Breitburn Equity Committee Attacks ‘Artificially Low’ Plan Enterprise Value, Says Management Incentive Plan Creates Conflict of Interest

Relevant Documents:
UCC Reservation of Rights
Equity Committee Objection

This afternoon, the Breitburn equity committee filed its anticipated objection to the debtors’ plan. The equity committee argues that the plan cannot be confirmed because (1) the plan does not provide the same treatment for each claim in Class 5A unsecured notes claims, (2) the plan is not fair and equitable to the debtors’ equityholders, and (3) the plan was not proposed in good faith. In particular, the committee points to the debtors’ management incentive plan, which it asserts is still under negotiation and which causes CEO Hal Washburn to be conflicted. The committee also asserts that the plan exposes equityholders to “unjustifiable” risk of cancellation of debt income, or CODI, which could result in a $525 million tax liability for existing equity. Additionally, the committee argues that the debtors are relying on an artificially low valuation as justification for not providing any recovery to existing equity and argues that the committee’s expert will testify that the debtors’ enterprise value is substantially higher, at $3.8 billion. 

Separately, the UCC submitted a reservation of rights noting that it continues to negotiate the documents necessary to effectuate the transactions contemplated in the plan with the debtors, the unsecured senior notes groups and various other parties, and that there are still unresolved substantive issues, including the provisions in the New Permian Corp. governance documents addressing minority shareholder protections. “At present, certain terms of these documents do not reflect agreements reached in mediation,” says the UCC. As a result, to the extent the foregoing issues cannot be resolved consensually prior to confirmation, the UCC reserves its rights.

The confirmation hearing is scheduled for Jan. 11 at 10 a.m. ET.

Equity Committee Objection (Exhibits)

The equity committee emphasizes that the price of oil has significantly increased since the debtors filed for bankruptcy, echoing its objection against the debtors’ motion to exclude the committee’s valuation expert evidence from the Jan. 11 confirmation hearing. However, says the committee, the debtors filed a chapter 11 plan premised upon a total enterprise value between $1.35 and $1.9 billion, which Lazard (the debtors’ investment banker) has not changed since it last gave an opinion about value in September 2016, “even though the price of oil has increased by more than 30% over the last two years.” Under this valuation, existing equity would not receive a recovery, and the plan does not eliminate the risk of cancellation of debt income, says the objection.

First, argues the objection, the plan violates section 1129(a)(3) of the Bankruptcy Code, which requires that a plan must be filed in good faith and must not by any means be forbidden by law. The debtors’ proposed management incentive plan “gives management a perverse incentive - the lower the negotiated value of the Debtors, the more valuable the management team’s MIP becomes,” contends the filing. Citing to an allegedly outsized amount of communications relating to the MIP, the equity committee asserts that MIP negotiations “ran concurrently with the negotiation of the Plan and apparently are not concluded” and that the conflicts of interest relating to those negotiations have not been addressed. According to the committee, the MIP is structured such that EIG, the debtors’ largest second lien noteholder, and the other second lien noteholders, would recoup their capital, plus a preferred return or “hurdle” rate. Once the “hurdle” is cleared, “any profits would be shared with the management team in the agreed-upon percentages,” says the committee, adding, “Of course, the lower the initial equity value, the faster incentives may be achieved.” Currently, according to the committee, the first hurdle is an 8% return.

As a result of this structure, says the committee, the management team’s interest was in the lowest possible valuation of LegacyCo because “the lower that valuation, the higher the value of the management team’s MIP.” The MIP also gave the debtors’ management an incentive to “ignore sale overtures from interested parties outside of the capital structure,” the committee continues. The committee contends that management and the board of the company ignored the conflict created by this structure, and that the debtors never took the legal steps required to approve the conflicted plan structure as required by Breitburn’s partnership agreement. Moreover, it is unclear whether the board was informed of the MIP when it voted to approve the plan, adds the committee. Because the MIP created a conflict of interest for the debtors’ CEO and board member, Hal Washburn, the plan should have been treated as a conflicted transaction, but “[t]here was no Committee appointed, there was no unitholder vote, and the Board made none of the findings necessary to approve the conflicted transaction,” says the filing.

As such, says the committee, because conflicted management failed to propose the plan in good faith, the plan cannot be approved under section 1129(a)(3). The filing points out that the company’s board has questioned whether the unsecured bondholders are already discussing a deal to flip the assets but has not yet obtained an answer to that question. Good faith “cannot encompass a situation in which a select group of bondholders acquires the Debtors’ crown jewel assets in a below-market sale and then flips them for a substantial profit while the unsecured creditors who are not in that select group take pennies and equity gets extinguished,” the filing asserts.

The plan would also leave equityholders exposed to “substantial and unjustifiable” CODI risk, urges the committee, because approximately $1.42 billion of CODI would be recognized by the debtors, and this income would flow through to the debtors’ equityholders. Although the debtors’ strategy to mitigate CODI is to generate a taxable sale of the debtors’ assets, the plan permits the “Requisite Consenting Second Lien Creditors” to make a “Corporation Election,” says the committee. Under this election, there is a “substantial likelihood” that the $1.42 billion anticipated ordinary loss “would be disallowed as a result of certain related party loss rules,” and at a 37% federal income tax rate, “that equals approximately a $525 million tax liability to the common equity holders,” the filing emphasizes. According to the committee, there is an alternative plan structure that could “block” CODI from flowing through to the equityholders by putting the losses in a corporation, but the debtors have rejected that approach, instead “capitulating” to their second lien noteholders.

The plan also treats members of Class 5 unsecured noteholders differently, because eligible offerees who elect not to participate in the rights offering for any reason whatsoever would receive no distribution under the plan, says the objection. According to the filing, “creditors should not have to pay the Debtors for the privilege to recover on claims already owed to them.”

The objection argues that the debtors have failed to satisfy certain provisions of section 1129(a)(5), which provides that the debtors must disclose the identities of any individuals who are proposed to serve as directors or officers as well as the identity and nature of the compensation to be paid to insiders. Although the plan says the identities of these individuals will be disclosed prior to next week’s confirmation hearing, that condition has not yet been satisfied, according to the objection. The equity committee also takes issue with the fact that the debtors have not yet disclosed the amounts to be paid under the management incentive plan. The committee reiterates that “MIP negotiations are still ongoing” and that the court “should require those negotiations to be resolved before confirming a Plan.”

The equity committee then alleges that the plan’s “artificially low” enterprise valuation “improperly diverts value” away from the equityholders. Reiterating the reasons stated in its objection against the debtors’ motion to exclude the committee’s expert evidence, the equity committee argues that Lazard’s midpoint valuation of $1.6 billion is “low-balling in the extreme.” The committee says that its expert will testify at the confirmation hearing that the debtors’ enterprise value is $3.8 billion. “Simply put,” the objection says, “the Plan should not be confirmed because the Debtors have a total enterprise value that puts equity holders ‘in the money,’ and therefore, any plan that denies them any recovery is not fair and equitable under section 1129.” According to the objection, the plan, in effect, “transfers the equity value of the Reorganized Debtors - an enterprise worth over $3 billion to the Plan Sponsors.” The committee argues that a plan that “overcompensates the Plan Sponsors and deprives equity holders of their rightful allocation of estate value” is “antithetical to the Bankruptcy Code’s ‘fair and equitable’ requirement” and therefore cannot be confirmed.

The equity committee further rejects the ad hoc bondholder group and second lien group arguments that they have settled “all valuation disputes,” arguing that these groups have “purport[ed] to settle litigation that otherwise would benefit the entire class by designing a settlement that only benefits a select few.” Certain bondholders are taking “fees and expenses and at least 50% of the Permian Assets” to do what Diamondback, or another purchaser, would do at a potentially higher valuation had the debtors run a market test or engaged with offerors, contends the filing. The committee argues that the settlement “facilitates the transfer of assets at a predetermined enterprise valuation that the Debtors have not tested, while affirmatively turning off competitive market interest.” The committee contends that the court cannot confirm the plan because the settlement “clearly falls outside the range of reasonableness and fails to satisfy Bankruptcy Code section 1123(b)(3)(A) and Bankruptcy Rule 9019.”

Finally, the committee notes that it does not object to the release provisions on the sole basis that because equityholders did not vote on the plan, they do not grant a release under the plan.