February 7, 2019 – On Thursday, following three intensive days of firmly kicking the tires on ESL Investments, Inc.’s (“ESL”) $5.2bn purchase of the Debtors’ “going concern” assets, Judge Robert Drain of the Southern District of New York gave the deal the go ahead. Approval of the sale allows the Debtors a new life and 45,000 of the Debtors’ employees some short-term job security; failure would almost certainly have resulted in the rapid, piecemeal sale of the Debtors’ assets, an outcome that some unsecured creditors vigorously argued was the most fair outcome for these Chapter 11 cases. For those creditors, and ESL, there almost certainly remains another day in court.
The sale hearing (“Sale Hearing”) was not a pro forma rubber stamping (or kicking) exercise, but a rigorous, testy trial which was exactly what the Debtors and ESL needed; it was only via impeachable rigor, effort and professionalism, ie real integrity in the last few months of the Debtors’ old life, could it emerge into a new one, albeit in the hands of a man whose integrity and leadership of Sears was viewed as eminently impeachable. In short, the bankruptcy process itself is what gave Sears new life; the Debtors were not reborn because they got through it, they were reborn because of what happened in it. In coming years and months, yesterday’s result will largely be attributed to two men, Alan Carr and William Transier, independent Directors who saved Sears and the reputation of its Board from itself.
On Friday February 1, on the last business day prior to the scheduled Sale Hearing, Judge Drain and his team had their Super Bowl plans wrecked. As part of a concerted effort to push back on objections from the Debtors’ Official Committee of Unsecured Creditors (the “Creditors Committee”) [Docket No. 2309], the Debtors, ESL and their respective teams of advisors bombarded Drain with filings intended to convince him that, whatever may have happened in the Debtors’ recent, painful past, the sale to ESL had been handled with skill, competence and rigor. Judge Drain was being asked exactly what he wanted to be asked…and have demonstrated to him…that good corporate governance during the Chapter 11 process, and observance of bankruptcy rules, could and should absolve the sins of bad governance past. From Monday through Thursday, the Debtors argued (and were prepared to encourage and address Judge Drain’s aggressive challenges) that truly independent Directors advised by bankruptcy professionals had actually cut a disinterested deal with the very man whose interests have for so long been conflated with those of the Debtors; that last hour professionalism and independence could more than net out the long, suspect history of Edward Lampert and his hand-picked Board.
The February 1 filings, effectively the agenda for the trial, argued that ESL has paid more, worked harder and gotten less than it asked for. The filings detailed blow by blow each rejected ESL offer, each of ESL’s deal sweeteners, each pushback on ESL’s asks; trying to present the case that it was the Debtors, and not ESL, that exerted the real bargaining power in the end. Of course, this is what everyone except the Creditors Committee wanted, a reason to say yes; to approve the ESL transaction in spite of itself. 45,000 jobs...is a lot of jobs.
The Debtors seem to have accomplished their goal and even ESL (and its advisors) pitched in with their “wow, they were tough” affirmation as to how the Debtors purportedly inflicted pain throughout the negotiating process. Some of that pain, however, is very real, as it undoubtedly had to be in order to convince Judge Drain. As discussed further below, two of the most aggressive blows landed by the Debtors’ restructuring sub-committee (ie Carr and Transier, the “Subcommittee”) of the Debtors’ restructuring committee (the “Restructuring Committee”) were (i) the hard cutback of ESL’s demand for a blanket release for pre-petition liabilities and (ii) the finding by Carr that the Creditors Committee may probably be right as to insider allegations. As it stands, the Creditors Committee will now be allowed to pursue many of its allegations against ESL and the emerged Debtors post-petition, notably as to the Land’s End and Seritage transactions, they will also have some powerful testimony from Carr and Transier with which to attack Lampert and ESL. Judge Drain was pushed by the Creditors Committee as to whether he really thought that could be good enough, whether the bankruptcy Court should be punting to a future Court claims that could more properly be resolved now; whether expediency and the public interest in nominally “saving” 45,000 jobs should trump massive legitimate claims of injury resulting from insider dealing. Yesterday they did not get the answer they were looking for, but thanks to the efforts of the Debtors' independent Directors, they have the right to ask it again.
Even more emotive than whether ESL insider dealing charges could be punted, the Creditors Committee questioned whether ESL should be allowed to credit bid $1.3bn of debt amassed, at least in part claimed the Creditors Committee, as a result of tainted financial transactions. If you take away the $1.3bn as part of the package of consideration being offered by ESL, the ESL deal was dead in the water even by ESL’s own estimation as to recoveries in a liquidation. Again, Judge Drain’s answer will have been a disappointment to the Creditors Committee. It is also the one issue that might keep Carr, Transier and Drain up at night as it gets second guessed and relitigated, but it was the sine qua non of this transaction, no credit bid meant…no sale.
The Independents Weigh-In
More than anything, the result yesterday was about the appointment of independent Directors. Most important amongst the February 1 filings were not the omnibus responses to the Creditors Committee’s objections filed by the Debtors and ESL, but those by Alan Carr and William Transier, notably (i) the response of the Subcommittee, (ii) the Declaration of Alan Carr in support of the Subcommittee’s response [Docket No. 2321] and (iii) the Declaration of William Transier [Docket No. 2341].
The roles of the two men were largely split, with Transier detailing the rigor with which the Debtors treated ESL throughout the negotiating process and Carr detailing the Debtors efforts to get to the bottom of insider dealing claims lodged against Lampert/ESL. Carr’s effort was very much the shorter because it comes to a quick and simple solution; finding that ESL and Lampert may very well be guilty as charged by the Creditors Committee. Transier’s longer effort was about presenting a purely overwhelming pile of evidence as to the bona fides efforts of the Debtors’ independent Directors to do the right thing, wherever those efforts might take the Debtors and whatever might be the result.
The Carr Declaration
We have known since January 18, 2019 [Docket No. 1730] that ESL had agreed to have its blanket release for all pre-petition actions trimmed back, but buried in the heart of the Carr Declaration is a stunning statement:
“Based on the work performed so far by Counsel and the Financial Advisors, the Subcommittee has identified valuable claims arising from the Related-Party Transactions, including claims against Mr. Lampert, ESL, and others, including claims for actual and constructive fraudulent transfer and illegal dividend payments arising from the Lands’ End and Seritage transactions. As noted, the Seritage and Lands’ End claims together involve transfers in excess of $3.7 billion.”
This is remarkable language, not just because it is so certain in its presentation, but because it so clearly takes a position that is anathema to the interests of ESL. This language, and probably Mr Carr himself, will be used against ESL in future court proceedings. It is a strong statement of independence, and combined with the now limited release, stands to leave ESL to foot the bill for any liability that the Creditors Committee may someday prove. In a transaction full of unpleasant surprises for all involved, this language, penned after ESL had committed to a deal, may be amongst the biggest.
One of the principal concerns raise by the Creditors Committee and others is that the terms of the ESL sale allowed ESL to escape liability as to self-dealing transactions that have lined the pockets of ESL as it headed towards bankruptcy. The Creditors Committee claimed that, “The ESL-centric financing facilities were put in place while Sears was lying on its deathbed following a series of spin-off transactions, like Seritage and Lands’ End, that lined Lampert’s and ESL’s pockets while stripping Sears of its most valuable business lines and real estate assets.”
Up to the very end, ESL had in fact existed on exactly this level of blanket release as part of each of its proposals. The language of its most recent public proposal (the “Revised Proposal”) which incorporates the “Going Concern Proposal” of December 28, 2018, except as expressly changed by the ESL’s letter to Lazard Freres of January 9, 2019, was very clear on this point, ie that ESL required “a full release by the Debtors of ESL and certain ESL-related parties from any liability related to any prepetition transactions involving ESL.” The Carr and Transier Declarations make it clear that late in the process (late on the evening of January 15 to be precise) a blanket release was taken off the table, with Carr asserting that, “The APA does not include a global release for claims arising from the Related-Party Transactions as ESL had previously required. Instead, ESL agreed to the Subcommittee’s demand that the release discharge only the equitable subordination, recharacterization, and other claims against ESL associated with its ability to credit bid (the ‘Limited Release’). The Limited Release expressly excludes all other claims and causes of action including: (a) claims for actual or constructive fraudulent transfer; (b) claims for illegal dividend; (c) claims for breach of fiduciary duty; (d) all claims related to the Lands’ End or Seritage transactions; and (e) certain claims that have been alleged in the CCAA proceedings of Sears Canada.”
That is not all, the APA makes clear that “Mr. Lampert and ESL cannot benefit from prospective litigation involving Seritage or Lands’ End, including claims asserted by third parties or any other claims involving willful misconduct by ESL or Mr. Lampert. Specifically, (a) Mr. Lampert and ESL cannot assert 507(b) claims or deficiency claims on proceeds of litigation involving Seritage, Lands’ End, or any willful misconduct by ESL; and (b) Any 507(b) recoveries by ESL from the proceeds of any other litigation are limited to $50 million, with the remainder of any such 507(b) claims to be treated as unsecured prepetition deficiency claims."
The Transier Declaration
The Transier Declaration concludes “I firmly believe—and it is the view of the entire Restructuring Committee—that the ESL sale transaction described in the Revised Proposed Sale Order represents a higher and better offer than any alternative scenario presented, and that approval of the transaction is the best means to preserve and maximize the value of the Debtors’ estates for the benefit of all creditors and interested parties.”
It is not the end, however, but the means to the end, that clearly matter here and Transier provides detailed back-up as to the points that will have mattered to Judge Drain, (i) the independence of the individuals charged with assessing the transaction, (ii) the rigor with which independent Directors assessed that transaction and its alternatives and (iii) the degree to which the actual transaction reflected that independence and rigor. Viewing the Debtors’ filings holistically, it is clear that the role of Transier is to hammer home this last “the proof is in the pudding” point. Over and over again, Transier details (i) the sheer volume of the efforts by independent Directors and their professional advisors, (ii) the Debtors’ willingness to walk away from ESL and (iii) efforts to extract a better deal and to consider alternatives, including liquidation. It is rare to see such a detailed blow-by-blow insight into such a high stakes negotiation, and this particular effort will make many a future textbook on negotiating.
The Transier Declaration (provides considerably more detailed than the brief summary below) notes:
- Prior to joining the Restructuring Committee, Transier did not have any association or interactions with Lampert, ESL President Kunal Kamlani or any other ESL management or leadership (Carr makes the same statement).
- The Restructuring Committee met no less than fifty-eight times prior to accepting a proposed ESL transaction at a meeting on January 16.
- The Restructuring Committee convened no less than six (6) meetings after receiving the first ESL Bid before ultimately determining, on January 4, 2019, that the ESL Bid was NOT a qualified bid.
- The Restructuring Committee actually recommended on January 8, 2019 that the Debtors pivot to a liquidation.
- ESL’s next (January 9, 2019) bid, predicated on an increased deposit to $120 million, of which $17.9 million would be non-refundable, was rejected.
- ESL’s next (January 15, 2019) bid, including ESL’s agreement to (i) remove its debt financing conditions, (ii) accept the forfeiture of the $120 million deposit for financing failure, (iii) agreeing to assume certain environmental liabilities and (iv) agree to certain protections for employees AND even as the only going concern bid, was rejected. Transier states, “The Restructuring Committee unanimously agreed that the January 15 ESL Bid was still not a higher or otherwise better alternative to a wind-down [even when] weighed against the heavy consideration that a wind-down scenario would mean the immediate loss of tens of thousands of jobs in communities across the country.”
- ESL’s next (January 15, 2019-revised) bid, included some breakthrough concessions by ESL, including what may ultimately prove the most important, not only in respect of emerging from Chapter 11, but also in determining the success or failure of the emerged company. Transier states, “ESL agreed to a release that was substantially more limited and narrow, releasing only equitable subordination, recharacterization, and disallowance claims, yet preserving for the benefit of the estates all remaining litigation claims against ESL and its affiliates, which the Restructuring Subcommittee, in reliance on its advisors, determined to have substantial value.”
Transier sums up the experience, “In total, the Restructuring Committee formally met no less than twenty- two times between when we received the initial ESL Bid on December 28, 2018, and when the Auction was closed on January 17, 2019. During that period, we twice concluded that the ESL bid on the table at the time was not the “highest or otherwise better bid” and therefore were prepared to pivot to a liquidation. It was only after intense negotiations at the Auction that we succeeded in getting ESL to significantly improve its bid, at which point we approved the Successful Bid because in our business judgment, it would maximize value for the estates and their creditors.”