The Role of Hedge Funds in Corporate Restructurings. A new major player is emerging on the corporate restructuring and bankruptcy scene world-wide; hedge funds. Playing the role of "liquidity provider", for a price, hedge funds can bring sorely needed cash to the table early in a corporate reorganization. Much has been written about hedge funds in the financial press. The image that is most often portrayed is that of an entity with huge amounts of money at its disposal, taking very aggressive positions in the equity, debt, and arbitrage markets. First, a quick look at what a hedge fund is. The term "hedge", from the phrase "to hedge your bets", has traditionally referred to a strategy where a company with exposure to price changes of commodities, such as petroleum, precious metals, or agricultural commodities, will take a position in the futures market which will offset any negative price swings in the commodity in question. Thus, hedging has been viewed as a risk-limiting strategy, since in limits downside risk if the price of the commodity decreases, but eliminates the upside potential if the market price of the commodity increases. Suffice it to say, modern hedge funds are not in the business of eliminating upside in order to limit downside. The hedge fund of today is an entity that is: 1) unregulated or minimally regulated; 2) not a bank or insurance company; 3) that is in control of sizable amounts of money; 4) invested mainly by large investors able to withstand financial risk; and finally 5) attempting to make truly outstanding returns in return for taking above-average risks. Hedge funds are able to find opportunities in dealing with troubled companies either inside or outside of bankruptcy, due to their flexibility and willingness to take whatever position makes financial sense. This makes them very valuable players in cases of companies which have a strong core business, but are beset with a serious financial downturn. A hedge fund can extend credit, being able to move more quickly, and with less regulatory restraints than a commercial bank. It can also take an equity position, majority, or even minority, giving them an edge on the private equity firms which normally insist on control. They can adjust their target rates for the risk which they asses to be inherent in the transaction, keeping in mind that a substantial component of their business is assessing risk. In a recent article by John Willcock, Editor of Global Turnaround, London, UK, which appeared in Insol World, the journal of Insol, the organization of insolvency professionals and investors world-wide, Terry Hughes of Silver Point Capital, a 6 billion dollar hedge fund, made several poignant observations regarding the role of hedge funds in corporate restructurings. First, he showed the flexibility of hedge funds over traditional players with the following illustration: "You can understand hedge funds by comparing them to private equity, banks, and mezzanine investors. All three live in silos. Private equity houses buy all of the equity in a company, and want to control the whole company. If they can’t, they don’t invest. Banks want to lend, and if a company can’t pass the appropriate credit assessment, then they don’t lend. Mezzanine investors want a minimum rate of return before they invest." Huges continues: "Our ability is to run up and down the capital structure of the company, investing where we want. We’re not restricted to one silo." Assessing the risk of investing in companies which have already entered the bankruptcy process offers unique challenges. Investing in bankrupt companies has been referred to as "investment’s black art". One thing is sure, when investing in bankrupt companies: you are really are buying at the bottom. The question is, of course, will it ever come off of the bottom. Many hedge fund managers have had very good experiences that answer in the positive. If the company has good fundamentals, an established core business, and a discernable market share, than it can, through the chapter 11 process, confirm a plan of reorganization that will enable it to shed millions if not billions in debt, and emerge from bankruptcy is leaner more attractive entity. Corporate bankruptcy has been compared to the "fat farm, where people go to shed pounds, hopefully emerging ready for their high school reunion." The hedge-fund industry is widely reported to exceed $1 trillion in assets. In the mean time, the face value of distressed debt has grown to $718 billion this year, nearly 10 times the $77 billion it amounted to in 1998, according to Bloomberg. Due to their ability to be aggressive, flexible, and fast to act, hedge funds will continue to play an expanding role in bringing liquidity to the table in more and more corporate insolvencies, both inside and outside of bankruptcy. Stay tuned. The Law of Recovery of Preferential Transfers; "Can They Really Do This"? No area of bankruptcy law is less understood, and causes more shock and upset, than the law pertaining to the recovery of preferential transfers, referred to as "preferences". A businesses’ first exposure to the law of preferences usually comes when they receive an unpleasant letter, or a complaint initiating a lawsuit, from a bankruptcy trustee, or a debtor-in-possession in bankruptcy, demanding the return of a payment made on a legitimate debt by a company that later filed bankruptcy. Every attorney has heard the following hue and cry: "It was a legitimate debt, not fraudulent; Can they really do this? I got the complaint in the mail; can they do that? Is there any way to fight this? The answers are yes, yes and yes. The details follow. Two things are helpful to a business facing a preference demand or lawsuit: 1) knowing that there is "method to the madness" regarding the recovery of preferences; 2) knowing that all is not lost, and that there are well established defenses which may be asserted even before a lawsuit is filed. Preference law exists due to the overriding principle in bankruptcy that all creditors with the same type of claim should be treated equally. When a company files bankruptcy, it is presumed that it was insolvent 90 days prior to the date of filing. In order that all creditors be treated equally, certain payments made by the debtor within 90 days of the bankruptcy filing can be brought back into the "pool", with the creditor receiving a claim against the bankruptcy estate equal to the amount that it was forced to "put back". In a nutshell, preference law exists to even the playing field between those that were preferred by receiving payments in the 90 days prior to bankruptcy (thus the term preferences), and those who did not. The concept is that creditors, preferred and non-preferred, should share and share alike. The payment is a preference if it was a transfer of property of the company that filed bankruptcy: 1) to or for the benefit of a creditor; 2) on account of a pre-existing debt; 3) made within 90 days of the bankruptcy filing (or 1 year if the transferee was a relative or entity closely related to the debtor); 4) while the debtor was insolvent; 5) which allowed the transferee to receive more than it would have received in a chapter 7 bankruptcy case if the transfer had not been made. Congress has granted the Bankruptcy Courts jurisdiction over any person who has received a preference. Service of process can be accomplished by first class mail; personal service of the summons and complaint on the transferee is not required. A company which is the target of a preference action or demand does have defenses which are built in to the Bankruptcy Code. These are: - Contemporary Exchange of New Value. This applies when the transfer of money from the debtor to the transferee was accompanied by a transfer of value from the transferee to the debtor. Example: a cash sale.
- Ordinary Course of Business. This is the "softest" and most difficult defense to prove. It applies when the payment meets three separate standards of "ordinariness". Example: a payment within the terms of the invoice.
- Subsequent Advance: This defense applies when the transferee advanced value to the debtor after the original transfer. For any amount which is a preference, the transferee is given a dollar-for-dollar credit for all amounts advanced to the debtor after the initial transfer. Example: after receiving a payment from the debtor within 90 days of bankruptcy, the transferee ships additional merchandise to the debtor. The transferee is given a dollar-for-dollar credit for the invoiced value of the merchandise shipped. This applies whether or not the transferee was ever paid for the subsequent advances prior to the debtor’s bankruptcy case.
The foregoing is a very basic description of the law of preferences, and is not meant to be taken as legal advice in any specific instance. Consult an attorney knowledgeable regarding preferences in bankruptcy for advice regarding specific maters. Reeder Law Corporation represents companies and individuals who are the targets of preference lawsuits or demands. If the trustee or debtor-in-possession is "on your case", call for a look at your options The Reederlaw Report  The Reederlaw Report is published by David M. Reeder and Reeder Law Corporation. Reeder Law Corporation represents all parties to insolvency proceedings, including:
debtors (both business and individual) creditors (both secured and unsecured) creditors' committees bankruptcy trustees businesses and individuals who are sued by bankruptcy trustees landlords when the tenant files or threatens to file a bankruptcy case, and buyers of assets from bankruptcy estates.
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