March 25, 2008 at 7:20 PM EDT
When the phone book-sized proposal to salvage $32-billion of asset-backed commercial paper (ABCP) landed in an Ontario court last week, there was only one passage that really mattered to investors. Near the bottom of page 127 was a demand that will make or break the impossibly big bailout.
In 38 crisp lines, the section outlines the terms of a Master Release Agreement. The agreement calls for investors to give up their rights to sue just about anyone linked to the shipwrecked notes. In exchange for the legal surrender, a cluster of foreign and domestic banks backing the stricken notes are giving up some monetary claims and offering to provide an additional $14-billion line of credit to bolster a new series of replacement notes.
By any measure, it is the largest legal release ever sought. It would protect any bank, broker, trust, sponsor, lawyer, adviser, consultant, credit rating agency and even public relations consultant linked to ABCP from any lawsuit “forever.” That means that any broker or bank that may have improperly sold the notes; any bank that may have shut off emergency lines of credit; or any ABCP sponsor or rating agency that may have been slow to sound the alarm will get Kevlar-strength protection from legal bullets.
The release comes with a clever bit of legal design work, known as a cram down, which means that all of the estimated 1,600 ABCP investors are barred from lawsuits if only a simple majority approve it. In other words, even if hundreds of investors vote against giving up their right to sue, the court will defer to the majority and prohibit all legal claims.
Will it fly? Purdy Crawford, the Toronto lawyer leading the rescue operation, says investors have no choice. Without the legal releases, the banks won't co-operate and the rescue operation fails.
“Simply put, there can be no plan unless these releases are included and I believe that the benefits of the plan, taken as a whole, justify the releases,” Mr. Crawford said in a court affidavit last week.
It's easy to understand why the banks and the other ABCP backers want the release. They walk away with a Get Out Of Jail Free pass and the comfort of knowing that billions of dollars of intricately linked financial instruments won't unravel and further devastate credit markets and balance sheets.
Furthermore, by calling for a sweeping release that protects virtually everyone connected to ABCP, the banks will be able to shield themselves from so-called third-party lawsuits. Third-party claims allow small players targeted in lawsuits to turn around and file claims against larger players, such as ABCP banks, as a way of tapping into bigger pools of liability insurance. For example, when a pair of investors recently sued Vancouver's Canaccord Capital Inc. for allegedly improperly plunking ABCP into their portfolios, the brokerage responded by suing the bank, Bank of Nova Scotia, which was its dealer for the notes. Canaccord and Scotiabank have denied any wrongdoing.
For investors, the advantages of approving the restructuring are not so clear. The surest thing Mr. Crawford can say about the proposed bailout is that it represents “the art of the possible.” In other words, he and his advisers can't say for sure in these troubled times what the new investments contemplated under the plan will be worth. Nor have they been able to clarify how they are going to finance a new market for the new notes if investors need to sell. It doesn't help that some analysts are estimating that ABCP notes have lost more than 40 per cent of their value in recent months.
The lack of certainty means the demand for the legal release is a tough sell.
“They haven't put enough on the table to make it worth my while to sign the release,” said Brian Iler, a Toronto commercial lawyer who owns $229,000 of the marooned notes. Mr. Iler argues he is legally entitled to get back all of his money because when he transferred his savings to an Ontario Credit Union investment account last year he specified that he only wanted to buy government-backed investments.
“If they are not going to make me whole, why would I sign away my rights to hold people accountable?” he said.
Jay Hoffman and Jeffrey Carhart at Miller Thomson LLP have heard the same arguments. They are advising an ad hoc committee of 14 corporate and individual ABCP investors. Mr. Crawford's committee has given the lawyers and PricewaterhouseCoopers LLP $1-million to analyze confidential details about the proposed workout. In exchange for signing confidentiality agreements, the lawyers and financial advisers have been granted access to undisclosed data about the state of some of the trusts.
The lawyers said they have not yet decided what to advise clients when they are asked to vote on the ABCP proposal April 25. Although investors are furious, Mr. Hoffman said, emotions must be pushed to the side so that the best choices are made at a time when credit markets are deteriorating.
“People are understandably angry and many have gone through a very difficult time with the meltdown …. at the end of day they have to make a rational decision based on the current circumstances and the consequences of the proposal not going forward,” he said.
Mr. Carhart has advised clients in previous corporate insolvency proceedings to sign less sweeping legal releases because the concession was the price creditors and plaintiffs had to pay to salvage something from the wreckage.
He said there is no assurance that anyone will succeed with ABCP lawsuits, which will be “long, grinding and costly.” Investors, he said, “owe it to themselves to look very hard at the reorganization.”