Friday was a bad day for most of the directors of Dynegy. And shareholders were not celebrating either as the stock price was down by over a third to 76¢ by the end of the day. It is a big change from the tender offer by Carl Icahn of $5.50 per share in cash (over seven times Friday’s close) that shareholders turned down as too low just over a year ago.
The cause of Friday’s consternation was an examiner’s report in the Chapter 11 bankruptcy proceeding of Dynegy’s subsidiary, Dynegy Holdings. Dynegy started the bankruptcy case for Dynegy Holdings to restructure its debt. But in bankruptcy, a creditor can ask the court to appoint an independent investigator (referred to as an “examiner”), to look at suspicious transactions. In Dynegy’s case, the judge told the examiner to look at a series of complex reorganization transactions entered into starting last summer which appeared to benefit Dynegy’s stockholders but disadvantage the creditors of Dynegy Holdings.
On Friday, the examiner let Dynegy have it with both barrels. Dynegy said in a release that the boards of both its parent and holding companies “take the examiner’s findings seriously and intend to review the full report” to determine the effect on the holding company’s bankruptcy proceedings.
The examiner found that a portion of the pre-bankruptcy restructuring was a breach of fiduciary duty on the part of the boards of directors of the two principal corporations involved, including the publicly owned Dynegy. In the case of the directors of Dynegy Holdings, he characterized their actions as “willful misconduct.” And although the examiner does not get into the issue, in general the breach of the duty of loyalty which the directors are accused of can result in personal liability of directors.
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The examiner went further and found that it would not be “in the interest of creditors and public policy” if any of the non-executive directors of Dynegy were to be directors post-bankruptcy. The directors selected about a year ago by Carl Icahn and Seneca Capital, the largest equity holders of Dynegy, were among those tarred and feathered.
Finally, the examiner found that the critical transaction in which $1.25 billion of coal-powered generating plants were “sold” out from under the various creditors of Dynegy Holdings was a “fraudulent conveyance.” The Examiner did find that Dynegy told creditors exactly what it was doing so creditors were not defrauded as we commonly use the word. However, actual fraud is not required to prove a transaction is a fraudulent conveyance. Indeed because most fraudulent conveyances do not involve fraud, a better description would be voidable transaction.
The examiner found this transaction voidable for two reasons. According to the examiner, Dynegy intended to delay and hinder creditors, which by itself is enough to void a transaction. He also found that Dynegy used a complex security worth less –possibly far less –than the estimated 70% of the value of those coal plants. Because of the lack of equivalent value, this would also void a transaction assuming Dynegy Holdings was insolvent.
There are other issues referenced in the publicly available portions of the report, including whether Dynegy’s professional advisors had conflicts of interests by trying to represent both Dynegy and its subsidiaries.
In fairness, the examiner assumed, without independently investigating, that Dynegy Holdings was insolvent at the time of the challenged transactions. That assumption was critical to some (but not all) of his conclusions. While the Examiner believed that assumption was reasonable, he also said there was evidence that could be presented to show solvency.
However, any defense of claiming Dynegy Holdings was solvent could be severely undercut by the CEO of Dynegy. He told the examiner that he believed Dynegy Holdings was insolvent when he joined the company in June of 2011, before the transactions at issue.
The Examiner’s report was not critical of everyone or everything at Dynegy. He found no fault with the executives (as opposed to the non-executive directors) of Dynegy whom he obviously thought were working hard through a difficult situation. And he did not take issue with with some of the early steps of the pre-bankruptcy restructuring. He just attacked the parts where value was being moved from creditors of Dynegy Holdings to shareholders of Dynegy (where Icahn and Seneca hold their shares).
In my view, the Examiner has brought some clarity to the fight commenced 18 months ago between prior management of Dynegy, who very badly wanted to sell the company (for $4.50 to $5.50 per share in cash) and Icahn and Seneca, who thought the offered prices woefully inadequate. The former management believed the crushing debt burden at Dynegy Holdings could ultimately destroy the equity value of Dynegy. Icahn and Seneca, it now appears, believed that the limited covenant protections bondholders and other creditors had obtained could be used against the creditors to create higher equity values for shareholders. The Examiner’s report lends credence to former management’s position, much too late of course for shareholders who left $5.50 per share on the table at the beginning of last year.
Looking forward, the parties are free to litigate over the Examiner’s conclusions. That kind of litigation could pose some risk to the Dynegy directors, Icahn and Seneca however. Because of the examiner’s willful misconduct conclusions, Dynegy could be vulnerable to the unusual remedy of the appointment of a Chapter 11 trustee which would essentially take away all authority of the Dynegy board (and, as a corollary, Icahn and Seneca).
The examiner has already effectively recommended that the Bankruptcy Court take away Dynegy’s exclusive right to propose a reorganization plan. That means there could be competing plans proposed which would substantially dilute the Dynegy board’s (and Icahn’s and Seneca’s) control of any reorganization.
Still, bankruptcy is a land of shifting alliances and deal-making. And cash is king in bankruptcy because creditors are always anxious to get some cash. Icahn and Seneca each have access to cash to make a deal and buy back into a favorable equity position (and get their directors off the hook).
Thus, despite any alleged bad conduct by the Dynegy directors, Icahn and Seneca still have an opportunity to make a deal as long as they can get creditor support. But where would that leave public shareholders of Dynegy who repeatedly followed Icahn and Seneca into battle against prior management and turned down $5.50 per share in cash? Frequently, equity is totally wiped out in bankruptcy. Even if Icahn and Seneca use their cash to buy new equity on favorable terms, public shareholders may not have that opportunity or the cash to buy back in. And if that happens, those shareholders who followed Icahn and Seneca’s lead and rejected the cash buyouts from a year ago will be very unhappy campers.
