What is a 'Hedge Fund'Hedge funds are alternative investments using pooled funds that employ numerous different strategies to earn active return, or alpha, for their investors. Hedge funds may be aggressively managed or make use of derivatives and leverage in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). It is important to note that hedge funds are generally only accessible to accredited investors as they require less SEC regulations than other funds. One aspect that has set the hedge fund industry apart is the fact that hedge funds face less regulation than mutual funds and other investment vehicles.
Read Article: http://www.investopedia.com/terms/h/hedgefund.asp By Daniel McNulty
Hedge funds can generate massive returns in relatively short periods of time, and they can also go into financial crises just as quickly. What kind of investments can produce such diverse returns? One answer is distressed debt. The term can be loosely defined as the debt of companies that have filed for bankruptcy or have a significant chance of filing for bankruptcy in the near future. You might wonder why a hedge fund - or any investor, for that matter - would want to invest in bonds with such a high likelihood of defaulting. The answer is simple: the more risk you take on, the more reward you can potentially make. Distressed debt sells at a very low percentage of par value. If the once-distressed company emerges from bankruptcy as a viable firm, that once-distressed debt will be selling for a considerably higher price. These potentially large returns attract investors, particularly investors such as hedge funds. In this article we'll look at the connection between hedge funds and distressed debt, what ordinary investors can do to get involved and if the risks are really worth the rewards. Read Article: http://www.investopedia.com/articles/bonds/08/distressed-debt-hedge-fund.asp By Joshua Nahas
On May 15, 2012 The United States Court of Appeals for the Eleventh Circuit reversed the decision of Judge Alan S. Gold of the U.S. District Court for the Southern District of Florida in the Bankruptcy of homebuilder TOUSA Inc. The Circuit court upheld the previous ruling by the Bankruptcy Court that in fact the financing of the payment to Transeastern Lenders constituted a fraudulent conveyance. The issues in the case have has been closely followed by bankruptcy attorneys, secured lenders and distressed investors as the implications are far reaching, particularly as it relates to rescue financing for companies near insolvency. Link to ruling: http://react.bracewellgiuliani.com/reaction/documents/BasisPointsTousa11thCircuitOpinion.pdf Not only did the Circuit court uphold the Bankruptcy Court’s finding that a fraudulent conveyance had occurred, but it also found that the Transeatern Lenders were repaid by the proceeds of that fraudulent conveyance and were subject to potential claw back litigation as “initial transferees”. In addition, the court found that the Transeatern Lenders bore some responsibility for diligencing the source of funds that was being used to repay them, and therefore should have known that their repayment was likely the result of a fraudulent transfer. The distressed community has been split on the issues in TOUSA with most willing to acknowledge that the 2007 financing was highly suspect, while uncomfortable with idea that lenders should be held responsible for diligencing the sources of their repayment. Funds specializing in rescue financing and secured lending, as well as distressed funds who were in the Transeatern Loan, were the most disturbed by the ruling; while distressed investors, and certainly TOUSA’s unsecured bondholders, felt that a line was finally being drawn over perceived corporate maneuvering and asset shuffling prior to a Chapter 11 filing. As a quick refresh for our readers (see earlier post for more details) TOUSA was a Florida based homebuilder focused on the construction of single-family residences as well as townhomes and condominiums. TOUSA Inc and its subsidiary TOUSA Homes LP had also entered into a JV with Falcone/Ritchie LLC (Transeastern) that was funded by the group of creditors referred to by the court as the “Transeastern Lenders”. However, when the housing market began to turn down, the JV failed. As a result TOUSA wound up in litigation with lenders to the JV and ultimately agreed to a $420mm settlement. In order to pay for the settlement TOUSA raised a new first and second lien term loan facility. The loan was secured by essentially all of TOUSA’s unencumbered assets including its previously unencumbered subsidiaries, the “Conveying subsidiaries” (the subsidiaries were guarantors on the $700mm revolver). In January 2008, approximately six months after the closing of the new loan, TOUSA and its subsidiaries filed for Chapter 11 Bankruptcy protection. (1) The Unsecured Creditors Committee (“UCC”) sought to have the new loan avoided as a fraudulent conveyance on behalf of the debtors’ estate and the proceeds paid out to the Transeastern Lenders returned for the benefit of the unsecured creditors. The UCC argued that the Conveying Subsidiaries had not received reasonably equivalent value in exchange for securing the new credit facilities. The unsecured creditors filed litigation to recover the value of said liens from the Transeastern Lenders under section 550(a)(1) of the Bankruptcy Code on the ground that the Transeastern Lenders were the entities to whose benefit the liens had been granted. (2) Judge John K. Olson of the Bankruptcy Court for the Southern District of Florida agreed with the claims asserted by the unsecured creditors and found that a fraudulent conveyance had indeed occurred. As part of his decision Judge Olson relied heavily on the evidence from the public domain regarding the condition of the housing market, TOUSA’s sagging stock price as well as the public comments of TOUSA executives regarding a potential restructuring that demonstrated the company’s precarious financial situation and called into question the solvency of the debtor prior to the 2007 refinancing. On appeal Judge Gold heavily criticized the Bankruptcy Court’s reasoning and its reliance on anecdotal evidence and took the unusual step of quashing the bankruptcy courts ruling. Judge Gold found that the Transeatern Lenders had no duty to conduct what he deemed “extraordinary due diligence” and that the Conveying Subsidiaries received reasonably equivalent value. This value was almost entirely attributed to TOUSA avoiding bankruptcy as a result of the Transeatern Lenders being repaid and thus averting a a Chapter 11 filing.. The 11th Circuit disagreed with Judge Gold’s finding and held that a fraudulent transfer had taken place and that lenders should have a duty to conduct some level of due diligence as to the source of their repayment, particularly when the entity is in financial difficulty. While the Circuit court did not address specifically whether reasonably equivalent value was received by the Conveying Subsidiaries and affirmed that avoiding bankruptcy is a source of value, the court found in favor of the Bankruptcy Court’s ruling that the risk assumed by the Conveying Subsidiaries far outweighed the perceived benefits of avoiding bankruptcy. The Circuit court also addressed the question of whether the Transeatern Lenders constituted initial transferees under section 550(a)(1) of the Bankruptcy Code subject to a clawback of funds as a “subsequent transferee” under section 550(b)(1) which provides for good faith defense against litigation seeking the recovery of funds. Ultimately the court ruled that the Transeastern Lenders met the definition of initial transferees which will likely make them subject to recovery actions by the UCC. The Court has now remanded the case back to the District court to determine what the appropriate remedies should be given that a fraudulent transfer has been ruled to have occurred.(3) It appears that the Court is not looking to impose unrealistic expectations on all future lenders, nor is it questioning the value attributable to avoiding restructuring. Rather, they seem to be focused on the facts in TOUSA which appear to be particularly egregious and therefore should not be considered standard. Indeed, the Court’s analogy to TOUSA’s demise being more akin to a “slow-moving category 5 hurricane than an unforeseen tsunami.” seems to indicate that debtors will still be able to exercise their best judgment and pre-petition rescue lenders will not routinely be found liable for fraudulent conveyance, despite what opponents to the Bankruptcy Court’s ruling feared it would imply. However, debtors, lenders and their advisors will likely now be more cautious in situations where they are operating near the zone of insolvency. Given that many distressed investors participate in rescue financing as well as in distressed loans that they believe may be refinanced, there are reasons to be concerned about a ruling that requires investors to diligence the source of funds being used to repay them. Nevertheless, distressed investors routinely find themselves in situations where they feel the debtor is given far too much leeway to maneuver its assets and engage in rescue financing when an orderly restructuring is in the best interests of creditors and is likely inevitable. The courts both in and out of bankruptcy already provide the debtor with broad latitude in their financial decisions as per the business judgment rule and efforts by distressed investors to negotiate a consensual restructuring are frequently stymied as a result. Dynegy is a good analog for the TOUSA situation and most distressed investors (and the court appointed examiner) would agree that the kind of maneuvering that occurred in that case was disturbing and should be prevented from occurring in the future. Finally, while potential fraudulent conveyance litigation is not usually the primary driver behind an investment thesis, it is a valuable chip in the negotiations with the debtor and the pre-petition lenders. Had the district court’s ruling stood, distressed investors would have faced an almost insurmountable hurdle in proving a fraudulent conveyance had occurred, and would have lost a valuable leverage point in negotiating with the debtor. Moreover, it would have likely emboldened debtors and their advisors to engage in even more pre-petition maneuvering rather than pursue a meaningful restructuring. Too often creditor value is eroded while management of financially distressed companies pursue unrealistic plans to avoid the inevitable restructuring. Net/Net while the ruling has some potential negative effects for distressed investors focused on rescue lending or when betting on a distressed piece of paper being refinanced, the ruling itself will likely be a positive for distressed investors. Hopefully it will encourage debtors to engage its creditors in meaningful dialog prior to filing a Chapter 11 and avoid some of the more questionable transactions such as TOUSA, Dynegy and Tribune. Notes: (1) Judicial Backlash Adds to Challenges Faced by Lenders. Edward Estrada, Reed Smith. The Journal Of Corporate Renewal, July/August 2010 (2) Eleventh Circuit Upholds Bankruptcy Court’s Fraudulent Transfer Ruling in TOUSA Debra Dandeneau. Weil Bankruptcy Blog, MAY 16, 2012 http://business-finance-restructuring.weil.com/fraudulent-transfers/eleventh-circuit-upholds-bankruptcy-courts-fraudulent-transfer-ruling-in-tousa/#axzz1vANZnoP5 Specializing in distressed credit/special situations, deep value opportunities, trade and litigation claims, as well as event driven situations, Joshua Nahas is an expert in his field. Click here to contact Mr. Nahas directly Read Original Article: http://joshua-nahas.com/uncategorized/tousa-two-step-ruled-fraudulent-conveyance-11th-circuit-court-appeals/ Introduction
While bank lenders and bondholders generally represent the largest portion of debtor’s pre- petition claims, upon filing there is a large constituency of other creditors who also possess claims against the debtor at various levels of priority within the capital structure. Because the sale, assignment and transfer of ownership of these claims are not considered securities, securities trading laws do not apply. The lack of uniformity and active market for these claims makes the instruments less liquid and transparent, thereby providing an opportunity for outsize returns for those willing to perform the necessary due diligence and shoulder the liquidity risk. Vendor claims generally trade at a 10-20% discount to other wise pari passu securities and therefore present a potential arbitrage opportunity for investors. The typical vendor does not wish, or may not be financially able, to wait months or possibly years to receive his money and is usually sufficiently motivated to sell his claim at a discount. A distressed investors may also purchase trade claims as a way to obtain strategic advantage in a restructuring. By gaining control of a larger share of a company’s General Unsecured Claims (“GUCs”), a sophisticated distressed investor can gain leverage to influence negotiations with the Debtor and other Creditors. By purchasing trade claims at a discount to the unsecured debt he already owns, the investor also lowers the effective cost basis of his investment (assuming trade and bonds will receive the same consideration in the reorganization). In addition, if the claims pool is large enough an investor can set up a capital structure arbitrage trade by going long a trade claim and short pari passu unsecured bonds of the same company. In structuring such a trade, one must ensure that the bond and the claim are at the same entity and that the bond does not have any guarantees or claims on subsidiaries that might make it more valuable. For instance in the case of Nortel Networks, their North American bonds issued at Nortel Networks Inc (“NNI”) had guarantees from their Canadian parent which the trade claims of NNI did not. Thus, one had to segregate the value of the North American and Canadian operations to determine the value of an NNI claim. Fortunately in this case there were bonds issued at the Canadian parent Nortel Networks Corp (“NNC”) that did not have recourse to NNI, so one could subtract the value of an NNC bond from an NNI bond to find the implied value of an NNI claim. Many times this is not the case and one needs to try and apportion the value using information available in the company’s financial statements. If the company has subsidiaries that are not guarantors of its debt then it will segregate the financials of the guarantor and non-guarantor subs. Also, one may look to segment reporting of revenue and EBITDA and attempt estimate how much value may be attributable to the various entities. In a scenario where the investor faces a great deal of uncertainty over valuation and how it will be attributed amongst various entities, he must bid an appropriate discount to compensate for the risk. Types of Claims A “Claim” is a right to payment, whether that right is fixed, liquidated, potential or contingent (i.e., based on the outcome of litigation). Claims can fall into different categories: priority, secured, unsecured, contingent, liquidated, disputed or matured. The most common claim to arise out of a bankruptcy filing is a vendor claim or trade claim as they are more commonly known. These claims arise due to the fact that a company’s suppliers ship goods on credit ranging anywhere from 30-90 days. When a company files for bankruptcy it likely to be in arrears on its accounts payable, this increases the amount of debt on its balance sheet (AP), thereby increasing the tradeable instruments in the debtor’s obligations. While trade claims are the most common, there several other types of claims that arise from a bankruptcy filing which provide potential investment opportunities. These include:
Proof of Claim In order for the Creditor’s claim to be paid he must file a Proof of Claim (“POC”) with the court. This is done by filling out Official Form 10 within 90 days from the Section 341 meeting of creditors and filing it with the Bankruptcy Court. The date past which a claim can no longer be filed is known as the Claims Bar Date, and claims past this date generally will not be paid, although it is possible to appeal. The POC will have a Docket Stamp on it denoting the date of its filing. The POC must be signed by the creditor, include the amount of the claim, whether there is a perfected security interest and have attached to the POC documentation evidencing the claim such as invoices, purchase orders or contracts. Sample of Proof of Claim Form 10 Sourcing Trade Claims Upon filing of its petition for bankruptcy, or within 14 days of filing, the Debtor is required to file its Schedule of Assets and Liabilties and its Statement of Financial Affairs (“SOFA”). The Schedules are the primary source used to locate claim holders. In practice the Debtor routinely is granted extensions to the filing of schedules and it can take some time before a potential investor has the requisite information in order to bid on a claim. Nevertheless, upon petition the Debtor must file a list containing the name, address and claim of the creditors that hold the 20 largest unsecured claims, excluding insiders. For a sophisticated trade claims investor it is possible to begin negotiations to purchase a claim utilizing this information, albeit without knowing whether the debtor is disputing the claim or if the amount of the claim at petition will be the same as what is listed on the Schedules. The Schedules also contain the name, address, amount of claim and whether that claim is, Contingent, Liquidated/Unliquidated or Disputed. Contingent claims are claims that may arise contingent upon an event taking place in the future, such as an adverse judgment in an ongoing lawsuit or claims related to remediation for environmental damages that are not fully know. A Liquidated Claim is a claim where the dollar amount is known. An Unliquidated Claim is one where the debtor has liability, but the exact monetary measure of that liability is unknown. A tort case where the Debtor has been found guilty, but where the amount of the liability has yet to be established would fall into this category. Disputed claims are claims where the Debtor is disputing the validity of the claim and intends to file an objection to the claim. This generally occurs later in the case in the form of an Omnibus Objection made by the debtor. Below is an example of a Debtor’s Schedule of Assets and Liabilities filed by Tronox Inc. Purchasing a Trade Claim In examining the schedules it best to bid on an Allowed Claim. Under Section 502(a), a claim for which a proof of claim has been filed is deemed “Allowed” unless a party of interest (e.g. Bankruptcy Trustee, or the Debtor) objects to the claim, in which case the Bankruptcy Court will conduct a hearing to determine whether, or to what extent, the claim should be allowed. There are instances where the Debtor marks every claim on the schedule as disputed or contingent. This increases the risk and will required extra due diligence as well as the willingness to litigate if need be. Once a claim holder willing to sell has been located, the negotiation process for purchasing the claim begins. This process can take anywhere from a few days to several weeks depending on the complexity of the issues involved. Since the seller is not a capital markets participant, he may change his mind several times throughout the negotiation process and also increase his offer based on competing bids. Moreover, factors may come into play in the due diligence phase that require a re-pricing or cancellation of the trade altogether. If an investor is bidding on a disputed claim he will need to factor the risk that the claim might ultimately be disallowed into his bid price. In addition, he may want to reduce price of his bid to allow him to negotiate with the debtor for a reduction in claim size in exchange for a stipulation that the debtor will treat the claim as an Allowed Claim. Due Diligence Once an initial bid is agreed upon, the parties enter into a trade confirmation, subject to final due diligence. This phase again can take a few days to a few weeks depending on the issues involved. At this stage in the process the buyer will begin examining the documentation supporting the claim. This includes reviewing invoices, purchase orders, or other contracts in order to determine the validity of the claim. It is also necessary to reconcile the amounts on the invoices with what is filed on the POC and the Schedules. If the invoice is for less than what is listed on the POC or what is listed on the POC is less than on the schedules, the purchaser must reconcile these discrepancies before funding, or have the buyer agree to indemnification provisions should the claim be allowed at a lower amount. The purchaser must also confirm that the entity at which the claim he is purchasing is filed corresponds to the entity listed on the supporting invoices as well as have been filed prior to the Claims Bar Date. The claims purchase will be executed via a custom tailored contract known as a Purchase Sale Agreement (“PSA”). The PSA will contain provisions governing the transfer of the claim, Representations and Warranties and Indemnification provisions. The PSA will required the seller to provide Reps and Warranties on the ownership, validity and lack of any encumbrances on the claim. In addition, the PSA will contain Indemnification provisions, should the claim be impaired or disallowed . This means that if for some reason the purchaser of the claim needs to seek recourse because the seller misrepresented his claim or it was disallowed as a result of actions taken by the seller, , the purchaser must be able to rely on the counter party to indemnify him for his losses. If the counter party is financially unstable, not a well established enterprise, or is itself at risk of bankruptcy, then there is risk that he will not be able to perform his duties under the PSA. When the counter party is a publicly traded company, has, publicly issued debt or has a credit rating, it is fairly easy to do counter party due diligence. However, if the counter party is a small, private business, then counter party risk assessment becomes more difficult. One source of information is Dun & Bradstreet which compiles credit and other financial information on private businesses. In addition, the purchaser can and should ask for financial statements, bank statements, summary of tax returns and other information as needed to gain comfort with the counter party’s credit worthiness. Should legal disputes arise the between the buyer and seller, the PSA should contain provisions for settling the disputes. It is common for the PSA to require disputes to be litigated under New York or Delaware law, courts which routinely handle complex commercial litigation. This also avoids being in the home town court of the seller of the claim. If the claim being purchased is from a foreign supplier whose country is a signatory to the NY Convention of the International Chamber of Commerce (“ICC”) arbitration, then the PSA should include provisions for disputes to be settled via arbitration as courts of signatory countries are required to enforce arbitration judgments conducted in accordance with ICC rules. Legal Issues Affecting Trade Claims There are several legal issues that can impact the value of a claim or cause the claim to be disallowed. The following is a brief summary of some of the major issues that need to be diligenced from a legal perspective before purchasing a claim. Equitable Subordination. If the seller of the claim aided and abetted fraud, insider trading or breach of fiduciary duty his claim may be equitably subordinated causing the priority of the claim to be moved to the end of the priority chain. This has the effect of the claim being treated as equity, not debt. This risk is heightened when a claim is purchased from an insider and one must have strong reps and warranties from an insider that he has not aided and or abetted any malfeasance. The purchaser must also have indemnification provisions covering such breaches. It can be several months post closing of a trade that these issues are discovered and even longer until they are adjudicated. In order to minimize this risk seek to avoid purchasing claims of company, insiders or those where the relationship could be potentially deemed as “insider”. Avoidance Actions. When a company files for bankruptcy all payments made in the 90 days prior to bankruptcy (1 year for payments to insiders) are investigated as potential Preference Payments. A Preference Payment is the payment of a debt to one creditor rather than dividing the assets equally among all those to whom he/she/it owes money, often by making a payment to a favored creditor just before filing a petition to be declared bankrupt. The Bankruptcy Trustee has the power to Avoid (unwind) any payments that are deemed to be a Preference This is known as an Avoidance Action and the money is reclaimed by the bankruptcy estate . There are several criteria that are used to evaluate whether a payment was a Preference:
However, Section 547© of the Bankruptcy Code contains exceptions for payments made in the ordinary course of business. The prior course of dealings between the parties, including the amount and timing of payments, and circumstances surrounding the payments, should be analyzed. Additionally, inquiries may be made into the collection activities or practices between the parties, whether the payments were designed to give the transferee an advantage over other creditors in bankruptcy, or whether there was any change in the status of the transferee such as the ability to obtain security in the event of nonpayment. If there has been any unusual pressure or collection activity by the creditor resulting in the payment, the payment would not be ordinary course of business. The transfer at issue is not required to be the type that occurs in every transaction between the parties. It is necessary only that the type of payment be somewhat consistent with prior dealings and transactions Closing the Trade Once the due diligence and legal review is complete, the PSA is finalized and the trade is executed via Delivery vs Payment (“DVP”) format. ). DVP occurs when, to complete a trade, there is a simultaneous exchange of securities, in this case they are not securities but the format is the same, for cash that ensures that delivery occurs if, and only if, payment occurs. To be true DVP, there must be an element of finality in the process, whereby neither side of the trade can unwind the transaction after settlement. The funds are then wired within one day of execution. Closing can occur anywhere from 10-30 days post initial confirmation of the trade. The standard practice is that once the trade has closed, the Transferee files a Notice of Transfer and Evidence of Transfer (supporting documentation to evidence the transfer of claim) with the Bankruptcy Court pursuant to Bankruptcy Rule 3001(e). Rule 3001(e) reads as follows:
Conclusion Investing in trade claims provides a unique opportunity set for distressed investors who already understand the bankruptcy process, are familiar with analyzing complicated capital structures and understand inter-creditor issues. While trade claims are an illiquid market, they are also highly uncorrelated to the stock and equity markets making them attractive to distressed and special situation funds. Furthermore, it is possible in many cases to bid on claims at a discount to an established plan recovery for the reasons: stated earlier: that many trade creditors do not wish, or are unable, to wait for the exit from bankruptcy for payment. With that said the market has grown more competitive and sophisticated in the last several years, so do you due diligence and invest wisely. Link to other articles by Joshua Nahas: http://joshuanahas.com/joshua-nahas-publications/ 2.10.2011A few months ago, I introduced readers to a new author at Distressed Debt Investing, Joshua Nahas, principal of Wolf Capital Advisors. Wolf Capital is a Philadelphia based advisory firm focused on distressed debt, corporate restructuring, corporate finance advisory and capital raising services. Wolf provides advisory services to hedge funds and private equity funds on distressed investing and provides restructuring services to debtors as well as creditor committees. He wrote an incredible piece on investing in trade claims.
In this article, Joshua tackles a number of the more important rulings that have affected secured creditors in the most recent bankruptcy cycle. It is a first in a number of articles you will be seeing over the coming months -while the current 2011 credit market bubble leaves few opportunities to allocate capital to, it doesn't mean we can't sharpen our pencils in anticipation for the next bankruptcy cycle. Enjoy! Recent Bankruptcy Rulings and Their Implications for Distressed Investors During this most recent bankruptcy cycle there have been a series of rulings impacting secured creditors in general, and in particular secured creditors seeking to gain control of a debtor through credit bidding. Whether creditors in cases such as Philadelphia Newspapers, Scotia Pacific and DBSD intended to loan-to-own from the outset, or opted to control to take control mid-process in order to maximize recoveries, the rulings that impacted them will shape both the court’s and creditors’ actions in the cycle to come. While the Chrysler case received much broader media attention, its implications are more limited given the unique constituencies and circumstances. That said, distressed investors in secured debt should consider carefully the risks when deploying capital in sectors with significant union concentration where the federal and state governments are going to bring significant influence to bear given the effects a bankruptcy has on working class voters and their communities. This article is the first in a series of articles examining key legal decisions during last bankruptcy cycle. The purpose is to synthesize the voluminous array of legal analysis and opinions on these rulings and develop essential take aways for distressed investors. While distressed investors rely heavily on the advice and counsel of their FAs and attorneys, in the final analysis the PM must execute his strategy and be accountable for the results. Therefore, it is important to survey the legal landscape and be aware of some of the pitfalls distressed investors face. Particularly for funds that focus on control investments, or who have holdings concentrated in an industry that may result in them being deemed a “strategic investor”. Given the enormous growth in the leveraged loan market, particularly the 2nd lien loan market, many of the rulings in the last bankruptcy cycle were related to secured creditors. The focus of this article is on decisions impacting control distressed investments more commonly referred to as loan-to-own. In late 2008 and early 2009 as the markets began a precipitous decline, credit, including traditional third party DIP financing from commercial banks, dried up. Many distressed investors were unable to deploy funds to capitalize on the markets’ dislocation. They were getting margin calls on the total return swaps, redemptions from investors and suffering significant mark-to-market losses. For those players with sufficient dry powder and locked up capital, being the DIP provider gave them the most strategic position in the capital structure, and very often the DIP was the fulcrum security. DIP loans with stringent covenants and milestones calling for a POR or sale within 120 days, enabled the DIP lender’s to gain control of the company. With traditional DIP lenders on the sidelines, first lien lenders seized the opportunity to roll-up their pre-petition debt into post-petition debt. Such actions are generally frowned upon by the courts because pre-petition debt effectively becomes cross-collateralized with post-petition assets. Moreover, some members of the first lien facility such as CLO’s or long only asset managers are precluded by their charters from originating or participating in DIP loans. Those creditors who were left behind by the roll-up DIP objected to these loans on the basis that the rules and procedures of bankruptcy did not allow for members of the same class to leap frog them and obtain better recoveries and terms. Nevertheless, with no viable alternative the courts approved many of these loans, although frequently they amended some of the more egregious terms after some trial-and-error. Roll-up DIPs effectively became de facto bridge loans to a credit bid. In situations where the first lien lenders were not the DIP lender, the scenarios were far different and led to some interesting conflicts between debtors and secured creditors, particularly related to secured creditors’ right to credit bid their claims. Philadelphia Newspapers In 2006, Philadelphia Newspapers, LLC (debtor), acquired the Philadelphia Inquirer, Philadelphia Daily News, and philly.com for $515 million with a $295 million loan secured by a first priority lien on substantially all of the debtors’ assets. In February 2009, the debtors filed for Chapter 11 after defaulting on their loan agreements. The debtors’ proposed plan called for a sale of substantially all the debtors’ assets in an auction as well as a transfer of their Philadelphia headquarters to the secured lenders. The bid procedures required cash funding and specifically precluded the lenders from credit bidding. (1) The Stalking Horse bidder in this case was an entity controlled by the local Carpenters Union pension fund and Bruce Toll, a personal friend of the debtor’s CEO. Additionally, until the day before the asset purchase agreement was signed, the Stalking Horse held 50% of the ownership interests in the parent of the debtor corporation. (2) Since the Newspaper properties represent iconic brands in Philadelphia, the debtor also engaged in a public relations campaign branding itself as David “local newspaper” vs. Goliath “Wall Street hedge funds”. This was ironic given that the CEO had mismanaged the leveraged buyout of the company, filed it for bankruptcy and instituted significant head count reductions effecting middle class working people while he earned an $800K annual salary. Nevertheless, the debtor successfully painted the banks as the villain. The debtor’s POR included a 363 sale at public auction of substantially all the debtor’s assets free and clear of all liens. The sale would not include the debtor’s headquarters which would be transferred to the secured lenders in full satisfaction of their claim. Under the Plan, the purchase would generate approximately $37 million in cash for the Lenders. Additionally, the Philadelphia headquarters which was valued at $29.5 million and would be subject to a two-year rent free lease for the new owners (representing a recovery of about 20%). The Lenders would receive any cash generated by a higher bid at the auction. The plan also established a $750,000 to $1.2 million liquidating trust fund in favor of general unsecured trade creditors and provided for a distribution of 3% ownership to the GUCs if the senior lenders agreed to waive their deficiency claims. (3) Secured lenders objected to the plan because it required all bids on the sale to be in cash, thus if the secured lenders wanted to bid on the assets they would have to pay in cash only to receive the cash back under the plan. Although secured creditors would essentially be paying themselves with a cash bid, the group held firm to the principle of a secured creditors’ right to credit bid. In October 2009, the bankruptcy court issued an order refusing to bar the lenders from credit bidding. The bankruptcy court reasoned that Section 1129(b)(2)(A) of the Bankruptcy Code (known as the cramdown provision), when read in conjunction with Sections 363(k) and 1111(b), required that a secured lender be able to credit bid in any sale of the debtors’ assets. This provision states that a plan is “fair and equitable” and thus confirmable over the objections of a secured class, provided that the secured class is given the “indubitable equivalent” of its secured interest. Moreover, before a court may “cram down” a plan over the objection of a dissenting creditor class, both the absolute priority rule and the fair and equitable standard must be satisfied. However, the debtor appealed and the district court reversed the bankruptcy court’s decision. The 3rd US Circuit Court of Appeals affirmed the district court’s ruling and addressed the issue of whether secured creditors have a statutory right to credit bid their claims in a 363 sale done in the context of a plan of reorganization. (4) The 3rd Circuit upheld the POR relying on what is characterized as the “plain meaning” of the Bankruptcy Code Section 1129 (b)(2)(A). The court held the plan could be confirmed as it met the “fair and equitable” requirement of Section 1129 (b)(1) arguing that secured creditors received the “indubitable equivalent” of their claims under the plan. Section 1129(b)(2)(A) lists three alternative paths by which a plan may be “fair and equitable” to secured lenders:
http://www.ca3.uscourts.gov/opinarch/094266p.pdf The court reasoned that according to the plain meaning of the statute, the use of the word “or” between the three subsections is a disjunctive clause which allows the debtor to choose one of the three alternatives when selling its assets free and clear of liens. Therefore, if the debtor offers the indubitable equivalent under subsection (iii), the secured lender’s right to credit bid is precluded. The court applied reasoning used by the 5th Circuit In Re Pacific Lumber Co. In the PALCO case the court terminated the debtor’s exclusivity after 1 year and confirmed a plan put forth by a joint bid by a secured creditor and competitor. Additionally, the plan paid the noteholders full cash value of their claims while precluding them from credit bidding on the assets. The court rejected the secured creditors’ claim that they had the right to credit bid and commented that the credit bid was unnecessary given that noteholders were receiving the full cash value of their claim. The court in Philadelphia Newspapers cited the approach the 5th Circuit took in the PALCO case as one concerned with “fairness to creditors” rather than the mecanics of a cramdown. Moreover, the court emphasized that lenders retained the right to object to the plan at confirmation on the grounds that “the absence of a credit bid did not provide it with the ‘indubitable equivalent’ of its collateral.” (6) http://business-finance-restructuring.weil.com/wp-content/uploads/2010/10/SCOPAC-09-40307-CV0-10-19-2010-USCA5.pdf Judge Thomas Ambro of the 3rd Circuit wrote a strong dissenting opinion based on the principle of statutory construction; that specific principles prevail over general ones. (7) The legal reasoning employed in the dissent is beyond the scope of this article, however it provides some great insight and is worth reading. The PALCO and Philadelphia Newspapers rulings have established that in the context of a plan of reorganization credit bidding is not a right (at least in the 3rd and 5th Circuits). This is significant in that the 3rd Circuit governs Delaware where many large corporate bankruptcies are overseen. However, the issue of the right to credit bid in a 363 sale outside of a plan was not addressed. The court remanded back to the bankruptcy court the issue of whether secured creditors were receiving the Indubitable Equivalent and that the plan met the Fair and Equitable test. That issue was never decided as creditors took matters into their own hands and won the auction with a cash bid of $138.9mm. What these rulings demonstrate is that secured creditors have lost some strategic ground in being able exercise influence and take possession of the collateral through the right to credit bid. Funds employing a loan-to-own strategy should weigh carefully how these decisions may impact the timing and manner of deployment of capital in a distressed investment. Had the secured creditors been the DIP lenders in these situations, they would have been able to exert far more influence in determining the outcome. It is likely that during the next cycle banks will again be reeling from mark-to-market losses in their trading and CMBS books and will again not be able to deploy DIP capital as was the case in the 2008-2009 cycle. The early part of the cycle will be ripe with opportunities for those funds with dry powder to effectuate control through a third party or roll-up DIP loan. DBSD DBSD, a subsidiary of ICO Global, is a satellite communications company focused on S-Band spectrum that received authorization from the FCC to integrate an ancillary terrestrial component (ATC) into its MSS (Mobile Satellite Service) system allowing them to provide integrated mobile satellite and terrestrial communications services. While the spectrum has enormous value, the large capital expenditures required to launch satellites and fund the cash burn until they are operational, has forced two major players DBSD and Terrestar, majority-owned by Harbinger Management, to seek bankruptcy protection. The strategic value of these assets has brought into conflict hedge funds such as Harbinger a major player in the space through its company LightSquared, and DISH Network, controlled by satellite mogul Charlie Ergen, who also owns Echo Star Communications. Mr. Ergen has tried to gain control of both DBSD and Terrestar through a loan-own-strategy by investing in the debt of these two companies. The prospect of a strategic buyer using a loan-own-strategy has generated a lot of controversy. In the case of DBSD, it led to a rare decision by Judge Robert E. Gerber of the United States Bankruptcy Court for the Southern District of New York to “designate” or disallow the vote of DISH, a ruling the Second Circuit Court of Appeals upheld. The facts in the DBSD case are unique in that a strategic buyer (rival corporation) had purchased all of the debtors’ $40mm first-lien secured debt at par in addition to $111mm of $650mm 2nd lien debt not subject to a PSA (Plan Support Agreement). The purchases were made after the debtors had filed an amended plan of reorganization that would have satisfied the first lien debt in full with a new secured PIK note and modified liens. The creditor’s admitted purpose in buying the debt was to vote against the plan and take control of the debtor. The court found that: “When an entity becomes a creditor late in the game paying 100 cents on the dollar, as here, the inference is compelling that it has done so not to maximize the return on its claim, acquired only a few weeks earlier, but to advance an ‘ulterior motive’ condemned in the case law.” (8) Under section 1126(e) of the Bankruptcy Code, a court may, on request of a party in interest, “designate” (disqualify) the votes of an entity whose acceptance or rejection of a plan of reorganization is not in good faith. (9) The Bankruptcy Code does not define good faith, thus courts have developed a basis for determining actions that demonstrate a “badge of bad faith”. Such actions include, among other things, attempting to assume control of the debtor, to put the debtor out of business or otherwise gain a competitive advantage, or to destroy the debtor out of pure malice (10) The court found that “DISH’s acquisition of First Lien Debt was not a purchase to make a profit or increase recoveries under a reorganization plan. Instead DISH made its investment in DBSD as a strategic investor looking ‘to establish control over this strategic asset.’ The Court cited evidence that DISH purchased the debt at par after an amended plan had been filed; and that internal DISH documents and sworn testimony revealed plans to use the purchase of debt to “control the bankruptcy process” and “acquire control” of the debtor, a “potentially strategic asset.” Therefore, Judge Gerber concluded that “DISH’s conduct is indistinguishable in any legally cognizable respect from the conduct that resulted in designation in Allegheny, and DISH’s vote must be designated for the same reasons.” (11) http://www.scribd.com/doc/48438738/Second-Circuit-Ruling-in-DBSD-Case Under the proposed plan, the first lien debt was to be restructured under an amended facility that extended the maturity of the Senior Debt from one year to four years, provided payment in kind (“PIK”) interest at 12.5 percent, with no cash payments until final maturity. In addition, the first lien creditors would receive liens on all of reorganized DBSD’s operating assets, but not on the securities, which were to be used to secure a working capital line and fund continuing operations. In determining whether the plan should be confirmed, the court analyzed whether the creditor was provided the indubitable equivalent of its claim. The court examined the issue of whether the secured creditors' claim would have the same level of protection as it did prior to confirmation, in other words, did the new note have sufficient collateral cushion. The court ruled that given the assets securing the debt had an enterprise value six times the amount of debt due at maturity, their level of protection was equal. (12) DISH appealed Judge Gerber’s ruling and upon appeal, the United States District Court for the Southern District of New York affirmed his decision. The District Court held that the Bankruptcy Court’s finding that DISH had acted as a strategic investor seeking control over the debtor was not clearly in error, and rejected the argument by DISH that there was insufficient evidence to establish that they had displayed a lack of good to satisfy section 1126(e) of the Bankruptcy Code. (13) DISH appealed to the 2nd US Circuit Court the designation of its vote and in addition argued that they cannot be forced to accept a reduced collateral package that strips them of their lien on the securities with no substitution. (14) The Second Circuit upheld the District court’s ruling. However, it appears that Mr. Ergen is not going away quietly. It was announced recently that DISH struck a deal with DBSD’s management that would keep all of the debt unimpaired and allow DISH to acquire a controlling interest in the debtor. While this ruling had unique circumstances given that the creditor was a strategic buyer who purchased its claim at par after a plan had been disclosed, it may provide ammunition to junior creditors seeking to assert leverage in a case where a control distressed hedge fund or private equity fund is seeking to obtain control through the debt. Would the decision be applicable if all the facts were the same except that the creditor in question was a large distressed fund? At the very least distressed investors looking to acquire controlling interests need to be aware of the risks of being deemed a “strategic investor” It is likely that aggressive junior creditors seeking to avoid a cramdown will now cite this case as a basis for leaving senior creditors unimpaired or unable to vote. Moreover, Philly News and PALCO have left open the question of credit bidding outside of a plan. While not all distressed investors seek control when investing, very often it becomes the only effective means for exercising remedies and maximizing recoveries. In light of these rulings, control distressed investors should be prepared to face some challenges on several fronts in the next cycle.Praemonitus Praemunitus. (Forewarned is Forearmed) Endnotes: (1) In re Philadelphia Newspapers: Potential Ramifications for Secured Lenders in Debt Restructurings. McDermott Publications: 12.2.2009 (2) Ibid. (3) Recent Decisions May Stop Secured Creditors from Credit Bidding. Elena González. http://www.abanet.org/litigation/committees/bankruptcy/articles/071310-gonzalez-credit-bidding-secured-creditors.html (4) Ibid. (5) Ibid. (6) Ibid. (7) Right To Credit Bid Denied In Philadelphia Newspapers, Dow Jones Daily Bankruptcy Review | 10. Wednesday, March 31, 2010. Marshall S. Huebner and Kevin J. Coco. (8) Disenfranchising Strategic Investors in Chapter 11: “Loan to own” Acquisition Strategy May Result in Vote Designation Jones Day, Recent Developments in Bankruptcy and Restructuring. (9) SDNY Bankruptcy Court Thwarts Takeover by Claims Purchaser. Cadwalder Restructuring Review April 2010. By Peter Friedman, Leslie W. Chervokas and Samuel S. Cavior. (10) Ibid. (11) Ibid. (12) Ingredients for a Successful Cram Up Reorganization. New York Law Journal, March 1, 2010. Jeffrey Levitan. (13) Ibid (13) Ibid Read Article: www.distressed-debt-investing.com/2011/02/recent-bankruptcy-rulings-and-their.html Baby pictures of a newborn supernova have captured this stellar explosion after the first half-dozen hours of its life, shedding light on how these giant explosions happen, a new study finds.
This newly discovered cosmic baby is the type of supernova that occurs when a giant star runs out of fuel and explodes. Supernovas are so bright that they can briefly outshine all of the other stars in their home galaxy. Astronomers have previously seen glimpses of supernovas within the first minutes after they explode. However, until now, researchers had not captured light from a newborn supernova across the so many wavelengths — including radio waves, visible light and X-rays. The new images add to evidence that suggests that these dying stars may signal their upcoming demise by spewing a disk of material in the months before their deaths, according to a paper describing the finding. [Know Your Novas: Star Explosions Explained (Infographic)] Much remains unknown about how and why dying stars can detonate with such violence. Studying the final years of a star that is destined to die as a supernova could reveal key details about the way in which these explosions happen, but stars in these brief, final stages are rare — statistically, it is very likely that none of the 100 billion to 400 billion stars in the Milky Way galaxy are within one year of dying as a supernova, according to the new paper. Read Article: http://www.foxnews.com/science/2017/02/15/baby-supernova-discovery-hints-at-how-star-explosions-are-born.html Baby pictures of a newborn supernova have captured this stellar explosion after the first half-dozen hours of its life, shedding light on how these giant explosions happen, a new study finds.
This newly discovered cosmic baby is the type of supernova that occurs when a giant star runs out of fuel and explodes. Supernovas are so bright that they can briefly outshine all of the other stars in their home galaxy. Astronomers have previously seen glimpses of supernovas within the first minutes after they explode. However, until now, researchers had not captured light from a newborn supernova across the so many wavelengths — including radio waves, visible light and X-rays. The new images add to evidence that suggests that these dying stars may signal their upcoming demise by spewing a disk of material in the months before their deaths, according to a paper describing the finding. [Know Your Novas: Star Explosions Explained (Infographic)] Much remains unknown about how and why dying stars can detonate with such violence. Studying the final years of a star that is destined to die as a supernova could reveal key details about the way in which these explosions happen, but stars in these brief, final stages are rare — statistically, it is very likely that none of the 100 billion to 400 billion stars in the Milky Way galaxy are within one year of dying as a supernova, according to the new paper. Read Article: http://www.foxnews.com/science/2017/02/15/baby-supernova-discovery-hints-at-how-star-explosions-are-born.html Please visit Joshua Nahas on his websites, blogs and social media;
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