General Motors Corp. (GM:US)’s bankruptcy, which wiped out shareholders and left taxpayers on the hook for billions of dollars, is generating a new wave of profit for hedge funds that supersized their claim by betting on an obscure pool of GM debt issued in the Canadian province of Nova Scotia.
A settlement reached last week proposes giving Fortress Investment Group LLC (FIG:US), Elliott Management Corp. and other holders of GM Nova Scotia notes a $1.55 billion bankruptcy claim on $1.07 billion in debt. Holders of that same pool of debt had earlier received $367 million in cash.
If the settlement is approved, holders of the Nova Scotia notes could walk away with as much as 1.8 times the recovery in the U.S. automaker as other unsecured creditors. That would mark a rare departure from the bankruptcy norm -- that one loss is entitled to one recovery.
The settlement marks a compromise from an initial deal the funds struck during a frenzied weekend of talks leading up to GM’s June 1, 2009, bankruptcy filing. The Nova Scotia noteholders realized at the time that a U.S. effort to save GM would break down if its Canada unit was put into bankruptcy, and they used a quirk of Nova Scotia law to force a deal.
That agreement promised the Nova Scotia noteholders, which included Appaloosa Management LP and Aurelius Capital Management LP, close to three times the recovery of other creditors.
The settlement, which is up for approval on Oct. 21, stands to be the culmination of a complex and legally intense investment play that, for Fortress, dates to 2005.
Believing the U.S. auto giant was probably bound for bankruptcy, Fortress began in 2006 to buy bonds issued by General Motors Nova Scotia Finance Co., a unit of General Motors of Canada Ltd. Elliott started buying in 2008. By June 2009, the four funds had acquired, for pennies on the dollar, the majority of $1 billion in notes issued by the Nova Scotia unit.
The funds anticipated that in a GM bankruptcy, the Nova Scotia law governing the notes would allow the holders to make multiple claims on the same debt. One Elliott portfolio manager called the strategy a “double-dip litigation play.” A Morgan Stanley (MS:US) analyst likened the deal to sticking “two straws in one milkshake.”
Armed with the Nova Scotia bonds, representatives of Fortress and Elliott sat on the committee that steered restructuring talks ahead of the 2009 filing and rejected GM’s last attempt to avoid bankruptcy.
Later, bargaining with GM’s lawyers as minutes ticked down before the automaker’s deadline to file for Chapter 11, the Nova Scotia noteholders used their double-dip theory as leverage to get the best possible deal on how the notes would be treated in the fourth-largest bankruptcy filing in U.S. history. GM, fearful of having its Canada unit tipped into bankruptcy by the hedge funds’ claims, acceded to a deal that promised the noteholders multiple recoveries.
“The noteholders were playing hardball in a big way,” said Stephen Lubben, a professor in corporate finance and restructuring at Seton Hall University School of Law in Newark, New Jersey.
In the suit, filed last year in U.S. Bankruptcy Court in Manhattan, a trust representing unsecured GM creditors alleged that the Nova Scotia noteholders unfairly put a multibillion-dollar dent in others’ recoveries.
A review of hours of cross-examination, dozens of e-mails and hundreds of pages of court filings in the suit provides a window into the often drawn-out “litigation plays” that make the hedge funds that trade in distressed companies top performers. Such funds had one-year returns of 14.37 percent for the period ended August 2013, more than any other type of hedge fund, according to a Credit Suisse Group AG index.
Before last week’s proposed settlement, many of the funds had already profited from the $367 million in cash they negotiated at the time of the 2009 bankruptcy filing. Many hedge funds had bought the Nova Scotia bonds at less than 36 cents on the dollar, according to court testimony, with Elliott buying them for 20.5 cents to 43 cents on the dollar.
As of June 3, 2009, Fortress, which also held credit-default swaps against a GM default, calculated its annualized return at 218 percent, according to court testimony.
“Amazing, really, really amazing. Let’s all plan to get beers,” a colleague wrote to Fortress analyst Bao Truong on May 30, 2009, after Truong and representatives of the three other funds hashed out the so-called lockup agreement outlining how Nova Scotia notes would be treated in the bankruptcy.
Later that weekend, they would camp out in the New York offices of GM’s bankruptcy lawyers, Weil Gotshal & Manges LLP, to work out final details that the creditors allege would benefit the Nova Scotia noteholders further.
The lawsuit sought to scrap the funds’ claims -- arguing the $367 million cash fee already represented a 37 percent recovery and should be subtracted from any claim. They also said the majority of the funds’ $2.7 billion in claims were duplicative. The creditors said Fortress improperly influenced the committee that helped steer GM toward bankruptcy, and that the bondholders’ lockup deal should be disqualified because it was completed hours after GM filed for bankruptcy, meaning it should have been reviewed by the bankruptcy court.
“There was no one in the room negotiating on my behalf,” said Garry Lakin of Naples, Florida, who has a $33,252 investment in regular GM bonds and was one of the unsecured creditors represented in the suit.
A lawyer himself, Lakin said he can’t understand the deal the hedge funds worked out. “When it comes to the political and abstruse legal maneuvering that goes on in bankruptcies, small investors are outclassed by hedge funds,” he said.
The funds denied wrongdoing, saying in the court proceedings that they simply made smart use of pricing inequity. They said they didn’t coerce Old GM into the lockup agreement or unduly steer it toward bankruptcy.
Gordon Runte, a Fortress spokesman, didn’t return calls for comment on the case. Peter Truell, an Elliott spokesman, declined to comment. Bruce Zirinsky, a lawyer from Greenberg Traurig LLP who represented the four funds as they negotiated the lockup agreement, also declined to comment.
Appaloosa and Aurelius dropped out as defendants in the case, having sold their stake to Paulson Partners, Morgan Stanley & Co. International Plc and others who are among new noteholders that will benefit from the settlement.
$10 Billion Loss
The claims granted by the settlement, like the other unsecured claims in the bankruptcy, are to be repaid in common shares (GM:US) of the restructured company, General Motors Co., or New GM. Approval of the settlement would free a reserve that includes shares and warrants for distribution.
GM Chief Financial Officer Daniel Ammann, who at the time of the bankruptcy filing was a Morgan Stanley banker advising GM, has said GM stands by the lockup deal. Undoing it could have effectively voided the transaction that split GM’s old liabilities off in the bankruptcy and risked opening New GM to litigation costing as much as $918 million, he has said.
In 2005, GM lost $10 billion. Researching Nova Scotia notes that year, Truong, the Fortress analyst, called the treasurer of GM Canada and learned that GM Nova Scotia Finance had made intercompany loans to its parent, Truong testified.
Such knowledge would prove useful. Under the 1900 Nova Scotia Companies Act, a company’s owner is obligated to pay the debts of all subsidiaries. Such unlimited liability companies, or ULCs, confer tax advantages on their parents.
Truong believed that GM Nova Scotia Finance’s ULC status would allow creditors to reach up to its parents to collect repayment in the event of a bankruptcy, he wrote in a Dec. 10, 2008, e-mail presented at the trial.
Fortress first bought the notes in 2006 and raised its bet with more purchases in 2008. The three other funds also began buying them that year, according to court testimony. The four would come to own more than two-thirds of the notes -- or more than $666 million worth -- by the time of GM’s bankruptcy filing, giving them the ability to negotiate on behalf of all the Nova Scotia bondholders.
Elliott’s Didric Cederholm, now the fund’s portfolio manager of distressed investments, testified that his fund had believed since 2005 that there was a “high probability” that GM would file for bankruptcy. In 2008, he testified, he told a colleague at Elliott that he believed the Nova Scotia notes would do better than regular bonds in a bankruptcy.
“The holders of them had multiple claims and multiple sources of recovery,” he testified. In fact, he believed there were four dips, or separate ways to make claims for the notes.
One of Cederholm’s colleagues expressed hope that word wouldn’t get out.
“An extremely high-profile out-of-court example of double dip bonds getting substantially enhanced treatment could be just the thing to insure that these low cost or no cost options for the slightly more savvy no longer widely exist in the marketplace in the future,” David Miller, a portfolio manager at Elliott, wrote to Cederholm in a Jan. 16, 2009, e-mail that Cederholm read into the court record.
Truong and Cederholm didn’t return calls and e-mails seeking comment.
By early 2009, the chiefs of Detroit’s Big Three automakers had asked for U.S. government bailouts. For GM and Chrysler, bankruptcy appeared increasingly likely.
Chrysler, which filed on April 30 that year, provided an example of what the U.S. government wanted to do with GM -- save it by quickly selling the unsustainable businesses as an old company while reorganizing its most promising assets (GM:US) as a new entity.
GM wanted to keep GM Canada, an integral part of the U.S. operation, out of bankruptcy, according to testimony by GM’s CFO Ammann.
A GM Canada bankruptcy would have made a quick Chrysler-style workout impossible, said Seton Hall’s Lubben. “If they understood that,” he said of the funds, “they had a little more power.”
On March 2, a group that included Aurelius, Fortress and Appaloosa filed suit in Nova Scotia Supreme Court against GM’s Nova Scotia finance unit, GM Canada and GM. The plaintiffs alleged the defendants had engaged in “oppressive conduct” because the Nova Scotia unit had transferred money to GM in May 2008. The suit sought to recover the money to be paid out to investors in the Nova Scotia notes.
Creditors called the Canada lawsuit frivolous, noting that the role of a financing unit would obviously be to move money to its parent. The creditors alleged the suit was a bargaining tool “to assert maximum leverage in GM’s restructuring.”
Also in early 2009, Fortress’s Truong and Elliott’s Cederholm were among the hedge fund representatives who sat on a steering committee to restructure GM’s debt.
Creditors said Truong tried to rally the committee to push for the U.S. auto giant’s bankruptcy. Both Elliott and Fortress held credit-default swaps on GM debt, their representatives told the court. Such insurance against a default would reward the funds should GM fail.
Elliott’s Cederholm testified that the steering committee had been in favor of an out-of-court restructuring for GM. Asked whether such restructuring would be against Elliott’s economic interests -- as it meant Elliott’s swaps would have expired worthless -- he said “no” and didn’t comment further.
Truong wrote at the time that he believed an out-of-court restructuring would be impossible and that bankruptcy was a “better forum for us to assert our multiple claims,” according to an e-mail presented by lawyers for creditors. Truong also wrote in a Jan. 22 e-mail that he had discussed “getting other members of the steering committee on board” with a Chapter 11 filing.
Truong testified that he didn’t believe he was rooting for a GM bankruptcy filing by January 2009. In court papers, the funds said they didn’t tip the automaker into Chapter 11, because other debt holders had also voted, in late April, against GM’s offer to exchange $27.2 billion in bonds for equity.
That vote marked the final failure that would push GM toward bankruptcy.
Fortress and Elliott didn’t say how many CDSs they held or how much they profited. They disputed creditors’ allegations that they should have disclosed their holdings in court, saying in court papers that they were under no obligation to do so because the swaps had terminated with GM’s filing.
In mid-May, representatives from GM, GM Canada and the U.S. and Canadian governments set a June 1 deadline for GM to restructure its debt out of court or face bankruptcy. GM had until then to work out a deal with the Nova Scotia noteholders.
By late May, GM Canada had resolved differences with its dealer networks and unions (GM:US). Only the unresolved Nova Scotia claims risked forcing GM Canada into bankruptcy.
As time ticked down, GM decided to use some of the $53 billion in taxpayer bailout money and financing extended by the U.S. government to make a deal with the funds.
New GM has said it didn’t know whether the funds had a valid legal argument that the Nova Scotia notes had twice as many claims as other notes. Striking a deal with the funds, New GM said in court papers, would allow GM Canada to avoid filing for bankruptcy, yet would preserve the hedge funds’ “‘two claims’ issue for eventual resolution by the court.”
Negotiating on GM’s behalf, Ammann first offered the hedge funds 20 cents on the dollar to drop their claims against the Nova Scotia unit -- twice the level he had suggested in e-mails he had written less than two weeks earlier.
In coming days, that sum would rise.
Final negotiations on how much the Nova Scotia bondholders would get in the GM filing got under way on May 28, 2009, in the offices of Weil Gotshal, GM’s counsel. Morgan Stanley’s Ammann was still leading the talks, with representatives for Fortress, Appaloosa and Aurelius -- and, in the final day, Elliott -- on site.
By May 30, a Saturday, the funds were confident they were going to get most of what they sought -- a “consent fee” for forgiving an intercompany loan between the Nova Scotia unit and GM Canada, which had now increased to roughly $350 million.
Plus, instead of dropping their other claims, the holders would retain the right to pursue them on behalf of the same $1 billion -- the double dip.
“I think we may end up with 35 cents cash [and] 2.25 times claim at GM Corp.,” Truong wrote that day in an e-mail.
Later that day, responding in his colleagues’ e-mailed kudos, Truong wrote that he couldn’t make it for beers. “Dude, I’d love to, but GM is filing Monday,” he e-mailed.
Representatives camped out at Weil’s office through the day and night. Canadian officials were in Weil’s office and on the phone, ready to put GM Canada into bankruptcy if a deal couldn’t be reached. The funds pushed back deadlines as they pressed for advantageous terms, the unsecured creditors alleged.
“You need to get more time,” Dan Gropper, representing Aurelius, wrote to Ammann on Sunday.
“More time is not going to happen. They need to brief Prime Minister, etc. We were talking them off the ledge as it was,” Ammann responded.
The Canadian deadline was pushed until 5 p.m., then until midnight, and again until dawn, Ammann later testified.
By the time the lockup deal was completed, it would contain five other provisions aside from the consent fee -- now $367 million--and the two bankruptcy claims. One obliged the Nova Scotia finance unit to be put into bankruptcy, even though it hadn’t defaulted. The unsecured creditors’ trust alleged that the funds took that action because such a bankruptcy was necessary to allow the funds to make their duplicative claim under Nova Scotia law.
Creditors allege that the funds had continued to negotiate past GM’s 7:57 a.m. bankruptcy filing. That meant the entire deal should have been subject to court approval and could be voided since it didn’t get a judge’s signoff, creditors said.
The creditors cite metadata that showed the final version of the lockup agreement -- version 20 -- was finished at 10:37 a.m. The agreement as of 7:57 a.m. was version 18.
The defendants said everyone had signed off on a final deal by 7:15 a.m. Numerous drafts arose, they said in court papers, because one of Weil’s lawyers hadn’t always entered revisions accurately, while Aurelius’s Gropper pulled out his own laptop and made “real time” changes that were entered before the GM deadline but bore a later time stamp. Gropper testified that he sent changes to Weil at 6:30 a.m. and left its offices between 8 and 8:30.
With a settlement rather than a ruling sealing the deal that the four funds hashed out, there is still no clear legal precedent on double-dip claims. Two other bankruptcies that involve the Nova Scotia law have also failed to provide a precedent. AbitibiBowater Inc. settled, and Smurfit-Stone Container Corp. didn’t provide a clear precedent because there was specific language in the bond indenture that waived such liability.
Seton Hall’s Lubben said last week’s ruling may encourage distressed-debt investors. As for the hedge funds, he said, even though the settlement is for less than initially sought, “I suspect they’re still reasonably happy.”
The two Nova Scotia notes at issue, 8.375 percent notes due 2015 and 8.875 percent notes due 2023, both traded at 40.75 cents on the dollar according to data compiled by Bloomberg on Sept. 30. Their 52-week high was 44.18.
The GM Chapter 11 case is In re Motors Liquidation Co., 09-50026, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The adversary case is Motors Liquidation Co. GUC Trust v. Appaloosa Investment LP I, 12-09802, U.S. Bankruptcy Court, Southern District of New York (Manhattan).
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