCo) and the gas assets in separate entities. The CoalCo equity interests were then transferred to DLLC’s parent Dynegy Inc. (DInc), a
publicly traded company whose only asset until then was its ownership of the DLLC equity, in exchange for an illiquid and unsecured undertaking by DInc to make certain payments in satisfaction of debt owed by DLLC. This undertaking, which the DInc board valued at $1.25 billion, was then amended to reduce the DInc payment obligation in proportion to the amount of DLLC bonds that DInc either acquired or retired.
Four days after DLLC and certain affiliates commenced their bankruptcy cases, In re Dynegy Holdings LLC et al., Case No. 11-38111 (CGM) (Bankr. S.D.N.Y. 2011), certain bondholders moved for and obtained the appointment of an examiner to investigate the prepetition transfers. The bondholders argued that the prepetition restructuring transferred hundreds of millions of dollars in assets away from DLLC’s creditors to and for the benefit of the share-holders of nondebtor DInc. More specifically, the bondholders alleged that DLLC transferred the CoalCo assets in an effort to avoid defaults on its secured debt and reduce DInc’s unsecured debt while simultaneously increasing shareholder value.
After a comprehensive investi-gation, the examiner issued a report identifying the value of the undertaking at approximately $860 million—far less than the $1.25 billion value ascribed by the DInc board—and concluding that the transfer of CoalCo to DInc was an actual fraudulent transfer and, if DLLC was insolvent at the time of the transaction, was also a constructive fraudulent transfer as well as a breach of fiduciary duties by the DLLC board. The report
supported creditors’ allegations that the prepetition restructuring was impermissible, despite complying with the terms of Dynegy’s indebtedness, and led to significant improvements in recoveries of the DLLC creditors.
DInc, DLLC and DLLC’s unsecured creditors ultimately reached a settlement that averted the appointment of a Chapter 11 trustee or the prosecution of fraudulent conveyance actions. Under the agreement, DInc and DLLC merged and unsecured creditors (including holders of about $3.4 billion in senior notes) received 99 percent of the equity of the merged entity. In addition, the settlement provided for the cancellation of the undertaking, the payment of the bondholders’ legal fees by DInc and the settlement of prepetition lawsuits challenging the transfer of the CoalCo assets.
The Edison Mission TransfersWhile a prepetition restructuring raised creditors’ eyebrows in Dynegy, a long-standing pattern of behavior came under significant creditor scrutiny in the Edison Mission Energy bankruptcy cases, In re Edison Mission Energy et al., Case No. 12-49219 (JPC) (Bankr. N.D. Ill. 2012). With the support of certain senior noteholders and other parties in interest, the committee of unsecured creditors pursued claims on behalf of the debtors’ estate against certain nondebtor affiliates of the debtors, including Edison International (EIX), the debtors’ ultimate parent. The creditors alleged that EIX had controlled and exploited the debtors by, among other things, forcing debtor Edison Mission Energy (EME) to pay a series of dividends to EIX,
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overcharging the debtors for shared services and wrongfully procuring a large payment under certain tax-sharing agreements.
The creditors committee used its investigative abilities under Bankruptcy Rule 2004 to extensively review the prepetition actions of EIX and other nondebtor affiliates. Ultimately, the majority of the senior noteholders entered into a settlement agreement with EME and EIX that was considered to be highly favorable to the noteholders. Among other things, the settlement provided that in return for a release of EIX from fraudulent conveyance actions and other similar claims, EIX and the unsecured creditors would evenly split approximately $1.2 billion of tax attributes and EIX would assume $350 million of EME’s debts.
ConclusionDepressed energy prices, unsea-sonably warm weather and other volatile market conditions suggest that additional energy companies will seek to restructure in the near future. Whether in or out of court, such restructurings have been characterized by negotiations and
differing incentives across complex capital structures involving multiple debt issuances with varying structural subordination and collateral packages. Creditors of PGCs, and particularly creditors that hold notes or bonds issued at the operating level or by the ultimate parent of a company, should be wary of the parent’s relationship with the yieldco that holds the company’s operating assets. In addition, creditors may also seek to leverage the recent Education Management Corp. and Caesars decisions regarding protections for minority noteholders under the Trust Indenture Act to further improve returns on qualified indentures if facing less than full recoveries after potentially problematic intercom-pany transactions.
Analyzing a sophisticated PGC structure in the context of an in-court or out-of-court restructuring requires an in-depth understanding of tax law, corporate governance issues, bankruptcy considerations and more. If a PGC is expected to restructure its debts, creditors should retain counsel promptly and prepare for a thorough investigation into the debtor’s affairs with its affiliates.
Deryck Palmer is a partner in Pillsbury’s New York office and leads the firm’s Insolvency and Restructuring practice.
Richard Epling is a senior partner, David Forsh is a counsel and Matt Oliver is an associate. They also are based in Pillsbury’s New York office and are members of the Insolvency & Restructuring practice.
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Considerations for Power Generation Co. Restructuring
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