Apollo’s Sanchez Energy Win Is Rebuke of Bankruptcy Court Fix

A federal appeals court opinion flipping the ownership of Texas oil driller Mesquite Energy Inc. to a group of lenders, including Apollo Global Management Inc., turned a crafty arrangement by a bankruptcy judge on its head.

A Houston bankruptcy court’s efforts to fairly split the equity of the company formerly known as Sanchez Energy Corp. among secured and unsecured creditors strayed from a straightforward application of the US bankruptcy code, the US Court of Appeals for the Fifth Circuit ruled last week, handing 100% of the reorganized company to the group of senior secured lenders.

The May 30 decision, uprooting the ownership of equity now worth hundreds of millions of dollars, put into focus a unique trial process orchestrated by Judge Marvin Isgur of the US Bankruptcy Court for the Southern District of Texas to resolve a tense creditor dispute made worse by the Covid-19 pandemic.

Isgur was largely concerned with fixing what he viewed as an uneven playing field for the junior creditors when he ruled in 2023 that a majority of Mesquite’s equity belonged to unsecured noteholders. But the Fifth Circuit found he didn’t follow the letter of the law when calculating the amount secured lenders owed on account of insufficiently perfected, pre-bankruptcy liens that the lenders willingly released back to the company during the case.

“The decision could serve as a warning against using a Chapter 11 plan to eschew Code provisions and also emphasizes that a court’s concerns about fairness don’t justify moving away from the plain meaning of a statute,” Bloomberg Intelligence analyst Negisa Balluku said.

Bankruptcy Findings

Sanchez Energy’s bankruptcy proceedings, and the ensuing fights with lenders, serve as a stark reminder of the pandemic’s impact on the global economy.

Due to plummeting oil and gas prices in early 2020, the company’s assets began rapidly depreciating while it was in the process of reorganizing. The enterprise value ultimately fell to $85 million, an amount even less than the loan that secured lenders provided to fund operations and costs during the Chapter 11 case.

Acknowledging the quick change in circumstances, Isgur approved a bankruptcy plan in April 2020 that allowed the company to emerge from Chapter 11 while setting aside questions related to lender liens and equity ownership. The judge then spent years adjudicating a multistep litigation to determine winners and losers as Mesquite’s value ticked up by hundreds of millions of dollars, according to court papers.

“They rushed through the plan and got it confirmed without determining the equity split,” Thompson Coburn LLP bankruptcy partner Mark Indelicato said. “The facts in the case are quite honestly screwed up and it came during the pandemic, which I think made it worse.”

Complications in large part stemmed from events that occurred shortly before Sanchez Energy filed for bankruptcy in August 2019, when secured noteholders tried to fix insufficiently perfected liens on valuable oil and gas interests. Those corrections counted as transfers of Sanchez Energy’s property within the 90-day time period in which those liens could be voided under bankruptcy law, Isgur found.

The judge’s findings led to an unusual situation in bankruptcy where unsecured creditors were awarded a dominant stake in the reorganized company. He based that award on a hypothetical $200 million valuation of the recoveries unsecured creditors could have received from the voided transfers.

Ultimately, Isgur awarded about 30% of Mesquite’s stock to a group of the company’s secured lenders—who also provided the company a bankruptcy loan—and about 70% to unsecured creditors. A 70% stake in Mesquite may now be worth roughly $700 million, according to court papers.

Pointing to Section 550 of the bankruptcy code, the Fifth Circuit found that Isgur’s valuation technique improperly authorized a double recovery for avoidance of the pre-bankruptcy liens.

“The bankruptcy court erred in concluding that the unsecured creditors could have their cake and eat it too,” Judge Edith H. Jones wrote for the panel.

‘Solution-Minded’

The appeals court’s opinion highlights a “fundamental mismatch” between the sometimes “solution-minded” Southern District of Texas bankruptcy court and the Fifth Circuit, said Douglas S. Mintz, a restructuring partner at Cadwalader, Wickersham & Taft LLP.

The Southern District of Texas bankruptcy court is often perceived as prioritizing solutions to bankruptcy problems with the goal of moving them through the process efficiently, Mintz said. The Fifth Circuit, by contrast, has “always been among the more process-oriented when evaluating decisions that debtors have made in bankruptcy,” he noted.

That can sometimes lead to conflicts, as seen in a decision late last year involving Serta Simmons Bedding LLC, Mintz said. In a major reversal of the Houston bankruptcy court—a popular venue for large, corporate bankruptcies—the Fifth Circuit in December struck down an “uptier” debt transaction between Serta and a group of its lenders.

That decision changed the calculus of some liability management exercises, sent ripples through the secondary debt markets, and was also a win for Apollo.

Mintz noted that the “disconnect” between the bankruptcy judges and the Fifth Circuit isn’t new and has historically influenced where bankruptcies are filed.

With respect to Sanchez Energy’s case, Isgur “was largely concerned with restoring fairness,” Balluku said.

Isgur focused on how the secured lenders utilized their pre-bankruptcy lien position to edge out other parties willing to finance the bankruptcy case, putting themselves at the front of the line for repayment.

As a result, the judge viewed the $200 million bankruptcy loan claim as a windfall for the senior lenders since the enterprise value had already fallen below that amount, according to Balluku.

“His focus turned to putting the estate back to its pre-transfer position and maintained that the simple avoidance of liens wouldn’t accomplish that,” she said in an email. “The 5th Circuit did away with most of those questions, pointing to Code language but also expressing concern that Isgur’s ruling would require a value award in cases that involve transfers of depreciating assets, even if the asset is returned.”

The case is Sr Secured Noteholders v. DE Tr. Co., 5th Cir., No. 23-20557, 5/30/25.