GREGORY L. TADDONIO, UNITED STATES BANKRUPTCY JUDGE.
After just over 100 days in bankruptcy, rue21, inc.
But is it happening too fast? The Official Committee of Unsecured Creditors opposes the Plan to the extent it releases the Debtors' claims against its equity holder. The claims currently have no merit, but the Committee suggests they could be resurrected by a favorable ruling from the Supreme Court of the United States over the next ten months. The Committee asks this Court to preserve those claims by striking the release language from the plan and inserting a new provision which creates a liquidating trust to prosecute the claims if they ever become viable.
After considering the evidence presented at the confirmation hearing, the Court finds no basis to delay confirmation pending a ruling that may never come. It also finds no basis to materially rewrite a plan that the creditor body overwhelmingly accepted. For the reasons set forth herein, the Court overrules the Committee's objection and will approve confirmation of the Plan.
rue21 is a specialty fashion retailer of girls' and guys' apparel and accessories, employing approximately 3,500 full-time and 15,800 part-time employees as of the petition date. At the time of its bankruptcy filing, rue21 sold merchandise through an online store and 1,179 brick-and-mortar stores located in strip malls, regional malls, and outlet centers throughout the contiguous forty-eight states.
rue21 has been in the retail clothing business for over thirty-seven years under a variety of organizational and ownership forms. It was originally a trade name of Pennsylvania Fashions, Inc., a company that exited from chapter 11 bankruptcy proceedings in 2004, after which funds advised by Saunders, Karp & Megrue Partners, LLP (the "SKM Funds") owned the majority of rue21 shares. In 2005, the SKM Funds became associated with Apax Partners L.P. ("Apax") which became the advisor to the SKM Funds.
In 2009, rue21 made its initial public offering ("IPO") and became a publicly traded company on the NASDAQ Global Select Market under the ticker "RUE." After a second IPO in 2010, the SKM Funds controlled by Apax owned 29% of the publicly traded shares in rue21. In 2013, Apax-controlled funds agreed to acquire
Following the LBO, rue21 undertook several debt obligations. On October 10, 2013, rue21 entered into a $150 million [Prepetition] ABL Credit Agreement with Bank of America, N.A. ("BOA"). As of the petition date, approximately $72 million was owed under the Prepetition ABL Facility.
rue21 and JPMorgan Chase Bank, N.A. (succeeded by Wilmington Savings Fund, FSB) executed a [Prepetition] Term Loan Credit Agreement on October 10, 2013. This senior secured term loan facility was in an initial aggregate principal amount of $538.5 million, maturing in October of 2020. On the petition date, approximately $521 million was outstanding on the Prepetition Term Loan Credit Agreement.
Indenture Trustee Wilmington Trust, N.A. (successor to Wells Fargo Bank, N.A.) and rue21, inc. (successor to Rhodes Merger Sub, Inc.) signed the Unsecured Notes Indenture also on October 10, 2013. Under the Unsecured Notes Indenture, rue21 issued $250 million of its 9% senior unsecured notes due October of 2020. As of the petition date, the debtors owed approximately $239 million on the Unsecured Notes.
Also as of the petition date, rue21 owed approximately $132 million in general unsecured claims.
The parties do not dispute that retail businesses are facing difficult financial times. As the Debtors concede (without objection by the other parties):
In fiscal year 2015, rue21 had gross sales of $1.130 billion, with earnings before interest, tax, depreciation, and amortization ("EBITDA") of approximately $105 million. However, in just one year, sales increased modestly to $1.137 billion, but EBITDA collapsed by almost 50% to $54 million.
The Debtors faced deteriorating liquidity, and on March 31, 2017, they failed to
Pursuant to the Forbearance Agreements, rue21 agreed to prepare for a chapter 11 bankruptcy proceeding in an expeditious manner.
Before the petition was filed, the ABL Credit Agreement Lenders agreed to provide a $125 million DIP ABL Credit Facility to replace the Prepetition ABL Credit Agreement, and the term-loan lenders approved a DIP Term Loan DIP Facility of $150 million, which provided up to $50 million in new-money loans and conversion of up to $100 million of the Prepetition Term Loans.
Finally, on May 15, 2017, the Debtors, ABL Lenders, Term Lenders, and Apax (through debtor Rhodes Holdings, LP) executed a Restructuring Support Agreement.
The Debtors each filed a voluntary petition for relief under chapter 11 of title 11 of the U.S. Code on May 15, 2017, and their cases are jointly administered for procedural purposes. On May 23, 2017, the Committee was appointed.
The bankruptcy cases moved swiftly with relatively few disputes. Just two weeks into the proceeding, the Debtors filed their initial plan of reorganization.
The Committee initially objected to the Disclosure Statement and raised issues concerning the confirmability of the plan. Intense negotiations soon followed, culminating in the filing of the Debtors' first amended plan on July 12, 2017,
After all the qualified ballots were tallied, it became clear that the Plan obtained support from all levels of the Debtors' capital structure. The impaired classes who were entitled to vote on the Plan overwhelmingly accepted its terms. In Class 4 (Prepetition Term Loan Secured Claims), 100% of the creditors voted to accept the plan.
The Court received a smattering of Plan objections. Importantly, no one comprehensively challenged the Plan's compliance with each of the elements required under 11 U.S.C. § 1129 for confirmation. While many creditors filed limited objections seeking to clarify their rights under the executory contracts and unexpired leases assumed under the Plan (including the cure amount necessary for assumption), these objections were largely settled or withdrawn prior to the confirmation hearing.
The Committee filed the only objection of any significance.
The focus of the Committee's objection is quite narrow. It does not contest any third-party release granted in Article VIII.D of the Plan, nor does it oppose the release of claims against Apax in its capacity as a lender under the senior secured term loan facility. The Committee also confirmed it is no longer seeking to preserve claims against the Debtors' current and former directors and officers. To the contrary, the Committee's sole concern is that the bankruptcy estate may forfeit potentially valuable constructive fraudulent transfer claims against Apax arising out of the LBO if the release is approved in its entirety.
The Court conducted an evidentiary hearing on August 30, 2017 to consider confirmation of the Plan and the Committee's objection. This matter is now ripe for adjudication.
The Court has jurisdiction in this matter under 28 U.S.C. §§ 1334 and 157(b)(2)(L). Venue is proper in this district pursuant to 28 U.S.C. § 1408.
A consensual plan of reorganization will be confirmed if it satisfies all the requirements set forth in 11 U.S.C. § 1129(a).
As the plan proponent, the Debtors bear the burden of proving that a plan containing the release is confirmable by a preponderance of the evidence.
The Debtors claim the Apax Release represents a settlement and compromise of claims which may be included in the Plan pursuant to 11 U.S.C. § 1123(b)(3)(A).
The Committee counters that a more exacting standard is necessary. Citing to a series of cases emanating from the bankruptcy court in Delaware, the Committee suggests that when evaluating the fairness of the debtor's release of non-debtors, bankruptcy courts within the Circuit consider five factors:
Known as the
To determine the applicable standard, the Court must first discern whether the release represents the compromise of a claim or an integrated component of the plan. This requires an examination into the essence of the transaction. A release shown to be part of a discernable settlement agreement should be evaluated under the
For this Court, the determinative test is whether the settlement and its corresponding release are severable from the plan and are capable of existing as a free-standing agreement. A compromise which arises out of negotiations on a discrete claim or involves a limited number of parties may satisfy this standard. The Court reaches this conclusion because a bona fide settlement should not be analyzed differently simply because it was, as a matter of expediency or efficiency, incorporated within the terms of a comprehensive plan.
Here, the record lacks sufficient proof to demonstrate that the Apax Release was intended to be a settlement of a claim. The Debtors appear to have done nothing more than a cursory assessment of their potential claims against Apax prior to the bankruptcy filing. In the flurry of pre-bankruptcy activity, the Debtors were justifiably consumed with stabilizing the business and obtaining the liquidity necessary to reorganize. With their funding tied to an aggressive timetable for emergence, the Debtors danced to the tune of the lenders' barrel organ and appear to have given little thought to the Apax Release when the Restructuring Support Agreement was signed. It was not until after the Committee was formed and began its own inquiry that the Debtors marshaled the resources necessary to form the independent committee, retain professionals, and
Having found insufficient proof that the Apax Release is part of a settlement or compromise, the Court will consult the
The Court finds that augmentation of the
The Debtors have already indicated they will not pursue claims against Apax if the release is denied, thereby requiring derivative standing for any party who intends to commence the claim in their place.
As to the initial factor, the Court finds insufficient proof of an identity of interest between the Debtors and Apax. A constructive fraudulent-transfer action against Apax could no doubt cause the Debtors to incur time and expense responding to discovery or providing testimony. But the Court finds that such actions would not substantially drain assets from the estate nor distract management's focus on a successful emergence from bankruptcy. Assuming the claim is brought derivatively, the Debtors would not be a party to the action, and the level of executive involvement should be modest because virtually all the Debtors' board members and key executives at the time of the LBO no longer serve in those capacities.
The second factor requires the Court to determine whether a substantial contribution was made in exchange for the release. It is within the Court's discretion to determine whether the nature and size of the consideration rises to the level of a "substantial" contribution. This can lead to varied and seemingly inconsistent results. In some cases, courts demand a "critical financial contribution ... necessary to make the plan feasible,"
Apax provided no monetary contribution to the plan. The Debtors instead suggest value was provided through its participation in the Restructuring Support Agreement. As a signatory to the agreement, Apax agreed to relinquish its equity without a fight. Armed with Apax's consent (and those of other stakeholders), the Debtors gained the ability to emerge from bankruptcy in a matter of months — something they could not do without a consensual plan. The Debtors consider this to be a substantial contribution because their business could not survive in bankruptcy during a prolonged fight over plan terms.
The Debtors also suggest Apax provided indirect financial value in the Restructuring Support Agreement because it agreed not to sell or transfer any interest in the Debtors' stock. In doing so, Apax agreed to forego the benefit of claiming a worthless stock deduction on account of its equity,
The Committee discounts the role Apax played in the restructuring. It notes that any postpetition conduct of Apax was guided
The Court concludes that the Apax contributions to the estate were indeed "substantial." Apax provided a valuable benefit to the reorganized debtors when it agreed to retain its stock holdings through the effective date of the Plan and forego the use of the worthless stock deductions. The result is a potential savings for the reorganized debtors through the preservation of tax attributes that could offset millions of dollars in taxable income.
The third factor requires the Court to consider whether the release is essential to the reorganization such that, without it, there is little likelihood of success. Here, the Court finds the Apax Release to be a critical component of the multi-party agreement by which Debtors were able to achieve consensus to support a plan of reorganization on an expedited track. It is foreseeable that unraveling one aspect of that agreement could lead to an unwinding of the entire enterprise. A default may occur under § 3(b) of the Restructuring Support Agreement if the Plan "adversely affects ... the economic rights, waivers, or releases proposed to be granted to, or received by [Apax]."
The remaining two factors in the
The Court's final determination turns on whether the released claims are colorable. As bankruptcy is a value-maximizing exercise, claims which have intrinsic value should be preserved for the benefit of the estate, while those lacking merit can be abandoned. The standard for determining whether a claim is colorable is the same used to evaluate a motion to dismiss for failure to state a claim.
After reviewing the record, the Court concludes that the constructive fraudulent-transfer claim against Apax has no merit and is barred as a matter of law. Section 546(e) of the Bankruptcy Code prohibits the avoidance of transfers by or to a financial institution that are made in connection with a securities contract or that constitute settlement payments.
The Committee nonetheless challenges the application of the section 546(e) safe harbor on the basis that the financial institution handling the transfers of stock and money in the LBO was merely acting as a conduit in the transaction. Under binding Third Circuit precedent, however, the section 546(e) safe harbor defense is not vitiated simply because the financial institution serves as a conduit for the transfer.
During the confirmation hearing, the Committee conceded that, at present, no viable claims exist against Apax. It acknowledged that, under prevailing Third Circuit law, the safe harbor of 11 U.S.C. § 546(e) bars recovery against parties who received settlement payments from financial institutions during the LBO, including Apax. Nevertheless, the Committee suggests that the Court not follow a binding precedent of our Court of Appeals,
There is a fundamental legal error in the Committee's position. It conflicts with one of the central principles of American jurisprudence: stare decisis.
As the Court warned Committee counsel, it "takes its marching orders" from the Third Circuit. Simply stated, this Court has no authority to ignore binding precedent from its Court of Appeals.
It is unquestioned that this Court is a lower court under the U.S. Court of Appeals for the Third Circuit.
Thus, the precedential decision of the Third Circuit in
The Court concludes that the safe harbor provision of section 546(e), as applied in this Circuit, operates as a complete defense to state-law avoidance claims and constructive claims as alleged by the Committee against Apax. Thus, it does not reach the question of the applicable statutes of limitations.
In summary, this Court must apply the law as it exists today. It will not speculate on the outcome of future rulings, nor is it required to do so. Because the Committee's objection is rooted in a fundamental error of law, the Court cannot conclude that any colorable constructive fraudulent transfer claims exist against Apax. Having reviewed all of the factors necessary to assess the fairness of the Apax Release, the Court finds no compelling reason to exclude Apax from the release provisions of Article VIII.C of the Plan.
For the reasons expressed above, the Court overrules the Committee's objection and will authorize confirmation of the Plan, inclusive of the Apax Release. A separate Order will issue.