Recent Developments in Bankruptcy and RestructuringVolume 13 l No. 4 l July-August 2014 JONES DAY

BUSINESS RESTRUCTURING REVIEW

A BABY STEP FORWARD: EXECUTIVE BENEFITS INSURANCE AGENCY V. ARKISONBenjamin Rosenblum

In Executive Benefits Insurance Agency v. Arkison, 2014 BL 158582, 189 L. Ed.

2d 83 (2014), a unanimous U.S. Supreme Court took a small step forward in

clarifying the contours of a bankruptcy judge’s jurisdictional authority. The

case explained that when a bankruptcy court is confronted with a claim that

is statutorily denominated as “core,” but is not constitutionally determinable

by a bankruptcy judge under Article III of the U.S. Constitution, the bank-

ruptcy judge should treat such a claim as a non-core “related to” matter that

the district court reviews anew. The ruling eliminates any supposed statu-

tory gap created by the Supreme Court’s 2011 Stern v. Marshall decision, but

Arkison nonetheless leaves many potentially larger jurisdictional and consti-

tutional questions unanswered.

THE DISPUTE

Nicholas Paleveda and his wife owned Bellingham Insurance Agency, Inc.

(“Bellingham”). In early 2006, Bellingham became insolvent and ceased oper-

ating. A day later, Paleveda used Bellingham’s funds to incorporate another

insurance agency, Executive Benefits Insurance Agency, Inc. (“EBIA”). Paleveda

and others thereafter initiated a scheme to transfer assets from the defunct

Bellingham to the new EBIA. In June 2006, Bellingham filed for bankruptcy relief

in the Western District of Washington. A chapter 7 bankruptcy trustee, Peter

Arkison, was appointed to administer Bellingham’s estate. After his appointment,

Arkison commenced suit in the bankruptcy court against EBIA and others to,

among other things, avoid the fraudulent transfer of Bellingham’s assets.

The bankruptcy court rendered summary judgment in favor of Arkison on all

claims. EBIA appealed to the district court. On appeal, the district court con-

ducted a de novo review, affirmed the bankruptcy court’s decision, and

entered judgment for Arkison. EBIA again appealed, this time to the U.S. Court

of Appeals for the Ninth Circuit. While the case was pending before the circuit

court, the Supreme Court issued its now well-known Stern v. Marshall opinion.

IN THIS ISSUE

1 A Baby Step Forward: Executive Benefits Insurance Agency v. Arkison

5 Newsworthy

6 Focusing on Intent in Recharacterization Analysis, Delaware Bankruptcy Court Ruling Indicates that Creditors Seeking Derivative Standing Face High Hurdle

9 Grede v. FCStone, LLC: A Confirmation of the Broad Scope of the Section 546(e) Safe Harbor

13 “Cleverly Insidious” Bankruptcy Waiver in SPE Operating Agreement Unenforceable As Matter of Public Policy

16 In re Denver Merchandise Mart—Fifth Circuit Emphasizes Need for Clear Contractual Language Regarding Prepayment Premiums

19 From the Top In Brief

20 Sovereign Debt Update

2

In light of Stern, EBIA moved to dismiss the appeal, contending

that the bankruptcy court could not have constitutionally deter-

mined the fraudulent transfer claims against it.

The Ninth Circuit denied EBIA’s motion to dismiss. While it held

that the fraudulent conveyance claim was not, under Stern,

constitutionally determinable absent consent of the parties,

the Ninth Circuit held that EBIA had impliedly consented to the

bankruptcy court determining the summary judgment motion.

The court also held that the bankruptcy court’s ruling on the

summary judgment motion could be treated as a report and

recommendation subject to de novo review by the district court.

EBIA petitioned for certiorari, identifying two fundamental ques-

tions: (i) whether litigants can consent to the exercise of the

judicial power of the U.S. by a non-Article III judge in the form

of entry of a final, enforceable judgment; and (ii) whether bank-

ruptcy judges have statutory authority to propose findings of

fact and conclusions of law in “core” proceedings.

The Supreme Court granted certiorari.

BANKRUPTCY JURISDICTION IN A STERN V. MARSHALL WORLD

Article III, Section 1 of the U.S. Constitution provides that

“[t]he judicial Power of the United States, shall be vested in one

supreme Court, and in such inferior Courts as the Congress

may from time to time ordain and establish.” The Article

states that such judges “shall hold their Offices during good

Behaviour, and shall, at stated Times, receive for their Services

a Compensation, which shall not be diminished during their

Continuance in Office.”

Given these provisions, the exercise of the “judicial Power

of the United States” is vested in so-called Article III judges.

Bankruptcy judges, however, are not Article III judges. They do

not have life tenure, and their salaries are subject to diminution.

Instead, bankruptcy judges are technically authorized under

Article I, which governs the legislative branch and authorizes the

establishment of a uniform system of federal bankruptcy laws.

Under principles of separation of powers, bankruptcy judges

cannot exercise the judicial power reserved for Article III judges.

Thirty-two years ago, in Northern Pipeline Constr. Co. v.

Marathon Pipe Line Co., 458 U.S. 50 (1982), the Supreme Court

struck down certain provisions of the Bankruptcy Act of 1978

because it conferred Article III judicial power upon bankruptcy

judges who lacked life tenure and protection against sal-

ary diminution. After more than two years of delay, Congress

enacted the Bankruptcy Amendments and Federal Judgeship

Act of 1984 to fix the statutory infirmity identified in Marathon.

The jurisdictional scheme for bankruptcy courts continues in

force today. Sort of.

Arkison is a welcome clarification of how the bank-

ruptcy statute should allocate work among the

bankruptcy and district courts with respect to Stern

claims. The opinion, however, does not resolve some

of the larger constitutional and jurisdictional ques-

tions that have arisen since the Court’s last foray into

this complicated area of the law. For this, bankruptcy

professionals will need to await the next installment

from the Supreme Court, which may come in the

Court’s next term.

Congress established the jurisdiction of the bankruptcy courts

in the Federal Judicial Code, 28 U.S.C. §§ 1 et seq. (“title 28”). As

amended in 1984, title 28 provides that the district courts shall

have “original and exclusive jurisdiction of all cases under title 11”

and “original but not exclusive jurisdiction of all civil proceedings

arising under title 11, or arising in or related to cases under title 11.”

Title 28 further provides that each bankruptcy court is “a unit of

the district court” in the federal district where it is located. District

courts may—but need not—refer cases and matters within the

scope of bankruptcy jurisdiction to the bankruptcy courts.

Title 28’s jurisdictional strictures for bankruptcy courts provide

that “Bankruptcy judges may hear and determine all cases

under title 11 and all core proceedings arising under title 11, or

arising in a case under title 11.” Thus, a bankruptcy court may

enter a final order with respect to all bankruptcy cases before it

and all matters within the scope of its “core” jurisdiction. Such a

final order is subject to appellate review by the applicable dis-

trict court or bankruptcy appellate panel (and thereafter, by the

applicable court of appeals).

A bankruptcy court may also hear a non-core proceeding that

is “related to” a bankruptcy case, but, absent consent of the

3

litigants, a bankruptcy court cannot enter a final order when

exercising related to jurisdiction. Instead, it may issue only a

proposed order, which is reviewed de novo by the district court.

In 2011, the Supreme Court in Stern v. Marshall, 564 U.S. ___,

131 S. Ct. 2594 (2011), shook up the jurisdictional scheme estab-

lished by statute and declared that a portion of the Federal

Judicial Code addressing the bankruptcy courts’ core jurisdic-

tion was unconstitutional. According to Stern, the 1984 jurisdic-

tional scheme did not adequately address the Marathon issue,

at least not in all instances. Stern held that even though bank-

ruptcy courts are statutorily authorized to enter final judgments

on various categories of bankruptcy-related claims, Article III

prohibits bankruptcy courts from finally adjudicating certain of

those claims. Specifically, Stern ruled that a bankruptcy court

lacks constitutional authority under Article III to enter a final

judgment on a state law counterclaim that is not resolved in the

process of ruling on a creditor’s proof of claim.

While Stern itself purported to be a narrow decision, it has given

rise to a great deal of litigation concerning whether or not a

particular claim, though statutorily denominated as core, is in

fact a claim that is finally determinable by a bankruptcy judge.

Further, in the years since Stern, courts have also struggled with

the following issues: (i) how should a bankruptcy court deal

with a claim that, while statutorily denominated as core, is not in

fact constitutionally determinable by an Article III judge; and (ii)

the effect of a party’s consent to adjudication of a claim of this

nature by a bankruptcy court.

In Executive Benefits Insurance Agency v. Arkison , the

Supreme Court teased the bankruptcy community with the

possibility of resolving both of these issues, but ultimately

decided just the first.

FILLING THE STATUTORY GAP

Stern held that some claims, while labeled in the statute as

core, may not be adjudicated by a bankruptcy court as a con-

stitutional matter. The existence of such “Stern claims” threat-

ened to create a gap in section 157 of title 28, the statute that

addresses the scope of matters that may be heard and deter-

mined by a bankruptcy court.

The statute provides a limited menu of options. The entire

world of bankruptcy jurisdiction is divided into three catego-

ries: (i) bankruptcy cases; (ii) core claims; and (iii) non-core,

but “related to” claims. As noted, bankruptcy courts can enter

final orders with respect to core matters. Bankruptcy courts

may (absent consent) enter only proposed findings of fact and

conclusions of law with respect to non-core related to matters.

Nowhere does the statute expressly provide for a procedure

where a bankruptcy court can enter proposed findings of fact

and conclusions of law with respect to a statutorily-denomi-

nated core matter; instead, the statute presumes that a bank-

ruptcy court may finally determine all statutorily-denominated

core claims. Thus, in a post-Stern world, the question arose—

what does a bankruptcy court do with a statutorily core claim

that it cannot finally determine under Article III? Stern did not

provide the lower courts with any directions on how they should

proceed with respect to such Stern claims.

In Arkison, the petitioner, EBIA, asserted that the gap rendered

the bankruptcy court powerless to act on Stern claims and

that all such claims must be heard by district courts in the first

instance. A unanimous Supreme Court disagreed. The statute,

according to the Court, permits a Stern claim to proceed before

the bankruptcy court as a non-core matter.

To reach this result, the Court first looked to the severability pro-

vision contained in the Federal Judgeship Act of 1984 (98 Stat.

344), which provides that “[i]f any provision of this Act or the

application thereof . . . is held invalid, the remainder of this Act . .

. is not affected thereby.” This severability provision was disposi-

tive in the Court’s view. This is because, when a court identifies a

claim as a Stern claim, it has necessarily “held invalid” the appli-

cation of the “core” label to such claim, along with the associated

procedures. With the “core” option invalidated and unavailable to

such a claim, the Court explained, the only other category avail-

able is to treat such claim as non-core or “related to” the bank-

ruptcy. Therefore, as a “related to” claim, the bankruptcy court

could submit to the district court proposed findings of fact and

conclusions of law, which would then be reviewed de novo.

The Court explained that this conclusion is consistent with its

general approach to severability—absent statutory text or con-

text to the contrary, Congress generally prefers the Court to

give effect to a partially unconstitutional statute than to have no

statute at all. Here, nothing indicated to the Court that Congress

wished to place Stern claims in “limbo.” According to the Court,

doing so would unnecessarily change the “division of labor” set

4

out in the statute between bankruptcy judges and district court

judges. Having reached this conclusion, the Court easily deter-

mined that the fraudulent conveyance claims at issue were non-

core “related to” claims as to which the bankruptcy court could

submit proposed findings of fact and conclusions of law.

Finally, the Court explained that, although the bankruptcy court

did not style its entry of summary judgment as a report and rec-

ommendation, and although the district court did not re-label the

bankruptcy order as proposed findings of fact and conclusions

of law, the district court effectively cured any Stern problem by

reviewing the matter de novo and entering a judgment of its own.

In essence, EBIA received exactly what it asserted it was entitled

to—a de novo review by an Article III judge.

THE OPEN QUESTION OF CONSENT

The Court did not reach the question of whether EBIA could

and, in fact, did consent to adjudication of the matter before the

bankruptcy court. Because the district court’s de novo review

and entry of its own final judgment cured any potential error,

the question of the litigants’ consent to adjudication before

the bankruptcy judge did not matter. In other words, the Court

did not need to reach the issue of whether the parties con-

sented to the bankruptcy court’s final determination of the mat-

ter because the bankruptcy court’s judgment was reviewed de

novo by the district court.

OUTLOOK

Arkison is a welcome clarification of how the bankruptcy stat-

ute should allocate work among the bankruptcy and district

courts with respect to Stern claims. The opinion, however, does

not resolve some of the larger constitutional and jurisdictional

questions that have arisen since the Court’s last foray into this

complicated area of the law. For this, bankruptcy professionals

will need to await the next installment from the Supreme Court,

which may come in the Court’s next term.

In particular, Arkison plugs the potential gap in the statute cre-

ated by Stern. But Arkison does nothing to help explain which

claims, as a constitutional matter, can be finally determined by

a bankruptcy judge. Until there is additional guidance, disputes

over whether a claim is a Stern claim or not will likely continue

to be a fertile source of conflict in bankruptcy cases throughout

the country.

In addition, the Arkison Court expressly “reserve[d] … for

another day” the question of “whether Article III permits a

bankruptcy court, with the consent of the parties, to enter final

judgment on a Stern claim.” This question is significant. For

example, until there is guidance from the Supreme Court, liti-

gants may feel emboldened to challenge a bankruptcy court’s

adjudication of “related to” matters when all parties have con-

sented or, for that matter, the propriety of bankruptcy appellate

panels (which consist entirely of bankruptcy judges and hear

appeals from bankruptcy judges in several circuits). Arguably,

the consequences of a ruling by the Court on consent could

extend to disputes far beyond the context of bankruptcy law,

including such broadly used mechanisms as arbitration and the

use of magistrate judges—both of which were discussed during

oral argument before the Court.

It bears noting that most, but not all, lower courts had already

come to the same conclusion reached by the Supreme Court

with respect to the so-called statutory gap. The district courts

for two important jurisdictions—the District of Delaware and

the Southern District of New York—had issued amended stand-

ing orders of reference that expressly provided for bankruptcy

courts to issue reports and recommendations with respect to

Stern claims. In this sense, Arkison is a helpful step in clarify-

ing the post-Stern world of bankruptcy jurisdiction—but only a

baby step.

As it turns out, the lower courts and bankruptcy professionals

may not have to wait long for the Court’s next step with respect

to these issues. Shortly after deciding Arkison , the Court

granted certiorari in Wellness Int’l Network v. Sharif, No. 13-935,

2014 BL 182626 (July 1, 2014). That case appears likely to pres-

ent the issue of consent, and it also provides the Court with an

opportunity to define further the post-Stern landscape.

5

NEWSWORTHYJones Day received a “Top Tier Recommendation” in the field of “Municipal Bankruptcy” in The Legal 500 United States 2014.

Jones Day was “Recommended” in the field of “Finance-Corporate restructuring (including bankruptcy)” in The Legal 500

United States 2014.

Sidney P. Levinson (Los Angeles) participated in a panel discussion entitled “Don’t Get Burned: Current Developments in

Chapter 11 You Need to Know” on May 17, 2014 at the 26th Annual California Bankruptcy Forum in Santa Barbara.

An article featuring “Bankruptcy Examiner” Paul D. Leake (New York) appeared in the “Bankruptcy Beat” column of the May 1,

2014 edition of The Wall Street Journal.

David G. Heiman (Cleveland), Paul D. Leake (New York), Bruce Bennett (Los Angeles), Sidney P. Levinson (Los Angeles),

Michael Rutstein (London), and Corinne Ball (New York) were awarded a “most highly regarded” designation in the field of

Insolvency & Restructuring in Who’s Who Legal 100 2014.

Gregory M. Gordon (Dallas), Bruce Bennett (Los Angeles), Paul D. Leake (New York) and Corinne Ball (New York) were recom-

mended in the field of “Finance-Corporate restructuring (including bankruptcy” in The Legal 500 United States 2014.

Amy Edgy Ferber (Atlanta), Brad B. Erens (Chicago), Bruce Bennett (Los Angeles), Corinne Ball (New York), David G. Heiman

(Cleveland), Heather Lennox (New York and Cleveland), James O. Johnston (Los Angeles), Jeffrey B. Ellman (Atlanta), Joshua

D. Morse (San Francisco) and Mark A. Cody (Chicago) were recommended in the field of “Municipal Bankruptcy” in The Legal

500 United States 2014.

An article written by Brad B. Erens (Chicago) and David A. Hall (Chicago) entitled “Marking the Boundaries of Secured and

Undersecured in Multi-Debtor Chapter 11 Cases: Collecting Postpetition Interest Under Section 506(b) of the Bankruptcy

Code” was published in the June 2014 issue of Pratt’s Journal of Bankruptcy Law.

Bruce Bennett (Los Angeles) was named a “Leading Lawyer” in the field of “Municipal Bankruptcy” in The Legal 500 United

States 2014.

Dara R. Levinson (San Francisco) participated in a panel discussion entitled “Where the Rubber Hits the Gold: Claims and

Claim Objections” on May 17, 2014 at the 26th Annual California Bankruptcy Forum in Santa Barbara.

Paul D. Leake (New York) and Corinne Ball (New York) were named “Leading Lawyers” in the field of “Corporate restructuring

(including bankruptcy)” in The Legal 500 United States 2014.

An article written by Charles M. Oellermann (Columbus) and Mark G. Douglas (New York) entitled “Eighth Circuit Expands

Subsequent New Value Preference Defense in Cases Involving Three-Party Relationships” was posted on July 1, 2014 on the

website of the Harvard Law School Bankruptcy Roundtable.

The restructuring of FriendFinder Networks, Inc. won the 2014 ACG New York Champions Award for Technology, Media,

Telecom Transaction (over $100 million). Jones Day attorneys involved in the restructuring included Joshua M. Mester (Los

Angeles) and Joshua D. Morse (San Francisco).

6

FOCUSING ON INTENT IN RECHARACTERIZATION ANALYSIS, DELAWARE BANKRUPTCY COURT RULING INDICATES THAT CREDITORS SEEKING DERIVATIVE STANDING FACE HIGH HURDLEOliver S. Zeltner and Mark G. Douglas

In In re Optim Energy, LLC, 2014 BL 132735 (Bankr. D. Del. May 13,

2014), a Delaware bankruptcy court denied a creditor’s motion

for “derivative standing” to assert recharacterization, equita-

ble subordination and breach of fiduciary duty claims against

claimants that were senior secured lenders to, and holders

of equity in, the debtors. In assessing whether the underlying

claims were colorable, the court declined to apply the prevail-

ing multifactor test to determine whether recharacterization of

debt as equity is appropriate. Instead, the court relied on recent

Third Circuit precedent in adopting an intent-based approach.

Optim Energy confirms that, at least in Delaware, creditors seek-

ing derivative standing face a high bar.

DERIVATIVE STANDING

The Bankruptcy Code does not expressly authorize anyone

other than a trustee or chapter 11 debtor-in-possession (“DIP”)

to prosecute claims belonging to the bankruptcy estate. Many

courts, however, will allow official creditors’ committees or indi-

vidual creditors to commence litigation on behalf of the estate

under narrowly defined circumstances. In one of the semi-

nal cases addressing this issue, the Second Circuit Court of

Appeals held in Unsecured Creditors Committee of Debtor STN

Enterprises, Inc. v. Noyes (In re STN Enterprises), 779 F.2d 901 (2d

Cir. 1985), that, in considering a creditors’ committee’s request

for leave to sue a director for misconduct, a court is required

to consider whether the debtor unjustifiably failed to initiate suit

against the director and whether the action is likely to benefit

the debtor’s estate.

The Second Circuit later refined the doctrine of “derivative stand-

ing” in Commodore Int’l Ltd. v. Gould (In re Commodore Int’l Ltd.),

262 F.3d 96 (2d Cir. 2001). In Commodore, the court ruled that

a committee may bring suit even if the trustee or DIP does not

unjustifiably refuse to do so as long as: (i) the trustee or DIP con-

sents; and (ii) the court finds that the litigation is (a) in the best

interests of the estate and (b) necessary and beneficial to the fair

and efficient resolution of the bankruptcy proceedings.

The Third Circuit articulated a slightly different standard for

derivative standing in Official Committee of Unsecured Creditors

of Cybergenics Corp. v. Chinery, 330 F.3d 548 (3d Cir. 2003). In

Cybergenics, the court held that, to be granted derivative stand-

ing, a movant must demonstrate that: (i) the DIP or trustee has

unjustifiably refused either to pursue the claim or to consent to

the movant’s prosecution of the claim on behalf of the estate; (ii)

the movant has alleged colorable claims; and (iii) the movant has

received leave to sue from the bankruptcy court.

EQUITABLE SUBORDINATION AND RECHARACTERIZATION

Equitable subordination is a remedy developed under com-

mon law prior to the enactment of the current Bankruptcy

Code to remedy misconduct that results in injury to creditors

or shareholders. It is expressly recognized in section 510(c) of

the Bankruptcy Code, which provides that the bankruptcy court

may, “under principles of equitable subordination, subordinate

for purposes of distribution all or part of an allowed claim to

all or part of another allowed claim or all or part of an allowed

interest to all or part of another allowed interest.” However, the

statute explains neither the equitable subordination theory nor

the standard that should be used to apply it.

In In re Mobile Steel Co., 563 F.2d 692 (5th Cir. 1977), the Fifth

Circuit articulated what has become the most commonly

accepted standard for equitable subordination of a claim.

Under this standard, a claim can be subordinated if the claim-

ant engaged in some type of inequitable conduct that resulted

in injury to creditors (or conferred an unfair advantage on the

claimant) and if equitable subordination of the claim is con-

sistent with the provisions of the Bankruptcy Code. Courts

have refined the test to account for special circumstances. For

example, many courts make a distinction between insiders (e.g.,

corporate fiduciaries) and noninsiders in assessing the level of

misconduct necessary to warrant subordination.

A related but distinct remedy is “recharacterization.” Like equita-

ble subordination, the power to treat a debt as if it were actually

an equity interest is derived from principles of equity. It ema-

nates from the bankruptcy court’s power to ignore the form of a

transaction and give effect to its substance. However, because

the Bankruptcy Code does not expressly empower a bank-

ruptcy court to recharacterize debt as equity, some courts dis-

agree as to whether they have the authority to do so and, if so,

the source of such authority.

7

Four circuits have held that a bankruptcy court’s power to

recharacterize debt derives from the broad equitable pow-

ers set forth in section 105(a) of the Bankruptcy Code, which

provides that “[t]he court may issue any order, process, or

judgment that is necessary or appropriate to carry out the pro-

visions of [the Bankruptcy Code].” See Committee of Unsecured

Creditors for Dornier Aviation (North America), Inc., 453 F.3d

225 (4th Cir. 2006); Cohen v. KB Mezzanine Fund, II, LP (In re

SubMicron Systems Corp.), 432 F.3d 448 (3d Cir. 2006); Sender

v. Bronze Group, Ltd. (In re Hedged-Invs. Assocs., Inc.), 380

F.3d 1292 (10th Cir. 2004); Bayer Corp. v. MascoTech, Inc. (In re

AutoStyle Plastics, Inc.), 269 F.3d 726 (6th Cir. 2001). In Grossman

v. Lothian Oil Inc. (In re Lothian Oil Inc.), 650 F.3d 539 (5th Cir.

2011), the Fifth Circuit adopted a nuanced approach to the

question, ruling that a bankruptcy court’s ability to recharacter-

ize debt as equity is part of the court’s authority to allow and

disallow claims under section 502 of the Bankruptcy Code. In

Official Committee of Unsecured Creditors v. Hancock Park

Capital II, L.P. (In re Fitness Holdings International, Inc.), 714 F.3d

1141 (9th Cir. 2013), the Ninth Circuit ruled that “a court has the

authority to determine whether a transaction creates a debt or

an equity interest for purposes of § 548, and that a transaction

creates a debt if it creates a ‘right to payment’ under state law,”

as required by section 101(5)(A) of the Bankruptcy Code.

In some jurisdictions that recognize the doctrine of recharac-

terization, uncertainty exists regarding the legal standard for

determining when recharacterization is appropriate. In AutoStyle

Plastics, the Sixth Circuit applied an 11-factor test derived from

federal tax law. Among the enumerated factors are the labels

given to the alleged debt; the presence or absence of a fixed

maturity date, interest rate, and schedule of payments; whether

the borrower is adequately capitalized; any identity of interest

between the creditor and the stockholder; whether the loan is

secured; and the corporation’s ability to obtain financing from

outside lending institutions. Under this test, no single factor is

controlling. Instead, each factor is to be considered in the par-

ticular circumstances of the case.

In SubMicron, however, the Third Circuit questioned the utility of

the Autostyle test, cautioning against the application of the test

as a “mechanistic scorecard.” According to the Third Circuit,

although such multifactor frameworks “undoubtedly include per-

tinent factors, they devolve to an overarching inquiry: the char-

acterization as debt or equity is a court’s attempt to discern

whether the parties called an instrument one thing when in fact

they intended it as something else.” SubMicron has given rise to

uncertainty regarding whether courts in the Third Circuit, which

have traditionally applied the Autostyle test, will continue to do

so. This was one of the issues addressed by the bankruptcy

court in Optim Energy.

Optim Energy indicates that, at least in the Delaware,

creditors seeking derivative standing to pursue estate

claims face a high bar in alleging facts sufficient to

support colorable claims. The ruling should provide

some assurance to lenders that, absent evidence of

misconduct, their claims will not be equitably sub-

ordinated, and that a lender can structure an equity

position in a borrower in a way that minimizes the risk

that a debt obligation will later be recharacterized as

equity by a bankruptcy court.

OPTIM ENERGY

In 2007, Optim Energy, LLC (“Optim Energy”)—which, together

with certain affiliates, owned and operated three Texas power

plants—entered into a $1 billion credit facility with a lender.

The credit facility was guaranteed by Cascade Investments,

L.L.C. (“Cascade”). Optim Energy also entered into a guar-

anty reimbursement agreement with Cascade whereby Optim

Energy agreed to reimburse Cascade for any payments made

by Cascade to the lender. That agreement stated that Optim

Energy’s reimbursement obligations “constitute indebtedness

of [Optim Energy] and shall not, in any event, constitute or be

treated as an equity or capital contribution by the Guarantors.”

As security for its reimbursement obligations, Optim Energy

granted Cascade a lien on substantially all of its assets. At the

time of these transactions, Cascade owned 50 percent of Optim

Energy’s equity.

Pursuant to a 2011 restructuring, Cascade made a $5 million

payment to the lender on behalf of Optim Energy. In exchange,

Cascade increased its ownership interest in Optim Energy to

99 percent. In the documents effectuating these transactions,

Cascade’s $5 million payment to the lender on behalf of Optim

Energy was described as a capital contribution.

8

In early 2014, as Optim Energy and certain of its affiliates were

preparing to file for bankruptcy, Cascade paid the lender the full

amount outstanding on Optim Energy’s credit facility. That pay-

ment triggered certain obligations under the 2007 agreements

between Optim Energy and Cascade, which had the effect of

making Cascade the senior secured creditor of the debtors.

Optim Energy and its affiliates filed for chapter 11 protection

in the District of Delaware in February 2014. Walnut Creek

Mining Company (“Walnut Creek”)—a coal supplier to Optim

Energy and the debtors’ largest non-insider unsecured credi-

tor—filed a motion seeking derivative standing to prosecute

claims against Cascade for recharacterization, breach of fidu-

ciary duty and equitable subordination. Walnut Creek argued

that, beginning in 2007 with Cascade’s agreement to guar-

antee repayment of Optim Energy’s obligations to the lender,

Cascade engaged in a series of inequitable transactions

designed to transform Cascade from an equity interest holder

to a senior secured lender.

THE BANKRUPTCY COURT’S RULING

The bankruptcy court denied Walnut Creek’s motion for deriv-

ative standing. The court initially explained that, in the Third

Circuit, a party seeking derivative standing must establish that

the debtor: (i) has “unjustifiably refused” to pursue an estate

claim itself or to allow the moving party to pursue such a claim

on its behalf; and (ii) that the movant has alleged “colorable

claims.” The court focused its analysis on the second element.

In examining whether the recharacterization claim was color-

able, the court did not rely on the Autostyle factors. Instead, cit-

ing SubMicron, the court wrote that “the overarching inquiry with

respect to recharacterizing debt as equity is whether the par-

ties to the transaction in question intended the loan to be a dis-

guised equity contribution.” According to the bankruptcy court,

such intent “may be inferred from what the parties say in their

contracts, from what they do through their actions, and from the

economic reality of the surrounding circumstances.”

Applying this analysis, the court concluded that “the many trans-

actions and financial arrangements that give rise to [Cascade’s]

secured claims were structured and intended as debt obliga-

tions and are not susceptible to being recharacterized as

equity contributions.” The court rejected six principal arguments

asserted by Walnut Creek, as follows:

• Walnut Creek argued that the debtors were inadequately

capitalized when Cascade guaranteed Optim Energy’s line of

credit. The court rejected this argument, finding that the tim-

ing of the guarantee agreement and the capital structure of

Optim Energy supported the conclusion that Optim Energy’s

obligations to Cascade were intended to be debt.

• Walnut Creek argued that no prudent, bona fide lender would

have entered into the 2007 guarantee agreement because

Optim Energy was newly-formed and insufficiently capitalized

in 2007. The court found that Walnut Creek failed to plead any

facts supporting this inference.

• Walnut Creek asserted that Optim Energy granted security

interests to Cascade at a time when Optim Energy had no

debt. The court held that this argument failed because the

2007 credit facility transaction between the lender and Optim

Energy was contingent upon the granting of such security

interests, and that such arrangements are not unusual.

• Walnut Creek alleged that Cascade’s waiver of certain fees

as part of the reimbursement agreement indicated that

Cascade’s claims should be recharacterized as equity. The

court disagreed, noting that Cascade and Optim Energy later

entered into a forbearance agreement that was indicative of a

“true creditor relationship.”

• Walnut Creek pointed to the fact that, under various agree-

ments, Optim Energy’s obligations to Cascade were subor-

dinated to Optim Energy’s obligations under its bank credit

facility. The court acknowledged that, under Autostyle, “sub-

ordination to all other claims may be an indication that the

claims are capital contributions, not loans.” Even so, the court

rejected this argument because Cascade’s claims for reim-

bursement were subordinated to the lender’s claims only until

the lender was paid in full, and because such subordination

clauses are typical.

• Walnut Creek argued that the parties treated certain capital

contributions made by Cascade as equity because Cascade

never demanded reimbursement from Optim Energy pursuant

to the 2007 reimbursement agreement. The court disagreed.

It found that the reimbursement agreement was separate and

distinct from the capital contributions cited by Walnut Creek,

9

and that the guarantee was never triggered because Optim

Energy never defaulted on its obligations under the credit

facility agreement.

The court also briefly addressed Walnut Creek’s arguments

regarding potential equitable subordination and breach of fidu-

ciary duty claims. The court ruled that Walnut Creek failed to

allege a colorable claim for equitable subordination because

Walnut Creek failed to allege any inequitable conduct. The court

also held that Walnut Creek had not stated a colorable claim

for breach of fiduciary duty because Optim Energy’s operat-

ing agreement expressly provided that “that no fiduciary duties

were owed” by Cascade to Optim Energy.

OUTLOOK

Optim Energy indicates that, at least in the Delaware, creditors

seeking derivative standing to pursue estate claims face a high

bar in alleging facts sufficient to support colorable claims. The

ruling should provide some assurance to lenders that, absent

evidence of misconduct, their claims will not be equitably sub-

ordinated, and that a lender can structure an equity position in a

borrower in a way that minimizes the risk that a debt obligation

will later be recharacterized as equity by a bankruptcy court.

Taking its cue from the binding precedent of SubMicron, the

bankruptcy court in Optim Energy focused its inquiry on the

parties’ intent, rather than performing an Autostyle factor-based

analysis, in assessing whether a debt should be recharacterized

as equity. Although this might appear to be a significant depar-

ture from the approach used by the vast majority of courts, it

appears to be largely a case of form over substance. As with

“badges of fraud” in the context of fraudulent transfer litigation,

the Autostyle factors merely provide a roadmap for courts in

assessing whether the parties intended a transaction to create

a credit or equity relationship. As the Optim Energy court noted,

slavish reliance on the factors as a “scorecard” for applying the

remedy of recharacterization should be viewed as consistent

neither with Autostyle nor the rulings of the majority of courts

that employ the Autostyle approach.

GREDE V. FCSTONE, LLC : A CONFIRMATION OF THE BROAD SCOPE OF THE SECTION 546(e) SAFE HARBORAlex M. Sher

Avoidance actions are an important source of recovery for

the creditors of a bankruptcy estate. Although estate repre-

sentatives are given significant avoidance powers under the

Bankruptcy Code, section 546(e)’s safe harbor prevents the

unwinding of certain transactions that, if undone, could cause

disruption to the securities and commodities markets. Recently,

in Grede v. FCStone, LLC, 746 F.3d 244 (7th Cir. 2014), the U.S.

Court of Appeals for the Seventh Circuit confirmed courts’ view

of the expansiveness of the 546(e) safe harbor when it overruled

a district court’s “equitable” approach to creditor distributions.

The Seventh Circuit held that, among other things, a trustee

could not avoid a prepetition transfer to a favored customer (an

investor in one of the debtor’s securities investment portfolios)

as a constructively fraudulent transfer because the transferred

funds came from the debtor’s sale of securities. The court rea-

soned that the distribution to the customer from its investment

account, like the payment made by the purchaser to the debtor

for securities whose proceeds were deposited into the account,

qualified as a “settlement payment” and was made “in connec-

tion with a securities contract.”

THE 546(E) SAFE HARBOR

In 1982, Congress broadened a limited safe harbor for securities

transactions then set forth in section 764(c) of the Bankruptcy

Code, which applied only in commodity-broker liquidation cases

under chapter 7, by replacing the provision with section 546(e)

(then designated as section 546(d), until renumbering in 1984).

Section 546 of the Bankruptcy Code imposes a number of limi-

tations on a bankruptcy trustee’s avoidance powers, including

the power to avoid certain preferential and/or fraudulent trans-

fers. Section 546(e) provides:

Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and

548(b) of [the Bankruptcy Code], the trustee may not

avoid a transfer that is a margin payment, as defined

in section 101, 741, or 761 of [the Bankruptcy Code], or

settlement payment as defined in section 101 or 741 of

10

[the Bankruptcy Code], made by or to (or for the ben-

efit of) a commodity broker, forward contract merchant,

stockbroker, financial institution, financial participant,

or securities clearing agency, or that is a transfer made

by or to (or for the benefit of) a commodity broker, for-

ward contract merchant, stockbroker, financial institu-

tion, financial participant, or securities clearing agency,

in connection with a securities contract, as defined in

section 741(7) [of the Bankruptcy Code], commodity

contract, as defined in section 761(4) [of the Bankruptcy

Code], or forward contract, that is made before the

commencement of the case, except under section

548(a)(1)(A) of [the Bankruptcy Code].

The purpose of section 546(e) is to prevent “the insolvency of

one commodity or security firm from spreading to other firms

and possibly threatening the collapse of the affected market.”

H.R. Rep. No. 97-420, at 1 (1982), reprinted in 1982 U.S.C.C.A.N.

583, 583, 1982 WL 25042. The provision was “intended to mini-

mize the displacement caused in the commodities and securi-

ties markets in the event of a major bankruptcy affecting those

industries.” Id.

If a transaction falls within the scope of section 546(e), it may

not be avoided unless the transfer is avoidable under section

548(a)(1)(A) of the Bankruptcy Code because it was made with

actual fraud (i.e., with the intent to hinder, delay or defraud cred-

itors). However, in determining whether a preferential or con-

structively fraudulent transfer (i.e., the debtor did not receive

reasonably equivalent value in exchange and was insolvent,

undercapitalized, unable to pay its debts or paid an insider

under an employment agreement) is shielded from avoidance

under section 546(e), key issues are often whether the transfer

qualifies as a “settlement payment” and whether the transfer is

made under a “securities contract.” In addition, to be within the

scope of the safe harbor, a transfer must have been “made by

or to (or for the benefit of)” a commodity broker, a forward con-

tract merchant, a stockbroker, a financial institution, a financial

participant or a securities clearing agency.

The Seventh Circuit examined these issues in Grede.

GREDE

Sentinel Management Group Inc. (“Sentinel”) was in the busi-

ness of managing investments for various clients, including

futures commission merchants, hedge funds, financial institu-

tions and individuals. To invest, a customer deposited cash

with Sentinel, which used the funds, pursuant to an investment

agreement, to purchase securities that satisfied the guidelines

of each customer’s chosen investment portfolio.

Under SEC and CFTC regulations, Sentinel was obligated to hold

customer property in trust segregated from its own property.

Nonetheless, Sentinel comingled cash and securities and failed

to comply with the risk guidelines established for each portfolio.

Sentinel also engaged in proprietary trading. Its trades were

financed by the Bank of New York (“BNY”). The debt was

secured by a lien on a BNY-maintained account (the “Lien

Account”) that originally held only Sentinel assets. However, as

time progressed, Sentinel began moving customer securities

from segregated customer accounts into the Lien Account to

fund its continued trading activities.

In the summer of 2007, Sentinel was undone when the sub-

prime mortgage industry collapsed and credit markets tight-

ened. It filed for chapter 11 protection on August 17, 2007 in the

Northern District of Illinois, shortly after BNY notified Sentinel

that the bank would liquidate the Lien Account collateral (which

included both Sentinel and customer securities) unless Sentinel

repaid the approximately $370 million loan in full.

On the eve of bankruptcy, Sentinel engaged in several transac-

tions that greatly improved the position of certain favored cus-

tomers. For example, Sentinel removed from the Lien Account

$264 million worth of securities belonging to a favored cus-

tomer group and replenished the Lien Account with $290 million

worth of securities belonging to another customer group. Hours

before the bankruptcy filing, Sentinel also distributed $22.5 mil-

lion in cash to certain favored customers, including $1.1 million to

FCStone, LLC (“FCStone”).

After the bankruptcy filing, Sentinel continued to favor certain

customers. Among other things, it filed an emergency motion

seeking court authority to sell $300 million worth of securities

and distribute the proceeds to the customers, including FCStone,

which received nearly $14.5 million. The bankruptcy court subse-

quently clarified that its order did not “authorize” the distribution

within the meaning of section 549 of the Bankruptcy Code, which

provides for the avoidance of unauthorized post-bankruptcy

11

transfers, because authorization necessarily would have been

premised on a ruling that the transferred property belonged to

the estate—a ruling that the court stated it had not made.

The bankruptcy court later appointed a chapter 11 trustee for

Sentinel. The trustee sued the favored customers, among other

things, to avoid Sentinel’s prepetition payments to those cus-

tomers as preferences under section 547(b) of the Bankruptcy

Code and to avoid the postpetition transfers described above

under section 549. The FCStone transfers were litigated as

the first test case in the district court, which had withdrawn

the reference of the avoidance action to the bankruptcy court

because it found that the actions raised significant and unre-

solved issues of non-bankruptcy law.

Grede is yet another illustration of the broad interpre-

tation given by most courts to the section 546(e) safe

harbor to protect the securities and commodities mar-

kets—irrespective of a result that may arguably lead

to inequality in creditor distributions and despite indi-

cations of a debtor’s prepetition misconduct.

The district court held that the assets transferred postpetition

to FCStone were property of Sentinel’s estate and that the post-

petition payment was unauthorized under section 549 notwith-

standing the bankruptcy court’s original order approving the

payment. In concluding that the distribution to FCStone was not

authorized, the district court deferred to the bankruptcy court’s

subsequent clarification of its original order.

The district court also held that the prepetition payment to

FCStone was avoidable as a preference. Relying largely on

policy grounds to justify avoidance, the district court concluded

that section 546(e) did not apply, without addressing the liti-

gants’ specific arguments regarding the scope of the safe har-

bor. The district court reasoned that it was “inconceivable” that

Congress could have intended section 546(e) to apply in the

circumstances before it.

The court distinguished between an insolvent debtor selling a

security to a buyer shortly before filing for bankruptcy and an

insolvent debtor distributing the proceeds of the sale of a cus-

tomer’s security. According to the district court, shielding the

transaction between the debtor and the buyer would serve sec-

tion 546(e)’s purpose of preventing destructive ripple effects in

the case of a bankruptcy. However, in the district court’s view,

shielding the debtor’s distribution of the sale proceeds to the

customer would destabilize the financial system because it

would be impossible to predict who would receive money in the

event of a bankruptcy.

Applying the safe harbor to shield the prepetition payments to

FCStone, the court wrote, “would create the very type of sys-

temic market risks that Congress sought to prevent.” According

to the court, where the debtor is a financial institution that

sells securities on behalf of third-party customers, Ҥ 546(e)

is invoked not to shield the actual exchange between Debtor

and Buyer but to uphold the manner in which Debtor distributes

exchange proceeds to its customers.” See Grede v. FCStone,

LLC, 485 B.R. 854, 885 (N.D. Ill. 2013). Moreover, the court rea-

soned, declining to apply the safe harbor would “not result in

the unwinding of completed securities and commodities trans-

actions that Congress sought to protect.” FCStone appealed to

the Seventh Circuit.

THE SEVENTH CIRCUIT’S RULING

A three-judge panel of the Seventh Circuit reversed. At the

outset, the court noted that the district court’s findings of fact

clearly indicated that FCStone was a “commodity broker,” the

prepetition transfer to FCStone qualified as a “settlement pay-

ment” and the transaction was effected “in connection with a

securities contract,” as required by section 546(e).

Section 741(8) of the Bankruptcy Code, the court explained,

circularly defines a settlement payment as “a preliminary set-

tlement payment, a partial settlement payment, an interim

settlement payment, a settlement payment on account, a final

settlement payment, or any other similar payment commonly

used in the securities trade.” The Seventh Circuit (among oth-

ers) has held that “swapping shares of a security for money”

falls within the definition. See Peterson v. Somers Dublin Ltd.,

729 F.3d 741, 749 (7th Cir. 2013); accord In Official Comm. of

Unsecured Creditors of Quebecor World (U.S.A) Inc. v. Am. Life

Ins. Co. (In re Quebecor World (U.S.A.) Inc.), 719 F.3d 94, 98 (2d

Cir. 2013) (defining a settlement payment as a “transfer of cash

made to complete a securities transaction”) (quoting Enron

Creditors Recovery Corp. v. Alfa, S.A.B. de C.V. (In re Enron

Creditors Recovery Corp.), 651 F.3d 329, 339 (2d Cir. 2011)).

12

The trustee argued that Sentinel’s customers had no right to

buy, sell or obtain the securities, but rather were entitled only

to share in the value of the portfolio in which they invested.

This meant that Sentinel, as distinguished from the customer,

transacted to sell the securities in order to finance customer

redemptions (i.e., distributions). In other words, the trustee

argued that the relevant securities transaction, for purposes of

considering whether section 546(e) applied, should have been

the sale transaction between Sentinel and the purchaser of the

securities, as distinguished from the redemption transaction

between Sentinel and its customers—who only had an indirect

beneficial interest in the securities sale transaction. However,

the Seventh Circuit panel found the payment from Sentinel

to FCStone to be a “settlement payment” because customer

redemptions “were meant to settle, at least partially, the cus-

tomers’ securities accounts with Sentinel.”

The Seventh Circuit panel also held that the transfer to FCStone

was made “in connection with a securities contract.” Section

741(7) of the Bankruptcy Code, the court explained, defines a

“securities contract” broadly to include a “contract for the pur-

chase, sale, or loan of a security.” The court reasoned that,

because Sentinel was expected to purchase and sell securities

on behalf of its customers pursuant to investment agreements

it entered into with its customers, the investment agreements

qualified as securities contracts. The fact that that the custom-

ers were entitled to cash rather than to the securities them-

selves, the court wrote, “does not change the fact that these

customers’ investment agreements were contracts for the pur-

chase and sale of securities.” The court was unmoved by the

fact that at least some of the funds distributed to FCStone may

not have come from the sale of securities held within FCStone’s

portfolio because the funds were intended to satisfy Sentinel’s

obligations under the parties’ investment agreement.

The Seventh Circuit faulted the district court’s conclusion that

transfers of the kind made to FCStone were not intended to

be protected by Congress. The court wrote that, “[b]y enacting

§ 546(e), Congress chose finality over equity for most pre-peti-

tion transfers in the securities industry—i.e., those not involving

actual fraud.” Section 546(e), the court reasoned, “reflects a pol-

icy judgment by Congress that allowing some otherwise avoid-

able pre-petition transfers in the securities industry to stand

would probably be a lesser evil than the uncertainty and poten-

tial lack of liquidity that would be caused by putting every recip-

ient of settlement payments in the past 90 days at risk of having

its transactions unwound in bankruptcy court.” “We understand

the district court’s powerful and equitable purpose” in attempt-

ing to resolve the conflict between the wronged customers

fairly, the court wrote, “but its reasoning runs directly contrary to

the broad language of § 546(e).”

The Seventh Circuit panel also ruled that held that the postpeti-

tion transfer to FCStone could not be undone under section 549

of the Bankruptcy Code because the transfer was authorized by

the bankruptcy court. Despite the bankruptcy court’s attempt to

“clarify” (i.e., modify) its order to permit the trustee to avoid the

transfer, the Seventh Circuit panel found the initial order to have

been clear on its face and the “clarification” to have been an

abuse of discretion. According to the Seventh Circuit panel, “[w]

e doubt whether a bankruptcy court can ever authorize a trans-

fer without authorizing it under § 549, but that’s a larger puzzle

we leave for another day.” Given its conclusion that the postpeti-

tion transfer was authorized within the meaning of section 549,

the court declined to decide whether the funds at issue were

property of Sentinel’s estate.

OUTLOOK

Grede is yet another illustration of the broad interpretation given

by most courts to the section 546(e) safe harbor to protect the

securities and commodities markets—irrespective of a result

that may arguably lead to inequality in creditor distributions

and despite indications of a debtor’s prepetition misconduct.

Ultimately, unless there is a sound claim for actual fraud under

section 548(a)(1)(A), estate representatives face an uphill battle

in seeking to avoid a transaction that falls within section 546(e)’s

broad definition of “settlement payment” or a transfer made “in

connection with a securities contract.”

13

“CLEVERLY INSIDIOUS” BANKRUPTCY WAIVER IN SPE OPERATING AGREEMENT UNENFORCEABLE AS MATTER OF PUBLIC POLICYTim W. Hoffmann and Mark G. Douglas

It is generally recognized that an outright contractual waiver

of an entity’s right to file for bankruptcy is invalid as a matter

of public policy. Nevertheless, lenders sometimes attempt to

prevent a borrower from seeking bankruptcy protection by, for

example, providing for a waiver of the automatic stay or a bank-

ruptcy discharge in a loan agreement, or conditioning a loan or

other financing on a covenant, by-law or corporate charter pro-

vision that prohibits a bankruptcy filing or restricts the power of

the borrower’s governing body to authorize such a filing.

One such restriction was recently addressed by the U.S.

Bankruptcy Court for the District of Oregon in In re Bay Club

Partners-472, LLC, 2014 BL 125871 (Bankr. D. Or. May 6, 2014).

The court ruled that a creditor possessed standing to seek

dismissal of a chapter 11 case on the basis that the debtor—a

limited liability company established as a special purpose entity

(“SPE”)—was not properly authorized to file for bankruptcy.

The court went on to rule, however, that a restrictive covenant

added at the creditor’s insistence to the debtor’s operating

agreement prohibiting a bankruptcy filing was unenforceable

and that the debtor accordingly was duly authorized to file for

chapter 11 protection.

WAIVER OF BANKRUPTCY, “CAUSE” TO DISMISS AND

STANDING

The enforceability of prepetition waivers of the right to seek

bankruptcy protection or specific bankruptcy benefits (such

as the automatic stay) has been the subject of substantial liti-

gation. Under case law dating back to at least the 1930s, the

maxim that a waiver of the right to file for bankruptcy is unen-

forceable because it violates public policy has long been the

general rule. See In re Weitzen, 3 F. Supp. 698, 698 (S.D.N.Y. 1933);

accord Continental Ins. Co. v. Thorpe Insulation Co. (In re Thorpe

Insulation Co.), 671 F.3d 1011, 1026 (9th Cir. 2012); Wank v. Gordon

(In re Wank), 505 B.R. 878, 887-88 (9th Cir. BAP 2014); Nw. Bank

& Trust Co. v. Edwards (In re Edwards), 439 B.R. 870, 874 (Bankr.

C.D. Ill. 2010); Double v. Cole (In re Cole), 428 B.R. 747, 752 (Bankr.

N.D. Ohio 2009); see also In re Madison, 184 B.R. 686 (Bankr. E.D.

Pa. 1995) (agreement not to file bankruptcy for certain time period

is not binding). If the law were otherwise, “astute creditors would

require their debtors to waive.” Bank of China v. Huang (In re

Huang), 275 F.3d 173, 1177 (9th Cir. 2002). By contrast, pre-bank-

ruptcy waivers of the automatic stay are sometimes enforceable.

See, e.g., In re DB Capital Holdings, LLC, 454 B.R. 804 (Bankr. D.

Colo. 2011); In re Bryan Road, LLC, 382 B.R. 844, 848 (Bankr. S.D.

Fla. 2008). But see Ostano Commerzanstalt v. Telewide Systems,

Inc., 790 F.2d 206, 207 (2d Cir. 1986) (stating that “[s]ince the pur-

pose of the stay is to protect creditors as well as the debtor, the

debtor may not waive the automatic stay.”).

Section 1112(b) of the Bankruptcy Code provides that a bank-

ruptcy case may be dismissed for “cause,” and provides a

non-exclusive list of grounds that constitute cause. Although

not specif ically enumerated, lack of authority to com-

mence a bankruptcy case constitutes cause for dismissal

under section 1112(b). See In re NNN 123 N. Wacker, LLC, 2014

BL 146967, *2 (Bankr. N.D. Ill. May 27, 2014); In re ComScape

Telecommunications, Inc., 423 B.R. 816, 830 (Bankr. S.D. Ohio

2010); In re A-Z Elec., LLC, 350 B.R. 886, 891 (Bankr. D. Idaho

2006). Moreover, a bankruptcy court need not rely on section

1112(b) for authority to dismiss a case if it concludes that the fil-

ing was not duly authorized under applicable non-bankruptcy

law. In re Southern Elegant Homes, Inc., 2009 BL 123847, *1

(Bankr. E.D.N.C. June 9, 2009); In re N2N Commerce, Inc., 405

B.R. 34, 41 (Bankr. D. Mass. 2009); In re Telluride Income Growth

Ltd. P’ship, 311 B.R. 585, 591 (Bankr. D. Colo. 2004).

Not all parties in a bankruptcy case, however, have standing to

raise such issues as due authorization. “Standing” is the ability

to commence litigation in a court of law. It is a threshold issue—

a court must determine whether a litigant has the legal capacity

to pursue claims before the court can adjudicate the dispute.

Section 1109(b) of the Bankruptcy Code specifically provides

that any “party in interest,” including the debtor, the trustee, a

committee of creditors or equity interest holders, a creditor or

an indenture trustee, “may appear and may be heard on any

issue” in a chapter 11 case.

Courts have sometimes disagreed as to whether a creditor has

standing to raise the issue of proper authorization to file a bank-

ruptcy petition on behalf of a legal entity. See, e.g., In re Carolina

Park Assocs., 430 B.R. 744, 749 (Bankr. D.S.C. 2010) (finding

standing); In re Orchard at Hansen Park, LLC, 347 B.R. 822, 825-

26 (Bankr. N.D. Tex. 2006) (same); In re Gucci, 174 B.R. 401, 412

14

(Bankr. S.D.N.Y. 1994) (standing depends on creditor’s stake in

case); In re Giggles Restaurant, Inc., 103 B.R. 549, 555-56 (Bankr.

D. N.J. 1989) (standing not limited to shareholders and direc-

tors). But see In re Sterling Mining Co., 2009 BL 171156 (Bankr.

D. Idaho Aug. 11, 2009) (creditor lacks standing); In re Southwest

Equipment Rental, 152 B.R. 207 (Bankr. E.D. Tenn. 1992) (same).

In Bay Club Partners, the bankruptcy court considered both the

ability of an SPE debtor to commence bankruptcy proceedings

and whether certain parties possessed the necessary standing

to challenge the validity of the bankruptcy filing.

BAY CLUB PARTNERS

Bay Club Partners-472, LLC (“BCP”) was formed as an Oregon

limited liability company (“LLC”) in 2005 for the purpose of

acquiring, renovating and operating a large apartment com-

plex in Arizona. In November 2005, the predecessor in interest

of Legg Mason Real Estate CDO I, Ltd. (“Legg Mason”) loaned

BCP approximately $24 million on a secured basis to acquire

the property.

BCP, a manager-managed (as distinguished from a member-

managed) LLC under Oregon law, is managed by Bay Club

Management, LLC (“BCM”). BCP’s LLC operating agreement

provides in relevant part that the manager “shall have the sole

and exclusive authority to manage” BCP and that “[t]he affirma-

tive consent (regardless of whether written, oral, or by course

of conduct) of the Manager shall constitute the sole requisite

for purposes of any provision of this Agreement, excepting only

the dissolution of the Company which shall require the con-

sent of the majority in interest of the Members.” It further states

that “[a]ll other decisions concerning the business affairs of the

Company shall be made by the Manager.”

Notwithstanding this broad grant of authority to BCM, BCP’s

operating agreement contains a negative covenant providing

that, until such time as the indebtedness incurred by BCP to

acquire the property was paid in full:

[BCP] shall not institute proceedings to be adjudi-

cated bankrupt or insolvent; or consent to the institu-

tion of bankruptcy or insolvency proceedings against

it; or file a petition seeking, or consent to, reorganiza-

tion or relief under any applicable federal or state law

relating to bankruptcy; or consent to the appointment

of a receiver, liquidator, assignee, trustee, sequestra-

tor (or other similar official) of the Company or a sub-

stantial part of the Company’s property; or make any

assignment for the benefit of creditors; or admit in

writing its inability to pay its debts generally as they

become due; or take any action in furtherance of any

such action.

Bay Club Partners suggests that lenders and investors

in the Ninth Circuit should continue to be skeptical

that SPEs are truly bankruptcy remote.

Although representatives of all BCP members at the time signed

the operating agreement, there was no evidence that the mem-

bers or their representatives discussed this restrictive covenant

beforehand. The non-bankruptcy covenant was included at the

request of Legg Mason.

BCP defaulted on the loan in January 2014. Shortly after-

ward, BCP filed a chapter 11 petition in the District of Oregon.

The petition was signed by a representative of BCM. It was

accompanied by a document entitled “Written Consent and

Resolutions of Bay Club Members,” executed by or on behalf

of three of BCP’s four members (representing 80 percent of

BCP’s member ownership interests). The remaining member,

Trail Ranch Partners, LLC (“Trail Ranch”), actively opposed the

bankruptcy filing.

Legg Mason moved to dismiss the chapter 11 case for cause

under section 1112(b). According to Legg Mason, BCP’s operat-

ing agreement prohibited BCP from filing for bankruptcy protec-

tion, and BCM possessed no authority to cause BCP to file for

bankruptcy without the affirmative votes of 100 percent of BCP’s

members. Trail Ranch later joined in the motion.

THE BANKRUPTCY COURT’S RULING

The bankruptcy court denied the motion to dismiss. At the out-

set, the court addressed the standing issue. The court explained

that, despite the expansive language of section 1109(b) of the

Bankruptcy Code, some courts outside of the Ninth Circuit have

held that creditors do not have standing to seek dismissal of a

15

business entity’s bankruptcy case because creditors are moti-

vated more by self interest rather than concerns that would

benefit the creditor body as a whole. See, e.g., In re John Hicks

Chrysler-Plymouth, Inc., 152 B.R. 503, 510 (Bankr. E.D. Tenn. 1992).

However, the court emphasized, the classic “pecuniary interest”

test is applied in the Ninth Circuit (citing Fondiller v. Robertson

(In re Fondiller), 707 F.2d 441 (9th Cir. 1983)). Under this standard,

only those persons “who are directly and adversely affected

pecuniarily” by a bankruptcy case have standing to appear and

be heard.

Given Legg Mason’s direct pecuniary interest as the only

secured creditor in BCP’s chapter 11 case, the court ruled that

Legg Mason had standing to seek dismissal of the case under

both the pecuniary interest test and section 1109(b). Even if it

had concluded otherwise, the court noted, Trail Ranch had

standing as a BCP member to prosecute the motion to dismiss,

which it had joined.

On the issue of the enforceability of the waiver of the right to

file for bankruptcy protection prior to the repayment of the

Legg Mason debt, the court stated that the parties’ arguments

concerning the validity of the non-bankruptcy covenant under

Oregon law were misplaced because federal law governs the

issue. In the Ninth Circuit, the court explained, the law is “very

clear” that a debtor’s prepetition waiver of the right to file a

bankruptcy case is unenforceable because it violates public

policy. The court acknowledged the absence of any evidence

that Legg Mason insisted on a bankruptcy waiver in its loan

agreement with BCP. Instead, the court wrote, Legg Mason’s

conduct in requesting that a bankruptcy waiver be included

in BCP’s operating agreement along with other restrictive cov-

enants without any discussion among BCP’s members was

“more cleverly insidious.” The bankruptcy waiver in the oper-

ating agreement, the court wrote, “is no less the maneuver of

an ‘astute creditor’ to preclude [BCP] from availing itself of the

protections of the Bankruptcy Code prepetition, and it is unen-

forceable as such, as a matter of public policy.”

Finally, the court ruled that BCP’s chapter 11 filing was properly

authorized by BCM, despite the refusal of Trail Ranch to sign the

consent resolution. Under the operating agreement, the court

explained, BCM clearly had the authority to initiate a chapter 11

case on BCP’s behalf.

Accordingly, the court denied the motion to dismiss BCP’s chap-

ter 11 case.

OUTLOOK

The enforceability of bankruptcy waivers or restrictions fre-

quently arises in the context of SPEs that, like the debtor in

Bay Club Partners, are designed to be “bankruptcy remote”

as a way to encourage investment and limit the risks of both

investors and lenders. See, e.g., In re Gen. Growth Props.,

Inc., 409 B.R. 43, 54 (Bankr. S.D.N.Y. 2009) (denying dismissal

of chapter 11 cases where loan agreement with bankruptcy

remote debtor provided that debtor could not file for bank-

ruptcy without approval of independent director that rep-

resented lender’s interest); see also Sheri P. Chromow & K.C.

McDaniel, Surviving A CMBS Bankruptcy, Modern Real Est.

Transactions 747, 754 (ALI-ABA Continuing Legal Education,

Course of Study No. SJ004, 2003) (“Case law has rejected

the idea of limiting the power of directors or requiring them

to refuse a vote in favor of bankruptcy.”). Bay Club Partners

is representative of the dim view traditionally taken by bank-

ruptcy courts confronting such waivers.

The blanket rule against waiver in this context, as distinguished

from cases involving waivers by individual debtors of the right

to file for bankruptcy or to receive a discharge, has been

the subject of considerable debate. Some commentators,

for example, have argued that bankruptcy waivers or restric-

tions should be enforceable for business entities like SPEs,

provided they are solvent. See, e.g., Comment, Bankruptcy-

Remote Special Purpose Entities and A Business’s Right to

Waive Its Ability to File for Bankruptcy, 28 Emory Bankr. Dev. J.

507 (2012). This is one of the many issues being considered by

the American Bankruptcy Institute’s Commission to Study the

Reform of Chapter 11.

At this juncture, however, Bay Club Partners suggests that lend-

ers and investors in the Ninth Circuit should continue to be

skeptical that SPEs are truly bankruptcy remote.

16

IN RE DENVER MERCHANDISE MART—FIFTH CIRCUIT EMPHASIZES NEED FOR CLEAR CONTRACTUAL LANGUAGE REGARDING PREPAYMENT PREMIUMSJonathan M. Fisher and Mark G. Douglas

Prepayment premiums have recently been a source of con-

troversy in bankruptcy and appellate courts. One of the latest

examples of this trend is the Fifth Circuit’s ruling in In re Denver

Merchandise Mart, Inc., 740 F.3d 1052 (5th Cir. 2014). The deci-

sion in Merchandise Mart stands for the proposition that, in

the absence of clear contractual language stating otherwise, a

lender’s voluntary decision to accelerate a loan generally acts

as a waiver of any right to a prepayment premium. The ruling

underscores the importance of using unambiguous language

in a loan agreement detailing the circumstances under which a

borrower is obligated to pay a prepayment premium.

ENFORCEABILITY OF PREPAYMENT PREMIUMS IN BANKRUPTCY

Restrictions on a borrower’s ability to prepay secured debt

are a common feature of bond indentures and credit agree-

ments. Lenders often incorporate “no-call” provisions to prevent

borrowers from refinancing or retiring debt prior to maturity.

Alternatively, a loan agreement may allow prepayment at the

borrower’s option, but only upon payment of a “make-whole pre-

mium” (commonly referred to as a “prepayment penalty”). The

purpose of these prepayment penalties is to compensate the

lender for the loss of the remaining stream of interest payments

it would otherwise have received had the borrower paid the

debt through maturity.

Bankruptcy courts almost uniformly refuse to enforce no-call

provisions against debtors and routinely allow the debtor to

repay outstanding debt. Also, courts sometimes disallow a lend-

er’s claim for payment of a make-whole premium for breach

of a no-call provision because the premium is generally not

due under the applicable loan documents during the no-call

period. The courts are also divided on the alternative argument

sometimes made that a lender should be entitled to contract

damages (apart from a make-whole premium) for “dashed

expectations” when its outstanding debt has been paid prior

to its original maturity. See, e.g., U.S. Bank Trust Nat’l Assoc. v.

Am. Airlines, Inc. (In re AMR Corp.), 730 F.3d 88 (2d Cir. 2013)

(debtors not required to pay make-whole premium when pre-

paying secured debt where plain language of loan documents

did not require any such payment where default event, a volun-

tary bankruptcy filing, triggered automatic acceleration of debt);

HSBC Bank USA, Nat’l Ass’n v. Calpine Corp., 2010 WL 3835200

(S.D.N.Y. Sept. 15, 2010) (damage claim for breach of no-call pro-

vision disallowed under section 502(b)(2) of claim for unmatured

interest); In re Trico Marine Services, Inc., 450 B.R. 474 (Bankr. D.

Del. 2011) (make-whole premium is in nature of liquidated dam-

ages, not interest, so that lenders were entitled only to unse-

cured claim for make-whole premium); In re Solutia Inc., 379 B.R.

473 (Bankr. S.D.N.Y. 2007) (disallowing claim for make-whole pre-

mium and reasoning that, by incorporating provision for auto-

matic acceleration upon bankruptcy in indenture, noteholders

made decision to give up future income stream in favor of hav-

ing immediate right to collect entire debt). But see In re School

Specialty, Inc., 2013 BL 107127 (Bankr. D. Del. Apr. 22, 2013) (allow-

ing claim for make-whole premium under New York law where

loan agreement specifically provided for make-whole premium

in event of “either prepayment or acceleration” and make-whole

premium not plainly disproportionate to lender’s probable loss);

Premier Entm’t Biloxi, LLC v. U.S. Bank Nat’l Ass’n (In re Premier

Entm’t Biloxi, LLC), 445 B.R. 582 (Bankr. S.D. Miss. 2010) (lenders

not entitled to secured claim for make-whole damages because

indenture required prepayment penalties only if debtor repaid

loan prior to maturity, and maturity was automatically acceler-

ated due to bankruptcy filing; however, lenders were entitled to

unsecured claim for dashed expectations).

The Fifth Circuit considered the enforceability of a prepayment

premium in Merchandise Mart.

MERCHANDISE MART

GC Merchandise Mart, LLC (the “debtor”) owns the Denver

Merchandise Mart , a large exposition center in Denver,

Colorado. In 1997, the debtor borrowed $30 million and executed

a secured promissory note in favor of the lender. The note

provided that the debtor could prepay the loan under certain

conditions, but that early repayment would trigger the debtor’s

obligation to pay a prepayment premium. Furthermore, the note

provided that any default would trigger acceleration of all out-

standing principal, interest and “all other moneys agreed or

provided to be paid by Borrower in this Note,” as well as the

accrual of default interest.

17

In addition, the court noted that section 506(b) of the

Bankruptcy Code provides that, to the extent the value of collat-

eral exceeds the amount of a claim secured by it, the creditor’s

allowed secured claim includes “any reasonable fees, costs, or

charges provided for under the agreement” (emphasis added).

According to the Fifth Circuit, a prepayment premium is not

subject to section 506(b)’s reasonableness standard if the pre-

mium is deemed to be consideration for the borrower’s privilege

to prepay rather than a remedy for breach of contract.

The central message of the Fifth Circuit’s ruling in

Merchandise Mart is that lenders should bargain for

specific and unambiguous language stating that a

prepayment premium is due in the event of an accel-

eration of a note by a lender. In the absence of such

language, lenders run the risk that a court will rule that

acceleration of a note does not trigger an automatic

right to a prepayment premium.

Turning to the language of the note, the Fifth Circuit focused

on two points: (i) the absence of any prepayment; and (ii) the

principle that, when a lender voluntarily accelerates a note

due to a default, no prepayment premium will be due unless

the contract specifically provides that such acceleration trig-

gers the lender’s right to a prepayment premium. The court

examined three separate sections of the note to determine

whether the debtor was expressly required to pay a prepay-

ment premium. Although the note gave the debtor the “right

or privilege” to prepay, it did not require the debtor to prepay.

In addition, even though the note required the payment of a

premium if the debtor prepaid the debt in the event of default

or acceleration, no prepayment had actually been made.

Similarly, although the note provided that a prepayment pre-

mium was payable regardless of whether a prepayment was

“voluntary or involuntary,” no prepayment actually occurred.

The Fifth Circuit panel noted that language could easily have

been included in the note making a prepayment premium due

upon acceleration, even in the absence of an actual prepay-

ment. However, the court wrote, the note in the case before it

evidenced “no such clear intent.”

The debtor stopped making payments on the note in October

2010, and the lender issued a notice of default. As permit-

ted by its security agreement, the lender then appointed a

receiver for the merchandise mart. The debtor and certain

affiliates filed for chapter 11 protection in the Northern District

of Texas shortly afterward.

The lender argued that payment of the $1.8 million prepay-

ment premium was required under the acceleration clause in

the note, even though the debtor stopped making payments

under the note before filing for bankruptcy and never repaid

the debt prior to maturity. The bankruptcy court disagreed. It

concluded that some prepayment, whether voluntary or involun-

tary, was required to trigger the obligation to pay the prepay-

ment premium. The court also emphasized that the note could

have expressly provided for payment of the premium in the

event of acceleration, but did not. The lender appealed to the

district court, which affirmed the ruling below. The lender then

appealed to the Fifth Circuit.

THE FIFTH CIRCUIT’S RULING

A three-judge panel of the Fifth Circuit affirmed. The court wrote

that, under Colorado law (which governed the note), “unless

specifically provided for by contract, a lender may not assess

a prepayment premium when a note is accelerated at the lend-

er’s option.” Therefore, the court explained, a lender’s decision

to accelerate generally acts as a waiver of any right to a pre-

payment premium. Even so, the Fifth Circuit stated, a court may

enforce a prepayment penalty even when a lender accelerates

the note at its option if the borrower defaulted to avoid addi-

tional interest.

In dicta, the Fif th Circuit panel noted that at least one

Colorado court has held that a prepayment premium is con-

sideration for a borrower’s right or privilege to prepay and

therefore not a remedy for breach of contract (discussing

Planned Pethood Plus, Inc. v. KeyCorp, Inc., 228 P.3d 262 (Colo.

App. 2010)). As a consequence, the Fifth Circuit explained, pre-

payment premiums are not considered to be liquidated dam-

ages under Colorado law, and they are not subject to the rules

of reasonableness applied in assessing whether a liquidated

damages clause is enforceable.

18

OUTLOOK

The central message of the Fifth Circuit’s ruling in Merchandise

Mart is that lenders should bargain for specific and unambigu-

ous language stating that a prepayment premium is due in the

event of an acceleration of a note by a lender. In the absence

of such language, lenders run the risk that a court will rule that

acceleration of a note does not trigger an automatic right to a

prepayment premium.

Notably, in Merchandise Mart , the Fifth Circuit’s analysis

extended no further than the question of whether accelera-

tion triggered the right to a prepayment premium. Having con-

cluded that it did not, the court did not undertake—nor was

it asked—to determine: (i) whether an otherwise enforceable

prepayment premium claim should be disallowed under sec-

tion 502(b)(2) as “unmatured interest”; or (ii) whether any such

claim, if allowed, should be treated as secured or unsecured

under section 506(b).

The court’s discussion in dicta regarding whether prepayment

premiums should be treated as liquidated damages may be con-

fusing. As noted above, citing Planned Pethood, the Fifth Circuit

observed that a prepayment premium should not be deemed

liquidated damages if the premium is not payable as a conse-

quence of default or acceleration, but rather is payable solely

because the borrower simply chose to prepay. As a result, the

Merchandise Mart panel did not provide any clear direction with

respect to the situation where a prepayment premium is contrac-

tually due as a result of a default or acceleration.

FROM THE TOP IN BRIEFIn its fourth bankruptcy-related ruling of the 2013-14, the U.S. Supreme Court handed down its decision on June 12 in Clark v. Ramaker, 2014 BL 162980 (June 12, 2014). In Clark, the Court considered whether an inherited individual retirement account (“IRA”) is exempt from a bankruptcy estate under section 522(b)(3)(C) of the Bankruptcy Code, which exempts “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation” under certain provisions of the Internal Revenue Code. In 2013, the Seventh Circuit Court of Appeals ruled that an IRA an individual debtor inherited from her mother was not exempt from the debtor’s bankruptcy estate. See Clark v. Rameker, 714 F.3d 559 (7th Cir. 2013), cert. granted, 134 S. Ct. 678 (2013). The Seventh Circuit ruling conflicted with a Fifth Circuit decision (Chilton v. Moser (In re Chilton), 674 F.3d 486 (5th Cir. 2012)), and the Supreme Court granted certiorari in Clark on November 26, 2013 to resolve the circuit split.

Writing for a unanimous Supreme Court , Justice Sonya Sotomayor explained that inherited IRAs do not have the same characteristics as other types of IRAs, such as traditional and Roth IRAs, established by a debtor and are not designed for retirement. Traditional and Roth IRAs established by debtors, she wrote, are designed to allow debtor account owners to accumulate funds “to ensure that debtors will be able to meet their basic needs during their retirement years.” The funds may not be withdrawn without penalty until an account owner reaches retirement age. By contrast, the holder of an inher-ited IRA account: (i) may never invest additional funds in the account; (ii) must withdraw money from the account either annu-ally or in a lump sum, regardless of the holder’s age or proximity to retirement; and (iii) may withdraw the entire balance of the account at any time—and for any purpose—without penalty.

Justice Sotomayor agreed with the Seventh Circuit’s observation that an inherited IRA constitutes “a pot of money that can be freely used for current consumption.” Because of this important distinction, the Supreme Court affirmed the decision below, rul-ing that funds held in an inherited IRA do not qualify as “retire-ment funds” that are exempt from an account holder’s estate under section 522(b)(3)(C) of the Bankruptcy Code.

A discussion of the Supreme Court’s third bankruptcy ruling of 2014 (Executive Benefits Insur. Agency v. Arkison, 2014 BL 158582 (June 9, 2014)) can be found elsewhere in this edition of the Business Restructuring Review. The two prior Supreme Court bankruptcy-related rulings in 2014 are briefly discussed at http://www.jonesday.com/from-the-top-in-brief-03-31-2014/.

On July 1, 2014, the Court granted certiorari in Wellness Int’l Network Ltd. v. Sharif, No. 13-935, 2014 BL 182626 (July 1, 2014), where the Court will be asked once again to decide whether Article III of the U.S. Constitution permits the exercise of the judi-cial power of the U.S. by a bankruptcy court on the basis of liti-gant consent—a question that the Court left unanswered in its recent ruling in Executive Benefits Ins. Agency v. Arkison.

19

SOVEREIGN DEBT UPDATEThe long-running dispute over the payment of Argentina’s sov-

ereign debt has been particularly active in recent months and

weeks. On June 16, 2014, despite the Republic of Argentina’s

warning that it may once again be forced to default on its sov-

ereign debt, the U.S. Supreme Court denied Argentina’s peti-

tion seeking review of lower court rulings that: (i) construed

pari passu, or equal footing, clauses of a bond indenture to

prohibit Argentina from making payments to bondholders

who participated in 2005 and 2010 debt restructurings before

it pays $1.4 billion to holdout bondholders (see NML Capital,

Ltd. v. Republic of Argentina, 699 F.3d 246 (2d Cir. 2012)); and

(ii) upheld a lower court’s order directing Argentina to pay hold-

out bondholders $1.4 billion (see NML Capital, Ltd. v. Republic

of Argentina, 727 F.3d 230 (2d Cir. 2013)). The Court also denied

certiorari in a related appeal by certain non-party bondholders

(Exchange Bondholder Group v. NML Capital Ltd., No. 13-991).

Argentina’s economy minister announced on June 17, 2014

that, in an effort to continue meeting Argentina’s obligations

to creditors who participated in the country’s previous debt

restructurings (the “exchange bondholders”), the government

is taking steps to execute a debt swap governed by Argentine

law. In response, U.S. District Court Judge Thomas Griesa, who

originally ordered Argentina to pay the $1.4 billion to holdout

bondholders on November 21, 2012, directed Argentina at a

hearing held on June 18, 2014 to comply with his previous orders

before it could make a $539 million payment on June 30 to its

exchange bondholders. Representatives from the Argentine

government later announced that they would meet with the

holdout bondholders, including NML Capital and Aurelius

Capital, in an effort to negotiate a settlement.

On June 20, 2014, Argentine President Cristina Kirchner stated

in a nationally-televised speech that her government wants to

reach a settlement with the holdout bondholders, but only if

U.S. courts create the right conditions for negotiations. On June

23, 2014, Argentina asked District Court Judge Griesa to sus-

pend rulings directing the country to pay holdout bondholders

so that the parties can engage in settlement talks. According

to Argentina, paying $1.4 billion to holdout bondholders when it

makes the next regularly scheduled payment on its restructured

debt would wipe out half its cash reserves due, among other

things, to a “right upon future offers” clause in the exchange

bond indentures Later that day, Judge Griesa appointed a spe-

cial master to preside over the negotiations. On June 24, 2014,

holdout bondholders objected to the Argentine government’s

request for additional time to negotiate a deal, saying a delay

would only give the country more time to launch a plan to evade

the judge’s orders.

On June 26, 2014, Judge Griesa issued an order rejecting

Argentina’s request to suspend his ruling directing the country

to pay holdout bondholders at the same time it pays exchange

bondholders. “Such a request is not appropriate,” Judge Griesa

wrote, explaining that “[t]he injunctive relief ordered by the

court (dealing with the pari passu issue) does not even come

into play unless the Republic makes payments to the exchange

bondholders.” He further stated that “[t]he court has no control

over whether or not the Republic makes such payments.” Earlier

that day, Argentina announced that it deposited $539 million

into trustee The Bank of New York Mellon Corp.’s (“BNY Mellon”)

accounts for the purpose of making interest payments on its

exchange bonds.

In a court hearing on June 27, 2014, Judge Griesa ruled that

Argentina’s attempt to pay $539 million to exchange bondhold-

ers without paying holdout bondholders is illegal and ordered

BNY Mellon to return the money to the Argentine government.

The judge characterized Argentina’s bid to pay exchange bond-

holders as “disruptive” and warned banks against facilitating

any such payment.

On June 29, 2014, investment firms that hold restructured euro-

denominated bonds issued by Argentina filed a petition seeking

a ruling from Judge Griesa that foreign banks which process

interest payments on such bonds are outside the jurisdiction of

U.S. courts. The investment firms contend that the euro-denom-

inated bonds are governed by the laws of England and Wales

and asked the court to clarify that prior injunctions restricting

payment on Argentina’s restructured debt do not apply to for-

eign banks processing such bonds.

Argentina missed a June 30 deadline for making a regularly

scheduled distribution to exchange bondholders. It has a

30-day grace period to avoid going into formal default for the

second time in 13 years.

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JONES DAY HAS OFFICES IN:

On July 7, 2014, a team of negotiators from Argentina met with

court-appointed mediator Daniel Pollack to discuss the nation’s

standoff with holdout bondholders and establish the ground-

work for future meetings.

On the same day, Argentina’s Ministry of Economy and Public

Finance issued a statement claiming that Judge Griesa did

not have the authority to block the payment of more than

$539 million to exchange bondholders, and that BNY Mellon

would be violating its obligations as trustee if it returned the

money. According to Argentina, Judge Griesa exceeded his

jurisdiction because the relevant bonds were issued under U.K.

law and denominated in euros, and the holders have an abso-

lute and unconditional right to the payments deposited with

BNY Mellon.

In a separate ruling handed down on June 16, 2014, the U.S.

Supreme Court, by a margin of seven to one (with one Justice

abstaining), affirmed a decision of the U.S. Court of Appeals

for the Second Circuit (EM Ltd. v. Republic of Argentina, 695

F.3d 201 (2d Cir. 2012)), directing two banks, in connection

with Argentina’s long-running dispute with holdout bondhold-

ers, to disclose comprehensive information concerning assets

Argentina owns outside the U.S. Writing for the majority, Justice

Scalia concluded that no provision of the Foreign Sovereign

Immunities Act of 1976 immunizes a foreign sovereign judgment-

debtor from post-judgment discovery of information concern-

ing its extraterritorial assets. In a dissenting opinion, Justice

Ginsburg objected to the “sweeping examination of Argentina’s

worldwide assets the Court exorbitantly approves today,” writing

that she “would limit NML’s discovery to property used [in the

U.S.] or abroad ‘in connection with . . . commercial activities.’”

On May 29, 2014, Argentina reached an agreement to repay

$9.7 billion in debt over a period of five years to the “Paris

Club,” an unofficial consortium of finance officials from 19

nations that provides financial services such as debt restruc-

turing, debt relief and debt cancellation to indebted countries

and their creditors. Under the agreement, Argentina will make

an initial payment of $650 million in July 2014, a $500 million

payment in May 2015, and three annual payments each year

thereafter to retire the debt. The interest rate is set at three

percent. The agreement provides that, if the Paris Club’s 19

member countries make significant investments in Argentina,

the required amount of Argentina’s payment installments may

increase. However, if those countries make insufficient invest-

ments in Argentina during the next five years, the maturity of

the Paris Club debt could be extended by two years, with a

one percent increase in the interest rate.