Fortress Investment Group (FIG) On Both Sides Of The Bargaining Table

July 14, 2009 9:12 AM EDT

Fortress Investment Group LLC (NYSE: FIG) is in serious discussions with lenders to refinance a critical $1.6 billion loan on real-estate and railroads company Florida East Coast Industries Inc., according to the Wall Street Journal. However, it is interesting situation because one of those lenders is actually Fortress Investment Group. In other words, Fortress is both an equity holder and bond holder on the deal and, therefore, it has conflicting interests.

Fortress has until July 27 to work out a plan, when the loan matures and Florida East Coast must pay back the amount. The WSJ reported that Fortress wants to extend the loan, and that it is expected to reach an accord that will delay the maturity and increase its interest rate.

The people involved in the deal say the talks have been complicated because Fortress is on both sides of the deal. FIG has a $2 billion equity investment, made when it spent $3.6 billion to buy Florida East Coast at the height of the credit bubble in 2007. But since that time, separate funds managed by Fortress have been buying up the company's debt. Fortress is now the largest lender, holding a $600 million position.

This obvious conflict of interest pits Fortress clients against each other. Does it demand tough terms for the loan or does it try to protect its equity holding?

To lessen the potential conflict, Apollo Management LP, another large holder of the debt, is leading negotiations for the lenders.

Fortress's situation shows some of the risks PE firms face in the world of distressed-debt investing. Many companies are no longer able to raise equity, thus these PE firms are instead buying up corporate debt, and they are often attracted to companies in which they already have significant ownership stakes.

Private-equity firms say that they manage these conflicts by, in some cases, recusing themselves from one side of the negotiating table.

Some private-equity investors think owning a company's equity and debt isn't a good idea. "We've adopted a policy not to wear more hats than you have heads," said distressed investor Wilbur Ross of W.L. Ross & Co. at a private-equity industry conference last year.

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