Reorg’s Court Opinion Review provides an update on recent noteworthy bankruptcy and creditors’ rights opinions, decisions and issues across courts. Today, we consider litigation over novel official committees in Pyxus and Chesapeake, the Lyondell/Brown Rudnick malpractice ruling, Judge Isgur’s view of rollups and other decisions.
The below article is just a preview of the coverage available to current Americas Core Credit by Reorg clients and trialists. Continue reading for the team's analysis of recent distressed debt situations including Pyxus International and Chesapeake energy, and request access to continue following.
Too Many Cooks?
Some of the most surprising aspects of the current mega-case boom have come from the equity side of the capital structure. Earlier this summer, bankruptcy professionals marveled at the tantalizing possibility
that Hertz could replace its contemplated DIP financing with an issuance of likely worthless stock (a plan that was ultimately scuttled
by the SEC). Retail investors' attention to bankrupt equity trading appears to have had a potentially more lasting impact on chapter 11 practice: a surge in requests for once-rare equity committees and increasing receptiveness to those requests from bankruptcy judges. The story doesn’t end there, though. We are seeing an increasing prevalence of non-statutory committees more generally, and below we explore this trend in the context of two cases: Pyxus International and Chesapeake Energy.
Pyxus: Equity Committees
Requests for appointment of an official equity committee have become a costly common occurrence in large chapter 11 cases, even in situations where value appears to break considerably higher in the capital structure. In the past 12 months, shareholder groups have sought official status and/or actively participated on an ad hoc basis in Tuesday Morning
, Quorum Health
, J.C. Penney
, Alta Mesa
, EP Energy
, Dean Foods
, Approach Resources
, Legacy Reserves
and Elk Petroleum
. Unsurprisingly, equity groups composed of institutional investors have fared better at getting official committee status, having their fees paid from the estate and carving out value compared with equity groups comprising individual shareholders.
But then: Pyxus, an international tobacco company. The debtors filed on June 15 with a prenegotiated plan
in place that would, the debtors say, restructure the parent company’s funded debt and pay unsecured creditors in full while preserving nondebtor operating entities’ essential seasonal funding for tobacco growing, picking and processing operations. The debtors set a confirmation hearing for July 27, hoping to have the deal wrapped up before the summer harvesting season.
The Office of the U.S. Trustee’s call for members of an official unsecured creditors committee was met with crickets
. No party raised their hand, and the cases moved on without the seemingly ubiquitous and costly UCC investigations and challenges. We love it when a plan comes together. Except on July 14, a single pro se
shareholder filed a motion for the appointment of an official committee for equityholders. The debtors and even the UST - which would actually have to appoint the members of an official equity committee - opposed.
Judge Laurie Selber Silverstein in Delaware, however, took the pro se
shareholder seriously and held a full-day evidentiary hearing
on July 17. On July 20, the judge issued an oral ruling: The shareholders would have their official committee. The judge concluded that an equity committee is warranted because the case “is just as much about liquidity as it is about debt,” and the debtors’ own financial statements and projections “raise questions” regarding their solvency. Judge Silverstein also noted that because the debtors’ plan was prepackaged, plan negotiations had occurred “without transparency,” and the interests of the debtors’ management, officers and directors - all of whom would benefit from typical plan releases and exculpation - may diverge from those of shareholders. The judge also ignored pleas from the debtors that appointment of an official equity committee would delay confirmation and threaten their seasonal funding for tobacco operations overseas. “Questions need to be explored,” the judge found.
We can think of at least one such question: If the debtors are truly in the “zone of solvency,” then why would second lien lenders agree to a plan that gives them either 50.1% of reorganized equity or cash equal to 2% of their claims? And why have Pyxus’ second lien notes traded below 15 cents since the petition date, as the debtors have pointed out?
Immediately after Judge Silverstein’s ruling, the debtors duly adjourned their confirmation hearing to Aug. 18 from July 27; they then filed a motion for reconsideration, full of apologies for failing to explain the obvious at the July 17 hearing. Shareholders are “out of the money by hundreds of millions of dollars,” the debtors say, and the second lien lenders’ share of reorganized equity will not provide them “anything close to a par recovery.” The debtors also tout the independence of their board of directors and special committee notwithstanding the plan releases (there may now be actual precedent
for this). Finally, the debtors point out that postponement of the confirmation hearing to Aug. 18 triggers defaults of their DIP facility milestones and threatens “the Debtors’ loss of tens of millions of dollars of liquidity generated through its Foreign Credit Lines, the lifeline of the Debtors’ global tobacco operations.” A status conference “solely with respect to the Debtors’ request to confirm the scope of, and set a schedule for, confirmation proceedings” is set
for Aug. 3.
Separately, on Aug. 5, Judge Marvin Isgur in Houston will consider another equity committee motion
in the Ultra Petroleum case. Shareholders in the Lakeland Tours cases before Judge James Garrity in New York are also clamoring
for a piece of the DIP budget. In the latter case, Benjamin Mintz of Arnold & Porter argued at a July 23 hearing that the debtors’ own valuation analysis indicates that equity may be in the money - a familiar-sounding argument.
Chesapeake - Royalty Owners
Royalty owners are generally well-treated in most oil and gas cases. They have special rights under the local statutes of oil-rich states such as Texas, Colorado and Oklahoma that are designed to ensure they get paid if the operator goes bankrupt, and that’s generally what happens. Oil and gas debtors typically file a first day motion seeking authority to pay significant prepetition claims of royalty owners and other mineral interest holders in order to avoid fights over ownership of trust funds and other oilpatch disputes. In the Whiting case, for example, the debtors sought immediate authority
to pay more than $100 million in mineral obligations within 21 days of the filing, and final authority to pay more than $300 million. DIP lenders must generally feel this is money well spent, as objections are relatively rare.
Perhaps they may start to reconsider, as the UST in Chesapeake Energy has created a procedural roadblock that might make such payments less palatable. The Chesapeake debtors followed the oil and gas bankruptcy playbook: At the first day hearing, they secured authority to pay more than $500 million
on account of royalties and non-operating working interest payments owed to holders of mineral and other interests. Unfortunately, this did not stop the UST from forming an official royalty owners committee
, in addition to the existing UCC, on July 24, citing concerns that the UCC was controlled by bondholders and could not adequately represent royalty owners.
On July 30, the debtors responded by dropping dynamite down the hole: In a motion
to disband the committee, the debtors warn that “[t]his unprecedented decision will forever shift the burden to debtors to pay the fees and expenses of royalty owner plaintiff’s attorneys (an ever expanding industry) so that they may litigate individual claims.” The debtors conclude that the UST acted “arbitrarily and capriciously” by appointing the “unprecedented royalty committee,” which is “neither necessary nor appropriate in these cases and will be a waste of estate resources.” The UCC can represent the royalty owners’ concerns, the debtors say - to the extent they actually have any.
The debtors have asked for a hearing on Aug. 12.
: Debtors may be wise to include equityholders in their RSA discussions, or to propose some upside distribution for existing equity in prearranged plans to forestall fights over appointment of official committees and valuation. That may be going on already, of course - take for example the Denbury Resources plan
, which throws warrants at existing equityholders even though the debtors say
they are “woefully out of the money.” In the case of Whiting Petroleum, in addition to paying hundreds of millions in prepetition royalty payments, Whiting dropped 3% of reorganized equity through to shareholders. The Whiting debtors will have learned
though, that this strategy has its own risks: running afoul of the absolute priority rule and accusations of gerrymandering by unsecured creditors.
The Fine Print
: Other oft-neglected creditors - including landlords and vendors
- must be wondering how their recoveries might improve if they push for official status. At what point will the official and unofficial costs of placating these single-issue shareholder and creditor groups push the already astronomical cost of chapter 11 above what sponsors, secured lenders and purchasers are willing to bear?
On July 28, U.S. District Judge Paul Engelmayer in New York denied Brown Rudnick’s motion to dismiss malpractice claims
brought by the Lyondell litigation trust over the handling of a $300 million preference action against lender Access Industries, rejecting the law firm’s argument that it made “reasonable strategic decisions in the context of” the preference action “and the broader bankruptcy litigation.”
The dispositive issue in the litigation was the solvency of the transferor, a key element of the preference claim. Section 547(f) of the Bankruptcy Code gives the plaintiff a head start: Debtors are presumed insolvent within the 90-day preference period before bankruptcy. The defendant must rebut this presumption with evidence to defeat summary judgment. Access introduced evidence that the transferor entity had assets of more than $10.6 billion and liabilities of only $9.1 billion at the time of the transfer in October 2008. Access forgot, however, to take into account an $8 billion intercompany claim against the transferor.
The trust alleges that Brown Rudnick also failed to take that $8 billion intercompany claim into account. Instead, the firm relied on an alternative theory: that the transferor’s holding company parent was insolvent. The trustee asserts that “in choosing to pursue this theory, Brown Rudnick forewent the theory” that the transferor was itself insolvent “and therefore did not present expert evidence at summary judgment of Lyondell’s stand-alone insolvency” or “offer evidence of Lyondell’s $8 billion debt to other LBI entities.”
Summary judgment was denied, and in 2016 U.S. Bankruptcy Judge Martin Glenn in New York presided over a three-week
bench trial. At trial, the trustee alleges, Brown Rudnick failed to present expert testimony on the insolvency of the transferor entity and also failed to mention the $8 billion intercompany debt. The trustee also alleges that the evidence the firm did present - on the insolvency of the holding company, rather than the transferor - was based on data from December 2008, while the transfer took place in October 2008. And the trustee helpfully reminds us why this matters: This approach failed to take into account that the company’s finances “declined substantially between October 2008 and December 2008, due to the Great Recession.”
After the trial, the trustee contends, the firm finally realized that the trust needed to put the $8 billion intercompany claim at issue. “At some point after trial, Brown Rudnick attorneys marked up Access’s summary judgment briefing and wrote that Access’s valuation of Lyondell ‘plus $8 billion debt = insolvent,’” the opinion notes. In post-trial briefings, the firm tried to raise the issue of the transferor’s insolvency for the first time, the trustee says, but “because it had not introduced evidence of Lyondell’s $8 billion debt or the intercompany note at trial, it tried to prove the existence of an ‘$8.0 billion Related Party Note’ through reference to Lyondell’s securities filings.” Judge Glenn was not convinced and on April 21, 2017, issued a lengthy decision
in favor of Access, finding that the trustee had failed to establish that the transferor was insolvent at the time of the $300 million payment.
To the firm’s credit, it seems to have provided a thorough and comprehensive postmortem to appellate counsel after trial, which the trustee now portrays as an admission of malpractice regarding the $8 billion claim. According to the trustee, Brown Rudnick told appellate counsel that “it would have succeeded at summary judgment had it relied upon the intercompany note” and said it realized the importance of the intercompany claim “too little, too late.” The appeal failed, and the trustee sued Brown Rudnick for malpractice.
In its motion to dismiss, the firm argued that focusing on the solvency of the holding company rather than the transferor entity “enabled a more cohesive narrative.” The firm also asserted that “it was not required to formally offer the intercompany note into evidence, and that it did acknowledge the note in post-trial briefing and closing arguments.”
Judge Engelmayer, however, concludes that the trustee “has plausibly pled that Brown Rudnick’s decisions were neither strategic nor reasonable.” “Even though counsels’ theories of the case and evidentiary calls are often protected as strategic, courts have denied motions to dismiss where attorneys have not presented convincing explanations for such a decision,” the judge reasons. Considering the trustee’s allegations “alongside Brown Rudnick’s proffered reasons for its litigation choices, there are, at minimum, questions of fact as to whether Brown Rudnick deliberately made such choices and whether those choices were reasonable,” the judge adds.
: Malpractice claims are often extremely difficult to prove, thanks to deferential defenses such as the “reasonable and strategic decision” rule. But this is why every chapter 11 plan includes releases and exculpation for professionals, and virtually every chapter 11 ends with a confirmed plan rather than conversion to chapter 7
The Fine Print
: Keep in mind the decision assumes the accuracy of all of the trustee’s allegations and does not account for Brown Rudnick’s fact-based affirmative defenses. The firm is far from done defending this one.
Grin and Bear It
At a first day hearing
on July 17, Steven Serajeddini of Kirkland & Ellis, counsel for the Bruin E&P debtors, noted in his opening presentation that one-to-one rollup DIP facilities, such as the one proposed by the debtors, are “unfortunately” common because “capital is harder to find.” Judge Marvin Isgur agreed, calling rollups “heavily disfavored” and remarking that he “hates” to see them.
Nevertheless, the judge approved the proposed rollup in this case through gritted teeth, and then went a bit further: He remarked that he disagrees with decisions prohibiting rollup DIPs as a matter of law. Judge Isgur called the rollup another “economic accomodation to get the financing done” that - like excessive fees - need to be evaluated as such. Perhaps undermining his statement that rollups are “heavily disfavored,” the judge observed that few recent DIPs lack rollups and that “the record says that the capital markets aren’t there without this accommodation.” Those following the pandemic financing packages for revenue-deprived cruise lines
Strangely, we could not locate a single case in our archive in which a bankruptcy judge actually held that rollups are prohibited as a matter of law. We could not even find a story mentioning that anyone had argued this. Nor did anyone object to the proposed rollup in Bruin E&P, on any basis.
On July 30, Judge Isgur expressed
reservations with the fees and interest proposed in the California Pizza Kitchen DIP, which he figured added up to a 60% effective interest rate. The judge indicated that at the start of the hearing, he “walked out ready to deny” the DIP motion. However, the debtors’ witnesses convinced the judge that the DIP should really be viewed as exit financing, thus allowing the debtors to argue the fees should be looked at over 4.5 years rather than the life of the case (assuming the proposed plan
is confirmed). Judge Isgur again took into account the debtors’ need for liquidity in a difficult market: “If I don’t do this the company fails,” he concluded.
: A financing term may not fail just because it is “heavily disfavored” or the judge says he “hates” the concept: Economic realities and a mandate to save companies wherever possible have led to judges to continually reassess what they can tolerate.
The Fine Print
: Unlike the NBA, Judge Isgur does not live and work in a bubble.
- Legal Maneuver of the Month: Kudos to the team at Skadden for a nifty procedural maneuver in the New Cotai case, which has unfortunately failed to live up to its promise as a source of colorful headlines since 99% of bondholders and sponsor Silver Point agreed to a consensual debt-for-equity plan. With a confirmation hearing looming on July 30, on July 7 Studio City International majority holder Melco Resorts sucker-punched the parties with a Studio City private placement not anticipated in the plan. If the debtors did not immediately secure additional funding to participate, then their only asset - a 23.07% interest in Studio City - could be heavily diluted and possibly squeezed out by Melco. So the debtors filed an expedited motion for approval of a noteholder loan that would allow the debtors to buy in - which Judge Robert Drain duly approved on July 24. Problem is, the judge approved the financing on an interim rather than final basis and indicated that objections to final approval would be heard at the confirmation hearing on July 30 - before the debtors’ anticipated funding of their participation in the private placement. In other words, someone could object - that 1% of noteholders? - and prevent the debtors from going through with the investment by prevailing on July 30. The solution? The debtors simply pushed the confirmation hearing to Aug. 27 - long after the anticipated participation funding date in the first week of August - and scheduled the hearing on final approval of the DIP for that day. By then, the participation would be funded, and any objections to final approval of the DIP would be moot because the money had been spent. The delay means nothing for the debtors, because they have no operations or expenses (other than, in this case, well-earned professional fees).
- Denbury Drama: At today’s first day hearing in the Denbury case, Joshua Sussberg of Kirkland & Ellis briefly mentioned the infamous July 20 fraudulent press release announcing that the debtors had found an unnamed party willing to buy their equity despite the fact that equity is, as mentioned above, completely underwater. Fooled us, and a number of others, judging by the stock price movement after the phony buyout announcement. Haste makes waste. According to Sussberg, the debtors were actually poised to execute an RSA that very day, and he was instead rousted out of bed by management asking them “what the heck happened.” Sussberg said the NYSE is on the case, and the debtors are cooperating. Sussberg helpfully added that there is absolutely no truth to the acquisition rumor, while standing at a first day hearing in the company’s bankruptcy case pushing a plan that gives existing equity some warrants as a token for not asking for an official equity committee.