MBIA Gives Lynn Tilton 15 Months to Pay Zohar Debt in Bankruptcy

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(Bloomberg) -- New York financier Lynn Tilton and bond insurer MBIA Inc. have formally settled their fight over whether the investment funds Tilton used to buy distressed companies should be thrown out of bankruptcy.

Under the settlement, which had been agreed to in principle last week, Tilton will be replaced as the head of the Zohar funds for at least 15 months. If creditors are paid off by then, she will win back her position, according to court papers. She will keep her positions in Zohar’s various portfolio companies and begin the process of selling them.

The agreements leaves one potential for further conflict: Tilton will keep running the portfolio companies as she and the creditors try to use them to raise enough money to pay off the Zohar debts, most likely through a sale. Any dispute about how to monetize the assets will be referred to a mediator, according to the court documents.

The deal allows Tilton to avoid testifying in another trial in which creditors, including MBIA, could question her management of Zohar III Corp., its affiliates and the underlying companies they own. Tilton, founder and chief executive officer of Patriarch Partners, lost a related trial last year in Delaware Chancery Court that threatened her control of the funds she helped start in 2003 to buy distressed companies. That case was set to go before a state appeals court when Tilton put Zohar and some of its affiliates into bankruptcy, halting years of litigation.

‘Iconic’ Brands

Zohar III, which bundled the debt of distressed companies into securities and sold them to investors, filed for bankruptcy in March. Included were companies Tilton called "iconic” American brands, whose businesses and jobs she helped save with the securities she created.

MBIA has been at odds with Tilton over three Zohar funds they created together, vying for control through a series of lawsuits over the years. A prior bankruptcy in New York sought to resolve their differences, with limited success after MBIA fought back.

The current bankruptcy is intended to help unlock value for the funds’ noteholders, in part by stopping lawsuits that had cast a cloud over sales or debt refinancings for the portfolio companies, Tilton has said.

Collateral Dispute

U.S. Bankruptcy Judge Christopher Sontchi had scheduled a two-day trial over whether case should be dismissed, which would have allowed MBIA to pursue the appeal in the Delaware Chancery case. The trial would also have decided whether Zohar could fire its current collateral manager, Alvarez & Marsal, according to court filings. Alvarez & Marsal replaced Tilton in 2016, and has said her position allowed her to misappropriate assets.

MBIA and a "controlling class" of Zohar III noteholders asked to have the case dismissed, or an examiner appointed. They accused Tilton of using the bankruptcy to avoid lawsuits over what they say is her wrongdoing, including pillaging the Zohar funds, and "shameless self-dealing." Tilton was a collateral manager who also held a junior interest in the funds, and then misappropriated an equity stake, they said in court pleadings.

They also said that she diverted around $4 million from what should have been their cash collateral to pay for the company’s chief restructuring officer, Mark S. Kirschner.

Tilton said there isn’t "a shred of evidence to support their specious claims" and noted that prior courts had rejected claims of her personal wrongdoing. Tilton had been sued by the U.S. Securities and Exchange Commission, which alleged she had bilked investors of $200 million. She was cleared in September, and absolved of separate civil racketeering allegations in a lawsuit brought by the Zohar funds.

Finding Value

Tilton says the secured noteholders only have the right to "upside equity interests," not the equity itself. She also contends the value of the portfolio companies is worth more than the Zohar debts -- by "billions" according to some calculations -- and that proceeds from sales would repay secured creditors in full.

If the bankruptcy is dismissed, Tilton said, secured creditors would continue lawsuits and defaults would occur, leading to "potential fire sales" of the portfolio companies that would only benefit secured creditors.

"Ms. Tilton wants nothing more than to lay down arms, declare a cease-fire, and get on with the process of monetizing assets," her lawyers wrote in a court filing. She said she was compelled to file personal pleadings in the case because of the "vexatious allegations" made against her.

Of three Zohar funds, Zohar I and Zohar II have already defaulted, and Tilton has said Zohar III will likely default in March 2019. Zohar III and affiliates’ Chapter 11 filing in Delaware listed up to $10 billion in assets.

The case is Zohar III Corp., 18-10512, U.S. Bankruptcy Court, District of Delaware (Delaware.)

©2018 Bloomberg L.P.

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