The chapter 11 case of Energy Future Holdings (“EFH” or “Debtors”) roared back to life this month. Certain key conditions for the plan of reorganization approved last December (the “First Plan”) to become effective were not met by a deadline of April 30, and one of the major parties to the support agreement that underlay the First Plan gave written notice of termination on May 1.  The Debtors followed up immediately by filing a new proposed plan and a motion seeking a confirmation hearing in early August.  (Kelley Drye & Warren LLP represents a creditor of certain Debtors, but has taken no part in the matters discussed here).

EFH entered bankruptcy in April 2014 with over $42 billion in claims, and for well over a year it looked to be among the most intractable cases ever filed. The Debtors’ business operations are divided into two distinct silos: a majority interest in a regulated electrical utility, Oncor, indirectly owned by EFH subsidiary Energy Future Intermediate Holding Company LLC (the so-called “E side” of EFH), and non-regulated electricity generation, mining, and commodity risk management and trading operations, indirectly owned by EFH subsidiary Texas Competitive Holdings Company LLC (the so-called “T side” of EFH).

At the outset, EFH had the support of its E side creditors, who stood to see a substantial recovery from a proposed sale of the Oncor interests, but was facing intense opposition from junior creditors on the T side, who appeared to be out of the money. In the summer of 2015, however, the T side creditors began to coalesce around a bold strategy to backstop a real estate investment trust (“REIT”) structure to take control of the Oncor assets.  A REIT is a hybrid tax entity that is able to reduce or eliminate substantially all of the entity-level federal income taxes otherwise imposed on corporations by distributing its taxable income to shareholders.  The junior T side creditors, who had been prepared to prosecute a campaign of scorched earth litigation against the Debtors, their private equity sponsors and the senior T side creditors, began instead to negotiate the terms under which they would agree to backstop the new REIT vehicle.

The junior T side creditors proposed to pair with Hunt Group, a long time Texas utility operator. When it became clear that a plan of reorganization based on the transfer of the Oncor assets to a REIT structure could (i) garner support from all levels of the T side capital structure, and (ii) generate sufficient value to pay all E side creditors in full, EFH agreed to move forward with it.  Under the First Plan, the Hunt Group committed to provide over $7 billion, and the junior T side creditors agreed to backstop a $5.2 billion rights offering.

The riskiness of the First Plan was acknowledged by all parties. It would require numerous state and federal approvals, including from the IRS and the Texas Public Utility Commission (the “PUC”).  As the quid pro quo for agreeing to pursue the REIT structure, the Debtors insisted that the junior T side creditors agree to a global settlement that would be binding regardless of whether the First Plan ever became effective.  If the REIT proposal failed to garner the necessary approvals, the global settlement was intended to allow the Debtors to focus on an alternative path to exit the chapter 11 cases.  The junior T side creditors agreed to waive any claims against the Debtors, their private equity sponsors and the senior T side creditors, and to accept under an alternative plan a payout of $550 million, a small fraction of their claims.

The PUC approved the deal in March, but with a crucial caveat. Responding to objections raised by municipalities and consumer groups, the PUC issued an approval order that expressly left open the possibility that the Oncor investors (i.e., the junior T side creditors) might not be given the full tax benefits of the REIT structure, but instead might have to share such benefits with ratepayers.  The Oncor investors refused to close the deal on that basis.

Under the First Plan and the related agreements, the Oncor investors were required to close by April 30. However, that date was subject to an extension to June 30 if the PUC approval order had been approved.  The Oncor investors and the Hunt Group evidently believed that they had the additional time, and had already requested a new hearing before the PUC.  The Debtors and the senior T side creditors took the position that the PUC’s order was insufficient, since it did not resolve the treatment of the REIT tax benefits.  The Oncor investors could have effectively bought additional time by agreeing to give up $50 million of the their alternative payout consideration of $550 million, but they declined.  The T side senior creditors sent a notice of termination of the plan support agreement, thus effectively rendering the First Plan “null and void”.

Where the case proceeds from here is anyone’s guess. The machinations of the past several weeks could all be an elaborately choreographed series of steps to place maximum pressure on both the PUC and the Oncor investors to reach a resolution that would lead the Oncor investors to proceed forward.  The Debtors could withdraw the proposed new plan and seek to revive the First Plan.  The Debtors’ new plan also leaves open the possibility of a new REIT structure deal.  It also leaves open virtually any other possible exit strategy, such as a new auction process for Oncor.  At least one earlier bidder for the Oncor assets, NextEra Energy, has already made clear its continued interest.

Confirming a new plan for the T side Debtors should be fairly straight forward at this point, given the agreement by the T side junior creditors to settle their litigation claims and accept $550 million. Formulating a confirmable plan for the E side Debtors without the substantial value created by the REIT transaction could be long and difficult.  At a hearing last week, Judge Christopher Sontchi effectively split up the cases.  Confirmation of a new plan for the T side Debtors is scheduled to take place in August.  Judge Sontchi tentatively scheduled a confirmation hearing for the E side Debtors to begin in late September, but he acknowledged that with so many unresolved issues, that timing is unlikely to hold.

Heightening the intrigue, as Judge Sontchi noted last week, is the fact that the 18 month period in which the Debtors had the exclusive right to propose a plan of reorganization has expired.  This means that any party now has the ability to put forward a plan for reorganizing or selling the E side Debtors’ interests in the Oncor assets.  NextEra Energy is strongly believed to be considering such a strategy.

Any exit path for the E side Debtors will likely take a minimum of several months. Several sophisticated parties with billions of dollars at stake are sitting around a table, each waiting to see who will reveal their hole cards first.