151 Search Results

October 11, 2018 |
Financing Arrangements and Documentation: Considerations Ahead of Brexit

Click for PDF Since the result of the Brexit referendum was announced in June 2016, there has been significant commentary regarding the potential effects of the UK’s withdrawal from the EU on the financial services industry. As long as the UK is negotiating its exit terms, a number of conceptual questions facing the sector still remain, such as market regulation and bank passporting. Many commentators have speculated from a ‘big picture’ perspective what the consequences will be if / when exit terms are agreed.  From a contractual perspective, the situation is nuanced. This article will consider certain areas within English law financing documentation which may or may not need to be addressed. Bank passporting The EU “passporting” regime has been the subject of much commentary since the result of the Brexit referendum.  In short, in some EU member states, lenders are required under domestic legislation to have licences to lend.  Many UK lenders have relied on EU passporting (currently provided for in MiFID II), which allows them to lend into EU member states simply by virtue of being regulated in the UK (and vice versa). The importance for the economy of the passporting regime is clear. Unless appropriate transitional arrangements are put in place to ensure that the underlying principle survives, however, there is a risk that following Brexit passporting could be lost.  Recent materials produced by the UK Government suggest that the loss of passporting may be postponed from March 2019 until the end of 2020, although financial institutions must still consider what will happen after 2020 if no replacement regime is agreed.  The UK Government has committed to legislate (if required) to put in place a temporary recognition regime to allow EU member states to continue their financial services in the UK for a limited time (assuming there is a “no deal” scenario and no agreed transition period). However, there has not to date been a commitment from the EU to agree to a mirror regime. Depending on the outcome of negotiations on passporting, financial institutions will need to consider the regulatory position in relation to the performance of their underlying financial service, whether that is: lending, issuance of letters of credit / guarantees, provision of bank accounts or other financial products, or performing agency / security agency roles. Financial institutions may need to look to transfer their participations to an appropriately licensed affiliate (if possible) or third party, change the branch through which it acts, resign from agency or account bank functions, and/or exit the underlying transaction using the illegality protections (although, determining what is “unlawful” for these purposes in terms of a lender being able to fund or maintain a loan will be a complex legal and factual analysis).  More generally, we expect these provisions to be the subject of increasing scrutiny, although there seems to be limited scope for lenders to move illegality provisions in their favour and away from an actual, objective illegality requirement, owing to long-standing commercial convention. From a documentary perspective, it will be necessary to analyse loan agreements individually to determine whether any provisions are invoked and/or breached, and/or any amendments are required.  For on-going structuring, it may be appropriate for facilities to be tranched – such tranches (to the extent the drawing requirements of international obligor group can be accurately determined ahead of time) being “ring-fenced”, with proportions of a facility made available to different members of the borrower group and to be participated in by different lenders – or otherwise structured in an alternative, inventive manner – for example, by “fronting” the facility with a single, adequately regulated lender with back-to-back lending mechanics (e.g. sub-participation) standing behind.  In the same way, we also expect that lenders will exert greater control – for example by requiring all lender consent in all instances – on the accession of additional members of the borrowing group to existing lending arrangements in an attempt to diversify the lending jurisdictions.  Derivatives If passporting rights are lost and transitional relief is not in place, this could have a significant impact on the derivatives markets.  Indeed, without specific transitional or equivalence agreements in place between the EU and the UK, market participants may not be able to use UK clearing houses to clear derivatives subject to mandatory clearing under EMIR.  Additionally, derivatives executed on UK exchanges could be viewed as “OTC derivatives” under EMIR and would therefore be counted towards the clearing thresholds under EMIR.  Further, derivatives lifecycle events (such as novations, amendments and portfolio compressions) could be viewed as regulated activities thereby raising questions about enforceability and additional regulatory restrictions and requirements. In addition to issues arising between EU and UK counterparties, equivalence agreements in the derivatives space between the EU and other jurisdictions, such as the United States, would not carry over to the UK.  Accordingly, the UK must put in place similar equivalence agreements with such jurisdictions or market participants trading with UK firms could be at a disadvantage compared to those trading with EU firms. As a result of the uncertainty around Brexit and the risk that passporting rights are likely to be lost, certain counterparties are considering whether to novate their outstanding derivatives with UK derivatives entities to EU derivatives entities ahead of the exit date.  Novating derivatives portfolios from a UK to an EU counterparty is a significant undertaking involving re-documentation, obtaining consents, reviewing existing documentation, identifying appropriate counterparties, etc. EU legislation and case law Loan agreements often contain references to EU legislation or case law and, therefore, it is necessary to consider whether amendments are required. One particular area to be considered within financing documentation is the inclusion of Article 55 Bail-In language[1].  In the last few years, Bail-In clauses have become common place in financing documentation, although they are only required for documents which are governed by the laws of a non-EEA country and where there is potential liability under that document for an EEA-incorporated credit institution or investment firm and their relevant affiliates, respectively.  Following withdrawal from the EU, the United Kingdom will (subject to any transitional or other agreed arrangements) cease to be a member of the EEA and therefore English law governed contracts containing in-scope liabilities of EU financial institutions may become subject to the requirements of Article 55.  Depending on the status of withdrawal negotiations as we head closer to March 2019, it may be appropriate as a precautionary measure to include Bail-In clauses ahead of time – however, this analysis is very fact specific, and will need to be carefully considered on a case-by-case basis. Governing law and jurisdiction Although EU law is now pervasive throughout the English legal system, English commercial contract law is, for the most part, untouched by EU law and therefore withdrawal from the EU is expected to have little or no impact.  Further, given that EU member states are required to give effect to the parties’ choice of law (regardless of whether that law is the law of an EU member state or another state)[2], the courts of EU member states will continue to give effect to English law in the same way they do currently.  Many loan agreements customarily include ‘one-way’ jurisdiction clauses which limit borrowers/obligors to bringing proceedings in the English courts (rather than having the flexibility to bring proceedings in any court of competent jurisdiction). This allows lenders to benefit from the perceived competency and commerciality of the English courts as regards disputes in the financial sector. Regardless of the outcome of the Brexit negotiations, such clauses  are likely to remain unchanged due to the experience of English judges in handling such disputes and the certainty of the common law system. It is possible that the UK’s withdrawal will impact the extent to which a judgement of the English courts will be enforceable in other EU member states.  Currently, an English judgement is enforceable in all other EU member states pursuant to EU legislation[3].  However, depending on the withdrawal terms agreed with the EU, the heart of this regulation may or may not be preserved. In other words, English judgements could be in the same position to that of, for example, judgements of the New York courts, where enforceability is dependent upon the underlying law of the relevant EU member state; or, an agreement could be reached for automatic recognition of English judgements across EU member states.  In the same vein, the UK’s withdrawal could also impact the enforcement in the UK of judgements of the courts of the remaining EU member states. Conclusion Just six months ahead of the UK’s 29 March 2019 exit date, there remains no agreed legal position as regards the terms of the UK’s withdrawal from the EU. It is clear that, for so long as such impasse remains, the contractual ramifications will continue to be fluid and the subject of discussion.  However, what is apparent is that the financial services sector, and financing arrangements more generally, are heavily impacted and it will be incumbent upon contracting parties, and their lawyers, to consider the relevant terms, consequences and solutions at the appropriate time. [1]   Article 55 of the Bank Resolution and Recovery Directive [2]   Rome I Regulation [3]   Brussels I regulation. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Global Finance practice group, or the authors: Amy Kennedy – London (+44 (0)20 7071 4283, akennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Alex Hillback – Dubai (+971 (0)4 318 4626, ahillback@gibsondunn.com) Please also feel free to contact the following leaders and members of the Global Finance and Financial Institutions practice groups: Global Finance Group: Thomas M. Budd – London (+44 (0)20 7071 4234, tbudd@gibsondunn.com) Gregory A. Campbell – London (+44 (0)20 7071 4236, gcampbell@gibsondunn.com) Richard Ernest – Dubai (+971 (0)4 318 4639, rernest@gibsondunn.com) Jamie Thomas – Singapore (+65 6507 3609, jthomas@gibsondunn.com) Michael Nicklin – Hong Kong (+852 2214 3809, mnicklin@gibsondunn.com) Linda L. Curtis – Los Angeles (+1 213 229 7582, lcurtis@gibsondunn.com) Aaron F. Adams – New York (+1 212 351 2494, afadams@gibsondunn.com) Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 31, 2018 |
Webcast: Strategies Regarding Corporate Veil Piercing and Alter Ego Doctrine

Please join a panel of seasoned Gibson Dunn attorneys for a presentation on how a company can best protect itself against “veil-piercing” claims and “alter ego” liability.  We provide an overview of what it means to “pierce the corporate veil” and the circumstances that have prompted courts to ignore the corporate separateness of entities and impose “alter ego” liability. We also focus on strategies to minimize the risk of facing claims for veil piercing and alter ego liability and maximize your chances for success in connection with any such claims. View Slides [PDF] PANELISTS: Robert A. Klyman is a partner in Gibson Dunn’s Los Angeles office. He is Co-Chair of the Firm’s Business Restructuring and Reorganization practice group. Mr. Klyman represents debtors, acquirers, lenders, ad hoc groups of bondholders and boards of directors in all phases of restructurings and workouts. His experience includes advising debtors in connection with traditional, prepackaged and “pre-negotiated” bankruptcies; representing lenders and bondholders in complex workouts; counseling strategic and financial players who acquire debt or provide financing as a path to take control of companies in bankruptcy; structuring and implementing numerous asset sales through Section 363 of the Bankruptcy Code; and litigating complex bankruptcy and commercial matters arising in chapter 11 cases, both at trial and on appeal. John M. Pollack is a partner in Gibson Dunn’s New York office. He is a member of the Firm’s Mergers and Acquisitions, Private Equity, Aerospace and Related Technologies and National Security practice groups. Mr. Pollack focuses his practice on public and private mergers, acquisitions, divestitures and tender offers, and his clients include private investment funds, publicly-traded companies and privately-held companies. Mr. Pollack has extensive experience working on complex M&A transactions in a wide range of industries, with a particular focus on the aerospace, defense and government contracts industries. Lori Zyskowski is a partner in Gibson Dunn’s New York office. She is Co-Chair of the Firm’s Securities Regulation and Corporate Governance practice group. Ms. Zyskowski advises public companies and their boards of directors on corporate governance matters, securities disclosure and compliance issues, executive compensation practices, and shareholder engagement and activism matters. Ms. Zyskowski advises clients, including public companies and their boards of directors, on corporate governance and securities disclosure matters, with a focus on Securities and Exchange Commission reporting requirements, proxy statements, annual shareholders meetings, director independence issues, and executive compensation disclosure best practices. Ms. Zyskowski also advises on board succession planning and board evaluations and has considerable experience advising nonprofit organizations on governance matters. Sabina Jacobs Margot is an associate in Gibson Dunn’s Los Angeles office. She is a member of the Firm’s Business Restructuring and Reorganization and Global Finance practice groups. Ms. Jacobs Margot practices in all aspects of corporate reorganization and handles a wide range of bankruptcy and restructuring matters, representing debtors, lenders, equity holders, and strategic buyers in chapter 11 cases, sales and acquisitions, bankruptcy litigation, and financing transactions. Ms. Jacobs Margot also represents borrowers, sponsors, and lending institutions in connection with acquisition financings, secured and unsecured credit facilities, asset-based loans, and debt restructurings. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. This program has been approved for credit in accordance with the requirements of the Texas State Bar for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the area of accredited general requirement. Attorneys seeking Texas credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hour. California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

June 5, 2018 |
Gibson Dunn Recognized in GRR 100 and Singapore Names to Know

Global Restructuring Review listed Gibson Dunn in the GRR 100, “a survey of the top 100 law firms verified as being able to handle cross-border restructurings and insolvencies.” In addition to the firm being recognized, Singapore partners Saptak Santra and Jamie Thomas, and senior restructuring counsel Troy Doyle were included in GRR’s “Singapore Names to Know.” The lists were published in June 2018.

June 28, 2018 |
French Supreme Court Holds That Ultimate Controlling Shareholder of a Liquidated French Subsidiary Should Compensate Employees for Job Loss

Click for PDF The French Supreme Court for civil law matters (Cour de cassation) made public on June 28, 2018 an important decision dated May 24, 2018.  The Social Chamber (Chambre sociale) of the Cour de cassation decided that the ultimate controlling shareholder of a liquidated French subsidiary committed several faults justifying to condemn it to compensate the French employees for the loss of their jobs. In early 2010, Lee Cooper France filed for bankruptcy and was ultimately liquidated.  74 employees were dismissed.  27 of these employees went to court to obtain that Sun Capital Partners Inc. be recognized as the co-employer of the dismissed employees.  The former employees were also asking that Sun Capital Partners Inc. be condemned to pay damages as a consequence of its extra-contractual tortious liability having led to the loss of their jobs. Sun Capital Partners Inc. was not found to be the co-employer of the French employees. It was held, however, that it was tortiously liable to pay damages (of several tens of thousands dollars) to each of the dismissed employees to compensate them for the loss of their jobs. The Court started by considering that Sun Capital Partners Inc. was the main shareholder of the “Lee Cooper group”, holding Lee Cooper France via companies it controls.  From the court decision, it appears that Lee Cooper France was 100% controlled by a Dutch company named Vivat Holding BV, itself 100% controlled by another Dutch company named Avatar BV, itself 100% controlled by another Dutch company named Lee Cooper Group SCA, itself controlled by Sun Capital Partners Inc. The issue raised by the Court is that Lee Cooper France financed the “group” for amounts disproportionate with its means.  Examples are as follows: the right to use the trademark “Lee Cooper” was transferred for no consideration to a company named “Doserno”, which was 100% controlled by Lee Cooper Group SCA which subsequently charged royalties for the use of the “Lee Cooper” trademark by Lee Cooper France; Lee Cooper France granted a mortgage over a building it owned to secure a bank loan to the exclusive benefit of another subsidiary of the group.  The building was subsequently sold to the benefit of the lenders; an inventory of goods to be resold was given as a security to lenders and then sold to Lee Cooper France which was then opposed the lenders’ retention right; and services performed for other entities of the group were only partially paid for. Although Sun Capital Partners Inc. was “isolated” from Lee Cooper France by four layers of corporate entities having the status of limited liability corporations, Sun Capital Partners Inc. was held liable for having “via the companies of the group, made detrimental decisions in its sole shareholder interest which led to the liquidation of Lee Cooper France.” The decision, which does not involve any piercing of the corporate veil, is based only on theories of tortious liability, the various entities of the group of companies controlled by Sun Capital Partners Inc. being treated as mere instruments for the commission of these faults by the controlling shareholders. This decision is a reminder that intra-group transactions involving French entities need to be carefully reviewed to ensure the existence of a corporate interest for the French entity. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. For further information, please contact the Gibson Dunn lawyer with whom you usually work or any of the following members of the Paris office by phone (+33 1 56 43 13 00) or by email (see below): Jean-Philippe Robé – jrobe@gibsondunn.com Eric Bouffard – ebouffard@gibsondunn.com Jean-Pierre Farges – jpfarges@gibsondunn.com Pierre-Emmanuel Fender – pefender@gibsondunn.com Benoît Fleury – bfleury@gibsondunn.com © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 25, 2018 |
Who’s Who Legal Recognizes Six Gibson Dunn Partners

Six Gibson Dunn partners were recognized by Who’s Who Legal in their respective fields. In Who’s Who Legal France 2018 guide Paris partners Nicolas Baverez and Jean-Pierre Farges were recognized in Administrative Litigation and Restructuring & Insolvency respectively. In Who’s Who Legal Restructuring & Insolvency 2018 Los Angeles partners Robert Klyman and Jeffrey Krause, and New York partner Michael Rosenthal were listed. Additionally in the Who’s Who Legal Life Sciences 2018 guide Orange County partner William Rooklidge was recognized.  

March 20, 2018 |
Supreme Court Approves Deferential Review of Bankruptcy-Court Determinations on “Insider” Status

Click for PDF On March 5, 2018, the U.S. Supreme Court issued a decision in U.S. Bank N.A. Trustee, By and Through CWCapital Asset Management LLC v. Village at Lakeridge, LLC (No. 15-1509), approving the application of the clear error standard of review in a case determining whether someone was a “non-statutory” insider under the Bankruptcy Code. We note that the Court’s narrow holding only addressed the appropriate standard of review, leaving for another day the question of whether the specific test that the Ninth Circuit used to determine whether the individual was a “non-statutory” insider was correct. The ruling is significant, however, because without the prospect of de novo review, a bankruptcy court’s ruling on whether a person is a “non-statutory” insider will be very difficult to overturn on appeal—which may have significant impact on case outcomes. The Bankruptcy Code “Insider” The Bankruptcy Code’s definition of an insider includes any director, officer, or “person in control” of the entity.[1] This definition is non-exhaustive, so courts have devised tests for identifying other, so-called “non-statutory” insiders, focusing, in whole or in part, on whether a person’s transactions with the debtor were at arm’s length. Background In this case, the debtor (Lakeridge) owed money to two main entities, its sole owner MBP Equity Partners for $2.76 million, and U.S. Bank for $10 million. Lakeridge submitted a plan of reorganization, but it was rejected by U.S. Bank. Lakeridge then turned to the “cramdown” option for imposing a plan impairing the interests of non-consenting creditors. This option requires that at least one impaired class of creditors vote to accept the plan, excluding the votes of all insiders. As the debtor’s sole owner, MBP plainly was an insider of the debtor, within the statutory definition of Bankruptcy Code §101(31)(B)(i)–(iii), so its vote would not count. Therefore, to gain the consent of the MBP voting block to pass the cramdown plan, Kathleen Bartlett (an MPB board member and Lakeridge officer), sold MPB’s claim of $2.76 million to a retired surgeon named Robert Rabkin, for $5,000. Rabkin agreed to buy the debt owed to MBP for $5,000 and proceeded to vote in favor of the proposed plan as a non-insider creditor. U.S. Bank, the other large creditor, objected, arguing that the transaction was a sham and pointing to a pre-existing romantic relationship between Rabkin and Bartlett. If Rabkin were an officer or director of the debtor, Rabkin’s status as an insider would have been undisputed. But because Rabkin had no formal relationship with the debtor, the bankruptcy court had to consider whether the particular relationship was close enough to make him a “non-statutory” insider. The bankruptcy court held an evidentiary hearing and concluded that Rabkin was not an insider, based on its finding that Rabkin and Bartlett negotiated the transaction at arm’s length. Because of this decision, the Debtor was able to confirm a cramdown plan over the objection of the senior secured lender. The Ninth Circuit affirmed the bankruptcy court’s ruling, holding that that the finding was entitled to clear-error review, and therefore would not be reversed. The Supreme Court Holds That the Standard of Review Is Clear Error On certiorari, the Supreme Court, in a unanimous opinion, took pains to emphasize that the sole issue on appeal was the appropriate standard of review, and not any determination of the merits of the “non-statutory” insider test that the Ninth Circuit had applied to determine whether Rabkin was an insider. The Supreme Court held that the Ninth Circuit was correct to review the bankruptcy court’s determination for “clear error” (rather than de novo). The Court discussed the difference between findings of law—which are reviewed de novo—and findings of fact—which are reviewed for clear error. The question in this case—whether Rabkin met the legal test for a non-statutory insider—was a “mixed” question of law and fact. Courts often review mixed questions de novo when they “require courts to expound on the law, particularly by amplifying or elaborating on a broad legal standard.”[2] Conversely, courts use the clearly erroneous standard for mixed questions that “immerse courts in case-specific factual issues.”[3] In sum, the Court explained, “the standard of review for a mixed question all depends on whether answering it entails primarily legal or factual work.”[4] Choosing between those two characterizations, the Court chose the latter. The basic question in this case was whether “[g]iven all the basic facts found, Rabkin’s purchase of MBP’s claim [was] conducted as if the two were strangers to each other.”[5] Because “[t]hat is about as factual sounding as any mixed question gets,”[6] the Court held that the clear error standard applied. The Supreme Court Avoids Adjudicating a Potentially Significant Circuit Split on Tests Used to Determine Non-Statutory Insiders All nine of the justices joined Justice Kagan’s opinion. However, the concurring opinion from Justice Sonia Sotomayor (joined by Justices Anthony Kennedy, Clarence Thomas and Neil Gorsuch) suggests grave doubts about the coherence of the Ninth Circuit’s standard for assessing non-statutory-insider status. Nevertheless, Justice Sotomayor agreed that resolving the propriety of that standard is not a task that warranted the Supreme Court’s attention. Impact of US Bank While this case does not break new ground, it firmly establishes the bankruptcy courts’ authority to make these determinations and limits appellate review. This opinion may embolden appellants (and bankruptcy courts) to push the envelope in the future. Debtors may be emboldened to seek to use a variety of affiliate-transaction structures as they seek the keys to confirming cramdown plans over the objections of senior lenders.    [1]   11 U.S.C. § 101(31)(B)(i)–(iii).    [2]   Decision at p. 8.    [3]   Ibid.    [4]   Id. at p. 2.    [5]   Id. at p. 10.    [6]   Ibid. Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Samuel A.  Newman – Los Angeles (+1 213-229-7644, snewman@gibsondunn.com) Daniel B. Denny – Los Angeles (+1 213-229-7646, ddenny@gibsondunn.com) Sara Ciccolari-Micaldi – Los Angeles (+1 213-229-7887, sciccolarimicaldi@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 7, 2018 |
“All Assets” First-Lien/Second-Lien Intercreditor Agreements

New York partner J. Eric Wise and New York of counsel Yair Galil are the authors of “‘All Assets’ First-Lien/Second-Lien Intercreditor Agreements,” [PDF] published by Bloomberg Law on March 7, 2018.

March 5, 2018 |
Supreme Court Settles Circuit Split Concerning Bankruptcy Code “Safe Harbor”

Click for PDF On February 27, 2018, the U.S. Supreme Court issued a decision in Merit Management Group, LP v. FTI Consulting, Inc. (No. 16-784), settling a circuit split regarding the “safe harbor” provision in § 546(e) of the Bankruptcy Code.  That section bars the avoidance of certain types of securities and commodities transactions that are made by, to or for the benefit of covered entities including financial institutions, stockbrokers and securities clearing agencies. Circuits had split regarding whether the safe harbor protects a transfer that passes through a covered entity, where the entity only acts as a conduit and has no beneficial interest in the property transferred.  In Merit Management, the Court held that the safe harbor does not apply when a covered entity only acts as a conduit, and that the safe harbor only applies when the “relevant transfer” (i.e., the “overarching” transfer sought to be avoided) is by, to or for the benefit of a covered entity.  As a result, the Court held that the safe harbor did not protect a private securities transaction where neither the buyer nor the seller was a covered entity, even though the funds passed through covered entities. The Bankruptcy Code “Safe Harbor” The Bankruptcy Code permits a trustee to bring claims to “avoid” (or undo) for the benefit of the bankruptcy estate certain prepetition transfers or obligations, including claims to avoid a preference (11 U.S.C. § 547) or fraudulent transfer (11 U.S.C. § 548(a)).  Section 546(e) limits those avoidance powers by providing that, “[n]otwithstanding” the trustee’s avoidance powers, “the trustee may not avoid a transfer that is” (1) a “margin payment” or “settlement payment” “made by or to (or for the benefit of)” a covered entity, or (2) “a transfer made by or to (or for the benefit of)” a covered entity “in connection with a securities contract . . . or forward contract.”  11 U.S.C. § 546(e).  The sole exception to the safe harbor is a claim for “actual fraudulent transfer” under § 548(a)(1)(A).  Id. Background Merit Management involved the acquisition of a “racino” (a combined horse racing and casino business) by its competitor.  To consummate the transaction, the buyer’s bank wired $55 million to another bank that acted as a third-party escrow agent, which disbursed the funds to the seller’s shareholders in exchange for their stock in the seller.  The buyer subsequently filed for Chapter 11 bankruptcy protection and a litigation trust was established pursuant to the buyer’s confirmed reorganization plan.  The trustee sued one of the selling shareholders that received $16.5 million from the buyer, alleging that the transaction was a constructive fraudulent transfer under § 548(a)(1)(B) because the buyer was insolvent at the time of the purchase and “significantly overpaid” for the stock. The district court held that the safe harbor barred the fraudulent transfer claim because the transaction was a securities settlement payment involving intermediate transfers “by” and “to” covered entities (the banks).  The Seventh Circuit reversed, holding that the safe harbor did not apply because the banks only acted as conduits and neither the buyer nor the shareholder was a covered entity.  In so holding, the Seventh Circuit diverged from other circuits that had applied the safe harbor to transactions consummated through a covered entity acting as a conduit.[1]  Those circuits interpreted the disjunctive language in the safe harbor that protects transfers “by or to (or for the benefit of)” a covered entity to mean that a transfer “by” or “to” a covered entity is protected even if the transfer is not “for the benefit of” the covered entity.  The Supreme Court granted certiorari to settle the circuit split. The Supreme Court Holds That the Safe Harbor Does Not Protect a Transfer When a Covered Entity Only Acts as a Conduit   The Supreme Court affirmed the Seventh Circuit’s decision, holding that the safe harbor does not protect a transfer when a covered entity only acts as a conduit.  The crux of the decision is that a safe harbor analysis must focus on whether the “relevant transfer,” meaning the “overarching” or “end-to-end” transfer that the trustee seeks to avoid, was by, to or for the benefit of a covered entity.  Whether an intermediate or “component” transfer was made by or to a covered entity is “simply irrelevant to the analysis under § 546(e).”[2]  The Court reasoned that, as an express limitation on the trustee’s avoidance powers, § 546(e) must be applied in relation to the trustee’s exercise of those powers with respect to the transfer that the trustee seeks to avoid, not component transfers that the trustee does not seek to avoid.[3]  In the case before it, because the trustee sought to avoid the “end-to-end” transfer from the buyer to the shareholder, and neither was a covered entity, the safe harbor did not apply. The Court Avoids Adjudicating a Potentially Significant Defense The shareholder did not argue in the lower courts that the buyer or the shareholder was a covered entity.  In its briefing in the Supreme Court, the shareholder argued that the buyer and seller were both covered entities because they were customers of the banks that facilitated the transaction, and the definition of “financial institution” in 11 U.S.C. § 101(22)(A) includes a “customer” of a financial institution when the institution “is acting as agent or custodian for a customer.”  During oral argument, Justice Breyer indicated that he might have been receptive to that potentially dispositive argument.  However, the decision expressly avoids adjudicating the argument on the basis that the shareholder raised the point “only in footnotes and did not argue that it somehow dictates the outcome in this case.”  Id. at n. 2.  As a result, the “customer-as-financial-institution defense” will likely be litigated in the lower courts going forward. Impact of Merit Management As a result of Merit Management, parties to securities and commodities transactions should expect that, in the event of a bankruptcy filing, the safe harbor will not protect a transaction unless the transferor, transferee or beneficiary of the “overarching” transfer is a covered entity.  Routing a transfer through a covered entity will no longer protect the transaction.  Given the increased importance placed on whether a party to the overarching transfer is a covered entity, Merit Management may lead to a new wave of litigation regarding the scope of the covered entities, including the circumstances in which the customer of a financial institution constitutes a covered entity, and related planning strategies to fall within such scope.    [1]   See, e.g., In re Quebecor World (USA) Inc., 719 F. 3d 94, 99 (2d Cir. 2013); In re QSI Holdings, Inc., 571 F. 3d 545, 551 (6th Cir. 2009); Contemporary Indus. Corp. v. Frost, 564 F. 3d 981, 987 (8th Cir. 2009); In re Resorts Int’l, Inc., 181 F. 3d 505, 516 (3d Cir. 1999); In re Kaiser Steel Corp., 952 F. 2d 1230, 1240 (10th Cir. 1991).    [2]   Decision at p. 14.    [3]   See id. at pp. 11-14 (“If a trustee properly identifies an avoidable transfer . . . the court has no reason to examine the relevance of component parts when considering a limit to the avoiding power, where that limit is defined by reference to an otherwise avoidable transfer, as is the case with §546(e). . . .”). Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Oscar Garza – Orange County, CA (+1 949-451-3849, ogarza@gibsondunn.com) Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Douglas G Levin – Orange County, CA (+1 949-451-4196, dlevin@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

February 6, 2018 |
New Threat of Substantive Consolidation for Real Estate Lending Structures

Groundbreaking Ninth Circuit Decision Declares Only One Class of Impaired, Consenting Creditors Is Needed to Confirm a Joint Plan Among Multiple Debtors   Click for PDF The Ninth Circuit’s recent opinion in In re Transwest Resort Properties, Inc. is the first circuit-level decision to address whether, under section 1129(a)(10) of the Bankruptcy Code, a multi-debtor joint chapter 11 plan can be “crammed down” with the consent of a single impaired class (the “per plan” interpretation), or whether a class of creditors from each individual debtor entity must consent (“per debtor”).[1] By adopting the per plan approach, Transwest puts creditors on notice that those who stand to lose out from chapter 11 plans that effectively ignore the separateness of related corporate entities—most notably, secured lenders in real estate financings—should be prepared to challenge those schemes as de facto substantive consolidation rather than relying on the voting requirements of section 1129(a)(10) for protection. Before Transwest: Whose Votes Do We Need, Anyway? In 2011, a Delaware bankruptcy court was the first to examine 11 U.S.C. § 1129(a)(10)—which provides that a plan of reorganization may only be confirmed if “at least one class of claims that is impaired under the plan has accepted the plan”—and conclude that this requirement must be met separately for each debtor entity included in a joint plan of reorganization.[2] In In re Tribune Co., Judge Kevin Carey held that a per plan interpretation of section 1129(a)(10) was irreconcilable with the principle that “[i]n the absence of substantive consolidation, entity separateness is fundamental.”[3] Moreover, he observed that a per debtor approach would be consistent with the other provisions of section 1129(a), e.g. the “best interest of creditors” requirement of section 1129(a)(7), which also must be satisfied on a per debtor basis.[4] While the court acknowledged that it might be challenging to obtain debtor-by-debtor consent in a complex case like Tribune, in which two competing joint plans would have reorganized over one hundred affiliated debtors, it concluded that “convenience alone is not sufficient reason to disturb the rights of impaired classes of creditors of a debtor not meeting confirmation standards.” In Tribune, both proposed joint plans contained provisions stating that they were not premised on substantive consolidation, the doctrine which, in certain circumstances, permits chapter 11 plans to treat liabilities of multiple affiliated debtors as liabilities of a single consolidated entity. As Judge Carey observed, such provisions are “not uncommon,” presumably because plan proponents wish to avoid an expensive battle to impose substantive consolidation, proponents of which face a heavy evidentiary burden within bankruptcy courts in the Third Circuit as a result of the circuit-level decision in In re Owens Corning.[5] In the absence of substantive consolidation, the Tribune court concluded that the joint plan in question “actually consists of a separate plan for each Debtor,” and each such plan must separately satisfy the confirmation requirements of section 1129(a).[6] Because several courts had previously held that section 1129(a)(10) could be satisfied on a per plan basis,[7] the decision in Tribune created a split of authority. While one subsequent Delaware case has followed the per debtor approach of Tribune, the Arizona bankruptcy court overseeing the chapter 11 cases of Transwest Resort Properties Inc. and its subsidiaries chose to adopt the per plan interpretation of the statute, setting in motion a string of appeals that led to the Ninth Circuit’s recent precedent-setting decision.[8] The Transwest Chapter 11 Cases Compared to the conglomeration of affiliated debtors in Tribune, the debtors in Transwest were relatively few in number and straightforward in purpose. The underlying assets were two resort hotel properties in Tucson, AZ and Hilton Head, SC, each owned by an operating company (together, the “OpCo Debtors”), and each subject to a single senior mortgage with the OpCo Debtor as the sole obligor.[9] The equity of each OpCo Debtor was 100% owned by a holding company (together, the “Mezzanine Debtors”) each of which incurred additional financing secured by equity in the corresponding OpCo. At the top of the corporate structure was a holding company that owned 100% of the equity of the Mezzanine Debtors. When all five entities filed for chapter 11 bankruptcy in 2010, the owner of the OpCo mortgage debt (the “Lender”) filed proofs of claim against the OpCo Debtors totaling $209 million, while secured claims against the Mezzanine Debtors (claims which the Lender eventually acquired) totaled $39 million. In March 2011, the Lender sought relief from the automatic stay in order to foreclose on its mortgage loans against the OpCo Debtors. The bankruptcy court denied this request, and also denied a June 2011 request to foreclose on the mezzanine debt, paving the way for the five Transwest debtors to propose a joint plan of reorganization (the “Plan”). Under the Plan, a third party would invest $30 million in exchange for the Mezzanine Debtors’ ownership interests in the OpCo Debtors, while the Lender’s senior mortgage debt would be repaid in smaller monthly installment over a longer period.[10] The Lender, which by this time was the also the sole creditor of the Mezzanine Debtors, sought to block confirmation of the plan, arguing, inter alia, that, since section 1129(a)(10) requires the consent of a dissenting class from each debtor, the Plan could not be confirmed without the Lender’s consent. Both the bankruptcy court and, on appeal, the district court concluded that the “per debtor” interpretation of section 1129(a)(10) set forth in Tribune was not persuasive, and that the plain language of the statute supported the per plan approach: The statute states that “[i]f a class of claims is impaired under the plan, at least one class of claims that is impaired under the plan has accepted the plan” then the court shall confirm the plan if additional requirements are met. 11 U.S.C. § 1129(a)(10) (emphasis added). Thus, once an impaired class has accepted the plan, § 1129(a)(10) is satisfied as to all debtors because all debtors are being reorganized under a joint plan of reorganization.[11] With five of ten classes having voted in favor of the joint Plan in Transwest, the lower courts concluded that section 1129(a)(10) was no obstacle to confirmation, notwithstanding the fact that the Lender, the sole creditor of the Mezzanine Debtors, had withheld its consent. The Ninth Circuit’s Decision in Transwest The Lender appealed to the Ninth Circuit, which became the first federal court of appeals to address whether the strictures of section 1129(a)(10) apply on a per debtor basis or per plan basis.[12] The panel of three judges unanimously affirmed the lower courts’ per plan interpretation of the statute. In a succinct opinion, Judge Milan Smith wrote that the plain language of section 1129(a) supported the per plan approach, and that neither the statutory context nor applicable rules of statutory construction altered this reading.[13] Acknowledging the Lender’s concerns that the per plan approach would lead to a “parade of horribles” for similarly situated real estate lenders, the court observed that these were policy concerns best resolved by Congress. Moreover, to the extent that Lenders now argued that the Transwest debtors’ Plan was, in effect, an impermissible substantive consolidation, the court declined to consider this argument since it was raised for the first time on appeal.[14] In a separate concurrence, Judge Friedland wrote to emphasize that she shared some of the Lender’s concerns with respect to substantive consolidation, though she agreed that the Lender waived them by failing to raise them earlier. Judge Friedland observed that, although the Plan provided that the various debtors “technically . . . remained separate,” distributions under the Plan were devised such that “creditors for different Debtors all drew from the same pool of assets.”[15] Given that this kind of de facto substantive consolidation is a common feature of joint plans with multiple related debtors, Judge Friedland emphasized that creditors who believe they lose out from consolidation of the debtors’ assets and liabilities should make their objections promptly and clearly in the bankruptcy courts: [I]f a creditor believes that a reorganization improperly intermingles different estates, the creditor can and should object that the plan—rather than the requirements for confirming the plan—results in de facto substantive consolidation. Such an approach would allow this issue to be assessed on a case-by-case basis, which would be appropriate given the fact-intensive nature of the substantive consolidation inquiry.[16] Conclusion While the Ninth Circuit’s opinion in Transwest provides a measure of comfort for plan proponents with respect to the voting requirements of section 1129(a)(10), it may foreshadow battles to come over de facto substantive consolidation. Moreover, for debtors and creditors in chapter 11 cases outside the Ninth Circuit, it remains to be seen whether bankruptcy courts will follow the per plan approach endorsed in Transwest, or whether the per debtor approach of Tribune will gain new adherents. In the meantime, mezzanine lenders and other creditors whose rights are threatened by multi-debtor plans of reorganization would be well-advised to raise both objections, lest they should find themselves in the unfortunate position of the Lender in Transwest, wondering whether they waived a winning argument. Failure to raise an argument in respect of a chapter 11 plan’s attempt to impermissibly substantively consolidate a multi-debtor estate may frustrate the entire purpose of the senior/mezzanine financing structure, which is to isolate the collateral—and claims—of the senior lender and the mezzanine lender at the appropriate legal entity, and to limit their remedies accordingly. The “per plan” approach, requiring only one impaired accepting class, could result in creditors of a mezzanine debtor determining the treatment of the senior lender’s claim at the opco debtor over the senior lender’s objection.[17] For borrowers and guarantors, the Transwest decision may incentivize parties to file chapter 11 bankruptcy within the Ninth Circuit. Debtors may be able to confirm a plan over the objections of certain creditor groups using the “cram down” mechanism affirmed by the Transwest decision’s interpretation of Section 1129(a)(10).    [1]   In re Transwest Resort Properties, Inc. (JPMCC 2007-C1 Grasslawn Lodging, LLC v. Transwest Resort Properties, Inc.), No. 16-16221, 2018 WL 615431 (9th Cir. Jan. 25, 2018). The Ninth Circuit addressed a second question in Transwest not discussed in this client alert, namely, whether a secured lender’s election to have its entire claim treated as secured under 11 U.S.C. § 1111(b)(2) requires a due-on-sale clause to be included in a debtor’s plan of reorganization. The Ninth Circuit’s opinion, which is marked for publication, is also available for download at http://cdn.ca9.uscourts.gov/datastore/opinions/2018/01/25/16-16221.pdf.    [2]   In re Tribune Co., 464 B.R. 126, 183 (Bankr. D. Del. 2011).    [3]   Id. at 182 (citing In re Owens Corning, 419 F.3d 195, 211 (3d Cir. 2007)).    [4]   Tribune, 464 B.R. at 182.    [5]   In re Owens Corning, 419 F.3d 195, 211–12 (3d Cir. 2007) (“The upshot is this. In our Court what must be proven (absent consent) concerning the entities for whom substantive consolidation is sought is that (i) prepetition they disregarded separateness so significantly their creditors relied on the breakdown of entity borders and treated them as one legal entity, or (ii) postpetition their assets and liabilities are so scrambled that separating them is prohibitive and hurts all creditors. Proponents of substantive consolidation have the burden of showing one or the other rationale for consolidation.”).    [6]   Tribune, 464 B.R. at 182.    [7]   See, e.g., In re SGPA, Inc., 2001 Bankr.LEXIS 2291 (Bankr. M.D. Pa. Sep. 28, 2001); In re Charter Commc’ns, 419 B.R. 221 (Bankr. S.D.N.Y. 2009).    [8]   In re JER/Jameson Mezz Borrower II, LLC, 461 B.R. 293 (Bankr. D. Del. 2011); In re: Transwest Resort Properties, Inc., 554 B.R. 894 (D. Ariz. 2016).    [9]   In re Transwest Resort Properties, Inc., 554 B.R. 894, 896–97 (D. Ariz. 2016). [10]   Id. at 897. [11]   Id. at 901. [12]   The Lender also appealed the lower court’s ruling that Section 1111(b) did not require the inclusion of a due-on-sale clause in the Plan, which the Court affirmed. Accordingly, even though the Lender was entitled to be treated as fully secured under the Plan, the Lender was not entitled to certain covenants and restrictions related to the disposition of its collateral under the terms of the Plan. [13]   In re Transwest Resort Properties, Inc., No. 16-16221, 2018 WL 615431 at *5 (9th Cir. Jan. 25, 2018). (“[T]he Lender provides no support for its position that all subsections [of section 1129(a)] must uniformly apply on a “per debtor” basis.”) [14]   Id. [15]   Id. at *6 (Friedland, J., concurring). [16]   Id. at *8 (citing In re Bonham, 229 F.3d at 765 (“[O]nly through a searching review of the record, on a case-by-case basis, can a court ensure that substantive consolidation effects its sole aim: fairness to all creditors.”)) [17]   The Ninth Circuit’s endorsement of the “per plan” interpretation of section 1129(a)(10) may also prompt renewed attention toward the bankruptcy provisions, including the voting rights with respect to each borrower’s bankruptcy case, in an intercreditor agreement between senior lender and mezzanine lender. Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Matthew K. Kelsey – New York (+1 212-351-2615, mkelsey@gibsondunn.com) Samuel A.  Newman – Los Angeles (+1 213-229-7644, snewman@gibsondunn.com) Daniel B. Denny – Los Angeles (+1 213-229-7646, ddenny@gibsondunn.com) Michael K. Gocksch – Los Angeles (+1 213-229-7076, mgocksch@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

February 1, 2018 |
Bankruptcy Court Upholds the Enforcement of the Ipso Facto Clause Against a Foreign Debtor

New York partner Michael Rosenthal, Orange County associate Matthew Bouslog and New York associate Dylan Cassidy are the authors of “Bankruptcy Court Upholds the Enforcement of the Ipso Facto Clause Against a Foreign Debtor,” [PDF] published by American Bankruptcy Institute Journal in February 2018.

January 31, 2018 |
Navigating Loan Documentation in Pre-Distressed or Distressed Scenarios

Click for PDF As some sectors of the UK economy continue to falter and feel the negative impact of various macro-economic events (including depressed oil and commodity prices, low interest rates and the uncertainty caused by the Brexit referendum decision and ensuing withdrawal process), it is inevitable that a number of borrowers will find themselves in pre-distressed or distressed scenarios. The vast majority of loan documentation governing live credits has either been entered into since the financial crisis in 2008 or reflects refinancings that have taken place since then.  Far from being more lender-friendly, however, it is generally acknowledged that there has been a gradual erosion of traditional lender protections – e.g. a watering down of financial covenant protections with the emergence of covenant-loose or covenant-lite loans – together with an influx of pro-sponsor/borrower provisions, often imported from the US market. Whilst on the one hand this is great news for borrowers – their loan documentation is, often, inherently more flexible than it once would have been and there are arguably fewer so-called early warning signs or hair triggers for lenders – it is clear that there are still a number of provisions within loan documentation that may present challenges to borrowers in pre-distressed or distressed situations.  This article looks to identify and navigate through a number of these. Material Adverse Effect, and Default or Event of Default In analyzing loan documentation from the perspective of a pre-distressed or distressed credit, it is key to have an understanding as to the scope of the Material Adverse Effect definition,  and the application of the Default or Event of Default definitions.  This is because the drafting of these seemingly innocuous defined terms can have a key bearing on whether a distressed or pre-distressed borrower is able to continue to utilize its debt facilities and/or avoid having to make premature disclosure of possible financial difficulties to its lenders. The definition of Material Adverse Effect typically acts as a qualifier for representations and/or positive covenants.  In addition, an immediate Event of Default typically arises if any event or circumstance occurs which has, or is reasonably likely to have, a Material Adverse Effect, giving lenders the ability to exercise their acceleration rights. There are customarily three limbs included within a Loan Market Association (“LMA”) form of Material Adverse Effect definition, as set out below: “an event or circumstance which has (or is reasonably likely to have) a material adverse effect on: (a) the business, assets or financial condition of the Group (taken as a whole); (b) the ability of the [Obligors] (taken as a whole) to perform their payment obligations under the Finance Documents; and (c) the validity or enforceability of or the effectiveness or ranking of transaction security.” Of course, top-tier sponsors successfully negotiate significantly more borrower-friendly Material Adverse Effect definitions.  However, it would be wrong to assume that in all instances the definition is well negotiated from the perspective of the borrower and, despite both its importance and prevalence, there are a number of recent examples of loan agreements which include one or more of the following lender-friendly concepts: (i) the inclusion of a subjective test such that the question whether the relevant event or circumstance has a material adverse effect is determined in the opinion, or reasonable opinion, of the lenders, (ii) the reach to any event or circumstance that has an effect not only on the assets or financial condition of the Group but also the prospects of that Group, and (iii) the material adverse effect bites on the ability of the relevant entities to perform their obligations in relation to financial covenant testing. A subjective test should always be avoided (as is the general rule of thumb for any determination to be made by a lender or agent throughout loan documentation) as it is much more difficult to challenge a subjective determination rather than an objective one, but often the significance of either a reference to “prospects” or to the ability of the relevant entities to perform their financial covenant obligations only becomes apparent when considering a distressed or pre-distressed scenario. Let’s consider a practical example: If a company delivers to its lenders monthly financial statements that show in all likelihood that the financial covenants, which are tested by reference to the quarterly financial statements delivered at the end of the following month, will be breached, does that give the company’s lenders grounds to conclude that there has been a material adverse effect on either the prospects of the Group or the ability of the relevant entities to perform their financial covenant obligations? No two situations are the same and so, to some extent, the answer will turn on the unique facts. If a situation like this were to arise, a court would look to determine whether a reasonable person, having the same knowledge and skill as the lenders, would determine that, on those facts, an event had occurred which had, or was reasonably likely to have, a material adverse effect on the prospects of the group or the ability of the relevant entity to comply with the financial covenants.  This is not a question of law but, rather, one of judgment – whilst declaring a material adverse effect in this instance would not be without risk for the lenders, it is something which they could consider.  There have been very few instances where lenders have relied solely on the occurrence of a material adverse effect to call an Event of Default and exercise their rights and remedies, particularly as lenders will generally err on the side of caution, but it is not unheard of or theoretically impossible. In addition to Material Adverse Effect, the concepts of Default and Event of Default are also key.  Typically, a Default is an event or circumstance which would, “with the expiry of a grace period, the giving of notice, the making of any determination under the Finance Documents or any combination of any of the foregoing“, be an Event of Default. As we noted with the Material Adverse Effect definition above, it is the occurrence of Defaults and Events of Default which trigger certain key rights and remedies for lenders under the underlying finance documentation – including putting the underlying debt on demand, declaring all or some of the debt immediately due and payable, or taking steps to enforce security.  Even if lenders choose not to exercise any of these rights following the occurrence of a Default or an Event of Default, the fact that they could do so is likely to underpin their stance towards the relevant borrower, and there may also be further consequences for that borrower as well (some of which we explore in some detail below). Possible Default Triggers Having regard to the above hypothetical fact pattern again, it is worth considering whether a Default or Event of Default may be deemed to have occurred following delivery of the monthly financial statements/management accounts.  Let’s suppose that the borrower/group is approaching impending financial distress, and the monthly financial statements suggest that some or all of the company’s financial covenants may not be complied with on the next test date. In that scenario, it is unlikely that delivery of such monthly financial statements would of itself be a Default (and therefore, also unlikely that the Borrower would be obliged to notify the agent of the occurrence of Default or an Event of Default, see further below).  This view is based on a legal analysis of the typical definition of “Default” and the fact that that definition does not (as is sometimes the case) include or refer to events that “with the passage of time” would become Events of Default.  It would of course be open to a company to choose to notify the lenders in any event, and/or the lenders may (incorrectly from a strictly legal point of view) consider delivery of such financials to have given rise to a “Default”.  Of course, if the relevant compliance certificate eventually delivered with the underlying financial statements does show a breach of all or certain financial covenants, this will give rise to an Event of Default on the date on which the covenants are tested.   The key point here is to be very clear about what the definition of “Default” says in analysing whether events or circumstances that may inexorably lead to an Event of Default necessarily constitute a Default. In a distressed, or soon-to-be distressed scenario, there are three other common events which may or may not trigger a Default or Event of Default. First, it is often an Event of Default if the auditors of the relevant borrower or borrower group qualify the audited annual consolidated financial statements of the group, and, e.g. the grounds giving rise to the qualification would be material in the context of the financing documents, or the qualification would be adverse (or materially adverse) to the interests of the finance parties.  The permutations of this Event of Default are important – rather like the Material Adverse Effect definition, there are a range of different provisions throughout the market and it is important for a borrower to understand whether any qualification is expected, and, if so, what the documentary and practical consequences of it may be – early-stage discussions and dialogue with the auditors and accountants of the group are key. Second, will the fact that an entity is balance sheet insolvent i.e. that its assets are less than its actual and contingent liabilities, result in the occurrence of a Default?  Often, the existence of a balance sheet insolvency test will be included as a Default – and usually, on an individual-company (rather than consolidated) basis. This creates the opportunity for an individual company within the group to trip a Default, notwithstanding that the company is not actually in financial difficulty, can meet its liabilities as they fall due and is not presumed insolvent under English law. Borrowers should, therefore, resist inclusion of a standalone balance sheet solvency Event of Default and should point to separate, customary lender protections e.g. an Event of Default that is triggered upon actual commencement of informal or formal insolvency proceedings, as providing sufficient lender comfort. Third, the LMA form of insolvency Event of Default captures the commencement of informal measures (such as negotiations with creditors) in relation to actual or anticipated financial difficulty, as set out below: (a)     A member of the Group: is unable or admits inability to pay its debts as they fall due; [is deemed to, or is declared to, be unable to pay its debts under applicable law]; suspends or threatens to suspend making payments on any of its debts; or by reason of actual or anticipated financial difficulties, commences negotiations with one or more of its creditors (excluding any Finance Party in its capacity as such) with a view to rescheduling any of its indebtedness. On its face, limb (iv) of the standard LMA formulation covers rescheduling of any indebtedness with any single creditor, including a company’s bank lenders, its landlords and trade creditors, irrespective of the quantum of those liabilities. The extent to which any particular approach or negotiations with a single or class of creditors might trip this Event of Default will invariably turn on the factual matrix; however, it should be noted that the High Court[1] has previously held that the term “rescheduling” implies a degree of formality and relates to the formal deferment of debt-service payments and the application of new and extended maturities to the deferred debt. It is not, therefore, concerned with an informal telephone conversation with or email to a relationship or credit manager requesting “a bit more time to pay”, which would be commercially unfeasible (particularly for highly leveraged entities which might have such conversations on a daily basis). Furthermore, the High Court has stated that the lead-in wording, which requires that informal negotiations be commenced by reason of “actual or anticipated financial difficulties”, in the context of a clause dealing with insolvency, envisages “difficulties” of a substantial nature. Notwithstanding the foregoing, however, a court will (subject to the particular facts) find that an event of default has occurred where negotiations are or the proposed rescheduling is beyond the ordinary course of a borrower’s business or is not simply a case of rolling-over existing indebtedness into new indebtedness. Prudent borrowers might try to limit the ambit of the above Event of Default to exclude negotiations with trade creditors; require that negotiations be with a “class” rather than single creditor; or specify that the Event of Default is triggered only on the occurrence of formal legal proceedings. Given the fact-sensitive nature of this provision, it is also important that borrowers and their advisers are alert to and carefully consider the potential to trigger a Default at the outset of a stressed or soon-to-be distressed scenario upon commencement of informal discussions with a single creditor or class of creditors. Finally, it is always important for a company to have one eye on its repeating representations – many borrowers will be unaware that a number of representations will be given automatically (including those buried in side letters or ancillary agreements such as security documents) – e.g. on each interest payment date.  Whilst a number of these representations are often technical or legal in nature, a number also extend to factual scenarios and, in some cases, to a representation that there is no Default. Consequences of the Occurrence of a Default or Event of Default At this juncture, it is worth noting – again perhaps obviously – that whilst as a commercial matter a distinction is sometimes drawn between a payment or “money” default and other so-called “technical” defaults (e.g. breach of undertaking, failure to deliver financial statements, etc.), as a legal matter, there is no such distinction, and there is no qualitative difference in terms of consequences between a payment or money Event of Default and any other Event of Default – the occurrence of any of them entitles the lenders to exercise the rights and remedies available to them under the relevant finance documents.  Although there are a handful of exceptions, it is best practice to assume that a technical default is the same as any other default and therefore the consequences of any such default are the same. Borrowers should ensure that all Events of Default, technical or otherwise, are waived in writing and confirmed as no longer “continuing”. As to the practical consequences of a Default or Event of Default, typically in many facilities, a drawstop to funding will be the occurrence of a Default in respect of new loans, and an actual Event of Default in relation to the rollover of existing loans (although, in some documents, even the occurrence of a potential Event of Default is a drawstop to rollover loans).  Clearly, if the trigger in either case is a Default, both the risk of the drawstop occurring is increased but, more practically, the company needs to be more attuned to when a Default may or may not arise.  As above, this drawstop would apply equally to so-called “technical” Defaults.  In some cases a funding drawstop (particularly in relation to existing or rollover loans) may be the beginning of a company’s downfall – if a company requires an on-going revolving facility / working capital line such that it cannot continue trading without these facilities, if existing borrowings are draw stopped, this may signal the end.  It is, therefore, particularly important to be aware of the triggers for funding draw stops, whether there is any advantage to a premature drawing of a revolving credit line (noting that this may not necessarily glean favour with the lending group) and how vital any undrawn facilities (particularly working capital facilities) are to the going concern nature of the group. It is also worth noting that any such drawstop may also apply to any overdraft facility (or equivalent) provided by way of ancillary facility. By way of reminder, customary loan documentation will typically require a borrower to provide the following information: (at any time) a certificate signed by certain senior officers of the company certifying that no Default is continuing (or, if a Default is continuing, specifying the Default and steps taken to remedy the same). This is a seemingly innocuous but potentially very important tool in the lenders’ armory and may be relied upon as the lenders become aware of potential financial difficulties (e.g. upon receipt of financial statements and/or compliance certificates) as a means of procuring an acknowledgment from the company that a Default has occurred and triggering the protections that arise on a Default. Borrowers and their advisers should ensure that provisions and the potential tripwires noted above are read with care to avoid responding to the lenders acknowledging a Default where, legally, and on an interpretation of the finance documents, there is no Default; and (promptly upon request) such further information regarding the financial condition, assets and operations of the group and/or any member of the group as any finance party may reasonably request. It is not uncommon for lenders to invoke this information request right in a stressed scenario as a means to obtaining further information; requests and responses to the lenders should be carefully considered by borrowers and their advisers, particularly to ensure that the response, if any, does not of itself constitute or give rise to a Default or Event of Default. In addition to the information undertakings/rights referred to above, loan agreements will usually also include a general undertaking requiring the group, in the event that a Default is continuing or the agent reasonably suspects such, to permit the agent and its professional advisers free access at all reasonable times and on reasonable notice (at the borrower’s cost) to the premises, assets, books and accounts of each group company, and to meet and discuss matters with members of senior management. Since this undertaking extends to a situation where the agent reasonably suspects a Default may have occurred, it may be invoked by the lender group ahead of an actual Default and upon receipt of financial information which is sufficiently concerning to the lenders. It is, typically, this right which permits the lenders to commission an independent business review (or so-called “IBR”) whereby a firm of accountants will be appointed to investigate and report on the financial condition of the group and which is invariably a preliminary condition to implementing a restructuring plan. Other In a stressed or distressed scenario, it is also helpful for a company to have one eye on the transfer provisions contained within the finance documents. Typically, where lenders are subject to restrictions on transferability – e.g. to affiliates and entities on a white/permitted list – these will fall away following an Event of Default which is continuing.  In essence, this means that following an Event of Default, lenders would have the ability to transfer to distressed investors and/or so-called “vulture” or other credit funds (assuming, of course, that such entities are not already included on the White List).   As result, the complexion and disposition of the relevant lender group towards the underlying credit group could change quite radically following the occurrence of an Event of Default in circumstances where one or more of the existing lenders decided to trade out of the credit and sell to “loan-to-own” or “distressed-for-control” investors whose approach and motivations may be different. In light of recent aggressive, sponsor-driven documentation, however, some borrowers may find transfers to “loan-to-own” lenders are actually prohibited or that consent to trading is still required during an Event of Default (save in relation to non-payment or insolvency Events of Default only). Borrowers should also keep in mind the amendment and/or waiver provisions contained in the finance documents, particularly in the context of a lending syndicate where relationships with the borrower and/or treatment of the credit diverges between lenders. The traditional LMA construct provides that the vast majority of amendments and/or waivers to the finance documents require majority lender consent (typically lenders whose commitments aggregate more than 662/3 per cent. of the total commitments). Loan documentation will usually also include customary “yank the bank”, “snooze you lose” and “structural adjustment” provisions which may be used to the borrower’s advantage; for example, in a scenario where the revolving facility provider is less amenable to a restructuring plan than the other lenders, subject to the ongoing working capital needs of the group, undrawn revolving commitments and amounts that are committed by way of ancillaries such as overdrafts but not actually drawn  may be cancelled to adjust lender hold levels to the company’s advantage. Other facilities provided by favourable lenders, e.g. capex and acquisition facilities may also be drawn to adjust lender commitment levels. Again, it may be the case that in more recent documentation, the majority lender threshold is lower (for example, 50 per cent.) or that the scope of amendments requiring only affected/participating lender consent is greater, allowing more flexibility for borrowers. Refinancing Borrowers should also be alive to the inclusion of potential hair triggers when undertaking a refinancing or amendment to loan documentation in a non-distressed context; often, the terms of a refinancing will provide that documentation is amended to include updates to the most recent LMA form of loan agreement, to the extent required. Borrowers should resist wholesale acceptance of such amendments, however, and take care to ensure that these are purely mechanical. For example, a recent LMA update provides that a hedging agreement shall be deemed to be a “Finance Document” for the purposes of the definition of “Default”. Borrowers will, usually, have less control over and scope to negotiate hedging arrangements, and the inclusion of hedging agreements as a “Finance Document” for the purposes of the definition of “Default” will give the lenders a far earlier trigger on which to act than they otherwise had; instead, Borrowers should point to the protections built into separate ISDA documentation and to other events of default – e.g.  MAE – as providing sufficient comfort for the lenders. The inclusion of new “LMA” undertakings and representations should also be closely analysed to determine any risk that the borrower might trip these. Conclusion Whilst it is hoped that the above provides some food for thought, the overriding message is that borrowers (and sponsors) must look to understand their financing documents – not only to regularly review compliance with repeating representations and on-going covenants, but also to ensure they know their obligations should a Default or Event of Default arise, and to understand the consequences of any such Default or Event of Default.  Even if lenders do not look to accelerate the underlying debt or enforce security following a Default or Event of Default, they are more likely to use it as leverage as against the borrower, and could look to force an upward re-pricing, payment of a one-off fee or, just generally, be less amenable to agree to any required waiver or amendment. [1] Grupo Hotelero Urvasco SA v Carey Value Added SL and another [2013] EWHC 1039 (Comm) (26 April 2013). Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Global Finance practice group, or the authors: Amy Kennedy – London (+44 (0)20 7071 4283, akennedy@gibsondunn.com) Alex Hillback – London (+44 (0)20 7071 4248, ahillback@gibsondunn.com) Please also feel free to contact the following leaders and members of the Global Finance group: Thomas M. Budd – London (+44 (0)20 7071 4234, tbudd@gibsondunn.com) Gregory A. Campbell – London (+44 (0)20 7071 4236, gcampbell@gibsondunn.com) Richard Ernest – Dubai (+971 (0)4 318 4639, rernest@gibsondunn.com) Jamie Thomas – Singapore (+65 6507.3609, jthomas@gibsondunn.com) Michael Nicklin – Hong Kong (+852 2214 3809, mnicklin@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 17, 2017 |
The Battle Over 3rd-Party Releases Continues

​New York partners Matthew Kelsey and J. Eric Wise and associate Matthew Porcelli are the authors of “The Battle Over 3rd-Party Releases Continues,” [PDF] published by Law360 on November 17, 2017.

November 16, 2017 |
Post-Confirmation SunEdison Bankruptcy Release Decision Rejects Operative Proceeding Analysis, Finds Lack of Jurisdiction to Approve Third-Party Releases

I.     Introduction As discussed in our October 23, 2017 client alert, bankruptcy courts considering whether to approve non-consensual third-party non-debtor releases included in a plan of reorganization have taken divergent approaches to determine which “operative proceeding” is appropriate for analyzing whether the court has jurisdiction or constitutional authority to approve the releases.[1] The question before these courts is whether the relevant operative proceeding is (1) the actual proceeding before the bankruptcy court (i.e., a confirmation hearing involving a plan that includes such releases)[2] or (2) a separate proceeding (whether actual or hypothetical) in which a third party has asserted or could assert claims to be released under a proposed plan.[3] Two weeks later, on November 8, 2017, the Bankruptcy Court for the Southern District of New York issued a decision and order invalidating certain non-consensual third-party non-debtor releases included in SunEdison, Inc.’s confirmed plan of reorganization.[4] In so doing, the court followed the second approach to the operative proceeding analysis recently articulated in the Midway Gold case, essentially holding that it lacked subject matter jurisdiction to grant releases that would enjoin unasserted potential claims held by non-objecting third parties against non-debtor parties. II.     Overview of the SunEdison Decision The SunEdison non-consensual third-party release dispute arose in an unusual procedural context. The debtors’ plan of reorganization contained a broad third-party release provision in favor of certain non-debtors, and the parties who were deemed to grant releases under the plan included all holders of claims entitled to vote on the plan who did not vote to reject the plan (the “Non-Voting Releasors”). No Non-Voting Releasors objected to the plan’s release provisions. Nevertheless, in connection with the confirmation hearing, the court sua sponte raised the issue of whether it should approve the releases by the Non-Voting Releasors. The court confirmed the debtors’ plan on July 28, 2017, reserving decision on the release issue.[5] After supplemental briefing, the court declined to approve the releases in their proposed form. First, the court rejected the debtors’ argument that the Non-Voting Releasors had implicitly consented to the releases. The debtors contended that the conspicuous warning included in the disclosure statement and ballots regarding the effect of the releases on Non-Voting Releasors was sufficient to deem them as having consented to the non-debtor release.[6] The court rejected this position, concluding that, under New York law, silence cannot be deemed to be consent unless the silent party is under a duty to speak. As the court noted, the debtors failed to identify any such duty of the Non-Voting Releasors.[7] Next, the court held that the debtors had not met their burden of showing that the court had subject matter jurisdiction to approve the non-debtor releases. The debtors argued that the court’s jurisdiction was supported by their potential indemnification obligations to the released parties under the debtors’ charters, indemnification agreements, and the DIP credit agreements.[8] While the court acknowledged that, generally, such indemnification obligations would be sufficient to establish jurisdiction, the court also noted that the releases granted under the plan were broader than the debtors’ potential indemnification obligations.[9] For example, the indemnification obligations under the DIP credit agreement related solely to postpetition acts, but the plan releases enjoined claims taking place on or before the effective date of the plan—i.e. “claims … that arose from the beginning of time to an unspecified date in the future when the Effective Date occurs.”[10] Further, the plan release covered more parties than were covered by the potential indemnification obligations cited by the debtors, including underwriters, arrangers, and placement agents for the prepetition second lien notes and current and former affiliates, subsidiaries, advisors, management, employees, and other representatives and professionals of each of the released parties. As the court observed, the debtors had “not pointed to any indemnification obligations running in favor of these unidentifiable Released Parties.”[11] Accordingly, the court concluded that the debtors had not established subject matter jurisdiction because “[t]he reference to certain indemnity obligations owed to a few parties does not prove that the outcome of the universe of claims the Debtors seek to enjoin will have a conceivable effect on the estate.”[12] Lastly, the court observed that the debtors had also failed to demonstrate that the releases were appropriate under the Second Circuit’s Metromedia standard.[13] Accordingly, the court declined to approve the releases and granted the debtors leave to propose a modified form of release within 30 days of the order.[14] III.     The SunEdison Court’s Operative Proceeding Analysis The SunEdison court’s consideration of the “operative proceeding” issue was articulated as follows: In assessing a court’s jurisdiction to enjoin a third party dispute under a plan, the question is not whether the court has jurisdiction over the settlement that incorporates the third party release, but whether it has jurisdiction over the attempts to enjoin the creditors’ unasserted claims against the third party.[15] In support of this statement, the court cited a Second Circuit decision from the Johns-Manville bankruptcy case and a decision from Matter of Zale Corp., a Fifth Circuit case relied on by the Johns-Manville court.[16] In Zale, the creditors’ committee planned to sue the debtor’s officers and directors, who were covered by a primary insurance policy with CIGNA and an excess policy with the National Union Fire Insurance Company (NUFIC).[17] The bankruptcy court granted a motion to approve a multi-party settlement agreement, which included an injunction barring NUFIC from suing CIGNA for its actions related to the settlement.[18] On appeal, NUFIC challenged the injunction, arguing that the bankruptcy court did not have jurisdiction over its tort claims against CIGNA.[19] The Fifth Circuit agreed, explaining that because NUFIC’s claims against CIGNA were not property of the debtor’s estate and did not implicate any independent obligation of the debtor in favor of CIGNA, “the settlement cannot provide the basis for jurisdiction over the [tort] claims.”[20] Following Zale, the Second Circuit in Johns-Manville concluded that the bankruptcy court had no jurisdiction to enjoin third-party plaintiffs’ direct action claims against Travelers, a primary insurer of the debtor asbestos manufacturer, in connection with its approval of a settlement agreement.[21] Thus, in considering its jurisdiction not in the context of the confirmation hearing before it, but by looking at the universe of claims that would be enjoined, the SunEdison court took the approach of the Midway Gold court, rather than the “operative proceeding” analysis in Millennium Labs.[22] In other words, the SunEdison court focused not on the nature of the proceeding before it—a confirmation hearing—but on the nature of separate hypothetical proceedings in which the Non-Voting Releasors could assert claims against the non-debtor releasees. Like the Midway Gold court, the SunEdison court never used the words “operative proceeding” in its decision, yet implicitly rejected the framework established in Millennium Labs. Notably, both the Zale and Johns-Manville cases relied upon by the SunEdison court involved approval of a settlement agreement, while the SunEdison plan releases arose in the context of plan confirmation hearing. By relying on these precedents, the SunEdison court did not consider whether this distinction was relevant. By contrast, in Millennium Labs, the court was satisfied that it had subject matter jurisdiction because the challenged releases arose in the context of a confirmation hearing, and confirmation of a plan is a statutorily enumerated “core” proceeding covered by Congress’s grant of jurisdiction for cases “arising in” or “arising under” a case under title 11 of the United States Code.[23] The SunEdison debtors brought the Millennium Labs decision to the court’s attention in a supplemental letter brief.[24] Urging the court to approve the releases, the debtors cited the Millennium Labs court’s conclusion that “the operative proceeding for purposes of a constitutional analysis [was] confirmation of a plan” and not any actions “that would be released incident to plan confirmation.”[25] In a footnote, the SunEdison court acknowledged that the Millennium Labs court concluded that it had the constitutional authority under Stern v. Marshall[26] to enter a final judgment enjoining the assertion of a third-party claim by a non-consenting creditor, but stated that because it was not approving the releases, it did not need to resolve the question of its constitutional authority. The court did not, however, consider whether the Millennium Labs “operative proceeding” analysis could also be relevant in connection with the related question of whether a court has subject matter jurisdiction to confirm a plan including non-consensual third-party non-debtor releases. IV.     Practical Implications While the SunEdison decision provides another data point regarding courts’ analysis of non-consensual third-party releases, it leaves some questions unanswered. First, by limiting its analysis of the Millennium Labs decision to a footnote on its constitutional authority under Stern, the court declined to consider how the Millennium Labs court’s “operative proceeding” analysis would apply in connection with determining whether a court has subject matter jurisdiction to confirm a plan containing a third-party release provision. Second, by concluding that the subject matter jurisdiction analysis was properly focused not on “the settlement that incorporates the third party release” but on “the attempts to enjoin the creditors’ unasserted claims against [a] third party,”[27] the court did not expressly consider whether the context of a plan confirmation (as opposed to approval of a settlement) was relevant to the analysis. Future decisions, including the pending appeal of the Millennium Labs decision, will shed more light on how courts will ultimately bear down on this developing issue. [1] http://www.gibsondunn.com/publications/documents/Two-Bankruptcy-Decisions–3rd-Party-Releases–Divergent-Approaches–Operative-Proceeding-Analysis.pdf. [2] See In re Millennium Lab Holdings II, LLC, No. 15-12284 (LSS), __ B.R.__, 2017 WL 4417562 (Bankr. D. Del. Oct. 3, 2017) (“Millennium Labs“). [3] See In re Midway Gold US, Inc., No. 15-16835 (MER), __ B.R. __, 2017 WL 4480818 (Bankr. D. Colo. Oct. 6, 2017) (“Midway Gold“). [4] In re SunEdison, Inc., No. 16-10992 (SMB) (“SunEdison“), Dkt. No. 4253 (Bankr. S.D.N.Y. Nov. 8, 2017) (the “Decision”). [5] Specifically, the confirmation order provided that “whether Holders of Claims entitled to vote to accept or reject the Plan that did not in fact vote either to accept or reject the Plan are included as Releasing Parties [] and therefore subject to the releases contemplated in [] the Plan, is reserved by the Court for subsequent determination.” SunEdison, Dkt. No. 3735 at ¶ HH (Jul. 28, 2017). [6] Decision at 6. [7] Decision at 10-11. [8] Decision at 13. [9] Decision at 14-15. [10] Decision at 15 (emphasis in original). [11] Decision at 16. [12] Id. [13] Id.; see Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 135, 142 (2d Cir. 2005) (in deciding whether a third-party release is appropriate, courts have considered whether the estate has received a substantial contribution, whether the enjoined claims are channeled to a settlement fund rather than extinguished, whether the enjoined claims would indirectly impact the debtor’s reorganization through claims of indemnification or contribution, whether the plan otherwise provides for payment in full of the enjoined claims, and whether the creditor has consented). [14] Decision at 16. [15] Decision at 12 (emphasis added). [16] Johns-Manville Corp. v. Chubb Indem. Ins. Co. (In re Johns-Manville Corp.), 517 F.3d 52, 65 (2d Cir. 2008), vacated & remanded on other grounds, 557 U.S. 137 (2009), aff’g in part & rev’g in part, 600 F.3d 135 (2d Cir.); Feld v. Zale Corp. (In re Zale Corp.), 62 F.3d 746, 755 (5th Cir. 1995). The court separately cited an Eleventh Circuit decision, Shearson Lehman Bros, Inc. v. Munford, Inc. (In re Munford, Inc.), 97 F.3d 449, 454 (11th Cir. 1996). [17] Zale, 62 F.3d at 749-50. [18] Id. [19] Id. at 755. [20] Id. at 756-57. [21] Johns-Manville, 517 F.3d at 65. Similarly, the Eleventh Circuit held in Munford that it was “not the language of the settlement agreement that confers subject matter jurisdiction in this case. Rather, it is the ‘nexus’ of those claims to the settlement agreement . . .  that the bankruptcy court must approve . . . .” 97 F.3d at 454. [22] See Midway Gold, 2017 WL 4480818 at *30-34; Millennium Labs, 2017 WL 4417562 at *14-16. [23] Millennium Labs at *6. [24] In re SunEdison, No. 16-10992, Dkt. No. 4139 (Bankr. S.D.N.Y. Oct. 13, 2017). [25] Id. at 2 (citing Millennium Labs, No. 15-12284, Dkt. No. 476 at 27, 31-33 (Bankr. D. Del. Oct. 3, 2017)). [26] 131 S. Ct. 2594 (2011). [27] Decision at 12.   Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Matthew K. Kelsey – New York (+1 212-351-2615, mkelsey@gibsondunn.com) J. Eric Wise – New York (+1 212-351-2620, ewise@gibsondunn.com) Matthew P. Porcelli – New York (+1 212-351-3803, mporcelli@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 9, 2017 |
A Tale of Two Cases on 3rd-Party Releases

​New York partners Matthew Kelsey and J. Eric Wise and associate Matthew Porcelli are the authors of “A Tale of Two Cases on 3rd-Party Releases,” [PDF] published by Law360 on November 9, 2017.

November 3, 2017 |
Two Recent Cases Demonstrate That Disputes over Substantive Consolidation Are a Live Issue for Corporate Debtors in Chapter 11

Substantive consolidation is an equitable doctrine that permits a bankruptcy court, under certain circumstances, to disregard distinctions between parent companies, subsidiaries and affiliates that operate together as a corporate group. In some instances, bankruptcy courts will formally dissolve and combine the assets and liabilities of all or a portion of the entities within a corporate family, so that all assets and liabilities are actually pooled together into a single entity. More commonly, however, bankruptcy courts will permit a “deemed consolidation” of debtors, so that creditors of various entities within a corporate group simply assert their claims and vote as if assets and liabilities of the consolidated group belonged to a single entity for plan voting and distribution purposes only, but the corporate group’s elaborate structure will survive the bankruptcy case. Notwithstanding the Third Circuit’s influential opinion in In re Owens Corning—which called substantive consolidation an “extraordinary remedy” that is only rarely called for[1] and expressed strong skepticism that a deemed consolidation is ever permissible on a non-consensual basis—consensual consolidation of entities in bankruptcy, for purposes of administrative convenience and cost savings, remains a fairly common feature of corporate Ch. 11 cases. Two recent cases may signal a renewed viability of substantive consolidation claims in non-consensual proceedings, as well. In re ADPT DFW Holdings, LLC, __ B.R. __, 2017 WL 4457439 (Bankr. N.D. Tex. Sept. 29, 2017) and Official Comm. of Unsecured Creditors of HH Liquidation, LLC v. Comvest Group Holdings, LLC (In re HH Liquidation, LLC), 2017 WL 4457404 (Bankr. D. Del. Oct. 4, 2017), each involve requests to substantively consolidate multiple subsidiaries and affiliates seeking to reorganize or liquidate in Chapter 11.  ADPT DFW Holdings shows that courts may be willing to consider a more lenient standard for substantive consolidation when the proposed consolidation includes a large number of affiliated entities, while the HH Liquidation opinion displays a potential willingness to order substantive consolidation if the court believes certain entities were purposefully undercapitalized, even without evidence that corporate formalities were disrespected, and notwithstanding evidence that such consolidation would harm certain creditors. I.    In re ADPT DFW Holdings, LLC The Northern District of Texas Bankruptcy Court’s opinion in ADPT DFW Holdings demonstrates that, at least in the Fifth Circuit, a court may apply a more lenient standard in deciding whether affiliated debtors with a large, complex corporate structure should be substantively consolidated. The court authorized the “deemed consolidation” (i.e., consolidation for the limited purpose of voting and distribution under the plan) of 140 affiliated debtors, consisting of the parent company Adeptus Health Inc., two intermediate holding companies, Adeptus Health LLC and First Choice ER, LLC, and 137 operating companies which were direct and indirect subsidiaries of First Choice ER, over the objection of an unsecured creditor.[2] Secured creditors (the “Deerfield Parties”) held claims in excess of $228 million pursuant to a prepetition credit agreement and there was an undisputed finding by the debtors’ financial advisor that the debtors’ assets were worth between $113 million and $137 million.[3] Only 80 of the debtors were liable on the $228 million of secured indebtedness. However, the court found there was evidence that, of the 60 remaining debtors, 49 were inactive or had no assets, and the remaining 11 did not have any material value.[4] Additionally, all 140 debtors were liable under a $70 million post-petition DIP loan from the Deerfield Parties. The plan provided that the Deerfield Parties would exchange their secured claim for all of the equity of the debtors. The only recovery for unsecured creditors, which included the Deerfield Parties’ $191.8 million deficiency claim, would be from a litigation trust which would receive all causes of action of the debtors, $3 million in initial funding and would likely receive another $3 million of debt financing. The court found there was evidence that a number of the causes of action that would be transferred to the litigation trust were either jointly owned by all of the debtors or would be difficult to allocate between the debtors’ various estates. The plan provided that, solely for voting and distribution purposes, all 140 debtor entities would be substantively consolidated. An unsecured creditor with a $5 million disputed claim objected to this “deemed consolidation.” While recognizing that substantive consolidation is “an extreme and unusual remedy and should be used sparingly,”[5] the court noted that there should be a more liberal standard for so called “mega-bankruptcy” cases involving complex corporate structures.[6] Specifically, the court emphasized that this case involved 140 debtors, while Owens Corning involved only 18 debtors, stating: While there is no magic number that should necessarily change the legal analysis surely all reasonable minds must recognize that having 140 related debtors in bankruptcy together is rare and creates unique challenges in order to both: (a) protect stakeholders’ legal rights, but at the same time (b) preserve limited resources and not unnecessarily drive up administrative expenses.[7] By contrast, the Owens Corning opinion had stated “[f]or obvious reasons, we are loathe to entertain the argument that complex corporate families should have an expanded substantive consolidation option in bankruptcy.”[8] The opinion notes that the Fifth Circuit has not adopted a standard for substantive consolidation and surveyed the tests used from other circuits, which included: Multi-Factor Approach Distilled to Two Factors: Under Owens Corning, substantive consolidation requires either (a) pre-petition, the entities to be consolidated “disregarded separateness so significantly their creditors relied on the breakdown of entity borders and treated them as one legal entity,” or (b) post-petition, the “assets and liabilities [of such entities] are so scrambled that separating them is prohibitive and hurts all creditors.”[9] The ADPT DFW Holdings court noted that a similar test was adopted in an earlier case by the Second Circuit, and that this two-part test was created from a multi-factored approach. Harm Balancing Approach: The court noted that this approach, used by the Eleventh Circuit, considers certain elements from the multi-factor test but “ultimately balances the harms or prejudice along with considering how many of the traditional factors exist.”[10] In ordering substantive consolidation, the court did not decide which test was appropriate, finding that substantive consolidation was warranted under either test and stated: The preponderance of the evidence reflected that creditors tended to deal with the Debtors as a single economic unit and did not rely on their separate identity in extending credit. The preponderance of the evidence reflected that the liabilities and contracts of the Debtors were a “tangled mess” to try to unsort. Rephrased, the preponderance of the evidence reflected that creditors usually treated the Debtors as one legal entity. The preponderance of the evidence reflected that separating the Debtors would be prohibitive and hurt all creditors. The court is left to conclude that consolidation will benefit all creditors. There was no evidence of prejudice to any particular creditor. None whatsoever.[11] It is notable, however, that while the court made a finding that the assets of the debtors were a “tangled mess,” it appears most of the work to separate the assets and liabilities of each entity had already been done by the debtors’ financial advisor in preparing schedules and statements of financial affairs for each entity.[12] Indeed, the assets, liabilities and operations of the 60 debtors not liable under the debtor’s prepetition credit agreement were sufficiently untangled for the court to make a finding that none of these entities had material assets or operations.[13] The opinion further asserts that it was irrelevant whether the plan proposed actual substantive consolidation or only “deemed consolidation” and that “[n]o reported cases have singled this out as a special circumstance that would impact either negatively or positively the substantive consolidation analysis.”[14] Interestingly, the Owens Corning opinion that the court discusses in detail addressed nonconsensual “deemed consolidation,” stating “perhaps the most flaw most fatal to the Plan Proponents’ proposal is that the consolidation sought was ‘deemed’ (i.e., a pretend consolidation for all but the Banks)” and that “[s]uch deemed schemes we deem not Hoyle.”[15] It is important to note that the ADPT DFW Holdings court emphasizes in numerous places that, because the Deerfield Parties were undersecured, and the primary distribution to unsecured creditors would be on account of the causes of action owned by all of the debtors’ estates, substantive consolidation did not harm any creditor in this case.[16] The court could have explicitly limited its holding under the harm-balancing test and held that, in this circumstance, deemed consolidation was appropriate because no creditor was harmed, particularly since the primary asset unsecured creditors could recover from were causes of action jointly owned by all of the debtors. However, it did not do so, and, accordingly, practitioners should be aware that, at least in the Fifth Circuit, (i) there may be a greater risk of substantive consolidation to large corporate groups of debtors and (ii) nonconsensual “deemed consolidation” may be granted under a broader set of circumstances than previously thought. II.    In re HH Liquidation The Delaware bankruptcy court’s opinion in HH Liquidation demonstrates that, while substantive consolidation may be rarely granted, if a creditor can convincingly argue that the debtors have purposefully undercapitalized certain entities, it may be difficult to dismiss claims for substantive consolidation at the summary judgment stage. The case involves an attempt to substantively consolidate the holding-company debtor Haggen Holdings, LLC (“Holdings”) and its subsidiary debtors, all of which were operating companies of 146 grocery stores (the “OpCo Entities”), with affiliated non-debtors who owned and leased the stores to the Opco Entities (the “PropCo Entities”).[17] In February 2015, Holdings and its subsidiaries (“Haggen”) acquired the operational assets (including leases with third parties) for 146 grocery stores and placed the operational assets into the OpCo Entities (the “Acquisition”).[18] As part of the Acquisition, Haggens also acquired the real estate for 67 of the stores, of which 53 were located on property owned in fee simple by the sellers and 14 on property subject to long term ground leases. Twenty-eight of these properties were placed in the PropCo Entities, and the remaining 39 were sold to two third parties who entered into long term leases with the OpCo Entities.[19] Holdings guaranteed the OpCo Entities performance under these agreements.[20] The creditors committee (the “Committee”) filed an adversary proceeding against Haggen and its shareholders (the “Defendants”) requesting, among other claims, substantive consolidation of Holdings and the OpCo entities with the non-debtor PropCo entities.[21] The Defendants moved for partial summary judgment on the substantive consolidation claims arguing that (i) substantive consolidation is an extreme remedy which courts should rarely employ and (ii) substantive consolidation would reduce the recovery of the creditors of Holdings from 100% to as little as 21%, while granting a windfall to creditors of the OpCo entities, who would receive a 20% recovery rather than nothing,[22] and (iii) it was not permissible to substantively consolidate debtors with non-debtors.[23] At the outset, the court noted that Owens Corning does not prohibit substantive consolidation between debtor and non-debtor entities, stating that “the great weight of cases authorizes substantive consolidation of debtors and non-debtors[.]”[24] In denying summary judgment, the court observed that this was a problem the Defendants created themselves by segregating the operational assets from the real property assets Haggen acquired in the Acquisition, stating that, in a matter of a few months after the Acquisition, “the OpCo Entities were bankrupt and are unable to pay unsecured creditors anything while the PropCo Entities are flush with money. The Court and the OpCo Entities’ creditors need to see evidence at trial of why and how this happened.”[25] Regarding the argument that Holdings’ creditors would be harmed, while creditors of the OpCo Entities would receive a windfall, the court stated that both the Committee and the Defendants would have an opportunity to prove at trial what they knew and relied on and that, after trial “the Court will be in a better position to determine the creditors’ recovery rights. It is premature for the Court to make the determination on substantive consolidation now.”[26] The HH Liquidation opinion is notable because it does not cite the Owens Corning two-part test for substantive consolidation, and there did not appear to be any showing that either (a) pre-petition, the entities to be consolidated “disregarded separateness so significantly their creditors relied on the breakdown of entity borders and treated them as one legal entity,” or (b) post-petition, the “assets and liabilities [of such entities] are so scrambled that separating them is prohibitive and hurts all creditors.”[27] Instead, the court appeared to hold that it was not appropriate to grant summary judgment because it appeared that, in structuring the OpCo Entities and the PropCo Entities, Defendants had underfunded the OpCo Entities to the benefit of the PropCo Entities.[28] III.    Conclusion These cases demonstrate that, in certain circumstances, substantive consolidation may not be as rare a remedy as commonly believed. Specifically, practitioners advising a large number of potential affiliated debtors should be aware that ADPT DFW Holdings may be cited to argue a more lenient standard for substantive consolidation should apply. Additionally, those advising clients considering an OpCo/PropCo structure should be cognizant of the potential risk of substantive consolidation based solely on undercapitalizing OpCo entities.        [1]    419 F.3d 195, 211 (3d Cir. 2005) (“[B]ecause substantive consolidation is extreme (it may affect profoundly creditors’ rights and recoveries) and imprecise, this ‘rough justice’ remedy should be rare and, in any event, one of last resort after considering and rejecting other remedies”).        [2]    ADPT DFW Holdings, 2017 WL 4457439, at *1-2.        [3]    Id.        [4]    Id. at *12.        [5]    Id. at *5.        [6]    Id.        [7]    Id. at *12 (emphasis in original).        [8]    Owens Corning, 419 F.3d at 215.       [9]    ADPT DFW Holdings, 2017 WL 4457439, at *9.        [10]    Id. at *11.        [11]    Id. at *14 (emphasis in original).        [12]    Id. at *13 (“there was credible evidence that preparing separate Schedules and SOFAs was very difficult for the Debtors’ financial advisors.”).        [13]    Supra note 5.        [14]    ADPT DFW Holdings, 2017 WL 4457439, at *14.        [15]    Owens Corning, 419 F.3d at 216.        [16]    See, e.g., ADPT DFW Holdings, 2017 WL 4457439, at *12 (finding that a “hugely significant observation is that” no one challenged the valuation of the debtors assets at roughly $100 million below the secured debt, and, of the debtors who not liable under the secured debt facility, none had any material value.); Id. at *14 (“There was no evidence of prejudice to any particular creditor. None whatsoever.”); Id. at *14 (“[P]articularly since the causes of action that will produce most of the recovery to stakeholders have been determined to be owned by all Debtor estates—the court approves substantive consolidation.”).        [17]    HH Liquidation, 2017 WL 4457404, at *3.        [18]    Id. at *1.        [19]    Id. at *2.        [20]    Id.        [21]    Id. at *3.        [22]    The opinion does not address any potential harm to the creditors of the PropCo Entities, but, consolidation of the PropCo Entities with Holdings and the OpCo Entities would presumably also harm the creditors of the PropCo Entities.        [23]    HH Liquidation, 2017 WL 4457404, at *3.        [24]    Id.        [25]    Id.        [26]    Id. at *4.        [27]    Owens Corning, 419 F.3d at 211.        [28]    See supra note 25.     The following Gibson Dunn lawyers assisted in preparing this client update: Matthew K. Kelsey, Samuel A. Newman, Daniel B. Denny and Dylan S. Cassidy. Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following: Matthew K. Kelsey – New York (+1 212-351-2615, mkelsey@gibsondunn.com) Samuel A.  Newman – Los Angeles (+1 213-229-7644, snewman@gibsondunn.com) Daniel B. Denny – Los Angeles (+1 213-229-7646, ddenny@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 31, 2017 |
Webcast: Spinning Out of Control: Potential Pitfalls and Liabilities in Spin-Off Transactions

​Spin-off transactions offer opportunities and advantages under the right circumstances, but also come with the risk of post-transaction litigation. Please join a panel of seasoned Gibson Dunn attorneys for a discussion about the current spin-off landscape and best practices for structuring spin-offs to avoid, if possible, or defend against claims for breach of fiduciary duties, fraudulent transfers, and other potential post-transaction claims. View Slides [PDF] PANELISTS: Stephen I. Glover is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher and Co-Chair of Gibson Dunn’s Mergers and Acquisitions Practice Group. Mr. Glover has an extensive practice representing public and private companies in complex mergers and acquisitions, joint ventures, equity and debt offerings and corporate governance matters. Robert A. Klyman is a partner in the Los Angeles office of Gibson, Dunn & Crutcher and Co-Chair of Gibson Dunn’s Business Restructuring and Reorganization Practice Group. Mr. Klyman represents debtors, acquirers, lenders and boards of directors. His experience includes advising debtors in connection with traditional, prepackaged and “pre-negotiated” bankruptcies; representing lenders and other creditors in complex workouts; counseling strategic and financial players who acquire debt or provide financing as a path to take control of companies in bankruptcy; structuring and implementing numerous asset sales through Section 363 of the Bankruptcy Code; and litigating complex bankruptcy and commercial matters arising in chapter 11 cases, both at trial and on appeal. Kristin A. Linsley is a partner in the San Francisco office of Gibson, Dunn & Crutcher and a member of the Litigation Practice Group. Ms. Linsley focuses on complex business and appellate litigation across a spectrum of subject areas, including international and transnational law, technology and privacy, and complex financial litigation. She has earned a national reputation for achieving favorable results for her clients in high-profile complex matters, and is noted for the strength of her legal analysis and the depth and breadth of her litigation experience. Sabina Jacobs Margot is an associate in the Los Angeles office of Gibson, Dunn & Crutcher. She is a member of the Business Restructuring and Reorganization and Global Finance Practice Groups. Ms. Jacobs Margot practices in all aspects of corporate reorganization and handles a wide range of bankruptcy and restructuring matters, representing debtors, lenders, equity holders, and strategic buyers in chapter 11 cases, sales and acquisitions, bankruptcy litigation, and financing transactions. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.50 credit hours, of which 1.50 credit hours may be applied toward the areas of professional practice requirement.  This course is approved for transitional/non-transitional credit only. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast.  Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com  to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.25 hours. California attorneys may claim “self-study” credit for viewing the archived version of this webcast.  No certificate of attendance is required for California “self-study” credit.

October 27, 2017 |
Second Circuit Tackles Cramdown, Make-Whole Payments, Lien Subordination, and Equitable Mootness in Chapter 11

On October 20, 2017, the Second Circuit issued its opinion in Momentive Performance Materials Inc. v. BOKF, NA v. Wilmington Savings Fund Society, FSB (In re MPM Silicones, LLC), __ F.3d __, 2017 WL 4700314 (2d Cir. Oct. 20, 2017), affirming in part and reversing in part a decision by the District Court for the Southern District of New York.  The District and Bankruptcy Court decisions were previously discussed in our client alerts on May 14, 2015,[1] and November 12, 2014,[2] respectively.  Notably, the Second Circuit ruled that the Bankruptcy Court should have considered whether there was an efficient market before using the “formula approach” to calculate the “cramdown” interest rate that secured lenders should receive in a chapter 11 plan.  This Second Circuit ruling, which is consistent with the approach taken by the Sixth Circuit,  significantly weakens a chapter 11 debtor’s threat of “cramming down” its secured lenders in a plan of reorganization, thereby increasing secured lenders’ leverage in negotiations with distressed borrowers. I.    Background On May 4, 2015, the District Court affirmed an August 26, 2014 ruling by Judge Drain regarding several confirmation issues, including that the debtors had satisfied the cramdown requirements of section 1129(b) of the Bankruptcy Code even though the interest rate on the replacement notes delivered to the senior secured creditors was lower than a market interest rate.  See U.S. Bank Nat’l Ass’n v. Wilmington Savings Fund Society, FSB v. Momentive Performance Materials Inc. (In re MPM Silicones, LLC), 531 B.R. 321 (S.D.N.Y. 2015). The plan provided that the holders of first lien and “1.5” lien notes (the “Senior Lenders”) would receive long-term replacement notes based on a formula interest rate.  2017 WL 4700314, at *2.  Section 1129(b) of the Bankruptcy Code requires that a class of secured creditors that does not accept the plan must receive “deferred cash payments . . . of a value, as of the effective date of the plan, of at least” the allowed secured claim of the creditor.  One of the questions determined by Judge Drain and the District Court was whether the discount rate for determining the present value of the future payments should be a market rate of interest.  In this case, unlike many other chapter 11 cases, there was a readily available market rate because other lenders had offered to provide an exit facility to take out the senior secured notes in cash.  The Senior Lenders argued that the cramdown interest rate for the replacement notes should be equal to the market rate.  Id. at *9. The District Court affirmed Judge Drain’s application of the “formula approach” to calculate the cramdown interest rate, holding that section 1129(b) does not require payment of a market interest rate, and further affirmed the use of the treasury rate rather than the prime rate as the starting point to calculating the interest rate under the “formula approach.”  Both the District Court and Bankruptcy Court decisions noted that there was a minimal risk that the doctrine of equitable mootness would prevent the senior lenders from effectively contesting the decision on appeal.  Id. at *14. In addition to the cramdown interest rate issue, the District Court affirmed the following rulings by Judge Drain: (1) the appropriate construction of a make-whole provision that did not expressly require payment of a premium when the debt was accelerated, and (2) the scope of a contractual subordination provision.  Id. at *3. The Second Circuit affirmed the District Court’s rulings regarding (1) the make-whole provision, and (2) the scope of the contractual subordination provision, but reversed with respect to the method of calculating the interest rate on the senior lenders’ notes.  The court adopted the “two-step” approach to calculating interest rates used by the Sixth Circuit and remanded to the Bankruptcy Court, ruling that, prior to using the “formula rate,” the Bankruptcy Court should have first determined whether an efficient market existed and then applied the market rate, and it should only employ the formula approach if it found that an efficient market did not exist.  2017 WL 4700314, at *10.  Further, in a continuing blow to the doctrine of equitable mootness, the court held that the Senior Lenders’ appeal was not equitably moot, finding that the potential increase in the interest rate on the senior lenders’ new notes would not unravel the plan or threaten the debtors’ emergence from bankruptcy.  Id. II.    Cramdown Interest Rate The Second Circuit held that the use of the formula approach to calculate the cramdown interest rate in chapter 11, without first considering whether an efficient exit lending market existed, violated section 1129(b) of the Bankruptcy Code.  The court stated that the “lower courts erred in categorically dismissing the probative value of market rates of interest” and remanded to allow the Bankruptcy Court to determine whether an efficient market rate exists.  Id.  The court further stated that, if an efficient market rate did exist, the Bankruptcy Court was required to apply that rate.  Id. The decision stated that the lower courts had misinterpreted the Supreme Court’s decision in Till v. SCS Credit Corp, 541 U.S. 465 (2004), which had held that, in a chapter 13 case, the cramdown interest rate should be calculated according to the “formula approach.”  Pursuant to the formula approach, the interest rate is determined by applying an appropriate “risk of nonpayment” premium on a risk-free base rate and does not take into consideration market-based rates, which, among other things, also factor in a profit component.  The Second Circuit’s opinion references a footnote in the Till plurality opinion, which stated that, while the “formula” approach was appropriate in chapter 13 cases, it might not be in chapter 11 cases and, when picking a cramdown interest rate in a chapter 11 case, “it might make sense to ask what rate an efficient market would produce.”  Id. at 476 n.14.  Accordingly, the Second Circuit adopted a “two-step” approach from the Sixth Circuit, pursuant to which “‘the market rate should be applied in Chapter 11 cases where there exists an efficient market.  But where no efficient market exists for a Chapter 11 debtor, then the bankruptcy court should employ the formula endorsed by the Till plurality.'”  In re MPM Silicones, LLC, 2017 WL 4700314, at *9 (quoting In re Am. HomePatient, Inc., 420 F.3d 559, 568 (6th Cir. 2005)). Because the Bankruptcy Court explicitly declined to consider market forces, the Second Circuit remanded to allow the Bankruptcy Court to ascertain whether an efficient market exists pursuant to this two-step approach.  The opinion states that markets for financing are efficient where “they offer a loan with a term, size, and collateral comparable to the forced loan contemplated under the cramdown plan” and that expert testimony from the Senior Lenders in this case, “if credited, would have established a market rate.”  Id. at *9 (citations omitted).  This expert testimony established that the debtors “went out into the market seeking lenders to provide” financing to pay the Senior Lenders, which would have been required if the Senior Lenders accepted the plan, and potential exit lenders quoted the debtors interest rates.  Id.  However, the Second Circuit also acknowledged that both the District Court and Bankruptcy Court “made express their view that the rate produced by that process may not in fact have been produced by an efficient market.”  Id. at n.12.  Further, the Bankruptcy Court opinion demonstrates that Judge Drain believes an efficient market will rarely, if ever, exist under these circumstances.  Judge Drain had also discussed the Sixth Circuit’s two-step approach, stating that “the first step of the two-step approach is almost, if not always a dead end” and the courts that apply the first step spend “considerable time determining that there is no efficient market” prior to moving to the second step and applying either a prime plus approach or a base rate plus approach.  In re MPM Silicones, LLC, 2014 WL 4436335, at *28 (Bankr. S.D.N.Y. Sept. 9, 2014). Accordingly, while the Second Circuit’s opinion appears to at least imply that it believes there is an efficient market in this case, Judge Drain has clearly displayed a skepticism as to whether an efficient exit lending market for a chapter 11 debtor can ever exist, making it difficult to predict how the case will be decided on remand. Additionally, the Senior Lenders had argued at both the Bankruptcy Court and District Court level that, even if the formula approach were applied, the use of the treasury rate (which does not incorporate any default risk) was impermissible as the base rate in the formula approach, and that, instead, the prime rate (which does incorporate default risk) should have been used as base rate in the formula approach.  However, the Senior Lenders did not press this argument before the Second Circuit, and, therefore, the opinion does not address it.  2017 WL 4700314, at *9 n.7.  Consequently, if Judge Drain were to determine on remand there was no efficient market, it appears nothing in the Second Circuit’s opinion prevents him from upholding the “treasury plus” interest rate that he originally calculated. III.    Interpretation of Make-Whole Provision The Senior Lenders also argued that, in accordance with their respective indentures, they were entitled to a make-whole premium because the debtors “repaid” the first lien notes and “1.5 lien” notes prior to the original maturity date pursuant to the plan, albeit with new notes and not in cash.  To justify the make-whole claim, they referred to language in the indentures that provided: in the event of a bankruptcy, then, “the principal of, premium, if any, and interest on all of the notes shall become immediately due and payable.”  Id. at *11.  Judge Drain had overruled their objection, holding that (A) unless the parties have clearly and specifically provided for payment of a make-whole when the debt has been accelerated before the original maturity date of the notes, a make-whole will not be owed because the notes are not being prepaid or redeemed; and (B) the language cited above was not clear and specific enough.  Judge Drain reasoned that in order to be entitled to the make-whole, the relevant language must be “either an explicit recognition that the make-whole would be payable notwithstanding acceleration of the loan or . . . a provision that requires the borrower to pay a make-whole whenever debt is repaid prior to its original maturity.”  2014 WL 4436335, at *15 (Bankr. S.D.N.Y. Sept. 9, 2014).  Judge Drain found the “premium, if any” language to be insufficient to “overcome or satisfy the requirement under New York law that a make-whole be payable specifically notwithstanding acceleration or payment prior to the original maturity date under the terms of the parties’ agreements.”  Id. at 16. The District Court, agreeing with the Bankruptcy Court, held that the Senior Lenders were not entitled to a make-whole premium.  2017 WL 4700314, at *3.  The District Court reasoned that accelerating the balance of a loan forfeits the right to prepayment consideration because there simply is no prepayment—the notes became due as the result of the acceleration.  This is true even if the acceleration results automatically as the result of the bankruptcy filing unless there is a clear and unambiguous clause that calls for payment of the make-whole premium even if the debt is accelerated as a result of such filing.  Here, neither the acceleration clause nor the make-whole provision clearly and unambiguously called for the payment of the make-whole premium upon acceleration of the debt upon a bankruptcy filing, and, therefore, the Senior Lenders were not entitled to the make-whole payment.  531 B.R. 321, 336-37 (S.D.N.Y. 2015). The Second Circuit agreed with the District Court, finding that, because the acceleration of the notes occurred automatically upon the debtors’ bankruptcy filing, the maturity date was automatically moved to the petition date.  2017 WL 4700314, at *11 (citing In re AMR Corp., 730 F.3d 88 (2d Cir. 2013)).  The court stated that, because the make-whole premium was only payable if redemption occurred “at or before maturity,” any payment after the bankruptcy filing was necessarily a post-maturity payment, which did not entitle the Senior Lenders to the make-whole premium.  Id.  The court also rejected the Senior Lenders’ argument that the lower courts had disregarded their contractual right to rescind the automatic acceleration, holding that rescission would be barred by automatic stay.  Id. at *11-12. IV.    Interpretation of Subordination Provision The Second Circuit also decided an appeal by the subordinated noteholders, who argued that the second lien notes did not constitute “Senior Indebtedness” per the defined terms under the debt documents.  Id. at *3.  The District Court had agreed with the Bankruptcy Court that the second lien notes did constitute “Senior Indebtedness” per the defined terms under the debt documents, and, therefore, the fact that the plan did not provide distributions to the holders of the subordinated notes did not violate the absolute priority rule under section 1129(b) of the Bankruptcy Code.  Under the relevant indenture, “Senior Indebtedness” was defined as: all Indebtedness . . . unless the instrument creating or evidencing the same or pursuant to which the same is outstanding expressly provides that such obligations are subordinated in right of payment to any other Indebtedness of the Company[;] . . . provided, however, that Senior Indebtedness shall not include, as applicable: . . . 4) any Indebtedness or obligation of the Company or any Restricted Subsidiary that by its terms is subordinate or junior in any respect to any other Indebtedness or obligation of the Company . . . including any Pari Passu Indebtedness. 531 B.R. 321, 325 (S.D.N.Y. 2015). The subordinated noteholders argued that this definition provided that “Senior Indebtedness” expressly excluded debt that was “subordinated in right of payment” or “subordinate or junior in any respect” to any other debt.  The subordinated noteholders argued that the fact that the second liens were expressly subordinate to the first priority liens meant the second noteholders were subordinate or junior in respect of their liens.  The District Court disagreed and explained that the definition of “Senior Indebtedness” only excluded indebtedness subject to payment subordination, not indebtedness subject to lien subordination, and therefore, the second lien notes, which were lien subordinated only, were not excluded from the definition.  Accordingly, the District Court concluded that the second lien notes unambiguously constituted Senior Indebtedness.  2017 WL 4700314, at *4.  The Second Circuit did not agree with the lower courts that the language in the indenture was unambiguous; nevertheless, the court affirmed the District’s Court’s ruling that the second lien notes constituted Senior Indebtedness based on “the plethora of evidence in the record” that the parties so intended, including that the debtors had repeatedly represented to the SEC and the financial community that the second lien notes were Senior Indebtedness.  Id. V.    Equitable Mootness Finally, the debtors argued that the Senior Lenders’ appeal was equitably moot, asserting that granting the Senior Lenders’ requested relief would alter the terms of the chapter 11 plan which had been subject to “intense-multi-party negotiation,” would throw into doubt the viability of the plan and “cause debilitating financial uncertainty” to the reorganized debtors.  Id. at *13.  The Second Circuit rejected this argument, primarily because the Senior Lenders had sought a stay of the debtors’ plan prior to its implementation and the court did not believe that a potential upward adjustment of the Secured Lenders’ interest rate would unravel the plan or threaten the debtors’ emergence from bankruptcy.  Id. Specifically, the opinion states that when a reorganizational plan has been substantially consummated, it is presumed that an appeal is equitably moot.  The presumption gives way when the following five factors are met: i.      effective relief can be ordered; ii.     relief will not affect the debtor’s re-emergence; iii.    relief will not unravel intricate transactions; iv.    affected third parties are notified and able to participate in the appeal; and v.     the appellant diligently sought a stay of the reorganization plan. Id. (citing Frito-Lay Inc. v. LTV Steel Co.. (Chateaugay II), 10 F.3d 944 (2d Cir. 1993)).  However, the Second Circuit noted that a special emphasis should be placed on the fifth factor stating that, “if a stay was sought, we will provide relief if it is at all feasible, that is unless relief would knock the props out from under the authorization for every transaction that has taken place and create an unmanageable, uncontrollable situation for the Bankruptcy Court.”  Id.  The court then determined that, considering the scale of the debtors’ reorganization and the fact that an interest rate adjustment would require a payment of, at most, $32 million over seven years, the appeal was not equitably moot.  Id. at 13-14. VI.    Conclusion and Practice Pointers By increasing the likelihood that a debtor will be required to pay a market interest rate to cram down a plan on secured lenders, the opinion clearly reduces a debtor’s leverage in negotiations with secured creditors.  However, under the two-step approach adopted by the Second Circuit, bankruptcy judges appear to retain significant discretion to determine that no efficient market exists, after which they are free to apply the “formula approach” described in Till.  Thus, the Second Circuit’s decision may have limited impact if bankruptcy courts do not find that efficient markets exist in the relevant circumstances.  And because the Second Circuit did not specifically address whether a bankruptcy court must apply a “prime plus” or “treasury plus” interest rate under the formula approach, it remains to be seen what how bankruptcy courts in the Second Circuit will calculate cramdown interest rates.  Accordingly, original lenders and debt acquirers should monitor how bankruptcy courts apply the Second Circuit’s decision in cramdown situations to evaluate and price distressed notes. Additionally, as noted previously, the Second Circuit’s decision regarding the make-whole and subordination issues illustrate the importance of precise drafting of debt documents and underscore the notion that careful analysis of the terms and provisions of debt documents is imperative when evaluating the risks in buying paper in the secondary market. Finally, with respect to equitable mootness, the Second Circuit’s decision manifests the growing reluctance to invoke the doctrine of equitable mootness.  It suggests that, even after a plan’s substantial consummation, there is a significant risk that the terms of the plan will be altered so long as the objecting party diligently sought a stay of the chapter 11 plan.  Thus, parties and practitioners should be mindful of this risk unless or until a chapter 11 confirmation order is final and non-appealable.    [1]   Krause, Jeffrey C., Moskowitz, Alan & Rosenthal, Michael A., MPM Silicones, LLC – The Dawn of a New Age for Debtors?, Gibson Dunn Client Alert (May 14, 2015).    [2]   Rosenthal, Michael A. & Weisser, Josh, Silence Is Golden: Second Lien Creditor Rights Post-Momentive, Gibson Dunn Client Alert (Nov. 12, 2014). The following Gibson Dunn lawyers assisted in preparing this client update: Michael A. Rosenthal, Matthew G. Bouslog and Dylan Cassidy. Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Matthew G. Bouslog – Orange County (+1 949-451-4030, mbouslog@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 23, 2017 |
Two Recent Bankruptcy Court Decisions on Third-Party Releases Highlight Divergent Approaches to the “Operative Proceeding” Analysis

I.     Introduction Non-consensual third-party non-debtor releases are often included in chapter 11 plans. While the language and scope of these provisions vary, they all seek to prevent one or more non-debtor parties from pursuing claims against certain other non-debtor parties. Often, these releases are sought by prepetition lenders or equity owners of the debtors as part of a consensual restructuring deal in which the released parties obtain a release in exchange for a financial contribution of value which supports the debtor’s reorganization. Courts are divided on whether granting such releases on a non-consensual basis—i.e., over the objection (or without the affirmative consent) of the parties barred from bringing certain claims against the releasees—is permissible under any circumstances.[1] Before a bankruptcy court can examine the issue of whether this type of release is permissible, however, it must first determine whether it has both statutory subject matter jurisdiction[2] and constitutional authority[3] to enter the proposed confirmation order authorizing such releases. Two recent (and conflicting) opinions[4] suggest that that this determination depends on the bankruptcy court’s view as to what “operative proceeding” governs the matter. Is the “operative proceeding” (i) a core proceeding before the bankruptcy court (e.g., a confirmation hearing in which the debtor seeks entry of a proposed order confirming a plan that includes third-party releases), or (ii) a separate proceeding (whether actual or hypothetical) in which a non-debtor third party has asserted or could assert the claims to be released under the plan? Millennium Lab holds that plan releases are considered in the context of a confirmation hearing, and thus the court has jurisdiction to authorize a claim release, notwithstanding the existence (or potential existence) of a litigation in another forum brought to adjudicate one of the claims subject to release. Midway Gold holds that non-debtor claim releases should be viewed separately from the confirmation hearing, and that a bankruptcy court has no jurisdiction to “adjudicate” (by approving a release of) claims or potential claims between non-debtors that are not related to the bankruptcy case. II.     In re Millennium Lab Holdings II, LLC In Millennium Lab, the debtors sought to confirm a chapter 11 plan containing non-consensual third-party release provisions. These releases would prevent creditors and other releasing parties from asserting claims based on actions or events occurring prior to the plan effective date and relating to the debtors, the pre-petition credit agreement, or the restructuring (among other things)  against certain equity holders of the debtors. At the confirmation hearing, a group of lenders led by Voya (collectively, “Voya”) objected that the third-party releases were inappropriate, arguing (among other things) that the court did not have jurisdiction to grant  them, and, therefore, did not have authority to confirm a plan that included the releases. To crystalize claims against the non-debtor releasees, on the eve of the confirmation hearing Voya filed a complaint asserting RICO and common law fraud claims against those releasees in the United States District Court for the District of Delaware (the “RICO Lawsuit”). On December 11, 2015, the court issued a bench ruling confirming the debtors’ plan of reorganization over Voya’s objection, concluding that the court had jurisdiction to confirm the plan and approve its release provisions.[5] On appeal, the District Court for the District of Delaware agreed with the bankruptcy court’s conclusion that it had subject matter jurisdiction, but reversed and remanded asking the bankruptcy court to consider the separate issue of whether the court “had constitutional adjudicatory authority to approve the nonconsensual release of [Voya’s] direct non-bankruptcy common law fraud and RICO claims against the Non-Debtor Equity Holders.”[6] On remand, the court found that it had both subject matter jurisdiction and constitutional adjudicatory authority to enter the confirmation order.[7] The decisive issue for the court was whether the “operative proceeding” to adjudicate the release of third-party claims was the confirmation hearing or the RICO Lawsuit. Voya argued that the RICO Lawsuit was the “operative proceeding,” urging that because the claims asserted therein were non-bankruptcy claims similar to those at issue in Stern, the bankruptcy court lacked the constitutional authority to enter a final order that would effectively adjudicate the claims by enjoining their future prosecution.[8] The court rejected this argument, holding that “the operative proceeding for purposes of a constitutional analysis is confirmation of a plan.”[9] Because the releases were considered in the context of confirmation of a plan, the court found that it had the jurisdiction and constitutional authority to release those claims. First, the court found that it had statutory jurisdictional authority to enter final judgment confirming the plan because confirmation of a plan is an enumerated core proceeding.[10] The court then concluded that under any of the various interpretations of Stern adopted by courts, it also had constitutional authority to enter the confirmation order.[11] The court found that plan confirmation was a “proceeding at the core of bankruptcy law” and a “quintessential core proceeding,” noting that “in confirming a plan, even one with releases, the judge is applying a federal standard.”[12] In the court’s view, the issue before it was whether the proposed releases are legally permissible under the applicable federal standard—i.e., the plan confirmation standard under section 1129 of the Bankruptcy Code—which does not require the judge to make rulings with respect to the many claims that may be released by virtue of third-party release provisions in a plan.[13] The court rejected Voya’s argument that because it filed the RICO Lawsuit before confirmation, the appropriate Stern analysis in connection with confirmation should focus on that lawsuit rather than on the confirmation proceeding. Noting that Voya could not identify anything in Stern or cases interpreting Stern suggesting that the “action at issue” should be any proceeding other than the “operative proceeding” before the bankruptcy judge, the court distinguished Stern, where the bankruptcy court had entered a summary judgment order rejecting a state law counterclaim on the merits in the context of an adversary proceeding.[14] Citing two recent Third Circuit decisions (among other circuit court decisions), the court further held that a bankruptcy court’s entering an order that may preclude a third-party lawsuit does not violate Stern, because the relief being sought by the debtors in the operative proceeding before the court was “quintessentially federal in nature.”[15] In In re Lazy Days’ RV Center Inc., the Third Circuit upheld the bankruptcy court’s constitutional exercise of jurisdiction to confirm that a landlord could not refuse to honor a purchase option provision in its lease with the reorganized debtors because anti-assignment provisions are unenforceable under section 365(f) of the Bankruptcy Code.[16] In In re Linear Elec. Co., the Third Circuit held that Stern did not bar a bankruptcy judge from entering a final order enforcing the automatic stay and discharging construction liens filed by a non-debtor supplier against real property owned by a non-debtor, finding that the debtor’s claims—asserted through a motion to enforce of the automatic stay—are claims arising under the federal bankruptcy laws and are therefore outside the scope of Stern.[17] In both cases, the Third Circuit focused on the actual “operative proceeding” before the bankruptcy court and relief sought therein under the Bankruptcy Code, rather than on the underlying state law claims or rights asserted by the non-debtor entities. Accordingly, the Millennium Lab court found that “[t]here is no question . . . that, if the proper standard is met, a bankruptcy judge may enter a final order in a core matter that impacts or even precludes a state law action between two non-debtors.”[18] Finally, the court noted that adopting Voya’s interpretation of Stern would dramatically change the division of labor between the bankruptcy and district courts.[19] Specifically, if all final orders affecting asserted or potential state law claims with Stern implications could only be entered by district courts, bankruptcy courts would no longer be able to enter final orders approving section 363 sales that release purchasers from successor liability, substantively consolidating estates, or recharacterizing or subordinating claims, among other matters.[20] Because Justice Roberts stated in Stern that his majority decision did not “change all that much,” the court pointed to the sweeping practical implications of adopting Voya’s readings as support for its finding of constitutional authority.[21] III.     In re Midway Gold US, Inc. In Midway Gold, the United States Trustee objected to plan confirmation based in part on the notion that the bankruptcy court lacked the jurisdiction to rule on issues relating to the plan’s third-party release and exculpation provisions.[22] Though the court’s decision did not reference Stern and never used the words “operative proceeding,” its jurisdictional analysis reflects an approach to the operative proceeding issue that is almost diametrically opposed to that of the Millennium Lab court. The dispute in Midway Gold focused on whether the bankruptcy court had jurisdiction to approve the plan’s third-party non-debtor releases—specifically, to the extent such releases covered claims among non-debtors that had a tenuous connection (if any) to the debtors, the property of the debtors’ estates, or the administration of the debtors’ chapter 11 cases.[23] The releases provided, among other things, that all creditors that accept the plan, are deemed to accept the plan, or reject the plan but fail to affirmatively opt out of plan releases are deemed to have released all claims and causes of action existing as of the plan effective date that are in any way related to the debtors, the chapter 11 cases, or the debtors’ plan.[24] Having concluded that the Tenth Circuit did not categorically bar third-party releases in all cases,[25] the court stated that “[w]hether the Court may consider approval of releases of or injunctions against such claims hinges on whether the Court has jurisdiction over those peripheral claims in the first place.”[26] In his jurisdictional analysis, the court focused on the claims and disputes that could be brought between third-party non-debtors, noting that these claims would neither “arise in” nor “arise under” the Bankruptcy Code. Critically, the court held that the court could not find “arising in” jurisdiction over the proceedings simply because the releases are included within a proposed chapter 11 plan.[27] While recognizing that the court had subject matter jurisdiction over the chapter 11 cases and that confirmations of plans are expressly recognized as core proceedings under the bankruptcy jurisdiction statute, the court held that “[t]here must be some independent statutory basis for the Court to exercise jurisdiction over the third-parties’ disputes before the Court may adjudicate them.”[28] This holding reflects a concern that third-party non-debtors would otherwise be able to “bootstrap” their disputes into a bankruptcy case, and that without a requirement of independent jurisdiction over the disputes, the court could acquire “infinite jurisdiction.”[29] On this basis, the court found that it lacked jurisdiction over the causes of action and claims that would be released, because they included claims that were not “related to” the debtors, the property of the debtors’ estates, or the administration of the chapter 11 cases.[30] The court stated that even if the success of the plan of reorganization depended on non-debtor third-party releases being given in exchange for contributions and settlements entered into by the released parties, this would not provide a sufficient basis for the bankruptcy court to exercise jurisdiction over the claims, because “[o]therwise, ‘a debtor could create subject matter jurisdiction over any non-debtor third-party by structuring a plan in such a way that it depended on third-party contributions.'”[31] Thus, the court held that it would only have jurisdiction to approve releases under which “the disputes subject to releases or injunctions would have an effect, for example through indemnification or some other form of post-confirmation liability, on the debtor’s property or the administration of the estate.”[32] In light of this analysis, the court found that it lacked subject matter jurisdiction to enjoin or release the non-debtor claims covered by the plan provision and denied confirmation of the plan. In short, though discussing statutory jurisdiction rather than Stern issues of constitutional authority, the Midway Gold court adopted an “operative proceeding” analysis with a far narrower view of bankruptcy courts’ authority than that of the Millennium Lab court. Where the Millennium Lab court focused on the nature of the proceeding before it (i.e., a confirmation hearing in which the debtors sought confirmation of a plan that granted third-party non-debtor releases), the Midway Gold court set aside the confirmation context and focused on whether it would independently have jurisdiction over hypothetical, not-yet-asserted claims between non-debtors that would be covered by the plan releases. Put another way, the Millennium Lab court concluded that it was not adjudicating the underlying claims even though the effect of entry of the confirmation order would be to preclude those claims from being asserted or prosecuted. By contrast, the Midway Gold court’s jurisdictional analysis assumed that confirmation of the plan would require him “to enjoin or adjudicate the [claims]”.[33] IV.     Practical Implications The two bankruptcy courts’ approaches reflect countervailing concerns. The Millennium Lab court found no Stern issue with a bankruptcy court issuing a final order on a core issue—namely, confirming a plan—despite that order’s likely preclusive effect on claims similar to the counterclaims in Stern. This conclusion was partly driven by a concern that to hold otherwise would fundamentally change the division of labor between bankruptcy and district courts, as any bankruptcy proceeding impacting third-party rights—for instance, an asset sale under section 363 of the Bankruptcy Code—would need to be finally adjudicated by a district court. Conversely, the Midway Gold court feared that finding jurisdiction over the third-party releases in the plan would sanction “bootstrapping” an infinite jurisdictional scope, such that any proceedings over which a bankruptcy court has no independent jurisdiction could be placed within the court’s jurisdiction by simply including their release in a proposed plan. With its explicit and more comprehensive operative proceeding analysis, the Millennium Lab decision appears to be the better view, although the decision is under appeal. It remains unclear whether the Midway Gold decision will be appealed. [1] Courts in a majority of circuits, including the Second, Third, Fourth, Sixth, Seventh, and Eleventh Circuits, have held that non-consensual third-party releases are permitted under certain limited circumstances, see In re Metromedia Fiber Network, Inc., 416 F.3d 136, 143 (2d Cir. 2005); In re Washington Mut., Inc., 442 B.R. 314, 352 (D. Del. 2011); Nat’l Heritage Found., Inc. v. Highbourne Found., 760 F.3d 344, 351 (4th Cir. 2014); In re Dow Corning Corp., 280 F.3d 648, 657-58 (6th Cir. 2002); In re Airadigm Commc’ns, Inc., 519 F.3d 640, 656 (7th Cir. 2008); In re Seaside Eng’g & Surveying, Inc., 780 F.3d 1070, 1078 (11th Cir. 2015), while courts in the Fifth and Ninth Circuits have adopted a strict prohibition against such releases, see In re Pac. Lumber Co., 584 F.3d 229, 253 (5th Cir. 2009); In re Lowenschuss, 67 F.3d 1394, 1402 (9th Cir. 1995). [2] See 28 U.S.C. §§ 157, 1334. [3] See Stern v. Marshall, 131 S. Ct. 2594 (2011). In Stern, the Supreme Court held that notwithstanding Congress’s statutory grant of subject matter jurisdiction over counterclaims brought by the estate against persons filing claims against the estate, bankruptcy courts lacked the constitutional authority to enter a final order on a state law counterclaim against a creditor unless the claim is necessarily resolved in the process of ruling on the creditor’s proof of claim. Thus, the Supreme Court vacated a grant of summary judgment denying a tortious interference counterclaim filed in an adversary proceeding before the bankruptcy court in which the complaint brought defamation claims against the counterclaimant. [4] In re Millennium Lab Holdings II, LLC, No. 15-12284 (LSS), 2017 WL 4417562 (Bankr. D. Del. Oct. 3, 2017) (“Millennium Lab“); In re Midway Gold US, Inc., No. 15-16835 (MER), 2017 WL 4480818 (Bankr. D. Colo. Oct. 6, 2017) (“Midway Gold“). [5] No. 15-12284 (LSS) (Bankr. D. Del. Dec. 15, 2015) (Dkt. 206). [6] Opt-Out Lenders v. Millennium Lab Holdings II, LLC (In re Millennium Lab Holdings II, LLC), 242 F. Supp. 3d 322, 338, 340 (D. Del. 2017). [7] Millennium Lab at *1-2. [8] Id. at *5 and *23. [9] Id. at *14; see also id. at *6-7. [10] Id.; see 28 U.S.C. § 157(b)(2)(L). [11] Id. at *14-17. [12] Id. at *15. [13] Id. at *16. [14] Id. at *17. [15] Id. at *19-20. [16] 724 F.3d 418, 423-24 (3d Cir. 2013). [17] 852 F.3d 313, 320 (3d Cir. 2017). [18] Millennium Lab at *20. [19] Id. at *25-26. [20] Id. at *25. [21] Id. at *26. [22] 2017 WL 4480818 at *13. [23] Id. at *31 [24] Id. at *10. [25] Notably, the court’s view conflicts with other courts’ views on the matter. These courts have taken the position that the Tenth Circuit does categorically prohibit non-consensual non-debtor releases. Id. at *16 (noting that In re Western Real Estate Fund, Inc., 922 F.2d 592 (10th Cir. 1990), is frequently cited for the proposition that non-debtor releases of any type are prohibited in the Tenth Circuit (citing In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141 (2d Cir. 2005))). [26] 2017 WL 4480818 at *30-31. [27] Id. at *32. [28] Id. [29] Id. at *32 (quoting In re Digital Impact, Inc., 223 B.R. 1, 10 (Bankr. N.D. Okla. 1998)). [30] Id. at *33. [31] Id. (quoting In re Combustion Eng’g, Inc., 391 F.3d 225, 228 (3d Cir. 2004)). [32] Id. at *34. [33] Id. at *34. Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Matthew K. Kelsey – New York (+1 212-351-2615, mkelsey@gibsondunn.com) J. Eric Wise – New York (+1 212-351-2620, ewise@gibsondunn.com) Matthew P. Porcelli – New York (+1 212-351-3803, mporcelli@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 20, 2017 |
New York Bankruptcy Court Decision Illustrates the Risk That Routing Payments Through U.S. Banks Could Bring a Foreign Transaction Within the Reach of U.S. Bankruptcy Litigation

Several courts have held that the doctrine of international comity and the presumption against the extraterritorial application of U.S. law protect foreign transactions from avoidance actions in U.S. bankruptcy proceedings. However, on October 13, 2017, Judge Sean Lane of the United States Bankruptcy Court for the Southern District of New York held that the official committee of unsecured creditors could seek to avoid payments from the debtor, a Bahraini investment bank, to two Bahraini banks because the payments were routed through U.S. bank accounts and it was unclear whether the creditors’ committee could pursue similar claims in a foreign jurisdiction.[1] The decision illustrates the risk that routing a payment through U.S. bank accounts could unwittingly bring a foreign transaction within the reach of U.S. bankruptcy litigation in the event that the transferor subsequently files for bankruptcy, particularly when the transferee directs the payment to its U.S. bank account, and there is no foreign proceeding to which the U.S. court may defer. I.     Background Less than a month before the debtor commenced it chapter 11 case, the debtor and two foreign banks entered into investment agreements whereby the debtor agreed to transfer funds to the banks in connection with commodity transactions, and the banks agreed to repay the debtor on the designated maturity date. The parties negotiated and signed the agreements in Bahrain, which provided that they were governed by the laws of the Kingdom of Bahrain (except to the extent of a conflict with Islamic Shari’ah law, in which case Shari’ah law would prevail). The banks contended that they never maintained offices or conducted business in the U.S., and neither bank filed a proof of claim in the debtor’s bankruptcy case.[2] The banks allegedly directed the debtor to transfer the funds in U.S. dollars to bank accounts in New York maintained by the banks (or one of their affiliates). The debtor transferred the funds to the banks’ New York bank accounts from its own bank in New York. After the debtor made these transfers—but before the time for repayment by the banks—it commenced its chapter 11 case.[3] Thereafter, when the investment agreements matured, the banks refused to repay the debtor and sought to “set off” the amounts that they owed to the debtor against other debts that the debtor owed to the banks. The creditors’ committee appointed in the debtor’s bankruptcy case sued the banks seeking to recover the payments as, among other things, avoidable preferences pursuant to sections 547 and 550 of the Bankruptcy Code, seeking $10 million from one bank and $18.5 million from the other.[4] II.     The District Court Reverses the Bankruptcy Court’s Dismissal for Lack of Personal Jurisdiction Over the Banks The bankruptcy court dismissed the creditors’ committee actions for lack of personal jurisdiction over the banks, holding that their mere receipt of funds through New York bank accounts was insufficient contact with New York to establish personal jurisdiction over them.[5] The bankruptcy court reasoned that “the use of the accounts was not central to the alleged wrong,” which occurred when the banks refused to repay the debtor and asserted their right to a setoff, not the initial transfers to the banks.[6] The bankruptcy court also noted that “the money here passed through these correspondent bank accounts once, but only as part of a transaction that began in Bahrain between Bahraini parties under a Bahraini contract and that ended overseas.”[7] The district court reversed the dismissal, holding that the bankruptcy court had personal jurisdiction over the banks because a preference action focuses on the “transfer” of property by the debtor, and thus “[t]he Banks’ New York contacts−i.e., the receipt of the transferred funds in New York correspondent bank accounts−are at the heart of this cause of action. The receipt of the funds in New York is precisely the conduct targeted by the Committee, and the activity that the cause of action seeks to have voided.”[8] The district court further reasoned that “[t]he Banks selected U.S. dollars as the currency in which to execute the transaction” and “the selection of the New York correspondent bank accounts that received the funds originated with the Banks; they actively directed the funds at issue into those New York accounts.”[9] Thus, they “can hardly claim” that they could not foresee “being haled into court” in New York.[10] The district court acknowledged that, “[h]ad the record demonstrated that Arcapita [the debtor], as opposed to the Banks, selected the U.S. dollar and the New York accounts to effectuate the Placements, the Banks’ contacts with the United States would have been adventitious, and jurisdiction would not have lied.”[11] The district court also noted that it was reasonable for the bankruptcy court to exercise jurisdiction over the banks because there was no ancillary insolvency proceeding (e.g., a parallel insolvency proceeding in Bahrain), and it was unclear whether the creditors’ committee could bring similar claims in a foreign jurisdiction.[12] Thus, a failure to exercise jurisdiction would give the banks “priority over domestic creditors based simply on their foreign status.”[13] III.     On Remand, the Bankruptcy Court Denies the Banks’ Motion to Dismiss Based on the Doctrine of International Comity and the “Presumption Against Extraterritoriality” On remand to the bankruptcy court, the banks again moved to dismiss the creditors’ committee actions based on the doctrine of international comity and the presumption against extraterritorial application of U.S. law. Denying the motions, the bankruptcy court followed the district court’s analysis in holding that dismissal was not warranted because the banks had directed the payments to the U.S. bank accounts and it was unclear whether the creditors’ committee could pursue similar claims in a foreign jurisdiction. A.     The Doctrine of International Comity Under the doctrine of international comity, a court may refuse to exercise jurisdiction over a matter involving the affairs of a foreign nation “when the exercise of such jurisdiction is unreasonable.”[14] The bankruptcy court held that it is reasonable to assert jurisdiction over the banks because, quoting the district court, “the receipt of the transferred funds in New York correspondent bank accounts … are at the heart of this cause of action,” and a defendant “can hardly claim that it could not have foreseen being haled into court in the forum in which the correspondent bank account it had selected is located.”[15] It further reasoned that, while the debtor is a foreign entity, it “avail[ed] itself of U.S. law through its filing for bankruptcy and creating an estate pursuant to the Bankruptcy Code,” and “[t]he potential application of Bahraini law also does not mandate abstention based on comity given that the Court is competent to apply foreign law.”[16] The bankruptcy court distinguished previous authority that had declined to exercise jurisdiction over foreign defendants in avoidance actions, including In re Maxwell Commc’n Corp. plc by Homan, 93 F.3d 1036 (2d Cir. 1996), on the basis that “the Second Circuit’s international comity decisions primarily emphasize the doctrine’s bankruptcy significance in the context of parallel insolvency proceedings.”[17] But in the case at hand, “[g]iven the lack of foreign insolvency proceeding, it is questionable whether the Committee would be able to obtain relief under Bahraini law.”[18] Thus, declining to exercise jurisdiction would enable “foreign creditors to potentially obtain priority over domestic creditors based simply on their foreign status,” and also “allow[] parties to do an end run [of] the Code by simply arrang[ing] to have the transfer made overseas, thereby shielding them from United States law and recovery by creditors.”[19] B.     The “Presumption Against Extraterritoriality” The bankruptcy court explained that “[t]he presumption against extraterritoriality is a longstanding principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.”[20] The bankruptcy court held that it “need not resolve whether the avoidance provisions of the Bankruptcy Code apply extraterritorially” because the banks’ receipt of the funds in New York was the “heart of this cause of action” and thus “the transfers … were domestic rather than foreign.”[21] Recognizing that some cases had reached the opposite result in similar circumstances, the bankruptcy court explained that “the question of extraterritoriality depends very heavily on the specific facts of each case,” and “importantly, some of these cases did not involve instances where, as here, both sides of the challenged transfer used a U.S. bank to complete the transfer.”[22] IV.     Conclusion The Arcapita decision illustrates the risk of unwittingly bringing a foreign transaction within the reach of U.S. bankruptcy litigation by routing payments through U.S. bank accounts, particularly where the transferee (as putative defendant) directed payment to a U.S. bank account, both sides of the transfer are routed through U.S. bank accounts, and there is no foreign proceeding to which a bankruptcy court might defer. When, as in Arcapita, the litigation focuses on avoidance of a transfer by the debtor to a third party, the location of the transfer in the U.S. may be sufficient to overrule the presumption against extraterritorial application of avoidance powers extant in chapter 5 of the Bankruptcy Code.    [1]   The Memorandum of Decision (“Decision“) was filed in two adversary proceedings pending in the chapter 11 case of In re Arcapita Bank B.S.C.(c), Case No. 12-11076 (Bankr. S.D.N.Y.): Official Committee of Unsecured Creditors of Arcapita Bank B.S.C.(c) et al. v. Bahrain Islamic Bank, Case No. 13-01434, Dkt. No. 54; and Official Committee of Unsecured Creditors of Arcapita Bank B.S.C.(c) et al. v. Tadhamon Capital B.S.C., Case No. 13-01435, Dkt. No. 50.    [2]   In re Arcapita Bank B.S.C.(c), 529 B.R. 57, 61 (Bankr. S.D.N.Y. 2015).    [3]   Gibson Dunn represented Arcapita Bank B.S.C.(c) and affiliated debtors in their chapter 11 cases.    [4]   The creditors’ committee obtained standing to bring avoidance claims against the banks pursuant to the debtor’s chapter 11 plan, which the bankruptcy court confirmed in June 2013. In re Arcapita Bank B.S.C.(c), 529 B.R. at 63.    [5]   Id. at 73.    [6]   Id. at 71.    [7]   Id.    [8]   Official Comm. of Unsecured Creditors of Arcapita v. Bahrain Islamic Bank, 549 B.R. 56, 69 (S.D.N.Y. 2016).    [9]   Id. at 68-69 (emphasis in original). [10]   Id. at 68 (“[W]hen a defendant purposely selects and uses a correspondent bank account to effectuate a particular transaction, and a plaintiff later files a lawsuit asserting a cause of action arising out of that transaction, the defendant can hardly claim that it could not have foreseen being haled into court in the forum in which the correspondent bank account it had selected is located.”) (citation omitted). [11]   Id. at 71. [12]   Id. at 72. [13]   Id. [14]   Decision at 8 (“International comity is the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens, or of other persons who are under the protection of its laws. Under international comity, states normally refrain from prescribing laws that govern activities connected with another state when the exercise of such jurisdiction is unreasonable.”) (quotations and citations omitted). [15]   Id. at 12 (quotations and citations omitted); see also id. at 17 (“[T]his case involves parties who structured their deal the way they wanted−using U.S. banks−and are merely being held accountable for the consequences of that structure.”). [16]   Id. at 12. [17]   Id. at 15; see also id. at 15-16 (“Importantly, the Second Circuit in Maxwell II observed that ‘a different result [than dismissal based on comity] might be warranted were there no parallel proceeding in England−and, hence, no alternative mechanism for voiding preferences….’ Maxwell II, 93 F.3d at 1052.”). [18]   Id. at 16. [19]   Id. at 13 (quoting the district court), 16 (citations and quotations omitted). [20]   Id. at 17 (citations and quotations omitted). [21]   Id. at 21, 27 n 12. [22]   Id. at 24.   Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Matthew K. Kelsey – New York (+1 212-351-2615, mkelsey@gibsondunn.com) Samuel A.  Newman – Los Angeles (+1 213-229-7644, snewman@gibsondunn.com) Douglas G Levin – Orange County, CA (+1 949-451-4196, dlevin@gibsondunn.com) Please also feel free to contact the following practice group leaders: Business Restructuring and Reorganization Group: Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com) Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com) Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com) David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 26, 2017 |
Two Recent Cases Provide Additional Guidance on Valid Safeguards against Risk of Borrowers Commencing Bankruptcy

As discussed in our August 8, 2016 client alert,[1] lenders and borrowers continue to experiment with creative structures to prevent a bankruptcy filing. As discussed below, recent decisions clarify previous case law, develop the prevailing rules and highlight outstanding open issues. I.    Case Law Developments In two recent cases, In re Lexington Hospitality Group, LLC[2] and Squire Court Partners LP v. Centerline Credit Enhanced Partners LP (In re Squire Court Partners LP),[3] bankruptcy courts continue to look past parties’ structures and have invalidated restrictions where the intent is to allow a lender to prevent or control its borrower’s ability to seek bankruptcy protection. These decisions, from Kentucky and Arkansas respectively, provide further guidance to lenders seeking to protect against the risks of bankruptcy. A.    In re Lexington Hospitality Group, LLC In Lexington Hospitality, decided September 15, 2017, the court denied a secured lender’s motion to dismiss a borrower’s bankruptcy petition, holding that certain bankruptcy-filing restrictions in the borrower’s operating agreement, which was amended in connection with a loan and subsequent forbearance agreement, were void as contrary to public policy.[4] Under Lexington Hospitality’s original operating agreement, the company manager was authorized to manage the borrower’s business and affairs, with no express provisions authorizing the borrower’s manager to commence a bankruptcy on behalf of the borrower.[5] In connection with an acquisition loan secured by hotel assets, Lexington Hospitality agreed to: (1) amend its operating agreement to require the authorization of an independent manager and a 75% vote of the members before a bankruptcy filing could be authorized by the borrower, (2) grant the secured lender veto power over the borrower’s bankruptcy authorization regardless of obtaining the consent of the independent manager and 75% of the members, and (3) transfer 30% of its membership interests to an entity controlled by the lender.[6] When Lexington Hospitality initially defaulted on the loan and entered into a forbearance agreement with the secured lender, Lexington Hospitality agreed to amended its operating agreement to transfer an additional 20% of its membership interests to entities controlled by the secured lender.[7] Despite these significant limitations on its ability to commence a bankruptcy proceeding, Lexington Hospitality filed for bankruptcy without the secured lender’s consent. On that basis, the secured lender sought to dismiss the bankruptcy case, arguing that Lexington Hospitality did not obtain the appropriate corporate consents. Upon review, the court found that the borrower’s ability to ever file for bankruptcy protection was frustrated by the reduction in the company manager’s membership interests—making it impossible for the members to achieve a 75% majority without the lender’s affirmative vote—and by the lender’s veto power.[8] As a result, the court held that the bankruptcy restrictions benefitting Lexington Hospitality’s secured lender were void as contrary to public policy and denied the secured lender’s motion to dismiss.[9] B.    In re Squire Court Partners LP Earlier this year, in Squire Court, the court affirmed the bankruptcy court’s dismissal of a general partner’s bankruptcy petition, holding that the limited partners were permitted to retain for themselves the decision whether to file a bankruptcy petition, even if that decision required the unanimous consent of all of the partners in the partnership.[10] Here, the Squire Court partnership consisted of two limited partners and one general partner.[11] The amended partnership agreement gave the general partner the exclusive authority to manage and control the partnership, but required unanimous consent of both the general partner and the two limited partners before the partnership could file for bankruptcy protection.[12] The general partner filed a voluntary petition to commence a bankruptcy for the partnership without receiving unanimous consent. The general partner defended the bankruptcy filing, arguing that the provision in the partnership agreement requiring the unanimous consent of the general and limited partners to commence a bankruptcy case was void as contrary to public policy because only a fiduciary may decide whether an entity could receive relief by filing bankruptcy.[13] Upon review, the court found no cases had been presented to indicate that a bona fide equity owner must hold a fiduciary position before it can make a decision on whether to file for bankruptcy. Instead, as the court noted, relevant case law focuses on whether the persons or entities managing a partnership had been delegated the authority to file for bankruptcy by the other partners. Here, the limited partners did not delegate authority to file for bankruptcy to the general partner; rather, the limited partners retained the authority to make the decision for themselves.[14] Accordingly, the court affirmed the bankruptcy court’s dismissal of the general partner’s bankruptcy petition.[15] II.    Clarification Regarding Public Policy Limiting Bankruptcy Restrictions In our previous client alert, we discussed the Delaware bankruptcy court’s holding in In re Intervention Energy Holdings, LLC.[16] In that case, the court held that it is void as against public policy for a creditor to require a borrower to issue a creditor "golden share" and amend its operating agreement to require unanimous consent to file for bankruptcy, with the purpose that the creditor could control—and withhold consent from—potential filings.[17] We observed that, despite the holding in Intervention Energy, it remained uncertain whether a lender’s required consent to file bankruptcy may be valid if the transaction was structured so that a lender was also an equity investor in borrower with "more than immaterial actual equity investment."[18] The outcome in Lexington Hospitality—finding invalid an arrangement where an entity controlled by the creditor was transferred 30%, and then an additional 20% of the borrower’s membership interests—partially addresses this question. In Lexington Hospitality, a party that was a lender at the outset of the relationship, remained a lender for these purposes notwithstanding having been transferred a substantial equity stake in the borrower. It did not appear to matter that the lender had a meaningful actual equity investment, rather than simply one golden share. III.    Further Issues in Structuring Bankruptcy-Remote Entities The ruling in Squire Court adds weight to the line of cases that hold that members or equity holders of a business entity may agree among themselves the appropriate threshold for authorizing a bankruptcy filing. The caveat to this rule, as articulated in Lexington Hospitality and Intervention Energy, is that a lender cannot insert itself into this decision-making process by creating a veto right to authorize a bankruptcy filing, even if the lender holds a meaningful equity stake in the borrower. These rulings are consistent with the ruling by the Tenth Circuit BAP in DB Capital Holdings v. Aspen HH Ventures, LLC (In re DB Capital Holdings, LLC), [19] where the court affirmed the dismissal of a bankruptcy petition filed by the manager of an LLC where the operating agreement indicated the manager did not have authority to file the bankruptcy without consent of both of the members.[20] The logic of the DB Capital opinion appears to have increased its reach in the recent opinions discussed above. IV.    Remaining Open Issues We note several issues have not been resolved that may provide opportunities for lenders seeking to protect against the risks of a borrower bankruptcy. First, while Lexington Hospitality indicates that granting more than an immaterial amount of equity interest to a lender does not in and of itself allow the required-consent right to survive, the lender in that case also had an absolute veto right regardless of member consent. If the lender had a meaningful equity stake that did not result in a veto, the result could be different. Second, the reverse situation—where an equity holder freely entering an agreement not to file bankruptcy subsequently becomes a creditor—has not been addressed specifically in case law. As is often the case, equity holders seek to support a failing company and may become both equity holders and lenders as a situation deteriorates. It is not clear whether such a change in status will invalidate an otherwise valid authority-to-file restriction. Third, and finally, it is unclear under the current line of cases what level of independence an independent manager must have from a secured lender for a court to rule that the independent manager is really an alter ego of the lender and, therefore, requiring the vote of an independent manager to commence a bankruptcy is, in essence, giving the lender a veto right over the filing. Lenders and investors should continue monitoring new cases in this area as they consider how to mitigate risks associated with borrower bankruptcies. [1]    Bouslog, Matthew G., Little, Robert B. & Rosenthal, Michael A., Delaware Court Invalidates Lender’s Attempt to Prevent Bankruptcy Through Issuance of "Golden Share," Gibson Dunn Client Alert (August 8, 2016). [2]    No. 17-51568, 2017 WL 4118117 (Bankr. E.D. Ky. Sept. 15, 2017). [3]    No. 4:16CV00935JLH, 2017 WL 2901334 (E.D. Ark. July 7, 2017). The District Court’s order was appealed to the Eight Circuit Court of Appeals on August 3, 2017, but as of the date of this publication the appellants have filed a notice of settlement which may result in dismissal of the appeal. See docket for Appellate Case 17-2700 (8th Cir.). [4]    In re Lexington Hospitality Group, at *6. [5]    Id. at *2. [6]    Id. at *2-3. [7]    Id. at *4. [8]    Id. at *6-8. [9]    Id. at *8. [10]    In re Squire Court Partners LP, at 4-5. [11]    Id. at *1. [12]    Id.  [13]    Id. at 2. [14]    Id. at *4. [15]    Id. at *5. [16]    553 B.R. 258 (Bankr D. Del. 2016). [17]    Id. at 265-66. [18]    Bouslog, Little & Rosenthal, supra note 1. [19]    463 B.R. 142 (B.A.P. 10th Cir. 2010) (unpublished).  [20]    Id. at 3. Still, it should be noted that because the debtor in DB Capital failed to bring forth any evidence on whether the amendment to the operating agreement was coerced by a creditor, the court was not able to rule on the impact of creditor coercion in such an agreement among the members. Id. The following Gibson Dunn lawyers assisted in preparing this client update: Samuel A. Newman, Matthew K. Kelsey, Daniel B. Denny, and Brittany N. Schmeltz. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Business Restructuring and Reorganization practice group, or the following authors: Samuel A.  Newman – Los Angeles (+1 213-229-7644, snewman@gibsondunn.com)Daniel B. Denny – Los Angeles (+1 213-229-7646, ddenny@gibsondunn.com)Matthew K. Kelsey – New York (+1 212-351-2615, mkelsey@gibsondunn.com) Please also feel free to contact the following practice group leaders:  Business Restructuring and Reorganization Group:Michael A. Rosenthal – New York (+1 212-351-3969, mrosenthal@gibsondunn.com)Jeffrey C. Krause – Los Angeles (+1 213-229-7995, jkrause@gibsondunn.com)Robert A. Klyman – Los Angeles (+1 213-229-7562, rklyman@gibsondunn.com)David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com)   © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.