Emerge Energy Services LP – Aptly Named Debtors Emerge from Highly Contentious Chapter 11 Owned by Second Lien Notes Holders; Unsecured Creditors Holding $574mn of Debt Are Crammed Down and Get Nothing

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December 23, 2019 – The Debtors notified the Court [Docket No. 733] that their Second Amended Plan of Reorganization had become effective as of December 20, 2019. The Court had previously approved the Debtors’ Plan on December 18, 2019 [Docket No. 721]. The Debtors also filed a Plan supplement listing contracts to be assumed [Docket No. 732]. For more detail on a bitter fight pitting the Debtors and HPS Investment Partners, LLC ("HPS"), on the one hand, and the Debtors' unsecured creditors, on the other, please see our earlier coverage, including our story on the confirmation order. In a nutshell, unsecured creditors, holding more than $574.0mn of debt (and having accused the Debtors and HPS of an unholy alliance throughout) resoundingly rejected the Plan even with the knowledge that in doing so they would be accepting a 0% recovery (the Debtors had dangled equity nominally valued at 0.4-1.3% as an incentive to vote in favor). 

The Plan, however, did not need the unsecureds in order to be confirmed given that holders of $208.5mn in pre-petition notes claim, led by HPS, provided the Debtors with the requisite single class voting in favor of the Plan. As to the charges of foul play, the Debtors pushed back hard, summing up "And what did the Creditors Committee uncover pursuant to its inquisition? Nothing. The Creditors Committee’s repeated assertions against the Prepetition Noteholders in their confirmation objection should be seen for exactly what they are-nothing more than unsubstantiated and unfounded aspersions and disparaging innuendo."

On December 5th, the Court had denied [Docket No. 672] the confirmation of the Debtors’ Plan on the basis that the Plan’s incorporation of implied consents to deliver binding third-party releases simply did not pass muster; stating that “a party’s receipt of a notice imposing an artificial opt-out requirement, the recipient’s possible understanding of the meaning and ramifications of such 24 notice, and the recipient’s failure to opt-out simply do not qualify” as a mechanism by which consent/waiver in respect of third-party releases can be deemed to have been given. 

On December 10th, the Debtors bounced back with a revised Plan which has now gotten Court approval, the Court opining that the Plan "resolved all objections that were sustained by this Court in the [earlier] Confirmation Opinion." In order to earn that approval, the amended Plan, and related Plan solicitation procedures, removed a requirement that voting classes complete separate opt-out forms in order to avoid being treated as having refused to consent to third-party releases. 

On July 16, 2019, Emerge Energy Services LP (formerly NYSE: EMES and now OTC: EMESZ) and four affiliated Debtors (“Emerge Energy” or the “Debtors”) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the District of Delaware, lead case number 19-11563. In their lead Petition, the Debtors, a Delaware limited partnership that is engaged in the business of mining, processing, and distributing silica sand proppant used for hydraulic fracturing, noted between 200 and 1,000 creditors; estimated assets of $329.4mn and estimated liabilities of $266.1mn. 

Voting Results

The voting results [Docket No. 542] were as follows:

  • Class 5 (“Prepetition Notes Claims”): 18 holders, representing $208,512,307.81 (100%) in amount and 100% in number, accepted the Plan.
  • Class 6 – (“All Debtors”) 37 holders, representing $16,219,545.16 (3.86%) in amount and 45.68% in number, accepted the Plan. 44 Claims holders, representing $403,510,261.78 (96.14%) in amount and 54.32% in number, rejected the Plan. 8 Claims holders abstained representing $13,684.78.

Class 6 as sub-divided:

  • Class 6 – GUC – (“Emerge Energy Services LP”) 11 holders, representing $326,884.49 (0.10%) in amount and 64.71% in number, accepted the Plan. 6 claims holders, representing $332,724,624.33 (99.90%) in amount and 35.29% in number, rejected the Plan.
  • Class 6 – GUC – (“Emerge Energy Services GP LLC”): no votes were received.
  • Class 6 – GUC – (“Emerge Energy Services Operating LLC”) 2 holders, representing $7,157,020.08 (35.47%) in amount and 40% in number, accepted the Plan. 3 claims holders, representing $13,022,590.74 (64.53%) in amount and 60% in number, rejected the Plan.
  • Class 6 – GUC – (“Superior Silica Sands LLC”) 24 holders, representing $8,735,640.59 (13.14%) in amount and 40.68% in number, accepted the Plan. 35 Claims holders, representing $57,763,046.71 (86.86%) in amount and 59.32% in number, rejected the Plan. 8 claims holders abstained representing $13,684.78
  • Class 6 – GUC – (“Emerge Energy Services Finance Corporation”): no votes were received.

The following is a summary of classes, claims, voting rights and expected recoveries (Defined terms are as in the Plan and/or Disclosure Statement): 

  • Class 1 (“Other Priority Claims”) is unimpaired, deemed to accept and not entitled to vote on the Plan. The estimated aggregate amount of claims is $1,790,000 and the estimated recovery is 100% in cash.
  • Class 2 (“Other Secured Claims”) is unimpaired, deemed to accept and not entitled to vote on the Plan. The estimated aggregate amount of claims is $441,000 and the estimated recovery is 100% in cash.
  • Class 3 (“Secured Tax Claims”) is unimpaired, deemed to accept and not entitled to vote on the Plan. The estimated aggregate amount of claims is $2,288,000 and the estimated recovery is 100% in cash.
  • Class 4 (“Prepetition Credit Agreement Claims”) is unimpaired, deemed to accept and not entitled to vote on the Plan. The estimated aggregate amount of claims is $27,260,000 and the estimated recovery is 100% to be paid in cash from exit facility loans.
  • Class 5 (“Prepetition Notes Claims”) is impaired and entitled to vote on the Plan. The estimated aggregate amount of claims is $208,512,308 and the estimated recovery is 38–55%. If  Class 6 votes to accept the Plan, each Holder of an Allowed Prepetition Notes Claim shall receive its Pro Rata share of (i) the New Second Lien Notes, if any; (ii) the New Emerge GP Equity Interests; (iii) one hundred percent (100%) of the Perpetual Preferred Interests less any Preferred Interests issued to satisfy DIP Credit Agreement Claims; and (iv) 95% of the New Limited Partnership Interests issued and outstanding on the Effective Date prior to dilution by the New Management Incentive Plan Equity and any issuances pursuant to the New Warrants.  If  Class 6 votes to reject the Plan, each Holder of an Allowed Prepetition Notes Claim shall receive its Pro Rata share of (i) the New Second Lien Notes, if any; (ii) the New Emerge GP Equity Interests; (iii) one hundred percent (100%) of the Perpetual Preferred Interests less any Preferred Interests issued to satisfy DIP Credit Agreement Claims; and (iv) 100% of the New Limited Partnership Interests issued and outstanding on the Effective Date prior to dilution by the New Management Incentive Plan Equity and any issuances pursuant to the New Warrants.
  • Class 6 (“General Unsecured Claims”) is impaired and entitled to vote the Plan. The estimated aggregate amount of claims is $573,909,000 and the estimated recovery is 0.4 -1.3% If Class 6 votes in favor of the Plan, each Holder of an Allowed Class 6 Claim shall receive its pro rata share of (i) 5% of the New Limited Partnership Interests issued and outstanding on the Effective Date prior to dilution by the New Management Incentive Plan Equity and any issuances pursuant to the New Warrants and (ii) New Warrants representing 10.0% of the New Limited Partnership Interests issued and outstanding on the Effective Date prior to dilution by the New Management Incentive Plan Equity. If Class 6 does not vote in favor of the Plan, each Holder of a Class 6 Claim shall receive nothing.
  • Class 7 (“Intercompany Claims”) is unimpaired, deemed to accept and not entitled to vote on the Plan. The estimated aggregate amount of claims is $0 and the estimated recovery is 100%
  • Class 8 (“Old Emerge GP Equity Interests”) is impaired, deemed to reject and not entitled to vote on the Plan. Estimated recovery is 0%.
  • Class 9 (“Old Emerge LP Equity Interests”) is impaired, deemed to reject and not entitled to vote on the Plan. Estimated recovery is 0%.
  • Class 10 (“Old Affiliate Equity Interests”) is unimpaired, deemed to accept and not entitled to vote on the Plan. Estimated recovery is 100%.

The valuation analysis attached as Exhibit E to the Disclosure Statement provides the following insight as to the potential value being offered to Class 6 in order to encourage a vote in favor of the Plan: "Houlihan Lokey estimates the Total Enterprise Value of the Reorganized Debtors operations on a going concern basis to be approximately $180–220 million. Based on the range of Total Enterprise Value and the capital structure pro forma for the transaction contemplated by the Plan and outlined in the Financial Projections, the implied range of potential equity value is de minimis to approximately to $35.0 million. Based on the estimated range of the Reorganized Debtor’s equity value above, the value of the 15% New Warrants is estimated to be de minimis to approximately $2.2 million using a BlackBlack-Scholes valuation model at 70% volatility."

Plan Supplement

On December 20, 2019, the Debtors has also filed their fourth Plan Supplement to the Second Amended Joint Prepackaged Plan of Reorganization [Docket No. 732].

The Supplement attached the following document:

  • Exhibit 1: Contracts to be Assumed.

Further Background on Third-Party Releases

As previously reported:  "On December 5, 2019, further to objections from the Debtors’ Official Committee of Unsecured Creditors, the U.S. Trustee assigned to the Debtors’ cases and the Securities and Exchange Commission, the Court issued an order denying the confirmation of the Debtors’ Second Amended Joint Plan of Reorganization and an opinion explaining the grounds for doing so [Docket No. 672 and 671, respectively]. For the Debtors, a simple fix conceptually; modify the Plan's third-party release provisions by removing the existing affirmative opt-out mechanism…and the Court has committed to approving the Plan. 

For practitioners, an interesting examination of an issue that has yet to be settled, but would appear to be shifting towards the view expressed by Judge Karen Owens who stated (having acknowledged that her view remains in the minority): 'A party’s receipt of a notice imposing an artificial opt-out requirement, the recipient’s possible understanding of the meaning and ramifications of such 24 notice, and the recipient’s failure to opt-out simply do not qualify [as a waiver of rights in respect of third-party releases]'.

The Court opines: 'The Debtors’ Plan proposes that certain creditors and interest holders provide third-party releases to a number of non-debtor parties. Namely, Article X, Section B.2 of the Plan provides that, unless they complete and return a form (‘Opt-Out Form’) or ballot indicating their affirmative opt-out, holders of general unsecured claims in Class 6 and holders of the Partnership’s equity interests in Class 9 will be deemed to have consented to the release and waiver of current and future claims against the ‘Released Parties’ (which include HPS and Insight). 

The Debtors argue that they should be approved as typical, customary, and routine. The objecting parties disagree, asserting that consent cannot be inferred by the failure of a creditor or equity holder to return a ballot or Opt-Out Form. The Court agrees with the objecting parties. 

The Court understands that its position is a minority amongst the judges of this District. However, the Court must respectfully disagree with its colleagues who have held differently as it has concluded that a waiver cannot be discerned through a party’s silence or inaction unless specific circumstances are present. A party’s receipt of a notice imposing an artificial opt-out requirement, the recipient’s possible understanding of the meaning and ramifications of such 24 notice, and the recipient’s failure to opt-out simply do not qualify.

…with the exception of the proposed third-party releases, the Court finds that the Debtors have carried their burden to demonstrate that the Plan is fair and equitable, satisfies the Best Interests Test, has been proposed in good faith, and otherwise is sufficient for confirmation. An appropriate order will follow denying confirmation so that the third-party release provision may be revised.'

Events Leading to the Chapter 11 Filing

In a declaration in support of the Chapter 11 filing (the “Gaston Declaration”), Bryan Gaston, the Debtors' Restructuring Officer detailed the events leading to the Debtors’ Chapter 11 filing. In particular, the Gaston Declaration highlights the impact of two macro-economic factors that have led to an over-supply of frac sand and a resulting price erosion: (i) a decline in well completion activities by frac sand end-users and (ii) heightened competition from "in-basin" frac sand competitors (in-basin sand is directly mined, processed and delivered in the basin where customer consumption occurs). The Gaston Declaration also highlights the continuing impact of company-specific problems at a newly acquired and developed Texas in-basin site; where a levee breach has shut down several critical operating lines. 

As was also the case in respect of Shale Support's Chapter 11 filing, reduced operating revenues have made existing leasing arrangements in respect of idle railcars (and fixed costs exceeding $3.0mn per month for Emerge Energy) untenable. For these Debtors, the railcar glut is worsened by a move away from the sale of its Wisconsin-mined NWS (northern white sand), heavily reliant on railcars for delivery, to customer preferred in-basin frac sand. Key amongst the Debtors' first day motions is a motion to reject certain railcar leases [Docket No. 9].

The Gaston Declaration states: "Demand for frac sand decreased during 2015 and 2016 as a result of an industry downturn due to low commodity prices. Commodity prices stabilized in the middle of 2016, however, leading to an improvement in drilling activity during the third quarter of 2016, and into 2017 and early 2018. The market for frac sand began to soften again in early August 2018, due to a decline in well completion activities resulting from the exhaustion of capital budgets for oil and gas exploration and production companies. These factors, along with the new production from in-basin frac sand competitors…led the frac sand market to quickly turn from a state of short- supply in the first half of 2018 to over-supply in the second half of 2018. As a result of the imbalance between supply and demand, select in-basin markets for frac sand experienced price erosion as did NWS as a whole. 

While experiencing these negative macro-economic factors and a decline in demand for NWS, in April 2017 the Debtors acquired a site in San Antonio, Texas which had operated a small sand mine for decades. The Debtors then undertook a large capital expenditure project to develop this San Antonio site into a large, premier in-basin frac sand facility. The project, however, experienced certain complications and continues to produce below the facility’s nameplate capacity in its sixth full month of operation, in spite of reasonably strong customer demand and pricing. Exasperating the issue further, the facility has temporarily ceased mining operations at the facility’s A and B mines [as]…the result of a levee breach incident that occurred on Friday June 21, 2019….The full extent of damage to the C-line cannot be fully assessed until the water and sediment from the incident has abated or been cleared, but given the extent and nature of  the incident all equipment and operations related to the C-line are expected to require replacement and this part of the facility’s operation is expected to be idle for an extended period of time. Although lines A and B were not directly impacted by the levee breach, there are  shared water and related retaining structures that, pursuant to the Section 103(k) order, cannot be operated and, as a result, prevents the Debtors from operating lines A and B pending completion of remedial steps to ensure that these areas are safe to operate."

As to the railcar leases, Gaston continues: "Even with the signing of the RSA, however, the Debtors (with the support of their secured lenders) continued to negotiate with their material railcar and terminal lessors for months in the hopes of consummating an out-of-court restructuring. While the Debtors reached agreement with three counterparties, it became clear that there were no viable out-of-court restructuring option for the Debtors to pursue as compared to the benefits that chapter 11 would provide—most importantly the ability to reject burdensome contracts and leases under Section 365 of the Bankruptcy Code. Accordingly, when faced with a lack of viable  restructuring options and dwindling liquidity, and after extensive discussions with their advisors, the Debtors determined that filing for chapter 11 was in their best interest and in the best interest of their creditors and other stakeholders."

Prepetition Capital Structure

  • Revolving  Loan  Agreement (First Lien): Certain of the Debtors are parties to a January 2018 revolving credit and security agreement, (the “Revolving Loan Agreement”) with HPS Investment Partners, LLC (“HPS”), as administrative and collateral agent. As of the Petition date, the Revolving Loan Agreement had an aggregate outstanding principal amount of approximately $66.7mn, comprised of $3.5mn in the form of letters of credit and approximately $63.2mn in an aggregate outstanding principal amount in the form of outstanding loans, plus accrued but unpaid interest, fees, costs, and expenses. These obligations are secured by senior, first priority security interests in, and liens upon, substantially all of the Debtors’ assets.
  • Notes Purchase Agreement (Second Lien): Certain of the Debtors are parties to a January 2018 Notes Purchase Agreement, (the “Notes Purchase Agreement”), with HPS, as administrative and collateral agent. As of the Petition date, the Notes Purchase Agreement had an aggregate outstanding principal amount of approximately $215.8mn, plus accrued but unpaid interest, fees, costs, and expenses. These obligations are secured by second priority security interests in, and liens upon, substantially all of the Debtors’ assets, which liens are junior in priority to the security interests and liens arising in connection with the Revolving Loan. 
  • Unpaid Trade Debt & Related Obligations: As at the Petition date, the Debtors unsecured trade debt was in excess of $56.0mn

About the Pre-Petition Debtors

The Debtors are a publicly-traded Delaware limited partnership that is engaged in the business of mining, processing, and distributing silica sand proppant, a key component in the hydraulic fracturing (“fracking”) of oil and gas wells.  Proppant is sand or similar particulate material suspended in water or other fluid injected into wells at high pressure to keep fissures open to stimulate the extraction of hydrocarbons. The Debtors conduct their mining and processing operations from facilities located in Wisconsin and Texas. In addition to mining and processing silica sand primarily for use in the oil and gas industry, the Debtors also, to a lesser degree, sell their sand for use in building products and foundry operations.

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