Strategic Value Partners sued in case revealing distressed debt tensions

The $18bn distressed debt investor Strategic Value Partners seized control of the owner of US retail properties such as Rolling Oaks Mall in Texas and Tippecanoe Plaza in Indiana in a transaction approved by a bankruptcy judge last year.

Now, a group of minority shareholders in the mall company have sued SVP, saying they have been short-changed by the fund.

The case is part of a trend in distressed debt investing, in which investment funds snap up the discounted bonds of troubled companies in the hope of swapping that credit position for control of its assets in a subsequent bankruptcy.

The biggest investment groups are increasingly asserting their power to steer restructurings at target companies. This has led to grievances from smaller investors who claim that they have been steamrollered.

Washington Prime Group filed for bankruptcy protection in June 2021, citing a heavy debt load of $4bn, reduced traffic at its roughly 100 shopping centres and various concessions granted to retail tenants that were attempting to stay afloat in the coronavirus pandemic. The New York-listed company had been spun out in 2014 from the mall titan Simon Property Group.

Connecticut-based SVP, founded by Victor Khosla, was WPG’s largest individual creditor at the time of the bankruptcy filing. SVP led a group of creditors who held the vast majority of the company’s senior debt and unsecured junior bonds. According to the lawsuit, SVP owned 87 per cent of the reorganised company when it exited bankruptcy in October 2021 at an aggregate valuation of around $3bn.

In the lawsuit filed in Delaware state court on Thursday, minority holders in the reorganised WPG, led by Cygnus Capital, said that they were blindsided and ultimately cheated in a transaction earlier this year where SVP squeezed out the shareholders who owned just over a tenth of the remaining equity of WPG. Cygnus claimed that it only learned of the deal led by SVP when it closed at a price it deemed “grossly unfair”.

In its lawsuit, Cygnus alleges that “SVP took advantage of the Covid crisis to force and control a rushed bankruptcy process to take WPG Inc private”. The minority investor group seeks to either unwind SVP’s buyout of minority shareholders or be paid damages based on a revised valuation of Ohio-based WPG.

In an interview last year with Bloomberg television, Khosla denied that his firm engaged in “scorched earth” tactics, while acknowledging that his team could be tough negotiators. “We are not trying to find a little angle and make eight points on the bond we bought at 82. It gives you a lousy reputation . . . it’s just not us,” he said.

However, one creditor to WPG before its bankruptcy, who is not involved in the lawsuit, told the Financial Times that he was startled at the time by what he perceived to be the aggressiveness of SVP in the squeeze-out deal.

The person said that by leading a new cash investment of $325mn in WPG in the restructuring, SVP had already done well for itself. The fund had been able to purchase WPG equity at a 32.5 per cent discount to the mooted valuation of the new company, attractive terms related to SVP’s ability to commit significant capital. WPG had also sought alternative transactions to the SVP restructuring plan, but no credible counter offer emerged during the bankruptcy.

“Distress has never been an arena for the meek,” said Vincent Buccola, a professor at the Wharton School and a former corporate lawyer. “But in recent years, as norms of proportion and reciprocity have given way, many of the most sophisticated players have found themselves in court testing the boundaries of legal rights.”

The reorganised WPG is structured as a limited liability company, which typically offers fewer fiduciary protections to minority shareholders than a traditional corporation. The lawsuit plaintiffs allege that the transaction process “violated several requirements of the LLC agreement” and that SVP “obscured the Company’s asset valuations and concealed critical information from the Minority Unitholders”.

“Minority limited partners in many cases took the exact same economic risks and yet SVP is using is its majority control to create a two-class system that gives all the upside of the investment to SVP and leaves little for their limited partners,” said Christopher Swann, president of Cygnus Capital.

Cygnus challenged a WPG independent director, Martin Reid, describing him as being beholden to SVP. “Publicly available information indicate that Mr Reid’s livelihood depends on private equity real estate investors like SVP,” the plaintiffs wrote.

Reid did not respond to a request for comment.

SVP said: “We believe the lawsuit’s claims are completely without merit, and we intend to defend ourselves vigorously.”

The court papers also seize upon comments Khosla made at a Milken Institute financial conference earlier this year, where he seemed to boast about how surprisingly valuable WPG assets had become, describing what the plaintiffs said was the company’s mall located in Westminster, California.

“The mall is shut down and we got bids for it for a few hundred million dollars,” he said.