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 trend of post-reorg stock buybacks and payouts to plan investors, some clever post-reorg maneuvering in the Sanchez energy case and a contested sale process in Limetree Bay Energy, plus quick hits on the trouble with the appellate finality rule in bankruptcy and the new class of ‘independent’ future claims representatives in the Texas two-step cases.
The Parade of Wonderfuls
Judge Jerry Funk of the U.S. Bankruptcy Court for the Middle District of Florida -
happy retirement, Your Honor! - used to ask me back in my clerking days to tell him when I had a spare 10 minutes to learn everything I needed to know about bankruptcy. The judge meant ALL bankruptcy, of course - sometimes we forget the Men and Women in Robes need to handle chapter
13 confirmation hearings too - so I think we can do modern chapter 11 in a few seconds. Here goes:
- Get the fulcrum funded debt on board with a restructuring support agreement that includes accelerated, supposedly ironclad milestones;
- Secure a DIP facility that includes the same milestones;
- Get DIP (and milestones) approved;
- Propose plan that crams down any holdouts (and object to their claims if you can);
- Put off issues raised by the holdouts until confirmation;
- Tell the judge the “heavily negotiated” plan deal, a “monumental achievement,” will fall apart if he rules in favor of the holdouts;
- Objections overruled, plan confirmed and emerged.
At first blush, the power of the “
parade of horribles” seems intuitive: Every chapter 11 case is, presumably, a crisis - a company hanging by a thread thanks to bad fortune, mismanagement or both. From this angle, RSA parties, DIP lenders and plan sponsors must be rewarded for agreeing to accept reorganized equity or take-back paper rather than insisting the debtors be dismembered and sold for scrap (see below). Those who offer new financing or backstop new equity rights offerings deserve even more - including generous fees and discounted stock. Everybody should get releases, of course.
But paying attention to what happens
after companies emerge suggests a different story. Investing in a chapter 11 plan - not in a chapter 11 debtor, but in the plan - generally pays off quite handsomely, and sometimes very, very fast. For example, on Nov. 29, reorganized Hertz
announced plans to repurchase $2 billion in reorganized common equity about five months after
emerging from chapter 11. Most of that stock is
probably held by the parties who backstopped the $1.635 billion common equity rights offering, including Knighthead and Certares (who contributed $2.781 billion in equity as part of the plan deal). This follows the company’s Nov. 23
tender offer to redeem all $1.5 billion in Series A preferred stock issued under the confirmed plan, most of which is held by Apollo, at $1,250/share - a quick
$375 million profit for the preferred shareholders (without factoring in fees and other charges).
These plan sponsors are getting paid, and paid quickly, for investing in a plan that (if one accepts the Court Opinion Review’s admittedly cynical view of the bankruptcy playbook) had virtually no chance of failing at confirmation. If a company made a similar maneuver outside of bankruptcy - issuing new shares and buying them back just months later - we would all be aghast. But since these investors got involved during a chapter 11 case, in a supposedly high-risk situation, nobody blinks.
Well, not nobody. On Dec. 7, Senator Elizabeth Warren, D-Mass., issued a
press release excoriating Hertz for the Apollo buyback offer, along with a letter to the CEO. According to Warren, the Apollo cash-out “reveals that the company is happy to reward executives, company insiders, and big shareholders while stiffing consumers with record-high rental car costs and ignoring the recent history that nearly wiped out the company.” Warren says the program “would give the private equity firm Apollo - which has already earned nearly $3.7 billion in profits in the first nine months of 2021 - a 70% annualized return on its initial investment.” “The latest buybacks raise serious questions about how the move aligns with the long-term health of the company,” Warren concludes.
(Apollo appears to be a favorite target of Warren; on Nov. 19 she joined a group of progressive senators that
chastised Apollo, Blackstone and other private equity firms for “extractive practices,” including “loading debt onto companies to fund payouts for the private equity firm and its executives, engaging in severe cost-cutting measures that harm workers and consumers, and quickly cashing out after extracting as much value as they can.”)
Political points aside, what does this say about the health of the chapter 11 bankruptcy system, which is still the envy of the world. If investors are securing 70% returns on their investment in a chapter 11 plan within months of emergence, something seems off with our calculation of the risks investors take in bankruptcy - and that calculation is the basis for the level of compensation they receive for that risk and the level of deference they receive when judges bend the Bankruptcy Code to get their preferred plan through confirmation over the objections of holdouts.
Sure, you say, the unsecured creditors in Hertz were paid in full, so no harm, no foul. But what about the massive dilution of prepetition shareholders? Or the massive fees and costs paid by the debtors during the case - $175 million in
fees for the debtors’ professionals alone? Someone other than the sponsors paid the price for that speedy post-emergence windfall.
Think Hertz is an outlier? On Nov. 6, Garrett Motion
announced its intention to buy back $100 million in reorganized equity. Most of that would go to holders of Series A preferred shares, including
plan sponsors Oaktree and Centerbridge and a group of backstop investors that received a premium for supporting a rights offering no one believed would possibly be undersubscribed. Another recent example: On Dec. 2, Chesapeake Energy
announced that it would be repurchasing up to $1 billion in stock and warrants over the next two years. Less than a year ago, the Chesapeake plan was
confirmed by Judge David Jones over serious valuation objections after
12 days of trial. If the company is able to buy back $1 billion in stock within a year of emerging,
perhaps that confirmation valuation was a bit off, right?
Chesapeake isn’t the only post-reorg energy debtor giving money back to investors: On Nov. 11, California Resources
announced a 17-cent per share dividend, and on Nov. 2 Gulfport Energy
announced a $100 million share repurchase program. Sure, you could say that these windfalls resulted from an unexpected rise in commodity prices, but was that really totally unanticipated at the time the plans for these companies were confirmed? If not anticipated, at the least, energy sector valuations try to accommodate a range of prices and long-term trends.
How about the incredible maneuver pulled earlier this year by CEC Entertainment, aka Chuck E Cheese? On April 8, CEC
announced that it would be issuing $600 million in new debt to pay off a $375 million
new-money exit facility and related make whole incurred less than
four months earlier.
The Takeaway: Perhaps bankruptcy judges need to scrutinize the “parade of horribles” more carefully. Investors are making a lot of money, and quick, out of chapter 11 plan investments. The idea that they might walk because a confirmation hearing is delayed to allow for a full airing of contested issues seems a bit incredible.
The Fine Print: Taking this opportunity to plug Reorg’s fantastic new Post-Reorg coverage.
Check it out!
Haste Makes Waste?
On April 30, 2020, Judge Marvin Isgur
confirmed the Sanchez (now Mesquite Energy) debtors’ plan on a largely uncontested basis. Confirmation came with a serious litigation overhang, however: The plan failed to resolve
litigation over the validity of certain liens claimed by prepetition secured noteholders, who, led by Apollo and Fidelity, provided DIP financing in part to protect their priority and get lien validity stipulations. Under the plan, an allocation
of 80% of reorganized equity between the secured lenders and unsecured creditors would be determined by post-emergence litigation over the validity of those liens and the value of any property deemed unencumbered. In the meantime, the DIP lenders, led by Apollo and Fidelity, would receive 20% of reorganized equity on account of their DIP loans at emergence, allowing them to appoint directors and control the company as if they held 100% while the litigation proceeded.
Why bother getting a debt-for-equity plan confirmed without knowing who would get the equity? The “parade of horribles,” of course! In a
filing on April 7, 2020, the debtors argued that the plan absolutely, positively had to be confirmed by April 30 to avoid missing - surprise -
a DIP milestone, even though there was no way to litigate the crucial issue - the validity of the lenders’ liens and thus their right to post-emergence control of the company - prior to that deadline. The debtors stressed that “drastic measures,” including confirmation of a makeshift plan that handed control of the company to secured lenders notwithstanding the potential avoidance of their liens, were required to protect “the only viable path to a reorganization that will preserve the going concern of the business and ongoing employment of a majority of the Debtors’ workforce.”
On April 8 Judge Isgur
approved the debtors’ disclosure statement on a conditional basis and set a confirmation hearing for April 30 to hit the DIP lenders’ magic milestone. The judge accepted that if the plan was not confirmed by April 30, the DIP lenders could terminate, triggering a chapter 7 liquidation. The judge even instructed the parties to be ready to close by the evening of the confirmation hearing, lest the Sword of Damocles fall at midnight.
Subsequent events suggest why the lenders were really so eager to get that plan confirmed without resolving the validity of their liens. On June 30, 2020, the debtors’ plan went effective, vesting control of the reorganized company in the lenders pending the outcome of the lien litigation. Apollo and Fidelity took advantage of their (perhaps temporary) control of the company almost immediately by graciously making a $30 million first lien loan to the debtors at 15% interest on July 10, just 10 days after emergence. The debtors also granted the lenders a three-year option to convert the loan into new common stock at a valuation below the $85 million agreed at confirmation.
In other words, Apollo and Fidelity gave themselves the right to discounted equity that would dilute any percentage of reorganized equity awarded to unsecured creditors in the lien litigation that everybody agreed would be resolved after emergence. The lenders didn’t stop there, however: In November 2020, they loaned an additional $45 million to the company to finance the
acquisition of assets from
chapter 11 debtor Gavilan Resources. This loan provides for issuance of new equity to the lenders as fees, further diluting any future allocation of reorganized equity to unsecured creditors.
The lenders also declined to tell anyone about these loans, including Judge Isgur and the creditor representative who would receive any reorganized equity on behalf of unsecured creditors from the lien litigation.
On March 11 of this year, Judge Isgur
ruled that the secured creditors’ pre-bankruptcy liens on three of the debtors’ properties are avoidable as unperfected under state law, opening the door for a valuation trial that could result in unsecured creditors receiving a substantial amount of that 80% in unallocated reorganized equity. Of course, that didn’t matter so much for Apollo and Fidelity anymore: They had already locked in a substantial return and a bigger share of equity at a discount by making those loans to the company.
After finding out about the loans, on Aug. 13 the creditor representative
filed suit against Apollo and Fidelity, accusing them of violating the debtors’ chapter 11 plan by using their 20% of reorganized equity to undermine any adverse result in the lien litigation. According to the complaint, Fidelity “appears to be reporting a 345% return” on the July 2020 financing “in just ten months.” Further, the creditor representative says, Fidelity was reporting a nearly 470% return on the November 2020 loan. The creditor representative accused the lenders of using their potentially temporary control of the company to trigger “massive
de facto dividends to themselves.”
In a
motion to dismiss filed Oct. 11, the lenders countered that the loans allowed the company’s value to increase dramatically, and anyway the creditor representative lacks standing to challenge the loans
because it is not a shareholder. That’s right: Apollo and Fidelity argue that they can do whatever they want with the reorganized company, even though their share of equity could be dramatically diluted by the outcome of litigation
specifically reserved at confirmation, because they have
not yet entirely lost that litigation - and the creditor representative can’t even complain.
According to the company, which unsurprisingly sides with the lenders, “The Plan did not guarantee that the prevailing party in the Lien-Related Litigation would receive 80% of the equity in Mesquite, but only that it would receive 80% of the ‘New Common Stock’ - which was defined as the 10 million shares of common stock ‘to be issued pursuant to the Plan.’” It doesn’t matter if the company, while under the control of Apollo and Fidelity, elects to issue enough new stock to Apollo and Fidelity to dilute that “New Common Stock” - the centerpiece of the reorganization - into insignificance while the litigation is pending.
In a
reply filed Dec. 2, the lenders argued that the plan and related governance documents expressly authorize the reorganized debtors to issue additional stock, including convertible notes, and to offer them exclusively to
existing equityholders - and right now Apollo and Fidelity are the only existing shareholders, nevermind all those disputes over the validity of their liens and the allocation of 80% of reorganized equity under the plan. At the same time, the lenders deny that the loans constitute “dividends” or “distributions”
on account of their shares. They just loaned new money to the company, the lenders say, without giving the creditor representative - who could end up holding the majority of equity - any notice or opportunity to participate.
A hearing on the motion to dismiss is set for today, Monday, Dec. 13, at 11 a.m. ET.
The Takeaway: Congrats to Apollo and Fidelity for a rules interpretation maneuver that would make
Michael Masi proud. Worst-case-scenario, they end up right back where they started, dealing with the lien litigation. Best case, they just mooted that litigation.
The Fine Print: Take a close look at those governance documents in the plan supplement, people. And keep a close eye on post-reorg debtors and their new investor-appointed directors. Maybe keep a close eye on… our
post-reorg coverage!
The Art of Survival
Back on Sept. 8, we
discussed the U.S. Virgin Islands refinery Limetree Bay Energy’s DIP financing and budget. Having persevered, the debtors have moved on to conducting a refreshingly contentious sale process. It’s worth calling out times where the bankruptcy process is working to drive up value for stakeholders!
On Nov. 30, the debtors filed a
notice designating St. Croix Energy, a newly formed entity backed by “influential and wealthy individuals” in the USVI, as the winning bidder for the refinery complex. According to the debtors, St. Croix bid $33 million for the refinery, including $20 million in cash and $14 million in “assumed and avoided liabilities and expense reimbursement pursuant to the terms of” a yet-to-be signed transition services agreement, minus $1 million in “expense reimbursement.”
The St. Croix bid
contemplates restarting and operating the refinery, despite some pretty serious issues with the U.S. Environmental Protection Agency which led to a shutdown last December. The shutdown cut off the process of restarting the refinery in earnest after investors poured more than
$4 billion into “modernizing” the facility after a prior chapter 11 in 2015. Further, the EPA has
ominously suggested that any going-concern sale would require the buyer to enter into “one or two” consent decrees.
But St. Croix has to win the auction before getting to those issues, and that doesn’t look like it will be easy. On Dec. 2, disgruntled bidder Bay Ltd. filed an
objection to the debtors’ designation of St. Croix as the winning bidder. Bay and its bidding partner, Sabin Metal, offered up to $39 million in cash for the personal property at the facility, including $15.1 million for a catalyst and up to $24 million from the liquidation of the remaining equipment.
In the notice designating St. Croix as the winning bidder, the debtors say the Bay/Sabin bid lost out because "[t]here is no minimum consideration" and the amount offered “must be adjusted to include factors such as the uncertainty in total recovery, the Debtors’ cash flow needs, and the time-value of money.” In other words, the equipment could sell more slowly or for less than Bay expects, trimming the debtors’ cut of the proceeds.
According to Bay’s objection, however, its bid is clearly superior to the St. Croix bid, even taking into account the uncertainties. Bay points out that although St. Croix is offering $20 million in cash consideration, it could immediately sell the catalyst itself for $15 million (the amount offered by Sabin Metal), leaving it only $5 million out of pocket for what Bay views as at least $24 million in other equipment. Bay suggests that rather than actually restarting the refinery, St. Croix really intends to dismantle it and sell the parts, without sharing any of the proceeds with the debtors like Bay.
In its objection, Bay asserts that the sale process was “tilted from the start” toward St. Croix, for “reasons Bay cannot understand.” But the preference for a going-concern sale should surprise no one: Bankruptcy professionals and judges
always prefer a going-concern sale. This might be our most noble habit: We always prefer sending a troubled enterprise back out into the world whole (albeit laden with new obligations) rather than in pieces. Whatever the reason for the St. Croix choice, disgruntled bidders generally don’t get far with objections to a debtor’s business judgment in designating an alternate bid as the highest. As the debtors pointed out in a
discovery motion filed on Dec. 6, losing bidders may not even have standing to complain at all.
But St. Croix now has bigger problems. Also on Dec. 6, the debtors filed a
motion to reopen the bidding process after receiving a new qualified bid from West Indies Petroleum Ltd., a Jamaican entity. According to the debtors, WIPL has offered $33 million, including $30 million in cash at closing. WIPL is also willing to take the assets without any transition services agreement.
WIPL actually submitted a bid prior to the St. Croix designation, the debtors say, but failed to make the required 10% deposit. The motion indicates that WIPL’s failure to pay the deposit resulted from a “sudden and unforeseen medical emergency that incapacited WIPL’s CEO on the eve of the Bid Deadline - leaving WIPL unable to formally qualify as a bidder or participate in the Auction.” The CEO was apparently “the only person at WIPL who had sufficient knowledge of the proposed refinery transaction and sale process and was the only person at WIPL who could authorize a deposit or execute an asset purchase agreement.” St. Croix counsel are no doubt working on a subpoena for the WIPL CEO’s medical records as we speak.
Later that day, Judge David Jones
granted the debtors’ motion to reopen the bidding process at an emergency evidentiary hearing. Of course, that means St. Croix and Bay/Sabin can also submit new bids. The judge additionally agreed to preserve all bidders’ rights to object to the next designation of winning bidder. This could get even messier, stay tuned. The auction is now scheduled for Friday, Dec. 17, at 11 a.m. ET.
The Takeaway: Bay tries valiantly to make the point that liquidation makes real sense: “[T]he straightforward dismantlement of the plant” would employ locals in the task, open up “new opportunities for the island” and “facilitate the resolution of longstanding federal and state concerns over the site.” However, our money is still on a “going concern” sale. Above and beyond the bankruptcy process forces that push us to try to keep debtor assets afloat, the
USVI Bureau of Economic Research has estimated that closure of the refinery would eliminate $632 million in gross domestic product, about 15% of the islands’ total. Gov. Albert Bryan Jr. conceded that closure would be “an economic setback for the territory.” This has us guessing that some serious government incentives are in store for any entity trying to keep the refinery open.
Other Matters:
- The Oversight Problem: We’ve lamented before that the runaway doctrine of equitable mootness has effectively prevented any effective oversight of important bankruptcy court decisions, including sale approval and plan confirmation. But another issue prevents bankruptcy courts from receiving guidance from above when they need it the most: the requirement that an order be “final” and not interlocutory to be appealed. The problem is that so many important bankruptcy decisions are interlocutory and tend to send cases off in a particular direction that cannot be reversed later.A good example: On Dec. 3, Judge Craig Whitley lamented at a hearing in the Aldrich Pump/Murray Boiler case that it seems nearly impossible to secure an opinion from the appellate courts on whether the two-step strategy is an abuse of the bankruptcy process as alleged by asbestos claimants. Judge Whitley all but begged the parties to come up with some procedural mechanism to get the question above his pay grade before spending three or four years on claim estimation and fraudulent transfer litigation. The judge even suggested that adverse publicity and Congressional criticism surrounding the LTL Management filing could “warm up” an appellate court to consider the issue. Of course, the debtors weren’t much help - the whole point of the Texas two-step strategy is to delay mass tort litigation for years until the plaintiffs surrender and accept what they are offered. Counsel for asbestos claimant representatives suggested that the judge should issue a decision in connection with the debtors’ disclosure statement and see if they could get that up to the Fourth Circuit.
The real solution: a realistic approach to finality and interlocutory appeals in bankruptcy cases. Of course, frequent appeals could also stop a bankruptcy case in its tracks for years while the appellate court mulls it over. This system is antiquated, and so far efforts to get courts on board with modernizing it haven’t gotten far.
- The Next Big Thing in “Independent” Fiduciaries: Speaking of Congressional criticism, another practice in Congress’ crosshairs - the independent director whitewash investigation - may have spawned a new innovation in mass tort cases: the “independent” but “supportive” future claims representative. In many mass tort cases, future claims representatives are appointed to advocate for the interests of claimants who have been exposed to a defective or dangerous product but haven’t yet manifested injuries and thus have no way of knowing they need to protect their claims in a chapter 11 case.These representatives stand in for thousands of absent claimants, ostensibly to maximize their recoveries - but the concept is ripe for abuse, since they have virtually no oversight other than vague fiduciary duties to claimants who don’t even exist yet (and may not exist until well after the representative is gone). Often, the future claims representative aligns with existing claimants because they are nominated by those claimants, as in the DBMP Texas two-step case. Fiduciaries tending to side with those who hire them repeatedly - perish the thought!
In the Aldrich Pump Texas two-step case, however, the debtors secured the appointment of their choice, Joseph Grier, as a future claims representative over the objections of the official claimants committee. Surprise surprise: Grier supports the Aldrich Pump plan, which allocates considerably greater recoveries to future claimants. On Nov. 7, LTL Management filed a motion to appoint a future claims representative in its Texas two-step case. Guess who they nominated? Joseph Grier, who they laud for his “willingness to ‘work across the aisle’” and “unequivocal independence” from the plaintiffs’ bar. Jones Day represents both the Aldrich Pump debtors and LTL Management.
- Fare Thee Well: This morning, the Southern District of New York announced that Judge Shelley Chapman will be retiring effective June 2022, joining Judge Robert Drain in hanging up her robe. Judge Chapman handled a number of big cases with aplomb (including the ongoing Grupo Aeroméxico chapter 11), but will perhaps be best remembered as one of the foremost mediators in the district. No surprise she was asked to handle the Purdue mediation! Best of luck in whatever comes next. We long-in-the-tooth bankruptcy lawyers can’t help but marvel that the Lehman cases have now outlasted two judges who were relatively new to the bench upon taking on the assignment.
--Kevin Eckhardt