Reorg’s Court Opinion Review provides an update on recent noteworthy bankruptcy and creditors’ rights opinions, decisions and issues across courts. Today, we consider a novel jurisdictional ploy in the Calfrac restructuring, Nantahala Capital’s attack on NOL stock trading restrictions and more.We The North
Back in February, Calgary, Alberta-based fracking services supplier Calfrac, through affiliate Calfrac Holdings LP, or CHLP,
issued $120 million in second lien notes in connection with an exchange offer. The second lien notes sit below approximately $125 million in revolving first lien debt and above approximately $573 million in senior unsecured notes in the company’s
capital structure.
The second lien noteholders must have been reluctant to attend a closing in Calgary in February, so they set the deal up as a south-of-the-border transaction: The issuer, CHLP, is a Delaware partnership with no operations, and the credit agreement and indenture are governed by New York law. The second lien noteholders also secured a guarantee from CWSC, a Colorado corporation that controls the company’s U.S. operations - which provide the majority of the company’s revenue.
The second lien indenture includes a typical automatic bankruptcy acceleration provision: Upon the filing of an insolvency proceeding by the issuer or a guarantor, the second lien obligations become immediately due and payable. Keep that in mind.
Of course, February may have been a particularly challenging time for lenders to extend credit to a fracking company. In June, Wilks Brothers, owner of approximately 19% of common stock and holder of more than half of the second lien notes, made a series of restructuring offers to the company in the wake of the oil shocks of March and April, all of which were rebuffed.
Instead, the company agreed to a “recapitalization transaction” with the unsecured noteholders, which it
announced on July 14. The deal would hand over 86% of new common stock to the unsecured noteholders, subject to dilution from conversion of 50 million Canadian dollars in new 1.5 lien convertible notes issued largely to a group of consenting creditors. Second lien noteholders would maintain their liens and claims (behind the new 1.5 lien notes, at least until conversion), and existing equity would receive 3% of the new common stock - a substantial dilution of Wilks Brothers’ current position.
The company must have known the second lien noteholders - Wilks Brothers - would be less than enthusiastic about this proposal. If the company were to file for chapter 11 in the United States to effectuate the deal, or pursue a reorganization under the Canadian Companies' Creditor Arrangement Act (which generally resembles chapter 11 proceedings), then they would have to deal with Wilks Brothers, since a filing would trigger an immediate acceleration of the notes, without any action by the trustee that might violate the automatic stay. The company could reinstate the second lien notes and call them unimpaired to prevent Wilks Brothers from voting on the plan but that could get litigious (take a look at the reinstatement
fight in Frontier for a good example).
According to Wilks Brothers, the company found another way to dim prospects for recovery: by seeking approval of a plan of arrangement in a proceeding under section 192 of the Canadian Business Corporations Act, or CBCA. According to
Corporations Canada, Canada’s federal corporations regulator, section 192 of the CBCA has “been utilized by corporations to effect a wide range of different types of transactions, such as ‘spin-offs’ of business enterprises, combinations of business enterprises, continuances of corporations to or from other jurisdictions and so-called ‘going-private’ transactions.” Note that this list does not include “debt restructuring by insolvent entities.” In fact, section 192 of the CBCA specifically bars insolvent companies from filing an arrangement proceeding under section 192.
Corporations Canada takes the position that “transactions involving principally the compromise of debtholder claims against insolvent business enterprises may be more appropriately carried out under provisions of applicable insolvency laws.” The regulator acknowledges, however, that insolvent companies have used section 192 of the CBCA to restructure, generally by ensuring solvency at the
end of the proceeding (after completion of the restructuring) or by using a solvent affiliate as one of the petitioners.
But why bother with the CBCA, when the company could just file a CCAA insolvency proceeding and avoid these potential issues? Simple: As Corporations Canada points out, section 192 of the CBCA “does not require security holder approval as a pre-condition to a court order approving an arrangement.” The presiding judge need only find that the arrangement is “fair from the perspective of the security holder constituencies whose rights are affected by the arrangement.” And the judges are not the backward-skating referees overseeing black-and-blue corporate insolvency proceedings in Ontario, but local judges in the provinces more accustomed to handling the insolvency equivalent of weekend pond hockey.
Now, back to Calfrac. According to Wilks Brothers, on July 6 - the same day the company sent a letter rejecting Wilks Brothers’ last pre-filing restructuring proposal - the company formed an affiliate under the CBCA, 12178711 Canada Inc., for the express purpose of filing a section 192 proceeding in Calgary to implement the unsecured noteholder transaction.
On July 13, this entity, solvent as a newborn baby,
joined CHLP, CWSC and Canadian affiliates in a petition under section 192 in Calgary. Justice D.B Nixon, whose practice prior to taking the bench
focused on “commodity and income taxation,” dutifully issued an interim order staying all actions to collect on prepetition debt, including acceleration of the second lien note obligations.
An order from the Canadian court by itself would accomplish little with respect to the debtors’ U.S. assets and operations held by CWSC, so on July 14, the CBCA petitioners filed a chapter 15 case in the Southern District of Texas and asked Judge David Jones for emergency recognition of the Calgary court’s interim stay order. Judge Jones
granted interim recognition on July 14 over the objection of Wilks Brothers.
Then, on July 27, the Calgary judge issued an
oral ruling clarifying that the interim stay prevented the automatic acceleration of the second lien obligations, notwithstanding the automatic acceleration trigger in the indenture. “Based on my review of the law,” Justice Nixon says, “the Court has a jurisdiction under the CBCA to temporarily stay the contractual rights of a third party, including automatic acceleration provisions.” As far as the Calgary court is concerned, the second lien notes are not in default, even though the issuer and a key guarantor have now filed restructuring proceedings in both Canada and the United States and, according to Wilks Brothers, the automatic stay in a chapter 11 bankruptcy case would not prevent acceleration.
On Aug. 11, Wilks Brothers filed a scathing
objection to chapter 15 recognition of the CBCA proceeding and, in particular, the Calgary court’s orders superseding the automatic acceleration of the second lien debt. According to Wilks Brothers, the CBCA proceeding “is part of a brazen strategy by corporate insiders to enrich themselves at the cost to other stakeholders, like Wilks.” “In order to implement this strategy,” Wilks Brothers continues, “the company used a newly-formed shell company to gain access to the CBCA process and obtained entry of orders in the Canadian Proceeding that purport to prevent or to unwind the automatic acceleration of the Second Lien Notes that occurred when such proceedings were commenced, even though the Second Lien Notes were issued by a United States entity, are governed by New York law and are held primarily by United States creditors.”
The Takeaway: Lenders should consider the insolvency expertise of a former family law litigator now on the bench in Saskatchewan when pricing debt issued by a company with any ties to Canada. Keep that in mind next time you even think about criticizing the financial markets acumen of judges in New York, Wilmington, Houston and Toronto.
The Fine Print: If this ploy works, our hats off to the company lawyers. If Judge Jones denies recognition, will Wilks Brothers be so bold as to try enforcing its lien against the company’s U.S. assets in defiance of a Canadian court order?
Robinhood: Liquidity Provider
Remember those fun, head-scratching few days in the Hertz case when the debtors
tried to raise money by selling new common shares into a seemingly overenthusiastic market? The Securities and Exchange Commission put the
kibosh on the Hertz debtors’ stock-selling efforts, but the commission cannot keep holders of already outstanding shares from dumping them. At least one investment manager, Nantahala Capital, would like to strike while the iron is hot, but they have a different problem: Virtually every bankruptcy court overseeing publicly traded chapter 11 cases places strict limits on large holders’ ability to sell stock at the beginning of the case, and as a matter of course.
On Aug. 6, Nantahala filed an extremely rare
objection to these standard equity trading restrictions in the Global Eagle Entertainment case. Like virtually all publicly traded debtors, Global Eagle filed a first day motion giving it the ability to prevent substantial equityholders from selling out in order to prevent an ownership change that might compromise the debtors’ net operating loss carryforwards, or NOLs (you can find a link way, way, way down at the bottom of our
case summary, right below the motion for joint administration - which should give you an idea of the importance of these motions in most cases).
Generally, the ability to set off past losses against future profits does not mean much for a bankrupt company, which could struggle to make sufficient profits to utilize those losses (yes, PG&E
plans to monetize its tax attributes, special case), but debtors do not want to take any chances. Shareholders typically go along because they cannot find anyone to buy their worthless stock, which is almost always wiped out or heavily devalued by a chapter 11 plan.
Nantahala, however, recognizes the new normal. The objection concedes that “[i]f the Debtors’ and first lien lenders’
prearranged deal comes to fruition, Nantahala’s clients’ equity interest will be worthless.” Nevertheless, the objection continues, “since the Petition Date, there has been an active equity securities trading market in such equity.” How active? “In particular, the day after the Interim Trading Order was entered, the GEE stock price reached a high of $7.00, and the volume on that day was over 72 million shares traded.” Welcome to 2020!
Global Eagle is in the business of “licensing and managing media and entertainment content and providing related services to customers in the airline, maritime and other ‘away-from-home’ nontheatrical markets” and “providing satellite-based internet access and other connectivity solutions to airlines, cruise ships and other markets.” “Away from home,” we all wish. Even if the debtors’ customers were able to actually operate, however, the company has already proposed a plan under which lenders would take ownership, leaving nothing for equity. But people are buying that equity, and in large volumes.
Obviously, Nantahala does not want to wait for these punters to come to their senses before cashing out. But the trading restrictions designed to protect the NOLs stand in the way. “If not for the injunction in the Interim Trading Order,” the objection asserts, “Nantahala would have been able to monetize its clients’ equity position in GEE for millions of dollars.”
In order to get around the restrictions, Nantahala makes a legal argument that could have far-reaching implications: According to Nantahala, the standard trading restrictions approved in virtually every chapter 11 of a publicly traded entity on the first day via rubber stamp have absolutely no basis in the Bankruptcy Code. The automatic stay does not justify the restrictions, Nantahala says, because it “is not seeking to obtain property of the Debtors’ estate, nor is it exercising control over property of the Debtors’ estate.” Instead, Nantahala is “simply seeking to monetize its clients’ own property (GEE stock).” Further, Nantahala argues, section 105 of the Bankruptcy Code cannot justify the restrictions because that provision “cannot provide for independent relief,” and “must be tethered to another section of the Bankruptcy Code.”
Finally, Nantahala rains on the parade of every chapter 11 debtor hoping against hope to make use of those NOLs some day. “The Debtors allege that they have approximately $660 million in NOLs that ‘may’ be available to offset future income, as well as other Tax Attributes,” the objection argues, but “in the event of an ‘ownership change’ (generally, where there is a greater than 50 percentage point aggregate increase in the percentage of equity held by five percent shareholders over a rolling three-year lookback period), the U.S. federal tax rules, in particular Sections 382 and 383, imposes an annual limitation on the amount of taxable income that can be offset by pre-change-of-ownership Tax Attributes of a corporation.”
Said differently: “Given that the Debtors acknowledge that an ownership change occurred on June 5, 2019, and that an annual limitation is currently in place, the ‘gross’ $660 million figure does not come close to accurately describing the extent of the Debtors’ usable NOLs.” Additionally, Nantahala argues that “the Debtors have done no more than express their ‘intention’ to structure a sale” to preserve the NOLs “and have not demonstrated how much additional Tax Attributes benefit these special rules would afford.” In other words, the debtors’ “intentions” should not justify restrictions preventing Nantahala getting out of the debtors’ worthless stock while the getting is good. As an alternative to lifting the restrictions, Nantahala makes a modest proposal: The debtors could simply pay the investor the current market value of its stock.
The Takeaway: As discussed
in our last installment, shareholder concerns are increasingly becoming an issue in chapter 11 cases, even where equity seems to be clearly out of the money. A buoyant market for chapter 11 debtor stock could accelerate that trend.
The Fine Print: If Nantahala gets some traction on its argument questioning the real value of NOL “assets” and asserting that trading restrictions are not viable under the Bankruptcy Code, that could have implications for cases in which the NOLs actually are valuable.
Other Decisions
- No Special Treatment for JeffCo Tax Collector: If you get the shivers at the thought of a February closing in Calgary, well, consider bankruptcy court in Alabama this August, where intergovernmental tensions are boiling over. On Aug. 7, the bankrupt city of Fairfield filed a motion to enforce the automatic stay against J.T. Smallwood, the tax collector for Jefferson County, for the latter’s failure to turn over $750,000 in tax revenue. “The Debtor is in desperate need of the Tax Revenues in order to continue to pay city services,” the motion says, and “has the intention to use these revenues to address immediate needs, including the re-establishing of liability insurance coverage.” No Covid-19-related service as a hook? According to his biography on the Jefferson County website, Smallwood has a J.D. and has served “as a lecturer in Law and Ethics.” This could be interesting.
- Dockets for Dollars: Bravo to the U.S. Court of Appeals for the D.C. Circuit, which on Aug. 6 affirmed a lower court ruling barring the Administrative Office of the U.S. Courts from charging more to access court documents on PACER than is necessary to support PACER, CM/ECF, electronic bankruptcy noticing and courtroom audio recording. Although the decision may not reduce PACER fees immediately, it should prevent the AO from tacking on an extra five cents per page to cover the Houston judges’ sparkling new GoToMeeting interface (a huge improvement over join.me). The court of appeals acknowledges that “[i]f large swaths of the public cannot afford the fees required to access court records, it will diminish the public’s ability ‘to participate in and serve as a check upon the judicial process - an essential component in our structure of self-government.’” Amen. Not to mention basic principles of equity: If law firms are no longer allowed to mark up the cost of copies charged to clients, then PACER should not be able to do so either.
--Kevin Eckhardt