The Downfall of Rite Aid (RAD)

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Welcome to the 110th Pari Passu newsletter.

Last week, we understood the history and sources of financial distress across the broader retail pharmacy industry, comparing the business models of CVS, Walgreens, and Rite-Aid.

The previous article culminate in today’s grand finale – the downfall of Rite Aid, the hurdles that limited pursuing out-of-court solutions, and the strategic levers pulled from filing for Chapter 11 and navigating complex creditor dynamics. 

A good understanding of Rite Aid’s business model will help contextualize why debtors and creditors often have conflicting perspectives on the company’s true value after emerging from bankruptcy, often the reason behind long, messy valuation fights.

Let’s get to it.

Table of Contents

• Brief Overview of Rite Aid

• Early Signs of Financial Distress 

• Possible Alternatives to Chapter 11

• Rite Aid Files for Chapter 11

  • Rite Aid 2.0 Plan

  • Conflicts with McKesson

  • Negotiations With Unsecured Creditors

  • 363 Asset Sale of Elixir

• Final Recoveries

• Key Takeaways and Future Outlook 

Brief Overview of Rite Aid

As we saw last Friday, Rite Aid Corp. is a Philadelphia-based retail drugstore and pharmacy chain operator [1]. With more than 2,100 locations across 17 states and generating $24bn of revenue in FY 2023, the company operates in two main business segments:

• Retail Pharmacy (70%): sells prescription drugs and provides various other pharmacy services, such as administering immunizations against COVID-19, shingles, the flu, etc.

• Pharmacy Services (30%): provides an integrated suite of pharmacy benefit management (PBM) offerings through its mid-market PBM Elixir. These offerings include technology solutions, mail delivery services, specialty pharmacy, network and rebate administration, claims adjudication, and pharmacy discount programs. Check out last week’s post to learn more about the industry structure and the role of PBMs. 

Founded in 1962, Rite Aid rapidly grew through acquisitions to become the third-largest retail pharmacy in the U.S. For example, in 2007, they acquired Brooks and Eckerd drugstore chains for $3.4bn. In 2014, they acquired Health Dialog, which provides personalized healthcare coaching and disease management services. Then, in 2015, they entered the PBM business by acquiring Elixir for $2bn. In 2020, they acquired Bartell Drugs, a 67-location Seattle-area chain. However, this strategy put their leverage high at above 7x since pre-pandemic, which peaked at 13x in September 2023. 

To scale back from this aggressive expansion strategy, Rite Aid began to find ways to monetize its assets for cash. For example, between 2021 to 2023, they sold off parts of the Center of Medicare and Medicaid (CMS) receivables to Bank of America for ~$2bn under their Elixir business. This was a quick way to monetize future reimbursement payments they would have received from government health insurance programs such as Medicare and Medicaid. Rather than tying up these receivables, they could use this upfront cash to pay down debt or reinvest into the business. In 2015, Walgreens announced a $17.2bn acquisition of Rite Aid, but it was scaled down due to the Federal Trade Commission’s antitrust regulations. Instead, Walgreens purchased 1,932 stores, approximately half of the then-store count, including some of Rite Aid’s strongest performing locations, and three distribution centers for $4.38bn.  

Like most retail pharmacies, Rite Aid saw a temporary boost in revenue from the increase in demand for COVID test-kits and services. However, Rite Aid was the most vulnerable against long-term industry headwinds, such as competition from online pharmacies and retailers selling generic products and reduced demand for pharmacies post-pandemic. Their smaller scale made it difficult to negotiate attractive pricing for prescription drugs with manufacturers, and they had less operating leverage compared to their bigger competitors. 

Early Signs of Financial Distress 

As a quick recap, Rite Aid had multiple ongoing issues building up to filing for Chapter 11 in October 2023. In September 2023, their quarterly revenue declined by 6% YoY at $5.6bn and recorded a net loss of $1bn. They had $408.8mm of total liquidity including $390mm of available RCF but only $18.8mm cash on hand. From a capital structure perspective, they were highly leveraged at 13x with $4bn of total debt that generated $261mm of annual interest expense. From a timing perspective, $320mm of 7.5% senior secured notes were maturing in 2025 and more than $2bn of prepetition secured debt were maturing in 2026. In fact, maturity walls could come up at once in 2025 as the secured debt would ‘spring forward’ if the senior secured notes could not be refinanced, which seemed very likely from the notes trading at distressed levels [1]. Usually, if it seems a junior piece of debt with an early maturity date cannot be refinanced, the springing maturity will make sure the senior piece of debt, like a revolver, gets refinanced or repaid first. Given Rite Aid’s continued level of distress building up to its bankruptcy, it seemed like filing for Chapter 11 was inevitable by the end of September 2023. Before filing for Chapter 11, Rite Aid explored a few out-of-court solutions. This said, the situation was tragic with a combination of high-leverage, low liquidity, a deteriorating business, and massive tort liabilities. 

Rite Aid’s corporate decisions clearly signaled a high level of distress to the market. One sign was drawing down their revolving credit facility (RCF), which is a type of loan organized by banks for working capital and business operations that occupies the most senior position of the capital structure. Before filing in 2023, Rite Aid had already drawn down $1.6bn out of the $2.7bn maximum capacity. While a borrower can flexibly draw and repay the RCF as long as it is under the credit limit, it’s considered more as a backup source of funding, so drawing it down implies extremely low liquidity and an inability to raise new capital. 

Historically, Rite Aid has been able to push out maturities to buy more time for a turnaround. As long as investors were open to refinancing existing debt with new debt, borrowers would rely on this amend and extend strategy without addressing the core issues of their deteriorating businesses. In July 2020, they exchanged their outstanding $1.125bn of 6.125% Senior Notes due in 2023 for $849.9mm of 8.00% Senior Notes due in 2026 and $206.4mm in cash. Despite recording a quarterly net loss of $73mm, Rite Aid successfully encouraged 87% of the existing noteholders to participate with some sweeteners they wouldn’t want to miss out, such as a higher coupon rate and pari-passu status with the existing ‘25 notes. Furthermore, in August 2021, Rite Aid amended the pricing on their senior secured credit facilities by reducing the coupon rate from LIBOR+300 to LIBOR+275bps while extending the maturity date from 2023 to 2026 [1]. Through these out-of-court transactions, Rite Aid was able to extend the maturity date by 3 years, buying more time in expectation of a potential turnaround. 

However, in 2023, the market was already pricing in the high likelihood of Rite Aid’s filing. Despite being secured, the ‘25 and ‘26 notes were trading around sixty cents as they were junior to the $2bn of RCF, which had a priority claim over Rite Aid’s deteriorating collateral base. Not to mention, the unsecured notes were trading at twenty cents. To take advantage of the notes trading at a significant discount, in November 2022, Rite Aid launched a $165mm tender offer of ‘25 notes at 75 cents on the dollar to retire outstanding debt and reduce its interest payments [2]. Realistically, however, deleveraging by $280mm barely helped to address the 10x total debt-to-EBITDA leverage without a significant growth in EBITDA. For example, to satisfy the requirements of rating agencies targeting a 5x leverage ratio, they would have to reduce the debt by $900mm to $1bn. Rite Aid’s operating margins have been depressed since pre-COVID and recovered slightly during COVID due to an industry-wide surge in prescription volumes and favorable reimbursement rates. However, before their filing in 2023, Rite Aid began to lose clients, recorded negative growth in the front-end stores segment that sells generic products, and an increased medical loss ratio led to heightened costs for their insurance business, Elixir. 

Possible Alternatives to Chapter 11 and their Limitations 

Realistically, Rite Aid would have also explored creative liability management transactions, but there were limitations within the boundaries of the credit docs. Credit docs include covenants, which are restrictions imposed by lenders over borrowers to preserve collateral value and ensure debt repayment. Considering the covenants in the indentures of the secured 2025 and 2026 senior notes, here are some out-of-court solutions that would have been considered to raise new capital. 

1. Asset Transfer 

One method to raise new capital would have been an asset dropdown, a type of liability management transaction that transfers assets to an unrestricted subsidiary free from the covenants of the restricted subsidiaries. Rite Aid would have to create an unrestricted subsidiary, which is free from restrictions of the covenants, transfer the Elixir assets to raise new debt at this subsidiary, return the new capital to the parent company, and sold off the Elixir business. To do so, the borrower must get around the restricted payments basket, which regulates the amount of cash that can flow out of the borrower. However, the lender also acknowledges that the borrower may want to have flexibility to grow its business. The ‘permitted investment’ basket usually allows certain exceptions of investments that can increase the cash generation abilities of the issuer, one of which is investments into an unrestricted subsidiary. 

Calculating 1.75% of the total amount of assets ($7.13bn in September 2023) recorded in Rite Aid’s last quarterly statements, their permitted investment to the unrestricted subsidiary was a maximum of $124.7mm. Given that Elixir would have been valued at $1bn minimum, considering the value of comparable companies, this transfer would not have been allowed. 

2. Additional Debt Incurrence

The general lien basket allows for a borrower to pledge a certain amount of assets as collateral for additional loans without breaching the agreement’s restrictions. As the top section of figure 2 shows, Rite Aid could raise the greater of (i) $50mm and (ii) 0.75% of Total assets. The value of (ii) amounted to ~$53mm additional secured debt in 1L or 2L term loans (using their latest total asset value of $7.13bn in September 2023). 

As the second image shows, Rite Aid could have also increased its term loan or RCF commitments by $300mm. There were no restrictions to incurring unsecured debt, but they had to maintain an interest coverage ratio of at least 2x; however, they would have to compensate investors for issuing any unsecured debt given a significantly lower likelihood of waterfall recovery. 

3. Additional Sales-Leaseback

Rite Aid’s had $600mm basket capacity under their secured credit agreement and $350mm of basket capacity under their secured notes indentures to issue debt secured by real property.  The $600m in basket capacity under the secured credit agreement would be reduced by the proceeds from sales-leaseback if classified as an operating lease. However, for the secured notes indentures, the $350mm in basket capacity would be reduced by the proceeds generated by sales-leaseback if classified as a finance lease. The main difference between the two types of leases is that an operating lease is treated as a lease obligation, creating rent expenses as the lessee does not assume full ownership. However, finance leases are treated as additional debt on the balance sheet. Because Rite Aid classified their sales-leaseback as an operating lease, they would have used the $600mm capacity in the secured credit agreement. This is important to know because sales-leaseback has been an important source of additional liquidity for retail pharmacies to leverage their wide real estate footprint, but the capacity for additional sales-leaseback is capped as it generates additional operating expenses that pressure cash flows, as elaborated in our sales-leaseback post. For this reason, although Rite Aid earned $301mm of proceeds from sales-leaseback until 2023, they started to scale down the transactions since 2022, despite having additional basket capacity. 

4. Chapter 7 Bankruptcy

While extreme, a final alternative option Rite Aid had was to liquidate the business through Chapter 7, where creditors receive the proceeds from the liquidation of the debtor's assets, an alternative to Chapter 11. To see if Chapter 11 is the appropriate option over Chapter 7, the Bankruptcy Code requires two tests the debtor must pass: 1) the best interest test and 2) liquidation test. The debtor ran a scenario of a ‘fire sales’ of Rite Aid’s assets, including inventory, prescription files, real estate, and equipment. As illustrated in their disclosure statement, which needs approval from the bankruptcy court to receive confirmation of the POR, Rite Aid’s financial projections reflected a very rosy picture that Rite Aid’s business could operate healthy as a going concern. Projections included a net income of $81mm by FY26, assuming cost-cutting and 9% growth in front-end same-store sales and 6% growth in prescription same-store sales. Gross margins have been forecasted at ~23% and EBITDA margins at ~3%, which may seem unrealistic given they are above historical pre-pandemic levels. Even under assumptions of a recovery in vendor and customer relationships, we’ve established in Part 1 that Rite Aid lacks the scale to control a greater prescription volume, reducing their negotiating leverage with PBMs and insurers to control costs. With 400 stores planned to be closed prior to emergence, long-term profitability would be sacrificed for a short-term boost in margins. Furthermore, the projections discount the highly cyclical nature of the retail pharmacy business after the sale of the Elixir, which would increase exposure to consumer spending and competition from online pharmacies.  

Chapter 7 has been especially a common consideration among distressed retailers due to having a wide range of physical assets like inventory and merchandise. However, junior creditors might not be able to receive any recovery when the assets are sold off at a very discounted price, especially for commoditized products owned by Rite Aid. The figure below shows why the creditors were so actively opposed to a possible liquidation as only the DIP lenders would have been able to be guaranteed a full recovery. Although this may have seemed too optimistic, from both the secured and unsecured noteholders perspective, Chapter 11 was clearly the attractive option. 

In summary, Rite Aid was a clear candidate for filing Chapter 11 – a highly-levered, deteriorating business facing secular industry headwinds without the liquidity to fund future growth and deal with massive litigation claims and no ability to engage in creative out-of-court transactions. 

Rite Aid Files for Chapter 11

Rite Aid (the debtor)–represented by Kirkland & Ellis, Alvarez & Marsal, and Guggenheim–filed a Restructuring Support Agreement (RSA) entered into with an ad hoc secured 2L noteholder group represented by Paul Weiss, FTI Consulting, and Evercore [6]. With a total debt of $4bn, Rite Aid’s pre-petition capital structure is as follows:

• 1L Secured Debt (spring maturity) 

  • $2.2bn SOFR + 3.000% ABL Revolving Credit Facility, due 2026

  • $400mm SOFR + 3.000% FILO Term Loan, due 2026

• 2L Secured Debt

  • $320mm 7.500% Senior Secured Notes, due 2025

  • $850mm 8.000% Senior Secured Notes, due 2026

• Unsecured Debt

  • $186mm 7.700% Notes, due 2027

  • $2mm 6.875% Notes, due 2028

Shortly after filing, Rite Aid received $3.45bn in DIP financing from existing 1L creditors Bank of America comprising of:

• A senior secured superpriority $3.25 billion ABL facility, consisting of a $2.85 billion ABL revolver and a $400mm FILO facility

• A $200 million new money Term Loan facility

The $500mm proceeds of the DIP ABL revolver would be used for working capital needs, while the FILO facility would be used to refinance the debtors’ outstanding $400 million prepetition FILO facility obligations. The RSA and POR lay out a reorganization-based restructuring, with the ABL / FILO claims receiving a full recovery, while the claims of the 2L noteholders being equitized into 100% of Rite Aid’s post-reorganization common stock in exchange for cancellation of debt [11]. The DIP also featured an adequate protection package for the 2L noteholders, including a paydown from the proceeds from the sale of the non-debtor asset, Elixir. 

As the two impaired classes, the Senior Secured Notes and General Unsecured Claims were key creditors with the right to vote on the RSA. Holding ~946.2mm of the $1.17bn 2L secured debt,  the Ad Hoc Secured Noteholders represented 80.9% of the total amount of secured notes outstanding. They supported the RSA, which outlined a debt for equity exchange or an alternative 363 asset sale, including any of the Debtor’s assets excluding Elixir,  that would either be a third-party bid or credit bid by this ad hoc group. Credit bidding can be thought of as a trade between the debtor’s assets and the creditor’s claims. Instead of paying out in cash, the secured creditor purchases the assets with their claims, preventing the debtor from selling the assets at an unreasonably low price. 

While negotiations with the secured creditors were very expected and straightforward, the treatment of the unsecured claims reveals Rite Aid’s strategic decisions behind filing and the debtor-friendly toolkits offered by the bankruptcy court, such as the ability to reject executory leases and halt litigation. The unsecured creditors were also offered equity in the reorganized company and leftover proceeds from the asset sales only if DIP lenders would be paid out in cash and the adequate protection claims for the senior noteholders would be resolved. Adequate protection claims compensate secured creditors for the loss of collateral value from a sale, use, or lease, as they usually cannot seize the debtor’s assets under the bankruptcy code’s automatic stay. After the debtor pays out $400mm in professional and administrative fees, the unsecured creditors would be left with very little recovery. 

Rite Aid 2.0 Plan

Chapter 11 allowed Rite Aid to capitalize on Section 365 of the Bankruptcy Code: the ability to reject executory leases [1]. During the LTM period that ended September 2nd 2023, Rite Aid reduced its store footprint by about 210 stores, leaving them with about 2,100 stores as of the petition date. Rite Aid has proposed closing 400-500 stores, with their current store portfolio comprising approximately 550 EBITDA-negative stores. Prior to filing, Rite Aid was burdened with $80mm in annual “dead rent”–rent expense paid on properties that aren’t being used–because of its inability to exit long-term leases. However, filing for Chapter 11 allowed them to reject these lease contracts and preserve liquidity from stop paying out rent expenses.

Conflicts with McKesson

On top of facing various industry headwinds,  Rite Aid had heavy exposure to McKesson Corporation, which supplied 98% of their pharmaceutical products [7].  In FY23, Rite Aid had been paying McKesson over $9bn to carry out delivery across the majority of the stores. However, upon hearing the debtor would not offer them a $650-700mm prepetition claim, McKesson decided to cancel its supply agreement before Rite Aid’s filing. They argued that Rite Aid should pay them immediately after filing as they should be treated as a ‘critical vendor’ very critical to the debtor’s reorganization. If there is no enforceable contract, the vendor would be violating the automatic stay, which prevents creditors from collecting interest payments and seizing the debtor’s assets in-court. Since operating the business without McKesson was nearly impossible, Rite Aid ceded to offer McKesson a super-priority administrative claim as their vendor and post-petition payment. Overall, this was an unexpected drain in liquidity that resulted in more hurdles during the asset sales,  hurting the debtor and all lenders across the capital structure. 

Negotiations With Unsecured Creditors

Rite Aid had to undergo multiple rounds of settlements to balance the interests of many creditor groups pushing for different outcomes [8]. Here is a brief overview of the key creditor committee positions:  

• The Official Committee of Unsecured Creditors (UCC): wanted to maximize recovery through a possible sale or restructuring plan that maximized Rite Aid’s assets over a liquidation plan that would most likely entirely wipe out its position. Key players included the insurance company Humana, which wanted its members to continue using Rite Aid’s pharmacy services, two landlords, the Pension Benefit Guaranty Corporation, and the United Food and Commercial Workers International Union, representing 14k unionized employees. 

• The Official Committee of Tort Claimants (TCC): wanted settlements for claims tied to opioid overprescribing and distribution. The TCC argued that the 25,000 tort claim liabilities would exceed the value of the debtor’s assets. Represented claimants came from public sectors, including public schools and talc (a type of powder found in many consumer products) injury claims, and private sectors, including hospitals, independent emergency room physicians, opioid personal injury claims. 

• Government Agencies: While other states and unsecured creditors generally supported Rite Aid’s RSA, the state of Maryland opposed the plan. They argued that there was a substantial public interest in raising more funds for opioid abatement (the National Opioid Abatement Trust II distributes proceeds from litigation against drug wholesalers and pharmacies to local governments) that deleveraging unfairly treated the unsecured creditors. However, Judge Kaplan framed Maryland’s claims as ‘hypothetical’ and detrimental to the recovery of other unsecured creditors, especially the opioid victims. 

Let’s take a look at the main points of controversy. Firstly, the UCC and TCC pointed out that the DIP financing was especially structured to benefit only the secured creditors. The unsecured creditors identified a lot of unencumbered assets to monetize that the debtor does not have to pledge as collateral,  including its real estate footprint and the Elixir Insurance company. As part of Rite Aid’s Elixir PBM business, this was a non-guarantor subsidiary that was still an unencumbered asset (meaning it was not serving as the collateral of any debt) [1]. 

Because the debtor has not explored these asset sales yet, the roll-up DIP financing simply shows preferential treatment to the prepetition-secured creditors by reserving them a super-priority status. Elevated to the highest part of the capital structure, this makes them first in line to collect payments and enjoy proceeds from asset sales. Not to mention, DIP financing is usually extremely expensive for debtors. The coupon rate for the DIP was a hefty SOFR+7.5% compared to SOFR+3.00% on the existing 1L secured debt, generating an annual interest expense of ~$430mm, which could have been paid out to existing creditors. Another point of concern raised by the unsecured committee was the expedited timeline of the restructuring plan, such as the immediate progress into asset sales that would benefit secured creditors from waterfall recovery even if the assets were not being valued ‘fairly’ in the unsecured creditor’s perspective. From the debtor’s perspective, it was better to speed through the bankruptcy process with support from the secured creditors to minimize the drain on resources and focus on stabilizing the business as a newly emerged business. And while the unsecured creditors were equally invested in this outcome, they needed more time to investigate the liens and wait for the asset sales to fully play out. 

363 Asset Sale of Elixir

On January 9, Rite Aid also reached an agreement to sell its PBM Elixir in an asset 363 sale, with MedImpact Healthcare Systems as the stalking horse bidder [7]. The sale was finalized for $575mm [5]. A stalking horse bidder is the initial bidder selected by the debtor to set the minimum bidding price, ensuring that the assets are not sold at an unreasonably low price. Any competing offers would drive up the price from the minimum price for the benefit of both the debtor and creditors, especially the unsecured creditors that prefer a higher valuation. 

Since early 2023, the debtor has worked with Guggenheim to begin a marketing process to draw buyers interested in Elixir. In the midst of industry consolidation, the PBM Transparency Act in 2023 actively prevented larger PBMs from price manipulation. However, an independent PBM called MedImpact was able to avoid the regulatory scrutiny of scaling from acquiring companies like Elixir [9]. Operating as the sixth largest player, their revenue was only $10bn compared to the $100bn of the top 3 PBMs holding 80% of the market share. However, there were hurdles to closing this asset sale as both parties were unwilling to assume the $200mm of the Elixir liabilities. These liabilities included $68mm of rebates, $71mm claims payable, $35mm to McKesson, $6mm of other expenses, $6mm Pharmacy Performance Guarantee Reserves, and $40mm Ordinary Course Checks. 

Since current liabilities are subtracted from current assets to calculate working capital, the biggest dispute was determining this exact figure for Elixir. MedImpact denied that they had to assume over $225mm in current liabilities because they believed this figure was inflated as Rite Aid was in distress, so the liabilities should not be expected as part of Elixir’s daily operations. On the other hand, the debtor argued back that they were in perfectly normal business operations. They also argued that MedImpact was aware of the definition of ‘Closing Working Capital’ outlined in the original contract of the Sale Order, which clearly stated the target working capital was negative $206mm. 

MedImpact continued making adjustments to this working capital figure, arguing that the closing working capital should be positive at $84mm to reflect the significantly lower amount of liabilities they had to assume upon the transfer of ownership. Nonetheless, Judge Kaplan determined that the debtor’s calculations made the most sense and MedImpact would have to pay an additional $35mm of McKesson liabilities, which were the outstanding payments to their supplier McKesson. He also pointed out that MedImpact knew about Rite Aid’s negative operating cash flows for two years, so MedImpact should have assumed Rite Aid could not deal with Elixir’s debt when they first entered the asset sales. In total, MedImpact had to payout $11mm for the contract-related liabilities, assume Elixir’s $225mm of closing working capital, and pay a total of $575mm to acquire Elixir from Rite Aid. 

Even during these negotiations, Rite Aid continuously monetized any remaining assets. They sold off the term loan that initially funded MedImpact’s purchase of Elixir to a third party, generating an extra $43.1mm in cash and offloading $200mm of debt associated with Elixir. Any remaining proceeds went to the DIP lenders, which shows why the unsecured lenders were strongly opposed to the roll-up of DIP financing.

Final Recoveries

The final recoveries for the 2L secured noteholders were the following [10]: 

• 90% of Rite Aid’s common stock after emerging from bankruptcy 

• $350mm takeback notes at SOFR+15% (PIK) from the new Rite Aid 

• interests in the litigation trust that will have claims against insurance policies

There were lengthy negotiations between the lenders, secured noteholder, and debtors on the terms of exit facilities.  The debtors proposed an extra $75mm of DIP as an exit facility at SOFR+7% that would be a 1.5L superpriority junior secured notes facility, which would be senior to the existing secured notes. This facility also included rolling up $225mm of prepetition secured notes. The debtor argued that upsizing the DIP would be crucial for a successful emergence, including repayment and interest expenses on existing DIP facilities, general corporate purposes, and fees incurred during Chapter 11. However, the secured noteholders would have ongoing relationships with debtors as the owners of 90% of the post-reorg equity. This incentivized the debtors to offer a 15% backstop premium payable on the DIP notes to certain members of the Ad Hoc Secured noteholder group, balancing competing interests across a new capital structure under Rite Aid 2.0. 

One interesting concept here is ‘takeback’ notes structured as a paid-in-kind (PIK) debt at SOFR+15%. Take-back notes are issued by the debtor to holders of either pre-petition or post-petition debt, and the re-organized debtor usually guarantees the debt. It replaces existing debt obligations of the creditors to help debtors achieve better terms on the existing debt. Likewise, the terms on Rite Aid’s senior secured take-back debt were designed to stabilize their financial operations upon emergence. 

Designed to preserve cash, PIK debt allows coupon payments paid in non-cash that accrue to the total principal and will be repaid upon maturity. The coupon rate is usually above 10% to compensate lenders for missing out on regular coupon payments in cash and the risk of insolvency before the maturity date [11]. While PIK notes are usually subordinated and unsecured, in Rite Aid’s case, they were issued specifically as senior secured. However, despite being secured, noteholders had to concede a lot for the debtors: they had a junior claim on the assets and a seven-year maturity. Under the negative covenants, the debtors could incur structurally senior 1L debt up to 20% of the ABL Facilities, which would leave them with less recovery if the collateral base deteriorates, often referred to as a ‘deficiency claim.’ To compensate for the significant risk taken by these secured noteholders, it made sense to bump up the coupon rate to 15%. Regardless of whether Rite Aid would be generating enough cash in seven years to pay back the accrued coupon payments on top of the principal, the PIK take-back notes allow them to reinvest preserved cash into business operations. 

Overall, the GUC received a relatively negligible recovery: 

• 10% of Rite Aid’s common stock after emerging from bankruptcy 

• $20mm initial cash consideration 

• $20mm post-emergence cash consideration

• Proceeds from insurance rights and legal claims, including against Directors and Officers 

Even within the GUC, the remaining value of the company had to be split up between the tort and non-tort unsecured creditors. Such intercreditor conflicts are not surprising because in bankruptcy, each creditor group cannot perfectly align with other credit groups even if they are treated as a single entity as unsecured creditors. For example, 100% of the equity in the GUC Trust was allocated to the non-tort creditors, but the tort claimants received the majority of the cash consideration and litigation proceeds. As shown in the figure below, there were also rounds of negotiations among the TCC over how much each tort creditor would split up the remaining value. So while there are advantages to amassing more tort claimants to build negotiating leverage over the debtors, their individual recoveries may be diluted. 

Key Takeaways and Future Outlook 

Fast forward to today, it has been two months since Rite Aid emerged from bankruptcy on September 3, 2024 after reducing $2bn of debt from $4bn of pre-petition to $2bn of post-petition and obtaining $2.5bn in exit financing to support business operations. The company has turned private with a new CEO. Rite Aid’s bankruptcy shows how messy valuation fights can turn out when there are different stakeholders with conflicting incentives. Beyond the conflicts between secured and unsecured lenders on timing and valuation, there were multiple unsecured committees representing individual, public, and corporate interests. 

Judge Kaplan played a large role in making crucial judgments to settle these conflicts without clear legal precedence. However, some decisions such as evaluating Maryland’s claims required third parties for a more objective judgment. Judge Kaplan even commented that Maryland should revisit their claims later in the bankruptcy after his final decision was made. Perhaps one of the biggest grey areas in bankruptcy is to see through the intentions behind each creditor group with fundamentally different organizational purposes. 

But most importantly, Rite Aid is one of the many cases that show how debtors can use the automatic stay to gain a temporary breathing room from government-level claims, an unsustainable capital structure, and low liquidity. As Judge Kaplan put it, Rite Aid demonstrates how the bankruptcy court can act as a “central forum” to settle multiple claims, praising how creditors negotiated with debtors to avoid liquidation.

Sources: [1], [2], [3], [4], [5], [6], [7], [8], [9], [10], [11], [12]  

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