Debate Intensifies as to Whether the Bankruptcy Code’s Avoidance Provisions Apply Extraterritorially

by Charles M. Oellermann and Mark G. Douglas (Jones Day).

The ability to avoid fraudulent or preferential transfers is a fundamental part of U.S. bankruptcy law. However, when a transfer by a U.S. entity takes place outside the U.S. to a non-U.S. transferee—as is increasingly common in the global economy—courts disagree as to whether the Bankruptcy Code’s avoidance provisions apply extraterritorially to avoid the transfer and recover the transferred assets. Several bankruptcy courts have addressed this issue in recent years, with inconsistent results.

In a recent example, in In re CIL Limited, 582 B.R. 46 (Bankr. S.D.N.Y. 2018), the U.S. Bankruptcy Court for the Southern District of New York, disagreeing with other courts both within and outside its own district, ruled that the “transfer of an equity interest in a U.K. entity to a Marshall Islands entity was a foreign transfer” and that the Bankruptcy Code’s avoidance provisions do not apply extraterritorially because “[n]othing in the language of sections 544, 548 and 550 of the Bankruptcy Code suggests that Congress intended those provisions to apply to foreign transfers.”

The decision further muddies the waters on an issue that has become increasingly prominent as the volume of cross-border bankruptcy cases continues to grow and cross-border transactions become ubiquitous. The split on this issue exists not merely between courts in different jurisdictions, but also among courts in the Southern District of New York, where the majority of cross-border bankruptcy cases have traditionally been filed.

The full article is available here.

The Year in Bankruptcy: 2017

by Charles M. Oellermann and Mark G. Douglas (Jones Day).

In their annual chronicle of business bankruptcy, financial, economic, and related developments in the U.S., Charles M. Oellermann and Mark G. Douglas of Jones Day review the most significant events of 2017, including business bankruptcy filing statistics and industry trends; newsworthy developments regarding sovereign and commonwealth debt; the top 10 public-company bankruptcies of the year; notable private and cross-border bankruptcy cases; significant business bankruptcy and U.S. Supreme Court bankruptcy rulings; bankruptcy-related legislative and regulatory developments; noteworthy chapter 11 plan confirmations and exits from bankruptcy; and more.

The article is available here.

Fraudulent Transfer Avoidance Recovery Not Limited to Total Amount of Creditor Claims

posted in: Avoidance, fraudulent transfer | 0

By Jane Rue Wittstein and Mark G. Douglas (Jones Day)

Courts disagree as to whether the amount that a bankruptcy trustee or chapter 11 debtor-in-possession can recover in fraudulent transfer avoidance litigation should be capped at the total amount of unsecured claims against the estate. The U.S. Bankruptcy Court for the District of Delaware recently weighed in on this issue in PAH Litigation Trust v. Water Street Healthcare Partners, L.P. (In re Physiotherapy Holdings, Inc.), 2017 WL 5054308 (Bankr. D. Del. Nov. 1, 2017). Noting the absence of any guidance on the question from the U.S. Court of Appeals for the Third Circuit, the bankruptcy court ruled that, unlike most state fraudulent transfer laws, which limit a creditor’s recovery to the amount of its unpaid claim against the transferor, section 550 of the Bankruptcy Code imposes no such limitation on the estate’s recovery. The ruling reinforces the idea that federal and state fraudulent transfer avoidance laws are intended to be remedial rather than punitive. Under state law, this understandably means that an avoidance recovery is limited to the amount necessary to make an injured creditor whole. Under federal bankruptcy law, recoveries must benefit the bankruptcy estate, which includes the interests of creditors and other stakeholders.

The article is available here.

Recent Rulings Deepen the Divide on Whether the Bankruptcy Code’s Avoidance Provisions Apply Extraterritorially

By Charles M. Oellermann and Mark G. Douglas (Jones Day)

The ability to avoid fraudulent or preferential transfers is a fundamental part of U.S. bankruptcy law. However, when a transfer by a U.S. entity takes place outside the U.S. to a non-U.S. transferee—as is increasingly common in the global economy—courts disagree as to whether the Bankruptcy Code’s avoidance provisions apply extraterritorially to avoid the transfer and recover the transferred assets.

Several bankruptcy courts have addressed this issue in recent years, with inconsistent results. For example, in In re Ampal-Am. Israel Corp., the Bankruptcy Court for the Southern District of New York ruled that the avoidance provisions of the Bankruptcy Code do not apply outside the U.S, disagreeing with other courts both within and outside its own district. The Bankruptcy Court for the District of Delaware, however, held to the contrary in In re FAH Liquidating Corp., where it held that the presumption against territoriality did not prevent a trustee from avoiding an overseas transfer.

More recently, in a pair of adversary proceedings commenced in the chapter 11 case of Arcapita Bank, the Bankruptcy Court for the Southern District of New York held that the “presumption against extraterritoriality” did not defeat claims against foreign banks under sections 362 and 542 (while also ruling it need not decide whether sections 547 and 550 apply extraterritorially because it concluded that the challenged transfers occurred within the U.S.).

Taken together, these recent decisions further muddy the waters on an issue that has become increasingly prominent as the volume of cross-border bankruptcy cases continues to grow.

The article is available here.

FTI Roundup

The Seventh Circuit held last July in FTI Consulting, Inc. v. Merit Management Group, LP, 2016 BL 243677 (7th Cir. July 28, 2016), that § 546(e) of the Bankruptcy Code is not a safe harbor for “transfers that are simply conducted through financial institutions.” This decision deepens a circuit split on this issue. While the Second, Third, Sixth, Eighth, and Tenth Circuits have held that the plain language of § 546(e) protects transfers through financial institutions as settlement payments, the Seventh Circuit’s interpretation agrees with the Eleventh Circuit’s older decision in In re Munford, 98 F.3d 604, 610 (11th Cir. 1996). The legislative purpose of § 546(e) was to prevent the insolvency of one financial institution from causing systemic harm to the market as a whole. However, its text also has deep implications for leveraged buyouts that might render target corporations insolvent because payments to selling shareholders almost invariably pass through brokers and clearinghouses that are covered by the safe harbor.

Several law firms have now written memos on the FTI decision. Schiff Harden postulates that debtors will be more likely to forum shop when filing for bankruptcy when they have recently undergone a leveraged buyout. Jones Day makes clear that shareholders selling into a leveraged buyout face differing levels of risk depending on which forums the corporation could legally avail itself of in a bankruptcy proceeding. And Dechert argues that FTI Consulting will result in different treatment for parties selling identical securities in leveraged buyouts: financial institutions, stockbrokers, and the like will remain protected by the safe harbor when they are beneficial owners of stock, but other shareholders will be subject to avoidance action.

Tender Offer Approved to Implement Classwide Debt Exchange Outside Plan of Reorganization

posted in: Workouts and Pre-Packs | 0

By Charles M. Oellermann and Mark G. Douglas, Jones Day

Debt-for-equity swaps and debt exchanges are common features of out-of-court and chapter 11 restructurings. For publicly traded securities, out-of-court restructurings in the form of “exchange offers” or “tender offers” are, absent an exemption, subject to the rules governing an issuance of new securities under the Securities Exchange Act of 1933 (the “SEA”) as well as the SEA tender offer rules. By contrast, it is generally understood that the SEA rules do not apply if an exchange or tender offer takes place as part of a restructuring under chapter 11 of the Bankruptcy Code, which provides that certain federal and state securities laws do not apply to the offer or sale of securities under a chapter 11 plan.

In Del. Trust Co. v. Energy Future Intermediate Holdings, LLC (In re Energy Future Holding Corp.), 2015 BL 44121 (D. Del. Feb. 19, 2015), Judge Andrews affirmed a bankruptcy court order approving a settlement between debtors and certain secured noteholders where the vehicle was a postpetition tender offer (of old notes for new notes to be issued under a debtor-in-possession facility). The district court ruled that a tender offer may be used to implement a classwide debt exchange in bankruptcy outside a plan of reorganization. It also held that the Bankruptcy Code’s confirmation requirements do not apply to a pre-confirmation settlement and that the settlement at issue did not constitute a sub rosa chapter 11 plan.

The full-length article discussing the ruling can be found here.

“Trade Away!”—Bankruptcy Court for the Southern District of New York Decides That Original Issue Discount From Fair Value Exchanges Is Allowable in Bankruptcy

posted in: Claims Trading | 0

Authors: Richard L. Wynne and Lance Miller, Jones Day

Debt exchanges have long been utilized by distressed companies to address liquidity concerns and to take advantage of beneficial market conditions.  A company with burdensome debt obligations might seek to exchange existing notes for new notes with the same outstanding principal but with borrower-favorable terms (a “Face Value Exchange”).   Alternatively, the company could attempt to exchange existing notes for new notes with a lower face amount (a “Fair Value Exchange”).  Under either scenario, a debt exchange will create “original issue discount” (“OID”) equal to the difference between the face amount of the new notes and the value generated by the exchange for the company (i.e., the fair market value of the old notes).  For tax and accounting purposes, OID is treated as interest that is amortized over the life of the note, with the face amount scheduled to be paid on maturity.

When a company files for bankruptcy, however, unaccrued OID should arguably be disallowed under section 502(b)(2) of the Bankruptcy Code as “unmatured interest.”  However, to encourage out-of-court restructurings, both the Second and Fifth Circuit Courts of Appeal have ruled that unaccrued OID from Face Value Exchanges should not be disallowed.  In In re Residential Capital , LLC, 501 B.R. 549 (Bankr. S.D.N.Y. 2013), the court expanded that rationale to apply to Fair Value Exchanges.  If interpreted broadly and adopted by other courts, the decision will bring certainty to the markets that OID resulting from a debt-for-debt exchange will be allowed in bankruptcy, regardless of how the exchange is structured.

A more detailed discussion of the ruling is available here.