Lawsuit against Blackstone could test leveraged buyout defense

WILMINGTON, Del. ― An $8.4 billion lawsuit brought last week against Blackstone LP by creditors of the bankrupt Extended Stay hotel chain ranks as one of the largest ever filed over a failed leveraged buyout.

It could also take its direction from one of the smallest ever — the recent, and otherwise forgotten bankruptcy of a New York restaurant that sold for just $1.1 million.

Essentially, a trust representing creditors of Extended Stay accused Blackstone and others of arranging an overpriced sale of the hotel chain to private equity investor David Lichtenstein with an allegedly conflicted Citigroup Inc. in between.

The lawsuit accuses Blackstone and other parties of lining their pockets at the expense of the hotel chain and its creditors, who suffered in the bankruptcy two years later.

That much is pretty standard fare for so-called fraudulent transfer cases, which often follow in the wake of failed leveraged buyouts.

Blackstone has said the lawsuit was without merit and Citigroup declined to comment.

The lawsuit, in Manhattan bankruptcy court, follows a recent decision in the district that could undermine the use of the so-called “settlement payment defense” to shield shareholders who sold into a buyout that went bust.

“It’s actually become much harder to litigate LBOs because of the development of the settlement payment defense,” said Stephen Lubben, a professor at Seton Hall Law School. “If the payments went through a financial institution, it’s much harder to unwind them.”

That may have changed, however, because of a ruling arising from a tiny failed leveraged buyout involving MacMenamin’s Grill of the New York City suburb of New Rochelle.

Owners of the restaurant agreed to sell their shares to the restaurant in 2007 for a total $1.1 million — a leveraged buyout so small that it was done with a Small Business Administration loan.

A year later the restaurant went bankrupt.

When a trustee for creditors sued the shareholders, they cited the settlement payment defense. Judge Robert Drain of the Southern District of New York rejected that, in part because the transaction did not involve publicly traded stock ― just as in the Extended Stay sale.