Bankruptcy Court approves Rhythm And Hues DIP Financing ($17 Million) | February 15, 2013

February 16, 2013

Chapter 11, DIP Financing, Rhythm And Hues

Bankruptcy Court approves Rhythm And Hues DIP Financing ($17 Million) | February 15, 2013

The Honorable Neil Bason approved Rhythm And Hues’ $17-million DIP Financing Loan request on an interim basis on February 15, 2015. The DIP Loans are to be made by Twentieth Century Fox and Universal City Studios LLC.

Rhythm And Hues, Inc. is the financially troubled award-winning visual effects company that worked on the Oscar-nominated “Life of Pi.”

In connection with Rhythm And Hues reorganization efforts, it sought approval from the Bankruptcy Court to approve financing to the company during the bankruptcy (known as a DIP Loan because it is a loan to the company as Debtor in Possesion (DIP)). The Financing Motion seeks approval of the proposed debtor in possession financing being offered by Universal City Studios LLC and Twentieth Century Fox.

[fancy_link link=”http://chapter11dallas.com/?p=1521″]Detailed Discussion of the Bankruptcy Filing[/fancy_link]

Discussion of the Request for DIP Financing

John F. Hedge, the company’s Chief Restructuring Officer, stated, in connection with the request for DIP financing:

[pullquote4 align=”center” cite=”John F. Hedge, CRO | Rhythm And Hues, Inc.”]“[my] firm has reached out to or participated in direct discussions with all of the existing client film studios, including those identified as the Lenders, as well as others, in an attempt to solicit a necessary amount of working capital that would allow the Company to continue its operations in an uninterrupted manner. Additionally, together with the efforts of the Company’s investment bankers, the company solicited non-encumbered working capital or equity investments into the Company. Discussions were held in conjunction with a specific identified potential suitor to infuse immediate working capital that would have allowed the Company to fund the most recent payroll obligations in the U.S. and for its Canadian subsidiary.[/pullquote4]

A standard practice before seeking bankruptcy protection is to seek alternate sources of financing. However, as we will see, there is a limit on the amount that can be loaned absent the protections that Chapter 11 can provide potential new money lenders/investors. Mr. Hedge continues,

[pullquote4 align=”center” cite=”John F. Hedge, CRO | Rhythm And Hues, Inc.”]Ultimately, R&H was able to obtain unsecured financing from the DIP Lenders on January 18, 2013 in the amount of $750,000, which was used principally for payroll. On January 25, 2013, the DIP Lenders advanced an additional $5,250,000, also on an unsecured basis, which allowed the Debtor to meet its payroll and other immediate operating expenses. However, this unsecured financing was only made available by the DIP Lenders in contemplation of a possible and immediate sale of the business to a third party buyer, together with a guaranty of such financing executed by the proposed third party buyer. However, after those unsecured loans were made, the third party buyer failed to close and the sale fell through. Despite my efforts to obtain financing on an unsecured basis, R&H has been unable to obtain unsecured financing from any other sources.[/pullquote4]

So, they were able to borrow the $750K to cover payroll, but there’s a limit as to how much Universal and Fox (or any potential capital source) will be willing to lend absent protection. Mr. Hedge continues,

[pullquote4 align=”center” cite=”John F. Hedge, CRO | Rhythm And Hues, Inc.”]It is my understanding that the DIP Lenders are motivated to lend to R&H because R&H is in the midst of important projects for films being produced by Universal and Fox. However, the DIP Lenders have indicated that they will only loan further to R&H upon the terms set forth in the DIP Loan Agreement.[/pullquote4]

So, often, the source of additional working capital is not a traditional money source (bricks and mortar lending, private equity, etc.), but actually someone with a pecuniary interest in the health of the debtor. Here, actually one of the company’s customers who is motivated to ensure the health of its vendor because it is the sole source of a given material (that is, the digital work being performed for Universal/Fox).

[pullquote4 align=”center” cite=”John F. Hedge, CRO | Rhythm And Hues, Inc.”]Based upon my familiarity with the Company’s financial condition and cash flow, it is clear that the Company is unable to continue in business absent the debtor in possession financing being provided by the DIP Lenders. Without the DIP Loan, the Company will be forced to liquidate immediately. The Company’s projected cash collections, excluding the DIP Loan proceeds, through April 19, 2013 consist of only approximately $5,617,000 based upon current projects. These projected cash receipts are insufficient to pay the Company’s projected operating expenses. Even with the reduced staff, the Company’s estimated cost of operations with only the Fox and Universal projects is projected to be $22,056,000 through April 19, 2013. … Accordingly, I believe that the Company needs debtor in possession financing to complete the current level of film development for the DIP Lenders and to continue as a going concern even in the short term, in order to maintain the opportunity of exiting bankruptcy either through an internal restructuring plan or through a sale of the business.[/pullquote4]

Hence Fox/Universal’s motivation to lend. However, Fox/Universal in theory could have made the loan outside of bankruptcy. However, they would have lend money in behind existing creditors. If the existing creditor amount is too much, the DIP lender needs to lend ahead of the existing debt. So Mr. Hedge continues to describe the loan terms,

[pullquote4 align=”center” cite=”John F. Hedge, CRO | Rhythm And Hues, Inc.”]The proposed DIP Loan will be in the maximum amount of $17,086,000 (the “DIP Loan Amount”). It is anticipated that the DIP Loan will be advanced in four (4) installments as follows: (1) $6,000,000 to be advanced upon entry of an order approving the DIP Loan on an interim basis; (2) $5,000,000 to be advanced on February 19, 2013; (3) $4,000,000 to be advanced on March 18, 2013, but only after entry of an order approving the DIP Loan on a final basis; and (4) $1,586,000 to be advanced on April 8, 2013. In addition, there is a loan allowance amount for the Lenders’ counsel up to $500,000.[/pullquote4]

And then here’s why the bankruptcy was filed. Mr. Hedge continues:

[pullquote4 align=”center” cite=”John F. Hedge, CRO | Rhythm And Hues, Inc.”]The DIP Loan will be secured by a first priority security interest on substantially all of the Company’s assets, excluding the property of a Dormant Non Lender Project (the “Collateral”), subject to the Carve Out (as defined in the DIP Loan Agreement). The Collateral does not include avoidance actions owned by the Company’s bankruptcy estate. In addition, the DIP Lenders will receive a superpriority administrative expense claim for any unpaid obligations under the DIP Loan, again, subject to the Carve Out. The DIP Loan will bear interest at a fixed rate of 6% per annum, which I believe to be a reasonable interest rate in this circumstance. The default interest rate will be 9% per annum. [/pullquote4]

So it all comes together, the first priority security interest and the superpriority expense claim put Fox/Universal in line ahead of all preexisting creditors. This power is created by the Bankruptcy Code and is a key benefit/tool/opportunity provided by Congress to save existing businesses/jobs. Now, at least in theory, the Bankruptcy Court can only approve this if there is enough equity cushion in the asset value to make sure that the existing creditors will not ultimately be harmed by this priming loan.