Energy Future Holdings (“EFH” or “Debtors”) has cleared all of the preliminary hurdles in its path as it moves towards the confirmation of its plan of reorganization (the “Plan”). Last week Judge Christopher Sontchi of the United States Bankruptcy Court for the District of Delaware approved the Debtors’ disclosure statement in support of the Plan, authorized the Plan to be distributed to creditors for voting purposes, and scheduled the hearing on Plan confirmation to begin on November 3. In view of the complexity and contentiousness of these cases, bringing them to the verge of completion in less than eighteen months is a notable achievement for EFH and its professionals.

The final step, however, will be by far the toughest. EFH has reached this point mainly by successfully deferring the battle on certain crucial issues. In order to gain Judge Sontchi’s approval of the Plan and overcome the strong objections of key parties, EFH will need to show, among other things, that the Plan is “feasible,” and that under its terms many of its largest creditors will be “unimpaired.” These requirements will be the focal point of a proceeding that, absent an unexpected settlement, is expected to take several weeks. (Kelley Drye & Warren LLP represents certain creditors in the EFH cases, but will not be taking any position on the issues discussed here.)

EFH entered bankruptcy in April 2014 with over $42 billion in claims, and for most of the time since then these cases have looked to be among the most intractable ever filed. The Debtors’ business operations are divided into two distinct silos: a majority interest in a regulated electrical utility, Oncor, indirectly owned by EFH subsidiary Energy Future Intermediate Holding Company LLC (the so-called “E side” of EFH), and non-regulated electricity generation, mining, and commodity risk management and trading operations, indirectly owned by EFH subsidiary Texas Competitive Holdings Company LLC (the so-called “T side” of EFH). For the first year of these cases, EFH had the support of its E side creditors, who stood to see a substantial recovery from a proposed sale of the Oncor interests, but was facing intense opposition from junior creditors on the T side, who appeared to be out of the money.

Over the past summer, however, the T side creditors began to coalesce around a bold strategy to backstop a real estate investment trust (“REIT”) structure to take control of the Oncor assets, an approach projected to attract enough new capital to pay all E side creditors in full in cash immediately upon the effectiveness of the Plan. Such treatment of the E side creditors would render them “unimpaired” under section 1124 of the Bankruptcy Code, meaning that the Plan would not alter their “legal, equitable and contractual rights.” Unimpaired creditors are presumed to support a plan of reorganization and are not entitled to vote to approve or reject it.

The E side creditors, however, are attacking such characterization of their treatment. They contend that the Plan will not in fact pay all of their claims in full, and therefore that they are “impaired” creditors and entitled to vote. The E side creditors also believe that the Oncor sale process, which they view as a far more certain path towards getting repaid, was abandoned too soon, and have asserted that the REIT structure contemplated by the Plan has too many contingencies to succeed. This is another fundamental objection, as under the Bankruptcy Code Judge Sontchi must expressly determine that the Plan is “feasible.” In view of the numerous approvals which must be obtained from regulators and the IRS, and the billions of dollars of new capital which needs to be raised in a volatile financial environment, the E side creditors intend to show during the Plan confirmation hearing that the Debtors cannot demonstrate a sufficient likelihood that the Plan will ever become effective, and that it is the E side creditors who will bear all the economic risk if the REIT structure does not succeed.

Judge Sontchi has so far been supportive of EFH’s approach, and has approved the disclosure statement and other key agreements while deferring the major substantive objections to the Plan. He has made clear, however, that when the time comes he will be holding the Debtors’ feet to the fire. One argument made by the E side creditors against their supposed non-impairment under the Plan, for example, has been that it does not pay interest accrued on their billions of dollars in claims at the rates set forth in the underlying contracts or indentures, but instead proposes to pay at the much lower federal funds rate. Judge Sontchi has noted the importance of this issue, observing that EFH has placed “all of its eggs in the ‘unimpairment’ basket,” and has expressly warned EFH not to “get cute.”

In a similar vein, earlier this week he turned aside a request from certain E side creditors to postpone the start of the confirmation hearing until after Thanksgiving. This stemmed from a change in the Plan made immediately prior to the disclosure statement hearing, in which EFH suggested that, rather than paying certain E side unsecured note claims in cash, it instead may “reinstate” those claims under the Plan, with the note obligations being assumed by the reorganized T side companies. Technically, reinstatement can be one way to treat claims as “unimpaired,” and the Debtors contend that it is expressly permitted under the indenture governing the notes. However, while Judge Sontchi denied the requested delay, he appeared to agree that such reinstatement raises substantial questions about the future financial condition of the reorganized companies that payment in cash would not, and suggested that the Debtors were being somewhat “disingenuous” in trying to equate the two.

EFH has come this far in large part by convincing Judge Sontchi to push off several contentious and complex issues. Those issues must now finally be confronted. Although it is possible that the Debtors will manage to settle with the objecting E side creditors and avoid a lengthy and adversarial confirmation hearing, the one certainty here is that there is no more road down which the Debtors can kick what has become a very large can.

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