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 McKinsey’s effort to use state settlements to eradicate municipal opioid claims, Mallinckrodt’s abandonment of its efforts to protect CuraScript from post-emergence Acthar claims and denial of NorthEast Gas Generation’s unique motion to reopen its case to give its biggest shareholder more secured debt.
McKinsey Pits States Against Cities
The outcome of a fascinating dispute in the San Francisco opioid bellwether case against McKinsey Consulting could have broad implications for U.S. mass tort litigation and the
expected tide of “Texas two-step” chapter 11 cases in the wake of the LTL Management/Johnson & Johnson talc filing (not to mention the political and legal autonomy of U.S. local governments). The McKinsey fight requires a district court to consider just what claims cities, counties and municipalities can bring independent of the government of the state in which they are located.
Let’s start with the basics, assuming you, like us, have all forgotten what you learned in eighth grade civics. There are essentially three layers of elected government in the United States: the federal government, state and territorial governments, and municipal governments (including counties and incorporated cities). Each of these levels of government has overlapping areas of authority and limitations, but the key thing to remember is that the federal constitution says nothing about municipal governments specifically. The constitutional principle of “federalism” is defined as a relationship between the federal government and the states, not municipal governments.
There is nothing in the federal constitution that requires states to even allow municipal self-government; theoretically, each state could have one central government, and there would be no county or city councils or mayors (a boon to Brooklyn vegans tired of
worrying about what kind of fish Eric Adams is eating). Thus, each state sets its own rules regarding what local governments can and cannot do as legal entities - specifically, whether they have the right to sue for damages.
In the opioid litigation and, increasingly, other mass tort cases, thousands of municipalities have brought claims against opioid manufacturers, distributors and pharmacists under the doctrine of “public nuisance,” alleging that by flooding their jurisdiction with opioids, these defendants have created an interference not only with individual rights but also the health and well-being of all citizens. In fact, the vast majority of suits coordinated in the opioid MDL in Cleveland were brought by municipalities.
Part of the difficulty in resolving the nationwide opioid litigation has been this multiplicity of claimants, each controlled by an independently elected government with its own agenda (though many of them have retained the same counsel). Getting 50 states to agree to a global settlement of public nuisance claims is much easier than corralling 50 states plus thousands of counties and cities. Even within states, views on the proper resolution of the opioid crisis can differ dramatically since the politics of the state may not reflect local politics; as we know, the views of voters (and thus elected officials) in urban areas may diverge dramatically from the views of voters in the state as a whole.
Thus far, opioid defendants have at least tried to corral the states and the municipalities into common settlements. Take, for example, the Mallinckrodt and Purdue deals, which were supported by virtually all of the states and a substantial chunk of municipalities and included procedures for allocating recoveries among the governmental claimants. As Judge Michael Kaplan
found in the LTL case, chapter 11 makes this all a bit easier by coalescing municipal plaintiffs’ counsel into official tort committees with fiduciary duties that can ostensibly speak for the thousands of municipalities and by allowing cramdown of dissenters, among other things.
But what if this weren’t even necessary? What if a defendant could, by settling with a state, automatically preclude any individual actions brought by its municipalities? That is the approach being pushed by McKinsey in the San Francisco case. The consultancy is arguing in the San Francisco case that its settlement with the states automatically binds all of their constituent municipalities
as a matter of law, even though the settlements do not specifically provide for such preclusion or take into account individual states’ laws on when municipalities can sue.
In December 2021, McKinsey filed a
motion to dismiss all of the municipal opioid claims against it in the San Francisco case, citing its February 2021 $642 million global settlement with the states. According to McKinsey, after it entered into the settlement, “political subdivisions - cities, towns, counties and school districts from the settling States represented by private counsel retained by local governments and prosecutor offices - began filing lawsuits that replicated (sometimes to the word) the allegations in the complaints filed by the States.”
McKinsey argues that “[a]s a matter of law, sound public policy and efficient judicial administration,” these municipal claims “as well as any future claim by any political subdivision, school district or municipal body of any kind” “should be dismissed in their entirety because they have already been resolved” by the settlement.
In support of this argument, McKinsey principally relies on what we discussed up top: the idea that municipal governments exist solely for the convenience of the states and that municipalities’ powers can therefore be overridden by the state government through a tort settlement, even without specifically abrogating those powers in the settlement (or related legislation). “Our system of federalism is comprised of two sovereign bodies of government - federal and state,” whereas “[p]olitical subdivisions … are subordinate, administrative arms of the State created as a matter of convenience to carry out state functions at the local level,” McKinsey says.
McKinsey contends that municipalities, as mere “subordinate” and “administrative” bodies, cannot bring claims that the state government has released. McKinsey also makes a stirring defense of the powers of those state attorneys general that sued it for damages. “The attorney general is the chief law enforcement officer of each state with the authority to control litigation raising statewide issues, including the power to release overlapping claims brought by political subdivisions,” McKinsey proclaims. McKinsey suggests that municipalities’ continued pursuit of their own lawsuits “threaten[s] to undermine the statutory and constitutional allocation of state power as well as the authority of state attorneys general.”
“As a result,” McKinsey concludes, “courts have repeatedly held in numerous contexts that the State is the proper party to represent the public interest in matters affecting residents statewide and that, when the State does so, duplicative lawsuits filed by political subdivisions are barred.”
According to McKinsey, its settlement with the states already gave the municipalities what they were after anyway. “For the benefit of all their residents,” McKinsey explains, “each of the States already sought and obtained, on a statewide basis, financial relief to remediate the opioid epidemic, including relief for health care, addiction treatment, law enforcement, criminal justice and child welfare.” Despite this, McKinsey laments, these greedy municipalities “now attempt to obtain from McKinsey the same relief secured by the States.” According to McKinsey, the doctrine of
res judicata “bars such duplicative litigation.”
Finally, McKinsey notes that the multiplicity of municipal claims discourages settlement - a definite no-no in our modern jurisprudential setup, where
encouraging settlement is apparently the primary goal of not just bankruptcy courts but the entire U.S. judiciary. McKinsey says that absent assurance states can settle municipal claims, “defendants will be less likely to settle with the State, driving up costs for all parties, hindering judicial efficiency and frustrating both the State’s ability to resolve lawsuits of statewide interest and its responsibility to allocate funds in a fair and efficient manner based upon the needs of all state residents.”
On Feb. 14, the municipal plaintiffs
responded to McKinsey’s motion. The municipalities point out that the states didn’t actually sue McKinsey prior to settling; instead, after agreeing to the deal, they filed “cookie-cutter complaints and near-uniform consent judgments” releasing McKinsey. The municipalities note that these complaints and consent judgments were “silent as to a great universe of claims that the settling parties were aware could, and likely would, be asserted by local governments for their own injuries.”
The municipalities then call McKinsey’s arguments “fiction piled on fiction.” “It would be convenient for McKinsey if the subdivisions had no identity, function, or role to perform or protect,” the municipalities say, “but it isn’t true.” “As the Chamber of Commerce’s amicus brief illustrates,” the municipalities continue, “it is commonplace for subdivisions to litigate their own interests and harms distinct from those of their states or their residents, and they have long done so.”
Municipalities “have their own role in responding to the epidemic, providing services that the state does not: e.g., police, emergency response, and rescuing local residents in acute distress,” the response adds.
The municipalities also note that other defendants have been polite enough not to accuse them of irrelevance. “National settlements with three major distributors and Johnson & Johnson provide for resolution and payment of both state and subdivision claims, including a process for them to agree on allocations that ensure the $26 billion is shared between states and subdivisions, and is directed to opioid abatement,” the municipalities note. Nor have courts previously dismissed municipal claims, the plaintiffs add, citing jury verdicts in favor of individual municipalities in
Ohio and
New York.
“If McKinsey is right and subdivisions’ interests are entirely redundant of the States’, then what has everyone been doing all this time?” the municipalities wonder. “If an AG settlement could easily extinguish subdivision claims, then why did the distributors and J&J instead enter into settlements that require separate releases from subdivisions (or statutory bars accomplishing the same result)?”
According to the municipalities, their authority to continue suing McKinsey depends not on “whether a state has the foundational power to create subdivisions,” but on “how the different states established their subdivisions, what rights and liabilities these subdivisions were assigned, and how other sub-state actors may represent (or not) those rights, questions on which the motion, its appendices, and its supporting amici are conspicuously silent.”
“Essentially, McKinsey asks the Court to step into the shoes of the state legislatures and bar claims of subdivisions using the fullest legislative power of the state, when the legislatures themselves have not done that,” the municipalities conclude.
On March 31, U.S. District Judge Charles Breyer held oral argument on McKinsey’s motion, and on April 1 the court issued an
order directing McKinsey to provide supplemental briefing regarding “how the different states established their subdivisions” and “what rights and liabilities these subdivisions were assigned” - the dispositive question as framed by the municipalities. The judge also orders McKinsey to respond to the municipalities’ contention “that the attorneys general did not have authority to bring political subdivision claims (or that, at best, it is unclear whether the attorney general had the authority to assert subdivision claims).”
Unlike the broad federalism interests underlying McKinsey’s blanket request for dismissal of all municipal claims against it, these issues are
not novel or groundbreaking. Defendants commonly assert that municipalities lack standing to sue under relevant state statutes, and municipalities regularly respond to such arguments. As the municipalities point out, these arguments have not been hotly contested in the opioid litigation. We will see if the judge’s order foreshadows the failure of McKinsey’s approach or if the judge merely seeks justification for dismissal on more familiar grounds.
The Takeaway: If McKinsey prevails, at least some mass tort defendants may not have to undergo a divisional merger or file an old school chapter 11 case. Reaching a global settlement with 50 attorneys general is, as McKinsey suggested, a whole lot easier than reaching a global settlement with thousands of municipalities.
The Fine Print: This is not the first time the state/municipal divide has arisen in the opioid litigation, but it is the first time a settling defendant has raised the issue. In August 2019, Ohio Attorney General David Yost
asked the Sixth Circuit to stay an upcoming trial on municipal claims pending resolution of the states’ claims, arguing that only a state AG, as opposed to “political subdivisions,” has “
parens-patrie standing to prosecute claims vindicating generalized harm to a State’s inhabitants.” Yost even sent a
letter to a defendant threatening it with litigation should it settle with municipalities. Thirteen other states and Washington, D.C.,
joined Yost’s petition, but the Sixth Circuit found that the argument had been waived by Ohio’s failure to raise it earlier. Of course, Yost could not have raised it earlier because he had only recently been elected AG to replace newly elected Ohio Gov. Mike DeWine, who as AG had supported the municipalities’ right to sue. DeWine
openly opposed the new AG’s efforts to cut off the municipal claims. Yes, this is the world’s oldest and most successful democracy.
Mallinckrodt’s CuraScript Reversal
We have warned you all before to be skeptical when a debtor says in the heat of litigation that some apparently
tangential issue must be resolved in the debtor’s favor
immediately or the
entire case will collapse into chapter 7. Often these
threats are
intended to
convince risk-averse bankruptcy judges into
confirming a plan on a debtor’s terms without due process for third parties, with debtor and judge safe in the knowledge that thanks to the doctrine of
equitable mootness, an expeditious decision will rarely be subject to effective appellate review.
The Mallinckrodt debtors have now given us one more example of a canceled “parade of horribles” by reversing course and
seeking rejection of their distribution agreement with Express Scripts affiliate CuraScript. After spending months trying to get Judge John Dorsey to enter findings that would shield CuraScript from post-emergence antitrust claims related to the pricing of Acthar gel - findings purportedly important enough to be included as a condition precedent to the consummation of the debtors’ plan - on March 30, the debtors asked the judge to approve their rejection of the CuraScript agreement ahead of an anticipated late April emergence.
A little background: Just after the debtors’
chapter 11 filing in October 2020, CuraScript
demanded that the debtors indemnify it under the prepetition distribution agreement for any liability as a co-defendant in the multibillion Acthar antitrust litigation. Acthar claimants
accused the debtors of convincing CuraScript to send a “phony” indemnification demand in order to bolster the debtors’ request for an injunction halting litigation against nondebtors (including CuraScript) during the chapter 11 case, pointing to evidence of a meeting of counsel for the two companies to discuss the indemnity the day before it was sent.
The debtors disputed this characterization, and nothing much came of the claimants’ allegations. But the indemnification claims apparently remained an issue for the debtors, and on Sept. 17, 2021, just weeks short of the confirmation hearing, the debtors filed a
motion asking Judge Dorsey to approve their assumption of a revised distribution agreement with CuraScript.
As objectors later pointed out, it is pretty unusual for a debtor to ask a bankruptcy court for authority to assume a
new agreement. But the revised distribution agreement was in commercial terms the same as the prepetition agreement with one key modification: CuraScript “agreed to amend the Contract to eliminate any right to indemnification for judgments or settlements for product delivered prior to the Petition Date,” according to the debtors.
Why would CuraScript agree to this? The cynic might respond that the indemnification claims really were “phony” or
time-barred, as the claimants asserted. However, according to the assumption motion, there was a quid pro quo: CuraScript wanted findings from Judge Dorsey that the agreement and
any performance thereunder - basically, all of CuraScript’s prepetition conduct - did not violate antitrust laws, kneecapping if not outright precluding any post-emergence litigation against the distributor and making the indemnification potentially unnecessary.
Of course the debtors could just reject the distribution agreement to cut off the indemnification obligations, leave CuraScript with prepetition unsecured claims and find a new distributor. But according to the motion, the debtors really, really wanted to keep CuraScript on the job. “The Debtors rely on the experience of CuraScript to distribute Acthar to a limited patient population via a complicated transportation and patient administration process,” they asserted. If a court were to conclude that CuraScript was liable for antitrust violations, “then the Debtors’ long term strategic plan may not be achievable absent material operational changes such as finding replacement distributors for CuraScript,” according to the debtors.
In other words, the debtors faced a
Kobayashi Maru scenario: They had to either secure the findings sought by CuraScript to keep their preferred distributor or lose CuraScript and undertake “material operational changes.”
Here’s a follow-up question, though: When, exactly, did the debtors realize they had to make this choice? Was it presented to them in September 2021, just before they filed the assumption motion on the eve of confirmation? Or, again thinking like a veteran bankruptcy cynic, did the debtors know much earlier and wait until just before confirmation to jam the findings through as an integral part of their chapter 11 plan and post-emergence business plan? We will probably never get an answer on that, but the debtors did, in fact, choose to try and ram the findings through prior to confirmation, without full discovery and a trial on the merits (which the Acthar claimants said would take more than six months).
(Of course the debtors did go to trial on the Acthar insurance claimants’ confirmation-critical priority claims and
prevailed, but the insurance claimants agreed to go along with an expedited procedure. Those were also claims against the debtors, not CuraScript, and therefore subject to the bankruptcy court’s core jurisdiction to conduct summary, nonjury claim adjudications. Other Acthar claimants did not press their priority claims, and these were the claimants targeted by the proposed CuraScript findings.)
By the assumption motion, the debtors asked Judge Dorsey to hold an immediate antitrust trial on claims by a nondebtor against a nondebtor in the middle of their confirmation hearing. This is a pretty heavy lift, even for a bankruptcy court eager to approve a very popular $1.6 billion opioid settlement - the cornerstone of the debtors’ plan. So the debtors had to go a bit further than just expressing a preference for CuraScript as the distributor for their most important, and most controversial, drug: They tied resolution of the findings request to confirmation. The debtors told the judge that the CuraScript antitrust findings were “confirmation critical” and made issuance of the findings a
condition precedent to the effective date of their plan.
“[T]his Court’s findings concerning the propriety of the Debtors’ assumption of the Contract (as amended) are critical to the success of the Reorganized Debtors and the fresh start they entered this bankruptcy to obtain,” the debtors maintained.
At a
hearing on Dec. 1, 2021, counsel for the debtors told Judge Dorsey that the plan support parties - not just the debtors or CuraScript - were “entitled to some clarity” that the debtors’ relationship with CuraScript does not violate antitrust law and said the dispute was a “terminal issue” for the plan. The parade of horribles had been invoked.
Unsurprisingly, the ad hoc Acthar claimant group was having none of it. The Acthar claimants depicted the motion as an attempt to litigate their claims against a nondebtor without due process in as short a period of time as possible by using the specter of plan failure as a bogeyman. In a
pleading filed on Nov. 23, the claimants suggested that CuraScript was bluffing: It is “highly unlikely” that CuraScript would “take its ball and go home” if denied the requested findings, the claimants argued. They pointed out that if CuraScript walked away, it “would lose all future revenue and remain liable for all past conduct,” making it unlikely CuraScript would bail on the debtors. They were definitely wrong about that.
At a
status conference on Oct. 8, Judge Dorsey expressed skepticism regarding his authority to enter the findings sought by the debtors through expedited motion practice. On Oct. 14, the debtors sought to shore up the judge’s authority by filing an
adversary proceeding seeking the antitrust findings, naming as defendants every Acthar claimant it could find (and some it couldn’t). Then, on Oct. 15, the debtors gave a little bit of ground on timing,
proposing that a trial on the antitrust findings be set for January 2022 - after confirmation but before the anticipated effective date.
However, Judge Dorsey declined to approve this schedule at a
hearing on Oct. 19, instead holding the findings request in abeyance pending the filing of claimants’ promised motions to dismiss the adversary. At the hearing, counsel for the debtors also trimmed back the debtors’ view on the effect of the findings, conceding that they would not address all of the claimants’ theories against CuraScripts and Express Scripts.
Considering that limitation, Judge Dorsey suggested the whole dispute might be a “giant waste of time.” Counsel for the debtors disagreed, but the sense of urgency the debtors intended to create for immediate resolution of the issue was clearly dissipating rapidly.
At a Dec. 1
hearing on the claimants’ motions to dismiss, the judge for the second time expressed his doubts about his ability to issue the findings sought by the debtors and CuraScript, despite debtors’ counsel’s insistence that assumption of the new agreement (and thus entry of the CuraScript findings on which assumption was premised) were confirmation-critical. With the confirmation hearing looming, Judge Dorsey made it pretty clear he would not jam the findings through.
Prior to a
confirmation hearing date on Dec. 17, the Acthar claimants pulled their own procedural maneuver,
moving to withdraw their claims against the debtors and abandoning their plan objections in an effort to further undermine Judge Dorsey’s jurisdiction over post-emergence claims against CuraScript. Effectively, the claimants sought to waive their claims against the debtors to prevent their claims against CuraScript from being wiped out in a quick bankruptcy trial.
The debtors accused the claimants of sandbagging them by withdrawing the claims at the eleventh hour, but Judge Dorsey pointed out that the debtors had waited until the eleventh hour to seek the CuraScript findings in the first place - effectively begging that timing question we asked above.
The judge said, “The debtors knew that the ad hoc group intended to sue the debtors as soon as they emerged months ago” but failed to file the adversary complaint until mid-October, just weeks before confirmation. “Why’d you wait until then?” the judge asked. Counsel responded that the debtors had been working to reduce and resolve the Acthar claims all throughout the process.
It is not as if the debtors couldn’t see their parade of horribles failing to go off in this case. Judge Dorsey repeatedly either delayed supposedly urgent matters or placed due process concerns over expediency in the Mallinckrodt case. Specifically, the judge
refused to approve RSA parties’ fees on the first asking despite threats it could result in the loss of the opioid settlement and
denied the debtors’ motion for summary adjudication of the Acthar insurance claimants’ priority claims despite the challenge of holding a merits trial that, if decided against the debtors, would have scuppered the plan.
With the judge clearly reluctant to grant the antitrust findings - at least on an expedited basis, before emergence in late April - the debtors and the Acthar claimants started
discussing a settlement of the CuraScript antitrust findings adversary proceeding, which resulted in a
“mistaken” settlement that was later withdrawn. The debtors also said they were working with CuraScript on an amended distribution agreement that would drop the indemnification rights while allowing the debtors to maintain the relationship with CuraScript.
Those negotiations must have come to naught, because on March 30, the debtors asked to
reject the CuraScript agreement and indicated they would be hiring FFF Enterprises as their new Acthar distributor. According to the debtors, the threat of “meritless” post-emergence antitrust litigation related to the CuraScript agreement and the specter of potential indemnification claims or unilateral termination by CuraScript should the existing agreement be assumed forced them to select a different distributor for Acthar after the effective date of their
confirmed plan.
In other words: Look what the claimants made us do! Again, Judge Dorsey might point out, those claims were well known long before the debtors sought the CuraScript findings on the eve of confirmation.
What about those prior assertions that the relationship with CuraScript was crucial to ensuring the continued supply of Acthar to patients (and the continuing flow of Acthar proceeds to the debtors) and thus important enough to rush before the effective date? After all, didn’t the debtors go to all this trouble because the relationship with CuraScript was uniquely important to their post-emergence business?
Not to worry: The debtors say FFF has agreed to provide “the same scope of services and products,” has “a proven ability to distribute pharmaceuticals like Acthar” and will “do so on terms that are at least approximately comparable economically to the CuraScript Agreement.”
The Takeaway: The Mallinckrodt debtors ended up getting almost everything they wanted out of their chapter 11 case in the end: The plan was confirmed, the opioid claims were resolved, the Acthar antitrust claims were dealt a huge blow in the insurance claimants’ adversary, and the incentive plan and nondebtor releases for management (in control of the company the entire time they incurred the opioid and Acthar liabilities) were approved. At the same time, Judge Dorsey stuck firm to due process throughout, and when he drew a legal line beyond which he would not cross, he stuck to it, notwithstanding the consequences. In the era of the Texas two-step, this feels so
old school chapter 11.
The Fine Print: Although the debtors got most of what they wanted out of the case, all the Acthar shenanigans may have delayed emergence, leaving the debtors to try and refinance their term loans in a much more difficult market. All those threats the debtors made in the past two years about needing to emerge
immediately while the market favored borrowers have now come good.
No Do-Overs
Lots of rumors are
swirling about a potential Talen Energy chapter 11, but Reorg’s legal analysts have kept a closer eye on a much more arcane, academic issue related to the long since-consummated plan of former Talen affiliate NorthEast Gas Generation. We first
discussed this one back in October 2021, but now seems the time to revisit in more detail after Judge Walrath recently entered an order denying the reorganized debtors’ curious motion to reopen their case so they could hand out more secured debt to Beal Bank.
Recall that Judge Mary Walrath
confirmed the reorganized debtors’ plan back in December 2020. Under the
plan, secured creditor Beal Bank was granted an aggregate allowed claim of $539.9 million that was
not bifurcated and allowed in secured and unsecured amounts based on the value of the collateral. Instead, the plan avoided the collateral valuation issue and provided that Beal Bank would receive 100% of reorganized equity on account of its unsecured deficiency claim, whatever that was, and reinstated first lien debt of $200 million on account of its secured claim, whatever that was. The plan went
effective on Dec. 22, 2020.
About 11 months later, on Oct. 7, 2021, the reorganized debtors filed a
motion to reopen the case. By the motion, the reorganized debtors asked Judge Walrath to reopen the bankruptcy so they could effectively issue a further $275 million in reinstated first lien debt to Beal Bank on account of its secured claim under the plan in exchange for zero new consideration. We’re sure the reorganized debtors’ agreement to this proposal has nothing to do with the fact that Beal Bank received the bulk of reorganized equity under the plan.
How did the reorganized debtors attempt to sell this somewhat odd outcome? According to the reorganized debtors, the request was driven by “a further assessment of the value” of Beal Bank’s collateral, “market conditions” and “other factors” the reorganized debtors “deem relevant,” including “the objective of maximizing recoveries.”
How the issuance of $275 million in new “reinstated” debt secured by currently unencumbered asset value would maximize recoveries for anyone but Beal Bank was not specified. Whatever contribution Beal Bank provided to maximize recoveries of general unsecured creditors under the plan had already been made, and the reorganized debtors’ new, post-bankruptcy unsecured creditors, current and future, would probably rather not see a considerable amount of unencumbered value maximize Beal Bank’s recovery from a plan that had already been consummated.
The reorganized debtors assured the court that the motion was unopposed because equityholders and the first lien secured parties consented. This amazing level of unanimity and consensus could be attributed to the fact that Beal Bank holds almost all of the reorganized equity and first lien debt through the plan, and that the company’s post-emergence unsecured creditors may not have received notice of the motion (which was served on the chapter 11 “short list”). The reorganized debtors also noted that chapter 11 general unsecured creditors had been paid in full under the plan, so, as counsel later put it, “No harm, no foul.”
As a legal basis for the motion, the reorganized debtors cited section 502(j) of the Bankruptcy Code, which allows bankruptcy courts to reconsider allowed claims even after consummation of the plan. The reorganized debtors maintained that all they were doing was asking Judge Walrath to reconsider Beal Bank’s secured claim and increase it from $200 million - again, not an allowed amount actually specified in the plan - to $475 million. That, the reorganized debtors said, would allow them to “reset” the amount of the reinstated first lien debt - for example, increase the reinstated debt to $475 million from $200 million.
If the debtors hoped to sneak this request past the censors unnoticed, they were sorely mistaken. At a
hearing on Nov. 3, Judge Walrath pointed out to the debtors that section 1127(b) of the Bankruptcy Code specifically forbids post-consummation plan modifications and suggested that what the debtors were asking for sure looked like a plan modification.
Counsel for the reorganized debtors tried to put some meat on the bones at the hearing. According to counsel, Beal Bank learned after the effective date that “a robust market” existed for its collateral, justifying the increase in Beal Bank’s secured claim. Co-counsel added that the original $200 million collateral valuation - again, the collateral was not actually valued in the plan - was “chosen” as what “felt right.” Co-counsel suggested that the reallocation of value between debt and equity was an “internal tax” and “accounting issue” for Beal Bank.
Of course, no one was really asking why Beal Bank wanted an additional $275 million in first lien debt. Generally, lenders who can get more debt in exchange for nothing will take it, whatever the tax or accounting implications. Nor did counsel explain what they meant by a reallocation of value between debt and equity. The reorganized debtors had not asked that the reorganized equity distributed to Beal Bank on account of its deficiency claim be reduced at the same time the reinstated debt issued on account of its secured claim was increased. That might make sense if the reorganized debtors were really talking about increasing the amount of Beal Bank’s secured claim, which would necessarily mean reduction of the deficiency claim.
Both the judge and the U.S. Trustee were unconvinced, purely on section 1127(b) grounds. Judge Walrath said at the hearing that she was concerned “anyone after confirmation could ask for reconsideration through this guise.” The judge also warned that allowing changes in plan treatment through reconsideration of claims without any time limit could have a “far reaching impact.” Judge Walrath finally noted that she was “not inclined” to give Beal Bank “a pass” for failing to conduct due diligence and discover a “robust market” for the collateral.
On Nov. 17, the debtors filed a
supplemental brief attempting to assuage the judge’s concerns, in which they doubled down on the well-established no harm, no foul doctrine. According to the brief, the motion sought “to correct an error in respect of the allowed secured portion of the First Lien Claims” that “conferred no benefit on any creditor or party in interest” and whose correction “will impose no burden or detriment on any creditor or party in interest.”
The issue was really a matter of adjusting the allowed secured and deficiency portions of the claims of Beal Bank under the plan, the debtors said - even though, AGAIN, the plan didn’t actually provide an allowed amount for the secured and deficiency claims, only treatment on account of whatever they were. “Even though the claims were not bifurcated as between secured and deficiency,” the reorganized debtors conceded, “the allocation of debt and equity was intended to be roughly reflective of the parties’ views regarding the value of the collateral.”
On March 18, Judge Walrath issued an
opinion denying the reorganized debtors’ motion. The judge found that the debtors were really trying to change the
treatment of Beal Bank’s secured claim rather than its amount - which, dead horse here, had never been set - and thus sought an impermissible post-consummation plan modification forbidden by section 1127(b). The no harm, no foul argument was irrelevant, Judge Walrath said, because section 1127(b) is “an absolute bar to modification after substantial consummation.”
The judge nevertheless noted that it was not clear there was neither harm nor foul. Judge Walrath remarked that the proposed post-consummation modification created the possibility “of an adverse effect on the rights of numerous parties who have dealt with NEG in the year since confirmation, in reliance on the terms of the plan,” for example, those current and future unsecured creditors who could benefit from the unencumbered asset value being given to Beal Bank as additional collateral.
Further, the judge warned, if the plan had originally provided first lien claims with $475 million in reinstated first lien debt, then it “might not have been confirmable” because Beal Bank also received equity on account of a deficiency claim that might not have actually existed. Judge Walrath also asserted that the revised plan “might not have received the requisite approval of the other impaired creditors or met feasibility requirements” for confirmation.
The judge noted that the plan parties were “sophisticated parties” who voluntarily agreed to “clear and unambiguous” treatment for the first lien claims without bifurcating and valuing the secured and deficiency portions and could not now red-pencil the plan to include a new value.
The Takeaway: Collateral valuation should be taken seriously when negotiating a chapter 11 plan, rather than just going with whatever “feels right.”
The Fine Print: Would Judge Walrath have approved the proposed modification if the plan had in fact valued Beal Bank’s collateral and set an allowed amount for the secured and deficiency portions of the secured lender’s claims? We suspect not; the judge seemed troubled by the idea that, section 1127(b) or not, a debtor could change part of its plan after substantial consummation. Nevertheless, we eagerly await the next attempt by a clever post-reorg equityholder/lender to get more collateral on account of a claim already satisfied by plan distributions.
Other Matters:
- The Designated Decider: Speaking of appellate oversight, on March 29, the U.S. Court of Appeals for the Third Circuit designated one of its own, Judge Thomas Ambro, to hold a special district court in Delaware handling all existing and future Mallinckrodt appeals and other district court matters in that case. This seems like an excellent idea for district courts in every contested case, both to make sure everything goes to the same judge and to inject some circuit court-level legitimacy into initial bankruptcy appeals. Lo and behold, on March 31 the Third Circuit designated Judge Ambro to handle district court matters in the Zohar case and the consolidated motion to dismiss district court level appeals in the PWM Property Management case, each “for such a period as is necessary for the disposition of the above-entitled matter.” Hopefully these designations are a policy choice, and not the result of Judge Ambro developing a personal, highly perverse fascination with bankruptcy disputes.
--Kevin Eckhardt