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ReviewIN THIS ISSUE

B U S I N E S S R E S T R U C T U R I N G

Recent Developments in Bankruptcy and Restructuring Vol. 1 No. 1 April 2002

Validity of Third-PartyInjunctions UpheldAn injunction preventing creditors from suing an insurer or other non-debtorsource of funding for the payment of claims under a plan of reorganization hasbecome the cornerstone of nearly every chapter 11 case involving a companyseeking to deal with mass tort liabilities. Whether such an injunction is enforce-able to preclude litigation by non-consenting creditors was recently addressedby the Sixth Circuit Court of Appeals in In re Dow Corning Corporation. Thedecision reinforces the continuing viability of non-debtor injunctions based uponthe important policy considerations present in mass tort cases.

Effect of Plan Confirmation on Third Party ObligationsWith certain exceptions, the provisions of a confirmed chapter 11 plan of reor-ganization are binding upon all creditors, whether or not they vote to accept theplan. In addition, confirmation of a plan acts to discharge the debtor from anydebt that arose prior to the confirmation date, even if a creditor failed to file aproof of claim evidencing its debt or voted to reject the plan. However, whilethe Bankruptcy Code precludes actions against the reorganized debtor or itsproperty to collect on pre-bankruptcy debts, the same cannot be said with re-spect to litigation against non-debtor third parties who share liability for the samedebts. Thus, Bankruptcy Code section 524(e) provides that “the discharge of adebt of the debtor does not affect the liability of any other entity on, or the prop-erty of any other entity for, such debt.” Nevertheless, where the debtor-companyis ultimately responsible for any liability incurred by a non-debtor third party(e.g., when an officer or director has a contractual right of indemnification fromthe debtor) or where the third party has agreed to fund a debtor’s chapter 11plan of reorganization, many bankruptcy courts have enjoined litigation againstsuch non-debtors. In In re Dow Corning Corp., the Sixth Circuit examined thebankruptcy court’s power to issue and enforce an injunction benefiting non-debt-ors under Dow Corning’s chapter 11 plan of reorganization.

1 Validity of Third-PartyInjunctions Upheld

The Sixth Circuit held that achapter 11 plan of reorganizationcan enjoin creditors from suingnon-debtor third parties onlyunder unusual circumstances

3 What’s New at Jones Day

4 Creditor Inaction Results in For-feiture of Subordination Rights

Whether a subordination clausesurvives confirmation of a plan ofreorganization whose classificationscheme disregards it was recently ad-dressed by a Delaware district court

6 Chapter 11 Fiduciary’s Conflictof Interest Taints Reorganization

A Delaware bankruptcy court heldthat because the debtor’s CEO wasalso employed as a consultant byits largest creditor, the CEO’s con-flict of interest rendered any planof reorganization unconfirmable

8 Legislative Alert

9 The Important Role of U.S.Bankruptcy Courts in Cross-Border Bankruptcies

A New York bankruptcy court’sopinion reaffirms the importantrole played by U.S. courts in inter-national insolvency proceedings

2 I J o n e s , D a y , R e a v i s & P o g u e

BackgroundDow Corning was for nearly 30 yearsthe predominant producer of siliconegel breast implants. Its fortunes began toalter drastically after certain medicalstudies in the 1980s suggested that sili-cone gel may cause various auto-immune tissue diseases and the Foodand Drug Administration ordered thatsilicone gel implants be taken off the mar-ket in 1992. It was not long before tensof thousands of implant recipients suedDow and its two shareholders, DowChemical Company and Corning, con-tending that they had been injured byauto-immune reactions to the silicone inthe implants.

A $4.225 billion global settlementcollapsed in 1995 when hundreds ofthousands more women than antici-pated filed claims with the settlementfund. Dow filed a chapter 11 petitionlater that year. On November 30, 1999,the bankruptcy court confirmed a chap-ter 11 plan of reorganization jointly pro-posed by Dow and a committeerepresenting tort claimants.

Dow Corning’s Plan of ReorganizationThe chapter 11 plan created a $2.35 bil-lion fund to pay claims asserted by per-sonal injury claimants, governmenthealth care payers and various othercreditors asserting products liabilityclaims. Contributions to the fund camefrom Dow’s insurers, its shareholdersand the company’s operating cash re-serves. In exchange, the insurers andshareholders were released from all fur-ther liability on claims arising fromsettled personal injury claims, and theplan permanently enjoined any claimantfrom suing the non-debtor third partyinsurers and shareholders. Separatemechanisms were established under theplan to deal with settling and non-settling claimants. Those claimants who

elected to settle were channeled to a“settlement facility,” which was autho-rized to negotiate payments out of fundsset aside for that purpose. Claimantswho refused to settle were channeled toa “litigation facility” that acted as thedefendant in any litigation.

Although the bankruptcy courtconfirmed Dow’s plan, it construed thenon-debtor release and injunction pro-visions to apply only to consentingcreditors. Certain claimants who hadvoted to reject the plan of reorganiza-tion appealed. The district court af-firmed the order confirming Dow’schapter 11 plan, but reversed the bank-ruptcy court’s interpretation of the re-lease and injunction provisions, findingthat those provisions applied to allcreditors, consenting and otherwise.

The Sixth Circuit Rules that aConfirmed Plan May EnjoinNon-Consenting CreditorsNoting that the power of a bankruptcycourt to enjoin a non-consentingcreditor’s actions against a non-debtorwas a question of first impression in theSixth Circuit, the Court of Appealsfound that the issuance of such injunc-tions was within the powers conferredto bankruptcy courts under the Bank-ruptcy Code, but that this power couldbe wielded only under “unusual circum-

The Court of Appeals found that the issuance

of such injunctions was within the powers

conferred to bankruptcy courts under the

Bankruptcy Code, but that this power could

be wielded only under “unusual circumstances.”

stances.” The Bankruptcy Code, thecourt explained, neither explicitly sanc-tioned nor prohibited injunctions ofnon-consenting creditor’s claims againsta non-debtor to facilitate a plan of reor-ganization. Nevertheless, it noted, abankruptcy court has broad equitablepower to “issue any order, process, orjudgment that is necessary or appropri-ate to carry out the provisions” of theBankruptcy Code, including measuresdeemed necessary and appropriate in thecourt’s discretion to implement a chap-ter 11 plan of reorganization. Emphasiz-ing that a plan of reorganization mayinclude any appropriate provision notinconsistent with the applicable provi-sions of the Bankruptcy Code, theCourt of Appeals concluded that thebankruptcy court, “as a forum for re-solving large and complex mass litiga-tions, has substantial power to reordercreditor-debtor relations needed toachieve a successful reorganization.”

The Sixth Circuit acknowledgedthat the power of a bankruptcy court toenjoin the actions of non-consentingcreditors against non-debtors is by nomeans universally accepted. It gave shortshrift to the reliance by other courts onBankruptcy Code section 524(e) for theproposition that the provisions of achapter 11 plan of reorganization can-not affect the liability of a non-debtor,

B u s i n e s s R e s t r u c t u r i n g R e v i e w I 3

stating merely that while section 524(e)explains the effect of a debtor’s dis-charge, it does not address, let aloneprohibit, the release of a non-debtor.Next, the Court of Appeals found faultwith the bankruptcy court’s conclusionthat non-debtor releases are precludedby a limitation under non-bankruptcylaw on the equitable powers of a bank-ruptcy court. The bankruptcy court haddetermined that non-debtor releaseswere unprecedented in traditional equityjurisprudence, and therefore exceed thebankruptcy court’s equitable powers.According to the Sixth Circuit, becausethe Bankruptcy Code gives bankruptcycourts the power to grant injunctions“necessary or appropriate the carry outthe provisions” of the Bankruptcy Code,the bankruptcy court is not confined totraditional equity jurisprudence in de-fining the limits of its authority.

Unusual Circumstances RequiredThe Court of Appeals then turned to thecircumstances under which a third-partyinjunction is appropriate. It allied itselfwith those courts that have held that en-joining a non-consenting creditor’s actionsis appropriate only under “unusual cir-cumstances.” The Court of Appealsadopted the following seven-part test tobe applied in determining whether “un-usual circumstances” justify enjoiningnon-consenting creditors under a plan ofreorganization:

• There is an identity of interests betweenthe debtor and the third party, usuallyan indemnity relationship, such that asuit against the non-debtor is, in es-sence, a suit against the debtor or willdeplete assets of the debtor’s estate;

• The non-debtor has contributed sub-stantial assets to the reorganization;

• The injunction is essential to reorga-nization; namely, the reorganizationhinges on the debtor being free fromindirect suits against parties whowould have indemnity or contribu-tion claims against the debtor;

• The affected class or classes has over-whelmingly voted to accept the plan;

• The plan provides a mechanism to payfor all, or substantially all, of the classor classes affected by the injunction;

• The plan provides an opportunity forthose claimants who choose not tosettle to recover in full, and

• The bankruptcy court made a recordof specific factual findings that sup-port its conclusions.

continued on page 12

John J. Rapisardi’s (New York) quar-

terly Bankruptcy Practice column en-

titled “Debate Continues on Priority of

Securities Fraud Claims in Bankruptcy”

appeared in the March 14, 2002 edi-

tion of the The New York Law Journal.He will also be a participating panel-

ist at the American Bar Institute’s May

2, 2002 Bankruptcy Conference in

New York City.

Richard M. Cieri (Cleveland) was

among the outstanding bankruptcy

professionals selected for listing in the

2002 edition of the K & A Restructur-ing Register: America’s Top 100. He

was also named as one of the Out-

standing Bankruptcy Lawyers in 2001

in the December 15, 2001 edition of

Turnarounds & Workouts and will be

speaking in New York City on June 17,

2002 at the American Bankruptcy

Institute’s second annual conference on

Workouts, Restructurings and M&A

Transaction Alternatives: The Deal-

Maker’s Perspective.

Christopher L. Carson (Atlanta) spoke

on February 8, 2002 on perfection of

security interests under the revised Uni-

form Commercial Code at a Lorman

Education Seminar in Atlanta.

Debra K. Simpson (Dallas) and DanielP. Winikka (Dallas) co-authored an ar-

ticle entitled “The Broad Scope of Sub-

ordination of Claims Under Section

510(b) of the Bankruptcy Code” that will

appear in the May or June 2002 issue

of the Annual Survey of Bankruptcy Law.

On February 1-2, 2002, Neil P. Olack(Atlanta) participated in a panel dis-

cussion on “Director and Officer Liabil-

ity Issues” at the Seventh Annual Rocky

Mountain Bankruptcy Conference in

Denver.

What’s New at Jones Day?

Log on to www.jonesday.com for additional information concerning Jones Day’snationwide Restructuring and Reorganization Practice as well as the firm’s otherpractice groups throughout the world.


Whether a subordination clausesurvives confirmation of a plan ofreorganization whose classificationscheme disregards it was recently ad-dressed by the United States DistrictCourt for the District of Delaware in Inre American White Cross, Inc. The court’sdecision illustrates that senior creditorsmust be vigilant in ensuring that confir-mation of a chapter 11 plan of reorgani-zation does not extinguish theircontractual rights to priority of payment.

Subordination in BankruptcyThe concept of claims subordination,whether contractual, statutory or equi-table, is well recognized under the Bank-ruptcy Code. If the claims of one creditoror group of creditors are subordinated inaccordance with the provisions of a validand enforceable agreement, the subordi-nation clause is enforceable in a bank-ruptcy case to the same extent that itwould be enforceable under applicablenon-bankruptcy law. The BankruptcyCode also provides for mandatory subor-dination of damage claims arising fromthe rescission of a purchase or sale of adebtor-company’s securities to prevent thebootstrapping of equity interests intoclaims that are pari passu with other credi-tor claims. Finally, in cases where a credi-tor has engaged in misconduct that causesinjury to other creditors, the BankruptcyCode preserves the bankruptcy court’sgeneral equitable power to subordinatethat creditor’s claim.

Terms of a Confirmed Plan of Reorga-nization Binding on All CreditorsWith certain exceptions, the provisionsof a confirmed chapter 11 plan of reor-

ganization are binding on all creditors,whether or not they vote in favor of theplan. Upon expiration of the timewithin which any appeal of a bank-ruptcy court order confirming a planmust be filed, the order itself and anyfactual or legal determinations that itcontains become final under principlesof res judicata. This means that those de-terminations cannot be subsequentlychallenged by any creditor or otherparty-in-interest in the chapter 11 case.However, it is unclear whether a credi-tor or party-in-interest is precluded fromseeking to enforce rights that are at leastarguably not specifically abrogated bythe plan or the order confirming it. TheDelaware district court addressed thisquestion in American White Cross.

BackgroundAmerican White Cross Laboratories,Inc. was a manufacturer of private-labelfirst aid products. Its shareholders soldtheir stock in the company in 1993 toNPM Healthcare Products, Inc. (re-ferred to hereinafter as “NPM”) for ap-proximately $13 million, pursuant to astock purchase agreement that called fora lump sum to be paid at closing as wellas three annual deferred payments thatwere subject to adjustment based uponactual company earnings. Any disputeconcerning the deferrals was subject toarbitration. The stock purchase agree-ment also contained a clause that subor-dinated all deferred payments to NPM’spre-existing and antecedent obligations.

NPM changed its name after theacquisition to American White Cross,Inc. (referred to hereinafter as “AWC”).In 1994, AWC informed its former

Creditor Inaction Results inForfeiture of Subordination Rights

A pre-petition subordi-

nation agreement does

not survive confirmation

of a chapter 11 plan that

establishes equivalent

priority for claims with-

out specifically provid-

ing for the contractual

subordination.


shareholders that it would not honor itsdeferred payment obligations because itbelieved that they had committed fraudand made material misrepresentations inconnection with the sale. AWC and itsshareholders negotiated, litigated and ar-bitrated for the next two years withoutresolving the dispute. In July of 1996,AWC filed a chapter 11 petition.

AWC’s plan of reorganization calledfor liquidation of the company’s assets.The plan denominated and classified asgeneral unsecured creditor claims all theclaims of former shareholders for de-ferred payments under the stock pur-chase agreement. As such, stockholderclaims were classified together with theclaims of AWC’s other unsecured credi-tors, including two companies holdingsubstantial undisputed claims, ElectraInvestment Trust, P.L.C. and Electra As-sociates, Inc. (collectively referred to as“Electra”). All general unsecured creditorswere to receive a ratable portion of 97%of new common stock to be issued in thepost-confirmation liquidating entity.

In discussing the treatment ofAWC’s general unsecured creditors andformer shareholders, the plan made noreference to the contractual subordina-tion clause in the stock purchase agree-ment. However, it did refer to anothersubordination agreement among AWC,Electra and a major lender, providingthat the bank’s subordination rightswould be released if AWC met certainconditions in satisfying the bank’s claim.Electra voted in favor of the plan andwas expressly identified in the disclosurestatement disseminated to other credi-tors as a plan supporter.

The bankruptcy court confirmedAWC’s plan of reorganization. Follow-ing confirmation, AWC’s former share-holders, whose claims were designated as“disputed” under the plan, moved tocompel arbitration of the deferred pay-

ments dispute. The court granted thatrequest, and an arbitration tribunal ul-timately determined that AWC owed itsformer shareholders nearly $3 million indeferred payments. AWC and Electrathen sought to subordinate the share-holder claims under the contractual,mandatory and equitable subordinationprovisions of section 510 of the Bank-ruptcy Code.

The bankruptcy court held thatAWC and Electra waived their contrac-tual subordination rights by supportingconfirmation of AWC’s plan of reorga-nization. The court noted that the planaddressed the contractual subordinationof other claims, but failed to provide forsubordination of the deferred share-holder payments, and thus, principles ofres judicata precluded AWS and Electrafrom asserting contractual subordination.

Failure to Object to Plan Results inWaiver of Subordination RightsThe district court affirmed on appeal. Itconcluded that a pre-petition subordina-tion agreement does not survive confir-mation of a chapter 11 plan thatestablishes equivalent priority for claimswithout specifically providing for thecontractual subordination. The courtnoted that although Bankruptcy Codesection 510(a) provides that a subordi-nation agreement will be enforced inbankruptcy, subordinated claims aretypically addressed in chapter 11 bymeans of separate classification of sub-ordinated and non-subordinated claimsunder a plan of reorganization. By fail-ing to insist upon that treatment andsupporting confirmation of the plan, thecourt stressed, AWC and Electra waivedany rights they may have had to enforcethe stock purchase agreement’s subordi-nation provision.

AnalysisAmerican White Cross represents yet an-other illustration of the consequences ofless than vigilant enforcement of seniorcreditor rights.

In that respect, American WhiteCross is not unique. The ramifications ofcreditor inaction in the chapter 11 con-text were also addressed in a series of de-cisions beginning with the Fifth CircuitCourt of Appeals’ ruling in In re Penrod.In that case, the Court of Appeals heldthat the lien of a secured creditor whoparticipates in a chapter 11 case willcontinue to exist only if the plan ex-pressly provides that it will be preservedafter confirmation. The rationale ofPenrod and other cases like it is that if aplan of reorganization deals with prop-erty subject to a lien, the plan must spe-cifically provide for continuation of thelien or it will be extinguished. Althoughthe American White Cross court did notdiscuss Penrod, the two decisions sharea basic premise: senior creditors must ac-tively seek to safeguard their non-bankruptcy rights and remedies in achapter 11 case. Senior creditors mayforfeit certain rights even if the debtor’splan of reorganization does not expresslyabrogate them.

Apparently, the Delaware districtcourt did not consider the possibilitythat junior creditors might not be awareof the existence of a subordinationagreement between the debtor and acreditor. Absent full disclosure of anysuch agreement prior to voting and con-firmation of a plan, extinguishing non-subordinated creditor rights wouldappear to be fundamentally unfair.

___________________________In re American White Cross, Inc., 269B.R. 555 (D. Del. 2001).In re Penrod, 50 F.3d 459 (5th Cir.1995).


How much control can a lender assertover a troubled borrower before irrevo-cably tainting the borrower’s efforts toreorganize in chapter 11? Certainramifications of creditor control in thechapter 11 context were recently dis-cussed by a Delaware bankruptcy courtin In re Coram Healthcare Corp. The de-cision should be of interest to any lenderdealing with a financially distressed bor-rower that later seeks to reorganize un-der chapter 11 of the Bankruptcy Code.

The Bankruptcy Code’sGood Faith RequirementAny chapter 11 plan of reorganizationsubmitted to a bankruptcy court for ap-proval, or “confirmation,” must satisfycertain basic requirements set forth inthe Bankruptcy Code. The BankruptcyCode mandates, for example, that everychapter 11 plan of reorganization be“proposed in good faith and not by anymeans forbidden by law.” In keepingwith this “good faith” requirement,bankruptcy courts are commissionedwith determining whether every chapter11 plan, viewed in light of the totalityof the circumstances, fairly achieves a re-sult consistent with the BankruptcyCode. The scope of the court’s discre-tion in making that determination isconsiderable.

Ultimately, the chapter 11 debtor-in-possession will propose a plan of re-organization that will have to beapproved by its board of directors. Inthat regard, it is important to review the

fiduciary responsibilities of a chapter 11company’s board as they relate to the ad-ministration of the debtor’s chapter11 case.

Fiduciary Duties of Chapter 11Debtor’s ManagementIf a corporate debtor in a chapter 11 casecontinues to manage its properties andoperate its business as a debtor-in-posses-sion, the directors of the corporation bearessentially the same fiduciary responsibili-ties to creditors and shareholders as woulda bankruptcy trustee if one were ap-pointed. The willingness of courts to leavea corporate debtor in control is premisedupon the idea that the board of directorscan be depended upon to carry out the fi-duciary responsibilities of a trustee.

The directors of a chapter 11debtor-in-possession are bound by aduty of care requiring them to exercisethe measure of care, diligence and skillthat an ordinarily prudent person wouldexercise under comparable circum-stances. Directors are also bound by aduty of loyalty that includes obligationsto refrain from self-dealing, to avoidconflicts of interests and the appearanceof impropriety, to treat all parties fairlyand to maximize the value of the chap-ter 11 estate. Breach of the duty of loy-alty is typically found where directorsengage in outright self-dealing or wheretheir interests and those of the estate arein direct conflict. In In re CoramHealthcare Corp., a Delaware bank-ruptcy court held that because the

debtor’s chief executive officer was alsobeing paid as a consultant by one of itslargest creditors, the resulting conflict ofinterest meant that the debtor could notsatisfy the Bankruptcy Code’s “goodfaith” requirement.

BackgroundCoram Healthcare Corporation (to-gether with its affiliate Coram, Inc., col-lectively referred to hereinafter as“Coram”) was a leading providerthroughout the 1990s of alternative sitefusion therapy services in the UnitedStates. In part to finance acquisitions,Coram issued unsecured notes in theprincipal amount of $250 million.Three investment funds (collectively, the“Noteholders”) acquired approximately90% of the principal amount of thenotes. The Noteholders also subse-quently extended a revolving line ofcredit to Coram. Coram appointed theprincipal (the “Noteholder Board Des-ignee”) of one of the investment funds(referred to herein as the “InvestmentFund”) to its board of directors to rep-resent Noteholder interests. TheNoteholder Board Designee served as adirector for nearly two years.

The Noteholders’ IncreasingControl of CoramThe Investment Fund retained a turn-around consultant specializing in thehealthcare field (the “Consultant”) torender advice concerning financiallytroubled companies in which the fund

Chapter 11 Fiduciary’s Conflictof Interest Taints Reorganization


had a stake. At the Investment Fund’ssuggestion, Coram also hired the Con-sultant as an advisor to its chief execu-tive officer.

Coram’s CEO resigned after unsuc-cessfully attempting to guide the com-pany through severe financialdifficulties. As a condition to executinga restructuring and forbearance agree-ment, the Noteholders insisted that Co-ram hire the Consultant as its newCEO. The Consultant ultimately signeda three-year employment agreementwith Coram. Shortly thereafter, he en-tered into a consulting agreement withthe Investment Fund (the “ConsultingAgreement”). The Consulting Agree-ment provided that the Consultantwould have such duties as were assignedor delegated by the Noteholder BoardDesignee, that he would “devote his en-tire business time, attention, skill andenergy exclusively to” the InvestmentFund’s business and that he would use“his best efforts to promote the success”of the Investment Fund’s business. Theagreement further provided that the In-vestment Fund had the right to fire theConsultant if he failed to follow the rea-sonable instructions of the InvestmentFund, the Noteholder Board Designeeor Coram’s board. The Consultant didnot disclose any of the details of his con-sulting agreement to Coram’s board of di-rectors.

Coram’s continuing financial prob-lems led it to sell its pharmacy businessand to use a portion of the $38 milliongenerated by the sale to pay downamounts due to the Noteholders underthe revolving credit agreement. In addi-tion, at the Consultant’s behest, Corammade a $6.3 million interest payment incash to the Noteholders even though itcould have opted to make the paymentin kind. The Consultant did not tell ei-ther Coram’s board of directors or re-

cently retained bankruptcy counselabout the cash payment until after ithad been made.

Coram Files for Chapter 11Two weeks after the Noteholder BoardDesignee resigned from Coram’s board,Coram filed a voluntary petition for re-lief under chapter 11 of the BankruptcyCode. Its pre-bankruptcy management,including the Consultant, continued tocontrol Coram’s day-to-day affairs as adebtor-in-possession. Coram owed theNoteholders in excess of $252 million asof the petition date, and was indebted totrade creditors for approximately $7.5million.

Coram’s initial plan of reorganiza-tion provided for cancellation of allshareholder interests and the issuance ofnew stock to satisfy unsecuredNoteholder claims. Other general unse-cured creditors were to receive $2 mil-lion, or approximately 27% of theirclaims. Discovery conducted in con-junction with a five-day confirmationhearing revealed the existence of the pre-viously undisclosed Consulting Agree-ment. At the conclusion of the hearing,the bankruptcy court found that theConsulting Agreement created an actualconflict of interest that “tainted[Coram’s] restructuring of its debt,[Coram’s] negotiations towards a plan,[and] even [its] restructuring of its op-erations.” As a consequence, the courtruled that it was unable to find thatCoram’s first plan of reorganization wasproposed in “good faith.”

Thereafter, Coram established aspecial committee of independent direc-tors to perform an impartial evaluationof the company’s affairs and theConsultant’s relationship with the In-vestment Fund. A financial advisoryfirm retained by the committee (the “In-dependent Advisor”) issued a report in

The bankruptcy court

found that the Consulting

Agreement created an ac-

tual conflict of interest

that “tainted [Coram’s]

restructuring of its debt,

[Coram’s] negotiations

towards a plan, [and]

even [its] restructuring

of its operations.”


which it concluded, among otherthings, that although the failure of theConsultant and the Noteholder BoardDesignee to disclose to Coram’s boardthe full extent of the Consultant’s rela-tionship with the Investment Fund wasa breach of fiduciary duty, there was noevidence that the Consultant intended,or was expected or instructed, to ad-vance the interests of the InvestmentFund at Coram’s expense. However, theIndependent Advisor found that theConsultant did in fact advance the In-vestment Fund’s interests over Coram’sby causing Coram to pay $6.3 millionto the Noteholders at a time when itssupply of cash was depleted and it wasactively considering a bankruptcy filing.

CEO’s Conflict of InterestTainted ReorganizationCoram renewed its attempts to confirma plan after the Independent Advisor is-sued its report. The bankruptcy courtconcluded that nothing had changedsince it denied the company’s initialconfirmation motion, reiterating its ini-tial finding that Coram’s CEO — theConsultant — was compromised by anactual conflict of interest by reason ofhis Consulting Agreement with the In-vestment Fund. The court emphasizedthat even after it refused to confirmCoram’s first plan of reorganization be-cause of that conflict, the Consultantcontinued to be paid nearly $1 millionper year by one of Coram’s largest credi-tors, while concurrently serving asCoram’s CEO and president. The pecu-niary leverage wielded by the Invest-ment Fund over the Consultant, thecourt ruled, was manifestly improperfrom a fiduciary perspective. Accordingto the court, by causing Coram to makea $6.3 million cash interest payment ata time when it was considering bank-ruptcy and should have been conserving

all available cash, the Consultant clearlydemonstrated the “insidious effect” ofhis conflict of interest. Given the factthat Coram’s payment to theNoteholders might be avoidable as apreferential transfer, the court deemedthe Consultant’s conflict of interest tobe analogous to the conflict that typi-cally afflicts any officer of a chapter 11debtor that may have causes of actionfor the avoidance of a fraudulent orpreferential transfer made to the officerhimself or to a creditor in repayment ofan obligation that the officer guaran-teed.

Finally, the bankruptcy court re-jected Coram’s contention that the in-sidious effect of the Consultant’sconflict of interest was mitigated be-cause his relationship with the Invest-ment Fund and the Noteholders wasfully disclosed during the first confirma-tion hearing, and the Consultant’s ac-tions were thoroughly investigated bythe Independent Advisor. Even disclo-sure, the court stated, may not be suffi-cient to permit approval of a transactioninvolving an actual conflict of interest,particularly where it was clear that theConsultant’s actions actually harmedCoram by depriving it of access to cashthat might have allowed it to continueoperating and maintain leverage in ne-gotiations with creditors. Based upon itsexamination of the totality of the cir-cumstances, the bankruptcy court onceagain ruled that the Consultant’s con-flict of interest precluded Coram fromproposing a plan in good faith.

AnalysisCoram Healthcare is relatively unusualamong cases involving the interpretationof the good faith requirement for con-firmation of chapter 11 plans under theBankruptcy Code. Most decisions give

continued on page 11

The fallout from the Enron bank-

ruptcy appears to have reignited

Congressional efforts to enact the

most sweeping changes to U.S.

bankruptcy laws since 1994. After

the House and Senate passed com-

peting versions of the legislation in

March 2001, the proposed law has

since been mired in committee due

to partisan wrangling. There ap-

pears, given the prevailing climate,

to be little prospect for any mean-

ingful progress in the immediate fu-

ture. Among the proposed changes

to the Bankruptcy Code are provi-

sions designed to curb predatory

lending practices, significant restric-

tion of homestead exemptions, el-

evation of temporary provisions

empowering bankruptcy courts to

adjudicate all claims against ac-

countants and other financial advi-

sors arising from services that they

perform in connection with a

company’s bankruptcy filing, and

the creation of a new chapter 15 to

apply to international bankruptcies.

Stay tuned for further develop-

ments.

LEGISLATIVEA L E R T


Cross-border insolvency proceedingshave become almost endemic as busi-nesses increasingly strive to globalize op-erations and markets, and the worldeconomy continues to fluctuate in re-sponse to a wide variety of financial andpolitical influences. The last decade hasseen the development of an entirely newinternational jurisprudence conceived toaddress the multifarious problems asso-ciated with the financial distress of com-panies that conduct business and havecreditors in more than one country. Al-though the United States is not a signa-tory to any international insolvencytreaty, a decision recently issued by aNew York bankruptcy court in In re Pe-tition of Board of Directors of Compañiade Combustibles, S.A. illustrates howcourts in this country are interpretingU.S. law governing bankrupt foreigncompanies with assets in the U.S. in away that promotes the universality prin-ciples underpinning existing interna-tional insolvency guidelines.

International Insolvency Lawsand RegulationsRegulations governing international in-solvency proceedings are intended tocreate a comprehensive system of rulesthat transcend, yet accommodate asnearly as possible, the parochial interestsof individual nations. Several regulationsor principles governing cross-borderbankruptcies exist today. These includethe Model Law on Cross-Border Insol-vency promulgated by the United Na-tions Commission on International

Trade Law (UNCITRAL), the Ameri-can Law Institute’s NAFTATransnational Insolvency Project, the In-ternational Bar Association’s Cross-Bor-der Insolvency Concordat and theEuropean Union Regulation on Insol-vency Proceedings. Legislation currentlybeing considered by the United StatesCongress would incorporate theUNCITRAL Model Law into the Bank-ruptcy Code as chapter 15. At this time,however, the bills relating to the pro-posed legislation have not been resolved.

Ancillary Proceedingsunder the Bankruptcy CodeThe Bankruptcy Code already containscertain guidelines to deal with foreigndebtors that conduct business or haveassets in this country. Bankruptcy Codesection 304 permits an accredited repre-sentative of a company that is the sub-ject of a bankruptcy, insolvency orequivalent proceeding abroad to com-mence an “ancillary” bankruptcy case inthis country. An “ancillary” proceedingis not a full-fledged bankruptcy case,with the entire panoply of rights andprotections available to domestic debt-ors and their creditors, such as the au-tomatic stay and the ability to avoidfraudulent or preferential transfers. As aresult, the foreign representative gener-ally seeks an immediate injuction in thenature of a stay on the day he files a sec-tion 304 petition.

A proceeding under BankruptcyCode section 304 can be used to preventdomestic creditors from seizing a foreign

debtor’s U.S. assets, and thereby gainingan unfair advantage over non-U.S.creditors. It can also facilitate the repa-triation of a foreign debtor’s assets to thecompany’s home country for adminis-tration in the foreign bankruptcy case.The purpose of a proceeding under sec-tion 304 is “to prevent the piecemealdistribution of assets in the UnitedStates by means of legal proceedings ini-tiated in domestic courts by local credi-tors.”

Section 304 very carefully delin-eates the circumstances where a bank-ruptcy court can deploy its powers toassist a foreign bankruptcy proceeding.It provides that a U.S. “ancillary pro-ceeding” before a U.S. bankruptcy courtmay be commenced only by a “foreignrepresentative.” The Bankruptcy Codedefines a “foreign representative” as a“duly selected trustee, administrator orother representative of an estate” in a ju-dicial or administrative proceeding com-menced in a foreign country “for thepurpose of liquidating an estate, adjust-ing debts by composition, extension ordischarge or effecting a reorganization.”

Recognition Not AutomaticSince section 304 was enacted in 1978,U.S. bankruptcy courts have extendedrecognition to foreign bankruptcy pro-ceedings in many different countries, in-cluding Canada, Switzerland, theCayman Islands, Bermuda, England,Luxembourg, Zambia, Ecuador and Is-rael. Nevertheless, recognition and reliefunder section 304 is not automatic. In

The Important Role of U.S. BankruptcyCourts in Cross-Border Bankruptcies


determining whether to grant injunctiverelief, direct the turnover of property toa foreign representative or grant otherappropriate relief, a bankruptcy courtmust seek to promote the economicaland expeditious administration of theforeign debtor’s estate consistent withcertain important policy considerations.Those considerations include: (1) justtreatment of all creditors and sharehold-ers; (2) protection of U.S. creditorsagainst prejudice and inconveniencearising from asserting their claimsabroad; (3) prevention of preferential orfraudulent dispositions of the foreigndebtor’s assets; (4) distribution of theproceeds of the foreign debtor’s assetssubstantially in accordance with theprovisions of U.S. bankruptcy law; (5)“comity,” or the recognition that onenation allows within its territory to thelegislative, judicial or executive acts ofanother nation; and (6) affording theforeign debtor an opportunity for afresh start.

Section 304 does not require that acreditor’s rights under foreign law beidentical to those afforded to the credi-tor under the Bankruptcy Code. Rather,the statute requires only that thoserights be “substantially in accordance”with U.S. bankruptcy law and not “re-pugnant to a fundamental principle ofAmerican law.” In The Bank of NewYork v. Treco, the Court of Appeals forthe Second Circuit cautioned that reliefunder section 304 is inappropriate if thelaws governing a foreign bankruptcy

proceeding are fundamentally differentthan U.S. law.

In that case, the Second Circuit re-versed an order of the bankruptcy courtdirecting a U.S. bank to turn over ap-proximately $600,000 deposited in theaccount of a company that was the sub-ject of both Bahamian and U.S. insol-vency proceedings, even though thebank claimed it held a valid security in-terest in the funds. Under Bahamianlaw, the expenses incurred in windingup a bankrupt company (e.g., legal feesand expenses) are paid even before se-cured claims, while U.S. law permitssuch a super-priority only under excep-tional circumstances. The Court of Ap-peals found that Bahamian lawconcerning the priority of certain claimsdiffers so significantly from U.S. lawthat the liquidators of the Bahamian com-pany should not have been granted reliefunder Bankruptcy Code section 304.

The Ancillary Proceeding Commencedon Behalf of Compañia General deCombustiblesSociedad Commercial del Plata, S.A.(“SCP”) was a holding company orga-nized under the laws of Argentina. Itsholdings included the stock of an Ar-gentine oil company, Compañia Gen-eral de Combustibles (“CGC”), and atransportation and entertainment com-pany, Tren de la Costca. These threecompanies, as well as SCP’s corporateparent, Solfina, S.A., filed voluntary pe-titions for the commencement of reor-

ganization proceedings (“concursospreventivos”) in Argentina’s FederalCommercial Trial Court in Septemberof 2000. At that time, CGC’s reorgani-zation proceeding was the largest inArgentina’s history. In December of2000, the board of directors of SCP andCGC filed an ancillary case in New Yorkunder Bankruptcy Code section 304seeking to enjoin all persons from con-tinuing or commencing any litigationinvolving the companies or their assetsin the U.S.

The bankruptcy court entered apreliminary injunction over the objec-tion of various SCP and CGC creditors.In doing so, it found that a concursopreventivo under Argentine law is simi-lar to a chapter 11 reorganization.Among other things, the court dis-cussed, both proceedings provide for ju-dicial oversight, an automatic stay ofcreditor actions, notice to creditors ofthe proceedings, appointment of a credi-tors’ committee, filing and allowance ofclaims, the opportunity for further judi-cial review of claims determinations, andthe proposal and approval of a plan of re-organization treating creditor claims.

Two creditors whose claims hadbeen disallowed in whole or in part bythe Argentine court objected to anycontinuation of the bankruptcy court’sinjunction, contending that becausetheir claims would receive less favorabletreatment under Argentine law than un-der the bankruptcy law of this country,the bankruptcy court should refuse torecognize the Argentine reorganizationproceeding under section 304. Dissolu-tion of the injunction, they maintained,was mandated in accordance with theSecond Circuit’s ruling in The Bank ofNew York v. Treco.

The bankruptcy court rejected theargument that Treco must be construedto preclude section 304 relief if the

The purpose of a proceeding under section 304 is “to pre-

vent the piecemeal distribution of assets in the united

states by means of legal proceedings initiated in domestic

courts by local creditors.”


treatment of a creditor’s claim under for-eign bankruptcy or insolvency law is notidentical to the treatment afforded un-der U.S. law. The court emphasized thatthe Second Circuit’s ruling was likelymotivated in part by the fact that theoutrageously inflated costs of adminis-tering the Bahamian debtor’s bank-ruptcy estate consumed nearly all of thereceivables collected by the debtor’s liq-uidators. Stating that the “extreme ap-proach [advocated by the creditors]would effectively end cooperationamong countries because special interestpriority schemes vary greatly around theworld,” the bankruptcy court empha-sized that substantial similarity of treat-ment is all that is required underBankruptcy Code section 304. Thebankruptcy court concluded that Argen-tine law actually provides more favorabletreatment than one of the company’sdissenting creditors would have enjoyedunder U.S. law. It also found that all ofthe foreign company’s creditors wouldbe afforded an opportunity to contestthe merits of their claims against CGC inthe Argentine bankruptcy proceeding.

AnalysisThe Second Circuit’s ruling in The Bankof New York v. Treco can readily be inter-

Stating that the “extreme approach [advocated by

the creditors] would effectively end cooperation

among countries because special interest priority

schemes vary greatly around the world,” the bank-

ruptcy court emphasized that substantial similar-

ity of treatment is all that is required under

Bankruptcy Code section 304.

preted to limit significantly the circum-stances under which a U.S. bankruptcycourt can extend recognition to a for-eign bankruptcy or insolvency proceed-ing. For this reason, the bankruptcycourt’s decision in In re Petition of Boardof Directors of Compañia de Combus-tibles, S.A. comes as somewhat of a re-lief. By reaffirming the importantpremise that the law governing a foreigninsolvency proceeding need only be sub-stantially similar to U.S. bankruptcy lawto qualify the foreign proceeding for rec-ognition, the bankruptcy court’s deci-sion highlights the crucial importance ofjudicial cooperation on an internationalbasis as the preferred means of dealingwith financially distressed companies inthe global economy. It also illustratesthat universal guidelines must be imple-mented to harmonize competing inter-national considerations with respect tobankrupt and insolvent companies andtheir creditors.

______________________In re Petition of Board of Directors ofCompañia de Combustibles, S.A., 269B.R. 104 (Bankr. S.D.N.Y. 2001).Bank of New York v. Treco (In re Treco),240 F.3d 148 (2d Cir. 2001).

continued from page 8

rise to issues surrounding the debtor’sconduct in attempting to manipulatethe chapter 11 process for its own ben-efit. In Coram Healthcare, the court’s fo-cus was on creditor conduct as it relatedto the confirmation process. The courtwas particularly troubled by the fact thatthe individual entrusted with formulat-ing a plan of reorganization was at thesame time being paid a significantamount of money by one of the debtor’slargest creditors. It was undoubtedly alsoinfluenced by the CEO’s previous con-duct in failing to disclose the existenceof the Consulting Agreement and incausing the debtor to make a significantcash payment to the Noteholders on theeve of filing for bankruptcy. Regardlessof the CEO’s conduct, his dual role pre-vented him from fulfilling his fiduciaryduties as a director of a chapter 11debtor.

Coram Healthcare is a warning tolenders doing business with financiallytroubled borrowers that ultimately selectchapter 11 as a means of attempting tosort out their fiscal and/or business dif-ficulties. While a lender is frequentlygranted some degree of control or over-sight over a troubled borrower, that re-lationship directly conflicts with thefiduciary responsibilities borne by themanagement of a chapter 11 debtor-in-possession to its bankruptcy estate.Given that inherent conflict, even fulldisclosure of the relationship is unlikelyto remedy the problem.

______________________In re Coram Healthcare Corp., 271 B.R.228 (Bankr. D. Del. 2001).


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Applying this test to the facts beforeit, the Sixth Circuit found that therecord produced by the bankruptcycourt was inadequate to support a con-clusion that “unusual circumstances” ex-isted. It faulted both the bankruptcycourt’s ambiguous factual determinationthat the release and injunction provi-sions were essential to the reorganiza-tion, and the absence of detailed factualfindings that contributions to be madeby Dow’s insurers and affiliates weresubstantial. Finally, the Court took ex-ception to the absence of any finding bythe bankruptcy court that each claimantwho chose not to settle had an oppor-tunity to recover in full by pursuing liti-gation against the non-debtor insurersand shareholders.

AnalysisThe Sixth Circuit’s ruling in Dow Corn-ing reiterates the important principlesunderlying chapter 11 of the Bank-

continued from page 3

Review © Jones, Day, Reavis & Pogue, 2002All Rights Reserved

ruptcy Code, particularly in large casesinvolving mass tort liabilities. A greatmany chapter 11 plans are the productof extensive negotiations resulting in acarefully crafted settlement of complexdebtor-creditor, intercreditor and share-holder issues. This is especially so inmass tort cases involving tens of thou-sands of existing creditors, as well as anuntold number of future creditors whoseinjuries have not even manifested them-selves at the time of the chapter 11 case.

The magnitude of a debtor’s liabili-ties in a mass tort case is enormous. Inmany cases, it may significantly exceedthe value of the debtor’s assets. As such,the only way that existing and futuremass tort claimants can receive anymeaningful recovery on their claims is ifinsurers and other third parties providefunding for a chapter 11 plan, and thedebtor continues to generate revenue tosatisfy future claims as they are asserted.If non-consenting creditors are free to

pursue collection of their claims frominsurers and other non-debtor sources ofplan funding, the carefully negotiatedstructure of a global settlement predi-cated upon a continuing stream of rev-enue to pay existing and futureclaimants is likely to collapse.

In adopting the seven-part test in-cident to a finding of “unusual circum-stances,” the Sixth Circuit sought tobalance individual creditor rights againstcompelling policy considerations recog-nizing the efficacy of the chapter 11 re-organization process in generating valuefor all concerned. By reinforcing theutility of the Bankruptcy Code as ameans of effectively dealing with a chap-ter 11 debtor’s mass tort exposure, theruling represents a positive develop-ment.______________________Class Five Nevada Claimants v. DowCorning Corp. (In re Dow CorningCorp.), 280 F.3d 648 (6th Cir. 2002).

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