Hedge funds' rise to power has led to a host of complaints from more traditional parties in the corporate restructuring process. Committees are more complex and disputes are more aggressively litigated; DIP financing is opposed, blocking positions are bought, and cases drag on longer than some debtors can bear.
It's enough to prompt Harvey R. Miller to posit that hedge funds' goal of realizing quick returns on their investments is at the sacrifice of the long-term viability of the debtor. The system is broken, he has said.
Others, who cite the benefits of hedge fund participation, including, most significantly, the critical capital source they provide distressed companies, say that the process has merely evolved.
Broken, evolving, or somewhere in between, a new era of corporate restructuring is upon us. A seminar at the The Samuel and Ronnie Heyman Center On Corporate Governance at the Benjamin N. Cardozo School of Law at Yeshiva University titled Perspectives on Corporate Restructurings: The Impact of Hedge Funds in Corporate Restructuring Transactions, sought to vet the misconceptions, the rarely cited positive impacts, and the disadvantages of hedge funds' control over the Chapter 11 process.
Jonathan S. Henes, of Kirkland & Ellis LLP launched the seminar by sharing his own view, and perhaps fueling the dialogue.
He told the audience that while Chapter 11 still provides an opportunity to reorganize, "today, due to the mini-trading exchanges and the short-term focus of the distressed debt market, the bankruptcy tools, given to a debtor to negotiate and formulate a plan of reorganization by securing the votes of the majority while binding the minority, have lost their strength. The system is being tested and the dynamic has changed radically."
While Henes was quick to emphasize that there isn't anything wrong with what hedge funds do, and that each party is acting as one would expect, not surprisingly, Chaim J. Fortgang, of Silver Point Capital Advisors LLC was eager to offer a counter-point. "The notion that we are day traders is absurd," said Fortgang. "We are value investors."
Hedge funds' participation in corporate restructurings in many ways helps, not hinders a company's efforts to survive and reorganize, not just by providing DIP and exit financing, but also by purchasing the company. "Today's distressed debt market is so deep, the chance that the business will ultimately end up in the hands of someone who buys the fulcrum security and wants to own the company, is very good. From the company perspective, that may be the best option," he said.
"Back in the 70s, banks wanted to liquidate the company the minute it was transferred to a work out group. ... So, the notion that banks or insurance companies are more patient is just untrue. It may be the opposite."
Loan to own is but one investment strategy hedge funds employ, the panelists pointed out. Some funds don't want to make investments in the fulcrum security, the debt instrument most likely to convert to equity ownership in the restructuring, and instead choose to invest in the senior side of the capital structure. Funds may also change their strategy throughout the case or hold multiple positions in a case.
Fortgang doesn't deny that there are instances in which hedge funds behave badly, but he said that the negative impact of hedge funds' participation is largely a misconception. "Generally speaking, at least the larger hedge funds who have done this for a while are in this for the same reason as any one else. Sometimes the best way to make money is a quick trade, sometimes the best way to make money is go long-term. That may have nothing to with whether we're good or bad, that may have to do with the company. Not every company deserves to reorganize. Not every company is worth more in the hands of the current management."
The panelists agreed that hedge funds can facilitate a reorganization.
For instance, David Pauker of Goldin Associates LLC said that sometimes the hedge fund is the party that's most interested in the debtor's plan. That in itself produces some interesting and welcome changes in the case, he said. "For one thing, the hedge fund investor doesn't approach this the way a traditional investor did. There's no presumption that management is bad because it somehow led to the circumstances of the company. There's no desire to punish the sponsor - there's nothing but a total return mentality."
But while hedge fund investors are sometimes more than willing to hear debtors' counsel, there is a difference between hedge funds and traditional lenders. Unlike banks who are captive participants, hedge funds need a reason to stay invested. In other words, they need to be sure that they can generate as good a return after the company emerges as they would at any point during the bankruptcy.
"I disagree that they necessarily want a quick buck," Paulker said. "I think they want it demonstrated that they're going to get the same return over time."
The information divide
Where hedge funds do frequently cause problems for the reorganization process is when they choose not to sign confidentiality agreements allowing them access to the debtor's nonpublic information, and restricting their trading, said Timothy Coleman, of The Blackstone Group. Despite their lack of information on the debtor's situation, these funds sometimes attempt to steer the company's reorganization in the direction that is most advantageous to its trading book, without consideration of the debtor's business or its creditors.
It's precisely those kinds of investors that are causing so much havoc in the system, the panelists said.
"There was a time when everyone had the same information and there were still disagreements, but at least you were disagreeing over whatever was presented," Coleman said. "Today there are times when you're disagreeing with people who have their own analysis, but you don't know what that analysis says."
According to the panelists, the bottom line is that if hedge funds want to be taken seriously in the reorganization, they should be privy to all the information.
Access to the debtor's nonpublic information can have an enormous influence on a fund's or even a committee's views, the panelists said. In Delta, for instance, Coleman noted that while the Official Committee supported the airline's standalone plan, the ad hoc committee, which was not restricted, and therefore did not have access to the debtor's non-public information, wanted the debtor to sell "almost under any circumstances, because they saw themselves getting a big profit at that very moment."
While some panelists cited a fund's refusal to restrict their trading as a red flag that it may be a thorn in the debtor's side later on, Fortgang said that it's important to bear in mind that there are legitimate reasons why a fund would not or could not get restricted.
The bad actors
Of course, there are also those funds whose specialty is making trouble, the panel said, either through litigation or by buying up a class to vote against a plan. Their behavior is often inexplicable from an economic perspective, and it could one day attract the attention of a judge or trustee in bankruptcy, or generate liability for the fund outside bankruptcy.
"Where you clearly go buy a position in a class just to hurt another class or to oppose a plan, it's no different than a competitor buying a claim and then voting against a plan so the company can go under," Fortgang said. "The law doesn't permit that, and it shouldn't permit this either."
The challenge is proving it.
The issues addressed and the views expressed at the seminar do not necessarily represent those of the panelists or their respective firms.
Reprinted with permission from Bankruptcy Court Decisions Weekly News & Comment. Copyright LRP Publications. Horsham, PA 19044. All rights reserved. For details on this or other related products, call toll-free 1-800-341-7874 or visit www.shoplrp.com/banking.html