© 2014 The Texas Lawbook.
By Daniel P. Winikka and Craig F. Simon
Special Contributing Writers to The Texas Lawbook
(April 28) – When a trio of private equity firms bought Dallas-based Energy Future Holdings Corp. (EFH) for $45 billion in 2007, they made a calculated gamble on the rising price of natural gas. Since Texas electricity rates are determined by natural gas prices, the investment looked like a good bet.
Unfortunately for EFH, the cost for natural gas essentially has declined ever since because of numerous advances in shale drilling making natural gas less costly and easier to extract than ever before.
After months of speculation about how EFH would be able to deal with its mountain of debt that requires annual interest payments of $4 billion, it appears the company finally will be filing bankruptcy. If and when it happens, the EFH bankruptcy will be one of the biggest corporate restructurings in U.S. history.
Currently, many EFH creditors in Texas and across the U.S. are preparing – or should be preparing – to assert their rights to recover as much as possible of their portion of the billions the company owes to various creditors. For some, being a bankruptcy creditor represents familiar territory, but for others, the expected EFH bankruptcy may well be the first time they’ve dealt with the often-complicated process and related challenges they have not dealt with before.
How much will creditors be paid and when?
Once a bankruptcy petition is filed, most creditors shouldn’t expect a lot of information on the front end.
Like most large companies considering bankruptcy, EFH has been attempting to negotiate as many settlements as possible with major creditors to reduce the amount of time the company must spend in the restructuring process. Experts predict EFH will file in Delaware based on the track record of bankruptcy courts there for quickly handling large, complex corporate restructurings.
EFH’s goal is to reach enough key agreements to enable the company to file a proposed reorganization plan, which in turn will indicate what EFH proposes to pay its various creditors. How soon that might occur is hard to predict.
Once a proposed plan is filed and the bankruptcy court approves a related disclosure document for all creditors, then creditors will have the opportunity to vote to accept or decline the plan. The court won’t sign off unless enough creditors are in favor of the plan. Until such a plan is filed, however, no one can accurately predict how much creditors will be paid or when.
Preferential treatment for some creditors
As happens in any corporate bankruptcy, certain creditors will receive preferential treatment. Some creditors can expect to be paid in full, while others may receive only a fraction of what they’re owed.
One group that stands to benefit early are so called “critical vendors” or “sole-source providers” who EFH will ask permission to pay quickly to avoid substantial harm to the company’s business. Achieving this designation is an uphill climb since bankruptcy courts scrutinize requests to pay such creditors very carefully and few creditors qualify.
Typically, the only creditors who do qualify are those who have no long-term agreements with the company and whose goods and services are necessary to keep the creditor’s business operations from being significantly disrupted. Those who make the cut likely will see their claims paid in full during the first few weeks of the bankruptcy process.
Others likely to be paid in full are those who supplied goods to EFH within 20 days of the bankruptcy filing.
The U.S. Bankruptcy Code gives special priority to this group, which must be paid for those goods before a company can emerge from bankruptcy. Payments could be made in as little as six months to as many as several years, depending on how quickly the restructuring proceeds.
Although 20-day creditors may seek to get their payments quicker, bankruptcy courts traditionally have forced creditors to wait until the bankruptcy process is completed absent a strong showing that the failure to receive an earlier payment will jeopardize the creditors’ operations.
An important consideration for 20-day creditors seeking priority treatment is whether both goods and services were provided. Priority is given only to goods, which means payments for labor or transportation costs typically do not qualify.
Even in situations where the invoice does not separately list the labor component of the cost, many bankruptcy debtors have argued that only the actual material costs qualify for priority treatment. Bankruptcy courts decide these issues on a case-by-case basis.
It’s also worth noting that the priority treatment only applies to goods “received” by EFH during the 20 days prior to bankruptcy. There are sometimes disputes as to when goods are received. Transfer of title to the goods does not necessarily govern, and goods provided directly to third parties on behalf of EFH may not qualify. Creditors in the 20-day group also should be aware that any goods must have been sold to EFH in the ordinary course of business.
A 20-day creditor granted preferential treatment should be aware that the payment amount will be based on the “value” of the goods sold. Although the “value” typically is determined as the contract price, debtors such as EFH may argue that the true value is lower.
Perhaps the most important consideration for 20-day creditors is the need to carefully follow any procedures established by the bankruptcy court. In large corporate bankruptcies, debtors often ask the court to approve special qualifying procedures for priority treatment, including specific forms, documentation and, most importantly, the related submission deadlines.
The last thing a creditor wants is to find out that they are not eligible for priority treatment because they did not comply with the required procedures or meet a necessary deadline.
Selling a Claim for Quick Payment
Those creditors who are willing to recoup only a portion of what they’re owed and have a need for liquidity may be best served by accepting a cash payment in exchange for their claim against EFH. The sale and purchase of bankruptcy claims is common, requiring only that the buyer notify the court and fellow creditors that a claim has been transferred.
Currently, managers of hedge funds and other investment funds are busy calculating what they believe will be the value of creditors’ claims if and when EFH seeks bankruptcy protection.
Similarly, those who are considering selling their claims against EFH should be conducting their own investigations or seeking legal advice to assess the likely range of recoveries to make sure they don’t sell their claims for materially less than what they are worth.
Much like stock traders, the investment entities that buy and sell creditors’ claims are looking for a profit. They’re usually basing their pricing on the worst-case scenario in terms of what a debtor is likely to pay to an applicable creditor. If a hedge fund manager believes that the least amount EFH is likely to pay on a particular claim will be 10 cents on every dollar owed, then that’s what the creditor can expect to be offered.
EFH is preparing to wipe out billions of dollars of debt in hopes of emerging as a financially healthy company. For EFH creditors, some strategic early planning and a keen understanding of the bankruptcy process will allow them to move forward with as few business interruptions and as little financial loss as possible.
Attorneys Dan Winikka and Craig Simon from Dallas-based Simon Ray & Winikka LLP represent a variety of companies in complex Chapter 11 bankruptcies and other restructurings, including prior work in the SemCrude, Kaiser Aluminum, Lyondell, Kmart and Dana Corporation bankruptcies.
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