Distressed Debt Legal Insights

Welcome back to Distressed Debt Legal Insights, Ropes & Gray’s new source of timely insights for professionals navigating the complex world of liability management.

In this issue, we spotlight the unfolding litigation between the UCC and Oaktree in TPI Composites’ ongoing bankruptcy, which appears to be headed for a settlement. This case is unusual in that the uptier transformed former equity holders into senior creditors rather than elevating existing lenders.

The Unsecured Creditors Committee Challenge

On Oct. 1, the official committee of unsecured creditors (UCC) for TPI Composites, which includes the trustee of the unsecured convertible notes, filed an adversary complaint seeking to invalidate a 2023 uptier transaction in which Oaktree converted its $436 million preferred equity stake into $43 million of common equity and a $393 million first lien senior secured term loan. This maneuver elevated Oaktree from preferred equity holder to senior secured creditor, leapfrogging holders of the company’s unsecured convertible notes.

The UCC alleges that Oaktree used its insider position to extract value without providing reasonably equivalent consideration, at a time when Oaktree knew that TPI was, or would soon become, insolvent.

The complaint raises claims of constructive fraudulent transfer and equitable subordination and seeks to recharacterize Oaktree’s secured claim as equity. The committee also filed a motion for standing to pursue these claims and, on Oct. 2, sought a temporary restraining order to prevent Oaktree from credit bidding its purported secured debt.

Oaktree’s Response

On Oct. 24, Oaktree moved to dismiss the UCC’s complaint, arguing that it is a “misguided attempt” by the UCC to “manufacture leverage” in a case where the unsecured creditors are “far out of the money.” Oaktree asserts that the 2023 transaction was highly negotiated and provided the company with a “value-preserving lifeline.” Oaktree also contends that the UCC’s claims are disguised avoidance claims that the UCC does not have standing to pursue.

On Nov. 5, Oaktree filed an objection to the UCC’s motion for standing, saying the UCC wants to “consume all of the Debtors’ remaining liquidity on frivolous, wasteful litigation” that would not contribute “a single additional dollar of value” to the estates. Oaktree’s objection states that  the constructive fraudulent transfer claim is “not colorable” because the exchange contributed substantial value to TPI and TPI was not insolvent at the time.

The UCC Responds to Oaktree

On Nov. 14, the UCC filed a response to Oaktree’s motion to dismiss, stating that a motion to dismiss is not the “proper avenue for Oaktree to misconstrue the Complaint’s factual allegations.” In a motion to dismiss, the court must accept all well-pled allegations as true, and the complaint “more than plausibly alleges that Oaktree used its status as an insider” to force through the uptier exchange. The UCC’s response states that the complaint adequately alleged claims for recharacterization and equitable subordination, among other claims. The UCC reiterated its arguments in a Nov. 18 omnibus reply brief in further support of its motion for standing.

The Pending Settlement

On Nov. 24, the debtors announced that the previously-ordered mediation had failed, and a hearing began on the motion for standing and motion to dismiss. Presiding Judge Christopher Lopez expressed concern about the company’s liquidity, saying, “If I grant the UCC standing, who pays for the litigation?” He also stated his concern that TPI may be forced into a Chapter 7.

The hearing continued on Tuesday, Dec. 2, with Judge Lopez ordering a recess so that the parties could discuss settlement. Prior to the recess, Judge Lopez told the parties that neither side had a “slam dunk” and that he thought the real issue was the fraudulent transfer allegations and not the equitable subordination or recharacterization claims. Following the recess, the parties reached a “tentative framework” that would resolve the litigation.

A motion filed by the debtors on Dec. 9 provides additional detail on the settlement. In exchange for dropping the lawsuit, the UCC will be entitled to a portion of Oaktree’s cash distributions received from the debtor through a recovery sharing mechanism, and a trust will be established to achieve the sharing of future cash distributions.

Why This Matters

Onlookers hoping that this litigation would provide additional insight into how to challenge uptiers are set to be disappointed. The settlement means that the market will not gain additional judicial insight on liability management transactions, which is in high demand but low supply.

Liquidity concerns seem to have been behind Judge Lopez’s pushes for mediation and then settlement, as one independent director said the company was “running on fumes” and had no remaining DIP funding. In a situation where litigation might lead to liquidation, one cannot doubt that settlement is likely the most fruitful option for the involved parties. Because the unsecured creditors will receive some payout in the settlement, however, this may embolden leapfrogged creditors in other uptier transactions to raise similar claims.