This week PETITION welcomes Cindy Chen Delano, Partner at Invictus Global Management, an Austin-based investment firm focused on event-driven special situations and private credit opps. Cindy has a unique background that traverses biglaw (ex-Weil, Kirkland & Milbank), buyside (AIG Investments and Whitebox Advisors LLC) and now Invictus, where she leverages her legal and activism experience to (hopefully) drive returns on behalf of her fund’s limited partners. We’re excited to have her join us and hope you benefit from her insights.
PETITION. Cindy, welcome. Let’s dive right in. We’ve written a lot about the Hertz Global Holdings Inc. ($HTZGQ) case. Much of the focus has been on the results of the robust auction between the two competing plan sponsor groups and the resultant recovery for shareholders, but there’s a general unsecured creditor story there too that appears vastly under-appreciated. You’d been trading — as part of one of the core strategies of your fund — in general unsecured claims in that case for months leading up to the auction. Walk us through your investment process there and how did things pan out?
Cindy: Thank you for having me. Yes, Hertz is a rollercoaster of sorts but it also epitomizes the paradigm shift we’ve experienced in the last year with the rise in power and relevance of the retail investor in the public equity space, along with the central theme of economic recovery (albeit disproportionate) post-pandemic and the fragility of the global supply chain as tested by the pandemic. These factors led to a very competitive dynamic for a plan process as played out in the auction between plan sponsor groups (mega funds with a lot of dry power to deploy) and the ultimate result of a “large enough” pie to go around to equity holders. As the plan process was playing out in the last month or so, it was starting to look like junior equity holders could be “in the money” and as a result the more senior trade claims became a better risk adjusted investment (more likely to get paid in full in cash).
We started buying general unsecured claims at a discount to proposed plan recovery (the initial draft of the plan proposed approximately 70c on recovery) but we had been following the situation pre-bankruptcy as the byzantine capital structure was complex enough to bar investors who are not experienced in complex corporate bankruptcies and was likely to provide opportunities for my team. We could have also purchased equity but given the Bankruptcy Code and Third Circuit law on creditor rights, general unsecured claims could (should) do better as the plan process unfolded before a very experienced bankruptcy judge. Today, the trades claims are par (entitled to 100% recovery in cash or reinstatement under the solicitation version of the plan) and potentially worth more because unsecured creditors in solvent cases may be entitled to post-petition interest (arguably at the higher state rate). Here is a good chart from Claims Market that illustrates the price trajectory of the unsecured claims as net beneficiaries of the competitive plan sponsorship process:
It will be interesting to see how a bankruptcy judge in the Third Circuit rules on what the appropriate rate of post-petition interest a general unsecured creditor is entitled to in a solvent debtor case. As you know solvent debtor cases are rare, but we’ve seen a few of them in the last year (spanning the 5th circuit to the 9th circuit) with a split on the appropriate post-petition interest (ranging from the very low federal judgment rate to significantly higher state judgment rates/contract default rates).
PETITION: To what extent does the rise in super-speedy prepackaged plans — including the one-day variety largely put forth by your former Kirkland & Ellis LLP colleagues — dampen supply and make things more challenging for someone in your seat looking for claims trading opps?
Cindy: That was a record and I am not surprised that my friends at Kirkland managed to achieve that before a very well regarded bankruptcy judge in a precedent-setting jurisdiction. I love the innovation and creativity of bankruptcies to solve real life problems without getting bogged down by bureaucracy and unnecessary process. That said, we did manage to make money on Belk through vendor puts, where we as investors offered trade claimants protection for a designated period against at trigger event (e.g., bankruptcy) and received a premium in return.
PETITION: Let’s dive into the Tuesday Morning Corporation case. Your firm ended up holding ~$6mm of general unsecured claims against the debtor which, to the surprise of some, ended up solvent and providing a return to equity (something that, uncharacteristically, appears to be happening astonishingly often in chapter 11 cases of late). You had to roll up your sleeves there and object to the treatment of general unsecured creditors. Briefly walk us through what was going on there and how it was ultimately resolved.
Cindy: Tuesday Morning is an example of how we are able to add value in a seemingly over-looked situation through strategic activism (know the law and the players). Like most of our investments, we were compiling our research and forming a view on the company early in its bankruptcy. Given that it is a retail case, we were very cautious around value but there were a few factors that provided us comfort: (1) the presiding bankruptcy judge granted an equity committee in September 2020 after finding that the bids submitted in the sale process could result in recoveries to equity (i.e., a solvent debtor case), (2) a very well-reasoned decision by a Southern District of Texas bankruptcy judge in October 2020 setting forth the appropriate rate of post-petition interest (contract default rate) for unsecured creditors (noteholders) in a solvent debtor case and (3) our ability to be part of the solution by offering four different exit financing proposals that included rolling up pre-petition claims and doing a rights offering from the trade claims class to ensure an expeditious exit from bankruptcy (lower administrative expenses). We also had to object to the plan treatment as it was necessary to trigger the “fair and equitable” test with respect to dissenting impaired unsecured creditors (i.e., absolute priority), which would allow unsecured creditors to argue for a higher rate of interest than the proposed federal judgment rate under the plan.
Ultimately, the existing equity holders put new money in and our trade claims were paid off in full in cash with post-petition interest (but at the lower federal judgment rate as it was all “consensual” at the end). Traditionally, trade claimants lose out on value accretive transactions because they are often less sophisticated in complex restructurings and are reliant on statutory committees and their counsel (here, this was a lower middle market case without the presence of the usual suspects that represent UCCs). We believed that our presence in this case showcased our ability to create value given our sophistication and ability to offer solutions that benefit the little guys (the small business owners who were disproportionately impacted by COVID and needed liquidity). That said, we are not complaining because we’ve received most of our plan distributions already thanks to the hard work of the Tuesday Morning advisors.
PETITION: Let’s talk about litigation finance in bankruptcy. A few years back, a number of shops bolstered their teams with experienced restructuring professionals to try and create new revenue streams out of chapter 11 bankruptcies. Are we wrong that the opportunity set never really proved out and, if so, how? Some specific examples would be great to put some context around this.
Cindy: I think that bankruptcy courts are likely the best forums for litigation finance opportunities as these judges are experienced, fair and well-versed in complex issues (fraudulent conveyances/mass torts/third party releases/creditor rights) with the additional overlay of equity. Bankruptcy courts are courts of equity and restructurings, including litigation financings as another form of plan consideration, should be about fair and optimal outcomes for the greater good.
There are many litigation finance opportunities provided that you are experienced with complex bankruptcies and litigations. I have had several opportunities to combine these two areas, most notably, in NS8 (NKA “Cybersecurity Litigation Co.”) — which was a litigation finance funding structured as a debtor in possession loan in the Bankruptcy Court in the District of Delaware. Our $10 million DIP loan paved the way for the estate to seek turnover of funds from individuals and institutions that benefited from the cybersecurity startup founder’s fraud. Unlike traditional DIPs backed by hard assets, this loan was primarily collateralized by intangible assets in the form of valuable causes of actions against many deep-pocketed defendants. I was able to get comfortable with the viability of the causes of action, collectability of the claims and the protections offered by the Bankruptcy Code that enable the estate to effectuate a value maximizing litigation strategy. I also had great partners in the estate’s fiduciaries and advisors, some of whom I have worked with in the past on another litigation financing for the benefit of a liquidating trustee. The restructuring network is a key part of our sourcing and underwriting: I like investing with people I like and trust.
PETITION: You’ve been a lawyer at debtor-side shops (Weil & Kirkland), a lawyer at a creditor-focused shop (Milbank), and a lawyer-cum-hybrid-investor at AIG and Whitebox. If you can, distill each chapter in your professional story down to one primary lesson learned. What was the biggest takeaway from each stop?
Cindy: I am a bankruptcy veteran and love restructurings regardless of which seat I sit in. I have had the benefit of many viewpoints (advising management/boards as a debtor’s lawyer at Weil & Kirkland and defending creditors’ rights at Milbank, AIG, Whitebox and now my own shop (Invictus)) but the platform is the same: it is about bankruptcies and what could be achievable in a fair process through working with different stakeholders—which includes constructive activism and offering solutions but also to bring necessary litigation and being tough in negotiations when appropriate. Bankruptcy is a street-fight, but it offers the best way to get a fair result without the frills. For me, fighting for what is right and fair is very important. For example, adequate protection isn’t just an obscure secured creditor protection in the Bankruptcy Code, but it is fundamentally about the constitutional balance effected through the Code to allow for reorganizations while preventing an unconstitutional taking. The principles of fairness are central to bankruptcies and how I navigated my career choices in this space.
PETITION: As someone who has been in multiple seats, you must also have some thoughts about inefficiencies in the bankruptcy space. What is f*cked and needs fixing?
Cindy: Yes and yes! Retail equity holders are now powerful and relevant through “collective action” via Reddit boards and are virtually present at the bargaining table. In contrast, general unsecured creditors (trade claimants) are not well represented even though they are technically represented by statutory committees and their counsels. In Neiman Marcus, we saw a breakdown in the role of statutory committee members and how they do not protect the interests of the creditor class at large but this is just one example of the inefficiencies.
Unlike equity holders, unsecured creditors are the most diverse segment of the capital structure: they can be landlords, litigation plaintiffs, environmental tort claimants, vendors, suppliers, service providers, noteholders, and etc. but they get swept into a single statutory committee with the same set of advisors. The patchwork solution has been the formation of ad hoc groups consisting of noteholders representing their own interests and paying their own way, which has allowed for more efficient resolutions for funded debt holders. In contrast, trade vendors do not have the same voice: we tried to remedy that by forming an ad hoc group of trade claimants in Tuesday Morning but the statutory committee advisors in the case immediately cast aspersions on this ad hoc group as “claims buyers” without fully appreciating that like other contractual assignees, we step into the shoes of the sellers and bring our sophistication and experience to benefit all other similarly situated holders. Note that no one has ever treated buyers of noteholder claims (i.e., bonds on the secondary market) as being different from original holders. Why should buyers who provide immediate liquidity to vendors be treated any differently? Ultimately, I would love to see the bankruptcy process be accessible to the underdogs like the trade claimants through proxies like sophisticated investors like myself and my team, who know how to protect creditor rights and unlock value for the rest of the class. Stop treating claims buyers like lepers please!
PETITION: Drilling down more specifically, what is it about the claims trading space that has new VC-backed tech companies (and other brokers) looking to streamline the process?
Cindy: Claims trading is still very inefficient: it is not systemized like bonds and not uniform as the claims and its holders are very diverse. As a result, the trading of these financial instruments is typically transacted via bespoke, bi-lateral agreements and there are tremendous friction costs, especially when it comes to smaller claims and most claims do not reach the millions level. As a former bankruptcy lawyer who used to put together schedules, plans and facilitate claims resolutions processes, I have been able to streamline that process for my team and we have been able to capture the inefficiency discount in the smaller claims and most importantly, to scale our trade claims investments. We also work very closely with certain external brokers who are excellent at trading these inefficient financial instruments.
PETITION: Now that Jay Powell has Jay POW-ell’d the sh*t out of the economy and large cap bankruptcies are a thing of the past (2020), where are there distressed investing opportunities? You recently told the fine folks at EisnerAmper that you see opportunities on the horizon in the middle market. Where? Why?
Cindy: There are a number of lower middle market and middle market companies with significant maturities coming up. Since 2009, the amount of leveraged debt (bank debt and high yield) has doubled and it will take a fraction of the prior default rate to create the same level of distressed opportunities. Leveraged debt are often utilized by sponsor-backed companies that were underwritten to aggressive growth assumptions that cannot be achieved given the economic shock caused by the pandemic. Given the years of the low yield environment, risker underwriting is also backed by looser documents—consider the number of J.Crew/Revlon/Serta type litigations/skirmishes we’ve seen already.
In turn, the pandemic has further exacerbated the divide between the large caps versus these middle market companies: the federal stimulus went directly to support companies that had access to the capital markets (e.g., Carnival and American Airlines) and not Tuesday Morning (it could not even get a PPP loan) and Century 21. We will see more middle market companies (e.g., 2021 filings are skewing to smaller companies with obligations less than $100 million) filing at a steady pace notwithstanding the overall economic recovery. For us at Invictus, we have a structural advantage by being smaller and just as experienced: we do not need put a minimum of $100 million to work in each investment and can invest well in the middle market situations. I suspect that the larger funds are having a very difficult time putting capital to work as we are not seeing multi-billion structures filing bankruptcy given the expansionary monetary policy used to stem fallout from the pandemic. The expansionary monetary policy is limited to fixing liquidity issues as near zero interest rates will not allow an over-leveraged company to refinance when debt comes due. We are specifically following a few of these middle market companies with sizable near-term maturities in across many industries spanning travel, real estate and telecommunications. Did I mention that we are industry agnostic?
PETITION: You have now. You’ve characterized yourself as “recovering from private [biglaw] practice” in the past. We have a lot of students that read us who may be thinking about a career in biglaw. What words of wisdom would you like to share with them?
Cindy: Go to law school and work on as many novel cases as you can at the best firms you can get hired at! I loved law school and would not be who I am today without practicing hardcore bankruptcy law for almost a decade at the top firms. No secondary training is comparable to rolling up your sleeves and working on as many complex bankruptcies as you can. I was spoiled by tremendous mentors at each of the firms I worked at who gave me a chance and encouraged me to push my skills. Those tens of thousands of hours were worth it.
Law school and practicing law taught me a rigorous and disciplined approach to spotting and analyzing material issues—that is the core of a good investment process—how do you lose money and how do you make money. I also enjoyed practicing law and being a member of the bankruptcy bar and restructuring network. This network is also one of the sources for some of my best investments but also filled with people who I really like as friends (you know who you are!). It was through working on complex cases over and over again and seeing how some stakeholders fared better than others that I realized that I really liked investing—I could use my bankruptcy skills to execute on a value maximizing game plan. I also like taking risks in a subject matter domain that I know well: I know bankruptcies and love investing in them.
PETITION: This has become a NOA staple: what are some books or podcasts that have helped you get to where you are today?
Cindy: I am a bookworm. Nothing makes me happier than curling up with a book (even after a long day of reading bankruptcy documents). In no particular order, some books that helped me think about my career, the characters in corporate finance, along with the fatal flaws, and the path to change: Barbarians at the Gate, Den of Thieves, Bonfire of the Vanities, Too Big to Fail, Simple Justice: The History of Brown v. Board of Education, Just Mercy: A Story of Justice and Redemption, No No Boy, The Warmth of Other Suns, and Simulacra and Simulation.
I don’t listen to as many podcasts as I used to since I no longer go anywhere so I am in the car less but I like “Planet Money” and “Freakonomics Radio.” I am also a religious NPR listener — who doesn’t like “All Things Considered” or “The Moth Radio Hour”?!
PETITION: Finally, you’ve likely noticed that we like to snark “Long ABC” or “Short XYZ.” What are you “long” these days? What are you “short”? Feel free to be creative here.
Cindy: I am short socio-economic disparity, which translates into short-term profiteering off the back of human misery (e.g., prison bonds and payday loans) and further reinforcing the divides. The pandemic has highlighted and exacerbated the stark divide between the “haves” and “have nots” and this disparity has erupted into social and racial unrest. This crisis lays bare the “social fault lines” of our society. The consequences of the pandemic and the abrupt closure of our economy to stem a proliferation of a raging health crisis have reinforced social inequities and disadvantage among the groups most devastated by the 2008 global financial crisis.
I am long technology and scientific innovation, especially advances in biomedical research as we’ve seen the accelerated development of vaccines to meet the global crisis and other creative ways to solve global problems (climate change). I am also long socio-economic changes to create a more just and fair distribution of resources and access for all. I support greater access to capital for talented minority and women-owned businesses.
PETITION: Thanks Cindy. That’s a lot of good stuff!
Original source: PETITION