Sears Judge Skewers Cyrus on Motive for Opposing Survival Plan

(Bloomberg) -- Hedge fund Cyrus Capital Partners has tried everything it can to stop Sears Holdings Corp. from selling some obscure internal notes to raise cash. Now the judge overseeing the bankruptcy is losing his patience and openly questioning why Cyrus, a major creditor, is standing in the way of a deal that could help salvage the retailer.

“I want to know!” Judge Robert Drain said at the Thursday hearing as he rebuked Cyrus’s attorney. “I’m going to take it quite seriously, that point, the inquiry into your client’s motives on this.”

The dispute pits the hedge fund against Sears as it tries to line up more cash to get through the holiday season and craft a long-term survival plan. The note sale could buy some breathing room for Sears, which faces restive suppliers, landlords and other low-ranking creditors who say they’d be better off if Sears was dead.

Drain implied that Cyrus may be more concerned with its dealings in the credit-default swaps market, where the firm is believed by market participants to be one of the largest sellers of default insurance on Sears. While Cyrus hasn’t publicly disclosed its position, sellers of protection could be on the hook for millions of dollars if the Sears note sale gets approved.

‘Come Here’

The hedge fund argued that Sears’s plan to sell up to $900 million of the notes, designed to benefit the company and by extension its lenders, would instead dilute recoveries for creditors.

“Your client will have to come here and tell me why it thinks it’s going to be diluted,” Drain told a lawyer for Cyrus at Thursday’s hearing. “I don’t want you to just lob something in and tell me sotto voce ‘and we’re participants in the CDS market,’ which I think may be the reason they’re objecting.”

The dispute stems from the arcane rules that set the amount of compensation for swaps holders when a company defaults on its debts. In Sears’s case, the swaps are tied to a unit that has fewer bonds than there are swaps bets. That means protection sellers could avoid having to make significant payouts to other funds that bought the insurance. But if Sears puts more debt into circulation, that would give swaps buyers more notes on which they can collect, boosting the payout.

Boosting Value

Sears sees the situation creating a potential bidding war among swaps traders for the intercompany notes. A lawyer for the company said a sale might fetch more for the estate than the value on the company’s balance sheet.

Cyrus has also tried to block the sale outside of court, a maneuver that a judge might see as undermining the court’s authority. The hedge fund founded by Stephen C. Freidheim is linked to a request filed this week with a credit-swaps industry committee to exclude the Sears notes from the upcoming auction that will be used to settle some $400 million of the wagers on the retailer. Cyrus is one of the 15 voting members of the committee.

The committee has extended a self-imposed deadline to decide whether the notes will be admitted to the auction to Monday at 5 p.m.

Exactly how much is at stake for Cyrus might become clearer on Monday, when Drain demanded a Cyrus official attend a new hearing to address the matter. He also said Cyrus “should no longer interfere with the debtor’s right to sell these notes without running the risk of violating the stay.”

The judge is primarily concerned with preserving Sears’ rights to sell assets during the bankruptcy proceedings, so any potential interference with that process is a red flag for him, said Negisa Balluku, a Bloomberg Intelligence analyst focused on bankruptcy litigation.

Hedge funds have emerged as some of the largest players in the $10 trillion market for default insurance, often making bets worth hundreds of millions of dollars on the fate of individual companies. They have often used their exposure to strike side deals with the companies. In the past year, traders seeking to profit from bets on derivatives have extended financing to food distributor United Natural Foods Inc., homebuilder Hovnanian Enterprises Inc. and newspaper publisher McClatchy Co., Bloomberg News has reported.

To contact the reporters on this story: Josh Saul in New York at jsaul15@bloomberg.net;Davide Scigliuzzo in New York at dscigliuzzo2@bloomberg.net

To contact the editors responsible for this story: Rick Green at rgreen18@bloomberg.net, ;Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Shannon D. Harrington

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