It’s Paul Singer Versus Citigroup in a Bitter Bankruptcy Feud

As Peabody Energy Corp. stumbled toward bankruptcy last year, its Wall Street adviser raised a red flag for management.

Two powerful and litigious distressed-debt hedge funds held Peabody bonds. “Both are bomb throwers and we should be very suspicious,” wrote Tyler Cowan, a restructuring expert at Lazard Ltd.

Six months later, in April, the world’s largest private-sector coal company was in bankruptcy. And, sure enough, the two New York hedge funds -- Paul Singer’s Elliott Management Corp. and Mark Brodsky’s Aurelius Capital Management -- soon became embroiled in a bitter $1 billion dispute as they sought to extract a bigger share of Peabody’s assets.

The showdown has pitted Elliott and Aurelius against a Citigroup-led pool of lenders, and it centers on an arcane accounting change that highlights how the two funds, coming off a bruising, decade-long debt battle with Argentina, relentlessly look to gain an edge in bankruptcy proceedings.

In court filings, including emails and handwritten notes by Peabody executives, Elliott and Aurelius are shown to have privately lobbied management to make the accounting change that would shift $1 billion in collateral to benefit themselves and other holders of around $4 billion in unsecured bonds.

‘Fictional Tale’

The lenders led by Citigroup Inc., an agent to $2.8 billion in secured debt, contend that those assets rightly belong to them. Peabody caved to the demands of the hedge funds in their effort to “drive up their own recovery at the expense” of the secured creditors, Citibank says in court filings. Franklin Resources Inc., with 21 percent of one tranche of the debt, is among the biggest secured lenders.

Peabody dismisses the assertions as “an elaborate -- and wholly fictional -- tale of conspiracy.” There’s no evidence, it says, that management was “co-opted” or “acting at the direction” of the hedge funds and other unsecured lenders.

Elliott and Aurelius say in filings that in fact it was the Citi-led lenders that used their clout to get a leg up in the bankruptcy. The two firms, which lead a group that includes AllianceBernstein and Capital Research & Management, aren’t alleged to have engaged in any wrongdoing.

Allocation Dispute

Citibank, Aurelius and Elliott declined to comment on the case, which is being heard in bankruptcy court in St. Louis, where Peabody is based. The judge has said he will rule on the allocation dispute by Oct. 12 if the parties don’t reach a settlement in mediation.

In a statement, Peabody said that its approach “has been appropriate” and its financial statements comply with accepted accounting rules.

At stake is how Peabody will split its assets among holders of about $8.8 billion in various types of debt as it reorganizes. Peabody has said the fight is a barricade to its restructuring efforts.

For a QuickTake explainer on vulture investing, click here.

Called vulture funds by their critics, Elliott Management and Aurelius, founded by Brodsky, a former Elliott money manager, buy assets of troubled companies at deep discounts. Among other strategies, they’ve made a name for themselves in litigation arbitrage -- making investments that turn on an unsettled matter of law that they then pursue in court. 

Elliott oversees about $28 billion in assets. Aurelius had almost $5 billion under management, including leverage, as of Dec. 31, according to the latest regulatory filing.

In the funds’ best-known battle, they prevailed earlier this year when they reached a settlement with Argentina that landed them and two other firms $4.6 billion in cash. The funds had sued for full repayment after Argentina defaulted on its bonds in 2001. The contentious affair included former President Cristina Fernandez de Kirchner calling Singer a “Vulture Lord” and “bloodsucker.”

The funds also worked together in General Motors’ bankruptcy, trying to get what one Morgan Stanley analyst called “two straws in one milkshake.” A settlement gave their class 1.8 times the return of other creditors -- a rare departure from the bankruptcy norm that one loss is entitled to one recovery.

In the Peabody battle, the firms’ methods are on full display. Eli Bartov, an accounting professor at New York University’s Stern School of Business, said he found it unusual for investors to lobby a company for an accounting change.

"Management alone is responsible for accounting,” he said.

Accounting Change

In January, as declining coal prices took a toll on the industry, Peabody began negotiating with unsecured bondholders about a restructuring, its chief financial officer, Amy Schwetz, said in a recently unsealed deposition.

Aurelius Managing Director Dan Gropper proposed an accounting change, Schwetz testified. He said that if the company’s auditors ever expressed doubt about its ability to continue as a “going concern,” Peabody should reclassify its long-term debt as a current liability.

According to Citibank’s complaint, the company proceeded to do just that, even while knowing it would entail a waterfall of calculations that would mean a bonanza for the two hedge funds and other unsecured lenders in bankruptcy.

Essentially, the accounting change reduced Peabody’s net assets on paper, which in turn triggered a loan provision that Citi and other secured lenders say vaporized $1 billion of their collateral. Those assets instead went into a pool for unsecured lenders such as Aurelius and Elliott.

Expert Witness

Neither side disputes that the collateral was shifted. At issue is whether accounting rules mandated the reclassification. The Citi lenders presented an expert witness to say the change wasn’t required under generally accepted accounting principles. Peabody deployed its own expert to dispute that.

Bartov, the NYU professor, said that the decision to reclassify long-term debt is complex and depends on many factors.

Why would Peabody want to aid the two hedge funds, as alleged? Citi claims Aurelius had offered the company a smoother bankruptcy and would help it exit the reorganization with less secured debt. It also says the coal company was aware the hedge funds were a powerful source of future financing.

Pot, Kettle

Peabody’s response is that it didn’t have a dog in the fight. Whatever the outcome, it “will not reduce Peabody’s overall debt and instead will only dictate value allocation among two creditor constituencies,” it said.

Aurelius and Elliott say this is a case of the pot calling the kettle black, alleging in court papers that Citibank took steps before the bankruptcy on behalf of the secured lenders.

Starting in 2014, the coal company, a client of Citibank’s leveraged finance group since 2000, asked the bank for relief on a loan made in 2013. Citibank eventually granted it, a move that Aurelius and Elliott estimated benefited secured lenders by $455 million.

In recent weeks, court filings suggest that Elliott and Aurelius are taking no chances. As of Sept. 12, Aurelius cut its stake in Peabody’s unsecured debt to $165 million from the $235 million it had owned as of May 17. And, along with Elliott, it increased its position in the secured debt, seemingly hedging their bets if things don’t go their way.

— With assistance by Katia Porzecanski