From the Abstract:
Avoidance and Recovery
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From the Abstract:
“This article empirically examines and quantifies the effect of the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) on three distinct aspects of the Chapter 11 process: a) the duration of traditional Chapter 11 cases; b) the use of prepackaged and prenegotiated bankruptcies; and c) debtor refiling rates. The sample studied consists of companies with more than $100 million in assets that both filed for and exited Chapter 11 between 1997 and 2014. BAPCPA is found to be associated with shorter Chapter 11 case duration, and an increased use of prepackaged and prenegotiated bankruptcies. Additionally, BAPCPA is found to be associated with an increase in the proportion of firms that soon refile for bankruptcy. It seems that the 2005 amendments force the debtor to emerge hastily from its Chapter 11 proceedings, ignoring operational and structural problems and, therefore, not achieving true rehabilitation.”
Avoidance and Recovery
Back in May, this blog featured a post on some preliminary research addressing the idea of “probability-based” fraudulent transfer analysis. PBGC lawyer (and Cadwalader alum) John Ginsburg has argued that rather than merely asking whether insolvency is “reasonably foreseeable,” courts ought to clarify “reasonable foreseeability” in probabalistic terms. The basic idea underlying this argument is that it should be easier to attack (or to defend) a fraudulent transfer if it can be shown, for example, that the “probability” of insolvency at the time of an LBO was 50% – or 60%, or 75%.
Mr. Ginsberg argues further that courts ought to articulate what, for them, constitutes an acceptable margin of error (say, 40% risk of insolvency with a margin of error of +/- 15%).
Following comments offered here and elsewhere, Mr. Ginsberg – and colleagues Zachary Caldwell, Daniel Czerwonka, and Mary Burgess – have gone through a number of revisions and have a final draft version of the article available for review prior to going to publication with ABI Law Review in March.
A discussion is hosted at http://www.bulletinboards.com/view.cfm?comcode=LBO_FT, where anyone can critique and debate the paper, upload a rebuttal from a word-processor, or upload a handwritten mark-up in PDF. In written comments to South Bay Law Firm, Mr. Ginsberg notes that the authors are particularly “interested in hearing from private equity fund managers, from the investment bankers who finance their deals, and from the lawyers, financial analysts and others who earn fees helping put those deals together. The paper has significant implications for them.”
A recent MONDAQ article by Bryan S. Gadol and Wendy R. Kottmeier of Dorsey & Whitney’s Irvine, California office discusses financially distressed acquisitions and covers some of the high points attendant to an out-of-court “bargain basement” purchase:
– Fraudulent Transfer Claims: “[I]t is imperative for a buyer acquiring assets at a discount from a seller that is insolvent, or may become insolvent, to evaluate whether the purchase price is of a reasonably equivalent value based on a variety of factors, including the marketability of the assets at the time of the sale and the level of interest, if any, from other potential buyers.” Without such a determination, the acquisition is subject to attack from disgruntled creditors and the purchaser may be required to return the acquired assets (or their fair market value).
– Successor Liability Claims: “[U]nder certain legal theories purchasers of assets can sometimes be held liable as a successor for certain environmental, products liability, tax, employee benefits and labor and employment claims. Creditors of the insolvent seller have a greater incentive to look elsewhere to satisfy the seller ‘s unpaid debts, and consequently may choose to pursue successor liability claims against a purchaser.”
– Fiduciary Duty Claims: Until very recently, the boards of distressed corporations were routinely advised of their fiduciary duties to creditors, which arise when the corporation is in the “zone of insolvency.” This means that the boards of distressed companies are obligated to act in the best interests of the corporation’s creditors – an obligation which extends to management’s decision to sell distressed assets “on the cheap.” As discussed by Gadol and Kottmeier, recent Delaware case law has narrowed this liability by suggesting such fiduciary duties do not arise until the precise moment when the corporation becomes insolvent. However, such “precision” may do nothing more than afford corporate boards a false sense of security, since the concept of “insolvency” is itself subject to multiple definitions – and the question of specifically when a corporation becomes “insolvent” is, at best, often a subjective one.
Though somewhat cursory, the overview from Dorsey’s transactional lawyers is timely: Financial distress arising from the present economic downturn promises a wide range of opportunities for those companies poised to make strategic acquisitions. As noted by a more extensive piece appearing in late February in The Deal Magazine, journalist Suzanne Stevens and prominent Los Angeles practitioner (and UCLA Law School professor) Kenneth Klee note:
Who are the strategic buyers best positioned to take advantage of these buying opportunities? Klee and Stevens identify at least two types:
– Purchasers who find their key suppliers in trouble.
– Foreign buyers looking to improve their positions in the U.S.
There are undoubtedly more. Klee and Stevens also touch on some of the various types of deals likely to result, including:
– Acquisition of the target company’s debt and the offer of a much-needed capital infusion.
– Bidding for the assets, either out of court or in connection with a “Section 363″ sale inside a Chapter 11 case as a “stalking horse” or as a third-party participant. Though the “stalking horse” bidder typically takes on the risk of being “cherry-picked” by a late-comer to the bidding process, most prospective “stalking horse” purchasers are able to protect both their due diligence investments and their positions through the imposition of “break-up fees” as a part of the sale price to a third party.
What do strategic buyers have to contend with in consummating a successful acquisition? In addition to the potential liability outlined by Gadol and Kottmeier, Klee and Stevens highlight the often-complex nature of such acquisitions:
Even so, with enterprise and asset valuations growing cheaper and the synergies available from a well-thought-out acquisition negotiated at bargain prices, the attraction of such a purchase makes putting a foot in worth the risk.
Chapter 15 of the Bankruptcy Code – the Code’s “cross-border” provision – was enacted in 2005 to protect US-based assets and preserve US-based claims for administration overseas whenever a foreign debtor finds itself in insolvency proceedings outside the US. Though many of Chapter 15’s “core” concepts are the same as those that existed under prior US cross-border bankruptcy law, some significant differences exist.
A recent decision by Nevada Bankruptcy Court Judge (and UNLV Law School professor) Bruce Markell highlights an important one of those differences.
The facts presented to Judge Markell in In re Betcorp Limited (In Liduiqdation) were straightforward: Betcorp was an Australian-based on-line betting operation whose customers were located in the US. From about 2002 through 2006, the company grew its operations into a purported “one-stop shop” for on-line gamblers. In the process, it allegedly infringed on an Interenet data-transmission technology patent held by US-based 1st Technology LLC. Despite threats of litigation and offers to settle, Betcorp and 1st Technology could never come to terms.
Meanwhile, Betcorp’s business was effectively terminated in late 2006 when the US enacted the Unlawful Internet Gambling Enforcement Act (31 U.S.C. §§ 5361-67) and effectively cut off the company’s gambling revenues from its US customers. At an extraordinary directors’ meeting the following year, the company appointed two Australian liquidators and began a voluntary “winding up” under Australian insolvency law.
A voluntary “winding up” is essentially a private liquidation authorized by the Australian Corporations Act, conducted by company-retained liquidators under the auspices of the Australian Securities & Investments Commission (ASIC) and reviewable on appeal by Australian courts. It has statutory analogues in most countries whose civil law derives from the old British Commonwealth system, and is very generally anlogous to an American “assignment for the benefit of creditors” (ABC). ABC’s are recognized under the laws of virtually every state in the US, and – in California – are commonly used as a very quick and inexpensive means of winding up a company’s affairs and disposing of its assets.
Undeterred by Betcorp’s Australian winding up, 1st Technology commenced a patent infringement action against Betcorp in Nevada’s US District Court. After further, unsuccessful efforts to amicably resolve the infringement claims, the liquidators sought recognition under Chapter 15 to administer the dispute through the Australian winding-up process. 1st Technology disputed the request, arguing that Betcorp’s (essentially) private “winding up” was not a “foreign proceeding” to which Chapter 15 relief applies.
In a 39-page decision, available here, Judge Markell granted recogntion to the liquidators. To do so, he gave extensive discussion to the establishment of Australia as Betcorp’s “center of main interests” (COMI) – an important element in gaining relief under Chapter 15 and the subject of a number of prior, published decisions in the US. Of interest for this post, however, Judge Markell also delved into the amended meaning of the term “foreign proceeding.”
What is a “foreign proceeding” under the amended Bankruptcy Code? Judge Markell devoted nearly 15 pages – over half his analysis – to spell it out, applying a seven-part test to address this question of apparent first impression . . . and finding, in the end, that Betcorp’s private “winding up” met the test.
Judge Markell was not writing purely to satisfy his own intellectual interest. The definition of a “foreign proceeding” is a potentially critical one for international insolvency lawyers looking to strategize the preservation of assets and admnistration of claims in a multi-national case. It is noteworthy that the Bankruptcy Court for the Southern District of New York came to exactly the opposite conclusion under prior US law about a nearly identical “voluntary winding up” proceeding, this one in Hong Kong (like Australia, a former Commonwealth jurisdiction with roots in the British civil law system). That court’s decision – In re Tam – is located at 170 B.R. 838 (Bankr. S.D.N.Y. 1994).
Judge Markell’s decision suggests that at least some private liquidations in some foreign jurisdictions are now entitled to the very same level of recognition and protection in the US as are more formal, judicial insolvency proceedings. If this conclusion bears out, it permits foreign debtors the potential ability to use such liquidations to exert far greater control over the disposition of US-based assets and resolution of US-based claims than was available under former US law.