As the economy continues to emerge from the global recession in the late 2000s, one of the prevailing trends we have seen is the continuation of challenges to distressed investors that have employed a “loan-to-own” strategy. Boiled to its basics, the loan to own strategy is a method of investing by a distressed investor — frequently a private equity or hedge fund — that acquires the secured debt of a borrower at a discount (often deep) with the hope of either being paid at par or using the par value of the secured debt to acquire the company.
There are significant risks to investors embarking on this strategy, including litigation risks, liquidation risks (i.e., the target company fails) and the risk that others perceive value in the company that exceeds the investor’s value proposition. On the litigation side, holders of distressed debt acquired in the open market are increasingly becoming the target of litigation that asserts a variety of theories, including fraudulent transfer/preference claims, recharacterization of debt to equity, equitable subordination and breach of fiduciary duty.
Most recently, in the bankruptcy case of The Dolan Company pending in Delaware, the equity committee objected to the secured claims held by Bayside Capital. The Dolan Company provides business information and professional services to legal, financial and real estate sectors. Interestingly, The Dolan Company invested heavily in the “back office” business of assisting law firms in prosecuting residential mortgage foreclosures and court appeals.
In the objection filed by the equity committee, they complain about the “excessive fees,” “reduced availability,” “management control” and “lender coercion” allegedly imposed by Bayside Capital. While none of these allegations break new ground in the challenges to a loan to own lender, they serve as another reminder that a lender embarking on such a strategy must do so with eyes wide open and determination to “fight the fight” as they should expect one to be brought to them.