Court Opinion Review: The Fifth Circuit’s Latest Sanchez Reversal, Judge Goldblatt Goes Rogue in Yellow, and Judge Lopez Calls Pine Gate’s Rollup Bluff

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 Fifth Circuit’s latest Sanchez decision, Judge Goldblatt getting creative in Yellow and Judge Lopez calling a first day bluff.

Start Getting Real

Folks, you really do not want to get on the Fifth Circuit’s Naughty List, lest you end up spending an entire year taking lumps of coal right to the kisser, like the Honorable Dudes on the complex panel in Houston. Exhibit the latest: the appellate court’s Nov. 13 reversal of yet another Sanchez/Mesquite Energy decision from Judge Marvin Isgur.

We’ve had way, way too many mentions of the Sanchez Disaster in these pages, but a quick refresh: In April 2020, Judge Isgur confirmed the debtors’ plan with a few extinction-level-event-sized TBDs, including pending litigation over the validity of prepetition secured lenders’ liens and the resulting allocation of reorganized equity.

But hey, a mediated, consensual plan deal – even a plan deal that doesn’t resolve typical, you know, plan stuff like who will own the reorganized debtors – sure beats no deal at all! And you can’t question the nous of the mediator who helped the parties come to terms on the unique “confirm and fight over everything later” structure: Judge Isgur’s trusted then-colleague on the complex panel: Judge David R. Jones.

Did Jones’ secret paramour Liz Freeman of Jackson Walker represent the debtors in the case? Yes! Did Jones himself ask to get involved in the case, despite a lack of any formal request for mediation, allegedly to save Jackson Walker from litigating a contested confirmation hearing despite a fee cap? Yes!… allegedly.

Why is the complex panel still a thing at this point, given all that we know? No idea. The Fifth Circuit and the district courts overseeing the SDTX certainly act like the panel needs to be eliminated and are taking the only action they can: nuking the entire site from orbit, one caustic reversal at a time. We’ll get to the latest Wesco decision soon, but like seemingly every other appeal from the SDTX these days, it spared no punches.

In addition to leaving the central issue of who owns the reorganized debtors open for years of litigation (and sketchy LME-style maneuvering, and fights over litigation funding), the mediated plan did not resolve disputes between the debtors and their midstream counterparties, the folks who transport hydrocarbons from the wellhead to the distribution system via some very expensive pipes, pumps and whatnot.

We discussed this fight in detail in June 2022 – yes, two years after confirmation and more than three years ago. The debtors felt that they were overpaying midstream parties to remove product from the field, so they threatened to reject all of their midstream agreements – a nuclear option that would make the midstream counterparties’ investments in gathering equipment worthless but also leave the debtors carrying natural gas out of the field in wheelbarrows, surplus Blue Rhino cans and such. Typically oil and gas folks will go to great lengths to use a pipeline instead.

Well, the debtors threatened to reject most of their midstream agreements. Under the plan, the debtors listed for assumption a prepetition takeoff agreement for the Comanche field with Carnero G&P, a joint venture owned 50% by Targa and 50% by nondebtor affiliate Sanchez Midstream Partners, or SNMP. Note that this is a backup takeoff deal – essentially, assuming this agreement gave the debtors a fallback if they could not negotiate cheaper takeoff rates with primary Comanche midstream counterparties like Occidental and Western Midstream after emerging.

In October 2021, the reorganized debtors announced a midstream deal with Oxy and Western Midstream to resolve the potential rejection of their primary takeoff contracts for the Comanche field. Judge Isgur approved that deal in December 2021, and under the plan, that approval applied retroactively to the effective date of the plan 18 months earlier.

Meanwhile, Carnero got word of the revised Oxy/Western takeoff deal, which would have rendered its backup takeoff deal considerably less lucrative. This being the oil patch, they did the logical thing: In August 2021, they sued the reorganized debtors in Texas state court, arguing the new Oxy/Western deal breached the prepetition agreement that was actually assumed on the effective date.

The case then ping-ponged painfully between state and federal court until in February 2023, Judge Isgur ruled in favor of the reorganized debtors on the merits of Carnero’s claims and ordered Carnero to pay the defendants’ attorneys fees – a pretty extraordinary abrogation of the “American rule” that all parties bear their own costs, especially from a bankruptcy judge. Basically, Judge Isgur thought Carnero’s position was absurd.

Make your own call on what was actually absurd. According to Judge Isgur, Carnero wasn’t actually suing the debtors for breach of the prepetition agreement – instead, it was objecting to the assumption of its prepetition backup agreement in light of the new Oxy/Western agreement, since the latter related back to the effective date of the plan (which was also the effective date of assumption).

To Judge Isgur, it was not only reasonable but obvious that Carnero couldn’t object to assumption of its prepetition backup agreement years after confirmation, even though the grounds for the “objection” – the new Oxy/Western agreement – did not exist at confirmation.

Effectively, Judge Isgur felt that Carnero was obligated to raise its hand prior to confirmation and make clear that it objected to any post-“emergence” settlements with other Comanche midstream parties that might, someday, interfere with its rights under an agreement explicitly assumed under the plan.

Carnero could not “strategically choose to not exercise its bankruptcy rights during the bankruptcy case and later reframe an objection to the assumption of a contract” – which was being assumed! – “as a post-petition claim for breach.”

This sure seems absolutely bonkers. To conclude that Carnero was really objecting to assumption of its prepetition agreement, you would have to deny the reality of space and time, construing the prepetition Carnero agreement and the Oxy/Western agreements to have taken effect simultaneously, even though the latter would not exist for another 18 months.

But to Judge Isgur, this all made perfect sense – the prepetition Carnero and Oxy/Western agreements were assumed, under the plan assumption magically related back to confirmation, and Carnero should have said something at confirmation to protect itself.

“Even though the Existing Commitments” – the prepetition Oxy/Western agreements – “were amended in the bankruptcy process, they retained their prepetition nature by the express terms of the Plan,” the judge wrote. “Therefore, Carnero’s timeline where the Carnero Agreement exists and then the defendants breached the Carnero Agreement by entering into the Midstream Restructuring belies this Court’s order confirming the Plan” (emphasis added).

See what he did there? “Carnero’s timeline” – basic chronological order, right? – conflicts with the plan, and the plan prevails.

The district court affirmed, but of course the Fifth Circuit absolutely savaged Judge Isgur’s decision. First, the panel (Circuit Judges Edith H. Jones of earlier Sanchez decision fame, Carolyn Dineen King and Long-Time Friend of the Show Andrew Oldham) found that Judge Isgur lacked jurisdiction to even consider disputes among nondebtors regarding the effect of what they clearly saw as brand new Oxy/Western agreements approved 18 months after confirmation – whatever the plan said about retroactive effect.

“Bankruptcy jurisdiction does not last forever,” Judge Jones says. After confirmation, bankruptcy court jurisdiction terminates except for matters pertaining to the implementation or execution of the plan – no matter how much reorganized debtors may “perceive advantage in returning to the bankruptcy court’s protective womb” (emphasis added).

Next time some debtors’ counsel tells you the whitewashed reason why they fight so hard for certain venues and to keep fights in bankruptcy court, you can accuse them of attempting to return to the womb, a real dagger if they do the Freudian thing.

The Oxy/Western agreements were not, in fact, prepetition agreements because they “did not exist until eighteen months post-confirmation,” according to Judge Jones. Even if some part of the agreements predated the bankruptcy, the judge adds, they were assumed on a revised basis because the reorganized debtors “made deals to restructure all the midstream relationships and lower [their] midstream costs.”

The new Oxy/Western deals were a “post-bankruptcy confection” – sounds delicious! – that significantly modified pre-bankruptcy relationships, Judge Jones continues. The new agreements were a “fullscale revision of Sanchez’s midstream gathering, processing, transportation and marketing agreements in the Comanche Field,” made possible because of post-confirmation facts – a rebound in the price of Comanche field hydrocarbons – that enabled Mesquite to settle with the midstream providers on more favorable terms.

As for Judge Isgur’s argument that Carnero waived its claims because it failed to object at confirmation, well: “That any party in a bankruptcy would have to object to a debtor’s post-confirmation bargains sight unseen, eighteen months before they were achieved, seems ludicrous,” Judge Jones concludes. Slow clap.

So, first lesson from this decision: The Fifth Circuit still hates everything coming out of Houston, or at least everything coming out of Judge Isgur’s chambers. Second: Bankruptcy debtors have a limited amount of time to “return to the bankruptcy court’s protective womb” after emerging, even if, like Sanchez, they only “emerged” in an extremely technical “the plan is confirmed, but everybody is going to keep fighting” sense.

Third, the Galaxy Brain Take: Once again, the Fifth Circuit has stressed that bankruptcy judges need to recognize reality. Doesn’t seem too radical, except this is now the second time in less than 12 months the Fifth Circuit has felt it necessary to remind the Houston judges of this.

We are thinking here of the panel’s instruction in Serta that bankruptcy judges must look behind the language of the plan and consider the reality of what distributions are worth to individual creditors when determining whether similarly situated creditors are receiving the requisite “equal treatment” under a plan? And the district court’s reinforcement of that concept when considering backstop goodies in ConvergeOne, which relied on Serta?

Appellate courts – at least the Fifth Circuit – seem intent on dispelling the atmosphere of hyper-technical unreality they see in mega-case bankruptcy venues. We have warned about this before in a number of contexts.

We welcome the new reality-based bankruptcy jurisprudence coming out of the Fifth Circuit! Maybe someday soon they’ll get around to requiring that bankruptcy judges take the reality of liquidation analyses seriously, too. Why that specific issue, you ask? Read on!

Fiction Can Be Fun

Regular readers know we are big fans of Judge Craig T. Goldblatt’s typically rigorous and thoughtful approach to deciding contested issues in big chapter 11 cases. However, even Friends of the Show must come in for criticism when due, and Judge Goldblatt’s curious decision confirming the Yellow debtors’ fourth amended plan – delivered via oral ruling on Nov. 17 and a follow-up written opinion on Nov. 25 – has us scratching our heads.

We’ve talked about the Yellow case a number of times, as Judge Goldblatt has spent the past two-plus years resolving claims and settlement issues that rarely come up in big chapter 11 cases. The case is unusual because all of the funded debt claims have been paid in full, leaving a huge pile of rapidly shrinking cash for unsecured creditors and even – potentially – shareholders to fight over.

One major shareholder, MFN, objected to confirmation of the debtors’ “simple” waterfall fourth amended plan on two principal grounds. First, MFN opposed the plan’s liquidating trust governance provisions, which would give three members of the official committee of unsecured creditors – including one union litigation target and a multiemployer pension plan, or MEPP, claimant – seats on the liquidating trust oversight board.

According to MFN, allowing UCC members to control the liquidating trust board is equivalent to putting the “fox in charge of the henhouse.” MFN fears that the UCC members are likely to push the liquidating trustee to settle objections to the MEPPs’ claims and to settle the estate’s recently resurrected $1.5 billion suit against the Teamsters on unreasonably friendly terms, diluting other creditors’ recoveries and eliminating any recovery for equity (e.g., MFN).

As evidence of this, MFN points to the debtors’ and committee’s now-abandoned third amended plan, which proposed settlement amounts for the MEPP claims that MFN characterized as “grossly inflated” and “unconscionable” in an April 29 motion to convert the cases to chapter 7. According to MFN, the excessive settlement amounts in the third amended plan, though now mooted, evidence that the debtors’ and UCC’s “fiduciary compasses” are broken, and they cannot be trusted to handle the ongoing claims objections or the Teamsters suit post-emergence.

The debtors and committee took the sting out of this objection by agreeing that settlements of the MEPP claims or the Teamsters litigation would be presented to Judge Goldblatt for approval, effectively taking the issue out of the oversight board’s hands. Judge Goldblatt made clear before confirmation that he felt this was a reasonable compromise, leaving as the main fight MFN’s second objection: that the plan does not satisfy section 1129(a)(7)’s “best interests” test.

The “best interests” test requires that a plan either be accepted by creditors and interest-holders or provide rejecting creditors and interest-holders with value equal to or greater than “the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7 of this title on such date.” Check out our excellent RX 101 article on confirmation basics for a deeper dive.

The idea is that the plan must add some value for creditors and equity above liquidation in chapter 7 – direct statutory evidence for our view that confirmation of a plan, any plan, is not the default conclusion to chapter 11 cases. We’ll add that in other countries – where laws are allowed to be amended more than once a quarter century – the test is more flexible and measured against the “relevant alternative,” but anyway.

Generally, U.S. debtors satisfy the best interests test by providing a liquidation analysis in their disclosure statement that shows recoveries under the plan exceed recoveries in a hypothetical chapter 7 liquidation, with an explanation of the assumptions that support the conclusion. Sometimes this is as crass as saying, “We’re ready to distribute cash now, and chapter 7 will cost more because of chapter 7 trustee fees.”

Other times debtors ensure compliance with the best interests test by assuming that recoveries under the plan are greater than in chapter 7 – usually because under the plan, senior creditors (typically secured creditors) are giving up some value to unsecured creditors or interest-holders that would otherwise be out of the money.

This couldn’t be done in the Yellow case, since there would be no “vertical” gift by a senior class to a junior class. The committee could have agreed that unsecured creditors – the remaining senior class – would peel off some recovery for equity from their distributions and then tried to establish that equity would get less in chapter 7, but it chose not to do so.

The plan did provide for a sort of horizontal gift – full payment of approximately $50 million in general unsecured convenience class and employee claims – but that would come from other general unsecured creditors, meaning it actually hurt the debtors’ case for satisfaction of the best interests test. In a chapter 7 case, those preferred creditors would have to share with everyone else.

The $50 million became a hurdle that the debtors would have to satisfy: Anything less than $50 million saved through the plan versus chapter 7 was not enough to pass the best interests test.

What is more, without a vertical gift, a given pile of value – here, about $700 million in cash from the debtors’ liquidation remaining after payment of funded debt claims – can only be divided by taking the value available (the numerator) and dividing it by creditors’ allowed claims (the denominator), and then doing the same with equity for any remainder.

The numerator and denominator would theoretically be very similar in chapter 11 or chapter 7 – so the debtors had to come up with something novel to satisfy the best interest test, especially considering that full payment gift to convenience and employee claims.

First off, they declined to provide any liquidation analysis in the disclosure statement. Instead, they waited until MFN objected on best interests grounds and provided the testimony of financial advisor Brian Whittman of Alvarez & Marsal, as summarized in a spreadsheet produced in discovery. We still haven’t seen that spreadsheet, which would sure be nice! But we were able to glean the debtors’ approach from arguments of counsel at the confirmation hearing.

Whittman did the typical nibbling at the edges of the liquidation analysis – for example, decreasing the chapter 7 numerator by adding additional chapter 7 administrator expenses like the trustee’s 3% statutory fee. Those nits didn’t swing the analysis, so Whittman had to try something novel.

The key assumption that allowed Whittman to conclude general unsecured creditors would recover more under the plan was a real whopper: Whittman assumed that allowed claims would increase by approximately 20%, or more than $200 million, in chapter 7, dramatically pumping up the denominator and therefore reducing the percentage recovery for general unsecured creditors.

His reasoning: When a case is converted to chapter 7, a new claims bar date is created, allowing claimants who missed the chapter 11 bar date to file timely claims. According to Whittman, that would happen in a very big way if the Yellow case were converted, even though the case had already been pending for more than two years and there was no evidence a big stampede of new claims would be filed after conversion.

MFN of course went after that 20% new claims “fudge factor” hard, arguing that there is no way that many new, valid claims could possibly be asserted against these debtors if the claims bar date is reopened. According to MFN, if this new claims assumption was reduced even a little, there was no way the best interests test was satisfied at three of the debtors – meaning, at a minimum, their cases would have to be converted.

MFN also argued that the liquidation analysis used illusory allowed claim amounts to determine the denominator for distributions. MFN argued, and the debtors’ witness confirmed, that the debtors had reached a “notional settlement of the pension plan claims,” as the judge put it in his written opinion.

MFN argued that the anticipated inflated settlement amounts should be used when calculating the best interests denominator under the plan, not the lower amounts, as calculated by MFN. This would increase the denominator on the chapter 11 side of the ledger, making it more difficult for the debtors to hit the best interests test.

Here’s the funny thing: In both his oral ruling on Nov. 17 and his written opinion on Nov. 25, Judge Goldblatt largely agreed with MFN on both points – yet went ahead and confirmed the plan at every debtor.

First, Judge Goldblatt concurred with MFN that the 20% new claims “fudge factor” was ridiculously high. “Perhaps in a mass tort case in which the claims pool can be notoriously elastic, there could be reason to believe that a new bar date might attract creditors that did not file proofs of claim in the chapter 11 case,” the judge said in his opinion. However, “this is not such a case.”

Instead, the judge assumed, for purposes of his own liquidation analysis, that the allowed claims pool would increase by only 5% – well below the threshold at which the debtors’ calculation would satisfy section 1129(a)(7).

Second, Judge Goldblatt acknowledged that the debtors were very likely to settle the MEPP claims quickly if the plan were confirmed, pointing to that “notional settlement” with the MEPPs. But instead of accepting MFN’s argument – that the notional settlement amounts should be used to calculate the anticipated recovery under the plan for best interests purposes – Judge Goldblatt used it to fashion an entirely new assumption that would allow him to confirm the plan.

According to the judge, “the appointment of a chapter 7 trustee” would scotch these settlements and “cause the extensive and expensive litigation that has marked these chapter 11 cases to go on for substantially longer – perhaps as much as 18 to 24 months longer than it would if the Court confirms the plan,” at an assumed $3 million per month burn rate.

Here’s Judge Goldblatt’s final analysis, with the $50 million in the last row under “Additional litigation expense beyond 3%” (the chapter 7 trustee’s statutory fee):
 

The judge says in his written opinion that, based on his experience with “61 chapter 7 business cases, 15 of which were cases originally filed under chapter 11 but later converted to chapter 7,” a chapter 7 trustee might drop the settlements and “engage in substantial high-stakes litigation with a view towards hitting a home run and returning value for equity.”

In other words: Judge Goldblatt assumed that a chapter 7 trustee would see a pile of $700 million in cash lying around and go all “Brewster’s Millions,” spending as much as he or she could rather than just picking up the debtors’ pending deals with the MEPPs, finalizing them, getting those claims allowed and distributing it. The judge put the assumed trustee burn rate at $3 million per month for 18 months and subtracted $50 million from the chapter 7 numerator, allowing the debtors to get past the best interests hurdle by the skin of their teeth.

We applaud the realpolitik here, but it does take a really dim view of the folks on the Delaware chapter 7 trustee panel, which the judge acknowledged and attempted to mollify. “That is not to suggest that the chapter 7 trustees in this district are not serious about their fiduciary duties to the estate,” the judge noted, but “reflects the reality of human nature that professionals have a way of persuading themselves and their clients that protracted and expensive litigation makes sense even in circumstances when a more sober assessment would counsel otherwise.”

Crucially, for us, is the fact that the parties didn’t even touch on this $50 million issue. The debtors, who bore the burden to show the plan passed the best interests test, did not present any evidence whatsoever regarding the likelihood that a chapter 7 trustee would go crazy running up fees when presented with a large pile of cash. Nor did the debtors provide any evidence regarding “human nature.”

Judge Goldblatt, being a relatively conscientious jurist, acknowledged that his new assumption that a chapter 7 trustee would treat the estate like a cash grab game “is a prediction about the future, and one that cannot be proven to be correct or incorrect based on information that is available today.” How convenient.

Of course a chapter 7 trustee fresh from handling hundreds of no-asset cases at a couple hundred bucks a pop might go a bit overboard when handed the keys to a multi-hundreds of millions of dollars war chest. But $50 million in fees? To achieve the exact same results in terms of assets and claims? That seems as fudged as the 20% new claims figure the debtors espoused.

Maybe we might agree with Judge Goldblatt if the plan itself had some mechanic or feature that made an MEPP settlement that avoided all those future fees more likely. The judge seems to have assumed it did: “The plan now before the Court sets the parties on a path towards resolution of the most important disputes,” he said in his opinion.

But that is patently untrue: Nothing in the plan puts the parties on a path toward resolution of anything. It’s a simple waterfall plan that sets up a liquidating trust that could decide to litigate just as hard as this hypothetical greedy chapter 7 trustee. There isn’t some special provision in there that facilitates settlement of the MEPP claims, or creates some forum for them to be resolved more quickly and cheaply.

What happened after Judge Goldblatt issued his confirmation ruling makes it seem all the more ridiculous: on Nov. 26, the day after the judge issued his written opinion, the debtors filed a motion to approve those claims settlements with the MEPPs, and, according to MFN, at least, the allowed MEPP claims are dramatically higher than the amounts plugged into the denominator in Judge Goldblatt’s liquidation analysis.

Now, we haven’t presided over “61 chapter 7 business cases, 15 of which were cases originally filed under chapter 11 but later converted to chapter 7.” Nor are we experts at the character of Delaware chapter 7 trustees, or human nature in general. But it is at least plausible that the debtors agreed to settlements with the MEPPs prior to confirmation, held them back so they could use lower claim figures when computing the chapter 11 denominator for the best interest test to get the plan confirmed and then unveiled the real numbers after a confirmation order was entered.

Why did everyone go forward with confirmation, with an expensive contested evidentiary hearing leading to a dicey opinion based on a very foggy assumption that the debtors themselves declined to advocate, when the real issue – the allowed amount of those MEPP claims – was set to be teed up almost immediately thereafter?

Again, we endorse Judge Goldblatt’s approach generally, but: This is some serious vibes-based Houstonfornication. Imagine how the Fifth Circuit would view this kind of ruling if it came from Judge Isgur.

Of course, MFN counsel argued at a status conference on Dec. 5 that the proposed claim amounts in the settlement are “beyond what we think is reasonable under any standard.” So now we will have tens of millions more in attorneys fees, burning more of that pile of cash, after going through a confirmation process that was supposed to forestall that burn, at least somewhat.

The MEPP settlements are set for hearing on Jan. 21. In a Houston case, we’d assume they are going to be approved because business judgment, but we count on Judge Goldblatt to be true to his oath and take a careful look.

The little devil on our left shoulder is whispering into our ear: This is why Houston gets all the big cases. If this one had been filed in Houston, it might have been over long ago – the complex panel judge would have provided some “preliminary impressions,” and the parties would have reached a quick deal and gotten the hell out of chapter 11. That’s not (really) our problem. We aren’t legal process zealots when it comes to this stuff. The problem in Houston is all the preliminary impressions always seem to go one way and that setup can’t promote good-faith deals to get the hell out of chapter 11.

We know we’re asking for a goldilocks perfect balance here and we’re not ready to toss Judge Goldblatt’s approach entirely. But this case sure could have used some common-sense predictability, at least when sequencing confirmation and the claim settlement disputes. Simply telling the debtors that confirmation would not proceed until they put the settlements everybody knew they had in hand on file would have been enough to avoid the whole sloppy shebang.

Signs of Progress

Speaking of Houstonfornication, how about Judge Lopez having a come-to-Jesus due process moment in the Pine Gate Renewables case? At a first day hearing on Nov. 10, Judge Lopez decided that approving a DIP with an astounding 5.6-to-1 rollup ratio on the first day might be a bit much.

Yeah, we’d love to see the complex panel set down some rational limits on what they will allow debtors and DIP lenders to get away with, but, hey, sometimes you gotta start at the extremes and work your way toward sanity.

Pine Gate filed on Nov. 6 with a plan to sell three distinct business silos to each of the three secured lenders that funded the silos. On Nov. 7, the debtors filed a motion seeking approval of a $1.65 billion DIP from the three lenders featuring only $250 million in new money and a rollup of $1.4 billion of prepetition debt on a dollar-for-dollar basis. That’s where we get that 5.6-to-1 rollup-to-new-money ratio (the debtors had some different math, see below).

The DIP also includes a commitment fee of 4% of the new money, an exit fee of 8% of the new money and a prepayment premium to ensure the lenders receive an MOI, of 1.3x on the new-money commitments. Basically, and rationally from their point of view, the lenders wanted to make very sure they would cash out handsomely if someone outbid them, which seems unlikely considering the assets – renewable energy projects – have been for sale for some time, and renewables are not exactly a hot commodity right now.

This was a divorce / split-up of the company’s assets that was negotiated prepetition, and the main risk now was monkey business. The DIP was designed to prevent any monkey business.

Aggressively, the debtors sought approval of the entire rollup on an interim basis at the first day hearing, which fell the Monday after the filing – and the debtors were prepared for a bit of resistance, even from the always-accommodating complex panel. According to the debtors, the rollup was really only 3-to-1, since they had advanced the debtors $232 million in new money via a prepetition bridge loan linked to the chapter 11 filing. $232 million plus $250 million = $482 million, $1.4 billion rollup = 2.9-to-1.

Here’s a problem with that argument: the $1.4 billion rollup would include a partial rollup of the bridge loan. You can’t add the prepetition new money to the new money being made available via the DIP if the prepetition new money is going to be refinanced immediately. That’s not new money.

Debtors love to characterize DIP proceeds specifically earmarked for refinancing prepetition debt as “new money” – but new money arguably should mean DIP proceeds available for operations and chapter 11 expenses, folks. We also shouldn’t include DIP proceeds for payment of interest on prepetition debt (e.g., adequate protection payments) as “new money,” either, but anyway.

The important thing to keep in mind is that the debtors probably expected one of the Houston complex judges to buy that argument and approve the rollup on the first day, if only to avoid immediate conversion to chapter 7 and liquidation blah blah blah, the “parade of horribles,” you know how this works. BUT: To their surprise and ours, even Judge Lopez has limits.

Judge Lopez told the debtors he felt even a 3-to-1 rollup ratio was “too rich” under the circumstances and indicated he might approve a 1.25-to-1 interim rollup ratio. The judge stressed that no official committee of unsecured creditors had been appointed yet, and due process requires that they be allowed to consider and object to such a large rollup and are we taking crazy pills here?

Judge Lopez also punted part of the debtors’ proposed bid procedures – specifically, the bidding protections for the lenders as stalking horses – a week to allow for UCC appointment. Judge Lopez acknowledged that the “normal ask” for bid protections is typically “much higher,” but the issue is not the amount of the expense reimbursement but “due process,” and “you can’t put a price on that.”

At this point, as predicted by the debtors, the lenders stomped out of the courtroom, called in the bridge loans and refused to provide the DIP financing because the rollup was an integrated part of the financing package. Ha, you know better: They took a break and quickly agreed to interim approval of a 1.25-to-1 rollup.

Under the bid procedures order, the sale transactions must close by Dec. 31. So the DIP would fund less than two months of operational and chapter 11 expenses, and the lenders would cash out their DIP loans within two months. What difference would it make to the lenders if they rolled up $1.4 billion or $1 billion or $500 million? They can credit-bid their prepetition secured claims, after all.

That sound you hear is First Brands DIP lenders washing this last paragraph down with a straight-from-the-bottle chug of tequila.

Probably, the whole DIP was gratuitous as well as egregious. Sure, we would have liked Judge Lopez to recognize the former as well as the latter in refusing to approve it, but we’ll take what we can get. A Houston bankruptcy judge called the debtors’ and lenders’ bluff, and the sky did not fall. Maybe all that abuse from the Fifth Circuit is finally getting through!

On Dec. 8, the debtors announced a global deal with two of the lenders and the newly appointed UCC, clearing the way for the asset sales. All’s well that ends well! Hopefully this sets a precedent for the Houston judges to call B.S. on more of these bogus DIP “deals,” though we won’t hold our breath.

Editors’ Note: Now that Judge Lopez is calling foot faults like he’s in Delaware, the Fifth Circuit will not let a Houston bankruptcy opinion stand and the funny wig crew in England is solving all our problems, is it time for Kevin to put Joni Mitchell (or, even better, Counting Crows) on repeat and fret about not knowing what he had till it’s gone? Stay tuned…