Court Opinion Review: The Fifth Circuit Reverses Sanchez, Administrative Insolvency Workarounds in Steward and Secret Asset Sales

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 the Fifth Circuit’s decision vacating Judge Marvin Isgur’s “purposive” Sanchez ruling, administrative claimants bearing the cost of confirmation for confirmation’s sake and the ultra-fast, ultra-secret Rite Aid 2.0 pharmacy asset sales.

The Fifth Circuit Element

A whole two months ago, we suggested in our discussion of the recent Highland exculpation decision that the Fifth Circuit was not, in fact, on a bankruptcy court-reversing rampage solely because of the whole Jones/Freeman kerfuffle in Houston, contrary to Friend of the Show Judge Michael Kaplan’s surmise. We are starting to have second thoughts.

On a sleepy Friday afternoon in late May, the Fifth Circuit dropped another hammer on the 713 by reversing Judge Marvin Isgur’s August 2023 final decision on the Sanchez post-effective-date preferential transfer/reorganized equity reallocation litigation. The Fifth Circuit’s opinion is bizarre and – dare we say – “purposive” in its own way, but at this point, we can’t help but think that maybe Judge Kaplan was right, and the circuit court does have a vendetta against the complex panel – or at least former members David R. Jones and mentor/friend/unwitting accomplice Judge Marvin Isgur.

Our commentary on Sanchez stretches all the way back to July 2020, one of our very first editions (too bad about The Fine Print, you know, creative differences) – but we really went deep into the post-effective-date litigation in December 2021. A quick refresher: Secured noteholders Apollo and Fidelity attempted to perfect liens on three crucial oil and gas leases just prior to the Sanchez chapter 11 filing in August 2019, meaning the liens might be avoidable as preferences and the properties – perhaps 50% of total enterprise value – unencumbered.

The debtors were well aware of the issue, but with the liens in place until avoided, they reluctantly accepted DIP financing from the noteholders to avoid a priming fight, with the DIP liens attaching to all of their assets – including the three possibly encumbered leases. In March 2020, the debtors filed suit to avoid the liens.

Note the time frame: Sanchez filed just before the pandemic and was in bankruptcy when oil prices cratered as the world economy ground to a halt (or seemed to).

The debtors were desperate to leave bankruptcy but were now worth far less than when they entered. In April 2020, Judge Isgur confirmed the debtors’ unusual plan, which preserved the lien avoidance suit until after emergence. Under the plan, the judge would consider the lien litigation and then readjust the allocation of reorganized equity depending on the result – a similar arrangement to the post-emergence reorganized equity reallocation mechanism in the Incora/Wesco plan. Keep that in mind.

Under the plan, the allocation of 80% of reorganized equity between the secured lenders and unsecured creditors would be determined by the post-emergence litigation. In the meantime, the noteholders, as DIP lenders, would receive 20% of reorganized equity on account of their DIP loans at emergence, allowing them to appoint directors and control the company as if they held 100%.

Needless to say, this all went sideways in a major way. Judge Isgur proceeded to spend more than three years resolving the lien litigation in three distinct phases while also addressing periodic disputes between the unsecured creditor representative that inherited the avoidance claims and the DIP lenders over litigation funding, dicey settlements and the lenders’ effort to cement their control and moot the litigation during the weird “who owns this thing” period after emergence.

Meanwhile, the company’s valuation soared from a Covid-19-depressed $85 million at confirmation to about $1 billion, dramatically increasing the stakes. Again: That’s what happens when you confirm a plan just to confirm a plan and leave niggling little details like who owns this company for years later.

In August 2020, Judge Isgur issued his ruling in Phase 1 of the post-emergence lien litigation, concluding that the noteholders, as DIP lenders, did not hold liens on the prepetition lien avoidance litigation – meaning that if the noteholders’ prepetition liens were avoidable, the value of the unencumbered property would go to unsecured creditors rather than to the DIP lenders. This allowed the litigation to proceed to Phase 2 – determining if the prepetition liens were avoidable.

We now know that Phase 2 and Phase 3 would be nothing more than an extremely costly detour – but hold that thought.

In March 2021, Judge Isgur concluded Phase 2 by holding that the noteholders’ prebankruptcy liens on the three properties were avoidable as preferences because they were perfected within 90 days before the filing. So, on to Phase 3: determining the value of the preference claims and the unencumbered property that would be awarded to the creditor representative (in the form of reallocated reorganized equity).

However, in July 2022 Judge Isgur reversed course and vacated his Phase 1 ruling related to the DIP liens. On reconsideration, the bankruptcy judge found that the DIP lenders actually do have liens on all of the debtors’ assets under the final DIP order.

At that point, Judge Isgur faced a binary choice: Consider the effect of this decision on the avoidance claims, or just ignore this finding and press on. The judge chose to punt, leaving the question of what value the creditor representative could recover under section 550 of the Bankruptcy Code despite the DIP liens unresolved until after Phase 3.

Section 550 provides the remedies for avoidance of a preference under section 547 of the Bankruptcy Code. Section 550(a) provides that the debtors – or, as here, a creditor representative acting on the debtors’ behalf – can recover “the property transferred, or, if the court so orders, the value of such property” from the transferee – here, the noteholders.

For you statutory interpretation fans who like to argue “or” can be read conjunctively: First, GTFO; second, section 550(d) goes out of its way to try to end this debate by dictating that “the trustee is entitled to only a single satisfaction under subsection (a) of this section.”

Because the transfers at issue involved liens on the debtors’ assets, that means that Judge Isgur could award the creditor representative either the noteholders’ prepetition liens or the value of those liens as a remedy. But the judge’s volte-face on the DIP loans created a problem: Judge Isgur could not award the noteholders’ prepetition liens on the three leases, because those liens had already been returned to the estate (and by extension the DIP lenders) under the plan.

Article VIII.E of the Sanchez plan provides that “on the Effective Date … all … Liens … against any property of the Estates … shall be fully released and discharged, and all of the right, title, and interest of any holder of such … Lien[s] … shall revert to” the reorganized debtors. So the estate already has those liens. We know this is boilerplate plan “plumbing” – we do this for a living – we’ll get there, we promise.

Since the liens reverted to the reorganized debtors, under section 550(a), Judge Isgur would have to award the creditor representative the value of the liens at the time of the transfer. But what value could the prepetition liens have if the priming DIP liens already encumbered all of the debtors’ assets? Judge Isgur chose not to confront that question before cranking up Phase 3.

Finally, in August 2023, more than three years after confirmation, Judge Isgur issued his Phase 3 ruling, awarding 53.54% of reorganized equity to unsecured noteholders on account of the avoided liens, 30.27% to Apollo and Fidelity as DIP lenders (including the 20% they already had), 14.19% to the secured noteholders on their surviving prepetition liens and 2% to other unsecured creditors. Suddenly, Apollo and Fidelity went from owning 100% of outstanding shares (though only 20% of the authorized shares) to minority shareholders.

You know how we feel about bankruptcy judges putting intercreditor disputes on the rocket docket to meet arbitrary RSA and DIP milestones, but as we said in 2023, “anything – even shoving litigation through on an absurdly expedited, arbitrary schedule prior to confirmation (or a section 363 sale!) – would be better than whatever Sanchez was, and will probably continue to be for years.”

Almost two more years, to be precise. On May 28, the Fifth Circuit overturned Judge Isgur’s Phase 3 ruling in an incredibly byzantine opinion penned by Circuit Judge Edith H. Jones (no relation!) and joined by Judges Kurt D. Engelhardt and Andrew S. Oldham.

That last name should ring a bell; amazing how Judge Oldham keeps snagging these big bankruptcy appeals. Maybe the Fifth Circuit employs the Houston complex panel horse-trading case assignment mechanism? Perhaps Judge Oldham has access to unlimited amounts of “shitty Mexican food”? Either way, he’s fast becoming the Judge Thomas Ambro of the Fifth Circuit – the circuit judge who wants all the bankruptcy appeals.

There’s a lot to consider in Judge Edith Jones’ Wikipedia entry, but we’ll just note for now that Judge Jones the Elder herself specialized in bankruptcy law in Houston, in the late 70s and early 80s.

On appeal, the DIP lenders focused not on whether their prepetition liens could be avoided as preferences under section 547 (the principal issue in Phase 2) but whether the unsecured creditor representative was entitled to a remedy under section 550(a) (the principal issue in Phase 3).

Specifically, the noteholders argued that the value of the prepetition liens was bupkus: Based on the now extremely obsolete $85 million plan valuation, the noteholders’ avoidable prepetition liens were out of the money because the $150 million in DIP liens – also held by the noteholders! – exceeded that amount.

Judge Isgur rejected this argument in his Phase 3 ruling, concluding that the value of the avoidable liens, and thus the value of the creditor representative’s preference claims, was approximately $197.1 million – the $210 million value of the liens based on the trading prices of the notes at the time of the transfer minus $13 million on account of liens on the Sanchez guarantors’ personal property, which were not challenged. The judge then awarded the creditor representative a share of reorganized equity equal to that value.

Judge Isgur explained that the DIP liens encumbering all of the debtors’ assets did not defeat the creditor representative’s remedy because the assertion of the liens harmed the estate by thwarting the debtors’ hopes for a third-party DIP. The avoidable prepetition liens “hamstrung Sanchez’s ability to negotiate DIP financing,” the judge said, because the liens, not yet avoided at the beginning of the case, would have forced a priming fight over third-party DIP loans and the debtors “could very well have been able to obtain superior DIP financing” absent the liens.

This conclusion has some common-sense, practical allure. We all know from experience that chapter 11 debtors without available unencumbered property – that is, virtually every chapter 11 debtor – ends up accepting DIP financing from prepetition secured creditors on onerous terms to avoid a costly and uncertain priming fight. This is why, for example, Invesco spent so much time and money litigating the Robertshaw “Required Lenders” maneuver – holding the senior prepetition liens opens the door to all kinds of DIP and exit financing goodies.

Judge Isgur’s ruling also took the massive post-Covid-19 increase in the company’s valuation into account, without explicitly saying so. And, again, that seems pretty fair at first blush: it is pretty ridiculous to deny a successful avoidance claimant any remedy based on an $85 million valuation that turned out to be a massively understated estimate based on incredible and unforeseeable circumstances.

If the company were valued at $1 billion at confirmation, then there would be $850 million in value for the prepetition noteholders on their avoidable liens after accounting for the measly $150 million DIP. Why should the noteholders get to keep all that value on account of $150 million in DIP claims while unsecureds get nothing? Especially when they were the ones who screwed up when perfecting their liens?

Alas, the Fifth Circuit had a simple, typically Fed Soc Fifth Circuit response: because section 550 says so. In her opinion, Circuit Judge Jones (again, no relation) concludes that because the noteholders’ prepetition liens were returned to the estate under the plan, Judge Isgur could not order the recovery of the value of those liens – even if they had any value – without running afoul of the “single satisfaction” rule in section 550(d).

“Courts cannot award value under Section 550(a) when the estate has recovered its transferred property in kind,” Judge Jones says. In other words: If a preference recipient voluntarily gives the transferred property back to the estate, then the preference action is kaput. There is nothing else to recover, period … even if the liens were worthless at the time of surrender and then surged in value to hundreds of millions of dollars afterward.

Yes, you heard that right: The Fifth Circuit ruled that the entire post-confirmation litigation over reallocation of Sanchez’s reorganized equity, and all the ancillary fights that generated over maneuvers to moot the litigation and litigation funding, was a complete and total waste of time because the preference claims were conclusively resolved at confirmation, when the noteholders returned the avoided liens. Five years of litigation.

Turns out that, like Galen Erso, Judge Isgur included a secret weakness that could destroy the entire process when he confirmed a plan under which the noteholders returned their then-worthless avoidable prepetition liens to the estate. Why didn’t the unsecured creditors committee object to the inclusion of the lien reversion language in the plan to prevent this from happening?

Simple: because that language is boilerplate baloney included in literally every big case chapter 11 plan. Check out the Global Clean Energy plan filed in Houston on May 28, the same day as the Fifth Circuit’s decision; it provides that “all mortgages, deeds of trust, Liens, pledges, or other security interests against any property of the Estates shall be fully released and discharged, and all of the right, title, and interest of any Holder of such mortgages, deeds of trust, Liens, pledges, or other security interests shall revert to the Reorganized Debtors.”

Steward Health (see below) filed a plan in Houston on April 28 that provides that “all mortgages, deeds of trust, Liens, pledges, or other security interests against any property of the Estates shall be fully released, settled, and compromised and all rights, titles, and interests of any holder of such mortgages, deeds of trust, Liens, pledges, or other security interests against any property of the Estates shall revert to the Plan Trust” – not the reorganized debtors, since Steward is liquidating. Still, same principle.

Think this is just a Houston thing? What about the plan filed in the Franchise Group case in Delaware on April 25: “all mortgages, deeds of trust, Liens, pledges, or other security interests against any property of the Estates shall be fully released and discharged, and all of the right, title, and interest of any Holder of such mortgages, deeds of trust, Liens, pledges, or other security interests shall revert to the applicable Reorganized Debtor and its successors and assigns.” Sound familiar?

Nobody notices a bit of boilerplate form bank gobbledygook in 2020 while fighting over how to reserve their rights for a post-confirmation brouhaha over reorganized equity, and five years later, the whole thing goes boom when the Fifth Circuit drops a section 550 bomb down a ventilation shaft. Yoinks.

Even if the return of the prepetition liens in the plan did not moot the whole shitty enchilada, Judge Jones asserts that Judge Isgur could not award the creditor representative any value now because the prepetition liens were worthless at the time they were surrendered, thanks to that $150 million in DIP debt.

So at the very least the Fifth Circuit panel believes that Judge Isgur should have stopped the litigation and ruled for the noteholders no later than July 2022, when he rejected the creditor representative’s claims to avoid the noteholders’ DIP liens – at that point, the creditor representative’s cake was baked, and Judge Isgur simply refused to serve it – even if we ignore the plan language about returning the liens to the estate.

“​​The facts were that DIP Lenders had injected over $100 million in new money to the company post-petition, while the value of the debtors’ assets slid to $85 million” at confirmation, Judge Jones explains. Thus, the plan “provided an opportunity for the unsecured creditors to recover some equity only if they were able to defeat the DIP liens” and avoid the prepetition liens.

“The bankruptcy court’s initial wrong turn” in August 2020 – avoiding the DIP liens in the Phase 1 decision vacated in July 2022 – “propelled the parties into subsequent stages of litigation that were unnecessary,” Judge Jones continues. Once Judge Isgur determined that the DIP liens were valid in July 2022, everything else was pointless. QED: The noteholders, as DIP lenders, get 100% of reorganized equity.

If we were playing Monday-morning quarterback, it’s here where the parties arguably could have been more clear. The dubious perfection on the crucial three liens was a major factor in the case from day one, and the DIP order could have more explicitly preserved the potential unencumbered value. Even more on point, the plan could have included some “notwithstanding anything else in the plan, blah blah” language preserving potential recoveries in the very much contemplated post-confirmation litigation.

More broadly, we are of two minds about the Fifth Circuit’s decision. On the one hand, it is objectively hilarious: After five years of litigation, the whole thing turned out to be a waste of time largely because of dispositive boilerplate in a form bank plan that nobody seemed to notice. Guess we have to start reading the Implementation section of proposed plans now, sigh. How many millions were spent in attorneys’ fees? How many vacations were unnecessarily ruined? Delightful. It’s like Jarndyce and Jarndyce.

On the other hand, this ruling does not make us feel very optimistic about the Fifth Circuit’s eventual review of Judge Isgur’s blockbuster Incora/Wesco LME decision, which we mentioned up top for a reason. Recall that in that case, Judge Isgur controversially restored the 2026 noteholders’ liens and voided the liens securing the participating noteholders’ $250 million in new notes as a legal remedy, when everyone – including the excluded noteholders – assumed that would have to be accomplished via an equitable remedy.

Judge Isgur explained that awarding a worthless unsecured claim to the Wesco 2026 excluded noteholders rather than unraveling the uptier would effectively reward the participating noteholders for their perfidy. At a hearing on June 26, 2024, when he unexpectedly announced his initial ruling, Judge Isgur told the participating lenders’ counsel that “[i]f what I do is award money damages, your clients would get the entire benefit of their bargain knowing they cheated, and that’s not happening.”

Sounds a bit … purposive, you might say? Judge Isgur’s Phase 3 decision reallocating reorganized equity in Sanchez sure had the same “there has to be a remedy for this mess” vibe; the bankruptcy judge says in his decision that “simple avoidance of the liens on the HHK Leases would not put the estate back in the pre-transfer position.”

Unfortunately for the Wesco excluded noteholders, Judge Jones takes aim at this “I have to do something” approach by calling Judge Isgur’s interpretation of section 550 “unapologetically purposive.” That’s Fed Soc-speak for “the judge ignored the plain language of the statute just to give the good guys a real win/sock the bad guys.” No bueno, apparently.

It’s pretty clear that in Incora/Wesco, Judge Isgur bent over backwards to find a way to sock it to the participating lenders without having to dive into the equitable remedy issue – and the decision in Sanchez could have implications for the permissibility of that unapologetically purposive approach.

Maybe the absence of a statute on point – the Incora/Wesco remedy ruling rests on New York law, not the Bankruptcy Code – will make a difference. But it sure seems like the Fifth Circuit is looking real hard at ways to clip Houston’s wings, whether because of the Jones/Freeman embarrassment or otherwise. As we have repeatedly warned: That’s what happens when bankruptcy judges repeatedly and unapologetically fly too close to the sun, and god knows the complex panel has done that often enough.

For now we are comforted by the knowledge that, unlike Orson Krennic, Judge Isgur was still around to witness his Sanchez Death Star kerplode, capping off a not very good week for the former complex panel member and his family. Please join us in pouring one out for the former complex member’s efforts and saluting the cratering of the Sanchez case with some mood-appropriate music: Judge, you might want to turn down the volume before clicking on that link at home.

Admin Creditors Jobbed, Again

Feels like a bit of 2008 in the air lately, eh? Or at least 2020? Thanks may be due to Steward Health and Judge Christopher Lopez for bringing back one of our favorites from the Covid-19 retail apocalypse: the administratively insolvent plan and the extremely stretched (dare we say unapologetically purposive?) efforts big-case chapter 11 judges undertake to circumvent the plain language of section 1129(a)(9) of the Bankruptcy Code.

You might remember the Sears case as the ultimate jam-job for postpetition vendors and suppliers holding administrative claims the debtors just can’t pay. In October 2019, Judge Robert Drain confirmed Sears’ proposed plan even though the debtors admitted they could not satisfy section 1129(a)(9) of the Bankruptcy Code, which unequivocally requires a chapter 11 debtor to pay all administrative claims in full to get a plan confirmed.

To get around section 1129(a)(9), the Sears debtors proposed a post-confirmation administrative expense claims consent program whereby vendors with priority claims could opt in to accept less than full payment in exchange for immediate payouts, avoiding years of delays while the debtors “litigated” their claims (for example, stalled and stalled until the claimants gave up and caved). Judge Drain agreed to confirm the plan subject to the proviso that it could not go effective until administrative claimants were either paid in full or agreed to accept less, reasoning that section 1129(a)(9) applied to the effectiveness of a plan and not confirmation (despite all textual evidence to the contrary).

At the confirmation hearing, Judge Drain lauded himself for approving an innovative solution that, although it completely jobbed vendors who provided goods to the debtors postpetition in defiance of one of the basic requirements for confirmation, avoided the dreaded chapter 7 liquidation. As of today, there are currently seven Sears stores remaining in operation – the one in Miami is slated to be demolished for condos, like every other structure in South Florida, eventually. Bravo, chapter 11 and Judge Drain!

Sounds like Sanchez: confirming a plan to confirm a plan. Of course, it could hardly have worked out worse than Sanchez; thanks to the debtors’ diligent efforts, the plan finally went effective in October 2022, three years after confirmation, after the debtors secured enough opt-ins, reduced enough claims and recovered enough on litigation to finally pay the holdouts. Needless to say, the professional fee claimants got their administrative claims paid right away, because of course.

Reminder for those who have practiced bankruptcy law long enough to forget the actual provisions of the Bankruptcy Code (we don’t blame you, they rarely come up!): Professional fee claims are equal in priority to other administrative claims. There is no legal requirement – or justification – to pay professionals ahead of vendors with administrative claims.

In October 2020, Forever 21 (the original Ridiculously Tight T-Shirt Company, no relation to the second Forever 21 chapter 11 filing except the name) tried a similar maneuver to circumvent the administrative solvency requirement for a liquidating plan. The debtors proposed an administrative claims consent program that required priority claimants to opt out of receiving less than full value as required under section 1129(a)(9) while of course proposing to pay professional fee administrative claimants in full.

Judge Walrath allowed the debtors to attempt this “moonshot,” but only on an opt-in basis and before confirmation, after debtors’ counsel Kirkland & Ellis quite honorably agreed not to charge any fees for its effort to get administrative creditors on board. The debtors gamely secured opt-ins from 90% of the administrative claimants, but could not pay the remaining 10% in full and still pay the opt-ins their 14% distribution – so Judge Walrath sensibly dismissed the case without a liquidating plan. For the record, the heavens did not fall.

Now Steward – basically the shambolic janitor-run hospital from Scrubs, without the charming musical numbers – wants to combine the worst elements of the Sears and Forever 21 consent program concepts: a post-confirmation, opt-out administrative claims consent program. And yes, the professionals would be paid in full at confirmation, because of course.

On May 20 several creditors, including the commonwealth of Massachusetts and a group of physicians upset about losing their $62 million deferred compensation fund, asked Judge Lopez to convert the case to chapter 7, citing the debtors’ obvious inability to satisfy section 1129(a)(9), one of the only clear, unambiguous requirements for confirmation of a plan.

The creditors also opposed the company’s proposed settlement with FILO lenders, which the UCC also supports, as a sub rosa plan. We’re not going to get into that here; suffice to say, Judge Lopez was not convinced by that.

The UST joined in on May 25, arguing that the administrative claim consent program would “force” non-estate professional administrative claimants to accept less than full payment while ensuring professionals of equal priority get paid more than $100 million in compensation. Again: There is nothing in the Bankruptcy Code that justifies paying professionals ahead of other administrative claimants, but bankruptcy judges routinely treat professionals as higher priority. Purposive?

“Permitting the Debtors to sidestep their obligation to pay the ordinary administrative claimants in full, many of whom faithfully provided post-petition goods and services that ensured the safety of patients and the Debtors’ continued operations during these cases, while allowing professionals to be paid in full undermines the integrity of the bankruptcy system,” the UST says. Bold!

Of course, Judge Lopez did the sensible thing, nipped the debtors’ pointless plan in the bud and avoided years of post-confirmation fights by rejecting the disclosure statement and immediately converting the woebegone hospitals’ case to chapter 7, where it rightfully belongs. Kidding! On May 30 Judge Lopez cleared the plan for solicitation – more administrative expenses – while giving his usual speech about confirmation not being a layup.

“There is no guarantee that there is a plan that can be confirmed” and the plan “will stand” or “fall on its own merits,” Judge Not-a-Layup remarked, presumably with a stern expression and a good old-fashioned finger-wag.

Sure. This being a big-case chapter 11 with management still in control and no apparent two-step shenanigans – our two recognized exceptions to the debtor-wins-in-Houston rule – we guarantee that the plan will be confirmed at the hearing scheduled for July 11.

How did this obvious turkey get past inspection? Maybe DOGE laid off the turkey inspectors? At the DS hearing, Judge Lopez cited supposedly unrefuted evidence put on by the debtors – namely, their liquidation analysis (insert side-eye emoji here), and found that the settlement is the “only path” to provide “any form of meaningful recovery” to creditors. Chef’s kiss.

Lest you think this is a Houston thang, check out the Silver Airways chapter 11 pending in the sleepy Southern District of Florida (soon to be converted to condos). On April 10, the UST moved to dismiss the Silver Airways case, pointing to the debtors’ obvious administrative insolvency and “fanciful” feasibility projections. Apparently the South Florida UST is not aware that chapter 11 financial projections always have a touch of Magical Realism to them (see Rite Aid below), children born with pig tails, astronomical increases in revenue and what-have-you.

At a hearing on May 7, Judge Peter Russin, like Judge Lopez, invoked the stern warning provisions of the Bankruptcy Code, suggesting that he would not approve bidding procedures for a proposed sale of the debtors’ assets or the DIP unless the debtors showed that all administrative creditors would be paid either from the proceeds or directly by secured creditors or the buyer. The cases cannot be run on a “hope and a prayer,” Judge Russin remarked, clearly unfamiliar with how this system works – of course, he only took the bench a few years ago.

On May 13, the debtors and secured creditors called the judge’s bluff, indicating they had not concocted any way to ensure payment of administrative expenses as a prerequisite to bidding procedures and DIP approval. Judge Russin responded that any deal between the debtors and secured creditors cannot bypass the Bankruptcy Code’s technical requirements and must provide for proper treatment for administrative claimants, which, see above. Stern warning No. 2!

Rather than cutting a seemingly unlikely deal with secured creditors, the debtors passed the hat around their known administrative claimants, conducting a sort of informal, non-court-approved administrative claims consent program. The debtors shared the results with the judge on May 15, providing a spreadsheet allegedly detailing their administrative claims liability and indicating that several large administrative claimants agreed to write down their claims to allow the case to proceed rather than convert.

This highly informal, partial go-ahead from administrative claimants gave Judge Russin sufficient good vibes to back down from the whole “Bankruptcy Code technical requirements must be met” concept and approve the bid procedures and DIP financing. “Nearly every administrative claimant of consequence – Azorra, Jetstream, UMB, TrueNoord, NAC, World Fuel, the airports – stood before the Court, weighed their options, and urged the Court to approve the path now adopted,” Judge Russin explains in a May 20 opinion.

That is a load-bearing “of consequence.” How does Judge Russin know these are the only administrative creditors “of consequence”? The debtors’ spreadsheet? Sounds like fellow South Florida Judge Corali Lopez-Castro’s back-of-the-envelope tort claims estimation in Bird Global. Well, we guess Judge Russin has good reasons to trust these debtors, right?

Wrong! In the same opinion in which he credits the debtors’ administrative consent “program,” the judge notes that “[t]he Debtors’ lack of financial transparency has been a persistent concern” in the case, with the company having filed cash collateral motions lacking “sufficient detail, particularly in light of unpaid administrative obligations” (emphasis ours).

What about the administrative creditors who did not chime in? “The Court does not interpret silence as approval, but neither can it infer opposition where none was expressed, particularly in the absence of any alternative relief sought,” Judge Russin adds, which, what? Administrative creditors do not bear the burden to object to not getting paid in full; the Bankruptcy Code guarantees that, without them having to do anything.

“Other administrative creditors’ silence “does not constitute consent,” the judge explains. “But it also does not alter the reality that no party has filed an objection or proposed an alternative to the process now before the Court.”

Eh, whatever. We all know what is really going on here, and it’s the same process as in Steward: The judge knows what the Bankruptcy Code requires, the debtors and secured creditors say they can’t or won’t satisfy that requirement, the judge gives a stern warning, and the debtors give said warning exactly as much credibility as it deserves, which is to say none at all. If strictly applying the requirements of the Bankruptcy Code might lead to conversion to chapter 7, the bankruptcy judge will fold.

Two problems here. First, our usual concern: Bankruptcy judges’ willingness to ignore the plain language of the Bankruptcy Code to pursue a purposive outcome – avoid conversion at all costs, ensure confirmation – on extremely flimsy evidence threatens the legitimacy of the bankruptcy system, yadda yadda, you’ve heard it all before.

Second, the requirement that administrative claims – not just professional fee administrative claims, but all administrative claims – be paid in full serves an important purpose: ensuring that vendors and suppliers continue providing goods and services to bankrupt debtors on credit during the chapter 11 case.

Disregarding the full payment requirement in favor of opt-out mechanisms and informal polls of creditors based on dubious spreadsheets from untrustworthy debtors clearly undermines that purpose.

“This is a core promise of the bankruptcy system – administrative claimants who continue to provide goods and services to a debtor after the bankruptcy filing will be paid in full for those goods or services,” the UST points out in its Steward conversion motion. If Judge Lopez authorizes the administrative claims consent program, the UST sternly warns, “ordinary administrative claimants in future cases – many of whom provide essential goods and services to debtors in bankruptcy – will think twice before providing services or supplies to debtors.”

If administrative trade creditors keep getting jobbed in the sacred mission to avoid conversion, they will eventually stop providing goods to chapter 11 debtors on credit – ensuring that in the future, more cases will have to convert or liquidate. For an example of what happens when vendors get tired of providing goods and services to a troubled company in exchange for nothing more than empty promises, see below.

Drugstore Cowboys

Let’s give it up for another debtor sop from Judge Kaplan. This time: the ultra-fast, ultra-secret sale “process” in the Rite Aid chapter 22.

A little background: The bankruptcy judge in the first Rite Aid case – oh, hey, also Judge Kaplan! – confirmed the company’s first chapter 11 plan after finding the plan was “feasible,” or as section 1129(a)(11) of the Bankruptcy Code puts it, that confirmation was “not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan.” Ooopsie!

In confirming the first Rite Aid plan on June 28, 2024, Judge Kaplan even gave a little speech, presumably aimed at other companies – exclusively New Jersey companies, of course! – considering a chapter 11 in his court. Rite Aid’s case served as an example of how the bankruptcy court can act as a “central forum” to address financial difficulties and “enterprise threatening litigation” – here, trillions in opioid claims. Aren’t we super?

Judge Kaplan also commended the cooperative efforts of “nearly all stakeholders” to achieve consensus with the debtors on the “precipice of liquidation.” Although the case was “arduous,” Judge Kaplan said, it was “not difficult” to confirm the plan, which was “far superior” to liquidation. Unfortunately, it in fact led to another chapter 11 filing and a liquidation in less than a year, but, eggs and omelettes, you know.

Judge Kaplan even gave the state of Maryland – a sovereign state represented by officials duly elected by the citizens of Maryland and endowed with all powers not reserved for the federal government under the U.S. Constitution – a little David Jones-ish lecture on playing along with the bankruptcy process, agreeing with the debtors’ “fiduciaries” – the same gang that said the first plan was feasible! – that Maryland’s citizens would be better off.

Maryland promptly appealed confirmation of the first Rite Aid plan to a real court. Anyway.

Rite Aid emerged from the first chapter 11 on Aug. 30, 2024, after Judge Kaplan denied Maryland’s motion for a stay pending appeal. It took a whole six months before the company reengaged with restructuring advisors – did they even pack up the War Room? – to address liquidity issues. The chapter 22 alarms started blaring for real in early April 2025, and on April 22, other outlets reported that even the ABL was underwater – the clearest sign what we are dealing with here is an absolute lemon.

Rite Aid filed the chapter 22 on May 5, a solid 248 days after emerging. Turns out, the feasibility of the first plan might have been just a bit dicey! The company blamed the rapid return to Judge Kaplan’s warm, soothing embrace on “unforeseen challenges that significantly impaired” its nonpharmacy “front-end” business, including vendors’ refusal to return to less restrictive pre-bankruptcy payment terms after emergence and ABL lenders’ refusal to provide letter-of-credit facilities “crucial to Rite Aid’s recovery.”

In other words: The folks selling Halloween candy, paper towels and single-use iPhone chargers to Rite Aid had a more realistic view on the feasibility of Rite Aid’s first plan than Judge Kaplan. Didn’t they hear the judge’s speech about what an amazing accomplishment the first plan was? Maybe he should have directed the “bankruptcy works best” speech to vendors instead of Maryland.

The debtors immediately filed a bidding procedures motion to sell off their more valuable pharmacy business to whoever might be interested. Note that the word “seal” does not appear anywhere in that motion, and keep that in mind. The debtors asked for an extremely tight sale timeline, with a binding bid deadline of May 13 – six days after the first day hearing – and a sale approval deadline of May 23.

According to the debtors, the tight sale timeline was justified by melting ice cube: “[D]ue to the nature of the Debtors’ retail pharmacy business, there is significant risk that disorderly customer attrition will cause the Debtors’ assets to materially deteriorate in value as the chapter 11 cases progress.” Read: Customers would hear Rite Aid filed chapter 11 and quickly take their prescriptions to other pharmacies.

Yeah, sure, but: That’s true in literally every consumer-facing bankruptcy, which is a lot of cases. Retail consumers have the ability to take their business elsewhere. Does that justify a light-speed section 363 sale process in every retail case?

Signs point to yes, at least in New Jersey. Unsurprisingly, at the first day hearing on May 7, Judge Kaplan approved the bidding procedures, including the hasty deadlines, although his reasoning was not exactly consistent with the debtors’ arguments. “This is not simply a retail case about books, shoes, fast food or car washes,” the judge said. “When you hear 8 million individuals are getting their pharmaceutical needs addressed” through “millions of transactions [each week], the court is going to support the process.”

So, the need for speed was actually to ensure that customers could continue getting their precious meds? I thought the concern was customers going elsewhere to get their meds and diminishing the value of the assets? Well, whatever works. Purposive, you know.

Plus, big-case bankruptcy judges absolutely love to pin their debtor-friendly decisions on supposed concern for those with no actual interest in the bankruptcy, like employees or customers or people who just want to watch the Tigers game after a long day of peeing in a bottle at the Amazon warehouse.

On May 15, the debtors announced the results of the sale process, with a list of winning bidders for their pharmacy assets – but without any indication as to the purchase prices. A few days later, the debtors filed the asset purchase agreements under seal ahead of the May 21 sale hearing.

In the boilerplate motion to file the APAs on the record without any of the economic terms of the bids, the debtors argued that “disclosure of the terms of current sales transactions could materially impair the Debtors’ efforts to monetize additional assets in future sales, including with respect to certain competitors of the Debtors that may be purchasers of the Debtors’ assets in future sales.”

Yeah, sure, but: That’s true in literally every case involving a sale of fewer than all of a debtor’s assets, which is a lot of cases. Like, for example, Rite Aid’s first chapter 11 case. Of course Judge Kaplan also approved sealing one APA in the first case, but even if you want to defend that, here we are talking about numerous APAs that are basically the whole show in the second case. The debtors are selling 90 million prescriptions.

Sure, other assets might remain to get picked up by bargain hunters after the big pharmacy sale, but the second case is little more than a liquidation of the pharmacy assets. Sealing the purchase price for those operations means creditors and other parties in interest basically had no idea what the debtors might recover for their benefit. The debtors ran an ultra-expedited sale process, supposedly for the benefit of creditors, and asked Judge Kaplan to approve the results without actually disclosing the results to the creditors.

But hey, they’re fiduciaries! You can always trust fiduciaries, right?

Needless to say, Judge Kaplan duly granted the motion to seal and on May 21 approved the proposed sales. Nobody objected to the sales, but of course nobody knew any of the economic terms, so. Not to mention that anyone with any bankruptcy experience – and many of Rite Aid’s creditors probably have bankruptcy experience at this point! – knew New Jersey Jones would approve the sales no matter what, so why bother?

Look, companies file chapter 11 to liquidate for very good reasons. Section 363 allows the bankruptcy court to approve the sale free and clear of liens, claims and encumbrances – a very valuable benefit to the buyer and, indirectly, the seller. The buyer gets a federal court order, the gold standard for clean title. But there are trade-offs – to get that sanitized title, the parties must go through a judicial process, and judicial processes are public – at least for now!

Of course, every debtor would rather be able to promise potential bidders their offers would remain secret and keep one buyer’s offer secret from the others – but that simply does not matter. If you choose to sell assets in chapter 11 to secure the benefits, you have to go along with the court process.

Or you could just file in New Jersey and ram through secret sales in a few weeks! Judge “Feelgood” Kaplan will write you an Rx for whatever you might want, and you can be pretty sure your local chain pharmacy will give you those pills, no matter how addictive, with no questions asked.