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November 5, 2020 – The Debtors' Official Committee of Unsecured Creditors (the “Committee”) objected to the Debtors’ debtor-in-financing ("DIP") financing motion [Docket No. 336], urging the Court to delay a scheduled November 12th hearing on that motion until after it decides whether or not to allow the Debtors' use of a $28.0mn "rabbi trust" (established to benefit/protect the Debtors' nonqualified defined contribution deferred compensation plans). As it stands, the issue of whether the Debtors may have access to the rabbi trust is to be considered at the same hearing as the proposed $6.9mn of DIP financing.
More important, however, than whether the matters need to be considered at separate hearings is the issue of whether the Debtors and DIP lenders should be able to use $28.0mn of "material unencumbered funds to run a sale process to enhance the lenders’ ultimate recoveries." The Committee argues that the Debtors have no clear path to emergence, having now missed sale milestones and failed to get a commitment for exit financing from the DIP lenders. Is it appropriate, the Committee asks, to allow the Debtors to use the $28.0mn, which might otherwise be available to unsecured creditors if the cases were more expeditiously concluded, to carry them through this uncertain period, when the benefits of surviving that period enure to the DIP lenders? The Committee argues: "The cost of this risk-free option that largely favors the Pre-Petition Lenders is to diminish unencumbered funds and assets otherwise available for unsecured creditors and to likely materially reduce or fully eliminate what would otherwise be a recovery for unsecured creditors on account of their claims."
The Committee points out that the $28.0mn rabbi trust is way more important to the Debtors' Chapter 11 cases and any post-emergence future that the Debtors might have than the modest $6.9mn; and hence determining the availability of the former is critical to determining the appropriateness of the latter. Even if the the rabbi trust funds become accessible, the Committee argues, there remain significant issues for the Debtors and the Court to consider, namely: (i) would any further DIP funds be necessary at all and (ii) if so, why give the DIP lenders control over (and the benefit of) the rabbi trust when their own financing contributions are minimal.
Critical to levels of funding necessary, the Committee further argues, is a determination as to the prospects for a sale process. That process has been delayed by COVID-19 and if a sales process is no longer viable, the rabbi trust funds would seem more than adequate to see the Debtors through their Chapter 11 cases.
NB: A "rabbi trust" is a trust created to support the non-qualified benefit obligations of employers to their employees and is so-named after an Internal Revenue Service (IRS) private letter ruling allowed a rabbi and his congregation to use this form of trust. Although the assets of a rabbi trust are typically irrevocablly outside the control of employers, they are not outside the control of creditors in the bankruptcy context.
The Committee's objection begins: "As a threshold matter, the Court should not consider the DIP Motion until it resolves the pending Rabbi Trust Motions on which these cases hinge."
So how prospective is access to the $28.0mn rabbi trust in the first place? Probably not very. The Committee's argument that access needs to be resolved first, may ring true, but that does not necessarily mean that the two matters cannot be considered at the same hearing; with access to the rabbi trust funds considered first.
In a motion asking the court to confirm their rights to access the rabbi trust assets [Docket No. 140], the Debtors state, "The Trust was intended to provide additional assurance to the Participants of the Plans that their unfunded deferred compensation benefits under the Plans would be met in the future, but like all rabbi trusts, the Trust Agreement provides that the Trust Assets remain the property of the Plan Sponsor, and the rights of the Participants to benefits provided by the Plans and the Trust Assets in the Trust do not exceed those of a general creditor of the Plan Sponsors in the event of the Plan Sponsor’s insolvency….
Thus, due to RTI’s insolvency, as well as its subsequent chapter 11 filing, the Trust assets can no longer be used to pay benefits to the Participants, but must be held by the Trustee for the benefit of the creditors of RTI in the manner directed by a court of competent jurisdiction."
Continuing with the Committee's objection.
The DIP financing objection states, “By the Debtors’ own admission, even if the DIP Motion is approved and they obtain the DIP Financing, they will run out of cash well before any potential projected emergence if they are unable to access the approximately $28 million of funds in the Rabbi Trusts. The Debtors have also revised their projections to indicate that they do not need to borrow additional money at this time and they may not need the additional funding at all if the Rabbi Trust Motions are approved and they obtain the funds as projected. Yet with those motions set to be heard on the same date as the DIP Motion, and without knowing their disposition, the Debtors insist that the Court approve extraordinary relief that would erode the rights of unsecured creditors. It is inappropriate – and judicially inefficient – to so fundamentally alter the rights of unsecured creditors when a ruling on the Rabbi Trust Motions could force the Debtors to convert these cases to chapter 7 or, conversely, obviate the need for additional DIP financing. Moreover, delaying the hearing on the DIP Motion until after the Court rules on the Rabbi Trust Motions – if the Court is in a position to rule within a reasonable period of time on the Rabbi Trust Motions – would afford the parties the opportunity to assess appropriate next steps. The Committee understands that, even without any further borrowing, the Company will have sufficient liquidity to operate through early December.
If, despite this critical threshold timing issue, the Court nonetheless finds it appropriate to consider final approval of the DIP Motion before ruling on the Rabbi Trust Motions, the DIP Motion should be denied absent significant and material modifications. The Debtors present the DIP Financing as their best option to obtain sufficient liquidity for the duration of these cases. The Committee, however, struggles to view the DIP Financing as anything other than an unwarranted shift of unencumbered assets to the Pre-Petition Lenders without offering any certainty to the ‘going concern’ exit for these cases or path to a sale with a recovery for unsecured creditors.
If the Debtors prevail on the Rabbi Trust Motions, the Debtors propose to use material unencumbered funds to run a sale process to enhance the lenders’ ultimate recoveries. They would run this process without any assurances of a going concern business emerging, either through a sale or reorganization, or a clear path to any benefit to the unsecured creditors or the estate from the depletion of unencumbered assets. The cost of this risk-free option that largely favors the Pre-Petition Lenders is to diminish unencumbered funds and assets otherwise available for unsecured creditors and to likely materially reduce or fully eliminate what would otherwise be a recovery for unsecured creditors on account of their claims. Unlike many other Chapter 11 cases funded by the secured lenders, these cases would be funded in partnership with the unsecured creditors by using a material amount of unencumbered cash and assets. At a minimum, the terms on which those funds and assets are used to run a sale process should be determined by the Debtors with the input and consent of the Committee, not dictated by milestones and other conditions determined by the Pre-Petition Lenders as if only their funds were at stake.
The Committee appreciates the challenges facing the Debtors and the restaurant industry as a result of the COVID-19 pandemic and understands that the Debtors need additional liquidity to run a value-maximizing sale process. However, the DIP Financing, by itself, does little to address this need. The proposed financing (without reliance upon the ‘funding partnership’ created from the use of material unencumbered assets) provides the Debtors with inadequate funding and establishes a sale process based on lender-driven case milestones. Moreover, despite the DIP facility having been billed as ‘a stepping stone into an exit facility’ as part of a reorganization, the Debtors have yet to receive any commitment from the DIP Lenders to provide exit financing under a chapter 11 plan.
While the DIP Financing’s long-term benefit to the estates and unsecured creditors is uncertain at best, the proposed financing provides a windfall to the lenders at the expense of unsecured creditors. Approval of the DIP Financing enhances the position of a substantial portion of the Pre-Petition Lenders’ prepetition claims with respect to significant unencumbered assets – particularly the roll-up of $2 million of prepetition term loans and over $9.6 million of prepetition letters of credit that would need to be repaid or cash collateralized as part of an exit financing. Specifically, value that would otherwise flow to unsecured creditors would instead be pledged to prepetition secured creditors through a roll-up and a prepetition debt prepayment provision that contravenes fundamental principles of bankruptcy law by marshaling any shortfall in the secured lenders’ prepetition claim to unencumbered assets. It permits the lenders to apply material unencumbered assets to secure their prepetition claims — again, in a context in which these Debtors could be forced to quickly liquidate with insufficient funds to pay their landlords, vendors, suppliers and other post-petition creditors who supported these Debtors and, in the case of landlords, are not being paid currently on account of their post-petition claims.
Beyond that, the prepetition debt that is being ‘rolled’ into the DIP Financing must be paid off with cash (as opposed to take-back debt) for the Debtors to reorganize successfully under chapter 11, thereby placing further limitations on the Debtors’ ability to achieve a viable restructuring. This limitation is not appropriate here given the small amount of new funding being provided by the Pre-Petition Lenders (only $6.9 million), the lack of a committed reorganization path supported by the lenders and the Debtors’ use of unencumbered assets to run a process. A sale process on a going concern basis is the best path for the lenders to maximize recovery on their prepetition claims versus potential recoveries in a liquidation.
In addition, the Proposed Final DIP Order contains various waivers of fundamental unsecured creditor protections that would all but guarantee that this case will have been run for the benefit of secured creditors and at the expense of unsecured creditors who have been supporting and continue to support this business and, through the concurrent use of unencumbered cash, are co-funding these cases.
Notwithstanding the Committee’s myriad concerns, assuming the Rabbi Trust Motions are granted, the Committee would support the Debtors obtaining financing on terms that reflect the shared funding approach between the DIP Financing and unencumbered cash, including reasonable case milestones (to be negotiated with the Committee), allowing for a proper sale process with a sharing of the ultimate recovery in recognition of the joint funding to pursue this path, and preservation of fundamental unsecured creditor protections in the event of an unsuccessful sale process. The Committee has been working with the Debtors and their lenders to address its concerns, and expects those discussions to continue in advance of the hearing. In the meantime, the Committee submits that the DIP Financing should not be approved absent the significant modifications requested here reflecting the circumstances and equities of these cases.”
A hearing on approval of the DIP financing is scheduled for November 12, 2020.
About the Debtors
According to the Debtors: “Founded in 1972 in Knoxville, Tennessee, Ruby Tuesday, Inc., is dedicated to delighting guests with exceptional casual dining experiences that offer uncompromising quality paired with passionate service every time they visit. From signature handcrafted burgers to the farm-grown goodness of the Endless Garden Bar, Ruby Tuesday is proud of its long-standing history as an American classic and international favorite for nearly 50 years. The Company currently owns, operates and franchises casual dining restaurants in the United States, Guam, and five foreign countries under the Ruby Tuesday® brand.”
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