In the day-to-day practice of bankruptcy law, it may occasionally be tempting to dismiss “reservation of rights” language as unnecessary or unimportant—after all, a pragmatically minded court will consider the economic reality of the case before it, placing greater importance on the overall transaction at hand. Right? Well, the U.S. District Court for the District of Delaware’s recent ruling in Emerald Capital Advisors v. Victory Park Capital Advisors (In re KII Liquidating), No. 18-1081-LPS, 2019 U.S. Dist. LEXIS 168308 (D. Del. Sep. 30, 2019) demonstrates the flaws in that way of thinking. Indeed, the KII ruling shows the tremendous impact that reserving one’s rights can have on the outcome of major bankruptcy transactions and serves as a cautionary tale to those who would overlook the importance of precision drafting.

The Katy Industries bankruptcy cases were commenced to effect a Section 363 sale to Jansan Acquisition, the debtors’ DIP lender and stalking horse bidder. Jansan itself was a joint venture between the debtors’ second-lien lenders, including Victory Park. First day motions sought approval of DIP financing as well as the intended 363 sale. Per standard practice, the proposed interim DIP order contained stipulations by the debtors as to the amount and validity of the second-lien debt and the absence of claims against second-lien lenders, along with affirmative releases in favor of those lenders. Consistent with Delaware’s local bankruptcy rules, the interim DIP order also provided for a “challenge period” during which an appointed creditors’ committee could challenge these stipulations and releases. Jansan’s proposed stalking-horse APA included a credit bid of the debtors’ second-lien debt as part of the purchase price.