Sears Holdings Might Remain In Ch.11 Bankruptcy For Years

Summary

• Judge Drain signed the confirmation order for the Ch.11 reorganization plan.
• The effective date for the plan could be years from now because there currently is not enough cash to pay administrative bankruptcy claims.
• Proceeds from preference payment litigation and perhaps even litigation against Lampert are needed to administrative claims.
• Sears Holdings shareholders are not even listed as liquidating trust beneficiaries and will get nothing under the plan.
• Sears shares could continue to trade for years until the plan's effective date.

Sears Holdings Corp. (OTCPK:OTCPK:SHLDQ) could remain in Ch.11 bankruptcy for years until the reorganization plan (docket 5293) becomes effective. The amended Ch.11 reorganization plan was confirmed by the bankruptcy judge (docket 5370) earlier this month after two days of hearings where Judge Drain actually walked out of the first day of the hearing in total disgust with certain lawyers objecting to the plan. SHLDQ shares could continue to trade until the plan is effective. There has been widespread incorrect and misleading information about this bankruptcy case by various media organizations and by comments posted on websites. The purpose of this article is to hopefully clarify for investors the status of this case.

Reorganization Plan's Effective Date

The Ch.11 reorganization plan was confirmed already, but it could be years before it becomes effective because "in no event shall the Plan go effective unless and until all Allowed Administrative Expense Claims are paid either in full as provided for in the Administrative Expense Claims Consent Program or, with respect to the NonSettled Administrative Expense Claims" according to the confirmation order. As I covered in a prior article, there is not currently enough cash to pay these claims nor will there be until Sears Holdings gets additional cash from "preference payment" litigation and/or litigation against Eddie Lampert/ESL and others.

The judge asserted in court that there is no requirement that sufficient funds to pay administrative claims need to be available on the actual confirmation date-just on the plan's effective date-as long as there is a high level of confidence that there will be funds to pay them in the future. He further stated that he was comfortable with his expectation that litigation would be successful, but stopped short of giving any specific dollar amount or time of payments.

While there are other specific time limits in the bankruptcy code on certain issues, there is no time limit between the confirmation date and the plan's effective date under section 1129 of the code. Judge Drain stressed this point multiple times during the hearings and he seemed comfortable with the fact this case could drag on for years before the effective date.

Litigation against Lampert/ESL (case No. 19-08250) and others has been covered in multiple Seeking Alpha articles already, but it is interesting to note the amount of money being spent on legal fees for this litigation. Millions already have been spent and a reserve for an additional $15 million is being established under the plan to pay future fees. There are also potential payments from insurance companies under Sears' directors and officers (D&O) liability coverage. If Lampert's lengthy legal attempt to avoid making certain payments under the Asset Purchase Agreement is an indication of his willingness to fight and pay legal fees, this litigation could take years to resolve, especially if there are lengthy appeals. If there is not enough cash to pay various administrative bankruptcy claims from other sources, Sears Holdings Corp. could remain in Ch.11 for years.

There has not been much coverage of the section 547 "Preference Payment Rule" litigation. Basically this section allows the debtor (Sears Holdings) to recover payment transfers made within the 90 day period (up to one year for insiders) prior to the bankruptcy filing date. There were payments of about $1.345 billion made during that period. This does not, however, mean all payments during that period are recoverable because there is a long list of defenses available against having to pay back the money. (Details of the defense analysis is beyond the scope of this particular article.)

In the confirmation order, the company estimated they would receive at least $100 million from preference payment actions. This compares to an company estimated shortfall to pay administrative expenses without proceeds from litigation of $36.5 million-$104.5 million (docket 5148). I actually expect the shortfall is even higher because I have doubts about some of their numbers. For example, the filing stated they have $50 million cash, but when pressed during the confirmation hearing, the current figure is now $45 million. I also have doubts about the $10 million proceeds from the Calder art work. In my opinion, there is the real risk preference payment recoveries alone will not be able to all administrative claims, even with the vendor's "haircut", without either additional "haircuts" and/or some proceeds from litigation against Lampert.

To avoid costly legal fees by both parties in preference payment cases, the amounts are usually negotiated. In the event there is a court proceeding, the bankruptcy court (Judge Drain) handles the case even though the actual payments were made by contracts governed by various state/international laws. Many of these individual preference payment cases could drag on for a very long time before actual cash is received. In addition, there could be length appeals for individual cases.

Litigation Designee/Liquidating Trust Board Members will share in incentive fees from proceeds received from litigations:

1. 0.0% of Gross Litigation Proceeds less than $150.0 million.

2. 1.5% of Gross Litigation Proceeds greater than $150.0 million up to $250.0 million.

3. 2.0% of Gross Litigation Proceeds greater than $250.0 million up to $350.0 million.

4. 2.5% of Gross Litigation Proceeds greater than $350.0 million up to $450.0 million.

5. 3.0% of Gross Litigation Proceeds greater than $450.0 million.

Source: docket 5335

(Note: from my own experience with incentive fees, it is the second one that is the most likely expected result.)

To complicate the current status, there still are motions (dockets 5161, 5178, 5241) to convert this case from Ch.11 to Ch. 7. A hearing to consider these motions was set for October 23, but is now set for November 20 (docket 5361). Given Judge Drain's contemptuous statements to the lead lawyer on these motions at the confirmation hearing and that he has already signed the confirmation order for the Ch.11 plan, I consider it very unlikely the judge would agree to convert this case to Ch.7 at this time.

Lampert/ESL are also complicating the process by filing an appeal of the plan confirmation to the federal district court (docket 5399). This was expected and is related to their appeal regarding their 507b super-priority claims, which I have covered in multiple prior article.

Confirmation Hearing-Judge Drain Walks Out

After many rescheduled confirmation hearing dates, there were two days of hearings on October 3 and 7. After about six hours of arguments, Judge Drain was so disgusted by objecting lawyers that he got up and started walking out waving his hands telling the court that the hearing would be continued the next day, but then sat back down. He proceeded to allow Ed Fox, the lawyer representing the bond indenture trustee, to make his presentation. After Mr. Fox started to state the negative voting results to the plan, Judge Drain became frustrated him, asking if the lawyer thought they would do better under Ch.7. As Mr. fox continued to speak, Judge Drain became extremely upset. He got up and walked out of court still talking saying "settle this and the hearing would continue next week". We were all standing and looking at each other thinking "now what?" (If you heard the court proceedings via a telephonic connection or just read the transcript, you would have missed what was actually happening because you could not see the judge's movement.)

The objecting parties were mostly vendors who thought they should get paid in full as administrative expenses and were upset that lawyers and other professionals were being paid in full while vendors were being asked to take a major "haircut" on their claims. The problem for vendors was the DIP loan order still governed this case and allowed for a special carve out for professional fees. (In my opinion, the vendors should have made stronger objections to the DIP agreement last year.)

Some of the lawyers for vendors were just plain terrible. One kept repeating the same questions over and over again annoying the judge and the courtroom. Judge Drain even stated to some lawyers they did not know the bankruptcy code and were misinforming their clients, which caused some courtroom laughter.

After some changes to the plan, such as having the "opt-in" and "opt-out" for vendors being the same date, the judge agreed to confirm the plan. Those vendors that opt-in could receive their first partial payment from a $21 million pool on December 1, but their total recovery is topped at a maximum of 75% of their claim.

Incorrect News and Comments

There has been a lot of incorrect reporting and comments on the internet regarding the confirmation. For example, Bloomberg Terminals have a report dated October 18 that stated, "After Sears emerged from bankruptcy, the company has borrowed about $150 m...." Sears Holdings Corp. has not emerged from bankruptcy nor is expected to. It is liquidating and will not be discharged under section 1141. The borrowing was by Transform Holdco LLC that now owns the Sears brand and various stores-not Sears Holdings (OTCPK:SHLDQ). Transform Holdco was never in bankruptcy (not yet).

There have been numerous comments that shareholders will still own assets after the effective date. Wrong. Sears Holdings will be dissolved and SHLDQ shares will be cancelled. As per the Confirmation Order:

On the Effective Date, all Liquidating Trust Assets of the Debtors shall be transferred to the Liquidating Trust in accordance with Article X of the Plan, and all Debtors shall be dissolved without the necessity for any other or further actions to be taken by or on behalf of such dissolving Debtor or its shareholders or any payments to be made in connection therewith, other than the filing of a certificate of dissolution with the appropriate governmental authorities."

Another area that I see incorrect comments is that Sears Holdings still directly or indirectly owns certain assets. They are still in the process of transferring ownership because of technicalities in local foreign laws, but SHLDQ shareholders will not own these on the plan's effective date. As per confirmation order:

The Asset Purchase Agreement provided for the transfer to Transform Holdco LLC or its affiliates of the Acquired Foreign Assets... pursuant to section 2.13 of the Asset Purchase Agreement and the Acquired Intellectual Property... pursuant to section 2.1. The parties are working to finalize the transfer of certain Acquired Foreign Assets comprising (1) minority interests in certain Mexican entities held by Sears Mexico Holdings Corp., and (2) equity interests in the Debtors’ non-Debtor Indian subsidiaries (1 and 2, collectively, the “Specified Foreign Assets”) to Transform Holdco LLC or its affiliates, in accordance with the Asset Purchase Agreement. Additionally, with respect to certain items of foreign Acquired Intellectual Property, certain local jurisdictions require filing of short-form ownership transfer documentation in their local intellectual property office to put in the record and perfect the transfer of ownership, which filing has not yet been completed.

(BTW-According to reports on October 25, Tramsform (Lampert/ESL) might be trying to sell the DieHard brand, one of these "Acquired Intellectual Properties", to raise much needed cash.)

Impact On Investors

On the effective date, all the assets get placed in a liquidating trust and any future payments to stakeholders would come from this trust. Investors holding vendor claims, unsecured notes, and 2lien 2018 notes expecting any future payment will not be able transfer/sell/assign their Liquidating Trust Interest "except by will, intestate succession or other operations of law". There will no longer be any trading after the effective date, so investors will not be able to sell nor buy. There not be trading in the Liquidating Trust Interests.

I do not even see SHLDQ shareholders having any interest in the Liquidating Trust. Holders of the unsecured notes would be considered in the General Unsecured Interest. (Because of litigation, it is uncertain what category exactly 2lien noteholders would fall in, but currently they would be General Unsecured Interest.) As per the plan:

1.105 “Liquidating Trust Beneficiaries” means the holders of Liquidating Trust Interests.

1.107 “Liquidating Trust Interests” means ((a)) the PBGC Liquidating Trust Priority Interest; ((b)) the General Unsecured Liquidating Trust Interests; ((c)) the Specified Unsecured Liquidating Trust Interests; ((d)) Kmart Corp. General Unsecured Liquidating Trust Interests; ((e)) Kmart Corp. Specified Unsecured Liquidating Trust Interests; ((f)) Kmart IL Guarantee General Unsecured Liquidating Trust Interest; ((g)) Kmart IL Guarantee Specified Unsecured Liquidating Trust Interest; ((h)) Kmart WA Guarantee General Unsecured Liquidating Trust Interest; and ((i)) Kmart WA Guarantee Specified Unsecured Liquidating Trust Interest.

For investors wishing to "play" the current litigation by Sears Holdings/Liquidating Trust against Lampert, it seems you need to own the notes or some other claim such as a vendor claim. SHLDQ shareholders will not benefit from any results because any cashed received will go into the Liquidating Trust payable solely to the "Liquidating Trust Beneficiaries". Repeat-SHLDQ shareholders are not on that list.

Prior to the confirmation hearing, I was still expecting that there could be a slight chance Lampert would settle and that there would be some token payment to shareholders and others for releases from any/all future liability litigation against Lampert. It never happened. Now for shareholders to receive any money, they would have to have some type of different new class-action lawsuit against Lampert. Often the if there is any payment from these types of lawsuits, it is based on owning shares during a set time period and not a specific date.

Repeat. SHLDQ will be cancelled on plan's effective date as per plan:

On the Effective Date, all Existing SHC Equity Interests shall be cancelled. Each such holder thereof shall neither receive nor retain any property of the Estate or direct interest in property of the Estate of SHC on account of such Existing SHC Equity Interest.

My Last Article

As I posted in comment area of some of my prior articles, I was no longer going to write Seeking Alpha articles, make comments, nor respond to messages because some of my limited partners of two funds I run strongly objected to my Seeking Alpha participation. They thought that my participation negatively impacted the fund's returns because SA readers were buying/selling/shorting the same securities mentioned in my articles we were trading. After reading some of the widespread incorrect information about the Sears Holdings bankruptcy, the limited partners agreed that there should be this last article-as one partner joked as a "public service" to challenge the "fake news" written about Sears.

Conclusion

I usually do not like to include long quotes from court filings in my articles, but I thought it was critical for SHLDQ shareholders to see that they are not listed as beneficiaries of the liquidating trust and would, therefore, not receiving proceeds from any successful litigation currently being brought by Sears Holdings against Lampert/ESL. I am assuming that one reason for not even bother to include the shareholders is there is so many priority claims that must be paid in full before shareholders would have received anything that they did include them. SHLDQ shares could still trade for years until the effective date and the price could be very volatile, but consider SHLDQ shares a sell.

Since I am not able to even able to make a guess about possible results from litigation against Lampert and preference payments, I will not make any recommendations about the Sears Holdings notes which are listed as beneficiaries of the liquidating trust.

This historic Ch.11 bankruptcy case of the former largest retailer in the U.S. could drag on for years before the plan becomes effective. The Liquidating Trust would then govern the distribution of any remaining cash.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.