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    Archive for September, 2010

    The Automatic Stay Gives Way to Universalism in Chapter 15 Proceedings . . . Sort Of

    Tuesday, September 28th, 2010

    JSC BTA Bank (BTA), one of Khazakstan’s largest banks, sought restructuring under the guidance of the Kazakh government early this year.  A prior post on BTA’s protective filing is available here.  BTA’s recognition order granted BTA “all of the relief set forth in section 1520 of the Bankruptcy Code including, without limitation, the application of the protection afforded by the automatic stay under section 362(a) of the Bankruptcy Code to the Bank worldwide and to the Bank’s property that is within the territorial jurisdiction of the United States.”

    Among its obligations, BTA was in default on a $20 million advance from Banque International de Commerce – BRED Paris, succursale de Geneve, Switzerland (“BIC-BRED”) for the construction of an entertainment complex in Moscow.  BIC-BRED commenced Swiss arbitration proceedings regarding this obligation.

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    After BTA commenced its Khazakh restructuring and obtained recognition in the US, it submitted a statement in the arbitration, requesting a stay of the arbitration and claiming the universal application of the automatic stay.  BIC-BRED refused to acknowledge the reach of the stay in BTA’s ancillary case.  Apparently, so did the arbitrator:  An award in the Swiss proceedings was entered in July 2010 against BTA.

    BTA sought a determination that the automatic stay did, in fact, apply – and that BIC-BRED ought to be sanctioned for its continued prosecution of the Swiss arbitration.

    In a decision issued late last month, Presiding Judge James Peck summarized the basis for his restrictive reading of the automatic stay as follows:

    If the provision regarding the automatic stay in chapter 15 cases were to be construed in the manner urged by the Foreign Representative, even the court in the foreign main proceeding in Kazakhstan would be subject to the stay and would need permission from this Court before taking any action that might impact the foreign debtor.  No rational cross-border insolvency regime would give a bankruptcy court in the United States so much unintended automatic extraterritorial power in conjunction with the recognition of a foreign proceeding . . . .  [A]ny application of the language of section 1520(a)(1) should reject an extraterritorial interpretation that would stay miscellaneous foreign litigation or arbitration proceedings having no meaningful nexus to property of the foreign debtor located in the United States.

    Instead, he concluded that

    [T]he automatic stay does not afford broad anti-suit injunctive relief to the debtor entity outside the territorial jurisdiction of the United States upon entry of an order of recognition in a chapter 15 case. This conclusion is based on the need to respect the international aspects of [chapter 15], the limited and specialized definition of the term “debtor” when used in chapter 15, and the fact that cases under chapter 15 are ancillary in nature and do not create an estate within the meaning of section 541 of the Bankruptcy Code.

    This is not to say, however, that the automatic stay arising under the US Bankruptcy Code is limited to the territorial reach of the US.

    After reviewing – and rejecting – the administrator’s interpretation of how the automatic stay ought to apply in ancillary cases “to the debtor and the property of the debtor that is within the territorial jurisdiction of the United States” Judge Peck went on to offer two possible legitimate interpretations (the Court had previously reviewed – and rejected – the administrator’s alternative interpretation):

    One possibility, but a terribly strained one, would be to construe the territorial limitation within section 1520(a)(1) as extending to both the debtor and its property. Such a reading would limit the effect of the automatic stay to actions against a debtor commenced within the United States and to debtor property located here and would tie the word ‘debtor’ to the phrase ‘within the territorial jurisdiction of the United States.’ That reading is consistent with international cooperation and avoids absurd results but fails to account for placement of the words ‘that is’ within the text of this sentence. Those words break the connection between the debtor and the United States.

    An alternative, and better “reading of section 1520(a)(1), and one that is consistent with the plain meaning of the words as written, is that the stay arising in a chapter 15 case upon recognition of a foreign main proceeding applies to the debtor within the United States for all purposes and may extend to the debtor as to proceedings in other jurisdictions for purposes of protecting property of the debtor that is within the territorial jurisdiction of the United States. This more limited extraterritorial application of the automatic stay to the debtor entity fulfills the cross-border purposes of chapter 15 within the United States without broadly imposing a stay on all actions or proceedings against the debtor including those lacking any proper connection to the chapter 15 case.”

    Under the latter reading, then, the automatic stay is applicable world-wide, but only where necessary to protect the US Bankruptcy Court’s in rem jurisdiction over the foreign debtor’s domesticated property.

    The BTA decision is noteworthy in a broader context as well:

    - This decision is one of several recent cases in which Bankruptcy Courts have sought to negotiate otherwise difficult applications of the Code’s other provisions within the context of Chapter 15 through an appeal to interpretation based on the statute’s “international aspects.”  “International” in these cases really means “universal” – Courts applying this statute have gone to some lengths to employ Chapter 15 as a vehicle for extending universal administration of the “main case,” wherever that case is located.

    - But “universalism” only goes so far:  In Judge Peck’s view, “The bankruptcy court, at least in the setting of an ancillary chapter 15 case, should not stand in the way of a foreign arbitration process when the outcome will have no foreseeable impact on any property of the foreign debtor in the United States.”   But what if the outcome of such litigation did have foreseeable impact on such property?  The answer, according to Judge Peck, is clear:  The US Bankruptcy Court’s in rem jurisdiction may not be trifled with, no matter where such efforts might occur.

    - This decision nevertheless suggests an additional area of “section shopping” – i.e., the strategic employment of plenary or ancillary procedures to take advantage of various protections or remedies arising under the laws of the jurisdictions involved.  Similar considerations attend the availability and application of avoidance powers arising under Sections 1521 and 1523 and Section 544 (which affords recoveries to unsecured creditors that would be available under “non-bankruptcy law”).  See Tacon v.Petroquest Res. Inc. (In re Condor Ins. Ltd.), 601 F.3d 319, 329 (5th Cir. 2010) (foreign representative of foreign proceeding authorized to pursue non-US avoidance claims against US defendants through ancillary proceeding), and a related post here.

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    Solvency Analysis in Preference Litigation

    Monday, September 13th, 2010

    Last week’s post discussed public-market data as the benchmark for solvency in assessing fraudulent transfers.  This week’s post covers solvency the “old fashioned” way – in addressing preference litigation.

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    Ray Clark, who runs Valcor Consulting – an Irvine-based restructuring, valuation, and litigation consultancy – and who contributes regularly to this blog, recently offered an overview of the solvency analysis and valuation techniques that apply when a company faces claims for payments made within 90 days of a debtor’s bankruptcy:

    The question of solvency in a voidable preference action depends upon the fair valuation of the debtor’s assets at the time of the transfer, along with other solvency analyses.  The question of whether to use a “going concern” valuation analysis versus a “liquidation” analysis depends upon whether the debtor was “on its death bed” at the testing date, e.g. the transfer date.  If the going concern premise is applied, then the BK court typically relies on an appraisal of the business, i.e., the value of the assets used in an ongoing enterprise, as the basis for the solvency analysis.  By contrast, if it is determined that the business was not a going concern at the transfer date, and then an asset-by-asset analysis under a liquidation scenario will be used.  Lastly, solvency can also be judged by whether the debtor is able to pay his debts as they come due.  So, there is essentially a two-pronged definition of insolvency:    

    1. A debtor is insolvent if the sum of the debtor’s debts is greater than all the debtor’s assets, at a fair valuation, or
    2. A debtor who is generally not paying his debts as they become due is presumed to be insolvent.

    Ultimately, stakeholders may rely on a so-called “Solvency Opinion,” which is designed to assess a company’s overall financial condition at a designated time and using a variety of tests determine whether the entity was solvent or insolvent.  The three tests that are typically applied include:

    1. The Balance Sheet Test (with case law references),
    2. The Capital Adequacy Test and
    3. The Cash Flow Test

    Ray’s article disucssing each of these tests is available here.  For further questions, contact mgood@southbaylawfirm.com or rclark@valcoronline.com.

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    Fraudulent Transfer Litigation – A New Use for Credit Default Swaps?

    Tuesday, September 7th, 2010

    Credit Default Swaps – those largely unregulated “side bets” over the likelihood of specific companies defaulting on one or more of their credit obligations, which were all the rage during the beginning of the decade - have become, in light of the 2008 financial crisis, “the financial instrument that scholars, journalists, government officials and even some prominent financiers love to hate.”

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    The problematic impact of CDS’s on firms in financial distress – and their separate treatment under existing securities “safe harbors” in the US Bankruptcy Code – have likewise provoked further commentary and calls for reform from the insolvency community (some of which has been covered in various posts on this blog, and which is summarized here).

    But despite the furor over much-maligned CDS’s, not everyone is casting aspersions.

    Last week, Seton Hall’s Michael Simkovic and Davis Polk’s Benjamin Kaminetzky released a paper arguing that CDS pricing at the time of a credit event (such as a loan made in connection with an LBO) can – when combined with other market information about a company’s debt securities – provide important indicators of a company’s solvency at the time of that transaction.

    Though it requires 58 pages (plus 12 pages of appendices) to develop, Simkovic’s and Kaminetzky’s basic premise is relatively simple:

    Fraudulent transfer analysis is too often susceptible to manipulation by self-interested experts, and too prone to after-the-fact “second guessing” by bankruptcy courts, to be consistently reliable and predictable.  Efficient securities markets are the best contemporaneous guides to the solvency of a debtor with publicly traded debt.  As a result, bankruptcy courts attempting to determine the solvency of a debtor at the time of an alleged fraudulent transfer should use contemporaneous credit-market data as a (or as the) key indicator of the debtor’s solvency.

     The idea is more than an abstract concept: Simkovic and Kaminetzky cite two relatively recent decisions in which bankruptcy courts applied public-market analysis to determine the debtor’s solvency and the resulting avoidability of a fraudulent transfer, each using equity market valuations contemporaneous with the time of the transfers.  Simkovic and Kaminetzky extend this approach, arguing that credit-market instruments and their derivatives – such as credit yield spreads and CDS pricing - provide a more reliable indication of solvency than the debtor’s equity.

    The idea of employing public market data is of limited use in cases where the debtor is closely held – or where public credit-market data is not readily available.  But Simkovic’s and Kaminetzky’s research represents yet another recent and important effort by scholars to impose greater uniformity and predictability on the question of whether a debtor is – or has become – insolvent as a result of a pre-bankruptcy transfer for less-than-equivalent value (for another approach to the same general problem, see an earlier post here).

    In light of the extensive, highly-leveraged financing that took place between 2004 and 2007 – and the correspondingly high anticipated default rates when that same debt matures over the next several years – Simkovic’s and Kaminetzky’s work also renews the focus on an important question, directly relevant to any inquiry into an alleged fraudulent transfer:  

    What did the participants in an allged fraudulent transfer – and all of those responsible for due diligence regarding that transfer – believe about the debtor’s present or resulting solvency at the time the transfer was made?  And what (if anything) was the basis for their belief?  

     

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