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 dismissal decision in Aearo Technologies, a venue maneuver by Sorrento Therapeutics, the Diamond Sports Group bankruptcy fight with MLB and appellate mootness denied in National CineMedia.
Aearo Tossed
Last time, we discussed the Second Circuit’s mushy opinion upholding nondebtor releases in the Purdue case. The decision is good news for mass tort debtors seeking to protect nondebtor shareholders (including corporate parents) from liability, sure - but what good does that do if a debtor actually has to be
near bankrupt to file for
bankruptcy? That’s certainly the implication of Judge Jeffrey Graham’s June 5 ruling
dismissing the mass tort case of 3M liability shield debtor Aearo Technologies.
Judge Graham’s decision does not reject the Third Circuit’s “financial distress” requirement from the first
LTL Management dismissal but places more emphasis on the
timing of a bankruptcy filing. According to the Indianapolis bankruptcy judge, the Aearo petition was “fatally premature” because Aearo “has been, and currently is, financially healthy … [and] remains a small, profitable enterprise.”
The judge specifically debunks the debtors’ insistence that the Combat Arms Earplugs multidistrict litigation compelled 3M to put the subsidiary that came up with the earplugs into bankruptcy. While Aearo is named as a defendant in the MDL, Judge Graham notes, it has not faced any collection efforts nor paid any of its own defense costs. “There is simply no compelling evidence that the Pending Actions have had or will have, at least in the near term, any substantial effect on Aearo’s operations,” the judge notes, adding that Aearo “is thriving even while living under the ‘overhang’ of the largest MDL in history.”
You can be sure that that “compelling evidence” phrase will be front and center in the appeal, as the phrase seems to assume that the burden of showing the case was filed in good faith rests on the debtor. That is, if Aearo decides not to follow LTL’s example and moot the appeal by modifying its funding agreement and filing again.
(Judge Graham notes only in passing that U.S. District Judge M. Casey Rodgers entered an
order in December 2022 specifically
barring 3M from trying to pass its CAE liability on to Aearo as a sanction for suddenly trying to do so after Aearo filed for bankruptcy - presumably because that order is on appeal to the Eleventh Circuit.)
In other words, Aearo did not
need to file when it did, and the “need” for the bankruptcy “toolbox” the debtors’ lawyers keep
going on about is a
jurisdictional issue. “In this Court’s view, allowing an otherwise financially healthy debtor with no impending solvency issues to remain in bankruptcy, much less one whose liability for most of its debts is supported by an even more financially healthy, Fortune 500 multinational conglomerate, exceeds the boundaries of the Court’s limited jurisdiction” and threatens turning bankruptcy courts into courts of “general jurisdiction.”
You hear that, Judge Michael Kaplan? The
floodgates have
teeth.
Without explicitly saying so, Judge Graham lends some credence to the somewhat novel constitutional bankruptcy jurisdiction theory laid out in post-
LTL motions to dismiss the
Bestwall and
Aldrich Pump Texas two-step cases in Charlotte, N.C. In those cases, movants have argued that the power to enact uniform bankruptcy laws delegated to Congress by the U.S. Constitution's
Bankruptcy Clause (Article I, Section 8, Clause 4) does not allow for bankruptcy laws to apply to financially healthy companies..
“Providing remedies available under the Bankruptcy Code to such entities would extend bankruptcy jurisdiction beyond the scope of the enabling powers granted to Congress by the Bankruptcy Clause of the Constitution,” the Aldrich Pump official committee of talc claimants argues. Sounds
kinda like what Judge Graham is getting at - though we would add this argument also
kinda misses the whole Article I-Article III constitutional issue
we have been
going on about.
Still, we cannot complain about a bankruptcy judge openly recognizing that bankruptcy courts cannot, as a jurisdictional matter, fix
all of the issues facing our medieval justice system. It’s a start - and the end of Indianapolis as a venue for big chapter 11 cases. Who are we kidding - that came months ago, when Judge Graham
denied the 3M litigation injunction for many of the same reasons set forth in his dismissal decision, differently stated. Or even at the first day hearing, when we needed earplugs to muffle the sound of Aearo’s attacks on its MDL judge
backfiring.
Well, more
breaded tenderloin for the rest of us!
And so it goes.
What is This, A Principal Place of Business for Ants?
Now let’s get back to two of our favorite topics: midmarket chapter 11 insanity and Houston hijinks! Who got chocolate in our peanut butter and peanut butter in our chocolate? Judge David R. Jones needs no introduction, but you’re really going to want to meet Sorrento Therapeutics and its
ersatz Texas twin with a Delaware twang, Scintilla Pharmaceuticals.
Sorrento and Scintilla
filed chapter 11 in Houston on Feb. 13. According to the petition, the biggest unsecured creditor is NantCell Inc., with a whopping $156.8 million claim; the next biggest unsecured creditor on the list is affiliate NANTibody LLC, with a piddling claim for $16.7 million. NantCell is
not in the indenture trustee business; you know something wonky is going when an apparent
trade creditor dominates the unsecured list with claims like that.
Turns out, the Nant companies hold a $175 million
arbitration award against the debtors. Not to worry, though: According to the debtors, they hold a $125 million arbitration award against Nant, leaving Nant with a mere $50 million net claim. Further, the debtors told Judge Jones at the first day hearing they have a “healthy” balance sheet, including a 52% equity stake in nondebtor subsidiary Scilex Holding Co. worth over $700 million as of the petition date.
NantCell counsel told Judge Jones at the first day hearing that the set-off situation isn’t so simple - turns out, the debtors’ $125 million award is not payable by NantCell but by a third party. Thus we have the classic “triangular set-off” - generally, in order for a debtor or creditor to offset their claims against each other, they must be claims among
those exact entities. You can’t use a claim against Bob to offset Tom’s claim against you.
Ominously, NantCell counsel also warned that the debtors might try to “dividend out” some or all of the Scilex stock to evade its judgment and suggested the debtors may have engaged in some suspicious transactions before filing. Later we learned that one of those suspicious prepetition transactions was, you guessed it, dividending out some of the Scilex stock. But another suspicious transaction is what
really caught our eye: the maneuver the debtors seem to have pulled to get to Texas.
(Get to Texas, or get to Judge Jones? If you just follow the mega-mega-cases, it sure
seems as though the vast majority of big Houston cases get assigned to the senior complex case panel member. To wit: On June 1,
Incora,
GenesisCare and
Diebold each filed in Houston, and all three cases went to Judge Jones. On June 11, the
Center for Autism and Related Disorders filed, followed by
Instant Brands on June 12. Both went to Judge Jones. The newest Houston case covered by Reorg that went to Judge Christopher Lopez is
Envision, which filed May 15.
However, if you check out Houston filings with liabilities over $50 million in the last three months in Reorg’s
very useful Credit Cloud Database, the distribution between the judges evens out a bit. During that period Judge Jones received 10 cases, while Judge Lopez caught five. Zoom out a bit further to cases filed in the
past six months, and Judge Jones received 18 against 12 for Judge Lopez. Not exactly an even distribution, but also not exactly predictable if you are debtors’ counsel looking to snag one or the other.)
Both Sorrento Therapeutics and Scintilla Pharmaceuticals are Delaware corporations, according to the board resolutions attached to their petitions. The company as a whole generally operates out of California, per its
website. Sorrento Therapeutics actively
does business in Texas, per the Texas comptroller, but that’s hardly surprising for a relatively large company. What’s interesting here is that Scintilla Pharmaceuticals - the entity that is actually the debtors’ jurisdictional hook to Texas (more on that below) - doesn’t appear to be actively doing business in Texas.
At some point, Scintilla Pharmaceuticals appears to have registered to do business in Texas. We can’t tell when, because the Texas comptroller
lists Scintilla’s Texas status as “FRANCHISE TAX ENDED.” According to the comptroller, this means “the entity has ceased to exist in its state or country of formation or has ceased doing business in Texas.” Presumably this means that at some point Scintilla had an active franchise tax status in Texas, but what is clear is it doesn’t have that status now.
Most …
interesting, the Texas
principal place of business address provided by Scintilla in its petition - 7 Switchbud Place, Suite 192-513, The Woodlands, Texas 77380 - appears to be a strip mall in suburban Houston. The petition also helpfully notes that Scintilla’s principal place of business is also “P.O. Box 513.”
We can’t say exactly which store in that strip mall houses a pharmaceutical company’s “principal place of business,” but we’re going to guess it isn’t Chef Chan’s. Our money is on the shop next door: a
UPS Store offering, you guessed it, P.O. boxes. Wild speculation: That UPS Store is Suite 192, and P.O. Box 513 is the tiny brass box where Scintilla Pharmaceuticals has its principal place of business.
In its 2010
Hertz decision, the Supreme Court defined a corporation’s “principal place of business” as its “nerve center,” where the majority of its executive and administrative functions are performed. In other words, corporate HQ. Unless Scintilla has made tremendous breakthroughs in
miniaturization tech, we really doubt that its officers and directors are shuffling papers and making big decisions in a P.O. box at a UPS store.
Here’s where this tactic adds a twist to the
widely reported (and subsequently
brushed under the rug) White Plains venue hook
scheme: Sure, Purdue secured Judge Robert Drain for its chapter 11 by changing the registered service of process agent for a phantom general partner to a drop box in White Plains, but that agent was acting for a
New York general partner. Here, Sorrento appears to have cooked up a Houston venue by listing a
Delaware corporation’s
principal place of business at a
P.O. box about
50 minutes by car from the courthouse.
Even White Plains doesn’t allow that kind of blatant venue shopping: Local Rule 1073-1 of the Southern District of New York unambiguously provides that no case assignment to a particular division, for example, White Plains, “will be based upon a post office box address.”
Section 1408 of title 28, which governs bankruptcy venue, provides (bit of simplification here) that a company may file in the district where its domicile, principal place of business or principal assets were located in the 180 days prior to the petition date. So, Delaware companies can file in Delaware because they are domiciled (incorporated) there; Aearo could file in Indianapolis because its principal place of business was in the Southern District of Indiana. Affiliates can then file in the same district, wherever they are domiciled or located.
But Scintilla, which yanked Sorrento into Houston via the affiliate venue rule, is not domiciled in Texas. Thus, to manufacture a Houston venue, Scintilla had to move its principal place of business or principal assets into the Southern District of Texas - specifically, a P.O. box in the Houston ’burbs.
No one has yet argued that the debtors could not file in the Southern District of Texas. And we are awfully glad about that! This is a fun case, and in the counterfactual world where the case was shipped to Delaware or California, there might be no
borderline-usurious, possibly
totally unnecessary DIP financing! No
sua sponte emergency
removal of the
largest unsecured creditor, NantCell, from the official committee of
unsecured creditors solely because NantCell holds a litigation claim rather than a trade claim! No
objection to a settlement with NantCell by the usurious DIP lender asserting a veto right! No
equity committee securing a
temporary restraining order barring brokers from “naked” short selling of the Scilex stock as a violation of the automatic stay!
This one deserves its own column, honestly. But for now, we will stick with the venue issue. We will report back on the rest
when it makes sense.
Diamond Gets Rough
In a somewhat emotional
oral ruling on June 1, Judge Lopez ruled that the Diamond Sports Group RSN debtors must pay four major league baseball teams full contractual rights fees while the debtors consider whether to assume or reject their purportedly above-market deals with the teams. You heard that right: A bankruptcy judge
in Houston ordered debtors to pay administrative trade creditors on a current basis during a bankruptcy case. Let’s take a look.
The debtors
argued that they should only have to pay the teams the fair-market value of their broadcast rights during the chapter 11 cases. This is not really a controversial position - in
NLRB V. Bildisco, the U.S. Supreme Court said that the proper measure of a postpetition administrative claim is the reasonable value of the goods or services provided to the debtor. The problem for the DSG debtors is that the Supreme Court also said the contract rate is presumed to be the measure of reasonable value, so the burden fell on the debtors to show a lesser amount should be paid.
Judge Lopez seemed swayed by Major League Baseball Commissioner Rob Manfred’s testimony indicating that MLB offered to take the RSNs’ rights back in exchange for assuming the RSNs’ $1 billion per year in obligations to the teams. According to Manfred, MLB also offered to allow the RSNs to keep profits during a transition period and to provide $150 million in DIP financing that would vanish at emergence, plus $60 million in cash that would be paid to the debtors. Counsel for MLB put the total consideration offered for the rights at $1.4 billion. This, the judge concluded, constituted an offer for the rights at the contract rate or more.
However: We are sure many administrative creditors who supply goods to a debtor and get stiffed would gladly reclaim the goods in exchange for dropping their priority claim, and that’s basically what MLB offered - give us back our IP and you can walk away from your obligation to pay for it. Once again, don’t take our word for it - you don’t see them written up in Reorg, but vendors often file a flurry of
reclamation demands soon after a bankruptcy is filed. Section 546(c) of the Bankruptcy Code specifically sets forth how to handle these.
For vendors, as for MLB, getting your stuff back now is worth more than payment of an administrative expense later. As for the DIP, the debtors insisted they have no need for one - they are funding the case using cash collateral - and the $60 million cash payment is little more than a tip.
Judge Lopez also seemed swayed by the fact that the MLB teams are “locked in” to their deals with the debtors during the case and can’t go to market and sell their IP to third parties to make up any shortfall in payments. But, this is also true of landlords in every retail case. If Forever 21 is using a space at the strip mall to sell undersize T-shirts and tiny backpacks without paying rent, the landlord can’t
also lease the space to a dialysis clinic to defray the lost rent.
Honestly, we are shocked the debtors went so far as to offer
any payment to the teams during the chapter 11 case. It might seem outrageous to anyone with a nonbankruptcy brain that a debtor could accept something of value from a counterparty (say, an MLB team’s broadcast rights), sell them to a third party (say, a satellite or cable company), pocket the profits and give the counterparty absolutely nothing but an IOU payable if the debtors are administratively solvent and confirm a plan years later, but as we have pointed out this happens in bankruptcy
all the time.
The debtors’ decision not to play, ahem,
hardball is doubly curious considering one of the major motivations for their bankruptcy filing is to put pressure on MLB to hand over precious direct-to-consumer, or DTC, broadcast rights for up to nine teams so the debtors can include them on their new DTC streaming service. Basically, DSG filed for the same reason retail debtors file: to put pressure on landlords to renegotiate by continuing to operate in the premises, refusing to pay rent and threatening to reject. Here, MLB is the landlord.
This is exactly the strategy Manfred
said the debtors’ owner, Sinclair Broadcasting, threatened during a personal meeting back when Sinclair controlled DSG. According to Manfred, Sinclair Chairman David Smith specifically told him that if MLB did not hand over the DTC rights, Sinclair would put DSG in bankruptcy, stop paying rights fees and threaten to reject in order to “squeeze” the teams into agreeing to lower rights fees. This should not have surprised Manfred, who has
some experience with chapter 11 - it’s standard operating procedure.
Despite this, the debtors chose to cease paying just four teams - the Diamondbacks, Guardians, Rangers and Twins - and even
agreed to pay those teams 75% of their contractual fees pending the judge’s decision. Maybe they intended to curry favor with MLB, though Manfred’s hatred for the debtors - or at least Sinclair - was
palpable, even over Zoom, and suggests there is no favor to curry here.
Now, though, the debtors have essentially no leverage over MLB. Thanks to Judge Lopez’s decision, they have to pay every team its full contractual rights fees until they decide to assume or reject. And rejection isn’t much of a threat: Manfred has repeatedly made clear that MLB
wants the debtors to reject so it can take the rights back and put local games on MLB.tv without blackout restrictions - just as it is doing with the Padres, whose rights a DSG nondebtor affiliate
surrendered on May 30.
This leaves the debtors without any leverage to get those DTC rights at a discount - and that is a crucial element of their plan to reorganize. Their
restructuring support agreement with lenders specifically requires an acceptable business plan and “Sports League Deals with each of the Sports Leagues, in form and substance consistent with the Acceptable Business Plan and otherwise acceptable to the Required Consenting Creditors.” Presumably, that means a DTC deal with MLB.
The debtors have National Basketball Association and National Hockey League DTC rights, but only for last season - at the first day hearing, the NBA
made clear it still needs to reach a long-term solution with the debtors before the next season begins. And as the debtors’ expert testified at the fees hearing, the MLB rights are by far the most important because of the number of MLB games, and MLB games running during the summer, when other sports go dark.
So-called RSN “shoulder programming” - your local assistant hockey coach’s Monday wrap show sponsored by a local wing joint, a repeat of a first-round playoff game from 2012 - isn’t going to bring in much revenue after the NHL and NBA seasons end.
So, where do the debtors go from here? A look at co-counsel Paul Weiss’ June 5
fee statement should give you a clue. Of the approximately $6 million in fees accrued by the firm so far, about $2 million falls under the category of “Litigation/Investigation into Potential Claims.” Claims against whom, you ask? Run a
ctrl-F for “Sinclair” and “Kirkland” (Sinclair’s counsel), and the answer will be obvious: Discovery is very much ongoing.
The UCC
says the debtors’ claims against Sinclair - including actions related to $8.2 billion in debt guaranteed by the debtors from the 2019 Sinclair acquisition, $900 million in distributions to Sinclair and $350 million in management and incentive fees - are worth more than $1 billion. Even Manfred took a
potshot at Sinclair’s management fees during his testimony on the
completely separate MLB fee issue. Again, he seems to hate Sinclair, maybe even more than Oakland A’s fans, and that
says a lot.
At the first day hearing, counsel for Sinclair suggested a deal with the debtors would be done in the “next few days.” That appears to have gone out the window.
Maybe the debtors can squeeze some juice out of Sinclair, but that might not matter much. Even if they prevail and actually
recover $1 billion - the debtors got Sinclair to
make assurances that its
own restructuring wouldn’t render it judgment-proof, but who knows - that will not allow the debtors to eliminate their $9 billion debt pile without lender support for equitization, and the equitization seems to depend on a business plan that includes MLB DTC rights - rights the debtors don’t seem to have much leverage to secure. Maybe $1 billion in free money will get MLB to budge?
Raining on the Parade
While we do seem to dig a lot on Judge Jones, keep in mind that this will happen with a single judge handling nearly 20% of all significant chapter 11 cases in the country (17 out of the 101 $50 million liabilities or more cases filed since Jan. 1, per Reorg’s
Credit Cloud - again,
really useful) and more than 33% of the really big cases (eight of the 19 $1 billion liabilities or more cases filed since Jan. 1; Judge Lopez has three of those, Judge Kaplan has two and nobody else has more than one). In other words, we don’t have Judge Drain to kick around anymore.
But we also give credit where credit is due: Judge Jones deserves real praise for not backing down on a legal ruling in the face of the “parade of horribles” thrown down by National CineMedia on its new Regal advertising deal.
At a
hearing on June 15, debtors’ counsel told Judge Jones that approval of National CineMedia’s reworked deal with Cineworld debtor Regal Cinemas is essential to NCM’s business plan. Regal has
threatened to reject its existing deal with NCM in the Cineworld case, and Judge Jones made clear he believes Judge Marvin Isgur would approve that rejection.
NCM’s financial advisor testified that Regal accounts for 30% of NCM’s screens and at least 24% of revenue. Without those screens, NCM would lose leverage with advertisers, reducing the rates NCM could charge. Basically, if Regal went to a competitor for advertising services, the debtors’ chokehold on on-screen advertising at three of the largest U.S. theater chains would be loosened, increasing competition and driving down rates.
Cinemark and AMC
objected, not to approval of the new Regal deal but to the debtors’ request that the court find the Regal competitors’ “most favored nation” rights are not triggered by the new agreement. If the MFNs are triggered, then Cinemark and AMC would be entitled to the more exhibitor-friendly economic terms in the new Regal deal, dealing a huge blow to the debtors’ profitability.
For this reason, counsel also told Judge Jones that section 363(m) protection is a critical part of the new deal. Section 363(m), as you probably recall from the
Sears SCOTUS situation, largely protects bankruptcy sale orders from reversal on appeal. The debtors sought section 363(m) protection for Judge Jones’ approval of the new deal because if they enter into the new deal with Regal, and then Cinemark and AMC prevail on appeal on their MFN argument, then NCM would be forced to give the competitors the rates in the Regal deal after they emerge.
But wait, this is clearly
not a sale of estate assets under section 363. The debtors argued that they are “selling” advertising services to Regal under the agreement, but if that works you could contort assumption of any contract to provide goods or services in the future into a “sale” for section 363(m) purposes. Nor was the MFN issue really “integral” to the new Regal agreement, except to the extent the debtors
really, really wanted the MFNs knocked out of
other contracts with
other parties.
Nevertheless, we cynically assumed Judge Jones would grant section 363(m) protection as a dubious tagalong “necessary” for more legitimate relief and to prevent an important new deal from cratering, rather than call the debtors’ bluff.
See also: nondebtor releases, backstop protections, etc. We also thought that if Judge Jones denied section 363(m) protection, NCM would drop that request and go forward with the Regal deal anyway, as often happens when dubious tagalong relief is denied.
We were
dead wrong on both counts.
As expected, Judge Jones did grant NCM’s request to approve the new Regal deal and concluded that the MFNs are not triggered. The judge focused on the passage of time since the MFNs were agreed to in 2007 and the changed circumstances - namely Regal’s bankruptcy, which gave that debtor “tremendous leverage” to renegotiate by threatening to reject. The original deal was not a “marriage in perpetuity,” Judge Jones reasoned, and Cinemark and AMC just need to come to terms with that. Stuff happens.
However, Judge Jones flatly denied NCM’s request for section 363(m) protection from reversal of his ruling on appeal. He made clear that he does not believe the new deal is a sale of estate assets under section 363, and therefore section 363(m) cannot apply.
NCM counsel then told the judge the debtors might abandon the new Regal deal without section 363(m) protection, screen count be damned. The risks of Cinemark and AMC prevailing on appeal and then demanding the Regal terms might outweigh the benefits of having a deal with Regal, counsel suggested. In other words: NCM is
not bluffing. Judge Jones kindly gave NCM and its lenders another day to think about it.
The next day, Friday, June 16, Judge Isgur
approved the new NCM/Regal deal in the Cineworld case - a foregone conclusion, considering the improved terms for Regal. Judge Isgur also denied the Cineworld debtors’ request for section 363(m) protection, deferring to Judge Jones.
A couple hours later, Judge Jones welcomed NCM back for a
continued hearing. Counsel for NCM said the lenders were still mulling over whether they wanted to take the risk of entering into the new Regal deal and then losing on appeal. According to counsel, the new deal is good for NCM but “not a home run,” and having to offer the Regal terms to Cinemark and AMC after losing on the MFN issue on appeal would be “catastrophic.” In other words: NCM is
really not bluffing.
But Judge Jones made it clear that he would not back out of his legal ruling the prior day, no matter how serious NCM is about walking away from the new Regal deal and all of its benefits. He suggested that perhaps he could certify his decision for direct, expedited appeal to the Fifth Circuit so the parties could get resolution before confirmation - though he admitted he does not believe the issues are “important” enough for the court of appeals to take the case.
A debtor implored Judge Jones to grant dubious but supposedly critical relief tagged on to more palatable relief, which would also insulate his own decision from reversal on appeal, and Judge Jones stonily refused to relent -
twice. Jason Sanjana, you are now one for 20.
--Kevin Eckhardt