Restructuring

Contributed by Michael F. Walsh
The chapter 11 case of Thornburg Mortgage, Inc. has generated substantial litigation against former officers and directors of the debtors, as well as the debtors’ corporate counsel.  The case is a useful reminder of some of the issues that may arise when representing a company whose officers, directors, or affiliates may have interests that are not completely aligned with those of the company.  In re TMST, Inc., Bankr. D. Md. 2009, Case No. 09-17787 (DWK).

Prior to its chapter 11 filing in May of 2009, TMST, Inc. (f/k/a Thornburg Mortgage, Inc.) (“TMST”) was a real estate investment trust which, through its subsidiaries, originated, acquired, securitized, and serviced residential mortgage loans.  TMST had none of its own employees, offices, or computer equipment.  Instead, TMST’s businesses were managed on a day to day basis by Thornburg Mortgage Advisory Corporation (“TMAC”) pursuant to the terms of a management agreement between TMST and TMAC.  TMAC’s majority shareholder was Garrett Thornburg, who was also chairman of TMST’s board of directors.  TMST’s CEO and CFO, Larry Goldstone and Clarence Simmons, were also equity holders in TMAC.
In late 2007, as TMST’s business faced increasing pressure from the slowdown in the housing and financial markets, TMST began to explore the conversion of its main business into a federally chartered thrift bank, which would enable the company to access the financing necessary for its continued operations.  Using this strategy, TMAC and TMST would share ownership of the thrift, though TMAC would be the majority shareholder.  The company pursued the thrift strategy throughout 2008 and into 2009, but by the spring of 2009, no transaction had been consummated, and a forbearance agreement with TMST’s repurchase counterparties was set to expire in March.
According to the complaint filed by the chapter 11 trustee (attached here), as well as a similar complaint filed by the U.S. Trustee, Goldstone, Simmons, and TMST’s corporate counsel engaged in “an unchecked frenzy of self-dealing and wanton and reckless breach of fiduciary duty and loyalty” in the weeks leading up to the May 1, 2009 petition date.  The heart of the allegations is that Goldstone and Simmons abandoned their fiduciary duties to TMST and formed a new entity to pursue the thrift strategy with TMAC, but without TMST.  This led them to take numerous actions in their capacity as officers of TMST that were only in the interests of themselves or TMAC, to the detriment of TMST and its creditors.  These actions included the following:
i.          amending the management agreement in a manner that provided no benefit to TMST, but ensured that TMAC would be immediately reimbursed for expenses owed by TMST to TMAC under the management agreement so that TMAC would not be left with a large unsecured claim in TMST’s chapter 11 case;
ii.          terminating the bankruptcy attorneys who advised TMST against paying anything to TMAC earlier than necessary under the management agreement;
iii.         pursuing the thrift strategy for their own gain prior to and during the chapter 11 case using TMST’s internal systems and assets, including confidential work product prepared for TMST by its advisors;
iv.         causing TMST to make approximately $1.2 million in prepetition payments to vendors who would be critical to the new business venture of TMAC and the insidera, with no benefit to TMST or its chapter 11 estate; and
v.         manipulating TMST’s payroll so that employees who were working for both the new enterprise and TMST’s chapter 11 estate overbilled the estate and underbilled the new company.
The U.S. Trustee’s complaint, relying on the same principal allegations found in the chapter 11 trustee’s complaint, seeks to deny and disgorge all of the fees charged by the debtors’ lead attorneys (totaling approximately $600,000).
The allegations in Thornburg, if taken at face value, make clear that Messrs. Simmons and Goldstone wore multiple hats in their dealings with the debtors.  Although it remains to be seen how the litigation will play out, the case is a stark reminder that in circumstances in which directors or officers of a debtor have interests or positions that are related to, but not necessarily consistent with, the interests of the debtor, steps must be taken to ensure that the directors and officers – and their advisors – are freed from even the appearance of a conflict.