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— Judgment Call —
Bankruptcy judges and hedge fund managers don't look at the world from the same point of view. When hedge fund managers actively participate in the bankruptcy process in an effort to maximize returns on investments in debtor companies, these competing world views can come into conflict. To be most effective in bankruptcy court, hedge fund managers and their lawyers must learn to mediate these differences and articulate their positions in a manner consistent with the values that animate the bankruptcy judges they seek to persuade. Bankruptcy judges aspire to create a forum premised upon transparency and equal access to information. The Bankruptcy Code and case law look to impose fiduciary responsibilities upon the creditor constituents that participate in a corporate bankruptcy proceeding. The bankruptcy judge's perspective is long term, focusing on the rehabilitation of ailing companies.
Hedge funds, on the other hand, thrive upon market inefficiencies often created by a lack of transparency. Hedge fund managers look to maximize returns to investors and would rather avoid having their available options restricted due to fiduciary duties owed to others. Hedge funds seek to maintain the liquidity of their investments and focus on short-term returns. They are usually agnostic as to the long-term performance of the companies in which they invest. While the above is a caricature, it is nonetheless helpful shorthand to understand the controversies that often surface when hedge funds go to bankruptcy court. When President Obama blamed Chrysler LLC's April 30 bankruptcy filing on a "small group of speculators" -- a group of "investment firms and hedge funds" that "held out when everybody else made sacrifices" -- he capitalized on this caricature. What ensued vis-à-vis these so-called holdout hedge funds had the feel of a traditional morality play, in which each character stands for a different virtue or vice. The government and other sponsors of Chrysler's plan successfully portrayed the investment firms as Greed Personified, willing to risk thousands of jobs and America's entire manufacturing future in exchange for an enhanced return on their investment of just a few more cents on the dollar. The government trounced the Chrysler holdouts. In a result that some have described as unprecedented, Chrysler's secured lenders, who are supposed to be close to the top of the creditor food chain, were left with just 29 cents on the dollar, while certain unsecured creditors reaped significant rewards ahead of them. While the Chrysler case is sui generis and no amount of lawyering would likely have changed the outcome, it nonetheless holds at least three important lessons for hedge funds looking to bankruptcy court to maximize the value of their investments: 1. There is strength in numbers. The group of secured lenders protesting the Chrysler plan formed what is known in bankruptcy parlance as an "ad hoc committee," which it called the Committee of Non-TARP Lenders (lender committee). At its peak, the lender committee reputedly represented about $2 billion of Chrysler's $6.9 billion of secured debt. From there, the lender committee proceeded to lose members such that, in the heat of its battle with the government, it could only claim to represent several hundreds of millions in secured debt. According to the lender committee, most of the other secured debtholders were unwilling to join the fight because, as recipients of government TARP funds, they were beholden to the government. Regardless of the reason, because the lender committee was unable to effectively organize its natural constituency, its effort seemed doomed from the start. Contentious, complicated bankruptcies are driven by committees of similarly-situated creditors. To be effective, committees and their counsel must make a concerted effort to enlist and mobilize as broad a swath of their constituency as possible. In Chrysler, the lender committee was outdone by a host of factors that conspired against it, not least of which was the government's superior skill in organizing the pro-plan constituents through persuasion, threats and strategic dealmaking. 2. Articulate a vision larger than "return on investment." Committees and their counsel should articulate a broader vision of the case that is at once consonant with the committee members' self-interest, but also speaks to the larger issues in the case, including the ultimate fate of the debtor. In Chrysler, the lender committee began the case in a significant public relations hole from which it never emerged. In an effort to lay claim to some goal larger than enhancing its members' individual returns, the lender committee emphasized the pension fund money its members managed and the retirees who depended on them to make sound investments. Ultimately, however, the party that the bankruptcy judge cares about the most is the debtor. Whenever possible, committees should strive to speak meaningfully to the issues faced by the debtor and offer a competing vision of the case, even if that vision is a negative one such as: This debtor has no realistic prospect of successfully reorganizing, and it is in everyone's interest to liquidate the debtor sooner rather than later. While the recasting of a committee's self-interest in terms that speak to a broader public interest may cynically be seen as just so much window-dressing, language matters. Bankruptcy judges are inherently interested in the question of whether the debtors before them have a prospect of reorganizing, and they care about whether one plan of reorganization or another is or is not economically viable. They could not care less, however, about whether one hedge fund or another makes or loses money on its investment in the debtor. To matter, ad hoc committees must find ways to speak about something larger than their specific investment. Under the Bankruptcy Code, at the end of the case, an ad hoc committee may apply to the bankruptcy court to have its professional fees reimbursed by the debtor where the committee can show that it conferred a substantial benefit on the debtor's estate. In order to be able to credibly claim at the end of the case that it conferred a substantial benefit on the bankruptcy estate, the committee should begin to articulate a coherent, larger vision of the case from the outset. 3. Use disclosure to enhance credibility. Bankruptcy Rule 2019 requires an ad hoc committee to disclose information about its composition and holdings, including when its members purchased their interests in the debtor and the prices at which the interests were acquired. For understandable reasons, hedge funds are often loathe to disclose this information and, as a practical matter, it is rare for funds to strictly comply with all of the particulars of Rule 2019. Unfortunately, the desire for confidentiality can often be at odds with the objectives of an ad hoc committee, engendering unwarranted suspicion on the part of other parties in interest and the court. In Chrysler, the lender committee fought unsuccessfully to file its Rule 2019 statement under seal. When it finally filed, the lender committee said nothing more than that it had acquired its secured debt holdings at various times and at various prices. While this sort of vague, meaningless disclosure is typical of Rule 2019 statements filed by ad hoc committees comprised of investment funds, it can actually work against the objectives of the committee. The lack of transparency leads other parties in interest to "assume the worst" -- namely, that the committee members acquired their interests in the debtor after the bankruptcy filing at steep discounts. This fuels the usually false narrative that the ad hoc committee is looking to game the system and turn a short-term profit into a short-term windfall, while others suffer significant losses. Hedge funds reflexively play things close to the vest. In bankruptcy court, this can often be counterproductive. Funds involved in bankruptcy court proceedings should consider the trade off between secrecy and credibility, and endeavor to strike a balance that will allow them to achieve their goals. Eric B. Fisher is a shareholder based in the New York office of law firm Butzel Long. His practice includes the representation of investment funds in commercial litigation and bankruptcy matters. Comments |
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Hedging is the best move in order to leverage your investment. We are facing uncertain future. We need to be more conservative in putting up our money. The bigger you invest the higher the risk.The purpose of investing was to accumulate gains and not to suffer from any probable loss. We had suffer much from the unstable economy and one of which are the increasing number of lay offs.With the unemployment rates still rising, more people are unable to get installment loans. Even an industry giant like Chrysler can fall, as they have yet to re-emerge from bankruptcy. Hopefully the stimulus package, which cost more than a pretty penny, will be able to restimulate growth and job creation, and bring a little debt relief to the single salary home.