Harch Capital Management has taken a swipe at Conn.-based hedge fund Old Hill Partners, which is behind a lawsuit alleging that Harch did not honor the terms of a collateral management agreement on a $425 million collateralized loan obligation (CLO). The lawsuit charges Harch with wrongfully taking a $7.6 million incentive fee and for breach of fiduciary duty on a Harch-sponsored hedge fund.
"These facts are complete baloney," said Michael Lewitt, senior investment advisor of Boca Raton, Fla.-based Harch Capital. "This lawsuit is based on fabricated factual allegations and should be barred from numerous procedural rules."
Last week Harch filed a memorandum of law in support of the motion to dismiss the lawsuit. The who's suing whom is complicated. The lawsuit was filed in April in New York on behalf of Harch International Limited (HIL), a hedge fund that Harch formed in 1997. Old Hill is actually not listed as the plaintiff in the allegation. But its Credit Arbitrage Fund has been the majority shareholder in HIL since late 2004. And it is Old Hill taking the shots from Lewitt. "Old Hill Partners profited enormously from this investment and should be thanking Harch Capital Management, rather than suing Harch Capital Management, for their efforts," he said.
Travis Pauley, general counsel of Old Hill and John Howe, president and founder, declined comment. Patrick Sweeney, a partner in the corporate department of Herrick, Feinstein, representing the plaintiff, did not return calls.
The roots of the case stretch back to 2000, when the CLO was originally raised. According to the suit, HIL provided the $30 million investment in the Class D subordinated notes, which represented the first-loss piece of the CLO. The suit alleges that the $30 million should never have been invested in the CLO, and approval from the Board was never sought, Harch states that under its subadvisory agreement, it had full discretion over the management of HIL.
Very soon after the notes were issued, the U.S. credit markets declined and the flight-to-quality led to redemption requests in HIL. Unable to sell illiquid positions, such as bank loans and private debt to meet these requests, the directors of the fund capped redemptions.
Meanwhile, the CLO was also suffering. "This decline posed an acute threat to the Class D noteholders," notes the memorandum from Harch Capital. To prevent the CLO from having to liquidate assets to pay off the senior notes and potentially wipe out the Class D noteholders, Harch reinvested $15.2 million of HIL's quarterly distributions back into the CLO. But the plaintiff states that this money should never have been reinvested and Harch did not obtain the approval or consent of the directors. Lewitt's firm disputes that the board was not informed and asserts that JPMorgan as trustee informed the investors. But Harch also argues that without the reinvestment of the $15.2 million, HIL would have received substantially less money.
Last Jan. 17 the directors of HIL were removed and replaced by a new board, which opted to liquidate the CLO and its investment in the Class D notes--totaling $45.2 million.
On March 22, JPMorgan distributed the $418 million of proceeds from the CLO. This new board, which included two partners from Old Hill, expected to receive $23.1 million, but instead Harch took $7.6 million as an incentive fee. HIL is now demanding the $7.6 million and punitive damages.
"When HCM refused to yield to the new HIL Board's meritless demands and strong-arm tactics and to return the incentive fee it had earned, HIL filed this frivolous lawsuit," Harch Capital's memo states. It describes the actions as an extreme example of Monday morning quarterbacking. "HIL takes exception to nearly every major investment decision made by [Harch Capital Management] since the formation of the Harch CLO--decisions which HIL has not alleged it ever complained of or objected to over the five years since the initial investment, but which it now suddenly asserts were rife with bad faith, conflicted interest and an array of other breaches of fiduciary duty," blasts the Harch response.
