Bankruptcy Court Dismisses Delaware Two-Step Divisional Merger Chapter 11, Says ‘Manufactured Financial Distress’ Not Good Faith

Relevant Document:
Opinion

On Aug. 29, Judge J. Kate Stickles issued an opinion rejecting the first attempt to pair a divisional merger under Delaware law with a chapter 11 filing – a Delaware, rather than Texas, two-step. Judge Stickles dismisses debtor Bedmar LLC’s chapter 11 case (filed by retired Delaware bankruptcy judge Christopher Sontchi as the debtor’s independent director) because it was not filed in good faith.

Judge Stickles finds that the debtor’s case lacked a valid bankruptcy purpose because the company was not truly in financial distress, as required by the U.S. Court of Appeals for the Third Circuit’s 2023 LTL Management decision rejecting Johnson & Johnson’s first Texas two-step divisional merger filing. “The facts demonstrate that the Debtor’s financial condition was ‘manufactured,’ and therefore, the financial distress is not bona fide and does not meet the good faith standard” under LTL, the judge concludes.

Judge Stickles recounts that Bedmar is part of the National Resilience family of companies, created in 2020 with the goal of supporting America’s biomanufacturing industry. According to Stickles, the company raised $2 billion in initial equity funding from over 50 institutional investors, including Arch Ventures and 8VC, to purchase and lease sites that would become manufacturing plants, process development facilities and laboratories.

However, a lack of demand and overexpansion led the company to seek additional financing, according to Judge Stickles. By “mid-March 2025,” the judge continues, the company had about $100 million in cash – about two to three months of liquidity.

“The Company ultimately considered two strategic alternatives,” Judge Stickles writes: “a chapter 11 for the entire Enterprise” or a “divisive merger.” It settled on the latter after securing $135 million in additional funding from Arch Ventures and 8VC, according to the judge.

To undertake this strategy, the company created the debtor entity to receive uneconomic or “toxic” leases and enough cash to fund a chapter 11 case. The cash would also be enough to fund a plan that would provide “full” recoveries to the debtor’s landlords, its only creditors.

However, Judge Stickles explains that the debtor planned to reject each of the toxic leases and argue that the landlords’ rejection damage claims should be automatically capped under section 502(b)(6) of the Bankruptcy Code, reducing the debtor’s exposure from approximately $372 million outside of bankruptcy to about $32 million.

The Delaware divisional merger was completed in a complicated series of transactions detailed in the opinion HERE. When the dust settled, the newly formed debtor’s assets included four uneconomic or “toxic” leases and about $41.4 million in cash to pay capped rejection damages claims, according to Judge Stickles. After the debtor filed, the U.S. Trustee and certain landlords moved to dismiss on the grounds the case was not filed in good faith.

Judge Stickles agreed. In finding that the debtor was not in bona fide financial distress as required by LTL, Judge Stickles points out that the debtor’s assets of about $41 million exceed its Bankruptcy Code-capped landlord liabilities about $32 million.

According to the judge, even assuming the debtor’s total liabilities are $372 million – the amount of landlord claims before application of the Bankruptcy Code’s cap on rejection damages claims – the financial health of the debtor “was not authentic.”

The debtor’s financial position was “designed” to “facilitate the bankruptcy filing and jettison lease liabilities,” Judge Stickles says, rather than a situation of real financial distress.

Judge Stickles also notes that during the fundraising for the divisive merger, the debtor “prepared a presentation to several of its shareholders entitled ‘Resilience 2.0’ which rebranded a slimmed down Enterprise, maintaining upside and exiting all underperforming leases.” The presentation projected the “right-sized Enterprise” to be profitable in 2026, the judge points out.

“The obstacles (i.e., the allocation of assets and liabilities) imposed on the newly-formed Debtor as a result of the Corporate Transactions, created financial circumstances that were a fiction – purportedly the financial distress necessary to justify chapter 11 relief,” the judge explains. “[T]he financial distress was concocted with an end-goal of ridding the Enterprise of its Lease liabilities for the benefit of its shareholders; not to maximize the value for the Debtor’s creditors.”

The judge also cites an email from the company’s CEO emphasizing that he “used a legal tool to rid Resilience of the toxic sites,” and the operating entity from the divisional merger now has “a profitable core that will only grow from here,” “the best path to return value to shareholders.”

The judge also reasons that the fact that the debtor had no employees or operations weighed in favor of finding the case lacking a valid bankruptcy purpose. “[T]he facts of this case are not representative of a typical chapter 11 case addressing financial distress,” the opinion states.

Judge Stickles underscores that “bona fide financial distress is a predicate to good faith; and in this instance, the ‘manufactured’ financial distress does not meet the good faith standard and is an abuse of the bankruptcy process.”

The debtor argued that the case was filed in good faith to avoid a “race to the courthouse” by landlords, but Judge Stickles dismisses this argument as based on “alternative facts and circumstances” not before the court.

Judge Stickles also criticized the filing of a case solely to take advantage of the section 502(b)(6) caps on landlord rejection damages claims. According to the judge, the Third Circuit’s 2004 Integrated Telecom decision prohibits such a maneuver.

According to Judge Stickles, “[A]although the Bankruptcy Code contains provisions that have the effect of redistributing value from one interest group to another, this redistribution is not the Bankruptcy Code’s purpose.” Instead, the judge says, the purpose of the Bankruptcy Code is to “preserve going concerns and to maximize the value of the debtor’s estate.”

“Here, the purpose of the Debtor’s case is to benefit the shareholders of the Enterprise – which is outside the purpose of the Bankruptcy Code and not done in good faith,” Judge Stickles says. If an enterprise’s shareholders wish to get the benefits of a bankruptcy case, the judge concludes, the entire enterprise must file.