Relativity Bankruptcy: Was Chapter 11 Unauthorized?

Ryan Kavanaugh Cover Splash Without Text - H 2015

On Friday, the three financial firms that put up interim financing for Relativity Media in its bankruptcy responded to objections over its proposed $250 million "stalking horse" bid for sale of the Ryan Kavanaugh studio's assets.

The biggest revelation concerns the objections of Manchester Securities, a subsidiary of Paul Singer's hedge fund firm Elliot Management, one of Relativity's earliest financial backers.

Manchester has conducted extensive discovery over the circumstances that led Relativity to file Chapter 11 in one of Hollywood's biggest ever bankruptcies. It has filed objections under seal, but papers by the DIP lenders on Friday outline the key concerns.

According to today's filing, Manchester argues that debtors “seek authority to sell substantially all of their assets,” but that “[t]hey lack authorization to do so.”

Manchester’s affiliate, Heatherden, is said to be a member of Relativity Holdings and never consented to the chapter 11 filing or the proposed sale process. The argument that has come is one for "ultra vires," or beyond the powers of the corporation's operating agreement.

"Manchester’s objection must be rejected for what it is—the over-the-top gambit of a disgruntled debtholder bent upon utilizing the insider status of its affiliate to compel payment of its deeply subordinated debt claims in violation of both fundamental Bankruptcy Code principles and a controlling intercreditor agreement," responds the DIP lenders made up of Anchorage Capital Group, Luxor Capital Group and Falcon Investment Advisors.

The DIP lenders tell the bankruptcy judge that agreements prospectively prohibiting future bankruptcy filings are typically found to be unenforceable and moreover the portion of the operating agreement that required consent for a bankruptcy filing was "coerced." The judge is also pointed to a subordination agreement where Manchester agreed to be “silent” as to any sale of shared collateral.

Manchester is also alleging that Brian Kushner "is impermissibly conflicted" from being appointed chief restructuring officer for Relativity, having been "handpicked" by senior lenders and an example of an "extreme case of self-dealing.”

Relativity lawyers respond in their own filing, blasting Manchster for "wild accusations" and telling the judge to "defer to the business judgment of a debtor." They say his appointment was a condition of the DIP loan and that his "hardly remarkable role" remains subject to board oversight.

"Moreover, before the sale closes, the Board will meet again to determine if the proposed asset sale is 'beneficial and appropriate,'" states the debtor's latest court papers. "Only then will the Board authorize (or choose not to authorize) Dr. Kushner to consummate the proposed sale. Manchester’s attempts to purposefully complicate this the process should be ignored. The Board has taken all of the appropriate procedural steps, and has authorized Dr. Kushner’s actions."

In its omnibus reply to various objections, the DIP lenders also stress the time-sensitive nature of putting Relativity up for sale. At a bankruptcy hearing on August 14, it was announced that the auction would be pushed back two weeks to allow the debtors to deal with the various objections, but those primed to make the first bid in an effort to recoup what they are owed don't want to wait too long either.

"While there are circumstances where more time is unquestionably better, this is not such a circumstance," they say. "The Debtors’ business must be sold as a going concern and the Debtors must be enabled to wind down their affairs in a way that preserves, rather than destroys, value. Only the timeline and auction rules set forth in the Bidding Procedures will achieve this goal."

Among other things, they point to the running costs of Chapter 11 ($17 million in professional fees over nine weeks) and potential negative impact on revenue and profits in an extended bankruptcy.

"Such uncertainty is particularly problematic in the film and television business given the long lead times required to develop product and the need to ensure inventory to counterparties months in advance," they say. "These concerns are more than purely theoretical."

The DIP lenders, represented by attorneys at Milbank, Tweed, say that Relativity's competitors are "actively recruiting" the company's key executive talent and also warn of Relativity's business partners potentially seeking to " terminate development deals."

On the other hand, they outline the "concessions" they've been willing to offer objectors including the extension of the sales process by two weeks, the relinquishing of "matching rights" on other bids, devoting some of the wind-up funds to support prosecution of claims by unsecured creditors and waiving a "break-up fee."

Separately, C.J. Brown, a senior managing director at Blackstone Group, which is advising on the sale of Relativity's assets, submits a declaration that his firm has thus far engaged conversations with 103 potential bidders including 20 who have already accessed a data room to review confidential documents. Here's an overview of the assets that are up for sale.