I OVERVIEW OF RESTRUCTURING AND INSOLVENCY ACTIVITY
The US economy, despite experiencing positive growth, remains fairly lacklustre as the recession of the past decade recedes. While the US economy showed rapid growth in the second quarter of 2015,2 third-quarter GDP advanced at a 2 per cent seasonally adjusted annual rate3 and the fourth quarter continued that slide at 1.4 per cent.4 The first quarter of 2016 saw GDP expand at a 0.8 per cent seasonally adjusted annual rate,5 adjusted up from an initial report of 0.5 per cent growth, which would have been its worst performance in two years.6 The bad news continued in June 2016 when the Labor Department reported that the US had added only 38,000 jobs in May, its weakest performance since September 2010.7 In addition, approximately 500,000 people dropped out of the workforce.8
While the Federal Reserve had indicated a plan to change course and raise interest rates, the jobs report led the Federal Reserve to further delay raising rates and propose that future increases will occur at a slower pace.9 Debt remains cheap and readily available. Accordingly, companies in distress continue to roll over and refinance their debt rather than explore court-supervised restructurings. These factors have translated into fewer bankruptcy filings. The US experienced an approximate 5.1 per cent decrease in commercial bankruptcy filings for the 12-month period ending 31 March 2016 compared with the same period ending 31 March 2015. However, Chapter 11 cases increased by approximately 4.6 per cent over the same period.10 This may be indicative of the rise in Moody’s global speculative default rate from 3.4 per cent at the end of 201511 to a trailing 12-month global speculative-grade default rate of 4.5 per cent at closing in May 2016.12 Moody’s expects the rate to rise to 4.9 per cent by the end of 2016.13
While there continue to be fewer bankruptcy filings, there were also fewer large bankruptcy filings than in previous years. There were some notable exceptions. Clocking in at the top was the bankruptcy filing of SunEdison Inc (SunEdison), one of the world’s leading developers of renewable-energy solutions. SunEdison (and certain of its affiliates) filed for bankruptcy on 21 April 2016, with approximately US$11.5 billion in assets. Other large bankruptcies included Peabody Energy, LINN Energy and Arch Coal.
II GENERAL INTRODUCTION TO THE RESTRUCTURING AND INSOLVENCY LEGAL FRAMEWORK
Title 11 of the United States Code (Bankruptcy Code) governs bankruptcy cases filed in the United States.14 The Bankruptcy Code is premised on the theory that an honest debtor deserves a fresh financial start and thus relief from its unsecured debts. It endeavours to allow for this fresh start, while at the same time balancing the rights of the debtor’s various constituents as fairly and equitably as possible. Over the years, however, special interest groups have lobbied Congress for various amendments to the Bankruptcy Code. The last major amendments were contained in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. These amendments have continued the gradual erosion of a debtor’s ability to obtain the benefits of a fresh start and shifted the balance of power among all interested parties in a bankruptcy case, a campaign started by various special interest groups not long after the Bankruptcy Code was enacted by Congress in 1978. In addition to economic factors, these amendments have resulted in substantially fewer bankruptcy cases and, for those that do file, cases of much shorter duration.
The filing of a petition by the debtor (for corporations, this is usually a petition for relief under either Chapter 7 or Chapter 11 of the Bankruptcy Code) commences the bankruptcy case. There is no requirement that a company be ‘insolvent’ to commence a voluntary bankruptcy case. Rather, case law has developed to require only that a petition be filed in good faith. Immediately upon filing a petition, the debtor obtains the benefit of an automatic stay. The stay prohibits most creditors from taking actions against the debtor and its property on account of pre-petition liabilities or agreements without express authorisation from the bankruptcy court.15 Thus, the stay gives the debtor the necessary ‘breathing space’ to complete its reorganisation or orderly liquidation consistent with the terms of the Bankruptcy Code.
A company hoping to reorganise or liquidate with its management in place will file a petition under Chapter 11; a company with no option but to liquidate under court supervision will commence a Chapter 7 case. Banks, savings and loan associations, insurance companies, stockbrokers and commodity brokers are not eligible to file for Chapter 11 protection. In general, these types of entities are liquidated under other federal or state winding-up laws or, in the case of stockbrokers and commodity brokers, under their own sub-chapter of the Bankruptcy Code.16
Unlike many other insolvency proceedings throughout the world, in a Chapter 11 case, the debtor generally continues to manage its own affairs following commencement of the bankruptcy case (referred to as a debtor-in-possession).17 A trustee is rarely appointed to oversee a debtor’s operations unless the situation suggests that one is necessary.18
In addition to the bankruptcy court judge and the US Trustee (UST) (a representative of the Department of Justice responsible for overseeing bankruptcy cases), the debtor-in-possession’s actions will often be subject to scrutiny by one or more ‘official’ committees appointed by the UST.19 The most common official committee is one composed of unsecured creditors. In larger cases, the committee typically retains its own professionals (including counsel) to represent the unsecured creditors’ interests, and the debtor pays for the cost of these professionals. In some cases, equity holders or retirees will convince the UST to appoint a special committee for their constituents, especially in cases in which it appears the debtor may be solvent. Other official committees can be formed to represent other creditor groups, although such committees are rare, except in cases driven by mass torts such as asbestos liability.
The goal of a debtor in commencing a Chapter 11 case is to confirm and consummate a Chapter 11 reorganisation plan. Unless a trustee has been appointed, the debtor initially has the exclusive right to file a reorganisation plan.20 The exclusivity period, however, is not indefinite. Indeed, plan exclusivity can only be extended up to a maximum of 18 months after the petition date, with the court’s permission.21 Before 2005, when extensive changes to the Bankruptcy Code became law (Revised Code), a debtor could obtain unlimited extensions to its exclusivity period, provided authorisation was obtained from the bankruptcy court. The limit imposed by the Revised Code on plan exclusivity provides an opportunity for creditors to wait out the debtor’s exclusivity period and ultimately propose their own plan.
Before a debtor can solicit votes on its reorganisation plan, it must provide creditors with a disclosure statement that has been approved by the bankruptcy court.22 The bankruptcy court’s role is not to approve the contents of the disclosure statement; rather, its role is to ensure that the disclosure statement contains ‘adequate information’ to permit a creditor to make an informed decision to accept or reject the related plan. Following approval of the adequacy of the disclosure statement,23 the debtor may solicit votes from creditors and equity holders entitled to vote on the plan. Groups of creditors and equity holders will be categorised into different ‘classes’. If the requisite votes are received, the debtor will seek confirmation, or approval, of the plan by the bankruptcy court.
Aside from the required votes, the most critical requirement of the Bankruptcy Code for the plan is the ‘best interests of creditors test’.24 This test requires that each creditor either accept the plan or receive under the plan a distribution equivalent to what it would receive if the debtor were to liquidate rather than reorganise.25 In some cases, the test requires valuation of property given to dissenting creditors. Because valuation is a complex and fact-intensive undertaking, a ‘best interests fight’ can lead to time-consuming and expensive litigation.
The second critical requirement is that at least one ‘class’ of claims votes for a plan if there is a class of impaired – or affected – claims. For this vote, the votes of insiders do not count. Two-thirds in amount and more than 50 per cent in number of creditor class members that vote must vote for the plan for the class to be deemed to have accepted the plan. Classes of equity security holders must vote for the plan by at least two-thirds in amount.
Usually, at least one class will either affirmatively reject or be deemed to have rejected the plan because that class is not slated to receive a distribution under the plan. In those cases, the debtor can confirm its plan by ‘cramming down’ these creditors. ‘Cram down’ requires the debtor to prove that the plan does not discriminate unfairly and is fair and equitable with respect to each class of claims or interests that is impaired under the plan and has not accepted it.26 The ‘unfair discrimination’ test is a nebulous concept. By contrast, the ‘fair and equitable’ test is more straightforward and basically follows an absolute priority waterfall, under which secured creditors are entitled to full payment (at least over time) before unsecured creditors and equity holders receive a distribution. Despite this rather simplistic concept, valuation and issues regarding the present value of future payments to secured creditors are often hotly contested.
Confirmation of a reorganisation plan provides a reorganising Chapter 11 debtor with the fresh start that most debtors hope to obtain by reorganising under the Bankruptcy Code. The discharge that the debtor receives under the Bankruptcy Code is key to the ‘fresh start’. This discharge bars creditors and equity security holders from looking to the debtor for satisfaction of claims owed to them prior to the commencement of the Chapter 11 case. Rather, their sole source of recovery is under the plan. Corporate debtors liquidating under either Chapter 7 or Chapter 11 of the Bankruptcy Code, however, do not obtain a discharge.
i Absolute priority rule
A basic premise under the Bankruptcy Code is that, in the absence of consent,27 distributions to creditors must follow the ‘absolute priority rule’. In applying this rule, lower priority creditors may receive a distribution only after more senior classes are paid in full.28 Secured creditors are first in the priority scheme. Secured claims typically include pre-petition lenders and trade creditors with security interests (including holders of mechanics’ liens and materialmen’s liens). ‘Administrative expense’ claims are second in priority. Included in this bucket are claims relating to the post-petition operations of the debtor, and ‘cure’ claims that arise when debtors ‘assume’, or agree to be bound by, pre-existing contracts. The Bankruptcy Code also elevates to administrative expense priority status certain pre-petition claims of vendors of goods that would ordinarily have been treated as general unsecured claims before the enactment of the Revised Code. A Chapter 11 reorganisation plan must provide for payment of administrative expense claims and priority claims in full on the plan’s effective date, although individual creditors may agree to a payout over time. Next in order of priority come ‘priority claims’, which include certain pre-petition wages and commissions, employee benefit plan contributions, unsecured claims in connection with certain prepayments for goods or services from the debtor (e.g., the pre-petition purchase of goods ‘laid away’ with the debtor, up to a cap) and certain taxes.
General unsecured claims, in terms of priority, come after secured claims, administrative claims and priority claims, but before subordinated debt claims.29 Equity interests (including equity-related damage claims that are treated as equity) are lowest on the distribution ‘waterfall’ and, as a result, equity holders rarely receive a bankruptcy distribution.
ii Treatment of contracts in bankruptcy
A debtor generally has the power to hand-pick which executory contracts and unexpired leases it wants to be bound by following its reorganisation. A contract is usually found to be ‘executory’ when both the debtor and the non-debtor party to the contract have material performance obligations outstanding. If the debtor chooses to assume (or keep) a contract, it will be bound under all the terms of the agreement. Alternatively, if the debtor no longer seeks to be bound by the agreement, it will ‘reject’ it. Upon rejection of a contract, the debtor is no longer required to perform and the contract is deemed breached as of the date the bankruptcy commenced. Damages resulting from such a breach are referred to as ‘rejection damages’. Under certain circumstances, a debtor may be able to assign its interest in a contract or lease to a third party.30
In the event a debtor does not assume an agreement, the default option under the Bankruptcy Code is rejection.31 The deadline to make the assumption or rejection decision with respect to unexpired leases and executory contracts (other than leases for non-residential real property) is the date a Chapter 11 plan is confirmed by the bankruptcy court. The deadline for a debtor to assume or reject an unexpired lease for non-residential real property can be much sooner (i.e., generally 210 days after commencement of the bankruptcy case, absent landlord consent). In a case where leased real property locations number in the hundreds, as in large retail cases, the debtor should make preliminary decisions on which leases it wants to assume or reject prior to commencing its bankruptcy case, and thereby attempt to avoid assuming leases it may not ultimately need.
iii Security interests
In the United States, Article 9 of the Uniform Commercial Code (Article 9 and the UCC, respectively), as adopted by each of the 50 states, generally applies to any security interest created by contract in personal property and fixtures securing payment or other performance of an obligation.32 Article 9, therefore, is the statute that sets forth the process by which one party may take and enforce a security interest in the property of another party.
There are three components to the creation and enforcement of a security interest under Article 9 – attachment, perfection and priority. Under Article 9, a security interest attaches to collateral at the moment it becomes enforceable against the debtor. Only an attached security interest may be perfected under Article 9. Perfection is the process by which a secured party gives public notice of its security interest in collateral. A perfected security interest will prevail over claims of an interest in collateral by other parties (including liens of creditors using the judicial process to obtain liens on the collateral). State law, generally uniform throughout the United States, will dictate the method for perfecting a consensual security interest.
In many cases, two or more creditors may have security interests in the same collateral. In such cases, Article 9 provides general rules as to the ranking of security interests – that is, which security interest takes priority over the others. As a general rule, an earlier-secured party will prevail over later-secured creditors. There are, however, exceptions to this general rule and, therefore, practitioners must refer to Article 9 in the applicable jurisdiction relevant to a particular transaction or consult local counsel.
Article 9 has a critical interplay with the Bankruptcy Code. Upon the bankruptcy filing, the debtor steps into the role of a ‘hypothetical lien creditor’.33 This means, in general, that it may void any unperfected security interest. Accordingly, it is critically important for secured creditors to ensure that their liens are properly perfected, especially when transacting business with a distressed company on the verge of bankruptcy. Again, while there are some variations in the details, security interests are usually ‘perfected’ by filing in a governmental registry or by taking possession of the collateral.
Whereas the UCC, which deals with the creation of security interests in personal property, is fairly uniform as adopted in all 50 states, security interests or mortgages in real property are controlled by different laws in each of the 50 states. Generally, though, the laws provide for the recording of mortgages in local governmental offices. As with security interests in personal property, a bankruptcy trustee or debtor-in-possession can avoid improperly recorded mortgages by stepping into the shoes of state-law creditors.
iv Clawback actions
The Bankruptcy Code gives a debtor certain ‘avoidance powers’ to recover property transferred by the debtor to third parties before the petition date. Generally, these avoidance actions fall into two categories: the transfers had the effect of preferring one creditor over others; or the transfers were made for the purpose of hindering, delaying or defrauding creditors from collecting on their claims.
‘Transfer’ is defined broadly and encompasses payments as well as the granting and perfection of liens. Transfers that the debtor can prove to be fraudulent or preferential can be treated as voidable transfers. In many instances it is unnecessary to prove that the debtor or the recipient, or both, had a wrongful motive – the Bankruptcy Code is concerned only with ensuring equal treatment of creditors, even if that means unwinding well-intentioned arm’s-length transfers of property. That said, the recipient of a voidable transfer has certain affirmative defences to shield all or a portion of the transfer from the debtor.
The most common voidable transfer is referred to as a ‘preference’. Preferences are those payments a debtor makes to a pre-petition creditor on the ‘eve’ of the bankruptcy filing34 that allow such creditor to receive more on account of its claim than it would have received had it waited in line with other creditors and received its distribution in a liquidation of the debtor pursuant to Chapter 7 of the Bankruptcy Code. The amount the creditor received in connection with the transfer will be voidable, subject to certain defences, although the net economic impact to the creditor (after negotiations with the trustee or debtor) will generally be a return of money in excess of the hypothetical liquidation distribution. To the extent the transfer is avoided, the preference recipient would have a claim against the debtor.
Fraudulent transfers that can be recovered include transfers made with the actual intent to hinder, delay or defraud creditors. Recoverable fraudulent transfers also include transfers for inadequate consideration when the debtor (transferor) is insolvent, undercapitalised or was unable to pay its debts as they became due. The Bankruptcy Code has its own fraudulent transfer provisions, but the debtor-in-possession may also prosecute such claims under similar state law provisions.
III SIGNIFICANT TRANSACTIONS, KEY DEVELOPMENTS AND MOST ACTIVE INDUSTRIES
i Pre-planned bankruptcies: a quick escape from an all-out bankruptcy
Pre-planned bankruptcies continue to be a useful tool for debtors as they try to manage the time and expense of a US bankruptcy filing. There are two types of pre-planned bankruptcies: pre-packaged and pre-negotiated bankruptcies. Pre-packaged bankruptcies (pre-packs) are typically utilised by companies seeking to right-size their capital structures (e.g., to address maturities or deleverage from existing secured lender or bondholder indebtedness). The pre-packaged bankruptcy mechanism is not useful for companies seeking to achieve an operational turnaround or that need to modify other significant liabilities such as pension, retiree medical or mass tort liabilities.
In a pre-pack, the Chapter 11 case is commenced after the plan proponent has obtained the requisite votes to approve a reorganisation plan.35 In pre-negotiated plans, the creditors entitled to vote on the plan indicate their support for the plan before the commencement of the case,36 often in the form of a ‘lock-up’ agreement, but the vote occurs following the commencement of the case. It is common for pre-packs to last less than 60 days. Absent complications, pre-negotiated bankruptcies will take 45 to 60 days longer than a pre-pack. These periods are far shorter than the duration of traditional Chapter 11 cases.
The pre-pack concept is an important negotiation tool as companies attempt to obtain concessions from their constituents. The requirement to achieve an accepting class of creditors (and, therefore, to bind non-accepting class members) under the Bankruptcy Code is two-thirds in amount and one-half in number of those creditors who cast a vote. If acceptance is received from almost all of the creditors from whom votes are solicited, companies will often consummate the restructuring without filing for bankruptcy. Moreover, the threat of a pre-pack makes it less likely that a filing will be required, because there is little reason for creditors to withhold their acceptance once the company has received acceptances sufficient to satisfy the minimum threshold for an accepting class in the Chapter 11 context.
This past year has seen numerous headline pre-negotiated and pre-packaged bankruptcy filings and exits, along with some pre-negotiated transactions that have not gone so smoothly. Vantage Drilling International (f/k/a Offshore Group Investment Limited) filed for Chapter 11 on 3 December 2015 with a pre-packaged plan to swap US$1.15 billion of debt for control of the company. The plan was confirmed on 14 January 2016 and went effective on 10 February 2016. The best-laid plans of debtors, however, often go awry. On 15 July 2015, Walter Energy Inc (Walter), a producer of high-grade metallurgical coal for steel production, filed for bankruptcy with a pre-negotiated plan that would convert US$1.8 billion of debt to equity and transfer ownership of the company to senior secured creditors. While a restructuring support agreement was approved in September 2015, it was later overturned based on objections by certain noteholders. As a result, Walter pursued and has completed a sale of substantially all of its assets to an entity formed by its senior lenders. In addition, Hercules Offshore Inc (Hercules), an oil and gas drilling services company, filed for Chapter 11 on 13 August 2015 with a pre-packaged plan to implement a US$1.2 billion debt-for-equity swap with its bondholders. The plan was confirmed on 24 September 2015 and went effective on 6 November 2015. However, Hercules refiled for Chapter 11 on 5 June 2016 with another pre-packaged plan that aims to pay creditors in full and liquidate its assets.
ii Active industries: oil and gas
Oil prices fell precipitously between June 2014 and April 2015, and hit a low of under US$30 per barrel in February 201637 before rebounding to approximately US$50 per barrel in June 2016.38 As a result, companies in the energy sector have experienced increased distress. In particular, as of 31 May 2016, 81 oil and gas producers had filed for bankruptcy since the beginning of 2015.39 This distress is not limited to companies that explore and produce oil and gas (E&P companies). For example, as mentioned above, Vantage Drilling International (f/k/a Offshore Group Investment Limited), a contractor providing services to E&P companies, filed for Chapter 11 on 3 December 2016 with a pre-packaged plan of reorganisation that was confirmed on 15 January 2016. With a constantly changing market, and projections ranging from another plunge in prices to a significant increase in prices by the end of the year, it is difficult to predict how companies will react, but this is still the industry to watch in 2016.
iii Case law developments
In a low interest rate environment, borrowers often seek to refinance their obligations prior to maturity to take advantage of lower interest rates. In such instances, the lender loses its bargained-for investment yield. Accordingly, indentures (contracts between bondholders and bond issuers) frequently include terms, such as make-whole provisions, that protect bondholders in the event of a prepayment. Make-whole provisions aim to compensate (or make whole) bondholders for this loss of future interest by obligating the borrower to pay some agreed-upon sum to the bondholder upon a prepayment.
In bankruptcy, borrowers and their lenders frequently spar regarding the enforceability of make-whole provisions. Recently, Momentive and Energy Future Holdings (EFH) confirmed what prior decisions had indicated: it is all about drafting. In both cases, the bankruptcy courts held that noteholders were not entitled to make-whole payments based on the language in the indentures at issue. In particular, the indentures in both cases provided that a bankruptcy filing triggered an automatic acceleration of the obligations and that a make-whole premium was due upon an optional prepayment of the obligations. Both courts distinguished an optional prepayment from an automatic acceleration. The EFH court explained that ‘there are only two ways to receive a make-whole upon acceleration under New York law: (i) explicit recognition that the make-whole would be payable notwithstanding the acceleration, or (ii) a provision that requires the borrower to pay a make-whole whenever debt is repaid prior to the original maturity.’ Adopting the ruling in Momentive, the court held that the EFH second-lien indenture was not sufficiently specific to trigger the make-whole premium following acceleration.40 The District Court affirmed, and this ruling and other similar rulings in EFH are on appeal to the Third Circuit Court of Appeals.
As described above, the Bankruptcy Code gives a debtor certain ‘avoidance powers’ to recover property transferred by the debtor to third parties before the petition date, including transfers that were made for the purpose of hindering, delaying or defrauding creditors from collecting on their claims and transfers for inadequate consideration when the debtor (transferor) is insolvent, undercapitalised or was unable to pay its debts as they became due. The Bankruptcy Code has its own fraudulent transfer provisions, but the debtor-in-possession may also prosecute such claims under similar state law provisions.
In an important decision regarding fraudulent transfers, the Second Circuit addressed whether creditors’ state law, constructive fraudulent transfer claims are pre-empted by Bankruptcy Code Section 546(e).41 The decision addressed the leveraged buyout (LBO) of Tribune Media Company (Tribune). In consummating the LBO, Tribune borrowed over US$11 billion secured by its assets to refinance Tribune’s debt and cash out Tribune’s shareholders. Soon after the LBO, Tribune filed for bankruptcy. The bankruptcy court authorised the official committee of unsecured creditors to pursue an intentional fraudulent transfer action to recover the payments to shareholders in connection with the LBO. In June 2011, after the confirmation of Tribune’s Chapter 11 plan, various creditors filed state law, fraudulent conveyance complaints alleging that the LBO payments, made through financial intermediaries, were for more than the reasonable value of the shares and made when Tribune was in distressed financial condition. Therefore, the complaints concluded, the payments were avoidable by creditors under the laws of various states. These actions were later consolidated with ongoing federal intentional fraud claims in a multi-district litigation proceeding that was transferred to the Southern District of New York.
After consolidation, the Tribune shareholders moved to dismiss the claims. The district court held that the claims were barred by the automatic stay but rejected the shareholders’ argument under Section 546(e) of the Bankruptcy Code, finding that on its face the statute only applied to the claims of a bankruptcy trustee and Congress did not extend the safe harbour to state law, fraudulent transfer claims brought by creditors.
The Second Circuit reversed but still dismissed the individual creditors’ state law constructive fraudulent transfer claims. The court held that the creditors were not enjoined by the automatic stay from prosecuting the claims, but their state law claims were pre-empted by federal bankruptcy law and barred by Section 546(e) of the Bankruptcy Code. The court found that, even though Section 546(e) of the Bankruptcy Code does not expressly refer to individual creditors, the prosecution of state law claims by individual creditors that would be barred if prosecuted by the trustee in a bankruptcy proceeding were pre-empted and barred by federal bankruptcy law.
Exceptions to discharge
The Bankruptcy Code prohibits debtors from discharging debts ‘obtained by...false pretenses, a false representation, or actual fraud’ (11 USC, Section 523(a)(2)(A)). In Husky International Electronics Inc v. Ritz, to resolve a circuit split, the US Supreme Court addressed the issue of whether ‘actual fraud’ requires a false representation or ‘whether it encompasses other traditional forms of fraud that can be accomplished without a false representation, such as a fraudulent conveyance of property made to evade payment to creditors.’42
Husky International Electronics Inc (Husky) sold electronic equipment to Chrysalis Manufacturing Corp (Chrysalis), where Daniel Ritz was a director and 30 per cent shareholder. In 2006 and 2007, Ritz transferred assets from Chrysalis to other entities that he owned, which drained Chrysalis of assets that the company could have used to pay its debts to Husky and other creditors. In 2009, Husky sued Ritz alleging that Ritz’s intercompany-transfer scheme was ‘actual fraud’ for purposes of a Texas law that allows creditors to hold shareholders responsible for corporate debt. Ritz then filed for Chapter 7 bankruptcy. Husky filed an adversary proceeding in Ritz’s bankruptcy case, asserting that Ritz was personally liable for Chrysalis’s debt under Texas law and that Ritz’s debt was not dischargeable in bankruptcy under Section 523(a)(2)(A) because he engaged in ‘actual fraud’ by causing fraudulent conveyances of Chrysalis’s property.
The district court held that Ritz was personally liable for the debt under Texas law, but that the debt was not ‘obtained by…actual fraud’ and therefore could be discharged in Ritz’s bankruptcy. The Fifth Circuit affirmed, but did not address whether Ritz was responsible for Chrysalis’ debt under Texas law because it agreed with the district court that Ritz did not commit ‘actual fraud’ under Section 523(a)(2)(A). The Fifth Circuit concluded that, while Ritz may have hindered Husky’s ability to recover its debt, he did not make any false representations to Husky regarding the assets or transfers and, therefore, did not commit ‘actual fraud’.
The Supreme Court reversed and held that the term ‘actual fraud’ in Section 523(a)(2)(A) ‘encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.’43 The Court began by pointing out that before 1978, the Bankruptcy Code prohibited discharge of debts obtained by ‘false pretenses or false representations.’ The Court concluded that when Congress added the term ‘actual fraud’ in 1978, the sensible presumption is that it did not intend the term ‘actual fraud’ to mean the same thing as ‘a false representation’, which was already in the statute. The Court also found that the historical meaning of ‘actual fraud’ provided even stronger evidence that the phrase has long encompassed a transfer scheme designed to hinder the collection of debt. The Court concluded that ‘a false representation has never been a required element of “actual fraud”, and we decline to adopt it as one today.’44
The Bankruptcy Code requires that attorneys (and other professionals) providing bankruptcy-related services to debtors submit their fees to the bankruptcy court for approval.45 Section 330(a) of the Bankruptcy Code governs the approval of those fees; it allows for ‘reasonable compensations for actual, necessary services rendered […] and reimbursement for actual, necessary expenses’.46 In addition, it allows such professionals to be compensated for the time required for preparing fee applications.47 In June 2015, the Supreme Court held that Section 330 of the Bankruptcy Code does not explicitly override the American Rule with respect to fee-defence litigation and, therefore, it does not permit bankruptcy courts to award compensation for such litigation.48
Since that decision, bankruptcy courts in Delaware have addressed creative attempts by professionals to recoup defence fees, but have not yet strayed from the decision in Asarco. In In re Boomerang Tube Inc, Judge Walrath held that a provision in the engagement letter for counsel to the official committee of unsecured creditors that required the estate to indemnify them for expenses incurred in any successful defence of their fees ran afoul of the Supreme Court’s ruling in Asarco.49 In New Gulf Resources, Judge Shannon held that a ‘fee premium’ payable in the event of litigation over Baker Botts’ fees, as debtors’ counsel, was also impermissible under Asarco and Boomerang Tube.50
i Background on Chapter 15
In 2005, Congress added Chapter 15 to the Bankruptcy Code. Chapter 15 ‘incorporates the Model Law on Cross-Border Insolvency to encourage cooperation between the United States and foreign countries with respect to transnational insolvency cases’.51 Chapter 15 is based on a ‘rigid recognition standard’ that one court labelled ‘consistent with the general goals of the Model Law’.52 Thus, if a US bankruptcy court denies recognition of a foreign proceeding, Section 1509(d) of the Bankruptcy Code provides that ‘the court may issue any appropriate order necessary to prevent the foreign representative from obtaining comity or cooperation from courts in the United States’.53 This has been interpreted to mean that Chapter 15 recognition is now the sole form of relief in the United States with respect to foreign insolvency proceedings.54
A foreign representative can obtain recognition under Chapter 15 of the Bankruptcy Code ‘by the filing of a petition for recognition of a foreign proceeding under Section 1515’.55 Two types of recognition of a foreign proceeding are possible under Chapter 15: recognition as a foreign main proceeding or recognition as a foreign non-main proceeding. Greater relief is available to a foreign representative of a foreign main proceeding than for a representative of a foreign non-main proceeding.
In order for a US court to recognise a foreign proceeding as a main proceeding, the foreign proceeding must be ‘pending in the country where the debtor has the center of its main interests’,56 or ‘COMI’. COMI is not defined in Chapter 15. Section 1516(c), however, sets out a presumption that the debtor’s registered office is the COMI ‘[i]n the absence of evidence to the contrary’.57 Moreover, one of the first bankruptcy decisions to analyse the matter defined a company’s COMI as a debtor’s ‘principal place of business’ under concepts of United States law’.58 Indeed, the concept of COMI is lifted from the EU Regulation, which defines COMI as ‘the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties’.59 On the other hand, the Second Circuit has rejected the notion that ‘principal place of business’ analysis should be used,60 but did note that the concept is still useful in determining the factors that point to a COMI. The court went on to say that ‘any relevant activities, including liquidation activities and administrative functions, may be considered in the COMI analysis’.61
The Second Circuit also provided more guidance in determining the relevant period to examine in establishing a debtor’s COMI, concluding that the relevant analysis should be based on the debtor’s ‘activities at or around the time the Chapter 15 petition is filed [...but] that a court may consider the period between the commencement of the foreign insolvency proceeding and the filing of the Chapter 15 petition to ensure that a debtor has not manipulated its COMI in bad faith’.62
Lacking the required COMI, a foreign proceeding may be recognised as a non-main proceeding under Chapter 15 if the foreign proceeding is ‘pending in a country where the debtor has an establishment’.63 ‘Establishment’ is defined in Chapter 15 as ‘any place of operations where the debtor carries out a nontransitory economic activity’.64 Determining whether a debtor has an establishment in the foreign proceeding jurisdiction ‘is essentially a factual question, with no presumption in its favour’.65 At least one court has held that non-main recognition is restricted to a jurisdiction in which a debtor has assets.66
ii Recent developments
In In re Creative Finance Ltd,67 the Bankruptcy Court for the Southern District of New York provided some guidance as to what conduct is necessary to shift COMI to an offshore jurisdiction to support Chapter 15 recognition. Creative Finance Ltd and Cosmorex Ltd (Debtors) were organised under the laws of the British Virgin Islands and were primarily engaged in foreign exchange trading through brokers located outside the BVI. In 2011, Marex Financial Ltd (Marex) sued the debtors in the English High Court of Justice (English Court) for amounts allegedly due under trading contracts. On 19 July 2013, in accordance with English practice, a judge of the English Court circulated a draft ruling advising of his decision to enter judgment in favour of Marex, in excess of US$5.6 million, against each of the debtors. He further directed that the debtors make payment on the judgment by 8 August 2013, and restrained actions to thwart the judgment that was about to be entered. Between receipt of the draft ruling and the deadline for payment, the debtors’ sole shareholder caused all of the debtors’ liquid assets to be transferred out of the debtors’ accounts in the UK.
After Marex attempted to enforce the English judgment in the US, but before judgment was entered, Marex applied to the High Court of Justice, British Virgin Islands (Commercial Division) to place the debtors in liquidation and appoint a liquidator. In December 2013, a liquidator was appointed for the debtors in the BVI. Upon his appointment, the BVI liquidator displaced the directors and principals and became the sole manager of the debtors. The liquidator performed certain administrative functions required by law, such as opening bank accounts, gathering and preparing required documents, providing notice of his appointment, calling for creditors to file claims, and holding a first meeting of creditors, but did nothing to manage or liquidate the debtors. Approximately two months after his appointment, the BVI liquidator filed the Chapter 15 case and, on the same day, sought recognition of the BVI insolvency proceeding as either a foreign main proceeding or a foreign non-main proceeding. Because recognition would likely result in a stay of any enforcement actions in the US, Marex opposed the liquidator’s request.
The court held that the BVI liquidation should not be recognised as a foreign main proceeding because the liquidator’s activities between his appointment and the time of the filing of the Chapter 15 case were so minimal that they did not support a finding that the debtors’ COMI migrated from other jurisdictions to the BVI. The court also held that the BVI liquidation could not be a non-main proceeding because the debtors never conducted any meaningful business in the BVI. In particular, ‘there was no nontransitory business activity in the BVI, and thus the Liquidator did not make a showing of an “establishment” in the BVI.’68
1 J Eric Ivester is a partner at Skadden, Arps, Slate, Meagher & Flom LLP. Mr Ivester acknowledges and gratefully appreciates the substantial work and assistance provided by Candice Korkis, an associate at the firm, in preparing this chapter.
2 Anna Louie Sussman, Wall Street Journal, ‘US Economy Expanded at Slightly Slower Pace’, 22 December 2015; available at www.wsj.com/articles/u-s-third-quarter-gdp-revised-down-to-2-0-growth-1450791178.
4 Eric Morath, Wall Street Journal, ‘US Fourth-Quarter GDP Revised Up to 1.4 per cent Growth but Corporate Profits Fall’, 25 March 2016; available at www.wsj.com/articles/u-s-fourth-quarter-gdp-revised-up-corporate-profits-fall-1458909252.
5 Nelson D Schwartz, The New York Times, ‘US Economy Better Than Thought, but Still Weak, 27 May 2016; available at www.nytimes.com/2016/05/28/business/economy/us-economy-gdp-q1-growth-revision.html?_r=0.
6 Eric Morath and Ben Leubsdorf, Wall Street Journal, ‘US Economy Posts Strongest Growth in More Than a Decade’, 23 December 2014; available at www.wsj.com/articles/u-s-third-quarter-gdp-revised-up-to-5-0-growth-1419341481.
7 Harriet Tory, Wall Street Journal, ‘Weak Hiring Pushes Back Fed’s Plans’, 3 June 2016; available at www.wsj.com/articles/u-s-added-only-38-000-jobs-in-may-1464957215.
9 Binyamin Appelbaum, The New York Times, ‘Fed Holds Interest Rates Steady and Plans Slower Increases’, 15 June 2016; available at www.nytimes.com/2016/06/16/business/economy/federal-reserve-interest-rates-janet-yellen.html?_r=0.
10 ‘March 2016 Bankruptcy Filings Down 8.5 Percent’, United States Courts, 28 April 2016; available at www.uscourts.gov/news/2016/04/28/march-2016-bankruptcy-filings-down-85-percent.
11 Moody’s Investor Services, ‘Moody’s: Global spec-grade default rate almost doubled in 2015 and will rise in 2016’, 13 January 2016; available at www.moodys.com/research/Moodys-Global-spec-grade-default-rate-almost-doubled-in-2015--PR_342302?WT.mc_id=AM~WWFob29fRmluYW5jZV9TQl9SYXRpbmcgTmV3c19BbGxfRW5n~2016011 3_PR_342302.
12 Moody’s Investor Services, ‘Moody’s: Global spec-grade default rate surpasses long-term average in May’, 9 June 2016; available at www.moodys.com/research/Moodys-Global-spec-grade-default-rate-surpasses-long-term-average--PR_350424.
14 11 USC, Sections 101–1532.
15 The few exceptions include certain offsets under various financial contracts, taxes and the actions by certain governmental authorities who are asserting their police and regulatory powers. See 11 USC, Section 362(b).
16 Note, however, that holding companies of banks, insurance companies and brokers are eligible to file for Chapter 11 relief: thus the filings of Lehman Brothers Holdings Inc and the holding company of Washington Mutual Bank. Insurance companies are liquidated under state law procedures, which differ among the 50 states. Banks are liquidated under the Federal Deposit Insurance Act.
17 11 USC, Section 1107.
18 11 USC, Section 1104. Fraud is the main reason a trustee is appointed.
19 11 USC, Section 1103.
20 Note that if a Chapter 11 trustee is appointed, neither the debtor nor the Chapter 11 trustee has the exclusive right to file a plan. 11 USC, Section 1121(c)(1).
21 11 USC, Section 1121(d)(2)(A).
22 USC, Section 1125(b).
23 Id. In some cases, the disclosure statement can be approved at the time the plan is approved.
24 See 11 USC, Section 1129(a)(7).
26 11 USC, Section 1129(b)(1).
27 Consent is obtained through the votes of classes of claims and interests.
28 The payments may be simultaneous, provided that the senior creditor will eventually be paid the present value of their claims in full.
29 See, generally, 11 USC, Section 507(a).
30 11 USC, Section 365(f). See also 11 USC, Section 365(c) for additional assignment restrictions.
31 11 USC, Section 365(d)(1).
32 Each of the 50 states and the District of Columbia have adopted their own version of the UCC. All references to Article 9 contained herein are to Article 9 as set out in the model UCC. Practitioners are encouraged to refer to Article 9 as adopted in the jurisdiction relevant to each particular transaction, to consult local counsel, or do both.
33 See 11 USC, Section 544.
34 The reach-back period is generally 90 days, unless the transferee is an ‘insider’ of the debtor, in which case the reach-back period is one year.
35 11 USC, Section 1125(g) of the Bankruptcy Code provides that an acceptance or rejection of the plan may be solicited from a holder of a claim or interest before the commencement of the case, provided that such solicitation complies with the applicable non-bankruptcy law.
36 The Bankruptcy Code requires that two-thirds in amount and more than one-half in number of a class of creditors vote to accept a plan for that class of creditors to be deemed to have accepted the plan. 11 USC, Section 1126(c).
37 Timothy Puko, Wall Street Journal, ‘Oil Settles Below $28 a Barrel’, 9 February 2016; available at www.wsj.com/articles/oil-prices-rise-on-output-uncertainty-1454993303.
38 Timothy Puko, Wall Street Journal, ‘Oil Prices Lower on Oversupply Concerns’, 15 June 2016; available at www.wsj.com/articles/oil-prices-continue-to-decline-on-oversupply-concerns-1465984008.
39 Haynes and Boone, LLP, Oil Patch Bankruptcy Monitor, 31 May 2016; available at www.haynesboone.com/~/media/files/attorney%20publications/2016/energy_bankruptcy_monitor/oil_patch_bankruptcy_20160106.ashx.
40 Computershare Trust Company, NA v. Energy Future Intermediate Holding Company LLC (In re Energy Future Holdings Corp), 539 BR 723 (Bankr D Del 2015).
41 In re Tribune Co Fraudulent Conveyance Litigation, 818 F.3d 98 (2d Cir 2016).
42 Husky Intern Electronics Inc v. Ritz, 136 S.Ct. 1581, 1585 (2016).
43 Id. at 1586.
44 Id. at 1588.
45 See e.g., 11 USC. Section 330(a); Fed Rul Bkrtcy Proc 2016(a).
46 11 USC, Section 330(a)(1).
47 See 11 USC, Section 330(a)(6).
48 Baker Botts LLP v. ASARCO LLC, 135 S.Ct. 2158 (2015).
49 No. 15-11247 (Bankr D Del 29 January 2016) (Docket No. 860).
50 In re New Gulf Resources LLC, No. 15-12566 (Bankr D Del 16 March 2016) (Docket No. 395).
51 HR Rep No. 109-31(1), at 105 (2005), reprinted in 2005 USCCAN 88, 169.
52 In re Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd, 389 BR 325, 332 (SDNY 2008).
53 11 USC, Section 1504.
54 See Iida v. Kitahara (In re Iida), 377 BR 243, 257 n21 (BAP 9th Cir 2007) (‘Subsections (b)(2), (b)(3), and (c) [of Section 1509] make it clear that Chapter 15 is intended to be the exclusive door to ancillary assistance to foreign proceedings’).
55 11 USC, Section 1504.
56 11 USC, Section 1502(4).
57 11 USC, Section 1516(c).
58 In re Tri-Continental Exch Ltd, 349 BR 627, 629 (Bankr. ED Cal 2006).
59 In re Bear Stearns, 389 BR at 336 (quoting Council Regulation (EC) No. 1346/2000, Paragraph 13).
60 Morning Mist Holdings Ltd v. Krys (In re Fairfield Sentry Ltd), Case No. 11-4376, 2013 WL 1593348, at *6 (2nd Cir 2013).
61 Id. at *8.
62 See Id. at *8.
63 11 USC, Section 1502(5).
64 Id. Section 1502(2).
65 In re Bear Stearns, 389 BR at 338.
66 Id. at 339 (‘In general, Section 1521(c) of the Bankruptcy Code limits the scope of relief available in a nonmain proceeding to relief related to assets located in the nonmain jurisdiction or closely connected thereto, while a plenary bankruptcy proceeding where the [debtors] are located would control the [debtors’] principal assets’).
67 543 BR 498 (Bankr SDNY 2016).
68 Id. at 521.