What is half of nothing? Wrongful trading developments in the ‘Robin Hood’ case

Case law on wrongful trading has developed significantly over the past two years, with the cases of Ralls Builders and Brooks increasing judicial consideration of the conduct of directors in the period preceding an insolvency.

The judgment of the appeal and cross-appeal in Brooks was handed down in late 2016. It provides an essential update on the factors a court must assess in determining the basis on which directors may be compelled to personally contribute to the company for their own wrongful trading actions. It also serves as a warning to liquidators to ensure the basis of the compensation sought is very clearly and correctly prepared.

Read the full client alert.

Amendment of Core Payment Terms Only: Second Circuit Court of Appeals reverses the Marblegate challenge to Section 316(b) of Trust Indenture Act 1939

Restructuring lawyers and distressed companies alike were granted welcome relief by the US Second Circuit Court of Appeals when it overturned the decision of the District Court in the case of Marblegate Asset Management, LLC v Education Management Finance Corp.[1]

In 2014, Education Management Finance Corp. (“EDMC”) sought to restructure its debts outside of a formal bankruptcy process, through creditor consultation and cooperation, reducing the company’s debt burden by approximately $1.1 billion. EDMC put two options to its creditors, settling on the second, as a result of failure to obtain unanimous creditor consent to option one, which would constitute an “Intercompany Sale” of foreclosed assets to a newly incorporated subsidiary of EDMC, releasing EDMC from a guarantee it had provided in favour of the company’s unsecured noteholders. After the Intercompany Sale had taken place, the new EDMC subsidiary would distribute debt and equity only to those consenting creditors. While no term of the noteholders indenture had changed, non-consenting noteholders would not receive anything from the new company.

As a non-consenting noteholder, Marblegate brought proceedings against EDMC to block the Intercompany Sale on the grounds that it violated Section 316(b) of the US Trust Indenture Act 1939 (“TIA”). Marblegate argued that, while the contractual terms of the note had not changed, the foreclosure on substantially all of EDMC’s assets and subsequent sale back to its newly formed subsidiary stripped non-consenting noteholders of their practicable ability to receive payment on the notes.

The core disagreement in the case was whether the phrase “right…to receive payment” forecloses more than formal amendments to payment terms that eliminate the right to sue for payment. Marblegate argued that the right to receive payment is impaired “when the source of assets for that payment is deliberately place beyond the reach of non-consenting noteholders”, an argument the Court of Appeals rejected. After analysis into the legislative text and its history, the Court of Appeals found in favour of EDMC, ruling that the TIA only prohibits amendments to core payment terms without the consent of all noteholders. As the restructure did not formally amend the payment terms of the indenture that governed the notes, no such violation of the TIA had occurred – absent changes to the Indenture’s core payment terms…Marblegate cannot invoke Section 316(b) to retain an “absolute and unconditional” right to payment of its notes.

The 2014 decision of the District Court chilled out-of-court restructurings. However, the Court of Appeals affirmation of the ability of entities to carry out an out-of-court restructuring without unanimous consent of its creditors will allow the market to regain some stability and give distressed companies an alternative option to instigating formal, expensive and time consuming court–ordered bankruptcy proceedings. The decision may still be subject to an appeal.

[1] Marblegate Asset Management, LLC, Marblegate Special Opportunities Master Fund, LP., v. Education Management Finance Corp., Education Management, LLC (Docket No. 15-2124-cv(L), 15.2141-cv(CON))

Watershed Ruling in U.S. Rejects OW Bunker’s Maritime Lien Claims

In a watershed decision concerning the scope of maritime liens under the U.S. Commercial Instruments and Maritime Lien Act (“CIMLA”), the District Court for the Southern District of New York recently held that OW Bunker entities did not have valid maritime liens for the supply of bunkers to vessels. In the first decision by a U.S. court to hold that the OW Bunker entities do not have maritime liens under U.S. law, the Court underscored that maritime liens are an extraordinary remedy for suppliers of necessaries to vessels and cannot be assumed to apply in all circumstances. This ruling, together with previous rulings by other courts holding physical suppliers did not have valid maritime liens, may leave no party with a valid maritime lien arising from the OW Bunker collapse and bankruptcies. Without a maritime lien, suppliers of necessaries to vessels do not have a right to arrest. Read more about the new ruling.

Au revoir bailiff notifications for the assignment of receivables

Starting on October 1st , 2016 the French law on receivable acquisition has changed to become simpler. Before, a formal bailiff’s notification was required in order to render a receivable acquisition enforceable towards the debtor of such receivable.

Now a mere notification will achieve the same result. If no special form is imposed upon such notification, we would nonetheless recommend to use a registered letter in order to obtain a proof of delivery. In addition, any party may make the notification, so an agent under a loan agreement or similar arrangement may provide such assignment notification to the debtor, although we would recommend that parties only rely on the agent to make the notification when the agent has agreed to do so under a contract, so that evidence of the notification can be obtained if so required.

Default interest gets washed out of the waterfall

The degree to which certain elements of a recovery right under a contract, including a debt instrument, are assignable or transferable to a third party has been questionable under English law for some time. “Litigation rights” are one example. Many English legal practitioners regard litigation rights as personal rights, and personal rights are by their nature not capable of assignment or transfer. However, given the economic importance many assignees attach to “litigation rights” as a recovery right, such rights are commonly assigned or transferred to assignees “to the extent that they are capable of being or permitted to be assigned or transferred.” In this manner, the effectiveness of the assignment of any such any right is reserved. In the latest Waterfall IIC litigation, another element of a recovery right, default interest, may now be added to the list of items the ability of which to assign or transfer is questionable under English law.

On 5 October 2016, Mr Justice Hildyard handed down the judgment in the latest Waterfall IIC litigation. This case considered the entitlement of counterparties to default interest, as described in the 1992 and 2002 ISDA Master Agreement (ISDA), in particular covering the interpretation of the phrase ‘cost (without proof or evidence of any actual cost) to the relevant payee (as certified by it) if it were to fund or of funding the relevant amount’.

Of particular note is the ruling on the meaning of ‘relevant payee’. It is a common occurrence, and indeed was for numerous claims against LBIE, that counterparties to an ISDA assign their claims to default interest pursuant to the express right set out in clause 7 of the ISDA to third party purchasers. Thus, it would typically be considered to be the third party purchaser that has the interest in the claim against the defaulting party. However, Mr Justice Hildyard ruled that it was the original contractual counterparty, and not the third party purchaser, that was the ‘relevant payee’ for the purpose of assessing the cost of funding the relevant amount. This restriction on the right of transfer is to protect against unknown credit risks and that purpose is undermined if the ‘relevant payee’ is an unknown assignee of the original counterparty. Further, following the principles set down in Snell’s Equity 33rd ed. at 3-027, ‘an assignee cannot recover more from the debtor than the assignor would have. The purpose of the principle is to prevent the assignment from prejudicing the debtor. This would happen if, for example, he had to pay damages to the assignee that he would not have had to pay to the assignor if the assignment had not taken place’. To rule otherwise would pose a foreseeable risk of the third party assignee claiming a greater amount than the original counterparty would have claimed.

In light of this ruling, consideration must now be given by third party purchasers that have purchased, or had assigned to them, default interest claims pursuant to the rights set out in clause 7 of an ISDA. Further, it is unclear how this ruling will affect equivalent rights of assignment that arise under similar agreements – such application will likely only become clear when new cases are brought before the courts.

While this decision should be borne in mind when counterparties are considering the use of clause 7 of an ISDA, it is subject to appeal which may reinforce or overrule the application of all or some of Mr Justice Hildyard’s decision.

Reed Smith Prepares Enforceability Opinion for IECA New Master Netting Agreement

On October 7, 2016, Reed Smith assisted the International Energy Credit Association (“IECA”)  in preparing an enforceability opinion for the release its Master Netting Agreement (the “MNA”) under both English and U.S. law.1 The MNA is billed as a state-of-the-art solution designed to manage the termination, close-out, and netting of both physical and financial transactions, including in the bankruptcy context. These legal opinions allow parties to the IECA MNA to be confident that their exposure on covered transactions can be viewed on a net, rather than a gross, basis, thereby reducing credit risk and potentially conserving working capital.

Benefits to users of the new MNA include its ease of use, support by legal enforceability opinions under both English and U.S. law, flexibility of use under bespoke and traditional master trading agreements, and its intended use with a variety of energy-related commodities, metals, freight, and emissions and other environmental products.

Market participants that are party to multiple trading agreements with a single counterparty should review the MNA and consider its applicability where the importance of netting exposures is a priority under covered transactions.

  1. The Master Netting Agreement is available for download from the IECA’s website.

Court of Appeal considers the treatment of contingent assets in balance sheet test

Evans v Jones [2016] EWCA Civ 660

Executive Summary

The Court of Appeal recently considered an appeal from the liquidators of a property development company which went into creditors’ voluntary liquidation. The company had made an unlawful dividend to its shareholders and the Court of Appeal considered whether the unlawful dividend should be treated as an asset of the company (being “something other than a dividend”) for the purposes of considering whether the company was insolvent at the “relevant time” subsequent preferences were given. Continue Reading

UAE Bankruptcy law

Currently in the UAE, laws related to insolvency are unclear. Companies face harsh penalties in a bankruptcy scenario, and individuals can face criminal sanctions and penal sentences. However, a new bankruptcy law drawing from international best practice is expected to come into force in early 2017, in the wake of low oil prices since 2015. With the implementation of the new law, the UAE government seeks to create a robust legal insolvency framework, within which all businesses can operate and parties can be sufficiently protected.

Under the proposed new law, a number of options (including financial restructuring) will be available to insolvent companies with the aim of identifying ways to prevent bankruptcy. According to local news reporting, the law will apply to companies established under the commercial companies law, companies that are partly or fully owned by the federal or the local government, and also companies and institutions established in free zones that are not governed by existing bankruptcy laws. The proposed new law will not apply to companies in the UAE already governed by bankruptcy provisions, which include, for example, companies in the Dubai International Finance Centre (DIFC) and the Abu Dhabi Global Market (ADGM). These are two free zones which have their own insolvency regime.

It is believed that the law will particularly assist owners of small and medium sized companies in the UAE, who have recently faced challenging economic conditions. More generally, it should also provide comfort to those doing business in the UAE, as well as prospective investors. The law is expected to be published in the official gazette in the coming weeks.

A lifeboat with conditions: new guidance from the PPF

The Pension Protection Fund (“PPF”) has updated its approach to employer restructuring guidance and its general guidance for restructuring and insolvency professionals. These documents set out certain criteria that should be met when making proposals to the PPF in respect of a sponsoring employer suffering an insolvency event.

1. The PPF Approach to Employer Restructuring:

The PPF states that it will only take part in a restructuring if the below principles are met. Such principles are designed to ensure the pension scheme is in a significantly better position than it would be in through a normal insolvency process. There are seven principles that are applied when considering any entity, irrespective of the type of restructure or rescue. In summary, these are:

1) Insolvency must be inevitable;
2) The pension scheme will receive money or assets which are significantly greater than it would otherwise receive through normal insolvency;
3) What is offered to the pension scheme is fair in comparison to what other creditors and shareholders would receive;
4) The PPF will receive at least 10 per cent equity in the restructured company for the scheme if future shareholders are not currently involved or 33 per cent if the future shareholders are involved;
5) The pension scheme would not be better off it the Pensions Regulator issued a contribution notice of financial support direction;
6) Where there is a refinancing, bank fees are reasonable;
7) The party seeking to restructure pays the costs incurred by the PPF and the trustees.

2. General Guidance for Restructuring and Insolvency Professionals:

The overriding objective in dealing with pension scheme members, transferred into the PPF, is to ensure that the right amount is paid to the right person at the right time.
This general guidance sets out the criteria restructuring practitioners should incorporate in any proposals made to the PPF in respect of an insolvent pension scheme employer. The guidance further works to provide information on how IPs should interact with the PPF during the assessment process. During this assessment period, the role of creditor of the employer (on behalf of the pension scheme trustees) passes to the PPF in relation to the money due to the pension scheme; the rights and powers of the trustees to represent the pension scheme as a creditor generally cease during this period. In practice, the assessment period will typically last between a year and two years, although this will vary depending on the complexity off the financial situation being reviewed.

The PPF will only assume responsibility for a pension scheme where:
1) A qualifying insolvency event has occurred in relation to an eligible pension scheme;
2) A pension scheme has not been rescued;
3) There has not been a withdrawal event; and
4) The valuation of the pension scheme shows that the assets of the pension scheme are below the amount required to fund the PPF level of protected liabilities.

Where these conditions are not met, the PPF will cease to be involved with the pension scheme and the creditor rights will pass back to the trustees.
For further information, please consult the detailed guidance, accessible here.

Troubled Waters: The Raging Storm over Safe Harbors

A pair of recent decisions adds more fuel to the debate over forum shopping by debtors.  This time the issue involves application of the Bankruptcy Code’s safe-harbor provision in section 546(e).  Conflicting interpretations by the courts in several circuits are undermining the certainty that was intended to protect financial markets and creating jurisprudence that varies with geography.     Read the full Client Alert.

 

LexBlog