I OVERVIEW OF RESTRUCTURING AND INSOLVENCY ACTIVITY
The US economy continued to strengthen in 2017 and early 2018, with a healthy 2.3 per cent annualised rate of growth in GDP in 2017 and advance estimates indicating the same 2.3 per cent growth for first-quarter 2018, although these figures fell short of the 3 per cent growth promised by President Trump.2 2017 also saw strong growth in job numbers, a steady unemployment rate (at a low not seen for 17 years) and a surging (but volatile) stock market.3 The Federal Reserve raised interest rates three times in 2017, and another 0.25 per cent raise in March 2018 set the federal funds rate at 1.75 per cent as of the date of this publication. The Federal Reserve is expected to continue to raise rates over the course of 2018.4 Despite the rising interest rate, debt remains cheap and readily available. Accordingly, companies in distress continue to roll over and refinance their debt rather than explore court-supervised restructurings. Bankruptcy filings were again down on an annual basis, with commercial Chapter 11 filings down 2 per cent for the 12-month period ending 31 March 2018 versus the 12-month period ending 31 March 2017. Total Chapter 11 filings over the same period were down 1.8 per cent.5 Despite this decline, the combined assets of all Chapter 11 and Chapter 7 filings increased slightly, in large measure because of the significant holdings of the year's two largest Chapter 11 filings: Seadrill Limited (US$21.7 billion) and Walter Investment Management Corp (US$16.8 billion).6
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.7 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. The Bankruptcy Code was enacted by Congress in 1978 and has been amended several times – the last substantial amendment was in 2005.
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.8 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.9
Unlike many insolvency regimes in other countries, in a Chapter 11 case, the debtor's management and directors generally remain in place and continue to manage the business and guide the restructuring (the filing entity is referred to as a debtor-in-possession).10 A trustee is rarely appointed to oversee a Chapter 11 debtor's operations unless the situation suggests that one is necessary.11 By contrast, in a Chapter 7 case, a trustee is appointed to manage the liquidation.
The bankruptcy court judge is typically heavily involved in the bankruptcy case. Many of the debtor's activities (e.g., financing, major asset sales, plan of reorganisation) must be brought to the bankruptcy court judge for approval. Also, the US Trustee (UST), a representative of the Department of Justice, acts as a watchdog over the debtor's case – particularly at the outset before creditors have had time to organise. In a Chapter 11 case, the debtor-in-possession's actions will often be subject to scrutiny by one or more 'official' committees appointed by the UST.12 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 separate 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.13 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.14
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.15 The bankruptcy court does not 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,16 the debtor may solicit votes from creditors and equity holders entitled to vote on the plan. Parties who are entitled to vote on the plan are those whose debt claims or equity interests are being affected by the plan, unless they receive no distribution, in which case they are deemed to have rejected 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'.17 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.18 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. A class will be deemed to accept the plan if two-thirds in amount and more than 50 per cent in number of creditor class members vote in favour of it. In the event that equity security holders are proposed to receive a distribution, 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 or equity security holders. '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.19 The 'fair and equitable' test is fairly 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. The 'unfair discrimination' requirement is more difficult to grasp but, at a minimum, it prevents creditors and interest holders with similar legal rights from receiving materially different treatment under a proposed plan without compelling justification for doing so.
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 the distribution proposed to be made to them 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,20 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.21 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, preexisting contracts. The Bankruptcy Code also elevates to administrative expense priority status certain pre-petition claims of vendors of goods that would otherwise be treated as general unsecured claims. 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. 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.
General unsecured claims, in terms of priority, come after secured claims, administrative claims and priority claims, but before subordinated debt claims.22 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 determine those executory contracts and unexpired leases by which it will continue to be bound 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' and are generally given the lowest priority status (i.e., pre-petition general unsecured claims). Under certain circumstances, a debtor may be able to assign its interest in a contract or lease to a third party.23
In the event a debtor does not assume an agreement, the default option under the Bankruptcy Code is rejection.24 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 to secure payment or other performance of an obligation.25 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'.26 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. However, most state 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 filing27 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 hypothetical 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, such as receipt of the transfer in the ordinary course of business. 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.28 In pre-negotiated plans, the creditors entitled to vote on the plan indicate their support for the plan before the commencement of the case,29 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 Chapter 11 cases that are not pre-planned or that require operational fixes.
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 greater than 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.
Pre-planned Chapter 11 filings were increasingly prevalent in 2017; 23 per cent of all public company (defined as companies with publicly traded stock or debt) Chapter 11 filings were pre-planned (a 44 per cent rise over 2016).30 Further, five of the year's 10 largest Chapter 11 cases were pre-packaged or pre-negotiated.31 Notably, some of these pre-planned Chapter 11 cases moved through the bankruptcy process extremely quickly. For example, Global A&T Electronics Ltd confirmed its plan of reorganisation a mere five days after filing for Chapter 11 protection. Roust Corporation was not far behind with seven days between its petition date and confirmation of its plan of reorganisation.
ii Active industries: oil and gas, and retail
Filings by public companies in the oil and gas, energy and mining industries represented 30 per cent of public company filings, down from 41 per cent in 2016 but still eclipsing other industries.32 Four of the year's 10 largest public filings came from the oil and gas, energy and mining industries. However, it is the retail industry that continues to dominate headlines. Retail bankruptcies hit a six-year high in 2017, with numerous major retailers filing for Chapter 11 protection, including Toys R Us Inc, True Religion, Gordmans, hhgregg, RadioShack (General Wireless Operations Inc), Gander Mountain, BCBG Max Azria, MC Sports, Eastern Outfitters, Wet Seal, The Limited, Payless Inc., Rue21, and Gymboree.33 The trend has continued in 2018, and, year-to-date, 11 major retailers, including Nine West, Claire's and The Bon-Ton Stores, have filed for bankruptcy. S&P Global Market Intelligence analysis indicates that the retail sector will continue to suffer higher default rates from 2018 to 2020, which likely presages further bankruptcy filings.34
iii Case law developments
Puerto Rico debt restructuring
The biggest bankruptcy of the year was filed by Puerto Rico, which on 3 May 2017 initiated proceedings to restructure US$74 billion in public bond debt under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). PROMESA was enacted on 30 June 2016 to give Puerto Rico new legal tools to restructure its crushing debt load and revive its economy. Title III of PROMESA established restructuring procedures similar to those available to municipalities under Chapter 9 of the Bankruptcy Code. PROMESA also established a seven-member Oversight Board, whose members were appointed by President Obama. Puerto Rico's governmental entities are responsible for drafting fiscal plans and budgets, but the Oversight Board has broad latitude to review and ultimately to approve those plans.
Creditors' actions against Puerto Rico were initially stayed by PROMESA's enactment, but after Puerto Rico failed to strike a deal with its creditors, the stay terminated and Puerto Rico – along with many of its largest instrumentalities – commenced Title III proceedings in May 2017.35 US District Court Judge Laura Taylor Swain was appointed by Chief Justice John Roberts of the US Supreme Court to preside over the proceedings. Judge Swain immediately appointed five sitting federal judges to serve as mediators in the Title III cases and asked the parties to resolve all open issues through mediation. This process was still ongoing when, in late 2017, hurricanes Irma and Maria devastated Puerto Rico. The impact on Puerto Rico's economy, finances and infrastructure was significant. As a result, certain timelines in the Title III proceedings were extended, and Puerto Rico and its instrumentalities were forced to review and revise their proposed fiscal plans to account for the financial impact of the hurricanes.
In April 2018, the Oversight Board declined to approve the fiscal plan submitted by Puerto Rico, and instead certified its own version of a fiscal plan for the Commonwealth.36 Puerto Rico Governor Ricardo Roselló continues to reject the plan certified by the Oversight Board, on the grounds that the pension cuts contained therein are too deep and the labour reforms too harsh. As of the date of writing, implementation of the fiscal plan remains uncertain.
In Merit Management Group, LP v. FTI Consulting, Inc, the US Supreme Court limited the circumstances in which the 'safe harbour' clause contained in Section 546(e) of the Bankruptcy Code may be invoked as a defence to avoidance actions.37 Section 546(e) prohibits a trustee from avoiding 'settlement payments' made by, to or for the benefit of certain financial market participants. The Supreme Court's unanimous decision clarified that the safe harbour does not apply where the financial institution was merely a conduit for the settlement payment and has no beneficial interest in the transferred assets. The decision resolved a significant split that had existed among several US Circuit Courts of Appeal. The Second, Third, Sixth, Eighth and Tenth Circuits had previously held that the mere presence of a 'financial institution' in a multistep transfer was sufficient to shield a transfer from clawback, while the Seventh and Eleventh Circuits had held it did not.
The facts of the case are uncomplicated. Valley View Downs had arranged to acquire a competitor, Bedford Downs, by purchasing all of Bedford Downs' stock for US$55 million. The transaction was financed by Credit Suisse. Credit Suisse transferred funds for the sale to Citizens Bank of Pennsylvania, which acted as escrow agent for the transaction. Citizens Bank disbursed the funds to Bedford Downs' shareholders, including shareholder Merit Management Group, which received a US$16.5 million transfer.
Valley View Downs subsequently filed for Chapter 11, and the litigation trustee appointed to pursue certain actions commenced a constructive fraudulent transfer action against Merit to avoid and recover the US$16.5 million payment. Merit invoked Section 546(e) as a defence, asserting that the involvement of Credit Suisse and Citizens Bank in the transfer of funds meant that the US$16.5 million had been transferred 'by or to' a financial institution. The Supreme Court confirmed the Seventh Circuit's decision that the transfer was not shielded by the safe harbour provision because neither bank acquired a beneficial interest in the US$16.5 million, and were merely conduits for the transfer to Merit.
The Section 546(e) safe harbour has been a bulwark against avoidance actions in connection with leveraged buyouts and other securities transactions, and the Merit Management decision has the potential to significantly enhance a trustee's ability to recover preferential or fraudulent transfers. However, the Supreme Court reserved judgment on the viability of a possible variant safe harbour defence. The definition of 'financial institution' is broad enough to encompass a bank's 'customer' when a bank serves as agent or custodian in connection with a securities contract. Neither Merit nor the litigation trustee addressed whether this interpretation of Section 546(e) might have shielded Merit, and so the court did not address whether it may prove a viable defence in future cases.
The Supreme Court's decision in US Bank Nat'l Ass'n v. Village at Lakeridge, is considerably less far-reaching, both in its scope and impact.38 In Lakeridge, the court considered what standard of review should be applied to a bankruptcy court's determination of whether a creditor is a 'non-statutory' insider. Section 101(31) of the Bankruptcy Code includes a lengthy list of who qualifies as an 'insider' of a debtor, but courts have consistently held that the list is not exhaustive, and that other individuals may be found to be 'non-statutory' insiders. Several courts, including the Ninth Circuit, have articulated tests to identify who is a 'non-statutory' insider, but the Supreme Court expressly declined to approve any test. Instead, the Court limited its review to whether the Ninth Circuit was right to review the bankruptcy court's decision on the clear error standard of review, rather than de novo.
MBP was the debtor's sole equity owner, and as such was a statutory insider under Section 101(31) of the Bankruptcy Code. In order to ensure Lakeridge's proposed plan had an consenting, impaired non-insider class, MBP sold its claim to one Mr Rabkin, who was romantically involved with an MBP board member and officer. The bankruptcy court found Mr Rabkin was not a non-statutory insider, resting its decision in part on the fact that he performed due diligence before purchasing the MBP claim and considered the purchase a speculative investment. When presented with the issue on appeal, the Ninth Circuit held that a creditor is a non-statutory insider if two criteria are met: '(1) the closeness of its relationship with the debtor is comparable to that of the enumerated insider classifications in § 101(31), and (2) the relevant transaction is negotiated at less than arm's length.'39 The Ninth Circuit upheld the bankruptcy court's finding that Mr Rabkin was not a non-statutory insider.
The Supreme Court found that the Ninth Circuit was correct to review the bankruptcy court's decision under a clear error standard of review, because the question of whether Mr Rabkin was a non-statutory insider was a mixed question of fact and law. The court pointedly did not rule on the correctness of the Ninth's Circuit's legal test, but the test was the object of some interesting dicta in the concurrences. Chief Justice Roberts suggested that the Ninth Circuit should 'continue tinkering' with different analyses. Justice Sotomayor, in a concurrence joined by Justices Kennedy, Thomas and Gorsuch, took specific issue with the test, noting that since statutory insiders cannot cleanse their votes by engaging in arm's-length transactions, neither should non-statutory insiders be able to do so. In the absence of a consensus view – even in dicta – as to the appropriate test for identifying non-statutory insiders from the Supreme Court, the task of developing such a test remains with the country's bankruptcy courts and courts of appeal.
Impaired accepting class requirement
In JMPCC 2007-C1 Grasslawn Lodging , LLC v. Transwest Resort Props, Inc, the Ninth Circuit became the first court of appeals to consider how Section 1129(a)(10) of the Bankruptcy Code, which requires that a plan have at least one impaired accepting class before it can be confirmed, should be applied to cases where multiple debtors have their Chapter 11 cases jointly administered but not substantively consolidated.40 Lower courts have split on this issue. Some follow the 'per-debtor' approach, which interprets Section 1129(a)(10) as requiring an impaired accepting class for each debtor. The best known proponent of this approach is In re Tribune, a decision of the Bankruptcy Court for the District of Delaware.41 Other courts adopt the 'per-plan' approach, which requires only one impaired accepting class across among all debtors.42 In Grasslawn, the Ninth Circuit endorsed the latter approach.
Grasslawn involved five different debtors. One debtor was a holding company and sole equity owners of two other debtors (the 'Mezzanine Debtors'), who in turn were the sole equity holders of two debtors who owned and operated two resorts (the 'Operating Debtors'). The resorts had been acquired using two sources of financing – a loan to the Operating Debtors which was secured by the resorts, and a loan secured by the Mezzanine Debtors' interests in the Operating Debtors. The debtors' cases were jointly administered but not substantively consolidated. The proposed plan gave no recovery for the Mezzanine Debtors' creditors, and those creditors voted against and objected to confirmation of the debtors' plan. The bankruptcy court found that the plan could be confirmed, in part, because impaired classes holding claims against the Operating Debtors had voted in favour of the plan.
The Ninth Circuit confirmed. The court focused on the plain language of Section 1129(a)(10) of the Bankruptcy Code, noting that the provision 'makes no distinction concerning or reference to the creditors of different debtors under “the plan,” nor does it distinguish between single-debtor and multi-debtor plans'.43 The court recognised that the Tribune court had also focused on the plain language of the statute in reaching the opposite conclusion, but rejected its analysis.
The majority of courts, including bankruptcy courts in the Southern District of New York, seem to be following this per-plan approach, but the risk that courts may take the per-debtor approach remains, particularly in Delaware. Until more guidance comes from higher courts, debtors must live with this uncertainty and factor it into decisions regarding choice of venue.
Cramdown interest rate and a new circuit split on make-wholes
The decision of the Second Circuit in MPM Silicones, LLC (Momentive) is notable for at least two reasons.44 The court's decision (1) reversed the bankruptcy court's formulation of an appropriate cram down interest rate; and (2) confirmed the bankruptcy court's determination that secured noteholders were not entitled to make-whole premiums when their notes were replaced under a debtor's plan.
The Momentive debtors filed for Chapter 11 protection in April 2014. The debtors had a fairly complicated capital structure, but the crux of the Second Circuit decision focuses on the creditors holding the debtors' over-secured senior lien notes. The indenture for the notes included a make-whole premium for redemptions prior to October 2015 and included an acceleration provision triggered by, among other events of default, the voluntary commencement of bankruptcy proceedings. The debtors' plan provided the holders of senior lien notes with two options. If the class voted in favour of the plan, the noteholders would not receive a make-whole premium but would receive cash for all outstanding principal and accrued interest on the senior lien notes. If, instead, the class voted against the plan, the noteholders would receive replacement notes with a present value equal to the allowed amount of such holder's claim. The notes would bear interest at the treasury rate plus a premium of roughly 1.5 to 2 per cent. This interest rate was considerably below market. The debtors suggested the replacement notes received by a rejecting class could also have a make-whole premium at the bankruptcy court's discretion. The noteholders voted to reject the plan. They argued that the below-market interest rate violated the requirement that a plan be 'fair and equitable' to dissenting classes, pursuant to Section 1129(b) of the Bankruptcy Code, and that they were entitled to the make-whole payment contracted for in the indenture.
The Second Circuit first determined that the interest rate on the replacement notes did not satisfy Section 1129(b)(2)(A)(ii), which requires that a dissenting class of secured creditors receive 'deferred cash payments totalling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder's interest in the estate's interest in such property'. In Momentive, this meant that the replacement notes' present value had to be equal to the value of the senior lien noteholders' secured claims. The bankruptcy court had approved a below-market interest rate on the notes by applying the Till standard, derived from a US Supreme Court decision in a Chapter 13 case (a bankruptcy process available to individuals only).45 The Supreme Court in Till adopted the 'prime plus' or 'formula' method of calculating Chapter 13 interest rates, under which the prime rate is adjusted by only a slight risk premium, generally between 1 and 3 per cent.
Notably, the Supreme Court decision in Till contained a discursive footnote in which the court considered the possibility that cramdown rates might be calculated differently in a Chapter 11 case because, unlike in Chapter 13 cases, there is a market of lenders who offer financing for Chapter 11 debtors. Therefore, in a Chapter 11 case, the court allowed that a better practice might be to consider what rate an efficient market would produce.46 The Second Circuit considered Till at length before determining that both precedent and the text of the Bankruptcy Code support that 'the best way to determine value is exposure to a market'.47 The Second Circuit followed the Sixth Circuit in determining that an appropriate cramdown interest rate in a Chapter 11 case should be calculated as follows: 'The market rate should be applied in Chapter 11 cases where there exists an efficient market. But where no efficient market exists for a Chapter 11 debtor, then the bankruptcy court should employ the formula approach endorsed by the Till plurality.'48 The issue was remanded to the bankruptcy court to determine an appropriate rate, and a trial on that issue is scheduled for August 2018.
The Second Circuit then turned to whether the senior lien noteholders were entitled to make-whole payments under the terms of the indenture. The court determined that a payment due on account of acceleration is not the same as redemption. The court reasoned that 'redemption' refers to pre-maturity payments of debt. Acceleration moves the maturity date of a debt forward, and hence any payment of a debt thereafter is not 'pre-maturity' and cannot be considered redemption. The issuance of the replacement notes was not a prepayment and, therefore, did not trigger the make-whole provision in the indenture. The court also rejected the noteholders' argument that, under the indenture, they had the right to rescind the acceleration which was triggered automatically by the bankruptcy filing, holding that such an action was an attempt to modify contract rights and as such was barred by the automatic stay.
In so deciding, the Second Circuit split with the Third Circuit, which just last year, faced with similar facts, held that noteholders were entitled to make-whole payments in In re Energy Future Holdings Corp.49 The implications of the split may decrease with time, as the Second Circuit decision noted that noteholders can avoid this outcome by clearly contracting for a make-whole payment in the event of a default or acceleration due to bankruptcy. At present, however, debtors in circumstances similar to the Momentive and EFH debtors have a clear reason to prefer bankruptcy courts in the Second Circuit.
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'.50 Chapter 15 is based on a 'rigid recognition standard' that one court labelled 'consistent with the general goals of the Model Law'.51 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'.52 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.53
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'.54 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 centre of its main interests',55 (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'.56 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'.57 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'.58 On the other hand, the Second Circuit has rejected the notion that 'principal place of business' analysis should be used,59 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'.60
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'.61
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'.62 'Establishment' is defined in Chapter 15 as 'any place of operations where the debtor carries out a nontransitory economic activity'.63 Determining whether a debtor has an establishment in the foreign proceeding jurisdiction 'is essentially a factual question, with no presumption in its favour'.64 At least one court has held that non-main recognition is restricted to a jurisdiction in which a debtor has assets.65
While the year 2016 saw a spike in Chapter 15 filings (up to 179 versus 91 in 2015), 2017 saw the number of Chapter 15 filings return to a more moderate 86 filings.66
ii Recent developments
In re Ocean Rig UDW Inc
In In re Ocean Rig UDW Inc, the Bankruptcy Court for the Southern District of New York determined that the Chapter 15 debtors were justified in shifting their COMI for the purpose of accessing more favourable restructuring laws, and that such a COMI shift did not constitute bad-faith manipulation.67
Ocean Rig shifted its COMI to the Cayman Islands less than a year before commencing restructuring proceedings under that country's laws. Previously, the company's COMI was the Republic of the Marshall Islands, a jurisdiction without any restructuring or bankruptcy statute. Under Marshall Islands law, the only option available to Ocean Rig and other distressed companies was to liquidate. Ocean Rig, instead, made the decision to shift its COMI to the Cayman Islands, a jurisdiction that permitted restructuring through a scheme of arrangement.
Ocean Rig's foreign representatives sought recognition of the debtors' proceedings pursuant to Chapter 15. The bankruptcy court found that, although recent and motivated by the desire to access the Cayman Island's restructuring regime, the debtors' decision to shift their COMI was legitimate. In particular, the bankruptcy court noted the numerous actions the debtors had taken to effect the COMI shift to the Cayman Islands. Among other things, the debtors now conducted management and operations, had offices, held board meetings, had directors and officers reside and maintained bank accounts and books and records in the Cayman Islands. The court concluded that the debtors' COMI shift to the Cayman Islands was real.
The court recognised that in any proceeding for foreign recognition, the potential for COMI manipulation is a concern. Further, where a shift in COMI has occurred immediately prior to filing, the court may engage in a more holistic analysis to ensure the debtor has not manipulated its COMI in bad faith. In the case of Ocean Rig, the court found the that the debtors had a legitimate, good faith purpose for shifting their COMI to the Cayman Islands, because they sought to 'maximize value for their creditors and preserve their assets' and to avoid the value-destroying liquidation process to which they would have been subject in the Marshall Islands.68 The fact that the shift was for the express purpose of utilising the Cayman Islands restructuring regime did not render it 'bad faith' manipulation of the debtors' COMI.
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 Julie Lanz, an associate at the firm, in preparing this chapter.
2 Jeff Stein, The Washington Post, 'U.S. economic growth slowed in 2017's fourth quarter, missing Trump's targets', 26 January 2018; available at https://www.washingtonpost.com/business/economy/the-us-economy-grew-23-percent-in-2017-as-growth-slowed-in-fourth-quarter/2018/01/26/ee7efb56-029a-11e8-bb03-722769454f82_story.html?noredirect=on&utm_term=.6a08279f2661; Bureau of Economic Analysis, US Department of Commerce, 'National Income and Product Accounts: Gross Domestic Product: First Quarter 2018 (Advance Estimate)', 27 April 2018; available at https://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.
3 Mamta Badkar, Financial Times, 'US Economy Creates 148,000 Jobs in December, wages pick up', 5 January 2018; available at https://www.ft.com/content/b927151c-5e04-3297-bf28-5bc264dbb704.
4 Lauren Gensler, Forbes, 'Fed Raises Rates For Third Time In 2017 As U.S. Economy Chugs Along', 13 December 2017; available at https://www.forbes.com/sites/laurengensler/2017/12/13/federal-reserve-
5 United States Courts, 'Bankruptcy Filings Continue to Decline', 26 April 2018; available at http://www.uscourts.gov/news/2018/04/26/bankruptcy-filings-continue-decline.
6 BankruptcyData, 'BankruptcyData's 2017 Corporate Bankruptcy Review', 10 January 2018; available at https://www.bankruptcydata.com/public/assets/filemanager/userfiles/BankruptcyData_2017_Corporate_Bankruptcy_Review.pdf.
7 11 USC, Sections 101–1532.
8 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).
9 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.
10 11 USC, Section 1107.
11 11 USC, Section 1104. Fraud is the main reason a trustee is appointed.
12 11 USC, Section 1103.
13 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).
14 11 USC, Section 1121(d)(2)(A).
15 USC, Section 1125(b).
16 Id. In some cases, the disclosure statement can be approved at the time the plan is approved.
17 See 11 USC, Section 1129(a)(7).
19 11 USC, Section 1129(b)(1).
20 Consent is obtained through the votes of classes of claims and interests.
21 The payments may be simultaneous, provided that the senior creditor will eventually be paid the present value of their claims in full.
22 See, generally, 11 USC, Section 507(a).
23 11 USC, Section 365(f). See also 11 USC, Section 365(c) for additional assignment restrictions.
24 11 USC, Section 365(d)(1).
25 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.
26 See 11 USC, Section 544.
27 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.
28 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 applicable non-bankruptcy law.
29 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).
30 BankruptcyData, 'BankruptcyData's 2017 Corporate Bankruptcy Review', 10 January 2018; available at https://www.bankruptcydata.com/public/assets/filemanager/userfiles/BankruptcyData_2017_Corporate_Bankruptcy_Review.pdf.
33 Tonya Garcia, MarketWatch, 'Retail bankruptcies hit highest number since 2011: S&P Global', 19 December 2017; available at https://www.marketwatch.com/story/retail-bankruptcies-hit-highest-
34 S&P Global Market Intelligence, 'Apparel, specialty retailer debt maturities to swell in 2019', May 2018; available at https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/44318698.
35 Many of Puerto Rico's key instrumentalities, such as the Puerto Rico Electricity and Power Authority (PREPA), Puerto Rico Aqueduct and Sewer Authority (PRASA), Puerto Rico's Highways and Transportation Authority and the Government Employees Retirement System, are also deeply indebted and seek to use Title III to restructure their debts.
36 The Oversight Board also rejected the fiscal plans submitted by PREPA and PRASA, choosing instead to certify its own versions of fiscal plans for those instrumentalities.
37 583 U. S. ____ (Feb. 27, 2018).
38 583 U.S. ____ (Mar. 5, 2018)
39 In re Village at Lakeridge, LLC, 814 F.3d 993, 1001 (9th Cir. 2016) (citing Anstine v. Carl Zeiss Meditec AG (In re U.S. Med., Inc.), 531 F.3d 1272, 1277 (10th Cir. 2008)).
40 881 F.3d 724 (9th Cir. 2018).
41 464 B.R. 126 (Bankr. D. Del. 2011).
42 JPMorgan Chase Bank, N.A. v. Charter Communications Operating, LLC (In re Charter Communications), 419 B.R. 221 (Bankr. S.D.N.Y. 2009).
43 881 F.3d at 730.
44 Apollo Global Mgmt., LLC v. Bokf, NA (In re MPM Silicones, L.L.C.), 874 F.3d 787 (2d Cir. 2017).
45 Till v. SCS Credit Corp., 541 U.S. 465 (2004).
46 Id. at 476 n.14.
47 Momentive, 874 F.3d at 800 (quoting Bank of Am. Nat'l Trust and Sav. Ass'n v. 203 N. LaSalle St. P'ship, 526 U.S. 434, 457 (1999).
48 Id. (quoting In re American Home Patient, Inc., 420 F.3d 559, 568 (6th Cir. 2005)).
49 842 F.3d 247 (3d. Cir. 2016).
50 HR Rep No. 109-31(1), at 105 (2005), reprinted in 2005 USCCAN 88, 169.
51 In re Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd, 389 BR 325, 332 (SDNY 2008).
52 11 USC, Section 1504.
53 See Iida v. Kitahara (In re Iida), 377 BR 243, 257 n.21 (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').
54 11 USC, Section 1504.
55 11 USC, Section 1502(4).
56 11 USC, Section 1516(c).
57 In re Tri-Continental Exch Ltd, 349 BR 627, 629 (Bankr. ED Cal 2006).
58 In re Bear Stearns, 389 BR at 336 (quoting Council Regulation (EC) No. 1346/2000, Paragraph 13).
59 Morning Mist Holdings Ltd v. Krys (In re Fairfield Sentry Ltd), Case No. 11-4376, 2013 WL 1593348, at *6 (2nd Cir 2013).
60 Id. at *8.
61 See Id. at *8.
62 11 USC, Section 1502(5).
63 Id. Section 1502(2).
64 In re Bear Stearns, 389 BR at 338.
65 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').
66 American Bankruptcy Institute, 'Chapter 15 Quarterly Filings (2005 to Present)'; available at https://www.abi.org/newsroom/bankruptcy-statistics.
67 570 B.R. 687 (Bankr. S.D.N.Y. 2017).
68 Id. at 707.