Article/Intelligence
Court Opinion Review: Bankruptcy Tactics Struggle in Citgo Sale Proceeding, Futile Disclosure in Incora/Wesco, Yellow Pension Claims Ruling
Reorg’s 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 Reorg as a whole. Today, we consider an attempted “parade of horribles” in the Venezuela/Citgo sale proceeding, another dubious disclosure approval in Incora/Wesco and Judge Goldblatt’s Pension Claims Ruling in Yellow.
Valuable lesson for bankruptcy folks from the Venezuela/Citgo forced sale proceeding: Do not bring your weak sauce “parade of horribles” to a federal circuit judge lest you want it to end up in the third row a la Mutombo (RIP, sigh). Counsel for the sale special master and “winning” bidder Elliott learned this lesson the hard way.
Background: For the last decade, various creditors of the Bolivarian Republic of Venezuela have pursued the nation and its asset-rich state owned oil company, Petróleos de Venezuela SA, or PDVSA (pronounced Peh-duh-vay-suh, to save you from embarrassment at the next bar function), in the courts of the Washingtonian States of America, seeking compensation for various anti-capitalist misdeeds of the Hugo Chavez/Nicolás Maduro regime.
After securing judgments piercing the corporate veil of the republic to reach PDVSA, the creditors set up a sale proceeding in the Bidenian State of Delaware to foreclose on PDVSA’s main U.S. asset: its shares in PDVH Holding, a Delaware entity. Why would anyone want to buy ownership of PDVH? PDVH is the entity that holds all of the shares in Citgo International – a gas station/refinery/distribution operation that seems to be worth billions despite losing its most valuable asset.
At every stage the republic – which in this context is actually the various iterations of government-in-exile stemming from Venezuela’s political crisis, not the actual Maduro regime that, you know, runs the country – has tried to stymie and delay the sale. Our favorite: insisting on a Delaware court ruling that PDVSA’s physical share certificate for PDVH cannot be produced, because it is probably in Maduro’s desk drawer.
In October 2023, Judge Leonard Stark set a July 15, 2024, tentative sale approval hearing. In April, the special master appointed by Judge Stark to oversee the sale set a final bid deadline of June 11. On July 2, Judge Stark kindly allowed the special master to push the sale hearing to Sept. 15 to tie up a few loose ends while warning him this would be a “real date.”
But there is no such thing as a “real date” to bankruptcy lawyers, and the special master is, in fact, represented by bankruptcy lawyers (which will become even more obvious in a moment). On Aug. 1, the special master requested a continuance of the sale hearing to Oct. 15, with the winning bid to be announced on Aug. 22. Judge Stark granted the request and pushed the hearing to Oct. 30, thereby inviting even more shenanigans. In the meantime, Judge Stark was sworn in to his new job on the Federal Circuit in D.C.
As you know, nothing can ever be simple with this many lawyers involved – every firm and fund with a claim against Venezuela has its own lawyers working on what has been a never-ending jockeying for position in the sale proceeds waterfall. The first complication: What to do with billions in PDVSA 2020 bonds claiming a lien on PDVH’s shares in Citgo? According to the bondholders, in 2016 PDVSA exchanged its 2017 notes for new 2020 notes secured by a pledge of 50.1% of the equity in Citgo Holding held by PDVH. The republic and PDVSA maintain that the lien is invalid under Venezuelan law and the federal “act of state” doctrine.
The bondholders do not claim a lien on PDVSA’s shares in PDVH – the assets being sold in the Delaware court – but obviously a lien on PDVH’s shares in Citgo, the real asset, could have a somewhat deleterious effect on the sale price.
In October 2020, District Judge Katherine Failla entered a $1.68 billion judgment in favor of the bondholders that the republic and PDVSA duly appealed to the Second Circuit. The Second Circuit certified the choice of law issue to the New York Court of Appeals, and the dispute remained live when Judge Stark entered his order kicking off the sale process in July 2023. There being many, many expensive lawyers involved, you would think they made some provision for the 2020 bondholders’ claims in the May 2022 sale process order and July 2023 kickoff order, and you’d be right.
In his July 2023 order, Judge Stark specifically brushes off concerns about starting the sale process while the 2020 bondholders litigation was ongoing – based on the special master’s very own brushing off of such concerns. The republic and PDVSA objected to starting the sale process because of the 2020 bondholder appeals but, according to the judge, the special master’s investment banker Evercore expressed “confidence” that bidders “will be fully capable of valuing the PDVH Shares and the CITGO operations agnostic to capital structure,” including a potential lien securing the 2020 bonds.
Ah, the dreaded vote of confidence. Keep that in mind. We’d add that – while we aren’t charging $3,000 an hour – just keeping track of the process here (let alone the actual economic merits/value) has been pretty taxing on our end. Anyway, by all accounts, every development in the 2020 bondholder litigation has gone the special master’s way since July 2023. In February, the New York Court of Appeals concluded that Venezuelan law governs the validity of the bondholders’ lien, and on July 3 the Second Circuit vacated the bondholders’ judgment and remanded to Judge Failla. So, there’s one problem down!
Problem #2: Gramercy, way down at the bottom of the waterfall priority list approved in the Delaware court, decided to get clever and bring alter ego claims to recover its PDVSA claims from PDVH. Basically, Gramercy tried to pull the same move as the 2020 bondholders: by asserting claims against PDVH’s assets (e.g. the Citgo shares), it could generate some holdup leverage by jeopardizing the value of the PDVH shares in the sale.
This should have been utterly predictable when the sale process began. If the 2020 bondholders could use claims against PDVH to manufacture leverage in settlement discussions with the special master as part of the sale process, then so could anyone else with a claim against PDVSA. Even if the special master didn’t see Gramercy’s maneuver coming, surely the same assurances provided with respect to the 2020 bondholders’ litigation would apply: Sophisticated bidders would consider the risks of a lien on PDVH’s assets when pricing their bids for the PDVH shares.
But bidders clearly were not willing to take on the risk of the 2020 bondholder and Gramercy alter ego claims, contrary to the special master’s assurances – at least at the price the special master wants. On Sept. 9, the special master asked Judge Stark to enjoin the Gramercy alter ego suits, asserting they are a direct threat to the sale process. “If successful, the Alter Ego Claimants will dramatically reduce the value of the PDVH Shares available to other creditors for their sole benefit,” the special master argues.
According to the special master, the alter ego suits “create a cloud of uncertainty over the PDVH Shares and thereby threaten to inhibit the Special Master’s ability to close a value-maximizing sale transaction and fulfill his mandate, since bidders are reasonably concerned about the risk that creditors will later lay claim to the assets the bidders are seeking to purchase.”
Well, that seems like a pretty dramatic volte-face from July 2023, huh? Apparently these Gramercy alter ego claims are so unique and dangerous – at least compared with the 2020 bondholder claims – that the special master can no longer “express confidence” that bidders “will be fully capable of valuing the PDVH Shares and the CITGO operations agnostic to capital structure.” Suddenly, these alter ego claims – which, arguably, are nothing more than less crystallized versions of the 2020 bondholders’ liens – are an existential threat to the sale.
And what is the legal basis for the stay motion? The hoary All Writs Act, which we alluded to back in March 2023. In case you are unfamiliar: The All Writs Act is section 105(a) of the Bankruptcy Code for Article III courts, complete with the same “if you are citing it, you’ve already lost” reality.
This is your clue as to what is really going on here: The special master’s bankruptcy counsel has gotten confused and run home to mama. If you’re programmed to do bankruptcy and encounter an obstacle, your natural inclination will be to try a solution you are familiar with, from bankruptcy.
This inclination seemed confirmed on Sept. 27, when the special master finally filed the “winning” bid: an offer from an Elliott affiliate at a $7.3 billion valuation. Sounds great, except: The bid requires the special master to escrow the purchase price for payment of the 2020 bondholders’ claims and any alter ego claims against PDVH. Surprise! The bid is most definitely not “agnostic as to capital structure.” We’ve seen this play before. The special master also refused to file an unredacted version of the purchase agreement or provide it to creditors – another classic bankruptcy move.
Even more chapter 11, the Elliott bid is explicitly conditioned on Judge Stark granting the special master’s motion to halt the alter ego claims. If that doesn’t happen, then Elliott supposedly walks. Sound familiar? Here we have the classic bankruptcy parade of horribles: Your honor, if you don’t approve this questionable sale provision/DIP rollup/backstop premium/nondebtor release, then everything falls apart. How convenient!
In its opposition, Gramercy made the perfectly cromulent point that the special master is selling PDVSA’s shares in PDVH, Gramercy is chasing PDVH’s shares in Citgo and hey, those are two different things, only one of which is subject to the Delaware proceeding. Sure, there might be an effect on the bidding, but sophisticated bidders can price that, right? Have to say we appreciate Gramercy’s move here – they seemed to have anticipated bidders’ reaction to their strategy and played it well to get some value out of the sale.
After all, if the Citgo station in Wilton, Conn., explodes, killing hundreds of gym-goers at the nearby YMCA, wouldn’t that also affect the value of the PDVH shares? Would the Delaware court have the authority to halt that suit and force the plaintiffs to litigate in Wilmington, or wait five years and go through a mandatory alternative dispute resolution process before finally getting their day in court? That’s ridiculous, unless you are a bankruptcy lawyer or bankruptcy judge, in which case it makes perfect sense and is the only prudent course of action.
(Ironic note: Among the signatories to Gramercy’s opposition brief is one Robert Drain of Skadden. According to the brief, “[B]ankruptcy courts lack jurisdiction even under the broad reach of 28 U.S.C. § 1334(b) over the subsidiary’s assets absent an established alter ego relationship.” That must have hurt.)
Judge Stark – again, a judge on the Federal Circuit, not a bankruptcy judge – seemed pretty perturbed by all this at the Oct. 1 hearing on the special master’s motion. Special master’s counsel from Weil came out reading the same script that must have worked a dozen times before Judge Drain – the tentative agreement with Elliott is “essential to maintaining positive momentum,” ugh – but Judge Stark seemed unconvinced, asking counsel to clarify exactly why this is so critical now.
Counsel for the special master responded that concerns about the alter ego claims did not “crystallize” until Gramercy sued PDHV, which, huh? Again, these are the same type of claims the 2020 bondholders had, except weaker because they do not involve a consensual lien. Meanwhile, several judgment creditors absolutely unloaded on the highly contingent Elliott offer and openly questioned whether Elliott would actually walk if the alter ego claims were allowed to proceed elsewhere. We will try to contain our amusement.
Judge Stark kindly declined to outright deny the special master’s motion, but made clear that he intends to allow Gramercy full due process – including a possible evidentiary hearing. More briefs will be filed, momentum be damned. Even if the judge eventually grants the motion, it appears that will happen on the merits, not because the bankruptcy lawyers said it has to happen now. The parade has come to an abrupt halt.
Back in May we expressed our frustration at bankruptcy judges approving disclosure statements for placeholder plans with zero chance of confirmation in the context of the WeWork case. We suggested that instead of approving disclosure for a hopeless plan to create “dynamic pressure” for settlement, judges should simply impose a deadline to reach agreement on a plan. Of course, no one took us up on this.
We think the suggestion needs a rehearing. Why? On Sept. 5, Judge Marvin Isgur approved a disclosure statement for an Incora/Wesco plan that he himself described as “one-sided” and “nonconfirmable” at the disclosure hearing.
But this is not even the first time Judge Isgur approved a pointless disclosure statement for a possibly unconfirmable plan in this case. In early January, Judge Isgur approved a disclosure statement for the debtors’ original plan, which assumed the validity of the company’s 2022 uptier exchange, while litigation over the validity of the transaction was pending. Sure, former judge David R. Jones also did that in Serta, but he knew (and we knew) he was going to validate the Serta uptier from the first day.
Judge Isgur did not seem to have made up his mind yet on the litigation. Unlike Jones, Judge Isgur denied motions for summary judgment on the 2026 noteholders’ most important contractual claims to invalidate the transaction and restore their liens, which if successful would render the original plan (and approved disclosure statement) a nullity. But hey, “dynamic pressure” for settlement.
That original Incora/Wesco disclosure statement did not even last as long as the uptier trial, which consumed 30 nonconsecutive days between January 30 and June 26. In late March, the debtors asked for approval of a disclosure supplement with new exit financing and take-back paper terms. Even if they couldn’t wait for the uptier trial to conclude, maybe, just maybe, the debtors should have waited to seek approval of the original disclosure statement until they had their exit financing ready?
Of course, on April 15 Judge Isgur approved the disclosure supplement for further solicitation on a plan that everyone knew might not survive the trial. And everyone knew the trial was not going well for the debtors. The judge also suggested that he was “running out of hope for a settlement” of the uptier dispute, which, then, maybe don’t keep approving disclosure statements until the uptier dispute is resolved? “Sometimes things just need a decision,” the judge remarked, which, LOL.
On July 10, Judge Isgur announced his ruling invalidating the uptier and restoring the 2026 noteholders’ liens, rendering the original plan, disclosure statement, disclosure supplement and voting a total waste of time and (allegedly) scarce debtor resources. The decision sent the debtors scrambling to cut a new deal with the uptier participants and the 2026 noteholders – which seems a tall order considering these litigants spent six months in trial.
But wait! Did peace break out after the decision? The debtors filed a new plan on Aug. 12 that attempted to reflect Judge Isgur’s ruling by splitting reorganized equity pro rata between the participants and the newly resecured 2026 noteholders while preserving the possibility of a re-reallocation on appeal. Eureka! At a status conference the next day, the debtors admitted that neither the participants nor the minority 2026 noteholder group supported the deal. Eh well.
Counsel actually said the plan had “the support of no one” and there was “still a fairly wide gap” between the litigants. In other words, yet another DOA plan. Well, surely they would simply leave that placeholder on the docket, for some reason. Why waste more time prosecuting a disclosure statement without the support of the two groups with a vote?
Reader, you know better. On Aug. 26, the debtors filed an amended version of the amended plan that still wasn’t supported by either side of the uptier fight and set another disclosure statement approval hearing for Sept. 5.
At this point you’d think Judge Isgur would put his foot down and tell the debtors to stop seeking approval of disclosure statements until they had a plan that had a snowball’s chance in hell of confirmation. You’d be wrong. On Sept. 5, Judge Isgur approved the disclosure statement for the latest futile plan, despite making clear on the record it was not confirmable and required significant “structural” changes.
Judge Isgur remarked that “I don’t want anyone to think I have even the slightest inkling” the latest plan is confirmable or “filed in good faith.” “It is so objectionable the way it is structured,” that the judge had “a visceral, bad reaction” to “the way that this was done.” Then he approved the disclosure statement.
The next day the debtors filed solicitation versions of the plan and disclosure statement, presumably as some kind of art piece about the hopelessness of consensus in a divided society or something.
Why did Judge Isgur approve yet another unripe disclosure statement? To maintain pressure for settlement, of course. Okay, but, that hasn’t exactly worked so far, right? The parties cannot even agree on what they are supposed to be negotiating – the uptier participants want a plan that gets the debtors out of bankruptcy quickly while preserving their appellate rights via a reorganized equity reallocation at some future date should they prevail. They are so insistent on not trying to reach a global settlement that counsel repeats a little script about needing a “Plan B” at every status conference.
Meanwhile, the minority group wants a final deal that ends all disputes, understandably wary of potential hijinks prior to reallocation a la Sanchez Energy. We definitely sympathize with that concern. We’ll even posit that the plan could very well be the debtors’ best attempt to articulate the practical effect of Judge Isgur’s uptier ruling.
But nobody thinks this exact plan is going to succeed at the end of the day. The concern for us is the continuing erosion of section 1125 of the Bankruptcy Code.
Back in May 2021, we lamented that the disclosure process required by section 1125 has become little more than an excuse for debtors to jam dissenting creditors with accelerated confirmation deadlines while preserving the right to provide essential terms or financial disclosures in a plan supplement days before the confirmation hearing. The process also encourages creditors to lodge early confirmation objections, forcing the debtors to respond to issues that often become moot when the plan is inevitably amended on the eve of confirmation.
The approval of a disclosure statement is supposed to be a watershed moment in the chapter 11 process: the point at which a plan is crystallized in its final form and submitted to voters with a concise summary of its terms for their consideration. Instead, the disclosure statement is now often a placeholder for a placeholder (or even patently unconfirmable) plan, approved solely to keep some tentative objection deadlines and hearing dates on the calendar so the parties feel some time pressure in settlement talks.
If bankruptcy courts want to be treated as Courts of Law and not Courts of Mediation, they need to take the disclosure process seriously and leave the settlement pressure to their beloved judicial mediators – they’re supposed to be so very good at it, right?
Back in April we questioned Judge Craig T. Goldblatt’s decision to adjudicate the Yellow Corp. debtors’ objections to billions in union-related pension claims asserted by several multiemployer pension funds, or MEPPs, suggesting Judge Goldblatt’s ruling might be an example of the “bankruptcy exceptionalism” the judge himself warned against. We also hinted at why the debtors wanted Judge Goldblatt, rather than an arbitrator, to handle the dispute: The debtors “think they have a better shot of winning in bankruptcy court.”
If the debtors (and largest single shareholder MFN) fought to keep the pension claim dispute in bankruptcy because they thought Judge Goldblatt might be more willing to knock out the claims than an arbitrator (or a Kansas district court), they had another thing coming. On Sept. 13, the bankruptcy judge issued an opinion rejecting the debtors’ principal argument: that the claims should be disallowed because the MEPPs received more than $40 billion in federal bailout funds and thus suffered no damages from Yellow’s shutdown and withdrawal from the MEPPs.
Specifically, Judge Goldblatt declined to invalidate two regulations issued by the Pension Benefit Guaranty Corp., or PBGC, that required the MEPPs to “phase-in” the bailout funds rather than treat them as plan assets that could be used to cover Yellow’s withdrawal obligations. The debtors and MFN maintained the regulations were not authorized by the American Recovery Plan Act, or ARPA, which provided for the bailouts, and conflicted with earlier statutes governing the calculation of pension withdrawal claims.
However, Judge Goldblatt found that ARPA authorizes PBGC to impose conditions on receipt of the bailout funds that prevent the money from subsidizing an employers’ withdrawal liability, effectively transferring taxpayer funds to shareholders (here, mainly MFN and, ironically, the U.S. Department of the Treasury). The debtors maintained that a federal agency cannot impose conditions on federal funds that directly prejudice a third party that did not receive such funds – here, the employer, Yellow, and its shareholders – but Judge Goldblatt disagreed, citing precedent on Social Security payments.
If the pension claims were wiped out, this would probably be a solvent estate, so deep down this one was really a question of who gets the windfall: the pension funds (which get an allowed claim and recovery from the debtors’ liquidation even though they are suddenly flush with bailout cash) or the debtors’ shareholders (who would get a pass-through of federal bailout funds after payment of much-reduced or wholly eliminated pension claims). The judge went with the pension funds.
According to PBGC, the decision should prevent a “stampede” of employers filing chapter 11 to eliminate pension withdrawal liabilities by pointing to the ARPA bailout funds. When asked for comment, other employers considering this maneuver muttered “thanks a lot for filing in Delaware, jerks” under their breath.
Why did Kirkland & Ellis file the debtors in Wilmington (in August 2023, months before the Jones resignation temporarily made Houston temporarily forum non grata for Kirkland cases) knowing the pension claims fight would be dispositive and require a judge to choose between creditors and debtors (easy call for the complex panel)? Please, let us know.
Will that venue decision end up preventing a new wave of “MEPP Two-Step” filings? Shame.
The decision may have also killed MFN’s hopes for a REIT reorganization plan that ensures it receives the upside from the debtors’ remaining real estate portfolio. Sure, Judge Goldblatt agreed with the debtors that the pension withdrawal claims must be capped at 20 years of payments, potentially reducing the $7 billion in claims to less than $2 billion – but that is still enough to prevent any meaningful value from falling to shareholders, according to MFN.
On Sept. 26, the debtors filed a motion restarting the sale process for their remaining real estate, suggesting they can no longer justify delaying the process to preserve optionality for MFN. Even if Judge Goldblatt’s decision is reversed on appeal, the process could be far enough along by then that the REIT plan is mooted by the sale of some of the valuable real estate assets.
Speaking of success on appeal: Hate to sound like a broken record, but sure seems like the debtors and MFN would have a better shot if the debtors filed in Houston. Even if one of the Houston complex panel judges agreed with Judge Goldblatt – we find it hard to believe they would, but – the conservative U.S. Court of Appeals for the Fifth Circuit, where Houston bankruptcy appeals eventually get heard, is more unfriendly to federal regulation than the Lochner-era Supreme Court. It’s hard to see the PBGC regulations survive Fifth Circuit review.
Perhaps the Third Circuit will strike down the regulations even under its less ideological approach to agency authority. The official committee for unsecured creditors took no position on the arbitration/venue issue, figuring an appeals court would ultimately decide the matter anyway, and we admire their unusual commitment to venue agnosticism in bankruptcy. Sure seems like every case nowadays involves at least one fight over whether a bankruptcy court or a real court should handle some key dispute; of course, the parties involved always disclaim any belief their chosen forum might rule differently on the merits. We all know better.
But if venue didn’t matter, what would we complain about?
Sidebar: Judge Goldblatt is quickly rising in our power rankings after this and a principled published opinion on the opt-in/opt-out post-Purdue drama. Stay tuned …