5.27.2015

Reorg Research: Nortel Reconsideration Motions Focus on ‘Inequitable’ Results, Potential Limits on Guarantee Claims

One of the main focal points of discussions in the distressed world the past two weeks has been the shocking Nortel allocation opinion that moved bond prices precipitously over the past few weeks. So many funds were affected and Reorg has spent many many hours talking with clients and going through the exercise to see how this opinion will affect recoveries, process, etc. 


Last night the U.S. debtors as well as the ad hoc bondholders filed motions for reconsideration of that opinion. I've reproduced the Reorg Research story in full below. Enjoy!

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Relevant Documents:
U.S. Debtors Motion for Reconsideration
Ad Hoc Bondholder Group Motion for Reconsideration
UCC Joinder and Reservation of Rights
NNCC Notes Indenture Trustee Motion for Partial Reconsideration

On Tuesday night, four U.S.-based parties filed motions asking Judge Kevin Gross to reconsider hisdecision in the $7.3 billion allocation dispute that tanked bond prices and left market participants grappling with follow-up questions. The motions for reconsideration all claim that clarification is needed in order to prevent the allocation decision from producing inequitable results. The motions for reconsideration include illustrative lockbox recovery estimates but also focus on the larger legal ramifications of the allocation dispute. Many of the motions take issue with the fact that bondholder guarantee claims against the U.S. estate have been already been quantified and allowed against various U.S. entities, but under the allocation decisions, such claims are not allowed to be factored into the claims pool being asserted with respect to the “pro rata” sharing.

The ad hoc group of bondholders argue against any reading of the plan that does not allow them to assert the full value of their claim against guarantors. The bondholders say this provision would conflict with existing case law on the legal right to assert guarantee claims.

The NNCC bondholders take a different tack entirely, arguing that without substantive consolidation, each debtor estate and its claims pool should be counted independently with respect to the allocation of sale proceeds. The U.S. debtors also support this argument.

All of the motions for reconsideration are scheduled to be heard on June 30 at 10 a.m. EDT, with objections due by June 15 at 4 p.m. EDT.

U.S. Debtors Motion for Reconsideration

The U.S. Nortel debtors say they are “undeniably disappointed” that although the allocation opinion “adopts most (if not all) of the U.S. Debtors’ pivotal factual assertions, it embraces an allocation methodology that is far different from that proposed by the U.S. Debtors and likely leaves its general unsecured creditors with the lowest recoveries … of all three of the Debtor groups.”

Despite this, NNI says, it is not seeking “to rehash these larger issues through this Motion.” Rather, the U.S. debtors say they are merely “seeking clarification and/or reconsideration of a few particular rulings, including ambiguities within the Allocation Opinion” as well as what they characterize as “inconsistencies” with the Canadian opinion. These ambiguities and inconsistencies, the U.S. debtors say, have the effect of “disproportionately and significantly driving down creditor Lockbox recoveries in the U.S. Debtors’ estates as compared to similarly situated creditors of the Canadian and EMEA Debtors, particularly in the context of a pro rata allocation framework.”

Specifically, the U.S. debtors say, implementing the court’s pro rata allocation method using the assumptions of Thomas Britven, an expert witness of the Canadian Creditors Committee, unsecured creditors of the Canadian debtors would see recoveries at 47 cents on the dollar, with EMEA unsecured creditors receiving 48 cents on the dollar. The allocation to U.S. unsecured creditors, on the other hand, would be only 14 cents on the dollar. In a footnote, the U.S. debtors acknowledge that an allowed $2 billion NNI-NNL claim would add an additional 17 cents to these recoveries, but they state that this is still “far lower” than what other similar creditors will receive.

The disparities in recovery amounts, the U.S. debtors say, are “primarily driven by” the exclusion from the U.S. debtors’ allocation claims base of claims made by holders of bonds issued by NNC and/or NNL but guaranteed by NNI, “even though those claims have been allowed against the U.S. Debtors in their full aggregate $3.93 billion amount.”

In order to “avoid these inequitable results, while honoring the spirit underlying the Court’s ruling,” the U.S. debtors seek reconsideration on two issues. The first issue is the impact of exclusion of guaranteed bondholders’ claims in the allocation formula. The second has to do with the NGS/Diamondware allocation.

On the exclusion of guaranteed bondholders’ claims, the U.S. debtors write that the effect of the Court’s decision on this matter “has the effect of severely depressing the amount of Lockbox proceeds available for distribution to general unsecured creditors holding claims solely against the U.S. debtors” relative to allocations made available for creditors holding claims solely against either the Canadian and EMEA debtors.

On the NGS/Diamondware allocation, the U.S. debtors say that the court’s decision not to allocate to the U.S. debtors any of the lockbox proceeds attributable to the sale of NGS and Diamondware is inconsistent with the fact that other debtors have sold “material subsidiaries for substantial sums” but are able to retain the proceeds from such sales. These include, for example, the proceeds from NNL’s interests in LG, which were sold for $242 million, as well as the sale of Netas, an EMEA non-debtor subsidiary, which yielded $83.7 million.

In addition to these two issues on which the U.S. debtors seek reconsideration, they are also seeking clarification on a number of issues. These include:
 
  • Inclusion of U.S. settlements in U.S. claims base;
  • Impact of intercompany claims within debtor groups;
  • Individual debtor allocation;
  • Oversight of U.K. pension claim reconciliation for allocation purposes; and
  • Inclusion of reserve for certain claims.

On each of these issues, the U.S. debtors offer detailed information about the nature of the clarification they are seeking. With respect to the inclusion of U.S. settlements in the U.S. claims base, the debtors seek clarification as to whether claim settlements with EMEA debtors, the U.K. pension claimants, U.S. retirees, and other groups are included in the Court’s reference to “settlements” that are to be incorporated in the allocation measurement. Failing to do so, the debtors suggest, would “unfairly penalize the U.S. Debtors for proactively resolving and paying such settlements.”

On the intercompany claims issue, the U.S. debtors ask for clarification, stating that the court’s reference to intercompany claims being included for purposes of calculating the claim base refers to intercompany claims between debtor groups, not within them. The inclusion of intra-group claims, the U.S. debtors argue, “would artificially inflate an estate’s allocation claims base.”

The U.S. debtors also ask the court to confirm that allocation will be determined on an individual debtor basis, rather than by debtor groups, based on each debtor’s own claims base. This is to ensure that monies allocated to a debtor will be paid to the creditors whose claims formed the basis of such allocation, and not diverted to creditors of other debtors within the same debtor group, an outcome that the U.S. debtors say would be “in contravention of the Court’s rationale for pro rata distribution of Sales Proceeds.”

In a nod to the new importance of the U.K. pension claims, the U.S. debtors also ask the court to “confirm that it will oversee the measurement of the amount of large disputed claims of all Debtors, particularly that of the U.K. Pension Claimants and other claims filed against the EMEA Debtors, and adopt prompt procedures detailing such oversight for purposes of determining how much of the Lockbox should be allocated on account of such claims” (emphasis added)

The debtors note that the court itself acknowledged in its allocation opinion that an “inflated” claim by the U.K. pension claimants “would, of course, skew a pro rata allocation and destroy the equitable allocation method.” While the U.S. debtors say they do not expect the court to assert jurisdiction over the determination of the ultimate amount of the pension claimants’ allowed claim against the EMEA debtors, there is nonetheless “no question” that the court can determine the “reasonable amount of such claim” for purposes of measuring how much of the lockbox proceeds should be allocated to the EMEA debtors. The U.S. debtors note that the pension claimants have “asserted a significant and seemingly over-inflated $3 billion claim against NNUK and each of the other EMEA Debtors.”

Because the allocation opinion “‘rewards’ Debtors based on their allowed claims,” the U.S. debtors argue, it disincentivizes any debtor from “challenging inflated claims of its own creditors that it would otherwise be inclined to reject.” This concern is especially heightened in regard to the EMEA debtors, given that they have not commenced their formal claims process. Furthermore, the allocation opinion offers “no guidance” as to how and when the U.K. pension claims can be challenged, but only seeks proposals in this regard. The U.S. debtors ask that the opinion be clarified to “include and ensure” adequate protection against claims inflation for allocation. The U.S. debtors further request that the court clarify that the EMEA debtors cannot avoid such court oversight by “privately agreeing to the claimed amount so as to avoid characterizing them as ‘disputed claims’ for purposes of the Court’s ruling.”

Finally, the U.S. debtors ask the court to confirm that it will permit them to receive an allocation in respect of reserved and estimated amounts of claims that arise “solely as a result, and therefore subsequent to, an actual allocation of the Sales Proceeds.” These claims “particularly include” claims for taxes that may arise against the debtors on the basis of the actual allocation and release of lockbox proceeds to the U.S. debtors, the motion states, and therefore cannot be made at this time.

The U.S. debtors state that while they have “identified various other aspects of the Court’s decision that could be subject to further argument or appellate review,” they are raising these issues “because of their potentially serious detrimental effects on the U.S. Debtors even within the context of a pro rata approach.”

The U.S. debtors note that the court wrote in its own ruling that “NNI is entitled to a greater share of the Sales Proceeds” due to the fact that it “generated the lion’s share of enterprise-wide revenues.” The court further expressed its belief, the motion states, that its modifications to the pro rata approach would ensure that the U.S. debtors received such a greater share of the proceeds, because that share was “already baked into the case” by virtue of the $2 billion NNI-NNL intercompany claim. Unfortunately, the U.S. debtors argue, the modified pro rata methodology the Court has created “has the opposite impact.” In fact, the motion notes, the court’s methodology “dramatically reduces” U.S. creditor recoveries “to a fraction of the amounts advocated by even the Canadian Debtors and the CCC.” Meanwhile, the EMEA debtors stand to receive lockbox proceeds “significantly in excess of not only the allocations proposed by the U.S. Debtors and the Canadian Debtors, but by the EMEA Debtors themselves.”

Under the court-created pro rata allocation, the U.S. debtors calculate that total recoveries will be as follows:
 
  • 40% for U.S. unsecured creditors
  • 49% for Canadian unsecured creditors (a percentage of their deficiency claims, the debtors note, adding that “many Canadian retirees are already receiving in excess of 70% of their pension claims” as a result of funds within their pension plans or governmental support)
  • 65% for EMEA unsecured creditors
  • 89% for the guaranteed bondholders

These projected recoveries, however, include “more than just the results of the Sales Proceeds allocation and therefore tell only part of the story,” the U.S. debtors say. Given that the pro rata methodology established by the court is intended to divide the lockbox proceeds pro rata for ultimate distribution to creditors, rather than ensure that the total distributions to creditors are made pro rata, whether a particular creditor ultimately receives a greater recovery depends on “factors unique to each Debtor estate,” such as a debtor’s pre-existing cash, allowed intercompany claims, distributions on guarantees and other local law priorities and requirements.

Noting that the court’s pro rata method “only applies to the division of the Lockbox, nothing more or less,” the U.S. debtors conclude that “it would seem that the Courts did not intend that the modified pro rata allocation penalize Debtor groups based on their relative cash or other assets by counting them against their respective allocations.”

For these reasons, the U.S. debtors say, they are seeking the proposed modifications and clarifications to the allocation opinion: “as drafted, neither the Allocation Opinion nor the Canadian Allocation opinion even approaches its intended result: an equitable, pro rata allocation of the Sales Proceeds based on allowed creditor claims,” the U.S. debtors argue.

Even given the corrections and clarifications, they continue, U.S. creditor recoveries would still be “far below the amounts that would logically follow” from the court’s interpretation of the MRDA. “The U.S. Debtors continue to firmly believe that the U.S. Debtors’ ownership rights in the assets sold entitle them to Lockbox proceeds well in excess of the amount that would be awarded under any pro rata approach.”

However, the motion concludes, “the U.S. Debtors recognize and share in the interest in bringing these cases to conclusion and to getting money into creditors’ hands and hope that reconsideration and clarification will achieve this result.”

Ad Hoc Bondholder Group Motion for Reconsideration

The ad hoc bondholder group filed a separate motion for reconsideration, seeking clarification that the allocation decision “did not intend to limit the claims that Bondholders are entitled to enforce against NNI, as guarantor, in any subsequent distribution of assets by the U.S. Debtors’ estates in light of the Court’s statement that ‘[a] claim for the shortfall can be recognized by the Estate that guaranteed the bond.’”

The motion notes that the scope of the bondholders’ guarantee claims is the sole issue for which it seeks “clarification and, if necessary, modification” because the allocation decision is “at best, ambiguous in its meaning and intent.” The ad hoc bondholder group adds that “[o[nly by addressing this issue, which is ambiguous in both the Allocation Opinion and Allocation Order, will the record accurately reflect the intent of this Court with respect to this critical question.”

At the same time, if the court intended to limit the bondholders’ guarantee claims to a “‘shortfall’“ and not permit bondholders to assert the full amount of their guarantee claim against the U.S. debtors, the motion argues that reconsideration is appropriate because “[s]uch an outcome would conflict with this Court’s prior orders, binding case law, and the stated purpose of the Court’s Allocation Decision.”

In support of its alternative request for reconsideration, the ad hoc bondholders point out that the court has “already allowed the full amount of Bondholders’ guarantee claims against NNI”  in the amount of nearly $4 billion, which represents “the full principal amount of Bondholders’ claims, plus accrued prepetition interest.” The motion adds that “even if this Court ignores its prior order, it could not limit Bondholders’ guarantee claims to just the ‘shortfall’” based on case law, in particular the Supreme Court’s 1935 ruling in Ivanhoe Building & Loan Association v. Orr, which provides that “a creditor may assert the full amount of its claim against a debtor regardless of payments received on account of collateral held by other parties, so long as the creditor’s recovery does not exceed 100% of its claim.”

The ad hoc bondholders maintain that, under Ivanhoe, they are “are entitled to assert the full amount of their claim—the full principal outstanding under the Bonds, plus accrued prepetition interest (i.e., the amount allowed, without any objection, under the 9019 Order) - regardless of any recoveries obtained from NNL or NNC as primary obligors.”

Finally, the ad hoc bondholder group argues that, regardless of the court’s prior orders and precedent, “the size of Bondholders’ claims against NNI after an allocation is made to each of the Nortel Debtors’ estates is not an allocation issue at all, but rather an issue of distribution.” Reinforcing this point, the motion asserts that the allocation litigation “dealt solely with the allocation of certain assets to estates; it had nothing to do with the fixing or modification of creditor claims or dictating how distributions would be made to creditors.” The ad hoc bondholder group points to the court’s position expressly set forth in the allocation decision that it “‘is not ordering a distribution scheme’” but instead “‘directing an allocation among the Estate for the Estates to distribute in an appropriate manner.’”

Because, according to the bondholders, “modification” of the their claims was “clearly outside the scope of the Allocation Litigation,” the motion asks the court to “clarify its order to state clearly that it did not intend to increase or decrease the value of creditors’ claims.”

UCC Joinder With Reservation of Rights

The UCC argues that reconsideration of the allocation decision is warranted “to prevent manifest injustice to U.S. general unsecured creditors [] and to correct clear legal error,” adding that while the court “decried the ‘extreme allocation proposals of the various debtors,” its proposed methodology “potentially leads to a result for U.S. GUCs that is even more ‘extreme’ than the Canadian and EMEA Debtor Groups had advocated” (emphasis added).

In its motion, like other movants, the UCC stresses that the allocation trial “was to be about allocation of assets, not about determination of claims, and accordingly the parties did not present the Courts with a complete factual record regarding the scope or complexities of their claims.” Considering the nature of the allocation trial, the UCC maintains that the court “could not have apprehended that its methodology would have extreme consequences, and would not represent a middle ground approach, or that the decision potentially causes disproportionate harm” to the U.S. GUCs.

The UCC notes that assuming both that “the figures in the publicly-available Britven exhibits, and that the Crossover Bond claim in the U.S. is not taken into consideration for allocation purposes,” both of which are assumptions with with the UCC disagrees, the motion notes that the bankruptcy court’s methodology “produces an allocation of 11% of the Lockbox proceeds to the U.S., 66% to Canada, and 23% to EMEA.” This allocation result, the motion argues, is not “‘fair and equitable’” and instead “results in particularly acute, and respectfully, unreasonable and inequitable damage to U.S. GUCs.” The UCC’s illustrative allocation is reproduced below.
 

The UCC takes issue with the court’s proposed methodology when compared with the proposals by the Canadian Monitor and the EMEA debtors, especially in light of the court’s comments on such. Ultimately, the motion charges that the court’s proposed methodology “would give extremely little to the U.S. Debtors, which magnifies the harm to ordinary U.S. GUCs after the payment of priority and administrative claims, the significant erosion of treasury cash during these proceedings, and the massive dilution from the Crossover Bonds’ guarantee claims.” As a result, the UCC argues, U.S. GUCs “would recover far less than the GUCs in Canada and EMEA.”

The UCC also joins in the motion for reconsideration filed by the U.S. debtors, noting the “ambiguities inherent in the Court’s methodology.” From the U.S. debtors’ motion, the UCC focuses on the court’s “reference to the ‘shortfall’ that the holders of Crossover Bonds will have, for purposes of calculating the amount of claims against the U.S. Debtors and then calculating allocation.” The UCC also asserts that the court must clarify “that settled claims are included when calculating the amount of ‘allowed claims’ against each Debtor.”

NNCC Notes Indenture Trustee Motion for Partial Reconsideration

Law Debenture Trust Company of New York, as trustee for the NNCC notes, moved for partial reconsideration of the allocation decision, seeking clarification that “NNCC is recognized as a separate and distinct entity from the rest of the U.S. Debtors” and that “each of the U.S. Debtors - including NNCC - will be entitled to a separate and distinct allocation of Lockbox funds.” In support of its clarification request, Law Debenture cites the court’s findings that “there will be no substantive consolidation - partial, geographic, or otherwise - and that intercompany claims will be recognized[.]”

The motion also seeks correction or clarification of an apparent typographical error, citing the court’s use of “NNC” in two instances and suggesting that the court likely intended to reference “NNCC” in those instances.

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4.01.2015

Breaking: Hayman Capital Targets Shire in Next Pharma Battle

This evening, Hayman Capital through the entity "Coalition For Affordable Drugs" filed a petition for Inter Parties Review on a patent controlled by Shire PLC. Importantly, the patent in question supports Shire's very profitable drug  LIALDA, which according to Shire's most recent investor presentation generated $634 million in sales in 2014, up 20% year over year.

Shire has initiated infringement cases concerning Patent #6773720 on numerous occasions over the past few years against generics that target the same health conditions in which LIALDA is prescribed to treat.

Hayman Capital has been in the news over the past four months with its plans to target big pharma over patents. Here are a sample of a few stories:

  • http://www.reuters.com/article/2015/01/07/pharmaceuticals-haymancapital-idUSL3N0UM42O20150107
  • http://www.businessinsider.com/kyle-bass-files-first-ipr-petition-2015-2
  • http://www.ft.com/cms/s/0/a2a706a0-969c-11e4-922f-00144feabdc0.html
Sources indicate that Hayman has raised a dedicated fund for such effort.

To review the IPR petition, you can view it here: Hayman Targets Shire

I personally find this form of activism FASCINATING. The IPR process that Hayman is employing really is on the cutting edge of the intersection of law and finance. IPRs are a very new animal in the world of patent law and I think this is a tool many funds and activists will use down the line given the relatively low cost to file them - and I truly don't think pharma will be the sole target. Every industry really is at risk at this point.

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Update: Hayman targeted a second patent tonight (7056886) owned by NPS Allelix. Shire announced the acquisition of NPSP in January (http://www.shire.com/shireplc/en/investors/irshirenews?id=1052).


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2.24.2015

Reorg Research Job Posting: Covenant Analyst

Reorg Research is hiring a number of Covenant Analysts who are experts in high yield bank and bond financings. The ideal candidate would have several years of experience working in a credit, financing or securities group at a major law firm. In addition to having spent time at a law firm, top candidates may also have experience in investment banking or in a credit research/investment function with a focus on loan agreements and indentures.

The Covenant Analyst will work closely with our team of in-house experts (from both legal and financial backgrounds) and will be responsible with the rest of the team for producing research, analysis and reporting on covenants and credit documents. The team of Covenant Analysts will also be working with our technology team to envision best-in-class technology offerings and solutions to help our clients in their day to day work flows.

An ideal candidate will have the following:

  • JD with a strong academic record.
  • 3+ years of experience involving high yield financings and a deep understanding of debt covenants.
  • Experience drafting and analyzing loan agreements and indentures.
  • A proven ability to multi-task and work both independently and as a team player in a fast-paced environment with people from varied professional backgrounds.  

This is an exciting position for anyone who is looking to transition to a new career at a rapidly growing provider of research and intelligence for the investment community. The candidate will work out of our New York City offices.

Interesting candidates can send their resumes to recruiting [at] reorg-research.com

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1.27.2015

iGlobal Forum's Sixth Global Distressed Investing Summit

iGlobal Forum will host its sixth Global Distressed Investing Summit on Feb. 4. As with years past, the conference has a stellar line up of panels and panelists to discuss the current trends and issues facing the distressed debt universe. The summit will take place on Feb. 4 at the Park Lane Hotel in New York. Senior representatives from distressed funds, private equity firms, advisors, and ratings agencies will be attending. Reorg Research will be in attendance,

Bruce Richards, CEO and founding partner of Marathon Asset Management will be the keynote speaker at the event. Aside from the keynote interview, which will be titled “Where in the Cycle are we?” the topics of the scheduled panels are:

  • Exploiting the Distress in Energy-Related Credits
  • Profiting from European Distressed Opportunities
  • Examining the Potential for Distress in the Retail Sector
  • Unlocking Opportunities in Puerto Rico and Other Emerging Markets
  • Examining the State of the Re-Financing Markets

Additionally, there will be two roundtables titled “Profiting from Financial Liquidations” and “Opportunities in Distressed Real Estate.” Other speakers include professionals from firms such as KKR Credit, HSBC, Citibank, Schultze Asset Management, Archview Investment Group, Raith Capital Partners, GLC Advisors, Blackstone, Apex, Centerview Partners, Eyck Capital, BB&T Capital Markets, Siguler Guff & Co., Maglan Capital, Deutsche Bank, Bowery Investment Management, Guggenheim Partners, PMD Capital, Versa Capital Management, Schulte Roth, WAMCO, Orrick Herrington and Sutcliffe, Weil Gotshal, Alumcreek HOldings, Marathon Asset, Alcentra, Halcyon and HIG Capital.

For more information visit the 6th Global Distressed Investing Summit page. http://www.iglobalforum.com/6dd.html 



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1.20.2015

2015 Wharton Restructuring and Distressed Investing Conference Taking Place in New York

The Wharton Restructuring and Distressed Investing Conference is always one of the best conferences of the year. This year’s theme is “Signs of Distress? Looking Past the Current Market Cycle.” This conference is always a valuable source of insight and networking opportunities for distressed debt and restructuring professionals. The conference will take place on Feb. 27 at the Pierre Hotel in New York.

The keynote speakers this year are Bennett Goodman of GSO and former Treasury Secretary Robert Rubin, who is now at Centerview. As usual, there will also be a number of panels that are sure to provide interesting and valuable insight on a number of topics. The panel topics are:

  • Distressed Private Equity
  • Legal Restructuring: Distressed Acquisitions in Chapter 11
  • Financial Restructuring
  • Distressed Hedge Fund
  • Operational Restructuring

The legal restructuring panel features several well-known experts, including Judge Shelley Chapman, a bankruptcy judge in the Southern District of New York.

Reorg Research is happy to be a media partner for the event and will be in attendance. For more information, please visit the conference home page here: Wharton Restructuring and Distressed Investing Conference.

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hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.