In recent weeks, the dispute in Windstream’s bankruptcy between Windstream and its REIT spinoff Uniti Group over the lease transaction that ultimately led to Windstream’s chapter 11 bankruptcy has continued to escalate with Windstream filing an adversary complaint against Uniti.  In its complaint, Windstream seeks to recharacterize the lease as a disguised financing alleging that the lease resulted in a long-term transfer of billions of dollars to Uniti to the detriment of Windstream’s creditors. The debtors’ complaint also alleges that they were insolvent no later than the third quarter of 2017, and argues that the above-market rent payments and tenant capital improvements they were required to make under the lease constitute constructively fraudulent transfers, as the debtors have not received reasonably equivalent value under the lease.

On August 20, Judge Drain authorized multiple secured and unsecured creditor groups to intervene in the case, given the potential impact on creditor recoveries and the related impact on which creditor group may be positioned to control the ultimate outcome of Windstream’s restructuring. This comes after Judge Drain’s appointment of colleague, Judge Shelley Chapman, as mediator, with several mediation sessions among the various constituents already having been held.

As outlined in Windstream’s complaint, the dispute arose out of a transaction that, while complex, had three general steps. First, a Windstream subsidiary spun off its copper wire and fiber optic cable networks to Uniti, which was structured as a REIT for tax purposes.  In the spin-off portion of the transaction, the agreed value of the assets transferred to Uniti was $7.45 billion, with Windstream’s subsidiary receiving just over $1 billion in cash and $2.45 billion of Uniti debt securities in return.  In the second step, approximately 80% of the equity in Uniti was distributed to Windstream’s shareholders.

In the final step of the transaction, Windstream entered into a lease — which Windstream’s complaint alleges was in substance a disguised financing — with Uniti to continue operating the transferred assets.  The lease had an initial 15-year term, with four 5-year renewal periods.  Under the lease, Windstream agreed to pay $650 million in annual rent to Uniti, with payments rising to more than $690 million in 2030.   Windstream alleges that the rent was not set at a market rate, but instead was set at an amount to “appease shareholders no longer receiving a Windstream dividend and to mimic traditional REIT structures involving traditional real estate.”

According to Windstream’s complaint, the rent payments exceed market rates, particularly since the leased assets were depreciating at a “precipitous clip” that would result in the assets having little to no useful life, or material value, at the end of the initial 15-year term.  Additionally, Windstream alleges that it has made nearly $840 million in tenant capital improvements, most of the benefits of which would be forfeited to Uniti if Windstream did not renew the lease.  Combined with the fact that Windstream’s business is dependent on the leased assets, Windstream would be left with no choice but to continue renewing the lease beyond the initial term, according to its complaint.  These factors, according to Windstream, merit recharacterizing the lease accordingly.

The debtors’ complaint also seeks a declaration that the lease is not a unexpired lease of real property for purposes of Section 365 of the Bankruptcy Code.  Such a declaratory judgment would free the debtors from the deadlines under Section 365(d)(4), whichotherwise would require them to make a determination to assume and continue performing under the lease, or to reject it and surrender the leased assets to Uniti, by no later than December 6, 2019.  In the interim, Windstream and Uniti have agreed, following one of their initial mediation sessions with Judge Chapman, that Windstream will continue to make payments under the lease and that Uniti will not seek to evict the debtors from the property governed by the lease.

The debtors’ complaint indicates that the consequences of the court recharacterizing the lease as a financing would be substantial.  According to Windstream, Uniti’s resulting claim would be almost entirely unsecured and structurally subordinated, and the excessive rent payments would cease.

Given the complexity of the transactions and issues involved, and the impact any resolution will have on the course of the restructuring, the case bears watching closely in the coming weeks and months.