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Judge Allows Refco To Pay Off Secured Lenders

by Glen Shapiro,, New York

05 October 2006

Refco's bankruptcy judge Robert Drain last week agreed at a hearing in New York to permit Refco to pay US$642m to secured lenders. The application had been resisted by a group of hedge funds holding 25% of Refco's stock - although they appeared to have acquired their holdings after the company's bankruptcy in October, 2005.

Refco filed for Chapter 11 protection from creditors on October 17th, one week after the firm said former chief executive Phillip Bennett had hidden $430 million of bad debt. The company is now selling assets to pay creditors that claim they are owed up to $16.8 billion. Bennett has pleaded not guilty to eight counts of conspiracy, fraud, and other charges.

Drain said that the settlement would protect the secured lenders from claims by third parties, and was a necessary precursor to an overall resolution of Refco’s Chapter 11 bankruptcy. “It is clear to me that it is important to resolve potential claims that have been aired against secured lenders, which this settlement effectively deals with,” said the judge.

Refco also wants to use settlement monies to be received from Austrian bank Bawag for the same purpose. In exchange, Bank of America would drop claims that Refco gave it misleading financial data related to the loans. Hedge funds JMB Capital and Lonestar have particularly objected to the proposed use of Bawag proceeds, saying that their allocation should be controlled by the court. Judge Drain did not rule on the issue of the Bawag proceeds.

As part of the settlement, creditors could receive compensation of up to US$200m if Morgan Stanley is successful in selling Bawag for more than EUR2bn. Morgan Stanley says it expects to have a deal to sell Bawag before the end of this year. Attorneys for Refco's creditors say that they will in all likelihood also have a veto or at any rate a right to call for an independent review of any sale.

The proposed settlement is distinct from the fate of Bermuda-based subsidiary Refco Capital Markets, the subject of a repayment plan put in front of the New York judge last month. Refco's lawyers said last week that the Capital Markets unit had 'billions' of cash in hand.

Judge Drain ruled earlier in the year that Refco Capital Markets should be liquidated under Chapter 7 of the US bankruptcy code, separately from the remainder of Refco, and that a trustee should be appointed for the offshore broker-dealer unit. However the preliminary ruling was suspended to give creditors time to work towards a consensual liquidation plan. Under the Chapter 7 procedure, assets would be sold and the proceeds distributed first to customers and then to other creditors.

Creditors have opposed a proposal that Refco Capital Markets should repay its customers (mainly large banks) 70 cents on the dollar in respect of $2.7 billion liabilities, while its unsecured creditors, owed $890m, would get only 26 cents on the dollar.

Although Refco Capital Markets was registered in Bermuda, it was incorporated as an exempt company, allowed to do business anywhere except Bermuda, and in fact had no staff in Bermuda. Neither the Bermuda Monetary Authority nor US regulators had any formal responsibility for its operations, and it appears to have ignored such elementary good practices such as the separation of client accounts from general corporate funds.

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