GameStop, Hertz, and § 1129: The Bankruptcy Code and “Efficient” Markets
February 5, 2021
By: Roy Leaf, Eric R. Tubbs, Kristina M. Stanger
Last week, share prices of a number of distressed companies including GameStop Corp. (GME), AMC Entertainment Holdings, Inc. (AMC), and Bed Bath & Beyond Inc. (BBBY) soared, lifted largely by individual investors based on discussions occurring on social media platforms such as Reddit. As of the close of trading on Friday, January 29, 2021, shares of GameStop were trading nearly 2,000% higher than they were at the beginning of the year. At that time, GameStop’s market capitalization—the value imputed to a company by multiplying the number of shares outstanding by the share price—was almost $28.9 billion. This value was a far cry from the $332 million book value of shareholder equity—calculated by subtracting total liabilities from total assets—reported on GameStop’s latest 10-Q for the period ending October 31, 2020. The Securities and Exchange Commission (SEC) issued a public statement and noted that it was “closely monitoring and evaluating the extreme price volatility of certain stocks.”
The story of The Hertz Corporation and its spike in share value after filing for Chapter 11 bankruptcy serves as a prelude to the current market irregularities.
While the run-up in share prices for companies like GameStop took market observers by surprise, it was not the first time that individual investors, fueled by social media, have driven up the price of a distressed company.
The story of The Hertz Corporation and its spike in share value after filing for Chapter 11 bankruptcy serves as a prelude to the current market irregularities. It also stands as a cautionary tale about whether the equity markets truly are “informed” and “efficient” in certain scenarios.
Bankruptcy Code § 1129
An understanding of how the Bankruptcy Code distributes property to a debtor’s creditors and stakeholders is important for perspective on the Hertz bankruptcy story.
Bankruptcy Code § 1129 sets forth the requirements that a Chapter 11 plan must meet in order to be confirmed by a court. Creditors under a Chapter 11 plan are generally divided into numerous “classes” based on the type of claim held. Each class comprises a similar type of claim. Generally, classes of administrative claims (i.e. generally post-petition claims incurred for the benefit of debtor’s estate) have the highest priority, followed by classes for secured claims, classes for unsecured claims, and finally, classes for claims based on equity ownership.
Among other things, § 1129 provides that creditors who are not paid in full on their claim are entitled to vote to accept or reject the proposed Chapter 11 plan and, in the event not all classes vote to approve a plan, the debtor must prove that the plan is “fair and equitable.” In order to be “fair and equitable” under § 1129(b), the plan must satisfy the “absolute priority rule,” which provides that creditors in a junior class may not receive any distributions under a Chapter 11 plan until members of all senior classes have been paid in full or consented to a different treatment.
A simple example can help illustrate how § 1129 works. Assume that Company A, a publicly traded corporation, is a Chapter 11 debtor-in-possession and has proposed four classes under its Chapter 11 plan of reorganization: Class 1 (administrative claims), Class 2 (secured claims), Class 3 (unsecured claims), and Class 4 (equity claims). Members of Class 4 who hold equity securities in Company A may not receive a distribution until members of Classes 1, 2, and 3 are paid in full on their claims (or vote to receive a different treatment).
In theory and practice, § 1129 makes getting a recovery for equity security holders in a highly-leveraged public company very difficult. Equity securities in Chapter 11 plans of public companies typically get cancelled and wiped out.
This hasn’t stopped certain traders on the internet, however, from “investing” in certain distressed companies.
In re The Hertz Corporation
On May 22, 2020 (the “Petition Date”), The Hertz Corporation and 28 of its affiliates (“Hertz”) filed Chapter 11 bankruptcy in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). Hertz was, in large part, driven into Chapter 11 by the COVID-19 pandemic’s effect on travel and as well as defaults under its rental car fleet financing facilities. The Hertz debtors did not enter Chapter 11 with a pre-planned or pre-negotiated Chapter 11 plan with critical stakeholders. Instead, Hertz filed what is known as a “free fall” Chapter 11 with no framework agreed to with its stakeholders for emergence from Chapter 11. Collectively, Hertz and its non-debtor affiliates had incurred $19 billion in aggregate debt as of the Petition Date.
By close of trading on May 26, 2020, the next trading day following the Petition Date, shares of Hertz were trading at $0.56. Carl Icahn, the famous Wall Street investor, liquidated his entire position in Hertz stock shortly thereafter and realized a loss of more than $1.8 billion.
That’s when Dave Portnoy, the founder of popular online blog Barstool Sports, started tweeting.
Portnoy, proclaiming himself “Davey Day Trader,” took to Twitter to sing the praises of Hertz’s stock, notwithstanding the fact that Hertz was a Chapter 11 debtor. Shares of Hertz took off. On June 4, 2020, Hertz closed at $1.50. On June 5, 2020, Hertz closed at $2.57. On June 8, 2020, Hertz peaked at $5.53 per share.
Seizing on the trading momentum and seeking to generate liquidity, the Hertz debtors made an unprecedented move on June 11, 2020 by filing an emergency motion with the Bankruptcy Court seeking authority to issue up to $1 billion in common shares of Hertz. In the motion, the Hertz debtors noted that “[t]he recent market prices of and the trading volumes in Hertz’s common stock potentially present a unique opportunity for the Debtors to raise capital on terms that are far superior to any debtor-in-possession financing.” The next day, June 12, 2020, the Bankruptcy Court entered an order approving the motion and issuance of up to $1 billion in common shares.
Those who are familiar with the Bankruptcy Code and § 1129, however, are all too familiar with the likely fate of Hertz’s market capitalization once a Chapter 11 plan is confirmed.
The Hertz debtors, however, never issued any shares following the Bankruptcy Court’s order. On June 18, 2020, Hertz announced via an 8-K filing with the SEC that it would not be issuing any common stock after the SEC notified Hertz it was “reviewing” the prospectus Hertz proposed submitting in support of its bankruptcy issuance. The SEC may have suggested to Hertz that it could not disclose away the risks associated with issuing worthless stock to the public, regardless of whether the public was purchasing it. Section 1129 would be a bar to any recovery for equity holders, present and future, under the proposed offering.
As of February 3, 2021, Hertz had not filed a proposed Chapter 11 plan of reorganization. Notably, the Hertz debtors had filed a motion pursuant to Bankruptcy Code § 363 to sell certain of their subsidiaries and had received a stalking horse bid. The § 363 sale has yet to close. Further, while the United States Trustee is empowered by § 1102(a) to appoint an official committee to represent equity holders’ interests if it appears like equity holders may be entitled to a recovery, the United States Trustee has yet to (and likely will not) appoint an equity committee in the Hertz bankruptcy case. Nevertheless, on February 3, 2021, shares of Hertz (now delisted from the New York Stock Exchange) closed at $1.82 per share, giving Hertz a market capitalization of approximately $297 million.
In its most simple form, proponents of the “efficient market hypothesis” believe that market prices reflect all available information on an asset and that, therefore, the price of an asset on a market reflects its real “value.” The story of the Hertz case, however, shows that a large number of participants in the equities market may not be fully informed about the Bankruptcy Code’s consequences for holders of a public company’s equity securities. Those who are familiar with the Bankruptcy Code and § 1129, however, are all too familiar with the likely fate of Hertz’s market capitalization once a Chapter 11 plan is confirmed.
Nyemaster Goode P.C. is Iowa’s largest law firm. If you have questions about Chapter 11, § 363 sales, or creditor rights generally under the Bankruptcy Code, contact Nyemaster Goode’s Creditor Rights team. Nyemaster’s Creditor Rights team offers a collaborative approach, with lawyers providing expertise in banking, secured transactions, foreclosures, out-of-court workouts and restructurings, bankruptcy, collections, and distressed commercial litigation.
This article is for informational purposes only. You should not construe any information herein as legal, tax, investment, financial, or other advice. Nothing contained herein constitutes a solicitation, recommendation, endorsement, or offer by Nyemaster Goode or any third parties to buy or sell any securities or other financial instruments. Seek advice from an investment professional prior to taking any actions related to equity securities or distressed companies.