The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

Articles By Topic

By Topic: Distressed Debt

  • From Vol. 9 No.40 (Oct. 13, 2016)

    Shareholders, Directors and Distressed Investors: What Hedge Fund Managers Need to Know About Investing in Spanish Restructurings

    Distressed Spanish companies have become targets of investors during the last few years, in part because new legislation has introduced tools to enhance out-of-court and in-court restructurings. In addition to considering the financials of the target companies and the business case behind each investment, investors in distressed debt in Spain must carefully assess the investment under Spanish law. In a guest article, Ignacio Buil Aldana, partner at Cuatrecasas, Gonçalves Pereira, highlights the key considerations hedge fund managers should regard when approaching Spanish distressed investments. Specifically, he outlines the rules that address subordination of claims and lender-shareholder relationships, including the rights of existing shareholders under Spanish law. For more on distressed investing, see “Investment Strategies, Considerations and Uncertainties of Distressed Debt Investments by Hedge Funds” (Apr. 9, 2015); and “Strategies for Handling Government Investigations, Challenges for CCOs, Distressed Debt Investing” (Dec. 5, 2013).

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  • From Vol. 9 No.28 (Jul. 14, 2016)

    Dechert Panel Discusses Recent Hedge Fund Fee and Liquidity Terms, the Growth of Direct Lending and Demands of Institutional Investors 

    A recent program sponsored by Dechert offered an overview of the current hedge fund landscape, focusing on fee and liquidity terms, the growth of direct lending, prime brokerage and institutional investors’ perspectives on alternative investments. The program featured John D’Agostino, a managing director at DMS Offshore Investment Services Ltd., and Dechert partners Matthew K. Kerfoot, David A. Vaughan, Karl J. Paulson Egbert and Timothy Spangler. This article highlights the panelists’ primary insights. For further insight from Kerfoot, see “Dechert Webinar Highlights Key Deal Points and Tactics in Negotiations Between Hedge Fund Managers and Futures Commission Merchants Regarding Cleared Derivative Agreements” (Apr. 18, 2013). For additional commentary from Vaughan, see “A Practical Comparison of Reporting Under AIFMD Versus Form PF” (Oct. 30, 2014). For further remarks from Egbert, see “Capital-Raising Opportunities, Regulatory Hurdles and Cultural Challenges Faced by Hedge Fund Managers in China and the Middle East” (Jun. 23, 2016).

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  • From Vol. 9 No.8 (Feb. 25, 2016)

    Hedge Fund Managers Trading Distressed Debt Must Understand LMA Standard Form Documentation

    The second decision handed down from the new U.K. Financial List addresses how failing to fully understand LMA standard form documentation can be disastrous for hedge fund managers. In 2013, certain funds purchased a surety bond position under a 2007 credit facility. That trade was subject to the Loan Market Association’s (LMA) 2012 Standard Terms and Conditions for Par and Distressed Trade Transactions (Bank Debt/Claims). However, the trade failed to settle because the parties disagreed as to whether the funds had purchased only the right to receive payment from the borrower or whether the funds were also obligated to pay claims to the surety bondholders. The U.K. High Court of Justice (Commercial Court) recently ruled on the trade. This article summarizes the underlying facts and the Court’s analysis. For a recent decision involving other LMA standard terms, see “U.K. Supreme Court Resolves Ambiguity in Standard LMA Terms for Sales of Loan Participations” (Apr. 2, 2015). For more on loan transactions governed by LMA standard terms, see “Should Hedge Funds Include Automatic Termination As a Term of Bank Debt Trades on the New Loan Market Association Forms?” (Mar. 11, 2010); and our two-part series on hedge funds’ trade risk in European secondary loans: Part One (Oct. 21, 2011); and Part Two (Oct. 27, 2011).

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  • From Vol. 8 No.40 (Oct. 15, 2015)

    Investor Lawsuit Against Lynn Tilton Alleges Misrepresentations and Excessive Fees

    A German bank and its affiliate that invested in two collateralized debt obligations (CDOs) sponsored and managed by Lynn Tilton’s firm, Patriarch Partners, have sued Tilton and the collateral managers of those CDOs in New York State Supreme Court for fraud and negligent misrepresentation.  The investors allege that the defendants improperly invested the CDOs’ assets in controlling equity positions in portfolio companies, enabling them to extract “excessive management fees” from those companies and benefit themselves at the expense of their investors.  The plaintiffs, who are seeking damages of more than $45 million, claim that the CDOs were in fact “poorly run and incredibly risky private equity ventures,” rather than traditional CDOs that invested in portfolios of debt.  This article summarizes the factual background of the dispute, the defendants’ alleged misconduct and the investors’ specific claims.  The suit follows the March 2015 SEC enforcement action against Tilton and the collateral managers of three CDOs sponsored by Patriarch Partners.  See “SEC Fraud Charges Against Lynn Tilton, So-Called ‘Diva of Distressed,’ Confirm the Agency’s Focus on Valuation and Conflicts of Interest,” The Hedge Fund Law Report, Vol. 8, No. 14 (Apr. 9, 2015).

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  • From Vol. 8 No.25 (Jun. 25, 2015)

    What Hedge Fund Claim Traders Need to Know About the Visa/MasterCard Settlement

    In a market environment in which hedge fund and other claim traders face a dearth of large-scale opportunities, a looming $6 billion class action settlement has captured the attention of savvy investors.  The settlement, which affects all merchants that accepted Visa and MasterCard since 2004, resolves whether various financial institutions violated antitrust laws by establishing and enforcing practices that charged merchants excessive fees for accepting Visa and MasterCard-branded credit and debit cards while also limiting merchants’ ability to steer customers toward other forms of payment.  Although the decision approving the settlement is currently facing pending appeals, merchants that are covered by the settlement have the ability to sell their claims now, thereby guaranteeing themselves a minimum fixed level of return in the class action litigation, while avoiding the risk of a delayed (and unknown) recovery.  In a guest article, Darius J. Goldman, head of the distressed debt and claims trading practice of Katten Muchin Rosenman, summarizes the key terms of the settlement as well as issues that claim traders should consider when purchasing a claim subject to the settlement.  For more insight from Katten, see “Katten Forum Identifies Best Practices for Hedge Fund Managers Regarding Best Execution, Soft Dollars, Principal Trades, Agency Cross Trades, Cross Trades and Trade Errors,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014); “Katten Partner Raymond Mouhadeb Discusses the Purpose, Applicability and Implications of the August 2012 ISDA Dodd-Frank Protocol for Hedge Fund Managers, Focusing on Whether Hedge Funds Should Adhere to the Protocol,” The Hedge Fund Law Report, Vol. 6, No. 4 (Jan. 24, 2013); and “Katten Seminar Provides Hedge Fund Managers with a Roadmap for JOBS Act Compliance,” The Hedge Fund Law Report, Vol. 6, No. 43 (Nov. 8, 2013).

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  • From Vol. 8 No.14 (Apr. 9, 2015)

    BakerHostetler Event Highlights Investment Strategies, Considerations and Uncertainties of Distressed Debt Investments by Hedge Funds

    In the current distressed debt environment, defaults have been relatively low, leading to fewer bankruptcies but opening the market up to increased restructurings and similar workouts.  However, the maneuvers available to distressed investors in the bankruptcy or restructuring process could be significantly impacted by two recent court cases, the results of which have created uncertainty in the marketplace by allowing minority bondholders to hold up or overturn restructuring proceedings and could have a major impact on future interpretations of the Trust Indenture Act of 1939 by courts in future proceedings.  See “A New Look at an Old Standard: The Power of Minority Bondholders Under the Trust Indenture Act,” The Hedge Fund Law Report, Vol. 8, No. 9 (Mar. 5, 2015); and “Trust Indenture Act May Give Hedge Funds the Right to Challenge Involuntary Non-Judicial Debt Restructurings,” The Hedge Fund Law Report, Vol. 8, No. 5 (Feb. 5, 2015).  Types and strategies of distressed investments, key legal issues relating to distressed investments, issues investors should consider in assessing distressed opportunities and the two recent court cases were highlights of a recent Hedge Funds and Distressed Debt Investing seminar held by law firm BakerHostetler.  This article summarizes the key issues discussed at that seminar.

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  • From Vol. 8 No.14 (Apr. 9, 2015)

    SEC Fraud Charges Against Lynn Tilton, So-Called “Diva of Distressed,” Confirm the Agency’s Focus on Valuation and Conflicts of Interest

    On March 30, 2015, the SEC announced the commencement of an enforcement action against Lynn Tilton, the so-called “Diva of Distressed,” and several entities she controls, arising out of the alleged overvaluation of distressed debt in the collateralized loan obligations (CLOs) they advise.  The SEC charges that Tilton improperly valued the loans owned by those CLOs, resulting in her receipt of nearly $200 million in compensation that she was not entitled to receive.  She also allegedly certified false and misleading financial statements for those CLOs and failed to disclose and obtain investor consent to the conflict of interest posed by her discretionary valuation method.  This article summarizes the SEC’s allegations and its specific charges.  For more on CLOs, see “Private Investment Funds Investing in CLO Equity and CLO Warehouse Facilities,” The Hedge Fund Law Report, Vol. 7, No. 18 (May 8, 2014).

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  • From Vol. 8 No.13 (Apr. 2, 2015)

    U.K. Supreme Court Resolves Ambiguity in Standard LMA Terms for Sales of Loan Participations

    A recent decision by the U.K. Supreme Court has resolved an ambiguity in the Loan Market Association Standard Terms and Conditions for Par Trade Transactions.  This article summarizes the facts underlying the dispute, the relevant provisions of the LMA terms and the Supreme Court’s reasoning.  For more on loan transactions governed by the LMA terms, see “The Impact of Asymmetric Information, Trade Documentation, Form of Transfer and Additional Terms of Trade on Hedge Funds’ Trade Risk in European Secondary Loans (Part Two of Two),” The Hedge Fund Law Report, Vol. 4, No. 38 (Oct. 27, 2011); “Regulatory, Tax and Credit Documentation Factors Impacting Hedge Funds’ Trade Risk in European Secondary Loans (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 37 (Oct. 21, 2011); and “Should Hedge Funds Include Automatic Termination as a Term of Bank Debt Trades on the New Loan Market Association Forms?,” The Hedge Fund Law Report, Vol. 3, No. 10 (Mar. 11, 2010).

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  • From Vol. 8 No.11 (Mar. 19, 2015)

    Structuring Private Funds to Profit from the Oil Price Decline: Due Diligence, Liquidity Management and Investment Options

    Energy companies directly or indirectly reliant on reserve based lending and public equity markets are feeling pressure as markets have tightened, as evidenced by recent significant stock declines, IPO delays, dividend and distribution cuts and missed interest payments leading to bankruptcy filings.  If lower prices are sustained, this financial pressure will continue over time as reserves are increasingly valued at lower prices, interest rates move upward and poorly hedged exploration and production companies and counterparties face unfavorable positions.  In such a market, leveraged and shale focused high-yield exploration and production companies, shale-reliant and undiversified oil field services companies and small- to medium-sized financial institutions with significant exposure to such companies and the boom oil patch areas generally will present distressed investors with plenty of opportunities to extract value from current market conditions.  Along with the financial considerations, investment funds looking to take advantage of distressed energy opportunities will have to consider various legal matters including structuring the investments, due diligence and dealing with potentially illiquid positions.  This guest article describes the market context, focusing on opportunities for hedge funds and other players arising out of the oil price plunge; the palette of investment options available to managers looking to invest in or around oil price movements; the balance between speed and comprehensiveness in due diligence; and tax, liquidity and other fund structuring considerations.  The authors of this article are James Deeken and Shubi Arora, both partners at Akin Gump Strauss Hauer & Feld; Jhett Nelson, counsel at Akin; and Stephen Harrington, an Akin associate.

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  • From Vol. 8 No.9 (Mar. 5, 2015)

    A New Look at an Old Standard: The Power of Minority Bondholders Under the Trust Indenture Act

    Could an obscure statutory provision dating back to the New Deal give a distressed company’s minority bondholders the power to hold up a restructuring agreed upon by all of the other bondholders?  The answer appears to be “yes.”  Two recent cases interpreting the Trust Indenture Act of 1939 (Act) have broadly read a provision of the Act to bar any non-consensual change to the existing bond indenture that would affect any bondholder’s ultimate payment rights in the context of an out-of-court restructuring.  This is regardless of any agreements reached by the majority of bondholders and regardless of the depth of sound business judgment underlying a company’s proposed restructuring plan.  By boosting minority bondholders’ leverage in restructurings, these recent cases interpreting the Act could have far-reaching implications.  Hedge funds and other investors looking to invest in distressed debt would be wise to analyze these decisions closely.  In a guest article, Marc D. Powers, Mark A. Kornfeld, Ferve E. Ozturk and M. Elizabeth Howe provide such an analysis, and discuss the implications of the decisions for hedge funds that invest in distressed debt.  Powers is the national leader of the Hedge Fund Industry and Securities Litigation practices at BakerHostetler; Kornfeld is a BakerHostetler partner; Ozturk and Howe are associates at the firm.

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  • From Vol. 8 No.5 (Feb. 5, 2015)

    Trust Indenture Act May Give Hedge Funds the Right to Challenge Involuntary Non-Judicial Debt Restructurings

    In late 2014, in a decision that may greatly increase the leverage of holdout bondholders in non-judicial debt restructurings, hedge fund managers holding unsecured debt were denied the injunction they sought of a proposed restructuring of a company’s debt.  This article summarizes the factual background of the case and the court’s reasoning.  For a discussion of other options available to aggrieved debt holders, see “Coercive Exchanges: How Hedge Fund Noteholders Can Salvage Value Under Duress,” The Hedge Fund Law Report, Vol. 6, No. 23 (Jun. 6, 2013).  For a look at holdout litigation involving sovereign debt, see “Bondholders, Including Hedge Funds, Win Latest Round in Battle with Republic of Argentina over Payments on Defaulted Sovereign Bonds,” The Hedge Fund Law Report, Vol. 6, No. 36 (Sep. 19, 2013).  For another interpretation of the Trust Indenture Act relevant to hedge fund managers that invest in structured products, see “Second Circuit Panel Stays Mum on Whether Trust Indenture Act Applies in All Securitization Deals,” The Hedge Fund Law Report, Vol. 7, No. 24 (Jun. 19, 2014).

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  • From Vol. 8 No.2 (Jan. 15, 2015)

    Public-Side Versus Private-Side Information – Which Side To Take?

    Fund managers investing in distressed debt, syndicated loans, notes and other types of debt often get invited to data rooms and deal websites where they are offered access to confidential information about a borrower.  In contrast to the traditional (perhaps, now antiquated) method of obtaining confidential borrower information directly from an existing lender or a dealer, subject to a written non-disclosure agreement, obtaining confidential information through such data rooms presents a number of special concerns.  First, the bank or dealer responsible for the data room commonly asks existing and potential lenders to choose between so-called “public-side” information and “private-side” information.  Second, in relation to distressed debt, the information so offered is often related to a restructuring, refinancing or other significant event with respect to the borrower and, especially with respect to what is labeled as “private-side” information, tends to be of a higher level or quality than the information generally available to all lenders or debt holders.  Third, the agreement embodying the terms of disclosure is typically contained in a non-negotiable splash page or a “click-through” agreement rather than a conventional, written, bilateral confidentiality agreement negotiated, executed and exchanged by trading parties.  See “Key Legal and Business Considerations for Hedge Fund Managers in Drafting and Negotiating Confidentiality Agreements (Part Three of Three),” The Hedge Fund Law Report, Vol. 5, No. 28 (Jul. 19, 2012).  In addition, there is often some confusion on the part of traders and analysts regarding the true nature of public-side versus private-side information and the consequences of choosing one or the other.  In a guest article, William G. Frenkel and Michael Y. Sukhman, partners at Frenkel Sukhman LLP, discussed the legal consequences and risks associated with making that decision.  For a discussion of another legal issue relevant to distressed debt trading, see “Can a Hedge Fund Holding Secured Debt Credit Bid Up to the Face Amount of the Debt Or Only Up to the Amount Paid for the Debt?,” The Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014).

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  • From Vol. 7 No.23 (Jun. 13, 2014)

    The Best-Laid Plans: Preventing Rule 10b5-1 Plans from Going Awry (Part Two of Two)

    This is the second article in a two-part series explaining the mechanics of 10b5-1 plans and their application to the private funds industry; examining the lessons that can be learned from an inquiry into possible insider trading by a major private equity fund manager that purchased debt of a portfolio company pursuant to a 10b5-1 plan (the inquiry ultimately determined that the trading had not violated insider trading restrictions); and recommending practices that may enhance the defensibility of a 10b5-1 plan.  The authors of the series are Daniel Laguardia, a partner in Shearman & Sterling’s Litigation Group, and K. Mallory Brennan and Ross Kamhi, both associates in that group.  See also “The Best-Laid Plans: Preventing Rule 10b5-1 Plans from Going Awry (Part One of Two),” The Hedge Fund Law Report, Vol. 7, No. 22 (Jun. 6, 2014).

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  • From Vol. 7 No.22 (Jun. 6, 2014)

    The Best-Laid Plans: Preventing Rule 10b5-1 Plans from Going Awry (Part One of Two)

    The increased focus of regulators, media and private litigants on insider trading has recently expanded to a new target: Rule 10b5-1 trading plans (10b5-1 plans), which are intended to invoke the affirmative defense against insider trading claims provided by Exchange Act Rule 10b5-1 for trades executed pursuant to a written plan that meets specific requirements.  10b5-1 plans are best known as devices to allow company insiders to buy or sell securities pursuant to a pre-arranged instruction without facing automatic liability for insider trading.  When properly implemented, the rule enables both investors and issuers to execute trades, even when they know material nonpublic information, so long as the trades are made pursuant to a plan established when the investor or issuer did not have inside information.  These protections can extend beyond the diversification needs of individual company executives.  For example, trades made by hedge funds pursuant to stop-loss and trailing-stop orders may be protected from insider trading liability if the orders are designed and implemented in accordance with Rule 10b5-1’s parameters.  And the protections of Rule 10b5-1 are not limited to publicly-traded stocks.  Private equity funds and other distressed debt investors and investment managers can also benefit from Rule 10b5-1, such as by using a 10b5-1 plan to make future acquisitions of company debt without running afoul of insider trading restrictions.  The protection of the affirmative defense is not absolute, however, and those trading under the auspices of even a properly adopted 10b5-1 plan have to be careful not to undermine their protection.  In a two-part series of guest articles, Daniel Laguardia, K. Mallory Brennan and Ross Kamhi explain the mechanics of 10b5-1 plans and their application to the private funds industry; examine the lessons that can be learned from an inquiry into possible insider trading by a major private equity fund manager that purchased debt of a portfolio company pursuant to a 10b5-1 plan (the inquiry ultimately determined that the trading had not violated insider trading restrictions); and recommend practices that may enhance the defensibility of a 10b5-1 plan.  Laguardia is a partner in Shearman & Sterling’s Litigation Group, and Brennan and Kamhi are associates in that group.  This is the first article in the two-part series.

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  • From Vol. 7 No.17 (May 2, 2014)

    Is a Hedge Fund a “Financial Institution” Under a Clause Restricting the Assignability of Debt?

    In 2013, hedge fund NB Distressed Debt Investment Fund Limited (NB Distressed) and affiliates purchased an interest in a defaulted loan to a bankrupt borrower.  Distressed debt investing can present a host of complexities, especially when the borrower is in bankruptcy.  See “ALM’s 7th Annual Hedge Fund General Counsel Summit Addresses Distressed Debt Investing (Part Two of Three),” The Hedge Fund Law Report, Vol. 6, No. 46 (Dec. 5, 2013).  Those issues may involve credit bidding, equitable subordination, disallowance risks, insider trading and recharacterization of debt as equity.  In the case of NB Distressed, the loan documents provided that the lender could only transfer the loan to “Eligible Assignees,” a term that included banks, insurance companies and “financial institutions.”  The bankruptcy court ruled that the funds were not financial institutions and therefore not entitled to vote on the borrower’s reorganization plan.  In a recent decision, a U.S. District Court reviewed the bankruptcy court’s decision.  The District Court’s decision and analysis are relevant to hedge funds that purchase distressed debt and other loans containing “Eligible Assignee” provisions.

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  • From Vol. 7 No.7 (Feb. 21, 2014)

    Can a Hedge Fund Holding Secured Debt Credit Bid Up to the Face Amount of the Debt Or Only Up to the Amount Paid for the Debt?

    The right of a secured creditor to bid the secured debt it holds to purchase the collateral securing that debt from the debtor in a Chapter 11 proceeding (a credit bid) is now firmly established.  See “U.S. Supreme Court Resolves Circuit Split and Affirms Secured Creditors’ Right to Credit Bid Under Chapter 11 Plan,” The Hedge Fund Law Report, Vol. 5, No. 25 (Jun. 21, 2012); and “Seventh Circuit Holds that Secured Lenders Must Have the Opportunity to Credit Bid in Asset Sales Under a Chapter 11 Plan,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  However, when the secured creditor purchased that debt at a steep discount, as is often the case in distressed debt transactions executed by hedge funds, issues may arise as to whether the creditor is entitled to credit bid up to the face amount of the debt it holds, or only a portion of that amount.  A U.S. District Court recently addressed this issue, and its analysis has implications for hedge funds that invest in secured credit.

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  • From Vol. 7 No.4 (Jan. 30, 2014)

    Tax Practitioners Discuss Taxation of Foreign Investments and Distressed Debt Investments at FRA/HFBOA Seminar (Part Three of Four)

    During the 15th Annual Effective Hedge Fund Tax Practices seminar sponsored by Financial Research Associates and the Hedge Fund Business Operations Association, tax experts at two separate sessions addressed the taxation of foreign investments, including withholding at the source, rules regarding controlled foreign corporations and issues concerning the taxation of distressed debt investments.  This article, our third in a four-part series covering the seminar, summarizes salient points from those two sessions.  Panelists for the “Working Through Tax Implications of Foreign Investments” session included, among others, Len Lipton, a managing director at GlobeTax Services and Philip S. Gross, a partner at Kleinberg, Kaplan, Wolff & Cohen, P.C.  The session entitled “Tax Considerations for Distressed Debt Transactions” was presented by David C. Garlock, Director of Financial Services at Ernst & Young LLP.  The first installment in this series covered three sessions addressing the contribution and distribution of property to fund investors, the allocation of investment gains and losses to fund investors and the preparation of Forms K-1.  See “Hedge Fund Tax Experts Discuss Allocations of Gains and Losses, Contributions to and Distributions of Property from a Fund, Expense Pass-Throughs and K-1 Preparation at FRA/HFBOA Seminar (Part One of Four),” The Hedge Fund Law Report, Vol. 7, No. 2 (Jan. 16, 2014).  The second installment discussed issues impacting foreign investors in foreign funds, including basics of withholding with respect to fixed or determinable annual or periodic gains, profits or income (FDAPI); the portfolio interest exemption from FDAPI withholding; the pitfalls of effectively connected income (ECI) for offshore hedge funds; and the sources of ECI.  See “Tax Experts Discuss Provisions Impacting Foreign Investors in Foreign Hedge Funds During FRA/HFBOA Seminar (Part Two of Four),” The Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014).

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  • From Vol. 6 No.46 (Dec. 5, 2013)

    ALM’s 7th Annual Hedge Fund General Counsel Summit Addresses Strategies for Handling Government Investigations, Challenges for CCOs, Distressed Debt Investing, OTC Derivatives Reforms, Insider Trading Best Practices, the JOBS Act, AIFMD and Activist Investing (Part Two of Three)

    Hedge fund industry thought leaders recently shared their insights on legal, operational and other issues impacting hedge fund managers during the 7th Annual Hedge Fund General Counsel Summit hosted by ALM Events.  This second installment in our three-part series covering the summit discusses topics including the impact of over-the-counter derivatives reforms on fund managers (including a discussion of new mandatory trade reporting, clearing and execution requirements as well as CFTC cross border rules); opportunities and challenges associated with distressed debt investing (including a discussion of opportunities to participate in Chapter 11 proceedings, considerations in claims trading and risks of distressed debt investing); and best practices to address insider trading risks.  The first installment discussed strategies for handling government investigations and challenges facing chief compliance officers, including dual-hatting and potential supervisory liability.  The third installment will provide regulatory updates on the JOBS Act, the Alternative Investment Fund Managers Directive and new Canadian and U.S. initiatives that will impact activist investing strategies.

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  • From Vol. 6 No.45 (Nov. 21, 2013)

    ALM’s 7th Annual Hedge Fund General Counsel Summit Addresses Strategies for Handling Government Investigations, Challenges for CCOs, Distressed Debt Investing, OTC Derivatives Reforms, Insider Trading Best Practices, JOBS Act, AIFMD and Activist Investing (Part One of Three)

    On September 30 and October 1, 2013, ALM Events hosted its 7th Annual Hedge Fund General Counsel Summit during which law firm and in-house practitioners shared insights on legal, operational and other challenges faced by hedge fund managers.  This first installment in a three-part series covering the summit highlights the salient points from panel discussions addressing strategies for handling government investigations and issues faced by chief compliance officers, including dual-hatting and supervisory liability.  See “Benefits, Challenges and Recommendations for Persons Simultaneously Serving as General Counsel and Chief Compliance Officer of a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012).  The second article in the series will address opportunities and challenges associated with distressed debt investing (including participation in Chapter 11 proceedings, claims trading and risks of distressed debt investing); the impact of over-the-counter derivatives reforms on fund managers (including new mandatory clearing, execution and reporting requirements as well as CFTC cross border rules); and best practices for addressing insider trading risks.  The third article will provide regulatory updates on the JOBS Act, the Alternative Investment Fund Managers Directive and new Canadian and U.S. initiatives that will impact activist investing strategies.

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  • From Vol. 6 No.23 (Jun. 6, 2013)

    Coercive Exchanges: How Hedge Fund Noteholders Can Salvage Value Under Duress

    Issuers are closing transactions that effectively change the character of their notes without soliciting input or consent from noteholders holding a significant portion (albeit a minority) of the issuance, often leaving such holders with illiquid investments whose value has declined, sometimes materially, as a result of the issuer’s financial engineering.  Fortunately, minority noteholders have recourse if they act quickly.  Although each situation and indenture presents different challenges and opportunities requiring a specifically tailored response and litigation strategy, in general, noteholders have various arguments at their disposal.  In a guest article, Andreas P. Andromalos, a partner at Brown Rudnick LLP, and Gabriel N. Carreiro and Patrick G.H. Mott, both associates at Brown Rudnick, detail those arguments, the stakes and the supporting caselaw.

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  • From Vol. 5 No.43 (Nov. 15, 2012)

    Tribune Bankruptcy Highlights the Importance of Close Reading of Indenture Agreements by Hedge Funds That Trade Bankruptcy Claims or Distressed Debt

    The interpretation of language contained in indenture agreements that are often entered into years prior to a bankruptcy filing of the borrower will significantly impact the ultimate recovery by noteholders – as demonstrated by the ongoing saga involving the Tribune Company.  In a guest article, Richard J. Corbi of Lowenstein Sandler PC provides an analysis of developments in the Tribune bankruptcy relevant to hedge funds that invest in distressed debt, bankruptcy claims and related instruments.

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  • From Vol. 5 No.35 (Sep. 13, 2012)

    Greenwich Associates Report Shows Hedge Funds “Reasserting Themselves” in Trading in U.S. Fixed Income Markets

    Greenwich Associates, LLC (Greenwich), has issued a report on trading volumes in the U.S. fixed income markets and the growing role that hedge funds play in those markets.

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  • From Vol. 5 No.33 (Aug. 23, 2012)

    Motors Liquidation Company Suit against Hedge Funds Holding Distressed Debt of General Motors Nova Scotia Finance Company Goes to Trial

    Motors Liquidation Company f/k/a General Motors Corporation (Old GM) filed for bankruptcy protection on June 1, 2009.  In the months leading up to that filing, hedge funds that specialize in distressed debt snapped up the unsecured debt of Old GM and its subsidiaries, including more than $1 billion of unsecured bonds (Notes) of General Motors Nova Scotia Finance Company (NS Finance).  Old GM had guaranteed repayment of the Notes.  As part of Old GM’s Chapter 11 reorganization, Motors Liquidation Company GUC Trust (GUC Trust) was established to handle disputed claims of unsecured creditors, including those of the Noteholders.  In a Southern District of New York adversary proceeding, GUC Trust claims that, in the days just prior to Old GM’s bankruptcy filing, certain of the Noteholders extracted a settlement from NS Finance that was an “egregious economic overreach.”  This article summarizes the transactions that led to the GUC Trust complaint and its specific allegations.  See also “GM Bankruptcy Judge Rejects Distressed Debt Hedge Fund Investors’ Objections to Reorganization Plan,” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011).

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  • From Vol. 5 No.28 (Jul. 19, 2012)

    When Is a Distressed Debt Trade Considered Consummated?

    Trades in distressed debt or bankruptcy claims are often characterized by cursory, and sometimes oral, agreements to enter into a trade, followed by months during which remaining terms are negotiated prior to settlement of the trade.  However, during the period between the initial agreement and the settlement of the trade, the value of the subject assets can fluctuate, sometimes significantly.  This may create certain disincentives for one party to complete the trade, which can lead to litigation.

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  • From Vol. 5 No.24 (Jun. 14, 2012)

    Five Steps Hedge Fund Managers Should Take to Mitigate Avoidance and Disallowance Risks After Delaware Court Finds That Avoidance and Disallowance Risks Travel with Trade Claims

    Distressed investors, such as hedge fund managers, purchasing trade claims against a debtor in the secondary market must now face the fact that certain disabilities may attach to and travel with claims following a May 4, 2012 decision by Judge Kevin J. Carey of the United States Bankruptcy Court for the District of Delaware (Court) in the KB Toys bankruptcy proceeding.  The Court held that a purchaser of a trade claim against a debtor takes such claim subject to the risk of disallowance of the claim under Bankruptcy Code Section 502(d) based on the original claimholder’s receipt of (and failure to pay) an avoidable transfer.  While Judge Carey specified that the decision was limited solely to trade claims purchased from the original holders of such claims, the Court’s reasoning could be extended to other circumstances, such as bank loans traded in the secondary market.  Therefore, it is essential that distressed investors perform the necessary diligence and negotiate sufficient protections in agreements to purchase distressed debt.  In a guest article, Steven F. Wasserman and Howard S. Steel, both Partners at Brown Rudnick, and Laura F. Weiss, an Associate at Brown Rudnick, provide an overview of the KB Toys decision and recommend five best practices to minimize risks to recoveries in light of this important decision.

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  • From Vol. 5 No.22 (May 31, 2012)

    What Risks – And Opportunities – Does the Euro Zone Crisis Present for Hedge Fund Managers?  An Interview with Richard Frase of Dechert

    The euro zone crisis is intensifying, and hedge fund managers must be prepared to address the myriad risks (and prospective opportunities) that are presented by the crisis.  The Hedge Fund Law Report recently interviewed Richard Frase, a Partner at Dechert LLP, who shared his perspective on euro zone risks and how hedge fund managers should prepare themselves to mitigate such risks.  Specifically, the interview covered: European counterparty risks, including risks posed by prime brokers, sub-custodians and trade counterparties; euro-related risks, including a discussion of hedging strategies and approaches with respect to euro-denominated funds or share classes; euro zone-related fund disclosures, including general euro zone economic risk factors, counterparty risks and euro-related risks; approaches to valuing euro-denominated assets; and investment opportunities presented by the euro zone crisis.  This article contains the full text of our interview with Frase.

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  • From Vol. 5 No.20 (May 17, 2012)

    Navigating the Insider Trading Risks in Distressed Debt Trading

    The past two years have seen a dramatic increase in the number and visibility of insider trading cases brought by regulatory and enforcement authorities and private plaintiffs.  If the first few months of 2012 are any indication, this trend will continue.  Indeed, not only are enforcement authorities becoming more active in bringing such actions, they are also becoming more aggressive in their interpretation of the scope of actions which may constitute insider trading.  Thus, insider trading cases have been brought against a “tippee” who found a copy of a presentation about a buyout that a banker mistakenly left behind and against a director who is not even alleged to have traded or otherwise profited from the alleged misconduct.  To date, however, there have been relatively few attempts to pursue insider trading charges or civil claims in the context of bankruptcy claims trading, and those cases that have been brought have been largely limited to situations involving creditors’ committee members.  There are good reasons that such actions should be limited to the context of a creditors’ committee.  However, in light of the increasing activity in this area, it is worth reviewing the complexities involved in the application of insider trading laws to distressed debt trading.  In a guest article, Daniel H.R. Laguardia and K. Mallory Tosch, Partner and Associate, respectively, at Shearman & Sterling LLP, provide a comprehensive analysis of insider trading law as it applies to hedge funds that invest in distressed debt, bankruptcy claims and similar assets.

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  • From Vol. 5 No.7 (Feb. 16, 2012)

    A New Year in Old World Distressed Debt: Distressed Investment Opportunities for Hedge Fund Managers in the UK/Europe for 2012

    The UK and Europe appear poised to provide unprecedented opportunities in distressed debt in 2012.  A variety of factors are expected to force banks in the UK/Europe to delever their balance sheets by a colossal sum of €1.5 to €2.5 trillion over the next 18 to 24 months.  Analysts anticipate, as a result, a spate of distressed bank loans coming to market.  In order to capitalize on this unique opportunity – which some have characterized as “the next great trade” – hedge fund managers will need to be well-versed in local law, particularly local insolvency law.  In a guest article, Solomon J. Noh discusses legal considerations that can impact the outcome of investments by hedge funds in UK and European distressed debt.  Noh is a Partner in the Bankruptcy & Reorganization Group at Shearman & Sterling LLP, currently resident in Shearman’s London office.  For related analysis by Noh, see “Treatment of a Hedge Fund’s Claims Against and Other Exposures To a Covered Financial Company Under the Orderly Liquidation Authority Created by the Dodd-Frank Act,” The Hedge Fund Law Report, Vol. 4, No. 15 (May 6, 2011).

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  • From Vol. 4 No.38 (Oct. 27, 2011)

    The Impact of Asymmetric Information, Trade Documentation, Form of Transfer and Additional Terms of Trade on Hedge Funds’ Trade Risk in European Secondary Loans (Part Two of Two)

    Although certain distressed debt investors in the European markets would like to believe that senior secured bonds can provide easier and more liquid access to the rights and influence of senior secured lenders, this is not the current reality.  Though both bonds and bank debt may have “senior secured” preceding their title, the rights and influence afforded to investors can vary significantly among instruments.  While many on the buy side are fighting to bring the senior secured bond structure more in line with bank debt on the premise that a Euro worth of senior secured bonds should be a Euro worth of senior secured bank debt, it remains to be seen when and if this will happen.  In most instances, the ability to quickly access the senior secured facility agreement and ancillary documents as well as steer a borrower’s proposed restructuring will continue to be driven initially by the senior bank debt lenders.  A misstep in trading bank debt while building a portfolio position could therefore shut an investor out from discussions.  This makes for a bitter pill to swallow if the investment strategy behind the debt purchase from the outset is to be active in restructuring talks.  Access by an investor to the traditionally “club” world of European bank debt, especially in middle market private situations, can come with challenges.  This is especially true for investment funds looking to trade across a borrower’s capital structure and seeking liquidity and a quick settlement if things don’t go according to plan.  In Part 1 of this two-part article series, David J. Karp, a Special Counsel at Schulte Roth & Zabel LLP (SRZ), and leader of the firm’s Distressed Debt and Claims Trading Group, Roxanne Yanofsky, an Associate at SRZ, and Erik Schneider, also an Associate at SRZ, examined regulatory and tax issues that may impact on an investor’s recovery; identified certain restrictions in the underlying credit documentation that could prohibit an investor from assuming a direct lender of record position; and discussed perfection issues that may affect a lender’s recovery in a borrower insolvency scenario.  See “Regulatory, Tax and Credit Documentation Factors Impacting Hedge Funds’ Trade Risk in European Secondary Loans (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 37 (Oct. 21, 2011).  In this article, Part 2 of the series, the authors, joined by their colleague Neil Robson (a Senior Associate in SRZ’s London office) touch upon issues relating to confidential information in the European secondary loan market and trading where a disparity of information exists between syndicate members and restructuring committee members under a credit agreement.  Additionally, the authors discuss the different forms of documentation available for trading bank debt, the various options for purchase of bank debt and the risks associated with each method of settlement.

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  • From Vol. 4 No.37 (Oct. 21, 2011)

    Regulatory, Tax and Credit Documentation Factors Impacting Hedge Funds’ Trade Risk in European Secondary Loans (Part One of Two)

    For the majority of 2011, European secondary loan markets had buy-side traders frustrated by low liquidity, volume and deal flow, and sell-side traders were left to wonder if and when they do source, will enough friends come out and play.  Is this the calm before the storm?  Many in the distressed community believe it is, and that loans will play a significant role in the corporate distressed wave expected to hit shore in 2012 as part of €221 billion worth of European leveraged loans set to mature between now and through 2015.  The high yield market was a savior in 2011 for many borrowers whose loans were set to mature in 2013 and 2014.  However, with some of these deals already having gone sour and the pool of remaining loans deteriorating, the high yield market is not likely to save the day again.  Regardless of the capital market options, when the refinancing peak reaches its heights in Europe and the U.S. in 2014, bad loans will likely be left behind in droves.  To assist investment funds in filling their proverbial sandbags and preparing to pick up potentially lucrative pieces in the aftermath, David J. Karp, Special Counsel at Schulte Roth & Zabel LLP (SRZ), Roxanne Yanofsky, an Associate at SRZ, and Erik Schneider, also an Associate at SRZ, are publishing in The Hedge Fund Law Report a two-part series on trade risks specific to loans in the European market.  This first article will focus on certain macro issues arising in the context of European secondary loan trading, through analyzing regulatory, tax and credit documentation factors which can impact the success of a trade.  In particular, this article analyzes, among many other relevant issues: what jurisdictions and applicable lender restrictions play into a trade; whether a debt purchase subjects an investor to a withholding tax, and, if so, whether the investor can obtain the benefit of an exemption or a reduced rate of withholding tax; the requirements to accede as a lender of record under a loan agreement, including eligibility requirements, minimum thresholds and borrower consent rights; and any additional steps an investor must take to perfect its debt transfer and consequences for failing to take the requisite action.  The second article, to be published in an upcoming issue of The Hedge Fund Law Report, will look at trade issues affecting an investor at time of trade and on a more micro level, covering transfer perfections, LMA transparency guidelines, trade documentation, form of transfer and additional terms of trade.

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  • From Vol. 4 No.35 (Oct. 6, 2011)

    WaMu Bankruptcy Judge Allows Equity Committee’s Action for Equitable Disallowance of Hedge Fund Noteholders’ Claims to Proceed on the Ground that Equity Committee Stated a “Colorable Claim” that those Noteholders Engaged in Insider Trading

    In a shot across the bow of investors who trade in the debt of bankrupt companies, a U.S. bankruptcy court has held that the Equity Committee of Washington Mutual, Inc. (WaMu) has stated a “colorable claim” that four hedge funds that held WaMu debt and participated in bankruptcy settlement negotiations engaged in insider trading when they traded WaMu’s debt.  Hedge funds Appaloosa Management, L.P., Aurelius Capital Management LP, Centerbridge Partners, LP, and Owl Creek Asset Management, L.P. (together, Noteholders), acquired enough WaMu debt that they were in a position to block approval of portions of WaMu’s plan of reorganization.  As a result, they were allowed to participate in negotiations among the various stakeholders in the bankruptcy.  WaMu’s Equity Committee alleged that the Noteholders had engaged in insider trading using information they received during settlement negotiations and that, as a result, their claims should be equitably disallowed.  In a wide-ranging decision denying confirmation of WaMu’s sixth amended reorganization plan, the Court ruled that the Equity Committee had alleged a colorable claim of insider trading by the Noteholders that could support equitable disallowance of their claims.  This article provides a feature length synopsis of the facts that gave rise to the insider trading charges, and the Court’s reasoning.

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  • From Vol. 4 No.35 (Oct. 6, 2011)

    DLA Piper Appoints Troy Doyle to Lead its Restructuring & Distressed Investment Team in Asia

    On October 6, 2011, DLA Piper announced the appointment of Troy Doyle as a partner in its Singapore office to lead the firm’s restructuring and distressed investment team in Asia.  Doyle is experienced in advising investment banks, private equity firms, hedge funds, insolvency practitioners and corporations on distressed situations throughout Australia, Singapore, Thailand, India, Indonesia, Philippines and China.  For an analysis of FCPA considerations in connection with engaging advisors for investments in and around non-U.S. bankruptcies, see “Practical Considerations for Compliance by Hedge Fund Managers with the FCPA When Evaluating and Engaging Foreign Advisors in Connection with Foreign Bankruptcy Investments,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    Merchant Power Regulatory Roulette

    Billions of dollars of merchant power debt tied to aging, largely coal-fired, power plants is subject to escalating financial stress and attracting increasing attention from hedge fund investors.  Recent public examples include Energy Future Holdings (TXU), EME Homer City and Astoria Generating.  To a large extent, current merchant power economics and future prospects are driven by overall power demand and natural gas prices insofar as natural gas plants currently have a price advantage in many competitive power pools they have not previously enjoyed.  Thus, investment decisions regarding debt related to coal-fired merchant plants will certainly be influenced by the investor’s view as to the persistence of low-cost natural gas as well as future demand recovery.  However, the value prospects for coal-fired and other legacy plants is also being significantly impacted by certain impending, highly contested and still spinning regulatory actions, and it is critical that hedge fund managers consider this regulatory roulette in their merchant power debt investment decisions.  In a guest article, Howard L. Siegel, a partner at Brown Rudnick LLP, where he is a member of the firm’s Bankruptcy and Corporate Restructuring Group and its Energy, Utilities and Environmental Practice Group, analyzes the key regulatory considerations impacting the outcomes of investments by hedge funds in the debt of merchant power projects.

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    Delaware Bankruptcy Court Rejects Efforts of Moll Industries’ Unsecured Creditors to Recharacterize as Equity the Secured Debt Held by Highland Capital Funds and to Hold Highland Capital Liable as Moll’s “Alter Ego”

    This adversary proceeding pits the committee of unsecured creditors (Committee) of Moll Industries, Inc. (Moll) against hedge fund manager Highland Capital Management, L.P. (Highland) and several Highland funds that were secured creditors of Moll (Funds).  The Committee claimed that the Moll senior debt held by the Funds should be equitably subordinated to Moll’s unsecured debt, or recharacterized as equity, thereby eliminating the priority that the Funds would otherwise have in the bankruptcy proceeding.  The Committee also claimed that Highland was liable to Moll’s unsecured creditors because it acted as Moll’s “alter ego.”  Finally, it sought to void a security interest held by the Funds in one of Moll’s bank accounts.  Highland and the Funds all moved to dismiss the Committee’s complaint.  The Court permitted the security interest avoidance claim to proceed but dismissed the equitable subordination, recharacterization and alter ego claims.  This article provides a comprehensive discussion of the Court’s decision and analysis.

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  • From Vol. 4 No.32 (Sep. 16, 2011)

    How Can Hedge Fund Managers Avoid Insider Trading Violations When Using Expert Networks in Connection with Leveraged Loan Market Transactions?

    On July 27, 2011, compliance software provider Compliance11 hosted a webinar entitled, “Best Practices for use of Expert Networks and the Leveraged Loan Market.”  The purpose of the event was to provide “solutions, tactical input and strategies” designed to avoid insider trading pitfalls when hedge fund managers use expert networks in connection with leveraged loan trades.  For more on this general topic, see “Insider Trading and Debt Securities: Practical Tips for Hedge Funds in Coping with Regulatory Enforcement,” The Hedge Fund Law Report, Vol. 4, No. 20 (Jun 17, 2011).  The webinar was moderated by Tracey Straub, Vice President of Strategy at Compliance11.  Laurence Herman, General Counsel and Managing Director of Gerson Lehrman Group (GLG), spoke about the use of expert networks, and Tim Houghton, Founding Principal of Cortland Capital Market Services (CCMS), spoke about trading in the leveraged loan market.  See “From Lender to Shareholder: How to Make Your Equity Work Harder for You,” The Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  This article summarizes the most important points made during the webinar.  In particular, this article discusses: the ways in which expert networks can diminish the opportunities for inappropriate conveyance of material nonpublic information (MNPI); four recommended steps for hedge fund managers to take prior to engaging an expert network firm or expert; seven best practices for using expert network firms; nine compliance policies and procedures for using experts; whether leveraged loans are “securities” for insider trading purposes; and how to manage MNPI at hedge fund managers that participate in the leveraged loan market.  See “Big Boys Don’t Cry: How ‘Big Boy’ Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations,” The Hedge Fund Law Report, Vol. 2, No. 48 (Dec. 3, 2009).

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  • From Vol. 4 No.32 (Sep. 16, 2011)

    When Can the Liquidators of Non-U.S. Hedge Funds Access U.S. Bankruptcy Courts to Obtain Ancillary Relief for Fund Investors?

    On August 26, 2011, the United States Bankruptcy Court for the Southern District of New York granted a petition by the joint liquidators of Millennium Global Emerging Credit Master Fund Limited (Master Fund) and Millennium Global Emerging Credit Fund Limited (Feeder Fund, collectively the Funds) seeking, inter alia, recognition in the United States of a Bermuda liquidation proceeding as a “foreign main proceeding” or “foreign nonmain proceeding.”  The decision is a noteworthy development on an obscure but important area of law for distressed debt hedge funds.  The case has particular relevance for hedge funds organized in Bermuda, because the Court also reaffirmed that Bermuda has a sophisticated, fair and impartial legal system entitled to recognition and comity in the United States.  For a comparison with the problems of recognition facing Cayman Islands proceedings, see “Delaware Bankruptcy Court Recognizes Cayman Islands Proceeding as ‘Foreign Main Proceeding’ Under Chapter 15 of the U.S. Bankruptcy Code,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb 11, 2010).  For more on the recent changes to the definition of “center of main interests," see “Amendments to Bankruptcy Rule 2019 Recently Approved by the U.S. Supreme Court Add Disclosure Requirements While Protecting Distressed Debt Funds’ Proprietary Trading Strategies,” The Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011).  This article details the background of the action and the Court’s pertinent legal analysis.

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  • From Vol. 4 No.24 (Jul. 14, 2011)

    Second Circuit Adopts Broad Interpretation of Bankruptcy Code § 546(e) Safe Harbor for Securities “Settlement Payments,” Ruling that Safe Harbor Applies to Enron’s Redemptions of Its Own Commercial Paper Prior to Maturity

    In the months leading up to Enron Corp.’s bankruptcy, Enron drew down on its available credit lines.  It used about $1.1 billion of the loan proceeds to redeem commercial paper that it had issued prior to maturity.  Enron redeemed the paper at face value even though it was trading at a substantial discount.  Enron filed for bankruptcy in December 2001 and emerged as a reorganized entity, Plaintiff Enron Creditors Recovery Corp. (together with Enron Corp., Enron).  In 2003, Enron commenced adversary proceedings against about 200 financial institutions from which it had repurchased commercial paper in 2001.  Enron claimed that those payments could be “avoided” and recovered because they were either preferential payments of antecedent debt made within ninety days prior to bankruptcy or fraudulent transfers because Enron paid more than fair market value for the paper.  The Defendants moved for summary judgment on the ground that Enron’s payments were securities “settlement payments” protected from recovery by a safe harbor in the Bankruptcy Code.  The Bankruptcy Court denied the Defendants’ motion.  The U.S. district court reversed the bankruptcy judge’s decision and dismissed the action.  On appeal, the Second Circuit upheld that dismissal, adopting a broad interpretation of the § 546(e) safe harbor.  We provide a detailed review of the Second Circuit’s legal analysis, and of the decisions below.

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  • From Vol. 4 No.20 (Jun. 17, 2011)

    Insider Trading and Debt Securities: Practical Tips for Hedge Funds in Coping with Regulatory Enforcement

    Recent events have brought increased regulatory and judicial focus on the world of debt instruments.  The stock market crash of the fall of 2008 was largely precipitated by the implosion of debt instruments linked to sub-prime mortgages loans.  These market crises put into relief the relative size and power of the bond markets.  The equity markets were, at least as of mid-2009, less than half the size of the debt markets, $14 trillion versus $32 trillion in the U.S. and $44 trillion versus $82 trillion globally.  Perhaps understanding this, since 2008, the SEC has begun new, unprecedented investigations of insider trading in the realm of debt instruments.  In a guest article, Mark S. Cohen, Co-Founder and Partner at Cohen & Gresser LLP, and Lawrence J. Lee, an Associate at Cohen & Gresser, discuss: hedge funds and the debt markets; the law of insider trading; potential sources of inside information; relationships that are likely to give rise to duties of confidentiality in connection with a debt trading strategy; types of insider trading cases concerning debt securities and credit, including discussions of specific cases involving derivatives, bankruptcy, distressed debt, government bonds and bank loans; and practical steps that hedge fund managers can take to avoid insider trading violations when trading various types of debt and debt-related instruments.

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  • From Vol. 4 No.16 (May 13, 2011)

    Amendments to Bankruptcy Rule 2019 Recently Approved by the U.S. Supreme Court Add Disclosure Requirements While Protecting Distressed Debt Funds’ Proprietary Trading Strategies

    The success or failure of a distressed debt investment strategy depends, in part, on the ability of a bankruptcy investor to prevent other investors in the same bankruptcy from obtaining information on its purchase and sale activity.  Rule 2019 of the Federal Rules of Bankruptcy Procedure has threatened to undermine the confidentiality of bankruptcy trading information.  At least some courts in the past two years have construed Rule 2019 to require bankruptcy investors to disclose the value of claims, the timing of purchase, amount paid and the fact of sales.  On April 26, 2011, the U.S. Supreme Court adopted amendments to Rule 2019.  This article details: relevant case law leading up to passage of the amendments; prior HFLR coverage of the extensive disagreement among courts regarding the level of disclosure required under the prior version of the rule; the key differences between the current version of Rule 2019 and the proposed amendment (Amended Rule 2019); the key definitions in Amended Rule 2019; what information must be disclosed under Amended Rule 2019; who must disclose it; and a new rule relating to identification of a chapter 15 debtor’s “center of main interests.”  For more on Rule 2019, see “Would the Expanded Disclosures Required by Proposed Amendments to Federal Rule of Bankruptcy Procedure 2019 Deter Hedge Funds from Investing in Distressed Debt? (Part Three of Three),” Vol. 2, No. 39 (Oct. 1, 2009); “How Can Hedge Funds that Invest in Distressed Debt Keep Their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)? (Part Two of Three),” The Hedge Fund Law Report, Vol. 2, No. 36 (Sep. 9, 2009); “How Can Hedge Funds that Invest in Distressed Debt Keep their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)?,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009).

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  • From Vol. 4 No.15 (May 6, 2011)

    Treatment of a Hedge Fund’s Claims Against and Other Exposures To a Covered Financial Company Under the Orderly Liquidation Authority Created by the Dodd-Frank Act

    On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), heralded as the most significant new financial regulation since the Great Depression.  Title II of the Dodd-Frank Act creates a framework to prevent the potential meltdown of systemically important U.S. financial businesses.  This framework includes a new federal receivership procedure, the so-called orderly liquidation authority (“OLA”), for significant, interconnected non-bank financial companies whose unmanaged collapse could jeopardize the national economy.  The OLA will form part of a new regulatory framework intended to improve economic stability, mitigate systemic risk, and end the practice of taxpayer-financed “bailouts.”  The OLA generally is modeled on the Federal Deposit Insurance Act (“FDIA”), which deals with insured bank insolvencies, and also borrows from the Bankruptcy Code.  Notwithstanding the enactment of Title II, there will be a heavy presumption that companies that otherwise qualify for protection under the Bankruptcy Code will be reorganized or liquidated through a traditional bankruptcy case.  If, however, an institution is deemed to warrant the special procedures under the OLA, Title II will apply, even if a bankruptcy case is then pending for such institution.  As discussed in this article, the decision of whether to invoke Title II will be made outside the public view.  As a result, hedge funds that have claims and other exposures to financial companies may find the playing field shifting overnight from the relatively predictable confines of the Bankruptcy Code to the novel and untested framework of the OLA.  In a guest article, Solomon J. Noh, a Senior Associate in the Bankruptcy & Reorganization Group at Shearman & Sterling LLP, provides a high-level discussion of how the following types of claims and exposures would be handled in a receivership governed by Title II based on the regulatory rules currently proposed or in effect: (i) secured claims; (ii) general unsecured claims (such as a claim arising out of unsecured bond debt); (iii) contingent claims (such as a claim relating to a guaranty); (iv) revolving lines of credit and other open commitments to fund; and (v) “qualified financial contracts” (i.e., swap agreements, forward contracts, commodity contracts, securities contracts and repurchase agreements).  Hedge funds employing a variety of strategies – notably, but not exclusively, distressed debt – routinely acquire the foregoing categories of claims and exposures.  For situations in which those claims or exposures face a firm that may be designated as systemically important, this article highlights the principal legal considerations that will inform any investment decision.

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  • From Vol. 4 No.11 (Apr. 1, 2011)

    GM Bankruptcy Judge Rejects Distressed Debt Hedge Fund Investors’ Objections to Reorganization Plan

    The U.S. Bankruptcy Court for the Southern District of New York has confirmed, subject to minor modifications, the proposed reorganization plan (Plan) of General Motors Corp., now known as Motors Liquidation Company (Old GM).  Although overwhelmingly approved by Old GM’s creditors, hedge funds (Funds) that held debt of one of Old GM’s subsidiaries objected to the Plan because their claims are disputed by Old GM’s creditors’ committee and the Plan does not require immediate distribution to holders of disputed claims.  The Funds claimed that the Plan was not proposed in good faith, that it unfairly discriminated between holders of disputed and undisputed unsecured claims, and that it failed to segregate a reserve for the Funds’ claims.  The Court rejected all of these contentions, holding that it was fair and reasonable for Old GM to delay even partial payment of disputed unsecured claims until such claims were resolved.  We summarize the Court’s decision, with an emphasis on the Funds’ objections.  See generally “Legal Considerations for Investors In and Around the General Motors Bankruptcy, And Similar Distressed Situations Involving Politically Important Stakeholders,” The Hedge Fund Law Report, Vol. 2, No. 23 (Jun. 10, 2009); “Equities of Bankrupt Companies Offer Hedge Funds a High Risk, Potentially High Return Method of Investing in Restructurings,” The Hedge Fund Law Report, Vol. 2, No. 27 (Jul. 8, 2009).

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  • From Vol. 3 No.18 (May 7, 2010)

    N.Y. Appeals Court Rules that Securities Clearance Broker Cannot Compel Arbitration Against Hedge Fund 3V Capital Master Fund Ltd. Over Bankruptcy Trade Claims Litigation

    On April 22, 2010, the New York State Supreme Court, Appellate Division, First Department, unanimously affirmed a trial court order dismissing a motion to compel arbitration by broker Imperial Capital LLC against distressed debt hedge fund 3V Capital Master Fund Ltd.  3V Capital faced a lawsuit by Deephaven Distressed Opportunities Trading, Ltd. and its affiliates for its alleged breach of a contract requiring it to purchase claims held by Deephaven against a bankruptcy estate.  3V Capital dragged Imperial, its securities clearance broker, and another hedge fund, Post Distressed Master Fund, L.P., which had promised but then failed to purchase those same claims from 3V Capital, into the lawsuit as third-party defendants.  Since the litigation at issue involved Imperial’s actions as broker for an uncompleted sale of bankruptcy claims, the Appellate Division agreed with the trial court that the sale fell outside the narrow terms of the securities clearance brokerage arbitration agreement between 3V Capital and Imperial.  This article details the background of the action and the court’s legal analysis.

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  • From Vol. 3 No.17 (Apr. 30, 2010)

    In a Significant Decision for Hedge Funds that Trade Bank Debt, Federal Court Holds that JPMorgan Breached the Implied Covenant of Good Faith and Fair Dealing it Owed to Cablevisión Pursuant to a Credit Agreement When JPMorgan Sold a Loan Participation in Cablevisión’s Debt to an Entity Affiliated With Cablevisión’s Primary Competitor

    Plaintiff Empresas Cablevisión, S.A.B. de C.V. (Cablevisión) is a Mexican telecommunications company.  In late 2007, it borrowed $225 million pursuant to a credit agreement with defendants JPMorgan Chase Bank, N.A. and J.P. Morgan Securities Inc. (together, JPMorgan) in order to fund the purchase of Empresas Bestel, which operated a large fiber optic network in Mexico.  Due to the tightening in the credit markets that preceded the 2008 credit crisis, JPMorgan was unable to syndicate the loan.  It eventually sought to assign 90% of the loan to Banco Inbursa, S.A. (Inbursa), a Mexican bank controlled by Carlos Slim Helu and his family, who also controlled a major Cablevisión competitor – Mexican telecommunications giant Telmex.  When Cablevisión refused to consent to the assignment, JPMorgan structured a loan participation agreement with Inbursa that gave Inbursa a 90% interest in the loan with many of the same benefits that it would have received through an outright assignment.  A critical aspect of this case is the distinction between an assignment of a loan, in which the assignee steps into the shoes of the original lender and has the right to deal directly with the borrower, and a loan participation, in which the purchaser of the participation shares only in the economic benefits of the loan, and the original lender continues to deal directly with the borrower.  Here, the credit agreement contained customary provisions requiring Cablevisión’s consent to any assignment of the loan, but permitted JPMorgan to sell participations in the loan without the Cablevisión’s consent.  Cablevisión sought to enjoin the JPMorgan-Inbursa participation agreement on the grounds that it was a de facto assignment masquerading as a participation in the loan and that the participation agreement violated the implied covenant of good faith and fair dealing embodied in the credit agreement.  Southern District Judge Jed S. Rakoff agreed, and issued a preliminary injunction prohibiting JPMorgan and Inbursa from proceeding with the participation agreement.  We review the facts of the case and the court’s analysis.

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  • From Vol. 3 No.10 (Mar. 11, 2010)

    Should Hedge Funds Include Automatic Termination as a Term of Bank Debt Trades on the New Loan Market Association Forms?

    On January 25, 2010, the Loan Market Association (LMA) – the European trade association for the syndicated loan market – launched a combined set of standard terms and conditions for par and distressed trading documentation (Combined Terms and Conditions).  One of the key additions to the form loan documentation is a termination upon insolvency provision.  Specifically, the new provision creates a default rule whereby the non-insolvent party to a bank debt trade may terminate the trade upon notice to the insolvent party.  The parties may also revise the default rule to provide for automatic termination upon the insolvency of either party.  In addition, the provision provides a mechanism for calculating damages upon a termination occasioned by insolvency of one of the parties.  The inclusion of the termination upon insolvency provision is widely perceived as a direct response to the experience of loan market participants in the Lehman Brothers bankruptcy.  In that case, absent a termination right on the part of Lehman’s non-insolvent bank debt trade counterparties (many of whom were hedge funds), Lehman generally had the right to (and in many cases did) keep open trades for which it was in the money, and cancel trades for which it was out of the money.  In short, the rules as they existed at the end of 2008 and through 2009 permitted Lehman entities to “cherry pick” favorable trades.  Part of the policy behind the new provision is to prevent parties trading in bank debt from using bankruptcy (or, in the U.K., administration) to obtain a trading advantage.  For hedge funds, one of the key questions raised by the new provision is whether to include automatic termination provisions in bank debt trade documentation.  This article explores that question, and in doing so discusses: the details of the new LMA Combined Terms and Conditions; the specifics of the termination on insolvency provision (including the default rule requiring notice of termination and permitted alterations to the default rule); the mechanism for calculating early termination payments; the disadvantages of providing for automatic termination, highlighting the different relevant bankruptcy rules in the U.K. and the U.S.; the advantages of providing for automatic termination, also highlighting the variations in analysis between the U.K. and the U.S.; the extent to which automatic termination can harmonize bank debt and derivatives documentation, at least in the U.K.; the effect of automatic termination on bank debt trade pricing; and relevant differences between LMA and LSTA documentation.

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  • From Vol. 2 No.48 (Dec. 3, 2009)

    Big Boys Don’t Cry: How “Big Boy” Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations

    Various factors recently have increased the sensitivity of hedge fund managers, lawyers, compliance professionals, investors and others to insider trading concerns.  Those factors include, but are not limited to: insider trading allegations against Galleon Group founder Raj Rajaratnam and others; remarks delivered by SEC Enforcement Division Director Robert Khuzami on November 23 indicating that the Division will increase its enforcement activity with respect to insider trading by hedge funds, and in particular will focus on insider trading in the derivatives context; and press reports that the SEC has sent at least three dozen subpoenas to hedge fund managers and broker-dealers during November 2009 relating to communications in connection with healthcare industry transactions closed during the past three years and certain retail industry transactions.  See “For Hedge Fund Managers in a Heightened Enforcement Environment, Internal Investigations Can Help Prevent or Mitigate Criminal and Civil Charges,” The Hedge Fund Law Report, Vol. 2, No. 47 (Nov. 25, 2009).  In light of the increased regulatory scrutiny of activity that may constitute insider trading, hedge fund lawyers, compliance professionals and others are re-examining how and where to draw the line between permissible and impermissible information, and how to police that line effectively.  See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009); “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?,” The Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  In addition, hedge fund industry participants are refocusing on the promise and limits of tools they may employ to prevent or mitigate allegations of trading on material, nonpublic information.  One such tool is the so-called “Big Boy” provision, or disclaimer of reliance.  In our November 19, 2009 issue, we published the first part of a two-part analysis of Big Boy provisions in the hedge fund context by Brian S. Fraser and Tamala E. Newbold, Partner and Staff Attorney, respectively, at Richards Kibbe & Orbe LLP.  That first part discussed the duty to disclose material, nonpublic information (or refrain from trading) and the differences between the federal securities laws and New York common law on that issue, in particular, the “superior knowledge” trigger for the duty to disclose under New York law which has no federal counterpart.  See “When Do Hedge Fund Managers Have a Duty to Disclose Material, Nonpublic Information?,” The Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009).  This second part expands on that analysis, focusing in depth on the enforceability of Big Boy provisions in securities and non-securities transactions, with a special emphasis on the enforceability of such provisions under New York law in the context of trading in bank loans.  In addition, this part includes a detailed discussion of, and a comprehensive review of the caselaw relating to, specific steps that hedge fund managers can take to increase the likelihood that a court will enforce a Big Boy provision.

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  • From Vol. 2 No.45 (Nov. 11, 2009)

    New York Court of Appeals Holds that State Champerty Statute Cannot Curb Rights of Distressed Debt Buyers to Sue to Enforce Contracts

    On October 15, 2009, the New York Court of Appeals decided that purchasers of distressed debt instruments, who buy them for the purpose of collecting damages by means of a lawsuit against the debtor, may do so without violating the New York champerty statute if they possess a pre-existing proprietary interest in the instrument.  The court issued its ruling in response to a request from the United States Court of Appeals for the Second Circuit for clarification as to the proper interpretation of the New York champerty statute, New York Judiciary Law Section 489.  We discuss the facts and the holding of the case, which has important implications for hedge funds that trade distressed debt.  In particular, the case enhances the certainty of property rights for distressed debt traders, and has the potential to expand liquidity in the distressed debt trading market.  It also may incentivize entry into that market, thereby undermining, at the margin, one of the competitive advantages of existing players, namely, the relative scarcity of specialized investors.  On the other hand, new entrants without the experience of existing players may offer interesting opportunities for incumbents with presumptive advantages in terms of experience, contacts and infrastructure.

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  • From Vol. 2 No.39 (Oct. 1, 2009)

    Why Does Capital Raising for Distressed Debt Hedge Funds Remain Particularly Challenging Despite the Recent and Anticipated Positive Performance of the Strategy?

    For hedge funds with distressed debt strategies, 2009 has been a good year.  As of August 2009, the HFRI distressed/restructuring index was up 15.3 percent for the year, and the HFN Research distressed index was up 18.4 percent, with August gains of 4.3 percent.  Corporate default rates have been at historical highs, and the prices of distressed bank debt have been at historical lows.  In short, 2009 appears to have been a golden era for distressed investing, and according to some sources interviewed by The Hedge Fund Law Report, the medium- and long-term prospects for the strategy are attractive.  One would expect investor money to be piling into the strategy.  And indeed, for a handful of the bigger players, that appears to be the case, as evidenced by reports of a recent commitment by China Investment Corp. to place approximately $1 billion with funds managed by Oaktree Capital Management LP.  However, for other distressed debt managers, and especially for new managers seeking to launch funds with such a strategy, anecdotal evidence suggests that money-raising has been a challenge.  Numerous explanations have been proffered for this phenomenon (if indeed it is a phenomenon and not just a series of isolated instances).  The illiquidity of distressed debt is the most often cited explanation.  But private equity funds – funds that invest in shares of private companies and thus are at least as illiquid as distressed debt funds – have raised money of late, so illiquidity cannot be the full story.  Perhaps it the perception that distressed debt is a counter-cyclical strategy, and the worst is behind us?  But the historical evidence suggests that distressed debt strategies do best in the years immediately following a crisis, so now would appear to be an ideal time for allocations to the strategy.  Perhaps it’s a perception that the strategy entails more risk than other strategies?  But that’s also insufficient as an explanation.  The risk in distressed debt, like in other strategies, can be mitigated via prudent risk management; and in any case, much of the debt in which distressed funds invest is secured by real assets.  So what accounts for the money raising challenges faced by existing and new distressed debt hedge fund managers?  This article seeks to answer that question, and in doing so describes: what a distressed debt strategy involves; the opportunity set over the short-, medium- and long-term; lock up terms; examples of the difficulty raising money for the strategy and potential reasons for the difficulty; and what managers can do (and what they should avoid doing) in an effort to address the difficulty.

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  • From Vol. 2 No.31 (Aug. 5, 2009)

    Appellate Division Upholds Dismissal of Complaint by Hedge Funds Holding More than $190 Million of Defaulted Loans Against Credit Suisse, as Arranger of Financing and Administrative and Collateral Agent, for Aiding and Abetting Fraud and Breach of Fiduciary Duty

    In a decision of profound interest to hedge funds that invest in distressed companies and the banks that arrange those loans, New York’s Appellate Division, First Department, has thrown out a claim that defendants Credit Suisse First Boston (USA), Inc. and Credit Suisse Securities (USA) LLC (together, Credit Suisse) aided and abetted a fraud committed by Meridian Automotive Systems, Inc. (Meridian) in a 2004 restructuring of its debt.  Credit Suisse helped to arrange a refinancing of Meridian’s debt.  Plaintiff hedge funds purchased a portion of Meridian’s debt.  Less than one year later, Meridian declared bankruptcy.  Plaintiffs claimed that Credit Suisse knew Meridian was insolvent at the time of the restructuring and failed to disclose it.  The court held that plaintiffs failed to plead a critical element of their claim, i.e., that Credit Suisse had “substantially assisted” Meridian in committing the alleged fraud.  We summarize the court’s reasoning and the cautions it provides for investors and lenders in the distressed debt market.

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