South Bay Law Firm will be back posting in 2011. In the meantime, have a safe and prosperous New Year!
Archive for December, 2010
The distribution scheme embodied in federal bankruptcy law serves several important functions. In Chapter 7, the detailed statutory distribution scheme imposes order on the chaos that might otherwise attend the liquidation of business assets. In Chapter 11, the fixed order of priority claims and the “absolute priority rule” – along with the requirement that similarly situated classes receive identical treatment – provide predictability within the confirmation process and a framework for out-of-court negotiations.
But not all resolutions of business insolvency afford this level of predictability. In particular, state and federal receiverships afford the prospect of considerably greater flexibility and discretion on the part of the appointed receiver and the appointing court.
The scope of a receiver’s discretion was illustrated early this month by the 7th Circuit Court of Appeals’ approval of a federal receiver’s proposed pro rata distribution of the assets of six insolvent hedge funds.
SEC v. Wealth Management LLC, — F.3d — 2010 WL 4862623 (7th Cir., Dec. 1, 2010) involved an SEC enforcement action against Appleton, Wisconsin-based investment firm Wealth Management LLC and its principals, alleging, among other things, misrepresentation and fraud. At the SEC’s request, the Wisconsin District Court appointed a receiver for Wealth Management and its six unregistered pooled investment funds.
The receiver’s plan, approved by the District Court, was relatively straightforward: All investors would be treated as equity holders, and would receive pro rata distributions of the over $102 million invested in the funds. Two investors who had sought redemption of their investments pre-petition disagreed and appealed the receiver’s plan. The essence of their argument was that Wisconsin law (and Delaware law, which governed several of the funds), required that investors who sought to redeem their investments be treated not as equity holders, but as creditors of the failed funds. As a result, their redemption claims were of a higher priority than investors who had not sought to withdraw their funds. The investors also relied on 28 USC § 959(b), which provides that receivers and trustees must “manage and operate” property under their control in conformity with state law.
The 7th Circuit rejected this argument, finding instead that federal receivers and trustees need not follow the requirements of state law when distributing assets under their control. Holding that “equality is equity,” the court found that to give unpaid redemption requests the same priority as any other equity interest “promotes fairness by preventing a redeeming investor from jumping to the head of the line . . . while similarly situated non-redeeming investors receive substantially less.”
The Wealth Management decision highlights the flexibility and ambiguity of the receivership system – itself a critical distinction from the well-defined priorities of federal bankruptcy law. Though the 7th Circuit’s reasoning – rooted in “similarly situated claims” – is consistent with the policy objectives of the Bankruptcy Code, the result is diametrically opposed to the scheme of priorities on which Wealth Management’s investors undoubtedly relied.
Wealth Management – like many receivership cases – is a case based on federal securities fraud. But federal and state receiverships are applicable in a variety of contexts – including business dissolutions, directorship disputes, marital dissolutions, and judgment enforcement. Where a proposed distribution to creditors can be fairly characterized as “equitable” under the circumstances of the case and where it represents a fair exercise of the receiver’s fiduciary duty on behalf of the receivership estate, the flexibility of a receivership may justify its typically high cost.
One of the historical attractions of the Bankruptcy Code as a vehicle for restructuring is the ability to sell the debtor’s assets quickly, cleanly, and with finality pursuant to a sale under Section 363.
So-called “section 363 sales” have been the subject of much recent interest and debate, as evidenced by the discussion surrounding 2009’s “section 363 sales” of both Chrysler LLC and General Motors Corporation (see, for example, blog posts here and here). In California, the effectiveness of such sales has been limited where the assets are worth less than the aggregate liens against them, and a lienholder objects to the sale.
Earlier this month, “Section 363 sales” received yet another potential challenge in California, this time from the Federal Trade Commission, which sought to undo Laboratory Corporation of America (“LabCorp”)’s acquisition of Westcliff Medical Laboratories, Inc. (“Westcliff”). According to the agency’s December 1 complaint to enjoin furtherance of the merger, filed in Washington DC and transferred to California’s Central District (redacted copy available here), the merger will substantially lessen competition among providers of capitated clinical laboratory testing services to physician groups in southern California.
LabCorp and Westcliff are clinical laboratory testing companies serving physician groups here in Southern California. In May 2010, Westcliff agreed to sell substantially all of its business assets to LabCorp for $57.5 million. As part of the sale, Westcliff agreed to file a voluntary petition for relief under Chapter 11 of the US Bankruptcy Code. The transaction was therefore subject to the approval of the US Bankruptcy Court for the Central District of California. In June, after a hearing at which no other bidder emerged to top the LabCorp offer, the court approved the sale, the parties closed the deal, and life went on – until the FTC stepped in.
Though after-the-fact challenges to mergers are not unknown, they have been – at least until recently – comparatively rare. Even rarer is the challenge to an acquisition completed with approval by the US Bankruptcy Court. The FTC claims Westcliff wasn’t a “failing firm,” whose assets otherwise would have exited the market absent the merger (and would therefore be exempt from anti-trust enforcement). Instead, the FTC alleges Westcliff was generating operating profits at the time of its sale and that there were other potential buyers available to purchase the company. According to the FTC, the reason these buyers didn’t show up was because none would have matched LabCorp’s $60 million “stalking horse” bid.
Counsel for LabCorp attempted to preempt the FTC’s action by filing an adversary complaint in Bankruptcy Court, seeking declaratory relief as well as an injunction against the FTC, arguing that the agency’s enforcement action constituted a “collateral attack” on the Bankruptcy Court’s prior sale order. The FTC responded with its own motion to dismiss and an argument that its enforcement action was limited merely to prospective violations of antitrust laws, and did not seek to disturb the bankruptcy sale. Bankruptcy Judge Theodor Albert abstained, and transferred the matter to the US District Court where the FTC’s action remains pending.
Though the Bankruptcy Court’s order authorizing the Westcliff acquisition remains undisturbed, the FTC’s action raises some important and often-overlooked questions about “363 sales”: Does counsel advising on the sale or purchase of a distressed business need to conduct or provide due diligence on the potential anti-trust effect of the transaction, despite the transaction’s failure to meet the Hart-Scott-Rodino reporting threshold? Is it necessary (or good practice) for bankruptcy counsel to obtain factual findings commensurate with the sale which would insulate the transaction from subsequent attack?
In any event, 363 sales in now carry another important caveat emptor.
- FTC to challenge LabCorp buy of small rival (reuters.com)
- FTC Challenges Acquisition of Westcliff Labs by LabCorp In Southern California-Why? (ducknetweb.blogspot.com)
- FTC Challenges LabCorp’s Acquisition of Rival Clinical Laboratory Testing Company (ftc.gov)
- FTC Challenges Acquisition by LabCorp (online.wsj.com)
- FTC Targets Yet Another Done Deal (legaltimes.typepad.com)
- 4 tips for buying a bankrupt competitor (venturebeat.com)
Last month, this blog featured a preliminary post on Ahcom Ltd. v. Smeding (9th Cir. Oct. 21, 2010, Docket No. 09-16020), a decision restating and reemphasizing the Ninth Circuit’s position that a creditor of a corporation in bankruptcy has standing to assert a claim against the corporation’s sole shareholders on an alter ego theory.
More recently, the Insolvency Law Committee of the California State Bar’s Business Law Section released an insightful and helpful e-bulletin discussing the Ahcom decision’s impact on commercial bankruptcy practice in California.
A hard copy of the Committee’s e-bulletin is available here.