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It started with a seismic event. The Kobe earthquake of January 1995 sent the Japanese stock market tumbling just when Nick Leeson, a 28-year-old trader at Barings plc, bet that it would climb. For two years Leeson had made secret, unhedged derivatives trades with company money. The cataclysm sent Barings’ losses soaring beyond a billion dollars. It spelled the end of Leeson’s game and, within weeks, the end of the venerable London bank that once financed the Louisiana Purchase. But for bondholders in European restructurings, and for their lawyers, like Andrew Wilkinson, now of Cadwalader, Wickersham & Taft, the bank’s implosion was only a beginning. With a multimillion-dollar claim against one of the bank’s auditors still in trial at press time, the Barings mess has yet to be fully resolved. But whatever the outcome of this individual chapter, Barings will be remembered, among other things, as the case that introduced Europe’s debtors to America’s bondholders — especially the distressed debt traders, or “vulture funds,” which are notorious for their aggressive tactics. Even as the Barings case plods on, distressed debt funds have reshaped both the law and the business of law in Europe and its financial capital, London. Most recently, the vultures have confirmed their power by shaping the restructuring, slated to take effect in January, of another fallen pillar of the British economy — Marconi plc, the British defense giant that unraveled after shifting course and investing heavily in the telecom sector. “For better or for worse,” says David Frauman of Allen & Overy, “U.S. bondholders have brought the U.S. restructuring model with them.” Critics say that the “vultures” have replaced civility with rapacity. But distressed debt investors like Elliot Konopko, a principal of New York’s Halcyon/Alan B. Slifka Management Company, see their defining trait as professionalism; they believe they are cleansing a musty corner of the finance world that generally favors liquidators and their lawyers at the expense of creditors. In the old days, European insolvency was simple. Virtually all the creditors were banks that issued commercial loans. A troubled company’s fate would be resolved consensually by a small, clubby group of bankruptcy professionals and establishment bankers. If by chance one of the creditors didn’t agree to the plan, an official from the Bank of England, who incidentally oversaw the private banks, would bring the good chap around by having a sit-down talk, with an implicit threat of revoking his bank’s license. This was known as the “London approach.” But over the past five years, European companies have discovered high-yield debt — and its downside. European firms defaulted on 24 billion euros of junk debt in the first five months of 2002, according to Moody’s Investors Service Inc. That’s more than in the previous 17 years combined — and it represents a higher rate of default than in the United States. As a result, the banks that issue commercial loans are no longer the only creditors sitting around the table in London. In contrast to banks, a typical bond investor is not beholden to the Bank of England, and thus is free to be obstreperous. What’s more, bondholders are apt to sell their stakes to vulture funds, which are constitutionally obstreperous. Creditors who bought their stakes at par value just want insolvencies to go away with a minimum of pain. But vulture funds are in the business of buying discounted securities from anxious sellers and working to increase their value. They do not hesitate to use litigation, delay, and hardball negotiations to pursue their investors’ interests. A gentleman’s game has now become more like a barroom brawl. In its initial phases, the Barings case illustrated the clubbiness of the old London insolvency world. Barings appointed Ernst & Young as its liquidator. E&Y, in turn, retained Slaughter and May as its counsel. Slaughter, as Cadwalader’s Wilkinson notes, also just happened to be the longtime counsel to Barings. E&Y quickly sold the ongoing banking business to the Dutch giant ING Groep, N.V., for $1 in a white knight deal, which saved the business and jobs. E&Y’s next task as liquidator was to maximize Barings’ assets and allocate them among the bondholders. Aside from some leftover cash, Barings’ main asset was the potential windfall from a lawsuit against its auditors, for failing to catch the Leeson fraud. These assets were to be divided among three bondholder groups, each owed roughly $150 million: a senior group, an intermediate group and a junior group. The senior group was intent on a full recovery of their debt, and the junior group knew that its recovery would be fragmentary. The fate of the intermediate group was most uncertain. Arguably, its interest was to pursue litigation aggressively, both to clarify its priority over the juniors, and to maximize the divisible assets. Ernst & Young did file suit against the auditors in January and February 1996. Vigorously pursuing that litigation would have been a natural strategy at this stage. But that’s rarely the “London approach.” So E&Y put the lawsuits on ice and pushed hard for a settlement. It referred the negotiations among the bondholders and auditors to the City Disputes Panel, an ad hoc civic group that aimed to head off divisive litigation in the London financial district. Led by a retired justice from the House of Lords, the panel was perceived by Wilkinson, at the time a Clifford Chance partner who was hired to represent the senior bondholders, as the ultimate representative of the fusty old order. In the spring of 1997, the City Disputes Panel summoned Wilkinson to a meeting. As Wilkinson recalls it, a superannuated judge in a tattered clubhouse golf sweater lectured him on why his clients, the senior bondholders, should help the deal reach a smooth closure and give up more than 20 percent of a claim that was, in Wilkinson’s view, unassailable. “It was like being called in by an elderly headmaster to get a right talking-to,” he says. Wilkinson refused to sell out his clients, and, after a few more months of negotiations overseen by the disputes panel, the senior bondholders were cashed out at full value. That left the intermediate and junior bondholders on their own. What followed next opened the door for the vultures to enter. The City Disputes Panel continued to hammer out a settlement plan, which was finally released in June 1998. It called for Barings’ auditors to contribute a mere $50 million. At the same time, it recommended a generous payout to the junior bondholders of 25 cents on the dollar. That would leave enough money only for a 60-cent payout to the intermediates. Yet even two barristers hired by E&Y estimated that a fair settlement would require the auditors to pay at least $150 million. E&Y itself did not formally endorse the proposal. Some intermediate bondholders were apoplectic. In their view, the report grossly overestimated the strength of the junior bondholders’ claim, and grossly underestimated the potential recovery from the auditors. They were outraged, too, that E&Y and Slaughter had charged Barings $36 million in fees for their role in crafting a deal that they would not stand behind. E&Y also — in a touch that some thought emblematic of its extravagance — approved the costly printing of the report on expensive glossy paper. “It’s rare that you see a proposal so unlikely to succeed,” says Wilkinson. “They might as well have printed on the cover, ‘Distressed debt: Buy now!’ “ In fact, American debt traders were quick to notice the unrealized value of Barings’ claims against its auditors. In the six months after publication of the glossy report, most of the intermediate bonds were snatched up at discount prices by American funds like Halcyon, Elliott Associates, Davidson & Kempner and Franklin Mutual Advisers. Together, they hired Wilkinson, who by now had moved to Cadwalader and wrapped up his representation of the senior bondholders. Wilkinson and his clients proceeded to shock the City of London on a number of fronts. First, they voted down the City Disputes Panel settlement and pursued the lawsuits against Barings’ auditors, Coopers & Lybrand and Deloitte & Touche, for negligence. Then they pressured Ernst & Young and its counsel, Slaughter, to eliminate their fee premiums and discount their fees by 17 percent. Finally, they pressured Ernst & Young to resign as liquidator. This was hardly insolvency business as usual — and neither were the results. Wilkinson succeeded in vastly increasing the total payout to creditors, as well as maximizing his clients’ share relative to the junior bondholders. The vultures won their first victory at the end of 2001, when one of the auditors settled. Coopers (now part of PricewaterhouseCoopers) paid more than $105 million in the settlement — a figure about double what the City Disputes Panel envisioned as a payout from both auditors. With the money from the Coopers settlement, the distressed debt funds have been able to comfortably fund their continuing litigation against the second Barings auditor, Deloitte & Touche. In the trial that’s been under way since autumn, KPMG, the new liquidator of the Barings estate (not-so-secretly backed by the vultures), blames the Leeson fraud on Deloitte’s negligence. It is claiming more than $300 million in damages. Barring settlement, the trial’s closing arguments should be heard in the first quarter of 2003. Deloitte has cast the vulture funds as villains and asserted that they’re “conducting investment activities disguised as a lawsuit.” Wilkinson dismisses those who moralize about vultures as being “mired in a nineteenth-century view of the business. Distressed debt is no different from any other trading activity,” he says. A more balanced view, shared by many observers, is offered by John Houghton, a partner in the London office of Latham & Watkins, who was not personally involved in the case. “The bondholders were very, very aggressive,” he says. “Throwing out a liquidator is practically unheard of, certainly in a case that high-profile. But their actions were vindicated by the results.” The distressed debt traders, of course, draw a far different lesson from Barings than do their critics — and they level some serious charges against the liquidator, E&Y, and its counsel, Slaughter and May. “Insolvency appears to be the City of London’s last unreformed practice area,” says Elliot Konopko of Halcyon, who played a leading role on the distressed bond committee. “In general, the insolvency professionals have little practical incentive to maximize returns to creditors and control costs unless they are supervised by activist creditors committees. Moreover, in Barings the liquidators and their lawyers seemed oblivious to conflicts that in the United States would likely have disqualified them, and might even have led to disciplinary proceedings. These conflicts likely cost the creditors money.” As Konopko sees it, E&Y and Slaughter wasted more than three years pursuing an obviously doomed settlement — and tried to charge $36 million in premium fees for a proposal they didn’t even endorse. Konopko chalks this up to bad business judgment and inattention to costs — as well as to the liquidator’s failure to resolve a crucial dispute between the intermediate and junior bondholders. Konopko thinks E&Y could have achieved a better and quicker settlement if it had tested in court the priority of the different bondholders. The liquidator declined to do so, relying partly, he believes, on the advice of Slaughter. But that advice was arguably tainted, because, as Barings’ corporate counsel, Slaughter had drafted documents for the junior bondholders, among others. Thus, disputes over the priority of the different bondholders were tied to the interpretation of Slaughter’s own documents. Slaughter partner George Seligman, who was one of the lead counsel to the first liquidator, E&Y, says that Slaughter sought an opinion from an independent barrister as soon as Konopko suggested the firm was caught in a conflict. That opinion, says Seligman, confirmed that the firm had complied fully with British law. The American disciplinary code, he adds, is irrelevant. The lead liquidator on E&Y’s team, Alan Bloom, insists that firms like E&Y and Slaughter are scrupulous about avoiding conflicts. He defends his overall record by pointing to the achievement of the white knight sale to ING. And while the vultures may deride the City Disputes Panel process, Bloom stresses that they weren’t yet on the scene. “Everything we did was tested with the lead counsel, the judge and the creditors,” he says. “We were 99 percent through the process, and the creditors at that time were prepared to do the deal.” At least one lawyer involved on the creditor side shares this view. Lyndon Norley, who worked on Barings with Wilkinson at both Clifford Chance and Cadwalader — and has since moved to Kirkland & Ellis — says that the City Disputes Panel process pursued by E&Y and Slaughter was not doomed: “It was a deal that was very close to approval until the distressed traders came in the summer of 1998, and took a completely new commercial view. If the deal had closed, everyone would have said it was a great success. Hindsight is a wonderful thing.” Slaughter’s Seligman defends both the fees and the strategy of his firm, as well as his client, E&Y. The fees struck the American vultures as high, he says, only because they became involved late in the game and did not understand the complexity of the English process. E&Y pursued a strategy of conciliation rather than litigation because, Seligman says, an English liquidator’s duty is to safeguard the interests of all creditors. In the end, Seligman says, it came down to a culture clash between the American bondholders, who focus on the bottom line, and the English insolvency professionals, who value consensus. “People in England are not as likely to be obsessed with maximizing profit,” he says. Not yet anyway. Love them or hate them, the vultures are in England — and Europe — to stay. And the latest major European restructuring, Marconi, strikingly illustrates the bondholder’s role in the new order. Like most restructuring tales, the story of Marconi begins with an epic business blunder. Four years ago, Marconi was called the General Electric Co., or GEC Ltd. (no relation to America’s General Electric). The company was a mainstay of Britain’s defense sector, the proud maker of howitzer missiles and Trident submarines. Then management sold the bulk of its assets to British Aerospace for $12.7 billion, changed the name, and began to buy telecom companies at inflated prices with borrowed money. By late 2001 the business was in desperate trouble: Marconi was laden with $6 billion in debt, of which more than $2.5 billion was in bonds. Marconi is what’s known in the bankruptcy trade as a “fallen angel” — it had so recently been a creditworthy company that its bank loans had been secured on unusually easy terms. As a result, the bond funds had exactly the same entitlement to be repaid as the banks did. In bankruptcy lingo, the two classes of debt were parri passu. The Marconi bondholders included both vulture funds and original investors in investment-grade bonds. They formed a committee and hired London partners Barry Russell and James Roome, of the law firm now known as Bingham McCutchen. Meanwhile, the bank consortium hired Nicholas Frome of Clifford Chance, and Marconi tapped David Morley and David Frauman of Allen & Overy. From October 2001 to March 2002, Marconi and the banks negotiated a deal to extend the company’s bank loans, in the hope of avoiding restructuring. Throughout that time, Bingham partners Roome and Russell begged Marconi to give them a seat at the table. Their clients, the bondholders, argued that a bank loan extension would only delay the inevitable restructuring while the company’s market position eroded. Roome and Russell’s clients feared that any new loan extension might give the banks priority over the bondholders and preferential access to the company’s $1.8 billion cash pile. Against the backdrop of Barings, the bondholders vowed to sue, if necessary, to block such a deal as failing to safeguard the interests of all creditors. “I suspect Barings affected the way the Marconi bondholders were perceived by the banks and the company,” says Roome, once a close colleague of Wilkinson’s. “It made them more nervous of the way we might react. It gave our threats credibility.” Maybe so. On March 21, the night before the loan extension was to close, the company backed out and agreed to a restructuring. “Marconi shows the rise to power of the American bondholder,” Roome says with satisfaction. “We were able to avoid a little City stitch-up that would give the banks preferential treatment in exchange for a pointless extension.” But Marconi’s lawyers see it differently. “I don’t believe that Barings played any role in any decision made by Marconi,” says Allen & Overy’s Frauman. “The loan extension didn’t get done because the company’s operating results deteriorated dramatically — not because of threats from the bondholders.” For whatever reason, Bingham’s clients were finally invited to the table, and the negotiations started over from scratch. Five months later, Marconi was again on the verge of a closing — this time of a restructuring plan. On the night of Aug. 27, the lawyers got no sleep. On the evening of Aug. 28, Russell found himself at a conference table in the basement of Clifford Chance, unshaven, greasy-haired, his tie loosened and his shirt, to put it charitably, wrinkled. At about 8 p.m., after finalizing the terms of the deal, one of the bankers rose, put on his coat, and picked up his attach� case. As Russell recalls the scene (none of the other participants would agree to comment), the banker turned toward Russell as he exited the room and said bitterly: “Your bonds are made to be subordinated. You shouldn’t be parri passu.” The memory makes Russell livid. “I was appalled,” he says. “He just didn’t like bondholders getting a good deal. There was no intellectual underpinning. It was just, ‘We are banks.’” Since Barings, Europe’s bankers and insolvency professionals have learned to share power. But, as Marconi shows, they haven’t yet learned to like it.

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