Posts Tagged ‘“bankruptcy court”’
Friday, January 13th, 2012
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Last year, the Supreme Court issued one of its more significant bankruptcy decisions in recent years with Stern v. Marshall (a very brief note concerning the Stern decision as reported on this blog is available here). Stern, which addressed the limits of bankruptcy courts’ “core” jurisdiction, has been the focus of a considerable amount of academic and professional interest – primarily because of its possible fundamental effect on the administration of bankruptcy cases.
Three weeks ago, the Seventh Circuit capped off 2011 with a decision – the first at an appellate level – discussing and applying Stern.
The procedural history of In re Ortiz is straightforward. Wisconsin medical provider Aurora Health Care, Inc. had filed proofs of claim in 3,200 individual debtors’ bankruptcy cases in the Eastern District of Wisconsin between 2003 and 2008. Two groups of these debtors took issue with these filings, claiming Aurora violated a Wisconsin statute that allows individuals to sue if their health care records are disclosed without permission. One group of debtors filed a class action adversary proceeding against Aurora in the Bankruptcy Court for Wisconsin’s Eastern District, while the other filed a similar class action complaint against Aurora in Wisconsin Superior Court.
For all their differences, it appears neither the debtor-plaintiffs nor Aurora wanted to have these matters heard by the US Bankruptcy Court. Aurora removed the Superior Court Action to the Bankruptcy Court, then immediately sought to have the US District Court for Wisconsin’s Eastern District withdraw the reference of these actions to the Bankruptcy Court and hear both matters itself. Both groups of debtor-plaintiffs, on the other hand, sought to have their claims heard by the Wisconsin Superior Court by asking the Bankruptcy Court to abstain from hearing them, and remand them to the state tribunal.
Both parties’ procedural jockeying for a forum other than the US Bankruptcy Court ultimately proved unfruitful: The District Court denied Aurora’s request to hear the matters, and the Bankruptcy Court declined to remand them back to Wisconsin Superior Court or otherwise abstain from hearing them. The District Court’s and the Bankruptcy Court’s reasoning was essentially the same – since the original “disclosure” of health records took place in the context of proofs of claim filed in individual debtors’ bankruptcy proceeding, both courts believed the matters were therefore “core” proceedings which Bankruptcy Courts were entitled to hear and determine on a final basis.
Ultimately, the Bankruptcy Court granted summary judgment and dismissed the class actions because both groups of debtors had failed to establish actual damages as required under the Wisconsin statute. Both the plaintiffs and Aurora requested, and were granted, a direct appeal to the Seventh Circuit Court of Appeals.
But if Ortiz’ procedural history is straightforward, the Seventh Circuit’s disposition of the appeal was not. After the case was argued on appeal in February 2011, the Supreme Court issued its decision in Stern v. Marshall. In that decision, the high court called into question the viability of Congress’ statutory scheme in which bankruptcy courts were empowered to finally adjudicate “core” proceedings – i.e., those proceedings “arising in a bankruptcy case or under title 11″ of the US Code. The Stern court held that a dispute – even if “core” – was nevertheless improper for final adjudication by a bankruptcy court if the dispute was not integral to the claims allowance process, and constituted a private, common-law action as recognized by the courts at Westminster in 1789. Such matters were – and are – the province of Article III (i.e., US District Court) judges, and it was not up to Congress to “chip away” at federal courts’ authority by delegating such matters to other, non-Article III (i.e., Bankruptcy) courts.
In order to resolve the Aurora class actions in a manner consistent with Stern, the Seventh Circuit requested supplemental briefing, and then undertook a lengthy analysis of that decision. To isolate and identify the type of dispute that the Stern court found “off-limits” for final decisions by bankruptcy courts, it distinguished the Aurora class action disputes from those cases which:
- Involved “public rights” or a government litigant;
- Flowed from a federal statutory scheme or a particularized area of law which Congress had determined best addressed through administrative proceedings; or
- Were “integral to the restructuring of the debtor-creditor relationship” or otherwise part of the process of allowance and disallowance of claims.
Instead, the Aurora disputes had nothing to do with the original claims filed by Aurora in the debtors’ cases, was between private litigants, and was not a federal statutory claim or an administrative matter. Consequently, the Bankruptcy Court had no jurisdiction to determine it on a final basis. Consequently, the Seventh Circuit had no jurisdiction to hear the appeal.
Ortiz, like Stern, has received a considerable amount of attention within the bankruptcy community. Among some of the community’s immediate reactions to Ortiz:
- Despite the fact that the class actions arose out of Aurora’s filing proofs of claim in bankruptcy cases, the bankruptcy court could not decide those class actions. More importantly, the Seventh Circuit suggested that a bankruptcy judge may not even have “authority to resolve disputes claiming that the way one party acted in the course of the court’s proceedings violated another party’s rights.” In other words, it seems possible to argue, under Ortiz (and Stern), that though US District Courts have authority to police their own dockets, Bankruptcy Courts do not.
- The Seventh Circuit’s decision appears circular in some respects. Specifically, the Seventh Circuit declined to hear the appeals from the bankruptcy court as proposed findings of fact and conclusions of law (rather than as a final judgment), because such recommendations from a bankruptcy court are available only in “non-core” proceedings – and since the Aurora class actions were “core,” an appellate review of such proposed findings and conclusions simply wasn’t available. But if a “core” matter is outside a bankruptcy court’s jurisdiction, is it really “core”? In other words, wouldn’t it have been easier for the Seventh Circuit to have simply sent the matter back to the bankruptcy court as a recommended resolution, not yet ripe for an appeal?
As the results of Stern begin to percolate their way through the bankruptcy system and other circuits weigh in on the Supreme Court’s 2011 guidance, it appears the administration of bankruptcy cases faces some significant adjustment.
Monday, May 16th, 2011
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?
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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:
“Filing a demand, but then doing little else in the end likely creates more litigation and pressure on the Bankruptcy Court than seeking relief from the automatic stay. . . or seeking a [temporary restraining order] or initiating an adversary proceeding. In this case, Paramount filed its reclamation demand, but then failed to seek court intervention to perfect that right. As the Bankruptcy Court held, the Bankruptcy Code is not self-executing. Although [the Bankruptcy Code] does not explicitly state that a reclaiming seller must seek judicial intervention, that statute does not exist in a vacuum. The mandatory stay as well as the other sections of the Bankruptcy Code that protect and enforce the hierarchy of creditors create a statutory scheme that cannot be overlooked. Once Paramount learned that Circuit City planned to use the goods in connection with the post-petition [debtor-in-possession financing], it should have objected. It didn’t. To make matters worse, Paramount then failed to object to Circuit City’s liquidation of its entire inventory as part of the closing [going-out-of-business] [s]ales.”
Let the seller beware.
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.
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.
Monday, August 30th, 2010
The advent of the information age has given rise to economies built not on steel, but on ideas. It is therefore no surprise that intellectual property assets have assumed an increasingly important component of firm balance sheets – and firm value – throughout advanced economies worldwide.
And yet, though the value of intellectual property is universally recognized and the rights attaching to it increasingly protected, “knowledge assets” are not always treated in the same manner whenever – and wherever – the firm enters restructuring or liquidation. The story of Qimonda AG is the story of what happens when one country’s rules governing the treatment of an insolvent firm’s intellectual property collide with those of another.
As the following post suggests, that story is far from over.
Quimonda AG’s Insolvency.
Qimonda AG (Qimonda), a producer of Dynamic Random Access Memory (DRAM) chips, also holds a portfolio of approximately 12,000 patents. A little more than one-third of this intellectual property originated in the US (i.e., it consists of US patents or pending applications); the balance is of German or other international origin.
Over a 13-year period, Qimonda entered into a series of joint venture and cross-licensing agreements with a number of semiconductor manufacturers. Under those agreements, Qimonda and these manufacturers cross-licensed tens of thousands of patents.
During 2007 and 2008, prices for PC-based DRAM technology collapsed. Despite efforts to restructure, Qimonda entered German insolvency proceedings in January 2009. The Munich court overseeing the proceeding appointed Dr. Michael Jaffé as Qimonda’s insolvency administrator.
Subsequently, Dr. Jaffé sought and obtained recognition in the US for Qimonda’s German insolvency proceeding. Dr. Jaffé also obtained concurrent, discretionary relief making certain sections of the US Bankruptcy Code applicable to Qimonda’s Chapter 15 proceeding. These sections included Section 365, which governs executory contracts – including licensing agreements.
Both the German Insolvency Code and the US Bankruptcy Code address the administration of executory contracts. However, US insolvency practitioners will be aware the US Bankruptcy Code – specifically, section 365(n) – protects the intellectual property licensees of a bankrupt licensor. Under this subsection, the licensee – at its own option – may preserve its rights under an intellectual property license, despite the bankruptcy trustee’s efforts to reject the license.
The German Insolvency Code provides no such protection. Instead, Section 103 of that statute simply provides that the court-appointed insolvency administrator may elect performance of contractual obligations or affirm that they remain unenforceable against the estate by electing non-performance.
Dr. Jaffé’s Proposed Treatment of Qimonda’s Cross-Licensing Agreements.
Sometime after obtaining recognition and discretionary relief in Virginia, Dr. Jaffé, acting pursuant to German law, provided notification to certain of Qimonda’s cross-licensing partners of his elected non-performance of Qimonda’s patent cross-licensing agreements.
Those partners, understandably, protested – and argued further that Section 365(n) (made applicable to Qimonda’s Chapter 15 proceeding at Dr. Jaffé’s own request) now prohibited Dr. Jaffé from electing non-performance. In response, Dr. Jaffe sought the US Bankruptcy Court’s amendment of his previously-granted relief in order to clarify the basis for his non-performance of the cross-licensing agreements. Specifically, Dr. Jaffé sought a modification of the prior order to provide that Section 365 (and, therefore, Section 365(n)) would be applicable only in such instances where he sought rejection of agreements pursuant to the US statute.
The Cross-Licensing Partners’ Appeal.
Following a hearing held 28 October 2009, US Bankruptcy Court Judge Robert Mayer issued a decision granting Dr. Jaffé’s further request, thereby clearing the way for him to elect non-performance of the cross-licensing agreements under German insolvency law. Qimonda’s partners promptly appealed to the US District Court for Virginia’s Eastern District, arguing (i) that Section 365 – including Section 365(n) – applies automatically to foreign proceedings recognized under Chapter 15 (and, presumably, may therefore not be “modified” or otherwise trifled with by the Bankruptcy Court in the manner proposed by Dr. Jaffé); and, further (ii) that principles of comity applicable under US case law (and the provisions of Chapter 15) did not require the requested modification of the Bankruptcy Court’s prior order.
In an appellate decision issued 2 July 2010, US District Judge Thomas Selby (Tim) Ellis III remanded the matter back to Judge Mayer for further clarification of two issues – one factual, one legal. Along the way, however, Judge Ellis offered several important observations regarding the construction of Sections 1521(a) (governing the provision of “any appropriate relief” to the representative of a recognized foreign proceeding) and 1509(c) (governing a recognized administrator’s requests for comity).
A significant portion of Judge Ellis’ 36-page decision is devoted to the conclusion that Section 365 of the US Bankruptcy Code does not apply automatically upon recognition of a foreign “main proceeding.” This seems unremarkable, given that a simple reading of Section 1520(a) makes only select provisions of the Bankruptcy Code applicable automatically in Chapter 15, and that Section 365 is not among them. As a result, Section 365 – available to a foreign representative only through specific request pursuant to Section 1521(a) – is susceptible to selective or otherwise limited application by the US Bankruptcy Court. Indeed, the Bankruptcy Court may determine it does not apply at all.
Far more interesting is Judge Ellis’ conclusion that Dr. Jaffe’s request had been granted without the requisite balancing test set forth in Section 1522. That section requires that, upon a request for modification of relief previously granted through Section 1519 or 1521, the Court may so modify only after ensuring that “the interests of the creditors and other interested entities, including the debtor, are sufficiently protected.” 11 U.S.C. §1522(a). Because the evidence relied upon by the Bankruptcy Court to balance creditors’ interests was “anemic,” Judge Ellis remanded the matter for a more full-bodied factual inquiry.
Specifically, Judge Ellis directed focus on two primary issues:
How the application of § 365(n) would unavoidably “splinter” or “shatter” the Qimonda patent portfolio “into many pieces that can never be reconstructed,” thereby diminishing its value and rendering the Qimonda patent portfolio essentially unsalable (“Left unexplained, in particular, is why this is so, given that the continuation of appellants’ non-exclusive licenses for an unspecified percentage of the Qimonda patent portfolio would preclude neither the sale of the patents themselves nor the grant of additional, non-exclusive licenses.”).
The nature of the U.S. patents licensed to appellants, and whether cancellation of licenses for those patents would put at risk appellants’ investments in manufacturing or sales facilities in this country for products covered by the U.S. patents (“At best, the Bankruptcy Court stated (i) that the application of dissimilar bankruptcy laws to different portions of Qimonda’s patent portfolio ‘may well be detrimental to parties who are or wish to license patents,’ and (ii) that appellees’ demanding that appellants pay new licensing or royalty fees was an ‘unfortunate but an inevitable result’ of Qimonda’s insolvency . . . . It is not readily apparent why this is so.”).
Though leaving little doubt that Section 365’s applicability to a Chapter 15 proceeding was entirely within the Bankruptcy Court’s sound discretion, Judge Ellis nevertheless observed that “the Bankruptcy Code nonetheless ‘limits the opportunity for a completely unencumbered new beginning to the honest but unfortunate debtor,’ as ‘statutory provisions governing nondischargeability reflect a congressional decision to exclude from the general policy of discharge certain categories of debts.’”
Under Judge Ellis’s reading of Sections 1521 (and 1522), a Bankruptcy Court enjoys broad discretion – not only to provide “any appropriate relief” to a foreign representative, but to further amend, modify, or terminate the same relief – provided that the Court engage in the affirmative exercise of articulating why the interests of the debtors and the creditor are protected.
Judge Ellis’ treatment of judicial discretion did not end with Section 1521. On appeal, Qimonda’s cross-licensing partners also called into question the Bankruptcy Court’s decision to grant comity to Dr. Jaffé’s application of German insolvency law to the cross-licensing agreements.
By contrast to the broad discretionary application of “appropriate relief” under Section 1521, Judge Ellis found that a US Bankruptcy Court’s discretion regarding the comity to be afforded determinations rendered under foreign law and pursuant to Section 1509 is far more limited:
Section 1509 states, in mandatory terms, that “a court in the United States shall grant comity or cooperation to the foreign representative.” 11 U.S.C. § 1509(b)(3) (emphasis added). . . . [U]nder the plain terms of § 1509(b)(3), the Bankruptcy Court lacked general discretion to deny the Foreign Administrator’s request for comity; rather, the Bankruptcy Court could only have refused to defer to German Insolvency Code § 103 on the ground that applying German law, instead of § 365(n), would be “manifestly contrary to the public policy of the United States” under § 1506. Put another way, §§ 1509(b)(3) and 1506, read in pari materia, provide that comity shall be granted following the U.S. recognition of a foreign proceeding under Chapter 15, subject to the caveat that comity shall not be granted when doing so would contravene fundamental U.S. public policy.
What sort of foreign relief would “contravene fundamental US public policy?”
Judge Ellis’ review of decisions addressing the “public policy” exception to Chapter 15’s comity mandate indicated that the focus of this exception is on (i) procedural inequity (e.g., a lack of “due process” as that term is commonly understood by US courts); and (ii) frustration of a US court’s ability to administer the Chapter 15 proceeding and/or severe impingement of a U.S. constitutional or statutory right, particularly if a party continues to enjoy the benefits of the Chapter 15 proceeding (e.g., frustration of the “automatic stay” made applicable upon recognition of Chapter 15).
However, Judge Ellis further found that – as with the “balancing test” required by Section 1522 – the Bankruptcy Court had not gone far enough in its analysis.
Congress enacted Section 365(n) in direct response to contrary case law and in order to protect the US-based licensees of intellectual property. Yet the entire section is subject to modification or amendment in Chapter 15 upon the Bankruptcy Court’s discretion – or not applicable at all.
In light of these mixed judicial signals, is the protection of Section 365(n) therefore “fundamental?” Or not? In granting Dr. Jaffé’s request, the Bankruptcy Court had not explicitly decided this question, so Judge Ellis direct that it do so upon remand.
What Does It Mean?
Judge Ellis’ Qimonda decision is significant for its analysis of Sections 1509 and 1522 – it appears to endorse, at least in general terms, the flexibility required of an internationally-oriented recognition statute and the latitude potentially available to recognized foreign representatives.
However, Judge Ellis’ Qimonda analysis is perhaps most significant for what it doesn’t say. It leaves unanswered what general factors courts might apply to the “balancing test” of creditors’ and debtors’ interests mandated by Sections 1521 and 1522. And though it describes the outer bounds of “fundamental US public policy” such that otherwise-mandatory comity ought not to apply to the determinations of non-US tribunals, it does little to address the import (if any) to be derived from Congressional amendments specifically intended to protect the rights (or the interests) of general or special US economic interests.
Monday, March 1st, 2010
With both the global and regional Southern California economies showing early signs of life – but still lacking the broad-based demand for goods and services required for robust growth – opportunities abound for strong industry players to make strategic acquisitions of troubled competitors or their distressed assets.
Ray Clark, CFA, ASA and Senior Managing Director of VALCOR Consulting, LLC, is no stranger to middle-market deals. His advisory firm provides middle market restructuring, transactional and valuation services throughout the Southwestern United States from offices in Orange County, San Francisco, and Phoenix.
As most readers are likely aware, distressed mergers and acquisitions can be handled through a variety of deal structures. Last week, Ray dropped by South Bay Law Firm to offer his thoughts on a process commonly known in bankruptcy parlance as a “Section 363 sale.”
In particular, Ray covers the “pros and cons” of this approach.
The floor is yours, Ray.
Today’s economic environment has created an opportunity to acquire assets of financially distressed entities at deeply discounted prices, and one of the most effective ways to make those acquisitions is through a purchase in the context of a bankruptcy under Section 363 of the Bankruptcy Code (the “Code”). When purchasing the assets of a failed company under Section 363, there are distinct advantages to being first in line. Depending on the circumstances, however, it may be best to wait and let the process unfold – and then, only after surveying the entire landscape, submit a bid.
The 363 Sale Process
A so-called “363 Sale” is a sale of assets of a bankrupt debtor, wherein certain discrete assets such as equipment or real estate – or substantially all the debtor’s business assets – are sold pursuant to Section 363 of the Bankruptcy Code (11 USC §363). Upon bankruptcy court approval, the assets will be conveyed to the purchaser free and clear of any liens or encumbrances. Those liens or encumbrances will then attach to the net proceeds of the sale and be paid as ordered by the Bankruptcy Court.
A Section 363 sale looks much like a traditional controlled auction. Basic Section 363 sale mechanics include an initial bidder, often referred to as the “stalking horse,” who reaches an agreement to purchase assets – typically from the Chapter 11 debtor, or “debtor-in-possession” (DIP). The buyer and the DIP negotiate an asset purchase agreement (APA), which rewards the stalking horse for investing the effort and expense to sign a transaction that will be exposed to “higher and better” or “over” bids. The Bankruptcy Court will approve the bidding procedures, including the incentives, i.e., a “bust-up” fee, for the stalking horse bidder, and will pronounce clear rules for the remainder of the sale process. Notice of the sale will be given, qualified bids will arrive and there will be an auction. The sale to the highest bidder will commonly close within four to six weeks after the notice and the stalking horse will either acquire the assets or take home its bust-up fee and expense reimbursement as a consolation.
Advantages for the Stalking Horse Bidder
Bidding Protections - During negotiations with the debtor for the purchase of assets, the stalking horse will also typically negotiate certain protections for itself during the bidding process. These bidding protections, which include a bust-up fee and expense reimbursement, will be set forth in the 363 sale motion and are generally approved by the bankruptcy Court. As a result, stalking horse bidders seek to insulate themselves against the risk of being out-bid. To do so, proposed stalking-horse bidders commonly require that any outside bidder will typically have to submit not only a bid that is higher than that of the stalking horse, but will also need to include an amount to cover the stalking horse’s transactional fees and expenses.
Bidding Procedures – The stalking horse will also negotiate certain bidding procedures with the debtor, which will be set forth in the 363 sale motion that will be evaluated, and most likely approved, by the Court. The sale procedures generally include the time frame during which other potential bidders must complete their due diligence and the date by which competing bids must be submitted.
Other delineated procedures typically included in the motion include the amount of any deposit accompanying a bid and the incremental amount by which a competing bid must exceed the stalking horse bid. In addition, if the sale procedures provide for an abbreviated time frame in which to complete an investigation of the assets, a competing bidder will be at a distinct disadvantage and may be unable, as a result, to even submit a bid.
Deal Structure – As the first in line, the stalking horse bidder will also negotiate all of the important elements of the transaction, including which assets to acquire, what contracts – if any – to assume, the purchase price and other terms and conditions. In doing so, it establishes the ground rules by which the sale process will unfold and the framework for the transaction, which will be difficult, if not impossible, for another outside bidder to change.
“First Mover” Advantage – The stalking horse bidder will typically be viewed by the Court as the favored asset purchaser in that it will have negotiated all of the relevant terms and procedures, and established its financial ability and intent to acquire the assets. As a result, short of an overbid by an outside party, which typically involves an additional amount to cover the stalking horse’s bust-up fee and expenses, the stalking horse bidder will prevail.
Cooperation of Stakeholders – As the lead bidder, the stalking horse also has an opportunity to negotiate with other key stakeholders in the process and establish a close relationship with those parties that may prove advantageous when all offers are evaluated.
Bust-up Fee and Expense Coverage – Lastly, if an outside party happens to submit the high bid, the stalking horse will typically receive its bust-up fee and expense reimbursement. This generally includes items such as due diligence fees, legal and accounting fees, and similar expenses, but is limited by negotiation.
Disadvantages to the Stalking Horse Bidder
Risk of Being Outbid – As noted, the stalking horse will expend a great deal of time, energy, and resources analyzing and negotiating for the purchase of the assets. All a competing bidder must do is show up to the sale and submit an over-bid. If the competing over-bidder prevails, the stalking horse runs the risk of walking away with only its bust-up fee and expense reimbursement.
Risk of Bidding Too High – After negotiating the APA, the stalking horse then participates in the 363 sale process. If no other bidders materialize, it may be because the stalking horse effectively over-paid for the assets.
Inability to Alter Terms – If some new information comes to light that would otherwise suggest a reduction in the price or alteration of the terms, the stalking horse may have difficulty altering either of these and may be locked in to the negotiated structure.
Contact email@example.com or firstname.lastname@example.org.
Meanwhile, happy hunting.
Monday, November 2nd, 2009
In an age of globalized business, US-based firms commonly find themselves dealing with foreign creditors or in contractual relationships with foreign parties. Those off-shore relationships can sometimes raise challenging issues when the firm needs to reorganize or wind down its operations under US insolvency law, and foreign creditors or contractual parties must determine how to proceed.
Last week, the Delaware bankruptcy court addressed just one of those challenging issues:
What happens when a claims dispute in US Bankruptcy Court runs afoul of European litigation procedures?
Here’s the set-up:
Global Power Equipment Group, Inc. and its related entities sought Chapter 11 protection in Delaware over three years ago after sustained losses in the companies’ heat recovery steam generator (HRSG) segment, and related liquidity problems, necessitated wind-down of the companies’ HRSG operations.
In connection with the wind-down, Global Power and its affiliates sought – and obtained – permission to reject existing HRSG development contracts and to enter into new “completion” contracts with customers who still required delivery of HRSG units. One of these customers was Maasvlakte, a Dutch company who had contracted for the construction of an HRSG project at a port facility in Rotterdam, the Netherlands. Maasvlakte and several other companies involved in the project were corporate subsidiaries of Air Liquide Engineering, S.A., a French concern.
Maasvlakte executed a completion contract which provided for a “step-down” of contractual claims commensurate with delivery of the project. In the meantime, it filed two proofs of claim based on the prior contract: One against Deltak L.L.C. (the entity responsible for the project), and one against Global Power as guarantor of Deltak’s obligations.
Sometime afterward, Deltak’s and Global Power’s plan administrator filed objections to Maasvlakte’s claims, on the basis of the “step-down” provisions in Deltak’s completion contract with Maasvlakte. Maasvlakte responded, and the parties prepared to litigate their respective positions under the Federal Rules of Civil Procedure (FRCP), made applicable to claims objections through the Federal Rules of Bankruptcy Procedure.
In early 2009, Deltak and Global Power propounded discovery on Maasvlakte to obtain information about testing in connection with the HRSG project; however, three days before production was due, Maasvlakte took the position that because many of the documents sought were physically located in France, under control of Air Liquide and unavailable to Maasvlakte, their production under the FRCP could not proceed because a French statute outlawed French companies’ participation in foreign discovery procedures outside those set forth in the Hague Convention.
Under the Hague Convention rules claimed by Maasvlakte, discovery would require issuance of Letters of Commission through the US Consulate to the French Ministry of Justice – and it appears compliance would not be mandatory. Processing them would require an additional 2 – 6 weeks. Failure to comply with this procedure would subject the participating French company to sanctions in France.
Deltak and Global Power disagreed, and sought to compel the discovery in Delaware. Judge Brendan Shannon ordered the parties to meet and confer; however, the parties were apparently unable to come to terms.
In a 40-page decision, Judge Shannon found that (i) Maasvlakte had the “control” of documents necessary for compelled production under the FRCP; and (ii) the “comity analysis” applicable to alternate discovery procedures in this case favored use of the FRCP.
For the “comity analysis,” Judge Shannon employed prior Supeme Court authority – Société Nationale Indust. Aérospatiale v. U.S. Dist. Ct. for the S. Dist. Of Iowa, 482 U.S. 522 (1987) – to note that the Hague convention need not be employed ahead of the FRCP to obtain discovery from foreign litigants in connection with actions pending in the US. Instead, it is an alternate procedure that does not automatically override existing US procedural rules. This is so even when foreign law – such as the French statute in question (which, coincidentally, was the same one at issue in Société Nationale) – requires compliance with the Hague convention.
To determine whether the Hague Convention should apply in place of ordinary US procedural rules, US courts are directed to apply a multi-part “comity analysis.” This involves an evaluation of:
– the importance of the documents or information requested to the litigation;
– the degree of specificity of the request;
– whether the information originated in the United States;
– the availability of alternative means of securing the information; and
– the extent to which noncompliance with the request would undermine important interests of the United States, or compliance with the requests would undermine important interests of the state where the information is located.
Some US courts have added two other steps to the analysis: (i) good faith of the party resisting discovery; and (ii) the hardship of compliance on the party or witness from whom discovery is sought.
In Maasvlakte’s case, Judge Shannon found that (i) the documents sought were central to the claims dispute between the parties; (ii) the request was sufficiently specific; (iii) the documents were originally produced in the Netherlands (where the French blocking statute does not apply) and only subsequently sent to France; (iv) the documents were not otherwise available to Deltak and Global Power, except through the Hague Convention; (v) the US interest in adjudicating the matter expeditiously through its courts outweighed the “attenuated” French interest occasioned by the fact that documents originally produced in the Netherlands were now held in France by a French company; and (vi) the hardship to Maasvlakte was “minimal” since, after all, it originally subjected itself to the Bankruptcy Court’s jurisdiction – and, apparently, assumed the risk of prosecution in France for so doing. As for the risk of criminal sanctions to Maasvlakte and Air Liquide, it was Judge Shannon’s estimation that the French statute in question would “not subject [Maasvlakte or Air Liquide] to a realistic risk of prosecution, and cannot be construed as a law intended to universally govern the conduct of litigation within the jurisdiction of a United States court.”
The only factor found weighing in favor of the Hague Convention in this case was Maasvlakte’s lack of bad faith.
Judge Shannon’s decision offers counsel something to consider the next time a trans-national dispute forms the basis for a claim in a US bankruptcy.
Monday, October 12th, 2009
Business bankruptcies in the US can be big business for hedge funds trading in distressed debt. But that business may be sharply curtailed – or effectively eliminated – if proposed new disclosure rules in bankruptcy take effect.
In a recent series of articles dealing with these proposed changes, the Hedge Fund Law Report (HFLR) has explored their anticipated impact on hedge funds’ participation in bankruptcy proceedings – and has graciously included in its analysis a couple of quotes by members of South Bay Law Firm.
Some background may be helpful.
Hedge Funds and Rule 2019
Hedge funds have become major participants in recent bankruptcy proceedings, in which they often form unofficial or ad hoc committees in order to aggregate their claims and benefit from the additional leverage such aggregation provides. For example, a committee might seek to consolidate a “blocking position” with respect to a class (or classes) of the distressed firm’s debt, then negotiate for financial or other concessions regarding the debtor’s reorganization plan. Though their investment strategies may differ, hedge funds are typically uniform in their insistence on the privacy and confidentiality of their investments. Further, such secrecy is viewed as necessary to protect the funds’ proprietary trading models from duplication.
The fiercely guarded privacy of hedge funds contrasts sharply with the insistence on disclosure that pervades American Bankruptcy Courts. The two have never co-existed comfortably. Bankruptcy Courts and other parties seeking to look behind the veil of secrecy surrounding a participating group of funds have looked for help to Bankruptcy Rule 2019. That Rule essentially requires disclosure of certain information from informal “committees” in a bankruptcy case.
Rule 2019 traces its roots to the correction of abuses unearthed in the 1930s, when a series of hearings conducted for the SEC by [as-of-then-yet-to-be-appointed Supreme Court Justice] William O. Douglas uncovered the frequent practice of inside groups (so-called “protective committees”) working with bankrupt companies to take advantage of creditors. Douglas’ investigation uncovered “[i]nside arrangements, unfair committee representation, lack of oversight, and outright fraud [that] often cheated investors in financially troubled or bankrupt companies out of their investments.”
Hedge funds do not occupy the same role as the “protective committees” of 70 years ago. But creditors have nevertheless relied on the Rule’s provision to claim that ad hoc committees must “open the kimono” to reveal not only their members’ purchased positions in the debtor, but the timing and pricing of those purchases. This most hedge funds will not do – at least not without without a very stiff fight.
Reaction to this use of Rule 2019 has been mixed. In a pair of decisions issued in 2007, the Bankruptcy Courts for the Southern District of New York and the Southern District of Texas went in opposite directions, finding that ad hoc committees in the respective cases of Northwest Airlines Corp. and Scotia Development LLC must comply (in New York) or were exempt (in Texas) from the provisions of Rule 2019. The measure of hedge funds’ resistance to this disclosure is gauged by the fact that in the wake of the court’s decision in Northwest Airlines, several funds withdrew from the case rather than divulge the information otherwise required of them.
Proposed Amendments to Rule 2019
On August 12, 2009, the Advisory Committee on the Federal Rules of Bankruptcy Procedure weighed in on this dispute by proposing a significant revision of Rule 2019. The Rule has been essentially re-drafted. According to the Committee Notes, subdivision (a) of the Rule defines a “disclosable economic interest” – i.e., “any economic interest that could affect the legal and strategic positions a stakeholder takes in a chapter 9 or chapter 11 case.” The term is employed in subdivisions (c)(2), (c)(3), (d), and (e), and – according to the Rules Committee that drafted it – is intended to extend beyond claims and interests owned by a stakeholder.
In addition to applying to indenture trustees (as the Rule presently does), subdivision (b) extends the Rule’s coverage to “committees . . . consist[ing] of more than one creditor or equity security holder,” as well as to any “group of creditors or equity security holders that act in concert to advance common interests, even if the group does not call itself a committee.” If these extensions of Rule 2019 weren’t broad enough, subdivision (b) goes even further. It permits the Court, on its own motion, to require “any other entity that seeks or opposes the granting of relief” to disclose the information specified in Rule 2019(c)(2). Although the Rule doesn’t automatically require disclosure by an individual party, the court may require disclosure when it “believes that knowledge of the party’s economic stake in the debtor will assist it in evaluating that party’s arguments.”
Subdivision (c) – and, in particular, (c)(2) – is the heart of the Rule. It requires disclosure of the nature, amount, and timing of acquisition of any “disclosable economic interest.” Such interests must be disclosed individually – and not merely in the aggregate. The court may, in its discretion, also require disclosure of the amount paid for such interests.
Subdivision (d) requires updates for any material changes made after the filing of an initial Rule 2019 statement, and subdivision (e) authorizes the court to determine where there has been a violation of this rule, any solicitation requirement, or other applicable law. Where appropriate, the court may impose sanctions for any such violation.
Though potentially broad-reaching, one of the obvious flashpoints for the amended Rule’s application will be on the continued participation of hedge funds in Chapter 11 cases.
WIll the Amendments Work?
Are the amendments necessary? Or helpful? And how – if at all – will they affect the participation of hedge funds or other parties in Chapter 11 cases?
Comments gathered by HFLR suggest that certain aspects of the amendments may, in fact, assist in blunting the effect of credit default swaps – derivative securities through which the holder of distressed debt can shift the economic risk of the debtor’s obligation to a non-debtor third party, and therfore refuse to negotiate with the debtor. But other provisions may, in fact, permit abuse similar to the type perceived by William O. Douglas’s original investigation: The debtor’s management may use the new Rule in collusion with a friendly committee (or other creditors) to harrass, embarrass, and pressure an individual creditor, who may not be in an economic position to resist this treatment.
Some hedge funds have offered the argument that Rule 2019’s disclosure requirements run afoul of the Bankruptcy Code section 107’s protection of “trade secrets,” which may be protected from the public through the sealing of papers filed with the Court. But is a hedge fund’s trading information in a specific case really a “trade secret?” HFLR quotes South Bay Law Firm’s Michael Good, who notes that “Where hedge funds are concerned, the plausibility of a ‘trade secret’ argument depends upon what can or can’t be reverse engineered, something that only people with access to and familiarity with the funds’ ‘black box’ trading models and expertise in understanding them can know.”
To date, Bankruptcy Courts have not been persuaded by the “trade secret” argument. The Bankruptcy Court for the Southern District of New York specifically rejected it in Northwest Airlines.
Even so, Bankruptcy Courts have questioned whether or not case-specific trading information (such as the timing and pricing of a fund’s purchase) is truly relevant to the disclosure issues that arise before them. HFLR cites to the Delaware Bankruptcy Court’s handling of similar concerns raised by parties in the Sea Containers bankruptcy case, where the court ordered attorneys for a group of five bondholders to “revise the 2019 statement to provide the information that’s required by 2019(a)(1), (2), and (3) but not (4) [subsection (4) requires disclosure of the purchase price, which is the information considered most sensitive by hedge fund managers] because I don’t think that [the purchase price] is relevant in any way.”
Many practitioners agree with this assessment. South Bay Law Firm’s Good opined that the Sea Containers court’s balancing of interests “is probably right. I don’t know that it is truly problematic for parties, hedge funds or others, to disclose who they are or what are their aggregate holdings. The problems more commonly arise with the revelation of the price at which they purchased distressed securities, and occasionally with the timing of the purchase. Though it might be relevant in certain circumstances, trading information is often far less relevant than identifying the participants in bankruptcy, their relationships with one another, and the conflicts of interest that can surface through the disclosure of these relationships.”
Why all the fuss, anyway? What’s really at stake with these amendments?
On the one hand, Temple law professor Jonathan Lipson has argued in a recent article that the business bankruptcy process serves an important informational function for the markets and for the economy generally by “outing” poor corporate practices and systemic inefficiencies that can only be addressed and corrected after they’ve seen the light of public scrutiny. Consequently, the proposed amendments should keep the bankruptcy process honest – and are therefore necessary.
But other scholars have suggested elsewhere that the glare of public scrutiny will keep many well-heeled investors out of the distressed investment market altogether. According to them, hedge funds are widely perceived as facilitating more competitive financing terms and increased liquidity in the debt markets. They are also particularly useful in the restructuring process because they can make different types of investments (debt and equity) in a single company. Additionally, their exemption from traditional regulation allows them to quickly adapt their investment strategies to the situation at hand. The proposed amendments to Rule 2019 – and even the proposed application of Rule 2019 in its present form – may effectively remove this “market lubricant” and may further deprive distressed firms of the liquidity they need at a time when they need it most.
Comment on the proposed amendments is due by February 16, 2010.
Monday, September 14th, 2009
Unfortunately, life is full of them . . . and so is the 2005 Bankruptcy Code. Today’s post will discuss just one: The expanded protection afforded trade creditors under Section 503(b)(9).
What does this section do? And just how much protection does it provide? As amended, Section 503(b)(9) was intended by Congress to protect vendors who supplied goods to a debtor within 20 days of a debtor’s bankruptcy filing by extending “administrative” (i.e., 100% payment) status to their claims. Along with amendments to Section 546(c), the idea was to protect vendors who extended credit to a debtor immediately before the debtor filed a case. But in fact, Section 503(b)(9)’s application may now be leaving many such vendors at greater risk.
How so? A recent Daily Deal piece by Natixis’ Christophe Razaire briefly outlines three general problem areas.
– Goods? Or services? Section 503(b)(9) protects suppliers of goods well enough, and understandably so: Along with Section 546(c), it is designed to preserve and augment the protections extended to the same vendors under the Uniform Commercial Code. But what about suppliers of services? Unfortunately, as a number of creative service providers have discovered, the Code offers no such similar protection. Moreover, where a company relies primarily on services for its activity, it appears doubtful that the Code’s amendment does anything to alleviate the risk of a debtor’s default and eventual bankruptcy.
– Payment? Or post-petition payables? Though Section 503(b)(9) provides administrative priority for “20-day” vendor claims and Section 546(c) likewise permits vendors to assert reclamation demands for goods supplied immediately prior to the debtor’s filing, in practice, vendors rarely see any early compensation in the case.
Instead, a bankruptcy court is far more likely to simply afford such claims their entitled administrative status, then require the vendors holding them to wait until the conclusion of the case for payment. Economically, this means that vendors who should be enjoying administrative protection and receiving cash are, in fact, merely exchanging one “IOU” for another – and, in the meantime, suffering as much liquidity distress as any other general unsecured creditor.
Needless to say, this liquidity distress has to be dealt with in some fashion. And it is often addressed through a refusal to further supply the debtor-in-possession except on “COD” or similarly restrictive terms. Alternatively, other customers of a cash-strapped vendor may feel the squeeze through tightened terms as the vendor struggles to compensate for large – but unsatisfied – administrative obligations owed by the debtor.
– Administrative protection? Or administrative insolvency? Perhaps the most unintended consequence of Section 503(b)(9)’s amendment is that business reorganizations involving large numbers of “20-day” claims may, in fact, be threatened by its application.
“20-day vendors” can, if they so choose, accept payments on their administrative claims at a discount – and, in fact, it is not uncommon for debtors to attempt to cut such deals. But where there are numerous “20-day” claimants, the debtor often faces very slow, arduous negotiations. Many vendors are reluctant to negotiate with the debtor for fear of “selling out” too low; others may try their hand at brinksmanship, betting that the debtor’s need to satisfy such claims prior to emerging from bankruptcy will reward their willingness to “hold out.”
Often, the “reward” for such bargaining is something less than creditors may have hoped for. The debtor concludes it cannot negotiate and must instead incur the [additional] administrative expense of contesting such claims directly in an effort to reduce their aggregate amount. If these claims disputes do not go the debtor’s way, or if the debtor is already struggling to emerge with sufficient cash, the debtor may be forced to liquidate – thereby leaving all creditors, from secured debt to general unsecured claims, with far less than might otherwise be the case.
How big can these problems get? A recent “Dealscape” blog post by Ben Fidler illustrates how the section is playing out in the troubled retail and auto parts sectors, where vendors of goods often play a significant role in a company’s operations. Fidler points to larger Chapter 11 filings, such as Empire Beef Co., Blackhawk Automotive Plastics, Inc., and Plastech Engineered Products, Inc., which have been left administratively insolvent or have been threatened with such insolvency, as a result of section 503(b)(9)’s amendments.
Though not every case is as large as the ones cited by Fidler – and not every case results in administrative insolvency – similar dynamics with similar results can just as easily arise in smaller Chapter 11’s.
In sum, this anecdotal data suggests that Congress’ well-intended efforts to afford some creditors with more options in a debtor’s reorganization may, in fact, have left all creditors with far less options.
Surely, this cannot have been Congress’ intended consequence.