Midway Creditors Attack Board: Shrewd Dealings or Illegal Manipulation?

May.15.09 | About: Midway Games (MWY)

Bankruptcies are rarely a lender’s friend. They’re a worst case scenario that often means a best outcome of pennies returned on the dollars of investment. Midway Games' (MWY) ongoing bankruptcy process has been a demonstration in point. Triggered by debt covenants and a sketchy transaction, the proceedings have been riddled with confrontational debate. The rancor’s even spilled over into a counter suit.

Monday, creditors filed suit against the company’s board members, former majority owner, Sumner Redstone, and the buyer of Redstone’s shares, Mark Thomas. The creditors are charging Redstone with fraudulent transfer, and accusing him and others of breaching their fiduciary duties.

Everything stems from Redstone’s firesale giveaway of his Midway holdings in November. Parting with 87% of the company for merely $100k gave Redstone and his affiliated holdings more than $700m in tax losses which created a massive tax write off. That write off, Redstone’s gain, creditors argue, helped shore up the finances at Redstone’s National Amusements but put Midway into a tailspin.

“The transaction caused Midway irretrievably to lose the ability to take advantage of its valuable accumulated net operating losses and other tax assets,” creditors say.

The sale of Redstone’s shares also gave the buyer of Redstone’s shares, Mark Thomas, senior status (the right to be paid first) on the collection of tens of millions in outstanding debt. Creditors argue that’s why he bought the stake in the first place: for the “sole and exclusive purpose of enforcing the debt.” In essence, Thomas had no interest in running, or salvaging the company, they suggest. He was wagering $100k plus legal expenses against the potential return of tens of millions in payback on the loans.

The lack of appropriate due diligence or consideration of other alternatives by Midway’s board, and Redstone, the creditors claim, was a breach of their fiduciary responsibilities.

To a certain extent, the litigation was expected. According to the creditors' court filing (see embedded document below), when Mark Thomas negotiated to buy Redstone’s shares, he initially offered $1m on the condition that he be indemnified against a future lawsuit. Redstone balked at that contingency and instead, accepted a non-conditional counter offer at the substantially reduced (because of the legal risk) price of $100k.

Further evidencing anticipation of legal action, the creditors note, Mark Thomas transferred title of his home to his wife’s name one day before the purchase – the implication being, he was intentionally seeking to shelter his personal assets from any legal claims relating from the deal.

Legal and shrewd dealing? Or illegal manipulation? There’s no telling how the case and bankruptcy will play out. A spokesperson for National Amusements says the suit is completely without merit. The court will sort this one out.

Meanwhile, buyers interested in picking up some of Midways’ IP and assets are assuredly waiting in the wings hoping to get a bargain of their own sometime in the future.

(More detailed information on the events that led to Midway’s bankruptcy and the contentious battle going on as creditors try to salvage value from the troubled company can be found here and here in past coverage from Metue. The filing related to the new litigation is embedded below)