Emerge Energy Services LP – With Issues with Third-Party Releases Now Resolved, Court Confirms Plan that Crams Down General Unsecured Creditors Who voted Overwhelmingly Against the Plan

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December 18, 2019 – The Court hearing the Emerge Energy Services cases confirmed the Debtors’ Second Amended Joint Plan of Reorganization [Docket No. 721]. On December 5th, the Court had denied 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.

The third-party releases, presumably not consented to by many claims holders, are hardly a theoretical issue for the Debtors. The Debtors and their now confirmed Plan had another significant and related problem throughout the Chapter 11 process, an overwhelming lack of support from general unsecured creditors who voted more than $403.0mn of their claims against the Plan. In a Plan that had only two voting classes, this means that the Court has crammed down the Debtors' largest class based on the support of a single class representing 18 holders of $208.5mn in value of senior notes. What the 44 claims holders (average claim approximately $9.0mn), who clearly have the financial wherewithal to pursue stakeholders in respect of whom they have not given third-party releases, do now…remains to be seen. 

Throughout the Debtors’ Chapter 11, the Debtors' Official Committee of Unsecured Creditors (the “Committee”) has been scathing as to the conduct of the Debtors, HPS Investment Partners, LLC ("HPS"), which held “dominant, controlling positions in each layer of the Debtors’ prepetition and post-petition secured debt” and “equally culpable…Insight Equity, the Debtors’ controlling equity holder for enabling the undue control exercised by HPS over the RSA, the Special Restructuring Committee, these Chapter 11 Cases and the Plan process in exchange for an improper payoff: warrants for reorganized equity.”

The most recent expression of the Committee's antipathy is in a December 9th objection to Plan confirmation [Docket No. 676], which stated: "The Debtors are pursuing a Plan that is premised on a deeply flawed, outcome driven valuation analysis that was prepared after entry into the RSA and, remarkably, after publishing a Disclosure Statement fixing the Debtors’ position to such value. The Plan is a blatant attempt by a lender-in-possession, through its hand-picked 'Special Restructuring Committee' of the Debtors’ board, to effect an inequitable transfer to itself of all of the value of the Debtors’ material encumbered assets through what is effectively a private sale (one falling far short of arms’ length no less). Just as bad, the Plan also affects a transfer to the lender-in-possession of all unencumbered assets. The Committee’s principal objections to the Plan are driven by (i) the Debtors’ total enterprise value (“TEV”), which pursuant to the valuation prepared by the Committee’s expert, Miller Buckfire & Co., LLC and Stifel, Nicolaus & Co. ('Miller Buckfire'), mandates that unsecured creditors receive substantially larger recoveries; (ii) valuable unencumbered assets that should inure to the benefit of unsecured creditors irrespective of TEV; and (iii) the complete elimination of the “at best” de minimus recovery for unsecured creditors unless they are willing (by voting to accept the Plan) to permit the distribution of consideration to the out of the money equity sponsor. As discussed herein, unless the Plan is substantially revised to appropriately account for the true value of the Debtors’ assets and the unencumbered nature of certain of them, the sole beneficiaries of the Plan will be the parties that negotiated it: HPS, Insight Equity, and the Debtors’ management team. Meanwhile, general unsecured creditors, whose claims are, according to the Debtors, in excess of $570 million, will receive a recovery as small as 0.13% (using the Debtors’ midpoint valuation), and that is only if such class of creditors votes to accept the Plan.9In the event general unsecured creditors reject the Plan, the recovery is zero. Neither outcome is legally supportable given (i) the fatal flaws contained in the Debtors’ valuation analysis, which analysis serves as the underpinning to the Debtors’ unconfirmable Plan; and (ii) the existence of valuable unencumbered assets that are not only artificially devalued, but also improperly allocated under the Plan to HPS rather than unsecured creditors."

In its memorandum in support of Plan confirmation [Docket No. 546], the Debtors acknowledge the Committee’s antagonism and pushed back as follows: "Since its appointment on July 31, 2019, the Creditors Committee has obsessively pushed its narrative that the Debtors abdicated their obligations and duties and allowed HPS Investment Partners, LLC (‘HPS’), agent to the prepetition secured noteholders and DIP lenders, to engage in improper and inequitable conduct with the Debtors. And this story continues in its objection to plan confirmation [Docket No. 495]…But after months of accusations and millions of dollars of fees incurred by the Creditors Committee investigating the Debtors and HPS for potential bad acts the Creditors Committee recently filed its long-awaited standing motion and related adversary proceeding with this Court [Docket No. 520] (the ‘Standing Motion’). 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 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 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."

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.'

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