Thu 10/19/2023 14:49 PM
Share this article:

Reorg’s Court Opinion Review provides an update on recent noteworthy bankruptcy and creditors’ rights opinions, decisions and issues across courts. We use this space to comment on and discuss emerging trends in the bankruptcy world; our opinions are not necessarily those of Reorg as a whole. Today we consider the future of the Houston complex panel, a rejected retention application in Lordstown, extension of exclusivity in Diamond Sports Group and Yellow’s billion-dollar Teamsters suit getting stuck in Kansas.

Fallout: New Houston

We have spent years worrying that mega-case venue bankruptcy judges’ lax attitudes about strict application of the Bankruptcy Code and disregard for the authority of Article III and state court judges could damage the legitimacy and credibility of the entire bankruptcy system and endanger the flexibility necessary to address real business restructuring challenges. Texas two-steps, rubber-stamping liability management transactions, automatic nondebtor litigation injunctions, runaway nondebtor releases, “bankruptcy process sales,” phony independent directors, overzealous judicial mediation, Star Chamber secrecy, unnecessary fees and backstops - you name it, we have fretted about it.

And what ended up putting the legitimacy of the bankruptcy courts at issue in the New York Post? Judge David R. Jones’ inexplicable failure to form an LLC to own a house with his ex-clerk whom he was in a long-term relationship with while working on the same cases. The Houston judge’s failure to pull a classic maneuver to hide real estate ownership is pretty ironic, considering debtors use similarly sketchy real estate tactics to get their cases in front of Judge Jones. Maybe if Judge Jones ever listened to the hedge fund creditors that appeared before him, they could have given him some suggestions for a suitably inscrutable entity name.

But Judge Jones failed to cover his tracks, and now we have Page Six-style innuendo about a big-time bankruptcy judge’s million-dollar love nest. Nice lawyer foyer, by the way.

Bankruptcy Twitter (no, we will not call it that) is of course abuzz with speculation about what this means for Judge Marvin Isgur (Judge Jones’ mentor and longtime colleague, who some believe must have known), Jackson Walker (the Houston firm that employed said ex-clerk and appeared before Judge Jones for years without disclosure) and Judge Jones’ decisions in dozens of cases involving Jackson Walker.

We don’t really care about the implications for Judge Isgur or Jackson Walker, at least not until we learn more - you can call a legal ethics professor for speculation if you need some hot takes right now. But the implications for the integrity of Judge Jones’ prior decisions - and the future of the Houston complex panel - should become evident pretty quickly.

To be clear: However much we disagreed with Judge Jones’ handling of certain issues in big chapter 11 cases, we think it would be a very bad thing for all of his rulings in cases involving Jackson Walker to per se get dragged back for rehearing. Sure, we hate equitable mootness as an appellate Get Out of Jail Free card, but there is a kernel of truth in there, somewhere: After years pass, it becomes impossible to unscramble the egg.

Cracking open six years of big bankruptcy decisions would unleash total chaos. There are limits to our appetite for destruction. Allow the creditors who got jammed to sue and investigate, sure. Maybe knock out some plan releases so they can bring claims against released parties. Maybe order some disgorgement. But leave the transactions alone. This is a lot trickier than disqualifying counsel in superficially similar circumstances.

As for ongoing cases: fire away. First up: the Tehum Care Texas two-step case, which is pending before Judge Christopher Lopez but features a very dicey plan settlement mediated by Judge Jones. Among those attorneys at the mediation was Jones’ housemate, representing YesCare, the entity that made off with the assets from the Texas divisional merger of prison healthcare company Corizon Health (the debtor’s predecessor-in-interest). That makes this one an obvious forum for asking questions not only about Judge Jones’ misconduct but also the concept of judicial mediation by the robe down the hall.

On Oct. 13, before Judge Jones resigned, the UST gingerly raised the issue in an objection to Tehum’s request for an accelerated disclosure statement hearing. According to the UST, “recent admissions by the judicial mediator concerning counsel for one of the settling parties that received the valuable assets in the divisional merger that left Tehum with little other than liabilities may raise issues about the propriety of the mediation that serves as the basis for the global settlement - and thus about the very propriety of the settlement and plan itself.”

The UST also raised a host of issues with the plan, most notably the patently coercive nondebtor releases. Under the plan, the UST says, unsecured creditors would not receive any recovery from the $37 million YesCare settlement payment if they opt out, leaving them with claims against a potentially “barren estate.” “Under this balloting scheme, the choice for unsecured creditors to consent to a third-party release, as required by the Fifth Circuit, is simply an illusion,” the UST concludes.

The UST didn’t mention the Boy Scouts-style $5,000 no-questions-asked carrot for claimants to go along with the releases. We’ll give them a pass - they’ve had a busier week than House Republicans.

The debtor responded by agreeing to delay the Oct. 17 “emergency” conditional disclosure hearing to let the parties work through the issue and, if necessary, mediate again before a judge who was not cohabitating with the lawyer for one of the key mediation parties. Just kidding! On the morning of the hearing, the debtor and the UCC filed an amended plan and disclosure statement that doubled down on the settlement by claiming that YesCare wasn’t really a party to the mediation.

According to the plan proponents, “the primary participants over the three days of hard-fought negotiations were the Committee and the Debtor, on one side, and the Perigrove and M2 LoanCo entities, on the other” - and not YesCare, whose attorney was Judge Jones’ girlfriend. M2 is an affiliate and the guarantor under the debtor’s $11 million prepetition funding agreement, while Perigrove is the ultimate owner. You probably didn’t know about either of them because they have yet to play any role in the case.

“The mediator pushed both sides aggressively and eventually, the Global Settlement was reached,” the plan proponents assert. “While disappointed by the lack of disclosure, neither the Debtor nor the Committee believe that any potential conflict associated with the relationship impacted the negotiations or the Global Settlement in any way,” the disclosure statement concludes.

Oh, well, OK then, that settles it. Of course, the inmate claimants potentially getting coerced into nondebtor releases under the plan were not at the mediation, so they will just have to take the proponents’ word for it.

Here’s our favorite part of the amended disclosure statement redline:

At the Oct. 17 hearing, debtor’s counsel played the fiduciary duty card and insisted the mediation was not tainted in any way. Counsel for the UCC claimed the committee members are just as angry as other creditors but after looking at the settlement again with a “jaundiced eye” decided to stay the course. The UST urged Judge Lopez to consider the inmates. Counsel for non-committee claimants said he was doing his best not to get angry and accused the debtor and the UCC of making a “mess” of a “simple” liquidating plan.

To his credit, Judge Lopez told the parties the disclosure statement would not go forward. The judge, insisting that counsel had acted ethically, said he simply did not have enough disclosure about the parties and the facts to determine whether the settlement was in the debtor’s business judgment. Specifically, the judge expressed frustration that he had no idea who the heck M2 and Perigrove were.

“I don’t know how to assess this deal. I don’t know how anybody could,” Judge Lopez said. Real side-eye to the guy down the hall who has a month of lonely courthouse lunches ahead of him. Notwithstanding the disclosure issues, Judge Lopez added that he thinks “the fundamental deal has to be reconsidered in light of what I’m saying.”

Last time around, we remarked that Judge Lopez might have a tough time outright rejecting a settlement mediated by Judge Jones. Well, that’s not an issue anymore - maybe there is a silver lining to this mess.

One other pending case could give us a clue as to how much damage Judge Jones’ resignation has caused to the legitimacy of bankruptcy courts: the appeal of the judge’s infamous Serta summary judgment decision currently pending in the Fifth Circuit. Seems like an odd venue to seek recusal or transfer after a judge has resigned, but hey, it’s the venue the nonparticipating lenders find themselves in.

On Oct. 17, the nonparticipating lenders used their reply brief in the Serta appeal to take a swipe at Judge Jones and do some forum-shopping of their own. Remember how, in Serta, Judge Jones rejected U.S. District Judge Katherine Failla’s prepetition ruling on the ambiguity of the “open market purchase” provision in the credit agreement? Citing Judge Jones’ resignation, the nonparticipating lenders ask the Fifth Circuit to reverse and remand the case back to Judge Failla in New York rather than to the Houston bankruptcy court, or at least have the Houston district court handle the case going forward.

“Serta’s bankruptcy case has ended, and the bankruptcy judge who presided over the proceedings below has now resigned from the bench,” the nonparticipating lenders say. “Although a remand for further proceedings will be required regardless of whether the Court reverses or vacates the summary judgment order, there is no reason to remand the case for further proceedings in the Bankruptcy Court for the Southern District of Texas.”

Considering that the Fifth Circuit chief judge’s ethics complaint was the coup de grace for Judge Jones’ judicial career, we suppose it is worth a shot. A long shot, to be sure - but if the Fifth Circuit agrees and sends the case back to either district court instead of the bankruptcy court, that might send the same message as the Richmond district court’s remand of the Ascena case to a new, non-Richmond bankruptcy judge: The Article III courts don’t trust the mega-case bankruptcy judges anymore.

As for future cases, there is a simple solution: blow up the Houston complex panel. Honestly, we don’t know why this hasn’t been done already - are the other non-panel judges in Houston that attached to the concept?

Maybe Judge Lopez and Judge Isgur - or a new judge, if Judge Isgur retires or drops from the panel again - can restore the Houston court’s reputation. We doubt it. Bankruptcy courts have enough issues, and they are already on trial in the Supreme Court. Keeping the Houston panel, which was already problematic for all the other reasons we have cited, sends the wrong message.

Delaware Destroyers

Speaking of formerly debtor-friendly venues, Judge Mary Walrath continues to absolutely wreck the norms that made Wilmington such a friendly place for debtors for so long. In her latest effort to reduce her colleagues’ workload, on Oct. 5 Judge Walrath denied the Lordstown Motors’ debtors’ application to retain Constitution State luminaries Richards Layton as local counsel because of conflict issues, even though only the U.S. Trustee objected. U.S. Trustee really vibing right now, huh?

The firm disclosed that it represents Lordstown’s directors and officers in litigation over the company’s October 2020 SPAC merger. Such disclosure should not merit mention, but see above. The firm promised it would not be representing management in the bankruptcy case, gave the usual assurances of internal procedures to avoid conflicts, and pointed to debtors’ retention of conflict counsel. All standard stuff that usually flies in big chapter 11s.

The debtors argued that the firm’s representation of insiders and the company didn’t count as a conflict because D&O insurers were paying the firm’s fees to represent management rather than the debtors.

Judge Walrath was unconvinced, finding that the firm’s representation of management created an “existing and actual conflict” that could not be mitigated or waived. Management holds indemnification claims against the debtors, the judge pointed out, and counsel cannot represent both debtor and creditor. The fact that insurers are currently paying the firm’s fees did not eliminate the indemnification claims, Judge Walrath added.

Even worse, the judge continued, the firm represents management in derivative actions brought on behalf of the debtors, which means it would be representing both plaintiff and defendants in those cases. Although the litigation was stayed by the filing, the conflict remains, the judge said.

Remember, this is the same court (though not the same judge) that had no problem with a lawyer for one side of a multibillion-dollar fraudulent transfer suit marrying counsel for the other side and going to work for his firm while the litigation was still ongoing. All you have to do to mitigate that situation, Judge Christopher Sontchi found in that case, is set up a “detailed screen.” Maybe they could have used Judge Sontchi in Houston.

Balls and Strikes

Back in June we suggested that the Diamond Sports Group regional sports network case had been set adrift by Judge Lopez’s ruling in favor of Major League Baseball teams on their demand for payment of full rights fees during the chapter 11. If a key goal of the case was, as we believe, to use nonpayment of rights fees to cajole MLB into agreeing to renegotiate deals and include direct-to-consumer streaming rights, then that decision pretty much blew up the case. MLB no longer had any reason to play ball and could simply wait the debtors out.

The last four months have not proven us wrong. Although the debtors brought anticipated fraudulent transfer suits against former parent Sinclair Broadcast and preferred holder JPMorgan, very little has happened on the restructuring front. As always, don’t take our word for it: On Oct. 11, MLB and five teams objected to the debtors’ request for exclusivity extensions and asked for an order compelling assumption or rejection of their rights agreements, arguing that DSG’s “time is up.”

Under the original RSA with funded debt creditors, the debtors’ time is quite literally up. The RSA required the debtors to reach an agreement on a go-forward business plan by Aug. 1, file a plan and disclosure statement by Sept. 1, secure disclosure statement approval by Oct. 6 and confirm a plan by Dec. 1. Other than the confirmation milestone, the debtors have blown through all those deadlines, and plan confirmation by Dec. 1 seems extremely unlikely.

Sure, as we have ourselves pointed out, RSA deadlines often exist solely to pressure bankruptcy judges into granting questionable relief to the debtor to avoid an imaginary default and liquidation. But the fact the debtors are out of reorganization position by so much as a boat-length suggests a change of direction is necessary.

According to MLB, there is “zero evidence” the debtors have “any reorganization prospects or a viable go-forward business plan that provides for the continued telecast of the Clubs’ games per the terms of the Telecast Rights Agreements.” That means there is zero evidence the debtors can reorganize at all, since the MLB games are a crucial chunk of the RSN’s programming and critical inventory for the debtors’ nascent direct-to-consumer platform. Without MLB games, the RSNs and DTC service would go dark or have to run low-rated “shoulder programming” during the entire NBA and NHL offseason, from June to Red October.

MLB isn’t the only league readying itself to jump off this sinking ship. On Oct. 19, the Wall Street Journal ran a story on the NBA’s plan to “remake” that league’s telecast rights deals. According to the article, the NBA is already preparing contingency plans for a DSG liquidation, in which case it “would take back the media rights in 15 markets” and “broadcast and distribute those games itself, with the NBA app serving as a platform for teams’ own streaming services.” That’s exactly what MLB did with the Padres and Diamondbacks after the debtors dropped their rights.

“No matter what, the league intends to have control of Diamond’s local-market rights in time to offer them along with its national rights packages. Diamond doesn’t control rights to several big markets, such as Boston and Philadelphia,” the Journal notes.

Meanwhile, the debtors have been forced to demand payment from key distributor DirecTV for games that they have not broadcast because the debtors voluntarily surrendered the rights. Yes, you read that right: The debtors say DirecTV has to pay them for programming they did not actually provide, and then submit a claim for rebates.

As strange as that may sound to non-bankruptcy brains, the debtors have a pretty good argument here: Like administrative creditors (other than MLB, apparently), executory contract counterparties often get jobbed in bankruptcy, forced to provide full consideration (for example contractual payments, a leased premises) without being able to exercise remedies for the debtors’ nonperformance absent stay relief.

Still, the DirecTV motion is not a good sign for the debtors’ dimming reorganization prospects. So here’s the question: Why bother extending the debtors’ exclusivity? Remember, it is not the creditors’ burden to show exclusivity should not be extended; the burden is on the debtor to provide evidence that it should be extended.

The debtors’ motion is full of the usual platitudes - the case is complex, management and counsel have been working super hard, the court has appointed Judge Isgur and (whispers) Judge Jones to mediate - but so what? The debtors can keep working hard and mediating if exclusivity terminates. The debtors can also continue suing Sinclair and JPMorgan; those cases won’t be done within the requested 60-day extension anyway. A chapter 7 trustee or liquidating trust could pursue those actions.

The attitude among bankruptcy lawyers seems to be that termination of exclusivity is a nuclear option that would immediately crater any reorganization efforts, and extensions should therefore be granted unless some compelling reason requires otherwise. But Congress put an expiration date on exclusivity for a reason: When the Bankruptcy Code was enacted, the idea of giving debtors the exclusive right to file a plan was seen as a problem.

Before the Code, debtors had exclusivity throughout their bankruptcy cases under chapter XI of the Bankruptcy Act. Congress saw this limitless exclusivity as an invitation for debtors to hold creditors hostage and exert undue leverage. So, the limited exclusivity periods in section 1121(c) of the Bankruptcy Code were included to prevent debtors from maintaining exclusivity forever. Then in 2005, Congress recognized that extensions were being granted too readily and for too long and inserted an absolute cap at 18 months. Congress clearly wants bankruptcy courts to allow creditors to file competing plans.

As one district court put it soon after the Bankruptcy Code came into effect, section 1121 “represents a departure from the procedure under the old Act,” and “[a]ll of the proposed revisions of the Act which Congress considered prior to passage of the Code contained provisions eliminating the debtor's exclusive right to file a plan.” Debtors, you should consider yourselves lucky you got 120 days and possible extensions.

Some of you may respond that there is no reason not to extend exclusivity unless MLB intends to file a competing plan, and MLB does not seem intent on doing so anytime soon. But again, the burden is on the debtor here to show that Congress’ 120-day plan filing exclusivity period should be disregarded in this particular case. And the threat of a competing plan could spur the debtors to cut a deal quickly, hand over the case to lenders or liquidate.

It’s really that possibility - liquidation - that spurs bankruptcy courts to mindlessly extend exclusivity when asked. Like a jittery umpire, bankruptcy judges are reluctant to make a decision that, however appropriate, could affect the outcome. From the linked Stanford study: “Oftentimes, the umpires face a choice between a call that would be really pivotal and a call that would be relatively inconsequential,” and “what we find is that they err on the side of the inconsequential call unless they’re absolutely certain that the pivotal call is the right one.”

So bankruptcy judges are told allowing exclusivity to lapse would result in a pivotal negative outcome - liquidation - and they choose the easier path, letting exclusivity continue, rather than making the correct decision under the Bankruptcy Code and affecting the outcome. This happens outside of the exclusivity extension context, of course - as we have explored, this “failure bias” underlies a ton of bad bankruptcy decisions.

Arguably, the DSG debtors have had enough time to formulate a plan without having to worry about anyone else trying. The worst that could happen is liquidation, and it is not the bankruptcy judge’s job to avoid liquidation. It’s the debtors’ job not to strike out.

Point of No Return

Here’s a lesson for prospective debtors from the Yellow Corp. bankruptcy: If you want to pursue a billion-dollar estate cause of action in the Friendly Confines of bankruptcy court, best file chapter 11 before filing suit.

We’ve talked about the Yellow/Teamsters fight before, but a bit of background: On June 28, Yellow sued the International Brotherhood of Teamsters and three local chapters in the District of Kansas, alleging that the unions violated their collective bargaining agreements by refusing to make concessions to facilitate further operational restructuring by the company. According to Yellow, the unions’ breaches would “result in the liquidation of the Company” if not cured.

The debtors’ insistence that union intransigence would immediately lead to bankruptcy seemed a bit off to us. As Reorg reported on July 6, the company’s claim it would run out of cash “as early as mid-July 2023” seemed dicey because the company appeared to have enough liquidity to operate well past August. Either a new, runaway cash leak had sprung - which, hey management, that’s your area of concern - or the debtors were using the threat of liquidation (and the loss of thousands of union jobs) as a negotiating tactic with the unions.

The debtors piled on the pressure in mid-July by declining to make $50 million in required pension contributions. The Teamsters responded by threatening to strike. On July 19, the company asked the Kansas district court to enjoin the strike, calling the union’s threat existential and suggesting that denial of the injunction would result in “a Chapter 7 liquidation bankruptcy proceeding.” Yeah, sure.

On July 21 U.S. District Judge Julie A. Robinson denied the injunction, finding, among other things, that she lacked jurisdiction because disputes over alleged labor law violations belong in the National Labor Relations Board, or NLRB - an argument also made by the unions in their motion to dismiss the action.

So yeah, maybe Yellow would prefer to have another court consider that motion to dismiss, apart from the usual debtor presumption (and the Teamsters’ contention) that the bankruptcy court looks more kindly on claims that could bring money into the estate.

Fortunately, the totally, 100% legitimate threat of an imminent chapter 7 filing got the parties talking, and the strike was averted by an agreement to try to agree on how to agree on July 23. Three days later Reorg reported that the company was fielding offers for DIP financing, which seems unnecessary if you intend to file chapter 7, but whatever. The next day Reorg reported that the company would file chapter 11 on July 31. The company ceased operations on July 30 and filed a liquidating chapter 11 on Aug. 6. Whew, that escalated quickly.

So what the heck happened? Yellow told the district court that if it didn’t enjoin the strike, the company would liquidate. That kinda suggests that if the district court did enjoin the strike, or the strike otherwise didn’t happen, the company would not need to immediately liquidate. The strike didn’t happen, but the company quickly filed a liquidating chapter 11 anyway.

Was there some show of stubbornness by the Teamsters during those few days of negotiations that convinced management a strike would happen soon anyway, so why not file? The unions sure don’t seem to think so. In a response to the debtors’ motion to transfer the Kansas suit to the bankruptcy court, the IBT said the company asked for a term sheet to “shop” to potential bridge lenders, the unions delivered a term sheet and the company rejected it without elaborating.

The first day declaration says that the threat of a strike was enough to push the company into liquidation, and the unions’ offer “was too little, too late.” But that seems to contradict what Yellow said in the district court.

According to the first day declaration, the company seeks more than $1.5 billion from the unions for “the loss of Yellow’s enterprise value,” among other things. The debtors duly sought to transfer the suit from Kansas to Delaware. The union responded by suggesting that Delaware bankruptcy courts are in the bag for debtors, as we discussed on Sept. 7. The debtors asked Judge Robinson to decide the transfer motion before deciding the motion to dismiss, reinforcing that they want Judge John Dorsey in Delaware to decide.

Judge Robinson agreed to consider transfer before dismissal, giving the debtors a little hope, and then denied the transfer motion anyway. Unfortunately, the judge declined to rule one way or the other on whether Delaware bankruptcy courts are per se debtor-friendly, which is a shame. Instead, Judge Robinson concludes the case cannot go to Delaware because it could not have been filed there in the first place under federal labor law. None of the defendants - the IBT and the local unions - have principal offices in Delaware, and the local unions have no officers or agents engaged in representing or acting for employee members in Delaware, the judge notes.

The debtors argued that despite the lack of original jurisdiction in Delaware, the suit should be transferred under section 1412 of title 28, which provides that a district court “may transfer a case or proceeding under title 11 to a district court for another district, in the interest of justice or for the convenience of the parties,” without regard to whether the transferee jurisdiction would have been a proper venue if the suit had been filed there.

However, Judge Robinson finds that section 1412 applies only to cases and proceedings arising “under title 11” - for example, core bankruptcy cases and proceedings - and not cases merely ”related to” a bankruptcy - for example, suits against unions for alleged prepetition breaches of a collective bargaining agreement. Even if section 1412 applied, the judge adds, the interests of justice and efficiency did not favor transfer because neither Yellow nor the unions are located in Delaware and the company had a “strong presence” in Kansas before shutting down.

The district court also notes that Yellow chose to file suit in Kansas in the first place. Yellow did allege a change in circumstances after the initial filing - that it filed chapter 11 in Delaware - but the judge disregards this as “forum shopping.” The timeline, the judge says, suggests that Yellow sought transfer after the injunction was denied to make sure another court decides the unions’ motion to dismiss the suit - a reasonable strategy considering the Kansas court’s ruling on the injunction motion, but not legitimate grounds for transfer.

So now Yellow must litigate its suit against the Teamsters in a Kansas district court rather than Wilmington - no chance for a Serta-esque summary bankruptcy court reversal of the adverse ruling on NLRB jurisdiction from the injunction phase. Judge Robinson’s section 1412 ruling is interesting, though not exactly novel - as the Kansas court points out, District Judge Michael Wiles in New York came to a similar conclusion in 2018.

The real lesson here is that if you leave a district judge to decide whether a suit goes to the bankruptcy court, you take a chance the district court will keep the matter.

Why didn’t Yellow file immediately after the unions threatened to strike, and bring a first day adversary proceeding against the unions in bankruptcy court? That’s standard operating procedure - for example, the Rite Aid debtors sued McKesson for breach of a crucial distribution agreement in their first day papers; they didn’t sue McKesson in Maryland and then file three weeks later.

Perhaps Yellow filed the Teamsters action in Kansas because it legitimately thought an injunction from that court could prevent the bankruptcy, but they were obviously mistaken - and were proven to be mistaken very quickly. Maybe the debtors thought a Kansas court would be more willing to halt a strike to purportedly protect Kansas jobs.

Or maybe the debtors intended to file chapter 11 all along, strike or not, and simply assumed the district court would send the case to the bankruptcy court as a matter of course after they filed. If so, then whoops.
Share this article:
This article is an example of the content you may receive if you subscribe to a product of Reorg Research, Inc. or one of its affiliates (collectively, “Reorg”). The information contained herein should not be construed as legal, investment, accounting or other professional services advice on any subject. Reorg, its affiliates, officers, directors, partners and employees expressly disclaim all liability in respect to actions taken or not taken based on any or all the contents of this publication. Copyright © 2024 Reorg Research, Inc. All rights reserved.
Thank you for signing up
for Weekly Insights!