While lenders have always dealt with “bad or problem loans” as part of the business, the size, complexity and speed in which First Brands collapsed into bankruptcy has rattled lending markets.   

The public bankruptcy filings listed the company’s liabilities between $10 billion and $50 billion dollars against assets between $1 billion to $10 billion dollars.  Reportedly, the catalyst for the bankruptcy filing was the company’s inability to finance more than $6billion of on-balance-sheet debt, plus over $3 billion in off-balance‐sheet obligations, which apparently was not disclosed to many of its lenders.  Factoring, whether in the form of a traditional factoring structure or a more nuanced True Sale structure, provides sources of cash reflected as the proceeds from the sale of receivables, as opposed to a loan secured by receivables.  Factoring structures, without proper financial disclosures, can obscure the contingent nature of this “debt” should the receivables purchased by the factor or encompassed in the True Sale not be collected.

Supply Chain Finance can also be used to create “off balance sheet debt” when payment terms are extended above normal trade terms offered by the underlying supplier.  Supply chain finance obligations are typically unsecured, due on a set date and reflected as “payables” on the borrower’s balance sheet. Here again, without proper disclosures, liquidity issues can be masked.

With First Brands’ bankruptcy filing, traditional lenders and off-balance‐sheet lenders are scrambling to assert their priority claims and avoid dilution by debtor-in-possession (DIP) financing or competing claims. The value of intercreditor agreements, as well as the timing and description of collateral embedded in their respective UCC filings, will now come into play.

First Brands bankruptcy will no doubt showcase how DIP financing and debtor restructuring can erode the position of factoring or ABL lenders if they lack perfect liens or have undocumented claims. Bankruptcy judges and advisors often favor DIP lenders and  to keep operations viable—potentially at the cost of existing secured lenders.

Factoring firms and asset-based lenders may push for court-approved “priming” protections or pro forma carve-outs that protect their collateral from being swept by new money lenders or estate claims. For the factors, the bankruptcy court will probably need to opine if they purchased receivables or granted loans secured by the receivable.

As one would expect, the First Brands saga will trigger many lenders to expand due diligence with a focus on enhanced financial and legal disclosure requirements.  What can  be expected:

Lenders tend to focus their due diligence on the direct borrower(s) which encompass their respective collateral. As noted in the First Brands case, the number of debtors (x100) and lenders (x12) involved in the filing highlights the need for more robust due diligence throughout the borrower’s corporate operating structure.

An increased level of disclosure among lenders in a complex bilateral structure: The complexity of the First Brands case provides a noteworthy reason for complex credits to be structured as syndicated multi-product loan facilities.

Increased monitoring of loan post-funding:  Timely and mandatory reporting by the borrower is the first step to detecting problems early.

 “Trust but verify”: Expect the scope and frequency of field examinations to increase with the requirements for QOEs. Lenders often take comfort from a borrower’s engagement of a large national accounting firm and the issuance of unqualified opinions, as apparently was the case with First Brands. As an old, seasoned lender once said, “the only balance sheet number I am sure about is my loan balance”. Cash is still king, and often, nothing works better than following the cash during field examinations.

In a complex multi-borrower structure, we can expect added requirements that the borrower’s accountant provide consolidating financials, which can shed light on inter-company transactions.

The bankruptcy trustee and new board are investigating whether First Brands double-pledged receivables, commingled collateral among lenders, or factored the same invoices more than once. As such, there is much more to learn here. The classroom will be the bankruptcy court, as more information is expected to be disclosed. However, the open question for the market remains whether First Brands represents an idiosyncratic event or a sign of a systemic issue in underwriting and portfolio management.

This article was produced with drafting support from ChatGPT.