The J. C. Penney's at Herald Square.

J.C. Penney will advance further toward life as a going concern outside of bankruptcy with a sale hearing scheduled Monday to consider its deal with landlords Simon Property Group, Brookfield Property and its majority first-lien lenders, which are also its debtor-in-possession lenders. 

On a parallel track, a vocal group of shareholders that have formed an ad hoc equity committee to represent their interests in the case have contested the process, arguing that the company has more value to divert toward its other creditors than its sale arrangement would indicate.

In filings in Texas bankruptcy court, the equity committee has challenged the DIP order, which it claimed was not ultimately needed. The committee argued that the loans the retailer took on wound up only limiting its options to emerge from bankruptcy and gave DIP lenders — that have credit bid their loans in order to take over the business — the upper hand at the expense of other creditors. That, the ad hoc equity committee claimed, resulted in the all but certain sale deal that is now before the court, as opposed to other options for reorganization, according to their filing. 

The ad hoc equity committee argued that “after multiple extensions and expansions of the DIP lender group’s control over these bankruptcy cases, the debtors pivoted to the singular pursuit of a sale of substantially all of the debtors’ assets to the exclusion of any other alternative — an outcome that produces value solely for the first-lien lenders and no other constituency.”

J.C. Penney has vehemently disputed those characterizations, arguing in court filings this month that the financing the retailer sought when it filed for bankruptcy in May was a necessity as it stared down pandemic-related store closures, and at a time when the vast majority of the company’s $500 million in cash at the time was bound to secured loans.

The retailer argued also that its months-long search for buyers, in order to remain a going concern, presented it with the only option the retailer is currently pursuing. 

“No one is willing to clear the first-lien debt to acquire the debtors, let alone provide a recovery to second-lien holders, unsecured creditors, or shareholders — who are billions out of the money,” the retailer said in a court filing. “Instead, the only bidder for the debtors’ businesses is a coalition of the company’s landlords, who have much to lose from a liquidation that would leave hundreds of stores vacant (and 60,000-plus people unemployed). 

“And the debtors’ ABL lender is only willing to support the go-forward company with the deleveraged capital structure contemplated by the anticipated sale and plan,” the retailer argued.  

The equity committee’s request to vacate the debtor-in-possession financing order is unusual but also reflects a kind of strategic approach that stakeholders in a bankruptcy with less bargaining power in the case may pursue as they advocate for their interests, bankruptcy experts said.

The dispute also gets at the ever-present conflict in bankruptcy cases about the actual value of a company’s assets and how its value will reach the different tiers of creditors entitled to recoveries — of which shareholders are among the lowest on the priority for repayment.

“The underlying issue is about the future value of J.C. Penney,” said Jonathan Lipson, professor at the Temple University Beasley School of Law, who is not involved in the case. “And it’s obviously very difficult to know what that future value is going to be.” 

Lipson added that the ad hoc equity committee’s move could be interpreted as the argument that, “If you permit the sale to occur as you propose, you’ll be eliminating any future equity that we might otherwise be entitled to.”    

Questions about valuation can persist throughout a case, particularly because they can be difficult to pin down in the early stages of a bankruptcy, experts said.

The kind of valuation calculations that need to be done to determine distributions to creditors usually come later in the case, and what the court usually relies on before then are the company’s financial reporting around the time of its bankruptcy filing, which are not necessarily as detailed or thorough at the time, said Diane Lourdes Dick, professor at the Seattle University School of Law.

“These reports are based on the debtors’ financial statements and balance sheets that have been prepared in accordance with GAAP, but not necessarily for the purpose of creating a valuation for bankruptcy purposes,” she said. 

That reflects part of the uncertainty that shareholders are navigating, in addition to having to figure out how to assert their procedural rights to participate in the case. Under the bankruptcy code, shareholders are parties-in-interest who can formally participate in a company’s bankruptcy process and be heard, but the extent to which they have a seat at the negotiating table can be a complicated question, she said. 

“The shareholders are in this difficult position,” she said. 

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