MBIA loses $100 million case vs flamboyant distressed debt investor

June 11, 2013

Is there any private equity investor with a more flamboyant personal style than Lynn Tilton, CEO of the distressed debt private equity firm Patriarch Partners? Tilton is Yale- and Columbia-educated and Wall Street-trained, but here’s the first impression she made in a 2011 interview with New York magazine: “Tilton’s lipstick is frosty pink, her eyelashes are long and inky black, her hair is Barbie-doll blonde, with curls spilling over cleavage that is invariably visible, invariably tan, invariably accentuated by a diamond necklace, and invariably supported by a tight-fitting garment made by one of her favorite designers. Today she has chosen a Roberto Cavalli miniskirt accessorized with spike-heeled suede boots and a fur-trimmed cape.”

Not your typical vulture fund investor, though Tilton did say, “There’s never been a carcass I wouldn’t put on my back.” (Patriarch’s current portfolio of 39 companies includes the Rand McNally map business, several cosmetics companies and a bevy of industrial concerns.) Forbes investigated whether Tilton should be included on its billionaires’ list in 2011 and ended up deciding that she’s probably worth at least $830 million, although the magazine found her so confounding a character that it produced an indelible week-long series of articlesabout (among other things) Patriarch’s predilection for extremely complex transactions and Tilton’s brassy, sex-tinged antics.

You might not think that a woman like Lynn Tilton would play well before a judge like U.S. Senior District JudgeRobert Sweet, who was appointed to the bench in 1978 and turned 90 years old last October. But it would be a mistake to underestimate either of them. In a 155-page decision issued late Monday in the bond insurer MBIA’s $100 million breach-of-contract suit against Patriarch, Judge Sweet found Tilton to be “vigorous, authoritative, informed and almost entirely supported by documentary evidence,” with a “clear and unshaken” recollection of her interactions with MBIA. “She was an effective witness and in the main entirely credible,” Sweet wrote. The judge even cited, in a footnote, an ABC News feature that called Tilton a “stylish job saver.”

More importantly for the case at hand, Sweet concluded that Tilton’s company did not breach an agreement with MBIA to remediate losses in MBIA-insured collateralized debt obligations via an equity note in another CDO. (From that description alone, you can see what I meant about complex deal structures.) Here’s the extremely condensed version of Patriarch’s transaction with MBIA. Back in 2003, MBIA was looking for ways to mitigate its exposure to seven troubled CDOs it had insured. Tilton had a reputation as a distressed debt wizard, so the insurer hired Patriarch to take over management of the troubled CDOs. At about the same time, Patriarch put together a new CDO, Zohar, to invest in distressed corporate loans. MBIA insured Zohar, which, in turn, included $150 million in unfunded junior notes that could, under certain circumstances, be converted to debt and dropped into the original troubled CDOs to remediate their losses. MBIA controlled 80 percent of the junior notes, known in Sweet’s opinion as B notes.

Both sides benefited from the deal. Patriarch collected fees as collateral manager on all of the CDOs and held 20 percent of the rights to the B notes. And MBIA, which was facing upward of $90 million in exposure to the troubled CDOs, had a strategy to avoid those losses.

But the strategy depended on Patriarch eventually obtaining credit ratings and a debt-for-tax legal opinion on the B notes. To make a very long story short, even though market conditions and investment strategies changed between 2003 and 2007, MBIA believed that the B notes were, at various times, ratable securities. Tilton insisted they were not. Asserting that seeking a rating on the junior notes would endanger the credit rating on senior Zohar notes, Patriarch said contractual conditions hadn’t been met. MBIA sued in 2009, alleging that Tilton breached their agreement to use the B notes to remediate the insurer’s losses in the original troubled CDOs. (Investors ended up suffering no losses in five of the CDOs, but MBIA paid out about $100 million in policies on the other two.)

The bench trial, which was interrupted for a week after Hurricane Sandy, came down to something of a battle between experts on the ratability of the B notes. MBIA pointed to the example of the Zohar A notes, which were rated, to argue that rating agencies often loosened their written guidelines to rate CDOs. MBIA also offered evidence that Natixis, Patriarch’s then investment banker, believed the notes were ratable. But Judge Sweet found that Patriarch’s expert, a former Moody’s analyst, “was the most qualified and credible of the experts,” and he said the B notes didn’t meet credit-rating guidelines at any time.

“The evidence shows that neither the rating condition nor the debt-for-tax condition could have been satisfied regardless of Patriarch’s efforts,” Sweet wrote. “The fact that neither of these conditions has been satisfied means that Patriarch’s contribution obligation was never triggered, so Patriarch’s failure to transfer the B notes to the troubled CDOs does not constitute a breach of contract.”

Patriarch’s lead lawyer, Hillary Richard of Brune & Richard, credited Sweet for writing a “thorough and meticulous” ruling in such a contentious case. She also credited her client. “It’s an impressive woman who can impress a judge who’s been on the bench as long as Judge Sweet,” she said. MBIA, which was represented byBingham McCutchen, said in an email statement that it is disappointed in the decision and considering its options.

(Reporting by Alison Frankel)

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