Owens Corning bank debt holders likely to appeal unfavorable ruling, distressed debt expert says

By Paul Deckelman

New York, Oct. 6 - Tuesday's bombshell legal ruling in the Owens Corning bankruptcy reorganization case - essentially stripping bank lenders of special claims on the Toledo, Ohio-based insulation maker's assets that gave them priority over bondholders and other claimants - roiled the debt markets, causing the company's bank debt to nosedive while its bonds firmed. But a distressed debt expert thinks that the decision by judge John Fullam of the U.S. Bankruptcy Court in Wilmington, Del. may not be the last word on the matter of substantive consolidation, as the legal maneuver is known

"I'm amazed at the ruling," said John Klinge, head of William E. Simon & Sons Special Situation Partners. "I was very surprised by the ruling. It's going to be hotly contested."

Klinge - whose Los Angeles-based company is the distressed-debt investment unit of the eponymous Morristown, N.J.-based investment banking firm founded by the late former U.S. Treasury Secretary William E. Simon - said that the disgruntled bank debt holders "will probably take it to the federal court.

"It's not the most pleasant thing in the world to do to try to appeal a federal bankruptcy judge - but it is what it is. I'm assuming that's what they will do."

A spokeswoman for Credit Suisse First Boston, the agent bank for the lenders' group, told Prospect News on Wednesday that CSFB would have no comment on the bankruptcy court ruling or on the lenders' group's possible responses.

In his ruling on Tuesday - which came exactly four years to the day after Owens Corning sought Chapter 11 protection from a flood of asbestos claim litigation- Fullam granted Owens Corning's request to treat the bankrupt company and its units as a single entity, and ordered competing creditors to reach a settlement on a plan of reorganization.

He ordered them to meet quickly, and to deliver a progress report to him within 30 days.

The ruling was a big setback to the group of 43 banks, led by CSFB, which fought against consolidation in pressing their claim that their approximately $1.6 billion in loans to the parent company and its units had priority over the claims presented by the bondholders and other creditors.

"The legal term [for what happened] is substantive consolidation," said Klinge. "The most important thing was that it stripped from the banks a guarantee of a Owens Corning entity that arguably the bondholders did not have rights to their assets or the value of that subsidiary until it was collapsed through the judge's order. That's the most important thing."

Under the U.S. Bankruptcy Code, he said, "each individual entity in a bankruptcy stands alone as an individual obligor - until there is a special ruling made like this, substantive consolidation. So banks frequently get guarantees to secure their debt from subsidiaries. This was a subsidiary they had a guarantee from."

Once Fullam handed down his substantive consolidation order, "effectively, there is no subsidiary - it's all one company. So everyone's effectively pari passu," or on an approximately equal footing in pursuing claims against the debtor's assets.

Normally, bank debt holders in a bankruptcy get paid before bondholders and other creditors further down the food chain, with equity holders almost always at the bottom of the ladder and subject to the most severe "haircut" - but this can differ from case to case. "It depends on absolute priority, depends on the collateral attributes" involved, Klinge said.

Loans drop, bonds rise

News of the ruling helped to drop Owens Corning's bank debt to levels below 70 from prior levels above 80, while the bonds, which had recently firmed to the upper 40s from prior levels in the lower 40s as the substantive consolidation issue came to a head, were quoted higher Tuesday, with at least one trader pegging the notes as high as 60 bid, while other saw the bonds in the 50s.

The fall of the bank debt versus the value of the bonds - to a difference of about 10 points versus about a 30-point difference previously - was "a recapitalization from basically specific additional values," Klinge said, with the banks reduced "to almost a pro rata participation in the overall asset value."

Besides the $1.6 billion of bank loans, there is about $1.5 billion of bond debt, $300 million of claims by trade creditors who supplied Owens Corning with materials and services before its filing - and an as yet undetermined amount of claims by persons who allege that Owens Corning is at fault for damage to their health arising from their handling of the company's asbestos-containing insulation products, either as employees involved in its manufacture or sale, or as end-users, such as construction workers who installed the fireproof insulation in houses and buildings. Owens Corning stopped making and selling the asbestos-containing insulation several decades ago, when it became widely accepted that asbestos is a potentially deadly carcinogen.

When the company initially filed for Chapter 11 status on Oct. 5, 2000, it was thought that the case might be resolved within about three years. But all kinds of problems popped up to drag the case out to the point where it is now beginning its fifth year under the bankruptcy umbrella, including the brouhaha earlier this year over whether the judge then hearing the case, veteran jurist Alfred Wolin, gave off the appearance of impropriety by having allegedly consulted with asbestos-claim plaintiff lawyers not involved in Owens Corning's case. At the request of the bank creditors, Wolin was removed from the case and from several other asbestos-claims cases in mid-May, ultimately being replaced by Fullam, and later retired from the federal bench to return to private law practice.

Simon sold Owens Corning position

Klinge said that William E. Simon, which frequently invests in the bank debt or bonds of bankrupt companies where it sees the prospect of a respectable return without too much muss or fuss, actually held some of Owens Corning's bank debt and bond debt earlier in the case - but decided to step out once it became apparent that the complex and increasingly nettlesome case would not be wrapped up within the originally anticipated three-year time frame.

"That's why we sold our position," he declared. "It took too long. In a bankruptcy, generally, unsecured claims do not accrue interest. They do not pay interest and they do not accrue it. We got some appreciation - but we saw things continued to drag on."

He noted that besides the creditor infighting, another factor adding to the uncertainty about the timing and cost of the case's outcome was the ongoing battle in Congress over how to deal with the explosion of asbestos-related litigation over the past several years, which has driven numerous companies such as Owens Corning, Southfield, Mich.-based auto parts maker Federal-Mogul Corp. and Lancaster, Pa.-based floorcovering manufacturer Armstrong World Industries Inc., to name just a few, to seek protection.

The Washington deadlock continues, with Senate Democrats and Republicans trying to narrow the gap between their positions on a proposed $140 billion asbestos claims fund that would be financed by the asbestos-challenged companies and their insurers - but which would entail claimants giving up their right to sue the companies for larger awards, a provision which is an anathema to organized labor and the tort bar.

With all of these things standing in the way of a quick resolution of the case, Klinge said, William E. Simon decided that enough was enough and eventually got out of Owens Corning, because "the process was just too long for us."

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