Specialty Retail Shops Holding Corp – Further to Plan Rejection, Files Amended Plan to Address McKesson Objection

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May 31, 2019 – Further to the Court's May 29th refusal to confirm the Debtors' Plan, the Debtors have now filed a Third Amended Plan and a motion requesting confirmation of that Plan [Docket No. 1495 and 1494, respectively]. The motion requesting confirmation was accompanied by a redline showing changes from the version filed on May 21, 2019. The amendments largely stem from an objection filed by McKesson Corporation (“McKesson”) and subsequently pursued by McKesson's counsel at the confirmation hearing and these appear to have been resolved to McKesson's satisfaction, ie targets of potential litigation will not be automatically released as a result of the plan's confirmation. 

What is not entirely clear, given that an affirmative opt-out provison remains in place as to other crammed down creditors (McKesson certain to affirmatively opt-out and preserve its rights), is whether Judge Saladino will be satisfied. He had voiced serious concerns as to McKesson specifically but also as to other crammed down creditors more generally; McKesson can be sure to advance its own interests, but what about other creditors who may still be unaware of their need to affirmatively opt-out of the Plan's release provisions? The Debtors' motion specifically allows some wiggle room, giving the Court the option to modify third-party release language (“[e]xcept as otherwise ordered by the Bankruptcy Court”).

The motion states, “Following the conclusion of the hearing on confirmation of the Prior Plan (the ‘Confirmation Hearing’), the Court entered an order denying confirmation because the Prior Plan contained nonconsensual third-party releases (the ‘Third-Party Release’) and an exculpation provision that covered prepetition conduct (the ‘Exculpation’ and together with the Third-Party Release, the ‘Release Provisions’). The Debtors and their key constituents have engaged in further negotiations regarding the Release Provisions in light of the Court’s ruling. Given that confirmation of a chapter 11 plan in the near future is the only viable path to a value-maximizing conclusion to these chapter 11 cases, the Debtors have modified the Modified Plan consistent with the Court’s ruling and their discussions with the parties in interest.

Like the Prior Plan, the Modified Plan incorporates numerous settlements between key parties in these cases, including the Debtors, the Creditors’ Committee, the Debtors’ lenders, the Debtors’ largest unsecured creditor, and Sun Capital. Without the settlements therein, these chapter 11 cases will quickly be mired in extensive, complex litigation.”

The motion notes the following changes:

"Third-Party Releases. The principal changes in Modified Plan relate to the Third-Party Release.

  • The Third-Party Release is only provided for on a consensual basis. All parties who did not previously opt out of the Third-Party Release will still be bound by such release.
  • The Third-Party Release is provided for “[e]xcept as otherwise ordered by the Bankruptcy Court[.]” To the extent the Court modifies the Third-Party Release, the Debtors will continue to support the Plan as modified by the Court.
  • By agreement with McKesson, the definition of Sun Capital has been expanded to include specific Sun Capital personnel.

Exculpation. The exculpation provided for in the Modified Plan shall be limited to postpetition conduct.

Avoidance Actions. The Debtors shall not release Avoidance Actions with respect to any party that has opted out of being a Releasing Party, unless otherwise ordered by the Court.

Discharge. Consistent with the Debtors’ representations at the Prior Plan confirmation hearing, the Modified Plan does not include a discharge provision.

Indemnification Obligations. The Debtors removed certain indemnification obligations contained in Article V.D. of the Modified Plan, and continue to negotiate theseprovisions with their key constituents.

As disclosed at the Confirmation Hearing, the Debtors will include agreed-upon language in the proposed Confirmation Order limiting the Third-Party Release as to the following parties: CGP Canadian, Ltd., CGP Seymour, Ltd., CGSK Tulia, Ltd., CGP Orofino, LLC, CGP Comanche, Ltd., CGP Jacksboro, Ltd., CGP Cotulla, Ltd., CGP Prosser, LLC, and  CGP  Clifton, Ltd. as well as preserving all other accommodations previously with objecting parties with respect to the Prior Plan."

Background

“Good luck guys.” With that, on May 29, 2019 Judge Thomas Saladino ended day two of the Debtors’ Plan confirmation hearing and left a stunned gathering of advisors to digest his refusal to confirm the Debtors’ Plan. Acknowledging the professionalism of the assembled teams of advisors and that he was disappointing the vast majority of them, Judge Saladino said that he “just could not get there” on the issue of third party releases and that he did not believe that it was “fair and equitable or in accordance with the intent and purposes of the Bankruptcy Code to require creditors such as McKesson, and anyone else who might have some sort of prepetition state law claim against non-debtor parties, to give that up so that the Debtor can get his Plan confirmed.”

The advocate of the day award would seemingly have to go to McKesson’s counsel who emotionally urged the Court not to take away McKesson’s most valuable property in these cases, the right to pursue the Debtors’ directors for prepetition fraud, by releasing those directors of all potential liability for that alleged fraud as part of the Plan. Suggesting that perhaps the Court should appoint a Chapter 11 Trustee (which may now happen) and that McKesson had no issue with any other aspect of the Plan (including the $15.5mn Sun Capital settlement: “We don’t care about Sun Capital, we do care about the people that defrauded McKesson”), McKesson’s counsel argued (words that would be largely repeated by Judge Saladino only minutes later) that “Our property is our direct claim against these officers, to strip that property that McKesson has…violates [the Bankruptcy Code’s] cramdown provisions.” 

McKesson’s allegations of fraud relate to reassuring statements made by the Debtors’ management to McKesson as to their financial and operational health as the Debtors were actually sliding towards bankruptcy in the second half of 2018; specifically reassurances given after McKesson threatened to pull the plug on the credit with which the Debtors purchased pharmaceuticals from McKesson (McKesson threatening to cut 45 day payment terms to one day, on what was then $70.0mn in outstanding credit).

On May 24, 2019, as many interested parties were filing court papers withdrawing outstanding objections in anticipation of the Debtors May 28, 2019 confirmation hearing, creditor McKesson Corporation (“McKesson”) was having other ideas, objecting [Docket No. 1431] vigorously to perceived attempts by the Debtors to slide a Plan past the Court at the last minute that would unfairly benefit insiders (notably with the removal of an opt out provision relating to the release of those insiders) and urging the Court to "reject this transparent artifice."

The objection states, “Debtors filed the Amended Plan on May 21, 2019, just four business days before the confirmation hearing, and, more critically, long after ballots were submitted and the plan objection deadline for most creditors passed. Yet, the Amended Plan represents no mere minor tinkering to the previous versions. Instead, it is a wholesale re-vamping of the earlier plans. The sweeping breadth of the revisions are obvious upon even a cursory look at the cumulative redline Debtors filed along with the Amended Plan.  One revision is particularly egregious and constitutes a material modification to the plan that significantly and adversely affects creditors. While the previous plan versions contained a mechanism whereby creditors could opt out of releasing non-Debtor parties (specifically Debtors’ insiders), the Amended Plan eliminates the opt out provision. As a result, notwithstanding that creditors voted and based their objections (or lack thereof) on a plan containing an opt out provision, Debtors now seek to confirm, in a classic bait and switch, a plan that requires creditors to release all claims they may have against Debtors’ insiders, among others.

The sale of Debtor’s pharmacy assets came up $20 to $30 million short of expectations, and their much-touted equity sponsor never materialized. Debtors are now nearing the end of a full-chain liquidation and there no realistic possibility that non-priority unsecured creditors will see a dime. Worse, Debtors remain administratively insolvent, and the professional fees and other administrative costs are mounting despite the lack of any demonstrable benefit to Debtors’ estates that will result from confirmation of the Amended Plan. Why? The answer can only be that Debtors and their insiders are singularly focused on the improper releases and other exculpatory and insider protection provisions contained in the Amended Plan. Accordingly, the scheme and the Amended Plan reek of bad faith.

In addition, the Amended Plan violates section 1129(a)(9) because it does not provide for full payment of allowed administrative claims on the effective date. Debtors, of course, cannot meet this requirement because they are administratively insolvent, possibly in the tens of millions of dollars. To skirt the problem, Debtors resort to a procedurally inappropriate sleight of hand – they ask the Court to deem a failure to object to the Amended Plan to constitute affirmative consent for acceptance of less than payment in full. The Court (as have other courts) must reject this transparent artifice. Moreover, the Amended Plan violates section 1129(a)(3) because it is not proposed in good faith. Among other things, good faith requires a reasonable likelihood that the Amended Plan will achieve a result consistent with the standards prescribed under the Code. For all of the reasons described herein, if confirmed, the Amended Plan would achieve precisely the opposite.”

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