Article/Intelligence
Court Opinion Review: Judge Lopez’s Ruling in Aztec Gives Creditors (Likely False) Hope; Judge Perez Calls His Shot in Hearthside; Yellow Corp. Plan Stalemate; Implications of Fifth Circuit’s Serta Decision
Legal Research: Kevin Eckhardt
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, formerly Reorg, as a whole. Today we consider a rare denial of confirmation from Judge Lopez, Judge Perez previewing confirmation rulings in Hearthside Foods, the Yellow Corp. plan impasse and a bumper crop of Serta-based equitable mootness and unequal treatment arguments.
Bravo to Judge Christopher “Not a Layup” Lopez for a Jan. 24 decision to express skepticism regarding the extremely sketchy Aztec Fund chapter 11 plan. Judge Lopez swore in the Robertshaw case that if we looked at his record, we would see that “sometimes a plan is confirmed, sometimes cases get converted.” The Aztec Fund case hasn’t been converted yet – heck, Judge Lopez didn’t even formally deny confirmation – but like an owner whose cat speaks Mandarin instead of English, we accept miracles as they come without picking nits.
That said, we must emphasize: The Aztec Fund plan is a prime candidate for a Houston trademark: the token anti-debtor ruling (see also: the utterly harmless breach of contract finding in the Robertshaw redemption litigation). The Mexico City-based debtors are essentially a conglomeration of single-asset real estate entities that own struggling commercial properties and undeveloped land in the United States.
Secured lender Bank of America foreclosed on two properties prepetition, and the debtors filed on Aug. 5, 2024, to prevent a forced sale of the remaining properties the following day. So, not exactly a shining example of the rehabilitative policies underlying the Bankruptcy Code.
Bank of America immediately warned that there is no possibility of a successful reorganization, asserting that the debtors “do not have sufficient liquidity or other resources to service the debt, repay the loan or address the properties’ capital needs,” and equityholders “have been repeatedly unable or unwilling to contribute the required further equity.”
Despite this, the debtors and Bank of America generally played nice until Oct. 28, 2024, when the lender filed a motion for relief from stay or to dismiss the case so it can proceed with the foreclosure process for any properties not sold via 363 sales. Bank of America argued that contrary to the debtors’ appraisals, the bank’s remaining collateral was worth considerably less than the $114 million in secured debt, and the value continues to decline because of the debtors’ inability to invest in fixes and upgrades.
Like the Yellow Corp. union and pension creditors (foreshadowing!), Bank of America also noted that its deficiency claim would “swamp” the other unsecured claims and prevent the debtors from securing a single impaired accepting class. Unlike the Yellow Corp. creditors, there does not seem to be any colorable objection to Bank of America’s claims except valuation – e.g., that there are no deficiency claims because the value of the properties exceeds the secured debt.
On Dec. 3, the day that Bank of America’s stay or dismissal motion was scheduled to be heard, the debtors filed their proposed plan. Again, not typically a good sign. Under the plan, equityholders would contribute a whopping $2.25 million to keep their equity. Bank of America’s secured claim would be crammed down in exchange for a five-year note at SOFR+3.5%. The debtors would make 23 interest-only payments during the term, with a balloon principal payment in month 60.
Bank of America unsurprisingly declined this generous offer and objected to confirmation, calling the $2.25 million new value contribution “meager” and noting that the debtors’ own appraiser said the properties need $21 million in capital investment. The lender also said the debtors’ tenant retention assumptions defy “both common sense and market realities,” and the financial projections are “unreasonable.” Wait, is that wrong? We thought dodgy projections and valuations were merely frowned upon.
In response to these broadsides, the debtors brought out the big guns: They increased the equity contribution from the “meager” $2.25 million to … a whopping $2.5 million. Practice tip: If you are thinking of increasing a meager equity new value contribution by a meager $225,000, just don’t. You’ll lose more credibility than you gain goodwill. If you can’t increase by a meaningful amount, just stick to your guns.
Maybe the debtors were counting on Judge Lopez to conjure up something to fill the gap between what they were offering and what the Bankruptcy Code or even common sense require, and normally, that’s a pretty safe bet. But there are some jagged little pills that even Judge Lopez won’t force-feed a creditor. And you can’t underestimate the judicial propaganda value of the occasional anti-debtor ruling you can cite in future cases with more at stake.
Thus: In the midst of confirmation on Jan. 24, the judge told the parties he had “concerns” about feasibility and declared that the plan’s “five-year ride” Bank of America cramdown proposal “isn’t going to work.” According to the judge, the debtors failed to present any evidence they would be able to make the 100% balloon payment at the end of five years or that the properties would increase in value sufficiently to refinance the cramdown note.
Wow! Real wrath-of-god-type stuff, fire and brimstone … dogs and cats living together. Someone hit the independent thought alarm, we got a live one in Houston! Perhaps out of shock more than anything else, on Jan. 27 the debtors and Bank of America agreed to postpone the rest of the confirmation hearing to talk settlement. Considering the context, we don’t expect this one to keep SDTX captions off debtors’ counsel first day forms just yet.
Honoring a Pioneer
Lest you just get too excited about the possible return of even-handedness to Houston, we also have bad news to report: On Jan. 24, Judge Alfredo R. Pérez pulled an absolute Jones Special by previewing his confirmation rulings at a Hearthside Foods disclosure statement hearing. It was truly a heartwarming tribute to the Houston complex panel Founding Dog-Father.
Remember how, back in February 2023, we chided Jones for telegraphing his ruling on the Serta Simmons “open market purchase” issue early in the case, long before he formally took over the litigation, heard any evidence, let alone received a full briefing? Three days after the petition date, at a scheduling conference, Jones indicated that he was already inclined to overrule a New York district judge’s ruling that the open market purchase language was ambiguous.
Certainly that’s bad from a merits perspective; as you hopefully know by now from several amazing Octus webinars on the subject, the Fifth Circuit not only disagreed with Jones that the Serta uptier complied with the credit agreement as a matter of law, it concluded that the uptier did not comply with the credit agreement as a matter of law.
But, setting the merits aside, we also suggested that a bankruptcy judge calling his/her/their shot on a crucial issue before it was ripe is bad from a case management perspective. We posited that the side that knows it will win long before the definitive ruling is due (let’s be honest, it’s Houston, it’s almost always the debtors) can dig in its heels and refuse to compromise, meaning expensive and entirely pointless litigation is prosecuted to the end rather than settled.
By previewing his ruling in Serta, we said, Jones would embolden the debtors to litigate through summary judgment to a confirmation trial, even though everyone knew which way it would go, instead of working out a deal with the excluded creditors a la Revlon. Then there would be appeals. Two years later, here we are. We aren’t wrong about everything (well, see below).
We’ve made the same point about the Purdue/Sackler settlement talks. Because the Sacklers appeared certain Judge Robert Drain would keep litigation against them on hold as long as it took to confirm a plan and would approve whatever settlement they offered, the Sacklers thus had no incentive to, and in fact didn’t, increase their offer during the bankruptcy. When the district court and then the Supreme Court knocked out their releases, surprise surprise, they found some more cash to contribute.
Uncertainty is good for settlement. Maybe that case would’ve settled long ago, and we would still have nonconsensual nondebtor releases if the Sacklers faced more uncertainty. Sow a little doubt, reap a consensual plan.
Judge Pérez clearly does not read this column, because in Hearthside he ignored our warnings and decided to make some advance rulings on confirmation objections at the disclosure hearing, for no discernable reason. First, the judge said he would approve the plan’s “deathtrap” provision for unsecured creditors. Under the deathtrap, if the class of unsecured creditors votes to accept the plan, it would receive a distribution; if it votes to reject, it would receive nothing.
We laid out the issues with deathtraps way back in June 2021, when Jones was faced with objections to similar treatment for two classes of preferred equityholders at the disclosure stage in the CBL case. Jones directed the debtors to remove the deathtrap prior to solicitation because it would not resolve all of the equityholders’ confirmation objections – basically, he suggested a deathtrap solicitation should only be approved if it might lead to a consensual confirmation hearing.
Did Jones call his shot on the deathtrap in CBL? Not really: The equityholders raised the issue as a disclosure matter by filing an objection to approval of the DS, so it was ripe for decision – and he at least had briefing and argument from the parties. Nor did the CBL ruling threaten the negative case management effect we have been warning about.
In fact, it worked in reverse: After Jones rejected the deathtrap, the debtors and equityholders worked out an alternative whereby the debtors’ fees for defending an equity confirmation objection would be borne by the whole equity class. We had our issues with that strange alternative and with the “reasoning” for Jones’ ruling, but by ruling against the debtors on what he made clear was not an important issue (see above!), Jones actually created uncertainty that led to a deal.
Maybe the No Shot-Calling Rule only applies to advance rulings in favor of the debtors, because their leverage in a debtor-friendly court is already so overwhelming? We have to think about that.
Anyway, in Hearthside Judge Pérez definitely called his shot before the deathtrap issue was ripe. No one actually objected to the deathtrap prior to the disclosure hearing in Hearthside; the UCC filed a reservation of rights suggesting the deathtrap was coercive, but the debtors agreed to include a statement from the committee to that effect in the solicitation materials, effectively pushing the question to confirmation. “The Committee hopes to engage in further discussions with the Debtors regarding the Plan,” the reservation of rights concludes.
Well, about that: At the very beginning of the Hearthside disclosure hearing Judge Pérez declared that he had “no problem” with the deathtrap. And that was all the “reasoning” provided. Sure feels like Serta, no? In an instant, there was no longer any incentive for the debtors to negotiate with the committee to remove the deathtrap or provide additional consideration for unsecured creditors in exchange for leaving the deathtrap in.
No, this isn’t the most crucial issue in the case. Maybe the debtors would have pushed the deathtrap anyway, though we suspect that deathtraps are pretty rare for a reason: Debtors don’t want to risk a bankruptcy judge denying confirmation on deathtrap grounds and forcing them to resolicit without the deathtrap. There are often good reasons to drop them, as in CBL.
Frankly, we suspect at least half of the deathtraps floated in initial plan proposals are designed to be fought over and traded in as negotiating chits when the rubber meets the road. In Houston, where creditors face a cough cough uphill battle, such chits are few and far between. By pre-ruling and making the odds zero, Judge Pérez handed the debtors an unearned win.
We can’t imagine Hearthside Foods is the next great appellate ruling in bankruptcy land, but it’s kind of amazing that the last two showstoppers – Purdue and Serta – both involved vibes-based bankruptcy court rulings that were telegraphed by the bankruptcy court well before a ruling was required or before the parties had a chance to work it out themselves.
Yellow Submarined
The Yellow Corp. official committee of unsecured creditors on Jan. 28 filed a fascinating motion to terminate exclusivity or convert. According to the UCC, by aggressively litigating objections to the claims of its largest creditors – unions and multiemployer pension funds, or MEPPs – Yellow has thwarted any possibility of a plan deal with those creditors and should step aside and let the UCC, on which those creditors sit, take over the plan process.
If it sounds like we’ve been here before, well. Back in April 2024, we discussed Judge Craig T. Goldblatt’s overruling of the committee’s objection to the debtors’ exclusivity extension motion, which made a similar point. One big difference between that objection and the latest motion, though: At that time, there was a real dispute over whether the plan would be a simple “pot plan” for distribution of liquidation proceeds pro rata or a galaxy-brained REIT reorganization that would benefit major shareholder MFN.
The UCC objected both to the Hail Mary MFN REIT concept and to the debtors’ scorched earth fights with the Teamsters union, the MEPPs, WARN Act claimants and environmental cleanup claimants (possibly spurred by the billion-dollar pile of cash from the liquidation to litigate said thorny questions). The UCC suggested that allowing a liquidating trustee to handle claims litigation after confirmation would be considerably less expensive.
Like the UCC, we harbored a bit of suspicion about the independence of management from MFN and hinted that even if the MEPP withdrawal claims survived the debtors’ and MFN’s summary judgment motions to zero them out based on the plans’ receipt of tens of billion in federal bailout funds, the debtors would still propose a REIT plan.
Boy, were we dead wrong about that. Weeks after Judge Goldblatt rejected the bailout-based claim objections in September 2024, the debtors filed an amended liquidating plan with a simple pot-distribution structure.
So why is the UCC still fighting over exclusivity? Well, the committee’s suspicion that MFN is really pulling the strings has not been completely dispelled by the plan. The pot-plan liquidating trust structure may be simple, but the plan includes one very unusual wrinkle: The post-emergence liquidating trustee would be selected by the debtors and controlled by a board of managers appointed by the debtors.
Generally, but maybe not in the first instance (see the above discussion of pre-baked negotiating concessions), liquidating trusts established to benefit unsecured creditors are controlled by, well, unsecured creditors – usually in the form of an “oversight committee” composed of former UCC members.
If you assume “the debtors” means MFN, then you’ve got to have a problem with Yellow’s current proposal; obviously, that is where the UCC (and its members) are coming from.
You might respond that this is not actually an issue because the liquidating trustee and board of managers, like the debtors and the UCC and current management and counsel and the advisors, would totally have a fiduciary duty to object to claims but not to pursue irresponsible litigation at MFN’s direction, right? Yeah, you could say that, but you could also say the moon is made of green cheese. You know how we feel about the value of fiduciary duties in bankruptcy: They are everywhere, so they are basically nowhere.
(Normcore Editor’s Note: We are all very much, in reality, constrained by duties, fiduciary or otherwise, that are far less easily actioned than estate fiduciary duty violations, so cut the people a break, Kevin!)
Anyway, we are not 100% on board with the UCC here! It seems a bit unseemly for the committee, which includes unions and pension plans, to suggest that the debtors should lose control of the plan process simply because they have chosen to prosecute perfectly plausible, if not entirely successful, objections to huge claims that would essentially eliminate recoveries for other unsecured creditors (putting aside recoveries for MFN and the other shareholders).
The committee’s maneuver smacks of counterparty shopping. The committee probably wants a liquidating trustee whose actions – and, more importantly, compensation – are overseen by a board that includes the unions and pension plans whose claims are subject to objections the trustee would prosecute. It’s not hard to see why the unions and pension plans might believe that would result in a quick and easy settlement of the claims objections – not to mention withdrawal of the debtors’ $1.5 billion damages suit against the Teamsters, which was dismissed but is still percolating.
To paper over this unseemliness, the committee very, very loosely alleges that the debtors’ litigation against the big creditors has somehow crossed some invisible line and provoked the unions and pension plans into unshakeable but reasonable intransigence. According to the UCC, because the unions and pension funds hold a blocking position in Class 5 – the only impaired voting class – and will never vote for a plan that features a liquidating trustee controlled by their implacable adversary, the plan is a “dead end.”
First issue with this: Do the unions and pension funds really control Class 5? Under the plan, creditors whose claims are subject to objections – and yeah, the union and pension claims are definitely that – cannot vote. So, the debtors did not send ballots to the pension plans, whose claims are still in dispute even if you accept that under the judge’s September 2024 ruling they will not be wholly disallowed due to their receipt of federal bailout funds. Of course, that ruling is currently on appeal.
At first blush, it seems awfully unfair to confirm a plan that binds the unions and pension plans to treatment accepted by unsecured creditors holding a tiny amount of claims compared with theirs. As the UCC points out, the debtors themselves estimated the pension claims at $2 billion to $4 billion in their liquidation analysis, with other general unsecured claims at $197 million to $543 million.
That’s exactly the argument the pension plans make in their motions for temporary allowance of their claims for voting purposes. The pension plans assert that if their claims are not temporarily allowed at approximately $3 billion, their “voting power” on the plan “will not be commensurate with their significant economic interest.” Simply ignoring those claims for voting purposes would also require ignoring all the work Judge Goldblatt has done paring down the claims and resolving objections to get down to the calculation issues that remain.
And ignoring the pension claims when counting votes would also create a real problem for creditor democracy (do try not to laugh out loud – other people are working). If the pension plans and the unions end up with massive allowed withdrawal liability and WARN Act claims but are bound to the terms of a plan approved by holders of a tiny fraction of the final Class 5 amount, then the plan would seem pretty illegitimate – “Reorganization Without Representation” has a ring.
But here’s the rub: The unions and pension plans are unlikely to actually suffer any real harm should that happen. Because all senior claims have been or will be satisfied from the ample proceeds of the debtors’ liquidation, the unions and pension plans would receive a pro rata share of any remaining assets – and if their claims are eventually allowed, that would be the largest share by far. The economic reality is that the plan ensures the unions and pension plans will get what they deserve if their claims are allowed.
In other words, this isn’t a case like Boy Scouts of America or LTL Management 3.0, where the debtors have (allegedly) tried to manipulate voting and manufacture a collusive majority to bind dissenters to objectionable plan treatment, like a 1% recovery where they would get 50% in a liquidation.
Without such harm, we can’t help but believe that what the unions and pension plans don’t like about the plan is that it would result in appointment of a liquidating trustee that would force them to continue defending their claims.
The UCC attempts to recast this pretty blatant claim objection counterparty-shopping maneuver by suggesting that it didn’t have to end up this way (tear emoji) and raising the possibility of every bankruptcy judge’s dream: settlement. “The Debtors’ litigious approach has largely foreclosed the occurrence of productive settlement negotiations in respect of a majority of the Debtors’ largest remaining disputed claims,” the committee says.
“The Committee, as a fiduciary for all unsecured creditors, stands ready and willing to propose a plan that will transfer control over all pending matters and all remaining assets in these estates to fiduciaries without deep-rooted animosity or deal fatigue,” the committee adds. There’s the fiduciary duty – take a drink!
This whole dispute illustrates why debtors, creditors and bankruptcy judges generally wait until after confirmation to litigate claims objections in liquidating chapter 11s. Without business pressure to get the debtors to consensually resolve claims as part of the plan treatment process, claims litigation can proceed unfettered, especially where the liquidation has produced sufficient proceeds to pay off secured creditors and fund the fight forever.
So what’s the alternative? Conversion, right? That would put the claims objections in the hands of an independent fiduciary beholden to no one. The UCC half-heartedly raises the appointment of a trustee in its motion, but its heart really isn’t in that. We’ll see if Judge Goldblatt has the stomach to take that drastic step, which would kinda resolve all the competing fiduciary duties here.
Serta Spreads
We aren’t above victory laps. Remember when we warned that the equitable mootness and equal treatment pronouncements in the Fifth Circuit’s Serta decision might lead to a wave of new objections to confirmation? Lo! It has come to pass, and we thought a roundup of some highlights was in order.
First, the Convergeone case out of Houston. About a week after the Fifth Circuit decision, a group of minority lenders filed a notice raising the Serta equal treatment doctrine in their district court confirmation appeal. According to the excluded lenders, the debtors’ prepackaged plan violated Serta by giving majority lenders the exclusive right to receive 30% of the debtors’ $245 million rights offering at a 35% discount.
The excluded lenders maintain that Serta “demands an ‘objective approach to equal treatment’ that requires a court to ‘look below the surface to determine whether distributions were in fact equal in value.’” “Otherwise, ‘any special gift could be recharacterized as equal treatment’ through creative drafting,” the minority maintains. Well, if the Fifth Circuit really outlawed “creative drafting,” we’ve got bigger problems.
On Jan. 14, the debtors and majority lender group responded, arguing as expected that the majority lenders did not get those discounted shares on account of their prepetition claims but in exchange for backstopping the rights offering. In other words, according to the plan proponents, the majority and minority received equal treatment for their prepetition claims, and the discounted shares were consideration for new value provided only by the majority.
Of course this is utter nonsense out here in reality. As we have repeatedly discussed, plan rights offering backstop commitments are worth absolutely diddly-squat in the overwhelming majority of cases, where there is zero chance the offering is less than fully subscribed. It sure seems like the rights offering shares in Convergeone were similarly desirable, because now we have an excluded group spending valuable cash on an appeal to fight the reservation of a huge chunk of those shares for somebody else.
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. 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. If a majority lender wants exclusive access to the goodies, they should have to take some actual risk by providing new money, not meaningless guarantees.
But under the plain language of the plan, the debtors and majority lenders have a point. The plan’s treatment of the prepetition lender claims does not, on its face, discriminate between the prepetition claims of majority and minority lenders. Will the district court, or eventually the Fifth Circuit, use Serta as an excuse to look beyond the “creative drafting” and call out the backstop premium scam? Could be fun! Even more fun … what does this mean for post-reorg equity sweeteners in DIP backstops?
Next, a disclosure reservation of rights in the WOM SA case in Delaware. On Jan. 17, a minority group ran Serta up the flagpole in a situation similar to Convergeone, arguing that the debtors’ grant of “blatantly unreasonable” rights offering backstop fees to a majority lender group violates the requirement of equal treatment.
According to the minority group, “[I]t is clear that the Debtors have purchased the affirmative votes of the Favored Noteholders and their prepetition claims” by offering lucrative fees and other compensation not made available to other holders of the same notes and claims, “who are willing to undertake and fulfill their pro rata share of the backstop commitment.”
Again: The argument for rights offering backstop goodies is that the backstop parties are taking on the real, totally not-made-up risk of undersubscription for the benefit of the debtors. How much risk can possibly be involved if creditors are literally fighting to be allowed to bear it?
Props to one of our faves, Judge Karen B. Owens, for heeding our advice and not prejudging the issue at the disclosure hearing on Jan. 23. The parties agreed to let the equal treatment objection play out at confirmation – if not resolved before then – and the judge kept her hunches and knee-jerk reactions to herself. Same deal as Convergeone – this could have major implications for postpetition non-pro-rata treatment of favored creditors, which has become endemic in big chapter 11 cases.
Finally, the case where Purdue and Serta collide: the Boy Scouts of America confirmation appeal. This time, the issue is equitable mootness. On Jan. 9, tort claimants filed a notice of supplemental authority arguing that under Serta, a confirmation appeal is not equitably moot when plan provisions “plainly violate” the Bankruptcy Code. The nondebtor releases in the Boy Scouts plan “plainly violate” the Bankruptcy Code under Purdue, the appellants say, so equitable mootness cannot apply.
The debtors and their insurers, which benefit most from the nondebtor releases imposed on the claimants pre-Purdue, responded on Jan. 14 that Serta is clearly distinguishable because removing the nondebtor releases from their confirmed plan would “fatally scramble” the reorganization. Basically, this is like saying that Serta doesn’t apply because the Serta confirmation appeal was not equitably moot and we think this one is.
To debtors, there is not a single drop of ink in a plan, even in the table of contents, whose modification or removal would not constitute a “wholesale reversal” and “fatally scramble” the reorganization.
More interesting: The debtors argue that removing the releases would violate the principle of equal treatment as expounded in Serta. Well, now you have our attention! According to the debtors, the only remedy for the release issue on appeal other than “wholesale reversal” would be to exempt appellants from the plan’s trust distribution procedures, leaving them free to pursue their claims against nondebtors in court.
That, the debtors suggest, would result in the appellants receiving different treatment than other claimants in the same class, who must go through the trust distribution procedures to recover. The unspoken implication here is that the appellants, if allowed out of the trust distribution procedures, would recover more than the other claimants in the courts – likely true – and that isn’t fair. If the carve-outs are going to get less, why would the debtors care?
We humbly suggest that the debtors maybe refrain from suggesting in the future that cutting the now-patently unlawful nonconsensual nondebtor releases out of a plan would benefit claimants who opt out. After all, isn’t the debtor-side mass tort bankruptcy narrative that the claimants benefit most of all from being shoved into the trust box via a chapter 11 plan while all the nondebtor defendants go about their business of giving out merit badges and whatnot?
We are most interested in how Serta’s unequal treatment language plays out in future cases, and based on some of the arguments out there, the implications could be as far reaching as the main Serta decision has been for LME drafters. But if volume counts, we would be doing a disservice by not noting that it seems like every bankruptcy appeal is getting some extra briefing on Serta and equitable mootness.