Posts Tagged ‘protection’
Monday, April 19th, 2010
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:
comity is not just a one-way street. Just as this Court will defer to a [non-US] court if the circumstances require it, so too should a foreign court defer to this Court when appropriate. In this case it was clear from the start that [this Court] expressed reservations about the distribution of Railpower US assets in the Canadian [p]roceeding . . . . The Monitor has [not] explained how this [reservation] is to be [addressed] unless the Canadian Court shows comity to this Court.
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.
Sunday, February 7th, 2010
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.
Monday, November 16th, 2009
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:
- 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.
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.