Wed 05/04/2022 11:25 AM
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Bausch Restructuring Update from Reorg's Americas Core Credit Team.

As institutional investors seeking damages for the Valeant Pharmaceuticals’ securities fraud challenge Bausch Health’s anticipated spinoff and initial public offering of the company’s Bausch + Lomb vision health business, the potential that the spinoff will be declared a fraudulent transfer is now in play. This article explores the possibility that Bausch Health will seek to address the securities fraud and fraudulent transfer claims through a chapter 11 filing.

The B+L IPO launched last Thursday, April 28, with an offering of 35 million common shares and an additional 5.25 million underwriter over-allotment at an expected pricing of $21 to $24 per share. The B+L spinoff is part of a broader restructuring of Bausch Health into three separate companies: the Bausch Pharma global business, B+L eye health business, and Solta Medical aesthetics business.

In addition to the corporate restructuring, Bausch Heath contemplates a refinancing of its existing credit agreement, funded in part by the B+L IPO proceeds and the issuance of new debt. B+L is also entering into a new credit agreement that will fund the repayment of an intercompany note issued to Bausch Health in connection with the spinoff.

The use of the chapter 11 toolbox to address multiparty liability has featured prominently in a number of cases - including Purdue Pharma, Mallinckrodt and the “Texas two-step” cases of Johnson & Johnnson subsidiary LTL Management, DBMP, Aldrich Pump and Bestwall (all spun-off entities created via a Texas divisional merger to cabin asbestos liabilities ahead of a chapter 11).

A potential bankruptcy filing by Bausch Health, however, could reverse the pattern, leave the bulk of liabilities with the parent entity and resolve the securities and fraudulent transfer claims through humbler, more well-known tools: subordination of claims relating to the purchase or sale of debtor securities, the lenient business-judgment standard for approval of bankruptcy settlements and the exclusive prerogative of bankruptcy trustees and chapter 11 debtors-in-possession to prosecute estate causes of action.

Following the spinoff, Bausch Heath could subordinate the securities fraud claims against the company under section 510(b) of the Bankruptcy Code and then settle the fraudulent transfer claims that the claimants have raised with respect to the spinoff with new B+L for an amount lower than what would be required to resolve the claims outside of bankruptcy.

The securities claimants would object, seek derivative standing to control the B+L fraudulent transfer claims and otherwise seek to preserve the value of their claims.

The securities plaintiffs, however, would face considerable barriers. Section 510(b) provides for mandatory subordination of securities-related claims, while derivative standing may not be available if the debtors actively seek to settle the subject claims. If settlements are negotiated by independent directors, however, the lenient business judgment standard may allow for considerable flexibility in settling the fraudulent transfer claims for reduced amounts, with the securities claimants to receive no distribution under a plan.

Intelsat Intercompany Settlement Model

A similar dynamic involving a debtor’s power to settle captive derivative claims was at play in the Intelsat chapter 11 cases, though in that instance both parties to the controversial transactions were debtor entities. A central issue in Intelsat was which debtor entities were entitled to recover accelerated C-band/5G spectrum accelerated relocation payments of approximately $4.9 billion anticipated to be received from the U.S. Federal Communications Commission.

The ad hoc group of Intelsat SA convertible noteholders and Intelsat’s former C-Band Alliance ally SES Americom both filed motions for standing to prosecute interdebtor claims over the ownership of the relocation payments on behalf of debtors Intelsat SA and Intelsat US, respectively.

The debtors proposed a plan that would settle competing claims to the payments largely in favor of the Intelsat Jackson entities, and sought approval of the settlement under a plan as an exercise of each of the debtor’s business judgment.

The convertible noteholders and SES, however, sought a more friendly allocation of the payments to debtors against which they held claims. In particular, the convertible noteholders attacked a settlement among the debtor entities negotiated by a special committee of intelsat SA, suggesting that “a five billion-dollar claim has been ‘settled’ for less than $37.5 million.” Asserting that the board of directors did not vigorously pursue the claims, the convertible noteholders said that “the S.A. Special Committee … decided to gift away Intelsat S.A.’s valuable asset before doing any meaningful diligence or analysis.”

The convertible noteholder and SES claims were ultimately settled for well below their face value.

Bausch Health Fraud Claims and B+L Fraudulent Transfer Action

The securities claims at issue in the B+L spinoff relate back to Bausch Health’s prior existence as Valeant Pharmaceuticals. According to the plaintiffs, the company used “sham” sales figures to project an image of organic growth in response to allegations that the company’s growth was unsustainable, which the plaintiffs say caused them $4 billion in damages.

Bausch Health settled a securities fraud class action relating to the same claims for $1.21 billion in 2019, but the plaintiffs - a group of institutional investors including GMO, Brahman, SunAmerica, Discovery, MSD, Incline, Okumus, Maverick, Pacific, PGGM, Schilders, USAA, INKA, GIC and Privet - opted out (a danger of settling tort claims outside of chapter 11) and are now challenging Bausch Health’s spinoff and IPO of its vision care assets.

These objectors have targeted the spinoff as an attempt to avoid “multi-billion dollar civil liability” and seek a declaration that it is voidable as a fraudulent transfer under New Jersey law. The lawsuit was originally filed in state court, Bausch Health removed the action to federal court, and the plaintiffs are now seeking to return to state court.

The plaintiffs have made clear that their goal is to collect any judgment in the securities fraud action from B+L after the IPO. The plaintiffs assert the spinoff’s overall effect “will be to prevent or impede creditors such as Plaintiffs from recovering on their substantial claims” and to provide “a vehicle for Bausch Health to protect its most valuable assets from the contingent liabilities created” by the plaintiffs’ suits.

The complaint points to the conclusions of “investment analysts” that “Bausch Health will have a negative valuation of -$0.70 per share post spin-off,” even before fully accounting for contingent liabilities, “whereas Bausch + Lomb will be worth almost $30 per share.”

As grounds for their fraudulent transfer argument, the plaintiffs say Bausch Health will not receive reasonable equivalent value in connection with the spinoff since Bauch Health will distribute the 80% equity interest in new Bausch + Lomb to existing shareholders, leaving the company without “anything in return.”

Moreover, new Bausch + Lomb will not be allocated “a proportionate share of liabilities” through the spinoff - including the plaintiffs’ claims and a potential $2.1 billion tax liability - leaving Bausch Health “three times more leveraged than Bausch + Lomb.”

Following the transaction, the plaintiffs say Bausch Health will “be rendered insolvent or, at a minimum, with insufficient capital to withstand normal, cyclical industry trends.” Additionally, Bausch Health will have transferred the B+L assets “without receiving reasonably equivalent value in return.”

In the transaction, Bausch Health will receive “only … some of the cash proceeds raised” through the sale of 20% of the B+L stock, while the remaining 80% will be “essentially” gifted to existing shareholders through a dividend.

“To make matters worse,” the plaintiffs assert, Bausch Health is also “not transferring a proportionate share of liabilities” to B+L. As a result, Bausch Health will have “insufficient assets to satisfy outstanding liabilities, including the multi-billion-dollar contingent liabilities represented by Plaintiffs’ federal securities fraud claims.”

Bausch Health Chapter 11 Subordination and Settlement Solutions

If the plaintiffs are correct, the asset-poor, post-spinoff Bausch Health will be set up for a bankruptcy filing in the obverse to the Texas two-step method. Following a bankruptcy filing, the securities claims could be automatically subordinated to the level of equity through the application of section 510(b) of the Bankruptcy Code, setting up a scenario where Bausch Health could shed itself of the securities liability while leaving creditors, including the approximately $14.9 billion in unsecured debt, completely intact.

Section 510(b) of the Bankruptcy Code provides for mandatory subordination of claims “arising from rescission of a purchase or sale of a security of the debtor or of an affiliate of the debtor, for damages arising from the purchase or sale of such a security,” including claims arising from fraud and other securities law violations. Securities-related claims are subordinated to the same level as the securities underlying the claim and, as a result, will fall behind both secured and unsecured claims in a recovery waterfall.

The overall purpose of this subordination is to preserve recoveries under the absolute priority rule and prevent shareholders from elevating their priority entitlement through claims arising out of equity interests. A Lehman opinion broadly applying section 510(b) to subordinate claims arising from securities of the debtor’s corporate parent notes the “two rationales supporting subordination” as “‘the dissimilar risk and return expectations of shareholders and creditors; and [] the reliance of creditors on the equity cushion provided by shareholder investment.’”

A bankruptcy filing would also place an additional hurdle to the securities plaintiffs’ pursuit of their fraudulent transfer claims, even if they are not subordinated. Under section 541 of the Bankruptcy Code, property of the estate includes all property of the debtor, including claims and causes of action, and the bankruptcy trustee, or a debtor operating as a debtor-in-possession in a chapter 11 case, is granted exclusive authority to settle these estate claims.

The scope of estate property is broad and includes claims under nonbankruptcy law - including state law fraudulent transfer claims against third parties such as those brought by the securities plaintiffs.

Although outside of bankruptcy creditors may have standing to bring fraudulent transfer claims against third parties under state law, once inside of bankruptcy creditors lack so-called statutory standing to pursue claims that are “derivative” of estate claims, including fraudulent transfer claims that would allow the hypothetical Bausch Health estate to claw back transfers made to B+L for less than reasonable equivalent value.

Consequently, upon filing Bausch Health would take control over the prosecution and settlement of any fraudulent transfer claims arising out of the B+L spinoff, cutting the plaintiffs out of the equation.

Creditors generally may seek derivative standing and obtain leave from the court to prosecute fraudulent transfer and other actions on behalf of the estate if they can establish that the debtor unjustifiably refused a demand to pursue the claim and the claim is colorable. But debtors typically oppose these derivative standing motions.

In Intelsat, the debtors countered requests for standing to assert interdebtor claims by pointing to their pursuit of a settlement negotiated by special committees of the debtors’ boards of directors. The debtors defended the interdebtor settlement under the lenient standard for approval of such settlements under Rule 9019 of the Federal Rules of Bankruptcy Procedure, which only requires that a proposed settlement of an estate claim fall above the lowest point in the range of reasonableness - for example, that it is a reasonable exercise of business judgment.

Aggrieved creditors may assert that any settlement of claims with debtor affiliates should be subject to a higher level of review than the lenient business judgment standard, such as the “entire fairness” standard for related-party transactions under state corporate law. However, compliance with governance best practices and the supervision of independent directors is generally effective to insulate all but the most egregiously one-sided settlements from more intensive standards of review.
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