Posts Tagged ‘“US Bankruptcy Court”’
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, February 15th, 2010
A brief update on Stanford (earlier posts are available here):
Evidentiary hearings scheduled for late January 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, were cancelled by presiding US District Court Judge David Godbey.
As readers of this blog are aware, Antiguan 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, were to culminate in a hearing set for late last month. But shortly after a scheduled status conference on pre-hearing matters, the evidentiary was cancelled.
Recent reporting by Reuters (available here) may provide a reason for the change: Reuters reported on February 5 that the liquidators and Mr. Janvey may, in fact, be settling. According to staff writer Anna Driver, a dispute over $370 million in assets traced to Stanford, as well as $200 million located in Switzerland and the UK, are driving the parties toward a deal.
But there may be other pressures as well. The Associated Press reported (here) that last Thursday, Judge Godbey indicated his intent to rule on a request by third-party investors to commence their own involuntary bankruptcy filing, thereby replacing Mr. Janvey as a receiver.
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 30th, 2009
The purchase of debt on the cheap and subsequent use of activist litigation to seize control of a troubled company, or obtain other economic concessions from the debtor, is a common tactic in Chapter 11 practice. But it is not without risk – especially when the purchased debt comes with possible strings attached.
From New York’s Southern District last week, a cautionary tale of what can happen when an agressive distressed debt investor presses its luck despite ambiguous lending documents:
ION Media Networks’ Pre-Petition Credit Arrangements and Pre-Arranged Chapter 11.
ION Media Networks Ltd. and its affiliates (“ION”) entered into a series of security agreements with its first- and second-priority lenders during the “go-go” days of 2005. The documents included an intercreditor agreement setting forth the respective parties’ rights to ION’s assets.
By early 2009, ION was involved in restructuring discussions with the first-priority lien holders. Those discussions resulted in a Restructuring Support Agreement (“RSA”) by which ION conveyed 100% of ION’s reorganized stock to the first-priority lien holders upon confirmation of a Chapter 11 plan. In furtherance of the RSA, the ION companies filed jointly administered Chapter 11 cases in May 2009.
Enter Stage Right: Cyrus.
In the meantime, Cyrus Select Opportunities Master Fund Ltd. (“Cyrus”) purchased some of ION’s second-lien debt for pennies on the dollar. Using its newly acquired stake, Cyrus systematically attempted to interpose itself into ION’s pre-arranged reorganzation: It objected to DIP financing proposed by the first-priority lien holders, requested reconsideration of the DIP financing order so it could offer alternative financing on better terms, objected to ION’s disclosure statement, commenced its own adversary proceeding for a declaratory judgment, prosecuted a motion to withdraw the reference with respect to two adversary proceedings concerning ION’s FCC broadcast licenses, objected to confirmation, proposed amendments to the Plan to enable it more effectively to appeal adverse rulings of the Bankruptcy Court, and even filed supplemental papers in opposition to confirmation on the morning of the confirmation hearing.
Cyrus’ basic objective in this campaign was quite straightforward. It sought to challenge the rights of ION’s first lien holders (and DIP lenders) to recover any of the enterprise value attributable to ION’s FCC broadcast licenses. Its ultimate objective was to leverage itself into economic concessions from ION and the first lien holders - and a hefty profit on its debt acquisition.
Cyrus picked its fight (i) while its position was “out of the money”; and (ii) in the face of an Intercreditor Agreement prohibiting Cyrus from “tak[ing] any action or vot[ing] [on a Chapter 11 plan] in any way . . . so as to contest (1) the validity or enforcement of any of the [first lien holders'] Security Documents … (2) the validity, priority, or enforceability of the [first lien holders'] Liens, mortgages, assignments, and security interests granted pursuant to the Security Documents … or (3) the relative rights and duties of the holders of the [first lien holders'] Secured Obligations . . .”).
Cyrus apparently decided to go forward because, in its view, ION’s valuable FCC broadcast licenses were not encumbered by the first-priority liens that were the subject of the Intercreditor Agreement. As a result, Cyrus claimed a right to pro rata distribution, along with the first-priority lien holders (who were themselves undersecured), in the proceeds of the purportedly unencumbered FCC licenses. Therefore, its objections, based on Cyrus’ position as an unsecured creditor, were appropriate. By the time the cases moved to confirmation, the ION debtors had commenced their own adversary proceeding to determine whether or not Cyrus’ objections were so justified.
Second-Guessing Cyrus’ Strategy.
Cyrus’ game of legal “chicken” was, in the words of New York Bankruptcy Judge James Peck, a “high risk strategy” designed to “gain negotiating leverage or obtain judicial rulings that will enable it to earn outsize returns on its bargain basement debt purchases at the expense of the [first lien holders].”
Unfortunately for Cyrus, its “high risk strategy” was not a winning one.
In a 30-page decision overruling Cyrus’ objections to ION’s Chapter 11 plan, Judge Peck appeared to have little quarrel with Cyrus’ economic objectives or with its activitst approach. But he was sharply critical of Cyrus’ apparent willingness to jump into the ION case without first obtaining a determination of its rights (or lack thereof) under the Intercreditor Agreement:
Cyrus has chosen . . . to object to confirmation and thereby assume the consequence of being found liable for a breach of the Intercreditor Agreement. Cyrus’ reasoning is based on the asserted correctness of its own legal position regarding the definition of collateral and the proper interpretation of the Intercreditor Agreement. To avoid potential liability for breach of the agreement, Cyrus must prevail in showing that objections to confirmation are not prohibited because those objections are grounded in the proposition that the FCC Licenses are not collateral and so are not covered by the agreement. But that argument is hopelessly circular. Cyrus is free to object only if it can convince this Court or an appellate court that it has correctly analyzed a disputed legal issue. It is objecting as if it has the right to do so without regard to the incremental administrative expenses that are being incurred in the process.
In contrast to Cyrus’ reading of the Intercreditor Agreement, Judge Peck read it to “expressly prohibit Cyrus from arguing that the FCC Licenses are unencumbered and that the [first lien holders'] claims . . . are therefore unsecured . . . . At bottom, the language of the Intercreditor Agreement demonstrates that [Cyrus' predecessors] agreed to be ‘silent’ as to any dispute regarding the validity of liens granted by the Debtors in favor of the [first lien holders] and conclusively accepted their relative priorities regardless of whether a lien ever was properly granted in the FCC Licenses.”
Judge Peck further found that because Cyrus’ second-priority predecessor had agreed to an indisputable first-priority interest in favor of the first lien holders regarding any “Collateral,” this agreement also included any purported “Collateral” – and, therefore, prohibited Cyrus’ dispute of liens in the FCC broadcast licenses . . . even if such licenses couldn’t be directly encumbered:
The objective was to prevent or render moot the very sort of technical argument that is being made here by Cyrus regarding the validity of liens on the FCC [l]icenses. By virtue of the Intercreditor Agreement, the parties have allocated among themselves the economic value of the FCC [l]icenses as “Collateral” (regardless of the actual validity of liens in these licenses). The claims of the First Lien Lenders are, therefore, entitled to higher priority . . . . Affirming the legal efficacy of unambiguous intercreditor agreements leads to more predictable and efficient commercial outcomes and minimizes the potential for wasteful and vexatious litigation . . . . Moreover, plainly worded contracts establishing priorities and limiting obstructionist, destabilizing and wasteful behavior should be enforced and creditor expectations should be appropriately fulfilled.
Judge Peck acknowledged case law from outside New York’s Southern District that disfavors pre-petition intercreditor agreements which prohibit junior creditor voting on a Chapter 11 plan or a junior creditor’s appearance in the case as an unsecured creditor. But these features were not the ones at issue here: Cyrus was permitted to vote, and it could (presumably) make a general appearance as an unsecured creditor. However, it could not, in this capacity, object to the ION Chapter 11 plan.
Finally, Judge Peck noted that his own prior DIP Order acknowledged the first lien holders’ senior liens on “substantially all the [ION] Debtors’ assets.” As a result, Cyrus was independently prohibited from re-litigating this issue before him – and couldn’t have done so in any event because it had no standing to raise a proper objection.
Food for Thought.
The ION decision raises a number of questions – about the activist litigation tactics often used to extract the perceived value inherent in distressed debt acquisitions, and about the debt itself.
Was Cyrus overly aggressive in enforcing its purchased position? Judge Peck suggests, in a footnote, that Cyrus would have been free to raise objections to a settlement between the ION debtors and unsecured creditors by which the unsecured creditors were provided consideration sufficient to meet the “best interests of creditors” test required for confirmation. But wouldn’t any objection ultimately have raised the same issues as those put forward by Cyrus independently – i.e., the claimed lack of any direct encumbrance on ION’s FCC licenses, and the extra value available to unsecured creditors?
Or perhaps Cyrus wasn’t agressive enough? For all the paper it filed in the ION cases, shouldn’t Cyrus have concurrently given appropriate notice under its second-priority debt Indenture and commenced an adversary proceeding to determine its rights under the Intercreditor Agreement?
Finally, what of Cyrus’ purchased position? Was the Intercreditor Agreement truly “unambiguous” regarding Cyrus’ rights? Didn’t the “Collateral” described and the difficulty of directly encumbering FCC licenses create sufficient ambiguity to trigger an objection of the sort Cyrus offered? Are “purported liens” the same as “purported collateral“? And is a distinction between the two merely “technical”?
For distressed debt investors (and for lenders negotiating pre-petition intercreditor agreements), ION Media offers provoking food for thought.
But while you’re thinking . . . be sure to check your loan documents.
Monday, October 19th, 2009
Postings on this blog have focused on the cross-border battle between Antiguan liquidators Peter Wastell and Nigel Hamilton-Smith and federal receiver Ralph Janvey for control of the financial assets previously controlled by Sir Allen Stanford, including Stanford International Bank, Ltd. (SIB). A complete digest of prior posts is available here.
Mr. Janvey, meanwhile, has had to address yet another challenge to his receivership - from investors seeking to commence an involuntary Chapter 7 case. In early September, an ad hoc group of CD and deposit-holders fronted by Dr. Samuel Bukrinsky, Jaime Alexis Arroyo Bornstein, and Mario Gebel requested an expedited hearing on their request for leave to commence an involuntary bankruptcy against the Stanford entities.
The ad hoc investor group’s September request was not their first: In May of this year, the same investors requested essentially the same relief. That request was never acted on, presumably because presiding US District Court Judge David Godbey already had imposed a 6-month moratorium on interference with the receivership.
With the moratorium’s expiration, the investors have raised the issue once again.
A Receivership Run Wild?
Their second request largely repeats the investors’ prior arguments, many of them rather personal: No one is happy with the way this receivership has been run, they claim. Specifically, the receivership is far too expensive and the lack of meaningful participation deprives creditors of significant due process rights. Instead, an involuntary liquidation under Chapter 7 of the US Bankruptcy Code is the best and most efficient means of reining in expenses and preserving those rights. The investors’ brief offers a picture of the 21st century Stanford receivership more closely resembling Dickens’ 19th century “Bleak House”: Professional fees accruing at an “alarming” rate (in this case, an estimated $1.1M per week); an estate at risk of being consumed entirely by administrative costs; and investors ultimately twice victimized.
The investors further argue that an injunction prohibiting creditors’ access to the US bankruptcy system is, at best, an interim measure. As such, it can never be employed on a permanent basis - and, therefore, cannot survive the standards for injunctive relief articulated under the Federal Rules of Civil Procedure. They cite a variety of decisions which stand – according to them – for the proposition that the US Bankruptcy Court offers the best forum for complex liquidations such as the one at hand.
Creditors Who Don’t Know What’s Best For Them?
Predictably, Mr. Janvey disagrees in the strongest terms.
As he sees it (and as he sees a string of federal cases referenced in his response), a federal equity receivership – and not a federal bankruptcy proceeding – is the accepted, “decades-long practice” of federal courts in winding up entities that were the subject of alleged Ponzi schemes and other frauds. Moreover, Mr. Janvey suggests that if creditors are dissatisfied with the expense and claimed inefficiency of this proceeding, transition to a liquidation under the US Bankruptcy Code would be even more so. In support, Mr. Janvey offers a “parade of horribles,” such as the “procedural nightmare” involved in transitioning much of the complex litigation already underway in the receivership to a bankruptcy trustee’s administration, the likely existence of multiple creditors’ committees (and the attendant expense of their counsel), and the need to sort out the Antiguans liquidators’ competing Chapter 15 recognition request even if a Chapter 7 petition is filed.
Perhaps most significantly, however, Mr. Janvey believes that flexibility regarding a plan of distribution should govern the administration of the Stanford matters:
Like the Bankruptcy Code, equity receiverships ensure that persons similarly situated receive similar treatment. In a case such as this involving massive deception, however, a searching evaluation of the facts is required to discern relevant differences between and among categories of creditors. Unlike a trustee in bankruptcy, the Receiver can take into account relative fault within a class of creditors, and fashion an equitable plan of distribution that does not treat all creditors within a class identically if they are not deserving of equal treatment.
Mr. Janvey does not develop how a receiver’s application of equitable principles might differ from the equitable and other subordination provisions of Bankruptcy Code section 510. Ultimately, his response reduces itself to a simple proposition for Judge Godbey and for creditors:
Unfortunately, Messr’s. Bukrinsky, Bornstein, and Gebel do not. Their reply brief - submitted last Friday – again reiterates that the Stanford receivership has outlived its usefulness in this highly complex insolvency. According to them, the Stanford record speaks for itself. It is time for a new regime.
Like the liquidators’ request for US recognition of their Antiguan-based wind-up of SIB, the parties now await Judge Godbey’s decision.
Monday, October 5th, 2009
After a blazing start during the first half of 2009, it was a longer, slower summer for newsworthy Chapter 15 filings. The last 3 months have produced a handful of new cases, including:
- Stomp Pork – The Saskatoon, Saskatchewan-based pig-farm operator sought Chapter 15 protection in Iowa’s Northern District on May 29 after being placed into receivership the same day under the Bankruptcy and Insolvency Act in the Court of the Queen’s Bench, Judicial Centre of Saskatoon. It was the company’s second trip to bankruptcy court after a prior, 2008 reorganization under the Companies’ Creditors Arrangement Act.
The company’s Candian receiver, Ernst & Young Inc., planned to liquidate the company’s assets and distribute the proceeds to its creditors. Prior to seeking protection in the US, the company received approval from the Candian court to sell its 130,000 pigs to Sheldon, Ohio-based G&D Pork LLC for $2.8 million. Of these proceeds, creditor National Bank reportedly received $2.7 million.
The filing was made in an abundance of caution, but ultimately proved unnecessary: Following the sale and the distribution of proceeds, the debtor obtained a dismissal of the recognition petition on the grounds that no further assets remained for the Iowa Bankruptcy Court to protect.
- Sky Power Corp. – The Toronto-based developer of solar and wind-powered energy projects in Canada, the US, India and Panama (and portfolio company of bankrupt Lehman Brothers) sought protection in Delaware in August, seven days after seeking protection under Canada’s Companies’ Creditors Arrangement Act in the Ontario Superior Court of Justice.
The company characterized its bankruptcy as part of a “domino effect” created by Lehman’s bankruptcy (Lehman was the major shareholder), as well as on reduced liquidity and on defaults triggered with respect to its senior debt by Lehman’s filing.
At the time of the filing, the company was reportedly relying on a $15 million DIP financing commitment from CIM Group Inc. for liquidity. The facility was priced at prime plus 875 basis points (prime is given a 3.5% floor), matures November 30, and permits CIM Group to credit bid the DIP obligation toward a purchase of SkyPower.
Judge Peter Walsh entered a recognition order on September 15.
- Daewoo Logistics Corp. - The Seoul, Korea-based shipping company sought protection in New York in mid-September to protect US-based assets from the immediate effects of an adverse arbitration ruling.
In addition to the award – obtained by Saga Forest Carriers International for $609,638 in New York’s Southern District – the company also faced 12 other actions, including five others pending in New York.
The company had previously sought creditors’ protection under the Republic of Korea’s Debtor Rehabilitation and Bankruptcy Act with the 8th Bankruptcy Division of the Seoul Central District Court. The Korean filing was allegedly a result of plummeting profits stemming from a decline in the market value of dry bulk shipping contracts. The company also identified a failed land purchase in Madagascar, which was disrupted by a military coup in that country, as a source of financial stress.
Bankruptcy Judge Burton Lifland granted a preliminary injunction on September 24.
Monday, September 28th, 2009
The bankruptcy blogosphere is replete with commentary on Chrysler LLC’s sale, through Section 363 of the Bankruptcy Code, to a newly-formed entity. The sale, of substantially all of Chrysler’s assets for $2 billion, gave secured creditors an estimated $0.29 on the dollar. Other, unsecured creditors received more. Though challenged, the sale ultimately received the 2d Circuit’s approval in a decision issued August 5.
Was the Chrysler sale proper? Or did it constitute an inappropriate “end run” around the reorganization provisions that ordinarily apply in a confirmed Chapter 11 plan?
Harvard Law’s Mark Roe and Penn Law’s David Skeel tackle this question in a paper released earlier this month entitled “Assessing the Chrysler Bankruptcy.” Roe and Skeel argue, in essence, that there was no way to tell whether or not the sale was proper because the sale lacked valuation, an arm’s length settlement, or a genuine market test (i.e., an auction) – all traditional measures of whether or not secured creditors received appropriate value for their collateral. They then suggest that the Chrysler transaction may portend a return of sorts to the equitable receiverships used to reorganize the nation’s railroads at the end of the ninenteenth century.
Roe and Skeel follow two fundamental strands of thought.
First, they review the basic facts of the Chrysler sale against the context of other so-called “363 sales” and ask where Chrysler fits within this context.
Their answer is that it really doesn’t fit.
Most complex bankruptcy sales (i.e., sales that effectively determine priorities and terms that the Code is structured to determine under Section 1129) are insulated from running afoul of the Code’s reorganization provisions through judicial innovations such as expert valuations or priority determinations, creditor consents, or competitive auctions. According to Roe and Skeel, the Chrysler sale had none of these. Instead,
“[Chrysler's] sale determined the core of the reorganization, but without adequately valuing the firm via [Section] 1129(b), without adequately structuring a . . . bargain [with creditors or classes of creditors], and without adequately market testing the sale itself. Although the bankruptcy court emphasized an emergency quality to the need to act quickly . . . there was no immediate emergency. Chrysler’s business posture in early June did not give the court an unlimited amount of time to reorganize, but it gave the court weeks to sort out priorities, even if in a makeshift way.”
How was the Chrysler sale deficient in these respects?
Though it involved a valuation presented by Chrysler, “the court did not give the objecting creditors time to present an alternative valuation from their experts . . . . Here, the judge saw evidence from only one side’s experts.”
For those who may protest that the Chrysler sale did, indeed, enjoy the consent of Chrysler’s secured lenders, Roe and Skeel argue that the largest of these lenders were beholden to the U.S. Treasury and to the Federal Reserve – not only as regulators, but as key patrons via the federal government’s rescue program. They were, therefore, willing to “go along with the program” – and the Bankruptcy Court was inclined to use their consent to overrule other objections from lenders not so well situtated. On this basis, Roe and Skeel contend that the secured lenders’ “consent” – such as it may have been – wasn’t independent “consent” at all.
Roe and Skeel also point out that the “market test” proposed as a means of validating the sale was, in fact, not a test of Chrysler’s assets, but of the proposed sale: “There was a market test of the Chrysler [sale], but unfortunately, it was a test that no one could believe adequately revealed Chrysler’s underlying value, as what was put to market was the . . . [sale] itself.”
The authors then go on to argue that the sale was mere pretense – and that, in fact, “there was no real sale [of Chrysler], . . . at its core Chrysler was a reorganization”:
“Consider a spectrum. At one end, the old firm is sold for cash through a straight-forward, arms-length sale to an unaffiliated buyer. It’s a prime candidate to be a legitimate [Section] 363 sale. At the other end, the firm is transferred to insider creditors who obtain control; no substantial third-party comes in; and the new owners are drawn from the old creditors. That’s not a [Section] 363 sale; it’s a reorganization that needs to comply with [Section] 1129.
. . . .
[To determine where a proposed sale falls along this spectrum,] [a] rough rule of thumb for the court to start with is this stark, two-prong test: If the post-transaction capital structure contains a majority of creditors and owners who had constituted more than half of the old company’s balance sheet, while the transfer leaves significant creditor layers behind, and if a majority of the equity in the purportedly acquiring firm was in the old capital structure, then the transaction must be presumed to be a reorganization, not a bona fide sale. In Chrysler, nearly 80% of the creditors in the new capital structure were from the old one and more than half of the new equity was not held by an arms-length purchaser, but by the old creditors. Chrysler was reorganized, not sold.”
Was the Chrysler transaction – however it may be called – simply a necessary expedient, borne of the unique economic circumtsances and policy concerns confronting the federal government during the summer of 2009?
Roe and Skeel argue that, in fact, the government could have acted differently: It could have picked up some of Chrysler’s unsecured obligations (i.e., its retiree obligations) separately. It could have offered the significant subsidies contemplated by the deal to qualified bidders rather than to Chrysler. It could even have paid off all of Chrysler’s creditors in full. But it did none of this.
Second, Roe and Skeel consider that “[t]he deal structure Chrysler used does not need the government’s involvement or a national industry in economic crisis.” Indeed, it has already been offered as precedent for proposed sales in the Delphi and Phoenix Coyotes NHL team bankruptcies – and, of course, in the subsequent GM case.
One very recent case in which South Bay Law Firm represented a significant trade creditor involved a similar acquisition structure, with an insider- and management-affiliated acquirer purchasing secured debt at a significant discount, advancing modest cash through a DIP facility to a struggling retailer, and proposing to transition significant trade debt to the purchasing entity as partial consideration for the purchase.
The deal got done.
What’s to become of this new acquisition dynamic? Employing a uniquely historical perspective, Roe and Skeel travel back in time to observe:
“The Chrysler deal was structured as a pseudo sale, mostly to insiders . . . in a way eerily resembling the ugliest equity receiverships at the end of the 19th century. The 19th century receivership process was a creature of necessity, and it facilitated reorganization of the nation’s railroads and other large corporations at a time when the nation lacked a statutory framework to do so. But early equity receiverships created opportunities for abuse. In the receiverships of the late 19th and early 20th century, insiders would set up a dummy corporation to buy the failed company’s assets. Some old creditors – the insiders – would come over to the new entity. Other, outsider creditors would be left behind, to claim against something less valuable, often an empty shell. Often those frozen-out creditors were the company’s trade creditors.”
They trace the treatment of equity receiverships, noting their curtailment in the US Supreme Court’s Boyd decision, the legislative reforms embodied in the Chandler Act of 1938, and the 1939 Case v. Los Angeles Lumber Products decision which articulated the subsequently-enacted “absolute priority rule” (but preserved the “new value exception”). Against this historical background, “Chrysler, in effect, overturned Boyd.”
But with a twist.
“One feature of Chrysler that differed from Boyd may portend future problems. Major creditors in Chrysler were were not pure financiers, but were deeply involved in the automaker’s production.” In cases where the value of the assets is enhanced by the continued involvement of key non-financial creditors, “players with similar [legal] priorities will not . . . be treated similarly.”
Translation: When non-financial creditors are driving enterprise value, a Chrysler-style sale suggests that some will make out, and some creditors - even, on occasion, some secured lenders – will get the shaft.
If accurate, Roe’s and Skeel’s Chrysler analysis raises some significant considerations about access to and pricing of business credit. It raises new concerns for trade creditors. It likewise presents the possibility that the Chapter 11 process – which has, in recent years, tilted heavily in favor of secured lenders – may not be quite as predictable or uniformly favorable as in the past.
Meanwhile . . . it’s back to the future.
Monday, August 31st, 2009
Chrysler’s and GM’s recent sales through the Bankruptcy Courts of New York’s Southern District have raised the question of whether some jurisdictions provide more receptive forums than others for getting a “distressed M&A” transaction accomplished. This sort of “forum shopping” is both a well-established concept in commercial insolvency practice and an integral part of reorganization planning.
Last week, a 7th Circuit decision highlighted another area where geography – at least as it concerns the choice of a Bankruptcy Court – can have an important effect on the outcome of a Chapter 11 case, as well as on a reorganized debtor’s post-confirmation operations: The resolution of environmental liabilities.
U.S. v. Apex Oil Company involved an environmental injunction obtained against Apex Oil, successor-by-merger to Clark Oil and Refining Corporation.
Clark Oil, its corporate parent, and a number of affiliates filed related Chapter 11 cases 12 years ago, in 1987. Clark was subsequently merged into Apex, and a Chapter 11 Plan confirmed in the debtors’ related Chapter 11 cases. Nearly two decades later, in 2005, the Environmental Protection Agency sought an injunction requiring Apex to clean up a contaminated site in Hartford, Illinois, which housed an oil refinery once owned by Clark.
Chief US District Court Judge David Herndon of Illinois’ Southern District conducted a 17-day bench trial in early 2008 and, in July 2008, issued a 178-page decision finding that, in fact, contamination was present at the site and that it was Apex’s responsibility to clean it up.
Apex appealed, arguing that confirmation of the Chapter 11 Plan and discharge obtained in Clark Oil’s Chapter 11 case 2 decades earlier precluded enforcement of the more recent federal injunction. In essence, Apex argued that Section 101 of the Bankruptcy Code defines a “claim” as a “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment.” Since cleaning up the contaminated Hartford, Ill. refinery site in response to the federal injunction would obviously require the significant expenditure of money, Apex reasoned that this obligation was effectively a “claim” subject to the earlier Chapter 11 discharge, and could not be enforced.
Judges Posner, Cudahy, and Kanne of the 7th Circuit were not persuaded. Judge Posner’s comparatively brief, 12-page decision issued last week held that the EPA’s federal injunction at issue did not give rise to a “claim” as that term is defined by the Bankruptcy Code . . . and, therefore, could not be discharged by means of Clark Oil’s Chapter 11 Plan.
Consequently, Apex now holds the clean-up tab for the old Clark refinery.
In order to hand Apex that tab, Judge Posner and his colleagues distinguished Apex’s case from a 1985 Supreme Court decision – Ohio v. Kovacs, 469 U.S. 274 - which involved Ohio’s appointment of a receiver to remediate environmental claims after the debtor failed to abide by a state court consent decree requiring him to do so. The Supreme Court found that these enforcement efforts constituted a dischargeable “claim” in Kovacs’ bankruptcy.
The result in Apex was different because, in Judge Posner’s view, the receiver in Kovacs sought money for clean-up, whereas the EPA in Apex merely sought clean-up . . . from Apex. And, in fact, the federal statute under which the EPA sought remediation (the federal Resource Conservation and Recovery Act – “RCRA”) affords only this relief – and nothing more.
Juge Posner’s analysis of RCRA relies in part on earlier 7th Circuit precedent (AM Int’l. v. Datacard Corp., 106 F.3d 1342) - which itself relies on other Supreme Court precedent (Meghrig v. KFC W., Inc., 516 U.S. 479) – to hold that RCRA doesn’t allow a party obtaining a “clean-up” order to clean up a contaminated site itself, then sue for response costs in lieu of seeking an injunction. For this reason, he held, RCRA cannot “give rise to a right to payment” for purposes of a bankruptcy discharge.
The 7th Circuit panel acknowledged that Apex’s case is similar to U.S. v. Whizco, 841 F.2d 147 - in which the 6th Circuit reached a conclusion opposite from Judge Posner and his 7th Circuit colleagues. But where Apex is concerned, that is no matter. As Judge Posner sees it, the 6th Circuit’s rationale “cannot be squared with . . . [7th Circuit] decisions [such as Datacard] which hold that cost incurred [to comply with an equitable order] is not equivalent to the ‘right to payment’ . . . .”
Though the 7th Circuit’s understanding of RCRA is based in part on Supreme Court precedent, few decisions outside either the 6th or 7th Circuit appear to discuss its application in the bankruptcy context. Moreover, other Supreme Court precedent (such as Kovacs) holds that, at least in certain circumstances, equitable remedies (such as appointment of a receiver) are, in reality, “claims” within the meaning of the Bankruptcy Code – and, therefore, can be discharged.
As a result, the resolution of environmental claims in bankruptcy appears to turn not only on the “clean-up” statute at issue – or, more specifically, its remedies – but also on the jurisdiciton where the debtor’s bankruptcy case is filed.
So who’s gonna clean up this environmental mess?
That depends, at least in part, on which court first decides the claims resolution mess.
Saturday, June 27th, 2009
Nearly two weeks ago, this blog highlighted further scuffling in the ongoing contest for administrative control between Ralph Janvey – a federal receiver appointed at the SEC’s behest to seize and administer financial assets once controlled by Sir Allen Stanford, and Peter Wastell and Nigel Hamilton-Smith – English liquidators charged with liquidating Stanford International Bank, Ltd. (SIB), an Antiguan entity through which Stanford did significant amounts of business.
To summarize prior posts - available by linking here – Wastell and Hamilton-Smith have sought recognition of SIB’s Antiguan liquidation through a Chapter 15 case commenced before U.S. District Judge David Godbey in Dallas. Janvey, along with the SEC and the Internal Revenue Service, vehemently oppose recognition of the Antiguan liquidation as the “main proceeding” in the Stanford entities’ administration.
In an extensive brief filed earlier in the month, Mr. Janvey – joined by the SEC in separate briefing - detailed his reasons for doing so. In essence, Mr. Janvey and the SEC claim that the “center of main interests” (COMI) of an investment fraud – which the SEC alleges Stanford perpetrated – is headquartered where the fraud is . . . and not from the presumptive location where the victims were led to believe a legitimate business was run. They also appear to place heavy reliance on the fact that, though SIB was physically located in Antigua, it was not authorized to do regular business with local residents – and its liquidation therefore resembles numerous hedge fund liquidations that, to date, have experienced difficulty obtaining recognition as foreign “main proceedings” in other US Bankruptcy Courts.
This week, Mess’rs. Wastell and Hamilton-Smith answered Janvey’s argument.
In a 25-page reply brief, supported by extensive Appendices, Wastell and Hamilton-Smith explain that Janvey’s “fraud-based” argument is beside the point – as is the fact that SIB was maintained primarily for “offshore” operations in the US, South America, and Europe.
Instead, the liquidators claim that the extent of SIB’s physical operations in Antigua make its liquidation far different from the “letter-box” entities in Caribbean tax havens that US Bankruptcy Courts have, to date, been reluctant to recognize. Wastell and Hamilton-Smith rely heavily on a California decision – In re Tri-Continental Exch. Ltd., 349 B.R. 627 (Bankr. E.D. Cal. 2006) - which involved alleged “sham” insurance entities that sold fraudulent insurance policies to US citizens through a network of domestic brokers and agents, but whose 20 employees and only office were operated in St. Vincent and the Grenadines. Over the objection of a US judgment creditor, the U.S. Bankruptcy Court in Tri-Continental recognized as the foreign “main proceeding” a liquidation commenced through the Eastern Caribbean Supreme Court, holding that even through the fraud was perpetrated primarily in the US and Canada, the debtors’ COMI was in St. Vincent and Grenadines because the debtors “conducted regular business operations” there. 349 B.R. at 629.
Using this analysis, Wastell and Hamilton-Smith argue that SIB’s Antiguan liquidation should likewise be recognized as a foreign “main proceeding” since, as even Mr. Janvey acknowledges, a debtor’s COMI is tantamount to its “principal place of business” under US law. According to the liquidators, a debtor’s “principal place of business” is essentially the location of its “business operations,” and their brief refers repeatedly to SIB’s extensive physical and administrative operations in Antigua. Wastell and Hamilton-Smith appear to tiptoe around Mr. Janvey’s argument that the Court should look to the debtor’s “nerve center” (in this case, the location of executive decisions) where a business’s operations are “far-flung,” using a brief (and conclusory) footnote to draw a distinction between the Stanford entities’ admittedly “far-flung” sales, on the one hand, and its operations on the other – which, according to the liquidators, were concentrated exclusively in Antigua.
Judge Godbey’s appointed examiner is due to weigh in on these issues shortly after the US July 4 holiday.