Equity Rights Offering in Chapter 11: Key Benefits Explained

An equity rights offering in Chapter 11 is a financing transaction that allows a debtor to offer existing creditors or equity holders the right to purchase new equity or debt securities in the reorganized company at a discounted price. This mechanism is often used by companies undergoing bankruptcy reorganization to raise capital, address liquidity needs, and facilitate plan negotiations.

Key Features:

1. Discounted Purchase: The new securities are typically offered at a discount to the assumed value of the reorganized company to incentivize participation. 14
2. Backstop Agreements: These offerings are often "backstopped" by certain claimants who commit to purchasing both their shares and any unsubscribed shares, usually in exchange for compensation. 12
3. Exemption from Registration: Rights offerings in Chapter 11 can be exempt from certain federal and state securities laws under Section 1145 of the Bankruptcy Code, providing flexibility and incentives for investors. 25
4. Limited Participation: Participation is usually confined to specific classes of creditors or equity holders, such as senior unsecured and second-lien noteholders. 46
5. Valuation Evidence: Courts may require evidence that the terms of the rights offering are fair and reflect market value to ensure compliance with the Bankruptcy Code's requirements. 37

Benefits:

1. Capital Raising: Rights offerings help debtors raise new capital without adding additional leverage, which is crucial for restructuring and emergence from bankruptcy. 46
2. Consensus Building: They can build consensus among contentious junior groups in the capital structure by offering them the opportunity to participate in the upside post-reorganization. 46
3. Flexibility: Debtors can use rights offerings to calibrate the amount of post-emergence debt and ensure a right-sized capital structure. 6

Legal Considerations:

1. Absolute Priority Rule: The distribution of reorganized equity must comply with the absolute priority rule, ensuring that no junior class receives value before a senior class is paid in full. 1
2. Fair and Equitable Requirement: The terms of the rights offering must be fair and equitable, and not unfairly discriminatory against similarly situated creditors. 13