Case Doc 328 Filed 12/19/17 Entered 12/19/17 17:13:46 Main Document Pg 1 of 12

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1 Pg 1 of 12 UNITED STATES BANKRUPTCY COURT EASTERN DISTRICT OF MISSOURI EASTERN DIVISION In re: ARMSTRONG ENERGY, INC., et al., 1 Debtors. Case No CHAPTER 11 (Jointly Administered Hearing Date: January 16, 2018 Hearing Time: 11:00 a.m. (prevailing Central Time Hearing Location: Courtroom 7 North MOTION BY THE OFFICIAL COMMITTEE OF UNSCURED CREDITORS FOR AN ORDER PURSUANT TO BANKRUPCY RULES 2004 AND 9016 AUTHORIZING THE ISSUANCE OF DOCUMENT REQUESTS, NOTICES OR SUBPOENAS FOR THE PRODUCTION OF DOCUMENTS AND THE PROVISION OF TESTIMONY BY THE DEBTORS AND OTHERS The Official Committee of Unsecured Creditors (the Committee of the debtors and debtors-in-possession (collectively, the Debtors in the above-captioned chapter 11 cases (the Chapter 11 Cases hereby moves for entry of an order (the Proposed Order 2 pursuant to sections 105(a and 1103(c of title 11 of the United States Code (the Bankruptcy Code and rules 2004, 9013, and 9016 of the Federal Rules of Bankruptcy Procedure (the Rules, authorizing the Committee to issue document requests, notices, and subpoenas compelling the production of documents and the provision of testimony by the Debtors and certain other entities and persons (the Motion. In support of the Motion, the Committee respectfully states as follows: 1 The Debtors in these chapter 11 cases, along with the last four digits of each Debtor s federal tax identification number, include: Armstrong Energy, Inc. (4058; Armstrong Air, LLC (2017; Armstrong Coal Company, Inc. (0349; Armstrong Coal Sales, LLC (8643; Armstrong Energy Holdings, Inc. (5664; Armstrong Logistics Services, LLC (0392; Thoroughfare Mining, LLC (7890; Western Diamond LLC (9356; Western Land Company, LLC (9821. The location of the Debtors service address is: 7733 Forsyth Boulevard, Suite 1625, St. Louis, Missouri A copy of the Proposed Order will be submitted by Judge s and served upon the Rule 2004 Parties (as defined below. 1

2 Pg 2 of 12 PRELIMINARY STATEMENT 1. Since its appointment, the Committee has worked diligently to identify estate claims and causes of action that may serve as a source of recovery for unsecured creditors, who are expected to receive next to nothing under the Debtors proposed Plan. 3 Although the investigation is still underway, the Committee has already identified a series of prepetition transactions (the Prepetition Transactions that appear to have resulted in a significant and improper transfer of value from the Debtors to their non-debtor affiliate, Thoroughbred Resources, L.P (together with its subsidiaries, the Thoroughbred Group, in the months prior to the Petition Date. On information and belief, these transactions were orchestrated by private equity sponsor Yorktown Partners LLC ( Yorktown, which directly or indirectly holds a majority of the equity interests in both the Debtors and the Thoroughbred Group and, through its power to appoint and remove directors and officers, controls their respective corporate decision-making processes. Further examination of the Prepetition Transactions is warranted under the Bankruptcy Code and is of particular importance in light of the fact that the Debtors proposed Plan purports to grant broad releases to the Debtors, Thoroughbred, and Yorktown (collectively, the Rule 2004 Parties. 2. Although the Committee is willing to work with the Rule 2004 Parties to streamline the discovery process and minimize unnecessary costs, it is operating under significant time constraints and is therefore in need of judicial supervision. The Debtors have filed a proposed Plan that, if confirmed, would release virtually any and all claims and causes of action arising from the Prepetition Transactions and have proposed, and obtained entry of an order granting, an 3 Capitalized terms used but not defined herein shall have the meanings ascribed to them in the Debtors First Amended Joint Chapter 11 Plan [Docket No. 219] (the Plan. 2

3 Pg 3 of 12 extremely truncated confirmation timeline under which objections to confirmation of the Plan are due on January 19, 2018 and the confirmation hearing is to be held on February 2, Rule 2004 discovery is warranted, and indeed necessary, so that the Committee can expeditiously complete its investigation of the Prepetition Transactions prior to the proposed deadline to object to Plan confirmation. Rule 2004 authority will enable the Committee to formally seek discovery from the Debtors and the other Rule 2004 Parties, and, if necessary, seek Court assistance to ensure timely compliance with the Committee s requests. Accordingly, and for the reasons outlined below, the Committee requests that it be permitted to immediately conduct examinations of the Rule 2004 Parties pursuant to Rules 2004 and JURISDICTION 4. The Court has subject matter jurisdiction to consider this matter pursuant to 28 U.S.C. 157 and This is a core proceeding pursuant to 28 U.S.C. 157(b(2. Venue is proper before this Court pursuant to 28 U.S.C and BACKGROUND A. The Committee s Investigation of the Prepetition Transactions 5. The Debtors and the Thoroughbred Group are under the common control of Yorktown, which directly or indirectly owns a majority equity stake in both companies and which has the power to appoint and remove both companies incumbent management. Based on the Committee s investigation to date, it appears that a number of individuals simultaneously held director, officer, and executive management positions within the Thoroughbred Group, the Debtors, and Yorktown (the Dual Fiduciaries. 4 The Committee believes that Yorktown and the 4 Although the Debtors filings with the Securities and Exchange Commission ( SEC indicate that certain of the transactions between the Debtors and Thoroughbred were approved by a conflicts committee composed of directors James C. Crain, Greg Walker, and Anson M. Beard, the Committee is investigating whether these directors were truly independent. Strikingly, it appears that James C. Crain, one of the ostensibly independent directors, is a director of Yorktown Energy Partners XI, L.P., a fund managed by Yorktown. This would appear to contradict the Debtors 3

4 Pg 4 of 12 Dual Fiduciaries orchestrated, negotiated, or were otherwise involved in transactions between the Debtors and the Thoroughbred Group that benefitted the Thoroughbred Group and Yorktown to the detriment of the Debtors. These transactions, include, but are not limited to, the following: 1. The Sale-Leaseback Transactions 6. The Debtors and the Thoroughbred Group are both in the business of owning coal assets, including mineral reserves, and conducting mining operations (or activities relating thereto on such reserves. Under the leadership of certain Dual Fiduciaries, the Debtors and the Thoroughbred Group entered into a series of transactions whereby the Debtors agreed to sell certain of their mineral reserves and appurtenant property interests to the Thoroughbred Group, and the Thoroughbred Group agreed to lease such reserves back to the Debtors in exchange for a 7.00% production royalty (the Sale-Leaseback Transactions. 7. The Committee believes that the Sale-Leaseback Transactions may have benefitted the Thoroughbred Group and Yorktown to the Debtors detriment. The Committee is accordingly investigating, among other things, whether the Debtors received fair consideration in exchange for the mineral reserves and other property interests that they sold to the Thoroughbred Group and whether the royalty rate that the Thoroughbred Group charged the Debtors exceeded fair market value. 2. The Royalty Deferment and Option Agreement 8. Many of the Sale-Leaseback Transactions between the Debtors and the Thoroughbred Group were consummated pursuant to a Royalty Deferment and Option Agreement (as amended, the RDOA. Since at least 2011, the Debtors (through Debtor Western Diamond assertion that Mr. Crain is independent of Yorktown. See Yorktown Energy Partners XI, L.P. Form D, dated March 2, 2016, available at xslformdx01/primary_doc.xml. 4

5 Pg 5 of 12 LLC and the Thoroughbred Group (through Western Mineral Development, LLC jointly owned certain coal reserves and related land interests (the Jointly-Held Property. In many cases, the entities that owned the Jointly-Held Property entered into leases (the Joint Leases with a second Debtor entity (often Debtor Armstrong Coal Company, Inc., pursuant to which such Debtor entity was granted a license to mine coal from the property in exchange for a 7.00% production royalty. 9. Pursuant to the RDOA, the Debtors were granted the option to defer payment of production royalties owed to the Thoroughbred Group under the Joint Leases. In exchange, the Debtors granted the Thoroughbred Group an option to acquire additional ownership interests in the Jointly-Held Property. In other words, the RDOA permitted the Debtors to defer royalty payments and instead satisfy those payments by giving the Thoroughbred Group a larger ownership stake rather than cash. 10. The Committee believes that the RDOA and the Sale-Leaseback Transactions consummated thereunder may have benefitted the Thoroughbred Group and Yorktown to the Debtors detriment, including by serving as a mechanism to transfer valuable assets from the Debtors to the Thoroughbred Group for less than fair consideration at a time when the Debtors were insolvent. Although the Committee is continuing to investigate the key details, the transactions consummated pursuant to the RDOA are particularly concerning because Yorktown stood on both sides of them and, through its power to appoint and remove the members of the Debtors board of directors and the incumbent management of Thoroughbred, heavily influenced (if not controlled the corporate decision-making processes of each entity that was a party to these transactions. 5 In light of these circumstances, the Committee submits that a thorough investigation is warranted. 5 Indeed, on information and belief, several of the Debtors current and former board members also hold fiduciary positions at Yorktown, including Brian R. Lawrence and W. Howard Keenan, who are Members of Yorktown, Joseph 5

6 Pg 6 of The March 2017 Settlement Agreement 11. In connection with the RDOA, in late 2016, a dispute arose between the Debtors and the Thoroughbred Group regarding the calculation of deferred royalties and the valuation of Jointly-Held Property. The dispute was resolved by a settlement agreement dated March 29, 2017 (the 2017 Settlement that resulted in a large transfer of value from the Debtors to the Thoroughbred Group. Specifically, the Debtors (a conveyed all of their remaining property interests in the Jointly-Held Property, (b agreed to pay the Thoroughbred Group $2.65 million for royalties that allegedly came due in January and February of 2017, (c waived the right to $314,000 fees that the Thoroughbred Group allegedly owed to the Debtors under an administrative services agreement, and (d waived the right to a credit for an alleged $2.2 million overpayment for prior production royalties. 12. The Committee understands that several Dual Fiduciaries sat on the Debtors board of directors and held influential managerial positions with the Debtors and Yorktown when the 2017 Settlement was negotiated and executed. Accordingly, and because the 2017 Settlement resulted in a significant transfer of value from the Debtors to the Thoroughbred Group shortly prior to the commencement of these Chapter 11 Cases, the Committee is investigating whether the 2017 Settlement gives rise to any estate causes of action. 4. The Peabody Acquisition 13. In late 2013, the Thoroughbred Group acquired significant coal reserves from Peabody Energy Company (the Peabody Acquisition. In connection with that transaction, the Debtors loaned $17.5 million to the Thoroughbred Group, which the Thoroughbred Group used to M. Stopper, who is an analyst at Yorktown, and James C. Crain, who, as noted above, appears to be a director of Yorktown Energy Partners XI, L.P. 6

7 Pg 7 of 12 fund the acquisition. Immediately thereafter, Thoroughbred leased the newly-acquired reserves to the Debtors in exchange for a 7.00% production royalty. 14. Owning coal reserves and conducting mining activities thereupon falls squarely within the Debtors core business. Subject to the Committee s ongoing investigation, the Committee believes that the Debtors estates may have colorable claims and causes of action against the Dual Fiduciaries for usurping a corporate opportunity. The Committee also believes that the Debtors estates may have claims and causes of action and against Yorktown and the Thoroughbred Group for aiding and abetting in such usurpation. B. The Committee is Under Significant Time Constraints 15. Prior to the Petition Date, the Debtors, Thoroughbred, Rhino Resource Partners Holdings LLC (the fund through which Yorktown holds its ownership interest in the Debtors, and certain other parties-in-interest (collectively, the RSA Parties executed a restructuring support agreement, dated as of October 5, 2017 [Docket No. 5] (the RSA. The RSA obligates the RSA Parties to support a restructuring of the Debtors on terms that are consistent with those set forth in the Plan. As noted, the RSA Parties are obligated to support a Plan that contains broad Debtor and third party releases (the Plan Releases pursuant to which the Debtors estates and each of the Debtors creditors are deemed to release virtually any and all prepetition claims and causes of action against, inter alia, the Debtors, Thoroughbred, Yorktown, and each of the Debtors current and former directors and officers. See generally Plan, Art. X. These releases are broad enough to include claims and causes of action arising from the Prepetition Transactions that are the subject of the Committee s investigation. 16. The RSA also obligates the Debtors to meet the narrow confirmation milestones set forth in the order authorizing the Debtors to use cash collateral [Docket No. 87]. The cash collateral order further requires the Debtors to obtain an order confirming the Plan by no later than 7

8 Pg 8 of 12 February 9, As a result, the Debtors have filed a solicitation procedures motion [Docket No. 149] (the Solicitation Procedures Motion that seeks an extremely truncated confirmation schedule. Among other things, the Solicitation Procedures Motion (a contemplates that the Debtors will finish soliciting votes on the Plan by December 22, 2017, (b proposes that the deadline to object to confirmation of the Plan be set for January 19, 2018 at 4:00 p.m. (prevailing Central Time (the Confirmation Objection Deadline, and (c proposes that the hearing to consider confirmation of the Plan take place on January 31, On December 18, 2017, the Court entered an order [Docket No. 322] granting the Solicitation Procedures Motion, setting the Confirmation Objection Deadline for January 19, 2018 at 4:00 p.m. (prevailing Central Time, and scheduling the confirmation hearing for February 2, 2018 at 11:00 a.m. (prevailing Central Time. 17. Given the breadth of the Plan Releases, the Committee s investigation has to be substantially completed in advance of the Confirmation Objection Deadline, which is less than five weeks away. Although the Committee intends to continue working with the Debtors and the other Rule 2004 Parties in order to streamline its investigation while minimizing unnecessary costs, Rule 2004 authority will substantially increase the Committee s ability to investigate the numerous transactions detailed above and for which the Committee may have causes of action. Given the significant time constraints, Rule 2004 authority will enable the Committee to formally seek discovery from the Debtors and third parties, and, if necessary, seek Court assistance to assure timely compliance with the Committee s requests so that the Committee can protect its rights and expeditiously complete its investigation. RELIEF REQUESTED 8

9 Pg 9 of Pursuant to Rules 2004 and 9016, the Committee seeks entry of an order, substantially in the form of the Proposed Order, authorizing it to issue document requests, 6 notices, and subpoenas compelling the production of documents and the provision of testimony by the Debtors and the other Rule 2004 Parties concerning the Prepetition Transactions and other prepetition dealings between the Debtors, Yorktown, and Thoroughbred. Additionally, the Committee respectfully requests that the Court authorize service of the document requests, notices or subpoenas by upon counsel for any parties that have appeared in these Chapter 11 Cases. BASIS FOR RELIEF REQUESTED A. The Committee is Obligated to Investigate Potential Estate Causes of Action 19. As the official committee appointed in these Chapter 11 Cases, the Committee has a statutory duty to investigate the acts, conduct, assets, liabilities, and financial condition of the debtor... and any other matter relevant to the case or to the formulation of a plan. 11 U.S.C. 1103(c(2; see also Loop Corp. v. United States Trustee, 379 F.3d 511, 519 (8th Cir (recognizing the duty of a creditors committee to advance creditors interests; In re Haskell- Dawes, Inc., 188 B.R. 515, 519 (Bankr. E.D. Pa ( The creditors committee is responsible for representing the interests of its constituents and maximizing their recovery. ; see also House Report No , 95th Cong., 1st Session, (1977 ( [Section 1102] provides for the appointment of creditors... committees, which will be the primary negotiating bodies for the formulation of the plan of reorganization. ; In re Global Intern, Airways Corp., 45 B.R. 258, 261 (Bankr. W.D. Mo ( The statutory duties imposed upon the committee presume that such activities are essential to the preservation of the estate.. 6 Proposed document requests directed at the Rule 2004 Parties are attached hereto as Exhibit A (the Proposed Document Requests. 9

10 Pg 10 of Given these duties and the factual background described above, the Committee is obligated to consider potential claims and causes of action arising from or relating to the Prepetition Transactions, and to do so prior to the Confirmation Objection Deadline. Additionally, the Committee is obligated to use its best efforts to maximize the value of the Debtors estates. See Haskell-Dawes, 188 B.R. at 519. The relief sought in this Motion is necessary to enable the Committee to satisfy these duties. B. The Discovery Sought Falls Within the Broad Scope of Rule The information that the Committee seeks falls within the broad contours of Rule Pursuant to Rule 2004, a party in interest may seek both documents and oral discovery related to acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor s estate, or to the debtor s right to a discharge. See Rule 2004(b-(c; see also In re Almatis, No , 2010 WL , at *3 (Bankr. S.D.N.Y. Nov. 24, 2010 ( The purpose of a Rule 2004 examination is to assist a party in interest in determining the nature and extent of the bankruptcy estate, revealing assets, examining transactions and assessing whether wrongdoing has occurred. ; Moore v. Eason (In re Bazemore, 216 B.R. 1020, 1023 (Bankr. S.D. Ga (Rule 2004 examination may include, among other things, any matter which may affect the administration of the debtor s estate. 22. Rule 2004 is uniquely suited to the investigatory tasks with which the Committee is charged because it can be used as a pre-litigation discovery device. See In re Wilson, No , 2009 WL , at *5 (Bankr. E.D. La. Feb. 6, No contested matter or adversary proceeding need be instituted as a prerequisite to conducting an examination under [Rule 2004]. In re Almatis, 2010 WL , at *3; see also In re Drexel Burnham Lambert Grp., Inc., 123 B.R. 702, 711 (Bankr. S.D.N.Y ( Rule 2004 discovery is broader than discovery under the 10

11 Pg 11 of 12 Federal Rules of Civil Procedure, and has fewer procedural safeguards.. Indeed, courts have frequently observed that Rule 2004 discovery is broad and unfettered and can be legitimately compared to a fishing expedition. Id.; see also In re Table Talk, Inc., 51 B.R. 143, 145 (Bankr. D. Mass Finally, the Court also has the authority to require compliance with Rule 2004 subpoenas on an expedited basis. See, e.g., In re Mirant Corp., 326 B.R. 354, 356 (Bankr. N.D. Tex Here, in light of the size and complexity of the Prepetition Transactions, and the fact that claims and causes of action arising from or relating to such transactions may prove to be the primary source of recovery for the Debtors unsecured creditors, the requested discovery is more than appropriate and falls well within the broad scope of Rule 2004 discovery. NOTICE 24. The Committee will provide notice of this Motion to: (a counsel to the Debtors; (b counsel to Thoroughbred; (c Yorktown; (d counsel the Office of the United States Trustee for the Eastern District of Missouri; (e counsel to the indenture trustee under the Debtors 11.75% senior secured notes due 2019; (f counsel to the ad hoc group of holders of the Debtors 11.75% senior secured notes due 2019; (g counsel to Knight Hawk Holdings, LLC; (h the United States Attorney s Office for the Eastern District of Missouri; (i the Internal Revenue Service; (j the Environmental Protection Agency and all state environmental protection agencies (or related regulatory bodies for the jurisdictions in which the Debtors held property or conducted business as of the Petition Date; (k the office of the attorneys general for the states in which the Debtors operate; (l the Securities and Exchange Commission; and (m any party that has requested notice pursuant to Rule The Committee submits that, in light of the nature of the relief requested, no other or further notice need be given. NO PRIOR REQUEST 11

12 Pg 12 of The Committee has made no prior request for the relief sought in this Motion to this Court or any other court. CONCLUSION WHEREFORE, the Committee respectfully requests that the Court (a enter an order granting the relief sought herein in the same form or substantially the same form as the Proposed Order, and (b grant such other and further relief as the Court deems just and proper. Dated: St. Louis, Missouri December 19, 2017 AFFINITY LAW GROUP, LLC DRAFT J. Talbot Sant, Jr., #35324MO 1610 Des Peres Road Suite 100 St. Louis, MO ( ( Fax -and- MORRISON & FOERSTER LLP Lorenzo Marinuzzi (admitted pro hac vice Jennifer L. Marines (admitted pro hac vice Daniel J. Harris (admitted pro hac vice 250 West 55th Street New York, NY ( ( Fax Proposed Counsel to the Official Committee of Unsecured Creditors of Armstrong Energy, Inc. 12