Avoidance Actions and Recoveries
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Posts Tagged ‘“automatic stay”’
Avoidance Actions and Recoveries
When a retailer¬†becomes insolvent, suppliers or vendors who have recently provided goods on credit typically¬†have the ability to¬†assert “reclamation” rights for the return of those goods.¬† Retailers may respond to these¬†rights by seeking the protection the federal bankruptcy laws – and, in particular, the automatic stay.
When a retailer files for bankruptcy while holding goods which are subject to creditors’ “reclamation” rights, what should “reclamation” creditors do?
The Bankruptcy Code itself provides some protection for “reclamation” creditors by providing such creditors additional time in which to assert their claims, and by affording administrative priority for a certain portion¬†for such claims even when they are not formally asserted.
But is merely asserting a reclamation claim under the Bankruptcy Code sufficient to protect a supplier once a retailer is in bankruptcy?¬† A recent appellate decision from Virginia’s Eastern District serves as a reminder that merely speaking up about a reclamation claim isn’t enough.
When Circuit City sought bankruptcy protection in 2009, Paramount Home Entertainment was stuck with the tab for more than $11 million in goods.¬† Though it didn’t object to blanket liens on Circuit City’s merchandise which came with the retailer’s debtor-in-possession financing, and stood by quietly while Circuit City later¬†liquidated its merchandise throug¬†a going-out-of-business sale, Paramount did file a timely reclamation demand as required by the Bankruptcy Code.¬† It also complied with what it understood to be the Bankruptcy Court’s orders regarding administrative procedures for processing its reclamation claims in Circuit City’s case.¬† It was therefore unpleasantly surprised when Circuit City objected to Paramount’s reclamation claim – and when the Bankruptcy Court sustained that objection – on the grounds that Paramount hadn’t done enough to establish or preserve its reclamation rights.
Paramount appealed the Bankruptcy Court’s ruling, claiming that it complied with what it understood to have been the Bankruptcy Court’s administrative procedures for processing reclamation claims.¬†¬†Paramount argued that to have done more (i.e., to have sought relief from the automatic stay to take back its goods or commenced litigation to preserve its rights to the proceeds of such goods) would have disrupted Circuit City’s bankruptcy case.
In affirming the Bankruptcy Court, US District Judge James Spencer held that the Bankruptcy Code, while protecting a creditor’s reclamation rights, doesn’t impose them on the debtor.¬† Instead, a reclaiming creditor must take further steps consistent with the Bankruptcy Code and state law to preserve the remedies which reclamation claims afford.¬† Merely asserting a reclamation claim under the Bankruptcy Code – or under a Bankruptcy Court’s administrative procedure – isn’t enough:
Let the seller beware.
A South Carolina bankruptcy court decision issued earlier this month highlights and illustrates the perils facing individual sole proprietors who struggle to reorganize their financial affairs through the Chapter 11 process.
The debtors – a husband and wife who owned a business and several pieces of rental property – filed a Chapter 11 in November 2009, but the case was dismissed approximately 10 months later.¬† In February this year, while their appeal of that dismissal was pending, they filed a second Chapter 11.
When an individual debtor seeks bankruptcy protection for a second time within 12 months, Section 362(c)(3) (added in connection with the 2005 BAPCPA amendments) terminates the automatic stay by default unless, within 30 days, the debtor can demonstrate that their second¬†attempt¬†is in “good faith.”
Put another way, an individual debtor’s second attempt at bankruptcy protection is presumptively in “bad faith” – and the automatic stay will self-terminate – unless the debtor can demonstrate otherwise.
Demonstrating otherwise¬†is what the debtors attempted to do in In re Washington.
So what does it take for an individual to establish “clear and convincing” evidence of “good faith” in these circumstances?
Apparently, a good deal of personal organization – and evidence of consistent, clearly documented efforts to reorganize, with clearly documented results to show for it.
In Washington, the debtors produced evidence regarding their business income and rental receipts which the Court characterized as “inconsistent and confusing.”¬† The Court took issue with the debtors’ estimates of present income, found holes in their testimony regarding decreased expenses, and found the debtors’ revenue projections to be “unjustifiably rosy.”
The Court found that the same result applied under section 362(c)(3)(i)(III)(bb). That subsection imposes a presumption that a debtor’s second case was not filed in good faith if the court finds reason to conclude that the current case will not be concluded ‚Äúwith a confirmed plan that will be fully performed.‚ÄĚ
But if Washington provides a cautionary tale for individual debtors who are struggling through the bankruptcy process, it also emphasizes the touchstone for every successful reorganization, no matter how small:¬† A viable business strategy.
JSC BTA Bank (BTA), one of Khazakstan‚Äôs largest banks, sought restructuring under the guidance of the Kazakh government early this year.¬† A prior post on BTA‚Äôs protective filing is available here.¬† BTA‚Äôs 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 ‚Äď 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.
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‚Äôs 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:
Instead, he concluded that
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 ‚Äď and rejecting ‚Äď the administrator‚Äôs interpretation of how the automatic stay ought to apply in ancillary cases ‚Äúto the debtor and the property of the debtor that is within the territorial jurisdiction of the United States‚ÄĚ Judge Peck went on to offer two possible legitimate interpretations (the Court had previously reviewed ‚Äď and rejected ‚Äď the administrator‚Äôs alternative interpretation):
An alternative, and better ‚Äúreading 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.‚ÄĚ
Under the latter reading, then, the automatic stay is applicable world-wide, but only where necessary to protect the US Bankruptcy Court‚Äôs in rem jurisdiction over the foreign debtor‚Äôs 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‚Äôs other provisions within the context of Chapter 15 through an appeal to interpretation based on the statute‚Äôs ‚Äúinternational aspects.‚ÄĚ¬† ‚ÄúInternational‚ÄĚ in these cases really means ‚Äúuniversal‚ÄĚ ‚Äď Courts applying this statute have gone to some lengths to employ Chapter 15 as a vehicle for extending universal administration of the ‚Äúmain case,‚ÄĚ wherever that case is located.
– But ‚Äúuniversalism‚ÄĚ only goes so far:¬† In Judge Peck‚Äôs view, ‚ÄúThe 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.‚ÄĚ¬† ¬†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‚Äôs in rem jurisdiction may not be trifled with, no matter where such efforts might occur.
– This decision nevertheless suggests an additional area of ‚Äúsection shopping‚ÄĚ ‚Äď 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 ‚Äúnon-bankruptcy law‚ÄĚ).¬† 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.
JSC BTA Bank (BTA), reportedly the¬†second largest bank in Khazakstan, sought protection for its US-based assets through Chapter 15 last Thursday in New York’s Southern District.
The Chapter 15 filing in Manhattan appears to be part of Khazakstan’s own banking bailout for BTA.¬† In papers submitted to Bankruptcy Judge James Peck, BTA Chairman Anvar Saidenov represented, through BTA’s counsel,¬†that between 2004 and 2007 BTA expanded rapidly with significant increases in its total assets and number of branches and cash offices.¬† This expansion was primarily funded through short- and medium-term bank borrowings and the issue of securities in the international capital markets.¬† Khazakstan’s credit-rating downgrade in late 2007 precluded BTA from refinancing its short-term credit lines, which in turn curtailed BTA’s ability to make new loans.
Beyond the Kazakh credit downgrades, BTA allegedly further suffered “significant losses” due to “fraudulent and ulawful transactions entered into by [BTA’s] former management prior to February 2009.”
Before last February, the Republic of Kazakhstan and its Agency for Regulation and Supervision of Financial Markets and Financial Organizations (FMSA) had previously announced a proposal to recapitalize BTA as part of a broader plan to stabilize the country‚Äôs financial system. The plan involved JSC National Welfare Fund Samruk-Kazyna (Samruk-Kazyna), Kazakhstan‚Äôs sovereign wealth fund, providing financial support to struggling financial institutions. At the same time, Samruk-Kazyna acquired a controlling 75.1 % of BTA‚Äôs total share capital. BTA also continued to down-size its operating activities in response to the deteriorating market and BTA‚Äôs financial condition.
¬†BTA’s recapitalization triggered “change-of-ownership” clauses and demands for repayment under some of its lines of credit from foreign lenders.¬† These and other, continuing¬†regulatory problems inside Khazakstan ultimately led to a preliminary restructuring plan in mid-2009.
At the end of¬†August 2009, the Kazakh government enacted banking regulatory legislation which put into place, among other things, an insolvency regime to deal with the restructuring of financial institutions.¬† BTA sought protection under this new legislation less than 45 days after its enactment, thereby obtaining a stay of all relevant claims of BTA’s creditors and protection of BTA’s property from execution and attachment until completion of the restructuring.
BTA’s restructuing – presently contemplated within the third quarter of 2010 – presently contemplates that creditors of the Bank, including Samruk-Kazyna and certain related parties (excluding depositors and certain government agencies funding special loan programs) will receive a mixture of cash, senior debt, subordinated debt, other forms of debt, equity and so-called “recovery notes” in consideration for the restructuring of their claims.¬† Payments on the “recovery notes” will be funded by cash recoveries on any provisioned assets, litigation recoveries, and deferred tax recoveries.
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.
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:
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?
2009 is shaping up to be an extraordinary¬†year for business bankruptcy.¬† Headlines and hoopla aside, however, it hasn’t been all about domestic Chapter 11 work.¬† The following brief summaries (drawn from news reports and from the national dockets) highlight some of the more newsworthy cross-border matters of the past 60 days:
– WC Wood – Guelph, Ontario-based W.C. Wood Ltd., manufacturer of freezers, fridges and commercial dehumidifiers, sought Chapter 15 recognition in Delaware along with its affiliates concurrently with¬†the companies’¬†application for protection under the Canadian Companies’ Creditors Arrangement Act.¬† The US filing was commenced to further the Canadian reorganization, and to extend the automatic stay to protect officers and directors of the companies.
– Kumkang Valve – Kumkang Valve Co. Ltd. sought Chapter 15 recognition in Houston to protect its US -based assets while it pursued a “revival proceeding” in the District Bankruptcy Court for Daegu, South Korea, where it is headquartered. To do so, the manufacturer of trunnion mount ball valves for the oil and gas industry had to overcome objections lodged by Enterprise Products Operating LLC, who had previously filed a US District Court suit alleging that Kumkang knowingly supplied faulty valves to Enterprise when it was constructing facilities in Wyoming and Colorado.¬† Bankruptcy Judge Wesley Steen is presiding over the US proceeding.
– Gandi Innovations – Canadian grand-format inkjet manufacturer Gandi Innovations, which operates under the brand name Gandinnovations, obtained recognition from Bankruptcy Judge Leif Clark in San Antonio, TX very shortly after its entry into Canadian Companies’ Creditors Arrangement Act proceedings.¬† The company sought to protect US assets and stay litigation then pending in Bexar County, TX while it prosecuted a plan of arrangement in Toronto.
– Straumur-Burdaras Investment Bank – Iceland’s Straumur-Burdaras Investment Bank hf is seeking recognition of its Reykjav√≠k-based restructuring efforts from New York Bankruptcy Judge Robert E. Gerber. Recognition would protect Straumur-Burdaras’ US-based assets, valued at $190 million.¬† The commercial bank’s Chapter 15 petition, filed June 2, follows that of three other Icelandic financial institutions – Glitnir Banki hf, Kaupthing Bank hf and Landsbanki Islands hf – all of which sought similar protection in New York. Straumur-Burdaras’ recognition hearing is calendared for July 14.
– Fraser Papers – Toronto-based lumber, pulp and paper producer Fraser Papers Inc. and affiliates sought recognition in Delaware for their restructuring under the Canadian Companies’ Creditors Arrangement Act (CCAA). According to papers filed in connection with the related June 18 petitions, the filing was commenced to further the effect of orders already entered under the CCAA and designed both to protect the companies’ US assets and to enjoin suits against officers and directors.
– Nanbu – Tokyo-based Nanbu Inc. has requested that US Bankruptcy Judge Robert J. Faris of Honolulu grant recognition of its foreign bankruptcy proceeding currently pending in the Civil Affairs division of Tokyo District Court. Court papers reveal virtually nothing about the company or its Japanese proceeding, and note only that recognition was sought in the US so that the company’s foreign representative, Tsunehiro Sasanami, can take title to and convey certain timeshare properties located in Hawaii.¬† A hearing on the recognition request is calendared for July 13; however, under the Bankruptcy Court’s local rules, a recognition order may be entered without a formal hearing where there are no objections.