Somewhere in the third year of Tribune Co.'s marathon Chapter 11 proceeding, U.S. Bankruptcy Judge Kevin Carey looked out at a Delaware courtroom packed with high-priced attorneys and conceded the case had broken down into what he called a "multiconstituent melee."
"The parties are represented by some of the best lawyers in the field," he said. "You know how to fight well ... but nobody ends up the better for it, really."
Carey was trying to make a point about the foundation of bankruptcy law, which recognizes that a company and its creditors are better off hammering out a settlement than fighting endless court battles.
But his exasperation reflected a difficult new reality. Aggressive investment funds and their lawyers, who earn as much as $1,000 an hour, can turn big corporate bankruptcies into gang wars fought in pinstripes -- with companies, their employees and business partners feeling powerless over the outcome.
In the same way that Chicago billionaire Sam Zell's disastrous leveraged buyout of Tribune Co. in 2007 drew back the curtain on an era of amped-up Wall Street deal-making, the Chicago-based media company's lengthy journey through Chapter 11 exposed a powerful but little-known industry thriving in the midst of the American bankruptcy court system.
It's a business built on the bewildering complexity of the global markets, and it attracts some of the brightest minds in law and finance.
They are members of a clubby group of specialist investors who buy up a troubled company's "distressed debt" and other securities for pennies on the dollar. Then they match wits at the negotiating table or in court to see who can walk away with the biggest pieces of bankrupt companies' value.
These players serve an important function. Their willingness to buy up claims provides a ready exit for creditors who are unable or unwilling to fight for their rights in bankruptcy court. But their participation can come at a staggering cost. For Tribune Co., Chapter 11 broke into a free-for-all that lasted four years, leaving the company hindered at a crucial moment in the transformation of the media industry.
Even before Tribune Co. filed for Chapter 11 protection, its fate was largely in the hands of a group of banks led by JPMorgan Chase & Co. and two investment funds with a combined $106 billion in assets -- Oaktree Capital Management and Angelo Gordon & Co. Their conflict with other funds, including Centerbridge Partners and Aurelius Capital Management, turned what might have been a basic restructuring effort into a war of attrition.
The difference between the funds and the banks is that the distressed-debt specialists chose to buy into the company's debt specifically to turn a profit, not recover losses. And many succeeded brilliantly, most notably Oaktree and Angelo Gordon, which emerged from the fray in control of a much healthier company with an array of iconic media assets, including the Chicago Tribune and the Los Angeles Times.
The Tribune Co. case raises many questions about the impact of investment funds on the bankruptcy process. Many scholars say the system is still the best way to protect creditors' rights, noting that the complexity of the Zell deal and its timing on the cusp of the economic crisis created a legal morass that was hardly typical. Some participants in the case questioned the effectiveness of Carey, arguing his seeming indecisiveness and insistence on a broad consensual settlement dragged out the case needlessly.
But for those trapped in the Tribune Co. saga against their will, arguments about creditors' rights and legal process seem more like a smoke screen to justify how Wall Street interests are allowed to profit with little or no concern for the health of a company or its employees.
For Tribune Co., its employees and many of its smaller creditors, bankruptcy became a debilitating period of missed opportunities and stalled strategy. The cost to Tribune Co. in legal and professional fees alone will likely run to more than $500 million.
Astoundingly, as many as 35,000 unwitting former Tribune Co. shareholders are now the target of pending creditor litigation that could potentially force them to give back money they received more than five years ago. Most can't fathom how the simple act of buying and selling stock in a major U.S. company could someday land them in front of a judge.
"What seems grossly unfair," Colorado investor Mark Lies wrote to Carey in 2011, "is there doesn't appear to be any adult supervision looking out for the average investor like myself. ... (Y)ou have unemotional, ruthlessly efficient and litigious investors attempting to extract whatever they can from whomever they can."
Carey sounded his own concerns in an opinion at a pivotal moment in the case.
"There is no moral to this story," the judge wrote, citing the fable of the Scorpion and the Fox, a tale of mutually assured destruction. "Its meaning lies in the exposition of an inescapable facet of human character: the willingness to visit harm upon others, even at one's own peril."
Corporate bankruptcy was never supposed to be easy, but it didn't become blood sport until specialized Wall Street investment firms got involved.
For decades, Chapter 11 protection was used by struggling companies and their managers to negotiate with lenders and anyone else owed money. The goal was to restructure the debt, with the guiding principle of preserving the company's long-term prosperity. Ownership often changed, but the idea was to maximize recovery for all.
Companies were capitalized with relatively straightforward financial instruments -- stocks, bonds and bank loans. Executives tended to know who their major creditors were and what motivated them, so consensus was usually within reach.
But in the high-octane global financial system that produced the complex Tribune Co. buyout, the sense of an enduring partnership between a company and its creditors has become an anachronism.
Balance sheets these days are like 3-D chessboards built on multiple classes of debt and other securities. Lenders like JPMorgan Chase or Citigroup dilute their interest in the company almost immediately by making loans, then selling them in pieces to other investors, who, in turn, slice and dice them again to create new derivative securities that eventually find their own markets.
When a company runs into trouble, these widely fragmented claims begin to churn. Worried investors sell, driving down the price of a company's securities. Soon the deflation attracts distressed-debt investors with a specialized understanding of how to profitably play the bankruptcy game.
This leads to what Jonathan Lipson of the Temple University law school calls a "shadow bankruptcy system," a largely unregulated marketplace where private funds trade claims behind closed doors, building positions they hedge with derivatives and other financial instruments.
During a case, investors move in and out to maximize their profits or augment their clout. Amid this gamesmanship, there may be few shared objectives among the investors, making it impossible to assume that everybody agrees that the goal is to create a healthy, restructured company.
"If somebody figures they can get more recovery in a courtroom than in a conference room, then that means complex litigation at a high cost," said Jack Butler, a leading bankruptcy attorney at Skadden, Arps, Slate, Meagher & Flom in Chicago. "Once you're in that kind of spiral, it's very difficult to turn it around."
Precisely because of the potential for courtroom chaos, most big insolvent companies try to avoid it altogether. Instead, they negotiate a restructuring plan before they file for Chapter 11, a solution known as a prepackaged bankruptcy. Prepacks let even massive companies enter and exit bankruptcy in a matter of weeks, as General Motors Co. did in 2009.
But for Tribune Co., the fast track through bankruptcy was not really an option. The company's creditors were too scattered and its situation too complicated to forge a quick deal. Instead it chose what is ruefully called a "free-fall bankruptcy."
Tribune Co. and its advisers -- led by the company's general counsel, a former Zell attorney named Don Liebentritt -- were officially in control of the restructuring process. But within months, their hopes of brokering a quick settlement stalled amid the forces arrayed against compromise.
By the time Tribune Co. filed for bankruptcy in 2008, Oaktree and Angelo Gordon already had begun laying their bets. Independently they had amassed large chunks of the $8.7 billion in "senior" debt used to fund the Zell buyout, making them Tribune Co.'s most powerful creditors alongside JPMorgan and the three other banks that made the original buyout loans.
The buyout debt was "senior" because it had been given special guarantees of payback in case of a bankruptcy. And because their claim was more than $1 billion above the estimated total value of the bankrupt company itself, the holders of this debt would likely end up owning Tribune Co. once it was reorganized in bankruptcy court. For Oaktree and Angelo, that would amount to a bargain-priced backdoor takeover.
What they didn't expect was a militant response from several other investors who had trained their sights on $1.28 billion of Tribune Co. bonds that the company had issued long before the buyout.
Those bonds had been rendered "junior" to the buyout debt by the Zell deal and were trading for just a few cents on the dollar, reflecting their slim chances of recovery. But to some Wall Street specialists, including Jeffrey Aronson, co-founder of a distressed-debt firm called Centerbridge Partners, they represented a ripe opportunity, sources said.
Although the banks, Liebentritt and an official committee representing creditors at first assumed these junior bondholders would be happy with a relatively small payment pegged to market prices, Aronson argued that they were all ignoring a key fact: The company had collapsed less than a year after the buyout closed.
From where Aronson sat, the botched Zell deal was a classic case of "fraudulent conveyance," a legal concept meaning the deal left the company insolvent from the start by swamping it with $13 billion in debt (including obligations already on Tribune Co.'s books). If Centerbridge and others could convince the court that a fraudulent conveyance had taken place, a judge might invalidate the senior claims, leading to a big payout for the juniors, said attorney David Rosner of Kasowitz Benson Torres and Friedman, who represents the trustee for those bonds.
That was a long shot; fraudulent conveyance was never easy to prove. But after researching the claims, Centerbridge bought $400 million of the junior bonds at a deep discount, reasoning that the case was strong enough to force Oaktree and the others to hand over a profitable settlement. Another fund called Aurelius Capital Management also saw the opportunity and bought a smaller stake in the junior bonds.
Tribune Co. and its advisers still believed a settlement was within reach, even if the senior creditors had to pay more. But they quickly learned that the Zell deal defied easy answers.
Though the transaction was by definition a failure open to challenge, the circumstances were unique: It closed in two steps, six months apart, a period straddling a historic collapse in the financial markets. It presented so many complex, untested legal issues that assigning blame was hardly clear-cut.
Early on, Kenneth Liang, the Oaktree executive in charge of the Tribune Co. investment, told Liebentritt that he had no intention of handing over a fat settlement to the junior bondholders, Liebentritt said. Based on its own research, Oaktree felt the fraudulent conveyance claims were baseless and preferred to file a plan that would give a token amount to the junior bondholders to settle claims against the banks and let the juniors litigate the rest.
Oaktree declined to comment, but documents show that Oaktree was loath to set a bad precedent for other cases by caving in to the junior bondholders. Liang and his bosses knew that the same players in bankruptcy court moved from case to case like a traveling roadshow. Raising expectations for the next negotiation and the one after that could encourage settlements that might erode Oaktree's returns.
As Oaktree Chairman Howard Marks put it later in an email to his partner, Bruce Karsh: "We need to show others that they can't come in, buy juniors where we're senior and get rich."
For Centerbridge, which declined to comment, and the other junior creditors, the seniors' stance only meant they had to fight harder to "educate" the judge and the other parties as to the strength of their case, Rosner said. Documents show they were demanding as much as $1 billion for their claims versus an offer from the seniors of closer to $75 million.
To build leverage, the junior creditors filed motion after tactical motion in bankruptcy court, aimed at showing Judge Carey how the senior creditors had co-opted everyone else in the case in an attempt to "cram-down" a plan the junior bondholders found unacceptable. Behind the scenes, Centerbridge waged a quieter campaign to win over Tribune Co. and push the official creditors committee to endorse a settlement based on the claims.
Much to the annoyance of Liang and the other senior debt holders, Liebentritt and his advisers responded to the Centerbridge incursion by continuing to push for a full settlement of the claims that would avoid costly litigation against anyone. Liebentritt said he believed this would be the cleanest solution for the company. But because that plan would include legal releases for Zell and company executives, fighting for it exposed Liebentritt to charges from all sides that he was trying to protect Zell, his longtime former boss.
In an interview, Liebentritt said, "I made no secret of my ties to Sam and acknowledged the criticism. But I truly believed (avoiding any litigation with a settlement) was the right thing for the company and all the other constituents."
In April 2010, after the growing acrimony dragged the case into its second year, Liebentritt almost got his wish.
He and Tribune Co.'s chief negotiators, investment banker David Kurtz of Lazard Ltd. and lawyer James Conlan of Sidley Austin, came close to brokering a compromise. But its ultimate failure only underlined how little power Tribune Co. really had to determine the outcome of its own Chapter 11 case.
Oaktree's Liang had backed away from the talks with management in early 2010, and lead bank JPMorgan seemed in no mood to budge. But as Kurtz and Conlan shuttled between camps trying to soften up both sides, they began to sense that Centerbridge and Angelo Gordon might be willing to deal, Kurtz said.
Before Aronson launched Centerbridge in 2005, he had run the distressed-debt business at Angelo Gordon and was still on good terms with Tom Fuller, who had taken over the job when Aronson left. The Tribune Co. team encouraged them to speak directly, rather than through more junior executives. And though Kurtz said neither would make the first call, afraid to lose face if the other balked, Aronson finally made a move.
One morning in March as Kurtz was at the doctor preparing for a routine procedure, Aronson called. "I will call Fuller if you call him first and make sure he is willing to deal," Kurtz recalls him saying. "If I call and he isn't, this is over."
As the nurse was trying to sedate him, Kurtz was still on his cellphone with Fuller, getting the assurances Aronson wanted. Kurtz said he reached Aronson shortly before the procedure began, then passed out. When he woke up, Aronson and Fuller had cut a deal giving the Centerbridge group a little more than $450 million, or 7.5 percent of the debtor's value.
JPMorgan balked at the price but eventually signed on to a slightly lower offer. The reason: Centerbridge agreed to release the banks as well as Zell and Tribune Co.'s leadership from any liability.
Oaktree, however, responded angrily. Emails show that Liang chastised Fuller at Angelo Gordon for breaking ranks. He then fired off his own set of motions, decrying the deal as "dead on arrival" because it forced Oaktree and other senior creditors who had little liability to fund the releases for others who were exposed. That included Zell, who was getting his release for free.
This skirmish threatened to bust up the alliance at the heart of the senior lender group. Upset at Oaktree, which was recruiting allies among other investors to block the plan, JPMorgan began flexing its muscles.
Officials at the bank declined to comment, but documents show JPMorgan threatened to pull unrelated business from Oaktree and began pressuring other players on Oaktree's side to support the settlement. One of those was Avenue Capital Group, which at the time was raising money for a new fund it hoped would include a $250 million investment from JPMorgan.
Sources said Avenue Chairman Marc Lasry told Oaktree's Karsh that he'd wait a month to see if Oaktree could force a new deal. But when that didn't happen, he defected to the other side, saying he couldn't afford to lose JPMorgan's business. That elicited a biting email response from Oaktree's Liang.
"Tell Marc that he should be fitted for a skirt and play off the women's tees," Liang wrote to Karsh.
As the battle raged, one voice at the center of the action was largely muted -- Judge Carey's.
Many pitched hearings ended with a simple "That's all for today," leaving the combatants puzzling over whose arguments had prevailed. Some argue -- anonymously, since they are reluctant to criticize a sitting judge -- that this left a leadership vacuum that prolonged the acrimony.
"You gotta make a decision one way or another," one of the main players complained in an interview. "We might think it's a right decision or a wrong decision. But we just need you to make a decision."
As a sitting judge, Carey could not discuss the case. But many experts say his reluctance to aggressively dictate an outcome may have stemmed partly from the fact that the bankruptcy code discourages it. Judges are supposed to guide the case toward a settlement but have few tools at their disposal to corral adversaries.
In 2011, at the end of confirmation hearings that failed to settle the case, Carey noted that he believed Oaktree and Angelo Gordon had every right to protect themselves from what they saw as bottom feeders. JPMorgan was free to push its weight around if that served its ends. And the juniors had the right to step in and pursue what they saw as the best business opportunity.
"But you know," he said, imploring the parties to find their own solution, "at the end there has to be an exit of some kind."
Ironically, one of Carey's most decisive moments -- his appointment of a bankruptcy examiner to provide a third-party assessment of the fraudulent-conveyance charges -- only produced a heightened level of acrimony in the case.
Once the senior group splintered, Carey recognized that the fraudulent-conveyance charges weren't going to be easily negotiated away. So he appointed a Los Angeles lawyer and bankruptcy scholar named Kenneth Klee to sort through the Zell buyout and determine who might be liable for what. He said he hoped the exercise would make a settlement easier.
Klee's report had the opposite effect.
Klee and his team spent long hours sifting through the Zell deal. When they were through, they produced four thick volumes running thousands of pages that carefully broke down the evidence and assigned probabilities to eight possible outcomes of litigation. Klee's bill: $12 million.
The problem was, the findings were so intricate and inconclusive that everybody felt the report supported their case. As David LeMay, an attorney for the committee representing creditors, put it, "You know, the examiner's statement is like the Bible. There's something there for everybody."
What happened next provided a classic example of how claims trading in bankruptcy court can change the complexion of a Chapter 11 proceeding overnight.
Aurelius had slowly been increasing its position in the junior bonds while accumulating a controlling stake in another esoteric form of junior Tribune Co. debt called the PHONES. A few months after the Klee report landed in late July 2010, Aurelius approached Centerbridge with an offer to buy out its stake, allowing Aronson to go home with what everybody assumed was a handsome profit.
The moves established Aurelius as by far the largest junior creditor with the power to control the fate of two classes of Tribune Co. debt. And that quashed any lingering chance of resuscitating the April 2010 settlement.
Even after the Klee report, Tribune Co. and the senior creditors held out hope they could strike a deal with Centerbridge. But in terms of its demands, Aurelius "was in another universe," Kurtz said.
Aurelius founder Mark Brodsky casts himself as the lonely voice of the oppressed junior creditor. His email signature contains a rolling selection of quotations from the 12-volume "Meditations" of the Roman emperor Marcus Aurelius. A favorite: "Pay no attention to the chatter of your critics. ... If it is good to say or do something, then it is even better to be criticized for having said or done it."
Brodsky, who wouldn't comment, is well-respected for his legal intellect. But his critics abound. He is viewed as a tenacious disrupter of Chapter 11 cases, using all legal remedies at his disposal to boost the value of his stake. In the Tribune Co. case, he publicly accused the original lenders of refusing to negotiate. Instead, he said, they were trying to "extort a cheap settlement as the price for allowing Tribune to emerge from bankruptcy" and suggested that company management had supported them to "cover up and gain releases for their own wrongdoing."
Once he bought out Centerbridge, Brodsky hired Aronson's legal team and began building a set of aggressive legal strategies based on the Klee report. They were, for the most part, untested and risky. But they were plausible enough to extend the case for two more years, including an expensive two-week trial on the fraudulent-conveyance issues.
Aurelius lost that battle. Ultimately, Carey blessed a plan that shared some similarities with the one that had fallen apart in 2010. It gave Aurelius and its allies $431 million for their $1.28 billion in claims -- much less than they wanted.
But Brodsky wasn't finished. He also won two other key victories that will allow Aurelius to keep the Tribune Co. case alive in the courts for years to come as the firm seeks to recover the rest of its money.
First, the approved plan contains a litigation trust that gives junior bondholders and holders of the PHONES the right to pursue a wide range of unsettled claims against a variety of defendants, including Zell, Tribune Co.'s former board and management, and the company's advisers.
Exploiting a controversial loophole in the law, Aurelius also won the right to shift the fraudulent-conveyance litigation out of bankruptcy court and into state courts around the country. The firm has filed 47 lawsuits nationwide against 35,000 former shareholders, seeking to recover every cent of the $34 a share they received in the original Zell deal.
The move is without a settled precedent, and Aurelius still has to win a preliminary judgment in federal district court before the cases can proceed. But if it prevails, Aurelius will be able to exert heavy pressure on the largest former shareholders for a major settlement.
Tribune Co. finally emerged from bankruptcy court Dec. 31, 2012, with a clean balance sheet and new prospects. Senior creditors led by Oaktree, Angelo Gordon and JPMorgan collected $3 billion in cash and 98 percent of the company's equity, which was initially valued at $4.5 billion. Aurelius and the other junior creditors, meanwhile, can keep fighting for what they think is rightfully theirs -- as long as they're willing to foot the legal bills.
Legal scholars like Douglas Baird at the University of Chicago Law School acknowledge that the Chapter 11 process is being stretched to the limit by investment funds with seemingly endless resources to fight for competing agendas.
But he and others argue that the system needs to be fine-tuned, not overhauled, to add more transparency and encourage compromise. The biggest problem, said Seton Hall University law professor Stephen Lubben, is that changing the law means involving Congress. Most experts and practitioners, he said, believe that would only make things worse.
One measure of the almost absurd complexity of the Tribune case was that Zell, the architect of the transaction that landed Tribune Co. in bankruptcy court, is both a defendant in the ongoing creditor litigation and a junior creditor himself by virtue of a $225 million piece of debt that was part of his investment.
Zell's attorneys continue to pursue that claim, so far unsuccessfully. And they have aggressively sought to have the creditor allegations thrown out as unfounded, noting that the Klee report largely absolves him of any wrongdoing.
Otherwise, Zell has largely gone silent on the topic of Tribune Co., a clear contrast to his early days with the company when he barnstormed the country confidently predicting his deal's success. Now, when the occasional interviewer asks for his reaction to the bankruptcy, Zell often provides a gruff answer, noting that the deal would have worked if not for a "perfect storm" of unforeseen circumstances.