On August 3, 2023, the U.S. Bankruptcy Court for the Southern District of Texas found that the majority of the shares of stock of a reorganized debtor should be allocated to unsecured creditors, and not the secured creditors, because the value of the secured creditors’ avoided liens became part of the unsecured claim pool. Sanchez Energy Corp., an operator of oil and gas wells, filed for bankruptcy with debts including $1.75 billion in unsecured notes and $500 million in secured notes. The bankruptcy court approved the debtor’s plan to swap the prepetition debt plus $150 million in debtor-in-possession financing for equity in the reorganized company. Under the plan, 20% of the equity in the reorganized company was immediately distributed to the DIP lenders, with the distribution of the remaining shares dependent on the outcome of an adversary proceeding that sought to avoid liens held by the secured creditors as defective and invalid.
The alleged defects in the liens arose from, among other things, (i) deeds of trusts that, while initially inaccurate, were corrected prepetition only within 90 days of the bankruptcy filing and would be avoided as preferential transfers, and (ii) lease financing statements being filed only with certain state agencies, and not in the counties where the oil and gas leases were located. Given that certain of the liens were defective and invalid, the unsecured noteholders argued that the avoidance claims should be included with their overall claims for purposes of determining an appropriate distribution of the remaining shares of the reorganized company. In contrast, the secured noteholders asserted that the avoidance claims had no value because the liens were subordinated to the DIP liens and waived pursuant to the previously confirmed bankruptcy plan. The bankruptcy court disagreed with the secured noteholders, finding that the adversary proceeding was the “main focus” of the plan, which preserved the unsecured noteholders’ right to pursue the lien challenges and recover the value of the avoided transfers.
The bankruptcy court found that it should not “focus on what the estate lost” pursuant to the inappropriate prepetition transfers; it should instead “determine how to put the estate back in its pre-transfer position. Restoration of the pre-transfer position includes the restoration of the relative priorities of the holders of claims against Sanchez and the Estate.” The bankruptcy court then turned to the value of the property transferred. It found that the value of the leases was the wrong focus because the liens were transferred pursuant to the prepetition corrected documents, not the leases themselves. With that, the bankruptcy court found that the “market prices of the secured notes compared to the unsecured notes is the best method to value the” liens. Using this valuation method, the bankruptcy court allocated approximately 80% of the remaining equity to the unsecured creditors, with the secured noteholders receiving the balance.
The case is In re Sanchez Energy Corp., No. 19-34508 (Bankr. S.D. Tex. Aug. 3, 2023). The creditor representative in the Lien Proceeding is represented by Quinn Emanuel Urquhart & Sullivan LLP. The ad hoc group of secured lenders is represented by Foley & Lardner LLP. The opinion is available here.
