LightSquared Bankruptcy Plan Rejected, Ergen’s Debt To Be Subordinated

May 9 2014 | 1:50pm ET

A federal bankruptcy judge dealt a blow to Harbinger Capital Partners’ effort to hold on to its wireless Internet venture, ordering it to the negotiating table with a bitter rival.

U.S. Bankruptcy Judge Shelley Chapman rejected LightSquared’s reorganization plan, a $2.65 billion proposal, backed by Fortress Investment Group, that would have allowed the company to exit bankruptcy after two years. Chapman found that the plan violated bankruptcy law by treating LightSquared’s biggest creditor, Dish Network Chairman Charles Ergen, unfairly.

But Chapman also rapped Ergen, blasting him for making an “end run” around debt covenants barring competitors from buying LightSquared debt. The judge ruled that part of Ergen’s $1 billion in LightSquared bonds would be subordinated.

Chapman ordered the two sides to negotiate a new bankruptcy plan, giving them two weeks and warning that she would impose the mediation of U.S. Bankruptcy Judge Robert Drain if the talks failed.

“If you come up with a deal, both with respect to amount of equitable subordination and a plan, no Judge Drain,” she said. “If you don’t, Judge Drain.”

Chapman ruled that Ergen had purposefully obstructed LightSquared’s bankruptcy process and violated the spirit of the company’s credit agreement using hedge fund Sound Point Capital, which she called “essentially a front used by Mr. Ergen.” She added that Ergen and other Dish witnesses were “not credible” when they claimed that Ergen was buying the debt as a personal investment and not on Dish’s behalf.

“Mr. Ergen found a loophole in the express terms of the credit agreement and exploited it,” she said.

But she also refused to cancel the debt, which she said was barred by the bankruptcy code. Chapman said a future trial will determine exactly how much of Ergen’s debt should be subordinated.

The judge also refused to award damages to LightSquared or to Harbinger founder Philip Falcone, saying they failed to contest Ergen’s purchases quickly enough.

She also agreed with Ergen that the seven-year third-lien note LightSquared proposed to give him was too risky. Chapman said that Ergen could be treated differently than other holders of LightSquared’s bank debt, but not worse.

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