Tighter Standards Emerge For Pleading Intentional Fraudulent Transfer Claims

posted in: Avoidance | 0

By Mark Chehi, Robert Weber and Stephen Della Penna of Skadden, Arps, Slate, Meagher & Flom LLP

The U.S. Bankruptcy Court for the Southern District of New York recently dismissed intentional fraudulent transfer claims asserted against former shareholders of Lyondell Chemical Company. Weisfelner v. Fund 1 (In re Lyondell Chemical Co.), 541 B.R. 172 (Bankr. S.D.N.Y. 2015) (“Lyondell II”). The Bankruptcy Court opinion adopts a strict view of what constitutes “intent,” and thereby tightens pleading standards applicable to complaints asserting intentional fraudulent transfers.

The intentional fraudulent transfer claims at issue focused on Basell AFSCA’s 2007 leveraged acquisition of Lyondell Chemical Company. As is typical in LBO transactions, Lyondell itself borrowed money to finance the LBO and pay its former shareholders for their Lyondell shares. Just 13 months later, Lyondell filed a voluntary chapter 11 petition.

A bankruptcy trustee subsequently asserted fraudulent transfer claims against the former Lyondell shareholders to recover the LBO payments received by them. The litigation asserted that the 2007 LBO transaction was avoidable as an intentional fraudulent transfer. The Bankruptcy Court dismissed the claims and adopted a restrictive pleading standard that requires an intentional fraudulent transfer plaintiff to plead facts that show “actual intent, as opposed to implied or presumed intent.” The plaintiff must allege some sort of “intentional action to injure creditors.” Alleging “[o]ther wrongful acts that . . . may be seriously prejudicial to creditors” – such as negligence or a breach of fiduciary duty – will not support an intentional fraudulent transfer claim.

The full article is available here.

The Abolition of Dysfunctional Contracts in Bankruptcy Reorganizations

posted in: Avoidance | 0

By Jay Lawrence Westbrook and Kelsi Marie Stayart, University of Texas at Austin School of Law

A traditional case law test has limited the application of bankruptcy contract rules to contracts that have a certain nearly mystical quality of “executoriness.” Contracts that fail the “Countryman” test are deemed not subject to those value-maximizing rules. Courts treat these contracts in a variety of ways, but often these contracts are removed entirely from the bankruptcy estate, destroying value and crippling reorganization efforts. These effects are especially serious with regard to less-traditional types of contracts, including IP licenses, options, and LLC operating agreements. The application of the test undercuts almost every policy underlying the Bankruptcy Code, including the fresh start and equal treatment of creditors. The test also gives judges an unpredictable and nearly unlimited discretion in resolving contracts often worth huge amounts of money.

Section 365 of the Bankruptcy Code allows a trustee or debtor-in-possession to assume or reject “executory contracts.” Assumption permits the estate to take on profitable contracts and make the contract counterparty perform, while elevating the counterparty to an administrative claimant. Rejection permits the bankruptcy estate to escape unprofitable or ill-advised contracts, leaving the contract counterparty with a damage claim payable in small Bankruptcy Dollars. The effect is to spread losses among all unsecured creditors while minimizing the overall loss. The existing approach prevents the achievement of these important results.

We propose an abolition of the requirement of “executoriness,” thus subjecting virtually all contracts to Section 365. In its place, we offer a simple approach to analyzing contracts in bankruptcy that aligns with and advances the fundamental principles of bankruptcy reorganization.

For the full article, see here.

Lehman’s Derivative Portfolio

By Stephen Lubben, Seton Hall University School of Law

Derivatives themselves were likely at most a secondary cause of the Lehman’s collapse, and played a more central role in other firms caught up in the financial crisis, like AIG. But the late Harvey Miller suggested that derivatives were responsible for a massive loss in value suffered by Lehman post-bankruptcy. Bryan P. Marsal, the Lehman estate administrator, likewise asserted that as much as $75 billion in value was destroyed, largely as a result of the sudden termination of Lehman’s derivatives book.

The singular losses caused by Lehman’s derivative portfolio to Lehman’s bankruptcy estate come from these safe harbors and the system of closeout netting the safe harbors support. While the safe harbors have been thoroughly studied and debated in the abstract, a close look at Lehman’s experience provides important insights for the future.

In particular, the largest part of Lehman’s derivative portfolio shows how financial institutions will suffer when resolution is attempted in the traditional bankruptcy system, despite the Dodd-Frank Act’s professed preference for “normal” bankruptcy process over specialized insolvency regimes like the new “Orderly Liquidation Authority.”

And the abrupt closeout of Lehman’s cleared derivatives portfolio by CME, which Lehman’s examiner noted as the source of several obvious losses to the bankruptcy estate, also provides important insights, especially given Dodd-Frank’s strong preference for central clearing going forward.

My paper Lehman’s Derivative Portfolio, written as a chapter for a forthcoming book, looks at both issues, and suggests that the continuation of the safe harbors “as is” renders chapter 11 nonviable for larger financial institutions, and recent contractual attempts to work around the safe harbors are insufficient to solve the problem, while the increased role of clearinghouses in financial institution failures will force regulators to confront difficult choices. In short, the regulators will have to balance two competing systemic risks: the risk of an unruly resolution of the financial institution, balanced against increased risk to the clearinghouse.

The Roundtable has previously posted multiple items on the derivatives safe harbors: on selling Lehman’s derivatives portfolio, systemic risk issues, the safe harbors’ history, two posts on the ISDA derivatives stay protocols (here and here), and on congressional testimony.

United States Court of Appeals for the Second Circuit Holds That Claims Arising from Securities of a Debtor’s Affiliate Must Be Subordinated to Senior or Equal Claims of the Same Type as the Underlying Securities

posted in: Cramdown and Priority | 0

By Fredric Sosnick, Douglas P. Bartner, Joel Moss, Solomon J. Noh and Ned S. Schodek of  Shearman & Sterling LLP

 

Lehman Brothers Inc. (“LBI”) was lead underwriter for unsecured notes issued by Lehman Brothers Holdings Inc., LBI’s affiliate and parent. A Master Agreement Among Underwriters governed the relationship between LBI and the offering’s junior underwriters, and created among them a right of indemnification for liabilities resulting from securities fraud claims related to the offerings.

 

Following the bankruptcy of Lehman Holdings and the SIPA proceeding of LBI, investors filed securities fraud lawsuits alleging material misstatements and omissions in the offering documents, and asserted claims for contribution against LBI. The SIPA trustee objected, arguing that the claims were subject to mandatory subordination under § 510(b) of the Bankruptcy Code. The underwriters argued that because Lehman Holdings, not LBI, issued the securities, § 510(b) did not apply to the underwriters’ claims.

 

The Second Circuit held that claims arising from securities of a debtor’s affiliate must be subordinated to all claims senior or equal to claims of the same type as the underlying securities. As a result, the claims for contribution and reimbursement for losses incurred in the course of defending and settling securities fraud lawsuits brought by investors in securities issued by LBI’s affiliate were subordinated to the claims of LBI’s general unsecured creditors pursuant to § 510(b).

 

This Court of Appeals’ decision was based on precedent, textual support and legislative history, and it clarifies the appropriate classification of claims in the affiliate-securities context.

 

For the full memo is available here.

 

The Trust Indenture Act of 1939 in Congress and the Courts in 2016: Bringing the SEC to the Table

posted in: Workouts and Pre-Packs | 0

By Mark J. Roe, Harvard Law School

The Trust Indenture Act’s ban on restructuring payment terms via a vote has come to the fore in recent litigation. This memo examines broad aspects of the recent controversies to outline a path forward for a sensible legal structure governing out-of-bankruptcy restructurings.

There are four points to be made:

  1. The recent Southern District of New York decisions striking down exit consent transactions are justified under the Trust Indenture Act.
  2. The Act impedes out-of-bankruptcy restructurings because it clearly but mistakenly bars votes that restructure bond payment terms. Restructurings outside bankruptcy cannot succeed when widespread consent is needed. But in an institutionalized bond market, there is little reason to bar restructuring by vote.
  3. The Act’s ban on votes creates the potential for holdouts (or earnest dissenters) to destroy a good deal that most bondholders sincerely want. But to combat the Act’s voting ban (and sometimes to force an unsound restructuring), issuers use exit consent offers, which can impair bondholders’ indenture rights so severely that they reluctantly accept an offer whose terms they dislike. Courts cannot resolve both of these distortions; other lawmakers need to come to the table.
  4. Legislative solutions are possible. While awaiting wise legislation, there is another way to construct sensible rules for bond workouts — one that has previously not been recognized. The Securities and Exchange Commission has broad authority to exempt indentures and transactions from the full force of the ban on voting.

SEC exemptive rulemaking provides a viable path to facilitate out-of-bankruptcy restructurings of public bond issues going forward. The appellate courts can and should affirm the lower court decisions that the Trust Indenture Act bans exit consent degradation, and the SEC can and should then use its exemptive power to carve out uncoerced votes on payment terms from the Act’s voting ban.

The full memo is available here.

For some of our most recent previous posts on the Trust Indenture Act see here, here, and here.