A bankruptcy judge Tuesday rejected Washington Mutual Inc.'s Chapter 11 plan for a second time, finding the company was too generous with senior creditors.
Judge Mary Walrath refused to confirm Washington Mutual's Chapter 11 plan in part because it awarded interest at the contract rate to holders of senior debt. The lower federal judgment rate of interest should apply, the judge said, a finding that potentially frees up hundreds of millions of dollars of value in the case.
The judge also said shareholders had sketched out a "colorable" case of insider trading against Appaloosa Management LP, Centerbridge Partners LP, Owl Creek Asset Management LP and Aurelius Capital Management LP. Known as the "settlement noteholders," the four invested in Washington Mutual's debt, buying and selling while they were involved in ongoing Chapter 11 plan negotiations. All deny running afoul of laws against profiting from material, nonpublic knowledge.
Centerbridge, Owl Creek and Aurelius didn't respond to invitations to comment.
"The lengthy confirmation record makes clear that there are no legitimate claims of insider trading against Appaloosa, 'colorable' or otherwise," Appaloosa said in a statement released through its attorneys.
"At no point did Appaloosa engage in improper conduct during these cases, and in fact, as the bankruptcy judge noted, the efforts of Appaloosa and the other settlement noteholders helped increase the value of the Debtors' estates," the hedge fund said.
Tuesday's ruling signals that Appaloosa, Centerbridge, Owl Creek and Aurelius could have to face trial against shareholders and risk losing the profits on their $2.5 billion of debt holdings. Walrath found that shareholders had turned up enough proof to move ahead with a case that "the settlement noteholders knowingly traded with knowledge that the debtors were engaged in global settlement negotiations...of which the trading public was unaware."
Washington Mutual's Chapter 11 plan is the result of lengthy negotiations with J.P. Morgan Chase & Co., which bought Washington Mutual Bank after it was seized by regulators, and with the Federal Deposit Insurance Corp., which brokered the deal. The central pact at the heart of the plan was not rejected Tuesday.
In a prepared statement, Washington Mutual said it was "pleased" that the court chose not to upset the settlement, which survived an attack the first time the company attempted to win confirmation of its Chapter 11 plan. Washington Mutual will renew its effort to end the bankruptcy case that began nearly three years ago as quickly as possible, the company said.
In a decision filed with the U.S. Bankruptcy Court in Wilmington, Del., Walrath said she was concerned that more delay in the case would erode the value going to creditors of the company, the former parent of Washington Mutual Bank, or WaMu.
Earlier this year, Walrath kicked back the plan due to a number of defects, many of which have since been remedied. Hedge funds that invested in the debt have been grumbling about the wait for their money in a big bankruptcy case where interest to senior creditors and legal fees were eating an estimated $30 million or more in value out of the recovery going to junior creditors.
That estimate will come down now that the judge has knocked down the interest due on Washington Mutual's senior debt. In a note to clients, CRT Capital Group analyst Kevin Starke said the decision on the interest rate added risk to certain levels of debt in Washington Mutual's complex capital structure. While senior noteholders might not get their contract rate directly from Washington Mutual, they will likely be able to claim it from lower-ranking creditors due to terms of the debt agreement, Starke wrote.
Many investors, including all four of the challenged hedge funds, own debt in several classes, court records say.
Walrath directed Washington Mutual and shareholders that once again succeeded in blocking the plan to go to mediation to resolve issues that are blocking confirmation.
Analyst Starke said he was "skeptical" settlement talks would resolve the stumbling blocks.
WaMu was seized by regulators in September 2008, sending its parent racing for bankruptcy with billions of dollars in debts to pay, angry shareholders and only scraps of its operating business left.
A settlement over the loss of WaMu struck in bankruptcy court provided about $7 billion in cash for the parent company creditors. The cash can't be paid out, however, until a plan is confirmed.
