Archive for August, 2009
Monday, August 31st, 2009
Chrysler’s and GM’s recent sales through the Bankruptcy Courts of New York’s Southern District have raised the question of whether some jurisdictions provide more receptive forums than others for getting a “distressed M&A” transaction accomplished. This sort of “forum shopping” is both a well-established concept in commercial insolvency practice and an integral part of reorganization planning.
Last week, a 7th Circuit decision highlighted another area where geography – at least as it concerns the choice of a Bankruptcy Court – can have an important effect on the outcome of a Chapter 11 case, as well as on a reorganized debtor’s post-confirmation operations: The resolution of environmental liabilities.
U.S. v. Apex Oil Company involved an environmental injunction obtained against Apex Oil, successor-by-merger to Clark Oil and Refining Corporation.
Clark Oil, its corporate parent, and a number of affiliates filed related Chapter 11 cases 12 years ago, in 1987. Clark was subsequently merged into Apex, and a Chapter 11 Plan confirmed in the debtors’ related Chapter 11 cases. Nearly two decades later, in 2005, the Environmental Protection Agency sought an injunction requiring Apex to clean up a contaminated site in Hartford, Illinois, which housed an oil refinery once owned by Clark.
Chief US District Court Judge David Herndon of Illinois’ Southern District conducted a 17-day bench trial in early 2008 and, in July 2008, issued a 178-page decision finding that, in fact, contamination was present at the site and that it was Apex’s responsibility to clean it up.
Apex appealed, arguing that confirmation of the Chapter 11 Plan and discharge obtained in Clark Oil’s Chapter 11 case 2 decades earlier precluded enforcement of the more recent federal injunction. In essence, Apex argued that Section 101 of the Bankruptcy Code defines a “claim” as a “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment.” Since cleaning up the contaminated Hartford, Ill. refinery site in response to the federal injunction would obviously require the significant expenditure of money, Apex reasoned that this obligation was effectively a “claim” subject to the earlier Chapter 11 discharge, and could not be enforced.
Judges Posner, Cudahy, and Kanne of the 7th Circuit were not persuaded. Judge Posner’s comparatively brief, 12-page decision issued last week held that the EPA’s federal injunction at issue did not give rise to a “claim” as that term is defined by the Bankruptcy Code . . . and, therefore, could not be discharged by means of Clark Oil’s Chapter 11 Plan.
Consequently, Apex now holds the clean-up tab for the old Clark refinery.
In order to hand Apex that tab, Judge Posner and his colleagues distinguished Apex’s case from a 1985 Supreme Court decision – Ohio v. Kovacs, 469 U.S. 274 - which involved Ohio’s appointment of a receiver to remediate environmental claims after the debtor failed to abide by a state court consent decree requiring him to do so. The Supreme Court found that these enforcement efforts constituted a dischargeable “claim” in Kovacs’ bankruptcy.
The result in Apex was different because, in Judge Posner’s view, the receiver in Kovacs sought money for clean-up, whereas the EPA in Apex merely sought clean-up . . . from Apex. And, in fact, the federal statute under which the EPA sought remediation (the federal Resource Conservation and Recovery Act – “RCRA”) affords only this relief – and nothing more.
Juge Posner’s analysis of RCRA relies in part on earlier 7th Circuit precedent (AM Int’l. v. Datacard Corp., 106 F.3d 1342) - which itself relies on other Supreme Court precedent (Meghrig v. KFC W., Inc., 516 U.S. 479) – to hold that RCRA doesn’t allow a party obtaining a “clean-up” order to clean up a contaminated site itself, then sue for response costs in lieu of seeking an injunction. For this reason, he held, RCRA cannot “give rise to a right to payment” for purposes of a bankruptcy discharge.
The 7th Circuit panel acknowledged that Apex’s case is similar to U.S. v. Whizco, 841 F.2d 147 - in which the 6th Circuit reached a conclusion opposite from Judge Posner and his 7th Circuit colleagues. But where Apex is concerned, that is no matter. As Judge Posner sees it, the 6th Circuit’s rationale “cannot be squared with . . . [7th Circuit] decisions [such as Datacard] which hold that cost incurred [to comply with an equitable order] is not equivalent to the ‘right to payment’ . . . .”
Though the 7th Circuit’s understanding of RCRA is based in part on Supreme Court precedent, few decisions outside either the 6th or 7th Circuit appear to discuss its application in the bankruptcy context. Moreover, other Supreme Court precedent (such as Kovacs) holds that, at least in certain circumstances, equitable remedies (such as appointment of a receiver) are, in reality, “claims” within the meaning of the Bankruptcy Code – and, therefore, can be discharged.
As a result, the resolution of environmental claims in bankruptcy appears to turn not only on the “clean-up” statute at issue – or, more specifically, its remedies – but also on the jurisdiciton where the debtor’s bankruptcy case is filed.
So who’s gonna clean up this environmental mess?
That depends, at least in part, on which court first decides the claims resolution mess.
Monday, August 24th, 2009
One of the little-emphasized features of the 2005 Bankruptcy Code is a series of amendments designed to insulate the financial markets from the effects of corporate bankruptcy. These changes build upon earlier provisions designed to accomplish the same objective, and continue a more general Congressional policy toward the separation of bankruptcy and securities law dating back to the Chandler Act of 1938.
But are the securities markets and the Bankruptcy Courts better off for this “insulation”? Do the Bankruptcy Code’s various “securities exemptions” truly work as advertised?
That is the question raised by the University of Pennsylvania’s David A. Skeel, Jr.
Skeel, Penn Law School’s S. Samuel Arsht Professor of Corporate Law, explores the intersection between bankruptcy and securities law in a recently-authored Penn Institute for Law and Economics research paper titled “Bankruptcy Boundary Games.” The paper focuses on Bankruptcy Code provisions intended to subordinate corporate bankruptcy protections to the work-a-day operation of securities markets. In particular, Skeel focsuses on three examples of this deference:
- The Chapter 11 “brokerage exclusion” set forth in Bankruptcy Code Section 109(d);
- Section 546(e)’s ”avoidance safe harbor” for securities-related “settlement payments;” and
- Special treatment of “derivative transactions” under Section 362(b)(7) and elsewhere in the Code.
According to Skeel, “Debtors have sidestepped the brokerage exclusion from Chapter 11, the settlement safe harbor has been invoked in contexts well outside the transactions it was originally designed to protect, and the exemption from the stay for derivatives and other financial contracts performed much differently than advertised when Bear Stearns, Lehman Brothers and then AIG failed.”
Specifically, Skeel delves into recent case law and Chapter 11 filings to argue:
- Congress’s original contemplation that a Chapter 7 liquidation would be “cleaner” and more efficient than Chapter 11 has been superseded by the current, actual corporate structure of investment banking, which has permitted firms such as Lehman to utilize Chapter 11 and the “363 sale” process to accomplish the same result, more quickly and economically than might occur in a brokerage’s ”straight 7.” As a result, this exclusion is largely irrelevant to the realities of present financial markets and their participants.
- Section 546(e)’s “avoidance safe harbor,” hobbled by a circular and virtually useless definition of the key term “settlement payment,” has been inconsistently applied by Bankruptcy Courts faced with challenges made on this ground to avoidance actions. These challenges are often raised in contexts far different from what Congress appears to have originally contemplated. In the context of LBO-related avoidance claims, courts are divided over when – or if – the “safe harbor” applies. In Enron, the “safe harbor” defense was interposed with respect to at least three different types of transactions, and each defense appears to have been resolved on fact-specific grounds – with differing results. Skeel suggests that this “safe harbor” may leave markets insulated, but at the cost of extreme uncertainty regarding specific transactions.
- The exemption of derivatives from the Code’s automatic stay and other provisions were originally implemented in order to avoid a feared “domino effect” in the securities markets created by a corporate Chapter 11 filing. Ironically, however, these exemptions appear to do as much to invite systemic problems in the markets (e.g., runs in the event of financial distress) as they do to avoid them. Among other examples, Skeel argues that Bear Stearns’ 2008 bailout (in lieu of a Chapter 11 filing) was borne of precisely this concern. He suggests these exemptions have, in reality, done little to curb the “spill-over” effects in the securities markets that result from corporate bankruptcies.
In an environment where a great deal of federal securities regulation is up for fresh review, is it time for a legislative re-write of the Bankruptcy Code’s “securities exemptions?”
Perhaps, suggests Skeel.
But ”Bankruptcy Boundary Games” also hints at a more immediate and pragmatic approach to reconiling the Code’s provisions with the realities of the market: Creative lawyering and intelligent judging. “Overall,” he writes, “the Bankruptcy Courts have done a relatively good job of handling the fallout from the sweeping protection of securities markets.”
A point well taken.
Sunday, August 16th, 2009
“There’s a cement slab on Ridge Lane, topped with a few pipes, an electrical box and a porta-john. Nearby, an empty house, a large sign in the driveway declaring ‘inventory home.’ Around the corner, a few muddy lots, rimmed with construction fences … ‘If [the developer] is gone,’ [Kathy] Koss [a resident in the neighborhood] said, ‘what is going to happen to these houses?’”
This quote from a story in March 15’s Charlotte Observer opens an extensive and intriguing study assembled by Sarah P. Woo, entitled “A Blighted Land: An Empirical Study of Residential Developer Bankruptcies in the United States – 2007-2008.” Woo is an independent risk management consultant and doctoral scholar at Stanford University with prior experience as a research manager at Moody’s KMV London and a background in corporate finance at White & Case LLP. She offers a simple premise as the basis for her 194-page work, which also serves as her dissertation:
Until the housing sector is stabilized, there will simply be no recovery in America. And as financially distressed residential developers and home builders are forced into liquidation or foreclosure, the unfinished projects they leave behind affect not only the immediate community, but area housing prices as well.
Woo is not alone in her assessment of the persistent weakness of the US residential housing sector. A Deutsche Bank study released in early August and briefly summarized in a CNN-Money article last Wednesday indicates that home prices may fall another 14% before hitting a bottom, leaving as many as 48% of mortgage holders “underwater” by 2011.
Among Woo’s findings on developers who have filed Chapter 11 cases over the last 2 years:
- Only 5.3% were able to successfully reorganize. In fact, the majority of cases were actually dismissed or converted to Chapter 7 – leaving real estate to be foreclosed or liquidated in forced sales.
- 72% of the cases sampled involved at least one request by a secured lender to lift the stay for purposes of foreclosure. In such instances, relief was granted approximately 90% of the time. However, foreclosure may not always have been the best outcome for the bank. According to Ms. Woo, “[i]n one case, the bank which repossessed the property not only had trouble with the remaining development process but also found itself in a position where it could not necessarily sell the property as a going concern . . . . In [another] case, the bank which repossessed the property was seized by regulators 2 months later for being insufficiently capitalized, raising the issue of the extent to which a bank’s own financial problems might have contributed to its preference for liquidation during bankruptcy proceedings.”
- Where properties were disposed of through “363 sales,” Woo “uncovered a pattern of winning credit bids where secured lenders acquired the properties . . . at low prices.”
- Access to DIP financing appears to have been severely impaired for developers (as it has been for many Chapter 11 debtors this cycle, regardless of industry). Even where DIP financing has been available, such financing often occurred in cases where the debtor was ultimately liquidated or packaged for sale (again, a common scenario this cycle regardless of the debtor’s industry).
Is the near-certain prospect of liquidation or sale facing struggling residential home developers a good one for the sector?
On the one hand, Woo’s study appears to suggest that the control available to lenders through mechanisms such as DIP financing and stay relief litigation, employed by highly regulated and troubled US banks desperate to raise capital by seizing and liquidating collateral, puts housing developers who might reorganize in Chapter 11 on a very slippery slope with little prospect of survival. On the other, it suggests that the industry may be ridding itself of weak performers very quickly, leaving only the strongest to survive as the residential housing sector struggles back to prior levels.
Where real estate development and the residential housing sector are concerned, is the shortest way up . . . straight down?
Monday, August 10th, 2009
Since mid-July, Antiguan liquidators Peter Wastell and Nigel Hamilton-Smith and federal receiver Ralph Janvey have awaited Judge David Godbey’s decision on the liquidators’ request for recognition of their liquidation of Stanford International Bank, Ltd. (SIB), now pending in Antigua.
As discussed in a number of previously-published posts (here, here, here, here, here, and . . . here), Messr’s. Wastell and Hamilton-Smith have been at odds with Mr. Janvey, who was appointed in Dallas’ U.S. District Court for the purpose of administering assets previously controlled by Sir Allen Stanford – including, presumably, SIB. Stanford’s assets and creditors span at least three continents – North America, South America, and Europe – and have spawned insolvency proceedings in several countries. Despite the apparent breadth of Judge Godbey’s original receivership order, the liquidators previously requested – and Judge Godbey (over Mr. Janvey’s strenuous objection) granted – a modification to that order for the purpose of commencing a case under Chapter 15 of the Bankruptcy Code on SIB’s behalf.
While the parties await a ruling on recognition of the Chapter 15 case, Mr. Janvey’s receivership continues forward, with pleadings filed almost daily on a variety of issues. Among the matters awaiting resolution in the receivership is a request by Sir Allen that raises issues which themselves may impact Judge Godbey’s decision on recognition.
In early July, Sir Allen filed a seemingly innocuous request for permission to certify tax returns for a number of Antiguan corporations. He argued that the Antiguan court already had held these companies outside the U.S. District Court’s jurisdiction – and, therefore, outside the jurisdiction of the receivership. Nevertheless, respect for the U.S. District Court and a preference for consistency between courts regarding the extent of the District Court’s jurisdiction made prudent a request further amendment of the receivership order to permit Stanford’s exercise of these corporate formalities. A failure to exercise such formalities in short order would, according to Sir Allen, subject the corporations to being stricken from the Antiguan Companies Register.
About 2 weeks ago, Mr. Janvey fired back with an 8-page opposition. In it, he argued that (i) the Antiguan court’s refusal to recognize his American receivership remains on appeal; (ii) Mr. Janvey himself never has been provided copies of the returns Sir Allen seeks to certify; (iii) Sir Allen has declined Mr. Janvey’s requests for these returns, apparently, on the basis that doing so would violate his 5th Amendment rights against self-incrimination under the US Constitution; and (iv) should Judge Godbey wish to preserve the Antiguan corporations in question from sanction, he need merely designate Mr. Janvey or his agent to certify the returns. Janvey’s arguments are based on his fundamental contention that corporate separateness should be disregarded where the corporate form has been used for a fraudulent purpose – and where the corporations in question have been used for this purpose, they ought to be treated as “alter egos” of Stanford himself and therefore are within the ambt of the District Court’s jurisdiction.
Last Thursday, Sir Allen replied. Relying once again on the Antiguan court’s prior denial of American jurisdiction over the corporations, Sir Allen insists that Mr. Janvey has no greater jurisdiction than the U.S. Court which appointed him - and that Judge Godbey cannot simply ignore the prior Antiguan ruling. Further, Sir Allen insists that his prior general assertion of 5th Amendment rights doesn’t justify an inference of fraudulent activity regarding these corporations – and that Mr. Janvey has never provided any other evidence in support of these allegations.
Distilled to their essence, the parties’ positions closely parallel similar issues relevant to the Antiguan liquidators’ pending recognition request. They also highlight a number of the complicated questions underlying that request, such as:
- What should be the effect of the Antiguan court’s prior order regarding Janvey’s receivership? Should the liquidators’ request for recognition of SIB’s liquidation be treated differently than Stanford’s request to certify returns for the Antiguan companies? Or should a similar analysis apply to both orders? How should the U.S. case law doctrine of comity (i.e., American courts’ respect for the rulings of foreign courts) – which informed many prior requests for ancillary relief under the US Bankruptcy Code and which even today informs much of the policy behind Chapter 15 – apply in either case?
- To what extent, if any, should allegations of fraudulent intent be relevant to determining the Stanford companies’ applicable “center of main interests” (COMI) – a decision critical to the relief that the liquidators seek? And if the allegations of fraud were relevant, what would be the level of evidence ncessary to establish the requisite fraud?
- To what extent, if any, must an equitable receivership commenced in aid of a governmental enforcement action arising from alleged violations of US securities laws bend to the statutory provisions of cross-border commercial insolvency law? And to what extent, if any, is a US Court able to uphold such enforcement in the face of a foreign court’s order (or, as here, multiple orders) apparently limiting its jurisdiction?
As with the recognition request, the parties now await Judge Godbey’s ruling.
Sunday, August 2nd, 2009
On Tuesday, Industry Week reported results of a recent study by Miami-based Hackett Group, Inc. which indicates that four out of five companies are unable to forecast mid-term (2-3 months out) operating cash flow to within 5% accuracy.
In an operating evironment where cash is king, that’s sobering news.
The study also reported that “top performers” do significantly better than their peers. A total of 74% of such top-tier companies are able to forecast mid-term cash within 5% accuracy. These top performers also complete their forecasts in less than half the time it takes typical companies, and require fewer staff to complete the process.
Among other findings:
- About 70% of all companies surveyed rely almost exclusively on standalone spreadsheets as their primary cash forecasting tool.
- A related Hackett survey also found that while forecast accuracy is measured by most companies, 80% don’t set accuracy targets and 85% do not incentivize improved accuracy.
- The best companies also have cross-functional teams with significant operational involvement.
- Top performers know their customers and suppliers better, conduct more frequent credit reviews, and have in place better-structured, interactive dispute resolution processes.
- Top performers look at operational leading indicators and macroeconomic assumptions 40 percent more often than typical companies, are 62% more likely to rely on best/worst case assumptions, and turn to what-if analyses 79% more frequently.
- Predictably, top performers are about 50% more likely to offer a range of numbers, footnotes and scenario analysis as part of their forecast, while others are not.
The Industry Week article can be accessed here. An executive summary of, and conclusions drawn from, the Hackett Group study can be located here.