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Bankruptcy: Oaktree Objection Hits Claire’s Plan Valuation, Distribution Scheme

Oaktree Capital Management on Sept. 6 objected to confirmation of Claire’s Stores’ reorganization plan, saying that “there are more than 20 material flaws” in the plan, “any one of which standing on its own could be a basis for the denial of confirmation of this plan at this time.”

Further, according to Oaktree, “taken in the aggregate, and viewed collectively as a body of work, these flaws can lead to but one conclusion: the process in these Chapter 11 cases, and the [reorganization] plan it has produced, are so tainted that the … plan cannot now be confirmed.”

As reported, a reorganization plan confirmation hearing is scheduled for Sept. 17.

The objection from Oaktree was expected. Oaktree, which holds nearly 72% of the company’s second-lien debt, has been fighting the company’s proposed reorganization plan tooth and nail since the Chapter 11 filing on March 19 (see “Claire’s 2L notes holder, Oaktree, slams RSA, proposed reorg plan,” LCD News, March 21, 2018).

As reported, prior to filing for Chapter 11 the company entered into a RSA with an ad hoc group of first-lien lenders led by Elliott Associates and Monarch Alternative Capital, as well as with the company’s equity sponsor, Apollo Management.

Among other things, the ad hoc group agreed to backstop a $575 million rights offering to fund the reorganization plan.

Under the proposed plan, first-lien lenders, with claims of about $1.43 billion, would receive 100% of the reorganized company’s equity, along with a deficiency claim—a recovery valued by the company’s disclosure statement at 69.9% (although the actual recovery will be slightly higher, just over 70%, because second-lien lenders voted to reject the plan, and therefore will not participate in the deficiency claim pool, increasing the first lien deficiency claim distribution by about $8 million).

Second-lien lenders—who, as noted, voted to reject the plan—will participate in the cash recovery for general unsecured creditors, a recovery valued at 0.003–0.495% (had second-lien lenders voted in favor of the plan, they would have participated in the deficiency claim recovery with first-lien lenders on a pro rata basis for a cash recovery of 3.5%).

Throughout the case, Oaktree has argued that the $1.4 billion total enterprise valuation upon which the RSA and proposed reorganization plan are based is too low. In late June, Oaktree successfully challenged the company’s limited and truncated initial marketing process, obtaining a court order requiring the company to extend the process through Aug. 31, and opening it to a wider variety of deals than the 100% payout-event plan initially demanded by the company.

Oaktree was expected to submit a bid in connection with that process, but apparently did not do so.

In its objection, however, Oaktree renewed its argument that the reorganization plan is nonetheless premised on a valuation that is too low.

According to Oaktree, the company’s own financial expert pegged the company’s TEV at a midpoint of roughly $1.52 billion, or $120 million more than plan value.

Oaktree said its expert valued the company at a midpoint TEV $1.992 billion, which the company said was “consistent with all indications of the debtors’ value” other than company’s aforementioned $1.52 billion valuation, which Oaktree described as an “outlier.”

Among the indications of value that Oaktree cited that were consistent with a higher valuation were a valuation of $2.022 billion used by the company in authorizing its 2016 exchange transaction, as well as “the $2.053 billion valuation implied by the percentage recovery provided to holders of general unsecured elective claims under the [reorganization] plan.”

At the higher valuation, the distribution to first-lien lenders would exceed the value of first-lien claims, Oaktree argued. Oaktree also noted that the full value of the first-lien lenders’ participation rights in the new money investment, given the low valuation and the rights offering’s below market rates and plan discounts, was not fully factored into the plan’s recovery calculations.

As for the company’s efforts to market test its valuation, Oaktree argued that the company ran “not one, but two flawed sale processes, the admitted purpose of which was to validate the low-ball valuation that underlies the [proposed reorganization] plan, rather than to obtain a value maximizing purchase offer.”

In addition, Oaktree said the marketing process “featured zero meaningful involvement from the [creditors’] committee, which was not permitted to participate in and had no role in shaping, the debtors’ communications with bidders.”

Oaktree alleged the company’s marketing “outreach was lackluster, rushed, and overseen by a conflicted finance committee with the assistance of conflicted professionals.”

Lastly, Oaktree also said that critical information was withheld from bidders during the marketing process (although the specific information withheld was redacted from the publicly-filed objection), arguing that this issue was “particularly troublesome” because the company had justified its lower plan valuation by citing the feedback from the marketing process, namely, the lack of a bid.

According to Oaktree, however, while an independent bid from the market can be evidence of enterprise value, “the absence of a bid that the debtors deem to be qualified is evidence of nothing.”

Oaktree added, “That is particularly true here where evidence will show that bidders were influenced by the compressed timing of the process, by the taint of a contentious bankruptcy, and by the perception that the debtors would resist any bid that was not favorable to Apollo and the ad hoc first lien group.”

Moving beyond its valuation claim, Oaktree charged that provisions of the company’s proposed reorganization plan providing for the $575 new money investment from first-lien lenders were neither properly vetted nor market tested.

In addition, Oaktree argued that Apollo’s participation rights in the new money investment, amounted to a recovery to equity holders greater than that for second-lien and unsecured claims in violation of the absolute priority rule.

With respect to the specific terms of the company’s proposed reorganization  plan, Oaktree charged a wide array of gerrymandering, gifting, and classification allegations that, taken as a whole, paint a picture of purported recoveries to other unsecured creditors at the expense of second-lien lenders.

For example, Oaktree expects to recover between 0.003–0.495% of its claim, compared to recoveries of 6.2% for first-lien deficiency claims, 14.6% for unsecured note claims, and 74.2% for general unsecured elective claims.

According to Oaktree, the magnitude of the difference in treatment among different flavors of unsecured claims exceed those that have previously been held to violate the Bankruptcy Code’s prohibition of discrimination within a creditor class. Oaktree further contends that the company’s rationale for these differences, the gifting of certain carve outs from the first-lien collateral, do not meet legal requirements for such gifts. — Alan Zimmerman

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