Mediation has become an invaluable tool in large chapter 11 cases. Traditionally viewed as a means for resolving discrete disputes between a debtor’s estate and an adversary party, in recent years mediation in certain complex cases has evolved into a multi-party undertaking involving claimants from all levels of a debtor’s capital structure, with the ambitious goal of resolving the entire case through a consensual plan of reorganization.
Recent examples include Residential Capital, LLC and Cengage Learning, Inc. These cases illuminate the primary benefits of mediation: the potential to expedite the plan process through a mediator’s assistance which can save both the estate and creditors from incurring enormous fees related to litigation, and a mediator’s ability to help parties craft unique solutions which would not be available through litigation. This year, over the past few months, mediation has led to a possible exit path in Energy Future Holdings Corp. (“EFH”), one of the most seemingly intractable chapter 11 cases ever filed. Although numerous hurdles remain for EFH and opposition from certain key parties remains, the mediation process in that case has led to a structure that could permit a consensual plan of reorganization to be confirmed by the end of 2015. (Kelley Drye & Warren LLP represents certain creditors in the EFH cases, but has had no role in the mediation process.)
EFH arose out of one of the largest leveraged buyouts ever undertaken. Falling natural gas prices upended all of the financial assumptions on which its capital structure was based, and when it filed for chapter 11 in spring 2014 its total debt exceeded $42 billion. Its 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). A sale process earlier in the case that was being undertaken for the Oncor interest suggested that the E side creditors would see substantial recoveries; however, it was clear from the outset that there would be insufficient value on the T side to provide recoveries to any but the most senior creditors.
The array of disputes complicating the cases has been substantial. Junior creditors on the T side have sought standing to commence litigation against the senior T side lenders arising from the leveraged buyout and subsequent refinancings. There has been extensive litigation over make-whole premiums. Conflicts of interest between the T side and the E side have necessitated detailed corporate governance protocols and the retention of numerous other professional advisors. In addition, there are difficult and highly technical issues arising from the EFH’s tax structure and the potential disposition of its subsidiaries’ assets, which threaten to impose multi-billion dollar tax liabilities on the EFH estates.
A mediation process was initiated earlier this year in an effort to resolve the intercreditor T side disputes. After several weeks, however, it became clear by statements being made in open court that the process had overrun its boundaries and had led to much more comprehensive discussions regarding overall case resolution. A seemingly pie-in-the-sky idea to create a real estate investment trust (“REIT”) structure to take control of the Oncor assets began to appear viable, and the junior T side creditors who had been prepared to prosecute a campaign of scorched earth litigation began instead to negotiate the terms under which they would agree to backstop it. When it became clear that a plan of reorganization based on the REIT structure could (i) garner support from all levels of the T side capital structure, and (ii) generate sufficient value to pay all E side creditors in full, EFH agreed to discontinue the Oncor sale process and to put forward a plan based on the terms reached with and among the T side creditors during the course of the mediation.
The REIT-based plan will not be easy to implement. Approvals must be obtained from Texas state regulators and the IRS, and billions of dollars of new capital need to be raised in a volatile financial environment. The E side creditors’ committee and other major E side creditors are opposed, believing that the Oncor sale process was abandoned too soon, that the REIT plan is not feasible, and that it will be the E side creditors who will bear all the economic risk if the REIT plan does not succeed.
Notwithstanding, the fact that the EFH chapter 11 cases have moved in a relatively short period of time from being poised for months (if not years) of contentious litigation, to being on the verge of a consensual plan that can obviate opposition by being able to pay the claims of non-consenting creditors in full, stands as a strong testament to the broad possibilities of bankruptcy mediation. If ultimately successful, the resolution achieved in EFH will likely cement the role of mediation in virtually all “mega” chapter 11 cases going forward.
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