Secured Lenders Win Victory in Sanchez Bankruptcy
The Ad Hoc Group of Senior Secured Noteholders and DIP Lenders (the "Ad Hoc Group") obtained a unanimous judgment in their favor in an appeal following Sanchez Energy Company's long-running, hard-fought bankruptcy case. Once the decision becomes final, it will provide the Ad Hoc Group with shares of reorganized Sanchez worth approximately $700 million.
Sanchez declared bankruptcy in 2019 with more than $2 billion of prepetition debt. Approximately $500 million of this debt was owed to the Ad Hoc Group's senior secured noteholders (the "SSNs") and was secured by prepetition liens on substantially all of Sanchez's assets. The SSNs also provided debtor-in-possession ("DIP") financing to Sanchez, investing another $100 million into the company postpetition.
After oil and gas prices dropped precipitously during the COVID-19 pandemic, the value of Sanchez's assets declined. To give the company a chance to survive, the creditors reached a consensual bankruptcy plan to reorganize the company. The plan provided for post-confirmation litigation of avoidance actions challenging the SSNs' prepetition liens and to allow the unsecured creditors to make a related claim that avoidance of these liens would also lead to avoidance of the postpetition liens securing the DIP loan. The plan reorganized Sanchez into Mesquite Energy, Inc. and issued 20% of the shares of Mesquite to the DIP Lenders. The remaining 80% of the company would be allocated in accordance with the results of the lien dispute—titled the "Lien Related Litigation" under the bankruptcy plan. The parties stipulated that Sanchez's equity value for purposes of the Lien Related Litigation was $85 million. To facilitate Sanchez's reorganization, the SSNs released their prepetition liens.
In the first phase of the Lien Related Litigation, the bankruptcy court ruled that the DIP Lenders' liens were coterminous with those held by the SSNs, so if the SSNs' liens were avoidable, then the DIP Lenders' liens were too. In a second phase of the proceeding, the bankruptcy court held that correction affidavits perfecting the SSNs' liens may be avoidable preferences if the elements of Bankruptcy Code Section 547(b)(5) were satisfied. At the beginning of a hearing on the third phase of the Lien Related Litigation, the bankruptcy court reversed its initial ruling that the DIP Lenders' and Senior Secured Noteholders' liens were coterminous with one another. The unsecured creditor representative then changed course and argued that the bankruptcy court could still award it shares, because Bankruptcy Code Section 550(a) allows courts to award the "value" of an avoidable transfer.
The bankruptcy court ruled that the plan allowed shares to be awarded based on a hypothetical valuation of the Section 550(a) causes of action. After a contentious evidentiary hearing, the bankruptcy court found that the correction affidavits were avoidable preferences and valued the Section 550(a) claims at $200 million, awarding the unsecured creditors approximately 70% of the shares of Mesquite.
The Fifth Circuit held that under Sanchez's bankruptcy plan, "when the bankruptcy court reversed course and upheld the DIP liens, not only were the Ad Hoc Secured Creditors entitled to twenty percent of the equity (the minimum specified by the Plan), but they should have been entitled to one hundred percent according to their superpriority liens that covered all of Sanchez's assets." The court also found that the Section 550(a) claims against the SSNs were valueless. Applying the single satisfaction rule, the Fifth Circuit held that "[c]ourts cannot award value under Section 550(a) when the estate has recovered its transferred property in kind." Because the SSNs returned their liens, a Section 550(a) claim could not net a monetary return.
Jones Day represented the Ad Hoc Group in this matter, obtaining a complete and unanimous reversal of the bankruptcy court's final order.
