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October 26, 2020 – The Debtors' Official Committee of Unsecured Creditors (the “Committee”) objected to the Debtors’ Disclosure Statement [Docket No. 1550] alleging "glaring deficiencies" that render the "Disclosure Statement…both facially and substantively deficient with respect to critical Plan-related issues" and leaves unsecured creditors without any hope of arriving at an informed decision as to their Plan vote.
In a scathing attack, the Committee uses its objection to the Disclosure Statement as a vehicle to share more "pertinent facts lying just below the surface," facts that relate to months of pre-filing maneuvers designed to protect the Debtors, the Debtors' management, the Debtors' FLLO lenders and the Debtors' second-lien noteholders (with unsecured noteholder-turned second-lien creditor Franklin Resources Inc. playing a particularly villainous role, NB: Franklin also holding 12.4% of the the Debtors'equity at the end of 2019)…all at the expense of unsecured creditors. "There is perhaps no better time," the Committee suggests "for the reveal than in connection with a woefully deficient Disclosure Statement."
The Committee argues In its version of events (or "reveal," which it also intends to use as a basis for requesting derivative standing (the "standing motion") to prosecute estate claims and causes of action) that the Debtors entered into a series of transactions that allowed $1.5bn of supposedly silo-ed debt assumed during the acquisition of its "Wildhorse (BVL)" assets in February 2019 to escape that silo and "infect" unwitting creditors in other parts of the Debtors' capital structure. That "infection" occurred as a result of two "liability-management" transactions: (i) the refinancing of the $1.5bn Wildhorse (BVL) funded debt at which point the $3.8bn FLLO loan was created and which extended guarantees beyond the silo-ed Wildhorse (BVL) debt and (ii) a simultaneous exchange of "selected" unsecured bond debt (ie not offered to all similarly situated bondholders) for second lien debt, "uptiering" that bond debt in the capital structure. The Committee argues that "of those select few, none was more preferred and enriched as Franklin."
Those two transactions, however, the Committee argues, simply set the stage for the final and most damaging maneuver by Debtors long aware that they were sliding into an inevitable bankruptcy. In connection with the FLLO financing, the Debtors were required to submit mortgages to be recorded/perfected; with any Chapter 11 filing occurring within 90 days of delivery of those mortgages subjecting them to a "direct preference attack" under bankruptcy law The Committee accuses the Debtors of dragging their heels long enough to take those transactions beyond the 90-day time frame, thereby "squander[ing] $3.8 billion in preference claims against the FLLO lenders and Second Lien Noteholders."
The Committee notes that the complaint advancing its proposed "standing motion "against the Debtors et. al. runs to over 100 pages, but groups their claims into three categories otherwise touched on above:
- First, each of the legacy Chesapeake Debtors (i.e., Debtors other than the Wildhorse (BVL) Debtors) have claims against the FLLO lenders to avoid, as fraudulent transfers, the guarantees and liens they delivered in December 2019.
- Second, the proposed complaint seeks to avoid liens delivered to the Second Lien Noteholders, also as fraudulent transfers (ie the "up-tier" exchange) which were intended to benefit select creditors ("Franklin, in particular") over all other unsecured creditors.
- Third, the proposed complaint seeks remedy for the Company’s unjustifiable decision to squander $3.8 billion in preference claims against the FLLO lenders and Second Lien Noteholders.
The objection notes, “The Debtors came to bankruptcy with a particular case theory and strategy. Claims arising under the Debtors’ ‘FLLO’ term loan are, say the Debtors, the ‘fulcrum’ debt. The Second Lien Notes and unsecured claims are, in turn, ‘out-of-the-money.’ There is, according to the Debtors, no reasonable factual or legal basis to challenge the pre-petition capital structure. Thus, the FLLO lenders are due the entirety of the Chapter 11 estates. Nevertheless, the Plan delivers to the FLLO lenders only the lion’s-share of distributable value; magnanimously, it also delivers 12% equity to each of the Second Lien and unsecured creditor classes. But, what is bequeathed is immediately taken away: Through a separate rights-offering, the FLLO lenders and certain select holders of Second Lien Notes (primarily Franklin) redistribute to themselves just about all of the allocation reserved for the other Second Lien Noteholders and all unsecured creditors. And, of course, these parties deliver to themselves (and all Directors and Officers) full Plan releases.
The problem is this: None of it comports with the underlying facts of the case or, in turn, applicable law. Of more immediate concern: No reader of the proposed Disclosure Statement learns any of the pertinent facts lying just below the surface. It is time for those underlying facts to become known. And, there is perhaps no better time for the reveal than in connection with a woefully deficient Disclosure Statement.
With the filing of this Objection, the Committee has also filed motions seeking derivative standing to prosecute estate claims and causes of action against various parties, including the FLLO lenders and Second Lien Noteholders (the ‘Derivative Standing Motions’). Those motions – and the complaints attached thereto – are incorporated herein by reference. The paragraphs below provide a summary.
Key Facts, In Brief. The story of these Chapter 11 cases begins in February 2019. By that point in time, Chesapeake (like so many other gas-oriented E&P companies) was reeling under long-depressed commodity pricing. To help hedge against fallen gas prices, Chesapeake bought a new business: An oil drilling concern operating in the Eagle Ford, called ‘Wildhorse.’ The M&A transaction was structured as a stock purchase; all Wildhorse assets and liabilities were tacked onto the conglomerate as a new ‘silo’ of subsidiaries. Among other assumed liabilities were approximately $1.5 billion in funded debt. Importantly, that debt remained the exclusive province of the new subsidiaries, named the ‘BVL’ entities. No other Chesapeake entity became a guarantor or provided lien support for any of that Wildhorse (BVL) debt. Wildhorse would, in other words, rise or fall on its own, at least that was the transaction’s design.
But, in December 2019, Chesapeake pulled-off two ‘liability-management’ transactions that succeeded in putting off the day of reckoning (for a few short months) but now give rise to a whole host of legal issues. The first transaction was the refinancing of the $1.5 billion Wildhorse (BVL) funded debt. This is, in fact, how the FLLO loan came into existence. The FLLO refinancing was not, however, entirely contained within the Wildhorse (BVL) silo; rather, the FLLO was guaranteed by – and thus infected – the entire Chesapeake corporate structure. Trade creditors and unsecured bondholders, with claims at the multitude of legacy Chesapeake entities (entities operating in Oklahoma, Wyoming, Appalachia, etc. – far removed from the Eagle Ford), woke up one morning to find themselves sitting behind $1.5 billion in secured debt that had nothing to do with their obligor’s business operations and was never part of their historical credit-risk profile. And, their particular Chesapeake obligor did not receive any FLLO money. Every penny of it went to the Wildhorse (BVL) lenders.
Second, on the same day that all of Chesapeake became infected with Wildhorse (BVL) debt, the Company exchanged certain select unsecured bonds for second lien bonds (i.e., the Second Lien Notes). This opportunity was not opened-up to all unsecured noteholders; it was available only to a select few. And, of those select few, none was more preferred and enriched as Franklin. That is because Franklin had established a preferred relationship with the Company, forged over time as one of the Chesapeake’s leading investors. This deference to Franklin became part of the terms of the ‘up-tier’ exchange. The exchange closed with, and was effectively an addendum to, the FLLO issuance.
Chesapeake’s Efforts To Insulate Their ‘Liability Management’ Transactions From Preference Attack: As the Court may recall from the EXCO Resources Chapter 11 case, E&P refinancing (when the borrower is obviously insolvent) bears peculiar preference risks. That is because, in this circumstance, there often is insufficient time for mortgage perfection at the loan closing. Here, as was the case in EXCO Resources, the FLLO Credit Agreement provided that the mortgages were due for delivery/recording 60 days after the loan closed and funds transferred. Thus, if Chesapeake were to file for Chapter 11 within 90-days of delivery/recording, the mortgages would have been subject to direct preference attack. Chesapeake was fully aware of this and [Redacted] But, when the 90-day inflection point came, Chesapeake (shockingly) did not file for bankruptcy. They did not even secure any accommodation from either the FLLO lenders or Second Lien Noteholders in exchange for squandering $3.8 billion in non-insider preference claims against them. Instead, they handed them the Company, memorializing the deal in the RSA and, eventually, the Plan.
The Lien Position Today: The Plan relies on the assumption that the FLLO lenders and Second Lien Noteholders enjoy properly perfected, fully enforceable ‘blanket’ liens across the entire Chesapeake asset-base. Not so….That is not all. The FLLO Term Loan Facility Lenders and Second Lien Noteholders did ‘catch-up’ mortgage filings within 90-days of the Petition Date, covering nearly of the Company’s reserves.
In sum, nearly [redacted] of the Debtors’ estate value will be rendered unencumbered by a rather succinct, pro forma adversary proceeding under Bankruptcy Code Sections 544 and 547. There is, consequently, no way to reconcile the Plan’s value allocation with the case’s underlying facts and, in turn, applicable legal principle. The creators of the RSA/Plan simply believed the facts to be different than they are, and this detachment from reality is enough to ‘put a pin’ in the solicitation and confirmation process today. And, that is before considering all of the other litigation issues arising from the nucleus of operative fact.
Additional Estate Claims: The complaint attached to the Affirmative Claims Standing Motion spans nearly 100 pages, telling the full story of the case. The claims at issue in this proposed complaint may, for ease of reference, be placed in three categories.
First, each of the legacy Chesapeake Debtors (i.e., Debtors other than the Wildhorse (BVL) Debtors) have claims against the FLLO lenders to avoid, as fraudulent transfers, the guarantees and liens they delivered in December 2019. This litigation category relies on a substantial body of bankruptcy jurisprudence respecting the avoidance of ‘sister’ company guarantees/liens typified by the 11th Circuit’s decision in In re TOUSA, Inc., 680 F.3d 1298 (11th Cir. 2012) (sustaining fraudulent transfer claim against secured lenders receiving ‘sister’ company guarantees and liens shortly before bankruptcy). Indeed, a close examination of the facts at issue in TOUSA shows remarkable alignment with the facts at issue in these Chapter 11 cases.
Second, the proposed complaint seeks to avoid liens delivered to the Second Lien Noteholders, also as fraudulent transfers. The ‘up-tier’ exchange adorned to, and should be considered a part of (via the ‘collapsing’ doctrine), the FLLO refinancing. And, as the allegations contained in the proposed complaint make eminently clear, the intent was to advantage select creditors (Franklin, in particular) over all other unsecured creditors.
Third, the proposed complaint seeks remedy for the Company’s unjustifiable decision to squander $3.8 billion in preference claims against the FLLO lenders and Second Lien Noteholders. Today, it is the Debtors’ view that they had no duty to file early and protect the lien avoidance opportunity. And, more to the point, such position is inconsistent with law. See, e.g., Skorheim v. Flanders, 2011 WL 13175962 (C.D. Cal. Feb. 22, 2011) (debtor violates fiduciary duties by intentionally filing late to squander valuable preference claims). The complaint demands remedy in alternative ways, such as aiding and abetting liability and equitable subordination.”
The hearing on the adequacy of the Disclosure Statement is scheduled for October 30, 2020.
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