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    Archive for June, 2010

    Examining Examiners

    Tuesday, June 29th, 2010

    What’s it worth to learn from prior mistakes or misdeeds?

    For interested parties in most large Chapter 11 cases, apparently not much.

    Bankruptcy “examiners” are private individuals appointed by the Office of the Unites States Trustee at the direction of a Bankruptcy Court to investigate and report on the causes of a company’s failure.

    Chapter 11 of the Bankruptcy Code provides that examiners “shall” be appointed if requested in any case involving, among other things, more than $5 million in certain types of unsecured debt.  In creating this position, Congress apparently expected examiners to be ubiquitous in the reorganization of large, public companies.

    Nevertheless, it simply ain’t so.  Anyone with restructuring experience can attest to the truisim that examiners are a rarity in Chapter 11 cases.

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    Earlier this month, Temple University Professor Jonathan Lipson posted statistical analysis on the appointment of bankruptcy examiners – and why, despite the mandatory language addressing their appointment in the Bankruptcy Code – so few are, in fact, actually appointed.

    In “Understanding Failure: Examiners and the Bankruptcy Reorganization of Large Public Companies,” Lipson – whose work will appear in a forthcoming edition of the American Bankruptcy Institute Law Journal – observes that examiners are rarely sought in Chapter 11 cases, and even less frequently appointed.  Lipson’s docket-level analysis of 576 of the largest chapter 11 reorganizations from 1991 to 2007 shows they were requested in only 15% of cases.  Despite the seemingly mandatory language of the Bankruptcy Code, examiners were appointed in fewer than half of the cases where sought, or less than 7% of the sample.

    So what does it take to get an examiner appointed?  Lipson summarizes the article’s findings as follows:

    - Size matters. Cases in which examiners are sought are huge. The average case in which an examiner was sought was almost twice as large as the sample measured by median asset values and more than four times larger measured by mean asset values. Holding other things equal, a request for an examiner was three times more likely in a case with a debtor having at least $100 million in net assets. Cases in which examiners were appointed had mean liabilities twice the size of cases where the motions were not granted.

    - Conflict matters. Cases in which examiners were sought or appointed were much more likely to be contentious, as measured by docket size and requests for chapter 11 trustees, than were cases without.  Holding other things equal, a request for a chapter 11 trustee in a large case increases the odds of an examiner request by a factor of five.

    - Venue matters. Examiners are much more likely to be sought—although not necessarily appointed—in the two districts that tend to have the largest cases, Delaware and the Southern District of New York (SDNY). Together, Delaware and the SDNY had forty-six (52%) of requests for an examiner, but actually appointed an examiner in only seventeen cases (about 43%). By contrast, examiners were appointed in twenty-two cases (about 57% of appointments) when requested in other districts.

    - Fraud matters—somewhat. Although requests for an examiner correlated with allegations of pre-bankruptcy fraud—the paradigm grounds for an examiner—they were nevertheless rare even when a bankruptcy was precipitated by that form of wrongdoing: Of the thirty-one cases in the sample that allegedly involved fraud, examiners were sought in only nine and, of those, were appointed in only five.

    - Strategy matters—somewhat.  There is evidence that examiners will sometimes be sought for strategic, not information-seeking, reasons. Requests to appoint an examiner were withdrawn in fourteen cases (about 17% of requests in the sample) and rendered moot by subsequent events (e.g., plan confirmation) in sixteen cases (about 20% of requests). Judges and system participants interviewed for [Lipson's] paper indicated that they believed that, in many cases, the arguably “mandatory” language of the Bankruptcy Code produces gamesmanship,not enlightenment.

    - Investors do not matter much.  Notwithstanding a purported goal of protecting the “investing public,” individual investors made only eighteen requests for examiners.  Far more likely to request an examiner (thirty-two cases) were individual creditors whose claims did not arise from investment securities (such as bonds) or fraud, but who apparently held claims for unpaid goods or services.

    Lipson’s work provides empirically grounded insight on this little-used feature of Chapter 11, and is well worth a read.

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    Squeezing the Most Value from Distressed Assets: Is Chapter 11 Always the Best Way?

    Monday, June 21st, 2010

    It is perhaps stating the obvious that Chapter 11 of the US Bankruptcy Code offers a well-known and very flexible means of extracting the most value from distressed assets.  But in these economic times, it is worth remembering that Chapter 11 is by no means the only avenue for addressing insolvency – nor is it always the best . . . or most appropriate.

    Bankruptcy (or “Section 363”) sales have been a time-honored and tested means of moving distressed assets quickly and cost-efficiently from buyer to seller.  But the lack of credit necessary to fund the transition period required for such sales during the recent downturn, combined with a handful of recent appellate decisions which cast doubt on the validity of contested sales, serve as reminders that other transactional structures sometimes work just as well – or even better.

    The folks at Turnaround Management Association (TMA) released a spate of articles last week which illustrate the point: Two of TMA’s pieces (one on ABC’s and Receiverships and one on alternative sale structures for distressed acquisitions) compare and contrast federal bankruptcy proceedings with other means of optimizing the transfer of distressed assets. A third focuses on “strict foreclosures” (or “Article 9 sales”).

    All three are well worth a read.

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    Rule 2019: A Kinder, Gentler, Amendment

    Monday, June 14th, 2010

    The Advisory Committee on Bankruptcy Rules of the Administrative Office of the U.S. Courts has pulled back from its earlier position on the disclosure required of hedge fund and other distressed debt investors participating as ad hoc committees or other, loosely organized creditor groups in Chapter 11 cases.

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    An earlier version of proposed amendments to Federal Rule of Bankruptcy Procedure 2019 would have required such investors to disclose the dates and prices paid for their purchases of distressed securities.  These changes were resisted by investor groups such as the Loan Syndications and Trading Association, and created some press coverage last year (an earlier post on the amendments is available here).

    That said, investors will still be required to reveal the “disclosable economic interest” they each hold in a company, including debt and derivatives. This includes the identity of specific investors and the date such investors acquired their interests.

    Morever, Committee notes to the proposed rule indicate that the previously-contested disclosures of pricing and purchase dates may be compelled through discovery or by the Court acting under its own authority outside the proposed rule.

    A copy of the proposed rule, along with a summary of comments received on earlier versions and the Committee’s advisory notes, is available here.

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    US Recognition of Individual Foreign Bankruptcies: What It (Doesn’t) Take

    Monday, June 7th, 2010

    From the Fifth Circuit Court of Appeals, a recent decision regarding the curious (and well-aged) bankruptcy of Yuval Ran offers a thought-provoking consideration of what is required to obtain US recognition of a foreign individual’s bankruptcy case.

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    The Curious Case of Mr. Ran

    Mr. Ran, an Israeli citizen, was at one point a director or shareholder in almost one hundred Israeli companies – some publicly-traded, and the largest of which was Israel Credit Lines Supplementary Financial Services Ltd. (“Credit Lines”), a public company co-founded and run by Ran, who served as CEO.

    After raising millions of dollars from investors and acquiring interests in numerous other companies, Credit Lines ultimately found itself in liquidation through an Israeli bankruptcy proceeding. Credit Lines’ bankruptcy receiver asserted claims against Ran for millions of dollars in damages.

    In June 1997, an involuntary bankruptcy proceeding was commenced against Ran in the Israeli District Court of Tel Aviv-Jaffa – but not before Ran and his family had departed Israel for Houston, Texas. Since their departure, Ran and his wife purchased a home and went to work for a local furniture company. Ran’s wife and five children are US citizens, and Ran himself is a permanent resident seeking US citizenship. With the exception of some minimal collection work on Credit Lines’ behalf shortly after he arrived in the US, Ran did no further business in Israel.

    In December 2006 – nearly a decade after Ran and his family emigrated, and more than eight years after being appointed receiver of Ran’s estate – Zuriel Lavie, the receiver appointed for Ran’s Israeli assets, sought recognition of the Israeli bankruptcy proceeding as a foreign main or non-main proceeding under Chapter 15 of the Bankruptcy Code in the Southern District of Texas’ Bankruptcy Court.

    Levie’s petition was denied the following May. After two rounds of appeals to the District Court, the parties finally found themselves before the Fifth Circuit Court of Appeals.

    In affirming the District Court and the Bankruptcy Court’s denials, the Fifth Circuit briefly reviewed the procedural requirements for recognition set forth in Section 1517 of the Bankruptcy Code, then turned its attention to the one item of substance – whether the debtor’s bankruptcy proceeding qualified either as a foreign “main” or “non-main” proceeding as contemplated by Chapter 15.

    Main Proceeding” – Where is COMI?

    Under US law – as under the UNCITRAL Model Law upon which it is based – a foreign “main proceeding” qualifies as such if the jurisdiction where it is pending is the debtor’s “center of main interests” (COMI). In the case of an individual such as Ran, COMI is presumptively the debtor’s “place of habitual residence” – a concept roughly equivalent to the debtor’s “domicile,” or physical presence coupled with an intent to remain there. One acquires a “domicile of origin” at birth, and that domicile continues until a new one (a “domicile of choice”) is acquired.

    A similar concept – that of “habitual residence” – likewise applies under foreign law when the individual intends to stay in a specified location permanently. Factors pertinent to establishing an individual’s “habitual residence” include: (1) the length of time spent in the location; (2) the occupational or familial ties to the area; and (3) the location of the individual’s regular activities, jobs, assets, investments, clubs, unions, and institutions of which he is a member.

    Under these facts, Ran’s COMI was presumptively in the US – and not in Israel. However, the presumption of COMI may be rebutted. Levie sought to do so by introducing evidence at the District Court that: (1) Ran’s creditors are located in Israel; (2) Ran’s principal assets are being administered in bankruptcy pending in Israel; and (3) Ran’s bankruptcy proceedings initiated in Israel and would be governed by Israeli law.

    Ran countered by pointing out that: (1) Ran along with his family left Israel nearly a decade prior to the filing of the Chapter 15 petition; (2) Ran has no intent to return to Israel; (3) Ran has established employment and a residence in Houston, Texas; (4) Ran is a permanent legal resident of the United States and his children are United States citizens; and (5) Ran maintains his finances exclusively in Texas.

    In weighing this evidence, the Fifth Circuit relied on earlier analysis in In re SPhinX, Ltd., 351 B.R. 103 (Bankr. S.D.N.Y. 2006), aff’d, 371 B.R. 10 (S.D.N.Y. 2007) – and more specifically, on analysis in In re Loy, 380 B.R. 154. 162 (Bankr. E.D. Va. 2007) (the only case to address the concept of COMI with respect to an individual debtor) – in which the Bankruptcy Court noted that factors such as (1) the location of a debtor’s primary assets; (2) the location of the majority of the debtor’s creditors; and (3) the jurisdiction whose law would apply to most disputes, may be used to determine an individual debtor’s COMI when there exists a serious dispute. The Fifth Circuit found that, unlike the Loy decision, the initial presumption (and the ultimate preponderance of evidence) under these factors weighed in Ran’s favor.

    Undeterred, Lavie argued that the Fifth Circuit ought not to confine its COMI inquiry to the “snapshot” of Ran’s domicile that existed at the time the Chapter 15 petition was filed. Instead, he argued that the Fifth Circuit ought to look back to Ran’s “operational history” in Israel for a more comprehensive determination of COMI.

    The Fifth Circuit panel was not persuaded. Instead, it looked to the statute’s use of present tense (i.e., a “main proceeding” is a “foreign proceeding pending in the country where the debtor has the center of its main interests”) to determine the COMI inquiry as dispositive of what evidence was relevant, and what evidence was not.

    The panel then went on to provide policy bases for the “snapshot” approach to COMI, explaining that locating COMI as of the date the petition is filed aids international harmonization and promotes predictability. Perhaps most significantly the panel noted “it is important that the debtor’s COMI be ascertainable by third parties . . . . The presumption is that creditors will look to the law of the jurisdiction in which they perceive the debtor to be operating to resolve any difficulties they have with that debtor, regardless of whether such resolution is informal, administrative or judicial.”

    Non-Main” Proceeding

    On the question of whether Ran’s proceeding was a foreign “non-main” proceeding, the Fifth Circuit panel pondered its definition, i.e., “a foreign proceeding, other than a foreign main proceeding, pending in a country where the debtor has an establishment.” Lavie argued that Ran’s involuntary proceeding in Israel was, in itself, an “establishment.” Section 1502(2), however, defines an “establishment” as “any place of operations where the debtor carries out a nontransitory economic activity.”

    Unlike COMI, the existence of an “establishment” is a simple factual determination with no presumptions in anyone’s favor.  However, one court has noted that “the bar is rather high” to prove the debtor maintains an “establishment” in a foreign jurisdiction.

    In essence, the Fifth Circuit found that in order to have an “establishment,” Ran must have had “a place from which economic activities are exercised on the market (i.e. externally), whether the said activities are commercial, industrial or professional” at the time that Lavie filed the petition for recognition.

    For the same reasons that gave rise to the Fifth Circuit’s weight of the evidence in Ran’s favor regarding the “main proceeding,” the Israeli proceeding was determined not to be a “non-main” proceeding – and, therefore, not entitled to any recognition within the US.

    In addition to being the first appellate decision addressing an individual’s COMI, the Ran case is noteworthy for the proposition that the mere existence of an individual’s insolvency proceeding, pending in another jurisdiction, is insufficient to qualify for recognition under US law. Instead, there must be a demonstration of ongoing activity – either through a showing of COMI, or through the “establishment” of ongoing activity – to qualify.

    Further, though it is specifically limited to its own facts, the Ran decision offers a glimpse into the Fifth Circuit’s general approach to COMI – in particular, its observance that the debtor’s COMI should be ascertainable by third parties. This observance may prove significant in the event that similar disputes over the much larger and more contentious Stanford proceedings (see prior posts about Stanford here) ever make their way to the Circuit Court.

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