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 Third Circuit’s FTX decision requiring examiner appointments, the consequences of Judge Isgur’s rulings in Incora/Wesco, DSG’s new Amazon RSA and Judge Owens’ fresh blow to releases in the second PREIT prepack.
FTX, Examined
Strike another blow for the
fiat justitia ruat caelum crowd: On Jan. 19 a three-judge panel of the Third Circuit in the FTX case
decreed that literally any case party can automatically secure the appointment of an examiner in a chapter 11 case involving more than $5 million in debt just by asking, no magic words required. FTX CEO John Ray III quickly said the debtors will not seek rehearing
en banc or ask the Supreme Court to weigh in, so this one is final: Delaware is now Examiner Land, where all a creditor, a shareholder or the U.S. Trustee has to do is click their heels and a new fiduciary appears.
Truth be told, the legal principle here was pretty plain:
Section 1104(c)(2) of the Bankruptcy Code provides that a bankruptcy court
shall appoint an examiner to conduct an investigation “as is appropriate” into “allegations of fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor of or by current or former management” if “the debtor’s fixed, liquidated, unsecured debts, other than debts for goods, services, or taxes, or owing to an insider, exceed $5,000,000.”
That
shall is pretty unequivocal, but bankruptcy judges have avoided it for years by finding discretion to deny examiner requests in the phrase “
as is appropriate.” Anyone
familiar with the lost art of sentence diagramming can see that phrase modifies “investigation” rather than “shall appoint,” but bankruptcy judges, true to their origin as
courts of equity, hate being told they lack discretion to do or not do anything.
Thus, the Third Circuit had to lay down the law, and did so in fastidious fashion. “The meaning of the word ‘shall’ is not ambiguous,” Judge L. Felipe Restrepo writes. “To interpret ‘shall’ as anything but an obligatory command to appoint an examiner, when the conditions of subsection 1104(c)(2) have been met, would require us ‘to abandon plain meanings altogether.’” We can hear Fed Soc members clutching their pearls in federal courthouse canteens as far away as Spokane.
Then Judge Restrepo gets
really pedantic. “Under the last-antecedent rule of statutory construction, ‘qualifying words, phrases, and clauses are to be applied to the words or phrase immediately preceding and not to others more remote.’” Surprisingly, there is
no Lawyer Latin for that one;
let’s blame Cicero. “Applying the rule, the phrase ‘as is appropriate’ modifies the words that immediately precede it - which are ‘to conduct such an examination of the debtor,’ not ‘shall order the appointment of an examiner.’”
The panel further points out that “
as is appropriate” is not the same as “
if appropriate.” “While ‘if appropriate’ indicates the Bankruptcy Court has a choice, the phrase ‘as is appropriate’ indicates it is permitted to determine what is pertinent given the specific circumstances of each case,” Judge Restrepo writes. Which - both of those sound like a choice, but whatever, our appellate courts rarely pass up the chance to gild the lily, even if the result is
word salad.
More interesting (if not really getting the beauty of “less is more”): The panel declines to stop with the Grammar Police schtick and proceeds to dig into the congressional intent behind section 1104 and absolutely
defame the motivations of all the non-examiner folks looking into the FTX fraud, throwing shade on the whole
concept of disinterested bankruptcy fiduciaries.
First, the panel takes some shots at Ray. As a “quintessential” insider, the panel says, Ray cannot be trusted to investigate the debtors, no matter that he was appointed as an independent fiduciary right before the filing. Wait - is the Third Circuit suggesting that even
independent officers and directors brought in by debtors’ counsel on the eve of bankruptcy cannot sufficiently investigate prepetition fraud or mismanagement? Have debtors been paying
independent directors for
biased investigations?
Up next: The Third Circuit is equally dubious of debtors’ counsel Sullivan & Cromwell. The firm cannot impartially investigate the FTX fraud, the panel suggests, because it served as
counsel for the company prior to the filing, during all that
Bankman-Fried fraud stuff. Section 1104(c)’s mandatory disinterested examiner-on-demand provision is especially important “where issues of potential conflicts of interest arising from debtor’s counsel serving as pre-petition advisors to FTX have been raised repeatedly,” Judge Restrepo says.
Oof.
To cap this off, the panel points out that unlike other investigations, the fruits of the examiner’s work must be made public. This ignores that the whole purpose of
insider investigations is to make public the company’s belief that claims against insiders lack merit and should therefore be released under a plan, but we do not expect appellate judges to know that. After all, they generally use equitable estoppel to avoid thinking about that kind of thing.
“Requiring a public report furthers Congress’s intent to protect the public’s interest as well as those creditors and debtors directly impacted by the bankruptcy,” Judge Restrepo writes, which, please, somebody appeal all those orders sealing pleadings to the Third Circuit, pronto. “In addition to providing much-needed elucidation, the investigation and examiner’s report ensure that the Bankruptcy Court will have the opportunity to consider the greater public interest when approving the FTX Group’s reorganization plan,” Restrepo concludes.
Finally, in a footnote the panel dismisses the debtors’ concern that the mandatory appointment of examiners will create practical problems for bankruptcy proceedings. Yes, the practical problems are dismissed in a footnote. A similar Sixth Circuit mandatory examiner ruling has hardly led to any “fallout,” Judge Restrepo writes, and anyway courts must “give effect to [a] plain command, even if doing that will reverse the longstanding practice under the statute.”
Shudder.
So, a decision riddled with Talmudic grammar-parsing, finger-wagging lectures and stunning
naivete. Where does that leave us? Point blank: If you file a case in Delaware, assume an examiner will be appointed. Sure, the bankruptcy judge has the power to limit the investigation “as is appropriate” - but be prepared to deal with the Third Circuit if the judge approves a $25 budget for the examiner to look into one specific day in the life of SBF’s
cuddle puddle condo in the Bahamas.
Maybe just move the budget for independent directors over to the examiner column, and start teaching the
usual independent director suspects you keep in the closet to
examine. Seems to have worked for
future claims representatives in
mass tort cases and
judicial mediators. Fiduciaries are only
so fiduciary, you know?
LME Bankruptcy Cases DOA
On Jan. 14 Judge Isgur issued a summary judgment
ruling (subsequently
amended in minor respects) in the
Wesco/Incora uptier litigation generally allowing the formerly secured 2024/2026 noteholders’ claims to proceed to trial. Not too surprising if you follow the liability management suits in New York state and federal courts, which have generally allowed breach of contract claims arising from liability management exercises and voting manipulation to proceed past dismissal.
That’s arguably one reason the
position-enhancing transaction, or PET, two-step exists: Get those liability management suits dragged into a friendly bankruptcy court, get them thrown out or narrowed down, get a plan confirmed on the basis of post-LME capital structure, and presto - equitable mootness means never having to say you’re sorry.
The Wesco/Incora uptier trial
started Jan. 25, less than
two weeks after the judge delivered his ruling and before the judge could even resolve
standing issues and the 2024/2026 noteholders’ motion to amend their complaint to bring fraudulent transfer and equitable subordination claims. This being bankruptcy court, the noteholders will be allowed to present evidence supporting those claims at trial, which could make for amusingly pedantic appellate fodder in two to three years.
Not only that, Judge Isgur will consider the evidence on those claims later, at a “remedies” trial, if the noteholders prevail on their challenge in Phase I of the trial on “liability” - basically, the validity of the transaction. So - the noteholders will present evidence on claims they may not be able to assert, which will be considered at a subsequent trial, which we may never get to. We are approaching galaxy brain mode.
Why is Judge Isgur following a procedure with more time-shifts and backwards car chases than
Tenet? Because, as contemplated by the PET two-step strategy, the debtors filed a plan on Dec. 27 that assumes the validity of the uptier, and started pushing for confirmation ASAP. As counsel for the ad hoc group of holders of the first lien notes - the notes issued as part of the transaction that displaced the 2024/2026 noteholders at the top of the capital structure - put it, the plan depends on the formerly secured noteholders remaining
formerly secured and not becoming
presently secured.
If the plan gets confirmed, the theory goes, the formerly secured noteholders have to stay unsecured, even if the bankruptcy court’s ruling on the merits is reversed on appeal - lest an appellate court have to “unscramble the egg.”
Voila: the
raison d’etre of the PET two-step filing.
Whether the bankruptcy endgame is really baked into the plan from the beginning is a key point of contention in the ongoing Wesco trial. For example, the briefs and trial demonstratives discuss early emails among nonparticipating noteholders discussing
Reorg articles about the
PET strategy, with the transaction’s supporters arguing that everyone involved knew the strategy was on the table and contemplated by their deal documents. Because of the Star Chamber level of sporadic redaction happening in this case, we’re hoping at least some of this makes it into Judge Isgur’s opinion.
Instead of telling the debtors and the first lien lenders to put their plan on ice pending the outcome of trial, as requested by the 2024/2026 noteholders, Judge Isgur played along and
approved the debtors’ disclosure statement for solicitation
while the trial the debtors must win to proceed with the plan is going on. The judge justified this approach by reasoning that it would create “dynamic pressure” for a settlement. The trial is already scheduled, and generally trials create considerable “dynamic pressure” for settlement, but whatever.
All of this cart-before-horse kind of, sort of has us missing former judge David R. Jones, who you might notice from the link above actually heard the summary judgment arguments on Oct. 11 - five days before resigning from the bench. We were pretty sure
how he would have ruled: summary judgment on the 2024/2026 noteholders’ contract claims arising from the “position enhancing transaction,” without any possibility the capital structure gets disturbed before confirmation.
How do we know? That’s what he did in Serta, and that’s exactly why Wesco/Incora filed in Houston. If only Jones had issued the same kind of
vibes-based summary judgment ruling he provided in Serta at that Oct. 11 hearing, this case could already be out the door and on its way to the
Fifth Circuit like, well, Serta.
But Judge Isgur’s decision to proceed to trial on the uptier claims doesn’t
exactly wreck the PET two-step concept. After all, Jones did allow some of the Serta challengers’ claims to proceed to trial at confirmation. Not the
important claims - the breach of contract claims to undo the transaction as a violation of the loan documents. And of course he ruled for the participants at confirmation on the remaining implied covenant claims. But he did at least hold a trial, like Judge Isgur.
No, what may ultimately kill the PET two-step is Judge Isgur’s insistence that he will not confirm the Wesco/Incora plan just so the debtors can rush to the effective date and use equitable estoppel to prevent an effective appeal on the challengers’ claims to upend the capital structure. As the judge has made clear more than once, no eggs will be scrambled until the challengers have their day in appellate court.
At the disclosure statement hearing on Jan. 11, Judge Isgur warned debtors’ counsel he would not confirm the plan just so they could use equitable mootness to block appellate review of his decision on the uptier challenges. The purpose of proceeding with confirmation cannot be “to invoke equitable mootness to avoid appeal” of any decision in the litigation, Judge Isgur emphasized.
One week later, Judge Isgur
used more forceful language: “Do you really think there is any chance I will confirm a plan the purpose of which is to perpetuate fraud by one creditor against another?” Judge Isgur asked debtors’ counsel. If the 2024/2026 noteholders can prove their liens were fraudulently stripped in the uptier transaction, Judge Isgur continued, then confirmation of any plan based on the post-uptier capital structure would “confirm fraud,” and “I’m not going to do that.”
That sound you hear is the bankruptcy lawyers preparing the Houston chapter 11 for PET enjoyer
Mitel putting their pencils down.
DSG Lives
Oh, hey, remember us
cracking wise a few weeks ago that only $700 million from Shohei Ohtani could save Diamond Sports Group from liquidation? Ah, well, about that: On Jan. 17, the debtors
announced a new
restructuring support agreement to keep the moribund regional sports network operator in business with a
$495 million settlement payment from owner Sinclair Broadcast, $115 million from
new “strategic partner” Amazon and
$100 million in new money DIP funding from existing funded debt holders (not counting the $350 million refinancing of first lien debt baked into the DIP here).
Hey, that’s $705 million! Just not from Ohtani. The debtors would pick up their existing NHL and NBA rights and hand them over to Amazon Prime Video, along with their rights to at least nine MLB teams, for undisclosed carriage fees, abandoning their previous Bally Sports streaming project (and the Bally naming rights deal). Problems solved!
Except: The NBA, NHL and MLB teams licensing their rights to the debtors have not yet agreed to the deal. Under the debtors’ pre-RSA wind-down cooperation agreement, the leagues would have recovered their rights at the end of their respective 2024 seasons - something MLB at least wanted very, very badly. Now, they are looking at those rights agreements dragging on long into the future, without the opportunity to, say, sell them to Amazon or another big service at auction. They may not like that!
About those MLB rights: The debtors only have direct-to-consumer streaming rights for four teams. Does Amazon qualify as DTC? If so, only those four teams will get their local games on Prime Video. Amazon might accept that, of course. But will MLB be able to secure its dream of blackout-free MLB.tv for all without at least four teams?
The UCC is also
complaining that the deal is less favorable to unsecured creditors than the cooperation agreement and accusing the debtors of seeking to start syndication of that new DIP pre-court approval to guarantee confirmation of an eventual plan. Non-funded debt unsecured creditors would share a whopping $5 million plus a tiny sliver of the litigation settlement with Sinclair under the RSA, while technically
pari passu unsecured funded debt creditors (holders of deficiency second lien, third lien and unsecured notes claims) would get
at least 10% of reorganized equity (and considerably more if they elect to participate in/are allowed to backstop the new DIP) plus litigation recoveries.
Finally, there is the small matter of the debtors’ existing linear and virtual streaming distributors. The debtors say they intend to continue selling games to existing multichannel video programming distributors, but those distributors were getting adversarial
before the debtors agreed to team up with Amazon. DirecTV is already
locked in litigation with the debtors over rebates, and the debtors’ agreement with Charter is
up for renewal in February.
Will these distributors want to pay to compete with Prime Video? Will they insist that
most favored nation provisions in their existing agreements require concessions? Will Judge Christopher Lopez be willing to
ignore the MFN provisions on vibes grounds like Jones did in the Cinemark case?
All of this will probably get worked out in the end, either via negotiation or the
well-established preference of bankruptcy judges for whatever debtors decide to call a “restructuring” over scary, scary liquidation. The debtors already scratched that itch in their
response to the UCC’s DIP syndication objection, suggesting that the committee is “recklessly throw[ing] a meritless monkey wrench into a key component” of the reorganization. The UCC prefers a
liquidation just because a group of unsecured creditors would be better off? Crazy talk.
But are we really looking at a “reorganization” here? The key difference between the RSA and the cooperation agreement is that under the RSA the debtors will not surrender their rights to the leagues and teams at the end of their 2024 seasons. Instead, the debtors would effectively hand those broadcast rights over to Amazon for $115 million in
loans, that the debtors must pay back with interest, plus a possible $50 million future investment and undisclosed carriage fees.
Of course, Amazon can convert the note to a 15% equity interest in the reorganized debtors, if all goes well (by our math, the additional $50 million equity investment would get them to 22%). If not (and some experts seem to think the debtors’ projections are
wildly optimistic), Amazon could insist on repayment from the debtors’ 20% stake in the YES Network, which
may be worth as much as $700 million. There’s that number again! The debtors’ partners in YES - including your
New York Yankees - might take issue with that, especially if MLB wants them to.
Either way, Amazon is probably getting DTC sports rights at a significant discount to market prices via the RSA. We don’t know how much Amazon has agreed to pay the debtors for the content itself, but we’re going to guess a whole lot less than Amazon would have to pay the leagues and teams directly if the cooperation agreement held up and the rights hit the open market at the end of 2024. Otherwise, why would Amazon bother getting involved now?
But we won’t call it a reorganization unless the debtors can keep those other distributors paying carriage fees despite Amazon carrying the games. Otherwise, this deal hands the company’s primo assets over to Amazon, with lenders taking contingent value rights in the proceeds.
PREIT Releases Rejected
Just when we think Delaware judges couldn’t possibly try harder to reduce their caseload, along comes another decision that strikes fear into the hearts of CROs everywhere. On Jan. 22, Judge Karen Owens
sua sponte - that’s Lawyer Latin for “
nobody asked you, Patrice” -
questioned the proposed releases in the PREIT prepackaged plan,
after the debtors got the U.S. Trustee to drop its objection.
Specifically, Judge Owens wholeheartedly endorsed Wilmington colleague Judge Craig Goldblatt’s January 2023 suggestion in the Kabbage case that parties cannot effectively consent to a nondebtor release simply by
failing to affirmatively opt out. A party’s failure to object to a release is “not a sufficient manifestation of consent” under “any circumstances,” Judge Owens declared, while leaving the door open to the debtors trying to satisfy the standard for
nonconsensual third-party releases.
That used to be a layup but, well, Delaware nowadays. See Judge Owens’ January 2023 decision
rejecting the proposed nonconsensual releases in the GT Real Estate case.
The debtors satisfied the UST by agreeing to delay the effectiveness of the releases until unimpaired claims are satisfied, which they
also agreed to do in their confirmed 2020 plan. The pro-debtor stooge who approved that compromise in November 2020?
Judge Karen Owens. This time, however, the judge felt that limitation did not go far enough. The debtors duly dropped the releases imposed on unimpaired creditors, because of course they did, because the releases were a throw-in like they are in
95% of other cases.
Interestingly, Judge Goldblatt’s own heel turn on releases also contradicted an earlier stance: In a
decision in November 2021, Judge Goldblatt chided the UST for objecting to nondebtor releases as a matter of principle and endorsed Judge Robert Drain’s
2018 Tops decision endorsing the “you snooze, you lose” approach to consent. In Kabbage, by contrast, Judge Goldblatt found that even parties who vote to reject must be given the chance to opt out.
If SCOTUS knocks out nonconsensual releases in the Purdue case and bankruptcy judges insist that creditors opt in to consensual releases, then we could be seeing the end of nondebtor releases, period. At least in Delaware. Alas, Acela seats gathering dust and the deserted streets of Wilmington could be the result of the
long decline of a uniquely American institution.