Highland Capital Management, L.P. – Dallas Fund Files Chapter 11 in Dispute Over Management Fees, Case Could Become Part of Texas-Sized Grudge Match Amongst Hedge Fund Executives

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October 15, 2019 − Highland Capital Management, L.P.  (“HCMLP” or the “Debtor”) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the District of Delaware, lead case number 19-12239. The Debtor, an investment entity managed by Dallas-based alternative investment platform Highland Capital Management (“Highland”), is represented by James E. O'Neill of Pachulski Stang Ziehl & Jones LLP. Further board-authorized engagements include Development Specialists, Inc. ("DSI") as financial advisor, with DSI to provide the Debtor with a chief restructuring officer.

The Debtors’ lead petition notes between 200 and 1,000 creditors; estimated assets between $100.0mn and $500.0mn; and estimated liabilities between $100.0mn and $500.0mn. Documents filed with the Court list the Debtors’ three largest unsecured creditors as (i) Redeemer Committee of the Highland Crusader Fund ($189.3mn disputed litigation claim), (ii) Patrick Daugherty ($11.7mn disputed litigation claim) and (iii) CLO Holdco, Ltd ($11.5mn contractual obligation claim).

In a press release announcing the filing, non-Debtor Highland advised that “HCMLP’s filing stems from a potential judgment being sought against that entity. Although Highland disputes the underlying claims, entry of the judgment in its maximum potential amount could result in a judgment against HCMLP greater than the entity’s liquid assets. HCMLP’s Chapter 11 filing was therefore necessary given its present liquidity position.

What the press release does not point out is that the dispute with Patrick Daugherty (the second largest unsecured creditor, listed above) has become notorious in its own right, Mr. Daugherty having been fired by Highland, where he was a portfolio manager, in 2011. Since then, Mr. Daugherty and Highland's President James Dondero have engaged in a series of fights (yes, one is accused of sleeping with the other's wife and then conspiring with that wife in divorce proceedings) that have captivated the attention of the Dallas, Texas media and the wider financial community; a protracted grudge match which has sucked in the Wall Street Journal. Mr Daugherty will undoubtedly be wondering whether this limited filing is being used in part to damage him. If so the salacious nature of his dispute with his former employer may very well spill over into this otherwise dry Chapter 11 cases nominally about CLOs and management fees. For more on the accusations of infidelity, Halloween parties gone wrong and "Dallas' Most Tabloid Worthy Hedge Fund" see here. If tawdry tales from the New York Post are not your thing, there is more on Highland's dispute with the WSJ (including the equally salacious falling out between Highland and another former portfolio manager, Josh Terry) in the WSJ's own article and also in a Highland press release assailing the WSJ's reporting practices and otherwise detailing a long list of grudges between Highland and its former senior executives.

Potential Judgment Against HCMLP

The press release continues, "The potential judgment against HCMLP relates to a crisis-era fund previously managed by HCMLP. The fund has been in liquidation since 2011. 

The liquidation plan, which was finalized and approved by investors and HCMLP in 2011, established a committee of fund investor representatives (the 'Redeemer Committee') to coordinate the liquidation process. Between 2011 and 2016, HCMLP distributed over $1.55 billion of the original account balance of approximately $1.70 billion. At that point, with over 90% of the liquidation process completed, the Redeemer Committee filed a complaint against HCMLP resulting from a contract dispute over the timing of management fees and other related claims. 

As noted above, Highland believes that HCMLP acted in the interest of investors and disputes the Redeemer Committee’s claims. However, in consideration of its liquidity profile, HCLMP determined that it was necessary to commence the voluntary Chapter 11 proceedings at this time."

Events Leading to the Chapter 11 Filing

In a declaration in support of the Chapter 11 filing (the “Waterhouse Declaration”), Frank Waterhouse, the Debtor's CFO, detailed the events leading to HCMLP's Chapter 11 filing.

The Waterhouse Declaration details a fairly straightforward story of a $189.0 arbitration award, the eminent enforcement of which caused the liquidity-stretched Debtor to seek shelter in Chapter 11. The declaration, which invokes the 2008 financial crisis generally without providing anything as to the current relevance of the crisis, does not, however, provide any detail as to the "variety of claims" in respect of which the arbitration panel made its award. Nor does it explain why Highland has not provided a backstop for HCMLP's arbitration-related debt. The declaration notes that the Debtor "does not have sufficient liquidity to immediately satisfy the Award or post a supersedeas bond necessary to pursue an appeal" while pointing out that it exists in order to provide "shared services for approximately $7.5 billion of assets managed by a variety of affiliated and unaffiliated entities." "None of these affiliates," the declaration notes, "are filing for Chapter 11 protection."

The Waterhouse Declaration states: "The Debtor’s filing was precipitated by an arbitration award (the ‘Award’) initially issued against the Debtor in March 2019, as subsequently modified and finalized, by a panel of the American Arbitration Association, in favor of a Committee of Redeemers in the Highland Crusader Fund (the ‘Redeemer Committee’). 

The Debtor was formerly the investment manager for the Highland Crusader Fund (the ‘Crusader Fund’) that was formed between 2000 and 2002. In September and October 2008, as the financial markets in the United States began to fail, the Debtor was flooded with redemption requests from Crusader Fund investors, as the Crusader Fund’s assets lost significant value. 

On October 15, 2008, the Debtor placed the Crusader Fund in wind-down, thereby compulsorily redeeming the Crusader Fund’s limited partnership interests. The Debtor also declared that it would liquidate the Crusader Fund’s remaining assets and distribute the proceeds to investors. 

However, disputes concerning the distribution of the assets arose among certain investors. After several years of negotiations, a Joint Plan of Distribution of the Crusader Fund (the ‘Crusader Plan’), and the Scheme of Arrangement between Highland Crusader Fund and its Scheme Creditors (the ‘Crusader Scheme’), were adopted in Bermuda and became effective in August 2011. As part of the Crusader Plan and the Crusader Scheme, the Redeemer Committee was elected from among the Crusader Fund’s investors to oversee the Debtor’s management of the Crusader Fund. Between October 2011 and January 2013, in accordance with the Crusader Plan and the Crusader Scheme, the Debtor distributed in excess of $1.2 billion to the Crusader Fund investors. The Debtor distributed a further $315.3 million through June 2016. 

However, disputes subsequently arose between the Redeemer Committee and the Debtor. On July 5, 2016, the Redeemer Committee (a) terminated and replaced the Debtor as investment manager of the Crusader Fund, (b) commenced an arbitration against the Debtor (the ‘Arbitration’), and (c) commenced litigation in Delaware Chancery Court, inter alia, to obtain a status quo order in aid of the arbitration, which order was subsequently entered. 

In March 2019, following post-trial briefing, the arbitration panel issued its Award, as subsequently modified and finalized, finding in favor of the Redeemer Committee on a variety of claims and requiring the Debtor to pay a gross amount of $189 million, which later would be partially netted against certain assets and deferred cash to be sent back to Debtor. The Redeemer Committee set a hearing in the Delaware Chancery Court for October 8, 2019, in order to obtain entry of a judgment with respect to the Award. The hearing was subsequently continued to October 16, 2019. The Debtor has sought to vacate certain aspects of the Award. 

The Debtor believes that it has substantial liquid and illiquid assets, which include interests in a large number of subsidiaries and contractual rights to receive management fees and other forms of compensation from affiliated and unaffiliated entities. Although the Debtor believes that the aggregate value of its assets exceeds the amount of its liabilities, the Debtor filed this chapter 11 case because it does not have sufficient liquidity to immediately satisfy the Award or post a supersedeas bond necessary to pursue an appeal

About the Debtor

HCMLP is an SEC-registered investment adviser on Highland Capital Management’s multibillion-dollar global alternative investment platform. The Highland platform was established in 1993 with an initial focus in alternative credit. A pioneer in the leveraged loan market, Highland helped advance the market’s development and expand investor access to the loan asset class. Highland has evolved over its more than 25-year history, building on its credit expertise and value-based approach to expand into other asset classes. Today, Highland operates a diverse investment platform, serving both institutional and retail investors worldwide. In addition to high-yield credit, Highland’s investment capabilities include public equities, real estate, private equity and special situations, structured credit, and sector- and region-specific verticals built around specialized teams. Highland is headquartered in Dallas, Texas and maintains offices in Buenos Aires, Rio de Janeiro, Singapore, and Seoul.

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