BNY Mellon Criticized in $400 Million Chesapeake Fight

By Erik Larson – Mar 13, 2013 12:01 AM ET

Bank of New York Mellon Corp. and a group of noteholders were criticized by a judge in their bid to force Chesapeake Energy Corp. (CHK) to pay $400 million in extra interest if it loses a lawsuit over its attempt to redeem $1.3 billion in notes early at par.

BNY Mellon, the trustee for the notes, and investors whose holdings total about $250 million seek a court ruling that Chesapeake would be automatically obliged to redeem the notes at a higher “make whole” price if its lawsuit fails. That is essentially “holding a sword” over Chesapeake in a way that could be viewed as “trickery,” U.S. District Judge Paul Engelmayer said at a hearing yesterday in Manhattan.

Engelmayer said he will decide tomorrow whether to award Chesapeake, the second-biggestU.S. natural gas producer, a preliminary injunction allowing it to tell bondholders by the following day that it will redeem the 6.775 percent notes at par six years before they mature.

Chesapeake argued that March 15 is the final date it can issue the formal notice of early redemption and avoid the make- whole provision, while indenture trustee BNY Mellon (BK) and investors holding $250 million in notes said it’s the deadline by which the call would need to be completed, and thus it’s too late to start the process. At yesterday’s hearing, both sides quoted from different parts of the bond issue’s indenture paperwork to back their interpretation of the deadline.

Make-Whole Penalty

The dispute over the meaning of the deadline could theoretically be dealt with separately from a make-whole penalty because Chesapeake made it clear it has no intention of redeeming the notes unless it can do so at par, the judge said.

Chesapeake sued on March 8 over claims BNY Mellon was misinterpreting the deadline. BNY Mellon is backed in the case by a group of noteholders, including hedge funds. The judge allowed them to intervene in the case at yesterday’s hearing.

The notes, issued in February 2012 and due March 2019, were pushed by traders to a record 105.9 cents on the dollar the day the lawsuit was filed, a signal they may believe the Oklahoma City-based company would have to pay a premium to call the debt.

The intervening investors, calling themselves an “ad hoc noteholder group,” include Archer Capital Management LP, Ares Management LLC, Aurelius Capital Management LP, Carlson Capital LP, Cetus Capital LLC, Latigo Partners LLP, Monarch Alternative Capital LP, P. Schoenfeld Asset Management LP, River Birch Capital LLC and Taconic Capital Advisors LP.

No Danger

BNY Mellon and the noteholders had argued Chesapeake isn’t in danger of “irreparable harm” in the case, citing a standard for obtaining such an injunction, because the energy company can seek money damages if it wins and won’t suffer permanent damage. The bank also said Chesapeake can’t prove it has a likelihood of success — another requirement.

Richard Ziegler, Chesapeake’s lawyer with Jenner & Block LLP in New York, said the dispute over the make-whole provision should be moot since the company has no intention of issuing the notice to noteholders if it fails to win the preliminary injunction protecting it from such a penalty.

Ziegler said at yesterday’s hearing that the injunction should be granted because the potential harm to Chesapeake in the absence of such a ruling would be greater than the harm to investors who are accustomed to managing, buying and selling notes based on a wide range of events that are common in the marketplace.

“One wouldn’t want to pay out six years of interest and get no benefit,” Ziegler said. The noteholders “will get an incredible windfall” from a make-whole payment, which they don’t deserve, he said.

Chafing at Bit

The noteholders “are chafing at the bit” for Chesapeake’s early redemption notice to inadvertently “trigger a make-whole payment,” Ziegler said.

The group of noteholders are entitled to the make-whole provision because it’s included in the “plain language” of the indemnity for the notes’ issue, said Steven Bierman, a lawyer for the investors. The group shouldn’t be punished as a result of Chesapeake failing to issue the early redemption notice on time, he said.

“Chesapeake is trying to shift the risk created by a problem of its own making onto the marketplace and noteholders,” Bierman said. While the company could have avoided the problem by issuing the notice earlier, “they failed to, or they forgot to — whatever — they didn’t do it.”

BNY Mellon and the intervenors “desire to take advantage of the ambiguity” in the contract, Engelmayer said. “That’s why we’re here, isn’t it?”

Full Trial

The judge questioned the idea that investors would be harmed by a ruling in Chesapeake’s favor, which would allow a full trial over the meaning of the deadline and possibly allow the early redemption by the middle of May.

“The last thing the trustee is trying to do is have a windfall,” BNY Mellon’s lawyer, Paul Weinstein, said at the hearing.

Weinstein rejected the judge’s suggestion that the situation could leave the New York-based bank open to a potential claim of gross negligence for allowing the dispute to develop between Chesapeake and the intervenors.

BNY Mellon initially supported Chesapeake’s plan when the energy company first discussed early redemption with the bank on Feb. 20, according to the complaint. Two days later, the bank changed its mind, Chesapeake said.

Chesapeake’s notes rose 0.125 cent on the dollar to 106 cents at 2:01 p.m. in New York yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

If the court rules that the company missed the opportunity to redeem the debt at par then the securities may trade as high as 110 cents, Brian Gibbons Jr., an analyst at New York-based CreditSights Inc., wrote in a report yesterday.

Both sides may seek to appeal the judge’s eventual order.

The case is Chesapeake Energy Corp. v. The Bank of New York Mellon Trust Co., 13-cv-01582, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporter on this story: Erik Larson in New York at elarson4@bloomberg.net

To contact the editor responsible for this story: John Pickering at jpickering@bloomberg.net