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Valeritas Holdings, Inc. – Creditors’ Committee Objects to Onerous DIP Financing Terms, Suggests that Developments as to Debtors’ Insulin Products May be Financing and Asset Sale Game-Changer


March 5, 2020 – The Debtors' Official Committee of Unsecured Creditors (the “Committee”) objected to the Debtors’ proposed debtor-in-possession (“DIP”) financing motion arguing, inter alia, that milestones in respect of the Debtors' intended sale to Zealand Pharma A/S (NASDAQ: ZEAL; "Zealand') are too aggressive, interest (18%) is too high, fees are excessive and that avoidance actions have been prematurely pledged to the DIP lender [Docket No. 120]. 

On February 10th, the Debtors requested Court authority to (i) access $12.0mn of DIP financing ($5.5mn of interim access now approved by a February 14th Court order) to be provided by HB Fund LLC (the “DIP Lender”) [Docket No. 16].

The Objection

Underlying the Committee's objections is their contention that commercial realities have shifted for the Debtors and that new (and cheaper) borrowing opportunities are likely available. Specifically, the Committee notes that issues as to the quality of inventoried product may now have been resolved; questions as to those insulin-based products having been a significant factor in the Debtors' decision to file for Chapter 11 in the first place and then reflected in the expensive terms of the DIP financing arrangements. The Committee notes that it has been approached by third parties expressing an interest in providing alternative DIP financing arrangements; although it is not clear whether those parties have also approached the Debtors. It is also not clear whether the Zealand sale itself might be called into question as under-priced; as discussed below in "Events Leading to the Chapter 11 Filing," the Debtors had advanced negotiations with several other potential purchasers before they became spooked by the Debtors' sourcing and quality issues. The Committee's objection as to "an expedited sale process" clearly suggesting that a challenge to Zealand's $23.0mn stalking horse bid is possible…with more time.

The Committee’s objection states, “The DIP Facility contemplates an expedited sale process constrained through unnecessary milestones. In addition to concerns regarding the milestones, other objectionable provisions contained in the Interim Order, and proposed to be incorporated into the Final Order, include (i) excessive fees to be paid to the DIP Lender as commitment fees; (ii) unwarranted waiver of various protections for unsecured creditors provided by the Bankruptcy Code, including under Sections 105, 506(c), and 552(b); (iii) the inability of the Debtors to use Cash Collateral during the Remedies Notice Period; (iv) the premature pledge of Avoidance Actions and other causes of action to the DIP Lender prior to any analysis or valuation of the Avoidance Actions and other causes of action themselves; (v) vague and potentially excessive adequate protection payments…; (vi) inadequate amounts budgeted for the Committee Professional Fee Escrow and Carve-Outfor the Committee's investigation; (vii) insufficient Committee consultation rights and provision of documents and pleadings to the Committee; and (viii) the absence of automatic standing for the Committee to bring a Challenge.

At the outset, the Committee notes that it has received interest from potential alternative providers of post-petition financing. The currently-proposed DIP Facility was entered into at a time when there may have been a doubt as to the viability of certain inventory of the Debtors, namely, whether or not certain lots of the Debtors’ insulin delivery systems would pass FDA-approved standards. This doubt led to the inclusion of a condition precedent in the proposed Asset Purchase Agreement that may have chilled interest by potential financiers. The Committee understands that initial concerns over the Debtors’ inventory have been assuaged since the time the DIP Motion was filed; therefore, other financiers may be more willing to support the Debtors’ restructuring on terms considerably better than the DIP Lender…The DIP Facility provides for an 18% interest rate, and 20% default rate, which exceed the effective rates charged by lenders for loans in other Chapter 11 cases.

Under the DIP Facility, the DIP Lender is entitled to a Commitment Fee of $200,000, which represents 1.6% of the maximum borrowing amount. However, this fee is required even if the DIP Lender never advances the entire amount of the DIP Facility to the Debtors. Furthermore, the DIP Facility provides that the DIP Lender may collect another $1,467,500 in fees in the event the DIP Facility is fully drawn. Altogether, the DIP Lender may generate nearly 14% of the total available funds as fees, or $1,667,500, not even considering the potential for an additional $600,000 should the maturity date be pushed back six (6) weeks. When combined with the exorbitant interest rates, the DIP Lender Fees incurred in connection with a loan that is less than three months are usurious and wholly inappropriate for funding in this amount, and only benefit the DIP Lender at the expense of all other creditors. Indeed, all monies due to the DIP Lender will be payment in kind, and rolled back into the principal, which interest will accrue on, and then be paid out upon the closing of a sale. A reduction in these staggering DIP Lender Fees will allow the recovery waterfall to flow down to more creditors of the estate, and is appropriate in the present situation.”

The objection continues, “If the Avoidance Actions and other claims and causes of action are preserved for any constituency, they should be preserved for the benefit of unsecured creditors, who in turn should decide whether such claims are pursued, after the proper vetting of the claims. The Debtors have not yet filed their statements of financial affairs or schedules, and the Committee has no information on the nature and scope of potential claims that might be brought under chapter 5. This case already has a melancholy prospect of meaningful recovery for unsecured creditors, and avoidance actions under chapter 5 of the Bankruptcy Code and other potential causes of action that are assets of the Debtors’ estates may provide one of the few avenues to generating value for unsecured creditors. Thus, the Court should not allow these potentially valuable, and currently unencumbered, causes of action to be pledged to the DIP Lender.”

On February 10, the Debtors and their pre-petition lenders (the “CRG Settlement”) that would allow for the priming of DIP financing, the Debtors have requested Court authority to (i) access $12.0mn of DIP financing ($5.5mn on an interim basis) to be provided by HB Fund LLC (the “DIP Lender”) [Docket No. 16]. On February 14, the court had issued an interim order authorizing the Debtors to access $5.5mn in debtor-in-possession (“DIP”) financing [Docket No. 66].

Further Background

In a press release announcing the filing, the Debtors advised that it had entered into an "agreement to sell substantially all of the business to Zealand Pharma A/S (NASDAQ: ZEAL) ('Zealand'), a Denmark-based biotechnology company. To accomplish the sale in the most efficient manner, Valeritas and its subsidiaries filed voluntary petitions for relief under Chapter 11…Concurrently, the Company filed a motion requesting approval of a stalking horse asset purchase agreement with Zealand and to initiate a competitive bidding process under Section 363 of the Bankruptcy Code designed to achieve the highest or otherwise best offer for the business….The agreement with Zealand, which was reached following a robust and extensive marketing process, provides total cash consideration of $23 million and includes the assumption of certain liabilities related to the ongoing business.”

Events Leading to the Chapter 11 Filing

In a declaration in support of the Chapter 11 filing (the “Declaration”), John E. Timberlake, the Debtors' President, Chief Executive Office, detailed the events leading to Valeritas' Chapter 11 filing. The Declaration's "tale of woe" details the slide into bankruptcy of medical technology company entirely reliant on a single (not yet profit making) insulin product that experienced a major supply interruption when Chinese supplier was unable to maintain product quality in respect of the insulin it was manufacturing for the Debtors. No small matter when that insulin is being used as part of a product (a patch) which is supposed to provide wearers with a stable supply of insulin. This supply issue, identified in December 2019, required the Debtors to discard much of its inventory; it also came at a time when the Chinese New Year…extended by the coronavirus outbreak, meant that inventory-replenishing shipments of a safe insulin product could not be made. Although the coranavirus plays an accelerating role in respect of a company already on a knife-edge; the Declaration does provide some macro-level insight on the potential for coronavirus disruption in respect of other companies doing business with Chinese manufacturers, the Declaration noting: "many Chinese businesses, including the Company’s CMO, employ rural workers and, as a result, may experience production capability issues due to the uncertainty surrounding when these rural employees will return to work." In sum, the Declaration provides something of a warning as to the one-two punch that a dependency on rural Chinese workers meant for these Debtors: Firstly a major quality issue in respect of a quality-dependent product and then the unforeseen impact of a health emergency in respect of a geographically and culturally workforce over which it has little direct control and almost no ability to mitigate its financial distress. The result of depleted inventory, and an indefinite delay in replenishing that stock, ultimately shutting down the Debtors' access to capital.

The Declaration states: "The Company relies on sales of V-Go® to generate all of its revenue. Although the Company has experienced commercial success with V-Go®, as of the Petition Date, the Company was still in the commercial growth stage of its operations and, therefore, had not generated profits or free cash flows. For approximately eleven months prior to the Petition Date, the Company was engaged in an out of court sale and marketing process (the 'Out of Court Process') led by a boutique investment bank. In December 2019, the Company was facing diminishing liquidity, a lack of access to additional capital, and potential near-term defaults under the Prepetition Term Loan when it experienced a temporary supply disruption due to a manufacturing yield issue.

This event led the Company’s two potential buyers in its Out of Court Process to withdraw their bids. 

The Company halted all deliveries of V-Go®, retested all of its existing inventory as well as product it controlled in the United States, opened a corrective-action preventative action (or CAPA) investigation, identified the root cause of the yield issue, modified production specifications to meet yield requirements going forward, and conducted a health hazard evaluation. 

While management quickly identified the root cause of the issue and implemented corrective actions, the Company’s existing liquidity constraints were further exacerbated by the supply disruption and the Company’s one-time write-off of approximately $3.5 million of inventory. Further, under these conditions, the Company’s existing lenders would not extend further credit, nor could the Company secure financing from another source. 

Moreover, the yield issue unfortunately coincided with certain external factors impacting production. The CMO and the Company’s other manufacturers and suppliers in China are closed for the Lunar New Year (Chinese New Year) celebrations, which took place this year between January 27, 2020 through February 3, 2020, which was extended through February 9, 2020 by the Chinese government due to the coronavirus epidemic in China.

The occurrence of the Chinese New Year holiday has not posed a problem in the past, because the Company historically maintained at least 3 months’ worth of finished product inventory to cover periods when its Chinese suppliers were closed. This year, however, inventory levels were substantially reduced as a result of the production disruption in December 2019. Thus, the work stoppage during the Chinese New Year holiday posed a problem for the Company for the first time. This problem was exacerbated due to the rapid onset of the coronavirus epidemic and the Chinese government’s measures to combat the spread of the disease, which included extending the holiday for an additional week."

About the Debtors

Valeritas is a commercial-stage medical technology company focused on improving health and simplifying life for people with diabetes by developing and commercializing innovative technologies. Valeritas' flagship product, V-Go® Wearable Insulin Delivery device, is a simple, affordable, all-in-one basal-bolus insulin delivery option for adult patients requiring insulin that is worn like a patch and can eliminate the need for taking multiple daily shots. V-Go® administers a continuous preset basal rate of insulin over 24 hours, and it provides discreet on-demand bolus dosing at mealtimes. It is the only basal-bolus insulin delivery device on the market today specifically designed keeping in mind the needs of type 2 diabetes patients. Headquartered in Bridgewater, New Jersey, Valeritas operates its R&D functions in Marlborough, Massachusetts.

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The post Valeritas Holdings, Inc. – Creditors’ Committee Objects to Onerous DIP Financing Terms, Suggests that Developments as to Debtors’ Insulin Products May be Financing and Asset Sale Game-Changer appeared first on Daily Bankrupt Company Updates | Bankrupt Company News.

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