Wednesday, May 28, 2014

LightSquared dispute may be resolved by a global restructuring, through mediation

The press reports that the LightSquared dispute has been sent to mediation.  Per Reuters, there is talk of a global restructuring that would require new financing, but details have not been disclosed concerning terms of a deal or the origin of new financing.

This is the latest news in the LightSquared case.  I have been getting a lot of questions about the events leading up to it, including what happened during the May 8, 2014 hearing before Judge Chapman...

I went down to the courthouse that day to observe.  There was much excitement in the courthouse on May 8 because the hearing followed weeks of trial.  The hearing lasted for over 4 hours while Judge Chapman read a series of rulings into the record concerning the treatment of Charlie Ergen's purchased claims.  Ultimately the Judge decided not to confirm a chapter 11 plan and to send the parties to mediation - even though she was none too pleased by Charlie Ergen's allegedly sharp dealings.

Below is an article I worked up concerning the implications of the LightSquared rulings on claims trading.

It is only because claims can be bought and sold that Charlie Ergen's company was able to get into the capital structure of LightSquared as it did.... And we are seeing more investors buying into bankruptcy cases lately, including the Carlyle Group, which is associated with investments in success, not investments in bankruptcy-related distress.

The article is still in draft form, a work in progress based on what was explained during the May 8, 2014 hearing and not on the very voluminous filings that preceded.  Comments and questions are welcome, by claims traders and others who may be interested in reviewing a transcript of the court's ruling.

Bankruptcy Court for the Southern District of New York Rules that Equitable Subordination of Debt Purchaser’s Claims is Warranted, Yet Refuses to Confirm Proposed Chapter 11 Plan over Debt Purchaser’s Objections

On May 8, 2014, the United States Bankruptcy Court for the Southern District of New York handed down highly anticipated bench rulings in the bankruptcy proceedings of LightSquared Inc., et al. (Chapter 11 Case No. 12-12080).  The Court determined that it would be appropriate for the claims of SP Special Opportunities, LLC (“Special Opportunities”) to be equitably subordinated to some extent, but that the debtors could not confirm a Chapter 11 plan over Special Opportunities’ objections.  The Court’s rulings with respect to treatment of the purchased claims are noteworthy insofar as they show the consequences of conduct allegedly rising to the level of breach of the duty of good faith and fair dealing are not necessarily as severe as claim disallowance or disenfranchisement from voting down a chapter 11 plan.

I. Facts

The Court’s ruling arose in the context of a dispute between Phil Falcone, founder of  LightSquared and Harbinger Capital Partners, and Charlie Ergen, the Chairman of the Board of Dish Network and Echostar Communications who had acquired LightSquared debt through Special Opportunities.  Over time, Ergen acquired nearly $1 billion of LightSquared’s prepetition debt.  Meanwhile, Dish Network made a bid for LightSquared’s assets, which it subsequently withdrew citing a technical issue.

LightSquared brought an adversary proceeding against Special Opportunities, Dish Network, Echostar Communications and Ergen, seeking relief including disallowance and equitable subordination of claims based on the acquired debt.  Conduct complained of included alleged sharp dealing by Ergen such as secretly buying up LightSquared debt that Dish Network was precluded from acquiring directly and delaying related trades.

LightSquared also tried to designate Special Opportunities’ vote and force confirmation of a Chapter 11 plan that would separately classify Special Opportunity’s debt and pay it out over the course of seven years under third lien notes providing for PIK at 12%, whereas other creditors similarly situated were to be paid out in cash.

Special Opportunities objected to the proposed treatment, which reportedly would have left Falcone’s company with at least a 35% stake in LightSquared.

II.  The Bankruptcy Court’s Decision

On May 8, 2014, United States Bankruptcy Judge Shelley C. Chapman, who is presiding over LightSquared’s Chapter 11 proceedings, gave guidance on these and related issues argued by the parties during weeks of trial.  The Court concluded that equitable subordination of Special Opportunities’ position to an extent to be determined was appropriate.  However, the Court refused to confirm the proposed Chapter 11 plan on a nonconsensual basis for reasons including that valuations underpinning the plan were speculative due to the need to obtain certain FCC approvals.  The Court gave the parties two weeks to come up with a deal both with respect to the extent of the subordination of Special Opportunities’ position and a plan, or be sent to United States Bankruptcy Judge Robert D. Drain for mediation.  The Court’s ruling was delivered from the bench over several hours, and is complicated.  Key aspects are discussed here, and we welcome further inquiries.

Claim Disallowance

The Court declined to disallow the claim based on Empresas Cablevisión, S.A.B. de C.V. v. JPMorgan Chase Bank, N.A., 680 F. Supp. 2d 625 (S.D.N.Y. 2010), a ruling by the United States District Court for the Southern District of New York arising under somewhat comparable circumstances though a different procedural posture.  In Empresas, the District Court enjoined banks from selling a participation interest in their loans to a Mexican telecommunications operator to a bank indirectly controlled by an individual who controlled the borrower’s primary competitor.  In LightSquared, while the Court was willing to accept that Special Opportunities’ conduct in connection with acquiring debt Dish Network could not acquire directly was a violation of spirit of the underlying credit agreement, the Court concluded that claim disallowance by the debtors was not an appropriate remedy. 

Equitable Subordination

Although the Court declined to impose claim disallowance as a remedy, the Court concluded that equitable subordination was appropriate based on alleged obstructive behavior such as Ergen’s delays in closing debt trades.  The Court invoked the seminal Mobile Steel case, which sets forth a three-part test for equitable subordination of claims: (1) the claimant must have engaged in inequitable conduct; (2) the misconduct must have resulted in injury to creditors of the debtor or conferred an unfair advantage on the claimant; and (3) equitable subordination must not be inconsistent with the provisions of the Bankruptcy Act, the predecessor to the Bankruptcy Code. In re Mobile Steel Co., 563 F.2d 692, 700 (5th Cir. 1977).

The Court left the extent of subordination for a later stage in the adversary proceeding, noting that there was not a basis for limiting Special Opportunities’ position to the purchase price of acquired debt as this would not be consistent with the requirement that subordination be to the extent of harm to creditors.

Vote Designation

After determining that Special Opportunities’ position in the case would be subordinated to some extent, the Court moved on to plan confirmation and, in that context, refused to designate Special Opportunities’ vote or cram a plan down over its objections.  In arriving at the conclusion that designation was not warranted, the Court looked to LightSquared founder Falcone’s behavior, which allegedly included telling prospective bidders for LightSquared’s assets that Ergen was buying up debt in order to drive up values.

III.            Potential Implications for Acquisitions of Distressed Debt

LightSquared is an unusual case insofar as it presents a “clash of the titans.”  The recent rulings reflect the broad discretion that bankruptcy judges enjoy in crafting remedies that try to strike a balance between rights of acquirers of distressed debt to act in their own self interest and the rights of other creditors who may be harmed by disruption of the Chapter 11 process. 

The LightSquared rulings reflect the state of the art in law concerning risks borne by acquirers of distressed debt.  Certain risks can be addressed by advance planning, including the careful documentation of trades.  We will continue to follow the case and provide updates.

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