In 2002, Adelphia Communications Corporation disclosed that it had previously unreported debt of over $2 billion and would have to file for bankruptcy.  Numerous litigations ensued, including one, Adelphia Communications Corporation v. FPL Grp., Inc., in which a trust for debtors made a claim to reclaim funds from a 1999 transaction in which Adelphia repurchased certain securities it had previously issued. The Recovery Trust argued that once one accounted for the previously undisclosed debt as well as other financial improprieties, Adelphia was insolvent as of the 1999 transaction. The trust argued as an additional matter that even if Adelphia were solvent in 1999, it was dependent on outside funding and that had the fraud at the company been known, Adelphia would have lost access to the capital markets and therefore been unable to remain an ongoing concern.

Dr. David Tabak of NERA’s Securities and Finance Practice was brought in by the law firm of Skadden, Arps, Slate, Meagher & Flom LLP to provide testimony for defendants, opining that a disclosure of the financial fraud at Adelphia would not have prevented the company from accessing the financial markets. When asked to provide an industry expert, the NERA team was expanded to include Dr. Christian Dippon of the firm’s Communications, Media, and Internet Practice, who provided testimony relevant to the telecommunications industry and specifically to the financial projections underlying the solvency opinions as of 1999. The case went to trial in May 2012 in the Bankruptcy Court for the Southern District of New York.

Bankruptcy Court
In a 6 May 2014 ruling, the Bankruptcy Court found for NERA’s client. The ruling covered many areas including reliance on the testimony of Drs. Tabak and Dippon.

The Bankruptcy Court found that Dr. Dippon “showed satisfactory expertise with respect to the cable television industry” and “provided a thoughtful analysis, demonstrating expertise.” The court noted its agreement with Dr. Dippon’s testimony that “[t]here was no competitive imperative for Adelphia to engage in a three-year upgrade program, as set forth by” the Plaintiffs’ valuation expert. The Court held that “Dippon was correct in challenging [Plaintiffs’ experts’] assumptions that Adelphia would have to completely upgrade over just a three-year time period.” This was an important input to the valuation assumptions that underlay the different conclusions on solvency and was a key factor in the differences between the solvency propositions put forth by the different sides in the litigation.

The Bankruptcy Court noted that Plaintiffs’ experts “argued that capital markets would be closed to Adelphia … but Dr. David Tabak (‘Tabak’), an expert FPL called on the issue, testified that Adelphia would still be able to borrow, merely experiencing an increased spread of 97.5 basis points in its borrowing costs.” The Bankruptcy Court noted that “Tabak examined an empirical study on access to capital markets after disclosures of fraud, and also examined five large companies that had disclosed fraudulent activity (Cendant, Waste Management, Rite-Aid, Enron, and WorldCom), each of which was able to obtain financing after the disclosure” before concluding that Dr. Tabak was correct in his opinion that Adelphia would still have been able to borrow. The Bankruptcy Court concluded, “Ultimately, the most persuasive aspect of FPL’s position was its analysis of other companies facing a similar confluence of factors. In particular, Tabak’s analysis of five companies facing similar situations (especially Rite-Aid, which was also highly leveraged) was persuasive; it showed how markets actually reacted to fraud at large public companies.”

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Affirmation by District Court
Plaintiffs challenged the ruling by the Bankruptcy Court, and on 13 March 2015, that ruling was affirmed by Judge Valerie Caproni of the United States District Court in the Southern District of New York. Judge Caproni found that the Recovery Trust failed to satisfy its burden of proving that the stock repurchase left Adelphia with inadequate capital. While the judge’s decision did not directly address the upgrade issues in Dr. Dippon’s testimony, she affirmed the Bankruptcy Court’s findings that were based in part on its valuation and Dr. Dippon’s testimony, as described above.

Judge Caproni further noted that “FPL’s restructuring expert David Tabak (‘Tabak’) argued that, while it was ‘a theoretical possibility’ that Adelphia would have lost access to the capital markets if the fraud had been disclosed, the empirical evidence shows that, under similar circumstances, companies were typically able to continue to raise capital after the disclosure of a fraud.” Her opinion noted that Dr. Tabak “cited empirical data showing that the majority of companies that issued restatements from 1997 through 2002 (237 of 437 companies for whom sufficient data was available), including nineteen companies that issued restatements due to fraud, were able to obtain post-restatement financing. Defs.’ Opp. at 13; Tabak Decl. ¶ 35-41.7 Recovery Trust has not disputed this data or objected to Tabak’s conclusions as to its significance.” With respect to the five companies, Judge Caproni held that “[t]he fact that all of these companies were able to obtain financing under such circumstances is persuasive evidence that cannot be ignored … Notably, Recovery Trust provided no empirical evidence of other major companies who were unable to obtain financing following disclosure of a fraud, effectively asking the Court to disregard Tabak’s evidence on Recovery Trust’s say-so.” 

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Decision Affirmed by Second Circuit
On 6 July 2016, the Second Circuit affirmed the judgment by the district court. With regard to the key issue of whether Adelphia would have been able to obtain funding had the fraud been disclosed, the Second Circuit’s ruling stated, “This finding is amply supported by the declarations and trial testimony of defendants’ experts, which showed, inter alia, that similarly-situated companies in the cable industry were able to access capital markets despite having negative cash flows and/or having high leverage ratios, and that numerous other companies obtained access to capital markets after disclosing a fraud.”

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