The South Bay Law Firm Law Blog highlights developing trends in bankruptcy law and practice. Our aim is to provide general commentary on this evolving practice specialty.
 





 
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    Archive for March, 2009

    An Out-of-Court “Winding Up” Entitled to Recognition Under Chapter 15? You Bet!

    Monday, March 23rd, 2009

    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.

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    “Seller-in-Possession” Financing?

    Sunday, March 15th, 2009

    By now, it’s no secret that DIP financing – once a mainstay of Chapter 11 reorganizations – has all but disappeared.  When available at all, post-petition debt financing in the present market has been accessible only at exorbitant prices and on terms that make it . . . well, nearly inaccessible.

    In this sort of lending market, what’s a struggling Debtor-in-Possession to do?

    The answer, in at least some cases, may be to negotiate for Seller-in-Possession financing.  In a March 6 article addressing this trend in the turbulent DIP financing market, The Deal’s Ben Fidler comments on the growing tendency for many DIP packages to include sale requirements.  Such so-called “fast-track” sale procedures were not unknown in prior markets.  But they are, according to Fidler, becoming “more the norm than the exception with DIPs.  Many [DIP financing packages] are laced with sale provisions, often mandating sales within a few months to avoid a default.”

    In support of this observation, Fidler points to Fluid Routing Solutions Inc., who received a DIP from Sun Capital Partners Inc. that initially gave the debtor 35 days to sell its fuel systems business, and to G.I. Joe’s Holding Corp. – a sporting goods retailer doing business as Joe’s Sports & Outdoor – who obtained a $51.2 million DIP financing from Wells Fargo Retail Finance LLC . . . but with the requirement that the company find a buyer in 30 days.

    Fidler goes on to comment that:

    These situations often leave unsecured creditors committees in the lurch. Because of such deadlines, a debtor will usually request a bidding procedures hearing date at the first-day hearing, before committees are even formed. And by the time they are, a debtor will likely be well on its way toward a sale, leaving the committee to scramble to try to push back all the deadlines.

    With lenders generally unwilling to float debtors toward reorganization and instead pushing them toward sales, this recent piece underscores the significant opportunities available for strategic buyers in this market.

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    The Year in Bankruptcy: 2008

    Saturday, March 7th, 2009

    For bankruptcy and insolvency specialists, 2008 was the year that was.

    In a 3-part article appearing on registration-based Mondaq.com (and available in one spot here), Jones Day’s Restructuring Practice Communications Coordinator Mark Douglas offers a bird’s-eye view of what may have been the most economically tumultuous 12 months since the early 1930’s.  In summarizing the article, there is little need for further hyperbole: The statistics speak for themselves.

    Among the tidbits offered by Mr. Douglas in parts 1 and 2:

    – 136 public companies filed for bankruptcy protection during, a 74 percent increase from 2007, when there were 78 public-company filings.

    – In 2008, 10,084 chapter 11 cases were filed, compared to only 6,200 in 2007, representing a 62.6 percent increase.

    – No fewer than 25 names were added to the public-company billion-dollar bankruptcy club in 2008 (the most since 2002 and a sixfold increase over 2007), including the two largest bankruptcy filings ever in U.S. history—Lehman Brothers Holdings Inc. and Washington Mutual, Inc.—as well as the 10th-largest bankruptcy filing of all time—IndyMac Bancorp, Inc.

    – Southern California-based financial institutions comprised 4 of the top ten filings for 2008. These included Pasadena-based IndyMac Bancorp, Inc.  (which, until July 11, 2008, was the holding company for hybrid thrift/mortgage bank IndyMac Bank prior to being placed into receivership by the Office of Thrift Supervision), Newport Beach-based Downey Financial Corp. (which operated as the holding company for Downey Savings and Loan Association, F.A., until November 21, 2008, when federal regulators seized the bank due to its failure to satisfy minimum capital requirements), Brea-based Fremont General Corporation (a financial services holding company that, through its subsidiary Fremont General Credit Corporation, owned the California bank Fremont Investment & Loan), and Rancho Cucamonga-based PFF Bancorp, Inc., the parent company of PFF Bank & Trust (which was seized by federal regulators on November 21, 2008, together with Downey Savings and Loan Association, F.A. – No. 4 on the Top 10 List – after posting losses from subprime-mortgage loans aggregating nearly $290 million through the first three quarters of 2008).

    What does 2009 have in store?  Part 3 suggests that:

    The fundamental strategy of commercial bankruptcies may also change in 2009, given the enduring difficulties in lining up debtor-in-possession (“DIP”) and exit financing (DIP loans dropped from $7.9 billion in the second quarter of 2008 to $2.9 billion in the fourth quarter, according to statistics published by the Deal Pipeline) and the more abbreviated “drop dead” dates built into the Bankruptcy Code for the debtor’s exclusive right to propose and solicit acceptances for a chapter 11 plan and to assume or reject unexpired leases of nonresidential real property. This means that more companies may resort to bankruptcy protection in 2009 to effect an orderly liquidation, rather than to reorganize, or to effect expeditious cash-generating asset sales under section 363 of the Bankruptcy Code. This year may also see a greater volume of “pre-packaged” chapter 11 cases, a trend that began in late 2005 after the new deadlines were implemented.

    Part 3 also provides a helpful summary of current case law developments of note – including the following summaries of some recent Ninth Circuit decisions:

    – In a matter of apparent first impression in the federal circuit courts of appeal, the Ninth Circuit ruled in Aalfs v. Wirum (In re Straightline Investments, Inc.), 525 F.3d 870 (9th Cir. 2008), that although “diminution of the estate” is required to support an avoidance recovery under sections 547 or 548 of the Bankruptcy Code, which involve preferential and fraudulent pre-petition transfers, no such requirement exists with respect to liability under section 549, which provides for the avoidance of unauthorized post-petition transfers. Thus, the Ninth Circuit held, a transferee who purchased receivables from an estate outside the ordinary course of business was not entitled to defend against a section 549 suit, based upon the fact that he paid the estate more than the receivables were worth.

    – An oversecured creditor’s right to interest, fees, and related charges as part of its allowed secured claim in a bankruptcy case is well established in U.S. bankruptcy law. Less clear, however, is whether that entitlement encompasses interest at the default rate specified in the underlying contract between the creditor and the debtor. The answer to that question can be a thorny issue in chapter 11 cases because the Bankruptcy Code provides that a chapter 11 plan may cure and reinstate most defaulted obligations, and courts disagree as to whether the power to cure defaults nullifies all consequences of default, including the obligation to pay default interest. The Ninth Circuit Court of Appeals had an opportunity in 2008 to examine the interplay between these seemingly incongruous provisions of the Bankruptcy Code. In General Elec. Capital Corp. v. Future Media Productions, Inc., 536 F.3d 969 (9th Cir. 2008), the court reversed a bankruptcy court order disallowing default interest and costs as part of the claim of a secured creditor whose collateral was sold by the debtor outside of a chapter 11 plan, ruling that the court erred by applying the Bankruptcy Code’s plan-confirmation provisions in a situation where cure and reinstatement of the secured creditor’s debt were neither contemplated nor possible.

    – A secured creditor’s right to “credit-bid” its claim in a proposed sale of the underlying collateral free and clear of interests under section 363(f) of the Bankruptcy Code was the subject of a significant ruling in 2008 by a bankruptcy appellate panel from the Ninth Circuit. In Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (Bankr. 9th Cir. 2008), the court ruled that section 363(f)(5) of the Bankruptcy Code does not allow a senior secured creditor to credit-bid its claim and, by doing so, wipe out the junior secured creditor’s interest. Adopting an extremely narrow view of when section 363(f) applies, the panel concluded that the debtor must establish that there is some form of legal or equitable proceeding in which the junior lienholder could be compelled to take less than the value of the claim secured by the lien. The court also held that section 363(m), which makes approved sale transactions irreversible unless the party objecting obtains a stay pending appeal, does not apply to lien stripping under 363(f).

    Overall, this is not recommended beach reading for the upcoming spring and summer holiday season.

    But for anyone grasping for a bit of economic and legal perspective on the year that was, it’s a all-too-quick-moving page-turner.

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    Irony Doesn’t Pay

    Sunday, March 1st, 2009

    Litigation has always been an important tool for unsecured creditors looking to augment their returns from a bankruptcy estate.  Besides preference, fraudulent transfer, and subordination claims, creditors typically look to the boards of bankrupt corporations and to their pre-petition advisors – or perhaps more accurately, to their professional liability insurers – as possible sources of recovery in a bankruptcy case.

    Last week, OakBridge Insurance Services’ Kevin M. LaCroix offered a solid round-up of the factors driving director and officer litigation in the present financial crisis.  In a post covering the real or perceived culpability of corporate boards and officers for the tsunami of business failures accompanying this downturn, Mr. LaCroix points to recent reporting from the Washington Post suggesting that incoming SEC Chairwoman Mary Schapiro’s first task will be to ascertain “‘whether the boards of banks and other financial institutions conducted effective oversight leading up to the financial crisis,’ as part of an SEC effort to ‘intensify scrutiny at the top levels of management.'”  Mr. LaCroix goes on to predict the likely effect of such increased scrutiny on directors’ litigation exposure:

    Were there to be an SEC initiative targeting boards, plaintiffs’ attorneys’ undoubtedly would be emboldened to bring even further litigation in the SEC’s wake . . . .  The prospect of the SEC deliberately targeting financial boards unquestionably elevates directors’ potential liability exposures. This heightened exposure extends not only to the boards of the high profile companies that have already failed, been bailed out or been merged out of existence. It also extends to the boards of the many other banks, insurance companies and other financial institutions, and even companies outside the financial sector, that are currently struggling.

    Mr. LaCroix further observes the irony attendant to this scrutiny, brought by regulators who themselves failed to see the present crisis and covered by a media likewise formerly blind to the mis-judgment of now-discredited “masters of the [financial] universe.”

    Unfortunately, irony cannot pay.

    Only well-insured boards and their equally well-insured professionals can pay.

    And so the D&O litigation beat goes on – and grows ever more intense as companies continue to fail and their creditors attempt to salvage what they can.

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