ESL Invs., Inc. v. Sears Holdings Corp. (In re Sears Holdings Corp.)

• Decision Date: 01 September 2020
• Docket Number: 19 CV 7660 (VB)
• Citation: 621 B.R. 563
• Parties: IN RE: SEARS HOLDINGS CORPORATION, et al., Debtors. ESL Investments, Inc., et al., Appellants, v. Sears Holdings Corporation, et al., Appellees.
• Court: U.S. District Court — Southern District of New York

621 B.R. 563

IN RE: SEARS HOLDINGS CORPORATION, et al., Debtors.

ESL Investments, Inc., et al., Appellants,

v.Sears Holdings Corporation, et al., Appellees.

19 CV 7660 (VB)

United States District Court, S.D. New York.

Signed September 1, 2020

Philip D. Anker, Wilmer Cutler Pickering Hale and Dorr LLP, Robert J. Liubicic, Milbank, Tweed, Hadley & McCloy LLP, Katherine Rosemary Lynch, Thomas J. Moloney, Sean Aaron O'Neal, Andrew W. Weaver, Cleary Gottlieb Steen & Hamilton LLP, Steven Robert Paradise, Seyfarth Shaw LLP, Chelsey Rosenbloom, Bryan Cave Leighton Paisner LLP, New York, NY, Brian Kinney, Milbank, Tweed, Hadley & McCloy LLP, Eric Reimer, Milbank LLP, Los Angeles, CA, for Appellants.

Z.W. Julius Chen, Akin Gump Strauss Hauer & Feld LLP, Washington DC, Jared R. Friedmann, David Lender, Ray C. Schrock, Gregory Stewart Silbert, Sunny Singh, Weil, Gotshal & Manges LLP, Joseph Lee Sorkin, Akin Gump Strauss Hauer & Feld LLP, New York, NY, Paul R. Genender, Weil, Gotshal & Manges LLP, Dallas, TX, for Appellees.

OPINION AND ORDER

Briccetti, J.:

Appellants ESL Investments, Inc., and certain of its affiliated entities (including JPP, LLC, JPP II, LLC) (together, "ESL"), Wilmington Trust, National Association, as Indenture Trustee and Collateral Agent, and Cyrus Capital Partners, L.P. (collectively, "Appellants" or "Second Lien-Creditors"), appeal from a July 31, 2019, bench ruling and an August 5, 2019, Order (together, the "Orders") of the U.S. Bankruptcy Court for the Southern District of New York (Hon. Robert D. Drain, Judge) finding no diminution in value of the Second Lien-Creditors' collateral following August 15, 2018 (the "Petition Date"), and thus, that the Second Lien-Creditors are not entitled to superpriority claims pursuant to 11 U.S.C. § 507(b). (Case No. 18-23538, Doc. #4740).

Appellants argue the bankruptcy court erred in its valuation of the Second-Lien Creditors' collateral (the "Second-Lien Collateral") after Sears Holdings Corporation ("Sears Holdings") and its affiliates (together, "Debtors") filed a voluntary petition for Chapter 11 bankruptcy protection. Specifically, Appellants argue the bankruptcy court errantly determined there was no net diminution in value of the Second-Lien Collateral from the Petition Date through February 19, 2019 (the "Sale Date"), when Sears Holdings was sold.

For the following reasons, the bankruptcy court's Orders are AFFIRMED.

The Court has subject matter jurisdiction pursuant to 28 U.S.C. § 158(a).

BACKGROUND

Founded in 1893, Sears, Roebuck and Co. ("Sears"), has a storied 125-year history. Long a staple of American shopping malls, Sears led all retailers in the tool, appliance, lawn and garden, and automotive repair and maintenance retail sectors.

Sears was purchased in 2005 and merged into Sears Holdings. Between 2005 and 2018, Sears struggled. Due to declining revenues, poor brick-and-mortar market conditions, and cash flow and liquidity issues, on October 15, 2018, Sears Holdings filed for Chapter 11 bankruptcy protection.

I. Bankruptcy Proceedings and Sale to ESL

As of the Petition Date, all of Sears Holdings's assets were encumbered. (See A-38).¹ Sears Holdings's secured debt totaled approximately $2.68 billion, comprising approximately $1.53 billion in first-lien debt, and approximately $1.15 billion in second-lien debt secured on a junior basis by certain assets including the Second-Lien Collateral.

Sears Holdings's largest secured creditor was ESL, a hedge fund owned by Edward Lampert, Sears Holdings's CEO and Chairman of its Board of Directors. (A-5–6).

The Chapter 11 filing triggered the automatic stay, which prevented the Second-Lien Creditors from foreclosing on the Second-Lien Collateral without the bankruptcy court's permission. The Second-Lien Creditors, as pre-petition lenders, received a protection package following the bankruptcy filing as part of the debtor-in-possession ("DIP") financing process, which allowed Debtors to continue to use, post-petition, the Second-Lien Collateral. (A-460–61).² To provide adequate protection, in the Final DIP Order, the Second-Lien Creditors were given Section 507(b) superpriority claims to the extent there was any net diminution in value of the Second-Lien Collateral after the Petition Date. (See A-464–65).

As of the Petition Date, neither Debtors nor their creditors knew whether Sears Holdings would be sold or liquidated. Accordingly, Sears Holdings continued to sell its inventory at Go-Forward Stores, going-out-business ("GOB") stores, and to collect accounts receivable.

In December 2018, ESL submitted a going-concern bid to purchase substantially all of Debtors' assets, but the proposal was deemed deficient by Debtors and thus, Debtors pivoted to liquidation. (A-4885–86). ESL requested more time to improve its bid, which Debtors allowed, and in January 2019, ESL submitted a second going-concern bid. (A-4886–89). According to Debtors, this bid too failed to address the deficiencies Debtors had identified in the initial proposal. ESL once again requested additional time to provide a better offer. It was that third offer that Debtors accepted, agreeing that ESL's proposal was the highest and best-provided alternative to liquidation. (A-4889–93).

On February 8, 2019, the bankruptcy court approved the transaction—over the objection of some creditors—and entered an order to that effect (the "Sale Order"). Three days later, on February 11, 2019, the sale closed pursuant to an asset purchase agreement ("APA") between Sears Holdings and Transform Holdco LLC ("Transform"), the ESL entity. Accordingly, Sears Holdings's assets were transferred to Transform.

ESL purchased substantially all of Debtors' assets for approximately $5.2 billion in cash and non-cash consideration. (A-1831). Included in the purchase price was a $433.45 million credit bid (the "Credit Bid") pursuant to Section 363(k) of the Bankruptcy Code, which in effect forgave some of the $1.15 billion debt owed by Debtors to the Second-Lien Creditors. (A-1012–14).³ Included in the purchase price was $885 million in cash paid by ESL for Sears Holdings's inventory and receivables, some of which comprised the Second-Lien Collateral. (A-1249).

II. Section 507(b) Claims

Following the sale, the Second Lien-Creditors asserted Section 507(b) claims pursuant to the Final DIP Order. The Second-Lien Creditors insisted they were still owed approximately $718 million in outstanding debt, accounting for $1.15 billion less the $433.45 million Credit Bid.

On May 26, 2019, Debtors filed a motion to estimate the Second-Lien Creditors' claims. By stipulation between the parties, the motion was converted into a proceeding under Federal Rule of Bankruptcy Procedure 3012 to: (i) determine the amount of the Second Lien-Creditors' secured claims and Section 507(b) claims; and (ii) adjudicate Debtors' request, pursuant to Section 506(c), to surcharge the Second-Lien Collateral with substantially all the costs of the bankruptcy proceedings. The court so ordered the stipulation.

Accordingly, the bankruptcy court held a two-day evidentiary hearing on July 23 and July 31, 2019. At the hearing, the Second-Lien Creditors presented expert testimony respecting the value of the Second-Lien Collateral as of the Petition Date, in order to assess the value of the Section 507(b) claims.

David M. Schulte, expert for ESL, testified that the value of the collateral on the Petition Date was $2.928 billion, which was $245 million more than the debt owed the first-lien creditors and Second-Lien Creditors, and nearly $600 million more than the maximum amount of any Section 507(b) claim in light of the Credit Bid. (A-2892). Schulte calculated this amount by using the inventory's book value for Go-Forward stores and net retail value for GOB stores, which was slightly lower than book value. (A-2888–92). And for the non-inventory collateral of cash, credit card receivables, pharmacy receivables, pharmacy prescriptions (or "Scripts"), Schulte used the book value provided by the Debtors. (See A-2887–88).⁴ Accordingly, Schulte testified that the diminution in value from the Petition Date for the 507(b) claims was $962.7 million, or $250 million more than the $718 million the Second-Lien Creditors were entitled to recover in light of the Credit Bid. (See A-4285).

William Heinrich, expert for Wilmington Trust, opined that the collateral on the Petition Date was worth $3.28 billion, which was nearly $600 million more than the debt owed the first-lien creditors and Second-Lien Creditors, and nearly $950 million more than the maximum amount of any Section 507(b) claim in light of the Credit Bid. (See A-3126). Heinrich calculated this amount by assuming the inventory would be sold at retail price at both the Go-Forward and GOB stores. (See A-3074–81). He too factored in accounts receivable, Scripts, and certain inventory that was deemed "ineligible" by the first-lien creditors. (See A-3074–81). Accordingly, Heinrich testified at the evidentiary hearing that that the diminution in value from the Petition Date for the 507(b) claims was $1.314 billion, or $200 million more than the total outstanding debt and nearly $600 million more than the $718 million the Second-Lien Creditors were entitled to recover in light of the Credit Bid. (See A-4321).

Marti P. Murray, expert for Cyrus Capital Partners, opined that the value of the collateral on the Petition Date was $2.46 billion, which was over $200 million more than the maximum amount of any Section 507(b) claim in light of the Credit Bid. (See A-2003). Murray calculated this amount by assuming the Second-Lien Collateral would be sold through an "orderly liquidation of its business," a company-wide GOB sale. (A-1971). Murray relied on appraisals performed by Tiger Capital Group ("Tiger"), an independent third-party appraiser hired by the first-lien creditors. (A-1971). Tiger ascribed an overall net orderly liquidation value ("NOLV") of 88.7 percent to the Second-Lien Collateral—the...