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Sabine UCC Expert’s Assumptions Under Scrutiny in Day 4 of Standing Trial

The fourth day of the trial on the Sabine Oil & Gas debtors’ unsecured creditors committee’s request for derivative standing took place before Judge Shelley Chapman today. Steven Zelin of PJT Partners, the committee’s expert and author of two expert reports, took the stand. Throughout the day, the parties conducted extensive questioning of Zelin, pressing him on the assumptions behind his estimates that the UCC, if granted standing, could prosecute claims  resulting in damages potentially recoverable by the debtors’ estates ranging from (i) $120 - $130 million with respect to claims based on Bankruptcy Code sections 552(b) and 506(c), (ii) $1,190 - $1,220 million with respect to fraudulent conveyance claims and (iii) $1,170 - $1,190 million with respect to “bad acts” related claims. The trial will resume tomorrow, Tuesday, Feb. 23 at 1 p.m., with Zelin back on the stand.

The UCC’s direct examination of Zelin took most of the morning, with Ross Martin of Ropes & Gray speaking for the committee. Martin elicited Zelin’s testimony relating to potential recoveries for the different categories of claims. Debtors’ counsel, A. Katrine Jakola from Kirkland & Ellis, and Margot Schonholtz of Linklaters, counsel to first lien agent Wells Fargo, interjected at multiple points, asking whether Zelin’s testimony was directed at the colorability of the UCC’s claims - the subject of the trial - or whether the committee’s prosecution of claims would be in the best interests of creditors. In an exchange with counsel, Judge Chapman clarified that in late-night conference calls with counsel last week, the parties had determined that this week’s proceedings would relate to colorability, with any best interests analysis “sloshing over” only as necessary. Judge Chapman agreed with Daniel Golden of Akin Gump, counsel for Bank of New York Mellon as indenture trustee for Sabine’s 9.75% senior notes due 2017, that the distinction was “not crisp,” noting that proceedings had not been bifurcated according to colorability and best interests issues.

Turning to the committee’s proposed prosecution of fraudulent conveyance claims, Zelin explained that he estimated that the cost of prosecution by the UCC to be about $20-30 million, and that he considered such amounts “reasonable.” Zelin also noted that under his analysis, if the Sabine-Forest merger had not closed, about $1 billion of value would have been available to unsecured creditors around the time of confirmation arising from “bad acts” claims - a figure that would increase to $1.18 billion when prejudgment interest was accounted for, he said. Zelin also suggested that a more fulsome marketing process could have been pursued as an alternative to the Sabine debtors’ plan.

Martin queried Zelin on his assessment of the expert report from Sabine CRO Jonathan Mitchell of Zolfo Cooper, in which Mitchell described the potential credit bid of the RBL lenders as an unrealistic reorganization option for the debtors and contrary to the best interests of the estates, because such sale would lock in significant operational losses and historic market lows in the oil and gas industry. Zelin disagreed with Mitchell’s analysis. The debtors’ proposed plan is delivering all of the value in the business to the RBL lenders except for certain amounts going to unsecured creditors, Zelin said, and he added that it also contemplates valuable releases of the banks. The RBL lenders, as the future owners of the business, could have participated in the upside while preserving value for general unsecured creditors, Zelin said, in alternative paths to restructuring.

Next, Abid Qureshi of Akin Gump, counsel to Bank of New York Mellon, asked Zelin about the benefits arising from the Forest Oil-Sabine merger in exchange for the obligations incurred by Forest pursuant to the transaction. Qureshi noted that there was a pre-merger to post-merger increase of $1.67 billion in obligations. Zelin responded that he was “not sure” what benefits Forest received, and “did not see any quantification of indirect benefits” in the report of the debtors’ expert Jack Williams of Mesirow Financial.

Jakola of Kirkland, representing the debtors, resumed the questioning of Zelin in the afternoon, conducting an extensive review of the assumptions underlying the analyses in Zelin’s reports. With Zelin emphasizing that he ran his analyses according to the directions provided to him by UCC counsel Ropes & Gray, Jakola repeatedly pressed him on whether he assessed the merits and reasonableness of those assumptions. For instance, Zelin said that his estimates of claims that would be available to unsecured creditors did not contain his expert opinion as to the merits of the claims, or the likelihood that the committee would prevail in their litigation. Instead, his estimates assumed a “100% chance of success,” Zelin noted. UCC counsel provided him with a methodology for calculating damages for the “bad acts” claims, he said, which was based upon the alleged $1.1 billion in value available to general unsecured creditors as of the date of the Sabine-Forest merger, and on that available today - about $30 million under the debtors’ proposed plan. Jakola pressed Zelin on whether this dramatic decline in value was attributable to the merger transaction itself, or whether there could be other key causes, such as changing market dynamics in the oil and gas industry. Zelin explained that the metric had been provided to him by counsel, but that he was not arguing that it was the proper way to evaluate the merits of the breach of duty claims. Pressed by Jakola, Zelin said that he had not independently assessed the reasonableness of the method. He also noted that he did not separate out specific, different claims - such as those alleged against the legacy Forest and Sabine boards and those against the RBL lenders - on a granular level.

Both Jakola and Schonholtz for Wells Fargo also questioned Zelin on his estimates of the RBL lenders’ adequate protection claims, which the debtors and the banks have argued are so large as to render the committee’s claims uncolorable. Rather than calculating the adequate protection claims starting from the chapter 11 petition date in July 2015 to the projected end of the case, Zelin used later start dates based on the “unique” characteristics of Texas foreclosure law, which led to his lower figures - between $0 and $15 million, he explained. Again, when asked by opposing counsel, he said that he was not endorsing these assumptions as reasonable, but had been following the direction of UCC counsel. Schonholtz queried if Zelin’s position was that the secured lenders’ adequate protection payments should be reduced because they had agreed to exclusivity extensions and participated in the restructuring process, thereby aiding the debtors in reaching a plan that the UCC disagreed with. Zelin responded by saying that he took no such position, but noted that the adequate protection payments could reduce recoveries for the general unsecured group. Judge Chapman remarked that she was “still unclear” on the implications of Zelin’s waterfall analysis and the interactions between the GUC recoveries, adequate protection and other buckets of claims set forth in his analyses.

In addition, Schonholtz asked Zelin about the influence that individual members of the official creditors’ committee had on his claim estimates. In particular, she asked him to confirm that he repeatedly discussed drafts of his reports with personnel at Aurelius Capital Partners, who offered allegedly strongly worded suggestions. Zelin pushed back, saying that members of the committee and their advisors were certainly given the opportunity to voice their opinions during the drafting process, but “ultimately, suggestions were given by Ropes.” 

This article appeared in the February 22, 2016 edition of Reorg Research. Reprinted with permission.