August 28, 2019 – As the slightly faded bumper sticker warns: "it happens." Once in a while a bankruptcy Court drops a bomb on assembled lawyers and flat out refuses to confirm a Chapter 11 Plan.
As recently as May 29, 2019, Judge Thomas Saladino uttered "Good luck guys," dropped the mic and left a courtroom stunned when he refused to confirm the Shopko Plan based on that Plan's treatment of third party releases. In that instance, however, the Debtors bounced back practically overnight; filing a revised Plan on May 31st. Admittedly that Plan, confirmed within a month, left much to be desired for the Shopko Debtors (and much-maligned board) who remain susceptible to a lawsuit from creditor McKesson (and others) post-emergence, but at least there was a quick, if painful, possibility for redrafting the Plan.
This may be much worse.
In this instance, the words that left lawyers gaping were: "The Debtors bear the burden of establishing by a preponderance of the evidence that the Second Amended Plan satisfies the confirmation standards in section 1129(a) of the Bankruptcy Code. As set forth below, the Court holds that the Debtors have failed to satisfy sections 1129(a)(1)-(3) to the extent that the Second Amended Plan purports to limit the Consumer Creditors’ ability to assert rights of recoupment against the Buyers. The Court also holds that the Debtors have not demonstrated that the Second Amended Plan satisfies the best interests of the holders of allowed Class 6 claims and as such, they have failed to satisfy section 1129(a)(7) of the Bankruptcy Code. Finally, the Court holds that the Debtors have failed to demonstrate that the Global Settlement is fair and equitable to the holders of allowed Class 6 claims and as such, the Debtors’ request to enter into the agreement is denied. For those reasons, the Debtors’ request to confirm the Second Amended Plan is denied.
So what does any of that mean?
The Plan as it stands
The Debtors' Plan is entirely premised on a pair of going concern sales that together stand to net the Debtors $588.0mn (a combined $1.817bn of sales proceeds less $1.229bn earmarked for repayment of DIP loans); sufficient cash to motivate a global settlement amongst the Debtors and their term loan lenders (owed $961.5mn as at the Petition date), almost 100% of whom support the asset-sale driven Plan. Just prior to the Debtors' Chapter 11 filing, most of these term loan lenders (holders of $736.6mn) had signed up to a restructuring support agreement which had as a "Plan A" a "Reorganization Transaction" that would see much of their pre-petition debt exchanged for equity. The RSA, however, also included a toggle to a clearly preferrable "Plan B" (one or more asset sales); allowing the term loan lenders to cleanly escape what for many of them is a recurring nightmare (this is the Debtors' second Chapter 11 in under 2 years).
If the going concern asset sales fell through now, or if the $588.0mn to be netted by those sales dropped significantly or disappeared altogether, the term loan lenders might once again have to think about Plan A.
The going concern asset sales
One of the going concern sales is of the Debtors' forward origination and servicing business, with New Residential Investment Corp. (the “Forward Buyer”) agreeing to a $1.055bn purchase price. The other is the sale of the Debtors' reorganized reverse servicing business to Mortgage Assets Management, LLC and SHAP 2018-1, LLC (collectively, the “Reverse Buyer”) which has agreed a purchase price of $762.0mn. Each of these businesses makes their money servicing mortgages; together servicing approximately 1,000,000 mortgages (what the Court calls "Consumer Credit Agreements").
"Consumer Creditors" and Class 6
The Debtors' Plan has only one voting class, Class 3 ("Term Loan Claims") comprised of the term loan lenders. All of the other creditor classes further down the waterfall are presumed to reject the Plan and are not entitled to vote on it; several classes have, however, been offered modest sweeteners by the term loan lenders. This largesse, memorialized in a "global settlement agreement" (global in scope if not creditor participation) is naturally somewhat predicated on what the term loan lenders expect to recover themselves. One of the classes nominally receiving something is Class 4 comprised of holders of the Debtors' second lien notes ($253.9mn outstanding as at the Petition date) who are being offered a nebulous "Second Lien Recovery Cash Pool," although it is highly likely that this class's relative quietude has more to do with it being out of the money and subject to an inevitable cramdown than with any meager slice from the term loan lenders' pie. Also offered a nibble by the global settlement are the Debtors' general unsecured creditors, the Official Committee of which has signed on to the Plan in exchange for something considerably less than $4.0mn for the class (and of course payment of their own advisory fees).
It is Class 6 ("Consumer Creditor Claims") that Judge James L. Garrity Jr. really cares about; these are claims that arise from disputes between the Debtors and their mortgage holding customers relating to Consumer Credit Agreements; of which there exist thousands in all shapes, sizes and courts, but what they appear to share, in the view of the Court, is mistreatment at the hands of the Debtors' Plan in three respects: (i) it restricts the rights of recoupment (ie the value of a Consumer Creditor's mitigating cross-claim when subject to an enforcement action at the hands of a mortgage lender), (ii) it does not pass the "best interests" test in that this class may actually fare better in a Chapter 7 liquidation (where an asset sale could only be done under section 363 rules which prohibit "free and clear" sales of the Consumer Creditors Agreements) than in a Chapter 11 and (iii) the Global Settlement, entered into amongst the Debtors, the term loan lenders and a committee representing general unsecured creditors in Class 5, gives Class 6 short shrift with its offer of $5.0mn to Class 6.
In combination, these Plan shortcomings would require the Debtors' to significantly alter the treatment of Consumer Creditors and if the Debtors' assets must be sold encumbered by that considerable and indeterminate baggage, the two going concern sales may be thrown into peril.
Reverse Buyer and Forward Buyer Reaction
Judge Garrity's memorandum gives some insight as to how the Debtors' two buyers would react to a revised Plan that would require them to purchase their mortgage portfolios encumbered with potential claims. The Reverse Buyer agreed "to a structure whereby the Debtors would continue to pursue a sale 'free and clear' of consumer liabilities, but if the Debtors could not consummate such a sale, the Reverse Buyer would continue with the sale, subject to a $10 million purchase price reduction. The more important Forward Buyer had an altogether different reaction, when the Debtors floated the idea that "the Forward Buyer take assets subject to potential consumer claims and defenses, the Forward Buyer went 'pencils down'." Asked to explain the position, the forward Buyer responded: "[I]t really goes to the core of our business. We are a fixed-income investor….[W]e like the returns to be predictable and, you know, we pay a fixed dividend to our shareholders that we look out for. The returns that we seek should be predictable and the reason free and clear is important is just because it’s hard to put your arms around what the exposure could be."
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