Sr Secured Noteholders v. DE Trust Co
- Case Type:
- Business
- Case Status:
- Reversed and Remanded
- Citation:
- 23-20557 (5th Circuit, May 30,2025) Published
- Tag(s):
-
- Ruling:
- Faced with a dispute among unsecured and secured creditors over the allocation of equity in a reconstituted chapter 11 debtor, the U.S. Court of Appeals for the Fifth Circuit (Circuit) found the decision of the U.S. Bankruptcy Court for the Southern District of Texas (BC) to award the former a dominant stake in the new entity after hypothetically valuing various preserved avoidance actions to have contravened 11 U.S.C. §§ 550(a) and (d) by approving more than a “single satisfaction” and thus, in effect, double recovery as a remedy for the avoided secured creditors’ liens.
- Procedural context:
- Sanchez Energy Corporation and its affiliates (DR) filed for chapter 11 relief on August 11, 2019. Initially, the DR received just one financing proposal after filing its petition, one that came from a group of its secured creditors to which a coterie of unsecured creditors objected and submitted their own proposal for consideration, which sought to subordinate the senior creditors’ existing liens. Ultimately, after the parties negotiated, the BC approved a modified version of the secured creditors’ (DIP Lenders) initial proposal on January 22, 2020. Unfortunately, "a catastrophic downturn in the oil and gas industry caused by the COVID pandemic" led the DR to default on its DIP obligations. By that time, the DR had already filed an adversary proceeding (Lien Challenge Complaint) to recover preferences pursuant to 11 U.S.C. § 547(b) and other claims against the secured creditors. With the DR's financial future now even more in doubt, this litigation was paused so that the DR and its creditors could negotiate a reorganization plan. "With lighting speed," the DR submitted different reorganization proposals, and the BC eventually approved a reorganization plan (Plan) designed to compensate creditors with equity in the DR's reorganized successor, Mesquite Energy Inc. (Mesquite). The Plan contained releases of the DIP liens and secured creditors’ liens, even though those liens were then perceived to have no value; stipulated a reconstituted enterprise value of $85 million for Mesquite; entitled the DIP lenders, a group comprised mostly of secured creditors, to receive at least twenty percent of the stock in exchange for releasing the DIP liens; and specified that the remaining equity shares were to be divided between the secured creditors and the unsecured creditors after resolution of the Lien Challenge Complaint and other litigation according to a three-phase process. In Phase One, the BC would decide whether the DIP liens were valid. If the court held for the DIP Lenders, their outstanding $100 million loan would swallow the entire remaining equity of Mesquite. However, if the unsecured creditors (acting through the Delaware Trust Company, as their Creditor Representative) prevailed, then the BC in
Phase Two had to determine the validity and enforceability of the secured creditors’ pre-petition liens. Finally, if the Creditor Representative succeeded in avoiding the secured creditors’ liens, the BC would assess the additional “value” to the debtors’ estate of those and other claims and allocate the equity proportionally. As long as the Lien-Related Litigation remained unresolved, there was a possibility that the unsecured creditors might receive equity shares.
The BC followed this process to a t. At the end of phase one the BC concluded that the DIP Lenders possessed valid liens encompassing the HHK Leases. Next, the BC held that, although valid under Texas law, the correction affidavits failed timely to perfect the pre-petition liens on the HHK Leases and resulted in avoidable preferential transfers pursuant to 11 U.S.C. § 547(b)’s ninety-day lookback period. Finally, during phase three, the BC decided to place a
hypothetical value on the debtors’ estate of the Phase Two meritorious avoidance claims, as a predicate for allocating the remaining eighty percent of Mesquite’s shares. After experts testified, the BC "charted its own approach and deemed the avoidance actions worth approximately $200 million." Accordingly, it apportioned to the Ad Hoc Secured Creditors and the DIP Lenders 30.27% of Mesquite’s share, which constituted the ratio of their stipulated $85 million enterprise value (plus $1 million from the insiders’ suit) to the augmented value of the estate. The unsecured creditors’ share of equity was 69.73%.
The appellants were a subgroup of secured noteholders (the Ad Hoc Secured Creditors) that obtained deeds of trust on April 13, 2018, from Sanchez granting nonpossessory liens on virtually all corporate assets, and thoguh they raised an array of issues on appeal, the Circuit focused on §§ 550(a) and (d) only.
- Facts:
- By the summer of 2019, Sanchez, a Texas-based oil and gas exploration and production company, and two or more affiliated companies stood on the verge of insolvency, with pre-bankruptcy liabilities including $500 million of secured notes and $1.75 billion of unsecured notes with maturity dates falling between 2021 and 2023. In June 2019, the DR solicited proposals for debtor-in-possession (DIP) financing. At around this time, the secured creditors realized that their deeds of trust pertaining to valuable oil and gas interests that the parties refer to as the “HHK Leases" (HKK Leases) might be insufficiently perfected. Accordingly, they filed correction affidavits between June 27 and July 24, 2019. To prevent the attempted perfection of the secured creditors’ liens from occurring outside of the ninety-day preference period, 11 U.S.C. § 547(b), the DR and its affiliated debtor companies filed for chapter 11 bankruptcy protection on August 11, 2019
- Judge(s):
- Edith H. Jones; Kurt D. Engelhardt; and Andrew S. Oldham
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