Enviva Dismisses UCC’s Appeal of ‘Unusual’ ‘Company Allocated Portion’ of DIP as ‘Litigation Tactics’ and ‘Negotiation Leverage’

Relevant Documents:
Appellant UCC Brief
Appellee Enviva Brief

As Enviva holds its breath while Judge Brian F. Kenney reconsiders whether to grant its application to retain Vinson & Elkins, another skirmish is unfolding in the District Court for the Eastern District of Virginia: the official committee of unsecured creditors’ appeal of Enviva’s “unusual” $500 million DIP order. Opening briefs from the UCC and the debtors are in, and a brief from the ad hoc group behind the company’s restructuring support agreement is expected by Monday, June 24.

In May, the UCC argued that Judge Kenney should deny a $100 million portion of the $500 million DIP that the parties refer to as the “company allocated portion.” That portion is funded by shareholders, who have the right, like other DIP lenders, to convert their tranche A DIP holdings to reorganized equity at a yet-to-be-determined discount under the terms of a future plan of reorganization. The UCC objected on the basis that such a future plan recovery for shareholders violates the absolute priority rule – the rule prohibits an equityholder from receiving any plan consideration on account of its interest if general unsecured creditors are not paid in full.

The committee also argued that the debtors had no legitimate business reason to open $100 million of the DIP to shareholders, pointing to the fact that the ad hoc group backstopped the entire $500 million DIP. The company-allocated portion therefore was done as a “giveaway” to shareholders, the UCC contended.

Judge Kenney denied the UCC’s objection, reasoning that any value received by shareholders would be on account of their DIP loans as opposed to their equity interests and that entering into the DIP is an exercise of the debtors’ sound business judgment.

On appeal, the UCC submits two questions for the district court. First, whether the absolute priority rule applies and the bankruptcy court erred by providing shareholders “an exclusive right to obtain equity in the reorganized Debtors on account of their status as existing shareholders.” And second, whether the bankruptcy court erred in finding that the debtors exercised sound business judgment in giving existing shareholders that exclusive right.

The committee argues that the DIP violates the absolute priority rule because shareholders are receiving an “exclusive” opportunity to fund the company-allocated portion of the DIP and thereby the opportunity to receive plan value at a discount. It further argues that the debtors had “no legitimate business reason” to offer the company-allocated portion of the DIP, and Judge Kenney “clearly erred in finding otherwise.”

In support of the latter argument, the UCC points to testimony from Enviva interim CEO Glenn Nunziata, who said that the company-allocated portion would “foster market confidence” in the debtors. The UCC contends that sentiment is “the only evidence in the record that would suggest a benefit to the estate,” given that the debtors’ board chairman, Ralph Alexander, “admitted” that the debtors “performed no analysis as to how the shareholders’ equity-conversion rights would impact unsecured creditors’ recovery.” The UCC maintains that unsecured creditors “are unmistakably worse off now” because “equity that would have been the subject of plan negotiations and potential compromises” is “now earmarked for shareholders alone.”

The debtors paint the appeal as “litigation tactics” to obtain “negotiation leverage” and reject that the appeal is based on “fundamental bankruptcy principles.” The debtors argue that the UCC’s constituents “suffered no injury” because even if the disputed $100 million portion of the DIP is allocated from shareholders to someone else, DIP claims “may be repaid in reorganized equity” ahead of GUCs. The UCC’s “constituents’ position within the capital structure is the same with or without the Company Allocation Portion of the DIP,” the debtors’ brief states.

In addition, the debtors argue that the UCC’s “suggestion that its bargaining position” would be “improved” if the ad hoc group were to fund the entire DIP is “entirely speculative.” The debtors therefore assert the UCC lacks standing to pursue the appeal.

The debtors likewise contend that the UCC did not obtain a stay of the DIP order, making the appeal “statutorily and equitably moot.” The debtors explain that under section 364(e) of the Bankruptcy Code, the appeal cannot affect the validity of the DIP financing because the appeal “attacks the validity of a debt extended in good faith and not stayed pending appeal.” Section 364(e) provides that “reversal or modification on appeal” of a DIP order “does not affect the validity of any debt so incurred” if it was “extended in good faith and not stayed pending appeal.”

The appeal is also equitably moot, argue the debtors, because a reversal of the bankruptcy court’s DIP order would “prejudice third parties that acted in reliance upon the bankruptcy court’s decision” by extending the DIP financing.

Finally, the debtors argue the UCC loses on the merits. Contrary to the committee’s position, the “absolute priority rule applies only in the context of plan confirmation or final distribution, not DIP financing,” the brief states. The debtors assert that no “plan has been proposed.”

Similarly, the UCC has waived any argument that the DIP is a “so-called ‘sub rosa plan’” or a plan in disguise, continue the debtors, adding that any “complaints about application of the absolute priority rule are inapplicable” or “not ripe.”

The debtors maintain that they “appropriately exercised their business judgment” in obtaining the DIP on “the best terms available, which “the record shows increased market and employee confidence.” They cite to the undisputed business judgment standard that instructs courts to “defer” to, and otherwise “not interfere” with, corporate decisions except upon a finding of “bad faith” or “gross abuse of their business discretion.” Although the UCC complains of what it views as a “poor decision” by the debtors, the decision is protected by the business judgment rule, say the debtors.

As noted above, the ad hoc group has a June 24 deadline to file an intervenor brief. Although the UCC has filed a motion for expedited consideration of the appeal, which the debtors have opposed, the court has yet to rule on that motion or set a date for oral argument.