Old Copper Co. Inc. (f/k/a CPPRQ/JCPNQ JC Penney)

[JohnSamuel]

Courts Looking Beyond Usual Standard

https://www.forbes.com/sites/maxfrumes/2016/10/14/the-equity-committee-trend-when-shareholders-of-a-bankrupt-company-hope-to-get-more-than-nothing/#571ad34a56b2

Recently, however, several bankruptcy judges have began to look beyond the typical, valuation-focused Pilgrim’s Pride factors when confronted with a request to appoint an equity committee, including in cases such as Energy XXI and Horsehead Holdings, signaling that courts may be searching for ways to improve equity’s chance of gaining a seat at the negotiating table.

In the case of Energy XXI, Judge Marvin Isgur of the bankruptcy court for the Southern District of Texas appointed an equity committee in light of bad-faith allegations of insider dealing, a lack of disclosure and the CEO’s misconduct that were potentially implicated in Energy XXI’s downward valuation shift in the months leading to its bankruptcy filing.

In Horsehead Holdings, Judge Christopher Sontchi from the bankruptcy court for the District of Delaware appointed an equity committee after noting that he was “going out on a limb” since he was not directing the appointment based on a showing of a substantial likelihood of recovery for shareholders or the other typical legal requirements. Instead, referencing Horsehead’s plummeting value, Judge Sontchi said, “To put it bluntly, something doesn’t smell right.”

Unlike in Energy XXI, Judge Sontchi explicitly noted that he was appointing an equity committee not on the basis of a belief that inappropriate conduct by management had a hand in causing Horsehead’s financial troubles. Rather, Judge Sontchi stressed, “I don’t know what happened as I sit here today.” In his view, the “valuation scenario that existed” before the bankruptcy was “radically different” from the valuation scenario after the company filed for chapter 11, rendering the appointment of an equity committee “appropriate in this unique situation.”

SandRidge Energy involved another ruling deviating from the typical Pilgrim’s Pride factors. In that case, Judge David Jones from the bankruptcy court for the Southern District of Texas refused to direct the appointment of an equity committee and said that in addition to the four Pilgrim’s Pride factors, he also considers a “practical fifth” factor focused on whether the appointment of an equity committee will “add something” to the bankruptcy case. Judge Jones denied the appointment request after concluding that the SandRidge shareholders failed to demonstrate the four Pilgrim’s Pride factors as well as the “practical fifth” factor he enunciated.

While Judge Bernstein’s ruling in Breitburn today did not explicitly reference a fifth factor and was not based on a suspicion of management wrongdoing, the judge relied on Breitburn’s prior SEC filings and other valuation-related disclosures as the “most probative” evidence that Breitburn was not “hopelessly insolvent.” Notably, Judge Bernstein did not base his decision on the parties’ competing preliminary valuation reports, which he noted were of “limited assistance.” Instead, the court focused on Breitburn’s impairment analysis of their oil and gas assets in relation to the company’s enterprise value. Judge Bernstein noted that the asset valuation derived from impairment charges is “more akin” to market value and that if the oil and gas assets were overvalued, the company would know, but no such overvaluation was identified. This ruling signaled the judge’s willingness to consider other potentially relevant evidence in determining whether to exercise his discretion to direct the appointment of an equity committee.

It remains to be seen whether other bankruptcy courts will adopt Judge Jones’ fifth factor or consider bad-faith allegations and other unique or case-specific circumstances as in Energy XII, Horsehead and Breitburn when confronted with future requests to appoint an equity committee.

Cost Safeguards

In recent cases where shareholders have succeeded in getting an official equity committee appointed, bankruptcy courts have appointed such committees either with court-imposed or strongly suggested expense safeguards aimed at minimizing the potentially costly burden that equity committees can impose on debtors’ estates once appointed. Such safeguards have included interim and global fee caps.

For example, at the June 20 hearing approving the retention of the equity committee’s professionals in Horsehead Holdings, Judge Sontchi imposed a global cap of $1.75 million through Aug. 31 for all three professionals retained on behalf of the equity committee, while reserving the right to revisit the cap at a later date. Judge Sontchi acknowledged that courts are typically reluctant to impose fee caps as they can have negative effects but added that “this is the rare case where it would be appropriate to … impose a reasonable preliminary cap on equity committee fees and expenses for professionals.”

Although Judge Sontchi ultimately eliminated the global fee cap after noting his belief at the Sept. 2 confirmation hearing that the equity committee had added “tremendous value to the process,” the court’s initial imposition of a global cap appears to have been prompted, at least partially, by cost concerns. Judge Sontchi made it clear at the May 2 hearing in which he directed an equity committee appointment that he would be carefully reviewing the fees incurred by the committee. As Judge Sontchi emphasized, he did not want his decision to appoint an equity committee to be interpreted as giving “carte blanche.”

Judge Isgur took a slightly different approach in Energy XXI to address the cost issue. Specifically, when appointing the equity committee, Judge Isgur indicated that he would allow the equity committee to negotiate hourly-rate representation for issues relating to the third-party releases and a management incentive plan equity distribution but suggested a contingency-fee representation in relation to valuation issues. Ultimately, the retention of the equity committee’s professionals followed Judge Isgur’s suggested structure.

During today’s bench ruling in Breitburn, Judge Bernstein did not impose any fee caps or otherwise address the issue of fees, but it may well be a topic of discussion once the equity committee seeks to officially retain its legal and financial advisors in the near future.

Measuring Success of Recent Equity Committees

Whether an equity committee “wins” or “loses” is most easily viewed by looking at whether shareholders were able to obtain a greater recovery than was originally proposed by the debtors. Under that rubric, the Horsehead equity committee recently lost. In Breitburn, Energy XXI and Hercules Offshore, however, it is too soon to tell whether their equity committees will succeed in obtaining more value for shareholders.

Today’s ruling in Breitburn represents a preliminary “win” for shareholders. But, as expected, the debtors announced at today’s hearing that the plan of reorganization they intend to file soon provides no distributions to shareholders. Consequently, the equity committee faces a significant battle in demonstrating that the company actually has enough value to provide for meaningful shareholder recoveries. Under both the debtors’ and unsecured creditors committee’s proposed preliminary valuations, no value exists for equityholders.

Similarly, as things stand in Energy XXI, equity is positioned to recover nothing under the debtors’ plan. Such is also the case based on the competing valuations advanced by certain creditor constituencies in the case. In advance of the confirmation hearing scheduled to begin Nov. 2, the debtors and their key constituents, including the equity committee, engaged in mediation from late September until recently. Those discussions, however, have since collapsed, in part due to the rally in crude oil, which renders moot the valuation underlying Energy XXI’s current restructuring plan.

Shareholders in Hercules Offshore are faring better under the Hercules debtors’ plan. In that case, the formation and participation of the equity committee appears to have pushed the debtors and their secured lenders to propose greater recoveries for equity. Specifically, a partial settlement with the lenders resulted in additional value for shareholders through a $32.5 million reduction in those lenders’ claims and a guaranteed cash distribution of $15 million to common shareholders in the event that they reject the plan. The equity committee, however, did not agree to the deal. Instead, it opposed plan confirmation, arguing that shareholders should receive far higher distributions. Confirmation concluded on Sept. 27. With post-confirmation briefs due Oct. 14, it remains to be seen whether the equity committee’s arguments will gain traction with Judge Kevin Carey of the bankruptcy court for the District of Delaware.

Importantly, even if equity succeeds in getting an official committee appointed, having a seat at the negotiating table does not guarantee a positive financial outcome for shareholders - whether through obtaining a greater or, more frequently, any distribution through the bankruptcy. Horsehead serves as the most recent example of this, as the company’s shareholders were left empty-handed after Judge Sontchi confirmed the plan, which wiped out equity’s interests.

From the viewpoint of process and transparency, however, the value added by equity committees may go beyond the question of shareholder recoveries. In Horsehead, the debtors’ plan proposed no distribution to shareholders, and the equity committee contested confirmation largely on valuation grounds. In overruling the equity committee’s objection and confirming the plan as proposed by the debtors, Judge Sontchi noted:

“Now, this is not the result that the shareholders were looking for. However, I believe more than ever that the appointment of an equity committee has been fully vindicated in this case. As I mentioned back in May, the issue here is valuation. Now, the lenders refused to allow for a market check, that’s their call. And the creditors’ committee settled. Someone had to show up and stand up under the facts and history of this case for the shareholders to challenge the valuation proposition, and appointing an estate funded fiduciary to do that was appropriate. … I think, frankly, [the equity committee] brought tremendous value to the process” (emphasis added).