A Delaware judge has ordered Patriarch Partners, the investment adviser founded by “Diva of Distressed” Lynn Tilton, to turn over books and records relating to its role as collateral manager of several CLO funds. (The term “Patriarch” is sometimes used here to refer to Patriarch Partners and each of the affiliated entities that served as collateral manager for the individual funds.) The ruling in Zohar CDO 2003-1, LLC v. Patriarch Partners, LLC, C.A. No. 12247-VCS (Del. Ch. Oct. 26, 2016) is another setback for Tilton, who is simultaneously fighting SEC fraud charges that she concealed poor performance of the funds from investors, and a civil complaint in which she and her family of Patriarch entities are accused of looting the Zohar I, Zohar II and Zohar III funds of more than a billion dollars of cash and other assets. 

The court in the Delaware proceedings candidly observed, “I am fully aware that the parties have more on their minds here than a dispute over the production of books and records. Patriarch believes that the Zohar Funds are acting at the behest of MBIA [Insurance Corp.], who they claim is attempting to push responsibility for the impending default of Zohar II onto Patriarch ... For their part, the Zohar Funds maintain that Patriarch’s reluctance to comply with its production and inspection obligations is driven by a desire to conceal what Defendants characterize as the ‘myriad, often conflicting roles’ played by Patriarch Partners, and in particular Tilton, in the management of the Zohar Funds.” Nonetheless, the Chancery Court refused to be drawn into these broader, and more salacious, disputes. As far as the court was concerned, this was “a straightforward breach of contract case, nothing more and nothing less.”

Background

The litigation arose out of Patriarch’s role as collateral manager of three CLO funds, collectively referred to as the Zohar Funds, each of which sold roughly $1 billion in notes to investors. To provide protection for the noteholders and enhance the credit rating of the notes, MBIA was engaged to provide monoline insurance.1 Tilton’s Patriarch Partners was responsible for overseeing the companies whose assets served as collateral for the CLOs.

The relationship between Patriarch and MBIA eventually soured, leading Patriarch to offer its resignation as collateral manager on several occasions, an offer that was repeatedly rebuffed by the Zohar Funds. However, in February 2016, with one of the Zohar Funds in bankruptcy, Patriarch’s offer to resign was accepted, and Alvarez & Marsal was appointed as the successor collateral manager. The Zohar Funds sued Patriarch for failing to turn over certain documents relating to the collateral management, as required under the Collateral Management Agreements between Patriarch and the Zohar Funds.

Rulings of the Court

Approaching the dispute as a typical contract case, the court invoked the usual canons of contract construction: Matters extrinsic to the agreement may not be considered when the intent of the parties can be gleaned from the face of the instrument; words and phrases are to be given their plain meaning; a contractual provision is unambiguous if, on its face, the provision is reasonably susceptible to only one meaning; and a contract is not ambiguous because one of the parties attaches a different, subjective meaning to one of its terms.

With these interpretational ground rules, the court had no difficulty finding that Patriarch was required to deliver to Alvarez & Marsal, as successor collateral manager, “all property and documents . . . relating to the Collateral then in the custody of [Patriarch as] collateral manager.” The court first rejected arguments advanced by Tilton that these provisions applied only if the collateral manager were terminated, but not if it voluntarily resigned, and that Patriarch was no longer required to maintain books and records after it had ceased to serve as collateral manager.

The court then addressed Patriarch’s affirmative defenses. The court dismissed the suggestion that it was required to consider the purposes of the Zohar Funds in seeking books and records, akin to a court’s consideration of a books and records demand under Section 220 of the Delaware corporations law. Because the Collateral Management Agreements contained no such requirement, the court declined to import one from Section 220. The court also saw no reason to address the Patriarch claim that it was not obligated to provide access to books and records because the Zohar Funds failed to pay for collateral services previously rendered. That issue, on which the court had no evidence before it, was being litigated in another case.

Finally, the court flatly rejected Tilton’s argument that Patriarch’s failure to provide access to the books and records was “immaterial,” such that the court had no authority to grant specific performance. The court reasoned that the primary purpose of the Collateral Management Agreements was to facilitate management of the assets of the Zohar Funds, and it was simply not credible to characterize the transition to a new collateral manager as immaterial. Finally, the court turned to what it termed the scope of Patriarch’s document production obligation. Here the court made a number of points. The production obligation was not limited to documents that themselves evidenced or represented collateral. Because the Collateral Management Agreements employed the formulation “relating to the Collateral,” the obligation to produce extended to all documents that were connected to the collateral. The turnover obligation was to be interpreted and implemented broadly. The court also rejected Patriarch’s attempt to interpose a confidentiality obligation, making it a requirement that Alvarez & Marsal enter into a confidentiality agreement as a condition to gaining access to the books and records. No such obligation was contained in the Collateral Management Agreements, and the court was not inclined to alter or modify the terms of those agreements by crafting such a confidentiality requirement. Finally, while imposing a broad obligation of disclosure on Patriarch, the court allowed Patriarch to withhold documents reflecting Patriarch’s internal analyses. The court went on to require production of virtually all the documents requested by Alvarez & Marsal.

Observations

Drafters of complex debt documentation often pay scant attention to provisions dealing with successor agents, for example, replacement trustees or, as in this case, collateral agents. Reliance on time-tested boilerplate for these purposes gives drafters and negotiators room to focus their attention on the transaction-specific issues. However, as the Zohar case demonstrates, in the infrequent situations where they make a difference, successor provisions can be critical. A battle royal such as the one unfolding in the Patriarch/Zohar litigation is not likely to occur very often, but the case serves as a useful reminder that even standard successor provisions are worth some consideration in the heat of negotiation. The court in Zohar observed, “It is rare that even sophisticated scriveners capture all that a court might like to see in a document to reveal the objective meaning of disputed terms. This case is no exception.” Fortunately for the plaintiff funds in this case, the successor provisions of the Collateral Management Agreements appear to have been adequate for their purposes.

The case, not surprisingly, goes on. Patriarch has appealed the court’s decision to the Delaware Supreme Court, which has yet to rule on the appeal.