Item 1. Business
Overview
Emergent Capital, Inc. was founded in December 2006 as a Florida limited liability company, Imperial Holdings, LLC, and converted into Imperial Holdings, Inc. on February 3, 2011, in connection with the Company’s initial public offering. Effective September 1, 2015, the name was changed to Emergent Capital, Inc. (with its subsidiary companies, the "Company" or "Emergent Capital").
Emergent Capital, through its consolidated and deconsolidated subsidiary companies as of November 14, 2018, owns a portfolio of 588 life insurance policies, also referred to as life settlements, with a fair value of $506.4 million and an aggregate death benefit of approximately $2.8 billion at November 30, 2018 .The Company primarily earns income on these policies from changes in their fair value and through death benefits. 586 of these policies, with an aggregate death benefit of approximately $2.8 billion and a fair value of approximately $505.2 million at November 30, 2018, are pledged under a $370.0 million, revolving credit agreement (the "White Eagle Revolving Credit Facility") entered into by the Company’s indirect subsidiary, White Eagle Asset Portfolio, LP ("White Eagle"). At November 30, 2018, two policies owned by the Company, with an aggregate death benefit of approximately $12.0 million and a fair value of $1.2 million, were not pledged as collateral under the White Eagle Revolving Credit Facility.
Change in Financial Year End
On September 7, 2018, the Board of Directors adopted resolutions to change the Company’s fiscal year end, and have the Company cause its direct and indirect subsidiaries change their fiscal year ends, from December 31 to November 30, effective immediately. The Company is filing this Transition Report on Form 10-KT in accordance with SEC rules and regulations. Our financial results for the fiscal year ended November 30, 2018 will cover eleven months of transactions from January 1, 2018 to November 30, 2018, while the financial results for fiscal years ended December 31, 2017 and 2016 will cover the two years then ended and the results for the eleven month transition period ending on November 30, 2018 are compared to the results of our previous twelve month fiscal year-end as of December 31, 2017. Subsequent to this Transition Report, our reports on Form 10-K will cover the period beginning December 1 and ending November 30, which will be our fiscal year. We refer in this Transition Report to the period beginning on January 1, 2018 and ended on November 30, 2018 as the "Transition Period."
Voluntary Petitions for Relief Under Chapter 11 and De-consolidation of Subsidiaries
On November 14, 2018 (the "Petition Date"), Lamington Road Designated Activity Company (formerly known as Lamington Road Limited), the Company’s wholly-owned indirect Irish subsidiary ("Lamington"), and White Eagle General Partner, LLC, the Company’s wholly-owned indirect Delaware subsidiary ("WEGP"), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court". Lamington is the limited partner and owns 99.99%, and WEGP is the general partner and owns 0.01%, of White Eagle. In its capacity as general partner, WEGP manages the affairs of White Eagle. The Lamington and WEGP filings are referred to as the "November Chapter 11 Cases."
The commencement of the November Chapter 11 Cases would constitute defaults and events of default under the terms of the Company’s Amended and Restated Senior Secured Indenture and the New Convertible Note Indenture (each as defined below). However, such defaults and events of default and their consequences were waived in advance of the November Chapter 11 Cases by holders of a majority of the outstanding principal amounts of each of the 8.5% Senior Secured Notes and the New Convertible Notes, and consequently, the Company believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred under either the Amended and Restated Senior Secured Indenture or the New Convertible Note Indenture. The commencement of the November Chapter 11 Cases constitutes an event of default under White Eagle Revolving Credit Facility, resulting in the principal and accrued interest due from White Eagle thereunder becoming immediately due and payable. Lamington and WEGP have pledged their respective interests in White Eagle to secure its obligations under the White Eagle Revolving Credit Facility. Any efforts by LNV Corporation, the lender under the White Eagle Revolving Credit Facility ("LNV"), or CLMG Corp., the administrative agent under the White Eagle Revolving Credit Facility ("CLMG"), to enforce such pledges by Lamington and WEGP of their respective interests in White Eagle in connection with the White Eagle Revolving Credit Facility are automatically stayed as a result of the commencement of the November Chapter 11 Cases and LNV’s and CLMG’s rights of enforcement in respect of the White Eagle Revolving Credit Facility are subject to the applicable provisions of the Bankruptcy Code. In addition, on November 15, 2018, White Eagle, LNV and CLMG entered into an Agreement Regarding Rights and Remedies (the "Standstill Agreement"), pursuant to
which LNV and CLMG agreed to refrain from exercising their rights and remedies in connection with the White Eagle Revolving Credit Facility, subject to the terms and provisions of the Standstill Agreement, until 12:00 p.m. noon Pacific time on November 26, 2018, to facilitate negotiations.
On November 23, 2018, the effective period under the Standstill Agreement was extended to November 27, 2018; on November 27, 2018, the effective period under the Standstill Agreement was extended to November 30, 2018; on November 30, 2018, the effective period under the Standstill Agreement was extended to December 4, 2018; on December 4, 2018, the effective period under the Standstill Agreement was extended to December 7, 2018; and on December 6, 2018, the effective period under the Standstill Agreement was extended to December 11, 2018; and on December 10, 2018, the effective period under the Standstill Agreement was extended to December 13, 2018.
Subsequent Event
On December 13, 2018, White Eagle filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "White Eagle Chapter 11 Case" and, together with the November Chapter 11 Cases, the "Chapter 11 Cases"). The Chapter 11 Cases are being jointly administered under Case No. 18-12808 (KG).See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information. The Company obtained waivers from the requisite holders of each of 8.5% Senior Secured Notes and the New Convertible Notes with respect to the White Eagle Chapter 11 Case, similar to the waivers for the November Chapter 11 Cases, and believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred with respect to both the 8.5% Senior Secured Notes and the New Convertible Notes.
Lamington's and its subsidiaries (White Eagle, WEGP and Lamington Road Bermuda Limited), financial results are included in the Company’s consolidated results through November 13, 2018, the day prior to the Petition Date. However, ASC 810, Consolidation require that an entity whose financial statements were previously consolidated with those of its parent that files for protection under the U.S. Bankruptcy Code, whether solvent or insolvent, generally must be prospectively deconsolidated from the parent and presented on the cost method (Deconsolidation applies to Lamington and all subsidiaries owned, directly or indirectly, by Lamington, including WEGP, White Eagle and Lamington Road Bermuda), (the "Deconsolidated Entities" or the "Debtors"). Therefore, our 2018 results are not comparable with 2017, the post-petition results are not included in our consolidated results for the eleven months ended November 30, 2018. The cost method requires the Company to present its ownership interests in the net assets of Lamington as an investment measured at fair value as of the Petition Date and not recognize the income or loss of Lamington in the Company’s results of operations during the reorganization period. When Lamington emerges from the jurisdiction of the Bankruptcy Court, the subsequent accounting will be determined based upon the applicable circumstances and facts at such time, including the terms of any plan of reorganization. The Debtors will continue to operate their businesses as "debtors-in-possession" under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. Emergent Capital (exclusive of its subsidiaries) is a separate entity with independent capital structures and has not filed for bankruptcy relief and is continuing to operate in the ordinary course.
Beal Litigation
On January 25, 2019, the Company, White Eagle, Lamington, and WEGP, the "Plaintiffs"), filed suit (the "Suit") against LNV Corporation ("LNV"), Silver Point Capital L.P. ("Silver Point") and GWG Holdings, Inc. ("GWG" and, with LNV and Sliver Point, the "Defendants") in the United States Bankruptcy Court for the District of Delaware (the "Court"), where the Suit will be administered together with the previously filed and announced petitions for relief under Chapter 11 of the United States Bankruptcy Code of White Eagle, Lamington and WEGP (the "Chapter 11 Cases" and White Eagle, Lamington and WEGP, the "Debtors"). LNV, a subsidiary of Beal Bank ("Beal"), is the lender under White Eagle’s outstanding revolving credit facility (the "Credit Facility").
In the Suit, the Plaintiffs allege that the Defendants engaged in a scheme to coerce the Plaintiffs into selling their valuable portfolio of life insurance policies to defendants for well below its true value. Pursuant to the Credit Facility, LNV agreed to lend $370 million to White Eagle, and in connection therewith received a 45% equity stake in White Eagle. That equity stake, and LNV’s significant control over White Eagle under the Credit Facility, creates a joint venture, and gives rise to fiduciary duties to White Eagle and Emergent, on the part of LNV. The Plaintiffs further allege that LNV has been engaged in a concerted campaign to "squeeze" White Eagle and Emergent by improperly restricting their cash flow, in the hopes that White Eagle and Emergent will have no choice but to sell the valuable policy portfolio to LNV or one of its proxies, including Silver Point and/or GWG, at below its true value.
In connection with the White Eagle Chapter 11 Case, on January 15, 2019, the Court authorized the Debtors to use the proceeds of pre-petition cash collateral for a period of twenty (20) weeks (the "Cash Collateral'). The Cash Collateral may be used solely for the purposes permitted under the budget approved by the Court, including (i) to provide working capital needs of the Debtors and general corporate purposes of the Debtors, (ii) to make the payments or fund amounts otherwise permitted in the final order that authorized such uses and such budget, (iii) to fund amounts necessary to pay certain fees; and (iv) to fund amounts necessary to pay certain professional fees in accordance with such Budget.
See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information.
The below shows the structure of the entities to be deconsolidated at November 13, 2018.
Life Settlements Portfolio & Portfolio Management
The life insurance policies in Emergent Capital’s portfolio were acquired through a combination of direct policy purchases from the original policy owners (the secondary market), purchases of policies owned by other institutional investors (the tertiary market) and from policy surrenders or foreclosures in satisfaction of loans issued under the Company’s legacy premium finance business. Emergent Capital uses a probabilistic method of valuing life insurance policies, meaning the insured individual's probability of survival and probability of death are applied to the required premiums and net death benefit of the policy to extrapolate the likely cash flows over the life expectancy of the insured. These likely cash flows are then discounted using a net present value formula. Management believes this to be the preferred valuation method in the industry at the present time.
Until a policy matures, the Company must pay ongoing premiums to keep that policy in force and to prevent it from lapsing. Upon a policy lapse, the Company would suffer a complete loss on its investment in that policy. Accordingly, the
Company must proactively manage its cash in order to effectively run its business, maintain liquidity and continue to pay premiums in order to maintain the policies in its portfolio.
Regulation
The sale and solicitation of life insurance policies in the secondary market is highly regulated by the laws and regulations of individual states and other applicable jurisdictions. The purchase of a policy directly from a policy owner is referred to as a life settlement and is regulated on a state-by-state basis.
At November 30, 2018, the Company, through its subsidiary Imperial Life Settlements, LLC, maintained licenses to transact life settlements as a provider in 28 of the states that currently require a license and could conduct business in 37 states, and the District of Columbia.
The primary regulator for Imperial Life Settlements, LLC when purchasing life settlements in the secondary market is the Florida Office of Insurance Regulation. A majority of the state laws and regulations concerning life settlements relate to: (i) provider and broker licensing requirements; (ii) reporting requirements; (iii) required contract provisions and disclosures; (iv) privacy requirements; (v) fraud prevention measures; (vi) criminal and civil remedies; (vii) marketing requirements; (viii) the time period in which policies cannot be sold in life settlement transactions; and (ix) other rules governing the relationship between policy owners, insured persons, insurers, and others.
Competition
Competition is primarily through two channels: life settlement providers and institutional investors. In order to be a life settlement provider and transact with the original holder of a life insurance policy, in most instances, a license on a state-by-state basis is required. The life settlement business is highly fragmented and, therefore, competition is diverse. Often, life settlement providers are originating life settlements on behalf of institutional investors who do not maintain the necessary licenses to transact in the secondary market for life insurance. These investors may have significantly more resources than the Company and can generally also transact directly in the tertiary market.
Employees
At November 30, 2018, we employed 11 full-time employees and no part-time employees. None of our employees are subject to any collective bargaining agreements. We believe that our employee relations are good.
Company Website Access and SEC Filings
Our website may be accessed at www.emergentcapital.com. All of our filings with the Securities and Exchange Commission ("SEC") can be accessed free of charge through our website promptly after filing; however, in the event that the website is inaccessible, we will provide paper copies of our most recent Transition Report on Form 10-KT, the most recent quarterly report on Form 10-Q, current reports filed or furnished on Form 8-K, and all related amendments, excluding exhibits, free of charge upon request. These filings are also accessible on the SEC’s website at www.sec.gov. Information on our website is not incorporated by reference into this Transition Report on Form 10-KT.
General Information
Our registrar and stock transfer agent is American Stock Transfer & Trust Company, LLC. Our transfer agent is responsible for maintaining all records of shareholders, canceling or issuing stock certificates and resolving problems related to lost, destroyed or stolen certificates. For more information, please contact: American Stock Transfer & Trust Company at 6201 15th Avenue, Brooklyn, NY 11219 Phone: 800-937-5449.
Item 1A.
Item 1A. Risk Factors
Risks Related to Our Indebtedness & Organizational Structure
We may not have sufficient funds to pay our debt and other obligations.
Our cash, cash equivalents, short-term investments and operating cash flows may be inadequate to meet our obligations under our outstanding indebtedness and our other obligations. At November 30, 2018, 586 of the policies owned by our deconsolidated subsidiary, were pledged as collateral under our White Eagle Revolving Credit Facility. When those policies
mature, subject to the outcome of the bankruptcy and litigation proceedings referenced below, distributions will be made pursuant to a "waterfall" payment structure and any amounts available to us will vary based on the respective then current loan to value ratio under the facility. The White Eagle Revolving Credit Facility contemplates that proceeds will be directed to pay fees to service providers and premiums, with any remaining proceeds directed to pay outstanding interest. To the extent there is not sufficient remaining proceeds in the "waterfall" to satisfy the amount of required interest, White Eagle will be obligated to pay any such shortfall amount, subject to the outcome of the bankruptcy and litigation proceedings referenced below.
As described elsewhere in this report, certain of our subsidiaries, consisting of Lamington Road Designated Activity Company (formerly known as Lamington Road Limited), White Eagle General Partner, LLC and White Eagle Asset Portfolio, LP, have filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"), accordingly, their operations, including their use of cash, are subject to the oversight and approval of the Bankruptcy Court during the pendency of the bankruptcies.
Subsequent Event
On January 25, 2019, the foregoing subsidiaries and the Company filed a complaint in the Bankruptcy Court against, among others, the lender under the White Eagle Revolving Credit Facility, thereby commencing an adversary proceeding. As set forth in the complaint, the plaintiffs assert, among other things, that: (a) the lender undervalued White Eagle’s policy portfolio by improperly reducing the loan-to-value ratio under the loan agreement and preventing White Eagle from receiving any proceeds generated from its own assets; (b) the lender imposed usurious fees on White Eagle under the Loan Agreement for unnecessary portfolio services at inflated prices; (c) the lender maintained significant control over White Eagle under the Loan Agreement, resulting in a de facto joint venture, and the lender breached its fiduciary duty when it siphoned cash from the joint venture for its own benefit and to the detriment of White Eagle; and (d) the portion of the lender’s claim against White Eagle for an original issue discount should be disallowed.
Under the White Eagle Revolving Credit Facility and outside of bankruptcy proceeds from the maturity of the policies pledged as collateral are distributed pursuant to a waterfall. After distributions for payments of premiums, fees to service providers, and interest, a percentage of the collections from policy proceeds are to be paid to the lenders, which will vary depending on the then loan-to-value ratio ("LTV") as illustrated below where the valuation is determined by the lenders:
Provided that (i) if (a) the Company failed to maintain a cash interest coverage ratio of at least 2.0:1 at any time during the immediately preceding calendar quarter or (b) the Company fails to take steps to improve its solvency in a manner acceptable to the required lenders (as determined in its sole and absolute discretion), then the cash flow sweep percentage to the lenders shall equal one-hundred percent (100)%and (ii) if such distribution date occurs on or after December 29, 2025, then the cash flow sweep percentage shall equal one-hundred percent (100)%. See Note 10, "White Eagle Revolving Credit Facility" to our accompanying consolidated financial statements.
Accordingly, there can be no assurance as to when proceeds or the amounts from maturities of the policies pledged as collateral under the White Eagle Revolving Credit Facility will be distributed to us. In addition, due to the pending bankruptcy proceedings, we are not able to borrow money under our White Eagle Revolving Credit Facility to pay premiums or any facility expense. By virtue of the pending bankruptcy proceedings, the White Eagle Revolving Credit Facility is currently in default, but any action to be taken by the lender thereunder is stayed. There is a risk that the lender seeks relief from stay or other form of relief in the Bankruptcy Court, such as the appointment of a chapter 11 trustee, conversion of the cases to chapter 7 of the Bankruptcy Code, or dismissal of the cases. If such relief is granted, the lender, or its agent, may dispose of, release, or foreclose on (including by means of strict foreclosure on all or any of the policies or on our interests in White Eagle, which might be exercised in a manner intended to impair our rights to excess proceeds of any liquidation of foreclosed assets), or take other actions with respect to the policies pledged as collateral under the White Eagle Revolving Credit Facility that we or our
shareholders may disagree with or that may be contrary to the interests of our shareholders. Further, the breach of the White Eagle Revolving Credit Facility would trigger defaults under our 5.5% Convertible Note Indenture and our 8.5% Senior Note Indenture, but the lenders under each such facility have waived such defaults, permanently with respect to the 5.0% Convertible Notes and through February 27, 2019 (as of the date of this report) with respect to the 8.5% Senior Notes.
On December 13, 2018, White Eagle Asset Portfolio, LP, Emergent Capital, Inc.’s (the "Company") wholly-owned indirect Delaware subsidiary ("White Eagle"), filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The Chapter 11 case is being administered under case number 18-12808 (the "White Eagle Chapter 11 Case").
In connection with the White Eagle Chapter 11 Case, on January 15, 2019, the Court authorized the Debtors to use the proceeds of pre-petition cash collateral for a period of twenty (20) weeks (the "Cash Collateral'). The Cash Collateral may be used solely for the purposes permitted under the budget approved by the Court, including (i) to provide working capital needs of the Debtors and general corporate purposes of the Debtors, (ii) to make the payments or fund amounts otherwise permitted in the final order that authorized such uses and such budget, (iii) to fund amounts necessary to pay certain fees; and (iv) to fund amounts necessary to pay certain professional fees in accordance with such Budget.
Our substantial leverage and significant debt service obligations could adversely affect our ability to fulfill our obligations and make it more difficult for us to fund our operations.
As of November 30, 2018, we had $475.8 million in outstanding long-term debt (including that held by our subsidiaries and without giving effect to the fair value of such indebtedness) consisting of borrowings under the White Eagle Revolving Credit Facility, our 8.50% senior unsecured convertible notes due 2019 (the "Convertible Notes"); 5.0% senior unsecured convertible notes due 2023 (the " New Convertible Notes") and the 8.5% senior secured notes due 2021 (the "8.5% Senior Secured Notes"). Our substantial level of indebtedness could have important negative consequences to you and us, including:
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we may have difficulty satisfying our debt obligations, including payment of current interest obligations;
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we may have difficulty refinancing our existing indebtedness or obtaining financing in the future for working capital, premium payments, portfolio lending, acquisitions or other purposes;
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we will need to use a substantial portion of our available cash flow to pay interest and principal on our debt, which will reduce the amount of money available to finance our operations and other business activities;
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our debt level increases our vulnerability to general economic downturns and adverse industry conditions;
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our debt level could limit our flexibility in planning for, or reacting to, changes in our business and in our industry in general; and
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our leverage could place us at a competitive disadvantage compared to our competitors that have less debt.
While the terms of the financing arrangements governing our debt contain restrictions on our ability to incur additional indebtedness, these restrictions are subject to a number of important qualifications and exceptions, and the indebtedness incurred in compliance with these restrictions could be substantial. Accordingly, we could incur significant additional indebtedness in the future; the more we increase our leverage, the more we become exposed to the risks described above.
We may require additional capital and there can be no assurance that we will be able to raise additional capital in a timely manner, at the level sought, on favorable terms or at all.
Ordinarily, subject to borrowing base limitations and other conditions to funding, White Eagle may borrow proceeds to pay premiums on all of the life insurance policies pledged as collateral under the White Eagle Revolving Credit Facility, we estimate that, in addition to general overhead expenses, we will need to pay approximately $162,000 in premiums to keep our remaining 2 life insurance policies that have not been pledged as collateral under the White Eagle Revolving Credit Facility in force through November 30, 2019. As of November 30, 2018, we had approximately $1.2 million of cash and cash equivalents and certificates of deposit of $500,000; of this amount, approximately $1.2 million is available to pay premiums on the 2 unencumbered policies and other overhead expenses, with approximately $33.7 million being restricted by the White Eagle Revolving Credit Facility. However, as part of the pending bankruptcy proceedings Chapter 11 Cases, White Eagle has been authorized by the Bankruptcy Court to use the pre-petition cash collateral for payment of premiums on the policies pledged as collateral under the White Eagle Revolving Credit Facility. It is uncertain whether White Eagle will have access to sufficient amounts of cash collateral in order to fund all ongoing premium obligations in the future. Accordingly, we must proactively manage our cash and may need to raise additional capital in order to effectively run our businesses, maintain the policies that
have not been pledged under the White Eagle Revolving Credit Facility, pay interest expense on our debt and opportunistically grow our assets. There can be no assurance, however, that we will, if needed, be able to raise additional or sufficient capital on favorable terms or at all.
As part of our cash management and business strategy, we may, subject to the covenants in our debt arrangements, determine to sell all or a portion of our portfolio, but there can be no assurance that we can consummate any sales or that, if consummated, sales of policies will be at or above their carrying values. We may also, subject to the covenants in our debt arrangements and lender approval, determine to lapse certain of these policies that have a low return profile or as our portfolio management needs dictate. The lapsing of policies, if any, could result in an event of default under our debt arrangements and would create losses as the policies would be written down to zero.
We may have exposure to greater than anticipated tax liabilities.
Our income tax obligations are based in part on our corporate operating structure and intercompany arrangements, including the manner that we own our life settlements and the valuations of our intercompany transactions. The tax laws applicable to our business, including the laws of the United States, Ireland and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax proceeds from companies. The taxing authorities of the jurisdictions in which we operate may challenge our methodologies for intercompany arrangements and ownership of life settlements, which could increase our effective tax rate and harm our financial position and results of operations. We are subject to regular review and audit by U.S. federal and state authorities and from 2014 on, foreign tax authorities. Tax authorities may disagree with certain positions we have taken and any adverse outcome of such a review or audit could have a material negative effect on our financial position and results of operations. In addition, the determination of our provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Although we believe that our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. In addition, our future income taxes could be adversely affected by changes in tax laws, regulations, or accounting principles.
Changes in tax laws or tax rulings could materially affect our financial position and results of operations.
The U.S., Ireland and many countries in the European Union, are actively considering changes to existing tax laws. Certain proposals, including proposals with retroactive effects, could include recommendations that would significantly increase our tax obligations where we do business or where our subsidiaries own life insurance policies. Any changes in the taxation of either international business activities or ownership of life settlements may increase our effective tax rate and harm our financial position and results of operations and, under certain circumstances, may constitute an additional event of default under the White Eagle Revolving Credit Facility.
On December 22, 2017, the United States enacted the "Tax Cuts and Jobs Act" (the "TCJA"). The TCJA is complex and includes significant amendments to the Code, including amendments that drastically change the taxation of offshore earnings and the deductibility of interest. The Company has assessed the impact of the TCJA on its business and consolidated financial statements. In connection with that ongoing assessment, the Company has identified at least five provisions that may have a material and adverse effect on its business.
First, the TCJA generally will require the Company to include in income with respect to its 2017 taxable year any undistributed and previously untaxed earnings of its foreign subsidiaries existing at December 31, 2017, subject to adjustments.
Second, going forward, the TCJA generally will subject the Company to a current U.S. tax on any undistributed earnings of its foreign subsidiaries to the extent such earnings are considered to be "global intangible low-taxed income" ("GILTI"), subject to certain deductions and adjustments.
Third, the TCJA generally will disallow the Company's U.S. interest deductions going forward to the extent such deductions exceed 30% of its U.S. "adjusted taxable income" (which will be roughly equivalent to earnings before interest, tax, depreciation and amortization ("EBITDA") through 2022 and to earnings before interest and tax ("EBIT") thereafter).
Fourth, any net operating loss incurred by the Company in taxable years beginning after December 31, 2017 cannot offset more than 80% of the Company’s taxable income in any tax year and cannot be carried back to offset prior year taxable income.
Finally, the TCJA significantly amends Section 162(m) of the Code. Pursuant to Section 162(m) of the Code, the Company may not deduct compensation of more than $1.0 million paid to the Company’s "covered employees," which includes (i) any individual who at any time during the taxable year is a chief executive officer, chief financial officer, or an employee whose total compensation for the tax year is required to be reported to stockholders because he or she is among the three highest compensated officers for the tax year, other than the chief executive officer or chief financial officer, and (ii) any person who was a covered employee at any time after December 31, 2016.
Prior to January 1, 2018, certain grants may have qualified as "performance-based compensation" and, as such, would be exempt from the $1.0 million limitation on deductible compensation. The TCJA eliminated the performance-based compensation exception with respect to tax years beginning on or after January 1, 2018. However, the TCJA provides a transition rule with respect to remuneration which is provided pursuant to a written binding contract which was in effect on November 2, 2017 and which was not materially modified after that date. These, and other provisions of the TCJA, may have a material and adverse impact on the Company's business and financial condition and the value of the Company's common shares. The Company is continuing to assess the impact of the TCJA. Holders should consult their tax advisors about the TCJA and its potential impact on their ownership of its common stock.
We may be unable to deduct interest payments on debt that is attributed to policies that we own and other operating losses, which would reduce any future income and cash flows.
Generally, under the Internal Revenue Code of 1986, as amended (the "Code"), interest paid or accrued on debt obligations is deductible in computing a taxpayer’s federal income tax liability. However, when the proceeds of indebtedness are used to pay premiums on life insurance policies that are owned by the entity incurring the debt or otherwise used to support the purchase or ownership of life insurance policies, the interest in respect of such proceeds may not be deductible. Accordingly, so long as we use a portion of debt financing to pay the premiums on policies owned by us or to support the continued ownership of life insurance policies by us, the interest paid or accrued on that portion of the debt may not be currently deductible by us for federal income tax purposes. We may have net operating losses that we may be able to use to reduce a portion of our future taxable income, but the inability to currently deduct interest accrued on debt could have a material adverse effect on our future earnings and cash flows available for the payment of interest.
In addition, under Section 382 of the Code, a corporation that undergoes an "ownership change" (generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period) is subject to limitation on its ability to utilize its pre-change net operating loss carry-forwards, or net operating losses, to offset future taxable income. Recent changes in our stock ownership triggered, an ownership change, and as a result our ability to utilize our net operating losses to offset income has been substantially limited.
We may not be able to refinance the White Eagle Revolving Credit Facility.
The White Eagle Revolving Credit Facility contains covenants that may significantly limit our ability to refinance, subject to the requirements of applicable bankruptcy law. In addition, the lender under the White Eagle Revolving Credit Facility has a substantial interest in and priority rights to distributions of certain proceeds from policies pledged to it by White Eagle subject to the outcome of the bankruptcy and litigation proceedings referenced above. Such covenants and such interests in and rights to distributions may significantly reduce our ability to attract replacement financing.
We may not have the cash necessary to repurchase the 5.0% Convertible Notes and the 8.50% Senior Secured Notes.
We have issued $75.8 million in aggregate principal amount of 5.0% Convertible Notes (the "New Convertible Notes") and $35.0 million in 8.5% Senior Secured Notes. The New Convertible Note Indenture provides for customary events of default, which include (subject in certain cases to customary grace and cure periods), among others: nonpayment of principal or interest; breach of covenants or other agreements in the New Convertible Note Indenture; defaults or failure to pay certain other indebtedness; and certain events of bankruptcy or insolvency. Generally, if an event of default occurs and is continuing under the New Convertible Note Indenture, the trustee or the holders of at least 25% in aggregate principal amount of the New Convertible Notes then outstanding may declare all unpaid principal plus accrued interest on the New Convertible Notes immediately due and payable, subject to certain conditions set forth in the New Convertible Note Indenture. In addition, holders of the New Convertible Notes may require the Company to repurchase the New Convertible Notes upon the occurrence of certain designated events at a repurchase price of 100% of the principal amount of the New Convertible Notes, plus accrued and unpaid interest.
The 8.5% Senior Secured Notes must be redeemed in full upon additional issuances of debt by the Company in each case, at a price equal to 100% of the principal amount redeemed plus (i) accrued and unpaid interest on the 8.5% Senior Secured Notes redeemed up to the date of redemption, and (ii) the Applicable Premium, if any, as defined in the Amended and Restated Senior Secured Indenture. Upon a change of control, the Company will be required to make an offer to holders of the 8.5% Senior Secured Notes to repurchase the 8.5% Senior Secured Notes at a price equal to 107.5% of their principal amount, plus accrued and unpaid interest up to the date of redemption.
The Amended and Restated Senior Secured Indenture provides for customary events of default which include (subject in certain cases to customary grace and cure periods), among others: nonpayment of principal or interest; breach of covenants or other agreements in the Amended and Restated Senior Secured Indenture; defaults in failure to pay certain other indebtedness; and certain events of bankruptcy or insolvency. Generally, if an event of default occurs and is continuing under the Amended and Restated Senior Secured Indenture, the trustee or the holders of at least 25% in aggregate principal amount of the 8.5% Senior Secured Notes then outstanding may declare the principal of and accrued but unpaid interest, plus a premium, if any, on all the 8.5% Senior Secured Notes immediately due and payable, subject to certain conditions set forth in the Amended and Restated Senior Secured Indenture.
However, we may not have enough available cash to make a required repurchase of the New Convertible Notes or the 8.5% Senior Secured Notes at the applicable time, and may not be able to obtain the necessary financing on favorable terms. In addition, our ability to repurchase the New Convertible Notes or the 8.5% Senior Secured Notes may be limited by law or by the agreements governing our other indebtedness that exist at the time of the repurchase, as the case may be. Our failure to repurchase the New Convertible Notes or the 8.5% Senior Secured Notes when required by their indenture would constitute a default, which could also lead to a default under the agreements governing our other indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and to repurchase the New Convertible Notes or the 8.5% Senior Secured Notes. Any such default would have a material adverse effect on our business, prospects, financial condition and operating results.
Interest on the New Convertible Notes and on the 8.5% Senior Secured Notes is due semi-annually and quarterly, respectively.
Risks Related to Our Business
We have been experiencing net losses and expect that net losses could continue for an uncertain period. If we continue to operate at a loss, our business may not be financially viable.
As of November 30, 2018, our net loss from continuing operations after deconsolidation was $169.9 million with an accumulated deficit of $306.0 million. As of November 30, 2018, our cash balance was $1.2 million and certificates of deposit were $500,000. We had net working capital of $4.4 million, outstanding debt of $112.0 million and we had life settlement assets of $1.2 million. If we do not succeed in our business plan’s objectives to achieve profitability, our business might continue to experience losses and may not be sustainable in the future.
Our success in operating our life finance business is dependent on making accurate assumptions about life expectancies and maintaining adequate cash balances to pay premiums.
We are responsible for paying all premiums necessary to keep the policies in our portfolio in force and prevent them from lapsing. We estimate that we will need to pay $162,000 in premiums to keep our current portfolio of life insurance policies that are not pledged as collateral under the White Eagle Revolving Credit Facility in force through 2019. As of November 30, 2018, we had approximately $1.2 million of cash and cash equivalents and certificates of deposit of $500,000; of this amount, approximately $1.2 million is available to pay premiums on the two unencumbered policies and general expenses, with approximately $33.7 million being restricted by the White Eagle Revolving Credit Facility. By using cash reserves to pay premiums for retained life insurance policies, we will have less cash available for other business purposes. Therefore, our cash flows and the required amount of our cash reserves to pay premiums is dependent on our assumptions about life expectancies being accurate.
Life expectancies are estimates of the expected longevity or mortality of an insured and are inherently uncertain. A life expectancy obtained on an insured for a life insurance policy may not be predictive of the future longevity or mortality of the insured. Inaccurate forecasting of an insured’s life expectancy could result from, among other things: (i) advances in medical treatment (e.g., new cancer treatments) resulting in deaths occurring later than forecasted; (ii) inaccurate diagnosis or prognosis; (iii) changes to life style habits or the individual’s ability to fight disease, resulting in improved health; (iv) reliance on outdated or incomplete age or health information about the insured, or on information that is inaccurate (whether or not due to fraud or
misrepresentation by the insured); or (v) improper or flawed methodology or assumptions in terms of modeling or crediting of medical conditions.
In forecasting estimated life expectancies, we utilize third party medical underwriters to evaluate the medical condition and life expectancy of each insured. The firms that provide health assessments and life expectancy information may depend on, among other things, actuarial tables and model inputs for insureds and third-party information from independent physicians who, in turn, may not have personally performed a physical examination of any of the insureds and may have relied solely on reports provided to them by attending physicians or other health care providers with whom they were authorized to communicate. The accuracy of this information has not been and will not be independently verified by us or our service providers.
If life expectancy valuations underestimate the longevity of the insureds, the actual maturity date of the life insurance policies may be farther in the future than projected. Consequently, we may not have sufficient cash for payment of insurance premiums or to service our indebtedness. The extension of time to receive a return on our policies could have a material adverse effect on our business, financial condition and results of operations.
The use of third party service providers may have an adverse effect on the operations of the Company.
Our business relies significantly on the use of third party service providers to support our day to day business operations. Any significant changes in prices these providers charge may have a material impact on our financial results. In addition, any reduction in service levels among our third party service providers, including delays or disruption of services may have an adverse effect on the operations of the Company.
Recent and future increases to the premiums due on life insurance policies that we own have adversely affected and will adversely affect the fair value and our returns on such life insurance policies.
To keep the life insurance policies that we own in force, insurance premiums must be paid in a timely manner. Projected premium payments are a critical component of our fair value estimates, and any increase in expected premiums will likely decrease the fair value of a given life insurance policy and adversely affect the return on that policy. Commencing in the third quarter of 2015, 38 of our policies became subject to a cost of insurance increase, with 14 of our policies impacted during the eleven months ended November 30, 2018 impacting the fair value buy approximately $659,000. Further cost of insurance increases may cause our projected premium payments to significantly increase, adversely affect the loan to value ratios under the White Eagle Revolving Credit Facility and otherwise could have an adverse, material effect on our business, results of operations and the value of any affected policies.
The premiums necessary to maintain our life finance assets are expected to increase if we were to acquire additional policies.
The premiums necessary to keep our policies in force may increase. Assuming no maturities in 2019, we would need to pay $163,000 in premiums in 2019 to maintain the policies owned as of November 30, 2018 that are not pledged under the White Eagle Revolving Credit Facility. For the 586 policies pledged as collateral under the White Eagle Revolving Credit Facility, White Eagle would need to pay an estimated $105.6 million in premiums for 2019 (assuming no maturities). See "Liquidity and Capital Resources" under Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations."
Contractions in the market for life insurance policies could make it more difficult for us to opportunistically sell policies that we own
A potential sale of a life insurance policy owned by us is subject to the approval of the Bankruptcy Court and depends significantly on the market for life insurance, which may contract or disappear depending on the impact of potential government regulation, future economic conditions and/or other market variables. For example, the secondary and tertiary markets for life insurance policies incurred a significant slowdown in 2008, which lasted several years. Historically, many investors who invest in life insurance policies are foreign investors who are attracted by potential investment returns from life insurance policies issued by United States life insurers with high ratings and financial strength, as well as by the view that such investments are non-correlated assets-meaning changes in the equity or debt markets should not affect returns on such investments. Changes in the value of the United States dollar and corresponding exchange rates, as well as changes to the ratings of United States life insurers can cause foreign investors to suffer a reduction in the value of their United States dollar
denominated investments and reduce their demand for such products, which could make it more difficult for us to opportunistically sell our life insurance policies.
Our fair value assumptions are inherently subjective and, if the fair value of our life insurance policies decreases, we will report losses with respect to these policies.
When we obtain ownership of a life insurance policy, we record the policy as an investment in life settlements at the transaction price as of the date of acquisition. At the end of each reporting period, we re-value the life insurance policies we own. To the extent that the calculation results in an adjustment to the fair value of the policy, we record this as a change in fair value of our life insurance policies. This evaluation of the fair value of life insurance policies is inherently subjective as it requires estimates and assumptions that are susceptible to significant revision as more information becomes available. Using our valuation model, we determine the fair value of life insurance policies on a discounted cash flow basis. The most significant assumptions that we estimate are the life expectancy of the insured, expected premium payments and the discount rate. The discount rate is based upon current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk margin an investor in the policy would require. Third party life expectancy providers review and analyze the medical records of an insured and provide us with a life expectancy estimate based on the insured’s health. We then calculate a mortality impairment factor for the insured as that factor which, when applied to our mortality table, reproduces the same life expectancy provided for that insured. We use the resulting mortality impairment factor to generate a series of probabilistic future cash flows for the policy, which we then discount and aggregate to arrive at the fair value of the policy. If we are unable to accurately estimate any of these factors, we may have to write down the fair value of our life settlements, which could materially and adversely affect our results of operations and our financial condition. See, "Our success in operating our life finance business is dependent on making accurate assumptions about life expectancies and maintaining adequate cash balances to pay premiums," under Item 1A, "Risk Factors."
Insurable interest concerns regarding a life insurance policy can also adversely impact its fair value. A claim or the perceived potential for a claim for rescission or a challenge to insurable interest by an insurance company or by persons with an insurable interest in the insured of a portion of or all of the policy death benefit can negatively impact the fair value of a life insurance policy.
If the calculation of fair value results in a decrease in value, we record this reduction as a loss. If we determine that it is appropriate to increase the discount rate or adjust other inputs to our fair value model, if we are otherwise unable to accurately estimate the assumptions in our valuation model, or if other factors cause the fair value of our life insurance policies to decrease, the carrying value of our assets may be materially adversely affected and may materially and adversely affect our business, financial condition and results of operations.
The life insurance policies that we own may be subject to contest, rescission and/or non-cooperation by the issuing life insurance company, which may have a material adverse effect on our business, financial condition and results of operations.
All states require that the initial purchaser of a new life insurance policy insuring the life of an individual have an "insurable interest," meaning a stake in the insured’s health and wellbeing, rather than the insured’s death, in such individual’s life at the time of original issuance of the policy. Whether an insurable interest exists in the context of the purchase of a life insurance policy is critical because, in the absence of a valid insurable interest, life insurance policies are unenforceable under most states’ laws. Where a life insurance policy has been issued to a policyholder without an insurable interest in the life of the individual who is insured, the life insurance company may be able to void or rescind the policy. Even if the insurance company cannot void or rescind the policy, the insurable interest laws of a number of states provide that persons with an insurable interest on the life of the insured may have the right to recover a portion or all of the death benefit payable under a policy from a person who has no insurable interest on the life of the insured. These claims can generally only be brought if the policy was originally issued to a person without an insurable interest in the life of the insured.
Many states have enacted statutes prohibiting stranger-originated life insurance, or STOLI, in which an individual purchases a life insurance policy with the intention of selling it to a third-party investor, who lacks an insurable interest in the insured’s life. Some insurance carriers have contested policies as STOLI arrangements, specifically citing the existence of certain nonrecourse premium financing arrangements as a basis to challenge the validity of the policies used to collateralize the financing. Additionally, if an insurance carrier alleges that there were misrepresentations or fraud in the application process for an insurance policy, they may sue us or others to contest or rescind that policy. Decisions in Florida have increased the risk that challenges to premium financed policies may be decided in favor of the issuing insurance company. Moreover, because life insurance policies we own were originated in the same or a similar manner and in a limited number of states, there is a
heightened risk that an adverse court decision or other challenge or determination by a regulatory or other interested party with respect to a policy could have a material adverse effect on a significant number of other policies. If a policy that we own is subject to a successful contest or rescission, the fair value of the policy could be reduced to zero, negatively impacting the discount rates used to value our portfolio generally and our ability to sell policies. Generally, life insurance policies may only be rescinded by the issuing life insurance company within the contestability period, which, in most states is two years. Lack of insurable interest can in some instances form the basis of loss of right to payment under a life insurance policy for many years beyond the contestability period and insurance carriers have been known to challenge claims for death benefits for more than five years from issuance of the policy.
From time to time, insurance carriers have challenged the validity of policies owned by us or that once served as the underlying collateral for a premium finance loan made by us. See "Litigation" under Note 17, "Commitments and Contingencies" to our consolidated financial statements. We believe the USAO Investigation (as defined below) and the SEC Investigation (as defined below) have caused us to experience more challenges to policies by insurers attempting to use such investigations and the Non-Prosecution Agreement (as defined below) as grounds for rescinding or contesting a policy. Any such future challenges may result in uncertainty over title and collectability, increased costs, delays in payment of life insurance proceeds or even the voiding of a policy, and could have a material adverse effect on the ability of the Company to comply with the covenants in the agreements governing our indebtedness, our business, financial condition and results of operations.
Additionally, if an insurance company successfully rescinds or contests a policy, the insurance company may not be required to refund all or, in some cases, any of the insurance premiums paid for the policy. While defending an action to contest or rescind a policy, premium payments may have to continue to be made to the life insurance company. Hence, in the case of a contest or rescission, premiums paid to the carrier (including those paid during the pendency of a contest or rescission action) may not be refunded. If they are not, we may suffer a complete loss with respect to a policy, which may adversely affect our business, financial condition and results of operations.
Premium financed life insurance policies are susceptible to a higher risk of fraud and misrepresentation on life insurance applications, which increases the risk of contest, rescission or non-cooperation by issuing life insurance carriers.
While fraud and misrepresentation by applicants and potential insureds in completing life insurance applications exist generally in the life insurance industry (especially with respect to the health and medical history and condition of the potential insured as well as the applicant’s net worth), such risk of fraud and misrepresentation may be heightened in connection with life insurance policies for which the premiums are financed through premium finance loans. In particular, there is a risk that applicants and potential insureds may not have truthfully or completely answered questions related to whether the life insurance policy premiums would be financed through a premium finance loan or otherwise, the applicants’ purpose for purchasing the policy or the applicants’ intention regarding the future sale or transfer of life insurance policies. Such risk may be further increased to the extent life insurance agents communicated to applicants and potential insureds regarding potential premium finance arrangements or transfers of life insurance policies through payment defaults under premium finance loans. In the ordinary course of our legacy premium finance business, our sales team received inquiries from life insurance agents and brokers regarding the availability of premium finance loans for their clients. However, any communication between the life insurance agent and the potential policyholder or insured is beyond our control and we may not know whether a life insurance agent discussed with the potential policyholder or the insured the possibility of a premium finance loan by us or the subsequent transfer of the life insurance policy. Consequently, notwithstanding the representations and certifications obtained from the policyholders, insureds and the life insurance agents, there is a risk that insurance carriers, the estates or heirs of insureds, or others could contest policies we acquired through foreclosures of premium finance loans based on fraud or misrepresentation as to any information provided to the life insurance company, including the life insurance application. See "Litigation" under Note 18, "Commitments and Contingencies" to the accompanying consolidated financial statements.
Misrepresentations, fraud, omissions or lack of insurable interest can also, in some instances, form the basis of loss of right to payment under a life insurance policy. Based on statements made in the Non-Prosecution Agreement, there is a risk that policies that we own may increasingly be challenged by insurance carriers and the estates or heirs of insureds. Any such challenges to the policies may result in increased costs, delays in payment of life insurance proceeds or even the voiding of a policy, a reduction in the fair value of a policy and could have a material adverse effect on our business, financial condition and results of operations.
As of November 30, 2018, of the 588 policies in the life settlement portfolio, 514 policies were previously premium financed.
Delays in payment and non-payment of life insurance policy proceeds can occur for many reasons and any such delays may have a material adverse effect on our business, financial condition and results of operations.
A number of arguments may be made by former beneficiaries (including but not limited to spouses, ex-spouses and descendants of the insured) under a life insurance policy, by the beneficiaries of the trust that once held the policy, by the estate or legal heirs of the insured or by the insurance company issuing such policy, to deny or delay payment of proceeds following the death of an insured, including arguments related to lack of mental capacity of the insured, usury, contestability or suicide provisions in a policy. The statements in the Non-Prosecution Agreement may make such delays more likely and may increase challenges by carriers to paying out death claims or challenges by families of insureds to policy proceeds. Furthermore, if the death of an insured cannot be verified and no death certificate can be produced, the related insurance company may not pay the proceeds of the life insurance policy until the passage of a statutory period (usually five to seven years) for the presumption of death without proof. Such delays in payment or non-payment of policy proceeds may have a material adverse effect on our business, financial condition and results of operations.
We compete with a number of other finance companies and investors and may encounter additional competition.
There are a number of finance companies and investors that compete with us in the life finance industry. Many are significantly larger and possess considerably greater financial, marketing, management and other resources than we do. The life finance business could also prove attractive to new entrants. As a consequence, competition in this sector may increase. Increased competition could result in increased acquisition costs, changes to discount rates, margin compression and/or less favorable financing terms, each of which could materially adversely affect our income, which would have a material adverse effect on our business, financial condition and results of operations.
If a regulator or court decides that trusts that were formed to own the life insurance policies that once served as collateral for our premium finance loans do not have an insurable interest in the life of the insured, such determination could have a material adverse effect on our business, financial condition and results of operations.
Generally, there are two forms of insurable interests in the life of an individual, familial and financial. Additionally, an individual is deemed to have an insurable interest in his or her own life. It is also a common practice for an individual, as a grantor or settlor, to form an irrevocable trust to purchase and own a life insurance policy insuring the life of the grantor or settlor, where the beneficiaries of the trust are persons who themselves, by virtue of certain familial relationships with the grantor or settlor, also have an insurable interest in the life of the insured. In the event of a payment default on our premium finance loan, we generally acquired life insurance policies owned by trusts (or the beneficial interests in the trust itself) that we believe had an insurable interest in the life of the related insureds. However, a state insurance regulatory authority or a court may determine that the trust or policy owner did not have an insurable interest in the life of the insured or that we, as lender, only have a limited insurable interest. Any such determination could result in our being unable to receive the proceeds of the life insurance policy, which could lead to a total loss on our investment in life settlements. Any such loss or losses could have a material adverse effect on our business, financial condition and results of operations.
We are dependent on the creditworthiness of the life insurance companies that issued the policies in comprising our portfolio. If a life insurance company defaults on its obligation to pay death benefits on a policy we own, we would experience a loss of our investment, which could have a material adverse effect on our business, financial condition and results of operations.
We are dependent on the creditworthiness of the life insurance companies that issued the policies that we own. We assume the credit risk associated with life insurance policies issued by various life insurance companies. The failure or bankruptcy of any such life insurance or annuity company could have a material adverse impact on our financial condition and results of operation. A life insurance company’s business tends to track general economic and market conditions that are beyond its control, including extended economic recessions or interest rate changes. Changes in investor perceptions regarding the strength of insurers generally and the policies or annuities they offer can adversely affect our ability to sell or finance our assets. Adverse economic factors and volatility in the financial markets may have a material adverse effect on a life insurance company’s business and credit rating, financial condition and operating results, and an issuing life insurance company may default on its obligation to pay death benefits on the life insurance policies that we own. In such event, we would experience a loss of our investment in such life insurance policies, which could have a material adverse effect on our business, financial condition and results of operations.
If we are unable to maintain effective internal control over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial reports and the trading price of our common stock may be negatively affected.
We are subject to Section 404 of the Sarbanes-Oxley Act (SOX), which requires us to maintain internal controls over financial reporting and to report any material weaknesses in such internal controls. We have consumed and will continue to consume management resources and incur expenses for SOX compliance on an ongoing basis. In addition, as we have reduced the number of our employees and moved certain of our operations to foreign subsidiaries, we have increased our reliance on third parties for various aspects of our internal controls. If we identify material weaknesses in our internal control over financial reporting, or if we are unable to comply with the requirements of Section 404 in a timely manner or are unable to assert that our internal control over financial reporting is effective, investors may lose confidence in the accuracy and completeness of our financial reports and the trading price of our common stock could be negatively affected, and we could become subject to investigations by the SEC, or other regulatory authorities, which could require additional financial and management resources.
Changes to statutory, licensing and regulatory regimes governing life settlements could have a material adverse effect on our activities and income.
Changes to statutory, licensing and regulatory regimes could result in the enforcement of stricter compliance measures or adoption of additional measures on us or on the insurance companies that stand behind the insurance policies that we own, which could have a material adverse impact on our business activities and income. The SEC issued a task force report in July 2010 recommending that sales of life insurance policies in life settlement transactions be regulated as securities for purposes of the federal securities laws. To date, the SEC has not made such a recommendation to Congress. However, if the statutory definitions of "security" were amended to encompass life settlements, we could become subject to additional extensive regulatory requirements under the federal securities laws, including the obligation to register sales and offerings of life settlements with the SEC as public offerings under the Securities Act of 1933 and, potentially, the obligation to register as an "investment company" pursuant to the Investment Company Act of 1940. Any legislation implementing such regulatory change or a change in the transactions that are characterized as life settlement transactions could lead to significantly increased compliance costs, increased liability risk and adversely affect our ability to acquire or sell life insurance policies in the future, which could have a material adverse effect on our business, financial condition and results of operations.
Under the current Presidential administration and U.S. Congress, we expect that there may be many changes to existing U.S. laws, regulations, and standards that may affect our business. Because of the uncertainty regarding existing law, we cannot quantify or predict with any certainty the likely impact of such change on our business model, prospects, financial condition or results of operations. We cannot assure you as to the ultimate content, timing, or effect of changes, nor is it possible at this time to estimate the impact of any such potential legislation.
Our former structured settlements business may expose us to future claims or contingent liabilities.
Pursuant to the terms of the asset purchase agreement we entered into in connection with the sale of our structured settlements business, we sold substantially all of that business’ operating assets in 2013 while retaining substantially all of its liabilities. In addition, we agreed to indemnify the purchaser for certain breaches of representations and warranties regarding us and various aspects of that business. Many of our indemnification obligations are subject to time and maximum liability limitations, however, in some instances our indemnification obligations are not subject to any limitations. Significant indemnification claims by the purchaser or other claims or contingent liability related to our former structured settlement business could materially and adversely affect our business, financial condition and results of operations.
Failure to maintain the security of personally identifiable and other information, non-compliance with our contractual or other legal obligations regarding such information, or a violation of our privacy and security policies with respect to such information, could adversely affect us.
In connection with our business, we collect and retain significant volumes of certain types of personally identifiable and other information pertaining to insureds and counterparties. The legal, regulatory and contractual environment surrounding information security and privacy is constantly evolving. A significant actual or potential theft, loss, fraudulent use or misuse of customer, counterparty, employee or our data by cybercrime or otherwise, non-compliance with our contractual or other legal obligations regarding such data or a violation of our privacy and security policies with respect to such data could adversely impact our reputation and could result in significant costs, fines, penalties, litigation or regulatory action.
Disasters, disruptions and other impairment of our information technologies and systems could adversely affect our business.
Our businesses depend upon the use of sophisticated information technologies and systems, including third party hosted services and data facilities that we do not control. While we have developed certain disaster recovery plans and backup systems, these plans and systems are not fully redundant. A system disruption caused by a natural disaster, cybercrime or other impairment could have a material adverse effect on our results of operations and may cause delays, loss of critical data and reputational harm, and could otherwise prevent us from servicing our portfolio of life insurance policies.
Certain of our subsidiaries filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy
Code.
The commencement of the Chapter 11 Cases constitutes an event of default under the White Eagle Revolving Credit Facility, resulting in the principal and accrued interest due from White Eagle thereunder becoming immediately due and payable. Lamington and WEGP have pledged their respective interests in White Eagle to secure its obligations under the White Eagle Revolving Credit Facility. Any efforts by LNV Corporation, the lender under the White Eagle Revolving Credit Facility ("LNV"), or CLMG Corp., the administrative agent under the White Eagle Revolving Credit Facility ("CLMG"), to enforce such pledges by Lamington and WEGP of their respective interests in White Eagle in connection with the White Eagle Revolving Credit Facility are automatically stayed as a result of the commencement of the November Chapter 11 Cases and LNV’s and CLMG’s rights of enforcement in respect of the White Eagle Revolving Credit Facility are subject to the applicable provisions of the Bankruptcy Code. White Eagle’s assets are similarly protected as a result of the White Eagle Chapter 11 Case.
Lamington, WEGP, White Eagle and Lamington Road Bermuda, have been deconsolidated from our financial statements since the Petition Date. The amount that will be necessary to settle the debt under the White Eagle Revolving Credit Facility is uncertain. Several risks and uncertainties result from these filings that could have a material adverse effect on our business, financial condition, results of operations and cash flows. Those risks and uncertainties include the following:
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the value of the deconsolidated subsidiaries reflected in our financial statements;
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the fair value of the debt under the White Eagle Revolving Credit Facility;
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the financial viability of White Eagle as it is currently unable to draw under the Revolving Credit Facility and servicing premiums through collection of maturity proceeds;
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our ability to secure financing needed to exit the bankruptcy process; and
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the costs of the bankruptcy proceedings and the length of time necessary to resolve the case, either through settlement or various court proceedings.
Risks Related to Our Common Stock
Provisions in our executive officers’ employment agreements could impede an attempt to replace or remove our directors or otherwise effect a change of control, which could diminish the price of our common stock.
We have entered into employment agreements with certain of our executive officers. These agreements provide for substantial payments upon the occurrence of certain triggering events, including a material diminution of base salaries or responsibilities. These payments may deter any transaction that would result in a change in control, which could diminish the price of our common stock.
These provisions could delay or prevent a change of control that a shareholder might consider favorable. For example, these provisions may prevent a shareholder from receiving the benefit from any premium over the market price of our common stock offered by a bidder in a potential takeover. Even in the absence of an attempt to effect a change in management or a takeover attempt, these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging changes in management and takeover attempts in the future. Furthermore, our articles of incorporation and our bylaws provide that the number of directors shall be fixed from time to time by our board of directors, provided that the board shall consist of at least three and no more than fifteen members.
The market price of our stock has been highly volatile.
The market price of our common stock has fluctuated and could fluctuate substantially in the future. This volatility may subject our stock price to material fluctuations due to the factors discussed in this Risk Factors section, and other factors including market reaction to the estimated fair value of our portfolio; our capital structure; cash position; our ability to service our debt; rumors or dissemination of false information; changes in coverage or earnings estimates by analysts; our ability to
meet analysts’ or market expectations; and sales of common stock by existing shareholders. A decline in the market price of our common stock could adversely affect our ability to raise capital by issuing additional securities.
The conversion rate for the Convertible Notes will be adjusted in connection with a make-whole fundamental change.
The provisions of the New Convertible Note Indenture include a make-whole provision to compensate the holders of such notes for the lost option time value and forgone interest payments upon the Company experiencing a Fundamental Change (as defined in the New Convertible Note Indenture). These Fundamental Changes revolve around change in beneficial ownership, the consummation of specified transactions which result in the conversion of common stock into other assets or the sale, transfer or lease of all or substantially all of the Company’s assets, a majority change in the composition of the Company’s Board of Directors, the Company’s stockholders' approval of any plan for liquidation of dissolution of the Company, and the Common Stock ceasing to be listed or quoted on a Trading Market (as defined under the New Convertible Notes). The number of incremental additional shares to be issued as a result of a Fundamental Change is based on a table which calculates the adjustment based on the inputs of time and share value. Such increase in the conversion rate will dilute the ownership interest of our common stock shareholders.
Provisions in our articles of incorporation and bylaws, as well as the Board Rights agreements entered into as part of our 2017 recapitalization, could impede an attempt to replace or remove our directors or otherwise effect a change of control, which could diminish the price of our common stock.
Our articles of incorporation and bylaws contain provisions that may entrench directors and make it more difficult for shareholders to replace directors even if the shareholders consider it beneficial to do so. In particular, shareholders are required to provide us with advance notice of shareholder nominations and proposals to be brought before any annual meeting of shareholders, which could discourage or deter a third party from conducting a solicitation of proxies to elect its own slate of directors or to introduce a proposal. In addition, our articles of incorporation eliminate our shareholders’ ability to act without a meeting and require the holders of not less than 50% of the voting power of our common stock to call a special meeting of shareholders. In addition, our bylaws require that in order to be eligible to nominate or propose for nomination a candidate for election as a director, a shareholder must own at least one percent of the Company's outstanding shares of common stock for no less than twelve months.
Certain laws of the State of Florida could impede a change of control, which could diminish the price of our common stock.
As a Florida corporation, we are subject to the Florida Business Corporation Act, which provides that a person who acquires shares in an "issuing public corporation," as defined in the statute, in excess of certain specified thresholds generally will not have any voting rights with respect to such shares, unless such voting rights are approved by the holders of a majority of the votes of each class of securities entitled to vote separately, excluding shares held or controlled by the acquiring person. The Florida Business Corporation Act also contains a statute which provides that an affiliated transaction with an interested shareholder generally must be approved by (i) the affirmative vote of the holders of two thirds of our voting shares, other than the shares beneficially owned by the interested shareholder, or (ii) a majority of the disinterested directors.
One of our subsidiaries, Imperial Life Settlements, LLC, a Delaware limited liability company, is licensed as a viatical settlement provider and is regulated by the Florida Office of Insurance Regulation. As a Florida viatical settlement provider, Imperial Life Settlements, LLC is subject to regulation as a specialty insurer under certain provisions of the Florida Insurance Code. Under applicable Florida law, no person can finally acquire, directly or indirectly, 10% or more of the voting securities of a viatical settlement provider or its controlling company without the written approval of the Florida Office of Insurance Regulation. Accordingly, any person who acquires beneficial ownership of 10% or more of our voting securities will be required by law to notify the Florida Office of Insurance Regulation no later than five days after any form of tender offer or exchange offer is proposed, or no later than five days after the acquisition of securities or ownership interest if no tender offer or exchange offer is involved. Such person will also be required to file with the Florida Office of Insurance Regulation an application for approval of the acquisition no later than 30 days after the same date that triggers the 5-day notice requirement.
The Florida Office of Insurance Regulation may disapprove the acquisition of 10% or more of our voting securities by any person who refuses to apply for and obtain regulatory approval of such acquisition. In addition, if the Florida Office of Insurance Regulation determines that any person has acquired 10% or more of our voting securities without obtaining its regulatory approval, it may order that person to cease the acquisition and divest itself of any shares of our voting securities that may have been acquired in violation of the applicable Florida law. Due to the requirement to file an application with and obtain approval from the Florida Office of Insurance Regulation, purchasers of 10% or more of our voting securities may incur
additional expenses in connection with preparing, filing and obtaining approval of the application, and the effectiveness of the acquisition will be delayed pending receipt of approval from the Florida Office of Insurance Regulation.
The Florida Office of Insurance Regulation may also take disciplinary action against Imperial Life Settlements, LLC’s license if it finds that an acquisition of our voting securities is made in violation of the applicable Florida law and would render the further transaction of business hazardous to our counterparties, creditors, shareholders or the public.
Due to delisting our common stock from the New York Stock Exchange ("NYSE"), you may find it difficult to dispose of your shares and our share price may be adversely affected.
On January 23, 2017, we voluntarily delisted our common stock from the NYSE, and on February 3, 2017, the trading of our common stock began on the over-the-counter market, OTCQB. On May 29, 2018, trading of our common stock moved to the OTCQX market. Such trading could reduce the market liquidity of our common stock. As a result, investors may find it more difficult to dispose of, or obtain accurate quotations for the price of, our common stock, and our ability to raise future capital through the sale of the shares of our common stock or other securities convertible into or exercisable for our common stock could be severely limited.
Trading in our common stock might also become subject to the requirements of certain rules promulgated under the Securities Exchange Act of 1934, which require additional disclosure by broker-dealers in connection with any trade involving a stock defined as a "penny stock" (generally, any equity security not listed on a national securities exchange that has a market price of less than $5.00 per share, subject to certain exceptions). Many brokerage firms are reluctant to recommend low-priced stocks to their clients. Moreover, various regulations and policies restrict the ability of stockholders to borrow against or "margin" low-priced stocks, and declines in the stock price below certain levels may trigger unexpected margin calls. Additionally, because brokers’ commissions on low-priced stocks generally represent a higher percentage of the stock price than commissions on higher priced stocks, the current price of the common stock can result in an individual stockholder paying transaction costs that represent a higher percentage of total share value than would be the case if our share price were higher. This factor may also limit the willingness of institutions to purchase our common stock. Finally, the additional burdens imposed upon broker-dealers by these requirements could discourage broker-dealers from facilitating trades in our common stock, which could severely limit the market liquidity of the stock and the ability of investors to trade our common stock, thereby negatively impacting the share price of our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our offices are located at 5355 Town Center Road, Suite 701, Boca Raton, Florida 33486 and consist of approximately 11,000 square feet of leased office space. We consider our facilities to be adequate for our current operations.
Item 3.
Item 3. Legal Proceedings
For a description of legal proceedings, see "Litigation” under Note 18, "Commitments and Contingencies" to the accompanying consolidated financial statements.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
During the eleven months ended November 30, 2018, shares of our common stock were traded on the OTC Market Group’s OTCQB marketplace through May 28, 2018, and beginning May 29, 2018, on the OTCQX marketplace under the trading symbol "EMGC."
The following table shows the high and low sales prices for our common stock for the periods indicated, as reported by the OTC:
As of March 14, 2019, we had 18 holders of record of our common stock and the closing stock price was 0.09.
Dividend Policy
We have never paid any cash dividends on our common stock and do not expect to pay any cash dividends on our common stock for the foreseeable future. We currently intend to retain any future earnings to finance our operations. Any future determination to pay cash dividends on our common stock will be at the discretion of our board of directors and will be dependent on our earnings, financial condition, operating results, capital requirements, any contractual, regulatory and other restrictions on the payment of dividends by us or by our subsidiaries to us, and other factors that our board of directors deems relevant.
We are a holding company and have no direct operations. Our ability to pay dividends in the future depends on the ability of our operating subsidiaries to pay dividends to us. Certain of our debt arrangements, including the White Eagle Revolving Credit Facility, restrict the ability of certain of our special purpose subsidiaries to pay dividends. In addition, future debt arrangements may contain prohibitions or limitations on the payment of dividends.
Equity Compensation Plans
Awards under our Amended and Restated 2010 Omnibus Incentive Plan (as amended, the "Omnibus Plan" may consist of incentive awards, stock options, stock appreciation rights, performance shares, performance units, and shares of common stock, restricted stock, restricted stock units or other stock-based awards as determined by the compensation committee of the Company's board of directors. The Omnibus Plan provides for an aggregate of 12,600,000 shares of common stock to be reserved for issuance under the Omnibus Plan, subject to adjustment as provided in the Omnibus Plan. See Item 12, "Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters" for additional information.
Recent Sales of Unregistered Securities
There are no recent sales of unregistered securities that have not been previously included in a Quarterly Report on Form 10-Q or in a Current Report on Form 8-K.
Purchases of Equity Securities
There were no purchases during the eleven months ended November 30, 2018.
Item 6.
Item 6. Selected Financial Data
The following table sets forth our selected historical consolidated financial and operating data as of such dates and for such periods indicated below. These selected historical consolidated results are not necessarily indicative of results to be expected in any future period. You should read the following financial information together with the other information
contained in this Transition Report on Form 10-KT, including Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and related notes.
The selected historical statement of operations data and balance sheet data for the last five years were derived from our audited consolidated financial statements and reflect the retroactive revision to reflect the classification of our structured settlement business as discontinued operations.
(1)
As of November 30, 2018, there were 158,733,928 and 158,125,928 shares of common stock issued and outstanding, respectively, and 608,000 shares of treasury stock.
Selected Operating Data (dollars in thousands):
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with the consolidated financial statements and accompanying notes and the information contained in other sections of this Transition Report on Form 10-KT, particularly under the headings "Risk Factors," "Selected Financial Data" and "Business." This discussion and analysis is based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. The statements in this discussion and analysis concerning expectations regarding our future performance, liquidity and capital resources, as well as other non-historical statements in this discussion and analysis, are forward-looking statements. See "Cautionary Statement Regarding Forward-Looking Statements." These forward-looking statements are subject to numerous risks and uncertainties, including those described under "Risk Factors." Our actual results could differ materially from those suggested or implied by any forward-looking statements.
Business Overview
Emergent Capital, Inc. was founded in December 2006 as a Florida limited liability company, Imperial Holdings, LLC, and converted into Imperial Holdings, Inc. on February 3, 2011, in connection with the Company’s initial public offering. Effective September 1, 2015, the name was changed to Emergent Capital, Inc. (with its subsidiary companies, the "Company" or "Emergent Capital").
Emergent Capital, through its consolidated and deconsolidated subsidiaries, owns a portfolio of 588 life insurance policies, also referred to as life settlements, with a fair value of $506.4 million and an aggregate death benefit of approximately $2.8 billion at November 30, 2018 .The Company primarily earns income on these policies from changes in their fair value and through death benefits. 586 of these policies, with an aggregate death benefit of approximately $2.8 billion and a fair value of approximately $505.2 million at November 30, 2018, are pledged under a $370.0 million, revolving credit agreement (the "White Eagle Revolving Credit Facility") entered into by the Company’s indirect subsidiary, White Eagle Asset Portfolio, LP ("White Eagle"). At November 30, 2018, two policies owned by the Company, with an aggregate death benefit of approximately $12.0 million and a fair value of $1.2 million, were not pledged as collateral under the White Eagle Revolving Credit Facility.
Stock Purchase Agreement
On January 22, 2018, the Company entered into a stock purchase agreement (the "Agreement") with SB Holdings, Inc., a California corporation ("Holdings"), and Sherman, Clay & Co., an Indiana corporation and wholly-owned Subsidiary of Holdings ("Sherman, Clay") pursuant to which the Company agreed to purchase all of the issued and outstanding capital stock of Sherman, Clay from Holdings for an initial purchase price of 18,000,000 shares (the "Initial Shares") of the Company’s common stock of which 2,700,000 shares will be held back for up to 18 months from closing to offset potential indemnified claims. The initial purchase price is subject to increase pursuant to earn-outs based on financial performance during the first year after the acquisition closes (the "Additional Shares") and, together with the Initial Shares, the "Consideration Shares") as provided for in the Agreement.
The Agreement contains standard representations and warranties related to each party, and may be terminated prior to the closing under certain circumstances. The closing of the purchase of Sherman, Clay under the Agreement (the "Purchase") is subject to a number of closing conditions, including certain regulatory approvals and obtaining financing for working capital and general corporate purposes.
In connection with the consummation of the Purchase, the Company also agreed to, among other things, enter into a registration rights agreement pursuant to which it will register the resale of the Consideration Shares.
On July 10, 2018, Company, Holdings and Sherman, Clay & Co. entered into a letter agreement (the "Letter") terminating the Agreement. The termination was effected by mutual written consent of the Parties pursuant to Section 7.01 of the Agreement, without any liability, obligation or penalty incurred by any Party.
Change in Trading Platform
During the eleven months ended November 30, 2018, the Company received approval for shares of its common stocks to be traded on the OTCQX® Best Market. Trading on the OTCQX commenced on May 29, 2018 and will continue under the ticker symbol "EMGC."
Change in Financial Year End
On September 7, 2018, the Board of Directors adopted resolutions to change the Company’s fiscal year end, and have the Company cause its direct and indirect subsidiaries change their fiscal year ends, from December 31 to November 30, effective immediately. The Company is filing this Transition Report on Form 10-KT in accordance with SEC rules and regulations. Our financial results for the fiscal year ended November 30, 2018 will cover transactions from January1, 2018 to November 30, 2018, while the financial results for fiscal year ended December 31, 2017 will cover the period from January1, 2017 to December 31, 2017, and the results for the eleven month transition period ending on November 30, 2018 are compared to the results of our previous twelve month fiscal year-end as of December 31, 2017.
Voluntary Petitions for Relief Under Chapter 11 and De-consolidation of Subsidiaries
On November 14, 2018 (the "Petition Date"), Lamington Road Designated Activity Company (formerly known as Lamington Road Limited), the Company’s wholly-owned indirect Irish subsidiary ("Lamington"), and White Eagle General Partner, LLC, the Company’s wholly-owned indirect Delaware subsidiary ("WEGP"), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court". Lamington is the limited partner and owns 99.99%, and WEGP is the general partner and owns 0.01%, of White Eagle. In its capacity as general partner, WEGP manages the affairs of White Eagle. The Lamington and WEGP filings are referred to as the "November Chapter 11 Cases."
Subsequent Event
On December 13, 2018, White Eagle filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The Chapter 11 case is being administered under case number 18-12808 (the "White Eagle Chapter 11 Case").
The commencement of the White Eagle Chapter 11 Case would constitute a default and event of default under the terms of the Amended and Restated Indenture between the Company and Wilmington Trust, National Association, as indenture trustee (the "Senior Note Indenture") relating to the Company’s 8.5% Senior Secured Notes due 2021 (the "Senior Notes") and the Indenture between the Company and U.S. Bank, National Association, as indenture trustee (the "Convertible Note Indenture") relating to the Company’s 5.0% Senior Unsecured Convertible Notes due 2023 (the "Convertible Notes"). However, such defaults and events of default and their consequences were waived in advance of the White Eagle Chapter 11 Case by holders of all of the outstanding principal amount of the outstanding Senior Notes and by holders of a majority of the outstanding principal amount of the outstanding Convertible Notes, and consequently, the Company believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred under either the Senior Note Indenture or the Convertible Note Indenture.
The commencement of the White Eagle Chapter 11 Case, together with the related filings of Chapter 11 cases for Lamington and WEGP on November 14, 2018 (collectively with the White Eagle Chapter 11 Case, the ("Chapter 11 Cases"), constitutes an event of default under the White Eagle’s Revolving Credit Facility (the "Credit Facility"), resulting in the principal and accrued interest due from White Eagle thereunder becoming immediately due and payable. Lamington and WEGP have pledged their respective interests in White Eagle to secure its obligations under the Credit Facility. Any efforts by LNV Corporation, the lender under the Credit Facility ("LNV"), or CLMG Corp., the administrative agent under the Credit Facility ("CLMG"), to enforce repayment by White Eagle and/or such pledges by Lamington and WEGP of their respective interests in White Eagle in connection with the Credit Facility are automatically stayed as a result of the commencement of the Chapter 11 Cases and LNV’s and CLMG’s rights of enforcement in respect of the Credit Facility are subject to the applicable provisions of the Bankruptcy Code. The previously announced Standstill Agreement among White Eagle, LNV and CLMG expired prior to the filing of the White Eagle Chapter 11 Case.
In connection with the White Eagle Chapter 11 Case, on January 15, 2019, the Court authorized the Debtors to use the proceeds of the cash collateral for a period of twenty (20) weeks (the "Cash Collateral'). The Cash Collateral may be used solely for the purposes permitted under the budget approved by the Court, including (i) to provide working capital needs of the Debtors and general corporate purposes of the Debtors, (ii) to make the payments or fund amounts otherwise permitted in the final order that authorized such uses and such budget, (iii) to fund amounts necessary to pay certain fees; and (iv) to fund amounts necessary to pay certain professional fees in accordance with such Budget.
See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information.
Lamington's and its subsidiaries (White Eagle, WEGP and Lamington Road Bermuda Limited), financial results are included in the Company’s consolidated results through November 13, 2018, the day prior to the Petition Date. However, ASC 810, Consolidation require that an entity whose financial statements were previously consolidated with those of its parent that files for protection under the U.S. Bankruptcy Code, whether solvent or insolvent, generally must be prospectively deconsolidated from the parent and presented on the cost method (Deconsolidation applies to Lamington and all subsidiaries owned, directly or indirectly, by Lamington, including WEGP, White Eagle and Lamington Road Bermuda), (the "Deconsolidated Entities" or the "Debtors"). Therefore, our 2018 results are not comparable with 2017, the post-petition results are not included in our consolidated results for the eleven months ended November 30, 2018. The cost method requires the Company to present its ownership interests in the net assets of Lamington as an investment measured at fair value as of the Petition Date and not recognize the income or loss of Lamington in the Company’s results of operations during the reorganization period. When Lamington emerges from the jurisdiction of the Bankruptcy Court, the subsequent accounting will be determined based upon the applicable circumstances and facts at such time, including the terms of any plan of reorganization. The Debtors will continue to operate their businesses as "debtors-in-possession" under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. Emergent Capital (exclusive of its subsidiaries) is a separate entity with independent capital structures and has not filed for bankruptcy relief and is continuing to operate in the ordinary course.
Liquidity
Historically, the Company has incurred substantial losses, which has resulted in an accumulated deficit of approximately $306.0 million as of November 30, 2018, of this amount, approximately $170.0 million relates to the activities for the eleven months ended November 30, 2018 for which $150.9 million represents change in fair value of investment in our deconsolidated subsidiaries as a result of their Chapter 11 filing. Cash flows used in operating activities were $41.2 million for the eleven months ended November 30, 2018 and $34.8 million for the year ended December 31, 2017. As of November 30, 2018, we had approximately $1.2 million of cash and cash equivalents and certificates of deposit of $500,000; of this amount, approximately $1.2 million is available to pay premiums on the two unencumbered policies of which such expenses will approximate $162,000 in 2019 and other overhead expenses. Further, on February 15, 2019, we were in default with respect to approximately $1.2 million of principal balance together with accrued and unpaid interest on our 8.5% Senior Unsecured Convertible Notes as a result of our failure to pay the principal and accrued and unpaid interest due and payable on such date, which date was the stated maturity date of the 8.5% Senior Unsecured Convertible Notes. See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information.
The Company’s ability to continue as a going concern is dependent on its ability to meet its liquidity needs through a combination of factors including but not limited to, the receipt of death benefits from life insurance policy maturities, strategic capital market raises, pledged policy sales (subject to certain asset sale restrictions by the bankruptcy court), secure financing needed to exit the bankruptcy process, the approval of the Bankruptcy Court to continue utilizing death benefits for payment of premiums and cash on hand.
As of the filing date of this Form 10-KT, we had approximately $3.3 million of cash and cash equivalents inclusive of certificates of deposit of $503,000. Our deconsolidated subsidiaries holds approximately $23.0 million in cash and cash equivalents which is restricted by the Bankruptcy Court. In considering our forecast for the next twelve months and the pending approval of the Debtors Chapter 11 reorganization plan by the Bankruptcy Court, these facts, aggregated with the current cash balance as of the filing for this Form 10-KT, create a substantial doubt of the Company’s ability to meet their financial needs. In considering the factors above, management plans to continue to operate our business and to seek Bankruptcy Court approval to continue to use cash collateral after the expiration of the initially approved twenty (20) week period.
The accompanying consolidated financial statements are prepared on a going concern basis and do not include any adjustments that might result from uncertainty about our ability to continue as a going concern.
Other Events Before Deconsolidation of Subsidiaries
Our deconsolidated subsidiary, White Eagle is the owner of 586 life insurance policies with an aggregate death benefit of approximately $2.8 billion and an estimated fair value of approximately $505.2 million at November 30, 2018. White Eagle pledged its policies as collateral to secure borrowings made under the White Eagle Revolving Credit Facility, which is used, among other things, to pay premiums on the life insurance policies owned by White Eagle. Borrowings under the White Eagle Revolving Credit Facility fund the payment of premiums on the life insurance policies that have
been pledged as collateral for the facility. Note 23, "Subsequent Events," of the accompanying consolidated financial statements for information on White Eagle's premium payments subsequent to its Chapter 11 filing.
See "Liquidity and Capital Resources" under Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations."
During the eleven months ended November 30, 2018, 20 life insurance policies with face amounts totaling $93.4 million matured. The net gain on these maturities was $53.3 million. The gains related to maturities are included in income from changes in fair value of life settlement in the consolidated statement of operations for the eleven months ended November 30, 2018. All 20 policies served as collateral under the White Eagle Revolving Credit Facility. Proceeds from maturities totaling $90.8 million were received pre-petition during the eleven months ended November 30, 2018 Of this amount, approximately $64.9 million inclusive of approximately $7.8 million collected during the year ended December 31, 2017, were utilized to repay borrowings, interest and expenses under the White Eagle Revolving Credit Facility during the eleven months ended November 30, 2018, approximately $5.0 million in proceeds was received after the petition period and is included in the $28.1 million on account for White Eagle awaiting distribution through the waterfall, this amount was subsequently approved by the Bankruptcy Court to be used solely for the purposes permitted under the budget approved by the Court. See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information.
Assuming we recognize no policy maturities, our estimated premiums for 2019 would be $105.8 million. White Eagle would be eligible to borrow approximately $105.6 million of this amount , subject to the Company securing new financing to exit the bankruptcy process, with approximately $163,000 in estimated premiums required to maintain the policies not pledged as collateral under the White Eagle Revolving Credit Facility as of November 30, 2018.
Critical Accounting Policies
Critical Accounting Estimates
The preparation of the financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. We base our judgments, estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions and conditions. We evaluate our judgments, estimates and assumptions on a regular basis and make changes accordingly. We believe that the judgments, estimates and assumptions involved in the accounting for income taxes, the valuation of life settlements, the valuation of the debt owing under the White Eagle Revolving Credit Facility, the valuation of the investment in deconsolidated subsidiaries and the valuation of our conversion derivative liability formerly embedded within the Convertible Notes have the greatest potential impact on our financial statements and accordingly believe these to be our critical accounting estimates.
Fair Value Measurement Guidance
We follow ASC 820, Fair Value Measurements and Disclosures, which defines fair value as an exit price representing the amount that would be received if an asset were sold or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our investments in life insurance policies and White Eagle Revolving Credit Facility debt are considered Level 3 as there is currently no active market where we are able to observe quoted prices for identical assets/liabilities and our valuation model incorporates significant inputs that are not observable. See Note 16 "Fair Value Measurements" to the accompanying consolidated financial statements for a discussion of our fair value measurement.
Fair Value Option
We have elected to account for life settlements using the fair value method. The fair value of the asset is the estimated amount that would be received to sell an asset in an orderly transaction between market participants at the measurement date. We calculate the fair value of the asset using a present value technique to estimate the fair value of its life settlements. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. See Note 9, "Life Settlements (Life Insurance Policies)" and Note 16, "Fair Value Measurements" for further information.
We have elected to account for the debt under the White Eagle Revolving Credit Facility, which includes the interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the estimated amount that would have to be paid to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of assumptions and/or estimation methodologies could have a material effect on the estimated fair values.
Income Recognition
Our primary sources of income are in the form of changes in fair value of life settlements and gains on life settlements, net. Our income recognition policies for these sources of income are as follows:
•
Changes in Fair Value of Life Settlements-When the Company acquires certain life insurance policies we initially record these investments at the transaction price, which is the fair value of the policy for those acquired upon relinquishment or the amount paid for those policies acquired for cash. The fair value of the investment in insurance policies is evaluated at the end of each reporting period. Changes in the fair value of the investment based on evaluations are recorded as changes in fair value of life settlements in our consolidated statement of operations. The fair value is determined on a discounted cash flow basis that incorporates current life expectancy assumptions. The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The Company recognizes income from life settlement maturities on the date we are in receipt of death notice or verified obituary of the insured. This income is the difference between the death benefits and fair values of the policy at the time of maturity.
•
Gain/Loss on Life Settlements, Net-The Company recognizes gains or losses from life settlement contracts that the Company owns upon the signed sale agreement and/or filing of ownership forms and funds transferred to escrow.
Deferred Debt Costs
Deferred debt costs include costs incurred in connection with acquiring and maintaining debt arrangements. These costs are directly deducted from the carrying amount of the liability in the consolidated balance sheets, are amortized over the life of the related debt using the effective interest method and are classified as interest expense in the accompanying consolidated statement of operations. These deferred costs are related to the Company's 8.5% Convertible Notes, 5% Convertible Notes and 8.5% Senior Secured Notes. The Company did not recognize any deferred debt costs on the Revolving Credit Facilities given all costs were expensed due to electing the fair value option in valuing the Revolving Credit Facilities.
Income Taxes
We account for income taxes in accordance with ASC 740, Income Taxes. Under ASC 740, deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies varies, adjustments to the carrying value of the deferred tax assets and liabilities may be required. Valuation allowances are based on the "more likely than not" criteria of ASC 740.
The accounting for uncertain tax positions guidance under ASC 740 requires that we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. We recognize interest and penalties (if any) on uncertain tax positions as a component of income tax expense.
On December 22, 2017, the United States enacted the Tax Cuts and Jobs Act ("TCJA"). Effective for tax years beginning after December 31, 2017, under certain circumstances, Section 245A enacted by the TCJA eliminated U.S. federal income tax on dividends received from foreign subsidiaries of domestic corporations under a new participation exemption. However, the TCJA also created a new tax on certain taxed foreign income under new Section 951A. Specifically, income earned in excess of a deemed return on tangible assets held by a controlled foreign corporation (such excess referred to as Global Intangible Low-Taxed Income ("GILTI") ) must now generally be included as U.S. taxable income on a current basis by its U.S. shareholders. Based on the Company’s life settlement assets held within Ireland, management expects the net income generated from these activities to qualify entirely as GILTI effective for its tax year beginning December 1, 2018. On January 10, 2018, the FASB provided guidance on how to account for deferred tax assets and liabilities expected to reverse in future years as GILTI. The FASB provided that a company may either (1) elect to treat taxes due on future U.S. inclusions of GILTI as a current-period expense when incurred or (2) factor such amounts into the Company’s measurement of its deferred taxes. For its reporting period ended December 31, 2017, the Company adopted an accounting policy to treat any future GILTI inclusion as a current-period expense instead of providing for U.S. deferred taxes on all temporary differences related to future GILTI items.
Stock-Based Compensation
We have adopted ASC 718, Compensation-Stock Compensation. ASC 718 addresses accounting for share-based awards, including stock options, restricted stock, performance shares and warrants, with compensation expense measured using fair value and recorded over the requisite service or performance period of the award. The fair value of equity instruments will be determined based on a valuation using an option pricing model that takes into account various assumptions that are subjective. Key assumptions used in the valuation will include the expected term of the equity award taking into account both the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award. Compensation expense associated with performance shares is only recognized to the extent that it is probable the performance measurement will be met.
Held-for-sale and discontinued operations
The Company reports a business as held-for-sale when management has approved or received approval to sell the business and is committed to a formal plan, the business is available for immediate sale, the business is being actively marketed, the sale is anticipated to occur during the ensuing year and certain other specified criteria are met. A business classified as held-for-sale is recorded at the lower of its carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Depreciation is not recorded on assets of a business classified as held-for-sale. Assets and liabilities related to a business classified as held-for-sale are segregated in the Consolidated Balance Sheet and major classes are separately disclosed in the notes to the Consolidated Financial Statements commencing in the period in which the business is classified as held-for-sale. The Company reports the results of operations of a business as discontinued operations if the business is classified as held-for-sale, the operations and cash flows of the business have been or will be eliminated from the ongoing operations of the Company as a result of a disposal transaction and the Company will not have any significant continuing involvement in the operations of the business after the disposal transaction. The results of discontinued operations are reported in Discontinued Operations in the Consolidated Statement of Operations for current and prior periods commencing in the period in which the business meets the criteria of a discontinued operation, and include any gain or loss recognized on closing or adjustment of the carrying amount to fair value less cost to sell. During the fourth quarter of 2013, the Company sold substantially all of its structured settlements business. As a result, the Company has classified its structured settlement operating results as discontinued operations.
Foreign Currency
The Company owns certain foreign subsidiaries formed under the laws of Ireland and Bermuda. These foreign subsidiaries utilize the U.S. dollar as their functional currency. The foreign subsidiaries’ financial statements are denominated in U.S. dollars and therefore, there are no translation gains and losses resulting from converting the financial statements at exchange rates other than the functional currency. Any gains and losses resulting from foreign currency transactions
(transactions denominated in a currency other than the subsidiaries’ functional currency) are included in income. These gains and losses are immaterial to the Company’s financial statements.
Deconsolidation
Lamington and its subsidiaries (White Eagle and WEGP) filing for reorganization was a reconsideration event for Emergent Capital to reevaluate whether consolidation of Lamington and its subsidiaries (White Eagle, WEGP and Lamington Road Bermuda Limited) (the deconsolidated entities) continued to be appropriate. Under ASC 810, Consolidation, specifically ASC 810-10-15, consolidation of a majority-owned subsidiary is precluded where control does not rest with the majority owners, for instance, where the subsidiary is in legal reorganization or bankruptcy. Accordingly, when a subsidiary files for bankruptcy, it is appropriate for the parent to deconsolidate the subsidiary. Under ASC 810, this loss of control would likely trigger a gain or loss for the parent as the parent would remeasure its retained noncontrolling investment at fair value. We assessed the inherent uncertainties associated with the outcome of the Chapter 11 reorganization process and the anticipated duration thereof, and concluded that it was appropriate to deconsolidate Lamington and its subsidiaries effective on the Petition Date.
At November 13, 2018, the pre-petition date, the Company valued its investment in Lamington to be $278.4 million, of which $127.3 million represents equity, $145.9 million represents promissory notes and interest receivable and $5.2 million in other liabilities, which is equivalent to the Company's book value. This valuation was determined by performing an internal fair value calculation of the assets and liabilities of Lamington under ASC 820, Fair Value Measurement. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The Company calculated the fair value of the White Eagle Revolving Credit Facility using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the Company’s estimates are not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values. All other assets and liabilities were deemed equivalent to their carrying value as at the pre-petition date. Note 16, "Fair Value Measurements," of the accompanying consolidated financial statements.
ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities was effective for calendar year-end public business entities in 2018. Under the new guidance, a reporting entity should account for its equity investments that are not consolidated or accounted for under the equity method at fair value, with changes to fair value recorded in current earnings. Lamington's main subsidiary, White Eagle, carries its life settlements policies and debt under the White Eagle Revolving Credit Facility at fair value, these valuation are based on inputs that are both significant to the fair value measurement and unobservable. As a result, the Company adopted ASU 2016-01 to value its investment in Lamington during the eleven months ended November 30, 2018. The calculation was performed consistent with ASC 820, Fair Value Measurement with changes in fair value recorded in current earnings.
Related Party Relationship
Upon filing for Chapter 11 and the subsequent deconsolidation, transactions with Lamington are no longer eliminated in consolidation and are treated as related party transactions for Emergent Capital. See Note 4 "Condensed and Consolidated Financial Statements For Entities in Bankruptcy" for all transactions between Emergent Capital and Lamington.
Accounting Changes
Note 2, "Summary of Significant Accounting Policies," of the Notes to Consolidated Financial Statements discusses accounting standards adopted in 2018, as well as accounting standards recently issued but not yet required to be adopted and the expected impact of these changes in accounting standards. Any material impact of adoption is discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Consolidated Financial Statements.
Consolidated Results of Operations
The following is our analysis of the results of operations for the periods indicated below. This analysis should be read in conjunction with our financial statements, including the related notes to the financial statements.
On September 7, 2018, the Board of Directors adopted resolutions to change the Company’s fiscal year end, and have the Company cause its direct and indirect subsidiaries change their fiscal year ends, from December 31 to November 30, effective immediately. The Company is filing this Transition Report on Form 10-KT in accordance with SEC rules and regulations. Our financial results for the fiscal period ended November 30, 2018 will cover transactions from January 1, 2018 to November 30, 2018, while the financial results for calendar years ended December 31, 2017 and 2016 will cover results for the two years then ended, the results for the eleven months transition period ending on November 30, 2018 are compared to the results of our previous twelve months calendar year-end as of December 31, 2017.
Additionally, as a result of our subsidiaries Chapter 11 Cases, Lamington's and its subsidiaries (White Eagle, WEGP and Lamington Road Bermuda Limited), financial results are included in the Company’s consolidated results through November 13, 2018, the day prior to the Petition Date. However, ASC 810, Consolidation require that an entity whose financial statements were previously consolidated with those of its parent that files for protection under the U.S. Bankruptcy Code, whether solvent or insolvent, generally must be prospectively deconsolidated from the parent and presented as an equity investment. Therefore, our 2018 results are not comparable with 2017, and the post-petition results are not included in our consolidated results for the eleven months ended November 30, 2018. The results of White Eagle represents the Company's core business, and although the results are deconsolidated, the Company will analyze significant activities for the post-petition.
Our results of operations are discussed below in four parts: (i) our consolidated results of continuing operations, (ii) our results of deconsolidated subsidiaries (iii) results of continuing operations for 2017 compared to 2016, and (iv) our results of discontinued operations.
Results of Continuing Operations - Pre-Petition Date
Eleven Months Ended November 30, 2018 Compared to Twelve Months Ended December 31, 2017
Net loss from continuing operations for the eleven months ended November 30, 2018 was $169.9 million as compared to a loss of $3.2 million for the year ended December 31, 2017. The following is our analysis of net loss for the eleven months ended November 30, 2018 compared to twelve months ended December 31, 2017 (in thousands).
Income included net gain on maturity of 20 life settlements of $53.3 million compared to a net gain of $35.9 million on maturity of 13 life settlements during the twelve months ended December 31, 2017.
Income from continuing operations for the eleven months ended November 30, 2018 was a loss, which was significantly impacted by a negative change in fair value of life settlements as a result of changes made by the provider of life expectancy reports. This impact is approximately $124.0 million.
Historically, the Company has procured the majority of its life expectancy reports from two life expectancy report providers (AVS Underwriting LLC and 21st Services, LLC) for valuation purposes and average or "blending," the results of the two life expectancy reports to establish a composite mortality factor.
On October 18, 2018, 21st Services, LLC ("21st Services") announced revisions to its underwriting methodology, these revisions have generally been understood to lengthen the average reported life expectancy furnished by this life expectancy
provider by 9%. On October 29, 2018, AVS Underwriting LLC ("AVS"), also announced revisions to its underwriting methodology without an estimated impact, which resulted in an average lengthening of the life expectancies by approximately 13%.
To account for the impact of the revisions by 21st Services and based off of market responses to the methodology change, the Company decided to lengthen the life expectancies furnished by 21st Services by 9% as at November 30, 2018. The resulting impact is approximately $124.0 million reduction in the fair value of its life settlements.
Further, the Company has decide to no longer utilize the results of life expectancy reports furnished by AVS for valuation purposes. The Company's decision was based on a series of events leading up to the announcement on October 29, 2018, which includes AVS inability to furnish timely reports to allow the Company to blend the results to facilitate timely quarterly reporting. Market participants have expressed concerns regarding their inability to connect the new AVS model to past model. Effective November 2018, the Company discontinued its blending approach. The resulting impact is approximately $23.1 million reduction in the fair value of its life settlements.
Total expenses from continuing operations for the eleven months ended November 30, 2018 were mainly comprised of interest expense on the White Eagle Revolving Credit Facility of $22.8 million; $4.6 million on the 5% Convertible Notes and$3.0 million on the 8.5% Senior Secured Notes.
Approximately $150.9 million included in expense represents impairment of our investment in deconsolidated subsidiaries. At November 13, 2018, the pre-petition date, the Company valued its investment in Lamington to be $278.4 million, which is equivalent to the Company's book value. This valuation was determined by performing an internal fair value calculation of the assets and liabilities of Lamington under ASC 820, Fair Value Measurement. As a result of the Chapter 11 Cases, consistent with ASC 321, Investments - Equity Securities, the Company subsequently, measured its investment in Lamington at fair value as of November 30, 2018. Further, the Company engaged a third party to perform a quantitative assessment to determine the value of its investment in Lamington. The valuation report showed the fair value of the Company's investment in Lamington to be $128.8 million, which is $150.9 million lower than its pre-petition value. As a result, the Company recognized an impairment on its investment in Lamington at November 30, 2018, the amount is reflected in current earnings as change in fair value of investment in deconsolidated subsidiaries. The fair value of $128.8 million has inherent estimates including, but not limited to, when the Company will emerge from bankruptcy, the estimated discount rate, the value of the debt under the White Eagle Revolving Credit Facility, as well as other factors inherent in the valuation process.
Expense was positively impacted by change in fair of the White Eagle Revolving Credit Facility of approximately $70.9 million. The White Eagle Revolving Credit Facility incurred pre-petition gain, which is mainly attributable to lengthen the life expectancies furnished by 21st Services by 9% to determine the value of the life insurance policies pledged as collateral in the facility. This impacted the value of the debt by approximately $66.7 million. This amount is shown as a reduction to expenses on the statement of operations for the period ended November 30, 2018.
Total expenses from continuing operations for the twelve months ended December 31, 2017 were mainly comprised of interest expense of $16.8 million on the White Eagle Revolving Credit Facility; $9.2 million on the 8.5% Convertible Notes; $2.1 million on the 5% Convertible Notes; $2.8 million on the 15% Senior Secured Notes; $1.4 million on the 8.5% Senior Secured Notes, $2.0 million loss on extinguishment of debt, and a change in the fair value of the White Eagle Revolving Credit Facility of $4.5 million.
Change in fair value of life settlements (in thousands)
During the eleven months ended November 30, 2018, 20 life insurance policies with face amounts totaling $93.4 million matured, compared to 13 policies with face amounts of $67.2 million for the twelve months ended December 31, 2017. The net gain of these maturities was $53.3 million and $35.9 million for 2018 and 2017, respectively, and is recorded as a change in fair value of life settlements in the consolidated statements of operations for the eleven months ended November 30, 2018 and twelve months ended December 31, 2017. All 20 of the maturities served as collateral under the White Eagle Revolving Credit Facility. Proceeds from maturities totaling $95.8 million were received during the eleven months ended November 30, 2018. Of this amount, approximately $76.6 million inclusive of approximately $7.8 million collected during the year ended December 31, 2017 were utilized to repay borrowings, interest and credit facility expenses under the White Eagle Revolving Credit Facility.
Other items impacting the change in fair value include updated life expectancies procured by the Company in respect to the insureds' lives and maturities. The updated life expectancy reports implied that in aggregate, the insureds’ health improved, therefore, lengthening their life expectancies relative to the prior life expectancies.
Historically, the Company has procured the majority of its life expectancy reports from two life expectancy report providers (AVS Underwriting LLC and 21st Services, LLC) for valuation purposes and average or "blending," the results of the two life expectancy reports to establish a composite mortality factor.
On October 18, 2018, 21st Services, LLC ("21st Services") announced revisions to its underwriting methodology, these revisions have generally been understood to lengthen the average reported life expectancy furnished by this life expectancy provider by 9%. On October 29, 2018, AVS Underwriting LLC ("AVS"), also announced revisions to its underwriting methodology without an estimated impact, which resulted in an average lengthening of the life expectancies by approximately 13%.
To account for the impact of the revisions by 21st Services and based off of market responses to the methodology change, the Company decided to lengthen the life expectancies furnished by 21st Services by 9% as at November 30, 2018. The resulting impact is approximately $124.0 million reduction in the fair value of its life settlements.
Further, the Company has decide to no longer utilize the results of life expectancy reports furnished by AVS for valuation purposes. The Company's decision was based on a series of events leading up to the announcement on October 29, 2018, which includes AVS inability to furnish timely reports to allow the Company to blend the results to facilitate timely quarterly reporting. Market participants have expressed concerns regarding their inability to connect the new AVS model to past model. Effective November 30, 2018, the Company discontinued its blending approach. The resulting impact is approximately $23.1 million reduction in the fair value of its life settlements.
The Company re-evaluates its discount rates at the end of each reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company's portfolio of life settlements. In doing so, consideration is given to the various factors influencing the rates, including risk tolerance, market activity, credit exposure of the insurance company that issued the life insurance policy, and the estimated risk premium an investor in the policy would require, among other factors. In considering these factors at November 30, 2018, the Company determined that the weighted average discount rate calculated based on death benefit was 13.43% compared to 15.95% at December 31, 2017 for all policies including those of the deconsolidated entities.
As of November 30, 2018, we owned two policies with an estimated fair value of $1.2 million compared to 608 policies with a fair value of $567.5 million at December 31, 2017, a decrease of $566.3 million due to the deconsolidation of White Eagle. As of November 30, 2018, the aggregate death benefit of these life settlements was $12.0 million.
Of these two policies owned as of November 30, 2018, all were previously premium financed and are valued using discount rates that range from 13.25% to 14.75%.
See Note 16, "Fair Value Measurements," to the accompanying consolidated financial statements.
Expenses (in thousands)
Interest expense (in thousands)
Outstanding debt as of November 30, 2018 included $1.2 million of 8.5% Senior Unsecured Convertible Notes, $75.8 million of 5% Senior Unsecured Convertible Notes and $35.0 million of 8.5% Senior Secured Notes.
Of the interest expense of $30.8 million for the eleven months ended November 30, 2018, approximately $22.8 million represents interest paid on the White Eagle Revolving Credit Facility prior to its deconsolidation. The increase in interest expense resulted from an increase in the principal balance of the facility. Interest expense also includes approximately $340,000 for participation interest on the White Eagle Revolving Credit Facility paid during the eleven months ended November 30, 2018.
Interest expense on the 8.5% Senior Unsecured Convertible Notes totaled $169,000, including $93,000, $66,000 and $10,000 from interest, amortizing debt discounts and origination costs, respectively, during the eleven months ended November 30, 2018.
The Company recorded $4.6 million of interest expense on the 5.0% Senior Unsecured Convertible Notes, including $3.5 million, $947,000 and $140,000 from interest, amortization of debt discount and origination costs, respectively, during the eleven months ended November 30, 2018.
The Company recorded approximately $3.0 million of interest expense on the 8.5% Senior Secured Notes, which includes $2.8 million of interest and $244,000 of amortizing debt issuance costs respectively, during the eleven months ended November 30, 2018.
Of the interest expense of $32.8 million for the twelve months ended December 31, 2017, approximately $16.8 million represents interest paid on the White Eagle Revolving Credit Facility. The increase in interest expense resulted from an increase in the principal balance of the facility at December 31, 2017. Interest expense also includes approximately $467,000 for participation interest on the Facility paid during the twelve months ended December 31, 2017.
Interest expense on the 8.5% Convertible Notes totaled $9.2 million, including $4.2 million, $2.5 million, $2.1 million and $314,000 from interest, one time debt modification cost, amortizing debt discounts and origination costs, respectively. Interest for the twelve months ended December 31, 2017 included approximately $522,000 of additional interest paid in kind to note holders.
The Company recorded approximately $2.8 million of interest expense on the 15% Senior Secured Notes, which includes $2.6 million of interest and $184,000 of amortizing debt issuance costs, respectively, during the twelve months ended December 31, 2017. The 15% Senior Secured Notes were repaid and canceled on July 28, 2017 in connection with the 2017 recapitalization.
The Company recorded $2.1 million of interest expense on the New Convertible Notes, including $1.6 million, $432,000 and $64,000 from interest, amortization of debt discount and origination costs, respectively, during the twelve months ended December 31, 2017.
The Company recorded approximately $1.4 million of interest expense on the 8.5% Senior Secured Notes, which includes $1.3 million of interest and $98,000 of amortizing debt issuance costs, respectively, during the twelve months ended December 31, 2017.
See Notes 10, "White Eagle Revolving Credit Facility," ," 11, "8.50% Senior Unsecured Convertible Notes," 12, "5% Senior Unsecured Convertible Notes," 13, "15.0% Senior Secured Notes," and 14, "8.5% Senior Secured Notes," to the accompanying consolidated financial statements for further information.
Extinguishment of debt (in thousands)
During the twelve months ended December 31, 2017, approximately $2.0 million was recorded in loss on the extinguishment of debt for the 15.0% Senior Secured Notes, including $1.5 million and $518,000 related to prepayment penalty and write off of origination cost, respectively.
Change in fair value of the White Eagle Revolving Credit Facility (in thousands)
For the eleven months ended November 30, 2018, the White Eagle Revolving Credit Facility shows a gain of approximately $70.9 million compared to a loss of $4.5 million for the twelve months ended December 31, 2017. This loss is attributable to a combination of offsetting factors as discussed below:
During the eleven months ended November 30, 2018, the fair value of the White Eagle Revolving Credit Facility was impacted by increased borrowings, the lengthening of life expectancies of certain insureds' underlying policies pledged under the White Eagle Revolving Credit Facility and a slight increase in the discount rate used to value the facility.
The Facility incurred pre-petition gain of approximately $70.9 million, which is mainly attributable to lengthen the life expectancies furnished by 21st Services by 9% to determine the value of the life insurance policies pledged as collateral in the facility. This impacted the value of the debt by approximately $66.7 million. This amount is shown as a reduction to expenses on the statement of operations for the period ended November 30, 2018
During the twelve months ended December 31, 2017, the fair value of the White Eagle Revolving Credit Facility was impacted by increased borrowings, the lengthening of life expectancies of certain insureds' underlying policies pledged under the White Eagle Revolving Credit Facility and a slight increase in the discount rate used to value the facility.
See Note 16, "Fair Value Measurements," to the accompanying consolidated financial statements.
Selling, general and administrative expenses (in thousands)
The decrease in SG&A expense was primarily the result of a decrease in personnel costs of $2.4 million, a decrease in legal expense of $669,000, a decrease in other SG &A of $214,000, and a decrease in insurance costs of $49,000 offset by an increase in professional fees $1.0 million.
On August 3, 2017 and August 11, 2017, as a reduction in force, the Company reduced its headcount from 20 employees to 12 employees. The Company recognized a onetime severance cost of approximately $1.0 million related to this reduction, the amounts were included in personnel cost and were being paid over a period of twelve months.
Results of Operations for Deconsolidated Subsidiaries Post-Petition Period
Net loss from deconsolidated operations for the post-petition period to November 30, 2018 was $61.1 million and comprise the below:
Total income for the post-petition period was a loss of $6.0 million and mainly comprised change in fair value of life settlements loss of approximately $6.0 million.
Expense was significantly impacted by change in fair value of the White Eagle Revolving Credit Facility of approximately of approximately $53.6 million.
Change in fair value of life settlements (in thousands)
The change in fair value was impacted by updated life expectancies procured by the Company in respect to the insureds' lives and maturities. The updated life expectancy reports implied that in aggregate, the insureds’ health improved, therefore, lengthening their life expectancies relative to the prior life expectancies.
The Company re-evaluates its discount rates at the end of each reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company's portfolio of life settlements. In doing so, consideration is given to the various factors influencing the rates, including risk tolerance, market activity, credit exposure of the insurance company that issued the life insurance policy, and the estimated risk premium an investor in the policy would require, among other factors. In considering these factors at November 30, 2018, White Eagle determined that the weighted average discount rate calculated based on death benefit was 13.42% compared to 15.94% at December 31, 2017.
As of November 30, 2018, White Eagle owned 586 policies with an estimated fair value of $505.2 million with an aggregate death benefit of these life settlements was $2.8 billion. All 586 policies were pledged to the White Eagle Revolving Credit Facility. The Company also recorded a $27.7 million receivable for maturity of life settlements at November 30, 2018 relating to policies pledged to the White Eagle Revolving Credit Facility.
Of these 586 policies owned as of November 30, 2018, 512 were previously premium financed and are valued using discount rates that range from 12.25% - 19.25%. The remaining 74 policies are valued using discount rates that range from 12.25% - 13.75%. See Note 16, "Fair Value Measurements," to the accompanying consolidated financial statements.
Change in fair value of White Eagle Revolving Credit Facility (in thousands)
The White Eagle Revolving Credit Facility incurred post-petition loss of approximately $53.6 million, which is mainly attributable assumptions incorporated due to the Chapter 11 filing of the entity. This amount is shown as an increase to White Eagle's expenses on the statement of operations for the period ended November 30, 2018. Outstanding debt under the facility at November 30, 2018 was $363.8 million of outstanding principal.
The White Eagle Revolving Credit Facility is valued at November 30, 2018 using discount rates of 23.27% compared to 18.57% for the year ended December 31, 2017.
Refer to Note 3 "Deconsolidation of Subsidiaries", Note 4 "Condensed and Consolidated Financial Statements of Entities in Bankruptcy" and Note 5 "Consolidation of Variable Interest Entities", of the Notes to Consolidated Financial Statements, provided in this report.
Results of Continuing Operations
2017 Compared to 2016
Net loss from continuing operations for the year ended December 31, 2017 was $3.2 million as compared to a loss of $49.4 million for the year ended December 31, 2016. There was no tax benefit for the year ended December 31, 2017. The following is our analysis of net loss for the period (in thousands).
Income for the year ended December 31, 2017 was comprised mainly of a gain on maturity of 13 life settlements of $35.9 million compared to a net gain of $17.9 million on maturity of 12 life settlements during the same period in 2016.
Our income for the year ended December 31, 2016 was also significantly impacted by the adoption of the 2015 VBT, which resulted in a reduction in fair value of life settlements of $17.6 million.
Total expenses from continuing operations for the year ended December 31, 2017 were mainly comprised of interest expense of $16.8 million on the White Eagle Revolving Credit Facility; $9.2 million on the 8.5% Convertible Notes; $2.1 million on the 5% Convertible Notes; $2.8 million on the 15% Senior Secured Notes; $1.4 million on the 8.5% Senior Secured Notes, $2.0 million loss on extinguishment of debt, and a change in the fair value of the White Eagle Revolving Credit Facility of$4.5 million.
Total expenses for the year ended December 31, 2016 were also significantly impacted by a $15.7 million gain for the change in fair value of the Revolving Credit Facilities which is associated with the adoption of the 2015 VBT (as defined below).
Change in Fair Value of Life Settlements (in thousands)
During the year ended December 31, 2017, 13 life insurance policies with face amounts totaling $67.2 million matured, compared to 12 policies with face amounts of $37.5 million for the same period in 2016. The net gain of these maturities was $35.9 million and $17.9 million for 2017 and 2016, respectively, and is recorded as a change in fair value of life settlements in the consolidated statements of operations for the years ended December 31, 2017 and 2016. All 13 of the maturities served as collateral under the White Eagle Revolving Credit Facility. Proceeds from maturities totaling $42.1 million were received during the year ended December 31, 2017. Of this amount, approximately $37.1 million inclusive of approximately $2.5 million collected during the year ended December 31, 2016 were utilized to repay borrowings, interest and credit facility expenses under the White Eagle Revolving Credit Facility. The Company also recorded a $30.0 million receivable for maturity of life settlements at December 31, 2017 relating to policies pledged to the White Eagle Revolving Credit Facility.
During the year ended December 31, 2016, the Company changed its valuation technique and decided to adopt the 2015 VBT, smoker and gender distinct tables, to determine the value of the policies. The resulting impact was a reduction in the fair value of the life settlements of approximately $17.6 million for the year ended December 31, 2017.
Other items impacting the change in fair value include updated life expectancies procured by the Company in respect of the insured lives and maturities. The updated life expectancy reports implied that in aggregate, the insureds’ health improved, therefore lengthening their life expectancies relative to the prior life expectancies, which resulted in a decrease in fair value.
The Company re-evaluates its discount rates at the end of each reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company's portfolio of life settlements. In doing so, consideration is given to the various factors influencing the rates, including credit exposure of the insurance company that issued the life insurance policy, and the estimated risk premium an investor in the policy would require, among other factors. At December 31, 2017, the Company determined that the weighted average discount rate calculated based on death benefit was 15.95% compared to 16.37% at December 31, 2016. This resulted in a positive impact for the change in fair value of our life settlement for the year ended December 31, 2017.
As of December 31, 2017, the Company owned 608 policies with an estimated fair value of $567.5 million compared to 621 policies with a fair value of $498.4 million at December 31, 2016, an increase of $69.1 million or 14%. Of the 608 policies, 606 policies were pledged to the White Eagle Revolving Credit Facility. During the year ended December 31, 2016, the Company purchased $3.1 million in additional death benefit by acquiring retained portions of policy benefits from 20 policies for approximately $1.4 million. In addition, we acquired one life insurance policy for the same period ended 2016, which resulted in a gain of approximately $262,000. As of December 31, 2017, the aggregate death benefit of our life settlements was $2.9 billion.
Of these 608 policies owned as of December 31, 2017, 530 were previously premium financed and are valued using discount rates that range from 15.00% - 21.00%. The remaining 78 policies are valued using discount rates that range from 14.50% -17.50%. See Note 16, "Fair Value Measurements"," to the accompanying consolidated financial statements.
Expenses (in thousands)
Interest expense (in thousands)
Outstanding debt for the year ended December 31, 2017 includes $329.0 million of outstanding principal on the White Eagle Revolving Credit Facility, $1.2 million of 8.5% Convertible Notes, $75.8 million of 5% Convertible Notes and $35.0 million of 8.5% Senior Secured Notes.
The Company's outstanding debt increased by $78.9 million from $362.1 million at December 31, 2016 to $441.1 million at December 31, 2017. The increase is mainly attributable to a net increase in principal of $67.7 million on the White Eagle Revolving Credit Facility, a $75.8 million increase in the 5% Convertible Notes, a $35.0 million increase in the 8.5% Senior Secured Notes, offset by a repayment of $30.0 million on the 15% Senior Secured Notes and a $69.5 million decrease in the 8.5% Convertible Notes.
Of the interest expense of $32.8 million for the year ended December 31, 2017, approximately $16.8 million represents interest paid on the White Eagle Revolving Credit Facility. The increase in interest expense resulted from an increase in the principal balance of the facility and an increase in the LIBOR floor from 1.69% to 2.11% at December 31, 2017. Interest expense also includes approximately $467,000 for participation interest on the Facility paid during the year ended December 31, 2017.
The Red Falcon Revolving Credit Facility which was held by one of our subsidiaries, Red Falcon Trust, was terminated in December 2016 and the policies were acquired by White Eagle, shows a decrease of approximately $4.3 million when compared to the year ended December 31, 2016. There was no interest expense for this facility during 2017 given the debt was fully repaid during the year ended December 31, 2016.
Interest expense on the 8.5% Convertible Notes totaled $9.2 million, including $4.2 million, $2.5 million, $2.1 million and $314,000 from interest, one time debt modification cost, amortizing debt discounts and originations costs, respectively, during the year ended December 31, 2017. Interest for the year ended December 31, 2017 included approximately $522,000 of additional interest paid in kind to note holders.
The Company recorded $2.1 million of interest expense on the 5.0% Convertible Notes, including $1.6 million, $432,000 and $64,000 from interest, amortization of debt discount and origination costs, respectively. The 5% Convertible Notes originated in 2017 and, therefore, there was no related interest expense during the year ended December 31, 2016.
The Company recorded $2.8 million of interest expense on the 15% Senior Secured Notes, including $2.6 million and $184,000 from interest and amortizing debt discounts, respectively, during the year ended December 31, 2017.
The Company recorded approximately $1.4 million of interest expense on the 8.5% Senior Secured Notes, which includes $1.3 million of interest and $98,000 of amortizing debt issuance costs. The 8.5% Senior Secured Notes originated in 2017 and, therefore, there was no related interest expense during the year ended December 31, 2017.
Of the interest expense of $29.4 million for the year ended December 31, 2016, approximately $11.4 million represents interest paid on the White Eagle Revolving Credit Facility and approximately $4.3 million was attributable to the Red Falcon Revolving Credit Facility. Interest included $388,000 and$297,000 of debt issuance costs for the White Eagle Revolving Credit Facility and the Red Falcon Revolving Credit Facility, respectively, which were not capitalized as a result of electing the fair value option for valuing these debt facilities, and $11.0 million and $4.0 million related to interest payments paid during the year ended December 31, 2016, respectively. The Red Falcon Revolving Credit Facility was fully repaid on December 29, 2016.
Interest expense on the 8.5% Convertible Notes totaled $9.7 million of interest expense on the 8.5% Convertible Notes, including $6.0 million, $3.2 million and $480,000 from interest, amortizing debt discounts and origination costs, respectively for the year ended December 31, 2016.
The Company recorded approximately $4.0 million of interest expense on the 15% Senior Secured Notes, which includes $3.7 million of interest and $356,000 of amortizing debt issuance costs, during the year ended December 31, 2016.
See Notes 10, "White Eagle Revolving Credit Facility," ," 11, "8.50% Senior Unsecured Convertible Notes," 12, "5% Senior Unsecured Convertible Notes," 13, "15.0% Senior Secured Notes," and 14, "8.5% Senior Secured Notes," to the accompanying consolidated financial statements for further information.
Extinguishment of debt (in thousands)
During the year ended December 31, 2017, approximately $2.0 million was recorded in loss on the extinguishment of debt for the 15.0% Senior Secured Notes, including $1.5 million and $518,000 related to prepayment penalty and write off of origination cost, respectively.
During the year ended December 31, 2016, the Company terminated the Red Falcon Revolving Credit Facility. The outstanding principal balance and unpaid interest due was paid upon termination of the facility on December 29, 2016 was $65.1 million. Approximately $554,000 was recorded as a loss on extinguishment of debt related to the early repayment of the facility. This includes the debt valuation allowance of $239,000 and costs incurred related to the facility termination of $315,000 at December 31, 2016.
Change in fair value of the Revolving Credit Facilities (in thousands)
At December 31, 2017, the White Eagle Revolving Credit Facility shows a loss of approximately $4.5 million compared to a gain of $1.4 million or the year ended December 31, 2016. This loss in 2017 is attributable to a combination of offsetting factors as discussed below:
During the year ended December 31, 2017, the fair value of the White Eagle Revolving Credit Facility was impacted by increased borrowings, the lengthening of life expectancies of certain insureds' underlying policies pledged under the White Eagle Revolving Credit Facility and a slight increase in the discount rate used to value the facility.
During the year ended December 31, 2016, the Company changed its valuation technique by adopting the 2015 VBT, smoker and gender distinct tables, to determine the value of the life insurance policies pledged as collateral in the facility. The resulting impact was a positive change in fair value of the White Eagle Revolving Credit Facility of approximately $14.7 million. This amount is shown as a reduction to our expenses on the statement of operations for the year ended December 31, 2016.
Change in fair value of Revolving Credit Facilities also includes a gain of $509,000 attributable to the Red Falcon Revolving Credit Facility for the year ended December 31, 2016.
The change resulting from the Company's adoption of the 2015 VBT resulted in a positive change in fair value of the Red Falcon Revolving Credit Facility of approximately $1.0 million. This amount is shown as a reduction to our expenses on the statement of operations for the year ended December 31, 2016. The Red Falcon Revolving Credit Facility was fully repaid on December 29, 2016.
The White Eagle Revolving Credit Facility is valued at December 31, 2017 using discount rates of 18.57% compared to 18.50% for the year ended December 31, 2016.
See Note 16, "Fair Value Measurements," to the accompanying consolidated financial statements.
Selling, General and Administrative Expenses (in thousands)
The decrease in SG&A expense was primarily the result of a decrease in legal expense of $2.7 million, a decrease in professional fees of $2.6 million, a decrease in personnel costs of $1.0 million, a decrease other SG &A of $259,000 and a decrease in insurance costs of $52,000.
On August 3, 2017 and August 11, 2017, as a reduction in force, the Company reduced its headcount from 20 employees to 12 employees, included in this reduction in force were two of the Company’s executive officers. During the year ended December 31, 2017, the Company recognized a onetime severance cost of approximately $1.0 million related to this reduction, which amounts are being paid over a period of twelve months.
Results of Discontinued Operations
2018 Compared to 2017
Net loss from our discontinued structured settlement operations for the eleven months ended November 30, 2018 was $29,000 as compared to a net loss of $271,000 for the twelve months ended December 31, 2017. Total income from our discontinued structured settlement operations was $17,000 compared to $33,000 for the eleven months ended November 30, 2018 and twelve months ended December 31, 2017, respectively.
Total expenses from our discontinued structured settlement operations were $46,000 for the eleven months ended November 30, 2018 compared to $304,000 incurred during the twelve months ended December 31, 2017. This decrease was mainly attributable to an $180,000 decrease in other SG&A and a $78,000 decrease in legal fees.
2017 Compared to 2016
Net loss from our discontinued structured settlement operations for the year ended December 31, 2017 was $271,000 as compared to a net loss of $260,000 for the same period in 2016. Total income from our discontinued structured settlement operations was $33,000 compared to $12,000 for the year ended December 31, 2017 and 2016, respectively.
Total expenses from our discontinued structured settlement operations were $304,000 for the year ended December 31, 2017compared to $272,000 incurred during the same period in 2016. This increase was attributable to a $138,000 increase in other SG&A, offset by a $93,000 decrease in legal fees.
Liquidity and Capital Resources
Our consolidated financial statements have been prepared assuming the realization of assets and the satisfaction of liabilities in the normal course of business, as well as continued compliance with the covenants contained in the indentures governing our 8.5% Convertible Notes, 5% Convertible Notes, 8.5% Senior Secured Notes and other financing arrangements.
Historically, the Company has incurred substantial losses, which has resulted in an accumulated deficit of approximately $306.0 million as of November 30, 2018, of this amount, approximately $170.0 million relates to the activities for the eleven months ended November 30, 2018 for which $150.9 million represents change in fair value of investment in our deconsolidated subsidiaries as a result of their Chapter 11 filing. Cash flows used in operating activities were $41.2 million for the eleven months ended November 30, 2018 and $34.8 million for the year ended December 31, 2017. As of November 30, 2018, we had approximately $1.2 million of cash and cash equivalents and certificates of deposit of $500,000; of this amount, approximately $1.2 million is available to pay premiums on the two unencumbered policies of which such expenses will approximate $162,000 in 2019 and other overhead expenses. Further, on February 15, 2019, we were in default with respect to approximately $1.2 million of principal balance together with accrued and unpaid interest on our 8.5% Senior Unsecured Convertible Notes as a result of our failure to pay the principal and accrued and unpaid interest due and payable on such date, which date was the stated maturity date of the 8.5% Senior Unsecured Convertible Notes. See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information.
The Company’s ability to continue as a going concern is dependent on its ability to meet its liquidity needs through a combination of factors including but not limited to, the receipt of death benefits from life insurance policy maturities, strategic capital market raises, pledged policy sales (subject to certain asset sale restrictions by the bankruptcy court), secure financing needed to exit the bankruptcy process, the approval of the Bankruptcy Court to continue utilizing death benefits for payment of premiums and cash on hand.
As of the filing date of this Form 10-KT, we had approximately $3.3 million of cash and cash equivalents inclusive of certificates of deposit of $503,000. Our deconsolidated subsidiaries holds approximately $23.0 million in cash and cash equivalents which is restricted by the Bankruptcy Court. In considering our forecast for the next twelve months and the pending approval of the Debtors Chapter 11 reorganization plan by the Bankruptcy Court, these facts, aggregated with the current cash balance as of the filing for this Form 10-KT, create a substantial doubt of the Company’s ability to meet their financial needs. In considering the factors above, management plans to continue to operate our business and to seek Bankruptcy Court approval to continue to use cash collateral after the expiration of the initially approved twenty (20) week period.
For the eleven months ended November 30, 2018, we paid $85.3 million in premiums to maintain our policies in force. Of this amount, $78.6 million was paid by White Eagle through its borrowings pre-petition and $6.6 million post-petition. With the Chapter 11 Cases, White Eagle can no longer borrow under the facility to pay premium or facility expenses. However, the Bankruptcy Court authorized the Debtors to use cash collateral for a period of twenty (20) weeks (the "Cash Collateral'). The
Cash Collateral may be used solely for the purposes permitted under the budget approved by the Court. Assuming no policy maturities, as of November 30, 2018, we expect to pay $105.6 million and $163,000 in premiums during 2019 on the 586 policies that have been pledged under the White Eagle Revolving Credit Facility and the two policies not pledged, respectively; however, any future cost of insurance increases may cause our projected premium payments to significantly increase. Additionally, at November 30, 2018, we had $75.8 million, $35.0 million and $1.2 million and in aggregate principal amount of outstanding 5% Convertible Notes, 8.5% Senior Secured Notes and 8.5% Convertible Notes, which accrue interest at 5.0%, 8.5%, and 8.5%, respectively. Interest on the 5.0% Convertible Notes and the 8.5% Convertible Notes are due semi-annually while interest on the 8.5% Senior Secured Notes is due quarterly.
The following table illustrates the total amount of face value of life insurance policies owned, the trailing 12- months of life insurance policy maturities realized and premiums paid on our portfolio. The trailing 12-month maturities/premium coverage ratio indicates the ratio of policy maturities realized to premiums paid over the trailing 12-month period from our portfolio of life insurance policies.
We believe that the life insurance policy maturities we receive will continue to increase over time in relation to the premiums we are required to pay on the remaining policies in the portfolio but do expect that our portfolio cash flow on a period-to-period basis will remain inconsistent given its dependence on actual maturities.
Financing Arrangements Summary
White Eagle Revolving Credit Facility
White Eagle is the borrower under a $370.0 million (as amended on December 29, 2016) revolving credit facility, with Imperial Finance and Trading, LLC, as the initial servicer, the initial portfolio manager and guarantor, Lamington Road Bermuda Ltd., as portfolio manager, LNV Corporation, as initial lender, the other financial institutions party thereto as lenders, and CLMG Corp., as administrative agent for the lenders.
Borrowing availability under the White Eagle Revolving Credit Facility is subject to a borrowing base, which, among other items, is capped at 75% of the valuation of the policies pledged as collateral. This loan to value calculation is determined by the lenders with a high degree of discretion. At November 30, 2018, $6.2 million was undrawn and $5.7 million was available to borrow under the White Eagle Revolving Credit Facility. For a description of the facility see Note10, "White Eagle Revolving Credit Facility - Borrowing Base & Availability," of the notes to Consolidated Financial Statements.
At November 30, 2018, the fair value of the debt under the White Eagle Revolving Credit Facility was $346.7 million. As of November 30, 2018, the borrowing base was approximately $369.4 million including $363.8 million in outstanding principal. Interest is calculated at LIBOR (subject to a floor of 1.5%) plus an applicable margin of 4.5% and is due quarterly. Interest totaling $22.8 million was paid during the eleven months ended November 30, 2018. Approximately $340,000 was paid to the lender as participation interest during the eleven months ended November 30, 2018. There are no scheduled repayments of principal prior to maturity although payments are due upon receipt of death benefits and distributed pursuant to the waterfall. Approximately $416,000 was received by the Company from the waterfall distribution during the eleven months ended November 30, 2018.
Based on the loan agreement, the LIBOR portion of the interest rate will re-adjust annually once the floor has exceeded 1.5%. The applicable rate will be dependent on the rate at the last business day of the preceding calendar year. In the event that an Event of Default has occurred and is continuing, the interest rate will be equal to the sum of (i) the greater of (a) (1) LIBOR or, if LIBOR is unavailable, (2) the Base Rate and (b) one and a half percent (1.5%) plus (ii) six percent (6%). Future increase in LIBOR could have a material adverse effect on the Company’s financial position and results of operations. At November 30, 2018, LIBOR was 2.11%.
Subsequent Event
On December 13, 2018, White Eagle filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The Chapter 11 case is being administered under case number 18-12808 (the "White Eagle Chapter 11 Case").
The commencement of the White Eagle Chapter 11 Case, together with the related Chapter 11 cases for Lamington and WEGP filed on November 14, 2018 (collectively with the White Eagle Chapter 11 Case, the "Chapter 11 Cases", constitutes an event of default under White Eagle’s revolving credit facility (the "Credit Facility"), resulting in the principal and accrued interest due from White Eagle thereunder becoming immediately due and payable. Lamington and WEGP have pledged their respective interests in White Eagle to secure its obligations under the Credit Facility. Any efforts by LNV Corporation, the lender under the Credit Facility ("LNV"), or CLMG Corp., the administrative agent under the Credit Facility ("CLMG"), to enforce repayment by White Eagle and/or such pledges by Lamington and WEGP of their respective interests in White Eagle in connection with the Credit Facility are automatically stayed as a result of the commencement of the Chapter 11 Cases and LNV’s and CLMG’s rights of enforcement in respect of the Credit Facility are subject to the applicable provisions of the Bankruptcy Code. The previously announced Standstill Agreement among White Eagle, LNV and CLMG expired prior to the filing of the White Eagle Chapter 11 Case.
Beal Litigation
On January 25, 2019, the Company, White Eagle, Lamington, and WEGP , the "Plaintiffs"), filed suit (the "Suit") against LNV Corporation ("LNV"), Silver Point Capital L.P. ("Silver Point") and GWG Holdings, Inc. ("GWG" and, with LNV and Sliver Point, the "Defendants") in the United States Bankruptcy Court for the District of Delaware (the "Court"), where the Suit will be administered together with the previously filed and announced petitions for relief under Chapter 11 of the United States Bankruptcy Code of White Eagle, Lamington and WEGP (the "Chapter 11 Cases" and White Eagle, Lamington and WEGP, the "Debtors"). LNV, a subsidiary of Beal Bank ("Beal"), is the lender under White Eagle’s outstanding revolving credit facility (the "Credit Facility").
In connection with the White Eagle Chapter 11 Case, on January 15, 2019, the Court authorized the Debtors to use the proceeds of pre-petition cash collateral for a period of twenty (20) weeks (the "Cash Collateral'). The Cash Collateral may be used solely for the purposes permitted under the budget approved by the Court, including (i) to provide working capital needs of the Debtors and general corporate purposes of the Debtors, (ii) to make the payments or fund amounts otherwise permitted in the final order that authorized such uses and such budget, (iii) to fund amounts necessary to pay certain fees; and (iv) to fund amounts necessary to pay certain professional fees in accordance with such Budget.
See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information.
For a description of the White Eagle Revolving Credit Facility, Note 10, "White Eagle Revolving Credit Facility," of the notes to the accompanying consolidated financial statements.
8.50% Senior Unsecured Convertible Notes
At November 30, 2018, there was $1.2 million in aggregate principal amount of the Company’s 8.50% Senior Unsecured Convertible Notes due 2019 outstanding. For a description of the Convertible Notes see Note 11, "8.50% Senior Unsecured Convertible Notes," of the accompanying consolidated financial statement.
During 2017, the Company entered into the Master Transaction Agreements regarding a series of integrated transactions with the intent to effect a recapitalization of the Company (the "Transaction") which included, among other transactions, a Convertible Note Exchange Offer and a New Convertible Note Indenture providing for the issuance of New Convertible Notes to be delivered in connection with the Transaction (each as defined in the Master Transaction Agreements).
As part of the Transaction, on April 18, 2017, the Company launched the Convertible Note Exchange Offer. At least 98% of the outstanding Convertible Notes were required to be tendered in the exchange offer as a condition to closing the Transaction.
On July 26, 2017, the Company’s Convertible Note Exchange Offer expired. At least 98% of the outstanding Convertible Notes were tendered in the Convertible Note Exchange Offer.
In connection with the Transaction Closing, the Company entered into a supplemental indenture (the "Supplemental Indenture") to the Convertible Note Indenture governing the Convertible Notes. The purpose of the Supplemental Indenture was to eliminate substantially all of the restrictive covenants, eliminate certain events of default, eliminate the covenant restricting mergers and consolidations and modify certain provisions relating to defeasance contained in the Convertible Notes Indenture and the Convertible Notes (collectively, the "Proposed Amendments") promptly after the receipt of the requisite consents for the Proposed Amendments.
5.0% Senior Unsecured Convertible Notes
At November 30, 2018, there was 75.8 million in aggregate principal amount of the Company’s 5.0% Senior Unsecured Convertible Notes due 2023 outstanding (the "New Convertible Notes" or "5% Convertible Notes"). For a description of the New Convertible Notes see Note 12, "5.0% Senior Unsecured Convertible Notes," of the accompanying consolidated financial statements for further information.
In connection with the Transaction Closing, the Company caused to be issued the New Convertible Notes in an aggregate amount of approximately $75.8 million pursuant to the New Convertible Note Indenture. The terms of the New Convertible Notes are governed by the New Convertible Note Indenture, which provides, among other things, that the New Convertible Notes are unsecured senior obligations of the Company and will mature on February 15, 2023. The New Convertible Notes bear interest at a rate of 5% per annum from the issue date, payable semi-annually on August 15 and February 15 of each year, beginning on August 15, 2017.
Holders of New Convertible Notes may convert their New Convertible Notes at their option on any day prior to the close of business on the second scheduled trading day immediately preceding February 15, 2023. Upon conversion, the Company will deliver shares of Common Stock, together with any cash payment for any fractional share of Common Stock. The initial conversion rate for the New Convertible Notes denominated in $1,000 increments will be 500 shares of Common Stock per $1,000 principal amount of New Convertible Notes, which corresponds to an initial conversion price of approximately $2.00 per share of Common Stock. The initial conversion rate for the New Convertible Notes denominated in $1.00 increments will be 0.5 shares of Common Stock per $1.00 principal amount of New Convertible Notes, which corresponds to an initial conversion price of approximately $2.00 per share of Common Stock. The conversion rate will be subject to adjustment in certain circumstances.
The Company may redeem, in whole but not in part, the New Convertible Notes at a redemption price of 100% of the principal amount of the New Convertible Notes to be redeemed, plus accrued and unpaid interest and additional interest, if any, if and only if the last reported sale price of the Common Stock equals or exceeds 120% of the conversion price for at least 15 trading days in any period of 15 consecutive trading days. The Company may, at its election, pay or deliver as the case may be, to all Holders of the New Convertible Notes, either (a) solely cash, (b) solely shares of Common Stock, or (c) a combination of cash and shares of Common Stock.
The New Convertible Note Indenture provides for customary events of default, which include (subject in certain cases to customary grace and cure periods), among others: nonpayment of principal or interest; breach of covenants or other agreements in the New Convertible Note Indenture; defaults or failure to pay certain other indebtedness; and certain events of bankruptcy
or insolvency. Generally, if an event of default occurs and is continuing under the New Convertible Note Indenture, the trustee or the holders of at least 25% in aggregate principal amount of the New Convertible Notes then outstanding may declare all unpaid principal plus accrued interest on the New Convertible Notes immediately due and payable, subject to certain conditions set forth in the New Convertible Note Indenture. In addition, holders of the New Convertible Notes may require the Company to repurchase the New Convertible Notes upon the occurrence of certain designated events at a repurchase price of 100% of the principal amount of the New Convertible Notes, plus accrued and unpaid interest.
8.5% Senior Secured Notes
At November 30, 2018, there was $35.0 million in aggregate principal amount of the Company’s 8.5% Senior Secured Notes due 2021 outstanding (the "8.5% Senior Secured Notes"). For a description of the 8.5% Senior Secured Notes see Note 13, "8.5% Senior Secured Notes," of the accompanying consolidated financial statements for further information.
In connection with the Transaction Closing, the Note Purchase Investors and the Senior Secured Note Holders representing 100% of the aggregate outstanding principal amount of the Company’s 15.0% Senior Secured Notes entered into the Note Purchase Agreement. Pursuant to the Note Purchase Agreement, the Note Purchase Investors purchased 100% of the 15% Senior Secured Notes held by each Senior Secured Note Holder for an aggregate purchase price equal to the face amount of such purchased 15.0% Senior Secured Notes. The Note Purchase Agreement contained customary representations, warranties, and covenants.
In connection with the Transaction Closing, the Company paid each Senior Secured Note Holder 5% of the face amount of the 15% Senior Secured Notes held by such Senior Secured Note Holder as of immediately prior to the Transaction Closing, plus all accrued but unpaid interest of such 15% Senior Secured Notes through the date of the Transaction Closing, pursuant to that certain Exchange Participation Agreement dated April 7, 2017 among the Company and Senior Secured Note Holders representing 100% of the aggregate outstanding principal amount of the 15% Senior Secured Notes.
In connection with the Transaction Closing, the Company and the Senior Secured Note Trustee entered into the Amended and Restated Senior Secured Indenture to amend and restate the Senior Secured Indenture between the Company and the Senior Secured Note Trustee following the Company’s receipt of requisite consents of the holders of the 15% Senior Secured Notes. Pursuant to the terms of the Amended and Restated Senior Secured Indenture, the Company caused the cancellation of all outstanding 15% Senior Secured Notes and the issuance of 8.5% Senior Secured Notes in an aggregate amount of $30.0 million. The Amended and Restated Senior Secured Indenture provides, among other things, that the 8.5% Senior Secured Notes will be secured senior obligations of the Company and will mature on July 15, 2021. The 8.5% Senior Secured Notes will bear interest at a rate of 8.5% per annum, payable quarterly on March 15, June 15, September 15 and December 15 of each year, beginning on September 15, 2017.
The Amended and Restated Senior Secured Indenture provides that the 8.5% Senior Secured Notes may be optionally redeemed in full by the Company at any time and must be redeemed in full upon additional issuances of debt by the Company in each case, at a price equal to 100% of the principal amount redeemed plus (i) accrued and unpaid interest on the 8.5% Senior Secured Notes redeemed up to the date of redemption, and (ii) the Applicable Premium, if any, as defined in the Amended and Restated Senior Secured Indenture. Upon a change of control, the Company will be required to make an offer to holders of the 8.5%Senior Secured Notes to repurchase the 8.5% Senior Secured Notes at a price equal to 107.5% of their principal amount, plus accrued and unpaid interest up to the date of redemption.
The Amended and Restated Senior Secured Indenture contains negative covenants restricting additional debt incurred by the Company, creation of liens on the collateral securing the 8.5%Senior Secured Notes, and restrictions on dividends and stock repurchases, among other things. The 8.5% Senior Secured Notes are secured by settlement proceeds, if any, received from certain litigation involving the Company, certain notes issued to the Company, and pledges of 65% of the equity interests in Blue Heron Designated Activity Company, OLIPP IV, LLC and Red Reef Alternative Investments, LLC.
The Amended and Restated Senior Secured Indenture provides for customary events of default which include (subject in certain cases to customary grace and cure periods), among others: nonpayment of principal or interest; breach of covenants or other agreements in the Amended and Restated Senior Secured Indenture; defaults in failure to pay certain other indebtedness; and certain events of bankruptcy or insolvency. Generally, if an event of default occurs and is continuing under the Amended and Restated Senior Secured Indenture, the trustee or the holders of at least 25% in aggregate principal amount of the 8.5% Senior Secured Notes then outstanding may declare the principal of and accrued but unpaid interest, plus a premium, if any, on all the 8.5% Senior Secured Notes immediately due and payable, subject to certain conditions set forth in the Amended and Restated Senior Secured Indenture.
On August 11, 2017, the Company entered into a Securities Purchase Agreement with Brennan Opportunities Fund
I LP ("Brennan") pursuant to which Brennan purchased from the Company (i) 12,500,000 shares (the "Brennan Shares") of Common Stock at a price of $0.40 per share for an aggregate purchase price of $5.0 million and (ii) $5.0 million principal amount of the Company’s 8.5% Senior Secured Notes (the "Brennan Notes," and together with the Brennan Shares, the "Brennan Securities"). The Securities Purchase Agreement contained customary representations, warranties, and covenants.
The sale of the Brennan Securities was consummated on August 11, 2017, as to 8,750,000 shares of Common Stock and $3.5 million principal amount of 8.5% Senior Secured Notes, and on August 14, 2017, as to 3,750,000 shares of Common Stock and $1.5 million principal amount of 8.5% Senior Secured Notes.
On January 10, 2018, the Company dissolved Red Falcon Trust, an indirect subsidiary of the Company ("Red Falcon"). On the same date, the Company also commenced the process of appointing a liquidator to liquidate Blue Heron Designated Activity Company, a direct subsidiary of the Company ("Blue Heron"). The completion of liquidation formalities of Blue Heron under Irish law is expected to take several months. Both Red Falcon and Blue Heron were inactive subsidiaries of the Company.
The Company had pledged 65% of the equity and certain other assets of Blue Heron in favor of the secured parties under the Amended and Restated Senior Secured Indenture. In connection with liquidation of Blue Heron, the Company and Wilmington Trust, National Association, as trustee under the Amended and Restated Senior Secured Indenture (the "Trustee"), entered into (i) the First Supplemental Indenture (the "First Supplemental Indenture"), dated as of January 10, 2018, to implement certain amendments to the Indenture and (ii) the Amendment to Pledge and Security Agreement ("Pledge and Security Amendment"), dated as of January 10, 2018, to implement certain amendments to the Pledge and Security Agreement ("Pledge and Security Agreement"), dated as of March 11, 2016, between the Company and Trustee. The First Supplemental Indenture and the Pledge and Security Amendment amend the Indenture and Pledge and Security Agreement, respectively, to: (i) remove from the assets pledged to the secured parties under the Amended and Restated Senior Secured Indenture, 65% of the equity and certain other assets of Blue Heron; and (ii) reflect the pledge by the Company, in favor of the secured parties under the Indenture, of the promissory note dated as of December 29, 2016 in the principal sum of $69.6 million issued by OLIPP IV, LLC to Blue Heron and subsequently assigned to the Company.
At November 30, 2018, the outstanding principal of the 8.5% Senior Secured Notes was $35.0 million with a carrying value of $34.2 million, net of unamortized debt issuance cost of $829,600.
8.5% Senior Secured Notes Amendment
On December 28, 2018, the Company entered into subscription agreements (the "Subscription Agreements") with several investors (the "Investors"), Pursuant to the Subscription Agreements, the Investors purchased from the Company an aggregate of $5.7 million principal amount of the Company’s 8.5% Senior Secured Notes for an aggregate purchase price of $4.3 million. The transactions were consummated on December 28, 2018.
On December 28, 2018, the Company received a commitment letter (the "Commitment Letter") from Ironsides Partners LLC, an entity affiliated with Robert Knapp, a member of the Board, for an aggregate investment, at the Company’s election, of up to $2.0 million principal amount of 8.5% Senior Secured Notes for an aggregate purchase price of up to $1.5 million no later than January 31, 2019. The Commitment Letter contains certain conditions precedent to Ironsides’ obligations to purchase such Senior Notes.
On January 30, 2019, the Company entered into a Note Purchase Agreement (the "Note Purchase Agreement") with Ironsides Partners Special Situations Master Fund III L.P. (the "Investor"), which is affiliated with Robert Knapp, a member of the Company’s Board of Directors. Pursuant to the Note Purchase Agreement, the Investor purchased from the Company $2.0 million principal amount of the Company’s 8.5% Senior Secured Notes for a purchase price of $1.5 million.
On February 11, 2019, the Company entered into a Subscription Agreement (the "Subscription Agreement") with Brennan Opportunities Fund I LP (the "Investor"), which is affiliated with Patrick T. Brennan, a member of the Company’s Board of Directors. Pursuant to the Subscription Agreement, the Investor purchased from the Company $967,000 principal amount of the Company’s 8.5% Senior Secured Notes (the "Senior Notes") for a purchase price of $725,250. The transaction was consummated on February 14, 2019.
See Note 23, "Subsequent Events" of the notes to Consolidated Financial Statements.
Cash Flows
The following table summarizes our cash flows, which includes both continuing and discontinued operations, from operating, investing and financing activities for the years ended November 30, 2018, 2017 and 2016 (in thousands):
Operating Activities
During the eleven months ended November 30, 2018, operating activities used cash of $41.2 million. Our net loss of $170.0 million was adjusted for the following: change in fair value of investment in deconsolidated subsidiaries of approximately $150.9 million, attributable to the deconsolidation of Lamington and its subsidiaries due to the Chapter 11 cases. White Eagle Revolving Credit Facility financing costs and fees of $927,000, which represent fees associated with the White Eagle Revolving Credit Facility withheld by the lender and added to the outstanding loan balance, amortization of discount and deferred cost for the 5% Convertible Notes of $1.1 million, amortization of discount and deferred cost for the 8.5% Senior Secured Notes of $244,000, amortization of discount and deferred cost for the 8.5% Convertible Notes of $76,000, stock based compensation of $562,000, change in fair value of life settlement gains of $46.9 million that is mainly attributable to maturities of 20 policies; change in fair value of White Eagle Revolving Credit Facility gain of $70.9 million that is mainly attributable to increased borrowings, the lengthening of life expectancies of certain insureds underlying policies pledged as collateral in the facility and an increase in the discount rates, and a net negative change in the components of operating assets and liabilities of $10,000. This $10,000 change in operating assets and liabilities is partially attributable to a $316,000 decrease in interest payable on the 5.0% Convertible Notes, a $1.0 million decrease in other liabilities, offset by a $877,000 increase in accounts payable and accrued expenses, and a $496,000 increase in interest payable on the 8.5% Senior Secured Noted.
During the year ended December 31, 2017, operating activities used cash of $34.8 million. Our net loss of $3.5 million was adjusted for the following: White Eagle Revolving Credit Facility financing costs and fees of $931,000, which represent fees associated with the White Eagle Revolving Credit Facility withheld by the lender and added to the outstanding loan balance, interest paid in kind on the 8.5% Convertible Notes of $6.3 million, debt modification costs for the 8.5% Convertible Notes of $2.5 million, amortization of discount and deferred cost for the Convertible Notes of $2.4 million, extinguishment of 15% Senior Secured notes of $2.0 million, change in fair value of life settlement gains of $51.6 million that is mainly attributable maturities of 13 policies; change in fair value of White Eagle Revolving Credit Facility loss of $4.5 million that is mainly attributable to increased borrowings, the lengthening of life expectancies of certain insureds underlying policies pledged as collateral in the facility and an increase in the discount rates, and a net positive change in the components of operating assets and liabilities of $312,000. This $312,000 change in operating assets and liabilities is partially attributable to $2.2 million decrease in interest payable on the 8.5% Convertible Notes and a $213,000 decrease in interest payable on the 15.0% Senior Secured Notes offset by a $1.4 million decrease in interest payable on the 5.0% Convertible Notes, offset by an increase in accounts payable and accrued expenses of $779,000 and increase in prepaid expenses of $323,000.
Investing Activities
Net cash used in investing activities for the eleven months ended November 30, 2018 was $17.4 million and included proceeds of $90.8 million from maturity of 20 life settlements and $516,000 for certificates of deposit. This was offset by $78.7 million for premiums paid on life settlements and $30.0 million in deconsolidation of subsidiaries cash.
Net cash used in investing activities for the year ended December 31, 2017 was $37.6 million and included proceeds of $42.1 million from maturity of 13 life settlements and $5.0 million for certificates of deposit. This was offset by $84.7 million for premiums paid on life settlements.
Financing Activities
Net cash provided by financing activities for the eleven months ended November 30, 2018 was $28.6 million and included $81.3 million of borrowings from the White Eagle Revolving Credit Facility offset by $52.7 million in repayment of borrowings under the White Eagle Revolving Credit Facility.
Net cash provided by financing activities for the year ended December 31, 2017 was $92.4 million and included $86.4 million of borrowings from the White Eagle Revolving Credit Facility; $19.2 million from issuance of common stock, $5.0 million of borrowings from the 8.5% Senior Secured Notes and $2.8 million of borrowings from the 15% Promissory Note. These were offset by $19.6 million in repayment of borrowings under the White Eagle Revolving Credit Facility and $1.3 million in payment of recapitalization transaction cost.
Contractual Obligations
The following table summarizes our contractual obligations as of November 30, 2018 (in thousands):
(1)
Please see Note 10, "White Eagle Revolving Credit Facility," to the accompanying consolidated financial statements.
(2)
Includes $3.7 million related to outstanding interest due for the White Eagle Revolving Credit Facility.
Inflation
Our assets and liabilities are, and will be in the future, interest-rate sensitive in nature. As a result, interest rates may influence our performance far more than inflation. Changes in interest rates do not necessarily correlate with inflation or changes in inflation rates. We do not believe that inflation had any material impact on our results of operations in the periods presented in our financial statements presented in this report.
Off-Balance Sheet Arrangements
At November 30, 2018, there were no off-balance sheet arrangements between us and any other entity that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to shareholders.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk are credit risk, interest rate risk and foreign currency risk. As of November 30, 2018, we did not hold material amount of financial instruments for trading purposes.
Credit Risk
Credit risk consists primarily of the potential loss arising from adverse changes in the financial condition of the issuers of the life insurance policies that we own. Although we may purchase life settlements from carriers rated below investment grade, to limit our credit risk, we generally only purchase life settlements from companies that are investment grade.
The following table provides information about the life insurance issuer concentrations that exceed 10% of total death benefit and 10% of total fair value of our life settlements as of November 30, 2018:
Interest Rate Risk
At November 30, 2018, fluctuations in interest rates did not impact interest expense in the life finance business. The White Eagle Revolving Credit Facility accrues interest at LIBOR plus an applicable margin. LIBOR is subject to a floor of 1.5%.
Based on the White Eagle Revolving Credit Facility loan agreement, the LIBOR portion of the interest rate will re-adjust annually once the floor has exceeded 1.5%. The applicable rate will be dependent on the rate at the last business day of the preceding calendar year. At November 30, 2018, the applicable LIBOR rate was 2.11%. In the event that an Event of Default has occurred and is continuing, the interest rate will be equal to the sum of (i) the greater of (a) (1) LIBOR or, if LIBOR is unavailable, (2) the Base Rate and (b) one and a half percent (1.5%) plus (ii) six percent (6%).
Future increases in LIBOR could have a material adverse effect on the Company’s financial position and results of operations. Increases in LIBOR above the floors provided in the White Eagle Revolving Credit Facility, will also affect the calculation of the fair value of the debt under the White Eagle Revolving Credit Facility. Additional increases in interest rates may impact the rates at which we are able to obtain financing in the future.
We earn income on the changes in fair value of the life insurance policies we own. However, if the fair value of the life insurance policies we own decreases, we record this reduction as a loss.
As of November 30, 2018, through its consolidated and deconsolidated subsidiaries we owned life settlements with a fair value of $506.4 million. A rise in interest rates could potentially have an adverse impact on the sale price if we were to sell some or all of these assets, which could also decrease the borrowing base available to White Eagle under the applicable White Eagle Revolving Credit Facility. There are several factors that affect the market value of life settlements, including the age and health of the insured, investors’ demand, available liquidity in the marketplace, duration and longevity of the policy, and interest rates. We currently do not view the risk of a decline in the sale price of life settlements due to normal changes in interest rates as a material risk.
Foreign Currency Exchange Rate Risk
Changes in the exchange rate between transactions denominated in a currency other than our foreign subsidiaries’ functional currency are immaterial to our operating results. Exposure to foreign currency exchange rate risk may increase over time as our business evolves.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements required by this Item are included in Item 15 of this Transition Report on Form 10-KT and are presented beginning on page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not Applicable.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of November 30, 2018. Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to management, including to the chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Transition Report on Form 10-KT.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the fourth quarter ended November 30, 2018 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined under Rule 13a-15(f) in the Securities Exchange Act of 1934. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements prepared for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of management, including the Company’s principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting based on the framework in 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the Company’s evaluation under the framework in Internal Control-Integrated Framework, management concluded that the Company’s internal control over financial reporting was effective as of November 30, 2018.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information relating to the directors and officers of the Company, information regarding compliance with Section 16(a) of the Exchange Act and information regarding the audit committee and audit committee financial expert is incorporated herein by reference to the Company’s Proxy Statement for the 2019 Annual Meeting of Stockholders (the "Proxy Statement") to be filed within 120 days after November 30, 2018.
All of the Company’s directors, officers and employees must act in accordance with our Code of Ethics. A copy of the Code of Ethics is available on the Company’s website at www.emergentcapital.com in the "Investor Relations" section, under the Corporate Governance tab. The Company intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding disclosure of an amendment to, or waiver from, a provision of this Code of Ethics with respect to its principal executive officer, principal financial officer, principal accounting officer or persons performing similar functions, by posting such information on the Company’s website discussed above, unless a Form 8-K is otherwise required by law or applicable listing rules.
Item 11.
Item 11. Executive Compensation
The information regarding executive compensation is incorporated herein by reference to the Proxy Statement to be filed within 120 days after November 30, 2018.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information setting forth the security ownership of certain beneficial owners and management is hereby incorporated by reference to the Proxy Statement to be filed within 120 days after November 30, 2018.
Shown below is certain information as of November 30, 2018 regarding equity compensation plans:
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information relating to certain relationships and related transactions and director independence is incorporated herein by reference to the Proxy Statement to be filed within 120 days after November 30, 2018.
Item 14.
Item 14. Principal Accountant Fees and Services
The information relating to the principal accountant fees and expenses is incorporated herein by reference to the Proxy Statement to be filed within 120 days after November 30, 2018.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements:
Our consolidated financial statements identified in the accompanying Index to Financial Statements at page herein are filed as part of this Transition Report on Form 10-KT.
(a)(2) Financial Statement Schedules: The schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
(a)(3) Exhibits:
The accompanying Exhibit Index on page E-1 sets forth the exhibits that are filed as part of this Transition Report on Form 10-KT.
EXHIBIT INDEX
In reviewing the agreements included as exhibits to this report, please remember they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about the Company, its subsidiaries or other parties to the agreements. The Agreements contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:
•
should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate;
•
have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;
•
may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors; and
•
were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments.
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this report not misleading. Additional information about the Company may be found elsewhere in this report and the Company’s other public files, which are available without charge through the SEC’s website at http://www.sec.gov.
††
Certain portions of the exhibit have been omitted pursuant to a confidential treatment order. An unredacted copy of the exhibit has been filed separately with the United States Securities and Exchange Commission pursuant to the request for confidential treatment.
*
Filed herewith.
†
Management compensatory arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
EMERGENT CAPITAL, INC.
By:
/S/ PATRICK CURRY
Name:
Patrick Curry
Title:
Chief Executive Officer
Date: March 15, 2019
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears below hereby constitutes and appoints Patrick J. Curry, Miriam Martinez and Harvey Werblowsky, and each of them individually, his or her true and lawful agent, proxy and attorney-in-fact, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to (i) act on, sign and file with the Securities and Exchange Commission any and all amendments to this Report together with all schedules and exhibits thereto, (ii) act on, sign and file with the Securities and Exchange Commission any and all exhibits to this Report and any and all exhibits and schedules thereto, (iii) act on, sign and file any and all such certificates, notices, communications, reports, instruments, agreements and other documents as may be necessary or appropriate in connection therewith and (iv) take any and all such actions which may be necessary or appropriate in connection therewith, granting unto such agents, proxies and attorneys-in-fact, and each of them individually, full power and authority to do and perform each and every act and thing necessary or appropriate to be done, as fully for all intents and purposes as he or she might or could do in person, and hereby approving, ratifying and confirming all that such agents, proxies and attorneys-in-fact, any of them or any of his, her or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Audited Consolidated Financial Statements as of November 30, 2018 and December 31, 2017 and for the eleven months ended November 30, 2018 and each of the two years in the period ended December 31, 2017 and 2016 of Emergent Capital, Inc.
REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
Board of Directors and Stockholders
Emergent Capital, Inc.
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of Emergent Capital, Inc. (a Florida corporation) and subsidiaries (the "Company") as of November 30, 2018 and December 31, 2017, the related consolidated statements of operations, stockholders’ equity, and cash flows for the eleven months ended November 30, 2018 and each of the two years in the period ended December 31, 2017, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of November 30, 2018 and December 31, 2017, and the results of its operations and its cash flows for the eleven months ended November 30, 2018 and each of the two years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Going concern
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has incurred a net loss of $170.0 million during the eleven months ended November 30, 2018 and has incurred recurring losses from operations in each of the two years in the period ended December 31, 2017. On November 14, 2018, two of the Company’s wholly-owned subsidiaries filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court. The Company has approximately $1.2 million of cash and cash equivalents as of November 30, 2018. These conditions, along with other matters as set forth in Note 2, raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2008
Fort Lauderdale, Florida
March 15, 2019
Emergent Capital, Inc.
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of this financial statement.
Emergent Capital, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Eleven Months Ended November 30, 2018 and For the Years Ended December 31, 2017 and 2016
The accompanying notes are an integral part of this financial statement.
Emergent Capital, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Eleven Months Ended November 30, 2018 and For the Years Ended December 31, 2017 and 2016
The accompanying notes are an integral part of this financial statement.
Emergent Capital, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Eleven Months Ended November 30, 2018 and For the Years Ended December 31, 2017 and 2016
The accompanying notes are an integral part of this financial statement.
Emergent Capital, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
November 30, 2018
NOTE 1-ORGANIZATION AND DESCRIPTION OF BUSINESS ACTIVITIES
Emergent Capital, Inc. was founded in December 2006 as a Florida limited liability company, Imperial Holdings, LLC, and converted into Imperial Holdings, Inc. on February 3, 2011, in connection with the Company’s initial public offering. Effective September 1, 2015, the name was changed to Emergent Capital, Inc. (with its subsidiary companies, the "Company" or "Emergent Capital").
Emergent Capital, through its consolidated and deconsolidated subsidiaries, owns a portfolio of 588 life insurance policies, also referred to as life settlements, with a fair value of $506.4 million and an aggregate death benefit of approximately $2.8 billion at November 30, 2018. The Company primarily earns income on these policies from changes in their fair value and through death benefits. 586 of these policies, with an aggregate death benefit of approximately $2.8 billion and a fair value of $505.2 million at November 30, 2018 are pledged under a $370.0 million, revolving credit agreement (the "White Eagle Revolving Credit Facility") entered into by the Company’s indirect subsidiary, White Eagle Asset Portfolio, LP ("White Eagle"). At November 30, 2018, 2 policies owned by the Company, with an aggregate death benefit of approximately $12.0 million and a fair value of $1.2 million were not pledged as collateral under the White Eagle Revolving Credit Facility.
Change in Financial Year End
On September 7, 2018, the Board of Directors adopted resolutions to change the Company’s fiscal year end, and therefore the Company and its direct and indirect subsidiaries changed their fiscal year ends, from December 31 to November 30, effective immediately. The Company is filing this Transition Report on Form 10-KT in accordance with SEC rules and regulations. Our financial results for the fiscal period ended November 30, 2018 will cover transactions from January 1, 2018 to November 30, 2018, while the financial results for fiscal years ended December 31, 2017 and 2016 will cover the twelve month periods then ended. The results for the eleven month transition period ending on November 30, 2018 are compared to the results of our previous twelve month fiscal year-end as of December 31, 2017. Subsequent to this Transition Report, our reports on Form 10-K will cover the period beginning December 1 and ending November 30, which will be our fiscal year. We refer in this Transition Report to the period beginning on January 1, 2018 and ended on November 30, 2018 as the "Transition Period."
Voluntary Petitions for Relief Under Chapter 11 and De-consolidation of Subsidiaries
On November 14, 2018 (the "Petition Date"), Lamington Road Designated Activity Company (formerly known as Lamington Road Limited), the Company’s wholly-owned indirect Irish subsidiary ("Lamington"), and White Eagle General Partner, LLC, the Company’s wholly-owned indirect Delaware subsidiary ("WEGP"), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). Lamington is the limited partner and owns 99.99%, and WEGP is the general partner and owns 0.01%, of White Eagle. In its capacity as general partner, WEGP manages the affairs of White Eagle. The Lamington and WEGP filings are referred to as the "November Chapter 11 Cases."
The commencement of the November Chapter 11 Cases would constitute defaults and events of default under the terms of the Company’s Amended and Restated Senior Secured Indenture and the New Convertible Note Indenture (each as defined
below).However, such defaults and events of default and their consequences were waived in advance of the November Chapter 11 Cases by holders of a majority of the outstanding principal amounts of each of the 8.5% Senior Secured Notes and the New Convertible Notes, and consequently, the Company believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred under either the Amended and Restated Senior Secured Indenture or the New Convertible Note Indenture. The commencement of the November Chapter 11 Cases constitutes an event of default under the White Eagle Revolving Credit Facility, resulting in the principal and accrued interest due from White Eagle thereunder becoming immediately due and payable. Lamington and WEGP have pledged their respective interests in White Eagle to secure its obligations under the White Eagle Revolving Credit Facility. Any efforts by LNV Corporation, the lender under the White Eagle Revolving Credit Facility ("LNV"), or CLMG Corp., the administrative agent under the White Eagle Revolving Credit Facility ("CLMG"), to enforce such pledges by Lamington and WEGP of their respective interests in White Eagle in connection with the White Eagle Revolving Credit Facility are automatically stayed as a result of the commencement of the November Chapter 11 Cases and LNV’s and CLMG’s rights of enforcement in respect of the White Eagle Revolving Credit Facility are subject to the applicable provisions of the Bankruptcy Code. In addition, on November 15, 2018, White
Eagle, LNV and CLMG entered into an Agreement Regarding Rights and Remedies (the "Standstill Agreement"), pursuant to which LNV and CLMG agreed to refrain from exercising their rights and remedies in connection with the White Eagle Revolving Credit Facility, subject to the terms and provisions of the Standstill Agreement, until 12:00 p.m. noon Pacific time on November 26, 2018, to facilitate negotiations.
On November 23, 2018, the effective period under the Standstill Agreement was extended to November 27, 2018; on November 27, 2018, the effective period under the Standstill Agreement was extended to November 30, 2018; on November 30, 2018, the effective period under the Standstill Agreement was extended to December 4, 2018; on December 4, 2018, the effective period under the Standstill Agreement was extended to December 7, 2018; and on December 6, 2018, the effective period under the Standstill Agreement was extended to December 11, 2018; and on December 10, 2018, the effective period under the Standstill Agreement was extended to December 13, 2018.
On December 13, 2018, White Eagle filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "White Eagle Chapter 11 Case"and, together with the November Chapter 11 Cases, the "Chapter 11 Cases"). See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information. The Company obtained waivers from the requisite holders of each of 8.5% Senior Secured Notes and the New Convertible Notes with respect to the White Eagle Chapter 11
Case, similar to the waivers for the November Chapter 11 Cases, and believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred with respect to both the
8.5% Senior Secured Notes and the New Convertible Notes.
Lamington and its subsidiaries (White Eagle, WEGP and Lamington Road Bermuda Limited), financial results are included in the Company’s consolidated results through November 13, 2018, the day prior to the Petition Date. However, ASC 810, Consolidation require that an entity whose financial statements were previously consolidated with those of its parent that files for protection under the U.S. Bankruptcy Code, whether solvent or insolvent, generally must be prospectively deconsolidated from the parent and presented as an equity investment (deconsolidation applies to Lamington and all subsidiaries owned, directly or indirectly, by Lamington, including WEGP, White Eagle and Lamington Road Bermuda), (the "Deconsolidated Entities" or the "Debtors"). Therefore, our 2018 results are not comparable with 2017, the post-petition results are not included in our consolidated results for the eleven months ended November 30, 2018. Under ASC 810, this loss of control would likely trigger a gain or loss for the parent as the parent would remeasure its retained noncontrolling investment at fair value. We assessed the inherent uncertainties associated with the outcome of the Chapter 11 reorganization process and the anticipated duration thereof, and concluded that it was appropriate to deconsolidate Lamington and its subsidiaries effective on the Petition Date.
At November 13, 2018, the pre-petition date, the Company valued its investment in Lamington to be $278.4 million, of which $127.3 million represents equity and $145.9 million represents promissory notes and interest receivable and $5.2 million represents other liabilities, which is equivalent to the Company's carrying value. This valuation was determined by performing a fair value calculation of the assets and liabilities of Lamington under ASC 820, Fair Value Measurement. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The Company calculated the fair value of the White Eagle Revolving Credit Facility using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the Company’s estimates are not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values. All other assets and liabilities were deemed equivalent to their carrying value as at the pre-petition date. See Note 16, "Fair Value Measurements," of the accompanying consolidated financial statements.
ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities was effective for calendar year-end public business entities in 2018. Under the new guidance, a reporting entity should account for its equity investments that are not consolidated or accounted for under the equity method at fair value, with changes to fair value recorded in current earnings. Lamington's main subsidiary, White Eagle, carries its life settlements policies and debt under the White Eagle Revolving Credit Facility at fair value, these valuation are based on inputs that are both significant to the fair value measurement and unobservable. As a result, the Company adopted ASU 2016-01 to value its investment in Lamington during the eleven months ended November 30, 2018. The calculation was performed consistent with ASC 820 with changes in fair value recorded in current earnings.
When Lamington emerges from the jurisdiction of the Bankruptcy Court, the subsequent accounting will be determined based upon the applicable circumstances and facts at such time, including the terms of any plan of reorganization. The Debtors will continue to operate their businesses as "debtors-in-possession" under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. Emergent Capital (exclusive of its subsidiaries) is a separate entity with independent capital structures and has not filed for bankruptcy relief and is continuing to operate in the ordinary course.
Beal Litigation
On January 25, 2019, the Company, White Eagle, Lamington, and WEGP , the ("Plaintiffs"), filed suit (the "Suit") against LNV Corporation ("LNV"), Silver Point Capital L.P. ("Silver Point") and GWG Holdings, Inc. ("GWG" and, with LNV and Sliver Point, the "Defendants") in the United States Bankruptcy Court for the District of Delaware (the "Court"), where the Suit will be administered together with the previously filed and announced petitions for relief under Chapter 11 of the United States Bankruptcy Code of White Eagle, Lamington and WEGP (the "Chapter 11 Cases" and White Eagle, Lamington and WEGP, the "Debtors"). LNV, a subsidiary of Beal Bank ("Beal"), is the lender under White Eagle’s outstanding revolving credit facility (the "Credit Facility").
In the Suit, the Plaintiffs allege that the Defendants engaged in a scheme to coerce the Plaintiffs into selling their valuable portfolio of life insurance policies to defendants for well below its true value. Pursuant to the Credit Facility, LNV agreed to lend $370 million to White Eagle, and in connection therewith received a 45% equity stake in White Eagle. That equity stake, and LNV’s significant control over White Eagle under the Credit Facility, creates a joint venture, and gives rise to fiduciary duties to White Eagle and Emergent, on the part of LNV. The Plaintiffs further allege that LNV has been engaged in a concerted campaign to "squeeze" White Eagle and Emergent by improperly restricting their cash flow, in the hopes that White Eagle and Emergent will have no choice but to sell the valuable policy portfolio to LNV or one of its proxies, including Silver Point and/or GWG, at below its true value.
In connection with the White Eagle Chapter 11 Case, on January 15, 2019, the Court authorized the Debtors to use the proceeds of pre-petition cash collateral for a period of twenty (20) weeks (the "Cash Collateral'). The Cash Collateral may be used solely for the purposes permitted under the budget approved by the Court, including (i) to provide working capital needs of the Debtors and general corporate purposes of the Debtors, (ii) to make the payments or fund amounts otherwise permitted in the final order that authorized such uses and such budget, (iii) to fund amounts necessary to pay certain fees; and (iv) to fund amounts necessary to pay certain professional fees in accordance with such Budget.
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company, all of its wholly-owned subsidiary companies and its special purpose entities, with the exception of Imperial Settlements Financing 2010, LLC ("ISF 2010"), an unconsolidated special purpose entity which is accounted for using the measurement alternative, which is measured at cost less impairment. The special purpose entity has been created to fulfill specific objectives. All significant intercompany balances and transactions except those related to Lamington after the November 13, 2018 (see Note 4) have been eliminated in consolidation, including income from services performed by subsidiary companies in connection with the White Eagle Revolving Credit Facility. Notwithstanding deconsolidation, as referenced above, White Eagle is the owner of 586 policies, with an aggregate death benefit of approximately $2.8 billion and an estimated fair value of approximately $505.2 million which has been deconsolidated as of November 13, 2018 the date prior to the bankruptcy proceedings.
Going Concern
Historically, the Company has incurred substantial losses, which has resulted in an accumulated deficit of approximately $306.0 million as of November 30, 2018, of this amount, approximately $170.0 million relates to the activities for the eleven months ended November 30, 2018 for which $150.9 million represents change in fair value of investment in our deconsolicated subsidiaries as a result of their Chapter 11 filing. Cash flows used in operating activities were $41.2 million for the eleven months ended November 30, 2018 and $34.8 million for the year ended December 31, 2017. As of November 30, 2018, we had approximately $1.2 million of cash and cash equivalents and certificates of deposit of $500,000; of this amount, approximately $1.2 million is available to pay premiums on the two unencumbered policies of which such expenses will approximate $162,000 in 2019 and other overhead expenses. Further, on February 15, 2019, we were in default with respect to approximately $1.2 million of principal balance together with accrued and unpaid interest on our 8.5% Senior Unsecured
Convertible Notes as a result of our failure to pay the principal and accrued and unpaid interest due and payable on such date, which date was the stated maturity date of the 8.5% Senior Unsecured Convertible Notes. See Note 23, "Subsequent Events" of the notes to Consolidated Financial Statements.
The Company’s ability to continue as a going concern is dependent on its ability to meet its liquidity needs through a combination of factors including but not limited to, the receipt of death benefits from life insurance policy maturities, strategic capital market raises, pledged policy sales (subject to certain asset sale restrictions by the bankruptcy court), secure financing needed to exit the bankruptcy process, the approval of the Bankruptcy Court to continue utilizing death benefits for payment of premiums and cash on hand. Management’s current plans to exit the bankruptcy process with a financing arrangement that is viable to the Company and will allow them to pay overhead expenses as well as other necessary expense for financing and to keep the policies in force.
As of the filing date of this Form 10-KT, we had approximately $3.3 million of cash and cash equivalents inclusive of certificates of deposit of $503,000. Our deconsolidated subsidiaries holds approximately $23.0 million in cash and cash equivalents which is restricted by the Bankruptcy Court. In considering our forecast for the next twelve months and the pending approval of the Debtors Chapter 11 reorganization plan by the Bankruptcy Court, these facts, aggregated with the current cash balance as of the filing for this Form 10-KT, create a substantial doubt of the Company’s ability to meet their financial needs and continue as a going concern. In considering the factors above, management plans to continue to operate our business and to seek Bankruptcy Court approval to continue to use cash collateral after the expiration of the initially approved twenty (20) week period.
The accompanying consolidated financial statements are prepared on a going concern basis and do not include any adjustments that might result from uncertainty about the Company’s ability to continue as a going concern.
Reorganization
On November 14, 2018 (the "Petition Date"), Lamington Road Designated Activity Company (formerly known as Lamington Road Limited), the Company’s wholly-owned indirect Irish subsidiary ("Lamington"), and White Eagle General Partner, LLC, the Company’s wholly-owned indirect Delaware subsidiary ("WEGP"), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court". Once a reporting entity has filed a petition for bankruptcy under Chapter 11 of the Bankruptcy Code, its accounting and financial reporting fall under the scope of ASC 852-10, Reorganizations which will serve as the foundation for accounting during bankruptcy. In accordance with ASC 852-10, transactions and events directly associated with the Chapter 11 Cases are required to be distinguished from the ongoing operations of the business. In addition, ASC 852-10 requires changes in the accounting and presentation of liabilities, as well as expenses and income directly associated with the Chapter 11 Cases.
Deconsolidation
Lamington and its subsidiaries (White Eagle and WEGP) filing for reorganization was a reconsideration event for Emergent Capital to reevaluate whether consolidation of Lamington and its subsidiaries (White Eagle, WEGP and Lamington Road Bermuda Limited) (the deconsolidated entities) continued to be appropriate. Under ASC 810, Consolidation, specifically ASC 810-10-15, consolidation of a majority-owned subsidiary is precluded where control does not rest with the majority owners, for instance, where the subsidiary is in legal reorganization or bankruptcy. Accordingly, when a subsidiary files for bankruptcy, it is appropriate for the parent to deconsolidate the subsidiary. Under ASC 810, this loss of control would likely trigger a gain or loss for the parent as the parent would remeasure its retained noncontrolling investment at fair value. We assessed the inherent uncertainties associated with the outcome of the Chapter 11 reorganization process and the anticipated duration thereof, and concluded that it was appropriate to deconsolidate Lamington and its subsidiaries effective on the Petition Date.
At November 13, 2018, the pre-petition date, the Company valued its investment in Lamington to be $278.4 million, of which $127.3 million represents equity and $145.9 million represents promissory notes and interest receivable, and $5.2 million represents other liabilities, which is equivalent to the Company's carrying value. The Company estimated fair value as of November 30, 2018 which is materially close to the November 14, 2018 filing of bankruptcy. This valuation was determined by performing a fair value calculation of the assets and liabilities of Lamington under ASC 820, Fair Value Measurement. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The Company calculated the fair value of the White Eagle Revolving Credit Facility using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the
Company’s estimates are not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values. All other assets and liabilities were deemed equivalent to their carrying value as at the pre-petition date. See Note 16, "Fair Value Measurements," of the accompanying consolidated financial statements.
Related Party Relationship
Upon filing for Chapter 11 and the subsequent deconsolidation, transactions with Lamington are no longer eliminated in consolidation and are treated as related party transactions for Emergent Capital. See Note 4 "Condensed and Consolidated Financial Statements For Entities in Bankruptcy" for all transactions between Emergent Capital and Lamington.
Discontinued Operations
On October 25, 2013, the Company sold substantially all of the assets comprising its structured settlement business. As a result, the Company has discontinued segment reporting and classified its operating results of the structured settlement business, net of income taxes, as discontinued operations. The accompanying consolidated statements of operations for the eleven months ended November 30, 2018 and the two years in the period ended 2017 and 2016 and the related notes to the consolidated financial statements reflect the classification of its structured settlement business operating results, net of tax, as discontinued operations. See Note 8, "Discontinued Operations," of the accompanying consolidated financial statements for further information. Unless otherwise noted, the following notes refer to the Company’s continuing operations.
Ownership of Life Insurance Policies
In the ordinary course of our legacy premium finance business, a large portion of our borrowers defaulted by not paying off their loans and relinquished ownership of their life insurance policies to us in exchange for our release of the obligation to pay amounts due. We also buy life insurance policies in the secondary and tertiary markets. We account for life insurance policies that we own as life settlements (life insurance policies) in accordance with ASC 325-30, Investments in Insurance Contracts, which requires us to either elect the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. We have elected to account for these life insurance policies as investments using the fair value method.
We initially record life settlements at the transaction price. For policies acquired upon relinquishment by our borrowers, we determined the transaction price based on fair value of the acquired policies at the date of relinquishment. The difference between the net carrying value of the loan and the transaction price is recorded as a gain (loss) on loan payoffs and settlement. For policies acquired for cash, the transaction price is the amount paid.
Valuation of Insurance Policies
Our valuation of insurance policies is a critical component of our estimate of the fair value of our life settlements (life insurance policies). We currently use a probabilistic method of valuing life insurance policies, which we believe to be the preferred valuation method in the industry. The most significant assumptions are the Company’s estimate of the life expectancy of the insured and the discount rate. See Note 16, "Fair Value Measurements" of the accompanying consolidated financial statements.
Fair Value Measurement Guidance
We follow ASC 820, Fair Value Measurements and Disclosures, which defines fair value as an exit price representing the amount that would be received if an asset were sold or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our investments in life insurance policies, and debt under the Revolving Credit Facilities are considered Level 3 as there is currently no active market where we are able to observe quoted prices for identical assets/liabilities and our valuation model incorporates significant inputs that are not observable. See Note 16, "Fair Value Measurements" of the accompanying consolidated financial statements.
Fair Value Option
We have elected to account for life settlements using the fair value method. The fair value of the asset is the estimated amount that would be received to sell an asset in an orderly transaction between market participants at the measurement date. We calculate the fair value of the asset using a present value technique to estimate the fair value of the life settlements. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. See Note 9, "Life Settlements (Life Insurance Policies)" and Note 16, "Fair Value Measurements" of the accompanying consolidated financial statements.
We have elected to account for the debt under the White Eagle Revolving Credit Facility, which includes the interests in policy proceeds to the lender, using the fair value method. The fair value of the debt is the estimated amount that would have to be paid to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of assumptions and/or estimation methodologies could have a material effect on estimated fair values.
Income Recognition from Continuing Operations
Our primary sources of income from continuing operations are in the form of changes in fair value and gains on life settlements, net. Our income recognition policies for these sources of income are as follows:
•
Changes in Fair Value of Life Settlements-When the Company acquires certain life insurance policies, we initially record these investments at the transaction price, which is the fair value of the policy for those acquired upon relinquishment or the amount paid for policies acquired for cash. The fair value of the investment in insurance policies is evaluated at the end of each reporting period. Changes in the fair value of the investment are recorded as changes in fair value of life settlements in our consolidated statement of operations. The fair value is determined on a discounted cash flow basis that incorporates current life expectancy assumptions. The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The Company recognizes income from life settlement maturities on the date we are in receipt of death notice or verified obituary of the insured. This income is the difference between the death benefit and fair value of the policy at the time of maturity.
•
Loss on Life Settlements, Net-The Company recognizes gains or losses from the sale of life settlement contracts that the Company owns upon the signed sale agreement and/or filing of ownership forms and funds transferred to escrow.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and all highly liquid instruments with an original maturity of three months or less, when purchased. The Company maintains the majority of its cash in several operating accounts with two commercial banks. Balances on deposit are insured by the Federal Deposit Insurance Corporation ("FDIC"). However, from time to time, the Company’s balances may exceed the FDIC insurable amount at its banks.
Certificate of Deposit
The Company maintains a portion of its operating funds in a certificate of deposit. At November 30, 2018 and December 31, 2017, the carrying amount of the certificate of deposits was $500,000 and $1.0 million, respectively, which approximates fair value. The certificate of deposit matures on September 22, 2019 and bears interest at a rate of 2.0%.
Deferred Debt Costs
Deferred debt costs include costs incurred in connection with acquiring and maintaining debt arrangements. These costs are directly deducted from the carrying amount of the liability in the consolidated balance sheets, are amortized over the life of the related debt using the effective interest method and are classified as interest expense in the accompanying consolidated statements of operations. These deferred costs are related to the Company's 8.5% Convertible Notes, 5% Convertible Notes and 8.5% Senior Secured Notes. The Company did not recognize any deferred debt costs on the White Eagle Revolving Credit Facility given all costs were expensed due to electing the fair value option in valuing the White Eagle Revolving Credit Facility.
Treasury Stock
The Company accounts for its treasury stock using the treasury stock method as set forth in ASC 505-30, Treasury Stock. Under the treasury stock method, the total amount paid to acquire the stock is recorded and no gain or loss is recognized at the time of purchase. Gains and losses are recognized at the time the treasury stock is reinstated or retired and are recorded in additional paid in capital or retained earnings. At November 30, 2018 and December 31, 2017, the Company owned 608,000 shares of treasury stock.
Stock-Based Compensation
We have adopted ASC 718, Compensation-Stock Compensation. ASC 718 addresses accounting for share-based awards, including stock options, restricted stock, performance shares and warrants, with compensation expense measured using fair value and recorded over the requisite service or performance period of the award. The fair value of equity instruments awarded will be determined based on a valuation using an option pricing model that takes into account various assumptions that are subjective. Key assumptions used in the valuation will include the expected term of the equity award taking into account both the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award. Compensation expense associated with performance shares is only recognized to the extent that it is probable the performance measurement will be met.
Earnings Per Share
The Company computes net income per share in accordance with ASC 260, Earnings Per Share. Under the provisions of ASC 260, basic net income per share is computed by dividing the net income available to common shareholders by the weighted average common shares outstanding during the period. Diluted net income per share adjusts basic net income per share for the effects of stock options, warrants, convertible notes and restricted stock awards only in periods, or for such awards in which the effect is dilutive. ASC 260 also requires the Company to present basic and diluted earnings per share information separately for each class of equity instruments that participate in any income distribution with primary equity instruments.
Held-for-sale and discontinued operations
We report a business as held-for-sale when management has approved or received approval to sell the business and is committed to a formal plan, the business is available for immediate sale, the business is being actively marketed, the sale is anticipated to occur during the ensuing year and certain other specified criteria are met. A business classified as held-for-sale is recorded at the lower of its carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Depreciation is not recorded on assets of a business classified as held-for-sale. Assets and liabilities related to a business classified as held-for-sale are segregated in the Consolidated Balance Sheet and major classes are separately disclosed in the notes to the Consolidated Financial Statements commencing in the period in which the business is classified as held-for-sale. We report the results of operations of a business as discontinued operations if the business is classified as held-for-sale, the operations and cash flows of the business have been or will be eliminated from the ongoing operations of the Company as a result of a disposal transaction and we will not have any significant continuing involvement in the operations of the business after the disposal transaction. The results of discontinued operations are reported in Discontinued Operations in the Consolidated Statement of Operations for current and prior periods commencing in the period in which the business meets the criteria of a discontinued operation, and include any gain or loss recognized on closing or adjustment of the carrying amount to fair value less cost to sell. During the fourth quarter of 2013, we sold substantially all of our structured settlements business. As a result, we have classified our structured settlement operating results as discontinued operations.
Foreign Currency
We own certain foreign subsidiary companies formed under the laws of Ireland, Bahamas and Bermuda. These foreign subsidiary companies utilize the U.S. dollar as their functional currency. The functional currency of foreign subsidiary companies' financial statements is the U.S. dollars and therefore, there are no translation gains and losses. Any gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the subsidiary companies functional currency) are included in income. These gains and losses are immaterial to our financial statements.
Use of Estimates
The preparation of these consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America ("GAAP"), requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from these estimates and such differences could be material. Significant estimates made by management include income taxes, the valuation of life settlements, the valuation of the debt owing under the White Eagle Revolving Credit Facility, the valuation of deconsolidated subsidiaries and the valuation of equity awards.
Risks and Uncertainties
In the normal course of business, the Company encounters economic, legal and longevity risk. There are two main components of economic risk that could potentially impact the Company: market risk and concentration of credit risk. Market risk for the Company includes interest rate risk. Market risk also reflects the risk of declines in valuation of the Company’s life settlements, including declines caused by the selection of increased discount rates associated with the Company’s fair value model for life settlements. It is reasonably possible that future changes to estimates involved in valuing life settlements could change and result in material effects to the future financial statements. Concentration of credit risk includes the risk that an insurance carrier who has issued life insurance policies held by the Company in its portfolio, does not remit the amount due under those policies due to the deteriorating financial condition of the carrier or otherwise. Legal risk includes the risk that statutes define or courts interpret insurable interest in a manner adverse to the Company’s ownership rights in its portfolio of life insurance policies and the risk that courts allow insurance carriers to retain premiums paid by the Company in respect of insurance policies that have been successfully rescinded or contested. Longevity risk refers to the risk that the Company does not experience the mortalities of insureds in its portfolio of life insurance policies that are anticipated to occur on an actuarial basis in a timely manner, which would result in the Company expending additional amounts for the payment of premiums.
Recent Accounting Pronouncements
In April 2015, the FASB issued ASU 2015- 05, "Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. If a cloud computing arrangement includes a license to internal-use software, then the software license is accounted for by the customer in accordance with Subtopic 350-40. If a cloud computing arrangement does not include a software license, the entity should account for the arrangement as a service contract. This generally means that the fees associated with the hosting element (service) of the arrangement are expensed as incurred. During the comment period and after the issuance of Update 2015-05, several stakeholders requested that the Board provide additional guidance on the accounting for costs of implementation activities performed in a cloud computing arrangement that is a service contract. In August 2018, the Board released the amendments on the accounting for implementation, setup, and other upfront costs (collectively referred to as implementation costs) apply to entities that are a customer in a hosting arrangement. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. We are currently evaluating the methods and impact if any of adopting this new standard on our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, "Leases" (Topic 842). The new guidance establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases. In December 2018, the Board released the amendments related to 1) sales taxes and other similar taxes collected from lessees that affect all lessors electing the accounting policy election; 2) lessor costs affecting all lessor entities that have lease contracts that either require lessees to pay lessor costs directly to a third party or require lessees to reimburse lessors for costs paid by lessors directly to third parties; and 3) recognition of variable payments for contracts with lease and nonlease components affecting all lessor entities with variable payments related to both lease and nonlease components. All entities, including early adopters, must apply the amendments in this Update to all new and existing leases. This ASU is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the methods and impact of adopting this new standard on our consolidated financial statements. We do not expect that it will have a material impact.
In February 2018, the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" to address stakeholder concerns about the guidance in current generally accepted accounting principles (GAAP) that requires deferred tax liabilities and assets to be adjusted for the effect of a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The amendments in this Update are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. We are currently evaluating the methods and impact of adopting this new standard on our consolidated financial statements.
In July 2018, the FASB issued ASU 2018-11, "Targeted Improvements to Leases (Topic 842) primarily to provide another transition method in addition to the existing transition method by allowing entities to initially apply the new leases standard at the adoption date (such as January 1, 2019, for calendar year-end public business entities) and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption consistent with preparers’ requests. The amendments in this Update address stakeholders’ concerns about the requirement for lessors to separate components of a contract by providing lessors with a practical expedient, by class of underlying asset, to not separate non-lease components from the associated lease component, similar to the expedient provided for lessees. The amendments in this Update also clarify which Topic (Topic 842 or Topic 606) applies for the combined component. For entities that have not adopted Topic 842 before the issuance of this Update, the effective date and transition requirements for the amendments in this Update related to separating components of a contract are the same as the effective date and transition requirements in Update 2016-02.
In August 2018, the FASB issued ASU 2018-13, "Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement" which modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, based on the concepts in the Concepts Statement, including the consideration of costs and benefits. The following disclosure requirements were removed from Topic 820 among others: 1) The amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy 2) The policy for timing of transfers between levels. The following disclosure requirements were part of the modifications in Topic 820:1) For investments in certain entities that calculate net asset value, an entity is required to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly. The amendments also clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. Lastly, the following disclosure requirements were added to Topic 820: 1) the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period; 2) the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information (such as the median or arithmetic average) in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. We are currently evaluating the methods and impact of adopting this new standard on our consolidated financial statements.
In October 2018, the FASB issued ASU No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities ("ASU 2018-17"). ASU 2018-17 provides that indirect interests held through related parties in common control arrangements should be considered on a proportional basis for determining whether fees paid to decision makers and service providers are variable interests. ASU 2018-17 is effective for public companies for annual and interim periods beginning after December 15, 2019, with early adoption permitted. We are currently evaluating the methods and impact of adopting this new standard on our consolidated financial statements.
In November 2018, the FASB issued ASU No. 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction Between Topic 808 and Topic 606 ("ASU 2018-18"). ASU 2018-18 clarifies when certain transactions between collaborative arrangement participants should be accounted for under ASC 606 and incorporates unit-of-account guidance consistent with ASC 606 to aid in this determination. ASU 2018-18 is effective for public companies for annual and interim periods beginning after December 15, 2019, with early adoption permitted. ASU 2018-18 should generally be applied retrospectively to the date of initial application of Topic 606. We do not expect this standard to have an impact on our consolidated financial position, results of operations or cash flows.
Adopted Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers," which converges the FASB and the International Accounting Standards Board ("IASB") standard on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. In April 2015, the FASB voted to defer the effective date of the new revenue recognition standard by one year. As a result, the provisions of this ASU are now effective for interim and annual periods beginning after December 15, 2017. This ASU became effective during eleven months ended November 30, 2018, but did not have any have a material impact on our financial position, results of operations or cash flows on our consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-06, "Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments." Topic 815 requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met. One of those criteria is that the economic characteristics and risks of the embedded derivatives are not clearly and closely related to the economic characteristics and risks of the host contract (the "clearly and closely related" criterion). The guidance in this ASU intends to resolve the diversity in practice resulting from the application of the existing four-step decision sequence defined in ASC 815-15-25-42 to call (put) options that can accelerate the repayment of principal on a debt instrument if they meet the clearly and closely related criterion by clarifying that an entity is required to perform only the four-step decision sequence. The entity does not have to separately assess whether the event that triggers its ability to exercise the contingent option is itself indexed only to interest rates or credit risk. This ASU is effective for annual periods beginning after December 15, 2017, and interim periods beginning after December 15, 2018. Early adoption is permitted including adoption in an interim period, as long as any adjustment is reflected as of the beginning of the fiscal year that includes the interim period. This ASU became effective during eleven months ended November 30, 2018, but did not have any have a material impact on our financial position, results of operations or cash flows on our consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments." This ASU provides specific guidance on eight cash flow classification issues that are either unclear or not included in current GAAP. These cash flow classification issues include debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. This ASU became effective during eleven months ended November 30, 2018 , but did not have any have a material impact on its financial position, results of operations or cash flows on our consolidated financial statements.
In October 2016, the FASB issued ASU No. 2016-16 Income Taxes (Topic 740): Intra-entity transfers of assets other than inventory ("ASU 2016-16"). Current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. This prohibition on recognition is an exception to the principle of comprehensive recognition of current and deferred income taxes in GAAP. The Board decided that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Consequently, the amendments in this update eliminate the exception for an intra-entity transfer of an asset other than inventory. For public business entities, the amendments in this update are effective for annual reporting periods beginning after December 15, 2017. The Company adopted this standard during the eleven months ended November 30, 2018 which resulted in the elimination of a deferred income tax charge of $17.6 million gross related to prior year sales of life settlement policies to its Ireland subsidiaries. The adoption resulted in a reduction of the valuation allowance and had no impact on earnings.
In January 2017, the FASB issued ASU 2017-01, "Business Combinations (Topic 805)," to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses by clarifying the definition of a business. The definition of a business affects many areas of accounting including acquisition, disposals, goodwill and consolidation. This amendment covers Phase 1 of a three phase project. The update is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The amendments in this update should be applied prospectively on or after the effective date. This ASU was effective during the eleven months ended November 30, 2018 and did not have an impact on our consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09, "Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting" to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. Under this new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The guidance is effective prospectively for annual periods beginning on or after December 15, 2017. This ASU was effective during the eleven months ended November 30, 2018 and did not have an impact on our consolidated financial statements.
In March 2018, the FASB issued ASU 2018-05, "Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update)" to amend certain SEC material in Topic 740 for the income tax accounting implications of the recently issued Tax Cuts and Jobs Act (Act). ASU 2018-05 is effective upon inclusion in the FASB Codification. We have adopted this ASU and continue to evaluate the impact of the Tax Cuts and Jobs Act on our consolidated financial statements.
In March 2018, the FASB issued ASU 2018-03, "Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" to clarify certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. In addition to amending Topic 825, Financial Instruments, the Board added Topic 321, Investments-Equity Securities, and made a number of consequential amendments to the Codification. The amendments in ASU 2018-03 are effective for public business entities for fiscal years beginning after December 15, 2017 and for interim periods within those fiscal years beginning after June 15, 2018. This ASU was effective during the eleven months ended November 30, 2018 and did not have an impact on our consolidated financial statements.
NOTE 3 - DECONSOLIDATION OF SUBSIDIARIES
On November 14, 2018 (the "Petition Date"), Lamington Road Designated Activity Company (formerly known as Lamington Road Limited), the Company’s wholly-owned indirect Irish subsidiary ("Lamington"), and White Eagle General Partner, LLC, the Company’s wholly-owned indirect Delaware subsidiary ("WEGP"), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court". Lamington is the limited partner and owns 99.99%, and WEGP is the general partner and owns 0.01%, of White Eagle. In its capacity as general partner, WEGP manages the affairs of White Eagle. Lamington and WEGP will continue to operate their businesses as "debtors-in-possession" under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. Emergent Capital (exclusive of its subsidiaries) a separate entity, and has not filed for bankruptcy relief and is continuing to operate in the ordinary course.
Lamington's and its subsidiaries' (White Eagle, WEGP and Lamington Road Bermuda Limited), ("Lamington", the "Deconsolidated Entities" or the "Debtors") financial results are included in the Company’s consolidated results through November 13, 2018, the day prior the Petition Date. However, Under ASC 810, Consolidation, specifically ASC 810-10-15, consolidation of a majority-owned subsidiary is precluded where control does not rest with the majority owners, for instance, where the subsidiary is in legal reorganization or bankruptcy. Accordingly, when a subsidiary files for bankruptcy, it is appropriate for the parent to deconsolidate the subsidiary. Under ASC 810, this loss of control would likely trigger a gain or loss for the parent as the parent would remeasure its retained noncontrolling investment at fair value. We assessed the inherent uncertainties associated with the outcome of the Chapter 11 reorganization process and the anticipated duration thereof, and concluded that it was appropriate to deconsolidate Lamington and its subsidiaries effective on the Petition Date.
At November 13, 2018, the pre-petition date, the Company valued its investment in Lamington to be $278.4 million, of which $127.3 million represents equity, $145.9 million represents promissory notes and interest receivable and $5.2 million represents other liabilities, which is equivalent to the Company's carrying value. This valuation was determined by performing a fair value calculation of the assets and liabilities of Lamington under ASC 820, Fair Value Measurement. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The Company calculated the fair value of the White Eagle Revolving Credit Facility using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the Company’s estimates are not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the
estimated fair values. All other assets and liabilities were deemed equivalent to their carrying value as at the pre-petition date. See Note 16, "Fair Value Measurements," of the accompanying consolidated financial statements.
ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities was effective for calendar year-end public business entities in 2018. Under the new guidance, a reporting entity should account for its equity investments that are not consolidated or accounted for under the equity method at fair value, with changes to fair value recorded in current earnings. Lamington's main subsidiary, White Eagle, carries its life settlements policies and debt under the White Eagle Revolving Credit Facility at fair value, these valuation are based on inputs that are both significant to the fair value measurement and unobservable. As a result, the Company adopted ASU 2016-01 to value its investment in Lamington during the eleven months ended November 30, 2018. The calculation was performed consistent with ASC 820 with changes in fair value recorded in current earnings.
When Lamington emerges from the jurisdiction of the Bankruptcy Court, the subsequent accounting will be determined based upon the applicable circumstances and facts at such time, including the terms of any plan of reorganization. The Debtors will continue to operate their businesses as "debtors-in-possession" under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. Emergent Capital (exclusive of its subsidiaries) is a separate entity with independent capital structures and has not filed for bankruptcy relief and is continuing to operate in the ordinary course.
As a result of the Chapter 11 Cases, consistent with ASC 321, Investments - Equity Securities, the Company subsequently, measured its investment in Lamington at fair value as of November 30, 2018. Further, the Company engaged a third party to perform a quantitative assessment to determine the value of its investment in Lamington. The valuation report showed the fair value of the Company's investment in Lamington to be $128.8 million, which is $150.9 million lower than its pre-petition value. As a result, the Company recognized an impairment on its investment in Lamington at November 30, 2018, the amount is reflected in current earnings as change in fair value of investment in deconsolidated subsidiaries. The fair value of $128.8 million has inherent estimates including, but not limited to, when the Company will emerge from bankruptcy, the estimated discount rate, the value of the debt under the White Eagle Revolving Credit Facility, as well as other factors inherent in the valuation process.
The fair value of the investment in Lamington is calculated as follows:
The table below summarizes the composition on the Company's investment in the deconsolidated entities for pre and post-petition.
NOTE 4 - CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS FOR ENTITIES IN BANKRUPTCY
Condensed consolidated financial information for Lamington Road DAC is set forth below, presented at historical cost basis
Lamington Road DAC
(Debtor-in-Possession)
Condensed and Consolidated Statements Balance Sheet
For November 14, 2018 to November 30, 2018 and For the Year Ended December 31, 2017
*Liabilities subject to compromise include pre-petition unsecured claims, which may be settled at amounts different from those recorded in the condensed consolidated balance sheet.
Lamington Road DAC
(Debtor-in-Possession)
Condensed and Consolidated Statements of Operations
For November 14, 2018 to November 30, 2018 and Year Ended December 31, 2017
Lamington Road DAC
(Debtor-in-Possession)
Condensed and Consolidated Statements of Cash Flows
For November 14, 2018 to November 30, 2018 and Year Ended December 31, 2017
Related Party Transactions
Certain related party transactions had been eliminated in consolidation. Due to the deconsolidation of Lamington, transactions after November 14, 2018 are no longer eliminated. The below is a description of related party transactions for the period.
Administrative Services Fees
In 2014, White Eagle entered in an Administrative Service Agreement with Imperial Finance and Trading ("IFT). Under the agreement, IFT will perform certain non-discretionary, administrative or ministerial services to assist with certain reporting, compliance and document retention duties and obligations arising under or in connection with the Amended and Restated Loan and Securities Agreement. IFT shall recover all cost incurred in performing these services, with billings quarterly or annually. Bills will be based on actual cost or an appropriate allocation methodology. White Eagle incurred pre-petition administrative service expenses of approximately $5.2 million and $3.6 million during the eleven months ended November 30, 2018 and twelve months ended December 31, 2017, respectively which were eliminated on consolidation, with approximately $229,000 incurred post-petition from November 14, 2018 to November 30, 2018 which was not eliminated due to the deconsolidation. Amounts due from White Eagle resulting from the administrative services are included in investment in deconsolidated subsidiaries and amounts payable to IFT are included in other liabilities on the Lamington Road DAC consolidated balance sheet totaling $5.4 million.
Promissory Notes Receivables
Effective May 16, 2014, Lamington entered into a 10 year, $59.3 million unsecured Promissory Note ("the 8.5% Promissory Note") with its Parent Company, Markley Asset Portfolio, LLC ("Markley"). The amount was used by Lamington as the partial purchase price of Markley’s interest in White Eagle. The annual interest rate on the Promissory Note is 8.5% and is due to be paid at the end of each calendar year; provided that any interest accrued at the end of a calendar year which is not paid within seven business days thereafter shall be capitalized and increased to the outstanding principal balance. As of November 30, 2018 the outstanding principal balance was $80.1 million, which includes $20.8 million in capitalized interest. Total interest expense related to the Promissory Note was $6.3 million and $6.4 million for the eleven months ended November 30, 2018 and the year ended December 31, 2017. The entire remaining principal balance of the Promissory Note shall be due and payable, together with all accrued but unpaid interest, on May 16, 2024. No principal payments are due prior to the maturity date.
Effective July 28, 2017, Lamington, issued an unsecured Promissory Note to Markley, in a principal amount of $57.0 million. The amount represents distributions of earnings from Lamington's share of profits of White Eagle, to satisfy Profit Participation Notes issued by Markley to Lamington (the "Special Dividend Note"). The Special Dividend Note matures on July 28, 2027 and bears interest at an annual rate of 5.0% provided that any interest accrued at the end of a calendar year which is not paid within seven business days thereafter shall be capitalized and increased to the outstanding principal balance. Total interest expense related to the Special Dividend Note was $2.7 million and $1.2 million for the eleven months ended November 30, 2018 and the year ended December 31, 2017, respectively. The entire remaining principal balance of the Special Dividend Note shall be due and payable, together with all accrued but unpaid interest, on July 28, 2027. No principal payments are due prior to the maturity date. Approximately $416,000 was paid as interest for the eleven months ended November 30, 2018. There was no payment for the year ended December 31, 2017.
At November 30, 2018, the notes were fair valued in accordance with ASC 820 and were included in the remaining investment in deconsolidated subsidiaries and not separately presented on the face of the consolidated balance sheet, which resulted in a loss on change in fair value adjustment of approximately $89.8 million with carrying value of approximately $56.6 million compared to pre-petition value of $145.9 million inclusive of principal and interest.
NOTE 5-CONSOLIDATION OF VARIABLE INTEREST ENTITIES
The Company evaluates its interests in variable interest entities ("VIEs") on an ongoing basis and consolidates those VIEs in which it has a controlling financial interest and is thus deemed to be the primary beneficiary. A controlling financial interest has both of the following characteristics: (i) the power to direct the activities of the VIE that most significantly impact its economic performance; and (ii) the obligation to absorb losses of the VIE that could potentially be significant to it or the right to receive benefits from the VIE that could be potentially significant to the VIE.
The following table presents the consolidated assets and consolidated liabilities of VIEs for which the Company has concluded that it is the primary beneficiary and which are consolidated in the Company’s financial statements as of November 30, 2018 and December 31, 2017, as well as non-consolidated VIEs for which the Company has determined it is not the primary beneficiary (in thousands):
As of November 30, 2018, 586 life insurance policies owned by White Eagle with an aggregate death benefit of approximately $2.8 billion and an estimated fair value of approximately $505.2 million were pledged as collateral under the White Eagle Revolving Credit Facility.
Voluntary Petitions for Relief Under Chapter 11 and De-consolidation of Subsidiaries
On November 14, 2018 (the "Petition Date"), Lamington Road Designated Activity Company (formerly known as Lamington Road Limited), the Company’s wholly-owned indirect Irish subsidiary ("Lamington"), and White Eagle General Partner, LLC, the Company’s wholly-owned indirect Delaware subsidiary ("WEGP"), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court". Lamington is the limited partner and owns 99.99%, and WEGP is the general partner and owns 0.01%, of White Eagle. In its capacity as general partner, WEGP manages the affairs of White Eagle.
Lamington and its subsidiaries (White Eagle, WEGP and Lamington Road Bermuda Limited), financial results are included in the Company’s consolidated results through November 13, 2018, the day prior to the Petition Date. However, ASC 810, Consolidation require that an entity whose financial statements were previously consolidated with those of its parent that files for protection under the U.S. Bankruptcy Code, whether solvent or insolvent, generally must be prospectively deconsolidated from the parent and presented as an equity investment (deconsolidation applies to Lamington and all subsidiaries owned, directly or indirectly, by Lamington, including WEGP, White Eagle and Lamington Road Bermuda), (the "Deconsolidated Entities" or the "Debtors"). Therefore, our 2018 results are not comparable with 2017, the post-petition results are not included in our consolidated results for the eleven months ended November 30, 2018. Under ASC 810, this loss of control would likely trigger a gain or loss for the parent as the parent would remeasure its retained noncontrolling investment at fair value. We assessed the inherent uncertainties associated with the outcome of the Chapter 11 reorganization process and the anticipated duration thereof, and concluded that it was appropriate to deconsolidate Lamington and its subsidiaries effective on the Petition Date.
In accordance with ASC 810, Consolidation, the Company has derecognized related assets and liabilities for White Eagle in its financial statements subsequent to the Petition Date. See Note 4, "Condensed and Consolidated Financial Statements for Entities in Bankruptcy, "to the accompanying consolidated financial statements for further information.
In accordance with ASC 810, Consolidation, the Company consolidated White Eagle in its financial statements for the year ended December 31, 2017.
Imperial Settlements Financing 2010, LLC ("ISF 2010"), which was formed as an affiliate of the Company to serve as a special purpose financing entity to allow the Company to sell structured settlements and assignable annuities, is a non-consolidated special purpose financing entity, as well as a non-consolidated VIE for which the Company has determined it is not the primary beneficiary. Approximately $2.4 million is included in investment in affiliates in the accompanying balance sheet as of November 30, 2018 and year ended December 31, 2017, respectively.
NOTE 6-EARNINGS PER SHARE
As of November 30, 2018, December 31, 2017 and 2016, there were 158,733,928, 158,495,399 and 29,021,844 shares of common stock issued, respectively, and 158,125,928, 157,887,399, and 28,413,844 of shares of common stock outstanding, respectively. Outstanding shares as of November 30, 2018 and December 31, 2017 and 2016 have been adjusted to reflect 608,000 treasury shares.
Basic net income per share is computed by dividing the net earnings attributable to common shareholders by the weighted average number of common shares outstanding during the period.
Diluted earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding, increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Conversion or exercise of the potential common shares is not reflected in diluted earnings per share unless the effect is dilutive. The dilutive effect, if any, of outstanding common share equivalents is reflected in diluted earnings per share by application of the treasury stock method and if-converted method, as applicable.
The following tables reconcile actual basic and diluted earnings per share for the eleven months ended November 30, 2018 and the years ended December 31, 2017 and 2016 (in thousands except per share data).
(1)
The computation of diluted EPS does not include 85,000 shares of common stock underlying options, 100,000 shares of stock appreciation rights, 1,400,000 shares of restricted stock, 44,500,000 shares of common stock underlying warrants, up to 37,918,483 shares of common stock issuable upon conversion of the 5% Convertible Notes (as defined below) and up to 181,249 shares of common stock issuable upon the conversion of the 8.5% Convertible Notes (as defined below), as the effect of their inclusion would have been anti-dilutive.
(2)
The computation of diluted EPS did not include 542,102 options, 48,740,521 warrants, 2,102,522 shares of restricted stock, up to 37,918,483 shares of underlying common stock issuable upon conversion of the Convertible Notes and up to 181,249 shares of underlying common stock issuable upon conversion of the 8.5% Convertible Notes (as defined below) for the year ended December 31, 2017, as the effect of their inclusion would have been anti-dilutive.
(3)
The computation of diluted EPS did not include 763,594 options and 6,240,521 warrants, 265,212 shares of restricted stock, up to 10,738,165 shares of underlying common stock issuable upon conversion of the Convertible Notes, and 319,500 performance shares for the year ended December 31, 2016, as the effect of their inclusion would have been anti-dilutive.
NOTE 7-STOCK-BASED COMPENSATION
On June 27, 2017, the shareholders of the Company voted to amend, and the Company amended, the Amended and Restated 2010 Omnibus Incentive Plan (as amended, the "Omnibus Plan") to increase the number of shares authorized for issuance thereunder by 9,900,000 shares. Awards under the Omnibus Plan may consist of incentive awards, stock options, stock appreciation rights, performance shares, performance units, and shares of common stock, restricted stock, restricted stock units or other stock-based awards as determined by the compensation committee of the Company's board of directors. The Omnibus Plan has an aggregate of 12,600,000 shares of common stock authorized for issuance thereunder, subject to adjustment as provided therein.
Options
As of November 30, 2018, all options to purchase shares of common stock issued by the Company were fully vested. There was no stock-based compensation expense relating to stock options it granted under the Omnibus Plan during the eleven months ended November 30, 2018 and the year ended December 31, 2017.
As of November 30, 2018, options to purchase 85,000 shares of common stock were outstanding under the Omnibus Plan at a weighted average exercise price of $6.94 per share. The following table presents the activity of the Company’s outstanding stock options of common stock for the eleven months ended November 30, 2018:
As of November 30, 2018, all outstanding stock options had an exercise price above the fair market value of the common stock on that date. There are no remaining unamortized amounts to be recognized on these options.
Restricted Stock
The Company incurred additional stock-based compensation expense of approximately $562,000, $388,000, and$411,000 relating to restricted stock granted to its board of directors and certain employees during the eleven months ended November 30, 2018 and the years ended December 31, 2017 and 2016, respectively.
Under the Omnibus Plan, 41,259 shares of restricted stock granted to the Company's directors during 2015 vested during the year ended December 31, 2016. The fair value of the restricted stock was valued at $255,000 based on the closing price of the Company’s shares on the day prior to the grant date. The Company incurred stock-based compensation expense of approximately $103,000 related to these 41,259 shares of restricted stock during the year ended December 31, 2016.
During the year ended December 31, 2016, the Company granted 65,212 shares of restricted stock to its directors under the Omnibus Plan, which are subject to a 1 year vesting period that commenced on the date of grant. The fair value of the restricted stock was valued at approximately $255,000 based on the closing price of the Company’s shares on the date prior to the grant date. The Company incurred stock-based compensation expense related to these 65,212 shares of restricted stock of approximately $106,000 and $141,000 during the years ended December 31, 2017 and 2016, respectively. The 65,212 shares of restricted stock vested during the year ended December 31, 2017.
During the year ended December 31, 2016, the Company granted 200,000 shares of restricted stock units to certain employees under the Omnibus Plan, which are subject to a two year vesting period that commenced on the date of grant. The fair value of the unvested restricted stock was valued at approximately $674,000 based on the closing price of the Company's
shares on the day prior to the grant date. Approximately 46,000 and 60,000 shares of restricted stock were vested and forfeited, respectively, during the year ended December 31, 2017 with 74,000 and 20,000 vested and forfeited, respectively, during the eleven months ended November 30, 2018 with 0 pending vesting at November 30, 2018.The Company incurred stock-based compensation expense of approximately $23,000, $215,000 and $168,000 related to these shares of restricted stock during the eleven months ended November 30, 2018, and the years ended December 31, 2017 and 2016, respectively.
During the year ended December 31, 2017, the Company granted 51,132 shares of restricted stock to its directors under the Omnibus Plan, which are subject to a 1 year vesting period that commenced on the date of grant. The fair value of the unvested restricted stock was valued at approximately $17,000 based on the closing price of the Company’s shares on the date prior to the grant date. The Company incurred stock-based compensation expense related to these 51,132 shares of restricted stock of approximately $17,000 during year ended December 31, 2017. Approximately 42,610 shares of restricted stock vested during the year ended December 31, 2017 with 8,522 vested during the eleven months ended November 30, 2018.
During the year ended December 31, 2017, the Company granted 2,000,000 shares of restricted stock units to certain employees under the Omnibus Plan, which are subject to a 2 year vesting period that commenced on the date of grant. The fair value of the unvested restricted stock was valued at approximately $745,000 based on the closing price of the Company's shares on the day prior to the grant date. Approximately 750,000 shares of restricted stock vested during the eleven months ended November 30, 2018 with 1,250,000 unvested at November 30, 2018.The Company incurred stock-based compensation expense of approximately $386,000 and $51,000 related to these 2,000,000 shares of restricted stock during the eleven months ended November 30, 2018 and the year ended December 31, 2017.
During the eleven months ended November 30, 2018, the Company granted 150,000 shares of restricted stock units to certain employees under the Omnibus Plan, with 100,000 shares and 50,000 subject to a 2 and 3 year vesting period, respectively, that commenced on the date of grant. The fair value of the unvested restricted stock was valued at approximately $58,000 based on the closing price of the Company's shares on the day prior to the grant date. The Company incurred stock-based compensation expense of approximately $17,000 related to these 150,000 shares of restricted stock during the eleven months ended November 30, 2018. All 150,000 shares remained unvested at November 30, 2018.
During the eleven months ended November 30, 2018, the Company established an ad hoc Capital Structure Committee, (the "Committee") consisting of members of the board of directors, to undertake a review of the Company's capital structure. As compensation to the sole non-employee member of the Committee, the Company granted 400,000 restricted stock units under the Omnibus Plan, which will vest on the later of (i) September 30, 2018 and (ii) termination of the director's service on the Committee. The fair value of the restricted stock was valued at approximately $128,000 based on the closing price of the Company’s shares on the date prior to the grant date. The Company incurred stock-based compensation expense related to these 400,000 restricted stock units of approximately $128,000 during the eleven months ended November 30, 2018. The 400,000 restricted stock units vested during the eleven months ended November 30, 2018.
The following table presents the activity of the Company’s unvested restricted stock for the eleven months ended November 30, 2018:
The aggregate intrinsic value of the awards of 150,000 and 1,250,000 is $41,000 and $359,000, respectively, and the remaining weighted average life of these awards is 1.62 years and 0.96 years, respectively, as of November 30, 2018 and December 31, 2017. As of November 30, 2018, a total of $400,000 in stock based compensation remained unrecognized.
Stock Appreciation Rights (SARs)
During the eleven months ended November 30, 2018, the Company issued 100,000 SARs to the sole non-employee member of the Committee, which will expire 10 years after the date the SARs were granted. The SARs will vest on the later of
(i) September 30, 2018 and (ii) termination of the director's service on the Committee and have a fair value of $8,000 on the grant date. Each SAR entitles the holder to receive, upon exercise, an amount equal to the excess of (a) the fair market value per share of stock on the exercise date, over (b) the exercise price, which is $1.00, being not less than the fair market value per share of stock on the grant date. Upon exercise of the SARs, the stock appreciation amount shall be paid, as determined solely at the discretion of the Company, in (a) whole shares, (b) cash, or (c) a combination of both cash and shares. The Company incurred stock-based compensation expense of $8,000 related to these 100,000 SARs during the eleven months ended November 30, 2018. The 100,000 SARs units vested during the eleven months ended November 30, 2018.
NOTE 8-DISCONTINUED OPERATIONS
On October 25, 2013, the Company sold substantially all of the operating assets comprising its structured settlement business to Majestic Opco LLC pursuant to an Asset Purchase Agreement. No structured settlement receivables were sold and no on-balance sheet liabilities were transferred in connection with the sale. On August 18, 2015, the Company sold its remaining structured settlement receivables asset for $920,000 to the buyer of its operating assets.
As a result of the sale of its structured settlements business, the Company reclassified its structured settlement business operating results as discontinued operations in the accompanying Consolidated Statements of Operations for all periods presented.
Operating results related to the Company’s discontinued structured settlement business are as follows:
NOTE 9-LIFE SETTLEMENTS (LIFE INSURANCE POLICIES)
The Company accounts for policies it acquires using the fair value method in accordance with ASC 325-30-50 Investments-Other-Investment in Insurance Contracts. Under the fair value method, the Company recognizes the initial investment at the purchase price. For policies that were relinquished in satisfaction of premium finance loans at maturity, the initial investment is the loan carrying value. For policies purchased in the secondary or tertiary markets, the initial investment is the amount of cash outlay at the time of purchase. At each reporting period, the Company re-measures the investment at fair value in its entirety and recognizes changes in the Statements of Operations in the periods in which the changes occur.
As of November 30, 2018 and December 31, 2017, the Company through its consolidated and deconsolidated subsidiary companies owned 588 and 608 policies, respectively, with an aggregate estimated fair value of life settlements of $506.4 million and $567.5 million, respectively. 586 of these policies with a fair value of approximately $505.2 million at November 30, 2018 are held by White Eagle whose results have been deconsolidated from the Company's results at November 30, 2018 and are pledged under a $370.0 million, revolving credit agreement. See Note 3, "Deconsolidation of Subsidiaries" and Note 4, "Condensed and Consolidated Financial Statements for Entities in Bankruptcy," to the accompanying consolidated financial statements for further information. Two policies owned by the Company, with an aggregate death benefit of approximately $12.0 million and a fair value of $1.2 million were not pledged as collateral under the White Eagle Revolving Credit Facility and are included in the Company's Consolidated financial statements.
The following describes the Company’s life settlements as of November 30, 2018 (dollars in thousands):
Policies Pledged Under White Eagle Revolving Credit Facility and Deconsolidated
The weighted average life expectancy calculated based on death benefit of insureds in the policies owned by the White Eagle at November 30, 2018 was 8.9 years.
*Based on remaining life expectancy at November 30, 2018, as derived from reports of third party life expectancy providers, and does not indicate the timing of expected death benefits. See "Life Settlements," in Note 16, "Fair Value Measurements," of the accompanying consolidated financial statements.
During the eleven months ended November 30, 2018 and the year ended December 31, 2017, the Company experienced maturities of 20 and 13 life insurance policies with face amounts totaling $93.4 million and $67.2 million, respectively, resulting in a net gain of approximately $53.3 million and $35.9 million, respectively.
The below is an analysis of policy maturities for the eleven months ended November 30, 2018 and the year ended December 31, 2017.
* Cost includes purchase price and premiums paid into the policy to date of maturity. Accumulated change in fair value is impacted by changes in discount rate, updated life expectancy estimates on the life insurance policy and cost of insurance increase.
Estimated premiums to be paid for each of the five succeeding fiscal years and thereafter to keep the life insurance policies in force as of November 30, 2018, are as follows (in thousands):
The amount of $1.54 billion noted above represents the estimated total future premium payments required to keep the life insurance policies in force during the life expectancies of all the underlying insured lives and does not give effect to projected receipt of death benefits. The estimated total future premium payments could increase or decrease significantly to the extent that insurance carriers increase the cost of insurance on their issued policies or that actual mortalities of insureds differs from the estimated life expectancies.
Policies Not Pledged
The weighted average life expectancy calculated based on death benefit of insureds in the policies owned by the Company at November 30, 2018 was 12.2 years.
Estimated premiums to be paid for each of the five succeeding fiscal years and thereafter to keep the life insurance policies in force as of November 30, 2018, are as follows (in thousands):
The amount of $6.0 million noted above represents the estimated total future premium payments required to keep the life insurance policies in force during the life expectancies of all the underlying insured lives and does not give effect to projected receipt of death benefits. The estimated total future premium payments could increase or decrease significantly to the extent that insurance carriers increase the cost of insurance on their issued policies or that actual mortalities of insureds differs from the estimated life expectancies.
The following describes the Company’s life settlements as of December 31, 2017 (dollars in thousands):
The weighted average life expectancy calculated based on death benefit of insureds in the policies owned by the Company at December 31, 2017 was 8.3 years. The following table describes the Company’s life settlements as of December 31, 2017 (dollars in thousands)
*Based on remaining life expectancy at December 31, 2017, as derived from reports of third party life expectancy providers, and does not indicate the timing of expected death benefits. See "Life Settlements," in Note 16, "Fair Value Measurements," of the accompanying consolidated financial statements.
NOTE 10-WHITE EAGLE REVOLVING CREDIT FACILITY
Effective April 29, 2013, White Eagle entered into a 15-year revolving credit agreement with LNV Corporation, as initial lender, Imperial Finance & Trading, LLC, as servicer and portfolio manager and CLMG Corp., as administrative agent. Proceeds from the initial advance under the facility were used, in part, to retire a bridge facility and to fund a payment to the lender protection insurance provider to release subrogation rights in certain of the policies pledged as collateral for the White Eagle Revolving Credit Facility. On May 16, 2014, White Eagle Asset Portfolio, LLC converted from a Delaware limited liability company to White Eagle Asset Portfolio, LP, a Delaware limited partnership (the "Conversion") and all of its ownership interests were transferred to an indirect, wholly-owned Irish subsidiary of the Company. In connection with the Conversion, the White Eagle Revolving Credit Facility was amended and restated among White Eagle, as borrower, Imperial Finance and Trading, LLC, as the initial servicer, the initial portfolio manager and guarantor, Lamington Road Bermuda Ltd., as portfolio manager, LNV Corporation, as initial lender, the other financial institutions party thereto as lenders, and CLMG Corp., as administrative agent for the lenders. The White Eagle Revolving Credit Facility was amended on November 9, 2015. As amended, the White Eagle Revolving Credit Facility may provide earlier participation in the portfolio cash flows if certain loan to value ("LTV") ratios are achieved. Additionally, the maximum facility limit was reduced from $300.0 million to $250.0 million, and the interest rate under the facility was increased by 50 basis points.
On December 29, 2016, White Eagle entered into a Second Amendment to the Amended and Restated Loan and Security Agreement ("White Eagle Second Amendment") and on January 31, 2017, as required by the terms of the White Eagle Amendment, White Eagle executed the Second Amended and Restated Loan and Security Agreement, dated January 31, 2017, which consolidated into a single document the amendments evidenced by the White Eagle Amendment and all previous amendments.
As amended, the White Eagle Revolving Credit Facility adjusted the loan-value ("LTV") ratios which directed cash flow participation and became subjected to achieving certain financial metrics, as more fully described below under "Amortization & Distributions." Pursuant to the White Eagle Second Amendment, 190 life settlement policies purchased from wholly owned subsidiaries of the Company were pledged as additional collateral under the facility for an additional policy advance of approximately $71.1 million. The maximum facility limit was increased to $370.0 million and the term of the facility was extended to December 31, 2031. Additional loan terms and amendment changes are more fully described in the sections that follow.
On October 4, 2017, White Eagle entered into an amendment to the Second Amended and Restated Loan and Security Agreement. The amendment changed the provisions over how participation of the proceeds from the maturity of the policies pledged as collateral under the White Eagle Revolving Credit Facility are distributed pursuant to a waterfall. The amendment included an exclusion from the cash interest coverage ratio of at least 2.0:1 for the period of July 1, 2017 through July 28, 2017. As a result of the amendment, the Company was able to participate in the waterfall distribution scheduled during October 2017.
General & Security. The White Eagle Revolving Credit Facility provides for an asset-based revolving credit facility backed by White Eagle’s portfolio of life insurance policies with an aggregate lender commitment of up to $370.0 million, subject to borrowing base availability. 586 life insurance policies with an aggregate death benefit of approximately $2.8 billion and an estimated fair value of approximately $505.2 million are pledged as collateral under the White Eagle Revolving Credit
Facility at November 30, 2018. In addition, the equity interests in White Eagle have been pledged under the White Eagle Revolving Credit Facility.
Borrowing Base. Borrowing availability under the White Eagle Revolving Credit Facility is subject to a borrowing base, which at any time is equal to the lesser of (A) the sum of all of the following amounts that have been funded or are to be funded through the next distribution date (i) the initial advance and all additional advances to acquire additional pledged policies that are not for ongoing maintenance advances, plus (ii) 100% of the sum of the ongoing maintenance costs, plus (iii) 100% of fees and expense deposits and other fees and expenses funded and to be funded as approved by the required lenders, less (iv) any required payments of principal and interest previously distributed and to be distributed through the next distribution date; (B) 75% of the valuation of the policies pledged as collateral as determined by the lenders; (C) 50% of the aggregate face amount of the policies pledged as collateral (excluding certain specified life insurance policies); and (D) the then applicable facility limit. At November 30, 2018, $6.2 million was undrawn and $5.7 million was available to borrow under the White Eagle Revolving Credit Facility. The amount available to borrow is calculated based on and limited to the premium payments and expenses if any, that are due as of the calculation date. In essence, what is available, is what is required to pay expenses and keep the policies in force as of the calculation date.
Amortization & Distributions. Proceeds from the maturity of the policies pledged as collateral under the White Eagle Revolving Credit Facility are distributed pursuant to a waterfall. After distributions for premium payments, fees to service providers and payments of interest, a percentage of the collections from policy proceeds are to be paid to the Company, which will vary depending on the then LTV ratio as illustrated below where the valuation is determined by the lenders:
Provided that (i) if (a) the Company failed to maintain a cash interest coverage ratio of at least 2.0:1 at any time during the immediately preceding calendar quarter or (b) the Company fails to take steps to improve its solvency in a manner acceptable to the required lenders (as determined in their sole and absolute discretion), then the cash flow sweep percentage to the lenders shall equal one-hundred percent (100%) and (ii) if such distribution date occurs on or after December 29, 2025, then the cash flow sweep percentage shall equal one-hundred percent (100%). As of November 30, 2018, the cash interest coverage ratio was 5.09:1 and the loan to value ratio was 66%, as calculated using the lenders' valuation most recent valuation dated October 31, 2018. The lender ceased provided its valuation to the Company subsequent to this date.
The cash interest coverage ratio is the ratio of (i) consolidated cash and cash equivalents maintained by the Company to (ii) the aggregate interest amounts that will be due and payable in cash on (x) the $35.0 million 8.5% Senior Secured Notes due July 15, 2021 (and any notes issued by the Company or any of its Affiliates in connection with refinancing, replacing, substituting or any similar action with respect to any such notes), the $75.8 million 5.0% Convertible Notes due February 15, 2023 (and any notes issued by the Company or any of its Affiliates in connection with refinancing, replacing, substituting or any similar action with respect to any such notes), and the $1.2 million 8.50% Convertible Notes due February 15, 2019 (and any notes issued by the Company or any of its Affiliates in connection with refinancing, replacing, substituting or any similar action with respect to any such notes) and (y) any additional indebtedness issued by the Company after December 29, 2016, in each case, during the twelve month period following such date of determination. See Note 11, "8.50% Senior Unsecured Convertible Notes", Note 12, "5.0% Senior Unsecured Convertible Notes" and Note 14, "8.5% Senior Secured Notes" to the accompanying consolidated financial statements for further information.
With respect to approximately 25% of the face amount of policies pledged as collateral under the White Eagle Revolving Credit Facility, White Eagle has agreed that if policy proceeds that are otherwise due are not paid by an insurance carrier, the foregoing distributions will be altered such that the lenders will receive any "catch-up" payments with respect to amounts that they would have received in the waterfall prior to distributions being made to White Eagle. During the continuance of events of default or unmatured events of default, the amounts from collections of policy proceeds that might otherwise be paid to White Eagle will instead be held in a designated account controlled by the lenders and may be applied to fund operating and third party expenses, interest and principal, "catch-up" payments or percentage payments that would go to the lenders as described above.
Assuming no event of default, funds on account from policy proceeds shall be distributed in specified stages of priority. For the eleven months ended November 30, 2018 and the year ended December 31, 2017, approximately $76.6 million and $37.1 million, respectively, of proceeds received from the maturity of policies pledged under the White Eagle Revolving Credit Facility, were distributed through the waterfall in the following stages of priority (in thousands):
Approximately $7.8 million of the amount distributed during the eleven months ended November 30, 2018 was from maturity proceeds collected during the year ended December 31, 2017.
The below is a reconciliation of proceeds collected by the White Eagle Revolving Credit Facility and distributed through the waterfall as shown above (in thousands):
*Includes refund of premiums and interest earned on maturity proceeds
Use of Proceeds. Generally, ongoing advances may be made for paying premiums on the life insurance policies pledged as collateral and to pay the fees of service providers. Effective with the White Eagle Amendment on November 9, 2015, ongoing advances may no longer be used to pay interest, which will now be paid by White Eagle if there is not otherwise
sufficient amounts available from policy proceeds to be distributed to pay interest expense pursuant to the waterfall described above in "Amortization and Distributions." Subsequent advances and the use of proceeds from those advances are at the discretion of the lenders. During the eleven months ended November 30, 2018 and the year ended December 31, 2017, advances for premium payments and fees to service providers amounted to (in thousands):
Interest. Borrowings under the White Eagle Revolving Credit Facility bear interest at a rate equal to LIBOR or, if LIBOR is unavailable, the base rate, in each case plus an applicable margin of 4.50%, which was increased from 4.00% pursuant to the November 9, 2015 amendment, and subject to a rate floor component equal to the greater of LIBOR (or the applicable rate) and 1.5%. The base rate under the White Eagle Revolving Credit Facility equals the sum of (i) the weighted average of the interest rates on overnight federal funds transactions or, if unavailable, the average of three federal funds quotations received by the Agent plus 0.75% and (ii) 0.5%. Based on the loan agreement, the LIBOR portion of the interest rate will re-adjust annually, once the floor has exceeded 1.5%. The applicable rate will be dependent on the rate at the last business day of the preceding calendar year. On December 29, 2017, the LIBOR floor increased from 1.69% to 2.11%. The effective rate was 6.61% at November 30, 2018 and December 31, 2017. In the event that an Event of Default has occurred and is continuing, the interest rate will be equal to the sum of (i) the greater of (a) (1) LIBOR or, if LIBOR is unavailable, (2) the Base Rate and (b) one and a half percent (1.5%) plus (ii) six percent (6%).
Interest paid during the period is recorded in the Company’s consolidated financial statements. Accrued interest is reflected as a component of the estimated fair value of the White Eagle Revolving Credit Facility debt. The below table shows the composition of interest for the eleven months ended November 30, 2018 and the year ended December 31, 2017 (in thousands):
Maturity. Effective with the White Eagle Second Amendment, the term of the White Eagle Revolving Credit Facility expires December 31, 2031, which is also the scheduled commitment termination date (though the lenders’ commitments to fund borrowings may terminate earlier in an event of default). The lenders’ interests in and rights to a portion of the proceeds of the policies does not terminate with the repayment of the principal borrowed and interest accrued thereon, the termination of the White Eagle Revolving Credit Facility or expiration of the lenders’ commitments.
Covenants/Events of Defaults. The White Eagle Revolving Credit Facility contains covenants and events of default that are customary for asset-based credit agreements of this type, but also include cross defaults under the servicing, account control, contribution and pledge agreements entered into in connection with the White Eagle Revolving Credit Facility (including in relation to breaches by third parties thereunder), certain changes in law, changes in control of or insolvency or bankruptcy of the Company and relevant subsidiary companies and performance of certain obligations by certain relevant subsidiary companies, White Eagle and third parties. Effective with the White Eagle Second Amendment, and as described above in "Amortization and Distributions", the White Eagle Revolving Credit Facility contains a financial covenant requiring White Eagle to maintain a cash interest coverage ratio of at least 1.75:1 commencing after June 30, 2019. Failure to maintain this ratio for 60 consecutive days after June 30, 2019 constitutes an event of default. There is no interest coverage ratio requirement that would result in an event of default prior to this date; however, any failure to maintain a cash interest coverage ratio of at least 2.0:1 does impact the cash flow sweep percentage for proceeds distributed through the waterfall. As of
November 30, 2018, the cash interest coverage ratio was 5.09:1. The White Eagle Revolving Credit Facility also contains certain tests relating to asset maintenance, performance and valuation, the satisfaction of which will be determined by the lenders with a high degree of discretion.
Remedies. The White Eagle Revolving Credit Facility and ancillary transaction documents afford the lenders a high degree of discretion in their selection and implementation of remedies, including strict foreclosure, in relation to any event of default, including a high degree of discretion in determining whether to foreclose upon and liquidate all or any pledged policies, the interests in White Eagle, and the manner of any such liquidation. White Eagle has limited ability to cure events of default through the sale of policies or the procurement of replacement financing.
The Company elected to account for the debt under the White Eagle Revolving Credit Facility in accordance with ASC 820, which includes the 45% interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. The Company calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the Company’s estimates are not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.
Voluntary Petitions for Relief Under Chapter 11
On November 14, 2018 (the "Petition Date"), Lamington Road Designated Activity Company (formerly known as Lamington Road Limited), the Company’s wholly-owned indirect Irish subsidiary ("Lamington"), and White Eagle General Partner, LLC, the Company’s wholly-owned indirect Delaware subsidiary ("WEGP"), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court". Lamington is the limited partner and owns 99.99%, and WEGP is the general partner and owns 0.01%, of White Eagle. In its capacity as general partner, WEGP manages the affairs of White Eagle. The Lamington and WEGP filings are referred to as the "November Chapter 11 Cases."
The commencement of the November Chapter 11 Cases constitutes an event of default under the White Eagle Revolving Credit Facility, resulting in the principal and accrued interest due from White Eagle thereunder becoming immediately due and payable. Lamington and WEGP have pledged their respective interests in White Eagle to secure its obligations under the White Eagle Revolving Credit Facility. Any efforts by LNV Corporation, the lender under the White Eagle Revolving Credit Facility ("LNV"), or CLMG Corp., the administrative agent under the White Eagle Revolving Credit Facility ("CLMG"), to enforce such pledges by Lamington and WEGP of their respective interests in White Eagle in connection with the White Eagle Revolving Credit Facility are automatically stayed as a result of the commencement of the November Chapter 11 Cases and LNV’s and CLMG’s rights of enforcement in respect of the White Eagle Revolving Credit Facility are subject to the applicable provisions of the Bankruptcy Code. In addition, on November 15, 2018, White Eagle, LNV and CLMG entered into an Agreement Regarding Rights and Remedies (the "Standstill Agreement"), pursuant to which LNV and CLMG agreed to refrain from exercising their rights and remedies in connection with the White Eagle Revolving Credit Facility, subject to the terms and provisions of the Standstill Agreement, until 12:00 p.m. noon Pacific time on November 26, 2018, to facilitate negotiations.
On November 23, 2018, the effective period under the Standstill Agreement was extended to November 27, 2018; on November 27, 2018, the effective period under the Standstill Agreement was extended to November 30, 2018; on November 30, 2018, the effective period under the Standstill Agreement was extended to December 4, 2018; on December 4, 2018, the effective period under the Standstill Agreement was extended to December 7, 2018; and on December 6, 2018, the effective period under the Standstill Agreement was extended to December 11, 2018; and on December 10, 2018, the effective period under the Standstill Agreement was extended to December 13, 2018.
On December 13, 2018, White Eagle, filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The Chapter 11 case is being administered under case number 18-12808 (the "White Eagle Chapter 11 Case").
The commencement of the White Eagle Chapter 11 Case would constitute a default and event of default under the terms of the Amended and Restated Indenture between the Company and Wilmington Trust, National Association, as indenture trustee (the "Senior Note Indenture") relating to the Company’s 8.5% Senior Secured Notes due 2021 (the "Senior Notes") and the Indenture between the Company and U.S. Bank, National Association, as indenture trustee (the "Convertible Note Indenture") relating to the Company’s 5.0% Senior Unsecured Convertible Notes due 2023 (the "Convertible Notes").
However, such defaults and events of default and their consequences were waived in advance of the White Eagle Chapter 11 Case by holders of all of the outstanding principal amount of the outstanding Senior Notes and by holders of a majority of the outstanding principal amount of the outstanding Convertible Notes, and consequently, the Company believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred under either the Senior Note Indenture or the Convertible Note Indenture.
The commencement of the White Eagle Chapter 11 Case, together with the related filings of Chapter 11 cases for Lamington and WEGP on November 14, 2018 (collectively with the White Eagle Chapter 11 Case, the "Chapter 11 Cases"), constitutes an event of default under White Eagle’s revolving credit facility (the "Credit Facility"), resulting in the principal and accrued interest due from White Eagle thereunder becoming immediately due and payable. Lamington and WEGP have pledged their respective interests in White Eagle to secure its obligations under the Credit Facility. Any efforts by LNV Corporation, the lender under the Credit Facility ("LNV"), or CLMG Corp., the administrative agent under the Credit Facility ("CLMG"), to enforce repayment by White Eagle and/or such pledges by Lamington and WEGP of their respective interests in White Eagle in connection with the Credit Facility are automatically stayed as a result of the commencement of the Chapter 11 Cases and LNV’s and CLMG’s rights of enforcement in respect of the Credit Facility are subject to the applicable provisions of the Bankruptcy Code. The previously announced Standstill Agreement among White Eagle, LNV and CLMG expired prior to the filing of the White Eagle Chapter 11 Case. The Company obtained waivers from the requisite holders of each of 8.5% Senior Secured Notes and the New Convertible Notes with respect to the White Eagle Chapter 11 Case, similar to the waivers for the November Chapter 11 Cases, and believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred with respect to both the 8.5% Senior Secured Notes and the New Convertible Notes.
Beal Litigation
On January 25, 2019, the Company, White Eagle, Lamington, and WEGP , the ("Plaintiffs"), filed suit (the "Suit") against LNV Corporation ("LNV"), Silver Point Capital L.P. ("Silver Point") and GWG Holdings, Inc. ("GWG" and, with LNV and Sliver Point, the "Defendants") in the United States Bankruptcy Court for the District of Delaware (the "Court"), where the Suit will be administered together with the previously filed and announced petitions for relief under Chapter 11 of the United States Bankruptcy Code of White Eagle, Lamington and WEGP (the "Chapter 11 Cases" and White Eagle, Lamington and WEGP, the "Debtors"). LNV, a subsidiary of Beal Bank ("Beal"), is the lender under White Eagle’s outstanding revolving credit facility (the "Credit Facility").
In the Suit, the Plaintiffs allege that the Defendants engaged in a scheme to coerce the Plaintiffs into selling their valuable portfolio of life insurance policies to defendants for well below its true value. Pursuant to the Credit Facility, LNV agreed to lend $370 million to White Eagle, and in connection therewith received a 45% equity stake in White Eagle. That equity stake, and LNV’s significant control over White Eagle under the Credit Facility, creates a joint venture, and gives rise to fiduciary duties to White Eagle and Emergent, on the part of LNV. The Plaintiffs further allege that LNV has been engaged in a concerted campaign to "squeeze" White Eagle and Emergent by improperly restricting their cash flow, in the hopes that White Eagle and Emergent will have no choice but to sell the valuable policy portfolio to LNV or one of its proxies, including Silver Point and/or GWG, at below its true value.
In connection with the White Eagle Chapter 11 Case, on January 15, 2019, the Bankruptcy Court authorized the Debtors to use the proceeds of the cash collateral for a period of twenty (20) weeks (the "Cash Collateral'). The Cash Collateral may be used solely for the purposes permitted under the budget approved by the Bankruptcy Court, including (i) to provide working capital needs of the Debtors and general corporate purposes of the Debtors, (ii) to make the payments or fund amounts otherwise permitted in the final order that authorized such uses and such budget, (iii) to fund amounts necessary to pay certain fees; and (iv) to fund amounts necessary to pay certain professional fees in accordance with such budget.
See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information.
Deconsolidation of Subsidiaries
Lamington and its subsidiaries (White Eagle, WEGP and Lamington Road Bermuda Limited), financial results are included in the Company’s consolidated results through November 13, 2018, the day prior to the Petition Date. However, ASC 810, Consolidation require that an entity whose financial statements were previously consolidated with those of its parent that files for protection under the U.S. Bankruptcy Code, whether solvent or insolvent, generally must be prospectively deconsolidated from the parent and presented as an equity investment (deconsolidation applies to Lamington and all subsidiaries owned, directly or indirectly, by Lamington, including WEGP, White Eagle and Lamington Road Bermuda), (the "Deconsolidated Entities" or the "Debtors"). Therefore, our 2018 results are not comparable with 2017, the post-petition results
are not included in our consolidated results for the eleven months ended November 30, 2018. Under ASC 810, this loss of control would likely trigger a gain or loss for the parent as the parent would remeasure its retained noncontrolling investment at fair value. We assessed the inherent uncertainties associated with the outcome of the Chapter 11 reorganization process and the anticipated duration thereof, and concluded that it was appropriate to deconsolidate Lamington and its subsidiaries effective on the Petition Date.
In addition, ASC 852, Reorganization allows consolidated financial statements that include one or more entities in reorganization proceedings and one or more entities not in reorganization proceedings shall include condensed consolidated financial statements of the entities in reorganization proceedings.
See Note 4, "Condensed and Consolidated Financial Statements for Entities in Bankruptcy," to the accompanying consolidated financial statements for further information.
At November 30, 2018, the fair value of the outstanding debt was $346.7 million and the borrowing base was approximately $369.4 million, which includes $363.8 million of outstanding principal. Approximately $6.2 million was available to borrow under the White Eagle Revolving Credit Facility. The Company had a standstill agreement in place with the lender until December 13, 2018 and the Company continued to borrow on the loan through November 30, 2018, even though in default.
There are no scheduled repayments of principal prior to maturity although payments are due upon the next distribution date following the receipt of death benefits and distributed pursuant to the waterfall as described above. At November 30, 2018, approximately $28.1 million included in cash of the deconsolidated subsidiaries was on account with White Eagle awaiting distribution through the waterfall. With the White Eagle Chapter 11 Case, the Bankruptcy Court authorized the Debtors to use the proceeds of the cash collateral for a period of twenty (20) weeks (the "Cash Collateral"). The Cash Collateral may be used solely for the purposes permitted under the budget approved by the Bankruptcy Court.
NOTE 11-8.50% SENIOR UNSECURED CONVERTIBLE NOTES
In February 2014, the Company issued $70.7 million in an aggregate principal amount of 8.50% senior unsecured convertible notes due 2019 (the "Convertible Notes" or "8.5% Convertible Notes"). The Convertible Notes were issued pursuant to an indenture dated February 21, 2014, between the Company and U.S. Bank National Association, as trustee (the "Convertible Note Indenture").
The Convertible Notes are general senior unsecured obligations and rank equally in right of payment with all of the Company's other existing and future senior unsecured indebtedness. The Convertible Notes are effectively subordinate to all of the Company's secured indebtedness to the extent of the value of the assets collateralizing such indebtedness. The Convertible Notes are not guaranteed by the Company's subsidiaries.
The maturity date of the Convertible Notes is February 15, 2019. The Convertible Notes accrue interest at the rate of 8.50% per annum on the principal amount of the Convertible Notes, payable semi-annually in arrears on August 15 and February 15 of each year.
The Convertible Notes are convertible into shares of common stock at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date. Initially, the Convertible Notes were convertible into shares of common stock at a conversion rate of 147.9290 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of $6.76 per share of common stock). In the second quarter of 2015, the conversion rate was adjusted to 151.7912 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of $6.59 per share of common stock) in connection with an anti-dilution adjustment triggered by a rights offering that resulted in the issuance of 6,688,433 shares of the Company’s common stock.
On and after February 15, 2017 and prior to the maturity date, the Company may redeem for cash all, but not less than all, of the Convertible Notes if the last reported sale price of the Company’s common stock equals or exceeds 130% of the applicable conversion price for at least 20 trading days during the 30 consecutive trading day period ending on the trading day immediately prior to the date the Company delivers notice of the redemption. The redemption price will be equal to 100% of the principal amount of the Convertible Notes, plus any accrued and unpaid interest to, but excluding, the redemption date. In addition, a make-whole fundamental change occurs prior to the maturity date, and a holder elects to convert its Convertible
Notes in connection therewith, the Company will, in certain circumstances, increase the conversion rate by a number of additional shares of common stock for holders who convert their notes prior to the redemption date.
The Company determined that an embedded conversion option existed in the Convertible Notes that was required to be separately accounted for as a derivative under ASC 815 which required the Company to bifurcate the embedded conversion option, record it as a liability at fair value and record a debt discount by an equal amount. Upon receipt of shareholder approval to issue shares of common stock upon conversion of the Convertible Notes in an amount that exceeded applicable New York Stock Exchange limits for issuances without shareholder approval, the Company reclassified the embedded conversion derivative liability to equity. The Convertible Notes are recorded at accreted value and will continue to be accreted up to the par value of the Convertible Notes at maturity.
On February 14, 2017, the Company solicited consents (the "Consent Solicitation") to issue additional 8.50% Convertible Notes (the "Additional Convertible Notes") in lieu of a cash payment of interest on February 15, 2017 (the "2017 Interest Payment Date") to holders of the Convertible Notes.
On March 14, 2017, the Company issued Additional Convertible Notes for an aggregate principal amount of $3.5 million following the Company’s receipt of the requisite consents of the holders of approximately 98% of the aggregate principal amount of Convertible Notes (the "Consenting Holders"), pursuant to the Consent Solicitation, whereby each Consenting Holder agreed to accept Additional Convertible Notes in lieu of a cash payment of interest on the Convertible Notes due on the 2017 Interest Payment Date. All Additional Convertible Notes issued by the Company to Consenting Holders were issued under the Convertible Note Indenture and such Additional Convertible Notes have identical terms to the existing Convertible Notes. Interest on the Additional Convertible Notes will accrue from February 15, 2017.
On March 15, 2017 and May 12, 2017, the Company entered into a series of separate Master Transaction Agreements (the "Master Transaction Agreements") by and among the Company, PJC Investments, LLC, a Texas limited liability company ("PJC") and each such Consenting Convertible Note Holder that is a party to such Master Transaction Agreement regarding a series of integrated transactions with the intent to effect a recapitalization of the Company (the "Transaction") which included, among other transactions, a Convertible Note Exchange Offer and a New Convertible Note Indenture providing for the issuance of New Convertible Notes to be delivered in connection with the Transaction (each as defined in the Master Transaction Agreements).
As part of the Transaction, on April 18, 2017, the Company launched an exchange offer (the "Convertible Note Exchange Offer") to the existing holders of its outstanding Convertible Notes for 5.0% Senior Unsecured Convertible Notes due 2023 (the "New Convertible Notes" or "5% Convertible Notes"). At least 98% of the holders of the Convertible Notes were required to tender in the Convertible Note Exchange Offer as a condition to closing the Transaction.
On July 26, 2017, the Company’s offer to exchange its outstanding $74.2 million aggregate principal amount of Convertible Notes for its New Convertible Notes expired. Holders of at least 98% of the Convertible Notes tendered in the Convertible Note Exchange Offer. On July 28, 2017, the Company consummated a series of integrated transactions to effect a recapitalization of the Company (the "Transaction Closing") pursuant to the Master Transaction Agreements, which transactions included the consummation of the Convertible Note Exchange Offer. The amount exchanged included approximately $73.0 million of principal outstanding prior to the exchange and approximately $2.8 million of interest paid in kind at the exchange date. The outstanding principal amount of the Convertible Notes after the exchange was approximately $1.2 million.
In connection with the Transaction Closing, the Company entered into a supplemental indenture (the "Supplemental Convertible Note Indenture") to the Convertible Note Indenture governing the Convertible Notes. The purpose of the Supplemental Convertible Note Indenture was to eliminate substantially all of the restrictive covenants, eliminate certain events of default, eliminate the covenant restricting mergers and consolidations and modify certain provisions relating to defeasance contained in the Convertible Note Indenture and the Convertible Notes (collectively, the "Proposed Amendments") promptly after the receipt of the requisite consents for the Proposed Amendments.
The Company performed an assessment of the modification of the Convertible Notes under ASC 470, Debt, and determined the transaction is a troubled debt restructuring. The Company did not recognize any gain as a result of the restructuring, therefore, approximately $7.7 million was reclassified to the New Convertible Notes, including $6.7 million and $1.0 million related to debt discount and origination cost, respectively. Additionally, approximately $2.5 million was recognized as expense as a onetime debt modification cost. See Note 12 "5.0% Senior Unsecured Convertible Notes" for a description of the changes in terms of the note.
As of November 30, 2018, the carrying value of the Convertible Notes was $1.2 million, net of unamortized debt discounts and deferred debt costs of $18,000 and $3,000, respectively. These are being amortized over the remaining life of the Convertible Notes using the effective interest method.
The Company recorded $169,000 of interest expense on the Convertible Notes, including $93,000, $66,000 and $10,000 from interest, amortizing debt discounts and originations costs, respectively, during the eleven months ended November 30, 2018.
For the year ended December 31, 2017, the Company recorded $9.2 million of interest expense on the Convertible Notes, including $4.2 million, $2.5 million, $2.1 million and $314,000 from interest, one time debt modification cost, amortizing debt discounts and origination costs, respectively. Interest for the year ended December 31, 2017 was higher due to approximately $522,000 of additional interest paid in kind to note holders.
Subsequent Event
Non-payment of 8.5% Senior Unsecured Convertible Notes
On February 20, 2019, the Company received written notice from U.S. Bank, National Association, the trustee under the Indenture, dated as of February 21, 2014, by and among the Company and U.S. Bank, National Association, as Trustee, as amended and supplemented (the "Indenture"), that the Company was in default (the "Event of Default") under the Indenture for failure to pay the principal amount and accrued interest due upon maturity on February 15, 2019 of the Company’s outstanding 8.5% Senior Unsecured Convertible Notes due 2019 (the "Convertible Notes"). The outstanding principal amount of the Convertible Notes was $1.2 million and accrued interest thereon was approximately $51,000.
The Event of Default, which caused an automatic acceleration of the outstanding principal and accrued interest, had no practical effect on the Company, as such amounts were already due and payable. The Event of Default does not result in a cross-default under other debt agreements or arrangements of the Company. The total amount of $1.2 million due, consisting of principal and accrued interest, will accrue interest at 8.5% per annum (the original interest rate of the Convertible Notes) until payment thereof is made.
NOTE 12- 5.0% SENIOR UNSECURED CONVERTIBLE NOTES
On July 26, 2017, the Company’s Convertible Note Exchange Offer expired. Holders of at least 98% of the Convertible Notes tendered in the Convertible Note Exchange Offer.
In connection with the Transaction Closing, the Company caused to be issued the New Convertible Notes in an aggregate amount of approximately $75.8 million pursuant to an Indenture (the "New Convertible Note Indenture") between the Company and U.S. Bank, National Association, as indenture trustee. The terms of the New Convertible Notes are governed by the New Convertible Note Indenture, which provide, among other things, that the New Convertible Notes are unsecured senior obligations of the Company and will mature on February 15, 2023. The New Convertible Notes bear interest at a rate of 5% per annum from the issue date, payable semi-annually on August 15 and February 15 of each year, beginning on August 15, 2017.
Holders of New Convertible Notes may convert their New Convertible Notes at their option on any day prior to the close of business on the second scheduled trading day immediately preceding February 15, 2023. Upon conversion, the Company will deliver shares of Common Stock, together with any cash payment for any fractional share of Common Stock. The initial conversion rate for the New Convertible Notes denominated in $1,000 increments will be 500 shares of Common Stock per $1,000 principal amount of New Convertible Notes, which corresponds to an initial conversion price of approximately $2.00 per share of Common Stock. The initial conversion rate for the New Convertible Notes denominated in $1.00 increments will be 0.5 shares of Common Stock per $1.00 principal amount of New Convertible Notes, which corresponds to an initial conversion price of approximately $2.00 per share of Common Stock. The conversion rate will be subject to adjustment in certain circumstances.
The Company may redeem, in whole but not in part, the New Convertible Notes at a redemption price of 100% of the principal amount of the New Convertible Notes to be redeemed, plus accrued and unpaid interest and additional interest, if any, if and only if the last reported sale price of the Common Stock equals or exceeds 120% of the conversion price for at least 15 trading days in any period of 30 consecutive trading days. The Company may, at its election, pay or deliver as the case may be, to all Holders of the New Convertible Notes, either (a) solely cash, (b) solely shares of Common Stock, or (c) a combination of cash and shares of Common Stock.
The provisions of the New Convertible Note Indenture include a make-whole provision to compensate the Company’s debt holders for the lost option time value and forgone interest payments upon the Company experiencing a Fundamental Change (as defined in the New Convertible Note Indenture). These Fundamental Changes revolve around change in beneficial ownership, the consummation of specified transactions which result in the conversion of common stock into other assets or the sale, transfer or lease of all or substantially all of the Company’s assets, a majority change in the composition of the Company’s Board of Directors, the Company’s stockholders approval of any plan for liquidation of dissolution of the Company, and the Common Stock ceasing to be listed or quoted on a Trading Market . The number of incremental additional shares to be issued as a result of a Fundamental Change is based on a table which calculates the adjustment based on the inputs of time and share value.
The New Convertible Note Indenture provides for customary events of default, which include (subject in certain cases to customary grace and cure periods), among others: nonpayment of principal or interest; breach of covenants or other agreements in the New Convertible Note Indenture; defaults or failure to pay certain other indebtedness; and certain events of bankruptcy or insolvency. Generally, if an event of default occurs and is continuing under the New Convertible Note Indenture, the trustee or the holders of at least 25% in aggregate principal amount of the New Convertible Notes then outstanding may declare all unpaid principal plus accrued interest on the New Convertible Notes immediately due and payable, subject to certain conditions set forth in the New Convertible Note Indenture. In addition, holders of the New Convertible Notes may require the Company to repurchase the New Convertible Notes upon the occurrence of certain designated events at a repurchase price of 100% of the principal amount of the New Convertible Notes, plus accrued and unpaid interest.
The New Convertible Note Indenture, among other things includes provisions such as the Company’s failure to timely file any document or report that is required to be filed with the SEC, as well as a registration statement covering the re-sale by holders of the New Convertible Notes not being declared effective by the SEC; the Company’s failure to cure such a default within 14 days after the occurrence will result in the Company being required to pay additional interest in cash.
Additional interest on the New Convertible Notes will accrue with respect to the first 90-day period (or portion thereof) following the restricted transfer triggering date, which is 120 days after the last date on which any securities are originally issued under the New Convertible Note Indenture or a registration statement regarding the resale by the holders of the securities or holders of any shares of common stock issuable upon conversion. For each day that a restricted transfer default is continuing at a rate equal to 0.25% per annum of the principal amount of New Convertible Notes, which rate will increase by an additional 0.25% per annum of the principal amount of the New Convertible Notes for each subsequent 90- day period (or portion thereof) while a restricted transfer default is continuing until all restricted transfer defaults have been cured, up to a maximum of 0.5% of the principal amount of the securities. Following the cure of all restricted transfer defaults, the accrual of additional interest arising from restricted transfer defaults will cease.
The New Convertible Note Indenture states that the sole remedy for an event of default relating to the failure by the Company to comply with the provisions of the New Convertible Note Indenture requiring timely reporting by the Company and for any failure to comply with Section 314(a)(1) of the Trust Indenture Act shall, for the first 365 days after the occurrence of such an Event of Default, consist exclusively of the right to receive special interest on the New Convertible Notes at an annual rate equal to 0.5% of the principal amount of the New Convertible Notes.
Voluntary Petitions for Relief Under Chapter 11
On November 14, 2018, the November Chapter 11 Cases were filed, and on December 13, 2018, the White Eagle Chapter 11 Case was filed. The commencement of the Chapter 11 Cases would constitute defaults and events of default under the terms of the Company’s Amended and Restated Senior Secured Indenture and the New Convertible Note Indenture. However, such defaults and events of default and their consequences were waived by holders of a majority of the outstanding principal amounts of each of the 8.5% Senior Secured Notes and the New Convertible Notes, and consequently, the Company believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred under either the Amended and Restated Senior Secured Indenture or the New Convertible Note Indenture.
As of November 30, 2018, the carrying value of the New Convertible Notes was $69.7 million, net of unamortized debt discounts and origination costs of $5.3 million and $786,000, respectively. These are being amortized over the remaining life of the New Convertible Notes using the effective interest method.
During the eleven months ended November 30, 2018, the Company recorded $4.6 million of interest expense on the New Convertible Notes, including $3.5 million, $947,000 and $140,000 from interest, amortization of debt discount and origination costs, respectively.
During the year ended December 31, 2017, the Company recorded $2.1 million of interest expense on the New Convertible Notes, including $1.6 million, $432,000 and $64,000 from interest, amortization of debt discount and origination costs, respectively.
NOTE 13-15% SENIOR SECURED NOTES
On March 11, 2016, the Company, as issuer, entered into an indenture with Wilmington Trust Company, as indenture trustee (the "Senior Secured Indenture"). The Senior Secured Indenture provides for the issuance of up to $30.0 million in senior secured notes (the "Senior Secured Notes"), of which approximately $21.2 million were issued on the Initial Closing Date with an additional $8.8 million issued on March 24, 2016. The 15% Senior Secured Notes were purchased in private transactions exempt from the registration requirements of the Securities Act of 1933, as amended, under the note purchase agreements with certain accredited investors and/or non U.S. persons, including certain members of the Company's board of directors, management and their affiliates, who purchased approximately $3.3 million of the 15% Senior Secured Notes issued.
All outstanding principal and interest amounts due under the 15.0% Senior Secured Note were repaid and canceled on July 28, 2017 in connection with the consummation of the Transaction Closing. See Note 14, 8.5% Senior Secured Notes to the consolidated financial statements.
As a result of the Transaction Closing, approximately $2.0 million was expensed as extinguishment related to early repayment of the facility, including $1.5 million and $518,000 related to prepayment penalty and write off of origination cost, respectively.
The Company recorded approximately $2.8 million of interest expense on the 15% Senior Secured Notes, which includes $2.6 million of interest and $184,000 of amortizing debt issuance costs, during the year ended December 31, 2017.
NOTE 14 - 8.5% SENIOR SECURED NOTES
In connection with the Transaction Closing, the Company and the Senior Secured Note Trustee entered into an Amended and Restated Senior Secured Note Indenture (the "Amended and Restated Senior Secured Indenture") to amend and restate the Senior Secured Indenture between the Company and the Senior Secured Note Trustee following the Company’s receipt of requisite consents of the holders of the 15% Senior Secured Notes. Pursuant to the terms of the Amended and Restated Senior Secured Indenture, the Company caused the cancellation of all outstanding 15% Senior Secured Notes and the issuance of 8.5% Senior Secured Notes due 2021 (the "8.5% Senior Secured Notes") in an aggregate amount of $30.0 million. The Amended and Restated Senior Secured Indenture provides, among other things, that the 8.5% Senior Secured Notes will be secured senior obligations of the Company and will mature on July 15, 2021. The 8.5% Senior Secured Notes will bear interest at a rate of 8.5% per annum, payable quarterly on March 15, June 15, September 15 and December 15 of each year, beginning on September 15, 2017. Certain holders of the Company's securities that are party to Board Designation Agreements (as discussed below), purchased approximately $24.5 million of the 8.5% Senior Secured Notes that were issued in exchange for 15% Senior Secured Notes during the year ended December 31, 2017.
The Amended and Restated Senior Secured Indenture provides that the 8.5% Senior Secured Notes may be optionally redeemed in full by the Company at any time and must be redeemed in full upon additional issuances of debt by the Company in each case, at a price equal to 100% of the principal amount redeemed plus (i) accrued and unpaid interest on the 8.5% Senior Secured Notes redeemed up to the date of redemption, and (ii) the Applicable Premium, if any, as defined in the Amended and Restated Senior Secured Indenture. Upon a change of control, the Company will be required to make an offer to holders of the 8.5% Senior Secured Notes to repurchase the 8.5% Senior Secured Notes at a price equal to 107.5% of their principal amount, plus accrued and unpaid interest up to the date of redemption.
The Amended and Restated Senior Secured Indenture contains negative covenants restricting additional debt incurred by the Company, creation of liens on the collateral securing the 8.5% Senior Secured Notes, and restrictions on dividends and stock repurchases, among other things. The 8.5% Senior Secured Notes are secured by settlement proceeds, if any, received from certain litigation involving the Company, certain notes issued to the Company, and pledges of 65% of the equity interests in Blue Heron Designated Activity Company, OLIPP IV, LLC and Red Reef Alternative Investments, LLC.
On January 10, 2018, the Company commenced the process of appointing a liquidator to liquidate Blue Heron. The completion of liquidation formalities of Blue Heron under Irish law is expected to take several months, and liquidation was still pending at November 30, 2018. Blue Heron is an inactive subsidiary of the Company. In connection with liquidation of Blue Heron, the Company and Wilmington Trust, National Association, as trustee under the Amended and Restated Senior Secured Indenture (the "Trustee"), entered into (i) the First Supplemental Indenture (the "First Supplemental Indenture"), dated as of
January 10, 2018, to implement certain amendments to the Indenture and (ii) the Amendment to Pledge and Security Agreement ("Pledge and Security Amendment"), dated as of January 10, 2018, to implement certain amendments to the Pledge and Security Agreement Pledge and Security Agreement, dated as of March 11, 2016, between the Company and Trustee. The First Supplemental Indenture and the Pledge and Security Amendment amend the Indenture and Pledge and Security Agreement, respectively, to: (i) remove from the assets pledged to the secured parties under the Amended and Restated Senior Secured Indenture, 65% of the equity and certain other assets of Blue Heron; and (ii) reflect the pledge by the Company, in favor of the secured parties under the Indenture, of the promissory note dated as of December 29, 2016 in the principal sum of $69.6 million issued by OLIPP IV, LLC to Blue Heron and subsequently assigned to the Company.
The Amended and Restated Senior Secured Indenture provides for customary events of default which include (subject in certain cases to customary grace and cure periods), among others: nonpayment of principal or interest; breach of covenants or other agreements in the Amended and Restated Senior Secured Indenture; defaults in failure to pay certain other indebtedness; and certain events of bankruptcy or insolvency. Generally, if an event of default occurs and is continuing under the Amended and Restated Senior Secured Indenture, the trustee or the holders of at least 25% in aggregate principal amount of the 8.5% Senior Secured Notes then outstanding may declare the principal of and accrued but unpaid interest, plus a premium, if any, on all the 8.5% Senior Secured Notes immediately due and payable, subject to certain conditions set forth in the Amended and Restated Senior Secured Indenture.
On August 11, 2017, the Company entered into a Securities Purchase Agreement (the "Securities Purchase Agreement") by and between the Company and Brennan Opportunities Fund I LP ("Brennan"). Pursuant to the Securities Purchase Agreement, Brennan purchased from the Company (i) 12,500,000 shares (the "Brennan Shares") of Common Stock at a price of $0.40 per share for an aggregate purchase price of $5.0 million and (ii) $5.0 million principal amount of the Company’s 8.5% Senior Secured Notes (the "Brennan Notes," and together with the Brennan Shares, the "Brennan Securities"). The Securities Purchase Agreement contained customary representations, warranties, and covenants.
The sale of the Brennan Securities was consummated on August 11, 2017, as to 8,750,000 shares of Common Stock and $3.5 million principal amount of 8.5% Senior Secured Notes, and on August 14, 2017, as to 3,750,000 shares of Common Stock and $1.5 million principal amount of 8.5% Senior Secured Notes.
Voluntary Petitions for Relief Under Chapter 11
On November 14, 2018, the November Chapter 11 Cases were filed, and on December 13, 2018, the White Eagle Chapter 11 Case was filed. The commencement of the Chapter 11 Cases would constitute defaults and events of default under the terms of the Company’s Amended and Restated Senior Secured Indenture and the New Convertible Note Indenture. However, such defaults and events of default and their consequences were waived by holders of a majority of the outstanding principal amounts of each of the 8.5% Senior Secured Notes and the New Convertible Notes, and consequently, the Company believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred under either the Amended and Restated Senior Secured Indenture or the New Convertible Note Indenture.
At November 30, 2018, the outstanding principal of the 8.5% Senior Secured Notes is $35.0 million with a carrying value of $34.2 million, net of unamortized debt issuance cost of $830,000.
During the eleven months ended November 30, 2018, the Company recorded approximately $3.0 million of interest expense on the 8.5% Senior Secured Notes, which includes $2.8 million of interest and $244,000 of amortizing debt issuance costs.
During the year ended December 31, 2017, the Company recorded approximately $1.4 million of interest expense on the 8.5% Senior Secured Notes, which includes $1.3 million of interest and $98,000 of amortizing debt issuance costs.
Subsequent Events
8.5% Senior Secured Notes Amendment
On December 10, 2018, the Company and Wilmington Trust, National Association, as indenture trustee, entered into a Second Supplemental Indenture (the "Second Supplemental Indenture") which amended the Amended and Restated Indenture, dated as of July 28, 2017, as amended by the First Supplemental Indenture dated as of January 10, 2018 (as so amended, the "Indenture"), relating to the Company’s 8.5% Senior Secured Notes due July 15, 2021 (the "8.5% Senior Secured Notes"). The Second Supplemental Indenture (i) increased the aggregate principal amount of Notes permitted to be issued under the Indenture from $40.0 million to $70.0 million and (ii) provided for interest on the Notes to be paid in kind, such that the
principal amount of the relevant holder’s note is increased by the amount of interest, in lieu of cash payment ("PIK"). The Company may elect to pay PIK interest instead of cash interest for any Interest Period (as defined in the Indenture) to holders of Notes who consented to accept PIK interest. Each holder of outstanding Notes made an election with respect to some or all of the outstanding principal amount of such holder’s Notes as to whether or not to accept PIK interest whenever the Company elects to pay interest in PIK in lieu of cash. Any new holder of Notes, other than a transferee who is an affiliate of a transferring holder that did not elect to accept PIK interest, will be deemed to have elected to accept PIK interest. A holder receiving PIK interest shall also automatically receive, for each applicable Interest Period, an amount equal to 3.0% per annum of additional interest on the principal amount of such holder’s Notes for which the holder elected to accept PIK interest.
All terms of the Indenture that were not amended by the Second Supplemental Indenture remain in full force and effect.
On December 28, 2018, the Company entered into subscription agreements (the "Subscription Agreements) with several investors (the "Investors"), Pursuant to the Subscription Agreements, the Investors purchased from the Company an aggregate of $5.7 million principal amount of the Company’s 8.5% Senior Secured Notes for an aggregate purchase price of $4.3 million. The transactions were consummated on December 28, 2018.
On December 28, 2018, the Company received a commitment letter (the "Commitment Letter") from Ironsides Partners LLC, an entity affiliated with Robert Knapp, a member of the Board, for an aggregate investment, at the Company’s election, of up to $2.0 million principal amount of 8.5% Senior Secured Notes for an aggregate purchase price of up to $1.5 million no later than January 31, 2019. The Commitment Letter contains certain conditions precedent to Ironsides’ obligations to purchase such Senior Notes.
On January 30, 2019, the Company entered into a Note Purchase Agreement (the "Note Purchase Agreement") with Ironsides Partners Special Situations Master Fund III L.P. (the "Investor"), which is affiliated with Robert Knapp, a member of the Company’s Board of Directors. Pursuant to the Note Purchase Agreement, the Investor purchased from the Company $2.0 million principal amount of the Company’s 8.5% Senior Secured Notes for a purchase price of $1.5 million.
On February 11, 2019, the Company entered into a Subscription Agreement (the "Subscription Agreement") with Brennan Opportunities Fund I LP (the "Investor"), which is affiliated with Patrick T. Brennan, a member of the Company’s Board of Directors. Pursuant to the Subscription Agreement, the Investor purchased from the Company $967,000 principal amount of the Company’s 8.5% Senior Secured Notes (the "Senior Notes") for a purchase price of $725,250. The transaction was consummated on February 14, 2019.
NOTE 15 - 15.0% PROMISSORY NOTE
On May 15, 2017, the Company entered into a $1.5 million Promissory Note with PJC Investments, LLC (the "Bridge Note"), to provide financing to fund the Company's continued operations with a maturity date of July 3, 2017.
The Bridge Note was amended on June 28, 2017 (the "Amended and Restated Bridge Note") to (i) increase the principal amount under the Bridge Note to $3.3 million and (ii) extend the maturity date from July 3, 2017 to the earlier of (a) July 28, 2017 or (b) the date on which the Master Transaction Agreements are consummated.
Under the Amended and Restated Bridge Note, the Company may request an advance of funds, and PJC shall make an advance to the Company, provided that (i) the aggregate amount of outstanding advances shall not exceed $3.3 million and (ii) the Company’s proposed budgeted use of proceeds for such advance is reasonably acceptable to PJC.
Advances under the Amended and Restated Bridge Note bear interest at an annual rate of 15%.
The Amended and Restated Bridge Note includes certain default provisions customary to bridge financing facilities of this type which are subject to customary grace periods, including, among others, (i) defaults related to payment failures; (ii) failure to comply with covenants; (iii) any material misrepresentation of fact made or deemed made by or on behalf of the Company; (iv) failure by the Company to comply with any of its obligations under any Master Transaction Agreement; (v) defaults in payment of any indebtedness of the Company that continues after the applicable grace or cure period; (vi) bankruptcy and related events and; (vii) change of control without the prior written consent of PJC. Default interest accrues at an annual rate of 17%.
The Amended and Restated Bridge Note contains certain affirmative and negative covenants customary for bridge financing facilities of this type.
In consideration for the Bridge Note and pursuant to a fee letter agreement by and between the Company and PJC dated May 15, 2017, the Company agreed to pay an additional termination fee equal to $1.5 million in the event that the Company becomes obligated to pay certain termination fees pursuant to certain termination provisions under the Master Transaction Agreements.
The Company drew approximately $2.8 million on the Amended and Restated Bridge Note and recorded interest expense of approximately $36,000 during the year ended December 31, 2017.
All outstanding principal and interest amounts due under the Amended and Restated Bridge Note were repaid on July 28, 2017 in connection with the Transaction Closing.
NOTE 16-FAIR VALUE MEASUREMENTS
The Company carries life settlements and debt under the White Eagle Revolving Credit Facility at fair value as shown in the consolidated balance sheets. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. Fair value measurements are classified based on the following fair value hierarchy:
Level 1-Valuation is based on unadjusted quoted prices in active markets for identical assets and liabilities that are accessible at the reporting date. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
Level 2-Valuation is determined from pricing inputs that are other than quoted prices in active markets that are either directly or indirectly observable as of the reporting date. Observable inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and interest rates and yield curves that are observable at commonly quoted intervals.
Level 3-Valuation is based on inputs that are both significant to the fair value measurement and unobservable. Level 3 inputs include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value generally require significant management judgment or estimation.
Assets and liabilities measured at fair value on a recurring basis
The balances of the Company’s assets measured at fair value on a recurring basis as of November 30, 2018, are as follows (in thousands):
The balances of the Company’s liability measured at fair value on a recurring basis as of November 30, 2018, are as follows (in thousands):
The balances of the Company’s assets measured at fair value on a recurring basis as of December 31, 2017, are as follows (in thousands):
The balances of the Company’s liabilities measured at fair value on a recurring basis as of December 31, 2017, are as follows (in thousands):
The Company categorizes its investment in life settlement portfolio in two classes, non-premium financed and premium financed. In considering the categories, historically, it has generally believed that market participants would require a lower risk premium for policies that were non-premium financed, while a higher risk premium would be required for policies that were premium financed; the Company believes that this risk premium has been declining.
Following is a description of the methodologies used to estimate the fair values of assets and liabilities measured at fair value on a recurring basis and within the fair value hierarchy.
Life settlements-The Company has elected to account for the life settlement policies it acquires using the fair value method. The Company uses a present value technique to estimate the fair value of its life settlements, which is a Level 3 fair value measurement as the significant inputs are unobservable and require significant management judgment or estimation. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate.
The Company provides medical records for each insured to LE providers. Each LE provider reviews and analyzes the medical records and identifies all medical conditions it feels are relevant to the life expectancy determination of the insured. Debits and credits are assigned by each LE provider to the individual’s health based on identified medical conditions which are
derived from the experience of mortality attributed to relevant conditions in the portfolio of lives that the LE provider monitors. The health of the insured is summarized by the LE provider into a life assessment of the individual’s life expectancy expressed both in terms of months and in mortality factor. The mortality factor represents the degree to which the given life can be considered more or less impaired than a life having similar characteristics (e.g. gender, age, smoking, etc.). For example, a standard insured (the average life for the given mortality table) would carry a mortality rating of 100%. A similar but impaired life bearing a mortality rating of 200% would be considered to have twice the chance of dying earlier than the standard life relative to the LE provider’s population. Since each provider’s mortality factor is based on its own mortality table, the Company calculates its own factors to apply to the table selected by the Company.
The Company calculates mortality factors so that when applied to the mortality table selected by the Company, the resulting LE equals the LE provided by each LE provider. The resulting mortality factors are then blended to determine a factor for each insured.
A mortality curve is then generated based on the calculated mortality factors and the rates from the Company selected mortality table to generate the best estimated probabilistic cash flow stream. The net present value of the cash flows is then calculated to determine the policy value.
If the insured dies earlier than expected, the return will be higher than if the insured dies when expected or later than expected. The calculation allows for the possibility that if the insured dies earlier than expected, the premiums needed to keep the policy in force will not have to be paid. Conversely, the calculation also considers the possibility that if the insured lives longer than expected, more premium payments will be necessary.
The Company uses the 2015 Valuation Basic tables, smoker distinct ("2015 VBT"), mortality tables developed by the U.S. Society of Actuaries (the "SOA"). The mortality tables are created based on the expected rates of death among different groups categorized by factors such as age and gender. The 2015 VBT is based on a large dataset of insured lives, face amount of policies and more current information and its dataset includes 266 million policies. The experience data in the 2015 VBT dataset includes 2.55 million claims on policies from 51 insurance carriers. Life experiences implied by the 2015 VBT are generally longer for male and female nonsmokers between the ages of 65 and 80, while smokers and insureds of both genders over the age of 85 have significantly lower life expectancies. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams.
Historically, the Company has procured the majority of its life expectancy reports from two life expectancy report providers (AVS Underwriting LLC and 21st Services, LLC) for valuation purposes and average or "blending," the results of the two life expectancy reports to establish a composite mortality factor.
On October 18, 2018, 21st Services, LLC ("21st Services") announced revisions to its underwriting methodology, these revisions have generally been understood to lengthen the average reported life expectancy furnished by this life expectancy provider by 9%. On October 29, 2018, AVS Underwriting LLC ("AVS"), also announced revisions to its underwriting methodology without an estimated impact, which resulted in an average lengthening of the life expectancies by approximately 13%.
To account for the impact of the revisions by 21st Services and based off of market responses to the methodology change, the Company decided to lengthen the life expectancies furnished by 21st Services by 9% during the eleven months ended November 30, 2018. The resulting impact is approximately $124.0 million reduction in the fair value of its life settlements.
Further, the Company has decide to no longer utilize the results of life expectancy reports furnished by AVS for valuation purposes. The Company's decision was based on a series of events leading up to the announcement on October 29, 2018, which includes AVS inability to furnish timely reports to allow the Company to blend the results to facilitate timely quarterly reporting. Market participants have expressed concerns regarding their inability to connect the new AVS model to past model. During the eleven months ended November 30, 2018, the Company discontinued its blending approach. The resulting impact is approximately $23.1 million reduction in the fair value of its life settlements.
Moving forward, the Company will procure its life expectancy report from 21st on a periodic basis and expects to continue to lengthen life expectancies furnished by 21st Services that have not been re-underwritten using their updated methodology. The amount of policies that are lengthened by the Company in this manner will decrease over time and the fair value calculations in future periods will, accordingly, reflect the actual impact of the revised 21st Services methodology on a policy by policy basis as updated life expectancy reports are procured.
Future changes in the life expectancies could have a material adverse effect on the fair value of the Company’s life settlements, which could have a material adverse effect on its business, financial condition and results of operations.
Life expectancy sensitivity analysis
If all of the insured lives in the Company’s life settlement portfolio lived six months shorter or longer than the life expectancies provided by these third parties, the change in estimated fair value would be as follows (dollars in thousands):
Discount rate
The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require.
The Company re-evaluates its discount rates at the end of every reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company’s portfolio of life settlements. In doing so, consideration is given to the various factors influencing the rates, including risk tolerance and market activity. The Company relies on management insight, engages third party consultants to corroborate its assessment, engages in discussions with other market participants and extrapolates the discount rate underlying actual sales of policies. In considering these factors, at November 30, 2018, the Company determined that the weighted average discount rate calculated based on death benefit was 13.43%, compared to 15.95% at December 31, 2017.
Credit exposure of insurance company
The Company considers the financial standing of the issuer of each life insurance policy. Typically, we seek to hold policies issued by insurance companies that are rated investment grade by the top three credit rating agencies. At November 30, 2018, the Company had 19 life insurance policies issued by three carriers that were rated non-investment grade as of that date. In order to compensate a market participant for the perceived credit and challenge risks associated with these policies, the Company applied an additional 300 basis point risk premium.
The following table provides information about the life insurance issuer concentrations that exceed 10% of total death benefit and 10% of total fair value of the Company's life settlements as of November 30, 2018:
Estimated risk premium
As of November 30, 2018, the life settlement portfolio includes 586 policies held by the deconsolidated subsidiaries with an estimated fair value of $505.2 million and 2 policies held by Emergent with an estimated fair value of $1.2 million, totaling 588 policies. Of these 588 policies, 512 were previously premium financed and are valued using discount rates that range from 12.25% to 19.25%. The remaining 74 policies, which are non-premium financed, are valued using discount rates that range from 13.25% to 14.75%. As of November 30, 2018, the weighted average discount rate calculated based on death benefit used in valuing the policies in the Company's life settlement portfolio was 13.43%.
Market interest rate sensitivity analysis
The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The extent to which the fair value could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount rate on the death benefit used to estimate the fair value. If the weighted average discount rate was increased or decreased by 1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in estimated fair value would be as follows (dollars in thousands):
Future changes in the discount rates we use to value life insurance policies could have a material effect on the Company's yield on life settlement transactions, which could have a material adverse effect on our business, financial condition and results of our operations.
At the end of each reporting period we re-value the life insurance policies using our valuation model in order to update our estimate of fair value for investments in policies held on our balance sheet. This includes reviewing our assumptions for discount rates and life expectancies as well as incorporating current information for premium payments and the passage of time.
White Eagle Revolving Credit Facility -As of November 30, 2018, 586 policies are pledged by White Eagle to serve as collateral for its obligations under the White Eagle Revolving Credit Facility. Absent an event of default under the White Eagle Revolving Credit Facility, ongoing borrowings will be used to pay the premiums on these policies and certain approved third party expenses. As more fully described in Note 10, "White Eagle Revolving Credit Facility," proceeds from the maturity of the policies pledged as collateral under the White Eagle Revolving Credit Facility are distributed pursuant to a waterfall. After premium payments, fees to service providers and payments of interest, a percentage of the collections from policy proceeds are to be paid to the Company, which will vary depending on the then LTV ratio.
When those policies mature, subject to the outcome of the bankruptcy and litigation proceedings referenced below, distributions will be made pursuant to a "waterfall" payment structure and any amounts available to us will vary based on the respective then current loan to value ratio under the facility. The White Eagle Revolving Credit Facility contemplates that proceeds will be directed to pay fees to service providers and premiums, with any remaining proceeds directed to pay outstanding interest. To the extent there is not sufficient remaining proceeds in the "waterfall" to satisfy the amount of required interest, White Eagle will be obligated to pay any such shortfall amount, subject to the outcome of the bankruptcy and litigation proceedings referenced below.
Voluntary Petitions for Relief Under Chapter 11
On November 14, 2018 (the "Petition Date"), Lamington Road Designated Activity Company (formerly known as Lamington Road Limited), the Company’s wholly-owned indirect Irish subsidiary ("Lamington"), and White Eagle General Partner, LLC, the Company’s wholly-owned indirect Delaware subsidiary ("WEGP"), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court". Lamington is the limited partner and owns 99.99%, and WEGP is the general partner and owns 0.01%, of White Eagle. In its capacity as general partner, WEGP manages the affairs of White Eagle. The Lamington and
WEGP filings are referred to as the "November Chapter 11 Cases."
The commencement of the November Chapter 11 Cases constitutes an event of default under the White Eagle Revolving Credit Facility, resulting in the principal and accrued interest due from White Eagle thereunder becoming immediately due and payable. Lamington and WEGP have pledged their respective interests in White Eagle to secure its obligations under the White Eagle Revolving Credit Facility. Any efforts by LNV Corporation, the lender under the White Eagle Revolving Credit Facility ("LNV"), or CLMG Corp., the administrative agent under the White Eagle Revolving Credit Facility ("CLMG"), to enforce such pledges by Lamington and WEGP of their respective interests in White Eagle in connection with the White Eagle Revolving Credit Facility are automatically stayed as a result of the commencement of the November Chapter 11 Cases and LNV’s and CLMG’s rights of enforcement in respect of the White Eagle Revolving Credit Facility are subject to the applicable provisions of the Bankruptcy Code. In addition, on November 15, 2018, White Eagle, LNV and CLMG entered into an Agreement Regarding Rights and Remedies (the "Standstill Agreement"), pursuant to which LNV and CLMG agreed to refrain from exercising their rights and remedies in connection with the White Eagle Revolving Credit Facility, subject to the terms and provisions of the Standstill Agreement, until 12:00 p.m. noon Pacific time on November 26, 2018, to facilitate negotiations.
On November 23, 2018, the effective period under the Standstill Agreement was extended to November 27, 2018; on November 27, 2018, the effective period under the Standstill Agreement was extended to November 30, 2018; on November 30, 2018, the effective period under the Standstill Agreement was extended to December 4, 2018; on December 4, 2018, the effective period under the Standstill Agreement was extended to December 7, 2018; and on December 6, 2018, the effective period under the Standstill Agreement was extended to December 11, 2018; and on December 10, 2018, the effective period under the Standstill Agreement was extended to December 13, 2018.
On December 13, 2018, White Eagle, filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The Chapter 11 case is being administered under case number 18-12808 (the "White Eagle Chapter 11 Case").
In connection with the White Eagle Chapter 11 Case, on January 15, 2019, the Bankruptcy Court authorized the Debtors to use the proceeds of the cash collateral for a period of twenty (20) weeks (the "Cash Collateral"). The Cash Collateral may be used solely for the purposes permitted under the budget approved by the Bankruptcy Court, including (i) to provide working capital needs of the Debtors and general corporate purposes of the Debtors, (ii) to make the payments or fund amounts otherwise permitted in the final order that authorized such uses and such budget, (iii) to fund amounts necessary to pay certain fees; and (iv) to fund amounts necessary to pay certain professional fees in accordance with such bud get.
The Company elected to account for the debt under the White Eagle Revolving Credit Facility in accordance with ASC 820, which includes the 45% interest in policy proceeds payable to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the White Eagle Revolving Credit Facility and probabilistic cash flows from the pledged policies. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values. The fair value calculation at November 30, 2018, incorporates expected cash flows as approved by the Bankruptcy Court as documented above.
To account for the impact of the revisions to the mortality tables and based off of market responses to the methodology change, White Eagle decided to lengthen the life expectancies furnished by 21st Services by 9% during the eleven months ended November 30, 2018. The resulting impact is a positive change in the fair value of the White Eagle Revolving Credit Facility of approximately $66.7 million.
Discount rate of the White Eagle Revolving Credit Facility
The discount rate incorporates current information about market interest rates, credit exposure to insurance companies and the Company’s estimate of the return a lender lending against the policies would require.
Market interest rate sensitivity analysis of the White Eagle Revolving Credit Facility
The extent to which the fair value of the White Eagle Revolving Credit Facility could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount. If the weighted average discount rate were increased or decreased by 1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in estimated fair value of the White Eagle Revolving Credit Facility as of November 30, 2018 would be as follows (dollars in thousands):
Future changes in the discount rates could have a material effect on the fair value of the White Eagle Revolving Credit Facility, which could have a material adverse effect on its business, financial condition and results of its operations.
At November 30, 2018, the fair value of the debt was $346.7 million and the outstanding principal was approximately $363.8 million.
Investment in deconsolidated subsidiaries - As previously discussed in Note 3, upon the deconsolidation of Lamington, an investment was recorded for $278.4 million which represented the fair value of the Company's investment in Lamington at November 13, 2018. The amount was equivalent to the carrying value of Lamington's net asset. The fair value measurements were calculated using unobservable inputs, primarily discounted cash flow analysis and classified as Level 3, requiring significant management judgment due to the absence of quoted market prices or observable inputs for assets of similar nature. The investment was further valued at November 30, 2018 by a third party also using unobservable inputs, which utilizes a discounted cash flow analysis considering the anticipated date the Company would emerge from bankruptcy, the settlement amount of debt, and future expenses, resulted in a fair value of approximately $128.8 million with change in fair value loss of approximately $150.9 million.
Changes in Fair Value
The following tables provides a roll-forward in the changes in fair value for the periods ended November 30, 2018, for all assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs, which consists solely of life settlements (in thousands):
The following tables provides a roll-forward in the changes in fair value for the periods ended November 30, 2018, for the White Eagle Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
The following table provides a roll-forward in the changes in fair value for the period ended November 30, 2018, for the investment in deconsolidated subsidiaries for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
The following table provides a roll-forward in the changes in fair value for the year ended December 31, 2017, for all assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs, which consists solely of life settlements (in thousands):
The following table provides a roll-forward in the changes in fair value for the year ended December 31, 2017, for the White Eagle Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
There were no transfers of financial assets or liabilities between levels of the fair value hierarchy during the eleven months ended November 30, 2018 and the year ended December 31, 2017.
Other Fair Value Considerations - Carrying value of certificate of deposits, prepaid expenses and other assets, receivable for maturity of life settlements, Promissory Notes receivable, Promissory Notes interest receivable, investment in affiliates, 8.5% Senior Secured Notes, 8.5% Senior Unsecured Convertible Notes, 5.0% Senior Unsecured Convertible Notes, accounts payable and accrued expenses approximate fair value due to their short-term maturities and/or low credit risk.
NOTE 17-SEGMENT INFORMATION
On October 25, 2013, the Company sold its structured settlement business, which was previously reported as an operating segment. The operating results related to the Company’s structured settlement business have been included in discontinued operations in the Company’s Consolidated Statements of Operations for all periods presented and the Company has discontinued segment reporting. See, Note 8 "Discontinued Operations" to the accompanying consolidated financial statements.
NOTE 18-COMMITMENTS AND CONTINGENCIES
Lease Agreements
The Company leases office space under a lease that commenced on October 1, 2014. The lease expires on September 30, 2020. The annual base rent is $261,000, with a provision for a 3% increase on each anniversary of the rent commencement date. Rent expense was approximately $396,000, $407,000 and $412,000 for the eleven months ended November 30, 2018, the year ended December 31, 2017 and 2016, respectively.
During the eleven months ended November 30, 2018, the Company entered into a sublease agreement with a subtenant that commenced on October 1, 2018 and expires on September 15, 2020. The annual base rent of the subtenant is $78,000.
Future minimum payments under operating leases for each of the two succeeding years subsequent to November 30, 2018 are as follows (in thousands):
Employment Agreements
The Company has entered into employment agreements with certain of its officers, including with its chief financial officer, whose agreement provides for payments in the event that the executive terminates her employment with the Company due to a material change in the geographic location where the chief financial officer performs her duties or upon a material diminution of her base salary or responsibilities, with or without cause (the "2018 Martinez Agreement"). If the Company terminates the 2018 Martinez Agreement without cause or she resigns with Good Reason (as defined in the 2018 Martinez Agreement), she will be entitled to receive her base salary or $352,229, whichever is greater, through the twelve (12) months following such termination (the "Martinez Severance Period") as well as any bonus earned but not yet paid. If Ms. Martinez resigns for good reason, she will also be entitled to have the Company continue to pay its portion of healthcare premiums for plans in which she is participating immediately prior to the termination through the Martinez Severance Period. If such termination or resignation occurs within two years after a change in control (as defined in the 2018 Martinez Agreement), then in lieu of receiving her base salary, Ms. Martinez would be entitled to receive (i) accrued vacation days, (ii) a lump sum payment equal to the sum of two times her then base salary, (iii) a portion of her bonus prorated through the termination date that would be due to her when bonus payments are otherwise made for the year in which the termination occurs, (iv) any unpaid portion of a bonus for the year preceding the termination, and (v) reimbursement of COBRA healthcare costs through the Martinez Severance Period.
On March 13, 2018, the Company entered into an employment agreement with Jack Simony (the "Simony Agreement"), pursuant to which Mr. Simony will continue to serve as Vice President and Chief Investment Officer of the Company. The term of the Simony Agreement commenced on March 13, 2018 and continues for one year, with automatic one-year extensions unless (x) either Mr. Simony or the Company gives written notice not to extend at least sixty (60) days’ prior to the end of the then-current term or (y) Mr. Simony’s employment is terminated in accordance with the terms of the Simony Agreement. Pursuant to the Simony Agreement, Mr. Simony will receive an annual base salary of $275,000.
The Simony Agreement further provides that Mr. Simony is entitled to participate in all benefit plans provided to executives of the Company. If the Company terminates Mr. Simony’s employment without cause or he resigns with Good Reason (as defined in the Simony Agreement), the Simony Agreement provides that he will be entitled to receive his base salary through the six (6) months following such termination (the "Simony Severance Period") as well as any incentive bonus that has been declared or awarded to him for a prior fiscal year but has not yet been paid. If Mr. Simony resigns for good reason, he will also be entitled to have the Company continue to pay its portion of health care premiums for plans in which he is participating immediately prior to the termination through the Simony Severance Period.
On March 13, 2018, the Company entered into an employment agreement with Harvey Werblowsky (the "Werblowsky Agreement"), pursuant to which Mr. Werblowsky will continue to serve as Vice President, Chief Legal Officer and General Counsel of the Company. The term of the Werblowsky Agreement commenced on March 13, 2018 and continues for one year, with automatic one-year extensions unless (x) either Mr. Werblowsky or the Company gives written notice not to extend at least sixty (60) days’ prior to the end of the then-current term or (y) Mr. Werblowsky’s employment is terminated in accordance with the terms of the Werblowsky Agreement. Pursuant to the Werblowsky Agreement, Mr. Werblowsky will receive an annual base salary of $250,000.
The Werblowsky Agreement further provides that Mr. Werblowsky is entitled to participate in all benefit plans provided to executives of the Company. If the Company terminates Mr. Werblowsky’s employment without cause or he resigns with Good Reason (as defined in the Werblowsky Agreement), the Werblowsky Agreement provides that he will be entitled to receive his base salary through the six (6) months following such termination (the "Werblowsky Severance Period") as well as any incentive bonus that has been declared or awarded to him for a prior fiscal year but has not yet been paid. If Mr. Werblowsky resigns for good reason, he will also be entitled to have the Company continue to pay its portion of health care premiums for plans in which he is participating immediately prior to the termination through the Werblowsky Severance Period.
The Company does not have any general policies regarding the use of employment agreements, but has and may, from time to time, enter into such a written agreement to reflect the terms and conditions of employment of a particular named executive officer, whether at the time of hire or thereafter.
Litigation
In accordance with applicable accounting guidance, the Company establishes an accrued liability for litigation and regulatory matters when those matters present loss contingencies that are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. When a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. As a litigation or regulatory matter develops, the Company, in conjunction with any outside counsel handling the matter, evaluates on an ongoing basis whether such matter presents a loss contingency that is probable and estimable. If, at the time of evaluation, the loss contingency related to a litigation or regulatory matter is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable. When a loss contingency related to a litigation or regulatory matter is deemed to be both probable and estimable, the Company will establish an accrued liability with respect to such loss contingency and record a corresponding amount of litigation-related expense. The Company will then continue to monitor the matter for further developments that could affect the amount of any such accrued liability.
Sun Life
On April 18, 2013, Sun Life Assurance Company of Canada ("Sun Life") filed a complaint against the Company and several of its affiliates in the United States District Court for the Southern District of Florida, entitled Sun Life Assurance Company of Canada v. Imperial Holdings, Inc., et al. ("Sun Life Case"), asserting, among other things, that at least 28 life insurance policies issued by Sun Life and owned by the Company through certain of its subsidiary companies were invalid. The Sun Life complaint, as amended, asserted the following claims: (1) violations of the federal Racketeer Influenced and Corrupt Organizations ("RICO") Act, (2) conspiracy to violate the RICO Act, (3) common law fraud, (4) aiding and abetting fraud, (5) civil conspiracy to commit fraud, (6) tortious interference with contractual obligations, and (7) a declaration that the policies issued were void. Following the filing of a motion by the Company to dismiss the Sun Life Case, on December 9, 2014, counts (2), (4), (5), (6) and (7) of the Sun Life Case were dismissed with prejudice. The Company then filed a motion for summary judgment on the remaining counts. On February 4, 2015, the Court issued an order (the "Order") granting the Company’s motion for summary judgment on counts (1) and (3), resulting in the Company prevailing on all counts in the Sun Life Case.
On July 29, 2013, the Company filed a separate complaint against Sun Life in the United States District Court for the Southern District of Florida, captioned Imperial Premium Finance, LLC v. Sun Life Assurance Company of Canada ("Imperial Case"), which was subsequently consolidated with the Sun Life Case. The Imperial Case asserted claims against Sun Life for breach of contract, breach of the covenant of good faith and fair dealing, and fraud, and sought a judgment declaring that Sun Life is obligated to comply with the promises made by it in certain insurance policies. The Imperial complaint also sought compensatory damages amounting to at least $30.0 million and an award of punitive damages. On August 23, 2013, Sun Life moved to dismiss the complaint, but the Court denied Sun Life’s motion in early 2015. Subsequently, on February 26, 2015, Sun Life appealed the denial to the United States Court of Appeals for the Eleventh Circuit. The Company moved to dismiss Sun Life’s appeal and, on December 17, 2015, the Court of Appeals ruled in favor of the Company, dismissing Sun Life’s appeal. The Imperial Case therefore returned to the District Court.
On September 22, 2016, however, the District Court granted summary judgment in favor of Sun Life on the entirety of the Imperial Case. Subsequently, on January 12, 2017, the Company appealed the District Court’s decision, and on January 24, 2017, Sun Life filed its own notice of appeal. As part of these two appeals, the Court of Appeals will review every dispositive order issued by the District Court throughout the consolidated case. Per the Court of Appeals, oral argument will be scheduled in the near future.
In January 2018, oral argument was held in the Eleventh Circuit Court of Appeals. In September 2018, the Circuit Court ruled that Florida is the jurisdiction for all the Sun Life cases.
Voluntary Petitions for Relief Under Chapter 11
On November 14, 2018 (the "Petition Date"), the November Chapter 11 Cases were filed. The commencement of the November Chapter 11 Cases constitutes an event of default under the White Eagle Revolving Credit Facility, resulting in the principal and accrued interest due from White Eagle thereunder becoming immediately due and payable. Lamington and
WEGP have pledged their respective interests in White Eagle to secure its obligations under the White Eagle Revolving Credit Facility. Any efforts by LNV Corporation, the lender under the White Eagle Revolving Credit Facility ("LNV"), or CLMG Corp., the administrative agent under the White Eagle Revolving Credit Facility ("CLMG"), to enforce such pledges by Lamington and WEGP of their respective interests in White Eagle in connection with the White Eagle Revolving Credit Facility are automatically stayed as a result of the commencement of the November Chapter 11 Cases and LNV’s and CLMG’s rights of enforcement in respect of the White Eagle Revolving Credit Facility are subject to the applicable provisions of the Bankruptcy Code. In addition, on November 15, 2018, White Eagle, LNV and CLMG entered into an Agreement Regarding Rights and Remedies (the "Standstill Agreement"), pursuant to which LNV and CLMG agreed to refrain from exercising their rights and remedies in connection with the White Eagle Revolving Credit Facility, subject to the terms and provisions of the Standstill Agreement, until 12:00 p.m. noon Pacific time on November 26, 2018, to facilitate negotiations.
On November 23, 2018, the effective period under the Standstill Agreement was extended to November 27, 2018; on November 27, 2018, the effective period under the Standstill Agreement was extended to November 30, 2018; on November 30, 2018, the effective period under the Standstill Agreement was extended to December 4, 2018; on December 4, 2018, the effective period under the Standstill Agreement was extended to December 7, 2018; and on December 6, 2018, the effective period under the Standstill Agreement was extended to December 11, 2018; and on December 10, 2018, the effective period under the Standstill Agreement was extended to December 13, 2018.
Subsequent Event
On December 13, 2018, the White Eagle Chapter 11 Case was filed. The commencement of the White Eagle Chapter 11 Case would constitute a default and event of default under the terms of the Amended and Restated Indenture between the Company and Wilmington Trust, National Association, as indenture trustee (the "Senior Note Indenture") relating to the Company’s 8.5% Senior Secured Notes due 2021 (the "Senior Notes") and the Indenture between the Company and U.S. Bank, National Association, as indenture trustee (the "Convertible Note Indenture") relating to the Company’s 5.0% Senior Unsecured Convertible Notes due 2023 (the "Convertible Notes"). However, such defaults and events of default and their consequences were waived by holders of all of the outstanding principal amount of the outstanding Senior Notes and by holders of a majority of the outstanding principal amount of the outstanding Convertible Notes, and consequently, the Company believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred under either the Senior Note Indenture or the Convertible Note Indenture.
See Note 23, "Subsequent Events," of the accompanying consolidated financial statements for further information.
Other Litigation
Other litigation is defined as smaller claims or litigations that are neither individually nor collectively material. It does not include lawsuits that relate to collections.
The Company is party to various other legal proceedings that arise in the ordinary course of business, separate from normal course accounts receivable collections matters. Due to the inherent difficulty of predicting the outcome of these litigations and other legal proceedings, the Company cannot predict the eventual outcome of these matters, and it is reasonably possible that some of them could be resolved unfavorably to the Company. As a result, it is possible that the Company’s results of operations or cash flows in a particular fiscal period could be materially affected by an unfavorable resolution of pending litigation or contingencies. However, the Company believes that the resolution of these other proceedings will not, based on information currently available, have a material adverse effect on the Company’s financial position or results of operations.
NOTE 19-STOCKHOLDERS’ EQUITY
Shares of Common Stock under Omnibus Plan
The Company has reserved an aggregate of 12,600,000 shares of common stock under its Omnibus Plan, of which 85,000 options to purchase shares of common stock granted to existing employees were outstanding as of November 30, 2018, 633,215 shares of restricted stock had been granted to directors under the plan and 1,400,000 shares of restricted stock units had been granted to certain employees, with a total of 1,400,000 shares subject to vesting. There were 9,511,785 securities remaining for future issuance under the Omnibus Plan as of November 30, 2018.
The Company has reserved an aggregate of 12,600,000 shares of common stock under its Omnibus Plan, pursuant to which, as of November 30, 2018, options to purchase 85,000 shares of common stock granted to existing employees were
outstanding, 100,000 shares of stock appreciation rights had been granted to directors and were vested during the eleven months ended November 30, 2018, 633,215 shares of restricted stock had been granted to directors with 408,522 shares vested during the eleven months ended November 30, 2018 and 2,270,000 shares of restricted stock units had been granted to certain employees, with a total of 1,400,000 shares subject to vesting. Approximately 870,000 shares have been vested since granted. There were 9,511,785 securities remaining for future issuance under the Omnibus Plan as of November 30, 2018.
Share Note Repurchase Program
On September 1, 2015, the Company announced that its Board of Directors authorized a $10.0 million share and note repurchase program. The program had a two-year expiration date, and authorized the Company to repurchase up to $10.0 million of its common stock and/or its Convertible Notes due 2019. During 2015, the Company purchased 608,000 shares for a total cost of approximately $2.5 million, which is an average cost of $4.17 per share, including transaction fees. As of November 30, 2018, the repurchase program has terminated.
Warrants
On February 11, 2011, three shareholders received warrants that may be exercised for up to a total of 4,240,521 shares of the Company’s common stock at a weighted average exercise price of $14.51 per share. The warrants expired seven years after the date of issuance which occurred during the eleven months ended November 30, 2018 and were un-exercised.
In connection with a settlement of class action litigation arising in connection with the investigation by the U.S. Attorney's Office for District of New Hampshire ("USAO") into the Company's now legacy premium finance business (the "USAO Investigation"), the Company issued warrants to purchase 2,000,000 shares of the Company’s stock into an escrow account in April of 2014. The estimated fair value as of the measurement date of such warrants was $5.4 million, which is included in stockholders’ equity. The warrants were distributed in October 2014 and have a five-year term from the date they were distributed to the class participants with an exercise price of $10.75. The Company is obligated to file a registration statement to register the shares underlying the warrants with the SEC if shares of the Company’s common stock have an average daily trading closing price of at least $8.50 per share for a 45 day period. The warrants will be exercisable upon effectiveness of the registration statement.
On July 28, 2017, in connection with the recapitalization transaction, the Company issued common stock purchase warrants to certain investors to purchase up to an aggregate of 42,500,000 shares of the Company’s common stock at an exercise price of $0.20 per share (the "Warrant Shares"). The warrants shall vest and become exercisable as follows: (i) with respect to 17,500,000 Warrant Shares, immediately upon the issuance of the warrants, and (ii) with respect to the remaining 25,000,000 Warrant Shares, at later times tied to the conversion of the Company’s Convertible Notes and New Convertible Notes (each as defined below) outstanding on July 28, 2017 into shares of the Company’s common stock or, if earlier, upon the date that all Convertible Notes or New Convertible Notes are no longer outstanding. The warrants have an eight year term. The number of Warrant Shares is subject to anti-dilution adjustment provisions.
Recapitalization Transactions
On July 28, 2017, the Company consummated a series of integrated transactions to effect a recapitalization of the Company (the "Transaction Closing") pursuant to the Master Transaction Agreements.
Common Stock Purchase Agreement
In connection with the Transaction Closing, the Company entered into a Common Stock Purchase Agreement (the "Stock Purchase Agreement") by and among the Company, PJC, certain investors jointly designated by PJC and Triax Capital Advisors LLC, a New York limited liability company ("Triax"), to be party to the Stock Purchase Agreement (collectively, the "Common Stock Investors"), and certain Convertible Note Holders that were a party to the Stock Purchase Agreement (collectively, the "Convertible Note Holder Purchasers," and together with PJC and the Common Stock Investors, the "Purchasers"). Pursuant to the Stock Purchase Agreement, the Company issued and sold to the Purchasers 115,000,000 shares (the "Stock Purchase Agreement Shares") of the Company’s common stock, $0.01 par value, at a price of $0.2 per share for an aggregate purchase price of $23.0 million, of which PJC and the Common Stock Investors purchased 75,000,000 Stock Purchase Agreement Shares for an aggregate purchase price of $15.0 million and the Convertible Note Holder Purchasers, pursuant to the previously announced rights offering which expired on July 26, 2017, purchased 40,000,000 Stock Purchase Agreement Shares for an aggregate purchase price of $8.0 million, of which PJC purchased 19,320,038 shares in connection with the exercise of rights assigned to it by certain Convertible Note Holder Purchasers. The Stock Purchase Agreement contained customary representations, warranties, and covenants.
In August 2017, the Company entered into a Securities Purchase Agreement (the "Securities Purchase Agreement") by and between the Company and Brennan Opportunities Fund I LP ("Brennan"). Pursuant to the Securities Purchase Agreement, Brennan purchased from the Company 12,500,000 shares (the "Brennan Shares") of Common Stock at a price of $0.40 per share for an aggregate purchase price of $5.0 million.
Articles Amendment
Effective on July 17, 2017, the Company filed an Articles of Amendment to Articles of Incorporation (the "Articles Amendment") to increase the authorized Common Stock from 80,000,000 shares to 415,000,000 shares. As previously disclosed, the Articles Amendment was approved by the Company’s shareholders at the Company’s 2017 Annual Meeting. The adoption of the Articles Amendment results in a greater number of shares of Common Stock available for issuance.
Change in Significant Holders
As a result of the consummation of the Master Transaction Agreements, on the date of the Transaction Closing, a change in significant holders of the Company's common stock occurred. PJC and Triax, together with certain of their affiliates, acquired beneficial ownership of approximately 38.9% of the outstanding Common Stock, based on their aggregate acquisition of 39,320,038 shares of Common Stock and warrants to purchase 27,150,000 shares of Common Stock. Other investors designated by PJC and Triax acquired beneficial ownership of approximately 43.6% of the outstanding Common Stock, based on their aggregate acquisition of 55,000,000 shares of Common Stock and warrants to purchase 13,350,000 shares of Common Stock. Additionally, pursuant to the Board Designation Agreements, PJC and Triax designated two of seven directors to the Company’s Board, two other investors designated a third new director and a fourth new director, and a fifth new director was designated by a holder of New Convertible Notes, collectively resulting in a change in the majority of the Company’s Board.
NOTE 20-EMPLOYEE BENEFIT PLAN
The Company has adopted a 401(k) plan that covers employees that have reached 18 years of age and completed three months of service. The plan provides for voluntary employee contributions through salary deductions, as well as discretionary employer contributions. For the eleven months ended November 30, 2018, the years ended December 31, 2017 and 2016, there were no employer contributions made.
NOTE 21-SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables set forth our unaudited consolidated financial data regarding continuing operations for each quarter of fiscal 2018 and 2017 (in thousands). This information, in the opinion of management, includes all adjustments necessary, consisting only of normal and recurring adjustments, to state fairly the information set forth therein. Certain amounts previously reported have been reclassified to conform to the current presentation. These reclassifications had no net impact on the results of operations (in thousands).
(1)
The sum of the basic and diluted earnings per share amounts for each quarter in fiscal year 2018 and 2017 do not equal the amount presented in the statements of operations for the eleven months ended November 30, 2018 November 30, 2018 and the year ended December 31, 2017 due to the Company having losses for the eleven months ended November 30, 2018 and fiscal years ended December 31, 2017 and therefore all common stock equivalents were antidilutive.
NOTE 22-INCOME TAXES
The provision (benefit) for income taxes from continuing operations consisted of (in thousands):
U.S. and foreign components of income (loss) from continuing operations before income taxes were as follows (in thousands):
The Company’s actual provision (benefit) for income taxes from continuing operations differ from the federal expected income tax provision as follows (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and tax liabilities were (in thousands):
The Company’s provision for income taxes from continuing operations results in an effective rate of (0.03)% for the eleven-month period ended November 30, 2018. The Company recorded a total tax expense of approximately $45,000 that represents taxes paid with the filing of its tax returns for the tax year ended November 30, 2017.
The Company evaluates its deferred tax assets to determine if valuation allowances are required. In its evaluation, management considers taxable loss carryback availability, expectations of sufficient future taxable income, trends in earnings, existence of taxable income in recent years, the future reversal of temporary differences, and available tax planning strategies that could be implemented, if required. Valuation allowances are established based on the consideration of all available evidence using a more likely than not standard. Based on the Company’s evaluation, a deferred tax valuation allowance was established against a portion of its net deferred tax assets as of November 30, 2018. This valuation allowance was determined to be necessary as an offset to the federal and state deferred tax asset exclusive of the Company’s deferred tax asset for unused AMT credit carryforwards, which it expects to fully realize in the next several years.
The federal and state net operating loss carryovers ("NOLs") that are available to the Company as of November 30, 2018 are approximately $93.6 million and $97.0 million, respectively. Of these amounts, the Company estimates that approximately $12.5 million and $9.1 million, may be available for utilization prior to their scheduled expiration periods, as a substantial portion of the NOLs are subject to limitations under Section 382 of the Internal Revenue Code. These NOLs are scheduled to begin expiring in 2031.
On December 22, 2017 the United States enacted the Tax Cuts and Jobs Act ("TCJA"). Under ASC 740, Income Taxes, the effects of new legislation are recognized upon enactment. Accordingly, Management has reviewed the legislation and addressed the provisions that are most relevant to its business, including the required accounting under ASC 740. The key provisions of the TCJA that have factored into the determination of the Company’s tax position for the year ended November 30, 2018 are discussed below.
Corporate Tax Rate
The TCJA reduced the corporate tax rate from 35% to 21% generally effective for tax years beginning after December 31, 2017. Consequently, management is maintaining its deferred tax inventory at November 30, 2018 using the new corporate tax rate.
Transition Tax
Under Section 965 as amended by the TCJA, a U.S. shareholder of a controlled foreign corporation ("CFC") must generally include in gross income as a deemed dividend, at the end of the CFC’s last tax year beginning before January 1, 2018, the U.S. shareholder’s share of certain undistributed and previously untaxed accumulated earnings and profits ("E&P"). The income inclusion can be offset by a deduction intended to result in an effective U.S. federal income tax rate of either 15.5% or 8% of the gross income inclusion amount. The guidance provided by SAB 118 was applied to the Transition Tax enacted by the TCJA. The Company made its best estimate of the impact of the Transition Tax as of December 31, 2017 and concluded that no cash tax obligation would arise from the Transition Tax. The Company changed its U.S. tax year from December 31st to November 30th and filed federal and state tax returns for the initial short year ended November 30, 2017. For the tax year ended November 30, 2017, the Company recognized a taxable dividend as it related to the Special Dividend Note issued on July 28, 2017 from Lamington Road Designated Activity Company (“Lamington”), its wholly-owned Irish subsidiary. The taxable dividend represented Lamington’s undistributed and previously untaxed accumulated earnings and profits ("E&P") of $45.4 million. The reduction in Lamington’s E&P from the taxable dividend coupled with its loss activities through December 31, 2017 resulted in an E&P deficit. Consequently, the Company has determined that it will not be subject to the Transition Tax.
Global Intangible Low-Taxed Income ("GILTI")
For tax years beginning after December 31, 2017, under certain circumstances, Section 245A enacted by the TCJA eliminated U.S. federal income tax on dividends received from foreign subsidiaries of domestic corporations under a new participation exemption. However, the TCJA also created a new tax on certain foreign income under new Section 951A. Specifically, for tax years beginning after December 31, 2017, income earned in excess of a deemed return on tangible assets held by a CFC (the excess referred to as "GILTI") must generally be included as U.S. taxable income on a current basis by its U.S. shareholders. In general, the gross income inclusion can be offset by a deduction in an amount up to 50% of the inclusion (through the end of 2025, thereafter the deduction is reduced to 37.5%) subject to certain limitations.
Based on the Company’s life settlement assets held within Ireland, management expects the net income generated from these activities to qualify entirely as GILTI in the coming years. For the period ended June 30, 2018, the Company reported a projected current income tax liability of $3.2 million. These projected cash taxes were principally driven by the GILTI. The Company changed the tax year of its U.S. parent (Emergent Capital, Inc.) from December 31st to November 30th coupled with a concurrent change to the tax year of Lamington Road Designated Activity Company ("Lamington"), its wholly-owned Irish subsidiary and its other subsidiaries. The change was timely made by filing Form 1128, Application to Adopt, Change, or Retain a Tax Year, in accordance with Rev. Proc. 2006-45 and resulted in a short tax year ended November 30, 2017. The Company timely filed federal and state tax returns for the short period ended November 30, 2017. As a result of the change in tax year, the Company is subject to GILTI regime for its first tax year beginning on December 1, 2018. Consequently, the Company reversed the entire $3.2 million tax expense recorded for the period ended June 30, 2018. The Company is currently researching and reviewing a potential change in one of their tax positions, which upon completion of that process, may mitigate some of the expected burden related to future GILTI tax and may result in the filing of additional tax returns. The Company's
exposure to GILTI tax for the reporting period ended February 28, 2019 will be accounted for in the financial statements for this period in accordance with ASC 740.
On January 10, 2018, the FASB provided guidance on how to account for deferred tax assets and liabilities expected to reverse in future years as GILTI. The FASB provided that a company may either (1) elect to treat taxes due on future U.S. inclusions of GILTI as a current-period expense when incurred or (2) factor such amounts into the Company’s measurement of its deferred taxes. For its reporting period ended on December 31, 2017, the Company adopted an accounting policy to treat any future GILTI inclusion as a current-period expense instead of providing for U.S. deferred taxes on all temporary differences related to future GILTI items.
Treatment of NOLs
The TCJA made changes to the treatment of NOLs arising in taxable years beginning after December 31, 2017. Such NOLs may only offset up to 80% of current year taxable income. Furthermore, such losses may not be carried back to prior years, but can be carried forward indefinitely. For fiscal year taxpayers with tax years beginning in 2017 and ending in 2018, the rules as currently enacted provide that NOLs for such period will not be subject to the 80% limitation, and will not be available for carryback to prior years. Based on the volatility in the Company’s earnings from year to year, the new NOL provisions could have an impact on the Company’s cash taxes in future years.
AMT Credits
The TCJA eliminated the corporate Alternative Minimum Tax effective for tax years beginning after December 31, 2017 and provided a mechanism to obtain refunds of unused AMT credit carryforwards. Under this mechanism, a corporation can utilize its AMT credit carryforwards to offset future regular income tax liability. In addition, a corporation will receive a refund equal to 50% of its AMT credit carryforwards for any amount of AMT credits that remain at the end of each tax year beginning in 2018 through 2020. Any AMT credits remaining at the beginning of the 2021 tax year will be entirely refunded. As of the year ended November 30, 2018, the Company has unused AMT credit carryforwards of $576,000. On January 14, 2019 the IRS announced that unused AMT credits are not subject to sequestration. As such, the Company expects the entire amount to be fully refunded over the course of the next several years.
Other Tax disclosures
In October 2016, the FASB issued ASU No. 2016-16 Income Taxes (Topic 740): Intra-entity transfers of assets other than inventory ("ASU 2016-16"). Current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. This prohibition on recognition is an exception to the principle of comprehensive recognition of current and deferred income taxes in GAAP. The Board decided that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Consequently, the amendments in this update eliminate the exception for an intra-entity transfer of an asset other than inventory. For public business entities, the amendments in this update are effective for annual reporting periods beginning after December 15, 2017. The Company adopted this standard in the current reporting period which resulted in the elimination of a deferred income tax charge of $17.6 million, gross related to prior year sales of life settlement policies to its Ireland subsidiaries. The adoption resulted in a reduction of the valuation allowance and had no impact on earnings.
Deconsolidation of Lamington and its Subsidiaries
On November 14, 2018 (the "Petition Date"), Lamington Road Designated Activity Company ("Lamington"), the Company's wholly-owned indirect Irish subsidiary and White Eagle General Partner, LLC, the Company’s wholly-owned indirect Delaware subsidiary ("WEGP"), and subsequently their jointly owned subsidiary White Eagle Asset Portfolio, L.P. filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). Lamington and its subsidiaries’ (White Eagle, WEGP and Lamington Road Bermuda Limited), financial results are included in the Company’s consolidated results through November 13, 2018, the day prior to the Petition Date. For financial results occurring subsequent to the Petition Date, GAAP requires that an entity whose financial statements were previously consolidated with those of its parent that files for protection under the U.S. Bankruptcy Code, generally must be prospectively deconsolidated from the parent and presented on the cost method. As the company maintains its assets at fair market value the accounting for the deconsolidation at November 13, 2018 did not result in a gain or loss being recognized upon the deconsolidation.
As a result, of the Chapter 11 Cases, consistent with ASC 321, Investments - Equity Securities, the Company subsequently, measured its investment in Lamington Road at fair value as of November 30, 2018. Further, the Company engaged a third party to perform a quantitative assessment to determine the value of its investment in Lamington. The valuation report showed the fair value of the Company's investment in Lamington to have reduced since its pre-petition value. As a result, the Company reflected in current earnings a loss of $150.9 million for the change in the fair value of its investment in Lamington which is not recognized for tax purposes. On its U.S. tax returns, the Company will continue to disclose its consolidated group in the same manner as done prior to the commencement of the Bankruptcy proceedings. The Company elected a policy of not recording U.S. deferred taxes on income expected to be subject to GILTI. As such, any deferred taxes for outside basis differences arising from the deconsolidation event are not recognized.
Unrecognized Tax Benefits
The Company recognizes interest and penalties accrued related to unrecognized tax benefits in tax expense. A reconciliation of the total amounts of unrecognized benefits at the beginning and end of the period was as follows (in thousands):
Prior to the year ended December 31, 2017, the Company reflected an unrecognized benefit of $6.3 million as a reduction of the deferred tax asset related to the federal and state NOLs. The Section 382 limitation that resulted in the year ended December 31, 2017 impacted the future utilization of a significant portion of the Company’s NOLs. As a result, the NOLs that gave rise to the unrecognized tax benefit will be entirely forfeited. The Company wrote off the deferred tax asset and eliminated the liability for unrecognized tax benefits in that year. The Company does not have any unrecognized tax benefits to record for the current year.
Tax years prior to 2015 are no longer subject to IRS examination. Various state jurisdiction tax years remain open to examination.
NOTE 23-SUBSEQUENT EVENTS
8.5% Senior Secured Notes Amendment
On December 10, 2018, the Company and Wilmington Trust, National Association, as indenture trustee, entered into a Second Supplemental Indenture (the "Second Supplemental Indenture") which amended the Amended and Restated Indenture, dated as of July 28, 2017, as amended by the First Supplemental Indenture dated as of January 10, 2018 (as so amended, the "Indenture"), relating to the Company’s 8.5% Senior Secured Notes due July 15, 2021 (the "8.5% Senior Secured Notes"). The Second Supplemental Indenture (i) increased the aggregate principal amount of Notes permitted to be issued under the Indenture from $$40.0 million to $70.0 million and (ii) provided for interest on the Notes to be paid in kind, such that the principal amount of the relevant holder’s note is increased by the amount of interest, in lieu of cash payment ("PIK"). The Company may elect to pay PIK interest instead of cash interest for any Interest Period (as defined in the Indenture) to holders of Notes who consented to accept PIK interest. Each holder of outstanding Notes made an election with respect to some or all of the outstanding principal amount of such holder’s Notes as to whether or not to accept PIK interest whenever the Company elects to pay interest in PIK in lieu of cash. Any new holder of Notes, other than a transferee who is an affiliate of a transferring holder that did not elect to accept PIK interest, will be deemed to have elected to accept PIK interest. A holder receiving PIK interest shall also automatically receive, for each applicable Interest Period, an amount equal to 3.0% per annum of additional interest on the principal amount of such holder’s Notes for which the holder elected to accept PIK interest.
All terms of the Indenture that were not amended by the Second Supplemental Indenture remain in full force and effect.
On December 28, 2018, the Company entered into subscription agreements (the "Subscription Agreements) with several investors (the "Investors"), Pursuant to the Subscription Agreements, the Investors purchased from the Company an aggregate
of $5.7 million principal amount of the Company’s 8.5% Senior Secured Notes for an aggregate purchase price of $4.3 million. The transactions were consummated on December 28, 2018.
On December 28, 2018, the Company received a commitment letter (the "Commitment Letter") from Ironsides Partners LLC, an entity affiliated with Robert Knapp, a member of the Board, for an aggregate investment, at the Company’s election, of up to $2.0 million principal amount of 8.5% Senior Secured Notes for an aggregate purchase price of up to $1.5 million no later than January 31, 2019. The Commitment Letter contains certain conditions precedent to Ironsides’ obligations to purchase such Senior Notes.
On January 30, 2019, the Company entered into a Note Purchase Agreement (the "Note Purchase Agreement")with Ironsides Partners Special Situations Master Fund III L.P. (the "Investor"), which is affiliated with Robert Knapp, a member of the Company’s Board of Directors. Pursuant to the Note Purchase Agreement, the Investor purchased from the Company $2.0 million principal amount of the Company’s 8.5% Senior Secured Notes for a purchase price of $1.5 million.
On February 11, 2019, the Company entered into a Subscription Agreement (the "Subscription Agreement") with Brennan Opportunities Fund I LP (the "Investor"), which is affiliated with Patrick T. Brennan, a member of the Company’s Board of Directors. Pursuant to the Subscription Agreement, the Investor purchased from the Company $967,000 principal amount of the Company’s 8.5% Senior Secured Notes (the "Senior Notes") for a purchase price of $725,250. The transaction was consummated on February 14, 2019.
Appointment of Directors
Effective December 11, 2018, the Company appointed Matthew D. Houk and Patrick T. Brennan to its Board of Directors (the "Board"). In connection with these appointments, the Board fixed the size of the Board at eight (8) directors. The Board has not appointed Mr. Houk or Mr. Brennan to any committees of the Board of Directors at this time.
Effective February 21, 2019, the Company appointed James G. Wolf to its Board. In connection with this appointment, the Board fixed the size of the Board at nine (9) directors. The Board has not appointed Mr. Wolf to serve on any committees of the Board of Directors at this time.
Voluntary Petitions for Relief Under Chapter 11
On December 13, 2018, White Eagle Asset Portfolio, LP, Emergent Capital, Inc.’s (the "Company") wholly-owned indirect Delaware subsidiary ("White Eagle"), filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The Chapter 11 case is being administered under case number 18-12808 (the "White Eagle Chapter 11 Case").
The commencement of the White Eagle Chapter 11 Case would constitute a default and event of default under the terms of the Amended and Restated Indenture between the Company and Wilmington Trust, National Association, as indenture trustee (the "Senior Note Indenture") relating to the Company’s 8.5% Senior Secured Notes due 2021 (the "Senior Notes") and the Indenture between the Company and U.S. Bank, National Association, as indenture trustee (the "Convertible Note Indenture") relating to the Company’s 5.0% Senior Unsecured Convertible Notes due 2023 (the "Convertible Notes"). However, such defaults and events of default and their consequences were waived by holders of all of the outstanding principal amount of the outstanding Senior Notes and by holders of a majority of the outstanding principal amount of the outstanding Convertible Notes, and consequently, the Company believes that no defaults, events of default or acceleration of the payment obligations thereunder, including principal or accrued interest, occurred under either the Senior Note Indenture or the Convertible Note Indenture.
Beal Litigation
On January 25, 2019, the Company, White Eagle, Lamington, and WEGP , the "Plaintiffs"), filed suit (the "Suit") against LNV Corporation ("LNV"), Silver Point Capital L.P. ("Silver Point") and GWG Holdings, Inc. ("GWG" and, with LNV and Sliver Point, the "Defendants") in the United States Bankruptcy Court for the District of Delaware (the "Court"), where the Suit will be administered together with the previously filed and announced petitions for relief under Chapter 11 of the United States Bankruptcy Code of White Eagle, Lamington and WEGP (the "Chapter 11 Cases" and White Eagle, Lamington and WEGP, the "Debtors"). LNV, a subsidiary of Beal Bank ("Beal"), is the lender under White Eagle’s outstanding revolving credit facility (the "Credit Facility").
In the Suit, the Plaintiffs allege that the Defendants engaged in a scheme to coerce the Plaintiffs into selling their valuable portfolio of life insurance policies to defendants for well below its true value. Pursuant to the Credit Facility, LNV agreed to lend $370 million to White Eagle, and in connection therewith received a 45% equity stake in White Eagle. That equity stake, and LNV’s significant control over White Eagle under the Credit Facility, creates a joint venture, and gives rise to fiduciary duties to White Eagle and Emergent, on the part of LNV. The Plaintiffs further allege that LNV has been engaged in a concerted campaign to "squeeze" White Eagle and Emergent by improperly restricting their cash flow, in the hopes that White Eagle and Emergent will have no choice but to sell the valuable policy portfolio to LNV or one of its proxies, including Silver Point and/or GWG, at below its true value.
The Plaintiffs seek, among other things, (i) economic damages and (ii) to have the Credit Facility recharacterized as equity rather than debt or, in the alternative, to have LNV’s 45% equity stake in White Eagle declared to be unmatured interest on the outstanding loan from LNV under the Credit Facility, should be disallowed through the effective date of any plan of reorganization of White Eagle.
In connection with the White Eagle Chapter 11 Case, on January 15, 2019, the Court authorized the Debtors to use the proceeds of the cash collateral for a period of twenty (20) weeks (the "Cash Collateral'). The Cash Collateral may be used solely for the purposes permitted under the budget approved by the Court, including (i) to provide working capital needs of the Debtors and general corporate purposes of the Debtors, (ii) to make the payments or fund amounts otherwise permitted in the final order that authorized such uses and such budget, (iii) to fund amounts necessary to pay certain fees; and (iv) to fund amounts necessary to pay certain professional fees in accordance with such Budget.
Non-payment of 8.5% Senior Unsecured Convertible Notes
On February 20, 2019, the Company received written notice from U.S. Bank, National Association, the trustee under the Indenture, dated as of February 21, 2014, by and among the Company and U.S. Bank, National Association, as Trustee, as amended and supplemented (the "Indenture"), that the Company was in default (the "Event of Default") under the Indenture for failure to pay the principal amount and accrued interest due upon maturity on February 15, 2019 of the Company’s outstanding 8.5% Senior Unsecured Convertible Notes due 2019 (the "Convertible Notes"). The outstanding principal amount of the Convertible Notes was $1.2 million and accrued interest thereon was approximately $51,000.
The Event of Default, which caused an automatic acceleration of the outstanding principal and accrued interest, had no practical effect on the Company, as such amounts were already due and payable. The Event of Default does not result in a cross-default under other debt agreements or arrangements of the Company. The total amount of $1.2 million due, consisting of principal and accrued interest, will accrue interest at 8.5% per annum (the original interest rate of the Convertible Notes) until payment thereof is made.