Court Opinion Review: SDTX Applies Serta to Nix Rights Offering Backstop in ConvergeOne, Judge Wiles Rejects Odebrecht and the Third Circuit Affirms Judge Kaplan in Whittaker Clark

Octus’ 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 Octus as a whole. Today, we consider the impact of the ConvergeOne appellate reversal of rights offering backstop goodies, the merits of random judicial assignment in Altice France and the Third Circuit’s affirmance of Judge Kaplan’s Whittaker Clark property of the estate decision.

Turn Out the Lights, the Backstop Party’s Over

“Do not be deceived,” we remember hearing at some point in ten years of hard-core Calvinist education: “God is not mocked, for whatever one sows, that will he also reap.” And so it is with Article III judges and bankruptcy judges: the latter’s casual disregard for legal standards and jurisdictional limitations hath wrought vengeance from on high, with nary an end in sight – as this Judicial Jeremiah has for so long warned all y’all.

The latest harbinger of the coming bankruptcy apocalypse – or perhaps “rapture” is a better term for a solid chunk of business as usual disappearing into thin air – is U.S. District Judge Andrew S. Hanen’s Sept. 26 decision rejecting non-pro-rata rights offering backstop incentives – which we like to call “backstop goodies” – in the ConvergeOne prepack chapter 11.

Yeah, we talked about this one before, but a refresher for those of you just heeding the altar call: In April 2024, ConvergeOne filed with a prepack plan and restructuring support agreement supported by holders of approximately 81% of first and second lien loans. The plan provided for a $245 million equity rights offering backstopped by the RSA holders, with 35% of the shares reserved for the backstop parties at a 35% discount to plan value. Nice symmetry there.

The backstop parties were also promised a 10% backstop fee/put option premium – even though they only “backstopped” their own pro rata share of the offering. You heard that right: they got a premium for backstopping themselves. Imagine someone promises to pay you $50,000 for your car, but also demands a $10,000 fee for their agreement to “backstop” the $50,000 purchase price. If you’re a bankrupt company, you jump on that deal.

What kind of bankruptcy judge would approve this kind of obvious flim-flammery? The debtors filed in Houston and the case was assigned to Judge Christopher Lopez, so you know where this is going. Minority lenders left out of the “Backstop Party” organized and objected, arguing the set-aside and fee for the majority group violated the requirement of equal treatment of similarly situated creditors under section 1123(a)(4) of the Bankruptcy Code.

The minority also papered their appeal with a futile counterproposal for a fully pro rata rights offering – they could not have possibly thought the debtors or Judge Lopez would accept that, right? – that included a backstop of the entire offering, because that’s how backstops are supposed to work, you backstop someone else’s performance.

Well, outside of chapter 11, you do. The debtors rejected the minority’s counterproposal, calling it “not serious” and “a litigation tactic.” Yes, it is the folks seeking a fee for backstopping someone else’s performance that are “not serious.” Of course, it was definitely a litigation tactic, but that is mostly because there was no way the debtors could accept the offer with the majority group holding a gun to their head.

Not to mention that CVC, the debtors’ sponsor, was part of the majority group. We’re sure the “independent” directors carefully considered their fiduciary “duties” before turning down the minority proposal.

The minority group anticipated the debtors’ principal argument on equal treatment: the bogus backstop was compensation for the majority lenders’ “new money commitments” and not a distribution on account of the majority’s prepetition first lien claims. According to the minority, this argument “ignores reality,” which we were not aware was a problem in Houston. The debtors capitulated to the majority, the minority maintained, for “one plainly obvious reason” – because the majority had the ability to control the lenders’ vote.

Well duh. The majority rejected the minority proposal because it would have deprived the majority of unwarranted backstop goodies and the debtors went along because the majority controlled the vote. Wouldn’t it be nice if they could’ve just said that? And ye shall know the truth, and the truth shall make you free, to stick with the Biblical theme.

Not that we wouldn’t do the exact same thing in the majority’s shoes. According to Judge Hanen, the RSA deal would have allowed the majority to recover approximately 31% more than the excluded lenders. If we had the chance to recover 31% more simply by voting to recover 31% more, we would do so, and we’d also have the good sense to deny that was the motivation behind our vote rather than “execution risk” or whatever.

And, bluntly, debtors should never care whether they are getting money from lenders pro rata or non-pro rata. It’s not the debtor’s problem.

The real theological query here is why Judge Lopez bought this baloney. He wasn’t looking at an outsized return! He was supposed to be looking at the Bankruptcy Code. But when it came to the confirmation ruling, he thought it was “not a close call.”

First, Judge Lopez credited the testimony of the debtors’ “independent” director, which, you know how much we think that’s worth. Judge Lopez even disregarded the “independent” director’s lack of counsel, which tells you exactly how unserious this whole setup was. I mean come on, was every Whitewash Specialist, Esq. unavailable that month? Could the lenders not pony up $500,000 for a real rubber stamp instead of getting a cheap one off Temu?

The judge got close to something resembling truth when he remarked that there was “no deal” on a plan without the support of the majority. But then he cited the “overwhelming support” for the plan. Reminder: that support is the result of 81% getting money for nothing. Not to get all Old Testament, but citing overwhelming support in this context is as much a tautology as “I Am that I Am.”

Anyway, support for a plan is only relevant when counting votes; it is entirely irrelevant when analyzing objections based on specific requirements in the Bankruptcy Code. Section 1123(a)(4) requires equal treatment for creditors within the same class, period. The voting stuff is in section 1129. And again, if you can’t build consensus without violating the Bankruptcy Code, you don’t really have consensus.

Turning to the section 1123(a)(4) equal treatment issue, Judge Lopez agreed with the debtors that the backstop goodies were compensation for the completely illusory majority backstop commitments. We would suggest some time in a Tibetan monastery for some judges who need to recognize the projections of their own mind.

Finally, Judge Lopez rejected the minority’s argument that the backstop commitments were not market tested, finding that no market test is required by the U.S. Supreme Court’s 203 North LaSalle decision outside of the cramdown context. Of course, there was no cramdown necessary because the debtors bought off 81% of the loans with non-market backstop goodies, but anyway.

The minority half-heartedly asked Judge Hanen to stay confirmation pending appeal, but really seemed to bet the farm on the deteriorating health of the doctrine of equitable mootness. In the meantime, the debtors raced to substantial consummation and then asked Judge Hanen to dismiss the appeal. Judge Hanen denied that motion in October 2024, and briefing proceeded apace.

After the briefs were filed, on Dec. 31, 2024, the Fifth Circuit handed the minority a lifeline: in its Serta “open market purchase” decision, the circuit court panel suggested that when evaluating whether a plan treats similarly situated creditors equally under section 1123(a)(4), a bankruptcy court must look beyond the language of the plan (specifically, the language of the class treatment provisions, which say “all lenders are getting X” without mentioning the backstop) and consider whether distributions are really equal, like, in reality.

In our analysis of the Serta decision, we suggested the equal treatment finding, not the “open market purchase” ruling, might be the most important part of the decision because bankruptcy judges could no longer just point at the language of the class treatment provision and say well, everybody is getting the same thing.

Later, we expanded on our Serta analysis, pointing to ConvergeOne specifically as a potential occasion for more careful examination of this nonsense. “We know rights offering backstop goodies really exist to provide non-pro-rata treatment for favored creditors without running afoul of the very equal treatment provisions discussed in Serta,” we remarked. “So, if Serta really creates a new rule that bankruptcy courts are required to call B.S. on these shenanigans, then the Convergeone minority group has a point.”

On Sept. 26, Judge Hanen became the newest Friend of the Show by agreeing with us, the surest way to our petty little hearts. According to Judge Hanen’s opinion reversing Judge Lopez, the debtors’ plan “offered a valuable and exclusive opportunity to backstop an equity-rights offering” to the majority “without any exchange of value for the opportunity,” and the opportunity “resulted in significantly higher recoveries to some class members for the same claims.”

In other words, Judge Hanen focused on whether the majority gave any consideration for the opportunity to provide consideration in the form of the backstop – and concluded they clearly did not. The only reason the majority got this opportunity, the judge said, was their prepetition loan claims adding up to a majority sufficient to accept the plan, striking off one of the requirements of section 1129 – but, again, not the requirements of section 1123.

In other words, Judge Hanen said, “the exclusive backstopping opportunity present in this case constituted treatment for a claim” – the prepetition loans held by the majority – “and allowed for some class members to receive higher recoveries than others in the same class.”

Under Serta, Judge Hanen explained, a court must look “below the surface to determine whether distributions were in fact equal in value” and “examine the inequality both in opportunity and result.” In this case, “participation in the backstopping opportunity – which provided discounted stock purchases and significantly higher recoveries – was offered exclusively to some creditors without any consideration for the opportunity to participate.” Preach!

Judge Hanen buttressed this conclusion by playing up 203 North LaSalle’s market test requirement. Absent a market test, the judge said, how could the debtors know they were getting sufficient new value for the valuable opportunity to get backstop goodies?

“To put it bluntly,” the judge said, “at the time the bankruptcy petition was filed” and the restructuring support agreement with the majority was executed, “the train had already left the station, and the Minority Lenders were never permitted to board.” The debtors asserted that the excluded lenders had the opportunity to propose an alternative to the backstop during the case and did so, Judge Hanen notes, but that opportunity “was illusory at best” in a quick, prepackaged chapter 11 with an RSA backed by the majority. King Solomon couldn’t have said it better.

Hallelujah! We are born again, washed in the cleansing light of plain, bullshit-free reality. The backstop goodies had nothing to do with the backstop, Judge Hanen suggests, because the backstop goodies were baked in from the start, the second enough lenders came on board to guarantee a majority. If the backstop were a real commitment, the judge hints, then the debtors would have marketed it to see if they could get a better deal, and they absolutely did not do that.

Judge Hanen also compared the required market test to the “open market exchange” exception to pro rata treatment for similarly situated lenders in the liability management context, another key issue in Serta. “There was certainly no attempt to allow new potential investors to bid,” the judge notes, “or submit the deal to an ‘open market’ as described in Serta.”

But the bigger question is, as always: Why? Why did Judge Hanen decide now is the time to force bankruptcy judges to ignore blarney from “independent” directors and reckon with reality when considering confirmation of a plan of reorganization? Was it just Serta? Or do we have another example of the Article III courts getting sick of bankruptcy judges outright flouting common sense and the statutory requirements of the Bankruptcy Code?

Given the recent streak of bankruptcy reversals over the last few years, we can’t help but think it’s the latter. How else do you explain District Judge Randy Crane’s impromptu and apparently improvised destruction of Judge Marvin Isgur’s Incora/Wesco uptier decision on Sept. 11 (which we will report back on when it makes sense)? Or Serta itself? Or the Fifth Circuit’s Sanchez reversal? Or the Highland decisions? Or LTL and Purdue?

The Article III courts have been on an absolute tear through bankruptcy courts for years at this point. Skepticism at bankruptcy courts pushing their jurisdictional boundaries and pressing the limits of the Bankruptcy Code is at an all-time high. Maybe the whole Jones kerfuffle triggered this, or maybe not – but clearly, the Great Reining-In is underway.

And this is a whole barrel full of 180-proof not good for those of us getting paid to do bankruptcy. We have warned, over and over and over, that the Article III courts would eventually clip bankruptcy judges’ wings if they kept pushing the envelope, and here we are. The valuable restructuring tools of bankruptcy are getting taken away because a few mega-case bankruptcy judges keep using them to pound round pegs into square holes.

Nondebtor releases might actually be useful and appropriate in truly “extraordinary” cases, but because bankruptcy judges kept approving them as a matter of course, they’re gone. This goes for rights offering backstop goodies as well: in some cases, we don’t doubt, backstop goodies might be essential to secure guaranteed exit funding for debtors. Now, they are in serious danger.

Up next: DIP backstop goodies. Section 1123(a)(4) doesn’t directly apply to DIP financing, but if the DIP backstop parties are in line to receive non-pro rata goodies under the plan – and they always are, because that’s the point of DIP backstops – then excluded lenders could argue that section 1123(a)(4) applies to those goodies at confirmation.

One caveat: DIPs already require at least a hand gesture to a market test (“we contacted 800 lenders, 40 signed NDAs and not a single one was willing to lend on a junior basis!”) … so there’s at least some argument that the decision might not reach the DIP context. Even so, if the issue gets to the Houston district court or Fifth Circuit on a dicey complex panel ruling, the postpetition liability management exercise could be doomed. Thanks a bunch, guys!

Altice in Chains

We aren’t the only ones concerned with the mega-chapter 11 dominance of the Houston complex panel. In late August, the Committee on the Administration of the Bankruptcy System of the U.S. Judicial Conference, a statutory body charged with considering “administrative and policy issues affecting the federal court system,” issued guidelines discouraging the use of complex panels, or, well, complex panel, because there is only one in the entire country, in you-know-where.

According to the committee, the use of complex bankruptcy case panels is inconsistent with “the policy of random case assignment” and encourages “judge-shopping,” which, yeah, that’s the whole point of the Houston panel – debtors know that if they are in Houston they will get one of two “debtor-friendly” (to put it mildly) judges.

The task of defending the complex panel fell to Judge Isgur, whose Aug. 25 letter to the committee is Macbeth-level sound and fury. Judge Isgur first takes issue with the committee for not consulting with the Houston bankruptcy judges first, which, what would they have said? Judge Isgur notes that the patent panel in south Texas got better treatment before it was taken to task, apparently forgetting the giant chasm of respect between Article III judges and bankruptcy judges.

Judge Isgur also unconvincingly attacked the alternatives to the complex panel. First, assignment of chapter 11 cases to local judges in each division of the court – the local courthouses spread around the district – would make judge-shopping easier, Judge Isgur says, by allowing debtors to secure the only judge in some of the divisions. For example, debtors would be guaranteed to get Judge Lopez if they filed in the Victoria, Texas, division, where all cases go to Judge Lopez.

That’s true, but kind of irrelevant – no one actually suggested that is the best way to handle big-case chapter 11 assignments. That setup is what gave us Judge Robert Drain’s automatic assignment for all filers in White Plains and the Purdue disaster. In the wake of Purdue’s obvious venue manipulation, the Southern District of New York abandoned divisional assignments in November 2021 and went to the second complex panel alternative: All cases involving assets or liabilities greater than $100 million are randomly assigned to any of the 10 bankruptcy judges in the district, whatever local division the case was filed in.

Judge Isgur says that won’t work for the Southern District of Texas because the district is just too large. Judge Isgur points out that under this system, “lawyers and business owners in Laredo would have to travel 350 miles to have a hearing if the case is assigned to a Houston Judge,” and a Brownsville business owner “would also have to drive 350 miles.” Sensible, right?

We hope you can see why this argument is dubious at best. How many $100 million-plus chapter 11 cases are filed by businesses based in Laredo or Brownsville? We certainly can’t think of any. The big cases getting filed in Houston and assigned to the complex panel are not local companies – they are national or international debtors that file in Houston to get Judge Lopez or Judge Alfredo Pérez.

Even if a $100 million-plus Brownsville debtor actually filed in the district, where do you think their lawyers, the people who actually have to show up in court all the time, are located? Probably in Houston or, more likely, New York, where the vast majority of Houston mega-case lawyers are located.

Of course the reverse is the real issue: If a big company files in Houston and gets assigned to the Brownsville court, it might be a real disincentive for national and international companies to file in the SDTX. But that argument would give away the game.

OK, so Judge Isgur is really knocking down some strawmen here, but what does preventing judge-shopping mean in practice? Why is it better to keep debtors from knowing which judge they will get? How about an example from New York, involving the thorny issue of nondebtor releases in chapter 15: the Altice France case.

We discussed Judge Martin Glenn’s bonkers Odebrecht decision in May. In Odebrecht, Judge Glenn, the poo-bah of Southern District of New York chapter 15 cases, somehow found it appropriate to grant nondebtor releases in an order recognizing a foreign restructuring plan that itself lacked any nondebtor releases. Judge Glenn found he could supplement a foreign plan with release provisions he absolutely could not approve in a chapter 11 plan under Purdue – or even under the local law governing the foreign insolvency proceeding – solely on the basis of the principle of comity.

We suggested that this could lead to a spree of foreign debtors filing chapter 15 cases in New York in order to get nondebtors released from U.S. claims, especially because chapter 15 venue can be manipulated as easily as chapter 11 venue. Just one obstacle to that: How can a debtor be sure they will get Judge Glenn under New York’s random mega-case assignment system? Or be sure the other SDNY judges would agree?

Well, about that: On June 17, Altice France filed a chapter 15 petition in New York seeking U.S. recognition of its French accelerated safeguard proceedings. Then, on Sept. 15, Altice asked Judge Michael Wiles to enter an order enforcing its approved French safeguard plan in the U.S. Seemed like a no-brainer, except: the proposed plan enforcement order included a release of the debtors’ and lenders’ claims against the prepetition agents and trustees with respect to the prepetition debt documents and exculpation for the prepetition and go-forward agents and trustees to cancel existing debt and issue new notes. Neither of those provisions is particularly unusual in U.S. chapter 11 plans (the release is much narrower than in Purdue, and the lenders consented), but neither was included in the French plan. In support of adding the exculpation provisions, counsel for the foreign representative understandably cited, you guessed it, Judge Glenn’s Odebrecht decision.

Unfortunately for Altice, the case was pending before Judge Wiles and not Judge Glenn. At a hearing on Sept. 30, Judge Wiles specifically rejected Judge Glenn’s Odebrecht decision and told Altice to remove those release and exculpation provisions from the proposed order if they wanted him to sign it, even though no one objected. According to Judge Wiles, the U.S. bankruptcy court “should be enforcing the French plan, not adding to it.”

And that is the beauty of debtors not being able to choose their own judge, or a couple of judges sitting on a complex panel designed specifically to attract big debtors. If one bankruptcy judge in the SDNY goes rogue, that doesn’t mean the other judges will follow. Debtors can’t be sure which judge they’ll get, so maybe they won’t push the envelope so far.

Did the removal of the releases and exculpation tank a perfectly cromulent reorganization plan for Altice? Of course you know better: On the afternoon of Sept. 30, Altice submitted a proposed order without the releases and exculpation which Judge Wiles duly signed, and the reorganization closed on Oct. 1.

Or, maybe foreign debtors will just file chapter 15 in Houston, where judicial consistency is a fait accompli. Unfortunately, there’s no sign that Houston will actually drop the complex panel in response to the committee’s guidance, meaning the race to the bottom will continue to end in Harris County – and we’ll continue to deal with the delegitimizing effect of the two judges that debtors can always count on.

Whittaker Clark

A whole month ago we went on a mega-case judge safari and took some potshots at Judge Michael Kaplan’s August 2024 decision on debtor ownership of successor liability personal injury claims in the Whittaker Clark cosmetic talc case. In that case, Judge Kaplan held that, because of the metaphysics of successor liability, nondebtors’ talc personal injury claims against the nondebtor entity that acquired the debtors’ assets prepetition actually belonged to the debtors, making them dischargeable under a plan – even though the debtors quite obviously could not have asserted such claims against the buyer themselves outside of bankruptcy.

We kinda, sorta suggested that this was completely bonkers. How can a debtor own claims asserted by its creditors against nondebtors that it could not itself bring? Well, about that: On Sept. 11, the Third Circuit went and affirmed Judge Kaplan’s ruling. Judge Thomas Ambro, writing for the panel, says his hands were tied by the Third Circuit’s 2014 Emoral decision, in which a panel concluded that prepetition claims against a nondebtor belong to the debtors if the claimants cannot show a “particularized injury.”

Wait a second – didn’t the talc claimants allege “particularized injuries” from exposure to the talc once produced by the debtors and now produced by the successor, e.g., cancer in their particular body? Oh you sweet, stupid little fools. The bodily injury may be particularized, Judge Ambro explains, but the claimant can only obtain compensation from the successor based “solely due to its status as the Debtors’ successor, not because of any ‘particularized injury that can be ‘traced’ to [its] conduct.’”

Sounds more like particular allegations of negligence than particular allegations of injury, but sure. We guess nobody can blame the successor for continuing to sell cancer-causing talc after buying a cancer-causing talc-selling operation, presumably at a price that reflected the whole cancer-causing talc thing.

How about the simple, common-sense notion that maybe a debtor does not own claims that it cannot actually assert? Again, Judge Ambro says Emoral makes that meaningless. In Emoral, Judge Ambro explains, the Third Circuit panel did not impose “an additional, freestanding condition that a debtor be able to pursue the cause of action under state law for it to become property of the estate.” According to Judge Ambro, “any inability by the Debtors to assert the Successor Liability Claims against Brenntag outside of bankruptcy does not affect whether those claims are property of the estate inside bankruptcy.”

Well: maybe it should? I mean, the debtors’ sole interest in “owning” these claims they cannot assert is preventing someone else from asserting them when that would be inconvenient for the debtors’ plan of reorganization, e.g. circumventing Purdue and getting rid of claims against a favored nondebtor without the claimants’ consent. Is that an “interest” in property under section 541 of the Bankruptcy Code? Apparently so.

But don’t worry, Judge Ambro is sure the debtors and Judge Kaplan will do the right thing with whatever kind of weirdo negative property interest they are deemed to hold here. How can he be so sure? “As debtors-in-possession,” the debtors “owe fiduciary duties to all creditors, including the Committee’s constituents, to maximize the value of the estate,” Judge Ambro says. Ah, fiduciary duties: the last refuge of scoundrels.

And Judge Kaplan? According to Judge Ambro, the panel has “no doubt the Bankruptcy Court will evaluate the Debtors’ proposed settlement” of claims that are absolutely worthless to them and only meaningful to their creditors with the “precepts” of Rule 9019 in mind. Maybe Judge Ambro thinks that the precepts of Rule 9019 actually mean something, and forgot the incredibly lenient “lowest point in the range of reasonableness” standard.

Even if Judge Kaplan weren’t the exact kind of judge we have in mind every time we sit down to write this litany of complaints every month, he could hardly reject the debtors’ agreement to drop claims they couldn’t assert themselves for little or no consideration under that standard.

And, for the record, Judge Kaplan is, in fact, a Friend of the Show! We disagree with him frequently, but we know for a fact he has agreed to bear it with remarkably good humor, presumably because he is a judge who has a robe and a gavel (if not a paycheck for a few weeks) and we are but ink-stained wretches with nary a mote of influence in this world or the next.

Such is the confidence of a jurist who, unlike his compadres in Houston (see above), feels empowered by the full backing of the local circuit court of appeals, at least when he is not opening floodgates.

Also, speaking of judicial assignments and circuit courts … are we all copacetic with Judge Ambro getting on every Third Circuit panel dealing with bankruptcy? Yes we know he’s one of the few circuit judges with deep bankruptcy experience. But still, stones and glass houses and whatnot.

We are old enough to remember when the Third Circuit was the weak link in the Delaware bankruptcy juggernaut and Judge Ambro was the hero that would fix that all. All things succumb to the relentless sweep of tempus fugit.