A New York state judge is preparing to hear a trial between Black Diamond Capital Management and Bank of America, the result of which could provide a better understanding of how lender DQ lists are enforced. In this episode of Cloud 9fin, Jane Komsky unpacks the case and the potential impacts on the broader market with Polsinelli restructuring chair David Karp and 9fin reporter Tom Quinn.
The discussion examines the three questions now facing the court: whether Bank of America should have settled a trade with an affiliate to a disqualified lender, whether it satisfied a requirement to provide an economic equivalent when the trade failed, and whether it acted as soon as practicable to find a solution.
Karp argues that any ruling is likely to focus on Bank of America’s post-trade conduct rather than overturn the core loan-market principle that a trade is a trade. The case also highlights the value of lender-of-record status, opaque DQ lists, voting rights and the risk to desks that leave trades unsettled.
You can read our original story on the litigation here.
And to get up to speed on all things LMEs, enrol in our crash course, curated by Jane and the distressed team.
Episode transcript
This transcript was generated with AI assistance. Report any material inconsistencies or inaccuracies by emailing podcast@9fin.com.
Jane Komsky
Hello, and welcome to Jane's LME Addiction, a Cloud 9fin podcast where we talk about all things liability management. I'm your host, Jane Komsky, and with me today is David Karp from Polsinelli and Tom Quinn, a reporter here at 9fin. Thank you guys so much for joining me.
David Karp
Thanks for having us.
Tom Quinn
Thanks, Jane.
Jane Komsky
For the benefit of our listeners, David, if you could just take a minute to tell us a little bit about your firm and the work that you do.
David Karp
Sure. I'm at Polsinelli, where I'm the chair of our restructuring practice and co-head of special situations and alternative investments. We are 1,000 lawyers across the U.S. in main financial centers like Dallas, Miami, Austin, Nashville and 20 other locations. We have incredible private equity M&A lawyers and restructuring lawyers, and we are focused on growing in New York and in those Wall Street-centric locations like Dallas and Miami. I'm excited to be here.
Jane Komsky
Thanks again for coming. And so, Tom, I'd ask you about what you do, but I think we're mainly here today to discuss an article that you wrote, along with Maria Heeter here at 9fin. And so, Tom, if you could just tell us a little bit about the article that brought us all in today.
Tom Quinn
Exactly. Yeah. So, Maria and I, we wrote an article about litigation that's happening in New York State Court. Black Diamond Capital Management has sued Bank of America over a trade that couldn't close, according to Bank of America, because of a DQ list. And so this litigation that has arisen from this trade is one of the first times that distressed debt investors, that private equity sponsors, that the sell side can all see what happens in litigation when a DQ list stops a trade from actually closing and settling.
Jane Komsky
And so we've spoken about DQ lists on this podcast before, but David, how often does something like this happen? One, how often do these trades not close? But more importantly, how often does it go into litigation?
David Karp
It doesn't go into litigation quite that often, but it happens more often than you think. But let's set the table and put some table stakes down. We have to start from the premise that a trade is a trade. I'm sure you've seen that and you've heard that and you hear that in the expert testimony. I don't think that's going to change here. What I mean by that is, when the sell-side trader and the buy-side trader either get on a recorded line, or trade a Bloomberg instant message, or trade an email for bank loans, and they agree to the price, the notional amount, and the facility, and they say, done. When they go home that night, the seller has moved the risk asset off their balance sheet to the buyer, and the buyer is on-risk. Doesn't mean that everything that happens after that trade date doesn't matter. It certainly does matter. I think that's what we're going to find out here. But I don't think this case is going to change that premise. I think that's really important for the functionality of the loan market, that a trade is a trade.
Jane Komsky
That makes a lot of sense. Tom, tell us what was different here. Also, first, tell us, did this trade follow the type of trade, a trade is a trade that David laid out just now.
Tom Quinn
Right, exactly. So there's a few issues that are present in this case. The first is the name that Black Diamond tried to trade on. So, yeah, in 2021, Black Diamond and Bank of America agreed that they would trade $20 million of term loans, and this was traded at $0.91. Sense. And the agreement here was under the CSLL, which was an entity that Black Diamond created in order to not have the name Black Diamond as the trading party.
Jane Komsky
And so before you continue, I'm going to ask David, how often does that happen? That a company or a firm creates a new name in which to trade under?
David Karp
Well, they were looking at the specific credit agreement and how to manage the definition of a disqualified lender under that specific credit agreement. So I think...
Jane Komsky
Which here had very specific language. Can you remind us?
Tom Quinn
Right. Exactly.
Jane Komsky
What did it say?
Tom Quinn
It said that it had to be reasonably recognizable in the name. So that was the crux of the question here is that it has to be recognizable in the name of the entity.
Jane Komsky
Okay. And so I cut you off. So continue.
David Karp
Well, it goes back to a DQ list is not a DQ list provision is not a DQ list provision. The LSTA, Model Credit Agreement, would prefer that we had a DQ list at the time that the loan was issued, and that if names were added to that DQ list, they would be on three days' notice, that any seller of the loan could immediately check with the agent and find out in a very easy and robust process who's on those DQ lists, and then not trade. In the event that someone did buy on a DQ list, who was on a DQ list, it wouldn't cancel the trade, but the parties would work together to either cash settle or to take as a participation where they would not receive information rights. All that theory being great if loan parties followed what the LSTA model prescribed. As we know, and the LSTA, to their chagrin, has written a commentary on this quite often, that's not how the market functions in reality. In reality, the way that DQ lists are working has been very ad hoc, and they've been changing, And in my experience, significantly since COVID, sponsors and borrowers have been more aggressive in putting large names on the list and changing the list at different times. And that can cause confusion in executing loan trades. And that's how we find ourselves here.
Jane Komsky
Exactly. And so, at the risk of giving our listeners a whiplash going back and forth between the two of you, Tom, tell us, what exactly happened here and why didn't it follow what David laid out?
Tom Quinn
Exactly. Bank of America agreed to the trade with CSLL. When they did the KYC on CSLL, they found that it had the same address as Black Diamond and shared a Black Diamond employee. So, there wasn't much of a confusion about where the actual owner of this position was coming from. And so, Bank of America, they call the private equity firm of Crown Paper, the company that was trading the loans, and they said, hey, can we have the DQ list? We want to settle this trade on participation with CSLL. Well, the Citizens, the bank that syndicated the term loan, sends the DQ list to Bank of America. They see that Black Diamond is on the list, and they then say, OK, now we're in a spot where we can't settle this loan. That's the position that they take. That because Black Diamond is on the list, and because they know that CSLL shares an employee and an address with Black Diamond, that they're not able to close and settle this trade. Time goes on. Crown Paper comes into significant distress. They bought it at 90. And all of a sudden, it's nine months later, and the private equity sponsor decides to sell the company. They sell the company. The loan's liquidated at $0.34. And throughout the process, Black Diamond had been attempting to direct, through CSLL, have been attempting to direct Bank of America to not vote to close the transaction. And so Bank of America took the position and takes the position that they were unable to take direction from Black Diamond because the trade was unable to settle. So that's the higher level overview of kind of the timeline of how this played out.
Jane Komsky
Yeah, thanks so much. And so my question for you, David, is what about this fact pattern is typical and what is atypical?
David Karp
So let's talk about the unable to follow the vote and how voting usually takes place. The baseline is that when a trade takes place, a seller is not required to follow the buyer's instruction with a vote on a restructuring or amendment or other types of plan voting unless it's expressly agreed at the time of trade, which we understand is a point of fact of contention here. There are some situations. There's carve-outs. There's exceptions to that as well. For example, if the seller owns $100 million and they've sold $49 million and they can only vote their position in one direction, they're going to follow the instructions of the majority, which may be another buyer or may be held by the seller. There are also reputational carve-outs, where a seller does not have to follow a buyer's voting instructions if it could reasonably negatively impact their reputation, or put them in the crosshairs of a regulator, or for other liability that they're not adequately indemnified for. But that's not what happened here. But that is the baseline that we're talking about when we're thinking about voting.
Jane Komsky
And so it sounds like even with the voting that usually these sort of disputes don't find their way into a courtroom. Tom, do you have any thoughts on why this one just made it all the way to litigation and then went through several or I guess various courts?
Tom Quinn
Right. I mean, there's a there's a nine million dollar difference, which is what the difference was between when Black Diamond agreed to purchase the loans and then when they were liquidated. So that's the crux of the question is, who's liable? Is it Bank of America for refusing to settle the trade? Or is it Black Diamond who had entered into this agreement? Who should be liable for that difference? And like you said, it's interesting, right? Because these are institutions that have known each other for a very long time. Through litigation, it showed up that they had done hundreds of trades together. They know each other very well. And somehow, you know, they've ended up in this place where where the litigation has has certainly sparked some emotions. I think the quote that we have is that Black Diamond's CEO in a statement to 9fin said that Bank of America was, you know, called them liars and and said that they had resorted to unlawful tactics here. So clearly the relationship that usually keeps this these types of disputes out of court has fallen apart over the course of those nine months.
Jane Komsky
And obviously not to lower or diminish $9 million, which is a large sum of money, but in our world where so many, I mean, in most cases that we follow, like the liabilities alone are hundreds of millions. And so, you know, $9 million is not that big of a quantum to basically burn a relationship with here, but it seems like there's something deeper here. And I don't know if you have thoughts on that. It's a fair
David Karp
Comment, but it's a big percentage of the trade. That's important here. I think that you're going to see most of these situations work themselves out because the overall economics are not that material. A buyer, and in this case Black Diamond, could have sold out their risk and then netted out the trades. There are other situations that come up that are similar, where the parties cash settle, or the seller sells back to the buyer, or they work it out with the other economic equivalent. But here, I think I take your point on the $9 million, but I think it's a significant percentage of the overall amount in dispute.
Jane Komsky
Right. And so, while the capital structures we're looking at are hundreds of billions, any one given trade, this is not usually the number that you're seeing. So, typically, what would you say when you think about typically reasonable economic equivalent, how large of a quantum are we talking about?
David Karp
Well, what I was really referring to is, let's say the spread is $2 million, right? Or this dispute comes up months after the trade has taken place. The parties may be more incentivized and may feel like they have other paths to work things out. It isn't necessarily the dollar amount, but it's how quickly can these desks come together and work constructively together to get out of it. I think here you had Bank of America taking certain unilateral action without Black Diamond. I'm sure that started this on a path in a certain direction. And I think all of that part of the story can't be underestimated when it comes to those relationships.
Jane Komsky
And so I think a lot of times when we think about LME litigation, we think, okay, well, no party is really interested in this going all the way because they don't necessarily want an answer. But here, it's kind of unclear whether or not the parties actually want a final answer and what the broader implications are for the market. And so, I guess my question for both of you is, what do you think, if the court decides to rule for Black Diamond, what are the implications for the market?
David Karp
So, in my view, if the court decides to rule for Black Diamond, it's going to be very narrow, construed and based on the specific facts of Bank of America's post-trade behaviors. I don't think that we're going to get a ruling that says that no longer a trade is a trade. There's no longer risk shifting on the trade date. I think it's going to be something in that, what is it, two years post-trade that took place that allows a court to get there. And I don't know that the court will. But I think the fear in the market, and the fear specifically from the sell side, is that, is this going to upend New York general obligations law? And the fact that parties rely on that they go home on risk or off risk in booking a trade, I don't think that's going to happen here.
Jane Komsky
Tom, is that what you've been hearing as you've been asking people in the market this question?
Tom Quinn
Exactly. So, the court is really looking now to answer three questions. And I think what everyone has said, which is what David just said, is that every case is specific and there are facts that will only apply to the case that we're talking about. But the three questions that are being answered are, should Bank of America have closed, settled the trade? Because on name alone, CSLL and BDCM or Black Diamond Capital Management are different, right? And the court has said that, that they are different in name alone. The next question is this question of economic equivalent. And normally, if you're in a situation where you try and close a loan and you can't because of a DQ list, you would go to participation. Now, most of them or some sort of TRS. Now, some DQ lists now will include derivatives, but most will include participation as did this loan. So, that's a question, too. What does it mean to provide an economic equivalent at this point? And then the final one is as soon as practicable. And some of the things that we've been talking about, which is really interesting, is what did Bank of America do in between the time? So from the time they found out that Black Diamond was DQ'd to the time the loans traded, there were some things that both Black Diamond did and then Bank of America did to try and get out of this situation. One of which was Black Diamond trying to just get itself off the DQ list, which it was unsuccessful at doing. But something else was they had directed Bank of America to trade these loans to a different party. And Bank of America, this is going to come out in factual dispute, but had started a KYC process and whether or not that KYC process took enough time for Bank of America. So to answer your question, as David said, every case is specific, and the implications of this might not be totally broad and sweeping, but it will give the market an idea of how courts will think about these three questions. And these three questions are important, and they're questions that we, at least at 9fin, don't think have strong answers yet in litigation in the market.
David Karp
I think what this case is doing, and clearly in both expert reports, is shine the light on some really important loan trading technical issues that can impact investment success or recovery. Because ultimately, neither of these parties are in the business of long-dated settlements and loan trade litigation disputes. And so, exactly, understanding what participations versus TRS versus other economic equivalent, what a KYC process can do to the timeline for you to take actual ownership of a loan and therefore have a seat at the table and be able to have access to all documents and all rights. Rights. All of those things are important when a portfolio manager is making a decision to invest in a name as to how quickly they're going to become, if they're going to become, a lender of record and have a seat at the table and what that means. In the environment that we're in, where a creditor is not a creditor is not a creditor, I'm not sure what the answer is. I I know there will be other exciting podcasts on that issue shortly, but that environment makes it much more important to be a lender of record rather than a participant or a derivative owner if you want to have a seat at the table, if you want to potentially be part of a co-op or a committee and get some of the goodies that go along with those types of seats.
Tom Quinn
Right. And just to add on to that too, like you said about the importance of being a lender of record, one of the strategies that we at 9fin have been reporting on is purposefully leaving trades unsettled. And that's as a way to get around DQ lists. If you know you're DQ'd and you purposefully do this, right? And so there are other side letters that can happen when you know you're, which is not what happened in this case. They didn't purposefully leave it unsettled. But there's real questions as to if the court rules in Black Diamond's favor, whether or not the sell side is going to be really comfortable sitting out there and saying, OK, we're going to allow these trades to stay open and allow them to be unsettled positions where you could be stuck in the middle on the sell side.
David Karp
I don't know how comfortable the sell side is with leaving trades open and unsettled in any scenario. I think those types of situations that you just described and leaving those trades in open are managed on a very specific relationship and case-by-case basis. And both parties are a little bit playing with fire. And I think the distinction between the expertise of different parties that have been in this market for 20 years and know how the sausage is made and how the trades settle and the moves that you can make in and out to keep a trade unsettled very differently from sell side desk to sell side desk and from buyer to buyer. Right.
Jane Komsky
And so I guess, I mean, when I think about the language, specifically the reasonably recognizable, you know, at first that just strikes you as like there had to be like firmer language that could have prevented this, right? But it sounds like because of the importance of if you actually want to be a player in a capital structure, you need to be a lender on record, that it doesn't really matter. But I don't know if you have thoughts about this type of language and why it's worded the way it is.
David Karp
Well, I think it goes back to who's an eligible assignee. I don't know why the affiliate definition was drafted the way that it was here, but words matter. And I think that's really what Black Diamond responded to. And I think they responded to it in a way that potentially met the contractual requirements. And that's what we're going to find out.
Jane Komsky
Definitely. And so, I guess my next question for you is, at what point in the process would you have sort of jumped in or thought about, this is getting out of hand?
David Karp
Well, that's a great question. I'm hopeful that on complex trades, that I'm getting outreach from the traders at the trade recap stage. Right? And so, one of the things I've said, the great joys of practicing law, and there's a couple different things. One is, if you've ever been involved with family office cases and family business enterprises, there's a lot of color and a lot of psychology and a lot of interest in those things. The other great joy is looking at trade recaps and the colorful language.
Jane Komsky
That's what everybody says. It's like you're all the time.
David Karp
The trade recaps have brought quite a chuckle across the law firms at different moments. But these are really important, and you are trading billions of dollars of paper on the back of a napkin, is effectively what it is. And so, if we know there's going to be a complex rights offering, or subscription rights, or there's a particular voting right, or big boy waivers that we need to look into, clients get me involved right at the trade recap stage. This is the type of situation I probably would have gotten a call right at the point of where, hey, we're on a DQ list. How do we get off the DQ list? What does this mean? What are our options to settle? What are our options to instruct the vote? And look, you have a great sell-side desk. You have a very sophisticated fund here that I'm sure was well-advised. But there was a pickle here. And not a lot of the pickles that we find ourselves in with these types of trade disputes, as I said, you work it out. You find a way to split the difference, make it up on another trade or whatever that settlement might be. And here, the parties couldn't find a way.
Jane Komsky
And so, Tom, as, someone that has their ear to the ground, where is this headed? What's next in this case?
Tom Quinn
Right. So there was a hearing about two weeks ago in this case as it as it heads toward a trial and the hearing. A lot of what's happening right now is very factually applicable to this case. But the general litigation here was it was decided in Bank of America's favor on summary judgment that was overturned on appeal. And it was sent back down to answer the three questions that I said before, which is should Bank of America have settled the trade? Did they provide an economic equivalent, and did they work as soon as practicable to find a solution to this problem? And so those three questions are the questions, you know, there's a lot of factual disputes that will come up as part of this case that are, of course, important to any trial. But those are the three questions that we're really looking at to see what the case says.
David Karp
And I want to note that as soon as practicable has been looked at a number of cases, and there's not a specific timeline, right? And this was a par trade, seven days, distressed trades, generally 20 days is the recommended timeframe. Although the average settlement for distressed trades more like 50 to 60, it is not unusual for trades for one reason or another, whether it's upstreams or subscription rights or other reasons to remain open for six months to a year. It's not common, but it happens. And that in and of itself doesn't mean you cross a certain 30-, 60-, 90-day threshold and the as soon as practicable timeline has not been met. So that, again, is something that a court is going to have to take a view on.
Jane Komsky
And so what's the lesson here? If you had to point to one, obviously we have to wait for the litigation decisions become hindsight as 20-20. But if you were to look at the situation and how it's unfolded, what are some takeaways that people should be thinking about?
David Karp
I think it's a tough one, and it's tough. The DQ lists are really tough because you don't necessarily, as a buyer or a seller, have access to understand that it's in play until you trade. I certainly have seen trades where a seller sells, has trouble with certain buyers, and does not flag for additional similarly situated buyers that there's an issue, that there is a growing DQ list and that the trade may remain unsettled. So I think what you're going to see here is that, number one, we're going to go back and the market's going to function, right? A trade is still a trade. And I think what you're going to find out here is that you have to look at the very specific language of the DQ list provision on a credit-by-credit basis. And I think buyers need to look at the credit agreement pre-trade and understand what the risk is. And that certainly is something that almost every credit agreement has a prospective assignee provision, where if you are a prospective buyer, you can agree to a confidentiality agreement with your prospective seller, and they can share the credit agreement with you. And you can look, among other things, you can look at who's an eligible assignee and the DQ provision and do a little bit of that work. It's not a catch-all and it's not bulletproof, but I think this is the kind of thing, and when things like this cost traders time and money, it becomes an area of focus for other traders as they move forward.
Jane Komsky
And Tom, same question to you. After doing all of your research and looking into this story? Is there any specific takeaway that you're thinking about?
Tom Quinn
Yeah, I mean, I think it's similar, right? Access to DQ lists. I think that's a huge question that we got asked over and over again, which is a factual question of Bank of America and finding out who was on the DQ list because this whole thing could have been avoided. But the real question is there's some, as you've said, there's some DQ lists now that can't be shared unless it's a lender of record. And so this idea that you could be potentially opening yourself into a situation where your client comes to you, they say, make a market, you go make a market for them. And then all of a sudden you're stuck in the middle of this trade because you believe you can't settle because of the DQ list that you didn't have access to before you tried to make a market for them. That is an issue that we're not really sure what the solution is. But that's an externality of this case as well. That could come up for sell-side participants.
Jane Komsky
Yeah. And it's interesting because, like you were saying, the DQ list rules come from credit agreements. They don't come from the market. They don't come from the people really making the trades. And typically, the person who's advising on this credit agreement is only thinking about the sponsor and how they're thinking about things. And so it's hard to imagine a world where we'd get clear certainty as to, this is the norm for DQ lists, this is how we should operate. I don't know if you have any thoughts on that.
David Karp
Yeah, look, one of the things you may see, you have certain sell-side banks that trade as principal and do back-to-back principal trades. You have a number of other sell-side institutions that trade riskless principal, meaning that they're matching the trades and stepping out, and they're agreeing to the buy only to the extent that they've confirmed the sell trade. And you might see your traditional bulge bracket type banks trading more riskless principal on some of these names with robust DQ lists so they don't get caught in the middle, kind of holding the potato.
Jane Komsky
Yeah. No, I think this is one to watch. It'll definitely be interesting to see where the court lands on it. Thank you both for coming in and talking about this with me today. It was fun having you.
David Karp
Thank you. Great to be here.
Tom Quinn
Yeah, thanks, Jane.
Jane Komsky
Sure. And thank you to our listeners. If you have any questions, please email podcast@9fin.com.