Overleveraged distressed companies with potentially sound business prospects may present opportunities for savvy well-financed purchasers that are willing to participate in the bankruptcy process. That participation is not limited to bidding at a bankruptcy sale under §363, but may also include purchasing debt to pursue what is sometimes called a “loan to own” strategy. Insiders have long been alert to the bankruptcy court’s authority to scrutinize their actions, intervene and potentially disallow their claims.1 Now competitors also need to be alert as well.
Recently, Charles Ergen, the founder, chairman of the board of directors and controlling shareholder of DISH Network and activist distressed investor in the LightSquared Chapter 11 case, was the focus of bankruptcy court scrutiny as his hotly contested attempt to take over LightSquared encountered and succumbed to the equitable power of the bankruptcy court. Despite amassing close to $1 billion in senior secured debt, a claim that ordinarily would place Ergen in control of a creditor class enjoying significant power in a Chapter 11 case, Ergen will not enjoy the rights associated with that position. Instead, Ergen faces the subordination or disallowance of his claim due to what the bankruptcy court determined was his inequitable conduct in purchasing LightSquared’s debt through an end-run around prohibitions in the credit agreement with the intent to manipulate the bankruptcy proceedings and the bankruptcy court.2
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