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Recently a swan of unknown color landed at the Yoda cave. Upon further examination, it turned out to be a black swan of the highest order. Unfortunately, this swan might be a scout for a whole flock of black swans heading in.

The story starts in the money is flowing like water era before the credit crash. Leveraged buyouts were coming fast and furious up through 2008. To say that some of the LBO’s might have used overly optimistic projections would be an understatement. Warren Buffet bought $ 2 billion of LBO bonds for a utility company called Energy Future Holdings. He recently called that acquisition “a big mistake” as the bonds have been written down substantially from par. Energy Future Holdings was an LBO of Texas Utilities, an old, stodgy electric utility. Energy Future Holdings is still in business and has not declared bankruptcy, but the outlook is NOT good.
Another LBO/merger that went bad was Lyondell Chemical. They floated $22 billion of new debt to consummate a merger with Basell in December 2007. In December 2008, Lyondell declared bankruptcy. So in a one year period of time, the financial projections that were used to justify the $22 billion in bonds were proved way off base.

So you say, “too bad for the bondholders, I guess they should not have loaned the company money.” Here is where it gets interesting.

In 2010, the trustee for the bondholders filed a claim in bankruptcy court in New York. The trustee is using a new “fraudulent transfer” argument in the court case. They have named every person/entity that owned over $100k in shares on the date of the buyout as defendants. The trustee claims that the $48 per share buyout price represents a fraudulent transfer. Stated differently, everyone that received the $48 was not and IS NOT entitled to it. The lawsuit seeks to “clawback” the buyout funds. The trustee wants to use the clawed back funds to help make the bond holders whole.

This is without regard to how long the shares were held before the buyout was consummated. They could have been held one day or one decade, it does NOT matter. Let me emphasize the point. The trustee is not attempting to get any gains that were recognized by owning the stock. The trustee wants the bankruptcy court to order maybe 50% or $24 per share to be forfeited by the holders of the stock on the buyout date.

They have served court papers on all holders of the stock above the $100k threshold. It is on the order of 2,000 funds/advisors/trusts and INDIVIDUAL INVESTORS.

All ~ 2,000 MUST file a formal response with the bankruptcy court. Failure to do so will result in the trustee asking for a “default judgment” against the shareholder. I do not know if the court would approve this, nor what amount they would grant.

The largest shareholder on the list “Fund 1” owned $343 million of shares on the buyout date. They have adequate vested interest and funds to fight the trustee. The folks that owned $100k of shares are lumped into the same boat legally. They have to fight the charges also. At a minimum, they have to retain their own legal counsel to file motions to the bankruptcy court seeking to join with the large holders. In the best case, these small holders will prevail in court and only be out their legal fees. Recall in America that “losers do not pay” the legal fees for the winning side. In the worst case, the holders will be out their legal fees plus a significant portion of the share buyout proceeds.
You can read all 274 pages of the “Second Amended Complaint” with this link. Most of the pages are lists of all of the stock holders on the date of the buyout.

Several legal scholars are predicting this type of litigation will expand as more of the credit crazed buyouts turn bad. Here is a legal paper that explains the new theories of “fraudulent transfer.”

BOTTOM LINE is you do not want to own any common stock that gets bought out through an LBO, then goes bankrupt. (Don’t ask me how you are supposed to always know this in advance.) If you own the shares as part of a mutual fund or ETF, they will fight the battle for you. If they lose, the losses will be amortized over the rest of the investments.

Unfortunately this black swan in not mythical and landed at the Yoda cave. If is not clear how this case will be resolved, but the financial outlays will be significant, win, lose or draw.

Welcome to America. . .

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