On Dec. 22, 2011, the Supreme Court of the State of New York for New York County granted summary judgment to Goldman Sachs Lending Partners LLC (“GS”) against High River Limited Partnership (“High River”) concerning GS’s purchase of Delphi Corporation’s (“Delphi”) “Tranche C” bank debt (the “Bank Debt”).1 The court held that High River, as the seller, was in breach of its contractual obligations when it failed to deliver the Bank Debt to GS, the buyer, prior to a rights offering record date, even though the trade documentation did not specify a delivery date. While the court’s decision did provide guidance to loan market participants on the meaning of certain of the Loan Syndication and Trading Association’s (“LSTA”) Standard Terms and Conditions (“STC”), it also left uncertainty with respect to the scope of a buyer’s rights to participate through its seller in a rights offering first formulated after the trade date. High River has appealed the decision to the Appellate Division for the First Department.

Background

In July 2009, High River agreed to sell to GS a $140 million piece of the Bank Debt (the “Trades”), pursuant to LSTA trade confirmations for distressed trades (the “Trade Confirmations”), which incorporated the STC. However, High River did not own any of the Bank Debt; rather it was short selling the Bank Debt. On July 30, 2009, the bankruptcy court overseeing Delphi’s bankruptcy case modified Delphi’s confirmed plan of reorganization (the “Plan”) providing for the sale of substantially all of Delphi’s assets to DIP Holdco 3 LLC (“Holdco”). Under the Plan, holders of the Bank Debt would receive one or more distributions of cash, which would be less than the face amount of their claim.

In connection with effectuating the Plan, Holdco circulated a memorandum (the “Memorandum”) on Aug. 25, 2009 describing Holdco’s offer to holders of certain tranches of Delphi’s bank debt to exchange their right to cash distributions under the Plan for certain interests in the entity succeeding to Holdco, including an equity interest, unsecured subordinate notes and term loan commitments under a new delayed draw credit facility (the “Rights Offering”). The Memorandum set a record date of Sept. 10, 2009 (the “Record Date”) for eligibility to participate in the Rights Offering.

GS expected to participate in the Rights Offering as a lender of record by settling the trades prior to the Record Date, and GS and its counsel attempted several times to contact High River and its counsel to demand settlement of the Trades prior to the Record Date. On Sept. 3, 2009, High River’s counsel informed GS that they would not be able to close the Trades prior to the Record Date. Thereafter, GS sent High River a draft letter agreement requesting High River to represent that it would subscribe to the Rights Offering on behalf of GS. Such a letter agreement typically provides that a seller will subscribe to a rights offering on behalf of a buyer and the buyer will pay for such subscription prior to any funding deadline in addition to indemnifying the seller for its actions on behalf of the buyer. Many secondary loan market participants use this type of letter agreement when their trades fail to settle before a record date for a rights offering. High River did not sign GS’s proposed letter agreement.

After Holdco had announced the Rights Offering, but prior to the Record Date, GS had sold the Bank Debt it was purchasing from High River to third parties. Unlike the language in High River’s Trade Confirmations, the purchasers of the Bank Debt from GS apparently had included specific language entitling them to the proceeds of the Rights Offering as part of their trades. To satisfy its obligation to these downstream purchasers of the Bank Debt, GS subsequently purchased the right to receive the Rights Offering proceeds on the secondary market at a higher price than the Trades. GS then sued High River to recover its damages.

The Court’s Decision

The court held that High River had breached its obligations under the Trade Confirmations when it failed to deliver the Bank Debt prior to the Record Date, even though the Trade Confirmations did not reference a specific date by which the Trades were to have settled. Each of the Trade Confirmations provided that settlement was to occur “as soon as practicable,” to which the court gave the plain meaning interpretation “speedily.” In the context of the Trades, the court stated that this language required High River to settle the Trades by the Record Date. The court found that High River did not deliver, and could not have delivered, the Bank Debt by the Record Date, because High River: (1) never owned the Bank Debt necessary to settle the Trades; (2) never entered into a trade to purchase the Bank Debt; (3) never sought to purchase the Bank Debt on the open market; and (4) failed to deliver the Bank Debt. The court further stated that it would have been feasible for High River to close the Trades by the Record Date if it had owned or purchased the Bank Debt.

In its counterclaim, High River argued that GS breached the Trade Confirmations, because GS was obligated to purchase the Bank Debt “as such Debt may be reorganized, restructured, converted or otherwise modified.” According to High River, while the Plan converted the Bank Debt into cash distributions only, the Rights Offering was separate from the Plan, and the Rights Offering was offered by Holdco and not by Delphi. In an effort to settle the Trades by alternate means, High River had offered GS a cash amount equal to the amount that the Bank Debt would have received under the Plan. This offer was equivalent to approximately $0.16 per dollar of Bank Debt — much less than GS’s purchase rate for the Bank Debt in the Trades. Thus, High River argued it had satisfied its obligation under the Trade Confirmations and GS was in breach when it refused to settle the Trades on cash proceeds. The court disagreed, stating that High River remained obligated to “proceed in good faith to close the trade by ‘assignment’ and ‘as soon as practicable’ following the trade date.” Further, the court found that High River never “delivered the Bank Debt to [GS]” and, therefore, was precluded from claiming that GS had breached its obligations under the Trade Confirmations.

Commentary

The court found that High River breached its obligations to settle the Trades “as soon as practicable” when it failed to deliver the Bank Debt prior to the Record Date. However, whether correct or not, the court neither analyzed a number of key facts nor clarified two questions of concern to the secondary bank debt market: (1) how quickly do short sellers have to cover their short trades (short selling in the loan market is not presently regulated nor subject to any rules); and (2) does entering into a trade entitle buyers to receive the right to subscribe to a rights offering or the proceeds of a rights offering when the rights offering is announced after the trade date.

As noted, sellers generally will work with buyers to grant access to a rights offering when they are precluded from participating based on a record date, in certain instances, even if that access is not contracted for in the trade confirmation. However, without express terms in the trade confirmation requiring the seller to subscribe, such a buyer may not have the leverage to negotiate acceptable terms for access to the rights offering and the decision did not clarify whether such rights are part of rights associated with the debt transferred from seller to buyer, which can be different for buyers to ascertain especially when as in this case, a rights offering has not been announced to the market at the time of trade. The court focused on High River’s failure to “deliver the Bank Debt” before the Record Date, or deliver the Bank Debt “as reorganized, restructured, converted, or otherwise modified,” including the proceeds of the Rights Offering.

The court appears to have presumed that participation in the Rights Offering was expressly required, rather than optional, for holders of the Bank Debt, and not considered the market practice of signing a letter agreement in which a seller and buyer contract for the seller to subscribe on behalf of a buyer at the time of trade. In addition, the court apparently did not distinguish between a rights offering as part of a plan of reorganization and a rights offering offered subsequently to the holders of claims by a non-debtor entity. Although the court did not address these issues directly, its decision could be read to require sellers to either: (1) ensure that their trades settle on or before a rights offering’s record date; or (2) subscribe to such rights offering on behalf of its buyer, without the benefit of such a letter agreement.

Loan market participants should note that the LSTA recently introduced “Distressed Buy-In/Sell-Out” (“Distressed BISO”), which went into effect on Sept. 9, 2011. Distressed BISO is intended to give a loan market participant leverage over its trade counterparty, when that counterparty has held up settlement of the trade.2 In this case, even if the Trades had been subject to Distressed BISO, this would likely not have changed the outcome. Under Distressed BISO, a so-called performing party can buy-in or sell-out of a trade (as applicable), when its counterparty remains a so-called “non-performing party” beyond the Distressed BISO trigger date (i.e., 50 days after the trade date). On the one hand, in this scenario, GS would not have been able to rely on Distressed BISO because the Record Date was less than the required 50 days after the Trade Date, after which a party could have triggered Distressed BISO. On the other hand, had the Trade Confirmations been subject to Distressed BISO and the Record Date had been after the Distressed BISO trigger date, then High River, as a short seller, who did not enter into a buy trade within T+5, could not rely on its open upstream trades to shield itself from a buyer’s Distressed BISO notice.

Take-Aways

While this decision is being appealed, participants in the secondary loan market may want to consider the following in the context of future trades:

  • When buying debt that is subject to a bankruptcy proceeding or other restructuring, a buyer should include clear language in the trade confirmation specifying that it expects the seller to subscribe to any rights offering or other subscription offered through a plan, the borrower, the agent or otherwise, even if no such rights offering or subscription has been announced at the time of the trade.
  • Short sellers of bank debt should be wary of developments or dates relating to a credit, as it now may be necessary to cover the short before any deadline or record date.