United States: Disqualified Lenders: The Lightsquared Controversy Over The Acquisition Of Its Debt By The Executive Chairman Of Its Competitors Illustrates The Importance Of Careful Drafting To Avoid Costly Pitfalls And Unintended Risks

In recent years, borrowers of leveraged loans have sought to include "Disqualified Lender" provisions in their credit agreements.  About two-thirds of recent credit agreements contained such provisions.1  The goal is to prevent competitors and other "unfriendlies" from infiltrating the borrower's senior-most piece of the capital structure and to prevent them from having access to confidential information or becoming a source of mischief in the event of a necessary amendment, workout, restructuring or bankruptcy.  This goal can be accomplished by carefully and unambiguously drafting the credit agreement to expressly provide that:

  • Transfers may only be made to Eligible Assignees (defined in the credit agreement to expressly exclude Disqualified Lenders);
  • The definition of Disqualified Lenders includes (x) a list of entities identified by the borrower at the time of commitment or closing and, in some cases, updated with additional entities identified by the borrower during the term of the loan and (y) "Affiliates" of any entity identified and listed under clause (x); and
  • Any purported assignment or grant of participation interest to such a Disqualified Lender is rendered null and void.

The absence of sufficiently broad and unambiguous "Disqualified Lender" provisions is fertile ground for materially divergent interpretations of the credit agreement that can lead to costly and unintended risks for all parties concerned.  The beleaguered (and much in the news) wireless technology company LightSquared LP ("LightSquared") and its majority owner, Harbinger Capital ("Harbinger"), which is controlled by Mr. Philip Falcone, find themselves locked in contentious and expensive litigation against their competitors Charlie Ergen, DISH Network Corporation ("DISH") and EchoStar Corporation ("EchoStar"). Mr. Ergen is the Executive Chairman of the board of directors and majority owner of DISH and EchoStar.  At the heart of the controversy is the acquisition of over $1 billion of LightSquared's senior secured loans by Mr. Ergen's wholly-owned investment vehicle.  These purchases, which have made Mr. Ergen the largest creditor of LightSquared and a driving force in its pending restructuring, have been challenged by Harbinger and LightSquared as being impermissible transfers under the terms of the credit agreement.  The case is scheduled to move to a full trial in January 2014.  If LightSquared and Harbinger prevail, Mr. Ergen's stake of over $1 billion in LightSquared debt may be disallowed or subordinated, and he, Dish and EchoStar may be liable for damages. Regardless of the final resolution of this controversy, it is safe to assume that none of the parties desired to find themselves enmeshed in this costly and protracted situation.

LightSquared Files For Bankruptcy Protection

LightSquared LP, a Delaware limited partnership, is a provider of communications and broadband services.  For several years, LightSquared was engaged in efforts to develop a next-generation ancillary terrestrial network ("ATC Network") that would employ both satellite service and ground-based antennas to provide nationwide state-of-the-art "4G-LTE" (Fourth Generation -Long Term Evolution) broadband mobile services. In 2010, the Federal Communications Commission ("FCC") approved the ATC Network and imposed certain build-out requirements on LightSquared.  Harbinger invested billions of dollars in LightSquared in connection with this FCC approval and indirectly owns more than 82% of the equity of LightSquared.

In order to raise the funds necessary to accomplish the ATC Network build-out, LightSquared entered into a credit agreement, dated as of October 10, 2010 (the "Credit Agreement"), with UBS AG, Stamford Branch as administrative agent (the "Administrative Agent"), and entities that were, or would serve as, "Lenders" under the Credit Agreement.

In February 2012, in response to allegations from GPS manufacturers and the US military that LightSquared's proposed use of its spectrum would cause interference with GPS devices, the FCC issued a formal notice proposing to suspend indefinitely LightSquared's plan to build out the ATC Network.  As a result, LightSquared was unable to proceed with the build-out of its ATC Network and it sought to reach a forbearance agreement with its creditors that would allow it to pursue a resolution with the FCC.  When those negotiations were unsuccessful, on May 14, 2012, LightSquared filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code (In re LightSquared Inc. et al., Case No. 12-12080 (SCC) Jointly Administered (collectively, the "LightSquared Bankruptcy Case").  The LightSquared Bankruptcy Case is pending before the Honorable Shelley C. Chapman in the United States Bankruptcy Court for the Southern District of New York.  LightSquared continues to operate its businesses and manage its properties as debtors-in-possession pursuant to Sections 1107(a) and 1108 of the Bankruptcy Code. 

Harbinger's and LightSquared's Adversary Proceedings Against Charlie Ergen, DISH, EchoStar and SPSO

In August 2013, Harbinger commenced adversary proceedings in the LightSquared Bankruptcy Case against Charlie Ergen, DISH, EchoStar, SP Special Opportunities, LLC ("SPSO"),2 the wholly-owned investment vehicle used by Mr. Ergen to make the loan purchases and certain other defendants. Mr. Ergen, personally and through his family trusts, beneficially owns and controls over 88% of DISH's voting shares and over 80% of EchoStar's voting shares. LightSquared intervened in these proceedings and filed a Complaint-In-Intervention. Harbinger and LightSquared alleged, among other things, that Mr. Ergen, DISH, EchoStar and SPSO knowingly violated the law and certain provisions of the Credit Agreement prohibiting the transfer of loans to "Disqualified Companies" by fraudulently purchasing, over the course of several transactions, a controlling position in LightSquared's senior secured loans outstanding under the Credit Agreement.  Harbinger and LightSquared alleged that such fraudulent and impermissible purchase of a controlling stake in LightSquared's senior-most capital tier was the lynchpin of an elaborate and multifaceted scheme3 on the part of Mr. Ergen, DISH and EchoStar to acquire LightSquared's valuable spectrum assets on the cheap and "on terms and conditions that were dictated by Mr. Ergen."

Disqualified Lender Provisions of the LightSquared Credit Agreement

The Credit Agreement includes a series of provisions that, as claimed by Harbinger and LightSquared in their filings in the LightSquared Bankruptcy Case, were meant to "protect LightSquared and Harbinger from opportunistic competitors . . . who might pose as lenders to develop a position in LightSquared's capital structure.

Section 10.04 (b) (Assignments By Lenders) of the Credit Agreement provides that: "any Lender may at any time assign to one or more Eligible Assignees all or a portion of its rights and obligations under this Agreement  . . . with the prior written consent (such consent not to be unreasonably withheld or delayed) of the Administrative Agent  . . . "

"Eligible Assignee" is defined in the Credit Agreement and provides that ". . . Eligible Assignee shall not include Borrower or any of its Affiliates4 or Subsidiaries,5 any natural person or any Disqualified Company."

"Disqualified Company" is defined in the Credit Agreement to mean "any operating company which is a direct competitor of the Borrower identified to the Administrative Agent in writing prior to the Closing Date and set forth on Schedule 1.01(a), and thereafter, upon the consent of the Administrative Agent (such consent not to be unreasonably withheld or delayed), such additional bona fide operating companies which are direct competitors of the Borrower as may be identified to the Administrative Agent from time to time and notified to the Lenders.  A Disqualified Company will include any known subsidiary thereof."

A list of Disqualified Companies is included on Schedule 1.01(a) to the Credit Agreement. The initial version of Schedule 1.01(a) included EchoStar, and it was amended in May, 2012 to add DISH, among other entities. Accordingly, each of DISH and EchoStar is a "Disqualified Company" under the Credit Agreement, and thus neither can be an "Eligible Assignee."  Mr. Ergen himself, as a natural person, also cannot be an "Eligible Assignee."  LightSquared and Harbinger alleged that because of these restrictions, Mr. Ergen made the loan purchases through a separate investment vehicle, SPSO, which he indirectly wholly-owns. Harbinger contended in the LightSquared Bankruptcy Case that the word "subsidiary" as used in the definition of "Disqualified Company" should be given the same meaning as the defined term "Subsidiary," which includes "any other person that is otherwise Controlled" by the parent and/or one or more subsidiaries of the parent. Accordingly, Harbinger contended that because SPSO is "Controlled" by DISH and/or EchoStar through Mr. Ergen, SPSO is or should be considered to be a "Subsidiary" of DISH and/or EchoStar and thus, a "Disqualified Company" pursuant to the terms of the Credit Agreement. LightSquared made a similar argument in its Complaint-In-Intervention by alleging that "DISH and EchoStar controlled SPSO, among other reasons, because their Executive Chairman, Mr. Ergen, and DISH's Treasurer and EchoStar executive, Mr. Kiser, acting within the scope of their agency and for the benefit of DISH and EchoStar, directed the investment and management policies of SPSO, specifically, its purchase of interests in the LP Debt."6 

As described above, in her order dated December 12, 2013, Judge Chapman permitted all but one of LightSquared's claims for relief in its Complaint-In-Intervention to move forward, including (1) declaratory relief that SPSO is not an "Eligible Assignee" under the Credit Agreement and is therefore in breach of Section 10.04(b) of the Credit Agreement, (2) breach of contract claim against SPSO, (3) disallowance of SPSO' s claims against LightSquared under Section 502(b) of the Bankruptcy Code,7 and (4) tortious interference with contractual claims against Mr. Ergen, DISH and EchoStar (but dismissed with prejudice against SPSO). The Bankruptcy Court also dismissed with prejudice LightSquared's claim for "equitable disallowance" of SPSO's claims.

In allowing certain of the claims to proceed, Judge Chapman noted that "A written agreement that is clear, complete and subject to only one reasonable interpretation must be enforced according to the plain meaning of the language chosen by the contracting parties,"8  but "a court does not read the words of a contract in a vacuum and must give due consideration to the surrounding circumstances and apparent purpose which the parties sought to accomplish."9 Judge Chapman also noted that "A court need not turn a blind eye to context." 

The case is now scheduled to move to full trial in January 2014. For now, we can safely assume that (A) LightSquared and Harbinger feel vindicated that several of LightSquared's key claims against Mr. Ergen, DISH, EchoStar and SPSO will "get their day in court," and (B) Mr. Ergen and related defendants are wary and disappointed that their efforts to "knockout" all of LightSquared's and Harbinger's complaints at the "motion to dismiss" stage have not been successful.

No matter how things go from here on out and regardless of which parties ultimately prevail, it is reasonable to conclude that the narrow scope of the Disqualified Company definition in the Credit Agreement and the absence of a provision therein that would expressly render null and void any impermissible transfer of a loan to a Disqualified Company played a role in leading to the current controversy. 

Let's make a few observations on the above and certain related provisions of the Credit Agreement:

  • Section 10.04(b) of the Credit Agreement permits an existing lender to assign all or a portion of its rights and obligations to an Eligible Assignee but only after obtaining the prior consent (not be unreasonably withheld or delayed), of the Administrative Agent. The Credit Agreement does not require any lender to obtain the consent of LightSquared to any transfers of the loans. A borrower's right to consent to assignments of and grants of participation interests in loans, while nice to have (for the borrower), becomes less important if clear and comprehensive terms are "hardwired" into the Credit Agreement to expressly prohibit the transfer of loans to Disqualified Companies and render any impermissible transfers null and void. 
  • The definition of Eligible Assignees excludes "the Borrower or any of its Affiliates or Subsidiaries, any natural person or any Disqualified Company." 
  • In contrast to the very broad scope of the exclusion as it applies to the Borrower, its Affiliates and Subsidiaries, "Disqualified Company" is narrowly defined as "any operating company which is a direct competitor of the Borrower," as well as "any known subsidiary thereof." This definition does not include the broad term "Affiliates" of any such competitor of LightSquared, which would have undoubtedly made SPSO a Disqualified Company since there is no dispute that SPSO, DISH and EchoStar are under "common control" of Mr. Ergen. The decision to limit the definition of Disqualified Company to only "known subsidiaries" of previously identified and scheduled Disqualified Companies likely was an important basis for Mr. Ergen's decision to buy the debt and to structure his purchases through SPSO, an entity that prima facie does not appear to be either a "subsidiary" or a "Subsidiary" of either DISH or EchoStar (that were both listed as Disqualified Companies on the schedule to the Credit Agreement).  This narrow definition of "Disqualified Company" is perplexing in light of LightSquared's assertion in court filings that "the parties intended for the transfer restrictions to prohibit LightSquared's direct competitors from acting as "Lenders," themselves or through other entities they had the power to control in any way . . . and to be as broad as possible, yet specific about which entities the Credit Agreement forbade from holding the LP Debt.
  • Under the Credit Agreement, the prior written consent of the Administrative Agent is required for any transfer of an interest in the loans.10  To effectuate such a transfer, the parties must execute and deliver to the Administrative Agent certain documentation, including an Assignment and Assumption Agreement, which requires the prospective purchaser to make various representations concerning, among other things, its status as an "Eligible Assignee."11  However, as is customary in syndicated loan financings, the Credit Agreement does not require that the Administrative Agent undertake any diligence or verification of any representations made to it by third parties, including representations by a prospective purchaser that it is an "Eligible Assignee."  Under the exculpatory provisions of the Credit Agreement, the Administrative Agent is not responsible for and does not have any duty to ascertain or inquire into any statement, warranty or representation made in or in connection with the Credit Agreement or any other loan document.12 The Credit Agreement also provides that the Administrative Agent is entitled to rely upon, and will not incur any liability for relying upon, any notice, request, certificate, consent, statement, instrument, document or other writing (including any electronic message, Internet or intranet website posting or other distribution) believed by it to be genuine and to have been signed, sent or otherwise authenticated by the proper person.13 The upshot of these customary provisions is that, in the absence of actual (prior or real time) knowledge regarding the veracity of the information it receives from third parties, the Administrative Agent cannot prevent impermissible transfers of loans to persons who represent that they are "Eligible Assignees," and those representations are at a later time (after the allegedly impermissible loan transfer) challenged by the borrower as inaccurate or worse.
  • Section 10.04(a) of the Credit Agreement provides that "the Borrower may not assign or otherwise transfer any of its rights or obligations hereunder without the prior written consent of the Administrative Agent . . . and any other attempted assignment or transfer by Borrower shall be null and void." In contrast, the Credit Agreement does not provide that any assignment or transfer by a Lender that does not comply with the Credit Agreement, including by reason of being made to a Disqualified Company, shall be null and void. The LSTA's Model Transfer Provisions provide that an attempted assignment or transfer by any party to the credit agreement in contravention of the provisions for such assignment or transfer shall be null and void. It seems safe to assume that this omission was part of Mr. Ergen's consideration in deciding whether to acquire over $1 billion of LightSquared's debt with his own money. 

Conclusion

It might seem odd to write a conclusion on a bitter and ongoing dispute between major players that is on the cusp of going to trial. Yet, there are sobering conclusions and lessons to be drawn from what has transpired so far in this case, especially for borrowers who desire to effectively prohibit their competitors from infiltrating their capital structure and using that as a staging ground to acquire valuable assets and/or confidential business information of such borrower.  

No matter how the dust finally settles in the trial or earlier settlement of this case, it is probable that Mr. Ergen would have desisted from acquiring over $1 billion of LightSquared's debt with his own money and executing the LiqhtSquared loan purchases through SPSO, and it is almost certain that the alleged grave harm, damages and undisputed heavy litigation expenses being endured by all parties could have been avoided if LightSquared's credit agreement had been carefully and unambiguously drafted to provide that:

  • The term "Disqualified Company" means (i) any "person"14 identified by LightSquared, whether on the Closing Date or any time thereafter, as a competitor of LightSquared and listed as such on a schedule to the Credit Agreement, and (ii) any Affiliate of any person identified and listed as a Disqualified Company under clause (i).  Importantly, such a definition would have squarely made SPSO a Disqualified Company because there is no dispute that SPSO, DISH and EchoStar are under "common control" of Mr. Ergen.
  • Any assignment of or grant of participation interest in any loan by any Lender to a Disqualified Company shall be null and void. This provision is critical to "give teeth" to the other prohibitions on transferring loans to Disqualified Companies by shifting all the risk of loss of on Disqualified Companies who attempt to acquire loans in violation of the Credit Agreement, knowingly or otherwise.

The costly and angst-ridden controversy between the LightSquared and Ergen camps will continue as the case is scheduled to move to a full trial in January 2014. It is unlikely that these adverse parties will ever see eye-to-eye on the existing disqualified lender provisions of the Credit Agreement that lie at the heart of this case. But with 20/20 hindsight and reflecting on how messy this situation has already become, the opposing camps may indeed agree that all concerned would have been better off if such disqualified lender provisions were sufficiently broad and unambiguous so as to avoid materially divergent interpretations. 

Footnote

1 Based on "Current Trends in U.S. Leveraged Loan Credit Agreements," a report by Xtract Covenant Intelligence in which they reviewed 118 credit agreements over June, July and August 2013.

2    SPSO is a Delaware limited liability company whose sole member and managing member is Special Opportunities Holdings LLC ("SO Holdings"). SO Holdings is a limited liability company whose sole member and managing member is Mr. Ergen.

3  The various prongs of Mr. Ergen's alleged conduct, the alleged harm caused thereby to Harbinger and LightSquared and the relief claimed by each of them are described in copious detail in their complaints and supporting memoranda filed in the LightSquared Bankruptcy Case. We shall not delve into these matters here in great detail since the primary focus of this Client Advisory is on the efficacy of the disqualified lender provisions in the Credit Agreement and how the narrow scope thereof played a role in leading to the current controversy.

4  "Affiliate" is defined in the Credit Agreement to mean "when used with respect to a specified person, another person that directly, or indirectly through one or more intermediaries, Controls or is Controlled by or is under common Control with the person specified; provided, however, that, for purposes of Section 6.08, the term "Affiliate" shall also include (i) any person that directly or indirectly owns more than 10% of the Equity Interests of the person specified or (ii) any person that is an executive officer or director of the person specified." This is typical 360 degree facing definition that picks up all persons in any type of control relationship with the subject "specified person."

5 "Subsidiary" is defined in the Credit Agreement to mean "with respect to any person (the "parent") at any date, (i) any corporation, limited liability company, association or other business entity of which securities or other ownership interests representing more than 50% of the voting power of all Equity Interests entitled (without regard to the occurrence of any contingency) to vote in the election of the Board of Directors thereof are, as of such date, owned, controlled or held by the parent and/or one or more subsidiaries of the parent, (ii) any partnership (a) the sole general partner or the managing general partner of which is the parent and/or one or more subsidiaries of the parent or (b) the only general partners of which are the parent and/or one or more subsidiaries of the parent, and (iii) any other person that is otherwise Controlled by the parent and/or one or more subsidiaries of the parent; provided that (x) the Specified Canadian Subsidiaries shall not be deemed to be "Subsidiaries" hereunder until such time that they become Wholly Owned Subsidiaries and (y) joint ventures or similar entities in which Borrower and its Subsidiaries own not more than 50% and formed with persons with whom there exists a Material Strategic Relationship for the purpose of building out the Network provided under Section 6.04(l) shall not be deemed to be "Subsidiaries" hereunder. Unless the context requires otherwise, "Subsidiary" refers to a Subsidiary of Borrower."

6 In mid-November, the Bankruptcy Court dismissed Harbinger's claims, including fraud claims, against the Ergen defendants because the court stated that Harbinger had failed to allege facts sufficient to support a fraud claim against the Ergen defendants. In the "Memorandum Decision Granting Motion to Dismiss Complaint," dated November 21, 2013, Judge Chapman stated that "[E]ven if one were to assume that the term "subsidiary" as used in the definition of "Disqualified Company" has the meaning of the defined term "Subsidiary," Harbinger has not pled facts sufficient to support its claim that DISH or EchoStar has the ability to control SPSO, making SPSO a "Subsidiary" or a "subsidiary" of either company and a "Disqualified Company" under the Credit Agreement." However, Judge Chapman in her order, dated December 12, 2013, that decided the Ergen defendants' motions to dismiss LightSquared's Complaint-In-Intervention and Harbinger's second amended complaint, allowed most of LightSquared's claims to move forward, including LightSquared's prayer for a declaration that SPSO is not an "Eligible Assignee" under the Credit Agreement and is therefore in breach of Section 10.04(b) of the Credit Agreement. While Judge Chapman did not provide a reasoned memorandum to accompany her December 12th order, it appears her decision to permit most of LightSquared's claims in its Complaint-In-Intervention to move forward may have been based, at least in part, on allegations in LightSquared's Complaint-In-Intervention that certain key executives of DISH and/or EchoStar, including DISH's Treasurer and EchoStar executive, Mr. Kiser, acted at the behest (and under the control) of Mr. Ergen in making the allegedly impermissible purchases of LightSquared loans.

7 Under Section 502(b) of the Bankruptcy Code, the court may disallow all or a portion of a creditor's claim where "such claim is unenforceable against the debtor and property of the debtor, under any agreement or applicable law for a reason other than because such claim is contingent or unmatured."

8 See Brad H. v. City of New York, 951 N.E. 2d 743, 746 (N.Y. 2011). 

9 See Thompson v. Gjivoje, 896 F. 2d 716 (2d Cir. 1990). 

10 See Section 10.04(b) of the Credit Agreement.

11 See Sections 10.04(a) and (b)(ii)(C) of the Credit Agreement.

12 See Section 9.03 of the Credit Agreement. 

13 See Section 9.04 of the Credit Agreement.

14 "person" is defined in the Credit Agreement to mean "any natural person, corporation, limited liability company, trust, joint venture, association, company, partnership, Governmental Authority or other entity."

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