June 16, 2020 - Today the LSTA published a Market Advisory addressing whether a credit trading on LSTA distressed documentation should trade on a “Settled Without Accrued Interest” basis or “Trades Flat” basis following the occurrence of a bankruptcy filing.  Under the “Settled Without Accrued Interest” or “SWOA” trading convention, subject to the application of delayed compensation in Section 6, all interest accrued but unpaid before the settlement date shall be for the seller’s account.  Under a “Trades Flat” trading convention, all interest, whether accruing before, on or after the Trade Date, if and when paid shall be for the buyer’s account Generally, distressed credits that are performing and timely paying interest (or timely paying cash adequate protection payments (APPs) in bankruptcy) will trade on a “Settled Without Accrued Interest” basis, and credits where interest is not being paid (nor are any cash APPs being paid in bankruptcy) will trade on a “Trades Flat” basis, but, as discussed in the advisory, there are exceptions to this. 

When a corporate borrower files for bankruptcy, generally all accrued but unpaid interest, fees, and outstanding loans owed by that borrower will automatically accelerate and become immediately due and payable.  Under those  circumstances, for unsettled distressed trades entered into on a “Settled Without Accrued Interest” basis, the interest convention shall be deemed automatically to switch to a “Trades Flat” basis.  The occurrence of such event is referred to colloquially in the secondary trading market as a “flip to flat” event.  However, there is a wrinkle in the foregoing analysis which depends on whether, after the bankruptcy filing date, an Adequate Protection Order (APO) is entered into which provides for the cash payment of APPs to pre-petition lenders under the traded pre-petition credit agreement.  Typically large corporate borrowers who file for chapter 11 bankruptcy protection will, within the first few days of the Filing Date, have certain “first day” orders entered by the bankruptcy court.  Such first day orders typically include an authorization and allowance for the borrower/debtor to be able to utilize available cash on hand to continue to function its business.  As a condition to allowing the borrower/debtor access to the cash collateral, the bankruptcy court will typically provide the pre-petition secured lenders with adequate protection from any diminution in value of its interest in its pre-petition collateral. When determining whether a credit with respect to a borrower that recently filed for bankruptcy should “flip to flat”, parties should first review the motion and related interim first day order which allows for borrowers/debtors to use cash collateral and provide adequate protection to pre-petition secured lenders.  Although the APO can provide for varying types of adequate protection, the determination whether the credit has flipped to flat will be based on whether such order provides for cash APPs and, if so, the frequency of those cash payments.  To the extent the interim APO provides for cash APPs and those payments are to be made no less frequently than interest was to be paid under the pre-petition credit agreement immediately prior to the filing date, then the credit should continue to trade on a “Settled Without Accrued Basis” and there should be no “flip to flat”.  Click here for the complete Market Advisory.