Today, Judge Shelley Chapman ordered that the Patriot Coal bankruptcy case be transferred to the United States Bankruptcy Court for the Eastern District of Missouri. We first wrote about a venue change here: Patriot Coal Venue Change proceedings.
For those interested in following along, I've embedded the order below (a must read in my opinion):
Patriot Coal Venue Change Order
The 8.25% Notes started the day 50-52 and closed 47.5-49.5. The converts were also quoted lower but I'm not sure how much actually traded.
Why were the bonds down? One desk analyst noted: "There isn't much case law in St. Louis, so the judge has more latitude to do what he pleases." The remainder of this post will try to drill down on the implications of a venue change to St Louis. As an aside, I have not heard yet if the Debtors will appeal this decision, but given how narrowly Judge Chapman wrote her opinion, it is hard to imagine it getting overturned.
As first discussed here on the blog (Patriot's hidden value for the guaranteed notes), there was a case to be made that if you separated the corporate structure of Patriot Coal into "clean" and "burdened" (clean being no legacy liabilities, burdened meaning many legacy liabilities), one could make the case that significant value would flow directly from operating assets to the guaranteed bonds without a rejected opeb claims getting a piece of that particular box. The bonds subsequently rallied as the "box theory" began to take hold.
Unfortunately, there is something that could put a bullet between the eyes of the box theory: substantial consolidation ("sub-con"). And unfortunately, the 8th circuit has a very small sample set (one to be exact) in sub-con decisions. Conversely, SDNY and the 2nd circuit have voluminous amounts of case law and definitive litmus test for sub-con.
There is currently a bankruptcy case being held in the District of Minnesota (also the 8th circuit) that discusses the 8th circuit's history with sub-con (Petters Company, Inc. - Case No. 08-45257). You can find the discussion here: Substantial consolidation in the 8th circuit. Some salient take-aways:
- The 8th Circuit applies a three-prong test for sub-con
- The 8th Circuit has addressed sub-con only once. A case in 1992 (First Nat’l Bank of El Dorado v. Giller)
- From the docket: "In determining the propriety of substantive consolidation, the Eighth Circuit identified several factors for review, including “(1) the necessity of consolidation due to the interrelationship among the debtors; (2) whether the benefits of consolidation outweigh the harm to creditors; and (3) prejudice resulting from not consolidating the debtors.”
- creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit, or
- the affairs of the debtors are so entangled that consolidation will benefit all creditors.
Before I move on from sub-con, I want to hit on one remaining point: partial sub-con is an established practice in other bankruptcy cases (and circuits). One could argue that if Patriot Coal was substantially consolidated, everything would collapse to one box which would, in effect, disenfranchise the guaranteed notes relative to the holdco converts (that are not guaranteed and at the bottom of the heap). I doubt that happens and instead believe, if a sub-con were to occur, it would be all the operating entities of PCX being consolidated, leaving hold-co in its own box and therefore structurally subordinated to everything.
Of course, sub-con is not the only thing that matters in this case. It is incredibly important but there are other value drivers here. In fact, one issue very much stuck out for me from Judge Chapman's ruling: The comments on issued related to Peabody's spin of Patriot. There were a number of comments in particular I thought relevant:
- "The agreements relating to Patriot’s October 31, 2007 spin-off from Peabody included a Delaware choice of law provision."
- "Counsel for the Debtors remarked at the Hearing that the 'circumstances surrounding Patriot’s spinoff from Peabody will most assuredly be looked at with extraordinary seriousness by both the Debtors and the Creditors’ Committee.'”
- "Moreover, the corporate headquarters of Peabody are also in St. Louis; this fact is significant in light of the issues that have been raised by the UMWA with respect to its spin-off of Patriot and its responsibility to provide promised cradle-to-grave health care benefits to Patriot employees and retirees who worked for Peabody prior to the spin-off."
My bias on the 8.25% bonds is currently negative for some of the reasons mentioned above but also because I do not want to be long super high cost thermal coal along with being long high vol met coal (of, on average, lower quality B coals). I think this case's timeline will play out a lot longer than people anticipate which, in the face of difficult structural and regulatory trends (and negative cash flow), could erode the value of the debtor's estates. I think there are better ways to play met coal (one particular low cost met producer comes to mind) in the coming years.
We will continue to follow the case and update readers on the Patriot Coal bankruptcy.