Happy Holidays from Distressed Debt Investing

2013 was an eventful year. One that I'll remember for the rest of my life...

As I've said in years past, I am humbled to have one of the greatest readerships out there. The blog will be coming up on its 5th year in 2014 - something I could never have fathomed back in 2009. In addition, Reorg Research has grown to a sizable staff and there is no way I could have accomplished what we've done without surrounding myself with an amazing group of talented individuals. I could not be more grateful for each of their contributions.

I want to wish everyone a happy and healthy holiday season. And a happy and profitable 2014!



iGlobal Forum's 5th Global Distressed Debt Investing Summit

I'm happy to announce and alert readers to iGlobal Forum's 5th Global Distressed Debt Investing Summit which will be held February 19th here in New York. As usual, iGlobal is going to put on a fantastic conference with some fantastic panels and speakers. The keynote this year will be given by Thomas Wagner, Co-Founding Partners and Co-Managing Member of Knighthead.

The panels this year again rely on a heavy focus on distressed debt investing with panels dedicated to very topical municipal processes and opportunities in Europe. Panelists come from a wide assortment of backgrounds and include professionals from firms including Halcyon, Canaccord Genuity, Fortress, Apex, KKR, Barclays, Bowery, Magnolia Road, Blackstone, CQS and Third Avenue.

I am also happy to announce I'll be speaking at the event as well.

For more information about the conference please visit here: http://www.iglobalforum.com/event.php?id=97

And for the agenda, you can find it here: http://www.iglobalforum.com/event.php?id=97&page=agenda

Looking forward to seeing you there!



Reorg Research Analysis: Judge Gropper Rules Anadarko's Kerr-McGee Owes Billions in Damages for Tronox Spinoff ($APC, $TROX)

We do this only rarely, but given the relevance to so many parties and case laws, I wanted to reproduce Reorg Research's analysis on the Anadarko / Tronox opinion that hit the docket yesterday afternoon.

I believe Reorg Research is currently the best provider of analysis, commentary, research and news on the distressed space in the market today and its pieces like this that we are putting out everyday that differentiates us from the competition.

Please reach out if you have questions. Enjoy!

Judge Gropper Rules Anadarko's Kerr-McGee Owes Billions in Damages for Tronox Spinoff

Relevant Document:
Judge Gropper Opinion

In a 166-page decision, Judge Allan Gropper ruled that the Anadarko owned Kerr-McGee E&P business is liable for its actions during the spinoff of the chemical business later named Tronox Worldwide. The amount of the damages is uncertain but could swing widely between $5.15 billion and $14.46 billion depending on certain factors.  Remarkably, the opinion also includes a discussion of consent to jurisdiction in the context of Stern v. Marshall, an issue that will be heard by the United States Supreme Court next month.

The opinion largely addresses the "basic issue" identified by Judge Gropper - "under what circumstances can an enterprise rid itself of its legacy environmental and tort liabilities by spinning off substantially all of its assets and leaving behind property incapable of supporting the liabilities."

It is highly expected that defendants will appeal. If the decision is allowed to stand it could have a chilling effect for companies with substantial environmental liabilities that are attempting to restructure outside of the bankruptcy process. Such companies may face narrowed out-of-court options and be forced to file for bankruptcy where they otherwise might have attempted spin-offs analogous to Tronox.

A striking feature of the opinion, when compared with other successful fraudulent conveyance suits, is Judge Gropper's finding of an "actual" (i.e. intended) fraudulent conveyance based on effort to free assets from environmental and tort liability. Notably, based on the structure of the spinoff in question, Gropper, supported by the Southern District of Texas case ASARCO LLC v. Americas Mining Corp., found actual fraud due to "the clear and intended consequence of the act, substantially certain to result from it."  Moreover, according to Judge Gropper, "the case raises issues of first impression regarding the application of the fraudulent conveyance laws in the face of substantial environmental and tort liability."

The extremely complicated case revolves around a spinoff and separation of Kerr-McGee's oil and gas business from its old holding company. The holding company faced billions of dollars in environmental cleanup liability. Judge Gropper found that the Kerr-McGee defendants "acted with intent to 'hinder and delay' the Debtors' creditors when they transferred out and then spun off the oil and gas assets, and that the transaction, which left the Debtors insolvent and undercapitalized, was not made for reasonably equivalent value." According to the opinion, because the profitable oil and gas business "was no longer owned by Old Kerr-McGee, which was responsible for the legacy liabilities, New Kerr-McGee, which owned the billions of dollars of equity in the E&P assets, was in a position to disclaim liability for the legacy liabilities."

Damningly, Judge Gropper concluded from the facts that it was "clear that Kerr-McGee management intended from the outset to free the valuable [oil and gas] assets from the legacy liabilities, especially as this burden precluded Kerr-McGee from being an attractive merger candidate." Further "the written record is also absolutely clear that freedom from Old Kerr-McGee's legacy liabilities was a central consideration in the decision to split the two businesses and in the structure that was devised."

The split of "old" and "new" Kerr-McGee was completed in 2005 when a chemical business was transferred out of "old" Kerr-McGee and the separations was formally documented. Old Kerr-McGee became Tronox pursuant to these agreements. Judge Gropper found that Tronox was left with insufficient cash and an "illusory" indemnity from New Kerr-McGee. Tronox was also left with hundreds of millions of dollars of pension and OPEB liabilities. Anadarko purchased the oil and gas business after it was split off.          


Judge Gropper did not decide, on a final basis, the measure of damages on the fraudulent conveyance counts. While the opinion noted that the "net value of the property transferred out was $14.459 billion, or stated differently, that Tronox on a consolidated basis suffered a diminution in value of $14.459 billion," there remains outstanding issues on whether damages can be limited.

Before a final determination is made, the defendants will be able to file a §502(h) claim in the debtors' bankruptcy case and all parties will brief the issue of the dilutive effect of such claim. The issue is limited but the difference in damages is large depending on the claims effect. For example, if the defendants § 502(h) claim is valued at 89% (GUC recovery under the DS) of the legacy liabilities of $10.459 billion, defendants would be entitled to offset $9.3 billion from plaintiffs' recovery of $14.459 billion, resulting in a damages award, not including attorneys' fees or costs, of $5.15 billion. But, if all If all general unsecured claims, including the section 502(h) claim, shared in this value, the recovery of a general unsecured creditor would be only 2.8 cents on the dollar, and defendants' section 502(h) claim would be worth only $292.852 million Offsetting this against plaintiffs' recovery would result in a damages award, not including attorneys' fees or costs, of $14.166 billion.

Fraudulent Transfer Considerations

The original complaint, filed in May 2009, set forth eleven claims for relief. Three of these claims revolved around fraudulent transfers: "(1) actual fraudulent transfers under the Oklahoma Uniform Fraudulent Transfer Act...; (2) constructive fraudulent transfers under the Oklahoma UFTA; (3) fraudulent transfers under §§ 548 and 550(a) of the Bankruptcy Code"

An issue distressed investors face in fraudulent transfer/fraudulent conveyance cases revolve around what applicable law is being used and the resulting statute of limitation. For example, Delaware state law has a 4 year look back window whereas New York has a 6 year window. In his opinion Judge Gropper notes, "There is no dispute that the "applicable law" in this case includes the law of Oklahoma. There is a dispute as to whether that law also includes Federal law under the FDCPA, the act under which the United States has filed its complaint-in-intervention"

Importantly though, Kerr McGee/Anadarko sought dismissal on the group that the claims in the complaint are "time-barred" under Oklahoma law. The plaintiffs therefore, Gropper, writes "must rely on either the Oklahoma UFTA or the FDCPA to survive a limitations defense, as the limitations period under the Bankruptcy Code is only two years from the challenged transfer to the petition date, and only minor transfers took place during the two years preceding the Debtors' filing under chapter 11 on January 12, 2009." Oklahoma provides a four year limitation period for claims of actual fraudulent conveyance and constructive fraudulent conveyance.

Critically, Judge Gropper determined that a contrary Fifth Circuit case, Mirant, was not applicable to Tronox and the FDCPA could be used in conjunction with section 544(b) of the bankruptcy code to extend the lookback period.

As noted above, even without reference to the oft-cited "badges of fraud," Judge Gropper found an "actual" fraudulent conveyance because "[i]n the present case, there can be no dispute that Kerr-McGee acted to free substantially all its assets - certainly its most valuable assets -- from 85 years of environmental and tort liabilities. The obvious consequence of this act was that the legacy creditors would not be able to claim against "substantially all of the Kerr-McGee assets," and with a minimal asset base against which to recover in the future, would accordingly be "hindered or delayed" as the direct consequence of the scheme. This was the clear and intended consequence of the act, substantially certain to result from it."

Nevertheless, Gropper found that several badges of fraud were present and none of defendants' purported "supervening purposes" - a belief that Tronox had upside potential, the unlocking of value via the spinoff and a general attempt to limit overall liability - were sufficient to defeat a finding of actual fraudulent conveyance.

Even so, Judge Glenn concluded that under the analysis of "constructive" fraudulent conveyance, neither side seriously disputed that "billions more" was transferred out than was transferred in as part of the transaction. The opinion rejects a number of reasonably equivalent value defenses, most notably defendants' contention that reasonably equivalent value should be tested on a strict entity-by-entity basis. On the critical issue of insolvency at the time of the transfer, Gropper applied a "balance sheet test" based on both a "market" and "ex post" analysis.

Recent cases such as Campbell's Soup and Iridium, generally speaking, relied on a debtor's ability to raise capital in public offerings as contemporaneous market evidence of solvency. Tronox had an IPO and issued hundreds of millions of dollars of debt. Critically, Judge Gropper concluded that this market evidence had to be discounted by a number of factors, including that the issuances were at the "height of a market of irrational exuberance" and that IPO prices were set using "inflated, sell-side projections." Moreover, "[t]he record is also clear that the financial statements omitted certain critical contingencies and potential liabilities." Further, "[a] principal reason why financial statements are of little use in a solvency analysis is that generally accepted accounting principles (GAAP) require reserves only for claims that are 'probable and reasonably estimable'...The record is replete with evidence that Kerr-McGee misapplied this standard and thereby understated its liabilities for GAAP purposes," according to the opinion.
On the issue of an "ex-post," academic valuation of Tronox at the time of the IPO, Judge Gropper frames the substance of the dispute as centered on the environmental and tort liabilities "which, again, is what this case is all about." As laid out in the decision, the plaintiffs' expert witness on the subject of environmental liability was Neil Ram of Roux Associates. Ram concluded that the present value of the future response costs of environmental remediation at the sites, as of November 2005, was between $1.499 billion and $1.684 billion. According to Judge Gropper,  "Kerr-McGee never performed such an analysis, either in connection with the IPO or otherwise, and there is no dispute that accounting reserves for environmental costs do not purport to be useful in a UFTA solvency analysis." The opinion continues by noting defendants also called their own expert witnesses on environmental costs, Neil Shifrin and Richard Lane White of Gnarus Advisors LLC, but "the only conclusion on this record is that it is Defendants' position that the net present value of the remediation costs of Tronox as of November 2005 was $278.1 million or, at most, $376.2 million." Judge Gropper took exception with this valuation, concluding that "Shifrin and White that Ram should have valued Tronox's future environmental liabilities as approximately the amount that Kerr-McGee had recently paid over a two-year period does not pass the common sense test."

The decision further goes into related detail about the sales process undertaken at Tronox prior to the spinoff. Judge Gropper describes the litany of private equity firms that simply passed on a bid for the business due to the legacy liabilities, as well as the failed bid by Apollo that eventually left the company with only one option - the spinoff and IPO. "the 'market,' except for Apollo, refused to bid on Tronox with all of the legacy liabilities included in the deal. As noted above, Lehman identified 60 potential bidders, and contacted 16, and 13 signed confidentiality agreements. The field was narrowed to four final bidders, who were given access to a virtual data room to perform due diligence. Only Apollo was willing to accept the legacy liabilities. Bain Capital, JP Morgan Partners and Madison Dearborn Partners eventually dropped out. Bain Capital chose not to make a final bid in part because of the cost to diligence the legacy liabilities, JP Morgan made a bid only for the assets of the chemical business, and the bid submitted by Madison Dearborn Partners excluded the assumption of any legacy liabilities."

Tronox began to struggle almost immediately after the March 30, 2006 spinoff, according to the complaint.

Issue of Consent

The opinion also includes a discussion of Stern v. Marshall and recent divergent case law discussing consent and whether or not a court can enter a final order in a case where a defendant does not consent to the court's jurisdiction. In this case, Kerr-McGee originally consented to the court's jurisdiction before withdrawing its consent eight months after filing an answer to the complaint. While Judge Gropper's opinion states that "it should be stressed that the issue of consent with regard to this Court's resolution of the fraudulent conveyance claims is not a real issue in this case," the court nevertheless concluded that "it has final authority to enter a final judgment" in the proceeding, but that "[i]f an appellate court should disagree, it is respectfully requested that this decision be deemed proposed findings of fact and conclusions of law for final entry by the District Court."

This decision was predicated on the fact that Kerr-McGee filed proofs of claims against the debtors for, among other things, damages for failure to abide by the terms of the spinoff and for failure to assume the defense of environmental litigation allocated to Tronox. Moreover, the relied on Second Circuit precedent to find that that Kerr-McGee's answer constituted "unconditional consent" to the entry of a final order.

On the issue of consent when a creditor files a proof of claim, Judge Gropper's ruling diverges from recent cases in the Seventh and Fifth circuits, but coincides with an older decision in the Seventh Circuit and also the Ninth Circuit. Case law in this area has become fragmented recently in advance of Executive Benefits Insurance Agency v. Arkison, a case that will be argued before the United States Supreme Court in Jan. 2014. The main issue presented in Executive Benefits is whether a bankruptcy judge can issue a final order on the basis of litigant consent, and if so, whether "implied consent" based on a litigant's conduct is sufficient. The court's decision will have significant ramifications in preference and fraudulent transfer litigation, as illustrated by Tronox.

Calls to the attorneys for the litigation trust were not returned prior to press time, and attorneys for the defendant either declined to comment or were not available by press time.



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.