Business Reorganization Committee

ABI Committee News

Hedge Fund Competition for Distressed Public Companies


While some hedge funds participate minimally in chapter 11 cases by simply trading securities, other hedge funds have become increasingly prominent players in large chapter 11 cases.  This involvement can result either from (a) pre-bankruptcy securities trading, refinancing and restructuring agreements, or (b) post-petition efforts to provide exit financing and new equity investments.  The funds in question typically do not wander into these cases as a result of pure trading activities.  Instead, they have made informed decisions to acquire the distressed businesses with a view to realization of substantial future value.  In instances where hedge funds are prominent players in chapter 11 cases, it is often the case that complicated, hotly contested issues arise, requiring substantial professional assistance.

Part II of this article reviews three cases in which hedge funds have played a major role in competing for control of public debtors.  Part III of this article addresses various issues which arise in these and other similar cases, including fiduciary duties and some of the requirements of the Bankruptcy Code and Bankruptcy Rules.  While this article does not purport to provide an exhaustive guide with regard to all of these topics, it sets forth a framework of issues with which participants in these cases should be familiar.

II. Representative Cases

      A. In re Delphi Corp., et al., Bankr. S.D.N.Y. 05-44481 (RDD)2

The bankruptcy cases of Delphi Corporation and its debtor affiliates (collectively, “Delphi”) have proven to be a battleground for various hedge funds competing to provide Delphi with exit financing and to invest new equity in the reorganized Delphi.  At least three groups, each led by one or more hedge funds, pursued competing investment proposals for Delphi.  Given the number of parties and complexity of the issues involved, the negotiations and litigation surrounding exit financing for and investments in Delphi took more than one year. 

       1. Framework Issue

Various issues have arisen in Delphi’s bankruptcy cases that necessitated either a consensual resolution or assistance from the Court.  Such issues include, in addition to Delphi’s future capital structure, issues related to the following:

                        GM.  Delphi indicated that it and its statutory committees believe that it holds multiple claims and causes of action against General Motors Corporation (“GM”) arising from, among other things, GM’s spin-off of Delphi in 1999.  Despite Delphi’s belief that it holds “colorable claims” against GM, Delphi stated that it believes that the pursuit of such claims would be costly and might result in a loss of business from GM (which is its largest single customer).  In addition, GM made it “clear and unequivocal” that it would not consider a settlement that did not include a determination of GM’s net exposure to Delphi.

                        Labor.  In March, 2006, Delphi moved to reject its U.S. labor agreements and to modify retiree benefits under sections 1113 and 1114 of the Bankruptcy Code.  After the initial phase of the hearing on such motion, the hearing was adjourned to allow the parties to explore a consensual resolution of the issues raised therein.

                        Creditor Recoveries.  Delphi’s statutory committees informed Delphi that they would not explore a consensual settlement with GM unless the anticipated creditor and equity recoveries were determined.

      2. The Original Framework

                        Starting in August, 2006, Delphi commenced discussions with its statutory committees, an ad hoc equity committee, GM and potential plan investors regarding “whether any viable path existed towards a comprehensive consensual transaction”.  In December, 2006, Delphi filed a motion for approval of an equity commitment and purchase agreement and a plan framework support agreement (the “Original Framework Agreements”).  The Original Framework Agreements provided, among other things, that A-D Acquisition Holdings, LLC (“Appaloosa”), Harbinger Del-Auto Investment Co. Ltd. (“Harbinger”), Dolce Investments LLC (“Cerberus”), Merrill Lynch, Pierce, Fenner & Smith Inc. (“Merrill”) and UBS Securities LLC (“UBS”) would invest up to $3.4 billion in the reorganized company.  The Original Framework Agreements provided, in part, that: (i) the plan investors would commit to purchase approximately $220 million of common stock and $1.2 billion of preferred shares in the reorganized Delphi; (ii) the plan investors would commit to purchasing any unsubscribed shares of common stock in connection with a rights offering to existing common stock holders; and (iii) the parties to a plan support agreement would agree to support certain plan terms, including plan terms related to distributions to creditors and shareholders, the treatment of GM’s claims, certain pension funding and the corporate governance of the reorganized Delphi.3

                        However, the motion for approval of the Original Framework Agreements drew objections from, among others, Highland Capital Management, LP, on behalf of itself and certain of its affiliates and related entities (collectively, “Highland”), which, at the time of its objection, was the second largest beneficial stockholder in Delphi and a holder of some of Delphi’s debt.  In its objection, Highland used strong language to depict its dissatisfaction with the Original Framework Agreements:

The [Original Framework Agreements] take an estimated $1.29 billion of aggregate value from common stockholders and constitute[] an inappropriate raid on the corporate treasury through a one day transfer of massive value from current stockholders to a small audience of privileged investors and to creditors whose claims are paid in excess of 100%. [. . .] [Such framework,] as currently supported by Delphi, disenfranchises stockholders, freezes them out of an equal opportunity to purchase [common stock] and represents a failure of Delphi’s board to uphold its fiduciary duties to current stockholders.4

                        In addition to filing an objection to the motion for approval of the Original Framework Agreements, in December, 2006, Highland submitted an unsolicited proposal to Delphi’s board of directors, whereby Highland would purchase up to $4.7 billion of Delphi’s common stock, and would enter into agreements on the same terms and subject to the same conditions as the Original Framework Agreements. 

                        Over the objections of Highland, among others, the Bankruptcy Court ultimately granted Delphi’s motion for approval of the Original Framework Agreements.  In early 2007, Delphi continued to take steps to further the transactions contemplated by the Original Framework Agreements. 

      3. The Subsequent Framework

         Also in early 2007, Highland informed Delphi’s board of its continuing interest in pursuing a role as plan investor.  In May, 2007, Highland announced that it had entered into a confidentiality agreement as a potential investor with Pardus Capital Management L.P. (“Pardus”) “to evaluate possible negotiated business arrangements”. 5 Ultimately, in July, 2007, Delphi confirmed that it had formally terminated the Original Framework Agreements.  At around that time, while Delphi was negotiating potential amendments to the Original Framework Agreements, it received an amended draft of the original equity commitment and purchase agreement from Appaloosa and a draft of a potential investment agreement from Highland.  In the ensuing days, Delphi developed a set of competing investment proposals from Appaloosa and Highland. 

         Ultimately, Delphi’s board, through a special committee, accepted a proposal by lead investors Appaloosa and Harbinger and additional investors Merrill, UBS, Goldman Sachs & Co. (“GS”) and Pardus.  Pursuant to the proposal (the “Subsequent Framework Agreement”), the plan investors therein could invest up to $2.55 billion in the reorganized Delphi.  The Subsequent Framework Agreement provides, in part, that: (i) the plan investors would commit to purchase approximately $175 million of common stock and $800 million of preferred shares in the reorganized Delphi, and (ii) the plan investors would commit to purchase any unsubscribed shares of common stock in connection with a rights offering to existing common stock holders. 6

         With regard to corporate governance, the Subsequent Framework Agreement provides for a five-member committee (the “Search Committee”), comprised of Delphi’s lead director, a representative of Appaloosa, a representative of the creditors’ committee, a representative of the co-lead investors other than UBS, GS and Merrill (who would be determined by Appaloosa) and one representative of the equity committee reasonably acceptable to the other members of the Search Committee.  The Search Committee will “select Delphi’s post-emergence executive chairman, have veto rights over all directors nominated” by Delphi’s plan investors and its statutory committees, and “appoint all directors to all board committees.”

         In an apparent surrender, Highland filed a statement regarding Delphi’s motion to approve the Subsequent Framework Agreement.7  In its statement, despite setting forth the reasons why it believes the total value of its proposal exceeded that of the proposal set forth in the Subsequent Framework Agreement and that it was “disappointed” that Delphi chose to accept the latter proposal, Highland stated that it did not intend to submit testimony or documentary evidence at the hearing on Delphi’s motion to approve the Subsequent Framework Agreement.8

      B. In re Dana Corp., et al., Bankr. S.D.N.Y. 06-10354 (BRL)9

                        Hedge funds have also been actively involved in the bankruptcy cases of Dana Corporation and its debtor affiliates (collectively, “Dana”).

      1. Settlement Objectives

Dana, its unions and its retirees faced serious issues upon Dana’s bankruptcy.  When Dana filed a motion for approval of a global settlement agreement with the United Steelworkers and United Autoworkers and of a plan support agreement and investment agreement with Centerbridge Capital Partners, L.P. (“Centerbridge”), among others, it stated that it sought to achieve the following principal objectives: (i) the reduction of union labor costs and non-pension retiree benefits within the range needed for Dana to achieve long-term viability; (ii) the extension of the terms of certain collective bargaining agreements; (iii) the resolution of litigation brought by Dana under sections 1113 and 1114 of the Bankruptcy Code; (iv) the mitigation of the risk of a likely strike or other actions in the event that the Court granted the relief requested under section 1113 of the Bankruptcy Code; and (v) the orderly closure of certain of Dana’s facilities.10

      2. Global Settlement

Pursuant to a global settlement, comprised of settlement agreements entered into by Dana and certain of its unions, a plan support agreement entered into by Dana, certain of its unions and Centerbridge, and an investment agreement with, among others, Dana and Centerbridge, Dana sought to resolve its union, retiree and funding issues.  The investment agreement provides that Centerbridge would invest up to $500 million in stock to fund the settlement agreements with the unions and would commit to facilitate an additional investment of up to $250 million by other investors.  Such agreement also provides, among other things, that Centerbridge has the right to choose two directors on Dana’s initial board (which will be comprised of seven directors), one director who will be an independent director, and will be able to prepare a list of candidates, at least three of whom must be independent, from which the creditors’ committee would choose one director. 

      3. Appaloosa’s Objection

In July, 2007, Appaloosa Management L.P. (“Appaloosa”) filed a preliminary objection to Dana’s motion for approval of the settlement.11  In its objection, Appaloosa stated that it believed that it is the largest single holder of Dana’s common stock and a substantial debtholder.  It expressed concern with regard to its belief that Dana intended to “completely wipe out equity”.  It also indicated that it believed that the settlement was “the product of a defective process conducted by [Dana] designed to be overly exclusive rather than inclusive”, and that the alleged 17% discount Centerbridge got on Dana’s stock rendered the deal unfair.12  Appaloosa subsequently filed a supplemental objection in which it set forth its additional issues with the settlement, including Dana’s alleged desire to delegate substantive decision-making power to non-debtor, non-fiduciary third parties, the “fatally defective flaw” of the settlement.13

                     In addition, in a letter to Dana’s board of directors filed as an exhibit to an SEC filing, Appaloosa referred to Centerbridge’s proposal as “absurd and one-sided” and took issue with certain aspects of the settlement, including decision-making authority, allocation of value and the way in which it was structured such that it “effectively preclude[s] competing proposals.”14  Appaloosa also stated that it was willing to “unconditionally commit [. . .] to fund and perform Centerbridge’s obligations” under the terms of Centerbridge’s investment, with certain “improvements”, and attached a term sheet to that effect.15

                        Brandes Investment Partners, L.P., a stockholder, also objected to the settlement, taking issue with Dana’s failure to provide information regarding the expected distribution to equity holders.16  Ultimately, the Court approved the settlement over such objections.  However, the Court’s order does not end the matter.  Clearly unsatisfied with the result, Appaloosa has appealed the Court’s decision to the District Court.

      4. Appaloosa Offer

Notwithstanding its appeal, Appaloosa has continued to aggressively pursue funding opportunities with Dana.17  In response, Dana announced in an SEC filing that, in light of Appaloosa’s indication of interest, it invited Appaloosa to submit its final offer on or before September 21, 2007, at which point Dana would consider it.18

      C. In re Granite Broadcasting Corp., et al., Bankr. S.D.N.Y. 06-12984 (ALG) 19

In the case of Granite Broadcasting Corporation and its debtor affiliates (collectively, “Granite”), a television broadcasting company, Silver Point Finance LLC (“Silver Point”) and a group of hedge funds led by Harbinger Capital Partners Master Fund I, Ltd. (collectively, “Harbinger”) each sought to control Granite, both prepetition and, after Granite’s prepackaged chapter 11 filing, post-emergence.   

      1. Competing Hedge Funds

Prior to Granite’s bankruptcy, Silver Point purchased a substantial control position in Granite’s senior debt.  Specifically, Silver Point held a majority of Granite’s senior notes, was the administrative agent under a credit agreement, was a significant holder of Granite’s preferred stock and had the right to convert amounts outstanding under certain term loans into additional shares of preferred stock.  Harbinger, together with another holder of Granite’s preferred stock, held over half of Granite’s preferred stock.

      2. Prepetition Events and Transactions20

In 2005, Granite failed to make dividend payments to its preferred equity holders, causing a default under the relevant documents and permitting the preferred shareholders to appoint two directors to Granite’s board.  Granite’s difficulties continued with, among other things, the acquisition of two television stations and the failed sale of certain other stations.  On June 1, 2006, Granite failed to make a payment of approximately $19 million on its secured notes.  As a result, after a 30-day grace period, the applicable documents permitted an acceleration of all amounts due under Granite’s senior notes.  Granite considered various options that would allow it to make the June 1, 2006 payment and to fund the purchase of a station in Binghamton, New York which Granite thought would be profitable for the company: (i) a sale of certain stations; (ii) financing from Silver Point or Harbinger; (iii) financing from outside investors; and (iv) a chapter 11 filing. 

                        With regard to its financing options, Granite’s board considered various proposals submitted by Silver Point and Harbinger during the summer of 2006.  Negotiations were complicated by the fact that various terms of Harbinger’s proposal required the consent of Granite’s controlling shareholder (who was also a director on Granite’s board).  The board eventually voted to approve the terms of a credit agreement with Silver Point, pursuant to which Granite would provide a restructuring plan to Silver Point.  Although Silver Point was to have agreed to the terms of Granite’s restructuring plan, Granite never obtained such agreement, which resulted in a technical default under the credit agreement.  Ultimately, the board determined that Granite would have to file for bankruptcy and, in connection therewith, Silver Point executed a restructuring support agreement whereby it agreed to support Granite’s plan of reorganization. 

      3. Confirmation

Harbinger objected to confirmation of Granite’s plan on the grounds that (i) it was not proposed in good faith, and (ii) the plan undervalued Granite and paid the secured creditors more than the full amount of their claims.  In its opinion granting confirmation of Granite’s plan, the Court rejected both arguments. 21

III. Legal and Business Issues

Many of the legal and business issues discussed in this section are relevant in any bankruptcy case.  However, these issues may be particularly important in the chapter 11 cases where hedge funds play an active role.  The purpose of this section is to identify the issues and to provide a brief overview thereof.

      A. Business Considerations

                        All parties in interest should be aware of various business issues that should be considered when an entity seeks to control a public company, whether prepetition or postpetition, particularly where more than one entity seeks control of a public company.  At the outset, all parties involved should consider the advantages and disadvantages of entering into a confidentiality agreement.  The target would likely want all interested parties seeking control to sign such an agreement, but should also attempt to determine whether such parties are going to make “serious” offers.  Parties seeking to control the target should weigh the benefits of entering into such an agreement, which, of course, include the potential control of the target, with the costs, namely, the inability to trade in the target’s securities. 

                        A party seeking control must consider how best to tackle the obstacle of currying favor with the target company.  In so doing, it must examine whether it proposes to retain current management, how it proposes to treat shareholders and, generally, the extent to which it should be aggressive in its positions.  Depending on the target’s capital structure, it may be worth considering whether to provide a loan to the target or, if bankruptcy seems like a realistic option, debtor-in-possession financing.  From a practical perspective, the party seeking control must also consider the costs, both economic and otherwise (i.e., effect on its reputation).  Once it obtains the confidence and support of the target, it must then maintain such support, the difficulty of which may be complicated to the extent other parties seek to control the target.

                        At the same time, as discussed more fully below, the target needs to be aware of and comply with its fiduciary duties, including the selection and consideration of competing offers, particularly when controlling insiders favor offers that may be to their advantage.  The target should also be aware of the effects of competition on its attempts to attract interested potential acquirers outside of the hedge funds already competing to control and/or own it.

      B. Fiduciary Duties

When hedge funds compete to control a target company, the directors of the target should be aware of the duties they have.  Directors, who manage and direct the business and affairs of a corporation, have, among other responsibilities, duties of care and loyalty.  See generally Smith v. Van Gorkom, 872 (Del. 1985), superseded by statute, 8 Del. C. § 102(b)(7), as recognized in, Emerald Partners v. Berlin, 787 A.2d 85 (Del. 2001); Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 360 (Del. Super Ct. 1993).  These duties exist at all times -- prior to an entity becoming a “target”, throughout the process of considering potential dispositions of the company, at which point all options should be considered, and during a bankruptcy case.22

                        The duty of care has been described in the following way: “[w]hile the Delaware courts use a variety of terms to describe the applicable standard of care, our analysis satisfies us that under the business judgment rule director liability is predicated upon concepts of gross negligence.”  Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (citations omitted).

                        There is a presumption that the board acted loyally, which “can be rebutted by alleging facts which, if accepted as true, establish that the board was either interested in the outcome of the transaction or lacked the independence to consider objectively whether the transaction was in the best interest of the company and all of its shareholders”.  Orman v. Cullman, 794 A.2d 5, 22 (Del. Ch. 2002) (emphasis in original).23  To establish the board’s interest or lack of independence, it must be shown that “a majority of the director defendants have a financial interest in the transaction or were dominated or controlled by a materially interested director.”  Id.

                        Directors should also be aware of the constituency to whom they owe fiduciary duties.  Generally, directors of a solvent corporation owe fiduciary duties to the shareholders of the company.  However, in the event of insolvency (or, in some cases, if the corporation is in the zone of insolvency), fiduciary duties extend to creditors.  See generally In re Granite Broadcasting Corp., et al., 369 B.R. 120, 135 (Bankr. S.D.N.Y. 2007) (collecting cases). 

                        When the business decisions of a board of directors are challenged, there is a presumption, known as the business judgment rule, codified in 8 Del. C. § 141(a), that directors who made a business decision did so “on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company.”  Aronson, 473 A.2d at 812; Orman, 794 A.2d at 21 (“the judgment of a properly functioning board will not be second-guessed and absent an abuse of discretion, that judgment will be respected by the courts) (citation and quotations omitted); Levine v. Smith, 591 A.2d 194, 207 (Del. 1991) (“If a board’s decision can be attributed to any rational business purpose, a court will not substitute its judgment for that of a board”) (citation and quotations omitted).

                        In certain circumstances (i.e., when a fact-finder determines that there was a breach of fiduciary duty or when a director is determined to be interested in the transaction), the “entire fairness” standard governs the review of the transaction.  See Aronson, 473 A.2d at 813.  In Delaware, “[t]he concept of fairness has two basic aspects: fair dealing and fair price.”  Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983).  The Delaware Supreme Court has elaborated as follows:

The former embraces questions of when the transaction was timed, and how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the shareholders were obtained.  The latter aspect of fairness relates to the economic and financial considerations of the proposed [transaction], including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of the company’s stock.  However, the test for fairness is not a bifurcated one as between fair dealing and fair price.  All aspects of the issue must be examined as a whole since the question is one of entire fairness.

Id. (citations omitted)  The weight given to each prong depends on the circumstances of the case.  Cinerama Inc. v. Technicolor, Inc., 663 A.2d 1134, 1140 (Del. Ch. 1994), aff’d, 663 A.2d 1156 (Del. 1995).

                        Directors of a public company should also be familiar with their “Revlon duties”.  Generally, Delaware law provides that, once the board’s goal is to sell the company, the directors’ duties change from preserving the company as a corporate entity to maximizing the company’s value at a sale for the benefit of shareholders.  Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986) (When it became clear that the “break-up of the company was inevitable”, the directors’ role “changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.”).  Cases interpreting Revlon have narrowly construed its holding to provide for “Revlon duties” only in the context of a change of control where the dissolution or break-up of the company is inevitable.  See, e.g., Paramount Commc’ns, Inc. v. Time, Inc., 571 A.2d 1140 (Del. 1989).

      C. Bankruptcy Rule 2019

Rule 2019(a) of the Bankruptcy Rules provides, in relevant part:

In a chapter 9 municipality or chapter 11 reorganization case, except with respect to a committee appointed pursuant to § 1102 or 1114 of the Code [an official committee], every entity or committee representing more than one creditor or equity security holder [. . .] shall file a verified statement setting forth

            (1)   the name and address of the creditor or equity security holder;

            (2)   the nature and amount of the claim or interest and the time of acquisition thereof unless it is alleged to have been acquired more than one year prior to the filing of the petition;

            (3)   [. . .] in the case of a committee, the name or names of the entity or entities at whose instance, directly or indirectly, the employment was arranged or the committee was organized or agreed to act; and

            (4)   with reference to the time of [. . .] the organization or formation of the committee [. . .] the amounts of claims or interests owned by [. . .] the members of the committee [. . .] the times when acquired, the amounts paid therefore, and any sales or other disposition thereof.

                        Until recently, Bankruptcy Rule 2019 was not particularly controversial.  However, two recent decisions analyzing the requirements and application of Bankruptcy Rule 2019 have reached opposite conclusions, prompting much discussion regarding disclosure requirements of “committees”.24  The salient issue is whether each member of a group represented by one law firm must disclose certain information under Bankruptcy Rule 2019, including the timing and price of its acquisitions and dispositions of its claims and interests related to the debtor.

                        In In re Northwest Airlines Corp., et al., 363 B.R. 701 (Bankr. S.D.N.Y. 2007), Judge Allan L. Gropper held that, pursuant to the “plain terms” of Bankruptcy Rule 2019, each member of an ad hoc committee of equity security holders had to comply with the requirements of Bankruptcy Rule 2019.  In so holding, Judge Gropper rejected the Committee’s “only substantive argument” that each committee member did not have to comply with Bankruptcy Rule 2019 because the rule applies only to “every entity or committee representing more than one creditor or equity security holder.” The committee, which filed a statement setting forth the aggregate holdings of the committee members (as opposed to holdings of each committee member), argued that no member of the committee represented any party other than itself and that only the law firm representing the committee represented “more than one creditor or equity security holder”, and had nothing to disclose. 

                        In contrast, a similar issue in the bankruptcy cases of Scotia Development yielded a different result.  In that case, the Court heard the issue of whether an ad hoc group of noteholders was required to strictly comply with Bankruptcy Rule 2019.  The ad hoc noteholder group argued that Bankruptcy Rule 2019 did not apply to it because it is not a “committee” within the meaning of the rule.25  It also contended that the Northwest Court “wrongly interpreted the plain meaning of Bankruptcy Rule 2019”.26  In addition, it distinguished the Northwest decision on the grounds that, among other reasons, that case involved a group that (unsuccessfully) sought to act on behalf of shareholders generally, whereas in the instant case, the noteholder group did not purport to act on behalf of other noteholders.  The judge, rejecting the debtor’s request to apply Bankruptcy Rule 2019 to the noteholder group and its arguments in support thereof, held that the noteholder group did not have to comply with the requirements of Bankruptcy Rule 2019.27  In a subsequent oral ruling, the Court clarified that even if the noteholder group were subject to Bankruptcy Rule 2019, the Court would not require further disclosure.28

      D. Safe Harbor Provision

Section 1125(e) of the Bankruptcy Code provides that a person that solicits acceptances or rejections of a plan, in good faith and in compliance with the applicable provisions of the Bankruptcy Code, or that participates in the offer, issuance, sale or purchase of a security of the debtor, affiliate participating in a joint plan with the debtor, or a newly organized successor of the debtor, is not liable on account of such solicitation or participation for violation of any applicable law, rule or regulation governing solicitation of acceptance or rejection of a plan or the offer, issuance, sale or purchase of securities. 

                        As set forth in the legislative history of Section 1125(e), the purpose of the safe harbor is to protect creditors, creditors’ committees, counsel for committees, and others involved in the case from potential liability under the securities laws for soliciting acceptances of a plan by use of an approved disclosure statement.  The securities laws generally provide for absolute liability of a person who offers or sells securities if there was the failure to state a material fact in connection with the offer or sale [. . . .]  Such liability would gut the effectiveness of the disclosure section, and require compliance with all securities laws in spite of the pending reorganization case [. . . .] [T]his would render the reorganization chapter far less valuable to distressed debtors than it would otherwise be.29

                        As a general matter, courts have narrowly interpreted the term “solicitation” in the chapter 11 context.  See Century Glove, Inc. v. First Am. Bank, 860 F.2d 94, 101 (3d. Cir. 1988) (“A broad reading of § 1125 can seriously inhibit free creditor negotiations.”).  However, as the statute indicates, those who solicit acceptances of a plan must do so “in good faith”.

      E. Good Faith Provision

Section 1126(e) of the Bankruptcy Code permits the Court to disqualify any acceptance or rejection that was not made in good faith or which was not solicited in good faith or in accordance with the Bankruptcy Code.  In one of the more extensive discussions of section 1126(e), the Bankruptcy Court for the Southern District of New York grappled with the issue of whether it should designate (i.e., disqualify) a secured creditor’s vote based on claims purchased during the bankruptcy case “for the avowed purpose of defeating confirmation”.  In re Dune Deck Owners Corp., 175 B.R. 839 (Bankr. S.D.N.Y. 1995) (finding evidence sufficient to require an evidentiary hearing to determine whether to designate the votes of a secured creditor).  In that case, the Court identified two types of bad faith: “(1) the claim holder attempts to extract or extort a personal advantage not available to other creditors in its class, and (2) the creditor has an ‘ulterior motive’, such as to procure some collateral or competitive advantage that does not relate to its claim.”  Id. at 844 (citations omitted).  Discussing the latter type in further detail, the Court observed that “[d]esignation is the exception rather than the rule”.  Id.  Although the term “good faith” is not defined in the Bankruptcy Code, the Court elaborated on the concept of “bad faith”, the presence of which may be determined based on the existence or absence of various badges of fraud.  Such badges of fraud

include creditor votes designed to (1) assume control of the debtor, (2) put the debtor out of business or otherwise gain a competitive advantage, (3) destroy the debtor out of pure malice, or (4) obtain benefits available under a private agreement with a third party which depends on the debtor’s failure to reorganize.

Id. at 844-45.  Courts may also designate a creditor’s vote when such creditor has a conflict of interest with the class in which it seeks to vote.  See id. at 845.  It is important to note that in designating a creditor’s vote, the Court must balance such disqualification with “one of the most sacred entitlements that a creditor has in a chapter 11 case”.  In re Adelphia Commc’ns Corp., 359 B.R. 54, 56 (Bankr. S.D.N.Y. 2006) (denying bondholders’ motion to designate certain creditors’ votes and noting that the bondholders did not meet the “heavy” burden of showing entitlement to such a “drastic” remedy).

IV. Conclusion

Competition between and among hedge funds has become prevalent in large chapter 11 cases.  Professionals representing target companies and hedge funds seeking to play an active and competitive role should be aware of the issues discussed above.  Although such issues may be important in other chapter 11 cases and, in some cases, they are “non-issues”, professionals involved in cases where hedge funds play an active role should have knowledge of such issues.


1 Richelle Eisendrath, an associate in the financial restructuring group at King & Spalding LLP, assisted in the preparation of these materials. These materials reflect the input of all the panelists, but do not necessarily reflect the views of their respective institutions.

2 Many of the statements set forth in this section II.A are based on statements made in various pleadings filed by Delphi and parties in interest.  References to such pleadings are set forth herein.

3 See Expedited Motion for Order Authorizing and Approving the Equity Purchase and Commitment Agreement Pursuant to Sections 105(a), 363(b), 503(b) and 507(a) of the Bankruptcy Code and the Plan Framework Support Agreement Pursuant to Sections 105(a), 363(b), and 1125(e) of the Bankruptcy Code (In re Delphi Corp., et al., Docket No. 6179).

4 See Highland Capital Management, LP’s Objection and Response to Expedited Motion for Order Authorizing and Approving the Equity Purchase and Commitment Agreement Pursuant to Sections 105(a), 363(b), 503(b) and 507(a) of the Bankruptcy Code and the Plan Framework Support Agreement Pursuant to Sections 105(a), 363(b) and 1125(e) of the Bankruptcy Code (In re Delphi Corp., et al., Docket No. 6330).

5 See Highland Capital Management, L.P., General Statement of Acquisition of Beneficial Ownership (Schedule 13D/A) (May 25, 2007).  Subsequently, in June, 2007, Highland executed a confidentiality agreement to lead its own investment group.  At around that time, Pardus joined Appaloosa’s investment proposal group.

6 For a more detailed description of the Subsequent Framework Agreement and the terms thereof, see Expedited Motion for Order Authorizing and Approving Delphi-Appaloosa Equity Purchase and Commitment Agreement Pursuant to 11 U.S.C. §§ 105(a), 363(b), 503(b) and 507(a) (In re Delphi Corp.,et al., Docket No. 8673).

7 See Statement of Highland Capital Management, LP Regarding Debtors’ Expedited Motion for Order Authorizing and Approving Delphi-Appaloosa Equity Purchase and Commitment Agreement Pursuant to 11 U.S.C. §§ 105(a), 363(b), 503(b) and 507(a) (In re Delphi Corp., et al., Docket No. 8754).

8 See id.

9 Many of the statements set forth in this section II.B are based on statements made in various pleadings filed by Dana and parties in interest.  References to such pleadings are set forth herein.

10 See Motion of Debtors and Debtors in Possession for Entry of an Order (A) Approving Settlement Agreements with the United Steelworkers and United Autoworkers, Pursuant to 11 U.S.C. §§ 1113 and 1114(E) and Federal Rule of Bankruptcy Procedure 9019, and (B) Authorizing the Debtors to Enter Into Plan Support Agreement, Investment Agreement and Related Agreements, Pursuant to 11 U.S.C. §§ 105(A), 363(b), 364(C)(1), 503 and 507 (In re Dana Corp., et al., Docket No. 5645).

11 See Preliminary Objection of Appaloosa Management to Motion of Debtors and Debtors in Possession for Entry of an Order (A) Approving Settlement Agreements with the United Steelworkers and United Autoworkers, Pursuant to 11 U.S.C. §§ 1113 and 1114(E) and Federal Rule of Bankruptcy Procedure 9019, and (B) Authorizing the Debtors to Enter Into Plan Support Agreement, Investment Agreement and Related Agreements, Pursuant to 11 U.S.C. §§ 105(A), 363(b), 364(C)(1), 503 and 507 (In re Dana Corp., et al., Docket No. 5656).

12 See id; see also Appaloosa Management, L.P., General Statement of Acquisition of Beneficial Ownership (Schedule 13D/A) (July 19, 2007).  According to Dana, the convertible preferred stock is 83% of the value, as set forth more fully in the Motion of Debtors and Debtors in Possession for Entry of an Order (A) Approving Settlement Agreements with the United Steelworkers and United Autoworkers, Pursuant to 11 U.S.C. §§ 1113 and 1114(E) and Federal Rule of Bankruptcy Procedure 9019, and (B) Authorizing the Debtors to Enter Into Plan Support Agreement, Investment Agreement and Related Agreements, Pursuant to 11 U.S.C. §§ 105(A), 363(b), 364(C)(1), 503 and 507 (In re Dana Corp., et al., Docket No. 5645).

13 See Supplemental Objection of Appaloosa Management L.P. to Motion of Debtors and Debtors in Possession for Entry of an Order (A) Approving Settlement Agreements with the United Steelworkers and United Autoworkers, Pursuant to 11 U.S.C. §§ 1113 and 1114(E) and Federal Rule of Bankruptcy Procedure 9019, and (B) Authorizing the Debtors to Enter Into Plan Support Agreement, Investment Agreement and Related Agreements, Pursuant to 11 U.S.C. §§ 105(A), 363(b), 364(C)(1), 503 and 507 (In re Dana Corp., et al., Docket No. 5766).

14 See Appaloosa Management, L.P., General Statement of Acquisition of Beneficial Ownership (Schedule 13D/A) (July 19, 2007).  In connection therewith, Appaloosa stated that it believed that Dana’s management and its advisors “resist[ed Appaloosa’s] efforts to obtain legitimately from the Company customary access to information”.  Id.

15 One of Dana’s unions subsequently responded with a letter to Dana’s chairman, president and chief executive offer, stating that it was not prepared to enter into the global settlement if Appaloosa was the investor.  See Exhibit A to Supplemental Objection of Appaloosa Management L.P. to Motion of Debtors and Debtors in Possession for Entry of an Order (A) Approving Settlement Agreements with the United Steelworkers and United Autoworkers, Pursuant to 11 U.S.C. §§ 1113 and 1114(E) and Federal Rule of Bankruptcy Procedure 9019, and (B) Authorizing the Debtors to Enter Into Plan Support Agreement, Investment Agreement and Related Agreements, Pursuant to 11 U.S.C. §§ 105(A), 363(b), 364(C)(1), 503 and 507 (In re Dana Corp., et al., Docket No. 5766).

16 See Objection of Brandes Investment Partners, L.P. to Motion of Debtors and Debtors in Possession for Entry of an Order (A) Approving Settlement Agreements with the United Steelworkers and United Autoworkers, Pursuant to 11 U.S.C. §§ 1113 and 1114(E) and Federal Rule of Bankruptcy Procedure 9019, and (B) Authorizing the Debtors to Enter Into Plan Support Agreement, Investment Agreement and Related Agreements, Pursuant to 11 U.S.C. §§ 105(A), 363(b), 364(C)(1), 503 and 507 (In re Dana Corp., et al., Docket No. 5747).

17 See Appaloosa Management, L.P., General Statement of Acquisition of Beneficial Ownership (Schedule 13D/A) (August 22, 2007).

18 See Dana Corporation, Current Report (Form 8-K) (August 24, 2007).

19 Many of the statements set forth in this section II.C are based on statements made in various pleadings filed by Granite and parties in interest and the Court’s confirmation opinion.

20 See generally In re Granite Broadcasting Corp., et al., 369 B.R. 120 (Bankr. S.D.N.Y. 2007), as well as other pleadings filed by various parties in interest, for facts relating to prepetition events and transactions.

21 See In re Granite Broadcasting Corp., et al., 369 B.R. 120 (Bankr. S.D.N.Y. 2007).

22 It should be noted that, as a practical matter, during a bankruptcy case, directors are protected to a greater degree due to the bankruptcy process.

23 For a more detailed discussion regarding the meaning of the terms “interest” and “independence” in the context of the duty of loyalty, see Aronson, 473 A.2d at 812-16 and Orman, 764 A.2d at 23-26.

24  For a discussion of such decisions and the issues surrounding them, see Mark Berman and Jo Ann J. Brighton, Will the Sunlight of Disclosure Chill Hedge Funds?, American Bankruptcy Institute Journal, May, 2007, and Evan Flashen and Kurt A. Mayr, Bankruptcy Rule 2019 and the Unwarranted Attack on Hedge Funds, American Bankruptcy Institute Journal, September, 2007.

25 See Noteholder Group’s Objection to Scotia Pacific Company LLC’s Motion for an Order Compelling the Ad Hoc Committee to Fully Comply with Bankruptcy Rule 2019(A) by Filing a Complete and Proper Verified Statement Disclosing its Membership and Their Interests (In re Scotia Development LLC, et al., Docket No. 599).

26 Id. at ¶ 38.

27 See Order Denying Scotia Pacific Company LLC’s Motion for an Order Compelling the Ad Hoc Committee to Fully Comply with Bankruptcy Rule 2019(A) by Filing a Complete and Proper Verified Statement Disclosing its Membership and Their Interests (In re Scotia Development LLC, et al., Docket No. 658).

28 See Bracewell Wins Key Ruling Defining Scope of Bankruptcy Disclosure Requirements, Ruling Protects Investors’ Privacy Rights, June 27, 2007, Click here for link (last visited Sept. 17, 2007.)

29  H.R. Rep. No. 595, 95th Cong., 1st Sess. 1, 229 (1977), reprinted in 1978 U.S.C.C.A.N. 5787, 6189.