Reorg Research Coverage of Rescap PSA

Because of Reorg Research's technology, our subscribers will be among the first to receive and review bankruptcy dockets in a litany of cases. Likewise, our reporters, analysts and I have first mover advantage in analyzing key documents in cases. We put out stories on developments in bankruptcy cases, whether for new docket filings or for court proceedings, before other services on the market. And I take pride in the depth of our analysis, about which we've heard unanimously positive feedback.

Here is our piece on Rescap's PSA that was filed shortly after the PSA hit the docket. Enjoy!

Ally Agrees to Pay $2.1B in ResCap Settlement

Residential Capital’s former parent Ally Financial agreed to pay a maximum of $2.1 billion in order to free itself from potential litigation after ResCap’s bankruptcy process has been completed.

ResCap filed the previously announced plan service agreement, the “global agreement”, the former mortgage servicer reached with Ally and multiple constituents after months of negotiations.

Ally will increase its contribution to the ResCap’s estate by $1.35 billion over the amount agreed to in the PSA to a total of $2.1 billion comprised of:

  • $1.95 billion in cash
  • $150 million from a settlement between Ally and its insurers (paid no later than Sept. 30, 2014), for any Director and Officers or Errors and Omission claims
The Ally Contribution, per the PSA term sheet, is capped at $2.1 billion. In exchange Ally will receive, among other things, ResCap releases and third party releases in favor of Ally. The releases do not release any claims against Ally held by the FDIC.

The contemplated plan provides for partial consolidation (for distribution purposes only) of ResCap’s estate into three groups (1) The ResCap debtors (which includes the holding company, GMAC Residential Holding Company, LLC, and GMAC-RFC Holding Company, LLC), (2) the GMAC Mortgage debtors (includes GMAC Mortgage, LLC and its direct and indirect subsidiaries), and (3) the RFC debtors (which include Residential Funding Company, LLC and its direct and indirect subsidiaries.) Plan distributions will be funded by a combination of $4.5 billion in proceeds from previous asset sales, assets remaining in the estate, the Ally contribution with certain security litigants and borrowers receiving distributions through three trusts.

Key points from the PSA also include that the creditors’ committee and supporting parties will support a partial paydown of no less than $800 million of the 9.625% junior secured notes due 2015 secured claim, provided that Ally is paid prior to any such paydown of the JSN secured claim in cash in full satisfaction of the outstanding Ally loan. The PSA term notes that the “Plan will provide payment in full on the Effective Date of the allowed prepetition claims of the

Junior Secured Noteholders” and that “The Plan will provide that the Junior Secured Noteholders are undersecured and not otherwise entitled to payment of any post-petition interest."

Also party to the settlement, Paulson & Co. may not seek to terminate this agreement if Wilmington Trust ceases to be a party to it.

The breakdown of the distributions to unsecured creditors is as follows:
  • Holders of allowed private securities claims will get their share of $225.7 million
  • Holders of allowed borrower claims share $57.6 million
  • Holders of allowed NJ carpenters claims share $100 million
  • Allowed estate unsecured claims at ResCap debtors get their pro rata share of available unsecured assets totaling $752 million
  • Allowed estate unsecured claims at the GMACM debtors share in $600 million
  • The allowed estate unsecured claims at the RFC debtors receive unsecured assets valued at $789.6 million
A Liquidating Trust will be established: Assets of this trust will include the Ally Contribution and Rescap’s remaining assets. From the term sheet: “Holders of allowed unsecured claims and the Private Securities Claims Trust will receive units of beneficial interests in the Liquidation Trust (“Trust Units”),allocated in accordance with the treatment under the Plan and the Allocation Percentages set forth on Annex I.

Of particular note, the senior unsecured notes claim recovery will be $351.4 million versus an allowed claim of $1.003 billion.

The plan shall provide for the allowance, priority, and allocation of the monoline claims, as follows:
  • MBIA claims fully and finally allowed as non-subordinated unsecured claims of $719 million against the ResCap Debtors, $1.45 billion against the GMACM debtors, and $1.45 billion against the RFC debtors.
  • FGIC claims shall be fully and finally allowed as non-subordinated, general unsecured claims in the aggregate amount of $596.5 million. The settlement and release of FGIC’s ResCap-related insurance indemnity obligations pursuant to the FGIC Settlement Agreement shall be approved by the bankruptcy court, by separate 9019 motion, and by the FGIC Rehabilitation Court
Conditions of the plan include court approval of the disclosure statement and the RMBS Settlement, a preliminary hearing for which takes place today. In addition, a termination even includes “the Examiner’s Report is disclosed to any party on or before the Bankruptcy."

Court enters the PSA Order;” From the PSA Term Sheet “The Examiner Report shall be sealed through and including the earlier of (a) the date the Bankruptcy Court approves the Plan Support Agreement, and (b) July 3, 2013, provided that if the Plan Support Agreement is terminated, the Examiner Report may be filed publicly the next Business Day after the effective date of such termination.”

PSA milestones include:

    July 3 - deadline to file plan and disclosure statement, receive court approval of the PSA

    Aug. 19 - court approval of a settlement agreement with FGIC and RMBS trustees

    Aug. 30 - approval of adequacy of disclosure statement

    Earlier of 30 days post-confirmation order and Dec. 15- plan effective date

Prior to the closing of ResCap’s court-approved asset sales, the company and its non-debtor affiliates operated the fifth largest mortgage servicing business and the tenth largest mortgage origination business in the U.S., according to the company description in the PSA.

For those looking for more information on Reorg Research and our product offerings, here is a direct link to our trial request: http://www.reorg-research.com/trial_signup.php . You can also reach me at hunter[at] distressed-debt-investing [dot] com for additional questions



Emerging Manager Series: Bowery Investment Management

Over the last few months, we have profiled a number of managers sub $250 million of assets that I have come to meet through various channels. I met Vladimir Jelisavcic over 5 years ago when he was co-portfolio manager at Longacre. He has always impressed me with his incredible analytical abilities and knowledge of the trade claims market where he is regarded as one of the most prominent players out there. This is an incredible interview. For more information on Bowery, you can visit their website here: http://www.boweryim.com/

Could you please give us a brief run down on your background?

I received my BS from NYU in 1987 and my JD from the University of Iowa in 1993. After graduating from law school, I began working at Bear Stearns trading distressed claims and loans where I became a Vice President. In 1998, I left Bear to found Longacre Fund Management with 2 partners, also from Bear. We ran Longacre from 1998 to 2012, where I served as co-portfolio manager, building assets from $1 million to $2.7 billion. In 2012, when my partners and I decided to return capital to Longacre investors, I founded a new firm called Bowery Investment Management where I continue to manage the Opportunity Strategy. In all, I have been in the distressed debt investment business for 20 years.

How has the investment strategy for Bowery evolved over time, or how is it different from previous iterations?

Longacre’s strategy was a fundamental, bottom-up, value-driven approach to distressed debt investing. We could invest up and down the capital structure in bank debt, bonds, trade claims and some reorganized or leveraged equities. By mandate we could invest up to 20% of the capital managed in trade claims. The Bowery Opportunity Strategy takes a similar approach to distressed debt investing but with a greater focus on niche assets. The Bowery Strategy allows us to invest in less liquid assets where we think there are better return opportunities. We focus on overlooked or underfollowed capital structures, smaller companies and issuances, and can invest up to 50% of our capital in trade claims. Bowery also focuses more heavily on risk management and volatility control than did Longacre, taking a systematic, top-down approach to hedging.

Vlad, you are well known in the distressed space as an expert in analyzing and investing in claims. Can you talk about how that market is changing and where you see it going in the future?

Trade claims are one of the purest forms of distressed debt investing and a natural byproduct of the bankruptcy cycle. During and immediately following the financial crisis, we saw an abundance of claims available for purchase at attractive prices, as creditors desperately needed liquidity. Now, with default rates at an all-time low, the claims market is less robust than it was 4 or 5 years ago and many of the largest bankruptcies (Lehman, Madoff, etc.) are finally distributing what assets remain in their respective estates. That being said, there are still plenty of opportunities to purchase claims if you know where to look. Large companies such as American Airlines, MF Global and Eastman Kodak have all filed for Chapter 11 within the last two years. A number of smaller companies have recently filed or soon will file, which will further improve supply. Moreover, having an in-house sourcing team, as Bowery does, allows us to locate untapped creditors and smaller counterparties which our counterparties cannot.  While the popularity of claims investing continues to rise among hedge funds, most transact in the largest “on-the-run” cases like Lehman, unwilling (or unable) to devote the time and resources to smaller cases. When interest rates rise, so should the number of new bankruptcies, which will give firms with experience buying claims, like Bowery, an edge in finding attractive opportunities.

You launched the Opportunity Strategy very near the end of the crisis period of 2009. Can you talk about investing then versus the current market environment?

2009 represented a historic market dislocation, and there was an unprecedented amount of distressed assets available for bargain prices. We didn’t have to look very hard to find attractive investment opportunities. Now, the opportunity paradigm has shifted as US companies’ corporate balance sheets are strong and persistent monetary policy intervention suppresses interest rates. Distressed capital is concentrated in the same few troubled names (Lehman, TXU, etc.), but there are plenty of smaller companies in distress, as well. In order to differentiate ourselves from other investment managers (and old Longacre), we focus on mid-market companies whose capital structures are too small for many of our distressed debt peers to build meaningful positions. This requires us to be more creative in sourcing opportunities, but this is what distinguishes the Bowery team. We especially like counter-consensus themes, such as old-media, European financials and shipping. Since we consider ourselves process experts, we can apply the same fundamental analysis to a company worth $100 million or $10 billion. Our method in 2009 versus now is the same, we just cast a wider net now, focus on the underfollowed names, and are more cognizant of the political and macroeconomic landscape.

Bowery has $125 million in assets under management yet it has invested in many of the well-known names targeted by megafunds and still managed to outperform the DJ-CS Distressed HF Index. What are the advantages and/or difficulties a smaller investment manager has compared with larger managers?

Over the last 5 years, assets in the distressed debt space have become ever more concentrated. The large investment managers have gotten larger and the largest have gotten super-sized. There are certainly advantages to this for these managers—scale, pricing power, coverage, perceived safety. But, this has also hindered their ability to access some of the most attractive opportunities in the form of smaller companies or issuances. In such cases, the large managers can’t source enough product to create a meaningful position in their portfolios that will “move the needle,” or in doing so they will move the market on the way in and out. This leaves many opportunities undiscovered which of course works to our benefit as a smaller player since it allows us to source a significant amount of product for our portfolio at an attractive price. Not only do these opportunities enhance returns, but they allow us to differentiate our book from those of our peers. A great example of this is the Tribune bankruptcy. Most distressed debt managers bought securities of the holding company, which there were plenty of. Bowery bought the trade claims of the operating companies of which there were only $80mm outstanding, inaccessible (or irrelevant) to larger managers. We started buying the claims at 40 cents on the dollar and received a par recovery
Can you talk about your investment process? How does an idea go from being a potential investment to become a portfolio holding?

Our investment process is a time consuming and rigorous approach, but one which has historically generated significant alpha. The process starts with the idea generation phase. Ideas are derived from weekly team meetings, buy and sell side relationships, news runs and bankruptcy filings, all viewed through a macroeconomic and thematic lens. We focus on finding unique, underfollowed opportunities with significant asymmetric return potential. We rely on our extensive industry contacts and market experience to source and vet only the best opportunities. Next we perform a deep, fundamental research analysis of the company, financials and industry in conjunction with discussions with management teams, other analysts and knowledgeable industry contacts. We then select the most compelling opportunities with what we perceive to be the highest risk-adjusted return potential. We evaluate possible catalysts and exit strategies in selecting the appropriate securities in the context of overall market fundamentals. Finally we determine the appropriate size of each position taking liquidity and technicals into consideration. The portfolio is monitored in real-time and positions are hedged, adjusted and traded around on an ongoing basis.

Nearly all of Bowery’s major investments have been in U.S.-based situations. Would you consider more global opportunities? How do you view the opportunity set in Europe?

We are very opportunistic, so while the portfolio has historically skewed towards North American opportunities, we are also active in Western Europe. We don’t do a whole lot of investing outside of these two regions because those are where we best understand bankruptcy case law. At the close of March 2013 we were 80% net long; 56% in North America and 24% in Europe. This significant European weighting is reflective of the current market environment in which fundamentals of American companies are relatively strong compared to those of European ones. I expect the opportunity set in Europe to remain attractive for the near term until sovereign debt issues are fully resolved and austerity measures absorbed. Nonetheless, we are never at a loss in finding unique opportunities domestically.

With so many people having differing opinions, we'd like to hear your thoughts on the credit markets today. Is high yield in a bubble right now?

I am not sure I would call the high yield market a bubble, but it is certainly overbought. The average yield on speculative grade bonds fell below 6% for the first time ever in recent months, and spreads are at historic lows. Treasury rates can only go up from here. This will tighten spreads even further before risk premiums undoubtedly rise, and the high yield market cools off. When and to what extent this happens is more difficult to say but a correction is likely.

How do you manage your book? Claims generally have a lower liquidity profile than on the run credit? How do you balance illiquid vs liquid?

Our strategy is constructed to match the duration of our book so we are not forced to sell out of a position prematurely and take a haircut. The strategy accommodates the less liquid trade claims part of the portfolio which can be up to 50% of capital (35% in claims at the end of March). We invest the rest of the book in more liquid distressed bonds and bank debt which generates a significant amount of alpha, but also provides liquidity and diversification away from claims. Furthermore, most of our claims portfolio is invested in liquidations where the distributions are in the form of cash, so there is little market risk associated with this type of exposure. The main risk of a claims position is process and time risk (that the bankruptcy will drag on for longer than expected), but we factor this probability weighting into the price we bid for a claim. In the case where a claim position results in reorganized equity, we may short sell an equity index, or buy a put on an individual name as a hedge. Away from our claims exposure, we characterize and hedge our portfolio in a number of buckets, from equity like risk (ex- unsecured bonds) to lower beta credit risk (ex- secured bank debt) and will express hedges using various indices like the HYG, LQD, and JNK.  Our book is constantly monitored in real-time by our head of risk management, and our smaller size allows us to be dynamic in adjusting hedges up and down as necessary.

Can you describe a specific situation where you have passed on a compelling idea because you couldn’t get comfortable with the risks?

One of the most popular shorts in the distressed space in recent months has been JC Penney (JCP). In fact, as of April 15, 36.8% of JCP’s equity float was short. New CEO Ron Johnson failed to transform the chain from a coupon-driven discount retailer to a higher-end, boutique shopping destination. Meanwhile, competitors such as Macy’s and Kohl’s continue to outperform. JCP was burning through cash, but also held unencumbered assets, like real estate, which could potentially be used to secure new financing. This was enough to make us wary of an investment from the short side. Sure enough, within the last week JCP secured a $1.75B financing package from Goldman Sachs, boosting the stock and buying the company time to get back on the right track.

Can you talk about an investment you find particularly compelling today that fits into Bowery's strategy?

We are very bullish on our first lien bank debt holding in R.H. Donnelley (RHD). The investment fits our strategy for a number of reasons. First, the company is a yellow-pages business, and as most people know, print media is out of favor with the advent of smart phones, tablets and digital publications. As I mentioned, we like counter-consensus themes. Secondly, there is only $750mm of the bank debt outstanding, trading today at about 72 cents on the dollar, half of which is held by long term holders. So, there is only about $375mm face value of float. As I also mentioned, we like smaller issuances. So, what is there to like about this company besides the fact that it fits into our investment criteria? First, while print businesses are in secular decline, the rate at which RHD’s business is shrinking has moderated. Second, with little overhead or fixed cost, the business produces an abundant amount of free cash flow which goes to first lien bank debt holders. Thirdly, RHD is “bundling” a digital component with its print renewal offers where the digital component will continue to grow and generate even more free cash flow. Finally, RHD’s parent company, Dex One, recently merged with Supermedia, a competitor, which provided a number of business synergies to reduce costs at both firms. But most importantly, the merger provides tax benefits to RHD which will benefit its creditors. We initiated the position in February 2012 at 39, and the bank debt now trades in the low-70’s. We expect it to be worth par by the end of 2014.

*Disclosure: Bowery is a client of Reorg Research



Advanced Distressed Debt Lesson: Bank Debt Trading

Over the past few months, David Karp, partner at Schulte Roth & Zabel has enlightened readers with a fascinating series on the technicalities inherent in trading and closing trades in the world of distressed debt. For the last piece of the series, David takes on the complexities of bank debt trading, which has become an increasingly prevalent instrument for distressed debt funds to engage in. It's an incredible read. Enjoy!

Bank Debt Trading on the Modern Day Back of the Napkin

While it may be surprising to market outsiders, every day bank debt traders in the Unites States, Europe and around the world enter into multimillion dollar binding trades — over the phone, on Bloomberg instant messages and via email — for which many complex collateral, tax, counterparty risk and other material terms and conditions are left off of the modern day “back of napkin.” While the Loan Syndication and Trading Association (“LSTA”) and the Loan Market Association (“LMA”) have set the baseline standards for bank debt trades in the United States and Europe respectively, trades often include material issues that need to be addressed after the traders say “done,” but before entry into a formal written confirmation and eventual settlement. While recent case law in the United States and Europe has confirmed that these informal communications are binding, it also shows traders the importance of at least including some reference to material issues (in addition to price, amount and facility) on the “napkin” at time of trade.

For instance, the U.S. Court of Appeals for the Fifth Circuit held on Oct. 2, 2012 that an oral trade of certain bank debt from Bank of America (“BofA”) to Highland Capital Management (“Highland”) was binding despite follow-up emails stating that the claim was “subject to appropriate consents and documentation.” Highland Capital Mgmt., L.P. v. Bank of America, N.A., 698 F.3d 202 (5th Cir. 2012). That decision brings U.S. case law in line with a 2007 English High Court decision, which held that oral trades are binding even if certain terms of the trade, such as the settlement date or the form of transfer, remain undecided. See Bear Stearns Bank plc v Forum Global Equity Ltd. [2007] EWCH 1576. While the bank debt market’s mantra continues to be “a trade is a trade” and the LSTA’s standard documentation makes clear the binding nature of oral trades, what is interesting (and perhaps scary) about these cases is that they were resolved only through years of protracted litigation, involving a significant commitment of time and expense by the parties. Even if all of your counterparties have a full appreciation of the market standard that an oral trade is binding, judges are not in the market and, if the economic incentives are tempting enough, a counterparty could try to take advantage of courts’ general lack of market awareness.


In 2009, Highland and BofA began negotiations on a potential sale of certain bank debt of Regency Hospital from BofA to Highland. (Footnote #1)  On Dec. 3, 2009, a representative from Highland called BofA to finalize the trade and its terms. Id. The parties agreed over the phone that Highland would purchase, and BofA would sell, $15.5 million of the debt at 93.5 percent of par and that the agreement incorporated the Standard Terms and Conditions published by the LSTA. Id. The BofA representative did not reserve any non-LSTA or non-industry terms during the Dec. 3, 2009 call. Id. After the call, the Highland representative sent an email to the BofA representative confirming that the debt-trade agreement was complete. Id. The BofA representative responded with a confirmation of the agreement, noting that it was “subject to appropriate consents and documentation.” Id.

After the Dec. 3, 2009 call, BofA refused to settle the trade unless Highland agreed to additional terms, including an indemnification, payment of legal fees and waiver of legal claims. Id. at 205. Highland viewed these additional terms as departing from the standard LSTA terms and the Dec. 3, 2009 oral agreement. Id. The Regency Hospital loan ended up paying out 100 percent of par and Highland subsequently sued BofA for breach of contract. Id.

Relying on BofA’s “subject to” language, the trial court held that the parties did not intend to be bound by the trade without additional “consents and documentation” and, therefore, granted BofA’s motion to dismiss. Highland Capital Mgmt., L.P. v. Bank of America, N.A., 2011 WL 5428779, at *5 (N.D. Tex. 2011). Highland appealed that decision to the Fifth Circuit arguing that the lower court failed to accept Highland’s pleaded facts as true, as required on a motion to dismiss (as explained in note 1) and improperly considered factual issues related to the parties’ intent and industry standards. Highland, 698 F.3d at 205.

Fifth Circuit’s Analysis

The Fifth Circuit began by observing that oral contracts are valid under New York law. Id. at 206. In fact, New York law specifies that bank debt oral trades are binding under a statute providing that the statute of frauds does not apply to the assignment, sale, trade, participation or exchange of indebtedness or claims relating thereto under certain qualified financial contracts, which include bank debt. See N.Y. Gen. Oblig. Law § 5-701(b)(2)(i) and (ii). However, if the parties do not intend to be bound until the oral contract is reduced to writing and signed, then the oral contract is not binding until that time. Highland, 698 F.3d at 206. Whether or not the parties intend to be bound is a factual issue to be determined by the court or a jury based on evidence. See id. The trial court nevertheless found BofA’s intent not to be bound in its “subject to appropriate consents and documentation” email. Id.

Highland’s complaint, however, alleged that the parties had agreed to all of the material terms on the Dec. 3, 2009 call because the LSTA standard terms specify that parties agree to be legally bound by any subsequent calls or emails that reach agreement on material terms. Id. at 207. Under Section 21 of the LSTA Standard Terms and Conditions for Par/Near Par Trade Confirmations, once you execute an LSTA trade confirmation, you are bound by the LSTA standard terms in all future debt trades with that same counterparty unless you specifically say otherwise at the time of trade. Section 21 LSTA Standard Terms and Conditions for Par/Near Par Trade Confirmations provides as follows:

By execution of a Confirmation incorporating by reference the Standard Terms and Conditions, each Buyer and Seller agrees to be legally bound to any other transaction between them … with respect to the assignment, purchase, sale and/or participation of commercial and/or bank par/near par loans, or any interest therein, upon reaching agreement to the terms thereof (whether by telephone, exchange of electronic messages or otherwise, directly or through their respective agents, and whether the subject of a confirmation), subject to all the other terms and conditions set forth in any confirmation relating to such transaction, or otherwise agreed.
This also applies to distressed trades pursuant to Section 22 of the LSTA Standard Terms and Conditions for Distressed Trade Confirmations. The same section also commits the parties to New York law, and to not raise a defense for lack of a writing based on the statute of frauds.

Highland’s complaint also correctly asserted that the “consents” referred to in BofA’s “subject to” email referred to borrower consent, which is often required to effect the assignment of bank debt transfers. Id. Highland explained that, even if borrower consent were not available, the LSTA standard term would still require the parties to close the transaction by participation or otherwise. (The LMA standard terms include a similar provision. The potential pitfalls related to borrower consent in Europe are discussed in a prior post, Prospecting for European Distressed Loans.) Id. Highland’s complaint also alleged that the “documentation” in BofA’s “subject to” email referred to the execution of a standard LSTA trade confirmation, noting that the execution of the trade confirmation is not a condition precedent to formation of a binding trade. Id. at 207-08.

In its consideration of whether or not the parties intended to be bound by the oral agreement, the Fifth Circuit used the four-factor test generally used by courts in breach-of-oral-contract cases. Id. at 206. The test considers: “(1) whether there has been an express reservation of the right not to be bound in the absence of a writing; (2) whether there has been partial performance of the contract; (3) whether all of the terms of the alleged contract have been agreed upon; and (4) whether the agreement at issue is the type of contract usually committed to writing.” Id. at 209. First, taking Highland’s allegations as true, the Fifth Circuit saw no indication that BofA had expressly reserved the right not to be bound without a written agreement. Id. Second, Highland alleged that the parties had agreed on all material terms. Id. Finally, the LSTA standard terms indicate that debt trades can be conducted orally and only later committed to writing in a trade confirmation. Id. Taken all together, the Fifth Circuit concluded that the emails following the Dec. 3, 2009 phone call did not unambiguously indicate that the parties did not intend to be bound and, therefore, the issue of the parties’ intent was unfit for a motion to dismiss at that early stage. See id. Given that the emails did not clearly negate an intention to be bound, without further evidence, the Fifth Circuit held that the district court erred in granting BofA’s motion to dismiss. Id. at 210.

Accord with English Case Law

The Fifth Circuit’s decision in Highland brings U.S. case law in line with English case law on the subject. In a 2007 opinion, the High Court held that parties to a notes trade were bound after they agreed on price over the phone, despite other outstanding terms of the trade, such as the settlement date. See Bear Stearns Bank plc v Forum Global Equity Ltd. [2007] EWCH 1576. In the Bear Stearns case, the High Court considered the binding effect of a phone call agreeing to the price of Parmalat SpA notes and accompanying claims in the Parmalat insolvency under the Marzano Law Decree. Much like the analysis performed by U.S. courts, the High Court considered the parties’ intent to be bound and held that the buyer did show such an intent when it orally provided a “firm bid” on the price. The court held that there was a binding oral agreement, even though there was no agreement on a settlement date or the form of transfer, because there was no legal reason why the parties could not later reduce the agreement to a writing in which the buyer obtained the economic benefit of the notes and claims in exchange for the agreed price. Unlike in the Highland case, however, the High Court did not conclude that the standard terms of the LMA, the English equivalent of the LSTA, applied because the parties did not specifically refer to LMA standard terms at the time of the call and there was no clear and convincing evidence that at the time of the trade (July 2005) it was an established practice to use LMA terms for transactions in this type of asset, given the unusual nature of the particular claims that accompanied the notes. Nevertheless, there is now clear case law in both the U.S. and England that upholds the binding nature of oral debt trades.

Practical Considerations

The trial court decision in Highland was completely at odds with market understanding and it took a successful appeal to the Fifth Circuit to bring the decision in line with market expectations. The time from trade to appellate decision (solely on the motion to dismiss) was almost three years. This is not the first time (and will not be the last) that parties have had to “take one for the team” and litigate an issue — one that perhaps the market had taken for granted — up to the circuit court level in order to get case law up to speed. For example, as discussed in Part I of this series, we saw Longacre fight the good fight in the Second Circuit to confirm that “objected to” means “objected to,” with respect to claim assignment put right triggers where a claim seller attempted to add a “substantive” objection requirement to the plain language of the claims trade contract.

The trial court in the Northern District of Texas missed the mark in Highland. There are plenty of other district and state courts that are not bound by the Fifth Circuit’s Highland decision that could do the same. In fact, we need only look to the New York Appellate Division, First Department’s decision in Credit Suisse First Boston v. Utrecht-America Finance Co., 80 A.D.3d 485 (N.Y. App. Div., 1st Dep’t 2011), which suggested that a trade confirmation that included language that the trade was “subject to negotiation, execution and delivery of reasonably acceptable contracts and instruments of transfer,” which is in all standard LSTA trade confirmations, imposed on the parties only an obligation to negotiate the definitive documents in good faith, not a binding obligation to close the transaction. See id. at 19-20. While that case settled after the Appellate Division remanded it to the trial court for determination of certain factual issues, the mere suggestion (by a New York court, no less) that a standard LSTA trade confirmation was not a binding agreement to close the transaction has certainly caused some jitters for traders and their counsel.

The take-away is to front load as many of your desired terms (amount, price, tranche, form of transfer, participation or assignment only, interest convention, etc.) into the initial trade conversation as possible so that there are no surprises in the written trade confirmation process.


Footnote #1: Procedurally, on an appeal of a motion to dismiss, the appellate court only considers the facts as presented in the appellant’s briefs and assumes those facts to be true, without taking the evidence or testimony that would be presented in a trial setting. Therefore, the facts presented in this piece, as taken from the Fifth Circuit’s opinion, are Highland’s version of the facts, and the Fifth Circuit made clear that it was not taking a position on the veracity of those facts but only considering the parties’ purely legal arguments.  Id. at 204.

David J. Karp is a partner in the New York and London offices of Schulte Roth & Zabel, where his practice focuses on corporate restructuring, special situations and distressed investments, distressed mergers and acquisitions, and the bankruptcy aspects of structured finance. David leads the firm’s Distressed Debt & Claims Trading Group, which provides advice in connection with U.S., European and emerging market credit trading matters. David is an avid speaker and writer on distressed investing related issues, recently co-authoring “European Insolvency Claims Trading: Is Iceland the Paradigm?” for Butterworths Journal of International Banking and Financial Law and “Trade Risk in European Secondary Loans” for The Hedge Fund Law Report. David is an active member of the LMA, APLMA, INSOL Europe and the LSTA where he is a member of the Trade Practices and Forms Committee. Alexia Petrou and Neil Begley, associates at SRZ, assisted in the preparation of this entry.



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.