Aralez Pharmaceuticals – Creditors Committee Objects to Sale of Assets to Deerfield, Urges Court to Recharacterize Deerfield’s Credit Bidding Debt as Equity

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May 2, 2019 – The Debtors' Official Committee of Unsecured Creditors (the “Committee”) objected [Docket No. 665] to the Debtors' proposed sales of its Toprol-XL assets and its Vimovo assets to "purportedly secured lender" Deerfield Management Company (together with affiliates, "Deerfield") and separately joined a related objection filed by AstraZeneca AB (“AstraZeneca”) [Docket Nos. 113 and 323, respectively]. The Committee vigorously assails what it views as a "Chapter 11 process is being orchestrated solely for Deerfield’s benefit…in a way that is inappropriate under the law" and urges the Court to see through Deerfield's efforts to dress equity up as debt; debt which Deerfield now proposes to credit bid for the Debtors' Toprol-XL assets. Deerfield's response to the objection follows at the end of this article.

The objection states, “Before the Court are proposed Section 363 sales of two categories of estate assets: (i) the “Toprol-XL Franchise;” and (ii) the “Vimovo” assets. Both asset bundles are being sold to the Debtors’ pre-petition, purportedly secured lender, Deerfield. Deerfield intends to take the Toprol-XL Franchise directly, via credit-bid pursuant to Section 363(k). Deerfield intends to take the Vimovo assets indirectly, by “rolling” its pre-petition debt into Nuvo [Nuvo Pharmaceuticals Inc.], which is 'fronting' the bid for Deerfield.

Neither bid comports with law and, so, both bids must be rejected. First, Deerfield’s proposed credit-bid for the Toprol-XL Franchise fails for three reasons: (1) at least $75 million of Deerfield’s purported secured debt must, under the peculiar facts of this case, be recharacterized as equity; (2) Deerfield failed to properly and fully perfect its liens on the assets comprising the Toprol-XL Franchise; and (3) Deerfield’s credit-bid is structured to impermissibly split AstraZeneca contracts that form an integrated contractual arrangement. 

Second, the bid for Vimovo assets must be rejected because it contemplates ‘selling’ avoidance actions to Deerfield/Nuvo—a structural component that, if ever permissible, must at least deliver the value of such claims to unsecured creditors—which the Deerfield/Nuvo bid does not do. 

Deerfield’s recharacterization (and, in turn, credit-bid) problem flows naturally from the fundamental “intent” question controlling this area of jurisprudence:  Did the party infusing capital act in the manner of a lender or in the manner of an equity stakeholder? The evidence is clear. Informed by its past successes reaping equity upside in pharmaceutical ventures run by Adrian Adams (Aralez Chief Executive Officer) and Andrew Koven (Aralez President and Chief Business Officer), Deerfield again ‘partnered’ with these two gentlemen in creating Aralez, a mere 2.5 years ago.  From the beginning, Aralez described its relationship with Deerfield – not in typical lender/borrower terms – but as a “partnership,” and it did so repeatedly, both internally and externally.

For its part, Deerfield contributed critical ‘start-up’ capital at a time when the new venture had little income, insufficient income-producing assets, a collateral base of questionable value, but a ‘shoot for the moon’ business plan focused on acquiring new pharmaceutical assets. Deerfield structured its initial $75 million seed funding in a highly unusual way, as a hybrid secured-yet-convertible (into equity) note. Internal documents make clear, however, that Deerfield was not motivated to supply the $75 million ‘risk’ capital by the small quantum (2.5% per annum) of cash-pay interest reserved under the ‘lending’ documents; it intended high equity returns. Moreover, Deerfield’s ‘partnership’ arrangement included (as a matter of contract and/or business understanding) Deerfield’s direct consent, as if Deerfield dominated the board of directors. Form notwithstanding, Deerfield did not provide traditional debt financing, it provided ‘equity venture’ financing, and the law demands that it now be recognized as such. Deerfield also may not credit-bid for the Toprol-XL Franchise because its asserted lien entitlements are voidable pursuant to Bankruptcy Code Sections 544(a)(1) and (2). The Debtor entity that is party to the suite of contracts comprising the Toprol-XL Franchise is Aralez Pharmaceuticals Trading DAC (‘Trading DAC’), an entity organized under the laws of Ireland. While Deerfield registered a ‘charge’ against Trading DAC assets, it failed to send a required notice or take any other steps required under Irish law for such charge to ‘crystallize.’

The objection continues, “Beyond these two credit bidding issues, the proposed Toprol-XL sale must be rejected for a third reason. As set forth in the separately filed AstraZeneca Objection, which the Committee joins in and incorporates herein by reference, the Toprol-XL sale depends upon the premise that Deerfield may pick and choose for assumption certain AstraZeneca contracts that are in fact components of a single, integrated contractual arrangement. This approach is flatly impermissible under the law, as the contracts at issue (the ones being assumed, and the one being rejected) were individual component parts of the entire transaction transferring the Toprol-XL Franchise from AstraZeneca to Aralez. Deerfield’s proposed bid structure intends to evade a large cure obligation owed to AstraZeneca, is ‘too clever by half,’ and for this reason alone must be rejected…Respecting the separate Vimovo asset sale, Deerfield intends to acquire (through Nuvo) the estates’ avoidance actions related to the assets being purchased. This is inappropriate…On information and belief, this transfer was made to accommodate Deerfield’s acquisition objectives, and may otherwise give rise to Chapter 5 theories of action benefitting Trading DAC unsecured creditors. It thus seems strategic – and wrongfully opportunistic – that the Deerfield/Nuvo bid incorporates a ‘purchase’ of such Chapter 5 theories of action. By way of summation, the Committee reiterates its frequent case objection: This Chapter 11 process is being orchestrated solely for Deerfield’s benefit and in a way that (i) has always presented at best an incomplete factual picture for the Court and (ii) in a way that is inappropriate under the law.”

Deerfield Response

On May 2, 2019, Deerfield responded [Docket No. 664-2] to the Committee’s objection, stating “The Committee Objection exposes the fundamental flaws of its own recharacterization theory by what it fails to do. 

  • First, the Committee Objection disregards this Court’s own decision on recharacterization, relegation the AutoStyle factors to a footnote and not referencing the majority of them in the remainder of its objection. It ignores the law because all of the AutoStyle factors weigh against recharacterization and demonstrate that the Committee Objection should be overruled. Furthermore, the Committee Objection also fails to identify a single case in this District where a court denied a credit bid under section 363(k) of the Bankruptcy Code or sustained an objection to a credit bid based on recharacterization. 
  • Second, the Committee Objection fails to address in any detail the following facts, which are dispositive: (i) the lender-borrower relationship between Deerfield and the Debtors was established through arms-length negotiation, indisputably documented and denominated as a loan, and secured by a first priority interest on substantially all of the Debtors’ assets; (ii) the Debtors were adequately capitalized at the time of the initial loan; (iii) Deerfield’s claims were not subordinated to anyone; (iv) the loan included a maturity date, fixed interest rate and a payment schedule; and (v) the initial loan, which is the only loan the Committee seeks to recharacterize, was used for working capital and not to purchase capital assets. 
  • Finally, the Committee Objection fails to discuss that, throughout the life of the loan, the parties conducted themselves as any lender and borrower would. The Debtors made their interest payments in a timely fashion and, when they could not, approached Deerfield and negotiated an extension or modification that was properly documented. For its part, Deerfield continued to fulfill its obligations as the lender by, among other things, funding acquisitions that it was obligated to fund under the negotiated agreement, regardless of its own views on the merits of the particular deal. 

In the face of this overwhelming opposition, all the Committee can offer are two specious theories divorced from the law, the loan documents, the parties’ testimony and the facts on the ground. 

  • First, the Committee claims that the presence of a small and common debt-to- equity conversion feature in the initial loan notes, which was never exercised and included a blocker that prevented Deerfield from converting debt into more than 9.985% of the Debtors’ shares, should cause all $75 million advanced under the initial loans to be recharacterized as equity. They cite no case to support this proposition, and, in fact courts in this District have expressly rejected recharacterization claims and objections even when a debt instrument includes a debt-to- equity conversion feature. 
  • Second, the Committee baldly contends that Deerfield controlled the Debtors. This assertion is belied by multiple uncontroverted facts. Deerfield was never a controlling shareholder and indeed was blocked from ever being one. Deerfield never held a seat on the board of directors, never had observer rights, never attended any of their meetings and never held any title or office at any of the Debtors. The Debtors were always free to exercise their own business judgment, and the Debtors were always entitled to reject or disregard Deerfield’s views, which in fact they did. The Committee’s “control” theory is entirely inconsistent with reality.

Finally, the Committee Objection only tries to recharacterize Deerfield’s right to credit bid under its initial $75 million loan as a part of Deerfield’s $130 million credit bid for the Toprol assets. It does not even try to challenge Deerfield’s credit bid rights with respect to the $200 million acquisition loan. As such, the Committee’s recharacterization objection is irrelevant. Even if the Court were to recharacterize the $75 million initial loan, Deerfield would still be authorized to credit bid up to $200 million of its debt to effectuate the Toprol sale transaction, which exceeds the Toprol sale price by $70 million.

For the foregoing reasons, as described in further detail below, the Committee’s recharacterization objection should be overruled."

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