Tuesday, February 17, 2015

Highlights From Unsecured Creditors' Rule 2004 Motion in RadioShack Case

The Committee represents more than half-a-billion dollars of unpaid trade creditors, landlords, employees, and bondholders and understands that RadioShack’s largest shareholder and recent secured lender (same hedge fund) has now assumed the role of buyer of the Debtors’ best assets. The cost to the estates for that transaction is a blanket judicial pardon for whatever it and swap-betting hedge funds may have done when they acquired the secured debt, then caused RadioShack to immediately commence liquidating their collateral, and then caused RadioShack’s crash landing into bankruptcy to finish the job. Not so fast.

RadioShack’s revenues have steadily declined over the past the past 3 years, with the company reporting losses in each of the 11 quarters leading up to the bankruptcy filing and losing nearly 1 billion dollars since the fourth quarter of 2011. Despite predictable (and indeed, foreseen) losses, RadioShack decided in very late 2013 to borrow as much money as it could on a senior secured basis and attempt a turnaround.

Upon information and belief, during the summer of 2014, RadioShack’s crisis managers and professionals explored various options, at least one of which could have provided a value-maximizing transaction through bankruptcy. Shareholders would have been wiped out, but losses would have been stemmed, jobs would have been saved, and unsecured creditors would have had a recovery. Something happened on the way to that place, however. Instead of pursuing that or other options that may have been available, the two largest shareholders acquired the first-lien debt and dictated a different process altogether. These shareholders created a secured first-lien structure that would give them control over a process to garner returns in two perfectly hedged ways: If RadioShack continued on its expected trajectory, they would loan-to-own and capture the potential turnaround value following bankruptcy, and if things miraculously turned around quickly, they would exchange part of their debt for majority ownership through a massively dilutive stock transaction. To fund this strategy, armed with confidential information and the express, contractual power to influence the timing of any bankruptcy, the shareholders located hedge funds which sought to avoid substantial losses on credit default swaps they had written on RadioShack debt. These are the lenders who now demand releases by the Debtors’ estates.

In connection with the October 2014 Transaction, RadioShack incurred $31.8 million in financing fees as well as approximately $142 million in additional obligations, despite the fact that the company had suffered losses in the previous 11 quarters. Tellingly, any and all representations that RadioShack was solvent were stricken from the Credit Agreement pursuant to the First Amendment. These fees and obligations owing to the Participating Investors represented only the disclosed portion of the financial reward realized by many of these hedge funds.

Several of the Participating Investors, including BlueCrest Capital Management LLP, DW Investment Management LP, Mudrick Capital Management, and Saba Capital Management LP (and/or any funds managed by or affiliated with the foregoing), had reportedly sold CDS protection on RadioShack bonds, betting that the company would not default on its bonds—at least not before December 20, 2014. If the company did default before that date, the Participating Investors who had sold that CDS protection would have suffered massive losses.

The October 2014 Transaction however, enabled the Participating Investors to avoid such losses and keep the Debtors out of bankruptcy until after December 20, 2014. This way, the Participating Investors that had previously sold CDS on RadioShack bonds could pocket the upfront payments received from the purchasers of that protection and actually prevent their own losses by orchestrating when RadioShack would default.

An investigation is warranted to determine whether Standard General, LiteSpeed, and/or other Participating Investors (or their affiliates) wrote CDS contracts on RadioShack bonds such that they had a motive to enter into the October 2014 Transaction either to injure RadioShack or to prevent CDS losses while such entities were in possession of material nonpublic information (“MNPI”) and, taking all facts into account, in a position to influence the fate of RadioShack, including the timing of its bankruptcy filing. A Rule 2004 investigation is similarly warranted to determine if any of the Participating Investors were executing a “steepener” strategy, betting that RadioShack would not default in the short term (because they were ensuring that that would not happen through the October 2014 Transaction and the Transaction Committee’s consultation rights), but would likely default in early 2015. In this regard, a review of the agreements underlying the October 2014 Transaction reveals provisions that indicate that the Participating Investors may have been executing such a “steepener” strategy.

For example, while the October 2014 Transaction may have been specifically engineered to prevent a default in the fourth quarter of 2014, several new events of defaults imposed by the First Amendment would likely be triggered in the first quarter of 2015. If the goal of the October 2014 Transaction was to delay bankruptcy for four months, the benefits that RadioShack and its other stakeholders received for such transaction must be investigated and assessed.

In addition to seeking information from the Participating Investors themselves, the Committee also requests information from Depository Trust & Clearing Corporation (“DTCC”) and Markit Group Holdings Ltd. and Markit Group Ltd. (together, “Markit”) relating to CDS activity on RadioShack debt from November 1, 2013 through the Petition Date. That information is not available from other sources due to the private nature of the CDS market.

The Committee is prepared to enter into appropriate protective orders with DTCC and Markit, as its undersigned proposed counsel has done in other actions involving the CDS industry.

If Standard General, LiteSpeed, or any other Participating Investor was an insider (even a temporary insider), liability may potentially be imposed to the extent they were in the possession of MNPI about the company and they used that information to make trades (including the avoidance of CDS losses), motivated in whole or in part by the substance of that information.

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