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 new Endo sale plan, the Mercon Coffee DIP dispute and Judge Lopez sidestepping the Sinclair/DSG management fees fight.
When a Plan Comes Together
Pour one out for bankruptcy innovation, thanks to the Endo case: On Dec. 19, the debtors officially bailed on their
not-that-novel section 363 credit bid sale strategy,
pirouetting to a chapter 11 sale plan that features the same recoveries for creditors as the sale plus a convoluted installment payment plan for the federal government. So what was the point of all that noise over “cheat codes” and
vertical gifting?
Let’s recap: Endo filed in August 2022 with a
stalking horse credit bid from first lien lender acquisition entity Tensor Ltd. and a deal with 34 states to accept a $550 million opioid settlement from Tensor after the sale closed. Unsecured creditors immediately
cried foul over the use of section 363 to turn the company over to lenders, asserting that this could be an end-run around confirmation in
every single chapter 11 case. We thought that was a little
rash, even by florid first day objection standards.
Why did the debtors choose a section 363 sale over a plan distribution of reorganized equity?
According to the debtors, their chances of confirming a plan were “grim,” and confirmation would require “many months (if not years) of litigation” and “cost many tens (if not hundreds) of millions of dollars.” Specifically, the debtors said that they were concerned that they could not confirm a plan over the objections of the federal government, which held a then-estimated hundreds of millions in priority tax claims the debtors could not pay as required by section 1129(a)(9)(C).
“The Debtors’ thorough but efficient sales process was clearly the best judgment,” the debtors said in response to objections, pointing to the damage done to Mallinckrodt by delays in its
emergence from its first chapter 11 case.
Gradually, holdout creditors’ apocalyptic fears regarding the section 363 sale were mollified with payoffs. The debtors resolved sale objections from a group of crossover holders, unsecured noteholders, the UCC and the private opioid claimants committee in March 2023. The sale process
ended in June 2023 with - you guessed it - no competing bids. Finally, all of the eligible states
signed on to the opioid settlement by July 25.
By that point, the only substantial
objections to the sale came from the government: The feds, as a creditor, took issue with unsecured creditors getting paid by Tensor via a “gift” ahead of billions - not hundreds of millions - in asserted priority tax claims, and the U.S. Trustee, as bankruptcy watchdog (
in for a penny, in for a pound!), opposed the section 363 strategy as a matter of principle, citing
sub rosa plan concerns.
The holdout states never made much noise about objecting to the plan, and a competing bidder was always unlikely, so we will date the “everyone but the government” consensus on the section 363 sale from March 24, when the unsecured noteholders
dropped their previously vociferous objection to the sale process. That means that for almost
nine months, the case was held up by negotiations over the treatment of the federal government’s claims and the feds’ desire for a plan process rather than a section 363 sale.
We can’t say how much of that delay can be traced to the negotiation of the economic terms of settlement talks with the government and how much can be traced to the government’s fundamental issue with a plan approach, but the complexity of the resulting plan structure - a
liquidating plan structure! - suggests that the latter was a substantial issue.
Even if it only took one month - from the
disclosure of the eventual economic terms of the plan pivot on Nov. 20 to the filing of the plan on Dec. 19 - you also have to consider the additional time and expense of disclosure statement approval, solicitation and confirmation over the process needed to approve the prepackaged sale (nothing more than a long-delayed sale hearing).
Why didn’t the feds just take their settlement payoff from Tensor after the closing of the section 363 sale like everybody else? Without an alternative explanation, we have to assume they pushed for a plan path to prevent future debtors from citing a non-
GM, non-
Chrysler precedent for a section 363 sale exception to the
vertical gifting doctrine. If you have another explanation, feel free to share.
So there’s two ways to look at this: either the federal government’s intransigence over the sale strategy forced months of needless delay and expense over a matter of principle, or the debtors’ misguided attempt to sidestep the crucial creditor protections of the plan process created a wasteful sideshow that threatened to turn the plan into the exact Mallinckrodt quagmire they initially hoped to avoid.
Where do we come down? Little bit of column A, little bit of column B.
On the “blame the government” side, we concluded in our January 2023 discussion of the sale strategy that there’s really no principled reason to object to a sale of substantially all of a debtor’s assets via a chapter 11 section 363 sale without nondebtor releases when the same result could be secured simply by filing chapter 7.
Would the government have objected if a chapter 7 trustee agreed to sell the debtors’ assets to Tensor after a sale process and Tensor separately entered into a side deal to pay off opioid creditors and give a smidge of equity in the buyer to other prepetition creditors? The trustee could simply seek Rule 9019 approval of a settlement resolving the debtors’ claims against Tensor, if any, in exchange for the same $60 million offered to general unsecured creditors under the plan, plus wind-down costs. How is that substantively different from the section 363 proposal? At the very least, the
UST wouldn’t object because the
UST only appears in chapter 11 cases.
But the debtors also bear some blame for dramatically underestimating both the quantum of the government’s claims and the steadfastness of its opposition to the sale strategy (of course, we underestimated the latter as well). The Endo debtors, like Mallinckrodt, seem to have unrealistically pinned their hopes for an easy case on a disadvantaged and sidelined creditor folding easily rather than fighting - the
Acthar antitrust creditors for Mallinckrodt and the feds for Endo. In an era of increasingly skeptical bankruptcy judges, that seems a dangerous risk.
As a result, assuming Endo emerges as planned on March 31, the company will have spent 593 days in bankruptcy, compared with 612 days for the first Mallinckrodt case. That is
not the outcome the debtors hoped for.
Unfortunately for future debtors, Endo’s abandonment of the section 363 strategy could bode ill for the renewed use of section 363 as a chapter 11 cheat code and the related vertical gifting doctrine. Expect the emboldened UST to cite Endo’s
volte-face the next time a debtor attempts to get free and clear on the cheap - especially without accommodating judges like former judge
David R. Jones to lend a sympathetic ear to the debtors’ concerns.
(Speaking of which, the irony of Jones
filing papers pro se in response to a
pro se lawsuit against him related to
l’affaire Freeman is pretty delicious, no? We trust the district judge will afford Jones as much deference as Jones himself
always showed pro se litigants in his court.)
The Best Part of Waking Up
Speaking of skeptical judges, on Dec. 8, Judge Michael Wiles in New York sent liquidating coffee supplier
Mercon Coffee and its would-be DIP lenders “
back to the drawing board” on what he called an “extraordinarily” high-priced $40 million bankruptcy loan. The DIP from prepetition secured lenders featured a $20 million 1:1 rollup, a 9% interest rate, a 3% upfront fee, a 1% arrangement fee on $20 million in new money and a 0.5% unused commitment fee on the new money.
Adequate protection included typical stuff: liens on avoidance actions on final approval, payment of fees and expenses, paydown of principal from liquidation proceeds, and cash or PIK interest at the debtors’ discretion.
Standard stuff, so far. The proposed DIP, however, also included a unique feature: $7.5 million of the $10 million interim availability and another $5 million of the total $20 million in new money would be earmarked for swingline loans to fund payment of nonordinary course margin calls by “Hedging Counterparties” on commodity futures trades, and funding of the swingline loans was not in the budget but subject to “the DIP Agent’s discretion.”
The debtors’ first day
motion to continue hedging practices does not specifically identify the “Hedging Counterparties” to whom those margin calls would be paid, but we would bet dollars to doughnuts they include the prepetition secured lenders - aka the DIP lenders. So in addition to a $20 million rollup, the DIP provided that the debtors could ask the DIP lenders to
pretty please loan them money to pay
the DIP lenders for swings in coffee prices.
Even better for the lenders, the DIP credit agreement included as an event of default the debtors’ failure to pay principal or interest on any postpetition “Debt” exceeding $50,000. “Debt” is defined to include obligations “under any Hedging Arrangement” - say, a commodity futures contract? Per the
first day declaration: “I have been advised that continuing the Prepetition Hedging Practices and honoring Hedging Obligations,
including posting margin calls, as necessary, is within the ordinary course of business and consistent with standard industry practice” (emphasis added).
So if the DIP lenders wanted to declare an event of default and terminate, all they would have to do is refuse to fund a swingline loan to pay a margin call on a commodities contract, and - boom - there goes the bankruptcy, whenever they like.
The debtors provided the usual
sturm und drang about their need for immediate liquidity and the dire consequences of DIP rejection, but Judge Wiles wasn’t buying. The judge said that he “cannot escape the feeling” that the DIP contemplated total lender control over an “arranged liquidation” for the benefit of the lenders under the “guise” of a DIP facility that would result in the lenders being repaid “handsomely.”
In other words, the margin call stuff, though not all
that novel, gave off some real “this is the lenders’ case”
vibes. According to the judge, the real purpose of the DIP was to
protect the lenders from coffee price fluctuations. The judge also dared to question the debtors’ hallowed business judgment on the necessity of DIP funding.
Although the use of cash collateral without access to the DIP facility may not cover margin calls over the “short term,” Judge Wiles suggested, when disregarding “excessive” adequate protection payments, that it was “quite clear” that enough cash would accumulate to eventually make margin calls.
Sure, we encourage judges to question debtors’ business judgment all the time, but this is pretty fuzzy stuff. Perhaps hoping that the judge just needed a strong cup of Joe and a think, the debtors came back
on Dec. 8 and reiterated their plea for DIP approval. Counsel for the debtors conceded that the DIP was “very rich” but reiterated that unexpected margin calls could leave the debtors unable to pay operating expenses, sending the case into “free fall” and “chaos.”
Unfortunately for the debtors, this argument missed the point Judge Wiles was making the first time: If the debtors intend to liquidate their assets for the benefit of prepetition lenders, then the possibility the liquidation could go sideways because of unexpected margin calls and swings in coffee prices is
the prepetition lenders’ problem.
Judge Wiles responded that there was “not a ghost of a chance” he would approve the DIP as presented. After conferring with the debtors, the DIP agent agreed to lower the interest rate to base plus 7% and forgo payment of interest but not professional fees and expenses as adequate protection. But by this point, Judge Wiles was dead set on rejecting the deal. The judge said that it was “not clear” the undersecured lenders were entitled to
anything other than replacement liens as adequate protection.
The judge even questioned the need for the DIP’s “overly aggressive” milestones, accelerated automatic stay relief, broad events of default, challenge period limits and waivers of the estates’ right to seek to surcharge its collateral pursuant to Bankruptcy Code section 506(c) and the “equities of the case” exception under section 552(b) - protections included in literally every complex chapter 11 DIP order. At this point, partners at other debtors’ firms were probably instructing junior associates to get to Bowling Green and pull the fire alarm.
The debtors and DIP lenders finally took the hint before Judge Wiles started criticizing the typeface used in their pleadings and the
quality of their made-to-measure suits. On the next Monday, Dec. 11, the debtors
returned to court with a cash collateral arrangement and told Judge Wiles that the whole margin call kerfuffle had blown over when the debtors’ commodities broker liquidated their positions and closed their accounts. A Christmas miracle?
The debtors
indicated on Dec. 19 that they were conducting a “feverish” search for DIP lenders and asset purchasers but on Dec. 22
noted that the Nicaraguan government is making their life difficult. Judge Wiles suggested that maybe the debtors could ask him to do something about that if they wanted to reorganize as a going concern but that in a liquidation for lenders that is
not his problem.
What strikes us most about Judge Wiles’ treatment of the Mercon Coffee DIP is not so much his rejection of standard DIP tropes but the underlying rationale: If prepetition secured lenders want the benefits of a chapter 11 proceeding, they have to bear some of the risks.
Radical, we know, but rarely recognized in this age of heads-the-lender-wins, tails-everyone-else-loses bankruptcy proceedings.
DSG / Sinclair Decision
In October we
suggested that Judge Christopher Lopez’s extension of exclusivity in the Diamond Sports Group case illustrated the
tendency of those calling balls and strikes to avoid making what they see as outcome-determinative decisions. We hinted that judges, like umpires, tend to avoid making pivotal decisions unless the correct call is truly obvious.
On Dec. 15, Judge Lopez provided further evidence for this hypothesis when he
denied Sinclair Broadcast Group’s potentially dispositive
motion to compel the debtors to assume or reject a management services agreement, or MSA, with the debtors’
owner/former milkmaid without addressing the real issue at hand: how much Sinclair is owed for ongoing postpetition services that qualify as administrative expenses.
If this sounds to you like a replay of the MLB postpetition payment fight, we don’t blame you. Recall that, back in June, Judge Lopez
ordered the debtors to pay MLB clubs the full contractual rights fees due under their agreements with the debtors’ regional sports networks on a current basis, finding that the debtors failed to prove that the clubs should be paid less than full value on their administrative claims during the case.
We suggested that this ruling kneecapped the debtors’ likely chapter 11 strategy: stiff the MLB postpetition while continuing to use their property (as is typically done with landlords in retail cases) and use bankruptcy leverage to negotiate new rights agreements that include valuable direct-to-consumer streaming rights. On Nov. 6, the debtors, their lenders and the official committee of unsecured creditors essentially confirmed our view by filing a “
cooperation agreement” that provides for the debtors to liquidate after the 2024 MLB season unless Shohei Ohtani steps in as a white knight with a $700 million (
very deferred) equity contribution.
Since the cooperation agreement was filed, the debtors have reached deals with the
NBA and
NHL to broadcast games through the end of their current seasons and then walk away, with a
similar MLB deal in the works. Meanwhile, the YES Network and MSG Networks have created a seriously unlikely joint venture to help MLB teams set up their own DTC streaming apps. The writing is on the wall.
So the MLB decision
contradicts our theory that bankruptcy judges shy away from making dispositive decisions, right? Judge Lopez took away the debtors’ leverage to negotiate DTC rights with MLB, and the case faltered. Except the debtors did not
tell the judge that a ruling in favor of MLB on the postpetition payment issue would result in liquidation, perhaps because that would essentially confirm
testimony from MLB Commissioner Rob Manfred that Sinclair intended to stiff the clubs in bankruptcy to generate leverage. Whatever motivated the strategy, the debtors declined to run out the parade of horribles at that stage.
The debtors did not make the same mistake in the dispute over postpetition payments to Sinclair. To set up the parade of horribles, the cash collateral budget in the cooperation agreement - which the debtors consider the most sacred American legal document this side of the Constitution - assumes the debtors would continue paying Sinclair about $4.5 million per month for essential services through the end of the 2024 MLB season rather than the full $11.5 million due under the MSA. The agreement is also specifically contingent on Judge Lopez denying Sinclair’s motion to compel assumption or rejection of the MSA.
Sinclair saw this pitch coming without any assistance from the Astros’ dugout. On Nov. 15, Sinclair filed a
limited objection to the cooperation agreement asking Judge Lopez to prohibit the debtors from arguing “that the MSA Motion must be denied because otherwise their Cooperation Agreement will fall apart.” “The Debtors cannot create an artificial condition to effectiveness under the Cooperation Agreement with third parties and then bootstrap that into a ‘defense’” to the rejection motion, according to Sinclair.
Judge Lopez
declined to bar the debtors from pulling on the cooperation agreement bootstrap, and the debtors duly obliged. At the Dec. 15 hearing, the debtors’ investment banker testified that if the judge directed the debtors to either reject the MSA or assume, pay arrears and pay full freight going forward, the debtors would be forced to reject because their lenders have not agreed to payment of arrears or full contractual fees to Sinclair. Without the MSA services, the CFO testified, the debtors would be forced to liquidate immediately -
bye-bye, cooperation agreement.
Counsel for Sinclair responded that the cooperation agreement is nothing more than a one-year delay of an inevitable liquidation, and anyway Sinclair is entitled to the same treatment as fellow postpetition value-provider MLB, whatever the implications for the debtors’ deal with lenders and the UCC.
As debtors’ counsel pointed out, however, there is
one crucial difference between the MLB postpetition payment decision and the Sinclair motion: There was no dispute regarding the amount of the full contractual payments due the MLB clubs, but there is a disagreement over the amount due Sinclair, thanks to a March 2022 deferral letter between the debtors and Sinclair (really, Sinclair and Sinclair because at that point the debtors’ management was not split off from Sinclair).
By the deferral letter, Sinclair agreed to accept the $4.5-million-per-month reduced MSA fees and defer past due amounts, an accommodation demanded by the first lien lenders as a condition for their $635 million loan. Sinclair pointed out that the deferral letter includes a provision restoring the $11.5 million monthly fees upon the debtors filing bankruptcy, and the debtors answered that this provision is an unenforceable
ipso facto executory contract term under section 365(e)(1) of the Bankruptcy Code.
Sinclair counsel responded that the ban on enforcing contract provisions triggered by a bankruptcy filing applies only to executory contracts and argued that the deferral letter is not an executory contract because the debtors’ only remaining obligation is payment of the fees - generally not an executory obligation under section 365.
Au contraire, the debtors replied - the deferral letter is an amendment to the MSA, which is unquestionably executory.
Sinclair counsel disagreed, arguing that although the deferral letter modified the fees due under the MSA, it did not “amend” the MSA - it was, in fact,
part of the March 2022 credit agreements with the first lien lenders. Sinclair CEO Christopher Ripley testified that the Sinclair MSA deferral was originally included in the credit agreements themselves but was excised into a side letter to keep the terms confidential when the credit agreement was disclosed in a Securities and Exchange Commission filing.
Whoa. Some seriously interesting issues here! We were eager to hear how Judge Lopez came out on this dispute, because a ruling for Sinclair could blow up the orderly wind-down contemplated by the cooperation agreement, provide precedent for treatment of similar side letters in future cases and make it impossible for us to watch that night’s
crucial Rockets-Grizzlies game.
Alas, rather than resolving the crucial dispute that the parties fully and unconditionally submitted to him, the judge completely punted on the issue by deciding that although the parties presented all of this to him in the context of a motion to compel assumption or rejection of the MSA, Sinclair should have filed a motion for payment of administrative expenses
à la MLB and he needed more evidence and argument to decide that
purely hypothetical motion that only exists in his head.
“I understand Sinclair’s frustration with not being paid the amount they believe that they’re owed,” the judge remarked, but “I don’t think this is the vehicle for that fight.”
Sinclair and the debtors seemed to think it was the vehicle for that fight, but apparently the Houston panel’s deference to agreements between the parties only goes
so far.
Judge Lopez also hinted that his decision on this motion - or that hypothetical one (we can’t tell, honestly) - might have been different if Sinclair were not getting paid anything, as opposed to receiving a discounted rate. Here’s your reminder that the MLB clubs were
also receiving discounted rights fees before Judge Lopez granted their request for full contractual payments.
Sigh.