Private Equity Newsletter - Winter 2014: Recent Developments in Acquisition Finance

by Dechert LLP

Several recent legal developments will likely impact acquisition finance. 

A recent decision of the U.S. Bankruptcy Court for the Southern District of New York examines who is an “Eligible Assignee” entitled to acquire loans and become a lender under a credit agreement. The case highlights a risk to sponsors when affiliates of a competitor of a portfolio company attempt to acquire a portion of the portfolio company’s debt, and thereby potentially acquire voting, informational and/or other rights in connection with matters affecting the portfolio company. Especially enticing for such attempts may be the chapter 11 context, particularly where significant value may remain in the portfolio company’s equity at a time when liquidity issues have forced a chapter 11 filing. The decision in question involved the issue of whether a competitor and potential strategic acquirer of a portfolio company’s assets could successfully structure the vehicle used to purchase the portfolio company’s distressed senior debt to avoid credit agreement prohibitions on purchases by competitors, and thereby successfully employ a “loan-to-own” strategy to the detriment of the sponsor. 

Harbinger Capital Partners LLC v. Ergen (In re LightSquared Inc.)1 stemmed from events leading to the bankruptcy of LightSquared Inc. (LightSquared), a provider of communications and broadband services owned primarily by Harbinger Capital Partners LLC (Harbinger). LightSquared commenced its bankruptcy case in May 2012 after the Federal Communications Commission suspended operation of LightSquared’s wireless spectrum due to suspected interactions with governmental global-positioning systems and other networks. At the time it filed for bankruptcy, LightSquared had approximately $1.7 billion in senior secured loans outstanding under its credit agreement. As of July 2013, about $825 million in principal amount of such loans was acquired by SP Special Opportunities, LLC (SPSO), an investment vehicle beneficially owned by Charles W. Ergen (Ergen), founder, chairman and majority shareholder of DISH Network Corporation (DISH), a competitor of LightSquared. 

Under the credit agreement, lenders could assign loans only to “Eligible Asignees,” which explicitly excluded any “Disqualified Company.” “Disqualified Company” was defined as “any operating company which is a direct competitor of the Borrower,” as well as “any known subsidiary thereof.” DISH was listed on a schedule to the credit agreement designating it as a Disqualified Company for such purpose, and thus was ineligible to purchase loans under the credit agreement.

By purchasing such a large portion of the company’s senior debt at a substantial discount on the secondary market, SPSO would enable itself potentially to credit-bid for the debtor’s wireless spectrum, its primary asset, in a court-approved auction, with the ability to offset any winning bid it made by the par value of its acquired loans (acquired at a significant discount). This would give SPSO a significant advantage over other bidders. Harbinger asserted a variety of causes of action against Ergen and DISH, including fraud, among others, alleging that, in order to circumvent the trading restrictions of the credit agreement, Ergen and DISH effectively created SPSO together for the improper purpose of purchasing LightSquared’s debt through this vehicle in order to wrest control of LightSquared and its principal assets from Harbinger, for DISH’s ultimate benefit.

In its analysis of whether SPSO should be considered an Eligible Assignee, the bankruptcy court examined the provisions of the credit agreement relevant to the definition of such term. It noted that the defined term referred to (lower-case) “subsidiaries” and not (capitalized) “Subsidiaries” of competitors. Whereas the capitalized term appeared to have a broader meaning than that of the ordinary, uncapitalized term, neither would appear to have covered commonly controlled affiliates of DISH or of any other disqualified competitor. Only if DISH itself had controlled SPSO, rather than Ergen, would the capitalized defined term have covered SPSO, and the court noted that an allegation of DISH’s control over SPSO had not even been made by Harbinger in its pleadings. 

Had the relevant defined terms in the credit agreement plainly covered commonly controlled affiliates of direct competitors as ineligible assignees, the court likely would have been more sympathetic to Harbinger’s assertion that SPSO was not an eligible assignee by virtue of Ergen’s control of both SPSO and DISH.  

While the court did not actually rule on this issue but based its decision on other grounds, a fairly plain lesson may be learned from the case, namely that sponsors and their portfolio companies need to place appropriately broad restrictions on who may become an assignee of loans and a lender under a loan agreement. Disqualifying only designated competitors and their subsidiaries, even while using an expansive definition of “Subsidiary” that includes entities actually controlled though not majority-owned by the competitor, may well prove insufficient. Affiliates of competitors, under common control with them, likely would not be covered by such a restriction. It is prudent, then, if at all practicable given the industry of a borrower and the related circumstances, for the sponsor and company to include commonly controlled affiliates of competitors within the excluded class prohibited from acquiring loans, in order to guard against the developments that lay at the heart of the Harbinger case. 

A decision this past summer of the U.S. Court of Appeals for the Second Circuit highlights the importance of certain terms in loan documents that on occasion may be overlooked as mere “boilerplate.” 

In Gaia House Mezz LLC v. State Street Bank and Trust Company,2 the court refused to allow a borrower to use equitable remedies to prevent its lender from enforcing the express terms of a loan agreement, even where the lender in the past had repeatedly waived defaults, so long as the lender had complied with the express terms of the loan agreement and had specifically reserved its other rights in connection with each waiver it had previously furnished.

The borrower, Gaia House Mezz, LLC (Gaia), had entered into a loan agreement to finance the construction of a residential building in Manhattan. Gaia failed to repay the debt on the loan’s original maturity in July 2009, after which Gaia and the lender modified the loan agreement to waive past defaults, set a new maturity date for the loan and, in the event there were no further events of default, waive certain accrued and unpaid interest. Several similar amendments ensued, but ultimately Gaia defaulted by failing to obtain a certificate of occupancy for the building by the deadline set forth in the loan agreement. That event of default was not waived by the lender, but the lender took no remedial action at the time of such default, and the parties thereafter continued to perform in accordance with the other terms of the loan agreement.

About six months later the lender sent Gaia a default notice and reservation of rights letter, in which it also notified Gaia that, due to Gaia’s default in having failed to obtain the certificate of occupancy by the deadline, the accrued interest waiver would not become effective, in accordance with the terms of the prior amendment. Gaia subsequently obtained alternate financing to refinance the loan, and paid the accrued interest portion under protest, asserting that it was not truly owing since the certificate of occupancy had indeed been obtained, albeit late, thus curing any default that had arisen by not obtaining it by the deadline. Gaia also asserted that, even if not cured, the default had been waived by the lender’s failure to declare the default when the loan agreement deadline passed, and also by the lender’s continuing performance under the loan agreement after the deadline without furnishing a default notice. 

Gaia brought suit against the lender in the U.S. District Court for the Southern District of New York, alleging that it was entitled to return of the accrued interest it had paid under protest, among other damages. The District Court ruled in Gaia’s favor. 

On appeal, the Court of Appeals for the Second Circuit reversed, making several noteworthy holdings. Applying New York law, the Court of Appeals held that the lender had no duty under the loan agreement to provide Gaia with notice of events of default, and that the lender’s course of performance in not enforcing certain of Gaia’s obligations under the loan agreement did not amount to a  modification of the loan agreement. The court noted that the loan agreement specifically stated that such waivers by the lender would not be implied from its conduct, or lack thereof. The court noted also that, whenever the lender waived any provision of the loan agreement, it had done so expressly and in writing, while specifically reserving all of its other rights. The court refused to allow equitable powers of a court to be invoked in order to prevent the occurrence of “contracted-for financial consequence[s]” under a loan agreement.3 Finally, the Court held, since the loan agreement contained a “time-is-of-the-essence” clause, that under New York law the various deadlines set forth in the loan agreement needed to be met and were not deemed cured when performed late, and further held that late performance in such circumstances did nothing to cure the continuing event of default due to the missed deadline, justifying revocation of the accrued interest waiver.

One of the practical take-aways of this decision is that, if a New York law-governed loan agreement contains a “time-is-of-the-essence” clause, then deadlines set forth in the agreement, including events of default triggered by missed deadlines, need to be taken with utmost seriousness by borrowers. Although a court may still consider issues of materiality and good faith, the general rule, as enunciated by the Gaia court, appears to be that such deadlines will be respected in such cases, with all the specified consequences that may ensue under the terms of the related documentation, notwithstanding late performance, after the missed deadline. The “time-is-of-the-essence” clause is thus one that should be resisted by borrowers from inclusion in such cases wherever possible. The case also is a reminder to borrowers that “boilerplate” provisions in loan documents can have important practical effects and will generally be respected in commercial transactions between sophisticated parties, and thus need to be considered carefully along with all other relevant documentation.

Another recent decision raises a concern for selling equity owners in a leveraged buyout context. The decision in question, by the U.S. District Court for the Southern District of New York,4 may help promote a new theory for a claim of “constructive” fraudulent transfer against selling equityholders that may potentially be brought by individual creditors of the target entity in certain circumstances. 

The case arose from the 2007 leveraged buyout and 2008 bankruptcy of Tribune Company (Tribune). In the bankruptcy case, the unsecured creditors committee (Creditors Committee) filed claims against the selling shareholders asserting only intentional fraudulent transfer (i.e., transfers made with actual intent to harm creditors) and not constructive fraudulent transfer (i.e., transfers made while insolvent for less than reasonably equivalent value, but without actual intent to harm creditors). The Creditors Committee presumably did not assert constructive fraudulent transfer claims because such claims would most likely have failed under the Bankruptcy Code’s safe-harbor provision protecting settlement payments in securities transactions from all fraudulent transfer claims other than intentional ones. Instead, in March 2011, hundreds of Tribune’s individual creditors sought and obtained permission from the bankruptcy court to file in state court, outside of the bankruptcy case, the state-law claims corresponding to the constructive fraudulent transfer claims. These claims were eventually consolidated in a multi-district litigation in the U.S. District Court for the Southern District of New York, and the defendants, the selling shareholders, moved to dismiss.

The District Court concluded that, based on the plain meaning of the relevant provisions of the Bankruptcy Code,5 the exclusion of claims for constructive fraudulent transfer does not apply to individual creditors. Yet the District Court ultimately dismissed the individual creditors’ claims for lack of standing, since the Creditors Committee was at that time itself seeking to avoid the same payments made to the selling shareholders, on the basis of intentional fraudulent transfer. 

The District Court’s reasoning that individual creditors are not barred from asserting claims for constructive fraudulent transfer for such payments made to selling shareholders raises a concern for sponsors, both as sellers and buyers in the leveraged buyout context. If a sponsor is a selling equityholder, it will be justified in seeking a degree of additional assurance that the transaction in question will not, in hindsight, be deemed a constructive fraudulent transfer, for example by receiving enhanced comfort as to the solvency of the target group at the closing of the buyout in question. Correspondingly, a sponsor as buyer may expect certain corresponding requests from their selling counterparties who may be harboring related concerns. 

We look forward to updating you on these and other developments in future newsletters.


Adv. Pro. No. 13-1390 2013 WL 6140717 (Bankr. S.D.N.Y. Nov. 21, 2013)

2 720 F.3d 84 (2d Cir. 2013).

3 Id. at 94.

4 In re Tribune Co. Fraudulent Conveyance Litig., 499 B.R. 310 (S.D.N.Y. 2013)

5 11 U.S.C. § 546(e).



DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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