Advanced Distressed Debt Lesson: Election Forms and DIMEQ

A few weeks ago, contributing author Rodney McFadden introduced readers to the DIMEQ security (Dime Litigation Tracking Warrants).  He ended his post with this:

"The max upside in this case for DIMEQ that would result from being classified as a Class 12 GUC claimant or an equitable lienholder is about $3.00 per LTW (versus today ~ 65 cents) before post-petition interest if the full $337 million reserve goes to the LTW Holders. If the federal judgment rate is applied to that award for 3.5 years it moves the recovery up to about $3.20. On the downside, if DIMEQ is deemed to be Equity and if the Debtor prevails in applying the improper conversion rate then the worst scenario based on Plan value would put the DIMEQ security between $0.07 and $0.10."

As those following the case now know, Judge Walrath opined that the litigation tracking warrants were more equity like and the stock collapsed.  The risk factors posed by judges ruling against you (in one shape or the other) is ever present in bankruptcy and investors need to use caution when approaching situations with such binary outcomes.  For full disclosure, I purchased DIMEQ AFTER the decision was released.  I have since sold my position on the settlement which we will get to shortly.

Rodney McFadden is back tonight with another post: This one digging into the DIMEQ election form.  Buying and selling a security is only part of the equation as it relates distressed debt investing.  Many forms and agreements are needed to be filed to insure that a creditor (or in some cases, equity holders) receive what is owed to them.  Warning: This is a highly technical post.  With that said, I think you'll definitely learn a lot from it.  Enjoy!

Parsing the DIME Litigation Tracking Warrant (DIMEQ) Class 21 Election Form

Anyone who has followed the DIMEQ situation within the Washington Mutual Inc., (WMI) Bankruptcy for the last year and a half would probably be willing to concede that the Dime LTW’s are one of the most esoteric securities ever created. Indeed, many millions of dollars were spent by the LTW Plaintiffs and the WMI estate to determine what the Holders of these securities were entitled to. Ultimately the Court determined that these were equity securities that were entitled only to whatever treatment was afforded to other Common Equity Interest Holders. Following the Court’s ruling, there was a subsequent Settlement entered into, by and between the LTW Plaintiffs and WMI, which provided that the LTW Holders would be entitled to receive a $9 million General Unsecured Claim in Class 12 (less up to $3.2 million for the legal expenses of the LTW Plaintiffs); a $10 million “out of the money” Subordinated Claim in Class 18 and 8.77% of the 30% portion of Reorganized WMI going to all Common Equity Interest Holders.

The Settlement seems fairly straightforward, right? Well at first blush, perhaps, but a closer look reveals a much more complex situation which primarily results from the trifurcated treatment of the Class 21 LTWs under the Settlement. When looking at the treatment under the Plan, and the Capitalized terms and definitions therein, in combination with the respective Ballots for Class 12 Claims and the Class 22 Interests, a Class 21 Election Form cannot, (and perhaps more precisely) will not be drafted to provide for the fairest or simplest of treatment for the LTW Holders. Before we go forward, and in the interest of clarity, the Class 21 LTW Holders are not entitled to vote under the plan because, despite the settlement, they remain “disputed” thus they receive “Election Forms” not Ballots. A link to a non-executable version of the LTW Election Form is provided below. The version that is currently available, for viewing only, urges Holders to “PLEASE CONTACT YOUR NOMINEE TO RECEIVE A VALID ELECTION FORM” which has me wondering if they ever intend to distribute executable versions, absent an overt request. The LTWs have always been the red headed stepchild of this Bankruptcy Estate, so I guess there’s no point in stopping that now.

It is only fitting that a security as esoteric as DIMEQ would be difficult to parse, all the way to the bitter end, and the Election Form for Class 21 does not disappoint. In fact, it presents some interesting decisions for an LTW Holder. Understand that in order to even find out what the options are, it requires a bit of reading and cross referencing. In order to receive anything under the Plan, you apparently have to take action because as I read the Class 21 Election Form, it appears that if you do nothing, you get nothing. So, in order to find out what you get as an LTW Holder, you need to avail yourself of a copy of the Reorganization Plan and Disclosure Statement, paying close attention to the deadlines and Capitalized Terms therein, and read them in combination with the Class 21 Election Form. In light of a reading and cross referencing of these, I understand the following to be correct for LTW Holders:

• Provide the releases by February 29, 2012 and receive: 
• Pro Rata share of 8.77% of whatever percentage (if any) that Common Equity Interests get under the Plan. Common Equity Interests are currently slated to share 30% of Newco but this is subject to Court approval;
• Pro Rata share of ($9.0 million less approximately $3.2 million) on account of the allowed Class 12 Claim; and
• Pro Rata share of a Class 18 Subordinated Claim, up to $10 million, which is currently viewed to be out of the money.

• Provide the releases after February 29, 2012 and receive:
• None of the Newco Stock going to Common Equity Interest Holders (if any). My understanding is that there either cannot or will not be any Newco Stock escrowed for the Common Equity Interest Holders. 
• The recovery on account of the Class 12 Claim and Class 18 Claim if you turn in your paperwork within 12 months following the Effective Date.

So, given the above, exactly what are the risks, going forward, for an LTW Holder and what is the potential value of these LTWs?

According to the liquidation analysis within the Disclosure Statement accompanying the 7th Amended Plan of Reorganization for WMI, the value attributable to “Equity Interests” is approximately $145 million. This amount is comprised of the $70 million value of Reorganized Common Stock as valued under the Plan plus the $75 million cash “Release Consideration” paid over from the Senior Noteholders. At a $145 million Plan value for all Equity Interests collectively, the theoretical value in the hands of LTW Holders, assuming nothing changes, would be calculated as (0.0877*.30*145,000,000/113,000,000) which yields a value of $0.034 per LTW on account of the Newco portion of the LTW Settlement. The $9 million Class 12 GUC claim, less up to $3.2 million in fees paid to LTW counsel, would yield a value of $0.051 per LTW on account of the allowed General Unsecured Claim portion of the LTW Settlement. The total theoretical value for DIMEQ would seem to be $0.085 per each LTW based on Plan value. And realize that this is discounting entirely the Class 18 claim of $10 million for now because it is “out of the money”. It also assumes that an LTW Holder tenders the releases so as to be received by February 29, 2012 and that the Common Equity Interests actually receive a recovery under the Plan.

However, the discussion doesn’t end there because there apparently is some risk that the Court will apply the Absolute Priority Rule (APR) and rule that Common Equity Interest Holders (Class 22 – WAMUQ & PFG Claimants and Class 21 - DIMEQ) can’t be paid until the Preferred Holders in Class 19 are paid in full and that would present a $7.5 Billion hurdle based on Par value. The TPS Group, representing the Cayman REIT Preferred Holders, has been lobbying for the application of the APR, and they are not alone. Near the end of the hearing on Wednesday, January 11, 2012, the Judge even opined that the Debtors’ assumption that it could violate the APR was “Optimistic”, which signals that she is giving some consideration to instituting the APR. Absent that, the Court has the discretion, and the blessing of the Debtors and the Equity Committee, to adjust the proposed distribution of 30% of Newco to Common Equity Interest Holders. The institution of the APR or any downward adjustment of the Newco allocation by the Court would necessarily mean that the currently proposed recovery for all Common Equity Interests would be decreased if not entirely eviscerated. Accordingly, there is risk that the Newco portion of the recent LTW Settlement may have no value in the hands of the LTW Holders.

So it begs the question, if the APR is instituted, why would the Preferred classes receive all of the Newco when senior classes of subordinated claims in Class 18 are projected to receive no recovery under the plan? The answer there would seem to be that, since the Court bestowed upon the Equity Committee the opportunity to pursue “Colorable Claims” for the purported insider trading of certain Settlement Noteholders, the EC would obviously not agree to give up the opportunity to pursue those claims (via the current settlement embodied within the Plan) if none of their constituency would receive any benefit. So my guess is that if the Absolute Priority Rule is applied, and that is still a big if, it would only be imposed amongst the equity classes. It remains to be seen what will happen there but it bears noting that, according to the Ballot Instructions, votes for the Common Equity Interest Holders (except for DIMEQ) and the Preferred Holders in Class 19 would have to be submitted and received no later than February 9th for the votes to count and the Releases would have to be tendered by February 29th in order for the equity classes to be eligible to receive a recovery under the Plan. The big downside is that by the time that the Releases are provided, Equity Interest Holders won’t know what the final treatment will be.

The resultant problem here for LTW Holders is that they also have until February 29th to tender their securities and give the Releases. In reality, to be safe, one would need to turn in the paperwork a few days in advance of the deadline to be certain it is timely received. Once again, based on a reading of the Class 21 Election Form, it would appear that if the Releases and the LTW securities are not tendered by the deadline, one would not be eligible to receive any Newco but could apparently still get the recovery on account of the allowed Class 12 Claim and the recovery from the Class 18 Claim (if any) if the Releases are provided within 12 months after confirmation. However, it appears that you have to request a special form from the Liquidation Trustee in order to affirmatively provide the releases on a post-confirmation basis if you miss the Feb. 29th deadline. Since the Confirmation hearing is on February 29th you have to tender the LTWs and releases before you know whether the APR will be applied so you are just flying blind at that point and can do nothing about it. Accordingly, heading into the February 29th Confirmation Hearing, the only guaranteed recovery for LTW Holders would be the Allowed Class 12 Claim of $9 million, less up to $3.2 million in legal fees for LTW Plaintiff Counsel, shared amongst approximately 113 million LTWs.

One final item that LTW Holders should be aware of is that once the Election Forms are turned in, if the Holder makes the choice to provide the requisite Releases in order to accept the treatment under the Plan, the securities themselves will also be tendered. As such, the LTWs would no longer be tradeable and likely a contra cusip would be issued within the Holder’s account to freeze the securities.

Link to non-executable LTW Election Form:

http://www.kccllc.net/documents/0812229/0812229120116000000000001.pdf

The main case In re Washington Mutual, Inc., Case No. 08-12229 (MFW)

The Adversary case is: Nantahala Capital Partners, LP, et al. v. Washington Mutual Inc., et al., Adv. Proc. No. 10-50911 (MFW)