The story began in 2003 when New York bond insurer MBIA was looking for a way to rescue a number of struggling CLOs it had written policies against. Facing losses which MBIA estimated at up to $200 million, the insurer turned to Tilton in her pitched role as a “solution provider.” Tilton agreed to replace the managers of the CLOs with Patriarch entities, while MBIA would insure the senior notes of a new Patriarch-sponsored CLO that would buy distressed debt on the secondary market, while the junior notes of the new CLO (which became the first Zohar fund) would be used to remediate losses on MBIA’s original bad CLOs. In the heady atmosphere of 2003, the new Patriarch-sponsored CLO was assigned a AAA/AA rating by S&P. But the market for bad debt turned, and the CLO didn’t end up buying distressed debt on the secondary market. Instead it sold loans to distressed companies – including Patriarch portfolio companies.
For a while, despite the scheme not progressing as planned, it was progressing, and in 2005 MBIA insured another $1 billion worth of senior notes issued by a second Zohar fund. The relationship began to fray in 2007 when MBIA refused to insure a further $1 billion effort because the insurer still hadn’t seen any proceeds from the junior notes that they were relying on to remediate the original CLOs. With no B note proceeds forthcoming, in 2009 MBIA sued Tilton, claiming she had not applied for Zohar’s junior notes to be rated investment grade. As a result of this lack of rating, MBIA didn’t receive the cash they believed they were due and therefore couldn’t remediate the original CLO.
After a four-year fight, a federal judge rejected MBIA’s claims and ruled in favour of Tilton, saying MBIA had not produced the evidence to establish that Patriarch violated the original agreement. He also said the Zohar funds could never have satisfied the conditions which would have granted the B notes an investment grade rating.
But the conclusion of this case was just the end of the beginning for Tilton. In 2015, two years later, the SEC came knocking, filing a case against Tilton alleging she had been providing “false and misleading information and engaging in a deceptive scheme, practice and course of business, relating to the values” of the Zohar funds assets. The SEC also accused her of taking “excessive fees” from the vehicles. A further blow came later that year when Hannover Funding, a subsidiary of state-owned German bank Norddeutsche Landesbank Girozentrale (Nord LB), sued the Zohar funds for $44 million, alleging Zohar “grossly mismanaged” their $144 million investment.
In January 2016 Zohar I defaulted on a scheduled payment and, faced with the new lawsuits and the Zohar default, Tilton and Patriarch resigned as managers of the fund in February, citing the MBIA case. She made no mention of the SEC or Land LB actions against her. She also announced she was withdrawing an effort she began in 2015 to force the first Zohar fund into involuntary bankruptcy, a step Tilton said she had taken because MBIA would not extend the fund’s deadlines.
In February 2016 advisory firm Alvarez and Marsal was named as the new manager of the funds, with Tilton and Patriarch originally welcoming their appointment saying they wanted to “ensure a smooth and cooperative transition process.” But the pillow talk didn’t last long. In April that year the new Zohar managers filed a lawsuit seeking a court order to provide information about the Zohar fund’s holdings. We “have been unable to obtain such basic information as a comprehensive list of Zohar’s collateral and financial reports needed to value the collateral,” Alvarez said in the lawsuit. In October a judge ordered Patriarch to turn over documents to the new manager.
2017 got off to a bad start for Tilton when Zohar brought a $1 billion civil racketeering case against the former funds’ manager, claiming she had employed a “toxic mix of fraud, theft and mismanagement,” to enrich herself at the expense of Patriarch portfolio companies to which the Zohar funds had written loans. Things improved markedly for Tilton in September 2017 when she defeated the SEC lawsuit, with the judge ruling that although Tilton didn’t make it easy for investors to find the information they wanted, there was no deliberate “effort to conceal or omit” key information. And her year ended on a high when the civil racketeering case was also dismissed, with the judge ruling that the case ran “headlong” into a ban on lawsuits predicating on the buying or selling of securities. But while a technical victory, it was not a moral one, with the judge writing in his ruling that integral to the Zohar strategy was the “pillaging of portfolio companies of their equity, re-directing Zohar’s equity interests for defendants’ benefit, and diverting the equity distributions into defendants’ coffers.”
Tilton’s second legal defeat came in late 2017 when a lower Delaware court awarded control of three Patriarch companies to the Zohar funds, a case also bought by the funds new manager. The ruling said Tilton had improperly awarded herself board seats at three Patriarch companies backed by Zohar-originated loans. She had appealed the decision and was due to be heard in mid-March 2018 before her bankruptcy move, taken to stem further lawsuits. In a statement following the announcement Tilton said that “value cannot be maximized in the litigious and charged atmosphere that currently exists,” and that Chapter 11 “was the only way forward.” Bryan Marsal, chief executive of Alvarez & Marsal, said Tilton’s move was “a last grasp to retain control of companies she does not own.”
The 2015 case brought by Nord LB remains ongoing. Tilton had requested the case be dismissed, given her victory over the SEC and the fact that Nord LB’s case rests on a similar premise. In February this year a New York Supreme Court judge did not dismiss the case but stopped short of allowing the claim to proceed, saying she would rule later. It appears a new season in one of the private fund industry’s longest-running sagas is coming soon.