Yesterday, Houghton Mifflin Harcourt Publishing Company and its affiliates (HMH), the leading provider of educational material to the elementary and secondary school market in the United States, filed bankruptcy in the Southern District of New York.  The consolidated cases are docketed under Case No. 12-12171.  The Company, which has published authors such as Mark Twain and J.R.R. Tolkien, sought bankruptcy protection to eliminate more than $3 billion in debt.

In its first day papers, the Boston-based Company listed $2.68 billion in assets and $3.53 billion in debt.  HMH provides products and services to over 65,000 schools in 11,000 school districts, and 7,000 other customers.  HMH’s products are sold to state and local public entities, large private and parochial school systems, and individual schools and educational institutions in all 50 U.S. states.  The Company employs approximately 3,300 employees nationwide.

In 2011, the Company purchased goods and services worth over $870 million from more than 12,000 vendors worldwide.  Annually, the Company owes royalty payments to more than 4,000 authors, publishers and literary agents.  As of December 31,2011, HMH generated $1.295 billion in annual revenue.

Financial Performance

According to its General Counsel, William F. Bayers, HMH’s financial performance has suffered over the past several years as a result of the global financial crisis, recession-driven decreases in state spending and significant purchase deferrals.  As a result, on March 9, 2010, the Company completed an out-of-court restructuring of certain indebtedness and an upper-tier reorganization.  As part of the reorganization, Riverdeep Interactive Learning, the previous parent of the Company, entered into a series of transactions, including a $650 million rights offering, that ultimately resulted in HMH and affiliates no longer being subsidiaries of Riverdeep.  In the out-of-court restructuring, the then-existing first lien lenders received approximately 90% of the equity in HMH (pre-dilution from the rights offering) in exchange for converting $2 billion of debt and the then-existing mezzanine lenders received approximately 10% of the equity, plus warrants to purchase up to an additional 12.5% of the incremental value above a specified equity value, in exchange for converting another $2 billion of debt.  HMH used the proceeds from the rights offering, in which certain then-existing first lien lenders and mezzanine lenders participated, to pay transaction fees, accrued cash interest and fund cash on the balance sheet.

Despite the out-of-court restructuring, due to the continuing contraction of funds for state education spending and higher deferrals of awarded business,  HMH has continued to experience financial difficulties.  While the Company recently amended its credit facilities to maintain liquidity, it has subsequently determined that a complete delevering of its capital structure is necessary.

Prepackaged Plan in Court

On May 10, 2012, HMH and an informal group of significant creditors under the Company’s secured credit facility and prepetition senior secured notes entered an agreement on how to comprehensively restructure the Debtor’s outstanding debt and equity.  The agreement is embodied in a prepackaged plan of reorganization and accompanying restructuring plan support agreement.

A prepackaged plan is a plan that has been shared with creditors and approved by creditors, through formal solicitation procedures, prior to the bankruptcy commencing.  After the bankruptcy commences, the debtor is able to then file the prepackaged plan and solicitation materials with the Court and seek a quick approval of both.  For example, CIT was able to exit bankruptcy in 41 days after it filed a prepackaged plan to restructure $10 billion in liabilities in November 2009.

In HMH’s case, the prepackaged plan attempts to restructure the Company’s obligations in a manner that maximizes recoveries to holders of claims against, and equity interests in, the Company.  The General Counsel explains that the prepackaged plan provides the best alternative in bankruptcy among several options, including liquidation under chapter 7.

Under the prepackaged plan, senior secured lenders will receive their pro rata share of (a) 100% of new common stock in the reorganized debtor, subject to dilution by new stock issued to management or issued upon exercise of new warrants; and (b) $30.3 million in cash.  The plan also provides that (a) holders of unsecured claims shall receive cash equal to the amount of their claims, plus post-petition interest and (b) if shareholders vote in favor of the plan, they will receive pro rata shares of new warrants to purchase new equity in the reorganized debtor.  The plan further provides that all other classes of claims and equity interests, except certain equity holders in class 9, will be satisfied in full and will be unimpaired.

As part of the process of soliciting votes for the plan prepetition, HMH distributed the prepackaged plan, disclosure statement (which describes the reorganization) and ballots to two impaired classes of creditors and interest holders, who then had a deadline to cast their ballots in favor or against the plan.  Although the solicitation period remained open as of the bankruptcy filing date, 90.3% of creditors and 76% of equity holders voted in favor of the plan.

As a result, HMH intends to move forward with the confirmation of the plan at the bankruptcy court’s first available date.  In tandem with the confirmation hearing, HMH will also seek retroactive approval of its disclosure statement as well as the solicitation procedures used to gain support for the plan.  In addition to approving the plan, the Bankruptcy Court will be required to bless HMH’s procedures of only soliciting votes from 2 impaired classes of stakeholders (i.e., classes 3 and 8).