Reporting from Wilmington, Del.— — Lawyers and expert witnesses at the confirmation hearings in Tribune Co.'s bankruptcy case began this week to address the complex question of when the Chicago-based media company became insolvent and who should have known about it.
But amid often-numbing testimony about discount rates and cash-flow tax values, strategies among the two groups of warring creditors in the case are becoming clearer as they each try to persuade U.S. Bankruptcy Judge Kevin J. Carey to accept their plan for restructuring the company.
Tribune is the parent company of the Los Angeles Times, the Chicago Tribune and other media properties.
The company and lenders that financed its ill-fated 2007 leveraged buyout maintain that the intricate, two-step deal did not itself bankrupt Tribune — a charge being pressed by junior creditors led by hedge fund Aurelius Capital Management.
On Thursday, former University of Chicago law scholar Daniel Fischel testified as an expert witness that it was reasonable for the lenders to assume the company was solvent at the time that each of the two steps of the deal closed in 2007.
But faced with ample evidence from other quarters, including the report of a court-appointed examiner, that the second step of the deal may have rendered the company insolvent, the senior group has also adopted another tactic.
On Wednesday they produced Bernard Black, a finance and law expert from Northwestern University, who has spent the last year, for a $500,000 fee, calculating probabilities for various potential legal conclusions in the case. He testified that even if the buyout were a form of fraudulent conveyance, potential recoveries for the junior creditors pressing the claims would most likely not be higher than the 34 cents on the dollar they've been offered by senior creditors to settle.
Black argued that the only way the junior creditors could do better is if they could prove that both Step 1 and Step 2 of the 2007 buyout were fraudulent conveyances. That would "avoid," or invalidate, the more than $8 billion in senior lender claims and give the junior creditors full recovery on the more than $2 billion they are owed.
Given the legal hurdles, Black concluded, there was only a small chance of that outcome.
Aurelius, however, is betting that it can convince the judge that there is ample value in its legal claims. While it will have to wait until next week to put on its case, David Zensky, a lawyer for the junior creditors, said in his opening statement Monday that "there are several routes that would provide recovery to the [junior creditors] far in excess of the proposed settlement."
Part of the Aurelius strategy is to show that the banks knew that the buyout was troubled but went along with it anyway. Because these are confirmation hearings and not an actual trial, the burden isn't to prove those charges but to provide Carey with enough evidence to support the idea that litigation might be fruitful.
On Tuesday, for example, an Aurelius attorney presented e-mails showing that JPMorgan Chase & Co. had "debated solvency" before the deal closed in 2007, and that credit managers had given the company a "distressed" internal rating.
But Aurelius also planned to argue that there are multiple ways to get paid. In his opening, Zensky said he would argue that the two steps of the buyout should be considered as one in assessing balance-sheet solvency — a conclusion both Black and Fischel rejected.
If the steps were collapsed, and the company's special tax benefits were treated the way the examiner suggested, Zensky said he could show that Tribune would have, in fact, been insolvent at Step 1, freeing up billions to pay the junior creditors.
Failing that, he said, there were two more scenarios that would produce higher returns than the 34-cent settlement. One involved getting a favorable ruling on the treatment of senior claims if Step 2 were found to be a fraudulent conveyance. In that case, the current Credit Agreement has a provision that gives Step 1 lenders a large share of the recoveries related to the "avoided" Step 2 debt. Aurelius contended in its papers that the provision should be overturned as unfair, but the senior group contended that that legal argument was completely untested.
Aurelius also argued that its recovery in the settlement was being depressed by the company's low estimation of its own value. Lazard Ltd., Tribune's investment bank, estimated that the company was worth $6.75 billion in October, but it hasn't raised that estimate since, despite evidence that the company's value has increased, Zensky said.
Aurelius argued that the equity value should be significantly higher. That would increase the value pie for everybody, but under the settlement, the junior recovery is fixed because the payment is in cash, not equity. "So that is another reason the settlement is inadequate," Zensky said.
Black argued that increasing the value wouldn't make that much difference to the junior note holders.
Point by point, the senior creditors said the junior group's arguments and proposed legal strategies were specious. But for Aurelius, bankruptcy experts said, it may be enough for now to simply plant sufficient doubt in Carey's mind about the fairness of the senior group's proposed settlement. If he decides the senior plan can't be confirmed as is, it might force the senior lenders back to the bargaining table with less leverage than they had before.