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Magazine-FW-January12.indd 1 19/12/11 11:31:39

S P E C I A L R E P O R T

G L O B A L R E S T R U C T U R I N G A N D I N S O LV E N C Y

© 2012 Financier Worldwide Limited.Permission to use this reprint has been granted by the publisher.

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JANUARY 2012 ISSUE

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FINANCIERWORLDWIDEcorporatefinanceintelligence

SPECIAL REPORT

Global restructuring and insolvency

sponsored byin association with

KRYS GLOBAL

OTTERBOURG, STEINDLER, HOUSTON & ROSEN, P.C.

TURNAROUND MANAGEMENT ASSOCIATION

Living wills

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www.financierworldwide.com | January 2012 FW | REPRINT

FORUM

Fallout from Madoff scandal hits banks in Fairfield Sentry litigationTURNAROUND MANAGEMENT ASSOCIATION

The public policy exception in cross-border recognition by American bankruptcy courtsOTTERBOURG, STEINDLER, HOUSTON & ROSEN, P.C.

Unfunded retirement liabilities in Europe and the US: can lessons be learned from corporate America?KIRKLAND & ELLIS LLP

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CONTENTSIntercreditor hot spots in 2011 and what to watch in 2012WHITE & CASE LLP

MF Global insolvency reveals risk in Dodd-Frank modelSUTHERLAND ASBILL & BRENNAN LLP

Fraud and the appointment of a liquidator – a BVI and Cayman perspectiveKRYS GLOBAL

The reform of the Spanish Insolvency Act and its impact on distress investing in SpainCUATRECASAS, GONÇALVES PEREIRA

ORGANISATION GLOSSARY

THE PANELLISTS

Partha Kar is a partner at Kirkland & Ellis International LLP. He can be contacted on +44 (0)20 7469 2350 or by email: [email protected].

Partha Kar is a partner in the London office of Kirkland’s restructuring practice group. He has a wide range of cross-border restructuring and insolvency experience. Mr Kar has acted for

financial creditors, turnaround advisers, corporates and insolvency practitioners in multi-jurisdictional restructurings and all classes of insolvency proceedings; directors, shareholders and creditors of companies that are financially impaired or subject to solvent reorganisation; and for vendors and purchasers of distressed debt or equity.

Melanie L. Cyganowski is a member of Otterbourg, Steindler, Houston & Rosen, P.C. She can be contacted on +1 (212) 905 3677 or by email: [email protected].

Melanie L. Cyganowski is a member of Otterbourg and the former Chief Judge of the United States Bankruptcy Court for the Eastern District of New York. She regularly serves as a mediator

in complex Chapter 11 cases and cross-border insolvencies, and as an expert in cross-border cases including SPhinX and Vitro.

Kenneth M. Krys is founder and chief executive officer of KRyS Global. He can be contacted on +1 (345) 815 8401 or by email: [email protected].

Kenneth Krys is a qualified and licensed insolvency practitioner in the Cayman Islands, the British Virgin Islands, and Bermuda with 20 years experience in a range of corporate recovery,

forensic accounting and regulatory compliance assignments. He has overseen the liquidation of a number of high profile and complex cross-border engagements in the Caribbean, including BCCI, SPhinX, and Fairfield Sentry.

Van Durrer is a partner at Skadden, Arps, Slate, Meagher & Flom LLP. He can be contacted on +1 (213) 687 5200 or by email: [email protected].

Van Durrer leads Skadden, Arps’ corporate restructuring practice in the western United States and advises clients in restructuring matters around the Pacific Rim. He regularly represents public

and private companies, major secured creditors, official and unofficial committees of unsecured creditors, investors, and asset-purchasers in troubled company M&A, financing and restructuring transactions, including out-of-court workouts and formal insolvency proceedings.

FORUM

FW moderates a discussion on key trends in corporate restructuring and insolvency between Partha Kar at Kirkland & Ellis International LLP, Kenneth M. Krys at KRyS Global, Melanie L. Cyganowski at Otterbourg, Steindler, Houston & Rosen, P.C, and Van Durrer at Skadden, Arps, Slate, Meagher & Flom LLP.

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FW: Broadly speaking, how would you de-scribe the restructuring and insolvency market over the last 12-18 months? What impact are economic and financial forces having on com-panies in general, and how are they coping?

Krys: We have seen a decrease in formal re-structuring and insolvency appointments over the past 12 to 18 months when compared to the previous period as the impacts of the financial crisis settle. In the Cayman Islands we are not currently seeing significant numbers of com-panies being put into an insolvency process by banks or financial institutions. This indicates that local banks are working with borrowers to assist restructuring and address debt issues. Following the fallout from the 2008 financial crisis and a period of inactivity in certain in-vestments, investors are starting to review these situations due to liquidity issues, to see what steps can be taken to turn those invest-ments into cash. However, a precautionary sentiment continues to linger with investors conscious of issues in large financial markets such as Europe.

Cyganowski: Throughout 2010 and the first half of 2011, the restructuring and insolvency markets have been relatively quiet, especially when contrasted against the firestorm of activ-ity that occurred several years prior. Recently, however, the volume of restructuring and insol-vency cases has steadily increased, with a num-ber of large or high profile companies filing for Chapter 11, including American Airlines, com-modity brokerage firm MF Global, and paper maker New Page Corp. Starting around the tail end of 2009, many lenders and their financially distressed borrowers, especially in the middle market, negotiated to delay debt maturities with the hope that the economy would rebound and business would pick up before the extend-ed maturity dates. However, with the economy still in flux and these extended maturity dates nearing expiration, many companies will soon be facing a liquidity crisis.

Kar: It is fair to say that the restructuring and insolvency market has generally been quieter than expected for the last 12 to 18 months al-though there has been a substantial pick up in enquiries and contingency planning work since the summer, a result primarily of the effective seizure of bank lending and the general down-turn in economic conditions. The European financial crisis has not been out of the news for several months and is having a clear impact on companies in general, their customers, their suppliers, and their lenders. There also appears to be issues in other parts of the world which are likely to contribute to the negative senti-ment, and have a negative impact on market conditions. Many businesses are finding it a challenge in the current environment.

Durrer: The number of companies entering default scenarios or otherwise in need of a fi-nancial restructuring has definitely increased in the past 12 months, and we see that trend continuing into 2012. There are several forces behind this activity. First, the general softness of the economic recovery continues to create revenue pressure for many companies. Sec-ond, the volatility of the capital markets makes it very challenging for companies to resolve issues in their capital structures absent going into default. Third, that same volatility con-tinues to create obstacles to companies that are developing go-forward business plans and strategies because there is so little visibility for long term planning. That said, we are seeing distress players invest more money in sound companies that have balance sheet issues. In other words, we are seeing more restructurings successfully completed.

FW: Have any high profile insolvencies or bankruptcy-related court decisions captured your attention in recent months?

Cyganowski: In July 2011, the United States Supreme Court issued its well publicised and highly controversial decision of Stern v Mar-

shall, 131 S. Ct. 2594 (2011). In Stern v Mar-shall, the Supreme Court ruled, in a five-four split decision, that US bankruptcy courts lack the constitutional authority to enter final judg-ment on a state law counterclaim that does not need to be resolved as part of the bankruptcy process. The ruling raised fundamental ques-tions concerning bankruptcy judges’ authority to determine a wide variety of issues that, prior to the decision, bankruptcy courts routinely determined as a matter of course. Although the decision is only a few months old, it has already been cited in more than 100 bankrupt-cy court cases, with bankruptcy judges ques-tioning their ability to issue final judgment in cases ranging from requests for relief from the automatic stay to fraudulent transfer pro-ceedings. While many bankruptcy courts have interpreted the decision narrowly – meaning they interpreted the decision as inapplicable to the matter before them, bankruptcy courts, as well as debtors and creditors involved in bank-ruptcy related litigation, will likely continue to struggle with the implications of the decision until the appellate courts provide the necessary clarity.

Kar: The decision of the English High Court in Rodenstock GmbH [2011] EWHC 1104 makes it clear that an English scheme of arrangement is now a legitimate tool that is available for European restructuring involv-ing English law credit agreements. This case confirms that a company does not need to shift its COMI to England or even have an Eng-lish establishment where an English scheme is proposed, provided there is sufficient con-nection established using the English law gov-erned credit agreements. Also, the European Directories case – HHY Luxembourg S.a.r.l. v Barclays Bank Plc & Ors [2010] EWCA Civ 1248 – was also an interesting decision where the Court of Appeal followed the Supreme Court’s approach in other cases that a com-mercial interpretation of clauses should be considered in the context of the agreement as a whole; relevant, in that case, when looking at the release clause in an intercreditor agree-ment.

Durrer: Judge Walrath’s recent rulings in the Washington Mutual case are beginning to gen-erate repercussions in restructuring negotia-tions. Briefly, in that case the court ruled that the status of settlement negotiations among key parties to a restructuring, including, po-tentially, the term sheets transmitted between such parties, could be material non-public in-formation required to be disclosed to the mar-ket following the expiration of a confidential-ity agreement among the parties. Already, we are seeing the law of unintended consequences play out, in that the decision has somewhat

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chilled restructuring negotiations or at least slowed the parties’ communications in certain instances.

Krys: The filing for Chapter 11 protection of MF Global in October 2011 triggered the larg-est corporate collapse in the US since Lehman Brothers in 2008, and is the eighth-largest fil-ing of its kind in the US. MF Global used a large number of complex and controversial repurchase agreements for funding and for le-veraging profits, and includes trades concern-ing some of Europe’s most indebted nations. The bankruptcy of MF Global is just one ex-ample and raises the question of whether more situations like this may exist globally in off-shore jurisdictions and in other countries trad-ing sovereign debts. It is not possible to know how many of these funds operate sincerely. More broadly speaking the negative impact from similar fund failures, and from the cur-rent issues in Europe, is very likely to be seen in financial markets globally and the offshore jurisdictions.

FW: Are you continuing to see a prefer-ence for out-of-court restructuring solutions, including pre-packaged and pre-negotiated bankruptcies?

Kar: Out of court restructuring solutions have always been the preferred way forward in Europe save that court processes may be used to implement agreed proposals that obtain a high majority of consent, but not 100 percent consent. Such implementation methods may include English administrations and prepacks, English schemes of arrangement, local share pledge enforcements, and so on. Many Euro-pean jurisdictions are moving to a rescue cul-ture and are enacting real restructuring – rather than insolvency – laws, but we are yet to see whether this results in more court filings for restructurings. I think this is fairly unlikely until a substantial precedent base is built up around those procedures. Few people want to

be the first to test these new laws, but the fact that they have been passed is great progress in itself.

Durrer: For a company that needs to correct its balance sheet, as opposed to a more in-depth operational restructuring, pre-packaged bankruptcies are ideal. The company spends less, or almost no time, in a formal proceeding which is not only cheaper for the company in terms of transaction costs, but is also more effi-cient in terms of potential loss of value through the process. More specifically, loss of value in a formal in-court proceeding can take many forms. First, competitors can try to take ad-vantage of a company’s distress – much more detailed information regarding the company in a proceeding becomes public, for one thing. Second, customers and other critical partners can become nervous regarding the uncertainty of an in-court process. Finally, employees are often distracted and concerned about a pro-longed in-court process and they may lose fo-cus on the task of running the company. The good news is that courts continue to embrace the notion of a pre-negotiated case, so even if there is time that must be spent in court, it can be as minimal as possible in such situations.

Krys: We have seen a trend whereby inves-tors or creditors are fatigued and have less appetite for pursuing recoveries through litiga-tion which can often take a number of years before there are recoveries through settle-ments or successful litigation of the claim and enforcement of any judgment. Investors and creditors are often willing to forgo potential future recoveries and will consider alternatives such as schemes of arrangement as a potential avenue to bring about a more timely resolution and distribution.

Cyganowski: Due in large part to the ad-ditional administrative and professional fees associated with Chapter 11, we see distressed companies continuing to seek restructur-

ing solutions out of court rather than through Chapter 11. For example, more companies are amending and extending their existing credit arrangements through either a forbearance or amendment agreement with an eye toward achieving a liquidity event or executing a turn-around business plan. Another out of court option is when the secured lender conducts a ‘friendly foreclosure’ sale of its collateral under Article 9 of the Uniform Commercial Code. Of course, in situations where Chapter 11 might be necessary to a restructuring, for instance where a distressed company wishes to jettison economically unfavourable con-tracts, pre-packaged and pre-arranged are the favoured remedy.

FW: Are distressed debtors finding it any easier to raise capital to fund restructuring plans? What financial solutions are they util-ising to resurrect their business?

Durrer: Interestingly, some companies are having some success in refinancing debt. Sus-pect industries, however, are having serious challenges. For instance, commercial real es-tate continues to face considerable challenges. Real estate companies are facing large maturi-ties in the coming months and years, and there is little money for refinancing in the markets for such companies. We should expect to con-tinue to see foreclosures and bankruptcies re-sulting from these scenarios.

Krys: Typical sources of capital such as banks or private investment have almost disap-peared. One of the things we have seen in the past year or two is an increase in the number of investment management firms and larger financial intuitions setting up distressed debt departments with the purpose of finding dis-tressed situations in which they can invest. Such parties typically have significant liquid-ity and a high risk appetite, however they are also expecting big returns for that risk, some-times taking up to 50 percent of future returns, and they will likely also want control over the process and any turnaround plan.

Cyganowski: Relative to 2009 and 2010, the financial markets have been more robust throughout 2011. However, lenders – having absorbed their fair share of losses over the past few years – are increasingly selective when it comes to determining which companies to finance. The more financially sound com-panies are able to attract fresh capital, often with lenders competing to participate in the financing. By contrast, financially distressed companies are struggling to obtain financing and, therefore, are often left trying to negoti-ate an ‘amend and extend’ with their existing lenders. Of course, companies with various

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layers of secured debt have a more difficult re-structuring task because the maturity dates and other key restructuring terms usually must be reached for all tranches of debt.

Kar: In terms of debtors, it is difficult to raise capital given the issues in the Eurozone at present, however we have seen a number of restructurings where lenders are asked to put new money in particular in distressed situa-tions. A recent example is Thomas Cook. It is interesting to note that many investors, despite the current environment, have in fact raised substantial new funds for distressed investing which means that, in general terms, there is capital in the market but this capital is not nec-essarily being deployed in the current round of restructuring transactions. Some of the re-structuring deals being currently undertaken probably leave too much debt on the company or may be seen as ‘extend and pretend’ and in those circumstances it is difficult for investors to use their new money capital. Of course, we have seen circumstances where new money has been provided to deal with liquidity issues and capex needs, so it is difficult to gener-alise on this. In relation to resurrecting busi-nesses, we have seen management teams and investors working together to formulate new business plans, looking to make investments, acquisitions, and so on, to improve businesses – but new investment is not always necessar-ily the answer. This remains a challenge in the current economic climate when there is much uncertainty and it is difficult to forecast with accuracy, particularly in the long term.

FW: Is it more likely in the current climate that a struggling company will be sold instead of passing through a traditional restructur-ing process and emerging intact on the other side?

Krys: In the current climate, there are few parties available to purchase struggling com-panies, and quite apart from the financial rea-

sons, these struggling companies tend to have other problems such as fund governance or some element of fraud which have resulted in the funds being diverted to the detriment of the company. In such cases, where there is fraud, liquidation is usually the most appropriate course of action. In the current market, there are fewer options, such that restructuring and working with creditors and lenders is often the only avenue.

Cyganowski: The assets of a struggling com-pany are today more likely to be sold, whether out of court or through a sale under Section 363 of the Bankruptcy Code than as part of a traditional reorganisation under Chapter 11. In fact, many ‘amend and extend’ arrangements require, as a condition to the extension, that the company agree to a sale process. Even companies that enter Chapter 11 hoping to reorganise often wind up selling instead. For example, mobile communications company TerreStar Networks and home video retail chain Blockbuster Video both wound up sell-ing under Section 363 after initially filing for Chapter 11 with the intent to reorganise.

Kar: It is difficult to generally say whether a company would be sold rather than restruc-tured – this needs to be looked at on a case by case basis. There are obviously benefits in selling a company but the down side is that the price expectations of the existing stakehold-ers may not be met, this means they may have to take a write down or a loss which, in the current environment, would be unacceptable. This is the very reason that ‘extend and pre-tend’ restructurings exist and, at the moment, it is unlikely that this is going to change in the short term when the lender community itself is under so much stress.

Durrer: Shorter, faster bankruptcies are be-coming the ‘new normal’ or, in other words, more traditional in the current climate. To the extent that “a traditional restructuring process”

refers to a distressed company that is in need of operational fixes – such as replacement of key managers, restructuring of labour and vendor costs, relocation of key facilities, com-promise of legacy liabilities, and renegotiation of key contracts – those are indeed rarer these days. For one thing, it takes a very robust com-pany to survive the process of an operational turnaround. It takes a great deal of liquid-ity and patience to accomplish that. In addi-tion, the in-court operational turnaround faces many challenges, not the least of which are the transaction costs and the fact that in the US, the Bankruptcy Code is less conducive to such activities due to amendments by Congress in 2005.

FW: In your experience, what are some of the challenges that frequently arise in corpo-rate liquidations?

Cyganowski: In my experience, one of the biggest challenges in corporate liquidations is that they increasingly involve litigation or threats of litigation. Having lived through the wave of liquidations and insolvencies that hit in 2008 and 2009, creditors are now more so-phisticated and have a better understanding of the process. Further, with many liquidating companies leveraged to the hilt, unsecured creditors, who might otherwise receive little or no recovery in the liquidation, are increas-ingly threatening, or actually pursuing, fraud-ulent transfer and other lender liability claims as a means to enhance their recovery – most often through a settlement with the secured lenders.

Kar: Finding new money on acceptable terms, ensuring the continuity of the business, and trying to find a buyer for any viable part of the business as quickly as possible, are key challenges. The reality is that, in the current environment, businesses that go into liquida-tion very rarely come out, or come out whole. Formal processes in Europe are often best avoided if the goal is to quickly preserve the going concern.

Durrer: One challenge that we often see in corporate liquidations is a struggle for control over the process. In liquidations, where there are certainly insufficient assets to satisfy all constituents, it is unfortunate that the dwin-dling assets must be allocated first to fund battles over who will control the process. For example, there may be a bankruptcy trustee or other fiduciary attempting to conduct an orderly wind-down, while a creditor or group of creditors are seeking to unseat the fiduciary and replace her with one of its own choosing. A more cooperative, negotiated approach will often yield a greater recovery to all.

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Fallout from Madoff scandal hits banks in Fairfield Sentry litigation| BY MARK S. INDELICATO, RONALD R. SUSSMAN AND NICHOLAS SMITHBERG

A perfect storm, formed in the Caribbean, is roaring into the United States, Europe and Asia. Not in the skies, but in the courts.

In the aftermath of the well-publicised scan-dal stemming from the Bernard Madoff Ponzi scheme, collateral litigation has proliferated in the US and abroad. One such lawsuit, the multi-party litigation in In re Fairfield Sentry Ltd., has created a legal black hole, drawing dozens of financial institutions in Europe, Asia,

the Caribbean and elsewhere into high-stakes litigation with billions of dollars at stake.

Before we delve into the dizzying array of substantive and procedural issues implicated by these cases, we should first meet our cast of characters.

As is now well known, Bernard L. Madoff operated an investment fund, Bernard L. Madoff Securities, Inc. (‘Madoff Securities’). Fairfield Sentry Ltd. (together with an affili-

ated fund, ‘Fairfield’) was the single largest investor in Madoff Securities. Fairfield, char-tered in the British Virgin Islands, acted as a ‘feeder fund’ for Madoff Securities, funnelling billions of dollars in offshore investments into the enterprise. Fairfield styled itself as an ‘In-ternational Investment Company’, offering its shares exclusively to investors outside of the United States. In reality, Fairfield was noth-ing more than a channel to Madoff Securities,

OPINIONS ARTICLES

Krys: Investors have become increasingly cautious and risk averse when it comes to con-sidering the options available to them. They often have less of an appetite for pursuing recoveries through lengthy litigation and are keener to chase low hanging fruit than longer term strategies through litigation. Often the entity will have very little in regard to cash or assets and legal remedies can be complex and involve significant cost with a number of stages and rulings involved. Courts have set a higher bar for disclosure with liquidation com-mittees and liquidators must maintain a rela-tionship of transparency with the liquidation committee and ensure they are involved in the process. Cross-border cases pose further chal-lenges such as obtaining recognition of your offshore proceeding in other jurisdictions.

FW: In terms of bankruptcy litigation, can you highlight some of the common disputes impacting the restructuring and bankruptcy process in today’s market?

Kar: The European Directories case is an example of common issues we are seeing in the current cycle of restructurings in Europe – documents with apparent errors or defects that may lead to parties being given apparent ‘hold up rights’ or not having rights they would otherwise expect, thus changing the expected balance of power between the stakeholders. Although very few of these cases have gone to a hearing, documentary and interpretation is-sues like this are very common and my expec-tation is that we will see more of these cases, notwithstanding that European Directories has given guidance on how these clauses should be interpreted. I also expect there will be some form of a large scale challenge against the use of English processes for European companies

or groups, although this may take some time if it is to be seen through to the European Court of Justice.

Durrer: There are two disputes that continue to arise with the most regularity. First, we still see many valuation disputes, where the senior constituent in the capital stack has a pessimis-tic view of value, believing most of the value of the company belongs to it, and where the less senior constituents have a more optimistic view of value, believing that more of the value of the company belongs to them. Sometimes there is a perverse incentive for junior con-stituents to use the threat of a valuation dispute to delay the process of a restructuring for so-called ‘hold-up’ value. Other times, however, the difference of opinion is entirely genuine and derives from different assumptions about future performance or direction that impact value. The other area where we still see quite a bit of litigation is where parties seek to reverse or avoid past transactions. In other words, the company cannot determine what parties are entitled to participate in the value of the company until these transactions are properly sorted. Again, this can be an expensive and time-consuming process. When it is clear that past transactions will become an issue, some companies have been successful in conducting their own independently-led investigations of such transactions in order to avoid the greater expense and delay of litigation.

Krys: Recently, the Supreme Court ruled in the matter of Stern v Marshal, on the bankrupt-cy court’s jurisdiction to enter final judgment in respect of certain state law matters. This has a number of possible implications to past, pres-ent, and future bankruptcy litigation. It is likely any litigation will involve more time fighting

‘turf wars’ about whether a particular action belongs in bankruptcy court or somewhere else and further arguments about the finality of past and future rulings of the bankruptcy court in light of the jurisdictional issues. A further practical effect will be a possible delay to proceedings with cases moving away from more efficient bankruptcy courts. UNCITRAL Model Law is still developing and INSOL is constantly revisiting whether any revisions or adjustments are necessary. Certainly, the num-ber of countries that have not adopted the UN-CITRAL model law, which would assist in the ability of a foreign liquidator to have foreign proceedings recognised in those jurisdictions, still continues to be a problem.

Cyganowski: With Chapter 11 continually used as vehicle to effectuate a sale of the as-sets of a distressed company pursuant to Sec-tion 363 of the Bankruptcy Code, many of the common disputes today arise in that context. For example, as 363 sales often leave the Chapter 11 debtor with little or no assets to pay the operating expenses it has incurred during the Chapter 11, including expenses incurred in furtherance of the 363 sale, bankruptcy judges will usually require a ‘carve out’ from the sale proceeds to pay these expenses. In this regard, disputes often arise with respect to the amount of the carve out and how it will be funded – usually by either the secured lender directly, or through an allocation of the sale proceeds for these expenses. Another dispute that often arises in the context of the 363 sales relates to which, if any, liabilities the buyer will assume as part of the sale. Labour unions often put pressure on the buyer, both in bankruptcy court and through the media, to hire the employees of the Chapter 11 debtor and to assume the Chapter 11 debtor’s pension liabilities.

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with more than 95 percent of its ‘investments’ in Madoff Securities.

Fairfield’s investors represent dozens of af-filiates of leading global financial institutions. In many cases, these institutions placed invest-ments in Madoff Securities on behalf of the unnamed ‘beneficial owners’ of the Fairfield shares.

As the world now knows, Madoff Securities was a fraud, and following Mr Madoff’s ar-rest, Irving Picard was appointed as trustee of Madoff Securities (the ‘Madoff Trustee’) pur-suant to the US Securities Investor Protection Act, or ‘SIPA’. Shortly thereafter, Fairfield declared itself to be insolvent and commenced liquidation proceedings under the insolvency laws of the British Virgin Islands. Kenneth Krys, a well-know Caribbean insolvency professional, was, along with one of his col-leagues, named Official Liquidator of Fairfield by the BVI court (together, the ‘Liquidator’).

The stage is now set to introduce the Fair-field litigation, and the procedural background which is illustrative of its complexity. The Madoff Trustee commenced hundreds of claw back actions against investors in Madoff Se-curities who were ‘net winners’, meaning they received more in aggregate redemptions than their investments in Madoff Securities. One such investor was Fairfield. In 2009, the Madoff Trustee commenced an action against Fairfield demanding the return of more than $3bn in transfers from Madoff Securities to Fairfield.

The Liquidator in turn commenced dozens of lawsuits in the British Virgin Islands against both ‘registered shareholders’ of Fairfield (i.e., the financial institutions that invested in Fairfield) and unnamed ‘beneficial owners’ of Fairfield (i.e., the customers of the defendant financial institutions). The Liquidator also commenced dozens of similar actions in New York State Supreme Court, listing the benefi-cial owners as unnamed ‘Doe’ defendants as is permitted under US procedural rules.

Thereafter, in July 2010, the US Bankruptcy Court in New York granted the application of the Liquidators for ‘recognition’ of the Fair-

field BVI insolvency proceedings as a ‘foreign main proceeding’ under Chapter 15 of the United States Bankruptcy Code. When its mo-tion was granted, the Liquidator proceeded to remove the cases pending in New York State court to the Bankruptcy Court, and to com-mence new actions against scores of additional defendants. To date, more than 200 lawsuits by the Liquidator against Fairfield shareholders and beneficial owners are pending before the Bankruptcy Court, naming more than 400 in-stitutions and individuals as defendants.

All of the US actions are based upon New York State common law theories of ‘quasi-contract’ and other, similar equitable princi-ples. In essence, the Liquidator alleges that the redemptions from Fairfield must be returned because they were based upon a ‘mistake’ by Fairfield that its investments in Madoff Secu-rities had actual value when they were in fact virtually worthless. The Liquidator’s ‘mis-take’ claims are generally viewed as a ‘novel’ legal theory, and his decision to frame these actions in this guise would appear motivated, at least in part, by the fact that Chapter 15 of the Bankruptcy Code does not permit foreign representatives to bring typical ‘avoidance ac-tions’ such as preference and fraudulent trans-fer claims. Notably, the Liquidator has since amended its Bankruptcy Court complaints to add claims under the BVI insolvency statute that are substantially the same as these types of avoidance claims under the Bankruptcy Code.

An avalanche of protracted motion practice on threshold procedural issues has ensued, re-sulting in hundreds of pages of briefing, multi-ple hearings and several lengthy opinions from various courts. At present, the issue of whether the cases originally commenced in State Court in New York is subject to an appeal to the Second Circuit Court of Appeals. At the same time, an order by the BVI Court dismissing the Liquidator’s claims is subject to an appeal be-fore the BVI appellate court.

Ultimately, the resolution of the Liquidator’s claims is likely to turn on the application of a number of as-yet unresolved legal issues. For example, the recent opinion from the United

States Supreme Court in Stern v. Marshall may impact these proceedings. In Marshall, the second opinion from the Supreme Court in the tortured legal saga of the late Anna Nicole Smith, the Supreme Court held that a bank-ruptcy court lacked the constitutional author-ity to issue a final judgment regarding the state law counterclaims of Ms Smith’s adversary in a lengthy probate contest. Courts in the US, including those involved in the Fairfield litiga-tion, have struggled to determine the implica-tions of the Marshall decision, which would tend to support, at a minimum, an argument that the Liquidator’s common-law ‘mistake’ claims may only be decided by an ‘Article III Judge’ (i.e., a district court judge, and not a bankruptcy judge). The Marshall decision is part of a long-running dispute in the US courts regarding the ‘separation of powers’ between Congress and the federal judiciary which is be-yond the scope of this article. Suffice it to say that given the pending BVI proceedings and the Marshall decision it is far from clear which court (or courts) will ultimately adjudicate the Liquidator’s claims. Perhaps the only certainty is that millions of dollars in legal fees will be consumed in the process.

The Fairfield litigation involves a number of other unsettled legal issues, including the powers of a trustee under the recently-enacted Chapter 15 of the Bankruptcy Code, the scope of the ‘safe harbour’ for certain securities-related ‘settlement payments’ under Section 346(e) of the Bankruptcy Code, and the show-ing that is necessary to recover in a ‘mistake’ claim under new York Common law. Given the sums at stake and the number of parties involved, it is likely that these and other novel legal issues will be thoroughly litigated before any of the Fairfield cases are resolved.

Mark S. Indelicato is the 2012 TMA chairperson and the managing partner at Hahn & Hessen LLP. He can be contacted on �1 (212) 478 7320 or by email: MIndelicato�hahnhessen.com. Ronald R. Sussman is the 2012 TMA president and a partner at Cooley LLP. He can be contacted on �1 (212) 479 6063 or by email: rsussman�cooley.com. Nicholas Smithberg is special counsel at Cooley LLP. He can be contacted on �1 (212) 479 6393 or by email: nsmithberg�cooley.com.

In a proceeding under Chapter 15 of the US Bankruptcy Code, the representative of a foreign insolvency proceeding seeks recog-nition of the foreign insolvency proceeding from the US Bankruptcy Court. Chapter 15 of the Bankruptcy Code provides the framework

by which bankruptcy courts consider foreign law and precedent in their determinations. All too frequently overlooked, however, is that Chapter 15 permits courts to decline to recognise a foreign insolvency proceeding if the requested action is “manifestly contrary”

to American public policy. Because of this public policy exception found in Section 1506 of the Bankruptcy Code, granting recognition is by no means automatic. Recent decisions shed light on the application of the public policy exception, and illustrate the degree of

The public policy exception in cross-border recognition by American bankruptcy courts | BY MELANIE L. CYGANOWSKI, LLOYD M. GREEN AND JAMES M. CRETELLA

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discretion possessed by the courts in granting Chapter 15 relief.

Determining what actions or practices are “manifestly contrary to the public policy of the United States” is an evolving process. In evaluating requests for comity, the integrity and absence of corruption of the foreign court are unquestionably overriding factors. Other public policies under US law that have been afforded protection are the automatic stay, property rights and industrial competitive-ness, and electronic privacy. This article ex-amines recent decisions interpreting the pub-lic policy exception in the context of Chapter 15 proceedings.

Public policy and denying assistanceIn contrast to the relatively straightforward process of initial recognition of a foreign bankruptcy proceeding, requests for sub-sequent judicial assistance in a Chapter 15 proceeding are subject to heightened judicial discretion. In re Qimonda AG (2011 Bankr. LEXIS 4191, (Bankr. E.D. Va. Oct. 28, 2011), is the latest illustration of the convergence of the exercise of judicial discretion in applying the public policy exception and comity after a court recognised the foreign proceeding. In Qimonda, the Bankruptcy Court initially recognised the German insolvency proceed-ing as the main bankruptcy proceeding for the purposes of Chapter 15 and the German Insolvent Company Administrator as the rep-resentative. However, the US Bankruptcy Court also determined that various Bankrupt-cy Code provisions were made applicable to the Chapter 15 proceeding, including Section 365, which governs the termination of execu-tory contracts.

Thereafter, the foreign administrator suc-cessfully moved to remove Section 365(n)

as a source of binding legal authority with regard to licence agreement termination, and the Bankruptcy Court granted the motion of the foreign insolvency administrator to “elect nonperformance” of certain intellectual prop-erty cross-licensing agreements under a sec-tion of the German Insolvency Code. On ap-peal, the District Court vacated the Bankruptcy Court’s Order. The District Court held that the Bankruptcy Court did not adequately consider whether comity should have been granted to the German law governing the cancellation of the licensing agreements. The Court stated that although comity was “mandatory”, comi-ty was to be read in the context of the public policy exception of Section 1506.

Following remand, the Qimonda Bank-ruptcy Court announced that it would enforce Section 365(n) and denied the request of the foreign representative. The Court posited two factors to be considered in determining wheth-er relief was “manifestly contrary” to public policy. The first concern was procedural fair-ness. The second concern was “whether the application of foreign law or the recognition of a foreign main proceeding under Chapter 15 would ‘severely impinge ... a U.S. statu-tory or constitutional right, such that granting comity would ‘severely hinder United States bankruptcy courts’ abilities to carry out . . . the most fundamental policies and purposes’ of these rights”. The Qimonda Court observed that the federal courts have dismissed actions on the grounds of forum non conveniens, not-withstanding the fact that the ultimate forum lacked a jury trial right. After examining the legislative history of Section 365(n), the Court held that industrial and competitive concerns are fundamental policy interests, and that fail-ure to apply them would “undermine a funda-mental U.S. public policy promoting techno-

logical innovation”.In In re Toft (453 B.R. 185 (Bankr. S.D.N.Y.

2011)), the Bankruptcy Court denied the ap-plication of a representative of a German in-solvency proceeding who had sought access to internet servers purportedly containing emails of the debtor. The foreign representative had argued that he needed access to the servers be-cause of the debtor’s obstruction and evasion. Under German law, the relief sought would have been available. The Court, however, determined that American electronic privacy laws reflected a fundamental public policy concern which warranted judicial protection.

Public policy and granting assistanceCourts are more inclined to grant post-rec-ognition relief where no specific American statute would be violated and the potential diminution of property rights appears mini-mal. Post-recognition relief has even been granted in instances where the relief in ques-tion would not have otherwise been available in a domestic Chapter 7 or Chapter 11 case. In In re Metcalfe (431 B.R. 685 (Bankr. S.D.N.Y. 2010)), the Bankruptcy Court recognised re-structuring orders and non-party releases ap-proved by a Canadian tribunal in the absence of objection. The fact that the “Second Circuit imposes significant limitations on bankruptcy courts ordering non-debtor releases and in-junctions in confirmed chapter 11 plans” was not determinative. The Bankruptcy Court reasoned that non-party releases are not en-tirely precluded under American law, and that the laws of a foreign legal system need not be identical to those of the United States to merit comity. See also In In re SphinX Group of Companies, [2010 (1) CILR 234] (Cayman, Feb. 12, 2010), where the Grand Court Finan-cial Services Division (a Cayman commercial Court) expressly rejected the proposition that an American Bankruptcy Court would auto-matically accord comity to a non-consensual non-party release issued by a Cayman Court and instead adopted the opinion proffered by author Cyganowski that such recognition was a matter of discretion.

Public policy and initial recognitionInitial recognition of a foreign proceeding is also subject to public policy review. In In re Gold & Honey, Ltd. (410 B.R. 357 (Bankr. E.D.N.Y. 2009)), the Bankruptcy Court de-clined to recognise certain Israeli bankruptcy proceedings because those proceedings had been commenced in violation of the automatic stay. The nominally Israeli companies were already the subject of a consolidated Chapter 11 bankruptcy. The Court explained that while the public policy exception should be applied “narrowly”, it applies to situations where “fundamental policies of the United States are

In contrast to the relatively straightforward process of initial recognition of a foreign bankruptcy proceeding, requests for subsequent judicial assistance in a Chapter 15 proceeding are subject to heightened judicial discretion.

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Since the start of the global economic cri-sis, politicians and the media have been focused on debt. As restructuring profession-als, debt is always on the forefront of our minds. For the most part, companies find themselves in financial distress because they have too much debt. Debt can take on differ-ent forms; most specifically, funded debt and unfunded debt. Funded debt is borrowed mon-ey that needs to be paid back sometime in the future. The borrower makes periodic interest payments and then, generally, is required to repay the principal when the debt matures. At maturity, the debt can be paid back from cash on hand, by rolling over or extending the debt or though a refinancing.

Unfunded debt is a promise to pay for goods or services rendered. These payments are made either from cash on hand or from borrowings. Both funded debt and unfunded debt are critical for sovereigns and compa-nies; yet, both funded debt and unfunded debt can cause significant financial distress if they are too large for the sovereign or company to handle. In determining how to handle a ‘debt crisis’, both funded and unfunded debt obli-gations need to be analysed.

As of late, European nations and the US have been taking on more funded debt. In the wake of the global financial crisis, they have borrowed significantly to fund bailouts for the banking sector and other industries and to use borrowed money to attempt to spur eco-nomic recovery. While some of the borrow-ing was necessary to stem a global banking crisis, with most nations in economic decline or malaise, the percentage of public debt to GDP is rising to dangerous levels, which places global economic growth at risk.

In that regard, Professors Kenneth S. Rog-off of Harvard University and Carmen M. Re-inhardt of the University of Maryland found

that when the percentage of a nation’s debt to GDP reaches 90 percent, “median growth rates fall by one percent, and average growth falls even more”. Currently, the percentage of public debt to GDP of Greece and Italy are over 100 percent and the US is above 90 percent. It is clear that public debt needs to be reduced to sustainable levels to allow real economic growth to return.

In addition to the funded debt, many Euro-pean nations and the US have large unfunded debt obligations; most notably, public pension and other retiree liabilities. In Europe and the US, unfunded pension obligations are grow-ing and some of the retirement programs and pension funds are already at risk of running out of assets in the relatively near future.

In the US, the primary unfunded retirement program is Social Security. As the National Commission on Fiscal Responsibility and Reform, better known as the Bowles-Simp-son Commission reported, demographic changes could bring Social Security “to its knees”. Currently, the Social Security pro-gram is spending more on retirees than it is collecting in revenue. If Social Security is not restructured, its “trust fund ... [will be] fully exhausted by 2037”.

The unfunded portion of pension plans of American states and municipalities ranges between $1 trillion and more than $3 trillion (depending on the assumed rate of return). Indeed Professor Joshua Rauh of Northwest-ern University found that the pension funds of seven states will run out of assets by 2020. In Europe, public pension obligations are ris-ing as a percentage of GDP. For instance, in 2007, Greece’s percentage was 11.7 percent, but it is projected to increase to 24.1 percent by 2060. As a result, funds are being diverted from services, such as education, to pay pen-sioners.

In understanding the risks to Europe and the US, the pension plight of corporate America is instructive. In 1950, GM and the United Auto Workers entered into the ‘Treaty of Detroit’, which established, among other things, pension benefits for the unionised em-ployees of GM. Shortly thereafter, Ford and Chrysler followed suit and the Big Three auto manufacturers in the US agreed to provide lifetime retiree benefits to their employees. At the time, the Big Three – huge, powerful and profitable companies – could not fathom that these unfunded retiree promises could become a financial drain on their business-es and risk their very existence. But, as the world witnessed, the promises became over-whelming and GM and Chrysler, in the midst of the financial crisis, filed for bankruptcy and, with significant government assistance, restructured their retiree and other liabilities, thereby rebuilding their foundations and be-ginning to operate competitively in the auto-motive industry once again.

The GM and Chrysler bankruptcies, while instructive, are not unique. Many companies – large and small – in the automotive, airline and steel industries established pension pro-grams. As the number of retirees grew and an ever-growing portion of the companies’ free cash flow was diverted from operations or investments to pension and other retiree payments, the companies’ businesses suf-fered. Consequently, to remain competitive and maximise the value of their businesses, these companies entered bankruptcy to either modify or terminate collective bargaining agreements and attempt to rid themselves of legacy retiree liabilities.

Unlike corporations, sovereigns (other than US municipalities) cannot file for bankrupt-cy. (Chapter 9 of the US Bankruptcy Code al-lows US municipalities to file for bankruptcy

Unfunded retirement liabilities in Europe and the US: can lessons be learned from corporate America? | BY JONATHAN S. HENES AND JAMES H.M. SPRAYREGEN

at risk”. However, in In re Ernst & Young, Inc. (383 B.R. 773 (Bankr. D. Colo. 2008)), the Court recognised a Canadian receivership pro-ceeding involving an investment company that had been suspected of securities fraud. Objec-tions to recognition were predicated upon the possibility that American investors might re-ceive less compensation on their claims than foreign investors, and that the costs arising from Chapter 15 proceedings would deplete the funds available to compensate investors. The Court observed that American and foreign

investors would share from the same common recovery fund, and rejected the contention that litigation costs would deplete assets otherwise available to satisfy investor claims.

ConclusionThe increase in Chapter 15 proceedings en-sures that the courts will continue to determine which policies comprise the “public policies of the United States” and which foreign laws or practices are “manifestly contrary” to those policies. Processes marred by fundamental

unfairness, by a conscious lack of notice, by fraud or by attempts to skirt the automatic stay will undoubtedly be denied comity. Be-yond that, facts and circumstances will likely dictate “what comes next”.

Melanie L. Cyganowski is a former Chief US Bankruptcy Judge for the Eastern District of New York and a partner, Lloyd M. Green is of counsel, and James M. Cretella is an associate, at Otterbourg, Steindler, Houston & Rosen, P.C. Ms Cyganowski can be contacted on �1 (212) 905 3677 or by email: mcyganowski�oshr.com. Mr Green can be contacted on �1 (212) 905 3620 or by email: lgreen�oshr.com. Mr Cretella can be contacted on �1 (212) 905 3611 or by email: jcretella�oshr.com.

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if the states in which they are incorporated authorise it.) Yet, if the retirement systems in Europe and the US are not restructured soon, taking into account current and projected de-mographics, then growth in these nations will continue to stagnate or decline. As Rogoff and Reinhardt demonstrate, too much public debt

hampers economic growth. As the Bowles-Simpson Commission points out, Social Se-curity, without a real restructuring, will run out of funds by 2037. The unfunded pension plans of Europe and US states are in similar peril. Consequently, politicians need to focus on the restructuring of both their funded and

unfunded debt, in an equitable way, so they can rebuild their economic foundations.

Jonathan S. Henes and James H.M. Sprayregen are partners at Kirkland & Ellis LLP. Mr Henes can be contacted on �1 (212) 446 4927 or by email: jonathan.henes�kirkland.com. Mr Sprayregen can be contacted on �1 (312) 862 2481 or by email: james.sprayregen�kirkland.com.

Given the increased level of primary issu-ances in the European high yield bond market in the last 12-18 months, high yield bondholders have sought to maximise their protections in intercreditor arrangements, cre-ating a number of potential flashpoints between senior lenders and bondholders.

This article provides an overview of a num-ber of intercreditor issues which will likely be intensely negotiated between bondholders and lenders, specifically in the context of a capi-tal structure comprised of pari passu senior secured high yield bonds and senior secured bank debt.

In the traditional pre-2009 structure, the bonds issued by leveraged European corporates were in a subordinated position, both in payment and in terms of enforcement, relative to senior bank debt. Following the credit crunch and collapse in the availability of bank loan finance to Euro-pean corporates, high yield investors refinanc-ing senior bank debt in 2009 and 2010 began to demand better terms in order to provide funding. With the increased number of senior secured bond deals in the market from the start of 2009, it has become generally acceptable for high yield bondholders to sit alongside a se-nior loan facility and to receive payments and to benefit from substantially the same security and guarantee package as senior lenders on a pari passu basis.

EnforcementThe enforcement mechanics in the intercreditor agreement are among the most negotiated and scrutinised provisions between bondholders and lenders. According to Moody’s, between 1982 and 2009, the average global corporate debt recovery rate on loans was 65.6 percent, while comparable figures for unsecured bonds was 36.6 percent. The principal discussion in relation to enforcement relates to the level of control which the bank lenders and bondhold-ers will have to enforce their security and guar-antees, i.e., which party will have priority to instruct the security agent in an enforcement event.

In a capital structure comprising a super se-nior revolving credit facility (‘RCF’) which ranks pari passu with high yield bonds but en-joys priority in relation to payment of proceeds in the case of an enforcement scenario, where there are conflicting enforcement instructions from the RCF lenders and bondholders, the bond investors will generally have initial prior-ity to control the enforcement action. However, such control is usually limited to a period of up to six months following the delivery of enforce-ment instructions – after which time the RCF lending group will be entitled to assume con-trol of the enforcement process. The fact that bondholders only have up to six months to fully discharge the liabilities owed to the RCF lend-ers has been subject to debate. Further, there are a number of recent transactions that specify that bondholders should have commenced ac-tion or taken certain preparatory enforcement steps (such as filing court proceedings, etc.) within the first three months of controlling the instructing group. The failure to do so will usu-ally permit RCF lenders to take control of the enforcement process. A number of bondhold-ers hold the view that it is difficult in practice to coordinate and commence an enforcement process involving a large number of bond in-vestors within a period of three or six months, let alone successfully discharge the liabilities owed to the RCF lenders within such time-frame. Bondholders have also expressed con-cerns with such limited time restraints imposed on them in relation to the enforcement process specifically given that the senior secured bonds in the super senior structure usually represent a far larger portion of the aggregate debt capital structure than the quantum of RCF debt.

On a related note, it may be that issuers (and sponsors) would be keen to ensure that the en-forcement process is kept within the control of its familiar relationship senior lenders, rather than being driven by a large and diverse bond-holder base.

VotingThere has been a good deal of recent discus-

sion surrounding the voting arrangements between senior pari passu high yield bond in-vestors and senior lenders. Bondholders have expressed concern that their votes do not ad-equately represent the aggregate proportion of the debt structure. Senior lenders (specifically in the context of a super senior RCF structure) who make up a far lower portion of the aggre-gate debt capital structure, may have greater voting rights than bondholders, especially with respect to an insolvency event of the issuer. It will be interesting to note, going forward, whether bondholders’ increasingly louder de-mands for ‘one euro, one vote’ will carry any weight with senior lenders and issuers. This is an issue which continues to be discussed be-tween market participants via the High Yield Investor Issues Committee of the Association for Financial Markets in Europe (‘AFME’, formerly the European High Yield Associa-tion), and it remains to be seen if the new year will bring new developments on this front.

Release provisionsA further contentious issue between senior lenders and high yield bondholders relates to the mechanics in relation to the release of se-curity and guarantees with respect to the dis-posal of assets during an enforcement process. In some recent super senior RCF transactions, high yield bondholders have specifically ne-gotiated language in the intercreditor agree-ment, preventing the release of any liabilities owed by a debtor to the bondholders during an enforcement process. Lenders have, of course, expressed concern with this language as it potentially may reduce the value of the asset being disposed of during enforcement, and therefore be inconsistent with the secu-rity enforcement principles and objectives set forth in the intercreditor agreement. Bond-holders typically push for liabilities owed to them by a debtor not to be released, as it gives them leverage to exercise their rights during an enforcement process. Given that the provision in the context of super senior RCF transactions generally remains untested

Intercreditor hot spots in 2011 and what to watch in 2012| BY MAYANK GUPTA, JEREMY DUFFY AND ANNE MARIE SALAN

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in enforcement proceedings, it will be inter-esting to see whether such language in the release provisions will have any bearing on the recovery of proceeds for bondholders and lenders alike.

Option to purchaseIt is standard for intercreditor agreements to permit bondholders to purchase all senior lender liabilities (including senior hedging liabilities) at par following a ‘trigger event’ (i.e., a distress event) of a debtor. The option to purchase the senior lender liabilities is ad-vantageous from the bondholders’ perspective as they will be able to take complete control of the enforcement process if the senior lenders are out of the debt structure.

However, the terms of the bondholders’ op-tion to purchase are coming under increased scrutiny, as bank lenders are requesting spe-cific indemnities from the bondholders in re-spect of any contingent or actual liabilities that may be claimed by a debtor against a lender. Bondholders, specifically in super senior RCF transactions, have typically been keen to win the right to purchase the RCF liabilities in a distressed scenario given the relatively small portion of the RCF liabilities, and so have been willing to provide such indemnities in favour of the senior lenders. However, ques-tions remain whether bondholders will con-tinue to provide blanket indemnities to lenders or whether they will provide restrictions and conditions on the scope of the indemnities to be given.

DisclosureHigh yield bond investors have been calling for greater levels of transparency and quality of information, consistent with the information being provided to the senior lender base, a call which has gathered pace and momentum over the past couple of years. Such calls for greater disclosure have been voiced for several years, and in June 2008 the AFME and the Loan Market Association (‘LMA’) issued a recom-mendation to issuers to improve the quality of information which issuers provide investors about their financing structures. However, the 2008 AFME / LMA recommendations were not adopted by the market wholesale, and the timing of this proposal was less than ideal – just before a 17 month-long drought in pri-mary European high yield issuance.

Largely in response to the March 2011 letter sent to most major underwriting banks active in European high yield by the European Lever-aged Finance Buyside Forum (comprising the 30 biggest institutional investors in Europe) regarding investors’ structural and disclosure concerns, and subsequent discussions between buy-side and sell-side market participants, on 1 December 2011 AFME issued new guide-lines aimed at improving financial disclosure from high yield issuers. One of the guidelines recommended by AFME includes that high yield bond issuers make publicly available the key documentations for its material debt fa-cilities and intercreditor arrangements, includ-ing any significant amendments and waivers. AFME has recommended that issuers publish

documents such as the intercreditor agreement on the issuer’s website, public news services and/or the stock exchange where the bonds are listed. If high yield issuers follow this rec-ommendation, bondholders will take comfort that such measures to increase disclosure and transparency will allow them to make more informed risk assessments on the investments they are undertaking. However, it remains to be seen whether issuers will adhere in full to the recommendations from AFME, especially private equity sponsors, some of whom have already expressed their reluctance to disclose certain details of senior facility agreements and intercreditor agreements which may be commercially sensitive (e.g., margin ratchets, covenant levels, etc.).

Given that, according to Moody’s, the high yield market is anticipated to play a major role in the refinancing of more than US$325bn of European leveraged debt that is set to mature in the next four years, there will be a contin-ued focus on negotiating intercreditor arrange-ments. Similarly, the ability to disclose such arrangements to the wider high yield investor base and other market participants will con-tinue to be the subject of much discussion.

Mayank Gupta is a senior associate, Jeremy Duffy is a partner and Anne Marie Salan is counsel at White & Case LLP. Mr Gupta can be contacted on �44 (0)20 7532 1297 or by email: mgupta�whitecase.com. Mr Duffy can be contacted on �44 (0)20 7532 1237 or by email: jduffy�whitecase.com. Ms Salan can be contacted on �44 (0)20 7532 1432 or by email: asalan�whitecase.com.

On 31 October 2011, the MF Global en-terprise collapsed into bankruptcy and a number of parallel insolvency proceed-ings. MF Global Finance USA Inc. and MF Global Holdings Ltd. filed voluntary bank-ruptcy petitions, amidst allegations of illegal commingling of customer accounts. Later the same day, the Securities Investor Protection Corporation filed a complaint in the Southern District of New York district court, demand-ing the appointment of a trustee to liquidate MF Global Inc. (MFGI) under the Securities Investor Protection Act (SIPA). Within days, other brokerage units were in administration under local insolvency regimes in the United Kingdom, Australia, Singapore, India, Hong Kong and Canada as well.

While the allegations of commingling are startling on their own, they raise a new form of concern when viewed on a macro level.

The MF Global saga comes at a time when the US authorities are finalising the regulatory structure required under the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was enacted in 2010 but gave regulators time to develop the underlying rules. Whatev-er the ultimate details, the framework requires the migration of the multi-trillion dollar swaps market from private, bilateral agreements to a model based on the futures markets. And the way in which futures markets work, of course, is the backdrop for the MF Global debacle.

Dodd-Frank framework and the futures market modelThe most basic feature of Dodd-Frank’s treat-ment of swaps is to require them (with certain exceptions) to be traded on an exchange, with central clearing and public reporting. Because swaps traditionally have traded over-the-coun-

ter, the legislation will require the creation of new platforms and mechanisms, including ex-changes, clearing organisations and informa-tion repositories.

As part of the clearing mechanism, any entity that holds margin for cleared swaps must reg-ister with regulators as a futures commission merchant (FCM). As in the futures market, the FCM must segregate all customer property that it holds as margin. The FCM cannot com-mingle that margin with its own funds, nor can it use it to margin, secure or guaranty trades or contracts with other customers.

The futures market model is generally based on the concept of mutualising the risks asso-ciated with a customer default. The clearing-house defines the amount of margin held by an FCM for its customers. If a customer de-faults and the FCM cannot cover the default-ing customer’s obligations, the clearinghouse

MF Global insolvency reveals risk in Dodd-Frank model| BY PAUL B. TURNER AND MARK D. SHERRILL

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is authorised to use the collateral held in the FCM’s omnibus account at the clearinghouse – which includes the assets of other customers of the FCM. The risk of a non-defaulting cus-tomer being forced to pay to cover a defaulting customer, known as ‘fellow customer risk’, is built into the system.

Regulators are considering whether to in-corporate fellow customer risk into the Dodd-Frank model as well. In any event, though, the concept of mutualising risks has not tradi-tionally been thought to expand to the losses resulting from a FCM’s failure to segregate customer property from the FCM’s own. In-deed, the mechanisms and their underlying policies seem not to have contemplated such a failure.

MF Global proceedingsThe multi-jurisdictional insolvency proceed-ings will likely complicate the liquidation of the MF Global enterprise. The unregulated en-tities in bankruptcy could conceivably achieve some value from their equity interests in the non-US brokerages, but inactive brokerages lose value quickly and it may be some time before they can monetise those interests. It is unclear exactly how they will survive in the meantime, without meaningful cash flow of their own.

More importantly, multiple layers of insol-vency regimes exist even within the single SIPA proceeding. Because MFGI was reg-istered as a securities broker-dealer and as a commodity broker, at least two specialised in-solvency laws apply. SIPA provides the frame-work for the liquidation of a broker-dealer. SIPA also applies the Bankruptcy Code, to the extent that it is consistent with SIPA provi-sions. Therefore, the subchapter of the Bank-ruptcy Code that governs the liquidation of commodity brokers will also apply.

When MFGI’s financial condition became clear, the Securities Exchange Commission and the Commodities Futures Trading Com-mission agreed on the appointment of a trustee under SIPA, with the understanding that the SIPA trustee will also need to apply the com-modity broker laws of the Bankruptcy Code. It is uncertain how well a securities-oriented trustee will be able to implement the commod-ity broker provisions of the Bankruptcy Code.

The reports of misappropriated funds – be-tween $600m and $1.2bn – from MFGI add even more complications. Many customers saw their accounts frozen for several weeks, and are now receiving only partial transfers of their customer property. After the partial trans-fers are completed, the SIPA trustee indicates that customers will need to pursue the bal-ance of their funds through the claims process – which may mean that only pro rata distribu-tions are available for the aggrieved custom-ers. If the trustee requires MFGI customers to proceed through the claims process, their existing losses may be further exacerbated by time-value-of-money issues.

Potential lessons from MF GlobalThe MF Global bankruptcy is a timely remind-er that no regulatory regime can fully insulate market participants from risk. Nevertheless, it should also cause some alarm among enti-ties trading in swaps, because MF Global has highlighted a type of risk that had gone largely underappreciated by legislators and regula-tors. The concept of segregated accounts is the keystone to the model used in the futures mar-kets and adopted by Dodd-Frank. If an FCM can simply choose not to segregate funds that it should be segregating, then regulators may need to reconsider certain aspects of the regu-latory regime. After all, the swaps market is many times larger than the futures market. If a

similar malfeasance to that alleged here were to occur with an FCM in the swaps market, customers’ losses could be enormous – and is-sues of system risk could easily follow.

Alternatively, a more innocuous explana-tion may exist for the MF Global shortfall. For example, while the futures markets regime re-stricts the FCM’s treatment of customers’ mar-gin, it has traditionally allowed for certain lim-ited activities. The FCM can commingle all of its customers’ funds into one or more account with a bank, trust company or clearinghouse. Existing regulations provide that such funds can be invested in certain governmental obli-gations. If MF Global – which was rumoured to have bet heavily on Eurobonds – proves to have been operating within the regulatory framework when it incurred the fateful losses, then most of the blame will lie at the feet of those who enacted the existing law. On 5 De-cember 2011, regulators finalised a rule that will limit the FCM’s ability to make such in-vestments. The same rule also prohibits FCMs from engaging in in-house transactions and repurchase agreements, which could conceiv-ably have been another cause of the disappear-ance of MF Global funds.

None of the foregoing scenarios is comfort-ing to MF Global customers. Perhaps the best outcome, however, would be for their losses to prove meaningful in the development of an efficient regulatory regime. Regulators should be redoubling their efforts to determine the cause of this scandal – not only to fulfil their investigatory objective, but to determine what flaws must be corrected in the regulatory framework.

Paul B. Turner is a partner and Mark D. Sherrill is counsel at Sutherland Asbill & Brennan LLP. Mr Turner can be contacted on �1 (713) 470 6105 or by email: paul.turner�sutherland.com. Mr Sherrill can be contacted on �1 (202) 383 0360 or by email: mark.sherrill�sutherland.com.

The British Virgin Islands (BVI) and the Cayman Islands are two of the largest in-ternational financial centres in terms of com-pany and fund registrations. The BVI at the end of March 2011 had approximately 450,000 registered companies with the Cayman Islands’ total approximately 90,000. The Cayman Is-lands has a higher concentration of investment funds with over 9000 registered mutual funds in comparison to circa 2600 registered in the BVI. Given the high volumes of company and fund registrations within each centre, it is very likely that most corporate financiers will be

familiar with corporate structures containing a company registered in either jurisdiction.

Unfortunately, a by-product of the high num-ber of incorporated entities within each territory is that it is possible readers of this article may encounter an issue with an entity from either jurisdiction. A common occurrence often seen by insolvency practitioners and legal advisers in these territories involves at first instance a creditor (or other interested parties) discover-ing some form of fraudulent activity occur-ring within a standard ‘onshore’ entity. Further investigations or forensic analysis lead them

to discover a transfer of funds or assets to an entity registered in either territory. Provisional research on the internet or by accessing either territories’ Company Register often yield little or no information and creditors generally form the view that they have reached a brick wall. In the majority of cases, creditors are uncertain of the system of law in each jurisdiction, and whether local legislation offers any protection to defrauded parties.

Both the BVI and the Cayman Islands are British Overseas Territories with appointed governors from the United Kingdom. Each

Fraud and the appointment of a liquidator – a BVI and Cayman perspective| BY FRANK MCGING

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territory is largely self-governing and self-suf-ficient with the UK retaining responsibility for security, defence and external affairs. Their respective legal systems derive from English common law and their courts frequently refer to English and other commonwealth countries’ case law. Furthermore, their civil procedure rules (the ‘CPR’) are based upon the English Court’s CPR. Within the Cayman Islands, Part V of the Companies Law (originally enacted in 1964 with the latest revision in 2010) deals with the winding up of Cayman Islands com-panies, and is based substantially upon the English Companies Act 1948. The Insolvency Act 2003 (the ‘2003 Act’) together with the Insolvency Rules 2005 (the ‘Rules’) are the BVI’s all-encompassing insolvency laws deal-ing with both companies and individuals. The 2003 Act is based on the UK Insolvency Act 1986, thereby affording creditors and members of BVI entities many of the same protections afforded to creditors and members of UK enti-ties. The legislation in both the BVI and the Cayman Islands can be used quite effectively as a fraud busting weapon through the initia-tion of winding up proceedings.

In either territory, once there is sufficient evidence to suggest that an entity was engaged in fraudulent activity a creditor or shareholder may apply to the court to have the company wound up on a just and equitable basis. The courts appear to accept that it may be just and equitable to wind up companies that are used as the instruments of fraud. It should be noted that for a winding up order to be issued by the court, there is no requirement in the Acts of either ter-ritory for the company to be insolvent. Appli-cations such as these can be a vital weapon for the applicant and can be instrumental in secur-ing ex parte interim relief. The courts have the option of appointing either a liquidator (termed as ‘official liquidator’ in the Cayman Islands) or a ‘provisional liquidator’ on an interim ba-sis. A key consideration in fraud related cases is the potency of a provisional liquidation. Pro-visional liquidators, pursuant to the appoint-ment order, typically have most of the powers afforded to full liquidators, bar the power to

liquidate and distribute assets. This has enor-mous benefit in fraud cases where assets need protection and the company’s affairs require thorough investigation. In either jurisdiction, a provisional liquidator may be appointed where the appointment for a liquidator has been filed but not determined, and the court is satisfied that there is a realistic need to secure the assets of the company from dissipation on an urgent basis. The court will limit the powers of the provisional liquidator as it sees fit.

When the court appoints a liquidator, cus-tody and control of all assets will rest with the liquidator. The liquidator, among other things, will have to the power to compel the local registered agent or local service provid-ers to deliver up all relevant company infor-mation and records. Likely information to be received from the registered agent includes the register of directors, register of members and possibly the identity of beneficial owners. Other relevant powers within the BVI include the right to interview former office holders before the court. This is to compel interested parties to appear before the court in the BVI and answer questions under oath regarding the company’s affairs. Within the Cayman Islands, the law is not as explicit but it is an offence for former company officers to hinder the work of the liquidator or refuse to cooperate with their investigation, which includes the deliv-ery of company documents and property. In the majority of cases, the powers afforded to the liquidators within each jurisdiction should provide the liquidators with various avenues for investigation. In the majority of cases, al-though the company or fund is registered in the BVI or the Cayman Islands, its trade is performed elsewhere. It is in these instances that the liquidators are required to use alterna-tive methods to exercise their powers across borders. Several options available to a liquida-tor include seeking assistance from a foreign court by way of a letter rogatory in order to in-terview company officers, seeking recognition of the liquidation in the foreign country (e.g., Chapter 15 in the US) or appointing a local liq-uidator in the foreign country to take control of

the company assets or property located in the foreign jurisdiction.

It is important to note that within the BVI, the BVI Business Companies Act 2004 (the ‘BCA’) offers a level of protection to members. Any member who feels the affairs of the company are being conducted in a manner that is likely to be oppressive or discriminatory may to apply to the court for an order. The court may make one or more orders including, in the case of a company limited by shares, requiring the com-pany or another person to acquire the shares of the applicant, requiring the company or another person to pay compensation to the applicant, regulating the future conduct of the company’s affairs, amending the memorandum or articles, appointing a receiver or liquidator, directing rectification of the corporate records or setting aside any decision or action taken by the com-pany or its directors in breach of the BCA or the memorandum or articles of the company. This section can often be used to force settlement and avoid the cost of a court petition.

With regard to cost, liquidators in the BVI and Cayman try to be as practical as possible. Making the various applications to court can often be a costly exercise in terms of legal fees and, as a result, most practitioners try to ex-plore ways to work with creditors. This is of-ten achieved by having the petitioner fund the costs of putting the company into liquidation and retaining the liquidator to perform initial investigations to determine if the company has any assets. Once the liquidator is in receipt of this information, they can work with the peti-tioning creditor to agree a fee structure going forward which may be paid out of recovered assets or directly by the petitioner, or a combi-nation of both.

To conclude, the BVI and the Cayman Is-lands should never be viewed as a dead end. With some investigation, and by utilising the territories’ creditor friendly legislation, these jurisdictions can act as the catalyst to trace as-sets and find solutions for defrauded parties.

Frank McGing is a manager at KRyS Global. He can be contacted on �1 (284) 494 1768 or by email: Frank.McGing�KRyS-Global.com.

The reform of the Spanish Insolvency Act and its impact on distress investing in Spain | BY IÑIGO RUBIO, CRISTOBAL COTTA AND IGNACIO BUIL ALDANA

After months of legislative work, in Sep-tember 2011 the Spanish Parliament passed Act 38/2011, dated 10 October, amend-ing the Spanish Insolvency Act. This highly an-ticipated reform is the third since the law came into force seven years ago and constitutes an extensive global reform pursuant to which sub-

stantial aspects of the Spanish Insolvency Act are amended.

The reform articulates certain measures that may provide new alternatives and opportuni-ties for different players in the Spanish restruc-turing market. More significantly, distressed investors will be provided with new tools to

build up their investment strategies (active or passive, controlling or non-controlling). In-deed, the reform of the Spanish Insolvency Act includes certain developments that can potenti-ate the distressed investing industry in Spain. These major developments consist on the fol-lowing: (i) enhancing out-of-court mandatory

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refinancings; (ii) favouring the making of capi-tal infusions into distressed companies both prepetition and postpetition; (iii) facilitating the sale of the estate assets in insolvency; and finally (iv) eliminating certain prior limitations that prevented the development of a robust in-solvency claims’ trading market in Spain.

Prepetition refinancing agreements: ‘straightforward’ ring-fenced refinancing agreements and court-sanctioned refinancingsThe legislator has further developed the prepe-tition refinancing scheme set forth in 2009. Where, initially, prepetition refinancing agree-ments (meeting the requirements set forth by the Insolvency Act) only benefitted from claw-back protection in bankruptcy; now, new fund-ing provided to the debtor through these agree-ments will additionally benefit from certain priorities in bankruptcy and, more importantly, the debtor will have the ability to petition the court-sanctioning of these agreements (if meet-ing additional requirements) ‘cramming down’ certain dissident hold-out financial creditors, as explained below.

The reform retains the former requirements set forth by the Insolvency Act for refinancing agreements to be ‘shielded’ from claw-back while introducing certain amendments to clari-fy or improve certain aspects of the former reg-ulation which had been controversial or needed further development (e.g., clarification of the legal regime applicable to group company refi-nancings or to the independent expert report).

However, the major development with respect to prepetition refinancing agreements is that these agreements can now be court sanctioned through the procedure introduced by the reform (a.k.a. ‘Spanish Scheme’). This constitutes a response to major Spanish companies having recently decided to conduct their refinancing transactions under the legal regime of foreign jurisdictions (for example, and most signifi-cantly, the UK’s scheme of arrangement).

For refinancing agreements to be court-sanc-tioned, these agreements have to be executed (in addition to the debtor) by creditor financial institutions representing at least 75 percent of the total liabilities held by these institutions at the time of the agreement. In this regard, the Spanish legislator appears to have limited the scope of this Scheme and its effects to finan-cial institutions (entidades financieras), such as banks or cajas. Further, it is being generally understood that, by virtue of a strict interpre-tation of the law, bondholders (which can be active participants of a refinancing and whose involvement in such transaction may be crucial for the success of the out-of-court workout) would not count for majority purposes nor be affected by the sanctioning of the agreement. If this finally turns out to be the interpretation

followed by Spanish courts (which cannot be anticipated at this time), this circumstance may jeopardise the effectiveness of the Span-ish Scheme in those instances where the capital structure of the debtor is complex and the debt-holders are not exclusively financial entities but also, for example, bondholders.

The debtor has to petition the sanction of the refinancing agreement before the commercial court and, if granted (through a relatively expe-dite procedure), the term of the payment mora-torium agreed in the refinancing agreement will be extended to hold-out financial creditors. This extension to hold-outs will only occur if: (i) their credit claims are not secured with an in-rem security such as pledges or mortgages (meaning that the contractual position of se-cured creditors would not be affected by this sanction, except deficiency claims which will indeed fall under the scope of the sanctioned agreement or personal guarantees in favour of secured creditors, the enforcement of which will be arguably subject to the effects of the court sanction); and (ii) the agreement does not represent a ‘disproportionate sacrifice’ for dis-sident financial entities (no statutory definition exists for such term). In the same court-sanc-tion petition, the debtor may request, for up to three years, the stay of all enforcement actions (personal actions primarily) that the creditor fi-nancial entities (i.e., the lenders) could initiate during this period.

In any event, and with growing expectation as to how the Spanish Scheme will play out in practice and how Spanish courts will interpret its most ambiguous and controversial provi-sions, the introduction of this Scheme repre-sents a potentially powerful tool to impose certain debt refinancing structures to dissident hold-out financial creditors to be used by debt-ors and controlling creditors when structuring refinancing transactions.

Capital infusions into distressed companies: prepetition ‘new money’ priorities and clarification of exit financing claims’ regimeThe reform has introduced, for the first time in the history of Spanish insolvency law, the ‘new money’ privilege for lending provided through the ring-fenced restructuring framework set f

fw reprint | financier worldwide magazine...chilled restructuring negotiations or at least slowed...

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