THE EXTENDED STAY LITIGATION TRUST V. THE BLACKSTONE GROUP L.P. ET AL.
A victory for Extended Stay--in one of the largest bankruptcies ever stemming from a failed leveraged buyout--could lead to greater risks for stakeholders in other privately held businesses should a company fail after an LBO.
For the Plaintiff: Baker & Hostetler
For the Defendant: Kirkland & Ellis; Simpson Thacher & Bartlett
When a privately held company changes hands in a leveraged buyout and then goes bust are its former stakeholders shielded from liability? Or can they face claims for fraud? That's the issue in a dispute between the trustee of Extended Stay America, Inc., and The Blackstone Group L.P., the private equity firm, in federal bankruptcy court in Manhattan. The estate is seeking damages of $8.4 billion, ranking it as one of the largest claims ever filed over a failed LBO.
Lawyers watching the case say it's emblematic of investor overconfidence and over-leveraging of real estate at the peak of the market, just before the financial crisis. Though fraudulent conveyance claims are common in LBO bankruptcy-related litigation, few reach the price tag on this one.
The suit, filed on June 15, stems from Blackstone's 2007 sale of the hotel chain to real estate investment firm The Lightstone Group, LLC. Extended Stay's trustee, Hobart Truesdell of New York's Walker, Truesdell, Roth & Associates claims that the sale price, $8 billion, was artificially inflated by Blackstone, its lender Bank of America Corporation, and its financial adviser Citigroup Global Markets Inc.
Truesdell maintains that Blackstone, Bank of America, and Citigroup siphoned off approximately $2.1 billion from the LBO. At the same time, Truesdell alleges, the buyer Lightstone financed the deal almost entirely through loans, leaving the hotel group with $7.6 billion in debt.
Extended Stay filed for bankruptcy protection just over two years later. The estate claims it is owed $2.1 billion as well as treble punitive damages on a claim that the defendants maliciously breached their fiduciary duties.
Blackstone calls the suit an "opportunistic" claim. It blames the LBO's failure on the 2008 recession and notes that the recession tipped every large hotel deal made in 2006 07 into either bankruptcy, foreclosure, or restructuring. Blackstone also claims that it can't be found liable under the traditional "settlement payment" defense, which typically protects sellers from litigation over failed LBOs to preserve the orderly functioning of capital markets.
But a contrary decision this past April in a case involving a much smaller business New Rochelle, New York based restaurant Mac-Menamin's Grill Ltd. may throw a wrench in Blackstone's argument. In that case, a bankruptcy judge in New York rejected the settlement payment defense because the restaurant was not a publicly held entity, and thus had no impact on any major capital market. Neither was Extended Stay at the time of its sale.
BofA, as Lightstone's lender, faces its own risks. The Bankruptcy Code allows trustees to recover funds transferred in deals that involved fraud. Extended Stay is claiming that the loan obligation that Lightstone signed with Bank of America came about through fraud.
"It's actually Bank of America who could actually be more exposed here," says Kenneth Ziman, a corporate restructuring partner at Skadden, Arps, Slate, Meagher & Flom who is not involved in the case directly. "There's a potential precedent there, with a lender being at greater risk like that."
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