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 Purdue’s U.S. Trustee standing arguments, a rare sub rosa
plan ruling in Rockport and Sorrento getting dragged into the Jones/Freeman mess.
Mea Culpa?
Here we were, yammering on and on month after month about bankruptcy judges putting their necks on the block while the Fed. Soc. types are swinging the Administrative State Axe, while the
real unelected bureaucracy threatening the legitimacy of our bankruptcy system was
right there, perniciously hijacking chapter 11 cases and scheming to steal billions from tort claimants right under our noses. We feel so foolish, but fortunately the
answering briefs in the
Purdue plan Supreme Court appeal have removed the scales from our eyes. That’s right - according to Purdue, the faceless stormtroopers of administrative overreach at the Office of the U.S. Trustee are
actually the baddies.
For those of you still unaware of the extent of the conspiracy, here’s a refresher. In our naiveté, we
thought the issue in the Purdue case was
judicial overreach: non-Article III bankruptcy judges imposing releases of state-law claims against nondebtors such as the Sacklers on creditors without their consent. We suggested, in our childlike ignorance, that perhaps bankruptcy judges should not take it upon themselves to quash claims that they could not themselves adjudicate, lest the Article III courts dramatically trim their sails.
The Purdue debtors and their allies have another take - the Purdue appeal is actually about overreach
by the UST. Purdue admits the Bankruptcy Code and title 28 allow the UST to act as a “watchdog” over the bankruptcy process, and the UST has done so largely without objection or even comment for decades. But
why? The democratically elected president does not appoint the UST, the Purdue plan proponents note, and the democratically elected Senate does not confirm the appointment. Who is this shadowy government agency to step in and “commandeer” the Sacklers’ efforts to generously compensate their alleged victims?
(We’ve been running this column for years and have assiduously avoided calling the UST a “watchdog” all this time, but as a great man once said,
all things must pass.)
The UST, of course, points out in its briefs that the plan proponents did not challenge its standing to object to the releases in the lower courts (in this or many other cases), to which the proponents respond that the UST was not the only party at that time and anyway that free citizens with concrete interests in a dispute are free to resist the totalitarian tendencies of disinterested bureaucrats anew at every level, without waiving or wavering.
Why, indeed, have
we allowed the UST to step into bankruptcy cases and threaten creditor democracy - that
hallowed institution - with release objections and petty quarrels about opt-outs and opt-ins? Who gave these bureaucrats the power to overrule the fiduciary judgment of debtors, official committees and independent directors, those honest fiduciaries with the real skin in the game?
Even more galling, according to a group of individual opioid claimants in their answering brief, is the motivation behind the UST efforts in the case: to steal $2 billion from opioid victims and hand it over to the federal Treasury. As the group points out, if the Supreme Court scotches the plan and the debtors liquidate (not a foregone conclusion,
if we remember correctly), the U.S. Department of Justice - the overseers of the UST program - would hold a $2 billion priority forfeiture claim,
ahead of individual opioid victims, who would likely recover nothing.
Look, our reaction to the UST’s boilerplate policy objections and hoary invocations of
due process is often the same as yours: bemused indifference at best, annoyance and irritation at worst. When the objections to a consensual plan start to roll in at the deadline, the UST’s filing generally does not compel us to immediately start writing. When the UST steps up at the confirmation hearing to deliver the same futile argument for the 50th time to a polite but unconcerned judge, our eyes roll just as hard as yours.
But: Purdue is no
ordinary “consensual” plan, with the UCC cutting a deal for trade creditors and disadvantaged lenders or noteholders reluctantly accepting their medicine. The Purdue case, and the allegations against the Sacklers, have important implications for a substantial chunk of the U.S. population. Tens of millions of citizens live in the smoldering wreckage left behind by the opioid crisis and have no effective voice in the bankruptcy case, other than perhaps state or local politicians operating with less-effective democratic oversight than the UST.
This is, of course, a good reason
not to open the floodgates for bankruptcy courts to handle mass tort cases requiring a careful balancing of policy interests affecting massive portions of the population. We have long maintained that bankruptcy courts should practice their own “Major Questions” doctrine to protect their core mission. Whether you agree with that or not, we’d humbly submit that, at the very least, we should not resist the active participation of the UST and the federal government in cases like this, just because the UST lacks a dollars-and-cents interest. Cases like Purdue are about a whole lot more than dollars and cents, and pretending otherwise costs us all credibility.
Rockport Rejected
Back in September 2022, we
discussed the Carestream and Lumileds prepacks, which each featured requests for final first-day relief better suited for confirmation.
In Carestream, the debtors asked Judge J. Kate Stickles to approve exit financing commitment fees at the first day hearing, and the Lumileds debtors asked Judge Lisa Beckerman to approve DIP fees that would give lenders control of reorganized equity before other creditors, or the scheming UST, could get their boots on. We quipped that if the Lumileds DIP arrangement was not a
sub rosa plan, then “brother, there’s no such thing.”
Honestly, we said that we thought there was no such thing as a
sub rosa plan anymore, notwithstanding Judge James Garrity Jr.’s
rejection of a LATAM Airlines subscription agreement as a
sub rosa plan in September 2020. Back then we quipped that “the
sub rosa plan argument is back in play,” but the
resurgence of the argument didn’t lead to a resurgence in rulings.
Until Oct. 31, that is. On All Hallows’ Eve, Judge Brendan Shannon
tolchocked The Rockport Co.’s proposed global settlement with the UCC, subordinated lenders and affiliate Reef
right on the Gulliver on
sub rosa grounds, remarking that if the settlement was not a
sub rosa plan, “I don’t know what is.”
The shoe company sold all of its assets in August, cashing out senior lenders and leaving the remaining parties to work out how much the subordinated lenders would take home from the proceeds. The UCC asserted that the usual secured creditor lien challenges and potential claims against Reef under shared services agreements (
a la Diamond Sports Group v. Sinclair Broadcast). Under the
proposed settlement, Reef and the lenders agreed to creation of a settlement fund for unsecured creditors in exchange for releases.
That sounds like every UCC settlement in every chapter 11 case ever. Sure, those settlements are often baked into a chapter 11 plan, but still -
every Rule 9019 bankruptcy settlement includes releases of estate claims. That’s
just how settlements work - one party agrees to give something of value, and the other agrees not to litigate.
So why was the Rockport settlement out of bounds? Because it provided for releases of nondebtors by creditors - albeit
arguably consensual nondebtor releases. Under the deal, general unsecured creditors would only get a share of the $500,000 if they executed a release in favor of the subordinated lenders and Reef.
That should set your alarm bells ringing. Remember our
discussion on the sketchy cash-for-releases plan
brokered by former judge David R. Jones in Tehum Care? The deal cut by the UCC in that case provides that if tort claimants opt out of the plan releases, they would not only waive any right to recover from the settlement proceeds but also have to go through the bankruptcy court as gatekeeper before bringing unreleased claims against nondebtors. The plan also provides for a $5,000 no-questions-asked payment to any claimant who opts in.
Notwithstanding the agreement of the parties with a real
pecuniary interest in the case, the faceless Deep State foot soldiers at the UST objected to the Tehum Care settlement as coercive. The settlement parties
initially stuck to their guns but then
agreed to re-mediate with former judge Christopher Sontchi under the watchful eye of the UST. Our prediction: the $5,000 instant payoff and gatekeeping provisions go out the window, but the “opt in or no distribution” concept sticks.
Anyway, if you
maybe can’t do that in a plan, you
definitely can’t do that via Rule 9019, at least in Judge Shannon’s court.
Sirens of Sorrento
Which brings us back to what you could get away with in former judge Jones’ court. Remember our favorite case, Sorrento Therapeutics? That’s the one where the debtors manufactured venue in Houston by saying their principal place of business was a
post office box. Still doesn’t ring a bell? Maybe you recall that probably-unnecessary DIP loan approved by former judge Jones despite a
34% effective interest rate, or former judge Jones kicking the tort claimant who objected to the DIP off the UCC even though it holds the largest unsecured claim? Not only has this case continued to entertain, but the equity committee has suggested a reason why: you guessed it,
love.
Sorrento
filed in Houston in February with an alleged $850 million in unencumbered assets, zero funded debt and an adverse arbitration award in favor of NantCell, that ornery tort claimant that was kicked off the UCC. In his typical breezy fashion, Judge Jones approved the encumbrance of a big part of those unencumbered assets - the 52% of the publicly traded stock of Scilex Holdings - with
$75 million in DIP debt at a Discover Card-level interest rate. On the petition date,
Scilex stock was trading at more than $7 per share.
On May 11, when the debtors’ lockup expired and they could freely sell their Scilex common shares, the stock was trading at $5.34. According to the first day declaration, the debtors held 59 million shares of Scilex common stock, so as of May 11, when the debtors could start selling, the shares were nominally worth about $315 million.
On June 29 - well over a month after the lockup terminated - the debtors announced a
replacement DIP to provide more liquidity when funds ran out. Guess they could just sell some of that Scilex common stock - now valued at $5.58 per share - but
whatevs, Judge Jones approved another $20 million in secured debt.
On July 24, the debtors filed a
motion to sell the Scilex common stock to a third party for $200 million.
There we go! Stock price: $5.63 per share, putting the market value of the debtors’ holdings at about $332 million. Quite a discount considering the control premium, but enough to pay off the DIP loans, cash out NantCell and get some recovery for equity from the remainder and other assets.
That sale fell through for unknown reasons, and on Aug. 7 the debtors
pivoted to another offer, from Oramed: $100 million for the Scilex stock sale plus
another $100 million in DIP financing and $115 million in
exit financing. Scilex stock price on Aug. 7: $4.49. Needless to say, Judge Jones
approved the Oramed stalking horse bid on Aug. 7. On Aug. 24, Scilex stepped in with a
$138 million bid. Naturally, Judge Jones postponed the Oramed sale hearing to allow Scilex’s potentially super offer to coalesce.
Just kidding! Judge Jones
approved the Oramed bid on Aug. 25 over the objections of the UCC, the equity committee and Scilex.
Judge Jones credited the testimony of the debtors’ CRO that he had “deep concerns about the Scilex bid and their ability to close.” Judge Jones also cited the “sanctity” of the bankruptcy auction process.
A real stickler for the sanctity of process, that Judge Jones. Scilex stock price on Aug. 25: $3.29 per share. But the debtors
pivoted again to a sale of Scilex stock to Scilex on Sept. 11. The next day Judge Jones duly
approved the new deal, which
closed Sept. 21. Scilex stock price on Sept. 21: $1.75 per share. During the bankruptcy, the market value of the debtors’ common stock in Scilex fell from about $413 million to about $103 million.
The debtors filed a
liquidating plan on Oct. 11 which the equity committee duly savaged in an
objection on Nov. 13. According to the equity committee, the debtors entered chapter 11 “unquestionably solvent” with the potential to exit as a “healthier and more profitable” business, but “gross mismanagement” led to a botched sale process and “burdensome” and “expensive” DIP financing.
So, that’s a comprehensive rundown of this flaming dumpster fire, right? Well, not exactly! As you
may have heard, on Oct. 16 Judge Jones announced he was resigning after the Fifth Circuit accused him of failing to disclose an intimate relationship with former Jackson Walker partner Elizabeth Freeman, leaving the case in the hands of Judge Christopher Lopez.
Jackson Walker serves as
bankruptcy co-counsel for the debtors, along with Latham & Watkins. Of course, Freeman
left Jackson Walker long before Sorrento filed, after she told the firm about her relationship with Jones in 2022. Well: In Jackson Walker’s Feb. 12, 2023,
engagement letter, the firm strongly recommended “the engagement of the Law Office of Liz Freeman as Conflicts Counsel” at $750/hour. Keep in mind, by its own admission the firm was well aware of Freeman’s relationship with Jones by this time.
At the
first day hearing, counsel for Bank of America mentioned he had “engaged in some conversation with Ms. Freeman, who is working with the Debtor” on the cash management order - presumably because Jackson Walker used her as conflicts counsel on Bank of America matters. A June 13
fee statement filed by CRO provider M3 Advisory Partners mentions several discussions between M3 and Freeman regarding Bank of America and other unspecified issues. Jackson Walker’s June 22
fee statement mentions Freeman six times, including discussions related to “retention” issues and “mediation.”
So it appears Freeman’s involvement as “conflicts counsel” was fairly minimal, on the basis of the record. Nothing to see here, right? Well, the equity committee is certainly not satisfied: On Nov. 10, committee counsel served a
discovery request on the debtors seeking all communications with Elizabeth Freeman, all documents “relating to Elizabeth Freeman’s role in the Chapter 11 Cases” and all documents “concerning any personal relationships” between the advisors (read: Jackson Walker) and Freeman.
The committee also served a
subpoena on Freeman on Nov. 11 seeking “[a]ll Communications between You and Judge David R. Jones concerning the Debtors or the Chapter 11 Cases.”
On Nov. 13, the debtors filed a
motion for protective order to quash the equity committee’s requests. According to the debtors, the requests “are in no way connected to the specific issues raised by the OEC in its Plan Objection” and “bear no relevance to the issues before the Court in connection with its consideration of confirmation of the Plan.”
An
email attached to the debtors’ motion indicates that equity committee counsel first reached out to debtors’ co-counsel Latham & Watkins about Freeman’s role on Nov. 2, asking Latham to
please say it ain’t so. Latham directed committee counsel to Jackson Walker. On Nov. 7, equity committee counsel sent a
letter to Latham suggesting that “Latham & Watkins and Jackson Walker were in contact with Ms. Freeman during the pendency of the Chapter 11 cases concerning numerous issues, including litigation strategy, the sale process, and the mediation.”
Further, the committee says, Latham “specifically ensured that Ms. Freeman was copied on certain communications between the Debtors and the Nant parties
notwithstanding the fact that Jackson Walker did not have any conflicts with them (as reflected in Jackson Walker’s retention application).” “The Equity Committee is deeply concerned that Latham & Watkins sought Ms. Freeman’s involvement in the mediation for improper purposes, including seeking to communicate and influence Judge Jones
ex parte to exploit her relationship with Judge Jones, the disclosure of confidential mediation information to Judge Jones, and influencing the outcome of the mediation as well as the administration of the Chapter 11 cases in general.”
The same day as the committee letter, Jackson Walker sent an
email to committee counsel indicating that Freeman “was asked questions about local practice and procedure a few times, but she was not retained and has not billed or received any payments in this case.” On Nov. 9, Latham sent committee counsel a letter suggesting Freeman “was widely known as a leading expert in the relevant legal issues and procedures at hand” and denying that Latham knew anything about her relationship with Jones.
According to the debtors’ motion, that is all the information the equity committee is entitled to discover. Freeman was a local rules guru, and that is that. On Nov. 16, Freeman filed a
motion to quash the committee’s subpoena. According to Freeman, “[t]here are no such communications” between herself and Jones regarding the Sorrento case. Freeman adds that she was not employed by the debtors and was paid $3,750 for prepetition work.
We assumed until this whole kerfuffle over who lives with who that Jones’ incredibly debtor-friendly decisions throughout the case had more to do with the Houston panel being “customer friendly” than romance, but then again this case has been anything but smooth sailing.
We
cannot wait to see the equity committee’s responses, and the debtors’ responses, should they be compelled to say more. Not to mention the confirmation hearing, currently
set for Nov. 30. Good luck, Judge Lopez.