Should vulture investors be required to act in “good faith” with their opponents?


Hedge funds, private equity groups and their lawyers are not known for their inherent spirit of generosity. Could the judiciary tie goodwill, serious or otherwise, to the typically bloodthirsty titans of Wall Street?

In recent years, participants in the leveraged buyout and distressed debt markets have increasingly engaged in ugly battles over portfolio company restructuring. The usual problem is that a group of stakeholders try to seize collateral or get priority repayment in a struggling business that their rivals believe is theirs.

Disputes end up in court and often require a judge to rule on some arcane part of a leveraged loan deal or high yield bond contract. At a time, however, when these contracts are free of covenants and have given borrowers substantial flexibility, private equity firms have engineered complex, value-snatching deals that, unsurprisingly, have gone mostly unpunished. .

Judges are tasked with making decisions based on what lies strictly within “the four corners of the document.” And a prevailing view is that if victims of an asset transfer or refinance don’t like how it worked out for them, they should have negotiated for a stricter document from the start.

Yet market participants and academics worry that increasingly litigious troubled debt markets are reaching a breaking point where the constant wave of deal disputes could be commercially, if not socially, destructive.

In a notable March ruling, a federal court in New York refused to dismiss a lawsuit against Serta mattress maker Simmons Bedding brought by LCM, a credit investment firm that owed $7 million in Serta loans. . Serta, in 2020, had raised $200 million in rescue funding.

The machinations behind this financing led a minority group of lenders, including LCM, to believe that the terms of their loan agreement regarding the addition of more senior debt had been breached. The judge allowed the LCM case to proceed first because the disagreement over what the wording of the contract allowed was compelling enough for further investigation.

But more intriguingly, Judge Katherine Polk Failla clung to another allegation by LCM, that Serta had restructured its debt in a way that violated the so-called “implied covenant of good faith and fair dealing.” In other words, the restructuring was so contrary to the spirit of the original agreement between Serta and LCM – the investor had negotiated to be in the highest debt category – that even if there was no strict contractual default, debt restructuring could always be found legally abusive.

“Indeed, one could reasonably conclude from the plaintiffs’ allegations that the defendant systematically combed through the agreement, tweaking every provision that apparently prevented him from issuing a tranche of senior debt, thereby turning a previously prohibited transaction into a authorized transaction”, wrote Failed.

The doctrine of good faith has existed for at least a century. Judges, however, have been reluctant to use it given that it requires them to pass judgment on a defendant’s state of mind. Rather, it is easier and perhaps more legitimate to examine the words written on the pages of a contract.

A lawyer said plaintiffs only add an allegation of bad faith to their lawsuits at the end when they have exhausted substantive arguments. But the creativity if not malevolence that now pervades corporate credit markets has left the judiciary struggling to keep up with the latest diabolical structures concocted by Wall Street. Pushing actors to restrain their worst instincts may now be the remaining option.

Serta’s financing transaction has become known as a “senior exchange” in which a slight majority of creditors offer new financing to a borrower while only those creditors’ debt is simultaneously exchanged for higher priority debt. high. In a sense, there may not be sympathetic victims to these agreements.

Companies are pitting one set of creditors against another to get the best possible terms on new funds. Creditors themselves are sophisticated and well-represented — all major asset managers and law firms are players in this market. warning emptor should be the dominant philosophy.

Still, the idea that a group of loan or bondholders could surreptitiously alter legal documents to pickpocket their brethren – a practice colloquially referred to as “creditor beating” – has rattled even Wall’s jaded fighters. Street. Judges with a broader sense of justice may be offended enough now to stray from what has traditionally been a highly technical task of analyzing contract language, which New York law allows.

[email protected]


About Author

Comments are closed.