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’s financial system. The plan involved JSC National Welfare Fund Samruk-Kazyna (Samruk-Kazyna), Kazakhstan’s sovereign wealth fund, providing financial support to struggling financial institutions. At the same time, Samruk-Kazyna acquired a controlling 75.1 % of BTA’s total share capital. BTA also continued to down-size its operating activities in response to the deteriorating market and BTA’s 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.

From New York’s Southern District comes the strange tale of the Canadian asset backed commercial paper market, and a decision that raises the question of whether foreign courts provide a possible strategic “end run” around US law for parties doing business in the US – and even for US litigants with a business presence overseas.

Collapse of the Canadian Asset Backed Commercial Paper Market

Asset backed commercial paper (ABCP) is a Canadian short-term investment with a low interest yield.  Generally marketed as a “safe” investment, ABCP is considered “asset backed” because the cash used to purchase these notes goes to create a portfolio of financial or other assets, which are then security for repayment of the originally issued paper.  In flush times, ABCPs were typically paid off with the proceeds from the purchase of new paper – or simply rolled over into new paper purchases themselves.

But times did not stay flush.

By 2007, ABCPs were collateralized by everything from auto loans to residential mortgages – which, unlike the “short-term” paper they backed, had much longer maturities.  With the rapidly-cresting economic downturn, uncertainty began to ripple through the ABCP market by mid-2007.  Because ABCPs were not transparent investments and investors could not determine which assets backed their paper, the uncertainty soon grew into a full-scale liquidity crisis.

The Big Freeze – And The Planned Thaw

In August 2007, approximately CAN$32 billion of non-bank sponsored ABCP in the Canadian market was frozen after an agreement between the major market participants.  This “freeze” was implemented pending an attempt to resolve the crisis through a restructuring of the market.  A “Pan-Canadian Investors Committee” was created, which introduced a creditor-initiated Plan of Compromise and Arrangement under the Canadian Companies’ Creditors Arrangement Act (CCAA).  The Plan was sanctioned in June 2008 in the Metcalfe cases.  Essentially, the Plan converted the noteholders’ frozen paper into new, long-term notes with a discounted face value that could be traded freely, in the hope that a strong secondary market for the notes would emerge in the long run.

Releases for Third Parties

Part of the Plan required that market participants, including banks, dealers, noteholders, asset providers, issuer trustees, and liquidity providers be released from any liability related to ABCP, with the exception of certain narrow fraud claims.  Among those receiving these releases were Bank of America, Deutsche Bank, HSBC Bank USA, Merrill Lynch International, UBS, and Wachovia Bank and their respective affiliates.

These third party releases were themselves the subject of appellate litigation in Canada, but were eventually upheld as within the ambit of the CCAA.  The Plan became effective in January 2009, and the court-appointed monitors (Ernst & Young, Inc.) sought US recognition of the Metcalfe cases in New York the following October.  More specifically, the monitors sought enforcement in the US of the third-party releases which were a centerpiece of the Canadian Plan.

Third-party releases of non-bankrupt parties are significantly limited under US bankruptcy law – and, in a number of circuits, prohibited altogether.  In the 2d Circuit – where the recognition cases are pending – they are permissible only where (i) “truly unusual circumstances render the release terms important to the success of the plan;” and (ii) the released claims “directly affect the res (i.e., the property) of the bankruptcy estate.”  In Bankruptcy Judge Martin Glenn’s view, the Canadian releases went a bit further than what the 2d Circuit would otherwise permit.  Nevertheless, Ernst & Young asked Judge Glenn to permit them.

Recognition and Enforcement In the US

Ernst & Young’s request was based, first, on Section 1509, which requires that if a US Bankruptcy Court grants recognition in a foreign main proceeding, it “shall grant comity or cooperation to the foreign representative.”  Moreover, where recognition is granted, the US court “may provide additional assistance to [the] foreign representative” (Section 1507(a)), provided that such assistance is “consistent with the principles of comity” and serves one or more articulated policy goals set forth in Section 1507(b).  The decision to provide such assistance “is largely discretionary and turns on subjective factors that embody principles of comity.”  It is also subject to a general but narrowly construed ”public policy” restriction in Section 1506.

Comity

Though it is given prominence in Chapter 15, the American concept of “comity” in fact grows out of many decades of US commercial experience: Over a century ago, the emerging freedom of markets, comparatively few limits on imports, exports, immigration and exchanges of information and capital flows gave rise to what has been termed as the “first age of globalization.” In keeping with the spirit of that age, US courts of the period sought to resolve commercial disputes involving international litigants in a manner that would facilitate free international trade. They did so by preserving, where possible, the sanctity of rulings rendered in foreign tribunals as those rulings pertained to US citizens involved in foreign transactions. Those efforts found their expression through application of the case law doctrine of “comity.”

As expressed long ago by the US Supreme Court, “comity” is that “recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation.” As described by more modern precedent, US courts will recognize the “[a]cts of foreign governments purporting to have extraterritorial effect” when those acts are consistent with US law and policy.

It is worth noting that “consistent with US law and policy” does not mean identical with US law and policy.  As Judge Glenn observed, “[t]he relief granted in the foreign proceeding and the relief available in a [US] proceeding need not be identical.”  Instead, the “key determination” is “whether the procedures used in [the foreign court] meet [US] fundamental standards of fairness.”

“Fundamental standards of fairness” are understandably vague, and – beyond the basic idea of due process – often difficult to establish.  In this case, Judge Glenn essentially found that though the releases in question likely went beyond what would pass muster under US law, third party releases weren’t completely unheard of – and besides, the decision of a Canadian court of competent jurisdiction should be entitled to recognition as a matter of comity in any event.

What It All Means

The Metcalfe decision is interesting.  One one hand, it seems to provide merely another example of the well-recognized fact that Canadian judgments are routinely upheld by US courts.  However, it also suggests that parties with access to foreign tribunals with insolvency schemes resembling the US, but providing relief somewhat different from (i.e., more favorable to) that available under US insolvency law, may be able to maneuver around US law by filing a “main [insolvency] case” in a foreign jurisdiction, then seeking recognition and enforcement of that relief in the US – on the basis of comity.

Something to think about.

As readers of this blog are aware, Antiguan liquidators Peter Wastell and Nigel Hamilton-Smith and federal receiver Ralph Janvey have been busy in several forums battling for control of the financial assets previously controlled by Allen Stanford, including Stanford International Bank, Ltd. (SIB).  Prior posts are accessible here.

Messr’s. Wastell and Hamilton-Smith have filed numerous pleadings from other courts in support of their pending request, before US District Court Judge David Godbey, for recognition of their liquidation of SIB as a “main case” under Chapter 15 of the US Bankruptcy Code.

Mr. Janvey has recently filed his own copies of several recent rulings.  These include a ruling in which the Quebec Superior Court’s Mr. Justice Claude Auclair found that Vantis Business Recovery Services – a division of British accounting, tax, and advisory firm Vantis plc, and the firm through which Messr’s. Wastell and Nigel Hamilton-Smith were appointed liquidators for SIB – should be removed from receivership of SIB’s Canadian operations.

More recently, Mr. Janvey has filed a copy of a recently unsealed plea agreement between Stanford affiliate James Davis and federal prosecutors.

Mr. Janvey’s papers provide a glimpse into Davis’ relationship with Stanford, and into the origins of SIB.  Summarized briefly:

SIB’s Background

- Davis’ and Stanford’s relationship dates back to the late 1980s, when Stanford retained Davis to act as the controller for then-Montserrat-based Guardian International Bank, Ltd.  Davis’ plea agreement recites that Stanford had Davis falsify the bank’s revenues and portfolio balances for banking regulators.  Continued regulatory scrutiny in Montserrat eventually led to Stanford’s closure of Guardian and removal of its banking operations to Antigua – where, in 1990, it resumed operations under the name of Stanford International Bank, Ltd.

- SIB and a “web of other affiliated financial services companies” operated under the corporate umbrella of Stanford Financial Group.  SIB’s primary function was to market supposedly safe and liquid “certificates of deposit” (CDs).  By 2008, SIB had sold nearly $7 billion of them to investors worldwide.

- Davis’ plea agreement further recites that investors were assured SIB’s operations were subject to scrutiny by the Antiguan Financial Services Regulatory Commission (FSRC), and to independent, outside audits.

SIB’s Asset Allocation and Operations

- In fact, SIB investor funds were neither safe nor secure.  According to Davis’ plea agreement, investor funds did not go into the marketed CDs.  Instead, they were placed into three general “tiers”: (i) cash and cash equivalents (“Tier I”); (ii) investments managed by outside advisors (“Tier II”); and (iii) “other” investments (“Tier III”).  By 2008, the majority of SIB’s investor funds – approximately 80% – were held in “highly illiquid real and personal property” in “Tier III,” including $2 billion in “undisclosed, unsecured personal loans” to Allen Stanford.  A further 10% was held in “Tier II.”  The remaining 10% balance was presumably held in “Tier I.”

- Likewise, SIB’s operations were not subject to any meaningful scrutiny.  Davis’ plea agreement recites that in or about 2002, Stanford introduced him to Leroy King, a former Bank of America executive and Antiguan ambassador to the US, and soon-to-be Chief Executive Officer of the FSRC.  Stanford, King, and another FSRC employee responsible for regulatory oversight performed a “blood oath” brotherhood ceremony sometime in 2003 – ostensibly to cement their commitment to one another and King’s commitment to the protection of SIB – i.e., to “ensure that Antiguan bank regulators would not ‘kill [SIB's] business’” in Antigua.

- Though blood may be thicker than water, it is not thicker than cash: Stanford’s and King’s “brotherhood” was cemented further by bribes paid to King for his protection of SIB.  Acccording to Davis’ plea agreement, these bribes ultimately exceeded $200,000.  In return for this largesse, King reassigned two overly inqusitive Antiguan examiners of which Stanford complained sometime in 2003.  In 2005 and again in 2006, King further cooperated with Stanford in providing misleading responses to the US Securities and Exchange Commission (SEC)’s inquiries to the FSRC, in which the SEC divulged to the FSRC that it had evidence of SIB’s involvement in a ”possible Ponzi scheme.”  King and Stanford similarly collaborated in responding to a 2006 inquiry by the Director of the Eastern Caribbean Central Bank’s Bank Supervision Department regarding SIB’s affiliate relationship with the Bank of Antigua.

SIB’s Financial Reporting

- A central premise of Stanford’s approach to soliciting investments – and, perhaps understandably, a central point of interest for would-be investors - was that SIB must show a profit each year.  To accomplish this, Davis and Stanford reportedly initially determined false revenue numbers for SIB.  Ultimately, this collaboration gave rise to a fabricated annual “budget” for SIB, which would show financial growth.  Using these “budgeted” growth numbers, Stanford accounting employees working in St. Croix would generate artificial revenues (and resulting artificial ROIs), which were then transmitted to Stanford’s Chief Accounting Officer in Houston and ultimately to Davis in Mississippi for final adjustment and approval before making their way back to the Caribbean for reporting to SIB investors.

- According to Davis’ plea agreement, “[t]his continued routine false reporting . . . created an ever-widening hole between reported assets and actual liabilities, causing the creation of a massive Ponzi scheme . . . .  By the end of 2008, [SIB reported] that it held over $7 billion in assets, when in truth . . . [SIB] actually held less than $2 billion in assets.”

- In about mid-2008, Stanford, Davis, and others attempted to plug this “hole” created by converting a $65 million real estate transaction in Antigua into a $3.2 billion asset of SIB through a “series of related party property flips through business entities controlled by Stanford.”

SEC Subpoenas and SIB’s Insolvency

- By early 2009, the SEC had issued subpoenas related to SIB’s investment portfolio.  At a February meeting held in advance of SEC testimony, Stanford management determined that SIB’s “Tier II” assets were then valued at approximately $350 million – down from $850 million in mid-2008.  Management further determined that  and SIB’s “Tier III” assets consisted of (i) real estate acquired for less than $90 million earlier in the year, but now valued at more than $3 billion; (ii) $1.6 billion in “loans” to Stanford; and (iii) other private equity investments.  Davis’ plea agreement recites that at that same meeting, and despite the apparent disparity between actual and reported asset values, Stanford insisted that SIB had “‘at least $850 million more in assets than liabilities.’”  In a separate meeting later that day, however, Stanford reportedly acknowledged that SIB’s “assets and financial health had been misrepresented to investors, and were overstated in [SIB's] financials.”

Janvey doesn’t describe exactly how these acknowledged facts integrate into his prior opposition to the Antiguan liquidators’ request for recognition.  His prior pleadings have questioned indirectly the integrity of the Antiguan wind-up proceedings; consequently, Mr. King’s role in protecting SIB under the auspices of the Antiguan FSRC may well be the point.  Likewise, Janvey may point to the US-based control and direction of financial reporting manipulations that ultimately created a $5 billion “hole” in SIB’s asset structure as evidence of the American origin of SIB’s allegedly fraudulent operations.  Or the filing may be intended to blunt the effect of a previously filed detention order – issued by another US District Court and affirmed by the US Fifth Circuit Court of Appeals – confining Stanford to the US and observing that his ties to Texas were “tenuous at best.”

It remains for Judge Godbey to determine whether – and in what way and to what degree – Davis’ plea agreement impacts on the liquidators’ request for a determination that SIB’s “center of main interests” remains in Antigua.

For the moment, the parties await his decision.