With an exciting but somewhat controversial finish in last night’s game, the Washington Nationals tied the series 3-3 with the Houston Astros, setting-up for a potentially exciting Game 7 conclusion to the World Series. Unlike the Cubs in 2016 and the Dodgers in 2017 and 2018, neither of this year’s teams is a former Chapter 11 debtor. However, the Astros are still very much tied-up in Houston Regional Sports Network, L.P.’s Texas Chapter 11 from 2013. Hence, our hook for our third bankruptcy-related World Series post.
Specifically, in March 2018, the Fifth Circuit Court of Appeals remanded a collateral valuation issue back to Bankruptcy Judge Marvin Isgur and, in the process, held that (i) the Bankruptcy Code does not impose a per se rule of which date a bankruptcy court must base valuation determinations on and (ii) courts have the flexibility to choose a valuation date based on the “purpose of the valuation” and “proposed use or disposition of the collateral at issue.”
In September 2013, various Comcast-related entities forced Houston Regional Sports Network, L.P. (the Network) into an involuntary Chapter 11 in the Southern District of Texas. Comcast took that step to delay termination of a lucrative broadcast agreement with the Astros.
The Network is a TV network that the Houston Astros and the Houston Rockets formed to televise their respective games. It entered into separate media-rights agreements with each of the teams whereby it obtained exclusive broadcast rights in exchange for fees. In turn, the Network entered into an Affiliation Agreement with a Comcast entity whereby Comcast could carry Astros and Rockets games on its cable systems through 2032 for a subscriber-based monthly fee. Additionally, another Comcast entity loaned $100 million to the Network in 2010, secured by all of the Network’s assets except for the Teams’ media rights.
The Network defaulted on two months of payments in July and August 2013; the Astros sent a termination demand letter with a late September 2013 deadline; and the Comcast entities initiated the involuntary just prior to the termination deadline. Although the Astros litigated heavily a dismissal motion, the Teams settled into negotiations to sell the equity in the Network to AT&T and DirecTV, a sale that was embodied in the Network’s Chapter 11 plan. Judge Isgur confirmed the plan in October 2014. Under the plan, the Teams waived $107 million in media fees that had accrued during the bankruptcy case.
Prior to confirmation, Comcast made an § 1111(b) election, such that its claim under the $100 million loan would be treated as fully, rather than partially, secured,- with Comcast to receive a stream of payments equal to its claim against the Network. Although § 1111(b) might be one of the most inscrutable and confounding provisions of the Code, it does bear on the valuation dispute in that the present value of the payments equals the value of Comcast’s applicable collateral and the nominal value of those payments is equal to Comcast’s claim amount. Thus, the court had to value the collateral.
The initial valuation proceeded as follows:
First, because § 1111(b) doesn’t extend to collateral that is to be sold, the parties stipulated that the value of Comcast’s tangible collateral to be sold (cash, A/R, FF&E, and the like) was $26.2 million.
Second, that left the court to value the remaining intangible collateral (i.e., the Affiliation Agreement). To make that valuation, the court projected the Network’s net income through 2032 and then, based on expert testimony, discounted that projection back to the petition date, resulting in a valuation of $54.3 million. However, because the Teams had waived $107 million in media fees that had accrued through the plan effective date, the court also discounted those back to the petition date and then subtracted them from the $54.3 million value, resulting in a negative and, thus, $0.00 valuation.
Third, because a creditor cannot make an § 1111(b) election as to collateral of an “inconsequential value,” the court determined that Comcast couldn’t elect to have its claim treated as fully secured.
Comcast appealed to the district court, which affirmed.
Fifth Circuit Remands
On appeal, Comcast argued that the bankruptcy court erred by (i) choosing a petition date, rather than a confirmation date, valuation and (ii) deducting the waived media fees from the value of the Agreement. The Astros argued that the Code and a related Fifth Circuit case (Stembridge) required the bankruptcy court to use a petition date valuation.
First, the Fifth Circuit observed that the Bankruptcy Code does not dictate a single valuation date in Chapter 11. Section 506(a)(1) simply provides that the value of a secured claim “shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.”
Second, the Court looked to § 1129(b)(2)(A)(i)(II)’s “fair and equitable” requirement for secured claims–i.e., the requirement that “each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property.”
Thus, when valuing a secured claim, a court must discount the value of the creditor’s collateral back to present value. Although a 2005 amendment dictates a petition date valuation for personal property in Chapter 7 and Chapter 13 cases, the Code is silent as to the valuation date for Chapter 11 valuations. Therefore, the above-quoted § 506(a)(1) language is all of the statutory guidance that the Code provides. And the result, according to the Fifth Circuit, is that a court can choose the petition date, confirmation date, plan effective date, or some other date based on the purpose of the valuation and the actual proposed use of the property. In support, the Court points to the Supreme Court’s oft-cited Rash case.
Third, the Court acknowledges that many courts, including the Third and Eighth Circuits, hold that the appropriate valuation date for cram-down under § 1129 is the plan’s effective or confirmation date. Indeed, if that question showed-up on an exam, that would be my and most attorneys’ obvious answer. Nevertheless, the Fifth Circuit continues “to follow the flexible approach to valuation timing that allows a bankruptcy court to take into account the development of the proceedings, as the value of the collateral may vary dramatically based on its proposed use under any given plan.”
Fourth, and this appears to be the Court’s primary point on the valuation date issue, the Court held that neither Stembridge (a Chapter 13 case) nor the Code requires a petition date valuation. Because Judge Isgur had indicated that he would have also chosen the petition date under the “flexible approach,” the Court determined that his “erroneous reliance on Stembridge is harmless.”
Deduction of Media Fees
The Fifth Circuit remanded on the issue of the waived $107 million in media fees because the deduction of those fees from the value of the Affiliation Agreement did not “consider [its] value in light of the actual proposed post-reorganization,” as required by § 506(a) and Rash.
That is, because the Teams had waived those fees and such fees were, under the plan, never to be paid, the “value of the Agreement in the reorganized debtor’s hands is unaffected by those waived fees.” Put another way, deducting them “would value the Agreement in light of a hypothetical disposition of the property . . . that will not occur.”
Further, the Court held, subtracting those administrative expense fees from collateral when such fees do not benefit the collateral or have anything to do with preserving or enhancing it under § 506(c) amounts to an “impermissible surcharge.”
Thus, the Court remanded so that the bankruptcy court could revalue the Affiliation Agreement in light of the plan and without reference to a hypothetical situation that is “neither proposed nor likely in this Chapter 11 cram-down.”
Status of the Remand
After a few status conferences on remand, Judge Isgur entered a Memorandum Opinion on July 31, 2019. The Opinion provides a good summary of the events leading-up to the remand. It also provides a detailed explanation of why he believes that his decision to use the petition date for the valuation–a decision that the Fifth Circuit did not disturb–took “into account the development of the proceedings.” It certainly wasn’t a simple consideration and his reasoning is worth a read for anyone who is wondering how a cram-down valuation would have anything other than the confirmation date as its basis.
To determine on remand whether the Affiliation Agreement was of “inconsequential value” as of the petition date based on its proposed use and disposition, Judge Isgur concluded that he must answer two questions in the coming months: (i) what was the fair market value of the Agreement to the reorganized debtor on the effective date and (ii) what adjustments, if any, should be made to determine the fair market value as of the petition date.
To that end, earlier this month the parties entered into a stipulated trial schedule to satisfy the Fifth Circuit’s mandate, with about five months of discovery in the lead-up to a March 16, 2020 confirmation hearing. We’ll try to keep our eye on this one as it develops.