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Posts Tagged ‘corporation’
International readers of this blog – and those in the US who practice internationally – are more than likely aware of the doctrine of “comity” embraced by US commercial law. In a nutshell, “comity” is shorthand for the idea that US courts typically afford respect and recogntion (i.e., enforcement) within the US to the judgment or decision of a non-US court – so long as that decision comports with those notions of “fundamental fairness” that are common to American jurisprudence.
In the bankruptcy context, “comity” forms the backbone for significant portions of the US Bankruptcy Code’s Chapter 15. Chapter 15 – enacted in 2005 – provides a mechanisim by which the administrators of non-US bankruptcy proceedings can obtain recogntion of those proceedings, and further protection and assistance for them, inside the US.
But in at least some US bankruptcy courts, “comity” for non-US insolvencies only goes so far. Last month, US Bankruptcy Judge Thomas Argesti, of Pennsylvania’s Western District, offered his understanding of where “comity” stops – and where US bankruptcy proceedings begin.
Judge Argesti currently presides over Chapter 15 proceedings commenced in furtherance of two companies – Canada’s Railpower Technologies Corp. (“Railpower Canada”) and its wholly-owned US subsidiary, Railpower US. The two Railpower entities commenced proceedings under the Canadian Companies Creditors’ Arrangement Act (“CCAA”) in Quebec in February 2009. Soon afterward, their court-appointed monitors, Ernst & Young, Inc., sought recogntition of the Canadian Railpower cases in the US.
Railpower US’ assets and employees – and 90% of its creditors – were located in the US. The company was managed from offices in Erie, PA. Nevertheless, it carried on its books an inter-company obligation of $66.9 million, owed to its Canadian parent. From the outset, Railpower US’ American creditors asserted this “intercompany debt” was, in fact, a contribution to equity which should be subordinate to their trade claims. Judge Argesti’s predecessor, now-retired Judge Warren Bentz, therefore conditioned recognition of Railpower US’ case upon his ability to review and approve any proposed distribution of Railpower US’ assets. After the company’s assets were sold, Judge Bentz further required segregation of the sale proceeds pending his authorization as to their distribution. Finally, after the Canadian monitors obtained a “Claims Process Order” for the resolution of claims in the CCAA proceedings and sought that order’s enforcement in the US, Judge Bentz further “carved out” jurisdiction for himself to adjudicate the inter-company claim if the trade creditors received anything less than a 100% distribution under the CCAA plan.
Railpower US’ assets were sold – along with the assets of its Canadian parent – to R.J. Corman Group, LLC. Railpower US was left with US$2 million in sale proceeds against US$9.3 million in claims (other than the inter-company debt). The Canadian monitor indicated its intention to file a “Notice of Disallowance” of the inter-company debt in the Canadian proceedings, but apparently never did. Meanwhile, approximately CN$700,000 was somehow “upstreamed” from Railpower US to Railpower Canada. Finally, despite the monitor’s assurances to the contrary, Railpower Canada’s largest shareholder – and an alleged secured creditor – sought relief in Quebec to throw both Railpower entities into liquidation proceedings under Canada’s Bankruptcy and Insolvency Act.
Enough was enough for Railpower US’ American creditors. In August 2009, they filed an involuntary Chapter 7 proceeding against Railpower US, seeking to regain control over the case – and Railpower US’ assets – under the auspices of an American panel trustee.
The Canadian monitor requested abstention under Section 305 of the Bankruptcy Code. Significantly re-drafted in the wake of Chapter 15’s enactment, that section permits a US bankruptcy court to dismiss a bankruptcy case, or to suspend bankruptcy proceedings, if doing so (1) would better serve the interests of the creditors and the debtor; or (2) would best serve the purposes of a recognized Chapter 15 case.
Judge Argesti’s 14-page decision, in which he denied the monitors’ motion and permitted the Chapter 7 case to proceed, is one of apparent first impression on this section where it regards a Chapter 15 case.
Where the “better interests of the creditors and the debtor” are concerned, Judge Argesti’s discussion essentially boils down to the proposition that because creditors representing 85% – by number and by dollar amount – of Railpower US’ case sought Chapter 7, those creditors have spoken for themselves as to what constitutes their “best interests” (“The Court starts with a presumption that these creditors have made a studied decision that their interests are best served by pursuing the involuntary Chapter 7 case rather than simply acquiescing in what happens in the Canadian [p]roceeding.”).
The more interesting aspect of the decision concerns Judge Argesti’s discussion of whether or not the requested dismissal “best serve[d] the purposes” of Railpower’s Chapter 15 cases. For guidance on this issue, Judge Argesti turned to Chapter 15’s statement of policy, set forth in Section 1501 (“Purpose and Scope of Application”) – which states Chapter 15’s purpose of furthering principles of comity and protecting the interests of all creditors. Then, proceeding point by point through each of the 5 enunciated principles behind the statute, he arrived at the conclusion that the purposes of Chapter 15 were not “best served” by dismissing the involuntary Chapter 7 case. As a result, Railpower US’ Chapter 7 case would be permitted to proceed.
Judge Argesti’s analysis appears to focus primarily on (i) the Canadian monitors’ apparent delay in seeking disallowance of the inter-company debt in Canada; (ii) the “upstreaming” of CN$700,000 to Railpower Canada; and (iii) the monitors’ apparent failure, as of the commencement of the involuntary Chapter 7, to “unwind” these transfers or to recover them from Railpower Canada for the benefit of Railpower US’ creditors. It also rests on the fact that Railpower US was – for all purposes – a US debtor, with its assets and creditors located primarily in the US.
In this context, and in response to the monitors’ protestations that comity entitled them to judicial deference regarding the Chapter 15 proceedings, Judge Argesti noted that:
Judge Argesti’s decision may be limited to its comparatively unique facts. However, it should also serve as a cautionary tale for representatives seeking to rely on principles of comity when administering business assets in the US. In addition to his more limited construction of “comity,” Judge Argesti also noted that recognition of Railpower US’ Chapter 15 case was itself subject to second-guessing where subsequently developed evidence suggested that the company’s “Center of Main Interests” was not in Canada, but in the US.
For anyone weighing strategy attendant to the American recognition of a non-US insolvency proceeding, this decision is important reading.
Evidentiary hearings are scheduled for later this month in the ongoing struggle for control over the financial assets of Stanford International Bank, Ltd. (SIB), the cornerstone of Allen Stanford’s financial-empire-turned-Ponzi-scheme. A series of posts on this blog have covered liquidators Peter Wastell and Nigel Hamilton-Smith’s efforts to obtain recognition in the US for their Antiguan wind-up of SIB, and US receiver Ralph Janvey’s competing efforts to do the same in Canadian and UK courts.
The Stanford case is of considerable significance in the US – and in the UK and Canada, where it has spawned at least two decisions and related appeals over the parties’ efforts to obtain cross-border recognition for their respective efforts to clean up the Stanford mess.
In Dallas, Texas, where an enforcement action commenced by the American Securities and Exchange Commission remains pending (and where Mr. Janvey has been appointed as a receiver for the purposes of marshalling Stanford assets for distribution to creditors), US District Court Judge David Godbey has taken prior pleadings from both sides under advisement and, in advance of this month’s hearing, has requested further briefing on three issues. Mr. Janvey’s brief, submitted last week, addresses each of these as follows:
The Liquidators have argued that, under applicable Fifth Circuit standards, SIB’s “principal place of business” was Antigua and that its activities were actively managed from Antigua, and were not “far flung” so as to render SIB’s Antiguan location irrelevant.
Predictably enough, Mr. Janvey responds that under appropriate circumstances, the Fifth Circuit applies principles of alter ego and disregards corporate formalities in determining an entity’s “principal place of business:” “The Fifth Circuit applies alter ego doctrines not only to enforce liability against shareholders and parent companies, but also to determine a corporation’s ‘principal place of business’ for jurisdictional purposes.” (citing Freeman v. Nw. Acceptance Corp., 754 F.2d 553, 558 (5th Cir. 1985)).
Based on this construction of Fifth Circuit law – and because COMI is generally equated to an entity’s “principal place of business” under US corporate law – Janvey then argues that consistency and logic require the same rules be followed for COMI purposes. He then goes on to argue that Stanford’s Ponzi scheme activities were “far flung,” that SIB’s Antiguan operations were “passive,” and that its “nerve center” and “place of activity” were both in the U.S.
Wastell and Hamilton-Smith have argued that financial advisors who sold SIB’s CDs to potential investors were, in fact, independent agents employed by other, independent Stanford broker-dealer entities and were not controlled by SIB.
Mr. Janvey pours scorn on this argument. According to him, it does not matter that there were inter-company “contracts” purporting to make the Stanford broker-dealer entities agents for SIB in the sale of CDs. As Mr. Janvey views it, a fraud is a fraud . . . from beginning to end. Consequently, there was no substance to the “contracts” as all the entities involved were instruments of Stanford’s fraud.
As noted above, Mr. Janvey takes the position that “alter ego” treatment of the Stanford entities is not only viable – it is the only appropriate means of treating SIB’s relationship to other, US-based Stanford entities, and of determining COMI for SIB. He argues further that substantive consolidation – the bankruptcy remedy referred to by Messr’s. Wastell and Hamilton-Smith – can be just as effectively accomplished through a federal receivership, which affords US District Courts significant latitude in fashioning equitable remedies and determining distributions to various classes of creditors.
Mr. Janvey’s argument appears quite straightforward. Because a fraud is a fraud, geography matters very little in determining its “center of main interests.” According to him, what should count instead is the location of the fraudsters and the place from which the fraud was managed and directed. Yet even Mr. Janvey acknowledges that “Antigua played a role in [Stanford's Ponzi] scheme . . . [in that] [Antigua] was where Stanford could buy off key officials in order to conduct his sham business without regulatory interference.” In other words, geography was important . . . at least for Stanford. Specifically, geography provided Stanford direct access to a corrupt regulator who would afford cover for the conduct of Stanford’s fraudulent CD sales to investors.
Mr. Janvey addresses this potential problem by taking aim at the entire Antiguan regulatory structure:
Mr. Janvey then goes further still, arguing that Messr’s. Wastell and Hamilton-Smith (and their employer, British-based Vantis plc) are precluded by Antiguan law from complying with the disclosure requirements Judge Godbey has imposed on the US receivership – and therefore simply unable to concurrently administer a “main case” in Antigua and cooperate with the Receiver (or with the District Court) in the US.
Finally, Mr. Janvey gets directly personal: He recites the opinion of the Canadian court that revoked Vantis’ administration of Stanford’s Canadian operations and refused recognition of the Antiguan wind-up on the grounds that “Vantis’ conduct, through [Messr's. Wastell and Hamiton-Smith], disqualifies it from acting and precludes it from presenting the motion [for Canadian recognition], as [Vantis] cannot be trusted by the [Canadian] Court . . . .” The Canadian court’s opinion has been upheld on appeal, and is now final.
In a nutshell, Mr. Janvey argues that geography shouldn’t matter where a fraud is concerned . . . but if it does matter, it ought to count against jurisdictions such as Antigua, an “impoverished island” which has a population “about 80% that of Waco, Texas” and a history of financial fraud.
As is sometimes said in Texas, “Them’s fightin’ words.”
The SEC’s brief, like Mr. Janvey’s, is also on file. Messr’s. Wastell and Hamilton-Smith’s reply will be due shortly.
The fiduciary duty of directors and officers to the shareholders of their corporation is a fundamental axiom of corporate law. Almost as familiar is the notion that when a corporation enters the “zone of insolvency”, those fiduciary duties expand to include creditors as well.
What may be far less familiar is determining precisely when the corporation has entered the zone of insolvency – and what to do when it does.
Where is the “zone of insolvency”?
It has been said that the zone of insolvency is a bit like obscenity: It’s practically impossible to define . . . but you sure know it when you see it. It may not be as well known that many businesses transit the zone of insolvency with surprising frequency at various points during their corporate lifecycles.
A recent law review article notes that “between 2000 and 2004, approximately 4% of 6,178 large publicly held companies engaged in merger and acquisition activity that placed over 75% of their assets at risk. Likewise, approximately 467 smaller businesses risked half their assets, and at least 603 smaller businesses risked one-fifth of their assets. Thus directors’ and officers’ fiduciary duties may oscillate between shareholders and creditors numerous times per year depending on the risk-taking strategies in which they engage.” Jonathan T. Edwards and Andrew D. Appleby, The Twilight Zone of Insolvency: New Developments in Fiduciary Duty Jurisprudence That May Affect Directors and Officers While in the Zone of Insolvency, 18 J. Bankr. L. & Prac. 3 Art. 2 (2009) (citing Anna M. Dionne, Living on the Edge: Fiduciary Duties, Business Judgment, and Expensive Uncertainty in the Zone of Insolvency, 13 Stan. J.L. Bus. & Fin. 188, 191 (2007)).
Add to this the changing nature of financial investments in many companies (which now feature “hybrid” instruments with both equity and debt characteristics) and the dramatic adjustment of multiples and valuations that have occured in the capital markets over the last 12 months, and it is easy to see that the “zone of insolvency” is hardly a bright line. Instead, it is more akin to a solar flare – it can depend as much upon the corporation’s financial structure and upon market conditions as upon the decisions made by the corporation’s officers and directors.
What to do once you’re there?
When a financially at-risk corporation faces either operational or balance sheet insolvency, its directors and officers may face a variety of unique pressures and challenges. Among them:
– Time pressure: A corporation with little or no operating liquidity is like a swimmer deprived of oxygen – precious little time remains before everything goes completely black.
– Credit constraint: The corporation may face an uphill battle for additional, needed credit. Frequently, the only readily available source of cash are parties with close ties to the corporation – i.e., insiders. And such parties are apt to require advantageous terms in exchange for their incremental risk.
– Anxious stakeholders: Creditors and shareholders anxious to protect their respective stakes in the corporation are likely to increase their scrutiny of every new transaction, and to “second-guess” anything that might further jeopardize their positions.
Top management’s response to these pressures is well-summarized by the adage that “process rules.” Because each corporation’s situation calls for a unique set of decisions, and because corporate officers and directors have general duties of care and loyalty to the corporation (and to creditors when the corporation is operating in the “zone of insolvency”), they best protect themselves who ensure that any decision:
– Is advised by (but not delegated to) outside advisors.
Two very recent articles offer similar advice and summarize some practical tips on insulating directors and officers – or on identifying behavior that may fall short of the fiduciary duties expected of such individuals when a corporation faces troubled times or elevated risk.
Gerard S. Catalanello and Jeffrey R. Manning offer their insights in a recent Turnaround Management Journal piece entitled “A Fresh Look into the Zone of Insolvency,” while Frank Aquila and Peter Naismith provide similar guidance in “Directing Within the ‘Zone’,” available in Banking Director magazine’s 4th Quarter’s issue. Each is worth perusal.
When do “zone of insolvency” considerations kick in? And how frequent are such concerns likely to be in this market? Catalanello and Manning put it this way:
Officers, directors . . . and creditors – take note.