A Contradiction over Jurisdiction? English Contract Law v Foreign Insolvency Law

money boatDuring contract negotiations parties usually agree what law and which courts will determine any disputes arising from that contract.  This brings certainty for the parties.  However that certainty can vanish if one party is a foreign registered company and becomes insolvent – the other party may suddenly become exposed to unexpected foreign insolvency law.  At this point, the drafting of a jurisdiction clause can be worth millions.

This is the situation in the recent case of Global Maritime Investments Cyprus Limited v O.W. Supply & Trading A/S  [2015] EWHC 2690 (Comm).


A Cypriote company, Global Maritime Investments Cyprus Limited (“GMI”), entered into derivative contracts with a Danish company, O.W. Supply & Trading A/S (“OW”).  The contracts stated:

“with respect to any suit, action or proceedings relating to these general terms and conditions each party irrevocably submits to the jurisdiction of the English courts.”

In November 2014 OW filed for bankruptcy in Denmark.  This was an Event of Default in the contracts and allowed GMI to either terminate the contracts or affirm the contracts but stop payments under them.  To avoid exposing itself to substantial “close-out” payments under a termination of the contracts, GMI chose to affirm the contracts, but stop payments.

However, the trustee in bankruptcy of OW applied to the Danish courts to have the contracts closed out under Danish insolvency law, potentially making GMI liable to pay approximately US$1.6 million to OW.

GMI subsequently brought an application in the English High Court which sought among other things a declaration prohibiting OW from starting any proceedings in relation to the contracts against GMI in any jurisdiction except England.

The case pitched English contract law directly against Danish insolvency law.

The Exclusive Decision

GMI argued that the jurisdiction clause was exclusive despite not containing the word ‘exclusive’.  The court found in GMI’s favour. The court’s rationale was that the “reasonable commercial man” would understand that the clause was to stop any proceedings being issued in any jurisdiction other than England.  Factors which the court took into account were:

  • the clause immediately preceding it stated that the general terms were to be governed by English law;
  • the clause applied to all proceedings relating to the general terms of the contracts;
  • the clause applied mutually to both parties; and
  • the submission to the English courts was “irrevocable”.

The result was that any determination with regard to the general terms would be heard in the English courts under English law. Therefore OW’s trustee in bankruptcy would be unable to close out the contracts and make GMI liable for US$1.6 million.

A “real and present dispute”

GMI also sought a more general declaration that no rule of Danish insolvency law would have any effect, as a matter of English law, to alter or disapply any provision of the general terms.

The court first considered whether there was a “real and present dispute” between the parties in order to make the declaration.  The court decided that a real and present dispute would only arise if OW obtained a judgment from the Danish courts on the interpretation of the general terms.  As OW had not obtained this judgment, there was not yet a “real and present dispute”.


While there are some questions left unanswered by this case it does raise a number of important implications:

  • Context is key If parties dispute jurisdiction over an ambiguous clause they must consider the context, not just the words.
  • Courts follow European regulations   While the High Court did not explicitly refer to the EU regulations on jurisdiction, the effect was to follow Article 25 of the EU Brussels Regulation (Recast) which gives primacy to what the parties agree (although this does not yet cover Denmark).   Parties should use principles of the current legislation as a starting point when assessing jurisdiction disputes.
  • Declarations will only be made in real disputes – Declarations can be attractive as a way for parties to clarify an issue at an early stage. However, this case is clear that the court will only take steps to clarify a legal position where there is a genuine dispute between the parties.

This case raises some questions and provides few concrete answers.  However it is clear that parties will continue to dispute jurisdiction, particularly in an ever more globalised world.  In cross border insolvency, this is at least one certainty.

Tread CAREfully, mind the funding gap…….

mind the gapThe health and social care sector is currently facing its most significant challenge since the Southern Cross care-homes collapse in 2011. A financial crisis is on the horizon, resulting from the unwelcome trifecta of rising staff costs, significant funding cuts and a steadily increasing regulatory burden.

In the five years since the Southern Cross collapse the sector has remained fragile, with insolvencies increasing by 722% from just 9 in 2011 to 74 in 2015. This trend shows no signs of slowing and today’s market conditions make it impossible to rule out the failure of another big provider or perhaps more worryingly, widespread distress across the industry.  

The announcement of the sale of Bupa Home Healthcare to Celesio at the start of the year and concerns about the future of two of the UK’s largest providers, Four Seasons and Care UK have done little to restore confidence in the sector. In the last month Four Seasons announced an eye watering annual loss of £264 million for 2015 and Care UK saw its debt downgraded by ratings agency Moodys and with over 500 homes and 25,000 beds between them, any threat to them is a threat to the sector as a whole. 

So where did it all go wrong? The care home industry is necessarily, and rightly, one of the most regulated industries given the vulnerable people it deals with and the myriad of health and safety issues arising from the day to day running of the business. But regulation, and ultimately compliance, come at a financial cost. Compliance monitoring, upgrading of facilities, dealing with inspections and payment of CQC fees all eat into profitability.

This coupled with significant staffing costs stemming from endemic use of agency staff in the absence of skilled workers means overheads are significant. But there may yet be worse to come as those providers who have thus far been able to attract permanent employees and avoid the high agency costs have had to contend with the cost of pension auto enrolment and, as of last month, the introduction of the National Living Wage.

The true impact of the National Living Wage remains to be seen but it is estimated that the increase to £7.20 per hour for adults over the age of 25 could cost the social care industry £1 billion by 2020 which does not even take into account projections that the National Living Wage itself will increase to £9.00 per hour in that period. It is likely that there will be an immediate, significant and adverse impact on the sector as existing staffing costs will rise sharply and businesses that are already strained may collapse under the additional financial burden further destabilising the sector. For a wider discussion on the impact of the National Living Wage please see our previous blog on the topic.

The issue of the rising cost of social care has been further compounded by the fact that the traditional funding model for care homes is heavily dependent on local authority funding with privately funded residents in the minority. In the same period that insolvencies in the health and social care sector rocketed, local authorities have faced government cuts amounting to a loss of over £4 billion in their funding which has left cash-strapped local councils unable, and some would argue unwilling, to plug the gap caused by escalating costs.

George Osbourne’s “Devolution Revolution” of local authority funding includes various measures such as 100% retention of business rates up to £26 billion and a 2% levy on council tax which are designed to address the impact of the local authority spending cuts on social care. Whilst this is a step in the right direction, in most areas, it will still fall well short of generating the estimated 5% increase in funding needed to cover the costs of rising social care and runs the risk of creating vast inequalities in funding across geographic areas as local authorities ability to capitalise on these new measures will vary dramatically from region to region. Any benefit in real terms from these measures is yet to be felt by the sector and it is clear to see that against a background of an ageing population, where rising demand will only stretch available funding further, Mr Osbourne’s measures simply don’t go far enough.

The current situation is clearly untenable and there is unavoidable pressure on all stakeholders across the financial and political landscape to take action to avoid the catastrophic projections of a funding shortfall of up to £6 billion by 2020 becoming a very unwelcome, and insurmountable, reality. The industry is beleaguered but not yet beaten however, without significant legislative intervention, it is difficult to see an end to the mounting crisis and we can expect to see a year on year increase in the number of care homes buckling under the financial strain with almost 20 care homes, including the Elder Homes Group, becoming casualties since the start of the year.

Supreme Court Deals a Blow to Debtors by Adopting an Expansive View of “Actual Fraud”

fraudLast week, the U.S. Supreme Court in Husky International Electronics, Inc. v. Ritz held a chapter 7 debtor accountable for “actual fraud” despite the absence of a specific fraudulent misrepresentation.  The Court’s expansive reading of section 523(a)(2)(A) of the Bankruptcy Code gives creditors a new weapon in their fight to attack the discharge of their debts.

Husky is a supplier of components used in electronic devices.  Between 2003 and 2007, Husky supplied Chrysalis Manufacturing Corp. with product and during that period, Chrysalis incurred a six-figure debt to Husky.  Daniel Ritz served as a director of Chrysalis and owned at least 30 percent of the common stock.  During this four year time period, Ritz initiated several large cash transfers from Chrysalis to other entities that Ritz controlled—funds that could have been used to pay Chrysalis’s creditors, including Husky, which was owed approximately $164,000.  Husky subsequently sued Ritz under a provision of Texas law that holds a corporate shareholder liable for the corporation’s fraudulent transfers.  Ritz then filed for protection under chapter 7 of the Bankruptcy Code.

Husky initiated an adversary proceeding in Ritz’s bankruptcy case to hold Ritz personally responsible for the debt and to object to the discharge of its debt under section 523(a)(2)(A) of the Bankruptcy Code.  Under the Bankruptcy Code, a debtor’s assets are distributed to creditors and then the creditors’ debts are discharged—permitting a debtor a fresh start.  However, the Bankruptcy Code does not permit a discharge and fresh start if there is evidence of misconduct by the debtor.  In particular, section 523(a)(2)(A) provides that an individual debtor may not receive a bankruptcy discharge for debts for money or credit obtained by “false pretenses, a false representation, or actual fraud….”

The district court held that Ritz was personally liable for Chrysalis’s debts to Husky under Texas law but that the credit was not obtained by “actual fraud” as that term is used section 523(a)(2)(A).  The Fifth Circuit Court of Appeals affirmed, holding that a necessary element of “actual fraud” is a misrepresentation from the debtor to the creditor.  Last week, however, the Supreme Court reversed the Fifth Circuit, holding that “[t]he term ‘actual fraud’ in § 523(a)(2)(A) encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without false representation.”

The Court’s analysis begins with a short statutory interpretation that plainly points out that Congress would not have included “false representation” in the same sentence as “actual fraud” if it intended them to mean the same thing or for one to be an element of the other.  The Court was also influenced by the historical meaning of “actual fraud”, noting that at common law, courts did not require the presence of an inducement or false misrepresentation to give rise to “actual fraud.”  The Court chose to follow this precedent.

Interestingly, the Court addressed but did not rule on the question of whether Ritz actually “obtained” debt through the fraudulent conveyances as typically, a transferor does not obtain debt in a fraudulent conveyance.  However, Ritz undeniably had an interest in the entities to which he transferred the Chrysalis assets and the Court left it to the lower court to determine whether the debt to Husky was “obtained” through Ritz’s actually fraudulent asset transfer conspiracy.

Husky resolves a circuit split—solidifying an expansive interpretation of section 523(a)(2)(A).  The Court’s expansive interpretation of section 523(a)(2)(A) unequivocally puts another arrow in the creditor’s quiver—allowing creditors to avoid the discharge of their debts when it is clear that the debtor has actively moved assets prepetition to avoid payment.  This decision should also further serve to deter debtors and their principals from transferring assets to other related entities to avoid payments to creditors.  The Supreme Court’s decision not only appears correct from a statutory construction and historical perspective, but it is also consistent with the notion that the equities in the bankruptcy court will favor the honest but unfortunate debtor, which is consistent with what practitioners have come to expect from the bankruptcy process.

The End of the Insolvency Shield for Insurers?

Consultant presenting insurance concept and risk managementThe Third Parties (Rights Against Insurers) Act 2010 (“TPR”) will finally come into force on 1 August 2016, making it easier for third parties to bring claims against insurers of insolvent companies.  It has taken more than six years, spread over three separate governments and was amended even before it came into force, but TPR will finally replace the Third Parties (Rights Against Insurers) Act 1930 (the “1930 Act”).

The Background

There is a gap in common law where a company is insured but insolvent.  The principle of privity of contract means that only the parties to the insurance contract can enforce its rights.  Therefore, under common law, only the liquidators or the insolvent company could bring a claim under an insurance policy and the proceeds would then be absorbed into the assets of the company and distributed to its creditors.  This means that a third party, who the policy may have been specifically intended to protect, is left to claim alongside all other unsecured creditors rather than being compensated directly.  For example, if a property developer takes out insurance to cover post-completion defects and then goes into liquidation, the new owner of the property could no longer benefit from the policy as the policyholder is insolvent.

This unfairness was rectified by the 1930 Act which allowed a third party to recover from a company’s liability insurer if the company became insolvent.  However the 1930 Act only went so far and neglected to deal with a number of unsatisfactory situations.  TPR aims to deal with these shortcomings.


TPR introduces a number of key changes:

  • Establishing liability of the insolvent company- A key tenet of the 1930 Act was that the third party had to first establish the liability of the insolvent insured company and if dissolved after liquidation, restore the company to the Companies’ Register. Not only was this time consuming, but the third party would often have to bring a claim without knowing the details and, crucially any limitations, of the insurance policy.  TPR allows third parties to bring claims directly against the insurer and can join the insolvent company as a party if they wish to.  Third parties will also no longer be required to reinstate a dissolved company before liability can be established.
  • Provision of information- Third parties now have the right to request information regarding the policy from the insured, the broker and/or any other relevant party. This information may include the terms of the policy, whether the insurer has disputed liability, any proceedings between the insured and insurer relating to the supposed liability and whether there is any limit on funds available.
  • Enhanced third party contractual rights- TPR largely echoes the 1930 Act in transferring the contractual rights of an insured insolvent company to a third party.  However TPR removes some of the defences which insurers have used to prevent paying out on the policy.  For example, where a policy requires that the policyholder perform an obligation and that action is taken by the third party, it will be now be treated as satisfied.


TPR is a very practical piece of legislation and therefore there are number of practical implications we may expect to see:

  • Fewer speculative claims-  The increased information sharing means that third parties will have a far clearer picture of the merits of a claim before bringing one as they will be able to analyse the exact wording of the policy and background to the relationship between the insurer and insured in advance.  This should result in fewer speculative claims being issued and disputes being settled earlier.
  • Increased administrative burdens for insurers-  The other side of the coin is that insurers will have to be more cooperative in providing information.  While this may increase the administrative burdens for insurers, increasing the information available at an early stage can only help to resolve disputes more quickly.
  • Reduction in legal costs- Unnecessary costs can increase rapidly as third parties first establish the liability of the insured and then reinstate the insolvent company if it has been dissolved, just to bring a claim against the insurer.  The greatest benefit of the new Act is the reduction in legal cost for third parties as these steps may no longer be necessary.

The grander hope is that third parties can contract with companies with greater confidence knowing that it is now easier to access the company’s insurance policy should the company become insolvent.  Let’s hope it was worth the wait.

Make Me a Tender Offer! EFH Settlement Gets Third Circuit Approval

Thinking young woman with yes or no choice looking up on grey wall background

On May 4, 2016, the Court of Appeals for the Third Circuit held that a bankruptcy settlement in the form of a tender offer did not violate the principles of the bankruptcy process. See opinion here.

In April 2014, Energy Future Holdings Corp. (“EFH”), a major Dallas-based power generator and distributor, filed for bankruptcy under Chapter 11 in the United States Bankruptcy Court for the District of Delaware. Upon filing its bankruptcy petition, EFH initiated a tender offer directed at its secured creditors, in an effort to settle its disputes with the creditors.  The proposal offered, subject to bankruptcy court approval, each secured creditor 105% of their notes’ aggregate principal amount and 101% of the accrued interest, in exchange for the release of any potential claim to the make-whole premium (which compensated noteholders for the loss of future interest resulting from an early refinancing).  Creditors who declined the offer retained their full claim and the right to litigate seeking to obtain full value for their make-whole premium.

When EFH sought approval of the settlement from the bankruptcy court, Delaware Trust Company, as indenture trustee (the “Trustee”), objected, alleging that settlement in the form of a tender offer constituted a violation of bankruptcy principles, in that it was not “fair and equitable.” The bankruptcy court approved the settlement, noting that the offer would save EFH’s estate over ten million dollars each month in interest payments.  The bankruptcy court also found that the settlement was a proper use of estate assets and included no “incidents of discriminatory treatment.”  The District Court for the District of Delaware affirmed the bankruptcy court’s decision, and the Trustee appealed to the Court of Appeals for the Third Circuit.

On appeal, the Trustee first alleged that the use of tender offers as a means to settle claims is impermissible under Chapter 11. The Court held that the tender offer “clearly did not violate the Bankruptcy Code” and was equivalent to “a detailed settlement memorandum.” The Court also noted that the Trustee had failed to identify any section of the Bankruptcy Code that forbids settlements through tender offers.  Just like the Bankruptcy Court, the appeals court found that the settlement would benefit the estate, as it “immediately saved the estate millions of dollars each month and thus provided more assets to satisfy all creditors.”  This view that an outcome can be equitably permitted unless specifically forbidden by the Bankruptcy Code seems to take a broader view of the equitable powers of the bankruptcy court that some other recent decisions. But there is no question that the immediate and substantial benefit to the estate had a material impact on the analysis of each court that considered the issue.

The Court of Appeals also dismissed the Trustee’s argument that the settlement violated the “equal treatment” rule, which requires that all similarly situated creditors in bankruptcy are entitled to equal treatment. The Court first found that the rule applies by its terms only to reorganization plans, and not to settlements.  Nevertheless, the Court stated that there was in fact equal treatment because each creditor “was offered the same percentage of both principal and accrued interest,” each was offered the opportunity to retain its rights to seek a ‘make whole remedy,’ and “no group of eligible creditors was deprived of the opportunity to participate.”  The proposal in this instance was not materially different from a plan of reorganization where creditors are given the ability to opt-in to cash treatment of their claims at a reduced basis. Such plans have been regularly upheld and are not commonly viewed as involving discriminatory treatment. The existence of an individual choice regarding treatment is the critical element, just as it was here.

While the immediate implications of this decision are unclear, it certainly demonstrates the Court’s flexibility and willingness to approve settlement offers. In affirming the bankruptcy court’s decision to approve the settlement, the Court of Appeals noted that it should adopt a “flexible approach” and “read the Code’s requirements together with the recognition of the importance of compromise in bankruptcy.”  The Court’s willingness to approve the settlement in the form of a tender offer was largely due to the financial benefit it would provide to the estate, and thus, the creditors.  Therefore, if you are representing a creditor in bankruptcy, you may now encounter more debtors who want to make you a (tender) offer.

Information and consultation in insolvencies – who wins, really?

steelThe Employment Tribunal ruled last month that ex-employees of Sahaviriya Steel Industries UK Limited (in liquidation) (“SSI”) are entitled to the maximum protective award for a complete failure by SSI to inform and consult with them about their redundancies (90 days’ pay for each of the 1100 employees affected).

Because of the insolvency of SSI (see our blog here on the difficulties facing the steel industry), the employees will need to look to the Secretary of State’s National Insurance Fund for payment of the award. However due to the cap on payments out of the Fund (being a maximum of just £479 per week for 8 weeks) they will not recover anything like the full amount from it. The balance of their claims will be unsecured against SSI but given the levels of debt compared to the value of the assets in that business, they should sadly not expect to recover much – if any – of the extra.

Consultation and insolvency

The SSI case is another example of the stark reality that distressed businesses face when contemplating collective (20+) redundancies.

In many cases, there will simply be insufficient time or resource to comply with these obligations before making redundancies – doing so may put the business in an even more precarious position that could ultimately result in more people losing their jobs or in its going under altogether. Against that, however, a failure to inform and consult where required to do so will expose the business to potentially significant financial penalties. Of even more concern to directors will be the possibility of criminal charges brought by the Insolvency Service (see our blog here about the City Link redundancies last year). The case law makes it clear that the “special circumstances” defence is not available merely because the employer is on the brink of insolvency or has already entered formal insolvency proceedings.

There are similar provisions for informing and consulting under TUPE, with similar sanctions for getting it wrong. Often the same (or more) urgency applies where a deal is being sought which seeks to preserve the value of the insolvent business and the jobs of the workforce. Any delay whilst carrying out an information and consultation process might jeopardise the value of the business or even risk the sale completely, leaving employees without the prospect of any job at all. On the other hand if no proper information and consultation process is carried out, the resultant liabilities could transfer to the purchaser under TUPE. That could also jeopardise the sale (affecting employees) or have a significant impact on the purchase price (affecting creditors).  We must remember in all of this that the fact or size of any protective award made will not usually be affected by whether the employees suffer any loss or whether that process would have made any difference to the end result.  At that level, the information and consultation rules could be said to be a triumph of form over substance.

Much will depend upon the particular circumstances but certainly anything the distressed business or insolvency practitioner can do to mitigate the risk of protective award claims should be carefully considered. To the extent that some form of information and consultation can be carried out – even if this clearly falls short of the strict statutory obligations – then this should be done so.  At least it may give the business a little moral high-ground, some notion of a defence and/or a reduction in the size of any potential awards. That may involve just a few days’ information and consultation or at least some written communications to the workforce.  These would set out so far as possible the information which a full process would require to be given to the employee representatives (or to the affected staff direct if there is no time to elect them) and invite comments or queries by return.  Such an attempt to do the right thing in difficult circumstances may help mitigate the risk of criminal charges against directors.

Ultimately, the SSI decision is a victory for employees as it reinforces the message that insolvency or difficult trading circumstances will not absolve employers of their statutory obligations. The SSI staff will receive a small proportion of their claims as a result. The decision is unlikely to make businesses or insolvency practitioners change materially how they deal with insolvency situations but probably will simply make it more difficult to promote a rescue culture.  That may mean that other businesses which (unlike SSI) could have been saved will not be, with hundreds or thousands of jobs lost as a result.  No real winners there.

In March 2015, the Government launched a Call for Evidence on collective consultation for employers facing insolvency. The Call closed in June 2015 and the Government issued its response in November 2015. It confirmed that it would be “analysing the feedback received” and considering the best way to clarify the requirements on employers in such circumstances. The fact we have not yet received anything perhaps reflects the challenges that the tensions between employment and insolvency law create. Interestingly, in its response the Government suggested it did not feel there was any such conflict whilst at the same time acknowledging that the majority of respondents thought otherwise!

Now You See It, Now You Don’t – The Search for “Unreasonably Small Capital”

businessman puts a coin in the stack

In a decision last month in Whyte v. SemGroup Litig. Trust (In re Semcrude L.P.), No. 14-4356, 2016 U.S. App. LEXIS 7690 (3d Cir. Apr. 28, 2016), the United States Court of Appeals for the Third Circuit held that proving that a debtor was left with unreasonably small capital will not turn on either hindsight or a “speculative exercise” based on what might have happened if certain things were known at the time.  Even though the decision was “not-precedential” since it was not issued by the full court, because it affirmed decisions of the bankruptcy and district courts, it is likely to have far-reaching significance in fraudulent conveyance litigation.

Under Section 548(a)(1)(B) of the Bankruptcy Code (and similar state-law fraudulent conveyance statutes), a transaction by a debtor may be set aside as constructively fraudulent if it can be proven that the debtor (i) received less than reasonably equivalent value in exchange, and (ii) was left with “unreasonably small capital” following, or according to some courts, as a result of the transfer.  But what does “unreasonably small capital” actually mean?  After all, the term is “is fuzzy, and in danger of being interpreted under the influence of hindsight bias.”  Boyer v. Crown Stock Distrib., Inc., 587 F.3d 787, 794 (7th Cir. 2009).

In SemGroup, the litigation trustee (the “Trustee”) for the estate of SemGroup L. P. (“SemGroup”) sought to claw-back as fraudulent conveyances more than $55 million in distributions made to certain of SemGroup’s equity holders.  SemGroup, then a very large “midstream” energy company, was party to a Credit Agreement with a syndicate of lenders (the “Bank Group”) under which it was prohibited from engaging in certain trading activity and insiders transactions.  SemGroup nevertheless engaged in the prohibited actions, and between July 2007 and February 2008, a period during which oil prices were erratic and the company incurred significant losses, SemGroup increased its borrowings under its credit line from $800 million to more than $1.7 billion.

The Bank Group ultimately declared SemGroup in default under the Credit Agreement, but not specifically based on the alleged improper activity.  SemGroup thereafter filed for bankruptcy in 2008 and successfully confirmed a plan of reorganization which established a litigation trust in order to pursue certain claims held by the SemGroup estate.  The Trustee then commenced two adversary proceedings against various SemGroup equity holders in order to avoid the approximately $55 million that was distributed to them by SemGroup’s management prior to the bankruptcy filing.

It was undisputed that “no reasonably equivalent value was provided” by the equity holders for the challenged distributions.  Therefore, what needed to be determined was whether, following those distributions, SemGroup was left with “unreasonably small capital.”  Based on applicable Third Circuit precedent, in determining the existence of “unreasonably small capital,” the Third Circuit found that the bankruptcy court had properly considered the continuing availability of credit to SemGroup under the Credit Agreement after the challenged distributions were made.  Thus, the sole issue in dispute was whether SemGroup would have been able to draw on its line of credit if the Bank Group had known of its alleged violations of the Credit Agreement.

In an earlier case, Moody v. Sec. Pac. Bus. Credit, Inc., 971 F.2d 1056, 1071 (3d Cir. 1992), the Third Circuit had ruled that “the test for unreasonably small capital is reasonable foreseeability.”  Based on Moody, the Trustee argued that it was reasonably foreseeable at the time of the equity distributions that SemGroup would not have access to its line of credit because it was engaging in activities that violated the terms of the Credit Agreement.  However, both the bankruptcy and district courts rejected the Trustee’s argument concerning continuing access under the Credit Agreement, since it “rested upon conjecture biased by hindsight.”  In affirming summary judgment in favor of the equity holders on that aspect of the Trustee’s constructive fraudulent conveyance claims, the Third Circuit held that arguments based upon what the Bank Group would have done were an insufficient basis for proving that SemGroup had unreasonably small capital:

Absent the bias of hindsight, it simply cannot be said that SemGroup was likely to be denied access to a credit facility that had been in place while it was engaging in the allegedly improper trading strategy.  Telling in this regard is the fact that SemGroup’s trading strategy was not cited by the Bank Group when they declared a default under the Credit Agreement.  As we observed in Moody, the test for unreasonably small capital holds debtors responsible “when it is reasonably foreseeable that [a company] will fail, but at the same time takes into account that ‘businesses fail for all sorts of reasons, and that fraudulent [conveyance] laws are not a panacea for all such failures.’” . . . In this case, the Trustee cannot show that SemGroup could reasonably foresee either that its trading strategy would fail or that the Bank Group would declare a default based upon that trading strategy.  The Trustee presented no evidence that SemGroup tried to disguise its trading strategy from the Bank Group or acted deceptively.  From SemGroup’s perspective, it was acting transparently vis-à-vis the Bank Group in connection with its trading strategy.  Under these circumstances, it cannot be said that it was reasonably foreseeable that its capitalization was unreasonably small because it would lose its ability to draw upon its credit facility.

What are the implications of the Third Circuit’s SemGroup decision?  The main “take-away” is that the bar for proving that a debtor was left with “unreasonably small capital” is high and will not be met with speculative arguments based on 20/20 hindsight.  In particular, having access to credit sufficient to keep the business running – even if the lender had the right to stop lending, but did not, and the company lands in bankruptcy shortly thereafter – will likely be sufficient to defeat any such claim.  More definitive evidence will be required to prove unreasonably small capital; for example, that that the lender knew about, and objected to, the debtor’s activity and was taking steps to curtail access to credit, or that the debtor was trying to hide its activities from the lender.  What is clear is that, at least in the Third Circuit, it is not enough that the lender had the right to stop lending.

To Brexit or to Bremain? That is the Question on 23 June 2016

A View from Brussels

As the 23 June date for the British referendum about its future in the European UK and Europe flagUnion (EU) comes closer, the EU political leadership in Brussels remains uncertain how best to support the ‘Bremain’ forces in order to avoid the embarrassing and damaging departure of one of its largest and strongest members.

None of the political leaders in Brussels or in other EU capitals want to see the UK leave, but they have learned to be cautious and show restraint when it comes to engaging in EU related discussions in Britain. Often enough they were told to stay neutral (or silent) in order not to make things worse for the pro-EU forces. But they now ask themselves whether their passive stance is a sufficiently supportive strategy for a decision of this magnitude for all partners involved – also because many traditionally pro-EU industry stakeholders in the UK have remained reserved so far, leaving a lot of momentum to the “Leave” side.

Supporting the (B)Remain Camp while Preparing for the Eventuality

The top EU leadership has clearly spoken out in favour of the UK to remain a part of the European family. Already in 2014 European Commission President Juncker has given the financial services dossier to the British EU Commissioner Jonathan Hill, and has recently asked Jonathan Faull, a top level UK EU official in Brussels, to lead the Commission’s high level Brexit task force.

Influential national political leaders, including German Chancellor Angela Merkel, have clearly spelled out that they want the UK to remain, and have grudgingly accepted UK specific political concessions in an EU summit in February 2016 in order to support David Cameron. They are wary of potential Brexit copycats across Europe.

Behind closed doors, EU institutions such as the European Central Bank and the European Commission are preparing itself for the eventuality of the British voting to “leave” on 23 June. They cannot afford not to, given the enormous impact it would have on Europe – akin to the “Grexit” situation in recent years.

A View from the United States

On 22 April 2016, President Obama visited London and argued that he had a right to respond to the claims of Brexit campaigners that Britain would easily be able to negotiate a fresh trade deal with the US. He said,

“They are voicing an opinion about what the United States is going to do, I figured you might want to hear from the president of the United States what I think the United States is going to do. And on that matter, for example, I think it’s fair to say that maybe some point down the line there might be a UK-US trade agreement, but it’s not going to happen any time soon because our focus is in negotiating with a big bloc, the European Union, to get a trade agreement done. The UK is going to be in the back of the queue.”

The Only Certain Thing is Uncertainty

The overall uncertainty related to a potential Brexit is large and little is known about how the separation process between the UK and the European Union would look like in practice. Many questions remain unanswered, including the political dynamics a Leave decision would trigger within and outside the UK.

What seems certain is that if Britain does leave the EU, a multi-year separation and negotiation process will commence.

When Greenland left the European Economic Community in 1985 it took a full three years to complete – and this even though they only had a few really important political issues to solve. The UK has been part of the European Union since 1973 – thus the social, legal and economic entanglement is much higher.

Brexit Legal

Squire Patton Boggs has launched a new blog called Brexit Legal where we are connecting business to law and policy, analysing the risks and considering contingency planning about how to prepare in case the majority of the British public vote in favour of Brexit. Click here to read the current articles or subscribe to receive future posts by email.

Retail CVAs – an unproven track record?

Businessman Builds a TowerOnly a month ago we were singing the praises of the CVA and calling them the saviour of the high street following the creditors’ approval of the BHS CVA. (See our earlier blog Move over Mary Portas, CVA’s are the real saviour of the High Street). In the last week, administrators were appointed to both BHS and Austin Reed (Squires are acting for the administrators), which begs the question how effective are CVAs in the retail sector?

CVAs first attracted the attention of the retail sector in 2006. The electrical retailer, Powerhouse, proposed a CVA to obtain a release of lease liabilities and parent company guarantees. Whilst the CVA did not succeed, this was on its drafting rather than on the principle that third party liabilities could be compromised. Although the next retail CVA which was proposed, Stylo Shoes, was rejected, the restructuring community then thought that they had discovered the winning formula with CVAs being approved for JJB Sports, Focus Do It All, Discover Leisure and Blacks.

So where are all these companies now? Unfortunately as the table below highlights, obtaining creditor approval to a CVA does not necessarily lead to the continued success of the company, with only a third of the companies ultimately avoiding administration and continuing to trade.

Company Date of CVA Approval Where is the company now?
JJB Sports plc April 2009 & March 2011 Administration October 2012
Focus Do It All August 2009 Administration May 2011
Discover Leisure June 2009 Administration January 2012
Blacks November 2009 Administration January 2012
Fitness First June 2012 Still trading
Travelodge August 2012 Still trading
Mamas and Papas September 2014 Still trading
Austin Reed February 2015 Administration April 2016
BHS March 2016 Administration April 2016

For the majority of companies at least, the CVA provided a few more years of trading, whereas for BHS it was only a few weeks. Unfortunately for BHS, the CVA was only part of wider restructuring plan. Although the CVA which was approved by 95% of creditors saw Landlords of 87 of its 164 stores agree to accept rental cuts of up to 75%, BHS’s failure to raise £100m to pay staff wages and continue trading led them to appoint administrators. It has also been well publicised that they have a significant £571m pension deficit.

The companies listed above are only some of the well-known names which have disappeared from the British high street since the recession, joining the ranks of Woolworths, Past Times, Blockbuster, Comet, Oddbins, USC, Tie Rack, HMV, Zavvi and Jane Norman.

Times are tough for retailers. The sector has always been susceptible to changes in the retail patterns of shoppers caused by factors which are difficult to predict, such as the weather, and events which draw the attention of the general public away from the high street such as the Olympics. The move to online shopping, as the stakeholders in many high street retailers will attest, remains a driving force for change on the high street with many retailers struggling to keep up with the pace of this ever changing landscape. Retailers who don’t move with the times put themselves at risk of insolvency, and whilst a CVA can provide a retailer with a breathing space, it can’t always guarantee a solution to the financial difficulties  which are often caused by prevailing market conditions beyond their control.

A Trip through an Oil and Gas Bankruptcy – In Only Seventeen Days

In the evening, the silhouette of the oil pump, it is very beautiful

In bankruptcy cases, things often move more slowly than people would like or expect.  In addition to dealing with oversight by the bankruptcy court and the United States Trustee, a debtor typically spends significant time engaging with its lenders and secured creditors, committees of unsecured creditors, and any number of other key stakeholders.  Court approval is needed for most significant events in the case, for anything out of the ordinary course of business, and, at times, even for small matters.  Transparency, adequate notice and opportunity to object, and due process are hallmarks of an effective bankruptcy case.  And all the while, chapter 11 costs and expenses continue to mount as the debtor pushes forward in its efforts to reach the goal line – confirmation of a plan of reorganization, consummation of a section 363 sale, a structured dismissal, or some other exit strategy.

With this as background, a seventeen day long bankruptcy case becomes all the more dramatic.  On March 27, 2016, Southcross Holdings LP and affiliated debtors each filed chapter 11 cases in the Southern District of Texas, Jointly Administered Case No. 16-20111.  Less than three weeks later, their plan of reorganization was confirmed and had gone effective.

The Southcross debtors, together with non-debtor subsidiaries and affiliates, provide a number of services across the “midstream” oil and gas sector.  According to court filings, Southcross collectively “owns and operates approximately 4,000 miles of pipelines, two sour gas treating facilities, three processing facilities, two fractionating facilities, and one facility with both processing and fractionating capabilities.”  The debtors’ most valuable assets, however, were their ownership interests in two non-debtor entities, one of which is publicly traded, who “carry out the majority of operations and drive value enterprise wide.”  The emergency timing in the case was primarily due to the need of these two non-debtor entities to issue a clean audit report by April 15, 2016, which in turn was dependent upon the successful consummation of the debtors’ restructuring.  Failure to so issue the audit report would have caused a default and potentially dragged these two entities into the bankruptcy cases, destroying value along the way.

But, under applicable Bankruptcy Rules, at least 28 days’ notice of a proposed disclosure statement must be given.  The big questions are how the debtors were able to accomplish plan confirmation so quickly and can other oil and gas companies learn something from the strategies employed?

Boiling it down, the facts of this case were very unique.  Over a three month period, the debtors and their advisors successfully negotiated a Restructuring Support Agreement and a fully consensual prepackaged plan of reorganization prior to commencing the bankruptcy case.  The cornerstone of the plan was a $170 million new money equity infusion, half of which would be initially funded as DIP financing and then converted into new equity upon emerging from bankruptcy, and a significant deleveraging of the balance sheet.  Importantly, unsecured creditors were paid in full and the plan received nearly unanimous support from all parties.  Only one objection to confirmation was filed by a term lender, which was ultimately overruled.

But the key was getting the bankruptcy court comfortable that due process was given and that parties had received a full and fair opportunity to object.  The debtors went to great lengths to demonstrate that they had given ample notice, including by contacting every creditor in an impaired class to ensure that actual notice was given and to solicit votes.  As a result of these efforts, the debtors were able to represent to the court that 100% of impaired creditors either had (a) signed on to the Restructuring Support Agreement, (b) actually cast a vote on the plan, or (c) received actual notice and provided no indication that they objected on due process grounds.

Taken together, the circumstances of this particular restructuring were indeed very unique.  Had there not been consensus prepetition, had unsecured creditors not received payment in full, had the plan not been accepted nearly unanimously, had the debtors not undertaken extensive noticing efforts, the results would likely have been very different.  The lesson to be learned is one for all parties involved in distressed situations: recognize that through building consensus and achieving a negotiated resolution before commencing the case, value will be maximized and the time spent in a chapter 11 proceeding could be drastically reduced.  Too many times, prepetition efforts to reach a negotiated resolution fail for the wrong reasons.  If resolution can be achieved, the end result could be much less painful for all involved – and may be over in as quick as seventeen days.