A new report from an examiner appointed by the court handling the bankruptcy of Dynegy Holdings LLC (DH) points out what the examiner sees as problems in how parent Dynegy Inc. (NYSE:DYN) handled these companies.
Dynegy Inc. said in a brief March 9 statement about the executive summary (the final report was not available yet to Dynegy) of the report: “The Board of Directors of Dynegy and the Board of Managers of DH take the examiner’s findings seriously and intend to review the full report, once it is made available, to determine its impact on DH’s chapter 11 proceedings, if any.”
On Jan. 11, Tracy Hope Davis, the United States Trustee for the U.S. Bankruptcy Court for the Southern District of New York, appointed Susheel Kirpalani as Chapter 11 examiner in the bankruptcy cases of DH and its debtor affiliates. On Jan. 12, Judge Cecelia Morris approved the appointment. The examiner was asked to complete an unfettered investigation of certain issues relating to the debtors’ conduct in the months leading up to the bankruptcy filing. The examiner was also charged to serve as a court-appointed mediator to attempt to forge a consensual Chapter 11 plan among the debtors’ various constituents.
Report targets Dynegy asset split
Before September 2011, Dynegy Inc.’s only asset was ownership of 100% of the equity in Dynegy Holdings, which in turn owned, through a variety of subsidiaries, all of Dynegy’s operations. Dynegy’s debt was issued by Dynegy Holdings or its subsidiaries, the report said. Dynegy Holdings and certain of its indirect subsidiaries filed for bankruptcy protection on Nov. 7, 2011. In the three months prior to filing, Dynegy Holdings had transferred or authorized the transfer of billions of dollars of its assets (stock or other direct or indirect ownership interests of subsidiaries) as part of a multi-step plan to reorganize Dynegy’s business segments and restructure Dynegy’s debts. The first phase of the restructuring facilitated a refinancing of Dynegy Holdings’s secured bank debt, which, in the absence of a refinancing, was in danger of a covenant breach.
The report executive summary added that once the crisis of the potential bank default was averted, Dynegy implemented the next phase of its restructuring plan. The goal of this second phase was to reduce the amount of Dynegy’s unsecured debt, while simultaneously increasing value for stockholders.
“To those familiar with the basic tenets of corporate finance, this may seem paradoxical, as it is a bedrock principle that a company’s creditors must be paid in full before its stockholders can receive or retain any value—unless, of course, creditors agree otherwise,” said the report summary. “Over the spring and summer of 2011, Dynegy devised and implemented a plan to move assets away from the reach of Dynegy Holdings’s unsecured creditors in order to encourage, for lack of a better word, such creditors to accept less than full payment and at the same time permit a recovery for stockholders. This report examines whether the techniques that Dynegy employed were legally permissible.”
In carrying out its restructuring strategy, Dynegy was principally concerned with whether it was violating any of the contractual prohibitions contained in Dynegy Holdings’s debt agreements, the report said. If it did not violate the letter of the contracts, then Dynegy believed it was free to implement the strategy of moving assets and, potentially, control away from Dynegy Holdings in the hope of convincing creditors to accept less than full payment for their debt. Dynegy expected that creditors would challenge this strategy and so Dynegy tried to structure its transfers of assets away from Dynegy Holdings in a manner that it could claim were transfers in exchange for fair value.
“Put simply, Dynegy believed that, even if Dynegy Holdings was insolvent, as long as it transferred assets in exchange for what the law considers ‘reasonably equivalent value,’ then creditors would have no legitimate cause to complain,” the summary said. “Dynegy’s strategy was permissible with respect to the transfers relating to the first phase of the restructuring, i.e., transfers incident to the creation of two distinct silos of assets, CoalCo and GasCo, because those transfers did not injure creditors and were not, in and of themselves, intended to do so. Indeed, following these so-called ‘ring-fencing’ transactions, both silos of assets continued ultimately to be owned (as they had been) by Dynegy Holdings. While it is true that as a result of the ring-fencing and attendant refinancing of pre-existing secured bank debt, unsecured creditors of Dynegy Holdings could look only to the residual equity value of CoalCo and GasCo, this was, as a practical matter, always the case for unsecured creditors of Dynegy Holdings, regardless of whether the silos were created.”
Report: Split plan was ‘ill-conceived’
The report summary added: “Dynegy’s strategy was ill-conceived, however, with respect to the second phase of the restructuring, i.e., the transfer or purported ‘sale’ of CoalCo by Dynegy Holdings to Dynegy Inc. in exchange for a piece of paper that Dynegy actively avoided valuing. This transfer of CoalCo, which the board of Dynegy Inc. then valued at $1.25 billion, was made in exchange for an illiquid, unsecured, highly unusual financial instrument called an ‘undertaking.’ In addition, the undertaking had no covenants to protect the holder’s value against other actions that might be taken by Dynegy Inc.”
If creditors of Dynegy Holdings had been willing to compromise their indebtedness at less than face value in exchange for new debt backed by a pledge of CoalCo stock (which was a Dynegy Holdings asset), absent Dynegy Holdings’s transfer of CoalCo to Dynegy Inc., that reduction of indebtedness would have appropriately inured to the benefit of Dynegy Holdings, and not to Dynegy Inc., said the report.
“Reduced to its essence, the transaction transferred hundreds of millions of dollars away from Dynegy’s creditors in favor of its stockholders,” the summary added. “The decision to ‘sell’ CoalCo to Dynegy Inc. in exchange for an undertaking and amended undertaking was made and implemented by directors and officers of Dynegy Inc. The three senior-most Dynegy Inc. officers also served as board members of Dynegy Holdings and its newly formed shell subsidiary, Dynegy Gas Investments, LLC. The boards of Dynegy Holdings and DGI did not appreciate that what may be good for Dynegy’s ultimate parent, Dynegy Inc., may not be good for Dynegy Inc.’s insolvent subsidiary, Dynegy Holdings. The examiner believes that these officers did not understand the distinction, from a corporate and fiduciary perspective, between Dynegy Holdings and Dynegy Inc.—a lapse perhaps caused by having the same professionals advise all entities within the consolidated Dynegy family of companies. Indeed, when authorizing the transfer of CoalCo away from Dynegy Holdings, they believed they were attempting to obtain creditor concessions for the benefit of the ‘company’ or ‘enterprise’ as a whole.”
The examiner concluded that the conveyance of CoalCo to Dynegy Inc. was an actual “fraudulent transfer,” and, assuming that Dynegy Holdings was insolvent on the date of the transfer (approximately two months before the bankruptcy filing), a constructive fraudulent transfer, and also a breach of fiduciary duty by the board of directors of Dynegy Holdings.
“Dynegy Inc., through its board of directors, used its power to control the affairs of Dynegy Holdings—an insolvent subsidiary whose property should have been maximized, or at least safeguarded, for the benefit of Dynegy Holding’s creditors—to disadvantage Dynegy Holdings for the benefit of Dynegy Inc.,” the report summary said. “Dynegy Inc.’s conduct provides a basis for disregarding the corporate separateness among Dynegy Inc., Dynegy Holdings, and Dynegy Holdings’s newly formed shell subsidiary, DGI. As such, DGI should be considered the alter ego of Dynegy Holdings, and DGI’s transfer of CoalCo should be deemed a transfer to Dynegy Inc. of an interest in property of Dynegy Holdings. In that event, Dynegy Holdings would have a claim against Dynegy Inc. for the fraudulent transfer of CoalCo. Alternatively, to remedy the injustice occasioned upon Dynegy Holdings and, derivatively, its creditors, CoalCo should be deemed property of Dynegy Holdings’s bankruptcy estate. Finally, the breach of fiduciary duty by the board of directors of Dynegy Holdings should be equally attributed to the board of directors of Dynegy Inc.”
Dynegy Inc.’s subsidiaries produce and sell electric energy, capacity and ancillary services in key U.S. markets. The Dynegy Power LLC (GasCo) power generation portfolio consists of approximately 6,771 MW of primarily natural gas-fired intermediate and peaking power generation facilities. The Dynegy Midwest Generation LLC (CoalCo) portfolio consists of approximately 3,132 MW of primarily coal-fired baseload power plants in Illinois. The Dynegy Northeast Generation portfolio, which is involved in the bankruptcy case, consists of approximately 1,693 MW from two power plants which are primarily natural gas-fired peaking and baseload coal generation facilities.
Dynegy describes ‘bankruptcy remote’ structure
Dynegy Inc. said about the 2011 reorganization in its March 8 annual Form 10-K statement: “In connection with the Reorganization, new companies were created, some of which are ‘bankruptcy remote.’ In addition, as part of the Reorganization, some companies within our portfolio were reorganized into ring-fenced companies to facilitate our financing efforts by maintaining certain of our entities and their assets separate from other entities and their assets.”
The Form 10-K added: “The new special purpose bankruptcy remote entities entered into limited liability company operating agreements, which contain certain restrictions including not allowing the ‘bankruptcy remote’ or ‘ring-fenced’ companies to act as an agent for a non ring-fenced company. Furthermore, bankruptcy remote and ring-fenced companies are required to present themselves to the public as separate entities and correct any misunderstandings that they are not separate entities, maintain separate books, records and bank accounts and separately appoint officers. Additionally, they pay liabilities from their own funds, they conduct business in their own names (other than any business relating to trading activities), they observe a higher level of formalities, and the ring-fenced entities have restrictions on pledging their assets for the benefit of certain other persons. Our ring-fenced entities include entities that own, directly or indirectly, the assets included in our Coal and Gas segments and such assets are available to satisfy the claims of creditors of such ring-fenced entities.”