Court Opinion Review: The Robertshaw PET Two-Step; a Vastly Undersubscribed Endo GUC Rights Offering; DSG UCC DIP Dilemma; Surging Private Asset Sales; Sorrento Venue Sanctions Denied

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 Robertshaw uptier/lender-on-lender violence case, why the Endo GUC rights offering fizzled out, the DSG sub rosa plan DIP dispute, an apparent increase in private section 363 sales and the Sorrento venue abuse decision.

Dead Man’s Switch

Oh hey everybody, remember our brilliant prediction of the era of post-enhancing-transaction, or PET, two-steps - where aggressive position enhancement transactions are whitewashed in bankruptcy - and how we then declared the concept dead on arrival thanks to Judge Marvin Isgur’s ongoing meltdown in the Wesco/Incora uptier case? Well, never mind that: The endangered strategy has been spotted alive and well in Houston, its native habitat, less than a month after we declared it extinct.

The Robertshaw filing sure looks the part, with a little extra bit of the old creditor-on-creditor ultraviolence for extra zest. First, the PET sets the plan in motion: In May 2023, a gang of four (natch) holding the majority of the company’s first and second lien loans (Invesco, Bain, Canyon and Eaton Vance - for now duh duh duh) holds the company’s shaky future ransom and convinces the thermostat and flow control system manufacturer to uptier their holdings to first- and second-out positions in exchange for $95 million in new funding, dropping nonparticipating secured lenders to fifth- and sixth-out and stripping their liens.

But what about the third- and fourth-out, you ask? Well, unlike the Wesco/Incora uptier proponents, the Robertshaw plotters offered a sweetener for nonparticipating lenders not to sue over the exchange: In exchange for consenting to the deal, the left-behinds could accept those third- and fourth-out interests.

How kind of them! Reminds us of Nuveen’s last-minute partial participation in the Mitel uptier, though that was less an open invitation than a payoff for Nuveen not blowing the whistle on the scheme after they caught wind of it.

One thing the Robertshaw and Mitel sweeteners have in common: Neither prevented the participating lenders from getting sued. But at least the Robertshaw participation trophy allowed the ad hoc group’s counsel to label the lenders that elected to sue “nonparticipating lenders” rather than “excluded lenders” (the left-behinds’ preferred nomenclature) at the first day hearing.

Post-PET, you have four plotters holding the ransom on a Houston MetroRAIL speeding toward the Theater District (while stopping at every red light, I know, suspend your disbelief). The air conditioning falters in the sticky summer heat, and the plotters start getting itchy. One of them, Invesco, is now the conductor, holding a majority of the aggregate first- and second-out loans, with a concentration in the first-out tranche.

According to counsel for the ad hoc group of first- and second-out lenders at the first day hearing (a group that includes Bain, Canyon and Eaton Vance, hint hint) the group thought everything was going according to plan until late November 2023. On Nov. 30, a group of nonparticipating lenders sued in New York state court challenging the uptier, but surely that was expected. Meanwhile, Invesco hired its own counsel and got to work on the debtors.

At some point in early December 2023, the three-lender group discovered that Invesco, as “Required Lender,” had jawboned the debtors into four new amendments to the loan agreements. According to the first day declaration, between Oct. 5 and Nov. 13, Invesco and its new, not-counsel-for-the-ad-hoc-group counsel scotched a new ABL facility with Brigade and bullied the company into an early January chapter 11 with Invesco as DIP and stalking horse. The other PET conspirators say they had no idea any of this had happened because the agent failed to inform them - the company is private, so no SEC filings.

After all this happened, the now three-member group says, the debtors reached out seeking a “lifeline” to “remove the noose from around their neck” and avoid a bankruptcy filing. Of course, that would be impossible with Invesco holding the Golden Snitch, so to accomplish their double-cross, the group had to come up with a way to deprive Invesco of its majority.

You have to admire the creativity of their solution: The group made a $218 million equity contribution to the company, $147 million of which was used to pay off most of the first-out loans. This deprived Invesco of “required lender” status, since much of Invesco’s holdings in the first- and second-out were in the former. Of course, a straight equity investment simply would not do, so the group lent the company $218 million - what a coincidence! - to repurchase the equity, effectively recreating the pre-payoff capital structure, sans Invesco.

Invesco even secured a make whole premium out of the deal, though the erstwhile leader of the gang seems strangely reluctant to thank the other members of the group for their largesse. According to Invesco’s scathing Dec. 20 state court complaint, the whole “sham” equity contribution and reborrowing transaction had no purpose other than to deprive Invesco of its voting control and consent rights as the majority senior debtholder.

Invesco maintains that the company’s repurchase of the equity used to pay off its loan is an obvious fraudulent transfer, which, yeah, stock repurchases by insolvent companies per se do not involve an exchange of reasonably equivalent value. How on earth would the group insulate this obviously gratuitous transfer from avoidance as a fraudulent conveyance under state law, while also resolving the challenges to the uptier transaction without years of litigation and a trial before a possibly very dumb state court judge and jury?

If only there were some kind of “safe harbor” that protected securities transactions from avoidance, they must have thought after Invesco raised the fraudulent transfer issue, which they surely never even considered prior to undertaking the whole equity/debt swap idea to get rid of their troublesome ex-partner. If only there were a court of equity where a judge, rather than a jury, could consider the validity of the uptier, in an incredibly compressed time frame, with the liquidation Sword of Damocles hanging and a parade of horribles passing by.

According to the debtors, they undertook the whole Invesco payoff transaction for one reason: to avoid the January 2024 bankruptcy filing targeted by Invesco, though they try to invoke the unfairness of it all. “[I]t was clear to the Debtors that, under the terms of the Fourth Superpriority Amendment, Invesco intended to credit bid the entirety of its anticipated debtor in possession term loan and asset based financing facility (which Invesco would have held on its own) and some part of its secured claim on account of the Prepetition First Out Term Loans without coming to consensus or resolution with other lenders in the capital structure,” the debtors say, which, why would they care?

Except - here we are, less than two months after Jan. 2, and the debtors filed chapter 11 anyway with a plan to sell their assets to the ad hoc group members via a credit bid - exactly what Invesco wanted to do. The only differences are the identity of the credit bidders and all the extra litigation the debtors must defend. The December 2023 Invesco payoff transaction bought the debtors a whole 44 days of additional time outside chapter 11, to do what?

According to Invesco, those 44 days allowed the ad hoc group to find-and-replace “Invesco” with “Bain, Canyon and Eaton Vance” in all the draft first day pleadings prepared for that Jan. 2 filing and hijack its section 363 credit bid strategy. Invesco counsel called the filing “forum shopping,” suggesting that the state court was ready to issue a preliminary injunction preventing the transactions from closing and that the ad hoc group went running to the Houston bankruptcy court for a more friendly venue. Which, duh.

According to the debtors, the December 2023 transaction secured $44 million in cash for the company after the first-out and ABL paydown. Sounds nice - but how much of that went to transaction costs? The debtors also try to blame the quick post-transaction filing on Invesco. By suing to prevent the December 2023 transaction from being fully implemented, the debtors say, Invesco undermined the debtors’ shot at survival. Sure.

That gets us back to the typical PET two-step stuff. As you might have guessed, the restructuring support agreement between the debtors and the ad hoc group minus Invesco includes a requirement that the credit bid sale close by no later than May 15, 90 days after the filing. As you have already doubtless figured out, the debtors proposed an incredibly accelerated schedule for the bankruptcy court to resolve the uptier and Invesco litigation that is designed to hit that deadline, with a hearing to begin April 25 - 70 days after the filing.

Credit to the ad hoc group: They at least put off seeking approval of a DIP with similarly compressed deadlines until late April, supposedly to allow breathing space for mediation, to get the four droogs back together and not crying over spilt Korova milk, right? But the DIP is belt-and-suspenders, because the ad hoc group still controls cash collateral authority and the sale timeline.

To put that timeline in perspective, trial in the Wesco/Incora uptier litigation before Judge Marvin Isgur - which only involves an uptier challenge and does not feature an ad hoc group worthy of a Knives Out film - began on Jan. 25 and is still going.

Of course, the debtors, like Wesco/Incora and Serta, also asked Judge Christopher Lopez to stay the state court actions against nondebtors - that would be the ad hoc group and equity sponsor One Rock - so the bankruptcy court can handle the whole shebang. To bolster those motions, the debtors also pulled the Serta/Wesco trick of granting the nondebtors indemnification rights to manufacture an “identity of interest” such that “claims against the nondebtors are really claims against the debtors” and blah blah blah, you know the drill.

Naturally, the debtors also hired an “independent director” in early December 2023 to cleanse the Invesco transaction and pushed for immediate appointment of a mediator. Because of course they did.

We suggested the PET two-step might be deader than Mr. Blue because Judge Isgur made clear in Wesco/Incora that he would not rush through adjudication of the uptier challenges prior to confirmation of a plan - a key feature of the strategy. However, we must revisit that now because Judge Lopez shows signs of allowing the playbook to play out. On Feb. 21, Judge Lopez set aside two weeks in May for a trial on the uptier and Invesco litigation, one month later than the debtors’ target but still hella quicker than Wesco/Incora.

Mitel bankruptcy lawyers, get those first day pleadings going again! Mortimer, we’re back.

An Endo Conspiracy Theory

Time for another of our trademark mea culpas: In December 2021, when we were young and foolish, we asserted that DIP and rights offering backstop premiums were nothing more than a sneaky way for majority holders to secure post-emergence control over a reorganized company’s board and ensure themselves a speedy cash-out shortly after a bankruptcy ended, while pretending they were making the goodies available to minority holders. We couldn’t recall a single example of an undersubscribed chapter 11 DIP or rights offering at the time.

In October 2022, we found one: the LATAM Airlines offering, which seemed poised to trigger backstop purchase obligations. But we blamed that on “an absolutely Chernobyl-esque bond market meltdown.” Typical confirmation bias it seems, since more than three years after our bold condemnation of backstop premiums as a symptom of “failure bias,” we finally found a failed rights offering we couldn’t easily dismiss: a $160 million GUC share program floated in the Endo case last summer.

According to a backstop approval motion filed Feb. 19 linked to the Endo debtors’ new plan strategy, at the end of the subscription period for a GUC rights offering that ended last year on July 18, 2023, just $2 million of the $160 million offering was subscribed. The debtors are now looking for approval of the backstop triggered by the undersubscription. Sure, it’s a “GUC” rights offering, so maybe vendors and customers just didn’t feel like ponying up more cash? Well, Endo doesn’t feature your typical class of “general unsecured creditors” - the rights offering was made available to out-of-the-money second lien creditors and unsecured noteholders. These are serious people.

So why didn’t they buy in? We would love to know. Perhaps the early solicitation - back when Endo was still pursuing a section 363 credit-bid sale to first lien creditors rather than a chapter 11 plan sale - has something to do with it. Perhaps coincidentally, on July 18, the day the subscription period ended, the federal government and Office of the U.S. Trustee filed their objections to the sale strategy, which ended up pushing the debtors onto the plan path after months of delay.

Certainly word of the feds’ opposition to the sale (and the billions in priority tax claims backing it up) was known at the time; perhaps that chilled participation in the offering?

Or - rank speculation here - perhaps the GUC offering was never intended to succeed from the beginning? After all, via the backstop, the beneficiaries of the failed offering might be the controlling first lien creditors who offered it as a sop to the official committee of unsecured creditors in the first place.

According to the backstop motion, holders of more than 50% of the first lien claims agreed to buy unsold GUC rights offering shares in exchange for a 5% backstop commitment premium (earned even if the offering was fully subscribed) and an additional 5% of any amount they had to buy. Sure, the majority first lien group now has to buy those GUC shares, but they also get that extra 5% premium - and they don’t have to worry about the second lien creditors and unsecured noteholders as minority shareholders.

More importantly, the GUC rights offering bought the first lien creditors a clear path to acquiring the debtors without opposition from the UCC, which had been throwing grenades since its appointment. The GUC rights offering was part of the UCC settlement that brought several opposing creditor groups into the fold and resolved the UCC’s motion for standing to bring claims to unwind several prepetition transactions. In other words, the GUC rights offering was consideration for the UCC dropping its objection to the first lien acquisition. And that definitely has some value.

In July 2023, after the settlement, the UCC joined the debtors in responding to the feds’ objection to the section 363 sale strategy, touting the deal (including the GUC rights offering) as “a significantly better outcome in these cases for non-opioid general unsecured creditors.” The UCC “did not seek to advocate for any particular non-opioid general unsecured creditor or single group of non-opioid general unsecured creditors” but “sought to structure the resolution to ensure appropriate consideration would be provided to as many unsecured creditors, and categories of unsecured creditors, as possible,” the UCC’s financial advisor said.

Creditor democracy and equality! Lovely. Except - what if you hold an election for general unsecured creditors, and nobody shows up? Under the backstop agreements, the first lien creditors get the rights the GUCs scorned. What was the point?

Remember, there are other currencies controlling creditors can use to buy the UCC’s assent to a reorganization. Some committees demand actual currency, or reorganized equity they don’t have to pay for. All of these cost the controlling creditors something, but only the rights offering option gives controlling creditors the chance to get something back, via backstop premiums and purchases of undersubscribed shares.

So, instead of agreeing to pay more cash to the second lien creditors or the unsecured noteholders as part of the April 2023 settlement to secure the UCC’s support for the acquisition, the Endo first lien creditors ended up securing their support in part by offering an option for the unsecureds to buy in, and if that failed, agreeing to purchase additional equity in the reorganized debtors for themselves and getting more for free via the extra 5% premium - something of value to the first lien creditors. Not a terrible deal, right?

More rank speculation: Is it possible the ad hoc cross-holder group, which held 71.5% of second lien principal debt and 47.7% of unsecured principal debt as of the April 2023 settlement, never really intended to participate in the GUC rights offering prior to the July 2023 end date? The group holds a good chunk of first lien debt too. Was there some sort of side deal (not that there’s anything wrong with that)?

Sure, you could say we’re being cynical - but then, why did the cross-holder group agree to accept a rights offering as consideration just three months before they ran away from the offering in droves? Why stump for a rights offering that you have no intention of participating in? How often does a chapter 11 rights offering end up this forlorn?

Or are we desperately trying to confirm our bias that rights offering backstop premiums are malarkey intended to channel more of reorganized equity to a control group of senior creditors than they would otherwise receive in pro rata distributions? Bit of column A, bit of column B, likely.

DSG UCC’s Sub Rosa DIP Reversal

At a hearing on Feb. 9, counsel for the Diamond Sports Group official committee of unsecured creditors made an interesting claim: Requiring participants in a DIP facility to also agree to the terms of a related restructuring support agreement is not “normal” and “stifles competition” in chapter 11 cases. Unsecured creditors are being held “hostage” to the RSA, counsel asserted. For real?

Of course, we need to take the UCC’s assertion in this case with a grain of salt. Not so long ago, the UCC was inside the tent, party to the debtors’ cooperation agreement with lenders that provided for a wind-down of the regional sports network business at the end of the 2024 MLB season. But on Jan. 17, the debtors announced a new deal to reorganize around a $115 million investment and commercial partnership with Amazon. The UCC is not a party to that deal and claims to have been kept in the dark while it coalesced and cannot stop complaining about it.

The UCC had to fight its way back into the tent by generating leverage somewhere, and the obvious target is the $450 million proposed DIP, $350 million of which is earmarked to pay off a portion of the first lien debt. The committee can hardly take pot shots at Amazon, though others seem game.

According to the UCC, the debtors turned down a superior DIP offer from a new group holding mostly second lien debt out of fear that the first lien group might walk from the RSA - and requiring unsecured creditors signing on to the DIP to also sign on to the RSA before the DIP is approved makes an RSA-compliant plan giving the company to first lien creditors a fait accompli before the DIP is even accompli. The UCC even invokes the dreaded sub rosa plan doctrine.

The debtors don’t exactly deny that the DIP was foisted upon them by the first lien group. According to the DIP motion, the $350 million DIP paydown was “crucial to “obtaining the first lien lenders’ consent to pivot away from the winddown contemplated by the Cooperation Agreement.” You know, the cooperation agreement that unlike the RSA, the UCC negotiated and supported - the one that just got thrown in the trash when Amazon came along with its Prime Video siren song and stole everybody’s hearts. The Boys sucks, and nobody wants ads, losers. Editors Note: Mr. and Mrs. Smith is the best show we are getting this year.

Here’s the thing, though: Is it really unusual to make wannabe DIP lenders agree to an RSA prior to DIP approval? Most DIPs are negotiated prepetition, before the UCC is even appointed, and the debtors file with an RSA agreed to by the DIP lenders that sets forth the terms of an RSA-compliant plan. And generally these RSAs do, in fact, end up dictating most of the terms of the confirmed plan, subject to a few adjustments to convince the UCC not to file or to drop that derivative standing motion.

At the very least, almost every DIP has termination events tied to a “conforming” plan, usually defined as one agreed to by the DIP lenders or some subset thereof. Why should a postpetition DIP syndication be any different?

You know we aren’t big fans of bankruptcy process sales, where senior creditors lock in the terms of a plan using an RSA, DIP and arbitrary milestones to ensure their preferred outcome before the petition is even filed (again, see above). But if courts are going to allow senior lenders to buy the process before the UCC is even appointed, why wouldn’t courts allow senior lenders to buy the process almost a year in, after the UCC has already had plenty of time to negotiate a better deal for unsecured creditors?

Nevertheless, the UCC’s opposition had the desired effect. On Feb. 23, the debtors filed a proposed DIP order that includes a UCC settlement: up to $13 million for general unsecured creditors, even if the RSA plan falls apart (we, too, have our doubts) and the debtors liquidate. The settlement also ensures the unsecured creditors get their cash ahead of the stonking 40% “Minimum Return Premium” make whole for DIP lenders. Yes, it’s a make whole - it’s in the “liquidated damages” provision:
 
(We’re used to buried terms, but this one was absolutely buried - check it out.)

The proposed DIP also sets the priorities of the MLB clubs’ adequate assurance obligations and contains other waterfall provisions, which, hmmm: Sure seems like the revised DIP order locks in the treatment of certain classes of creditors under any eventual plan of reorganization or liquidation. Kind of like a sub rosa plan, you know?

On Monday, Feb. 26, Judge Lopez approved the revised DIP deal, along with the $495 million Sinclair Broadcast settlement and the Amazon investment. Sure makes this fait feel really accompli, you know?

Trend Watch: Private Sales

Thanks largely to the FTX case, we are seeing a recent boom in private, no-auction section 363 sales. The FTX debtors are using this strategy for a whole host of assets: the Anthropic AI investment, Genesis bankruptcy claim, three “noncore” holdings, FTX Europe entities, limited partner interests in Sequoia Capital and preferred stock in Mysten Labs and SUI token warrants.

Other, smaller debtors, including Hartman SPE, Nashville Senior Care, Peer Street, iMedia, Jenny Craig and Independent Pet Partners, have proposed private asset sales over the past year, and most have been approved.

Not sure whether this is a good thing or a bad thing - some assets really do not need to be market tested, and a private sale is still noticed for hearing, meaning anyone can show up and “bid” between the approval motion and the sale order or at the sale hearing (although debtors and bankruptcy judges tend to view last-minute bids with skepticism). There are definitely good reasons not to put some assets up for formal section 363 auction, and the Uniform Commercial Code allows for private sales of collateral, so, what’s the big deal?

However, the Boxed debtors’ proposed private sale illustrates the dangers of letting the trend go too far, especially if the assets being sold are all or nearly all of debtors’ go-forward value. E-commerce software services provider Boxed (chuckle) filed in April 2023 to undertake a private section 363 sale of its Spresso (seriously?) business to prepetition first lien lenders for a $26.25 million credit bid. Okay, but: The first lien lenders also conditioned the debtors’ use of cash collateral on the bankruptcy court agreeing to the Spresso sale remaining private.

According to the debtors, “the Prepetition First Lien Secured Lenders were unwilling to allow the further use of their collateral to fund operational losses for the length of time it would take to run an additional marketing process involving post-petition marketing, approval of bid procedures, bidding deadlines and an auction, as delay of the sale for four or five additional weeks would mean funding losses that would exceed the cash available to the Debtors today.”

Hope the Robertshaw debtors realize they really could have had it worse than dealing with Invesco. The Boxed debtors trotted out the usual tripe about their prepetition marketing efforts, but so did Endo, and its lenders didn’t try to pull this off. We all know that some companies are more marketable in chapter 11, not least because of the free-and-clear provisions of section 363(f) of the Bankruptcy Code.

And the Boxed lenders did not win a prepetition auction; they simply wanted to take the company because no other bidders came forward. It’s a lot easier to justify relying on a prepetition auction process when there are actual bids to consider.

At the first day hearing, Judge Brandan Shannon called the proposed private sale “aggressive on an aggressive timeline” and warned that he would not approve the concept until after an official committee of unsecured creditors had a chance to look under the hood. Sure enough, a UCC was appointed a few days later and strenuously objected to the sale while taking the usual shots at the first lien lenders’ security interests. The UCC emphasized that the lenders were not providing any new-money financing yet were offered “overbroad concessions” and a “rapid” liquidation process that would leave general unsecured creditors “empty-handed.”

You know what happens next: A whole five days after the objection was filed, the UCC cut a deal with the first lien lenders and agreed to the private sale, which Judge Shannon approved at a hearing the next day, citing the intense arms-length negotiations between the UCC and the debtors. Under the settlement, first lien lender BlackRock agreed to advance $750,000 to a liquidating trust for unsecured creditors, which would be paid back from litigation recoveries (no litigation against the first lien lenders, of course). Any recoveries over $750,000 would be shared equally by the trust and BlackRock. The lenders also bumped the UCC’s investigation budget to $75,000 from $25,000.

So, the UCC agreed to drop its objections to a controversial accelerated private sale proposal in exchange for $50,000 in additional professional fees for UCC counsel and advisors, a $750,000 advance for the professional fees of a litigation trust and 50% of some hypothetical litigation proceeds. Oh hey, what a coincidence: Under the debtors’ liquidating plan, which went effective Sept. 1, UCC counsel Fox Rothschild serves as co-counsel for the liquidating trustee charged with spending that $750,000 in expenses. Neato. The sale closed May 1, the same day Judge Shannon signed the orders.

On June 2, the debtors proposed an “accelerated” auction process to sell their remaining IP assets just over a month later. Maybe they didn’t realize they could do that for the Spresso assets?

Our concern, as always, is that approval of borderline bankruptcy relief could lead to more widespread adoption of controversial measures that erode bankruptcy court legitimacy. Bankruptcy judges are often pressed to act quickly and, usually to their credit, like to stick with what worked the last time, even if the last time, and the time before that, the bankruptcy judge was also in a hurry and simply cited another time the debtors got away with something.

Back there, somewhere in this chain of causation, is a bankruptcy judge sanctioning something new and aggressive in unusual circumstances far more exotic than the instant case. This is how “extraordinary” nonconsensual nondebtor releases became commonplace and Purdue became the straw that might break the camel’s back. That, in turn, leads to the kind of high-level scrutiny chapter 11 plans are currently getting at the Supreme Court - something we should all try to avoid.

A Brief Update on Sorrento

We said our piece on the Sorrento venue maneuver way back in June 2023, so we won’t give you the full recap, but to (potentially) close the loop: On Monday, Feb. 26, Judge Lopez denied a pro se shareholder’s request for more than $500 million in sanctions against debtors’ counsel for the suburban Houston post office box principal place of business venue trick.

Judge Lopez “joined with other bankruptcy judges” in finding these legal maneuvers “disfavorable.” If only there was someone who could do something about it! Alas. The sanctions were sought for bankruptcy fraud, and of course that has an incredibly high bar. Without much equivocation, the judge concluded that the shareholder failed to prove that debtors’ counsel had an “intent to deceive” the court. The judge also noted that none of the parties raised the issue earlier in the case, which, fair enough.

The same shareholder’s separate venue transfer motion and a further venue transfer request from the Office of the U.S. Trustee - all focused on the infamous post office box - are still going to be considered by Judge Lopez, but in ruling on the sanctions the judge was clear that he had grave timeliness concerns about transferring venue at this late stage of the case.

Maybe ask for $1,000 donated to Legal Aid or the local bankruptcy clinic as sanctions next time? That’s the kind of deterrence a bankruptcy judge might really consider. To be fair, bankruptcy fraud is probably not the right venue, pun intended, for the kind of “pushing” the bounds of the law that we continue to warn about. There’s a big gap between zealous advocacy and the state of mind needed to prove “fraud on the court.” If only there was a semi-regular opinion piece in an industry news rag that tried to shame us into adhering to our better angels.