Tidewater Inc. Settles Its Remaining Charter Agreement Rejection Damage Claim After Judge Shannon Found Stipulated Loss Value Provision to be an Unenforceable Penalty

On November 28, 2017, Tidewater Inc. and its affiliated debtors (collectively, the “Tidewater Debtors”) withdrew their motion objecting to final allowance of rejection damage claims of Fifth Third Equipment Finance Company (“Fifth Third”).  The notice of withdrawal indicated that Fifth Third, the sole remaining non-settling vessel lessor, resolved its dispute with the Tidewater Debtors pursuant to which Fifth Third’s “Sale Leaseback Claim” was allowed in the amount of $67,500,000.

The Tidewater Debtors (and their non-debtor affiliates) own and operate Offshore Support Vessels (OSVs) that support offshore energy exploration and production activities worldwide.  The Tidewater Debtors commenced Chapter 11 proceedings on May 17, 2017 to implement a fully negotiated and consensual restructuring under a prepackaged plan of reorganization filed on the same day.

Before the bankruptcy filings, the Tidewater Debtors and Fifth Third (as well as the other vessel lessors, the “Lessors”) entered into sale-leaseback transactions pursuant to which some of the Tidewater Debtors (collectively, the “Charterers”) sold vessels to the Lessors, which then leased the vessels back to the Charterers under bareboat charter agreements (the “Bareboat Charter Agreements”).  The Bareboat Charter Agreements each provided that upon an Event of Default (as defined therein, but including the Tidewater Debtors’ insolvency and bankruptcy filings, confirmation of a plan and rejection), Lessors were entitled to recover a stipulated loss value (“SLV”) as liquidated damages.  Tidewater Inc. absolutely and unconditionally guaranteed the payment and performance of the Charterers’ obligations under the Bareboat Charter Agreements.

A bareboat charter agreement is one type of charter agreement that governs the terms and conditions for the lease of a vessel. A bareboat charter is an executory contract that can be assumed or rejected under Section 365(a) of the Bankruptcy Code.  Rejection allows a debtor to disavow contracts that are burdensome or no longer advantageous to its ongoing business operations.

On the petition date, the Tidewater Debtors filed a motion to reject the Bareboat Charter Agreements.  They asserted that rejecting the Bareboat Charter Agreements would save them approximately $171 million over the next seven years.  In the motion, the Tidewater Debtors preemptively also sought to disallow the Lessors’ rejection damage claims in the amount of the SLV stated in the respective Bareboat Charter Agreements as an “unreasonable and unenforceable liquidated damages provision.”  The Tidewater Debtors argued the claims should be limited to “the reasonable expectation damages incurred by the Lessors.”  They proposed the final damages claims to equal the total maximum amount owing under each Bareboat Charter Agreement discounted to present value.  With respect to Fifth Third, the difference in the parties’ positions was astronomical.  Fifth Third argued for an SLV claim of approximately $94 million, while the Debtors posited it should be $34 million.

Relying on two Third Circuit decisions (In re Transworld Airlines, Inc., 145 F.3d 123 (3d Cir. 1998) and In re Montgomery Ward Holding Corp., 326 F.3d 383 (3d. Cir. 2003)), on August 31, 2017, Judge Brendan Shannon of the U.S. Bankruptcy Court for the District of Delaware ruled that the SLV provision was an unenforceable penalty.  He scheduled an evidentiary hearing in late September to determine Fifth Third’s “actual and appropriate damages” from rejection of the Bareboat Charter Agreement.

As parties oftentimes do in bankruptcy proceedings, the Tidewater Debtors and Fifth Third sagaciously resolved their dispute.  Given the settlement of Fifth Third’s claim, Judge Shannon did not have to rule on Fifth Third’s argument that even if the SLV is an unenforceable penalty against the direct contract counterparty, under New York law, it is entitled to the SLV amount pursuant to Tidewater Inc.’s guaranty.  That was an argument with respect to which he reserved opinion at the August hearing. It is clear, however, that vessel lessors may not be able to enforce their contractual SLV provisions if the actual damages they incur from rejection of the charter agreement is less than the SLV.