Category: Bankruptcy

The Libor Scandal: What’s Next? Re: London Interbank Offered Rate

GT Law

The London Interbank Offered Rate (Libor) is calculated daily by the British Banking Association (BBA) and published by Thomson Reuters. The rates are calculated by surveying the interbank borrowing costs of a panel of banks and averaging them to create an index of 15 separate Libor rates for different maturities (ranging from overnight to one year) and currencies. The Libor rate is used to calculate interest rates in an estimated $350 trillion worth of transactions worldwide.

The Libor Scandal

The surveyed banks are not required to provide actual borrowing costs. Rather, they are asked only for estimates of how much peer financial institutions would charge them to borrow on a given day. Because they are not required to substantiate their estimates, banks have been accused of Libor “fixing,” or manipulating the Libor rate by submitting estimates that are exaggeratedly higher or lower than their true borrowing costs. This scandal has resulted in the firing and even arrest of bank employees.

Libor’s reputation came under fire in June 2012 when Barclays PLC agreed to pay over $450 million to settle allegations that some traders fixed their reported rates to increase profits and make the bank appear healthier than it was during the financial crisis. In the wake of this settlement, investigative agencies around the world began to look deeper into Libor rate fixing, leading to a $750 million settlement by the Royal Bank of Scotland and a record-setting $1.5 billion settlement by UBS AG. To date, there have been over $2.5 billion in settlements, with many more investigations ongoing. One investment bank estimates that, in total, legal settlements could amount to as much as $35 billion by the time investigations conclude.

Replacing the Libor

In the wake of the Libor scandal, international and domestic agencies have advocated for its replacement. The BBA, the group responsible for setting Libor since the 1980s, voted to relinquish that authority, and a committee of the UK’s Financial Reporting Council is currently vetting bids from other independent agencies interested in administering the new rate.

The International Organization of Securities Commissions (IOSCO) Task Force on Benchmark Rates, led by the head of the UK Financial Services Authority Martin Wheatley and the US Futures Trading Commission Chairman Gary Gensler, released a report last month saying that the new system should be based on data from actual trades in order to restore creditability. Wheatley and Gensler agree on the need to create a transaction-based rate, but disagree on how to transition from Libor to the new system.

Wheatley proposes that: the estimate-based Libor system be kept in place while a new transaction based rate is introduced to run alongside it under a “dual-track” system (so as to avoid disrupting existing transactions), and that the decision as to if and when to abandon Libor be left to market participants as opposed to regulators.

Gensler proposes a wholesale replacement of Libor as soon as possible and cautions that its continued use undermines market integrity and threatens financial stability.

IOSCO is also pushing for a code of conduct that would hold banks to a higher standard of honesty in reporting and setting index rates, while other agencies, including the Financial Stability Board and the European Union, are working on the development of other potential solutions including stricter regulations and greater penalties for rate-fixing conduct.

The future of Libor is unclear, but it is certain that whomever is chosen to replace the BBA will be under immense pressure and scrutiny from the international financial community.

Recommendations

To stay prepared, parties to financial transactions should view existing and future contracts with an eye towards potential benchmark changes. Parties should perform contractual due diligence to establish the range of Libor definitions and benchmarks to which they are exposed. In addition, parties should review the fallback provisions dealing with change or discontinuance of Libor and other benchmark rates to understand the potential impact of such changes.

Going forward, parties should include fallback provisions in their contracts to allocate risk and set up alternatives to mitigate the uncertainty that could arise in the event of any changes to the Libor system or other relevant benchmarks.

Article By:

 of

The Stockton Saga Continues: Untouchable Pensions on the Chopping Block?

Sheppard Mullin 2012

Judge Christopher M. Klein’s decision to accept the City of Stockton’s petition for bankruptcy on April 1, 2013 set the stage for a battle over whether public workers’ pensions can be reduced through municipal reorganization.

Stockton’s public revenues tumbled dramatically when the recession hit, leaving Stockton unable to meet its day-to-day obligations. Stockton slashed its police and fire departments, eliminated many city services, cut public employee benefits and suspended payments on municipal bonds it had used to finance various projects and close projected budget gaps. Stockton continues to pay its obligations to California Public Employees’ Retirement System (“CalPERS”) for its public workers’ pensions. Pension obligations are particularly high because during the years prior to the recession, city workers could “spike” their pensions—by augmenting their final year of compensation with unlimited accrued vacation and sick leave—in order to receive pension payments that grossly exceeded their annual salaries.

When Judge Klein accepted Stockton’s petition April 1, 2013, he reasoned that Stockton could not perform its basic functions “without the ability to have the muscle of the contract impairing power of federal bankruptcy law.” Judge Klein noted that his decision to “grant an order for relief … is merely the opening round in a much more complicated analysis.” The question looming is whether the contract-impairing power of federal bankruptcy law is strong enough to adjust state pension obligations.

Stockton will have the opportunity to present a plan of adjustment, which must be approved through the confirmation process. No plan of adjustment can be confirmed over rejection by a particular class of creditors unless the plan (1) does not discriminate unfairly, and (2) is fair and equitable with respect to each class of claims that is impaired under or has not accepted a plan. Judge Klein said that if Stockton “makes inappropriate compromises, the day of reckoning will be the day of plan confirmation.”

Stockton’s plan of adjustment will likely propose periods of debt service relief and interest-only payments for some municipal bonds, followed by amortization. Stockton intends to actually impair other municipal bonds, potentially paying only cents on the dollar. However, Stockton does not intend to reduce its pension obligations to CalPERS under the plan. Provisions of the California Constitution and state statutes prohibit the reduction of public workers’ pensions, even in bankruptcy proceedings. These California state law provisions were thought to make public pensions virtually untouchable. Yet, the plan may not be confirmable if it impairs Stockton’s obligations to bondholders but not its obligations to CalPERS. Bondholders and insurers will surely vote against and object to the plan, claiming it unfairly discriminates against them, and Judge Klein will have to decide whether the treatment constitutes unfair discrimination. The unfair discrimination claim may have merit, because an overarching goal of federal bankruptcy law is to equitably allocate losses among competing creditors. Federal bankruptcy law often trumps state laws, but there is no precedent for how federal bankruptcy law applies to California’s pension provisions.

For now, cash-strapped municipalities around the country—and their creditors—are watching to see just how Stockton will restructure its obligations.

 of

Where Do Your Interests Lie Under Chapter 15 of the Bankruptcy Code?

Mintz Logo

Determining a foreign debtor’s “center of main interests” and its effect on creditors’ rights

When doing business with a foreign company, it is important to identify the company’s “center of main interests” (“COMI”) as creditors may find themselves bound by the laws of the COMI locale. If a company initiates insolvency proceedings outside the U.S., it must petition a U.S. court under Chapter 15 of the Bankruptcy Code for recognition of the foreign proceeding. If the foreign proceeding is found to be a “foreign main proceeding” (i.e., a proceeding pending where the debtor has its COMI), Chapter 15 provides certain automatic, nondiscretionary relief, including an automatic stay of all proceedings against the debtor in the U.S. Therefore, when faced with a foreign insolvency proceeding, U.S. creditors’ rights will often be determined in the jurisdiction where the debtor’s COMI is located. However, despite its significance, COMI is left undefined by the statute, which prompted the Second Circuit Court of Appeals in Morning Mist Holdings Ltd. v. Krys, 2013 U.S. App. LEXIS 7608 (2nd Cir. April 16, 2013) to determine the relevant factors for locating a COMI and the appropriate time frame to consider those factors.

In Morning Mist, Miguel Lomeli and Morning Mist Holdings Limited (collectively, “Morning Mist”) filed a derivative action in New York state court against Fairfield Sentry Limited (the “Debtor”). The Debtor was one of Bernie Madoff’s largest “feeder funds,” having invested over $7 billion in the scheme. Shortly after the commencement of the derivative action, the Debtor initiated liquidation proceedings in the British Virgin Islands (the “BVI”). Then, in accordance with Chapter 15 of the Bankruptcy Code, the Debtor petitioned the U.S. Bankruptcy Court in the Southern District of New York for recognition of the BVI liquidation proceeding. The bankruptcy court granted the Chapter 15 petition, recognizing the BVI liquidation as a “foreign main proceeding” and imposing an automatic stay on all proceedings against the Debtor in the U.S., including the derivative action. The district court upheld the bankruptcy court’s decision, and Morning Mist appealed to the Second Circuit, arguing that the lower courts improperly found the BVIs to be the Debtor’s COMI.

To determine the Debtor’s COMI, the Second Circuit examined which factors should be considered and over what time period. Tackling the temporal element first, the Court concluded that the Chapter 15 petition filing date is the relevant review period, subject to an inquiry into whether the process has been manipulated. To offset a debtor’s ability to manipulate its COMI, a court may also review the period between the initiation of the foreign liquidation proceeding and the filing of the Chapter 15 petition. The Court squarely rejected Morning Mist’s suggestion that courts must consider a debtor’s entire operational history.

As for the appropriate factors to consider in locating a COMI, the Second Circuit held that any relevant activities, including liquidation activities and administrative functions, may be considered in a COMI analysis. Elaborating, the Court held that Chapter 15 creates a rebuttable presumption that the country where the debtor has its registered office will be its COMI, but recognized that courts have focused on a variety of other factors as well, including the location of the debtor’s headquarters, the location of those who actually manage the debtor, the location of the debtor’s primary assets, the location of the majority of the debtor’s creditors or the majority of the creditors who would be affected by the case, and/or the jurisdiction whose law would apply to most disputes. However, the Second Circuit emphasized that consideration of these factors is neither required nor dispositive.

Finally, Morning Mist argued that Chapter 15’s public policy exception (“Nothing in this chapter prevents the court from refusing to take an action governed by this chapter if the action would be manifestly contrary to the public policy of the United States.”) applied because the BVI proceedings were confidential and therefore “cloaked in secrecy.” The Second Circuit quickly dismissed this argument explaining that the public policy exception should be read restrictively and invoked only under exceptional circumstances concerning matters of fundamental importance for the enacting State. Recognizing that court pleadings can be sealed in U.S. cases, including bankruptcy cases, the Second Circuit found that the confidentiality of the BVI bankruptcy proceedings did not offend U.S. public policy.

The Morning Mist case adds some clarity to a significant issue in cross border insolvencies by highlighting the importance of understanding the internal operations and structure of foreign companies—factors that could affect the ability of U.S. creditors to seek redress in U.S. courts.

Article By:

of

Tribal Corporate Bankruptcy Petition Raises Issues of First Impression for Bankruptcy Court

The National Law Review recently featured an article by Christine L. Swanick, Carren B. Shulman, and Wilda Wahpepah with Sheppard, Mullin, Richter & Hampton LLP regarding Tribal Bankruptcy Petitions:

Sheppard Mullin 2012

On March 4, 2013, ‘SA’ NYU WA, Inc., a tribally-chartered corporation wholly owned by the Hualapai Indian Tribe, filed a Chapter 11 bankruptcy petition in the United States Bankruptcy Court, District of Arizona. This is a very important case for tribes and any party conducting business with tribes because the petition will raise a question of first impression for the Bankruptcy Court. The Bankruptcy Court will have to decide whether a tribal corporation is eligible to be a debtor under the Bankruptcy Code.

Federally recognized tribes likely are not eligible for bankruptcy protection. This is because Section 109 of the Bankruptcy Code provides direction as to who may be a debtor: only a “person” or a “municipality” may file a bankruptcy petition for relief. Neither “person” or “municipality,” as defined by the Bankruptcy Code, expressly includes or excludes an Indian tribe, and no reported court decisions have expressly addressed whether an Indian tribe is eligible to file for bankruptcy as person, municipality, or otherwise. The definition of “person” under the Bankruptcy Code excludes “governmental units” from being eligible debtors. The Bankruptcy Code defines a “governmental unit” as, among other things, an “other foreign or domestic government.” A number of courts have examined whether an Indian tribe is a “governmental unit” for purposes of applying the sovereign immunity provisions contained in Section 106 of the Bankruptcy Code. The majority of cases (including cases decided in the United States Bankruptcy Court for the District of Arizona) examining Section 106 of the Bankruptcy Code have found that an Indian tribe is a “governmental unit” within the meaning of the Bankruptcy Code. See In re Platinum Oil Properties, LLC, 465 B.R. 621 (Bankr. D.N.M. 2011) reconsideration denied, 11-09-10832 JA, 2011 WL 6293132 (Bankr. D.N.M. Dec. 12, 2011); Russell v. Ft. McDowell Yavapai Nation, 293 B.R. 34 (Bankr. D. Ariz. 2003); Davis Chevrolet Inc. v. Navajo Nation, 282 B.R. 674 (Bankr. D. Ariz. 2002); Turning Stone Casino v. Vianese, 195 B.R. 572 (Bankr. N.D.N.Y. 1995); Gilbert v. Shape, 25 B.R. 356 (Bankr. D. Mont. 1982); In re Sandmar Corp., 12 B.R. 910 (Bankr. N.M. 1981). Additionally, last year the United States Bankruptcy Court, Southern District of California dismissed a Chapter 11 petition filed by the Santa Ysabel Resort and Casino, a gaming enterprise of the Iipay Nation of Santa Ysabel, a federally recognized Indian tribe. The dismissal order of the Court simply granted the creditors’ motions to dismiss the petition.

However, in this case, the debtor alleges that it is a chartered tribal corporation, separate from the Hualapai Indian Tribe which owns it. The Bankruptcy Code allows a “corporation” to file for bankruptcy protection. The United States Bankruptcy Court, District of Arizona will have to decide whether a corporation organized under tribal law is a “corporation” for purposes of the Bankruptcy Code. In the non-bankruptcy context, the Seventh Circuit, in a case interpreting the federal Indian Gaming Regulatory Act and the federal diversity statute, 28 U.S.C. § 1332, held in Wells Fargo v. Lake of the Torches, 658 F.3d 684 (7th Cir. 2011), that a tribal corporation was a “corporation” and a citizen of the state of Wisconsin for purposes of determining federal diversity jurisdiction.

Outside of the bankruptcy context, federal and tribal law applicable to Indian tribes extends to a tribe’s wholly-owned instrumentalities and entities; however, whether the relief and remedies typically available with respect to non-tribal corporate debtors under the Bankruptcy Code is available to tribal corporate debtors, likely will be addressed by the Arizona bankruptcy court. For example, just as in the case of a tribe, land used or beneficially owned by a tribal corporation may actually be owned by the United States in trust for the tribe and therefore cannot be subject to sale or alienation in a bankruptcy case. Similarly, federal approvals may need to be obtained with respect to use or disposition of assets owned by a tribal corporation. If a tribal corporation is engaged in Indian gaming operations, which the debtor in the present case is not engaged in, federal law restricts the ownership of such gaming operations to the tribe on whose lands the tribal casino is located and requires third party managers to obtain federal approval.

The petition has the potential to make new law in other respects. For example, if a tribal corporation is found to be eligible as a debtor under the Bankruptcy Code, can creditors in future cases force tribal corporations into involuntary bankruptcy, despite the potential sovereign immunity of tribal corporations? If a tribal corporation is eligible as a debtor, can creditors “pierce” the corporate veil of the tribal corporation and reach assets of the shareholder tribe, or will the Bankruptcy Court follow non-recourse provisions that may be found in the tribal corporation’s organic documents or in its business contracts? Outside the context of bankruptcy, courts considering whether suits against a tribal corporate entity may also proceed against the parent tribe have declined to apply veil-piercing principles. See, e.g., Morgan Buildings & Spas, Inc. v. Iowa Tribe of Oklahoma d/b/a BKJ Solutions et al., Case No. CIV-09-730-M, 2011 WL 308889, *1 (Jan. 26, 2011 W.D. Okla.).

Given recent tribal defaults and restructurings, the outcome of this case will no doubt be watched by tribes and lenders to tribes.

Shawn Watts contributed to this article.

Copyright © 2013, Sheppard Mullin Richter & Hampton LLP

Private Equity Fund Is Not a “Trade or Business” Under ERISA

An article, Private Equity Fund Is Not a “Trade or Business” Under ERISA, written by Stanley F. Lechner of Morgan, Lewis & Bockius LLP was recently featured in The National Law Review:

Morgan Lewis logo

 

District court decision refutes 2007 Pension Benefit Guaranty Corporation opinion letter and could provide potential clarity to private equity firms and private equity funds in determining how to structure their investments.

In a significant ruling that directly refutes a controversial 2007 opinion by the Pension Benefit Guaranty Corporation (PBGC) Appeals Board, the U.S. District Court for the District of Massachusetts held in Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund that a private equity fund is not a “trade or business” under the Employee Retirement Income Security Act (ERISA) and therefore is not jointly and severally liable for millions of dollars in pension withdrawal liability incurred by a portfolio company in which the private equity fund had a substantial investment.[1] This ruling, if followed by other courts, will provide considerable clarity and relief to private equity funds that carefully structure their portfolios.

The Sun Capital Case

In Sun Capital, two private equity funds (Sun Fund III and Sun Fund IV) invested in a manufacturing company in 2006 through an affiliated subsidiary and obtained a 30% and 70% ownership interest, respectively, in the company. Two years after their investment, the company withdrew from a multiemployer pension plan in which it had participated and filed for protection under chapter 11 of the Bankruptcy Code. The pension fund assessed the company with withdrawal liability under section 4203 of ERISA in the amount of $4.5 million. In addition, the pension fund asserted that the two private equity funds were a joint venture or partnership under common control with the bankrupt company and thus were jointly and severally liable for the company’s withdrawal liability.

In response to the pension fund’s assessment, the private equity funds filed a lawsuit in federal district court in Massachusetts, seeking a declaratory judgment that, among other things, they were not an “employer” under section 4001(b)(1) of ERISA that could be liable for the bankrupt company’s pension withdrawal liability because they were neither (1) a “trade or business” nor (2) under “common control” with the bankrupt company.

Summary Judgment for the Private Equity Funds

After receiving cross-motions for summary judgment, the district court granted the private equity funds’ motion for summary judgment. In a lengthy and detailed written opinion, the court made three significant rulings.

First, the court held that the private equity funds were passive investors and not “trades or businesses” under common control with the bankrupt company and thus were not jointly and severally liable for the company’s withdrawal liability. In so holding, the court rejected a 2007 opinion letter of the PBGC Appeals Board, which had held that a private equity fund that owned a 96% interest in a company was a trade or business and was jointly and severally liable for unfunded employee benefit liabilities when the company’s single-employer pension plan terminated.

A fundamental difference between the legal reasoning of the court in the Sun Capital case compared to the reasoning of the PBGC in the 2007 opinion is the extent to which the actions of the private equity funds’ general partners were attributed to the private equity fund. In the PBGC opinion, the Appeals Board concluded that the private equity fund was not a “passive investor” because its agent, the fund’s general partner, was actively involved in the business activity of the company in which it invested and exercised control over the management of the company. In contrast, the court in Sun Capital stated that the PBGC Appeals Board “misunderstood the law of agency” and “incorrectly attributed the activity of the general partner to the investment fund.”[2]

Second, in responding to what the court described as a “creative” but unpersuasive argument by the pension fund, the court concluded that the private equity funds did not incur partnership liability due to the fact that they were both members in the affiliated Delaware limited liability company (LLC) that the funds created to serve as the fund’s investment vehicle in purchasing the manufacturing company. Applying Delaware state law, the court stated that the private equity funds, as members of an LLC, were not personally liable for the liabilities of the LLC. Therefore, the court concluded that, even if the LLC bore any responsibility for the bankrupt company’s withdrawal liability, the private equity funds were not jointly and severally liable for such liability.

Third, the court held that, even though each of the private equity funds limited its investment in the manufacturing company to less than 80% (i.e., 30% for Fund III and 70% for Fund IV) in part to “minimize their exposure to potential future withdrawal liability,” this did not subject the private equity funds to withdrawal liability under the “evade or avoid” provisions of section 4212(c) of ERISA.[3] Under section 4212(c) of ERISA, withdrawal liability could be incurred by an entity that engages in a transaction if “a principal purpose of [the] transaction is to evade or avoid liability” from a multiemployer pension plan. In so ruling, the court stated that the private equity funds had legitimate business reasons for limiting their investments to under 80% each and that it was not clear to the court that Congress intended the “evade or avoid” provisions of ERISA to apply to outside investors such as private equity funds.

Legal Context for the Court’s Ruling

Due to the distressed condition of many single-employer and multiemployer pension plans, the PBGC and many multiemployer pension plans are pursuing claims against solvent entities to satisfy unfunded benefit liabilities. For example, if a company files for bankruptcy and terminates its defined benefit pension plan, the PBGC generally will take over the plan and may file claims against the company’s corporate parents, affiliates, or investment funds that had a controlling interest in the company, or the PBGC will pursue claims against alleged alter egos, successor employers, or others for the unfunded benefit liabilities of the plan that the bankrupt company cannot satisfy.

Similarly, if a company contributes to a multiemployer pension plan and, for whatever reason, withdraws from the plan, the withdrawing company will be assessed “withdrawal liability” if the plan has unfunded vested benefits. In general, withdrawal liability consists of the employer’s pro rata share of any unfunded vested benefit liability of the multiemployer pension plan. If the withdrawing company is financially unable to pay the assessed withdrawal liability, the multiemployer plan may file claims against solvent entities pursuant to various legal theories, such as controlled group liability or successor liability, or may challenge transactions that have a principal purpose of “evading or avoiding” withdrawal liability.

Under ERISA, liability for unfunded or underfunded employee benefit plans is not limited to the employer that sponsors a single-employer plan and is not limited to the employer that contributes to a multiemployer pension plan. Instead, ERISA liability extends to all members of the employer’s “controlled group.” Members of an employer’s controlled group generally include those “trades or businesses” that are under “common control” with the employer. In parent-subsidiary controlled groups, for example, the parent company must own at least 80% of the subsidiary to be part of the controlled group. Under ERISA, being part of an employer’s controlled group is significant because all members of the controlled group are jointly and severally liable for the employee benefit liabilities that the company owes to an ERISA-covered plan.

Private Investment Funds as “Trades or Businesses”

Historically, private investment funds were not considered to be part of an employer’s controlled group because they were not considered to be a “trade or business.” Past rulings generally have supported the conclusion that a passive investment, such as through a private equity fund, is not a trade or business and therefore cannot be considered part of a controlled group.[4]

In 2007, however, the Appeals Board of the PBGC issued a contrary opinion, concluding a private equity fund that invested in a company that eventually failed was a “trade or business” and therefore was jointly and severally liable for the unfunded employee benefit liabilities of the company’s defined benefit pension plan, which was terminated by the PBGC. Although the 2007 PBGC opinion letter was disputed by many practitioners, it was endorsed by at least one court.[5]

The Palladium Capital Case

In Palladium Capital, a related group of companies participated in two multiemployer pension plans. The companies became insolvent, filed for bankruptcy, withdrew from the multiemployer pension plans, and were assessed more than $13 million in withdrawal liability. Unable to collect the withdrawal liability from the defunct companies, the pension plans initiated litigation against three private equity limited partnerships and a private equity firm that acted as an advisor to the limited partnerships. The three limited partnerships collectively owned more than 80% of the unrestricted shares of the defunct companies, although no single limited partnership owned more than 57%.

Based on the specific facts of the case, and relying in part on the PBGC’s 2007 opinion, the U.S. District Court for the Eastern District of Michigan denied the parties’ cross-motions for summary judgment. Among other things, the court stated that there were material facts in dispute over whether the three limited partnerships acted as a joint venture or partnership regarding their portfolio investments, whether the limited partnerships were passive investors or “investment plus” investors that actively and regularly exerted power and control over the financial and managerial activities of the portfolio companies, and whether the limited partnerships and their financial advisor were alter egos of the companies and jointly liable for the assessed withdrawal liability. Because there were genuine issues of material fact regarding each of these issues, the court denied each party’s motion for summary judgment.

Significance of the Sun Capital Decision

In concluding that a private equity fund is not a “trade or business,” the Sun Capital decision directly refutes the 2007 PBGC opinion letter and its reasoning. If the Sun Capital decision is followed by other courts, it will provide welcome clarity to private equity firms and private equity funds in determining how to structure their investments. Among other things, both private equity funds and defined benefit pension plans would benefit from knowing whether or under what circumstances a fund’s passive investment in a portfolio company can constitute a “trade or business” thus subjecting the private equity fund to potential controlled group liability. Similarly, both private equity firms and private equity funds need to know whether a court will attribute to the private equity fund the actions of a general partner or financial or management advisors in determining whether the investment fund is sufficiently and actively involved in the operations and management of a portfolio company to be considered a “trade or business.”

The Sun Capital decision was rendered, as noted above, against a backdrop in which the PBGC and underfunded pension plans are becoming more aggressive in pursuing new theories of liability against various solvent entities to collect substantial sums that are owed to the employee benefit plans by insolvent and bankrupt companies. Until the law becomes more developed and clear regarding the various theories of liability that are now being asserted against private equity funds investing in portfolio companies that are exposed to substantial employee benefits liability, it would be prudent for private equity firms and investment funds to do the following:

  • Structure carefully their operations and investment vehicles.
  • Be cautious in determining whether any particular fund should acquire a controlling interest in a portfolio company that faces substantial unfunded pension liability.
  • Ensure that the private equity fund is a passive investor and does not exercise “investment plus” power and influence over the operations and management of its portfolio companies.
  • Conduct thorough due diligence into the potential employee benefits liability of a portfolio company, including “hidden” liabilities, such as withdrawal liability, that generally do not appear on corporate balance sheets and financial statements.
  • Be aware of the risks in structuring a transaction in which an important objective is to elude withdrawal liability.

Similarly, until the law becomes more developed and clear, multiemployer pension plans may wish to devote particular attention to the nature and structure of both strategic and financial owners of the businesses that contribute to their plans and should weigh and balance the risks to which they are exposed by different ownership approaches.

[1]. Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, No. 10-10921-DPW, 2012 WL 5197117 (D. Mass. Oct. 18, 2012), available here.

[2]. Sun Capital, slip op. at 17.

[3]. Id. at 29-30.

[4]. See e.g., Whipple v. Comm’r., 373 U.S. 193, 202 (1963).

[5]. See, e.g., Bd. of Trs., Sheet Metal Workers’ Nat’l Pension Fund v. Palladium Equity Partners, LLC (Palladium Capital), 722 F. Supp. 2d 854 (E.D. Mich. 2010).

Copyright © 2012 by Morgan, Lewis & Bockius LLP

Michigan’s Homestead-Exemption Law for Bankruptcy Debtors Upheld

The National Law Review recently published an article, Michigan’s Homestead-Exemption Law for Bankruptcy Debtors Upheld, by Stephen F. MacGuidwin of Varnum LLP:

Varnum LLP

A Michigan law that allows bankruptcy debtors to exempt up to $45,000 of the value of their home is valid under the U.S. Constitution, according to the recent decision of the U.S. Court of Appeals for the Sixth Circuit in Richardson v. Schafer (In re: Schafer), — F.3d—-, 2012 WL 3553294 (6th Cir. 2012).   The decision resolves a split of authority that had developed between different decisions in the U.S. Bankruptcy Court for the Western District of Michigan.

Michigan law, as the Court explained, allows a debtor to choose her list of property exemptions from three sources:  the federal Bankruptcy Code, 11 U.S.C. § 522(d); a Michigan law applicable only to bankruptcy debtors, M.C.L. § 600.5451; or (3) a Michigan law that applies to all Michigan residents (regardless of bankruptcy status), M.C.L. § 600.6023.  As far as exempting the equity in a homestead, the Michigan law for bankruptcy debtors is the most generous, protecting up to $30,000 of the value of his homestead (or up to $45,000 if the debtors is disabled or at least 65 years old).  This is significantly more than what is protected under the Bankruptcy Code ($21,625) or the Michigan general exemptions statute ($3,500).

In Schafer, the bankruptcy trustee challenged the $35,000 homestead exemption, arguing that the Michigan statute was unconstitutional under the Bankruptcy Clause and the Supremacy Clause of the U.S. Constitution.  The bankruptcy court held that the statute was constitutional, but the U.S. Bankruptcy Appellate Panel of the Sixth Circuit reversed.

On appeal, the Sixth Circuit agreed with the State of Michigan, holding that the Michigan law did not violate the Bankruptcy Clause or the Supremacy Clause:

  • The Court rejected the argument that the Bankruptcy Clause endowed Congress with the exclusive authority to pass bankruptcy laws, reaffirming the concurrent authority shared between state and federal legislatures to promulgate bankruptcy laws.  Where state laws are inconsistent with federal bankruptcy laws, the Supremacy Clause and pre-emption doctrines will invalidate those state laws.
  • The Court held that the Michigan act does not violate the “uniform Laws” phrase in the Bankruptcy Clause.  Assuming that the phrase applies to state laws (and not just federal laws), the Michigan act operates uniformly because it provides a uniform process (as opposed to a uniform outcome).
  • Third, the Michigan act does not violate the Supremacy Clause, because there is no actual conflict between it and the Bankruptcy Code, because field pre-emption does not apply in the area of bankruptcy exemptions, and because the Michigan act “actually furthers, rather than frustrates, national bankruptcy policy.”

© 2012 Varnum LLP

Underwater Condos – They Have Their Own Considerations Before Deciding on a Short Sale or Other Option

The Business Real Estate and Transactions Practice Group of Williams Kastner recently had an article about Underwater Condos published in The National Law Review:

 

A client recently brought to me a situation where his nephew’s new wife had purchased a condominium unit prior to their wedding. She financed the entire price with two mortgages and now it’s under water.

When advising owners of distressed properties it’s easy to begin with a discussion of the owner’s financial situation. Is this the only problem or are they bankruptcy candidates? Will the owner need credit in the near future for a job transfer or to finance a business?

With condos, my first questions go to the marketability of the unit:

  • What’s the owner occupancy ratio? Are we looking for a landlord or someone who wants to live there? Owner occupancy rates affect the availability and cost of financing as well as the type and number of willing buyers.
  • How healthy is the homeowners association? If owners have stopped paying their assessments the HOA could be under funded. This would discourage almost all buyers.
  • How well has the HOA planned for major repairs and capital improvements? Is there a reserve study? Will there be large special assessments in the coming years for roofing, painting, deck replacement, etc.?
  • Has the owner been paying their assessments? If not, will they be able to bring the assessments current at closing?

Many owners are unable to answer these questions because they stopped reading newsletters and minutes from the Board or going to owners meetings.

There are opportunities for investors and others in distressed properties. But, to help an owner, much of the craft is in knowing the questions that will quickly tell you what you’re dealing with. When it comes to condos, I want to know about the marketability of the unit before spending much time on the owner’s financial situation.

© 2002-2012 by Williams Kastner

Club Membership Deposits in Bankruptcy

The National Law Review recently featured an article by the Hotels, Resorts & Clubs Group of Greenberg Traurig, LLP regarding Club Memberships and Bankruptcy:

GT Law

As noted in our “Club Membership Deposits — From Gold to Paper” posted on August 4, 2011,  many membership deposit clubs have resorted to bankruptcy to restructure their membership deposit debt liability.  Below are descriptions of how the membership deposits have been restructured in four bankruptcies.

Dominion Club. Members will receive in full satisfaction of their membership deposit claims, distributions pro rata from an escrow account to be funded in part from future new membership sales proceeds and certain contributions from a club owner affiliate. Each member had the option to receive in lieu of distributions from the escrow account an upfront payment equal to 11% of the member’s membership deposit.

Amelia Island. The purchaser of the multiple golf course club and resort entered into a lease/purchase agreement with a club member entity with respect to one golf course and clubhouse.  Members received in satisfaction of their membership deposit claims membership rights in the member owned club.  Under the new Membership Plan, a golf member who converted to equity membership by paying $2,000 was to receive a refund of 30% of the membership deposit after resignation from available funds, increasing to 80% over a seven year period.  Golf members who did not convert to equity membership were to receive a refund of 30% of their membership deposit after resignation from available funds.

Palmas del Mar. A government affiliated entity that acquired the club established a fund to pay, first, administrative claims and a tax claim, and then, if any amount remained, members would receive a pro rata share of the balance based on the present value of their membership deposit liability. It was expected that club members would be paid a very small percentage of their membership deposits.

PGA West.  Membership deposits payable after resignation and reissuance will be paid at 50% of the total membership deposit; starting two years after the date of the reorganization plan, the refund percentage will increase by 5% each year.  Members retain their right to 100% of their membership deposits at the end of 30 years and after death subject to annual caps on the total amount of payments under such provisions.

The individual circumstances for each club impacted the final provision governing the membership deposit restructure.

Membership deposits must be restructured so that members as a class of creditors vote in favor of the reorganization plan or the bankruptcy court determines that the reorganization plan does not unfairly discriminate and is fair and equitable.  The club governing documents and the economics of the restructure must be carefully reviewed.

©2012 Greenberg Traurig, LLP

Second Circuit Finds Anderson News Pleading Is Plausible . . . Enough

The National Law Review recently featured an article, Second Circuit Finds Anderson News Pleading Is Plausible . . . Enough, written by Scott Martin, Simon Harms, Mary K. Marks, Scott Martin, Irving Scher, and Stephen C. Tupper of Greenberg Traurig, LLP:

GT Law

Admonishing that motions to dismiss for failure to state a claim must be decided based on whethera plaintiff’s complaint is plausible rather than how plausible it is, which was the district’s view in granting a dismissal motion, the Second Circuit, in Anderson News, L.L.C. v. American Media, Inc.,[1] declared improper the district court’s denial of leave to file a proposed amended complaint and vacated the dismissal.

Prior to its bankruptcy, Anderson News was the second largest wholesaler of magazines to newsstands and bookstores in the United States. Anderson alleged in a lawsuit against its major publisher suppliers that in response to a magazine distribution surcharge that Anderson another wholesaler (Source) had announced, the publishers conspired with Anderson’s competitors and distribution service companies to refuse to deal with the two wholesalers in order to drive them out of business Anderson claimed that the group boycott resulted in its loss of access to 80 percent of the magazines it distributed.

The District Court Decision

Judge Paul A. Crotty of the Southern District of New York dismissed Anderson’s original complaint under Fed. R. Civ. P. 12(b)(6), denied reconsideration, and refused leave to file a proposed amended complaint, finding the alleged conspiracy to be facially implausible under the Twombly-Iqbalstandard,[2] and the original pleading’s defects incurable.[3] Among other things, Judge Crotty commented that eliminating Anderson and Source would have left 90 percent of the wholesale market share in the hands of two competitors. Because publishers and distributors have an economic self-interest in having more, not fewer, wholesalers (since that yields greater competition, which is good for suppliers), Judge Crotty concluded that the conspiracy’s alleged goal was implausible. By contrast, he believed that parallel, but unilateral, conduct was “completely plausible” under the circumstances. Specifically, the defendants initially had different reactions to the surcharge; there was no direct evidence of conspiracy alleged in the original complaint; and the defendants’ decisions to not pay the surcharge and instead stop shipping to Anderson were “in line with a wide swath of rational and competitive business strategy unilaterally prompted by common perceptions of the market.”[4]

The district court concluded that Anderson’s allegations presented only “an economically implausible antitrust conspiracy” that was “based on sparse parallel conduct allegations” and lacked “a context suggesting a preceding agreement.”[5]The district court further stated that while it was compelled to take “all factual allegations as true on a motion to dismiss, . . . factual inferences are not entitled to the same benefit.”[6]

The Court of Appeals Decision

The Second Circuit reversed. While acknowledging that Twombly required “some factual context suggesting [that the parties] reached an agreement, not facts that would be merely consistent with an agreement,”[7] the appellate court declared that it was not necessary for the plaintiff to show “that its allegations suggesting an agreement are more likely than not true or that they rule out the possibility of independent action, as would be required at later litigation stages such as a defense motion for summary judgment or a trial.”[8] The Second Circuit emphasized that “a given set of actions may well be subject to diverging interpretations, each of which is plausible,” but the choice between such interpretations was for the fact-finder, not for the court to make on a Rule 12(b)(6) motion, “even if it strikes a savvy judge that actual proof of the facts alleged is improbable, and that a recovery is very remote and unlikely.”[9] Unlike the Twombly complaint, however, Anderson’s proposed amended complaint did not rely solely on allegations of parallel conduct that was explicable as natural, unilateral reactions, but did, in fact, allege actual agreement — identifying dates, executives, and statements that could plausibly be interpreted as such. Ruling that these amendments would have stated a claim, the Second Circuit stressed that “[t]he plausibility standard is lower than a probability standard, and there may therefore be more than one plausible interpretation of a defendant’s words, gestures, or conduct.”[10] In such circumstances, taking all facts as true and making all reasonable inferences, “on a Rule 12(b)(6) motion it is not the province of the court to dismiss the complaint on the basis of the court’s choice among plausible alternatives.”[11]

Should We Discern A Trend?

In another recent Twombly-Iqbal decision, Liu v. AMERCO,[12] the First Circuit was similarly permissive in applying the plausibility test, this time with respect to the required element of damages in a claim under the Massachusetts unfair trade practices statute (“Chapter 93A”). The plaintiff in Liu had brought a class action against the U-Haul truck rental companies premised upon a recent Federal Trade Commission investigation and consent order concerning an alleged invitation to collude by U-Haul to its major competitors (which as an attempt to conspire would not be actionable under Section 1 of the Sherman Act, but could be challenged under Section 5 of the FTC Act and,could potentially provide a basis for a claim, under Massachusetts’ Chapter 93A).

Although the plaintiff claimed to have undertaken two U-Haul rentals in or to Massachusetts, she did not plead specific facts concerning those transactions, such as what she paid or what competitors’ rates were at the time. The district court dismissed her complaint, explaining that basic facts about her individual transactions where necessary to judge whether she had overpaid, and whether such overpayment was caused by U-Haul’s unconsummated conspiracy attempt. The First Circuit, in an opinion by Judge Michael Boudin, disagreed, finding sufficient the plaintiff’s reliance, inter alia, upon the FTC complaint’s allegations (including references to specific documents) that U-Haul had raisedits own prices as an essential element of its effort to collude. Although the appellate court noted that “U-Haul’s brief raises fair questions about the power of the analysis,”[13] it held, not unlike the Second Circuit in Anderson News, that “[t]he place to test factual assertions for deficiencies and against conflicting evidence is at summary judgment or trial.”[14] Again, although the First Circuit appeared skeptical of the claim, it required that the complaint set forth “only enough facts to make the claim plausible, and at this stage reasonable inferences are taken in favor of the pleader.”[15]

Author’s note: Several years ago, while participating on a panel not long after the Supreme Court decided Twombly, I was greeted with skepticism (to put it politely) when arguing that it would not be an extraordinary extension of the then-new pleading standard to require that a complaint alleging an agreement in restraint of trade set forth facts that, if true and allowing for all reasonable inferences in the plaintiff’s favor, stated a claim that was more plausibly consistent with conspiracy than with competition. After all, that would be a logical application of the summary judgment standard of Matsushita[16] — a decision that likewise is framed around notions of plausibility and economically rational behavior — in the pleading context: i.e., if the record were to develop consistent with plaintiff’s pleading, would it “tend to exclude the possibility” of independent, non-collusive action?[17] It would also respond to concerns expressed by the Supreme Court that even under the old Conley v. Gibson[18] “plaintiff can prove no set of facts” pleading standard in itsAssociated General Contractors[19] decision, a district court served an important gatekeeping role at the pleading stage in antitrust cases due to the significant expense of discovery.[20] From the perspective of this (principally defense) antitrust litigator, Judge Crotty’s approach in Anderson Newswas not unwelcome. For the time being, though, at least in the Second Circuit, it is not the law.

[1] ___ F.3d ___ (2d Cir. April 3, 2012). The decision is available on Westlaw at 2012 WL 1085948.

[2] See Ashcroft v. Iqbal, ___ U.S. ___, 129 S. Ct. 1937 (2009); Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007).

[3] Anderson News, L.L.C. v. Am. Media, Inc., 732 F. Supp. 2d 389 (S.D.N.Y. 2010).

[4] Id. at 397-99.

[5] Id. at 402.

[6] Id. (emphasis added).

[7] Anderson, 2012 WL 1085948, at *18 (internal quotations omitted).

[8] Id.

[9] Id. at *18-19 (internal quotation marks and citations omitted).

[10] Id. at *24.

[11] Id.

[12] F.3d ___ (1st Cir. May 4, 2012) (Boudin, J.). The decision is available on Westlaw at 2012 WL 1560170.

[13] Id. at *6.

[14] Id.

[15] Id. (citing SEC v. Tambone, 597 F.3d 436, 441 (1st Cir. 2010)).

[16] Matsushita Elec .Indus. Co. v. Zenith Radio, 475 U.S. 574 (1986).

[17] See id. at 588 (internal quotations omitted).

[18] 355 U.S. 41 (1957).

[19] Assoc. Gen. Contractors of Cal., Inc. v. Carpenters, 459 U.S. 519 (1983).

[20] See id. at 528 n.17 (“a district court must retain the power to insist upon some specificity in pleading before allowing a potentially massive factual controversy to proceed”).

©2012 Greenberg Traurig, LLP

Michigan Court of Appeals Issues Opinion Affecting Mortgages Foreclosed by Advertisement

The National Law Review published an article by Randall J. Groendyk of Varnum LLP regarding Mortgage Foreclosures:

Varnum LLP

The Michigan Court of Appeals has issued important opinion affecting foreclosure of mortgages by advertisement.

Michigan law prohibits starting a foreclosure by advertisement if a lawsuit has already been filed to recover payment of “the debt” secured by the mortgage.  Many have understood this law to mean that while a mortgagee may not file a lawsuit to recover a debt secured by a mortgage and at the same time foreclose the mortgage by advertisement, the mortgagee could simultaneously file a lawsuit against a guarantor based on a guaranty of the debt while at the same time foreclosing the mortgage by advertisement.  However, the recent Court of Appeals decision held that a bank could not foreclose by advertisement on a mortgage when at the same time it had filed suit against a guarantor.

The Court based its decision on the fact that the underlying loan documents contained language which defined “the debt” to include any guarantees, and held the bank violated Michigan law by foreclosing the mortgage by advertisement at the same time it was suing the guarantors.  The Court looked at the entire loan package, and not just the mortgage to reach its decision.  As a result, the Court held that the bank could not proceed with the foreclosure by advertisement.  Under the Court’s ruling, mortgagees may not foreclose a mortgage by advertisement while at the same time filing suit against guarantors.

© 2012 Varnum LLP