Decision in Washington Mutual, Inc. Holds that Litigation Tracking W...

Summary

In a 32 page decision signed January 3, 2012, Judge Walrath of the Delaware Bankruptcy Court ruled that holders of litigation tracking warrants that would be paid out in stock of the debtor were equity instruments, and would be paid out at the same priority as common equity under the bankruptcy plan. Judge Walrath’s opinion is available here (the “Opinion”).

Background

Washington Mutual, Inc. (“WMI”) was a holding company that owned Washington Mutual Bank (“WMB”). Through a series of mergers, WMI became the owner of litigation against the federal government, originally commenced by Anchor Savings Bank. In connection with the numerous mergers that led to WMB controlling the litigation, a group of investors was given litigation tracking warrants (“LTWs”) that would provide them with 85% of the value of any recovery from the litigation, in the form of WMI common stock. Opinion at *4.

As reflected by the length of the Opinion, there was extensive issues raised in argument regarding whether the LTWs should be considered debt or equity. Because of the disputes, some of which involved genuine issues of disputed facts, the Court was unable to grant summary judgment resolving this dispute, but required a hearing on the merits. Opinion at *6.

Judge Walrath’s Opinion

Judge Walrath divides the Opinion into resolving 4 questions : (A) Are the LTWs Debt or Equity? (B) Did WMI Breach the Warrant Agreement? (C) Are the LTW Holders’ Claims Subordinated? (D) Is the Anchor Litigation Property of the Estate?

Are the LTWs Debt or Equity?

In making this determination, Judge Walrath follows the standard form of contract interpretation. She begins by examining the plain language of the agreements. Opinion at *6. Finding the language to be “sufficiently ambiguous”, Opinion at *9, Judge Walrath then looked to testimony regarding the intent of the parties. She first looked to the testimony of expert witnesses, Opinion at *9, then turned to the opinion of the creators of the LTWs, Opinion at *18. Based on the testimony of these two groups, she determined that the LTWs were equity instruments. Opinion at *23.

Did WMI Breach the Warrant Agreement?

The LTW Holders argued, that regardless of the status of the LTWs as stock, they were entitled to receive cash, and WMI’s violation of that right advances their position to that of a creditor. Opinion at *23. Judge Walrath disagreed, citing precedent holding the exact opposite position. Namely, owners of equity instruments with a right to receive cash rather than stock are still only equity if that option was not exercised prepetition. Opinion at *25.

The LTW Holders also argued the following: (1) WMI breached the Warrant Agreement by selling substantially all its assets to JP Morgan Chase (“JPMC”) without obtaining assurance that JPMC would enter an agreement confirming that the LTW Holders retained their interest in the LTWs, Opinion at *26; and (2) WMI was required by the amended Warrant Agreement to assure that the LTW Holders receive the value of the LTWs, Opinion at *27. Judge Walrath held that because the transfer of assets to JPMC was in the nature of a settlement, rather than a sale, the argument of the LTW Holders was inapplicable. Opinion at *26-27. She then ruled that the assurance that the LTW Holders would receive the value of the litigation was permissive, and did not require WMI to provide the assurances sought by the LTW Holders. Opinion at *27.

Are the LTW Holders’ Claims Subordinated?

Section 510(b) of the Bankruptcy Code provides that claims arising from a purchase or sale of debtor securities will have the same priority of the security underlying the transaction. In this instance, Judge Walrath held that because the LTWs were warrants representing the right to receive WMI common stock, the LTW Holders’ claims would be subordinated to the level of common stock. Opinion at *30.

Is the Anchor Litigation Property of the Estate?

Citing Official Comm. of Unsecured Creditors of the Columbia Gas Transmission Corp. v. Columbia Gas Sys. Inc. (In re Columbia Gas Sys. Inc.), 997 F.2d 1039 (3d Cir. 1993), Judge Walrath held that WMI owned the litigation and the LTWs only owned a right to receive a distribution of equity equal to a portion of the recovery from the litigation. Opinion at *31. Thus, the debtors owned the litigation and all proceeds therefrom, and could transfer the recovery to JPMC. Judge Walrath thus granted judgment in favor of WMI and held that the LTW Holders’ claims were to be treated as equity claims.

John Bird practices with the law firm Fox Rothschild LLP in Wilmington, Delaware. You can reach John at 302-622-4263, or [email protected].