By Michael Oneal and Ameet Sachdev, Chicago Tribune reporters
November 27, 2011
On Nov. 8, a two-page letter appeared on Tribune Co.'s bankruptcy court docket, wedged between the usual stream of motions and lawyer fee applications.
It was written to the judge by an angry and bewildered Colorado investor named Mark Lies, who had owned stock in Tribune Co. when it was public and then cashed out like thousands of other shareholders when the media conglomerate went private in 2007.
Now, nearly four years later, Lies finds himself a defendant in one of dozens of lawsuits filed in courts around the country by a group of junior creditors hoping to claw back more than $2.5 billion of the $8.2 billion in proceeds from Tribune Co.'s disastrous leveraged buyout.
The lawsuits, 44 of them, target everyone who owned shares in the company when the deal closed, most of whom, it's safe to say, never considered the possibility that Tribune Co.'s descent into Chapter 11 less than a year after the buyout could come back to haunt them.
"What seems grossly unfair," Lies wrote to U.S. Bankruptcy Judge Kevin J. Carey, "is there doesn't seem to be any adult supervision looking out for the average investor like myself. … (Y)ou have unemotional, ruthlessly efficient and litigious investors attempting to extract whatever they can from whomever they can."
Lies and his fellow shareholders are caught in a legal battle that may be the most perplexing yet in a Tribune Co. bankruptcy case that has groaned on for nearly three years, producing a seemingly endless flood of expensive litigation.
The junior creditors, led by Aurelius Capital Management, a New York hedge fund, claim that the complex, debt-laden deal orchestrated by Chicago billionaire Sam Zell was a fraudulent conveyance, meaning the transaction left the company insolvent from the start.
If proven, the creditors argue, investors shouldn't have benefited, which means the money they received for their stock at the time the deal closed should be made available to satisfy the more than $2.5 billion creditors claim they are owed.
In all, an estimated 33,000 to 35,000 investors are potentially on the hook for money they received in 2007, when the company went private at $34 a share. It's a list that stretches from large institutional investors to mom and pop shareholders. Defendants include thousands of current and former employees of Tribune Co., which owns the Chicago Tribune, Los Angeles Times and other media assets. But many others are people around the country who, like Lies, had nothing to do with the company; they simply bought the stock on the open market.
It is far from clear that the creditors' maneuver will work, legal experts say. But defendants warn that if Aurelius and its allies prevail, markets that depend on the sanctity of a settled transaction could be disrupted by making it difficult for investors to assess the risk inherent in participating in an LBO. It also would call into question a traditional assumption of Chapter 11 reorganization: that bankruptcy court is a place where all constituents of an insolvent company come together to resolve their differences in a single courtroom.
With the exception of a similar case involving Lyondell Chemical Co., which is pending in bankruptcy court in New York, legal experts were hard-pressed to cite another case in which creditors sought to go after all shareholders of a large public company in this way. And for independent shareholders like Lies, who wouldn't comment beyond his letter, it is taking its toll in defense costs and heartache.
"I've heard from investors whose entire life savings was dependent on Tribune stock," said Gary Lawson, a Texas attorney representing the Employees Retirement Fund of the City of Dallas. "But they can't afford to defend themselves. It's outrageous."
Fraudulent conveyance laws have been on the books for decades to protect a company and its creditors from transactions that harm the enterprise by extracting value without giving anything in return. A leveraged buyout gone bad is a common example because lenders, management and shareholders often benefit mightily, while the massive debt used to finance the deal renders the company insolvent, wiping out prior creditors.
Anyone who benefited from the transaction can be found liable for the fraudulent transfer in suits filed on behalf of the debtor's estate. But typically, legal experts say, the company or the pre-buyout creditors sue for recovery from banks and other parties with the deepest pockets, not rank-and-file investors such as Lies. And because fraudulent conveyance claims are difficult and expensive to litigate, the creditors and banks most often agree to settle the case early on.
The U.S. Bankruptcy Code also specifically discourages lawsuits targeting shareholders of bankrupt companies in some circumstances. A number of years ago, Congress tweaked the code with a provision called 546(e), which has been broadly interpreted to insulate investors who sold stock into a busted leveraged buyout like the Zell deal.
But lawyers and other sources familiar with Tribune Co.'s situation say that twists and turns in the case have opened the door for Aurelius to find a way past the provision: by suing shareholders for constructive fraudulent conveyance under state law in 44 courts around the country, where they contend 546(e) doesn't apply.
"They came up with a workaround," said Kenneth Klee, the court-appointed independent examiner in the Tribune Co. case and one of the authors of the Bankruptcy Code. "They said, 'Let's abandon bankruptcy court and go into state law (using) old case law.'"
The situation facing Lies and other shareholders was nearly resolved before it started. Tribune Co.'s pre-buyout creditors and those that held the bank debt almost settled their differences in April 2010 with a deal that would have released all parties in the case from liability. But one large holdout, Los Angeles hedge fund Oaktree Capital Management, wouldn't buy into the settlement struck between junior creditors, the company and senior creditors led by JPMorgan Chase and Angelo, Gordon & Co.
That opportunity missed, the fraudulent conveyance claims gained a new head of steam later in 2010 when Klee and his team of examiners found that it was "highly likely" that the second step in the two-step Zell deal to take the company private left the company insolvent. That hardened positions among creditors on both sides of the charges and pushed the case toward its second anniversary with little hope of a consensual settlement.
The Tribune Co. case also differed from many others in that it featured a number of large, deep-pocketed shareholders who had sold billions of dollars worth of stock in the deal, most notably the Robert R. McCormick Foundation and several large institutions like mutual fund company T. Rowe Price. Creditors also had their eyes on large holdings sold by a number of former Tribune Co. managers, such as Dennis FitzSimons and Don Grenesko, former chief executive and chief financial officer, respectively.
Together, these shareholders presented a fat target for the junior creditors. But early in the case, they were relatively well insulated by 546(e). Klee points out that the provision was originally intended to shield financial intermediaries like stock brokers and clearinghouses who were really just conduits for a transaction. But it has been broadly interpreted by bankruptcy judges to protect shareholders who trade through those intermediaries as well.
Fraudulent conveyance law distinguishes between two types of fraud: constructive fraud, which merely requires a finding that the deal left the company insolvent, and intentional fraud, which requires a finding that participants in the deal had actual fraudulent intent. In bankruptcy court, either determination allows the plaintiff to go after the banks that lent the money to fund the deal. But 546(e) requires that plaintiffs prove intentional fraud to extract money from shareholders, a much higher hurdle.
Although Klee did find some evidence suggesting intentional fraud in the second step of the Zell transaction, he said the evidence supporting constructive fraud was much more compelling. If Aurelius and the other junior creditors could bring a constructive case, they might be able to target shareholders who sold $4 billion worth of stock in the vulnerable second step alone. The question was, how could they find a way around 546(e)? The answer: Exit bankruptcy court all together.
That opportunity presented itself as the Tribune case dragged on toward its second anniversary in December 2010.
Fraudulent conveyance charges must be filed within a two-year statute of limitations in bankruptcy court or the company, which is empowered to bring the cases on behalf of the estate, loses that right. In the Tribune Co. case, the company ceded its rights to bring the suits to the Official Committee of Unsecured Creditors, which got permission from Carey to file a claim alleging intentional fraud against shareholders before the two-year limit. Carey then stayed the suit pending the completion of the Chapter 11 process, hoping that the various constituents could find a way to settle the charges consensually.
What the committee didn't do, however, was sue the shareholders under constructive fraudulent conveyance law. After huddling with Aurelius and others, the committee agreed to let the statute pass on those claims, meaning the right to bring them under state law reverted to individual creditors. Aurelius and its allies quickly asserted those rights and convinced Carey to lift his stay provisionally so they could file their claims in courts around the country, arguably beyond the reach of 546(e).
This strategy, which eventually got baked into a new restructuring plan supported by the company, the senior creditors and the committee, was immediately opposed by the McCormick Foundation and other large shareholders. But Carey has twice affirmed his intention to allow the suits to go forward outside his jurisdiction. What he refused to do, however, is rule on the key question of whether it was appropriate to circumvent 546(e) in this way. That decision will likely be made by a federal district court judge.
Supporting a plan that anticipated the shareholder suits put a number of parties in an odd position. For instance, senior creditors like Oaktree and JPMorgan, which will end up owning the company, were agreeing to let Aurelius sue thousands of its future employees. Tribune Co., too, was agreeing to subject its workers to legal action. But it was also clear that the creditors' committee would balk at a plan process that opposed the suits. And both Tribune and the senior group desperately wanted a settlement.
In the end, the company demanded its own provision in the plan that would grant releases to Tribune Co. employees who sold stock through their 401(k) accounts. The company also sought to shield the first $100,000 sold by an employee otherwise. Carey, however, quashed that plan in October, saying it could not be supported legally.
What shareholders are left with is this: They are being sued by the creditors committee via the intentional fraud case filed in bankruptcy court, and they are being sued by junior creditors and its allies via the 44 suits scattered across the country. About 1,700 individual defendants are named in the state law suits, including institutions and individuals who sold more than $75,000 worth of stock. To capture the rank and file, the junior bondholders have also asserted "class allegations" intended to sweep up all other shareholders. That will lead to the formation of a "defense class action," which is an unusual mirror image of the more common plaintiff's class-action process.
Adding yet another level of complexity to the situation, Aurelius and its allies have petitioned the federal Judicial Panel of Multidistrict Litigation to consolidate the suits. For reasons of jurisdiction, the state law claims are mostly being brought in dozens of federal district courts nationwide. But the bondholders have asked a judicial panel to merge them before U.S. District Judge Richard Holwell in the Southern District of New York. The first hearing on the matter will be on Dec. 1 in lower Manhattan.
That move has been supported by the McCormick Foundation and other big shareholders, which would rather see the case tried by a judge experienced in the complex issues involved. But many smaller shareholders, including a large group of Tribune Co. retirees, have opposed the move on the grounds that the cost of defending themselves against the suits is burdensome enough without adding the cost of doing so in New York for an unspecified period of time.
"The bulk of the small Tribune investors do not want to be a part of this New York financial game between the major Tribune investors and the hedge fund (Aurelius) that purchased Tribune debentures," the lawyer for one group of California investors complained in court papers.
Despite the objections, most experts believe the cases will be consolidated before Holwell and that his first order of business will be deciding the key question Carey avoided: Should the Aurelius strategy to avoid 546(e) be allowed to move forward?
In court papers, the McCormick Foundation and its fellow defendants are making two main arguments. First, they claim that the Aurelius group's "unprecedented mechanism" to get around 546(e) is merely an attempt to skirt the intent of Congress to protect shareholders in cases like these. For this reason, they argue that federal law should pre-empt the state laws, especially because the state fraudulent transfer laws meet an important criteria of being almost identical nationwide.
The defendants have also argued that even if Aurelius could find a way around the 546(e) pre-emption, there's no case law to support the idea that the creditors' committee and individual creditors can sue the shareholders twice to go after the same pot of money. Creditors historically have been given the right to take up fraudulent transfer claims not subject to 546(e) that are abandoned by the debtor in bankruptcy court. But the foundation argues that never has been allowed when similar claims are being pressed simultaneously in bankruptcy court that target the same source of recovery.
Aurelius declined to comment. But sources close to the case predict that the junior bondholders will argue that the 546(e) statute is very explicit in what it protects. It has been amended repeatedly, but never to pre-empt state law claims. If Congress meant something different, lawmakers likely would have made those changes when they had the chance.
As for the defendants' argument that they can't be sued twice, Aurelius and its allies may agree that there is only one source of recovery. But they could also argue that case law is mixed regarding the issue of suits targeting the same recovery, especially in a case such as this one in which the creditors' committee, acting as the estate's representative, supports the state law suits.
What's clear, legal experts say, is that the shareholder suits are likely to turn on the 546(e) issue. If the creditors win on that score, they will likely press for a settlement from the big shareholders who have always provided the biggest target. If the creditors lose, shareholders can turn their attention to defending themselves in a much weaker bankruptcy court case.
In any event, the Tribune Co. and Lyondell cases together are likely to break new ground when it comes to defining the protections shareholders can expect when they become involved in a leveraged buyout, either willingly or unwillingly. Klee and others argue that the danger in bending over backward to protect shareholders is that you run the risk of compromising the rights of basic creditors, whose claims by long legal tradition have always come before those of equity holders.
Nevertheless, said University of Pennsylvania Law School professor David Skeel, judges have tended to expand the scope of 546(e) in recent years, even extending it to cover holders of derivatives and commercial paper.
"The general trajectory is toward expansion of use," Skeel said.
Tribune Co. shareholders may hope that the trend continues.
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