INTERNATIONAL RESTRUCTURING NEWSWIRE

Transcription

1 INTERNATIONAL RESTRUCTURING NEWSWIRE IN THIS ISSUE SUMMER CHADBOURNE & PARKE LLP, ALL RIGHTS RESERVED THIS MATERIAL MAY CONSTITUTE ATTORNEY ADVERTISING IN SOME JURISDICTIONS. PRIOR RESULTS DO NOT GUARANTEE A SIMILAR OUTCOME.

2 INTERNATIONAL RESTRUCTURING NEWSWIRE SUMMER 2013 EDITORS FOR MORE INFORMATION, CONTACT TO OUR READERS II CHADBOURNE & PARKE LLP Douglas E. Deutsch N. Theodore (Ted) Zink PARTNER PARTNER +1 (212) (212) Howard Seife David M. LeMay John Verrill GLOBAL DEPARTMENT CHAIR PARTNER PARTNER +1 (212) (212) (0) N. Theodore (Ted) Zink Douglas E. Deutsch PARTNER PARTNER +1 (212) (212) Seven Rivera Andrew Rosenblatt PARTNER PARTNER +1 (212) (212) Christy Rivera Francisco Vazquez COUNSEL COUNSEL +1 (212) (212) International Restructuring NewsWire is published by Chadbourne & Parke LLP for general information purposes only. It does not constitute the legal advice of Chadbourne & Parke LLP and it is not a substitute for fact-specific legal counsel. For complimentary copies or changes of address, please contact Helen Lamb at hlamb@chadbourne.com.

3 THE SECOND CIRCUIT EXAMINES COMI AND THE PUBLIC POLICY EXCEPTION TO CHAPTER 15 By Francisco Vazquez Chapter 15 of the Bankruptcy Code provides a procedure to obtain recognition in the United States of a foreign proceeding, which includes a foreign bankruptcy, insolvency, liquidation, or adjustment of debt proceeding. A United States bankruptcy court may grant recognition to (i) a foreign main proceeding, which refers to a foreign proceeding pending where the debtor has the center of its main interests, also known as COMI, or (ii) a foreign nonmain proceeding, which refers to a foreign proceeding pending where the debtor has any place of operations where the debtor carries out a nontransitory economic activity. Upon recognition of a foreign proceeding, the foreign representative may obtain relief from the bankruptcy court, including injunctive relief, to protect the foreign debtor from litigation. Chapter 15 further provides that a court may refrain from granting relief, including recognition if the action would be manifestly contrary to the public policy of the United States. In Important 2011 Rulings on Foreign Proceedings, International Restructuring NewsWire (February 2012), we reviewed the relevant time period a court must consider in determining a debtor s COMI as well as the parameters of the Chapter 15 public policy exception. Subsequently, we addressed the public policy exception in several articles examining the Mexican concurso of Vitro S.A.B. de C.V. See, e.g., Fifth Circuit Confirms Denial of Recognition to Mexican Concurso that Releases Claims Against Non-Debtors, International Restructuring NewsWire (March 2013). We now turn our attention to Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.), 714 F.3d 127 (2d Cir. 2013), an important decision from the Second Circuit (the court with jurisdiction over the Southern District of New York, the District with the most Chapter 15 filings) which analyzed both the timing of the COMI determination and the public policy exception in connection with a Chapter 15 petition for recognition. Liquidation of Fairfield Sentry Limited Fairfield Sentry was organized as an international business company in the British Virgin Islands (commonly referred to as the BVI ). Fairfield Sentry s registered office, registered agent, registered secretary and corporate documents were located in the BVI. However, all of Fairfield Sentry s directors resided outside of the BVI and Fairfield Sentry s day-to-day operations were managed by Fairfield Greenwich Group in New York. Moreover, roughly 95% of Fairfield Sentry s assets, totaling over $7 billion, were invested with Bernard L. Madoff Investment Securities LLC in New York. In fact, Fairfield Sentry was the largest feeder fund that invested with Madoff Investment Securities. Following Bernard Madoff s arrest in December 2008, Fairfield Sentry suspended operations and began winding down its business. On July 21, 2009, the High Court of Justice of the Eastern Caribbean Supreme Court (the court with jurisdiction in the BVI) appointed a liquidator for Fairfield Sentry. Prior to the appointment of the liquidator, Morning Mist Holdings Ltd., a shareholder of Fairfield Sentry, commenced a derivative action in New York asserting breach of duty claims against Fairfield Sentry s directors, management and service providers. The Bankruptcy Court s Recognition of Fairfield Sentry s BVI Liquidation Almost a year after his appointment, the BVI liquidator filed a petition under Chapter 15 of the Bankruptcy Code with the INTERNATIONAL RESTRUCTURING NEWSWIRE SUMMER

4 United States Bankruptcy Court for the Southern District of New York seeking recognition of the BVI liquidation. In determining Fairfield Sentry s COMI, the bankruptcy court analyzed Fairfield Sentry s conduct during the period from December 2008, when it ceased business operations, through June 2010, when the liquidator filed the Chapter 15 petition. The bankruptcy court determined that as of the Chapter 15 filing date, Fairfield Sentry had no place of business, no management, and no assets located in the United States. Moreover, Fairfield Sentry s activities were limited to winding down its business from the BVI. Therefore, the bankruptcy court held that Fairfield Sentry s COMI at the time of the filing of the Chapter 15 petition was the BVI and granted recognition to the BVI liquidation as a foreign main proceeding. Recognition triggered the automatic stay on any proceedings against Fairfield Sentry in the United States, including Morning Mist s derivative action. Morning Mist appealed the bankruptcy court s decision and argued that the court should have considered Fairfield Sentry s entire operational history in determining its COMI. Because Fairfield Sentry s operations in the BVI prior to December 2008 were minimal, adopting Morning Mist s approach would likely have led the bankruptcy court to conclude that Fairfield Sentry s COMI was someplace other than the BVI. Moreover, according to Morning Mist, recognition was manifestly contrary to U.S. public policy because the BVI court records were not publicly available. The district court rejected both arguments and affirmed the bankruptcy court s decision. Morning Mist appealed the district court s decision to the Second Circuit. The Second Circuit Affirms the Lower Courts Decisions The Second Circuit began its analysis by examining section 1517(b) of the Bankruptcy Code, which provides that a foreign proceeding shall be recognized as a foreign main proceeding if it is pending in the country where the debtor has its COMI. According to the court, the use of the present tense indicates that the COMI determination should be made as of the date of the Chapter 15 filing and not, as argued by Morning Mist, as of the date of the commencement of the foreign proceeding. The Second Circuit also considered decisions from other courts, the vast majority of which had determined that COMI should be considered as of the time the Chapter 15 petition is filed. The Second Circuit was especially persuaded by the Fifth Circuit s rationale in In re Ran, 607 F.3d 1017 (5th Cir. 2010), where the court of appeals rejected the argument that a debtor s COMI should be determined by considering the debtor s operational history. The Second Circuit concurred with the Fifth Circuit s analysis and noted that using the Chapter 15 filing date would permit creditors and other third parties to pinpoint a debtor s COMI. The Second Circuit acknowledged that the United States Bankruptcy Court for the Southern District of New York in the Chapter 15 case of Millennium Global Emerging Credit Master Fund Ltd., a case we examined in the Important 2011 Rulings article referenced above, adopted a different approach. In Millennium, the court equated COMI with the American concept of principal place of business and considered the debtor s operational activities in determining COMI. Because a debtor s operations generally terminate at or around the time of the commencement of a liquidation, the Millennium court concluded that COMI should be determined as of the date of the commencement of the foreign proceeding. The Second Circuit rejected the Millennium court s approach, noting that Congress intentionally drafted Chapter 15 to reference COMI rather than principal place of business. Consistent with the mandate of section 1508 to consider the international origin of Chapter 15, the Second Circuit also considered the relevant European Union regulation and case law. The Second Circuit was not persuaded by the approach reflected in the EU regulation, which refers to a broader time frame for considering a debtor s COMI. The Second Circuit acknowledged, however, that, as reflected by the relevant European case law, a court should focus on whether a debtor s COMI is regular and ascertainable, not subject to tactical removal. Ultimately, the Second Circuit held that a debtor s COMI should be determined based on its conduct at or about the date of the filing of the Chapter 15 petition. Given the international focus on the regular and ascertainable nature of a debtor s COMI, the Second Circuit concluded 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. After determining the appropriate time frame, the Second Circuit noted that given the absence of a statutory definition of COMI, courts should not limit themselves to or engage in a mechanical application of a set list of factors. Thus, a court may consider any relevant activities in determining a debtor s COMI, including its liquidation activities. In this instance, the bankruptcy court found that Fairfield Sentry s activities post-madoff s arrest were limited to winding up its 2 CHADBOURNE & PARKE LLP

5 CHADBOURNE REPRESENTS business from the BVI. Because it determined that the bankruptcy court s factual findings were not erroneous and there was no evidence that Fairfield Sentry manipulated its COMI between the commencement of the liquidation in 2008 and the Chapter 15 filing in 2009, the Second Circuit affirmed the lower courts decisions. The Second Circuit then analyzed the public policy exception to granting relief under Chapter 15. To trigger the public policy exception, an action must be manifestly contrary to U.S. public policy. The Second Circuit noted that this exception is to be invoked in limited circumstances concerning the most fundamental public policies of the U.S. and would not bar an action that may merely conflict with public policy. Morning Mist argued that recognition of the BVI liquidation was manifestly contrary to U.S. public policy, because the liquidation was cloaked in secrecy. The Second Circuit, however, was not troubled by the limited access to pleadings in the BVI, because (i) while the pleadings were under seal, public summaries were available, (ii) restricted access is not unusual in the BVI where only certain records are readily available to non-parties, and (iii) any non-party may apply for access to sealed documents. More significantly, the Second Circuit noted that public access to court documents is not an exceptional and fundamental right. Indeed, it is not uncommon for documents to be sealed in U.S. proceedings. Thus, [t]here is no basis on which to hold that recognition of the BVI liquidation is manifestly contrary to U.S. public policy. Conclusion With this ruling, the Second Circuit follows other courts that have narrowly interpreted the public policy exception to relief under Chapter 15. The Second Circuit also joins the Fifth Circuit as the only other court of appeals that has addressed the timing of the COMI determination. By addressing the timing issue, the Second Circuit has resolved a split among the lower courts in the Circuit. It remains to be seen whether courts in other circuits will follow the Second Circuit or instead follow the rationale of Millennium. Foreign representatives need to be cognizant of these issues and venue alternatives before filing any Chapter 15 cases. Francisco Vazquez is counsel in Chadbourne & Parke s New York office in the firm s bankruptcy and financial restructuring group. RESCAP EXAMINER REPORT IS RELEASED As previously reported, during the summer of 2012, Chadbourne was retained by Arthur J. Gonzalez, formerly chief judge of the Southern District of New York s bankruptcy court and currently Professor of Law and Senior Fellow at NYU School of Law, to assist him in his duties as Examiner of the Residential Capital LLC Chapter 11 case. Chadbourne began its work on what would become a ten-month investigation. As part of the process, Chadbourne gathered and analyzed almost nine million pages of documents, conducted ninety-nine interviews and met on approximately sixty-six occasions with various parties in interest. The Report was filed with the court in mid-may but, because the main parties in the case were seeking to reach a settlement, was sealed until the terms of the settlement could be finalized. At the June 26th hearing, Judge Glenn praised the Examiner Report as a masterful job. On June 26, 2013, U.S. Bankruptcy Judge Martin Glenn, overseeing the chapter 11 case of Residential Capital, LLC ( ResCap ), unsealed the 1,900 page Examiner Report. The Report identified a myriad of causes of action, potentially worth billions of dollars, arising from dozens of transactions involving ResCap s parent, Ally Financial Inc., its subsidiary Ally Bank, and Cerberus. At the June 26th hearing, Judge Glenn praised the Examiner Report as a masterful job. The Examiner and his professionals found that many of the claims initially identified by creditors and their representatives were unlikely to lead to valuable causes of action for ResCap or its creditors. However, the Examiner and his team independently discovered a number of causes of action including claims related to the misallocation of net revenues on loans brokered by GMAC Mortgage (a ResCap subsidiary), the use and allocation INTERNATIONAL RESTRUCTURING NEWSWIRE SUMMER

6 WHAT IS THE APPROPRIATE CRAM DOWN INTEREST RATE FOR A SECURED CREDITOR? By Douglas Deutsch and Bonnie Dye The Bankruptcy Code requires that secured creditors be paid value over time in an amount that at least equals the allowed amount of their claims at confirmation. This means that a secured creditor who is to receive distributions in satisfaction of its claim over a period of years is generally entitled to receive interest on such payments. Unfortunately, the Bankruptcy Code provides little guidance on how to determine an appropriate interest rate for such claims. In order to provide some clarity on this issue in the consumer arena, the Supreme Court issued an opinion in 2004 titled Till v. SCS Credit Corp., 541 U.S The Till opinion adopted an approach to address the proper interest rate called the prime-plus formula. Bankruptcy courts took the prime-plus approach established by Till and applied it to chapter 11 business cases. But this was not done without dispute. In the recent Fifth Circuit Court of Appeals decision of Wells Fargo Bank National Association v. Texas Grand Prairie Hotel Realty LLC (In re Texas Grand Prairie Hotel Realty, L.L.C.), 710 F.3d 324 (5th Cir. 2013), the Circuit suggested that in the chapter 11 context the Till decision was even more limited than many have thought. Secured creditors should take note: the prime-plus approach may not be the only game in town. Factual Background In 2007, the Texas Grand Prairie Hotel debtors obtained a loan in the amount of $49 million to purchase four hotels in Texas. The loan was secured by substantially all of the debtors assets. Wells Fargo Bank subsequently acquired the loan from the initial lender. In 2009, the debtors filed for chapter 11 protection and proposed a plan of reorganization. The plan valued Wells Fargo s secured claim at $39 million and sought to satisfy the secured claim with payouts to be made over the next ten years. The proposed interest rate for the ten year loan was 5%. This interest rate equaled 1.75% over the prime rate on the confirmation hearing date. Unsurprisingly, Wells Fargo objected to the proposed treatment for its loan on the basis that the interest rate was too low. To confirm over Wells Fargo s objection, the debtors needed to cram down their plan under Bankruptcy Code section 1129(b). This provision permits a plan proponent to obtain plan confirmation despite a class of claims rejecting the plan if the plan is, among other things, fair and equitable to the rejecting class. For a plan to be fair and equitable with respect to a class of secured claims, the plan must satisfy one of three tests. The test applicable in this case requires that the plan provide the secured claim holder with deferred cash payments of a value at least equal to the allowed amount of the secured claim as of the effective date of the plan. However, the parties disagreed on what interest rate would produce the required outcome for Wells Fargo. On one side, the debtors offered expert testimony to support a 5% interest rate. On the other side, Wells Fargo s expert offered testimony supporting a 8.8% interest rate. Ultimately, the bankruptcy court adopted the debtors expert s view on the appropriate interest rate and confirmed the debtors plan. Wells Fargo appealed the bankruptcy court s decision, challenging both the debtors expert s testimony and the court s adoption of the debtors interest rate analysis. The district court affirmed the bankruptcy court s decision. Wells Fargo then appealed the issue to the Fifth Circuit. Legal Background Determining the proper rate of interest to a secured creditor in a cram down case is not a new issue. The issue was most notably addressed by the Supreme Court in Till v. SCS Credit 4 CHADBOURNE & PARKE LLP

7 CHADBOURNE REPRESENTS Corp., 541 U.S The Till case involved a secured creditor who objected to an individual chapter 13 debtor s proposed interest rate for car payments of 9.5%, a rate substantially lower than the 21% subprime rate that was agreed to by the borrower when the loan was originated. While the parties in the case proposed different methodologies to calculate the interest rate, the Supreme Court rejected most as too complicated, costly, or incorrectly calculated. The Supreme Court determined that the prime-plus formula, an approach which requires an adjustment to the prime national interest rate based on risk of nonpayment, was an appropriate method for determining the cram down rate of interest. The Supreme Court specifically held that the adjustment under the prime-plus formula will depend on factors such as (i) the estate s circumstances, (ii) the security s nature and (iii) the reorganization plan s duration and feasibility. Given that a number of factors should be considered, the Court noted that each side should be able to present evidence as to the calculation of the proposed interest rate. Importantly, Till involved a chapter 13 proceeding, a type of bankruptcy case which offers protection to individuals, and a different (although somewhat similar) statutory scheme than chapter 11. In addition, the Till decision was a plurality decision four justices joined the reasoning of the opinion, one justice concurred with the judgment for a different reason and four justices dissented. The Court did not speak with one voice, as no single approach could obtain a majority of the justices. Despite the Till decision s shortfalls, courts still frequently used the methodology proposed by Till in chapter 11 business bankruptcy cases. This is especially interesting as even the Till plurality recognized that the prime-plus approach might not be the perfect methodology for chapter 11 cases. In fact, the plurality decision included a notation in footnote 14 that courts overseeing chapter 11 cases might want to consider an approach for cram down interest that would consider the rate an efficient market would produce. The Fifth Circuit s Analysis in Texas Grand Prairie The Fifth Circuit began its analysis in Texas Grand Prairie by noting that it did not agree that Till required bankruptcy courts to apply the prime-plus formula to calculate cram down interest in chapter 11 bankruptcy proceedings. According to the Circuit, Till was a splintered decision whose precedential value is limited even in the chapter 13 context. Additionally, the Circuit found that while courts interpreting Till suggest that the prime-plus formula that governs chapter 13 cases may also govern a chapter 11 case, Till is not controlling precedent that ties bankruptcy courts to a specific of ResCap s tax attributes, and claims under the Minnesota insider preference statute that could potentially provide substantial recoveries for the estate. Specifically, the Examiner found that ResCap s bankruptcy estates could bring potentially-viable causes of action asserting up to $5.5 billion in damages. The Report also noted that the Ally entities have significant potential liability to third-party claimants. The chair of Chadbourne s bankruptcy and financial restructuring practice, Howard Seife, called the release of the Examiner Report a significant event in the ResCap chapter 11 case one that we hope will assist the court and the parties in resolving the case. A summary of the background related to the Report and the findings of the Report can be found on our website in our June 27, 2013 Client Alert. A full copy of the Examiner Report is available at com/rescap. CHADBOURNE OBTAINS RECOGNITION OF A UNIQUE SCHEME IN A CHAPTER 15 CASE On May 1, 2013, Chadbourne & Parke, on behalf of Chartis Excess Ltd. (a subsidiary of AIG), obtained an order from the United States Bankruptcy Court for the Southern District of New York enforcing an Irish scheme of arrangement under Chapter 15 of the Bankruptcy Code. While United States courts have frequently recognized schemes of arrangement proposed by solvent insurance companies to fix and satisfy claims against the filing insurance company, the Chartis scheme was unique in that it was used to transfer certain businesses from one insurance company to another. This is the first time a United States court has granted recognition to a Chapter 15 that is designed as a transfer scheme of arrangement. INTERNATIONAL RESTRUCTURING NEWSWIRE SUMMER

8 The Fifth Circuit concluded its analysis by emphasizing that while the Till plurality s formula approach... has become the default rule in chapter 11 bankruptcies, it was not suggesting that the prime-plus formula is the only or even the optimal method for calculating the chapter 11 cram down rate. methodology when determining a cram down rate of interest in a chapter 11 case. Nevertheless, the Fifth Circuit found it was important that both parties stipulated that the primeplus formula would apply in this case. The Circuit turned to an examination of what the prime-plus formula requires. In the lower court proceeding, both the debtors and Wells Fargo offered expert testimony on an appropriate interest rate. The debtors expert began his analysis with the prime rate of 3.25% and then assessed the risk adjustment by evaluating the factors described in Till. The debtors expert testified that given the high quality of the bankruptcy estate s assets and the strength of the debtors management, the risk of default was slightly below average. He reasoned that a 1.75% risk adjustment was appropriate, for a total interest rate of 5%. Wells Fargo s expert also began with the prime rate of 3.25% but asserted that because there was no market for single tranche secured loans like the one proposed in the debtors plan, the market rate should be calculated by taking the weighted average of the interest rates the market would charge for a multi-tiered exit financing packing made up of senior debt, mezzanine debt, and equity. Wells Fargo s expert calculated the weighted average of the interest rates on these three hypothetical financing tranches to be 9.3%. Applying the standard set out in Till, the expert then made certain adjustments which ultimately led to his conclusion that an appropriate cram down interest rate was 8.8%. While the Wells Fargo expert appeared to take into account the factors enumerated in Till, the Fifth Circuit determined that Wells Fargo s expert analysis did not in fact apply the prime-plus formula, but instead used the comparable loan methodology. This alternative approach might be acceptable under footnote 14 of Till but Wells Fargo failed to argue that it relied on the footnote to propose the approach. Additionally, the Circuit concluded that even if Wells Fargo had argued this point, the bankruptcy court would not have erred in its finding because, as Wells Fargo s expert acknowledged, there was no market to make a similar secured loan of the type proposed by the debtors. In summary, although the market was charging rates in excess of 5% on smaller, over-collateralized loans to comparable companies, applying the 5% interest rate to the installment payments to Wells Fargo is, according to the Circuit, the natural consequence of the prime-plus method, which sacrifices market realities in favor of simple and feasible bankruptcy reorganizations. As such, recognizing the plurality opinion by the Supreme Court, the approach now accepted by the vast majority of bankruptcy courts and the fact that the parties had accepted Till as governing in this appeal, the Circuit concluded that the debtors cram down interest rate was in line with Till and affirmed the lower court s decision. The Fifth Circuit concluded its analysis by emphasizing that while the Till plurality s formula approach... has become the default rule in chapter 11 bankruptcies, it was not suggesting that the prime-plus formula is the only or even the optimal method for calculating the chapter 11 cram down rate. Conclusion and Takeaways The Fifth Circuit s Texas Grand Prairie opinion does not, as the ultimate outcome might lead one to believe, support the blind application of the Supreme Court s Till analysis to chapter 11 cases. Rather, it does almost the opposite, even highlighting Justice Scalia s spirited dissent in Till, which warned that the plurality s approach would systematically undercompensate creditors, and that it was impossible to view the modest risk premium (typically 1-3% in cases, but 1.5% in Till) as anything other than a smallish number picked out of a hat. In fact, the Texas Grand Prairie opinion may be inviting secured creditors to follow Till s footnote 14 and propose a marketbased interest approach to determine the proper treatment of secured creditors in a cram down scenario. This point is not perfectly clear, perhaps because the Fifth Circuit was itself not comfortable with any of the possible options. What is clear is that litigation over the proper cram down interest rate for second creditors is likely to follow. Douglas Deutsch is a partner in Chadbourne & Parke s New York office in the firm s bankruptcy and financial restructuring group. Bonnie Dye is also located in New York and is an associate in Chadbourne s bankruptcy and financial restructuring group. 6 CHADBOURNE & PARKE LLP

9 PROTECTIONS OF SECTION 546(E) CLARIFIED By Robert J. Gayda Section 546(e) of the Bankruptcy Code is a safe harbor that protects certain payments to creditors that might otherwise be clawed back, or recovered, by a debtor. A number of recent decisions on which we have reported have interpreted this safe harbor provision broadly. See Decisions in Enron and Madoff Cases Confirm Safe Harbor Protections, International Restructuring NewsWire (February 2012) and Fifth Circuit Concludes that the Section 546(e) Safe Harbor Protects Electricity Requirements Agreement, International Restructuring NewsWire (November 2012). This growing body of jurisprudence has been bolstered by two recent appellate court decisions. On June 10, 2013 in In re Quebecor World (USA) Inc., 2013 WL , the U.S. Court of Appeals for the Second Circuit issued a decision on section 546(e) clarifying what role a financial institution must play in a transaction to qualify for the safe harbor. On April 15, 2013, District Court Judge Jed Rakoff (a well-known judge in the Southern District of New York), issued another decision in the closely-watched Madoff cases. In Securities Investor Protection Corp. v. Bernard L. Madoff Inv. Sec. LLC, 2013 WL , Judge Rakoff reiterated that parties with actual knowledge of a fraud are not eligible for the protections of the safe harbor and elaborated on this issue. This article reviews the Second Circuit s and Southern District decisions and explains why these decisions are important in the analysis of future avoidance actions. Introduction to Section 546(e) s Safe Harbor In broad terms, section 546(e) acts as a safe harbor for otherwise preferential or fraudulent transfers made in the financial industry. Given the relatively recent bankruptcies of a number of industry participants, this safe harbor and its interpretation have become particularly important. In pertinent part, section 546(e) provides that a trustee [or debtor in possession] may not avoid a transfer that is a margin payment... or settlement payment... made by or to a... financial institution... or that is a transfer made by or to... a financial institution... in connection with a securities contract.... Accordingly, section 546(e) exempts two basic transfers from certain avoidance provisions of the Bankruptcy Code: (i) a transfer that is a margin or settlement payment made by or to a financial institution; and (ii) a transfer made by or to a financial institution in connection with a securities contract. In broad terms, section 546(e) acts as a safe harbor for otherwise preferential or fraudulent transfers made in the financial industry. Given the relatively recent bankruptcies of a number of industry participants, this safe harbor and its interpretation have become particularly important. The Second Circuit s Quebecor Decision Shortly before filing for bankruptcy, Quebecor transferred approximately $376 million to CIBC Mellon Trust Co., as noteholder trustee. CIBC Mellon distributed the funds to Quebecor s noteholders and, in return, the notes were surrendered to Quebecor s parent entity. Quebecor filed for bankruptcy less than ninety days after making the payment for the notes. The creditors committee appointed in Quebecor s bankruptcy commenced an action seeking to avoid and recover the $376 million transfer as a preference pursuant to section 547 of the Bankruptcy Code. The noteholders moved for summary judgment on the action, arguing that the transfer was exempt from avoidance under the safe harbor of section 546(e). Prior to the resolution of that motion, the Second INTERNATIONAL RESTRUCTURING NEWSWIRE SUMMER

10 Circuit issued its decision in Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329 (2d Cir. 2011), a case described in detail in the February 2012 edition of the International Restructuring NewsWire (linked on the previous page). In that case, the Second Circuit held that payments made to redeem commercial paper before the maturity date were settlement payments within the meaning of section 546(e) and defined the term settlement payment as transfer[s] of cash made to complete a securities transaction. Based on the Enron decision, the Quebecor bankruptcy court and, on appeal, the district court held that Quebecor s payment fit within the definition of settlement payment set forth in Enron and, therefore, was exempt. This decision was affirmed by the Second Circuit. Significantly, the Second Circuit also held that transfers by or to a financial institution solely as an intermediary qualify for the section 546(e) safe harbor. In so ruling, the Second Circuit sided with the Third, Sixth and Eighth Circuits. (The Eleventh Circuit has held otherwise, requiring the financial institution to acquire a beneficial interest in the transferred funds or securities for the safe harbor to apply.) The Second Circuit specifically stated that [t]o the extent that Enron left any ambiguity in this regard, we expressly follow the Third, Sixth, and Eight Circuits in holding that a transfer may qualify for the... safe harbor even if the financial intermediary is merely a conduit. The Southern District of New York s Madoff Decision The recent Madoff decision rendered by the New York southern district court stems from the highly publicized cases of Bernard L. Madoff Investment Securities. The district court, in two separate decisions (one of which was detailed along with the Enron decision referred above in the February 2012 NewsWire), held that section 546(e) precluded the [t]rustee from bringing any action to recover from any of Madoff s customers any of the monies paid... to those customers except in the case of actual fraud. In making those decisions, the court found that the transfers at issue were made by or to a... stockbroker, in connection with a securities contract. The court also found that the defendants withdrawals from their accounts constituted settlement payments from a stockbroker and therefore fall within the coverage of [section] 546(e) for that independent reason. In its most recent decision, the district court both reaffirmed its prior decisions and expanded on its rationale for doing so. The defendants that remained were primarily those Both of the Quebecor and Madoff decisions confirm that a very broad interpretation of the safe harbor provision in section 546(e) is warranted but, in Madoff, limit the protections to parties who did not have actual knowledge of the Madoff fraud. whom the trustee alleged had not acted in good faith. These defendants included both some of the initial transferees of funds from Madoff Securities and some of the subsequent transferees of those funds (i.e., some of those that received payments from so-called feeder funds ). The court ruled that if the trustee could demonstrate that a defendant, whether an initial or subsequent transferee, had actual knowledge of Madoff s scheme, such transferee stood in a different posture from an innocent transferee such that section 546(e) should not apply. The court specifically noted that it is not enough for the trustee simply to allege that a transferee did not take in good faith. Instead, the trustee must show at a minimum that the transferee had actual knowledge that there were no actual securities transactions being conducted. The court also addressed an issue similar to the conduit issue raised in Quebecor. The court held that both initial and subsequent transferees are entitled to raise a defense based on the application of section 546(e) to the initial transfer from Madoff Securities. The court suggested a hypothetical situation where an investment fund in Madoff Securities withdrew funds from its investment account because an investor in that fund sought redemption of its investment. The court stated that section 546(e) would apply if either the investment fund or the investor qualified as a financial institution. Conclusions and Takeaways Both of the Quebecor and Madoff decisions confirm that a very broad interpretation of the safe harbor provision in section 546(e) is warranted but, in Madoff, limit the 8 CHADBOURNE & PARKE LLP

11 IN THE NEWS protections to parties who did not have actual knowledge of the Madoff fraud. These rulings should provide additional certainty to participants in the financial industry. Given its significance, such participants should always consider whether the safe harbor of section 546(e) applies when faced with a potential avoidance action. Robert Gayda is an associate in Chadbourne & Parke s New York office in the Firm s bankruptcy and financial restructuring group. Awards Chadbourne s Bankruptcy and Financial Restructuring Department was recognized both nationally and in New York in the 2013 edition of Chambers USA: The World s Leading Lawyers for Business. The Department was recognized as a full-service bankruptcy and financial restructuring group that has been involved in many significant bankruptcies in recent years. As was the case last year, Chambers also noted that the Department is particularly skilled on advising senior lenders, creditors committees and parties involved in Chapter 15 filings. Overall, the Department s lawyers were cited as Highly competent, very responsive, and user-friendly and A good complement of different types of lawyers who work together well. Chambers USA 2013 found Chadbourne s Bankruptcy and Restructuring Department to be highly competent, very responsive, and user-friendly and A good complement of different types of lawyers who work together well. Chambers specifically highlighted two Chadbourne partners in this year s edition. Department chair Howard Seife was identified as a cross-border restructuring expert who also boasts considerable experience in creditor representations. He was further described as an excellent strategist and relationship manager with an established presence. He is calm and deliberate, and doesn t come to snap judgments. In addition, Chadbourne partner David LeMay was said by commentators to know the Bankruptcy Code inside and out. David was also reported to be experienced across the bankruptcy spectrum, with clients noting that he has consistently demonstrated a good courtroom presence, and is very thoughtful and intellectually powerful. INTERNATIONAL RESTRUCTURING NEWSWIRE SUMMER

12 FIFTH CIRCUIT APPROVES DEBTOR S ARTIFICIAL IMPAIRMENT OF CLAIMS TO OBTAIN CONFIRMATION By Michael Distefano The provisions in the Bankruptcy Code related to the Chapter 11 confirmation process seek to carefully balance the rights of a debtor to reorganize with the rights of creditors to receive their fair share of the debtor s value. The careful balance was recently tested in a case before the Fifth Circuit Court of Appeals the federal circuit responsible for Texas, Louisiana and Mississippi when the court was asked whether a debtor could artificially impair one class of creditors holding very modest claims in order to garner that class s favor and satisfy the Bankruptcy Code s confirmation requirement that at least one class of impaired creditors vote in favor of a proposed plan of reorganization. See In re Village at Camp Bowie I, 710 F.3d 239. The Fifth Circuit response was surprising to many: a debtor may artificially impair a class of creditors to satisfy the Chapter 11 confirmation requirements. The decision may be a shift in the balance of power between debtors and creditors at the plan confirmation stage. The Bankruptcy Plan Process Under chapter 11 of the Bankruptcy Code, a debtor in possession generally seeks to reorganize its debts through court approval of a plan of reorganization. If a debtor fails to propose or achieve confirmation of a plan in a finite period of time, creditors may also be given the opportunity to propose a plan. A plan will typically create various classes of creditors depending on the nature and amount of the claims against the debtor. In classifying claims, the plan proponent may impair or leave unimpaired any class of claims. Under the Bankruptcy Code, a plan impairs a class unless the plan leaves unaltered the legal, equitable, and contractual rights of the claim holders. Impairment is particularly important in light of the Bankruptcy Code s requirement that for a plan to be approved at least one class of claims that is impaired under the plan [ ] accept [ ] the plan. See Section 1129(a)(10). Artificial impairment occurs where a plan imposes an insignificant impairment on a class of claims simply for the purpose of creating a class of creditors who will accept the plan. While many of the courts that have considered artificial impairment have acknowledged that there is nothing in the relevant Bankruptcy Code provisions that expressly prohibits the practice, courts have nonetheless found it troubling. As noted by the Third Circuit in In re Combustion Eng g, Inc., 391 F.3d 190, 243 (3d Cir. 2004), [t]he chief concern with such conduct is that it potentially allows a debtor to manipulate the Chapter 11 confirmation process by engineering literal compliance with the [Bankruptcy] Code while avoiding opposition to reorganization by truly impaired creditors. Despite discussing artificial impairment in that case, the Third Circuit did not ultimately rule on its merits. Before the Fifth Circuit s opinion in Village at Camp Bowie, only two courts of appeals the Eighth Circuit and the Ninth Circuit had squarely ruled on this issue. Case Facts In 2004, the Village at Camp Bowie acquired a parcel of real estate in Fort Worth, Texas for the purpose of leasing it as retail and office space. To improve the property, the Village invested approximately $10 million of its own equity capital and obtained additional financing by issuing approximately $36.5 million in short-term promissory notes secured by the 10 CHADBOURNE & PARKE LLP

13 IN THE NEWS Artificial impairment occurs where a plan imposes an insignificant impairment on a class of claims simply for the purpose of creating a class of creditors who will accept the plan. property. The original maturity date of the notes was January 22, Following improvements to the property, the Village struggled to attract tenants and, as a result, it was unable to pay the notes as they became due. Following a series of modifications and forbearances with successive owners of the notes, the Village defaulted on the notes on February 11, 2010 and the owner of the notes Western Real Estate Equities resolved to foreclose on the property. The day before the foreclosure sale, the Village filed a chapter 11 petition, thereby staying the foreclosure proceedings. At the time of the filing, the outstanding principal on the notes was approximately $32.1 million. In addition, the Village owed approximately $60,000 in unsecured trade debt. In the course of the bankruptcy proceeding, the bankruptcy court determined that the value of the Village s real estate was approximately $34 million. This amount was greater than the total allowable claims of the Village s creditors. The plan of reorganization ultimately proposed by the Village provided for only two voting, impaired classes: one consisting of Western s secured notes claim and the other consisting of the unsecured trade debt. The proposed plan provided that Western would receive a new five-year note in the amount of its secured claim, with interest, and with a balloon payment of remaining principal and interest due at maturity. With respect to the trade claims, the plan proposed to pay trade creditors in full three months after the effective date. However, the trade creditors were not to be paid their accrued interest of approximately $900. Unsurprisingly, the unsecured trade creditors voted to accept the plan. Western voted its much larger secured claim against the plan. During the confirmation hearing, Western argued that the plan did not satisfy section 1129(a)(10) s requirement that at least one impaired class vote in favor of the plan because the trade creditors were only minimally impaired. According to Western, the debtor s purpose of The 2013 edition of The Legal 500: United States also recognized Chadbourne s Bankruptcy and Financial Restructuring Department. Three Chadbourne partners were specifically identified by The Legal 500: Howard Seife, Theodore Zink and David LeMay. In addition, the Restructuring & Turnaround Intelligence Forum recently recognized Chadbourne s work as a finalist in several categories of its 2013 Turnaround Atlas Awards. The two finalists in the large markets category were the Tribune Company s Chapter 11 plan of reorganization and the Centrais Elétricas do Pará SA (CELPA) restructuring. In the Tribune case, Chadbourne was counsel to the Official Committee of Unsecured Creditors, one of the Tribune plan proponents. The Tribune plan of reorganization was confirmed in July 2012 and became effective in December The Chadbourne team for the Official Committee of Unsecured Creditors in Tribune was led by Department chair Howard Seife and included partners David LeMay, Douglas Deutsch, Andrew Rosenblatt and Chadbourne litigation partner Thomas McCormack. In the CELPA matter, Chadbourne represented The Bank of New York Mellon, as trustee, in a matter involving a judicial restructuring in Brazil followed by a Chapter 15 case. The Chadbourne team was led by finance partner Marian Baldwin Fuerst and bankruptcy counsel Frank Vazquez. This matter was also honored by Latin Lawyer as Restructuring Deal of the Year Chadbourne was also honored as a finalist in the Turnaround Atlas Awards in the middle-market category. In that category, Chadbourne was recognized for its work on the PT Arpeni Pratama Ocean Line restructuring. In that case, Chadbourne represented HSBC Bank USA, N.A., as trustee, in connection with bonds guaranteed by Arpeni, an entity which filed for a suspension of payments proceeding in Indonesia. The Indonesian proceeding was subsequently recognized in the United States in a Chapter 15 case, the first of its kind involving an Indonesian debtor. The transaction, which was also awarded Restructuring Deal of the Year (Asia) by the International Financial Law Review (also known as the IFLR ), was led by Marian Baldwin Fuerst and Frank Vazquez. INTERNATIONAL RESTRUCTURING NEWSWIRE SUMMER

14 The Fifth Circuit explained that including within the definition of impairment a motive inquiry would be inconsistent with section 1123(b)(1) of the Bankruptcy Code, which provides that a plan proponent may impair or leave unimpaired any class of claims, and does not contain any indication that impairment must be driven by economic motives. minimally impairing the trade creditors was simply to create an accepting impaired class to satisfy section 1129(a)(10). Western alternatively argued that such tactics violated the good faith requirement found in Bankruptcy Code section 1129(a)(3). The bankruptcy court agreed that the Village had sufficient assets to leave the trade creditors claims unimpaired but rejected Western s distinction between artificial and economically driven impairment. The bankruptcy court explained that the plain language of the Bankruptcy Code is clear and cannot be read to require any particular degree of impairment. With respect to Western s argument that the impairment of the trade creditors was not proposed in good faith, the bankruptcy court concluded that while artificial impairment is a factor to consider in this analysis, artificial impairment does not amount per se to a failure of good faith. Because the Village had proposed the plan for the legitimate bankruptcy purposes of reorganizing its debts, continuing its business and preserving its equity in the subject real estate, the court concluded that the good faith requirement was satisfied. Accordingly, the bankruptcy court confirmed the plan, Western appealed the decision directly to the Fifth Circuit. Fifth Circuit Opinion The Fifth Circuit began its analysis by noting that a split on the issue existed between two Courts of Appeal. In In re Windsor on the River Assocs., Ltd., 7 F.3d 127 (8th Cir. 1993), the Eighth Circuit held that a claim is not impaired [for purposes of section 1129(a)(10)] if the alteration of the rights in question arises solely from the debtor s exercise of discretion. In contrast, in In re L&J Anaheim Assocs., 995 F.2d 940 (9th Cir. 1993), the Ninth Circuit held that section 1129(a)(10) does not distinguish between discretionary and economically driven impairment because the plain language of section 1124 says that a creditor s claim is impaired unless its rights are left unaltered by the plan and there is no suggestion that only alterations of a particular kind or degree can constitute impairment. The Fifth Circuit joined the Ninth Circuit in holding that section 1129(a)(10) does not distinguish between discretionary and economically driven impairment. This is because, according to the Fifth Circuit, section 1124 provides that any alteration of a creditor s rights, no matter how minor, constitutes impairment. The Fifth Circuit explained that including within the definition of impairment a motive inquiry would be inconsistent with section 1123(b)(1) of the Bankruptcy Code, which provides that a plan proponent may impair or leave unimpaired any class of claims, and does not contain any indication that impairment must be driven by economic motives. The Fifth Circuit agreed that a plan proponent s motives and methods for complying with the Bankruptcy Code s plan requirements must be scrutinized, if at all, under section 1129(a)(3) s good faith standard and in light of the totality of the circumstances. The Fifth Circuit then acknowledged that [w]here [a] plan is proposed with the legitimate and honest purpose to reorganize and has a reasonable hope of success, the good faith requirement of 1129(a)(3) is satisfied. On this issue, the Fifth Circuit deferred to the bankruptcy court s finding that the Village had proposed its plan in good faith. The Fifth Circuit made clear, however, that achieving literal compliance with 1129(a)(10) does not end a court s analysis. It suggested that an inference of bad faith might be stronger where a debtor creates an impaired accepting class out of whole cloth by incurring a debt with a related party, particularly if there is evidence that the lending transaction is a sham. 12 CHADBOURNE & PARKE LLP