Corinne Ball
Corinne Ball ()

On the day that the debtors in the SunEdison Chapter 11 case (Case No. 16-10992) (the debtors) filed for bankruptcy, they also moved to appoint an examiner. The debtors made this request because of, among other things, problems with the debtors’ prepetition internal controls over financial reporting. Indeed, only several months prior to filing for Chapter 11 protection, the debtors reported equity value in the billions of dollars. Ultimately, however, the debtors withdrew their examiner motion and the attendant investigative responsibilities were largely deferred to the Official Committee of Unsecured Creditors (the Committee). Notably, the Committee never filed an official report on the debtors’ value.

During the debtors’ Chapter 11 case, the debtors continued to publicly report substantial equity value. Notwithstanding these figures, the court twice declined to appoint an equity committee and ultimately overruled shareholder objections to confirmation of the debtors’ plan, which argued that the debtors were improperly funneling value that belonged to shareholders (who received nothing under the plan) to creditors, in violation of the absolute priority rule. In making these determinations, the court ruled that the debtors were “hopelessly insolvent,” basing that conclusion on the unreliability of the debtors’ publicly-reported figures and on evidence that the debtors’ debts far exceeded the debtors’ market value.

The SunEdison case serves as an important reminder to investors that a company’s publicly-reported equity value may not be indicative of the company’s true value. But this case also raises questions as to whether the process employed was the best way to arrive at the ultimate result. Among other questions—given that the Committee took on a role that preempted an examiner, should the Committee have been required to provide a report on its conclusions regarding the debtors’ value? And, if the Committee had filed such report, how much easier would it have been for the court to deal with frustrated equityholders? It will be interesting to see how such issues are handled as similar cases are filed in the future.

Background

The SunEdison debtors filed for Chapter 11 on April 21, 2016 (the petition date). Prior to the petition date, between 2013 and 2015, in order to fund their primary business (developing renewable-energy projects), the debtors raised approximately $24 billion in debt and equity. In the debtors’ unaudited Form 10-Q for the quarterly period ended September 30, 2015 (issued in November 2015), the debtors reported approximately $2.4 billion in cash and $4.5 billion in shareholder equity. In other words, just several months before filing for bankruptcy, the debtors publicly reported that they were substantially solvent.

On the petition date, the debtors sought the appointment of an examiner. See Examiner Motion [Docket No. 11]. The purpose of this request was to have an independent entity look into the debtors’ financial information, particularly given the debtors’ publicly-reported issues with internal controls over financial reporting. Notwithstanding this initial request, the debtors ultimately withdrew their examiner motion. See Notice of Withdrawal [Docket No. 533]. As a result, the would-be examiner’s investigative duties largely fell to the Committee.

At the same time, based on the massive prepetition equity value reported by the debtors, certain shareholders sought the appointment of an official committee of equityholders to represent shareholders’ interests. In spite of these figures, the court determined that the debtors appeared to be “hopelessly insolvent” and thus declined to appoint an equityholder committee. See In re SunEdison, 556 B.R. 94, 103-05 (Bankr. S.D.N.Y. 2016).

The court arrived at this conclusion based on three primary points. First, the court found that the debtors’ prepetition financial disclosures were unreliable. The court based this determination on other of the debtors’ prepetition disclosures (issued in March and early April 2016) that indicated that the debtors had “material weaknesses” in their internal controls over financial reporting and problems with cash forecasting and liquidity management. Second, the court noted that the debtors’ prepetition valuation disclosures included certain non-debtors, and thus did not accurately reflect the value of the debtors. Third, the court explained that the debtors’ prepetition financial disclosures were based on book value, and thus largely unhelpful because the relevant metric for solvency analyses is market value. The court also credited the testimony of the debtors’ financial advisor, who opined that the debtors were worth only $1.5 billion in an orderly liquidation—well shy of the debtors’ $4.2 billion in debt disclosed by the evidence. Based on these considerations, the court declined to appoint an official equityholders committee.

After this decision, the debtors filed monthly operating reports (MORs) reporting approximately $6 billion in equity value on a combined basis. Focusing on these new postpetition reports of substantial equity value, the shareholders renewed their request for an official equityholders committee. After a second hearing, the court again declined to appoint an equity committee, basing its decision largely on the same evidence presented at the first hearing. In addition, at this hearing, the debtors’ controller explained that the MORs showed significant equity value because the MORs were based on book value (rather than market value) and also combined the debtors’ financial information, rather than consolidating it (thus resulting in double-counting in certain instances).

Undeterred, certain shareholders objected to confirmation of the debtors’ plan. The shareholders again raised valuation issues, focusing on the disparity between the debtors’ petition date book value (alleged to be 10.5 billion) and the $1 billion in plan distribution value. Further, assuming that $1 billion was the correct distributable value, other shareholders questioned how the debtors could lose the $24 billion raised prepetition. As explained below, the court overruled these confirmation objections.

Decision

The court interpreted the shareholders’ confirmation objections as raising an argument that the debtors’ plan violated the “unwritten corollary to the absolute priority rule”—i.e., that creditors may not receive more than a 100 percent recovery. The court rejected this absolute priority rule argument, finding that the debtors were hopelessly insolvent, with approximately $1 billion in assets and over $6 billion in debt. The court based this on “the unrefuted evidence received by the court on three occasions including the confirmation hearing.” In rejecting the shareholders arguments, the court reiterated its previous holding that the debtors’ prepetition financial statement disclosures were of limited assistance, given that market value is the relevant consideration for insolvency analyses and “[f]inancial statements reflect book value, which does not ordinarily equate to market value.”

The court also responded to shareholders’ speculations that the debtors possessed significant undiscovered distributable value. These speculations were based, in large part, on (1) the disparity between the debtors’ publicly-reported equity value when compared with the debtors’ plan value and (2) the debtors’ failure to adequately explain what happened to the $24 billion raised prepetition.

In evaluating these issues, the court highlighted the very substantial efforts undertaken by both the debtors and the Committee to find additional value. Among other things, the court pointed to the debtors’ and Committee’s investigation into, and ultimate settlement of, various causes of action for the benefit of the estate. As the court explained: “At bottom, these numerous investigations and lawsuits have failed to uncover any claims of sufficient value to cover the $5 billion shortfall, and no one has provided evidence that something was missed.”

Finally, in what was effectively a market based “reality check,” the court noted and seemed to take comfort in the fact that the plan imposed very substantial haircuts on significant unsecured creditor groups (e.g., 3 percent recovery for general unsecured claims; 5 percent recovery for second-lien claims), and these creditor groups still supported the plan. For these reasons, the court overruled the shareholders’ objection to plan confirmation.

Conclusion

This case stands as a stark reminder that a company’s financial statements that are based on historical information may not accurately reflect value for purposes of investing or advocating for returns. Interestingly, this case began with the debtors advocating for the appointment of an examiner to investigate their financials, including valuation issues. Ultimately, however, the debtors withdrew this motion, and the responsibility of looking into these issues was largely deferred to creditors, in particular the Committee.

Not surprisingly, that deference to the Committee did not produce a report that would provide a reference point for creditors and investors. Instead, the Committee moved ahead to plan negotiations, satisfying itself that the returns and proposals made under the debtors’ plan were presumably the best reasonably available.

In some respects, these developments placed a great burden on the court to respond to investors without a readily available reference point. In analyzing investors’ positions, the court worked very hard, relied on its familiarity with the case and the reaction of the creditors, particularly the Committee as the fiduciary for creditors. The process and the diligence of the court seem beyond criticism.

Nevertheless, this process raises multiple questions as to whether it was the best way to achieve the ultimate result. Should the court have been put in this position not once, but on multiple occasions? Would a comprehensive examiner’s report ultimately have been more cost effective? If the Committee undertakes a role that preempts an examiner, should the Committee have a responsibility, in the event that it does not bring litigation, to file a report as to its reasons?

This case stands as a model for moving complex, difficult situations to consensus in a relatively short period. However, it is fortunate that the court was willing (and more than able) to address investor challenges in the face of what appeared to be irreconcilable positions between (1) the Committee’s support for a plan that provided minimal recoveries to unsecured creditors and (2) continuing financial statements reflecting substantial Debtor equity value. The court should be commended for taking on this task repeatedly.

This case was fortunate and the work done by the court admirable. Will future cases in other courts be as fortunate?