Big Businesses and Small Mistakes: How Failing to Understand the Facts Creates Confusion in the Delaware Courts

By: Maria Gomez

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Due to a “misapprehension” of the facts and law, in In re Energy Future Holdings Corp.,[1] the United State Bankruptcy Court for the District of Delaware took the extraordinary step of reconsidering and vacating its approval of a termination fee.  In April 2016, Energy Future Holdings Corp. (“EFH”) and other affiliated companies (collectively, “Debtors”), engaged in negotiations with NextEra Energy, Inc. (“NextEra”) for the sale of the Debtors’ economic interest in one of EFH’s subsidiaries, Oncor Electric Delivery Company LLC (“Oncor”).[2]  In July 2016, Debtors, NextEra and NextEra’s subsidiary, EFH Merger Co., LLC (“Merger Sub”), executed a merger agreement[3] of EFH with and into Merger Sub.[4]  According to the parties’ statements in the merger agreement, NextEra would wholly own EFH as a subsidiary and by implication, Oncor’s $18.7 billion approximate total enterprise value.[5]  The merger agreement included a termination fee of $275 million in favor of NextEra to be paid by Debtors from their estate as an administrative expense.[6]

The termination fee provision provided that the fee would be payable if EFH entered into any other transaction or terminated, even if forced to do so, because the Public Utility Commission of Texas (“PUCT”) did not approve the merger.[7]  Specifically, the fee would not be payable to NextEra if: (1) NextEra terminated at the termination date, where PUCT approval was the only unsatisfied closing condition; or (2) NextEra terminated because the PUCT either (a) approved the Merger Agreement transaction with burdensome conditions to NextEra; or (b) did not approve the Merger Agreement transaction.[8]  The provision also provided that the fee would be payable to NextEra if, after the entry of a court approval order, Debtors terminated the Merger Agreement to accept another proposal and that other proposal was consummated.[9]  Under this provision, NextEra would never be forced to terminate and instead, could just wait for largely growing economic pressure to force Debtors to do so.[10]  Additionally, the only way the Debtors would not have to pay the termination fee was if the PUCT approved the transaction and approved it without any burdensome condition to NextEra.[11]

Debtors and various creditors objected to the court’s approval of the Merger Agreement and termination fee.[12]  However, none of these objections pointed out the fact that the termination fee was impermissible because the merger agreement did not state a specific date by which PUCT approval needed to be obtained.[13]  One of the objectors argued the termination fee did not meet bankruptcy standards and violated due process, but did not argue that the fee was illicit because it could be payable even when Debtors did not receive any actual benefit.[14]  After the court approved the merger agreement and its termination fee, the PUCT held a hearing where it expressed concerns regarding Debtor’s potential liability for the termination fee calling it “an extraordinary requirement” which placed  “unusual and troubling” pressure on the PUCT and the court.[15]

The parties subsequently attempted to clarify to the court when the termination fee would be triggered.[16]  However, none of the parties brought to the court’s attention the critical issue that NextEra would never be compelled to terminate and instead could wait for the Debtors to do so.[17]  Eventually, the court approved the merger agreement, including the termination fee.[18]

Following the bankruptcy court’s approval of the merger agreement, the PUCT rejected the deal and continued to reject NextEra’s rehearing requests.[19]  NextEra failed to terminate the merger agreement even after it refused to budge on the conditions that the PUCT continued to reject.[20]  Debtors were forced to terminate the merger agreement and risked triggering the termination fee to avoid incurred months or even years of fee obligations and accrued interest that would develop after it became clear that NextEra intended to continue appealing the PUCT’s decision “at all levels of review.”[21]

Almost a year after the court approved the merger agreement and its termination fee, Elliott Associates, L.P., Elliot International, L.P., and The Liverpool Limited Partnership (collectively, “Elliot”), beneficial owners of EFIH notes, filed a motion to reconsider the court’s approval of the termination fee.[22] Though both NextEra and Debtors objected to Elliot’s motion, the court held a hearing in which it granted the motion to reconsider. [23]

The court had two issues with the termination fee.[24]  First, the merger agreement did not state a specific date by which PUCT approval needed to be obtained.[25]  Second, if the PUCT did not approve the transaction, then Debtors would be forced to terminate and pay the $275 million termination fee in order to avoid incurring months or years of fee obligations and interests related to NextEra’s endless appeals.[26]  The court did not understand these issues, nor did the parties attempt to clarify them at the time the court approved the merger agreement and termination fee in August 2016.[27]  The court determined that had it understood “there was a scenario in which NextEra would receive the Termination Fee even if the PUCT declined to approve the NextEra Transaction, it would not have approved the payment of the Termination Fee in those circumstances.”[28]

Under Bankruptcy Code §503(b), the payment of a termination fee as an administrative expense out of an estate is only allowed in narrow circumstances.[29] Because administrative expenses are narrow in scope, the termination fee must be one of the “actual, necessary costs and expenses of preserving the estate” to be deemed as such.[30]  Bankruptcy courts determining whether to approve a termination fee must also focus “on the conditions that must be met to consummate the transaction (e.g., financing, due diligence, regulatory approvals, etc.)”[31]  A termination fee is appropriate if the debtor pursues a better and higher offer for its asset.[32]

In vacating the fee and reconsidering the judgment, the bankruptcy court noted that the termination fee could not have provided an actual benefit to Debtors’ estate because the PUCT rejections of the merger agreement transaction forced the Debtors to terminate and pursue a lower offer.[33]  The merger agreement did not have a time limit for PUCT approval and Debtors were required to pay the termination fee if they terminated first.[34]  These facts gave NextEra an incentive to seek numerous pointless motions and appeals to indirectly force Debtors into terminating the merger agreement and explore other transactions.[35]

The Energy Future Holdings opinion encourages future parties in any transaction to clarify all misapprehensions of both fact and law to the court.[36]  This opinion emphasizes the interests of justice to include “requiring parties seeking relief from the Court to be accurate in their representations.”[37]  Even though both NextEra and Debtors objected, the court granted the related motion to reconsider.[38] The court explained that though it did “not believe the Debtors acted improperly or with malice,” it was clear from the record that NextEra “was happy to remain silent” and “made no effort to clarify the [misapprehended] record” to the court.[39]  The court also noted that its misapprehension as to when the termination fee did and did not apply was based on “imprecise and incorrect” witness testimony, “incomplete responses by [] counsel” to the court’s questions, and NextEra’s “conspicuous and unhelpful silence.”[40]  It is anticipated this ruling will not only encourage parties to be transparent and aid the court in understanding the facts and law at issue, but it will also scare off those who will wish to take advantage of the judicial system.  However, the bankruptcy field awaits the ramifications of this opinion after NextEra appealed to the United States Bankruptcy Court in the District of Delaware on October 30, 2017, and the parties requested certification from The United States Court of Appeals for the Third Circuit.