Hedge funds that pursue distressed debt strategies have good reason to follow the ongoing saga of Dynegy Inc. and its corporate family, where a control group of shareholders attempted a corporate restructuring last summer that retained valuable assets under the control of the parent corporation, while leaving the family’s liabilities within a subsidiary, Dynegy Holdings. The resulting intrigue seems worthy of ‘80s television.
One much remarked-upon fact about the bankruptcy is that the parent corporation, Dynegy Inc., (NYSE: DYN) did not file for bankruptcy. As of August 31 of last year, Dynegy’s only asset was the equity in Dynegy Holdings, which in turn owned various operating subsidiaries. But on September 1, Dynegy Holdings transferred its coal power facilities to Dynegy. Two months later Dynegy Holdings and related entities filed.
Upon motion by U.S. Bank N.A., an indenture trustee for noteholders in connection with two power plants, Danskammer and Roseton, the U.S. Bankruptcy Court, Southern District of New York, in January appointed Susheel Kirpalani as Chapter 11 Examiner for the bankruptcy cases of Dynegy Holdings LLC and affiliates.
Kirpalani, of the law firm Quinn Emanuel Urquhart & Sullivan, was asked to complete an independent study of contested pre-bankruptcy transactions. On Friday, March 9, he issued his 173 page report. He worded his conclusion bluntly thus:
The Examiner concludes that the conveyance of CoalCo to Dynegy Inc. was an actual fraudulent transfer and, assuming that Dynegy Holdings was insolvent on the date of the transfer (approximately two months before the bankruptcy filing), a constructive fraudulent transfer, and a breach of fiduciary duty by the board of directors of Dynegy Holdings.
Kirpalani objected in particular to the “purported ‘sale’ of CoalCo by Dynegy Holdings to Dynegy Inc. in exchange for a piece of paper that Dynegy actively avoided valuing.”
The air of television mini-series in all this is enhanced by the fact that the Kirpalani report, in the form available to the public, is heavily redacted. In a section of the report supposedly discussing the “retention of restructuring advisors,” for example, about the only sentence that is legible says simply, “[White & Case] and Lazard were ultimately selected.”
In legal terms, the situation was confused somewhat by virtue of the creation of an entity called DGI. Kirpalani described DGI as a “newly formed shell company … which was itself owned by Dynegy Holdings.” DGI had no creditors. Its creation complicated somewhat the question of whether the transfer of CoalCo can be avoided. But the Examiner’s Report argues that the corporate veil should be pierced: DGI ought to be recognized as the same entity for purposes of these proceedings as Dynegy Holdings.
“Even if there was some valid business justification for creating DGI, the use of DGI just weeks after its creation … to shield an acknowledged transfer of value away from creditors justifies finding that DGI is the alter ego of Dynegy Holdings.” The three most senior officers of Dynegy Inc. were members of the board of both DGI and Dynegy Holdings, and the Examiner indicates that when he spoke to these individuals they didn’t recall there being any distinction between those two. “Their uniform recollection was that Dynegy Holdings transferred CoalCo, which is what, in substance, occurred.”
Solvency and Reasonably Equivalent Value
Paul Silverstein, of the law firm Andrews Kurth LLP, represents the hedge fund CQS SO S1 Ltd., which is among the debtors. CQS bought out a position formerly held by Appaloosa.
Silverstein, reached by phone Monday, said that he didn’t think Kirpalani’s report was breaking any new ground here. Under the statutory test for “constructive fraudulent transfer” it is important to understand Kirpalani’s premise that Dynegy Holdings was already insolvent when it made this transfer, in return for what Silverstein characterized as a “useless scrap of paper.” Under section 548(a)(1)(B) of the Bankruptcy Code, the transfer of an interest in property is constructively fraudulent and thus avoidable if the debtor (Dynegy Holdings) was insolvent at the time of the transaction and received “less than a reasonably equivalent value” for the transfer.
The 2011 restructuring came about only after Dynegy Inc. had twice failed to arrange a merger. In August 2010 it entered into a merger agreement with an affiliate of Blackstone (Denali), but in November Dynegy shareholders voted to reject the Blackstone/Denali offer. Then in December, it reached an agreement with Icahn Enterprises. But that failed because an insufficient number of shares were tendered when the offer expired in 2011.
After that second merger effort failed, the equity value of Dynegy flat-lined, although the iShares Dow Jones US Utilities Sector enjoyed a surge beginning that March and continuing well into May. See the green and blue lines, respective, of the chart below.