Restructuring

The Delaware Chancery Court’s recent decision in Roseton OL, LLC v. Dynegy Holdings, Inc. highlights the importance of good drafting in corporate documents, this time in the context of guaranties.  The Chancery Court held that asset transfers between a guarantor’s subsidiaries will not trigger successor liability unless the relevant guaranty provision expressly covers intra-family transfers.  Accordingly, guaranties must be drafted carefully to reflect the specific terms of the parties’ agreement on intra-family transfers.
Background
The Plaintiffs in the Dynegy litigation are indirect subsidiaries of Public Service Enterprise Group (“PSEG”), a company engaged in the business of electric power generation, transmission, and distribution.  Dynegy is a holding company with indirect subsidiaries that own power generating facilities.  In May 2001, Dynegy and certain of its subsidiaries entered into a series of transactions with PSEG in which the Dynegy subsidiaries sold to, and then leased back from, PSEG two power generation facilities — Roseton and Danskammer.  In connection with the sale-leaseback transaction, Dynegy executed two identical guaranties in favor of PSEG under which Dynegy guaranteed the obligations of its subsidiary-lessees.  Section 4.2 of the guaranties — the successor liability clause — prohibits Dynegy from “transfer[ing]… its properties and assets substantially as an entirety to any Person in one or a series of transactions,” unless the successor expressly assumes all of Dynegy’s obligations under the applicable guaranty.
Subsequent market events lowered the price of electric energy, which reduced revenues at the Roseton and Danskammer power plants and adversely affected the entire Dynegy enterprise.  On July 10, 2011, Dynegy publicly announced its intent to reorganize the ownership structure of its subsidiaries such that substantially all of its gas-fired and coal-fired generation facilities would be held in two “bankruptcy-remote” groups dubbed “GasCo” and “CoalCo,” respectively.   In connection with this internal reorganization, GasCo and CoalCo would borrow $1.1 billion and $600 million, respectively, under new senior secured credit facilities.  The proceeds from these loans would, among other things, retire an existing credit facility under which Dynegy is the borrower, and $400 million would be immediately upstreamed to a Dynegy subsidiary outside of the GasCo and CoalCo ring-fences.  Pursuant to the proposed transaction, however, the Roseton and Danskammer power plants owned by PSEG would remain outside of the new ring-fenced groups, and no entity within GasCo or CoalCo would assume Dynegy’s obligations under the PSEG guaranties.
On July 22, 2011, PSEG filed a complaint in the Delaware Court of Chancery claiming that the proposed ring-fencing transaction constituted a breach of section 4.2 of the PSEG guaranties and violated the Delaware Uniform Fraudulent Transfer Act.  PSEG contemporaneously moved for a temporary restraining order seeking to enjoin Dynegy from consummating the proposed transaction.
The Chancery Court’s Analysis
Based on the circumstances, the court found it equitable to apply “something more like the preliminary injunction standard” instead of the more lenient TRO standard in determining whether to enjoin the proposed transaction.  As a result, the court stated that it would only enjoin the proposed transaction if PSEG demonstrated that its claims have a reasonable probability of success on the merits and that PSEG would suffer irreparable injury without the requested injunction.
The court found that PSEG is unlikely to succeed in showing that section 4.2 of the guaranties is ambiguous because that section “conspicuously fails to mention [Dynegy’s] subsidiaries and their assets when it details restrictions on consolidating, merging, conveying, transferring, or leasing assets.”  In contrast, the very next section in the guaranties expressly prevents both Dynegy and its subsidiaries from taking certain actions with respect to liens.  In addition, the court observed that PSEG was represented by sophisticated counsel during the sale-leaseback transaction, and, as a result, “there may be a number of different explanations for the absence of a successor obligor provision in § 4.2 covering [Dynegy’s] subsidiaries.”
Having determined that section 4.2 is not ambiguous, the court looked to the plain language of that section and found that PSEG is unlikely to succeed in showing a breach because the proposed transaction does not involve a transfer of all or substantially all of Dynegy’s assets.  Dynegy only owns equity interests in subsidiaries that own—directly or indirectly—the power generating facilities that would be transferred to GasCo or CoalCo.  The court explained that the transfer of equity assets from one Dynegy subsidiary to another bankruptcy remote Dynegy subsidiary did not constitute a transfer of Dynegy’s assets.  The court also noted that, even though such transfers among subsidiaries might alter the form of ownership and reduce Dynegy’s influence over the use of revenues generated by the power plant assets, they did not transfer the value of Dynegy’s indirectly-held assets away from the Dynegy corporate family, and, as a result, “the net effect of the Transaction will be that [Dynegy] still will own the same assets that it did before the Transaction.”
The court then found that, even if section 4.2 were ambiguous, the proposed transaction is unlikely to constitute a breach of that section in light of the qualitative and quantitative factors considered by both New York and Delaware courts when interpreting ambiguous contract provisions.  The court explained that under a qualitative analysis, no breach would occur because the proposed transaction would not alter Dynegy’s corporate purpose or existence:  Dynegy would remain a holding company with indirect subsidiaries that own power plants.  The only difference would be which companies Dynegy owns within the corporate family.  Quantitatively, the court stated that even though PSEG may be correct that substantially all of Dynegy’s valuable power plant assets would be transferred into a ring-fenced group of subsidiaries, these entities are still subsidiaries of Dynegy, and Dynegy “retains the value of the plants embedded in its ownership of the entities that directly own those plants today and will own them after the Transaction is consummated.”
Turning to PSEG’s fraudulent transfer claim, the court began by stating that the necessary predicate to PSEG’s fraudulent transfer claim was that Dynegy fraudulently transferred assets to GasCo and CoalCo, and “[a]s explained supra … [PSEG’s] allegations as to the physical power plants at issue do not involve the ‘transfer’ of any ‘asset’ of [Dynegy] because [Dynegy] does not directly own any of the power plants subject to transfer in the Proposed Transaction.”  The court continued to find that, even if the proposed transaction fell within the purview of Delaware fraudulent transfer law, PSEG is unlikely to succeed in showing that Dynegy transferred assets without receiving reasonably equivalent value “because [Dynegy] did not transfer any valuable assets away from its corporate structure.”  With respect to the insolvency element of PSEG’s fraudulent transfer claim, the court acknowledged that as a result of the proposed transaction, GasCo and CoalCo would have significant autonomy, and Dynegy may lose some control over distributions from these subsidiary groups.  The court, however, ultimately found that these changes did not render Dynegy insolvent.  Similarly, the court found that PSEG failed to present evidence of an “actual intent” to consummate the proposed transaction for the purpose of hindering or delaying PSEG’s ability to enforce the guaranties.  In fact, the court took a contrary view and observed that “the evidence to date supports a reasonable inference that the [proposed] Transaction’s effects would provide actual and substantial financial benefits to [Dynegy], which potentially could rebound to [PSEG’s] benefit over time.”
Finally, the court found that PSEG failed to demonstrate irreparable harm because the damages it articulated were “a speculative claim that if various contingencies occur, including [Dynegy’s] default under the Guaranties, [PSEG] might have a more difficult time collecting on a future judgment against DHI.”
Conclusion
For the foregoing reasons, the court denied PSEG’s motion for a TRO or preliminary injunction.  On August 5, 2011, PSEG’s application for interlocutory appeal and motions for expedited review and injunction pending appeal were all denied, and both GasCo and CoalCo closed on the new senior secured credit facilities.