The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Bankruptcy

  • From Vol. 10 No.4 (Jan. 26, 2017)

    How Claim Traders Can Pursue Reclamation and Administrative Expense Claims in Retail and Other Insolvencies

    As a result of changing consumer spending habits, numerous retailers – including Sports Authority, Pacific Sunware, Aeropostale and, most recently, American Apparel – have been forced to close down their storefronts or enter into bankruptcy. Others, such as Macy’s, Sears, J.Crew and ToysRUs, are also reaching distressed levels. While these retail bankruptcies have negative implications for landlords, tenants and other stakeholders, they may offer great opportunities for claim traders in light of two key provisions under the Bankruptcy Abuse Prevention and Customer Protection Act of 2005 (2005 Amendment), which sought to strengthen vendor-creditor rights under the federal bankruptcy law. In a guest article, Darius J. Goldman and Matthew W. Olsen, partners at Katten, along with associate Jessica P. Chue, outline how a vendor-creditor’s claim may qualify for reclamation or administrative expense priority under the 2005 Amendment. For additional insight from Goldman and Chue, see “What the LSTA’s Revised Delayed Compensation Requirements Mean for Loans Trading on Par/Near Par Documents” (Oct. 27, 2016). For more on claim trading from Goldman, see “How Hedge Fund Claim Traders Can Protect Their Interests in the Visa/MasterCard Litigation” (Jun. 14, 2016); and “What Hedge Fund Claim Traders Need to Know About the Visa/MasterCard Settlement” (Jun. 25, 2015). 

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  • From Vol. 8 No.30 (Jul. 30, 2015)

    Second Circuit Rules on Whether Repo Clients of Broker-Dealers Are “Customers” Under SIPA

    In 2008, Lehman Brothers, Inc. (Lehman) entered into a liquidation proceeding in the U.S. Bankruptcy Court for the Southern District of New York, in accordance with the Securities Investor Protection Act (SIPA).  A number of banks that had sold securities to Lehman under various repurchase agreements (repos) filed claims in the proceeding seeking to be treated as “customers” of Lehman, which would have given them priority claims in respect of the securities covered by the repos.  Lehman’s bankruptcy trustee determined that the banks were not “customers” within the meaning of SIPA.  Both the Bankruptcy Court and the U.S. District Court for the Southern District of New York affirmed the trustee’s determination.  See “U.S. District Court Rules on Whether a Party to a Repurchase Agreement with a Broker-Dealer That Enters Liquidation Is a ‘Customer’ of the Broker-Dealer under SIPA,” The Hedge Fund Law Report, Vol. 7, No. 18 (May 8, 2014).  In what is likely to be the last judicial word on the subject, the U.S. Court of Appeals for the Second Circuit recently ruled on the District Court’s decision.  This article summarizes the facts and circumstances surrounding the Lehman repos; examines the Second Circuit’s legal reasoning; and discusses possible implications of the decision on the hedge fund industry as a whole.  For coverage of a dispute over “customer” status in a liquidation of a futures commission merchant, see “Bankruptcy Court Rules on Whether Funds Held by Bankrupt Futures Commission Merchant for Retail Forex and OTC Metals Trading Are ‘Customer Property’ Entitled to Priority Distribution,” The Hedge Fund Law Report, Vol. 7, No. 20 (May 23, 2014).

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  • From Vol. 8 No.14 (Apr. 9, 2015)

    BakerHostetler Event Highlights Investment Strategies, Considerations and Uncertainties of Distressed Debt Investments by Hedge Funds

    In the current distressed debt environment, defaults have been relatively low, leading to fewer bankruptcies but opening the market up to increased restructurings and similar workouts.  However, the maneuvers available to distressed investors in the bankruptcy or restructuring process could be significantly impacted by two recent court cases, the results of which have created uncertainty in the marketplace by allowing minority bondholders to hold up or overturn restructuring proceedings and could have a major impact on future interpretations of the Trust Indenture Act of 1939 by courts in future proceedings.  See “A New Look at an Old Standard: The Power of Minority Bondholders Under the Trust Indenture Act,” The Hedge Fund Law Report, Vol. 8, No. 9 (Mar. 5, 2015); and “Trust Indenture Act May Give Hedge Funds the Right to Challenge Involuntary Non-Judicial Debt Restructurings,” The Hedge Fund Law Report, Vol. 8, No. 5 (Feb. 5, 2015).  Types and strategies of distressed investments, key legal issues relating to distressed investments, issues investors should consider in assessing distressed opportunities and the two recent court cases were highlights of a recent Hedge Funds and Distressed Debt Investing seminar held by law firm BakerHostetler.  This article summarizes the key issues discussed at that seminar.

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  • From Vol. 8 No.9 (Mar. 5, 2015)

    A New Look at an Old Standard: The Power of Minority Bondholders Under the Trust Indenture Act

    Could an obscure statutory provision dating back to the New Deal give a distressed company’s minority bondholders the power to hold up a restructuring agreed upon by all of the other bondholders?  The answer appears to be “yes.”  Two recent cases interpreting the Trust Indenture Act of 1939 (Act) have broadly read a provision of the Act to bar any non-consensual change to the existing bond indenture that would affect any bondholder’s ultimate payment rights in the context of an out-of-court restructuring.  This is regardless of any agreements reached by the majority of bondholders and regardless of the depth of sound business judgment underlying a company’s proposed restructuring plan.  By boosting minority bondholders’ leverage in restructurings, these recent cases interpreting the Act could have far-reaching implications.  Hedge funds and other investors looking to invest in distressed debt would be wise to analyze these decisions closely.  In a guest article, Marc D. Powers, Mark A. Kornfeld, Ferve E. Ozturk and M. Elizabeth Howe provide such an analysis, and discuss the implications of the decisions for hedge funds that invest in distressed debt.  Powers is the national leader of the Hedge Fund Industry and Securities Litigation practices at BakerHostetler; Kornfeld is a BakerHostetler partner; Ozturk and Howe are associates at the firm.

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  • From Vol. 7 No.44 (Nov. 20, 2014)

    Eighteen Major Banks Agree to Adopt FSB/ISDA Resolution Stay Protocol that Postpones Exercise of Right to Terminate Derivatives on Bank Counterparty Failure

    Normally, the bankruptcy of a party to a derivative contract gives the counterparty the right to terminate the contract or exercise certain rights with regard to collateral.  In an effort to reduce systemic risk upon failure of a systemically-important bank or other financial institution, the Financial Stability Board (FSB), in conjunction with the International Swaps and Derivatives Association, Inc. (ISDA), recently announced that 18 major banks have agreed to adopt a protocol that amends the ISDA Master Agreement to suspend early termination rights for two days upon the insolvency of a counterparty.  In theory, this two-day window will allow the distressed counterparty to deal with its derivatives book in an orderly fashion.  Many of those 18 banks (or subsidiaries) serve as prime brokers for private funds; the protocol could put those funds at a disadvantage if their prime broker were to fail.  See “Prime Brokerage Arrangements from the Hedge Fund Manager Perspective: Financing Structures; Trends in Services; Counterparty Risk; and Negotiating Agreements,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).  Not surprisingly, hedge funds and other interested trade organizations are pushing back, arguing that the protocol falls short on both substantive and procedural grounds.  In a letter to the FSB, a consortium of buy-side and other trade organizations have argued that the protocol will not work in practice and that it constitutes an improper end run on the legislative process.  This article summarizes the new protocol, the rationale behind its adoption, the buy-side pushback, and insights from Anne E. Beaumont, a partner in Friedman Kaplan Seiler & Adelman LLP.

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  • From Vol. 7 No.26 (Jul. 11, 2014)

    Potential Pitfalls for Hedge Fund Managers in the Ever-Expanding Use of English Schemes of Arrangement

    The English scheme of arrangement has surged in popularity in recent years as distressed hedge fund managers tackle Europe.  The appeal of this procedure is easy to identify.  First, the scheme is predictable: its legal requirements and parameters are clearly set forth in a robust body of law, and it is administered by sophisticated and commercially-minded courts in the United Kingdom.  Second, the scheme permits the company to continue operating (and its management to remain in control) throughout the restructuring – a feature that is prevalent in the United States but which is lacking in many other jurisdictions.  From the perspective of fund managers with American roots, the English scheme has the added benefit of familiarity as it resembles in many ways a “pre-packaged” chapter 11 procedure.  Due to a series of recent rulings in which English courts broadly interpret the scope of their own jurisdiction, the English scheme also has become ever-more accessible.  The courts, for example, have permitted companies with no UK presence to bind creditors under a scheme where the sole jurisdictional nexus to the UK was that the governing law clause of the debtor’s financing documents provided for the choice of English law.  Within the past few months, one English court went a step further and held that even when the foreign debtor’s financing documents originally were governed by foreign law, English jurisdiction could nevertheless be established through the amendment of the governing law clause to provide for English law.  As the English scheme becomes the preferred method of restructuring European companies, it is important to consider whether a scheme that has been “sanctioned” (or confirmed) by an English court will be given effect in other jurisdictions where the debtor has assets or where the debtor’s creditors might reside.  Indeed, before an English court will sanction a scheme, it must be satisfied that the terms of the sanctioned scheme will be respected in all of the relevant jurisdictions.  In a guest article, Solomon J. Noh and Edmund M. Emrich, partner and counsel, respectively, in the Financial Restructuring & Insolvency Group of Shearman & Sterling LLP, identify a potential blind-spot where a foreign company with assets or creditors in the U.S. seeks to restructure its debts through an English scheme of arrangement solely on the basis of the governing law being English law, and discuss potential ways to resolve issues that might arise.

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  • From Vol. 7 No.20 (May 23, 2014)

    Bankruptcy Court Rules on Whether Funds Held by Bankrupt Futures Commission Merchant for Retail Forex and OTC Metals Trading Are “Customer Property” Entitled to Priority Distribution

    Peregrine Financial Group, Inc. (PFG) was a registered futures commission merchant (FCM) and a “Forex Dealer Member” of the National Futures Association (NFA).  In July 2012, after discovering the theft of client funds, PFG filed for bankruptcy protection.  Later that year, PFG’s bankruptcy trustee (Trustee) sought permission to distribute “customer property” to PFG customers who traded “commodity contracts.”  Such customers are entitled to priority in distributions from a commodities broker bankruptcy.  The Trustee did not include in the proposed distribution PFG customers who engaged in retail foreign exchange (retail forex) and over-the-counter spot metals (OTC metals) transactions.  As a result, Secure Leverage Group, Inc. and other customers of PFG that had accounts with PFG for trading in retail forex and OTC metals commenced an adversary proceeding.  They sought a declaration that their retail forex and OTC metals trading constituted “commodity contracts” within the meaning of the U.S. Bankruptcy Code and that, accordingly, they were entitled to share in the proposed priority distribution of “customer property.”  Jockeying over “customer” status is not unique to bankruptcies of FCMs; similar issues arise in SIPA liquidations as well.  See “U.S. District Court Rules on Whether a Party to a Repurchase Agreement with a Broker-Dealer That Enters Liquidation Is a ‘Customer’ of the Broker-Dealer under SIPA,” The Hedge Fund Law Report, Vol. 7, No. 18 (May 8, 2014).

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  • From Vol. 7 No.18 (May 8, 2014)

    U.S. District Court Rules on Whether a Party to a Repurchase Agreement with a Broker-Dealer That Enters Liquidation Is a “Customer” of the Broker-Dealer under SIPA

    Following its collapse in 2008, broker-dealer Lehman Brothers Inc. (Lehman) entered a liquidation proceeding administered by the U.S. Bankruptcy Court for the Southern District of New York (Bankruptcy Court) in accordance with the Securities Investor Protection Act of 1970 (SIPA).  Under SIPA, “customers” of a failed broker-dealer are entitled to special protection in the broker-dealer’s liquidation.  In that regard, several banks that had entered into repurchase agreements with Lehman prior to its collapse sought to have their claims categorized by Lehman’s liquidation trustee as “customer” claims under SIPA.  The trustee refused to do so; and the Bankruptcy Court concurred.  The banks then appealed the Bankruptcy Court’s decision to the U.S. District Court for the Southern District of New York.  This article offers a detailed discussion of the District Court’s decision.  Although broker-dealer liquidations are rare, the Court’s decision should inform the drafting of hedge funds’ prime brokerage and repurchase agreements.  See “Prime Brokerage Arrangements from the Hedge Fund Manager Perspective: Financing Structures; Trends in Services; Counterparty Risk; and Negotiating Agreements,” The Hedge Fund Law Report, Vol. 6, No. 2 (Jan. 10, 2013).

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  • From Vol. 7 No.7 (Feb. 21, 2014)

    Can a Hedge Fund Holding Secured Debt Credit Bid Up to the Face Amount of the Debt Or Only Up to the Amount Paid for the Debt?

    The right of a secured creditor to bid the secured debt it holds to purchase the collateral securing that debt from the debtor in a Chapter 11 proceeding (a credit bid) is now firmly established.  See “U.S. Supreme Court Resolves Circuit Split and Affirms Secured Creditors’ Right to Credit Bid Under Chapter 11 Plan,” The Hedge Fund Law Report, Vol. 5, No. 25 (Jun. 21, 2012); and “Seventh Circuit Holds that Secured Lenders Must Have the Opportunity to Credit Bid in Asset Sales Under a Chapter 11 Plan,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  However, when the secured creditor purchased that debt at a steep discount, as is often the case in distressed debt transactions executed by hedge funds, issues may arise as to whether the creditor is entitled to credit bid up to the face amount of the debt it holds, or only a portion of that amount.  A U.S. District Court recently addressed this issue, and its analysis has implications for hedge funds that invest in secured credit.

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  • From Vol. 6 No.48 (Dec. 19, 2013)

    Six Implications for Bankruptcy Claims Traders, Including Hedge Funds, Arising Out of the Third Circuit’s Recent Decision Holding that Claims Subject to Disallowance under Section 502(d) Cannot Be “Washed” through Subsequent Transfers

    In a recent case related to the liquidation of KB Toys Inc. and affiliated entities, the U.S. Court of Appeals for the Third Circuit (Third Circuit) held that a trade claim disallowable under Section 502(d) of the U.S. Bankruptcy Code (Bankruptcy Code) in the hands of the original claimant is similarly disallowable in the hands of a subsequent transferee.  In other words, the Third Circuit affirmed the decision of the U.S. District Court, District of Delaware holding that disallowance risk attaches to and travels with claims.  The U.S. District Court for the Southern District of New York recently reached the opposite conclusion, holding that disallowance is a personal disability of the claimant, and not an attribute of the claim itself, unless the transferee took the claim by assignment rather than by sale.  This article summarizes the legal and factual background of the case and the Third Circuit’s analysis.  The article also highlights six implications arising out of the Third Circuit’s decision for prospective claims purchasers, including hedge funds.  For further discussion of the risks faced by hedge funds participating in claims trading, see “Two Key Levels of Risk Facing Hedge Funds That Buy or Sell Bankruptcy Claims,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).  For coverage of similar best practices helpful in managing the risk of claims disallowance under Bankruptcy Code Section 502(d) based on a seller’s avoidance liability, see “Five Steps Hedge Fund Managers Should Take to Mitigate Avoidance and Disallowance Risks After Delaware Court Finds That Avoidance and Disallowance Risks Travel with Trade Claims,” The Hedge Fund Law Report, Vol. 5, No. 24 (Jun. 14, 2012).

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  • From Vol. 6 No.42 (Nov. 1, 2013)

    Hedge Funds Realize Material Return by Funding Litigation Over a Tax Refund in a Bank Holding Company Bankruptcy

    Litigation funding – generally, debt, equity or other investments in third-party legal cases – can offer absolute and uncorrelated returns.  See “In Turbulent Markets, Hedge Fund Managers Turn to Litigation Funding for Absolute, Uncorrelated Returns,” The Hedge Fund Law Report, Vol. 2, No. 25 (Jun. 24, 2009).  In a recent example of a successful execution of such a strategy, several hedge funds funded litigation on behalf of a bankrupt bank holding company involving a tax refund dispute with the Federal Deposit Insurance Corporation (FDIC).  Those funds are poised to profit handsomely following a decision by the U.S. Bankruptcy Court for the District of Delaware (Court) in favor of the bank holding company.  The four hedge funds financed the tax refund litigation on behalf of the bank holding company after the bankruptcy trustee ran out of money to finance continuing litigation.  The hedge funds also held notes issued by the bank holding company.  At issue was whether a huge tax refund was owned by the bank holding company or by a bank subsidiary.  If the bank subsidiary owned the refund, its receiver, the FDIC, would take it all.  However, if the bank holding company owned the refund, the FDIC would have to share it with other creditors of the bank holding company, including the hedge funds and other noteholders.  This article summarizes the facts of the case, the Court’s legal analysis and the anticipated distribution of the tax refund.  This article also identifies an ongoing bankruptcy that is factually similar (i.e., a bank holding company bankruptcy involving a dispute over a sizable tax refund) and may therefore lend itself to a similar litigation funding strategy.

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  • From Vol. 6 No.38 (Oct. 3, 2013)

    Chapter 15 of the Bankruptcy Code Presents Litigation Risks and Liability for Creditors, Counterparties, Service Providers and Others Doing Business with Bankrupt Offshore Hedge Funds

    Chapter 15 of the United States Bankruptcy Code (Bankruptcy Code) provides certain protections and tools to offshore hedge funds in liquidation and opens up parties that do business with such funds to possible litigation risk.  That chapter was created to preserve, protect and maximize the recovery of a foreign debtor’s assets located in the United States so that all creditors of that debtor may share in their value.  It is available to foreign liquidators and trustees in foreign bankruptcies, such as those filed in the Cayman Islands, British Virgin Islands and Bermuda, three popular countries in which offshore hedge funds organize.  It allows these foreign liquidators to come to the United States and use its courts and laws to seek, through discovery and lawsuits, the return of assets purportedly belonging to the foreign estates.  It is not a well-known bankruptcy proceeding, and it can create uncertain and substantial legal costs and liability for uninformed persons and entities who have dealt with offshore funds.  To best protect information and assets when dealing with an offshore hedge fund, it is critical for parties dealing with such funds to understand the possible discovery and recovery rights that a foreign liquidator of a bankrupt hedge fund may have under Chapter 15.  In a guest article, Marc D. Powers and Natacha Carbajal, senior partner and associate, respectively, at BakerHostetler, describe Chapter 15 proceedings, including highlighting how such proceedings work and what types of relief are available to the petitioner.  Powers and Carbajal also provide practice tips to help those dealing with offshore hedge funds mitigate the risks associated with Chapter 15 proceedings.  For additional coverage of Chapter 15 proceedings, see “Cayman Islands Liquidations of Failed Bear Stearns Hedge Funds Denied Access to US Bankruptcy Court,” The Hedge Fund Law Report, Vol. 1, No. 13 (May 30, 2008).

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  • From Vol. 6 No.34 (Aug. 29, 2013)

    U.S. District Court Upholds Hedge Fund’s Security Interest in Marc Dreier’s Art Collection

    Disgraced attorney Marc Dreier swindled his victims out of nearly $400 million in a scheme involving the issuance of fraudulent promissory notes.  Elliott International L.P. and Elliott Associates, L.P. (together, Elliott), were among Dreier’s largest victims, having purchased $100 million of fake notes in Dreier’s fraud.  As part of that transaction, Dreier had granted Elliott a security interest in eighteen works of art by well-known artists such as Damien Hirst, Roy Lichtenstein, Mark Rothko and Andy Warhol (Artwork) in Dreier’s personal collection.  Following his fraud conviction, certain of Dreier’s assets – including the Artwork – were forfeited to the U.S. government.  Elliott sought to recover the Artwork on the ground that its security interest in the Artwork gave it priority over Dreier’s other victims seeking restitution from Dreier’s estate.  Not surprisingly, those other victims objected.  The U.S. District Court for the Southern District of New York (Court) recently ruled on whether Elliott was, in fact, entitled to the Artwork by virtue of the security interest that Dreier had granted.  The Court’s decision is relevant both to hedge funds that hold security interests in connection with investments and to funds that seek restitution out of forfeited assets in the event of fraud.  This article summarizes the facts of the dispute and the Court’s legal analysis.  Dreier’s victims have also been sparring in bankruptcy court.  See “Federal Judge Approves Settlement Agreements Arising out of Marc Dreier’s Criminal Fraud; Hedge Fund Victims ‘Squabble’ Over Proposed Recovery,” The Hedge Fund Law Report, Vol. 3, No. 7 (Feb. 17, 2010).  One victim, Fortress Credit Corp., has tried unsuccessfully to recover from Dreier’s outside counsel.  See “Dismissal of Fortress’ Complaint Against Dechert Illustrates the Limits of a Hedge Fund Manager’s Ability to Rely on a Legal Opinion Issued by a Law Firm of Which It Is Not a Client,” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011); and “Affiliates of Hedge Fund Manager Fortress Investment Group Sue Dechert Over Opinion Letter Endorsing Marc Dreier,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).

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  • From Vol. 6 No.31 (Aug. 7, 2013)

    Recent U.S. Bankruptcy Court Decision Outlines the Standard for Determining When Creditors, Including Hedge Funds, Will Be Liable for Attorney’s Fees and Punitive Damages When They File Unsuccessful Involuntary Chapter 7 Bankruptcy Petitions

    The U.S. Bankruptcy Court for the Southern District of New York recently decided a debtor’s motion for attorney’s fees and punitive damages following the dismissal of involuntary Chapter 7 bankruptcy petitions filed by petitioning creditors, who are affiliates of a hedge fund firm.  Section 303(i) of the U.S. Bankruptcy Code authorizes a court to award debtors such amounts upon dismissal of an involuntary Chapter 7 bankruptcy petition.  The decision is instructive for hedge funds and other creditors in evaluating whether to file such petitions and how to approach the petitioning process in light of the potential for such awards.  This article summarizes the factual background and the Court’s analysis in this case.

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  • From Vol. 6 No.23 (Jun. 6, 2013)

    Coercive Exchanges: How Hedge Fund Noteholders Can Salvage Value Under Duress

    Issuers are closing transactions that effectively change the character of their notes without soliciting input or consent from noteholders holding a significant portion (albeit a minority) of the issuance, often leaving such holders with illiquid investments whose value has declined, sometimes materially, as a result of the issuer’s financial engineering.  Fortunately, minority noteholders have recourse if they act quickly.  Although each situation and indenture presents different challenges and opportunities requiring a specifically tailored response and litigation strategy, in general, noteholders have various arguments at their disposal.  In a guest article, Andreas P. Andromalos, a partner at Brown Rudnick LLP, and Gabriel N. Carreiro and Patrick G.H. Mott, both associates at Brown Rudnick, detail those arguments, the stakes and the supporting caselaw.

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  • From Vol. 6 No.18 (May 2, 2013)

    When Can Hedge Fund Investors Bring Suit Against a Service Provider for Services Performed on Behalf of the Fund?

    A federal district court recently considered whether claims brought by investors in a bankrupt hedge fund against a lender for allegedly aiding and abetting the fund manager’s breach of fiduciary duty and fraud against the hedge fund should be permitted to proceed.  The fundamental question at issue was whether the investors’ claims were direct claims that should be permitted to proceed or derivative claims that should have been brought by the hedge fund and therefore should be dismissed.  For another discussion of derivative suits in the hedge fund context, see “U.S. District Court Holds That Hedge Fund Investors Do Not Have Standing to Bring a Direct, As Opposed to Derivative, Claim against Hedge Fund Auditor PricewaterhouseCoopers LLP,” The Hedge Fund Law Report, Vol. 3, No. 47 (Dec. 3, 2010).  This article summarizes the factual and procedural background of the case as well as the court’s legal analysis and decision.

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  • From Vol. 6 No.12 (Mar. 21, 2013)

    BVI Court of Appeal Rules on Priority of Redeemed Investors Versus Remaining Investors in a Hedge Fund Liquidation

    The Court of Appeal of the Eastern Caribbean Supreme Court recently ruled on whether investors in a hedge fund, who had given notice of redemption but who had not been paid in full at the time the fund went into liquidation, have priority in the liquidation over fund investors who had not redeemed their shares prior to the liquidation.  This article recounts the relevant facts of the case and summarizes the Court’s decision and reasoning.  For a discussion of the trial court’s decision, see “British Virgin Islands High Court Issues Landmark Decision Affecting the Distribution Rights of Redeemed Versus Continuing Investors in a Liquidating Hedge Fund,” The Hedge Fund Law Report, Vol. 5, No. 47 (Dec. 13, 2012).

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  • From Vol. 6 No.7 (Feb. 14, 2013)

    U.K. Court Decision Helps Define the Amount of “Client Money” That Hedge Funds and Other Clients Are Entitled to Receive After a Brokerage Firm Fails

    In the U.K., broker-dealers and other regulated firms must segregate “client money” from the firm’s own funds, and hold such money in trust, to ensure that such money is available for distribution to hedge funds and other clients if the regulated firm fails.  The U.K.’s Financial Services Authority defines “client money” as “any money that a firm receives from or holds for, or on behalf of, a client in the course of, or in connection with its MiFID business.”  When a brokerage firm enters insolvency in the U.K., clients are entitled to prompt distribution of their pro rata share of the client money held by the regulated firm, determined as of the date an administrator is appointed for the firm – an event that is deemed by applicable regulations to be a “primary pooling event” (PPE).  However, until recently, it was not clear how administrators should value client positions that are open upon the occurrence of a PPE.  The U.K. High Court of Justice recently issued a ruling that clarifies how open client positions are to be valued in determining client money entitlements.  This article describes the U.K.’s “client money” regime to protect clients of regulated firms; summarizes the court’s decision and analysis in the ruling; and provides insight from partners at Sidley Austin LLP on the implications of the court’s decision for clients of regulated firms.  See also “How Can Hedge Funds Get Their Money Out of Lehman Brothers International Europe?,” The Hedge Fund Law Report, Vol. 2, No. 31 (Aug. 5, 2009).

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  • From Vol. 6 No.5 (Feb. 1, 2013)

    What Happens to a Claims Trade If a U.S. Bankruptcy Court and a Foreign Court Disagree on the Validity of the Trade?

    Hedge funds that purchase bankruptcy claims assume numerous risks, including uncertainty relating to the timing and amount of distributions to be received in bankruptcy proceedings.  In particular, claims purchasers run the risk that the purchased claim will be disallowed, reduced, or subordinated altogether.  See “Five Steps Hedge Fund Managers Should Take to Mitigate Avoidance and Disallowance Risks After Delaware Court Finds that Avoidance and Disallowance Risks Travel with Trade Claims,” The Hedge Fund Law Report, Vol. 5, No. 24 (Jun. 14, 2012).  A recent bankruptcy court opinion highlights another risk associated with bankruptcy claims trading – a risk relating to seller’s remorse where a seller “forum shops” among courts in different jurisdictions in an attempt to undo a trade.  In this case, the seller’s representative brought the matter to the U.S. Bankruptcy Court (U.S. Court) following an adverse decision in a “foreign main proceeding” in which a foreign court upheld a bankruptcy claim transaction entered into with a hedge fund purchaser.  In evaluating whether it would contravene the foreign court’s judgment, the U.S. Court considered: whether it was appropriate for the U.S. Court to conduct a plenary review under Section 363 of the U.S Bankruptcy Code (Code) to determine whether the transaction involved a transfer of property in the U.S., as mandated by Chapter 15 of the Code; and whether undoing the foreign court’s ruling would offend the principle of comity integral to Chapter 15 of the Code.  This article summarizes the factual background, legal analysis and decision in the case, including a discussion of the mechanics of Section 363; the requirement under Chapter 15 of a transfer of interest in property within the U.S.; and the doctrine of comity as applied in bankruptcy situations.

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  • From Vol. 5 No.47 (Dec. 13, 2012)

    British Virgin Islands High Court Issues Landmark Decision Affecting the Distribution Rights of Redeemed Versus Continuing Investors in a Liquidating Hedge Fund

    On November 16, 2012, the Commercial Division of the High Court in the British Virgin Islands issued a landmark decision bearing on the distribution rights of redeemed versus continuing investors in a hedge fund in liquidation.  Among other things, the decision provides insight to a hedge fund investor who must evaluate whether to redeem its investment in a fund that is expected to liquidate in the near future.  This article summarizes the factual background and legal analysis of the decision.  See also “Seventh Circuit Approves Federal Receiver’s Hedge Fund Liquidation Plan Subordinating Priority Rights of Redeeming Investors,” The Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).

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  • From Vol. 5 No.43 (Nov. 15, 2012)

    Tribune Bankruptcy Highlights the Importance of Close Reading of Indenture Agreements by Hedge Funds That Trade Bankruptcy Claims or Distressed Debt

    The interpretation of language contained in indenture agreements that are often entered into years prior to a bankruptcy filing of the borrower will significantly impact the ultimate recovery by noteholders – as demonstrated by the ongoing saga involving the Tribune Company.  In a guest article, Richard J. Corbi of Lowenstein Sandler PC provides an analysis of developments in the Tribune bankruptcy relevant to hedge funds that invest in distressed debt, bankruptcy claims and related instruments.

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  • From Vol. 5 No.36 (Sep. 20, 2012)

    Bankruptcy Trustee of Banyon Hedge Funds Sues Crime Insurance Carriers and Broker Over Refusal to Pay on Crime Insurance Claim With Respect to Scott Rothstein/RRA Ponzi Scheme

    Hedge fund managers typically procure various categories of insurance coverage with respect to their activities, including directors and officers (D&O) insurance, errors and omissions insurance and crime insurance coverage.  See “Hedge Fund D&O Insurance: Purpose, Structure, Pricing, Covered Claims and Allocation of Premiums Among Funds and Management Entities,” The Hedge Fund Law Report, Vol. 4, No. 41 (Nov. 17, 2011).  However, as in many categories of insurance, insurers sometimes resist paying claims made by hedge fund managers.  A defense to payment of claims typically asserted by insurers is that the insured, e.g., the hedge fund manager, made misrepresentations on the insurance application.  An example of this type of dispute is the recent litigation between Level Global, L.P. and XL Special Insurance Company.  See “New York District Court Orders Insurer XL to Advance Defense Costs to Level Global Under D&O Policy,” The Hedge Fund Law Report, Vol. 5, No. 27 (Jul. 12, 2012).  Another dispute of this type was recently initiated when eight insurers refused to pay out on a claim for $70 million in crime insurance procured by a group of hedge fund managers.

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  • From Vol. 5 No.36 (Sep. 20, 2012)

    SEC Receiver for Arthur Nadel’s Scoop Capital Hedge Funds Moves to Settle Malpractice Claim Against Law Firm Holland & Knight

    In January 2009, hedge fund sponsor Arthur Nadel disappeared, and his $300 million Ponzi scheme collapsed.  Law firm Holland & Knight LLP, and one of its partners (together, H&K), had provided legal services to Nadel’s funds and management companies.  A receiver for Nadel’s funds was appointed at the request of the Securities and Exchange Commission.  As part of his efforts to recover funds for investors, the receiver sued H&K for malpractice.  H&K has recently agreed to settle that malpractice litigation for $25 million.  The receiver has asked the court supervising the receivership to approve the settlement.  This article provides background on Nadel’s fraud and summarizes the terms of the H&K settlement.

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  • From Vol. 5 No.29 (Jul. 26, 2012)

    U.S. Bankruptcy Court Rules on Whether Money Managers’ “Soft Dollar” Credits Are Entitled to “Customer” Priority in Lehman SIPA Liquidation

    When Lehman Brothers collapsed in 2008, hundreds of money managers that used its brokerage arm, Lehman Brothers Inc. (Lehman), to execute trades were left with unspent “soft dollar” commission credits.  In the Lehman liquidation proceeding, a number of those managers claimed that they were “customers” of Lehman with respect to those soft dollar balances within the meaning of the Securities Investor Protection Act of 1970 (SIPA).  Brokerage “customers” are entitled to priority in a SIPA liquidation over the claims of unsecured creditors of the brokerage firm.  The U.S. Bankruptcy Court for the Southern District of New York (Bankruptcy Court) recently ruled on whether the money managers’ claims for “soft dollar” credit balances represent “customer” claims under SIPA or whether such claims must be treated as general unsecured claims.  This article summarizes the background in this case and the Bankruptcy Court’s decision and reasoning.

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  • From Vol. 5 No.28 (Jul. 19, 2012)

    Second Circuit Panel Upholds $20.6 Million FINRA Arbitration Award Against Prime Broker Goldman Sachs in Connection with Fraudulent Transfers Into and Among Bayou Fund Accounts

    The amount of due diligence that hedge fund prime brokers should conduct with respect to the source of funds deposited and maintained in brokerage accounts has been a topic of keen interest for hedge fund managers, investors and prime brokers, particularly in light of the ongoing litigation between the creditors of the defunct Bayou Group funds and the funds’ prime broker, Goldman Sachs Execution & Clearing, P.C. (GSEC).  See “Does a Prime Broker Have a Due Diligence or Monitoring Obligation When Paying With Soft Dollars for a Hedge Fund Customer’s Access to Expert Networks or Other Alternative Research?,” The Hedge Fund Law Report, Vol. 3, No. 49 (Dec. 17, 2010).  In the latest round of that litigation, a three-judge panel of the U.S. Court of Appeals for the Second Circuit denied GSEC’s appeal of a district court ruling that upheld a $20.6 million arbitration award against GSEC.  See “District Court Suggests That Prime Brokers May Have Expanded Due Diligence Obligations,” The Hedge Fund Law Report, Vol. 3, No. 44 (Nov. 12, 2010).  The arbitrators’ decision, seemingly based in part on the theory that GSEC should have identified red flags in connection with the Bayou fraud, was not rendered in “manifest disregard of the law,” suggesting that prime brokers are indeed at risk for such types of claims.  See “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).  This article analyzes the Second Circuit’s Summary Order.

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  • From Vol. 5 No.28 (Jul. 19, 2012)

    Hedge Fund Fletcher International Sues to Prevent Liquidators of Its Feeder Funds from Forcing It into Voluntary Liquidation

    On July 2, 2012, days after it filed for bankruptcy relief in New York under Chapter 11 of the U.S. Bankruptcy Code (Bankruptcy Code), Fletcher International, Ltd. (Debtor), a master fund in a master-feeder structure, sued some of its own Cayman Islands-based feeder funds to block liquidators from disrupting its bankruptcy proceedings and forcing an asset sale.  The Debtor is appealing the ruling of the Grand Court of the Cayman Islands, which appointed Ernst & Young as liquidators of the feeder funds after three Louisiana pension funds sued to redeem their interests in the feeder funds.  See “Cayman Grand Court Ruling Supports Proposition That Hedge Fund Managers Do Not Have Unfettered Discretion in Making Distributions In Kind to Investors,” The Hedge Fund Law Report, Vol. 5, No. 19 (May 10, 2012).  The Debtor generally argues that the Ernst & Young liquidators lack the knowledge of its unique assets necessary to maximize returns for its creditors and shareholders in bankruptcy proceedings.  This article summarizes the factual background and the allegations in the Debtor’s complaint.

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  • From Vol. 5 No.27 (Jul. 12, 2012)

    Lesson from Lehman Brothers for Hedge Fund Managers: The Effect of a Bankruptcy Filing on the Value of the Debtor’s Derivative Book

    Prior to its bankruptcy filing, Lehman Brothers (Lehman) was a global broker-dealer/investment bank that conducted trades and made investments on behalf of itself as well as its clients, including many hedge fund managers.  As part of this business, Lehman entered into a large number of “derivatives” transactions – such as credit default swaps, interest rate swaps and currency swaps – both for speculative and hedging purposes.  As of August 2008, Lehman held over 900,000 derivatives positions worldwide, in each case through one of its operating subsidiaries.  In many instances, Lehman’s ultimate parent entity, Lehman Brothers Holdings Inc. (LBHI), guaranteed the obligations arising out of these derivatives positions.  As of August 31, 2008, Lehman internally estimated that, on an aggregate basis, its derivatives positions had a positive net value of approximately $22.2 billion, representing a significant asset of the company.  This substantial “in the money” position abruptly turned “out of the money” as the result of LBHI’s bankruptcy filing in the early morning of September 15, 2008.  The commencement of LBHI’s bankruptcy case – the largest by far in U.S. history, with claims well exceeding $300 billion – provided a contractual basis for a large majority of Lehman’s derivatives counterparties to terminate their transactions with Lehman.  As a result, more than 80 percent of Lehman’s derivatives positions terminated as of, or soon after, the date of the bankruptcy filing.  Alvarez & Marsal, Lehman’s restructuring advisors, concluded in a three-month internal study that the losses from terminated derivatives trades cost the bankruptcy estate “at least” $50 billion.  In a guest article, Solomon J. Noh, a partner in the Global Restructuring Group at Shearman & Sterling LLP, examines what may be one of the principal reasons why Lehman’s bankruptcy filing resulted in such an extraordinary loss in value for the Lehman estate and how Congress has proposed to address this problem in any future failure of a major financial institution.  See also “Treatment of a Hedge Fund’s Claims Against and Other Exposures To a Covered Financial Company Under the Orderly Liquidation Authority Created by the Dodd-Frank Act,” The Hedge Fund Law Report, Vol. 4, No 15 (May 6, 2011).

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  • From Vol. 5 No.25 (Jun. 21, 2012)

    U.S. Supreme Court Resolves Circuit Split and Affirms Secured Creditors’ Right to Credit Bid Under Chapter 11 Plan

    On May 29, 2012, in RadLAX Gateway Hotels, LLC et al. v. Amalgamated Bank, the United States Supreme Court (Court) unanimously upheld the right of a secured creditor (such as a hedge fund that invests in secured distressed debt) to credit bid up to the full face value of its claim at the sale of collateral conducted under a so-called “cramdown” reorganization plan pursuant to Chapter 11 of the U.S. Bankruptcy Code.  The RadLAX decision resolved a split among the courts of appeals that led to uncertainty among lenders and debt investors, and forum shopping by debtors.  Previously, the Seventh Circuit affirmed the right to credit bid, whereas the Third and Fifth Circuits held that debtors could cram down a plan on dissenting secured creditors without affording them the right to credit bid as long as they were provided the “indubitable equivalent” of their claim.  See “Seventh Circuit Holds that Secured Lenders Must Have the Opportunity to Credit Bid in Asset Sales Under a Chapter 11 Plan,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  This article summarizes the factual background of RadLAX, the Court’s decision and the implications of the decision for hedge fund managers.

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  • From Vol. 5 No.23 (Jun. 8, 2012)

    Recent Cayman Islands Developments Impacting Fund Governance, Master Fund Registration and the Insolvency Regime: An Interview with Neal Lomax, Simon Dickson and Simon Thomas of Mourant Ozannes

    Cayman Islands legislators and courts have been increasingly active in enacting reforms and deciding cases with relevance to hedge fund managers and fund investors.  The Hedge Fund Law Report recently interviewed Neal Lomax, Simon Dickson and Simon Thomas of Mourant Ozannes’ Cayman office to get their perspective on this recent activity.  Specifically, our interview covered developments and market practice with respect to: fund governance in the aftermath of the Cayman Grant Court’s decision in Weavering; recent legislative developments, including the new registration regime for Cayman-domiciled master funds; and recent judicial decisions that reshape the Cayman fund insolvency regime.  This article contains the full text of our interview.

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  • From Vol. 5 No.22 (May 31, 2012)

    In What Circumstances Can U.S. and Other Foreign Judgments Be Enforced Against Cayman Islands Hedge Funds?

    Parties considering bringing proceedings against Cayman Islands hedge funds in other jurisdictions should ensure that any judgment that might be obtained in a foreign jurisdiction will be recognized and enforced by the Cayman courts.  On the flip side, Cayman-domiciled hedge funds facing claims in foreign jurisdictions will need to consider the safety of ignoring and not participating in those proceedings, on the assumption that any judgment obtained will not be recognized and enforced by the Cayman courts.  In a guest article, Christopher Russell and Joanne Collett, Partner and Senior Associate, respectively, at Appleby, survey the landscape that informs whether Cayman courts will enforce such judgments.  These issues arise in particular in the context of enforceability of judgments obtained by default where the Cayman fund does not participate in the foreign proceedings, and in particular in the context of judgments and orders obtained in insolvency proceedings in light of the increasing trend towards universality of insolvency proceedings.

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  • From Vol. 5 No.12 (Mar. 22, 2012)

    Recent Bankruptcy Court Opinion Affirms That Safe Harbor Provision in Bankruptcy Code Provides Some Protection to Hedge Fund Investors Who Face Suits to Claw Back Redemption Proceeds from Trustees of Bankrupt Hedge Funds

    Hedge fund investors, including funds of funds, ultimately want certainty once they redeem their investments in hedge funds.  However, in recent years, this certainty has eroded (and therefore, investors’ confidence has been shaken) as proactive bankruptcy trustees have sought to claw back redemption proceeds from investors that redeemed their investments prior to the declaration of bankruptcy by hedge funds, particularly those funds that invested in Ponzi schemes.  See “Federal Court Affirms the Ability of a Bankruptcy Trustee to Claw Back Fictitious Profits from Investors in LPs or LLCs Operated as Ponzi Schemes,” The Hedge Fund Law Report, Vol. 4, No. 45 (Dec. 15, 2011).  In such cases, trustees have pressed claims based on the theory that the redemption proceeds represent fraudulent transfers.  However, the Bankruptcy Code (Code) provides a safe harbor provision (Safe Harbor Provision), found in Sections 546(e) and 546(g) of the Code, that protects investors by effectively barring trustees from making such claims against certain persons that have been paid prior to the declaration of bankruptcy by an estate, such as a hedge fund.  A recent opinion issued by a federal Bankruptcy Court provides some welcome news for hedge fund investors with respect to the application of the Safe Harbor Provision, as it is applied in the hedge fund context.  This article describes the facts and legal analysis in that opinion.

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  • From Vol. 5 No.9 (Mar. 1, 2012)

    Recent Federal Court Decision Outlines Approach to Determining When a Payment Received by a Service Provider Will Constitute a Fraudulent Transfer from Those Orchestrating a Ponzi Scheme

    The Madoff scandal has demonstrated that receivers appointed on behalf of troubled funds that were actually or allegedly run as Ponzi schemes can aggressively pursue legal action to recover funds misappropriated from investors.  See “Two Recent Federal Court Decisions Clarify the Differing Treatment under SIPA of Returned Principal and Fictitious Profits,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).  To date, receivers continue to aggressively pursue such actions.  This article outlines the approach recently taken by a federal court in determining when a fraudulent transfer has been made to a service provider from persons that have operated a Ponzi scheme.

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  • From Vol. 4 No.45 (Dec. 15, 2011)

    Federal Court Affirms the Ability of a Bankruptcy Trustee to Claw Back Fictitious Profits from Investors in LPs or LLCs Operated As Ponzi Schemes

    On October 27, 2011, the Federal Court of Appeals for the Eleventh Circuit issued an opinion upholding clawback protections for members of limited liability companies and partners of limited partnerships who are victims of a Ponzi scheme.  This decision reaffirmed the general rule that, in the case of a Ponzi scheme, the return of an investor’s principal cannot be avoided where the investor can prove that he took that money in good faith.  See “Two Recent Federal Court Decisions Clarify the Differing Treatment under SIPA of Returned Principal and Fictitious Profits,” The Hedge Fund Law Report, Vol. 4, No. 34 (Sep. 29, 2011).  Procedurally, the decision affirmed the lower court’s ruling and resolved an issue of first impression in the Eleventh Circuit.  This article explains the factual background of the decision and the court’s legal analysis, and references relevant HFLR articles.  Much of what we publish is intended to help hedge fund investors avoid Ponzi schemes and similar bad investment calls.  See, e.g., “What Should Hedge Fund Investors Be Looking for in the Course of Operational Due Diligence and How Can They Find It?,” The Hedge Fund Law Report, Vol. 4, No. 36 (Oct. 13, 2011).  However, despite best efforts, even savvy investors sometimes wind up in Ponzi schemes.  See “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).  This article is intended to help clarify the rights and obligations of such investors.

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  • From Vol. 4 No.43 (Dec. 1, 2011)

    Motion for Appointment of an Examiner in Dynegy Bankruptcy Illustrates the Divergence of Interests of Investors in Equity and Debt of the Same Issuer Group

    In the latest round of sparring between holders of bonds guaranteed by bankrupt defendant Dynegy Holdings LLC (Dynegy Holdings) and Dynegy’s equity holders, the indenture trustee for those bonds has moved that the Bankruptcy Court appoint an examiner to review the circumstances under which Dynegy sold its profitable coal-fired power plants to its parent company, Dynegy Inc., shortly before Dynegy Holdings filed for Chapter 11 protection.  Dynegy Inc. is not in bankruptcy and its shareholders stand to benefit from the deal at the expense of Dynegy Holdings’ bondholders.  The indenture trustee alleges, among other things, that the sale of assets was for less than fair value, involved self-dealing by Dynegy directors and was structured to frustrate the bondholders’ efforts to challenge the deal.  This article summarizes the bondholders’ allegations and legal arguments.  More generally, the motion illustrates one of the many fact patterns in which interests of holders of equity and debt of the same issuer group may diverge in a bankruptcy.  Hedge funds often get involved in distressed situations at different levels of the capital structure, and this article helps clarify the relative strengths and weaknesses of equity versus debt.  More generally, this article demonstrates that court decisions can affect investment outcomes in distressed investing as or more powerfully than economic fundamentals.  Given the unpredictability of legal outcomes, distressed investing – whether via debt, equity or something else – may offer a genuinely uncorrelated investment opportunity, which is increasingly rare in this era when debt, equity and even some commodity markets are moving in unison, all with an eye on Europe.  See “The Impact of Asymmetric Information, Trade Documentation, Form of Transfer and Additional Terms of Trade on Hedge Funds’ Trade Risk in European Secondary Loans (Part Two of Two),” The Hedge Fund Law Report, Vol. 4, No. 38 (Oct. 27, 2011).

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  • From Vol. 4 No.39 (Nov. 3, 2011)

    Bondholders of Bankrupt Icelandic Bank Kaupthing Singer and Friedlander Battle with Other Bank Creditors over Competing Claims

    This case pits the creditors of failed bank Kaupthing Singer and Friedlander Limited (KSF) against holders of bonds issued by KSF subsidiary Singer & Friedlander Funding plc (Funding).  Both of those entities are now in administration (bankruptcy) in the UK.  KSF had guaranteed Funding’s bonds and sought to use a claim for indemnification from Funding under that guarantee to offset other amounts it owed to Funding.  The UK Supreme Court ruled on whether the rule against double proof takes precedence over a conflicting equitable principle.  We summarize the Supreme Court’s decision.  For a deep discussion of the chief regulatory, tax, documentation, insider trading and other legal and business issues impacting hedge funds’ trade risk in European secondary loans, see Part One and Part Two of the two-part article series recently published in the HFLR by attorneys at Schulte Roth & Zabel LLP.

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  • From Vol. 4 No.37 (Oct. 21, 2011)

    Lehman Brothers Court Holds Triangular Setoff Provisions Unenforceable in Bankruptcy

    On October 4, 2011, the United States Bankruptcy Court for the Southern District of New York held that Section 553(a) of the Bankruptcy Code renders unenforceable cross-affiliate netting or “triangular” (non-mutual) setoff provisions to the extent they cover non-mutual debts between the debtor and entities affiliated with the creditor.

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  • From Vol. 4 No.37 (Oct. 21, 2011)

    CDOs are Not Necessarily Bankruptcy Remote: U.S. Judge Refuses to Dismiss Involuntary Bankruptcy Proceedings Against Cayman-Based CDO, Zais Investment Grade Limited VII

    On August 26, 2011, Judge Raymond T. Lyons of the United States Bankruptcy Court for the District of New Jersey issued an opinion refusing to either dismiss or abstain from the involuntary bankruptcy proceedings filed by senior noteholders of Cayman Islands collateralized debt obligation issuer (CDO) Zais Investment Grade Limited VII.  For further analysis of considerations when dealing with collateralized obligations, see “Key Legal and Business Considerations for Hedge Fund Managers When Purchasing Collateralized Loan Obligation Management Contracts,” The Hedge Fund Law Report, Vol. 3, No. 13 (Apr. 2, 2010).

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  • From Vol. 4 No.35 (Oct. 6, 2011)

    WaMu Bankruptcy Judge Allows Equity Committee’s Action for Equitable Disallowance of Hedge Fund Noteholders’ Claims to Proceed on the Ground that Equity Committee Stated a “Colorable Claim” that those Noteholders Engaged in Insider Trading

    In a shot across the bow of investors who trade in the debt of bankrupt companies, a U.S. bankruptcy court has held that the Equity Committee of Washington Mutual, Inc. (WaMu) has stated a “colorable claim” that four hedge funds that held WaMu debt and participated in bankruptcy settlement negotiations engaged in insider trading when they traded WaMu’s debt.  Hedge funds Appaloosa Management, L.P., Aurelius Capital Management LP, Centerbridge Partners, LP, and Owl Creek Asset Management, L.P. (together, Noteholders), acquired enough WaMu debt that they were in a position to block approval of portions of WaMu’s plan of reorganization.  As a result, they were allowed to participate in negotiations among the various stakeholders in the bankruptcy.  WaMu’s Equity Committee alleged that the Noteholders had engaged in insider trading using information they received during settlement negotiations and that, as a result, their claims should be equitably disallowed.  In a wide-ranging decision denying confirmation of WaMu’s sixth amended reorganization plan, the Court ruled that the Equity Committee had alleged a colorable claim of insider trading by the Noteholders that could support equitable disallowance of their claims.  This article provides a feature length synopsis of the facts that gave rise to the insider trading charges, and the Court’s reasoning.

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  • From Vol. 4 No.34 (Sep. 29, 2011)

    Two Recent Federal Court Decisions Clarify the Differing Treatment under SIPA of Returned Principal and Fictitious Profits

    Two recent federal court decisions – one at the circuit level and the other at the district court level, and both arising out of the Madoff Ponzi scheme – offer further clarification on the differing legal status of returns to investors in a fraud of invested principal versus returns of fictitious profits.  In turn, the differing legal status of these two categories of returns impacts the extent to which the trustee can claw back money from investors and the extent to which investors can make valid claims on the estate.  See “Two Key Levels of Risk Facing Hedge Funds That Buy or Sell Bankruptcy Claims,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).  For hedge fund managers that trade Madoff claims or other bankruptcy claims, these legal decisions will impact the investment calculus.  The circuit court decision also offers important insight on the complex process of calculating “net equity” under SIPA – an issue that many hedge fund managers first encountered when trying (often with limited success) to get money out of Lehman’s failed U.S. prime brokerage business, and an issue that continues to impact the value of Madoff claims.  See generally “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011).

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  • From Vol. 4 No.33 (Sep. 22, 2011)

    Delaware Bankruptcy Court Rejects Efforts of Moll Industries’ Unsecured Creditors to Recharacterize as Equity the Secured Debt Held by Highland Capital Funds and to Hold Highland Capital Liable as Moll’s “Alter Ego”

    This adversary proceeding pits the committee of unsecured creditors (Committee) of Moll Industries, Inc. (Moll) against hedge fund manager Highland Capital Management, L.P. (Highland) and several Highland funds that were secured creditors of Moll (Funds).  The Committee claimed that the Moll senior debt held by the Funds should be equitably subordinated to Moll’s unsecured debt, or recharacterized as equity, thereby eliminating the priority that the Funds would otherwise have in the bankruptcy proceeding.  The Committee also claimed that Highland was liable to Moll’s unsecured creditors because it acted as Moll’s “alter ego.”  Finally, it sought to void a security interest held by the Funds in one of Moll’s bank accounts.  Highland and the Funds all moved to dismiss the Committee’s complaint.  The Court permitted the security interest avoidance claim to proceed but dismissed the equitable subordination, recharacterization and alter ego claims.  This article provides a comprehensive discussion of the Court’s decision and analysis.

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  • From Vol. 4 No.32 (Sep. 16, 2011)

    When Can the Liquidators of Non-U.S. Hedge Funds Access U.S. Bankruptcy Courts to Obtain Ancillary Relief for Fund Investors?

    On August 26, 2011, the United States Bankruptcy Court for the Southern District of New York granted a petition by the joint liquidators of Millennium Global Emerging Credit Master Fund Limited (Master Fund) and Millennium Global Emerging Credit Fund Limited (Feeder Fund, collectively the Funds) seeking, inter alia, recognition in the United States of a Bermuda liquidation proceeding as a “foreign main proceeding” or “foreign nonmain proceeding.”  The decision is a noteworthy development on an obscure but important area of law for distressed debt hedge funds.  The case has particular relevance for hedge funds organized in Bermuda, because the Court also reaffirmed that Bermuda has a sophisticated, fair and impartial legal system entitled to recognition and comity in the United States.  For a comparison with the problems of recognition facing Cayman Islands proceedings, see “Delaware Bankruptcy Court Recognizes Cayman Islands Proceeding as ‘Foreign Main Proceeding’ Under Chapter 15 of the U.S. Bankruptcy Code,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb 11, 2010).  For more on the recent changes to the definition of “center of main interests," see “Amendments to Bankruptcy Rule 2019 Recently Approved by the U.S. Supreme Court Add Disclosure Requirements While Protecting Distressed Debt Funds’ Proprietary Trading Strategies,” The Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011).  This article details the background of the action and the Court’s pertinent legal analysis.

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  • From Vol. 4 No.27 (Aug. 12, 2011)

    Two Key Levels of Risk Facing Hedge Funds That Buy or Sell Bankruptcy Claims

    The bankruptcy claims trading market is growing at a rapid clip.  By one estimate, the global bankruptcy claims trading market grew by five times, from $8 billion in 2009 to $40 billion in 2010.  According to our sources, even with significant cash on corporate balance sheets, sovereign credit concerns are likely to lead, directly or indirectly, to corporate defaults – particularly in Europe – which will only increase the size of the claims trading opportunity set.  Claims trading is complex, interdisciplinary, obscure, laborious and largely unregulated.  In short, it is the sort of investment activity for which certain hedge funds are ideally structured and staffed; and, not surprisingly, trading by hedge funds has been a significant driver of the growth in claims trading.  See “Treatment of a Hedge Fund’s Claims Against and Other Exposures To a Covered Financial Company Under the Orderly Liquidation Authority Created by the Dodd-Frank Act,” The Hedge Fund Law Report, Vol. 4, No. 15 (May 6, 2011).  As hedge fund managers that participate in claims trading know, and as managers that consider entry into the claims trading market quickly find out, investment outcomes when trading claims are powerfully influenced by legal considerations.  See “Second Circuit Adopts Broad Interpretation of Bankruptcy Code § 546(e) Safe Harbor for Securities ‘Settlement Payments,’ Ruling that Safe Harbor Applies to Enron’s Redemptions of Its Own Commercial Paper Prior to Maturity,” The Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  And legal considerations typically apply to claims trades at two levels – the estate level and the trade level.  The chief risk at the estate level is that the ultimate value of the estate will depart significantly from the expected value of the estate at the time of purchase of a claim.  The chief risks at the trade level are that the claim will be disallowed, reduced or subordinated, or that the seller of the claim itself will become insolvent.  This article analyzes the two levels of legal risk in claims trading by examining two different sources.  First, with respect to “estate risk,” this article provides a comprehensive analysis of a recent decision by Judge Rakoff in the Madoff liquidation.  That decision generally held that the Trustee does not have standing to bring common law claims against third parties on behalf of creditors of the Madoff estate or the estate itself.  While one typically thinks of spreadsheets rather than standing when thinking about hedge fund returns, this decision may have a material impact on the value of Madoff claims, in which a robust market has developed.  (As of immediately prior to the Rakoff decision, Madoff claims were trading for 65 to 70 cents on the dollar.)  The common law claims that Judge Rakoff did not permit to proceed sought approximately $8.6 billion from deep-pocketed defendants.  Further, a significant portion of the expected value of the Madoff estate consisted (at least prior to this decision) of anticipated proceeds from similar common law claims against similarly situated defendants, i.e., large financial institutions that served as “conduits” for investments into the Madoff operation.  Moreover, Rakoff’s decision was stern, unambiguous and forcefully reasoned.  According to our sources, the decision is unlikely to be reversed or revised on appeal.  Second, with respect to trade risk, this article outlines an insightful recent article authored by Lawrence V. Gelber, David J. Karp, and Jamie Powell Schwartz, Partner, Special Counsel and Associate, respectively, at Schulte Roth & Zabel LLP.  In particular, this article outlines the relevant points from the Schulte article regarding “notional amount risk,” “counterparty credit risk” and how to mitigate both categories of risk in claim trade documentation.  In short, any hedge fund manager considering the purchase of a bankruptcy claim must ask two questions in order to assess whether to purchase and at what price: How big is the pie?  And how secure will my access to the pie be?  The purpose of this article is to highlight issues that are relevant in answering these two questions.

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  • From Vol. 4 No.25 (Jul. 27, 2011)

    Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices

    The United States District Court for the Southern District of New York recently issued judgments in favor of three bankrupt hedge funds in fraudulent conveyance actions against investors that redeemed within two years of the funds’ bankruptcy filings.  The hedge funds were members of the Bayou group of hedge funds, which – as the hedge fund industry knows well – was a fraud that collapsed in August 2005, resulting in bankruptcy filings by the Bayou funds and related entities in May 2006.  These judgments are very important for hedge fund investors because they illustrate what appears to be a direct conflict between bankruptcy law and hedge fund due diligence best practices.  In short, hedge fund due diligence best practices currently counsel in favor of redemption at the first whiff of fraud on the part of a manager.  However, bankruptcy law appears to require a hedge fund investor to undertake a “diligent investigation” when it obtains facts that put it on inquiry notice of insolvency of the fund or a fraudulent purpose on the part of the manager.  The immediacy of a prompt redemption is directly at odds with the delay inherent in a diligent investigation.  How can hedge fund investors reconcile the practical goal of prompt self-help with the legal obligation of a diligent investigation?  To help answer that question, this feature length article surveys the factual and procedural history of the Bayou matters, then analyzes the arguments and outcome in the recent Bayou trial.  The primary question at the trial was whether certain investors that redeemed from the Bayou funds could keep their redemption proceeds based on “good faith” defenses to the Bayou estate’s fraudulent conveyance actions.  In the absence of a court opinion, The Hedge Fund Law Report analyzed the 142-page transcript of the closing arguments, as well as the motion papers filed by the parties and four prior bankruptcy court and district court opinions.  This article embodies the results of our analysis.  The article concludes by identifying five ways in which hedge fund investors may reconcile hedge fund due diligence best practices with the seemingly draconian outcome in these recent Bayou judgments.

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  • From Vol. 4 No.24 (Jul. 14, 2011)

    Second Circuit Adopts Broad Interpretation of Bankruptcy Code § 546(e) Safe Harbor for Securities “Settlement Payments,” Ruling that Safe Harbor Applies to Enron’s Redemptions of Its Own Commercial Paper Prior to Maturity

    In the months leading up to Enron Corp.’s bankruptcy, Enron drew down on its available credit lines.  It used about $1.1 billion of the loan proceeds to redeem commercial paper that it had issued prior to maturity.  Enron redeemed the paper at face value even though it was trading at a substantial discount.  Enron filed for bankruptcy in December 2001 and emerged as a reorganized entity, Plaintiff Enron Creditors Recovery Corp. (together with Enron Corp., Enron).  In 2003, Enron commenced adversary proceedings against about 200 financial institutions from which it had repurchased commercial paper in 2001.  Enron claimed that those payments could be “avoided” and recovered because they were either preferential payments of antecedent debt made within ninety days prior to bankruptcy or fraudulent transfers because Enron paid more than fair market value for the paper.  The Defendants moved for summary judgment on the ground that Enron’s payments were securities “settlement payments” protected from recovery by a safe harbor in the Bankruptcy Code.  The Bankruptcy Court denied the Defendants’ motion.  The U.S. district court reversed the bankruptcy judge’s decision and dismissed the action.  On appeal, the Second Circuit upheld that dismissal, adopting a broad interpretation of the § 546(e) safe harbor.  We provide a detailed review of the Second Circuit’s legal analysis, and of the decisions below.

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  • From Vol. 4 No.22 (Jul. 1, 2011)

    Enforcement in the Cayman Islands of U.S. and Other Foreign Judgments: How Safe Is It for Hedge Fund Managers to Allow Judgment to Be Entered by Default?

    Cayman Islands hedge funds, their directors and service providers, are increasingly appearing as defendants in U.S. litigation, in particular in the aftermath of the Madoff fiasco.  These entities are facing a variety of claims, not always structured appropriately under Cayman Islands law, and not always structured with any particularity.  Broad, sweeping allegations of fraud, gross negligence, the existence of fiduciary and other duties, and clawback claims based on unjust enrichment are thrown in, not always with the application that should be displayed before launching such serious allegations.  Many of these claims face motions to dismiss, often on the basis of applicable Cayman Islands law, in particular, the existence of fiduciary and other duties under Cayman Islands law, derivative claims, reflective loss and exculpation and indemnity clauses.  See “Exculpation and Indemnity Clauses in the Hedge Fund Context: A Cayman Islands Perspective (Part Two of Two),” The Hedge Fund Law Report, Vol. 4, No. 1 (Jan. 7, 2011).  It was not uncommon for Cayman Islands lawyers in the past to advise Cayman Islands funds, and other related Cayman entities facing U.S. proceedings, that since they were Cayman Islands entities, it was safe not to participate in the U.S. proceedings, even for the purpose of challenging the jurisdiction of the U.S. court – and to allow a judgment to be entered in the U.S. court, because the U.S. judgment would not be enforceable against them in the Cayman court.  Such advice, even if (rarely) appropriate in individual cases, could not be, and never was, of universal applicability.  There are very clear risks in advising a Cayman entity not to challenge the jurisdiction of a U.S. or other foreign court, where such a challenge can be mounted with a sufficient prospect of success, and, whether or not such an application is made, in allowing a judgment to be entered in default by not participating to defend the proceedings, on the premise that any such judgment would not be enforceable in the Cayman Islands court.  In a guest article, Chris Russell, a partner and head of the litigation and insolvency department of Ogier Cayman, and Michael Makridakis, a senior associate at Ogier, provide an overview of relevant law; identify the relevant common law rules and defenses; and discuss the enforcement of judgments in foreign insolvency proceedings.

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  • From Vol. 4 No.18 (Jun. 1, 2011)

    Bankruptcy Court Holds That a Provision in a Derivative Contract Subordinating Payments to a Bankrupt Counterparty May Be an Unenforceable Ipso Facto Clause

    On May 12, 2011, the United States Bankruptcy Court for the Southern District of New York, in its oversight of the jointly administered chapter 11 bankruptcy cases of Lehman Brothers Holding, Inc. (LBHI) and Lehman Brothers Special Financing, Inc. (LBSF), found that a provision in a derivative contract that would subordinate payments to a counterparty in the event of its bankruptcy or insolvency may constitute an unenforceable ipso facto clause, and that the termination payments provision of the relevant contract was not eligible for the Bankruptcy Code safe harbor for qualified financial contracts.  This decision reaffirmed the holding in a prior decision in the LBHI bankruptcy.  See “Bankruptcy Court Finds Unenforceable CDO Provisions Subordinating Swap Termination Payments to Swap Counterparty Lehman Brothers as a Result of Its Bankruptcy,” The Hedge Fund Law Report, Vol. 3, No. 5 (Feb. 4, 2010).  Although this decision largely follows the legal analysis in the prior decision rather than breaking new legal ground, this decision is likely to increase the negotiating leverage of the LBHI estate vis-à-vis swap and other counterparties.  More generally, the decision sheds additional light on the treatment of bankruptcy/insolvency-based termination provisions in derivatives contracts.  This article details the background of the adversary proceeding and the Court’s legal analysis.  For more on the operation of bankruptcy/insolvency-based termination provisions in qualified financial contracts under the Bankruptcy Code and Title II of the Dodd-Frank Act, see “Treatment of a Hedge Fund’s Claims Against and Other Exposures To a Covered Financial Company Under the Orderly Liquidation Authority Created by the Dodd-Frank Act,” The Hedge Fund Law Report, Vol. 4, No. 15 (May 6, 2011).

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  • From Vol. 4 No.16 (May 13, 2011)

    Amendments to Bankruptcy Rule 2019 Recently Approved by the U.S. Supreme Court Add Disclosure Requirements While Protecting Distressed Debt Funds’ Proprietary Trading Strategies

    The success or failure of a distressed debt investment strategy depends, in part, on the ability of a bankruptcy investor to prevent other investors in the same bankruptcy from obtaining information on its purchase and sale activity.  Rule 2019 of the Federal Rules of Bankruptcy Procedure has threatened to undermine the confidentiality of bankruptcy trading information.  At least some courts in the past two years have construed Rule 2019 to require bankruptcy investors to disclose the value of claims, the timing of purchase, amount paid and the fact of sales.  On April 26, 2011, the U.S. Supreme Court adopted amendments to Rule 2019.  This article details: relevant case law leading up to passage of the amendments; prior HFLR coverage of the extensive disagreement among courts regarding the level of disclosure required under the prior version of the rule; the key differences between the current version of Rule 2019 and the proposed amendment (Amended Rule 2019); the key definitions in Amended Rule 2019; what information must be disclosed under Amended Rule 2019; who must disclose it; and a new rule relating to identification of a chapter 15 debtor’s “center of main interests.”  For more on Rule 2019, see “Would the Expanded Disclosures Required by Proposed Amendments to Federal Rule of Bankruptcy Procedure 2019 Deter Hedge Funds from Investing in Distressed Debt? (Part Three of Three),” Vol. 2, No. 39 (Oct. 1, 2009); “How Can Hedge Funds that Invest in Distressed Debt Keep Their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)? (Part Two of Three),” The Hedge Fund Law Report, Vol. 2, No. 36 (Sep. 9, 2009); “How Can Hedge Funds that Invest in Distressed Debt Keep their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)?,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009).

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  • From Vol. 4 No.15 (May 6, 2011)

    Treatment of a Hedge Fund’s Claims Against and Other Exposures To a Covered Financial Company Under the Orderly Liquidation Authority Created by the Dodd-Frank Act

    On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), heralded as the most significant new financial regulation since the Great Depression.  Title II of the Dodd-Frank Act creates a framework to prevent the potential meltdown of systemically important U.S. financial businesses.  This framework includes a new federal receivership procedure, the so-called orderly liquidation authority (“OLA”), for significant, interconnected non-bank financial companies whose unmanaged collapse could jeopardize the national economy.  The OLA will form part of a new regulatory framework intended to improve economic stability, mitigate systemic risk, and end the practice of taxpayer-financed “bailouts.”  The OLA generally is modeled on the Federal Deposit Insurance Act (“FDIA”), which deals with insured bank insolvencies, and also borrows from the Bankruptcy Code.  Notwithstanding the enactment of Title II, there will be a heavy presumption that companies that otherwise qualify for protection under the Bankruptcy Code will be reorganized or liquidated through a traditional bankruptcy case.  If, however, an institution is deemed to warrant the special procedures under the OLA, Title II will apply, even if a bankruptcy case is then pending for such institution.  As discussed in this article, the decision of whether to invoke Title II will be made outside the public view.  As a result, hedge funds that have claims and other exposures to financial companies may find the playing field shifting overnight from the relatively predictable confines of the Bankruptcy Code to the novel and untested framework of the OLA.  In a guest article, Solomon J. Noh, a Senior Associate in the Bankruptcy & Reorganization Group at Shearman & Sterling LLP, provides a high-level discussion of how the following types of claims and exposures would be handled in a receivership governed by Title II based on the regulatory rules currently proposed or in effect: (i) secured claims; (ii) general unsecured claims (such as a claim arising out of unsecured bond debt); (iii) contingent claims (such as a claim relating to a guaranty); (iv) revolving lines of credit and other open commitments to fund; and (v) “qualified financial contracts” (i.e., swap agreements, forward contracts, commodity contracts, securities contracts and repurchase agreements).  Hedge funds employing a variety of strategies – notably, but not exclusively, distressed debt – routinely acquire the foregoing categories of claims and exposures.  For situations in which those claims or exposures face a firm that may be designated as systemically important, this article highlights the principal legal considerations that will inform any investment decision.

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  • From Vol. 4 No.11 (Apr. 1, 2011)

    GM Bankruptcy Judge Rejects Distressed Debt Hedge Fund Investors’ Objections to Reorganization Plan

    The U.S. Bankruptcy Court for the Southern District of New York has confirmed, subject to minor modifications, the proposed reorganization plan (Plan) of General Motors Corp., now known as Motors Liquidation Company (Old GM).  Although overwhelmingly approved by Old GM’s creditors, hedge funds (Funds) that held debt of one of Old GM’s subsidiaries objected to the Plan because their claims are disputed by Old GM’s creditors’ committee and the Plan does not require immediate distribution to holders of disputed claims.  The Funds claimed that the Plan was not proposed in good faith, that it unfairly discriminated between holders of disputed and undisputed unsecured claims, and that it failed to segregate a reserve for the Funds’ claims.  The Court rejected all of these contentions, holding that it was fair and reasonable for Old GM to delay even partial payment of disputed unsecured claims until such claims were resolved.  We summarize the Court’s decision, with an emphasis on the Funds’ objections.  See generally “Legal Considerations for Investors In and Around the General Motors Bankruptcy, And Similar Distressed Situations Involving Politically Important Stakeholders,” The Hedge Fund Law Report, Vol. 2, No. 23 (Jun. 10, 2009); “Equities of Bankrupt Companies Offer Hedge Funds a High Risk, Potentially High Return Method of Investing in Restructurings,” The Hedge Fund Law Report, Vol. 2, No. 27 (Jul. 8, 2009).

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  • From Vol. 3 No.26 (Jul. 1, 2010)

    Liquidity for Post-Reorganization Securities Under Section 1145 of the Bankruptcy Code

    Are you a distressed debt creditor who has been turned into a security holder?  If so, you’re not alone.  The transformation – sometimes welcomed and sometimes not – is an increasingly common fate in the distressed community.  It happens, among other ways, when a company emerging from Chapter 11 issues new securities under its plan of reorganization in whole or partial settlement of outstanding loan or bond obligations.  If you are a creditor-cum-investor at the end of a Chapter 11 process, you face an important question: “How can I monetize the new securities that I’ve received in the claim distribution?”  In a guest article, Scott C. Budlong, a Partner at Richards Kibbe & Orbe LLP, explores a statutory provision that goes a long way toward answering that question: Section 1145 of the U.S. Bankruptcy Code.  Section 1145 offers a mechanism for unhindered public resales of securities that have been issued in exchange for creditors’ claims under a Chapter 11 plan of reorganization.  Understanding the operation and scope of §1145 is therefore crucial for a post-reorganization security holder that wishes to maximize its liquidity options.  The first part of this article provides an overview of §1145, including the ways it manipulates traditional Securities Act concepts to facilitate a debtor’s issuance of new securities in satisfaction of a class of claims against the bankruptcy estate, and to allow enhanced liquidity for creditors who receive those securities.  The second part of this article examines potential impediments to a creditor’s use of §1145 to resell post-reorganization securities, and describes how a creditor can try to preserve its access to §1145 or otherwise achieve liquidity.  This article, and a related article recently published in The Hedge Fund Law Report, provide important background and context for an upcoming breakfast discussion entitled “From Creditor to Equity Holder: How to Make Your Post-Reorganization Equity Work Harder for You.”  That breakfast discussion will be presented by Richards Kibbe & Orbe LLP, Halsey Lane Holdings, LLC and CRT Capital Group LLC, in conjunction with The Hedge Fund Law Report, and will be held on Wednesday, July 14, from 8:00 a.m. to 9:30 a.m. at The Yale Club at 50 Vanderbilt Avenue, New York, New York.  To read the related article, see “From Lender to Shareholder: How to Make Your Equity Work Harder for You,” The Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  For more on Halsey Lane, see “Video Interview with Mark Dalton, Alex Sorokin and Neil Wessan of Halsey Lane Holdings: Key Considerations for Distressed Debt Hedge Funds that become ‘Unnatural Owners’ of Equity Following a Reorganization,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).

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  • From Vol. 3 No.23 (Jun. 11, 2010)

    Bankruptcy Court Finds Swedbank AB Violated Automatic Stay in Lehman Brothers’ Bankruptcy; Rules Safe Harbor Provisions Do Not Override Setoff Mutuality Requirement

    In bankruptcy parlance, a “setoff” refers to the ability of a creditor and a debtor that owe each other money to apply their claims against one another, if called for under non-bankruptcy law.  As a prerequisite to exercising setoff rights, Section 553(a) of the Bankruptcy Code (the Code) requires “mutuality” between debtor and creditor and debt and credit.  Mutuality exists when “the debts and credits are in the same right and are between the same parties, standing in the same capacity.”  In the absence of mutuality, a creditor’s refusal to pay amounts due to a bankrupt estate may violate various sections of the Code, including Section 362, the automatic stay, even if the estate also owes the creditor money.  Exceptions exist, however.  For instance, in 2005, Congress amended Section 560 and enacted Section 561 of the Code, to provide safe harbors for, inter alia, any pre-existing contractual right of a swap participant to offset or net termination values from the swap agreements in another participant’s bankruptcy.  On May 5, 2010, Judge James Peck of the United States Bankruptcy Court for the Southern District of New York, presiding over the Chapter 11 Bankruptcy of Lehman Brothers Holdings Inc. (LBHI) and its affiliates (collectively, Lehman), squarely addressed whether these Code amendments erased the requirement of “mutuality” for a party to a swap agreement to engage in a “setoff” under Section 553(a).  The Court held that “A contractual right to setoff under derivative contracts does not change well established law that conditions such a right on the existence of mutual obligations.”

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  • From Vol. 3 No.22 (Jun. 3, 2010)

    U.S. Bankruptcy Court Approves Settlement Between Hedge Fund SageCrest and its Majority Creditors Replacing its Fund Manager, Windmill Management

    As previously reported in The Hedge Fund Law Report, in Fall 2008, the hedge funds SageCrest II, LLC (SC II), SageCrest Finance, LLC, SageCrest Dixon, Inc., and an offshore affiliate, SageCrest Holdings, Ltd. (collectively, SageCrest), filed for Chapter 11 bankruptcy protection.  See “SageCrest Files for Chapter 11 Bankruptcy, a Rare Move by a Hedge Fund,” The Hedge Fund Law Report, Vol. 1, No. 21 (Sept. 22, 2008).  In so doing, SageCrest informed its investors that the actions of Deutsche Bank, its primary lender, in demanding that SageCrest liquidate assets to accelerate repayment on its loans and in freezing a $400 million line of credit, as well as litigation with an investor, Wood Creek Capital Management, caused the bankruptcy filing.  In March 2010, SageCrest, its fund manager Windmill Management, LLC (Windmill), and Windmill principals Alan and Philip Milton (the Milton Brothers), the largest secured creditor Deutsche Bank, and the Official Committee of Equity Investors moved for court approval of a Settlement Agreement pursuant to Federal Rule of Bankruptcy Procedure 9019(a), that required, among other things, the replacement of Windmill with an interim manager, Ralph Harrison, the Equity Committee’s financial consultant.  Two creditors, Topwater and Art Capital, opposed the agreement, claiming that it was a sub rosa plan, and that Harrison was not a “disinterested” party.  On May 18, 2010, the United States Bankruptcy Court for the District of Connecticut approved the settlement after finding that it satisfied the “standard of reasonableness.”  We detail the background of the action and the Bankruptcy Court’s legal analysis.

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  • From Vol. 3 No.20 (May 21, 2010)

    From Lender to Shareholder: How to Make Your Equity Work Harder for You

    Scenario: You hold bank debt or bonds in a company that is being restructured, whether through a Chapter 11 bankruptcy reorganization or an out-of-court restructuring.  As part of the restructuring, you (as well as the company’s other creditors) are being asked to reduce (or extinguish entirely) the principal amount of debt you hold, but as an incentive to agree to the proposal, you are being offered equity securities in the newly restructured company.  Alternatively, you are receiving a cash payout on your debt, and you are being offered the right to subscribe for new equity in the company in a rights offering.  As part of either deal, you are presented with a suite of documents setting out your various rights with respect to the company and the other shareholders, almost always prepared by the lead lender’s attorneys and similar to venture capital agreements with the lead lender taking the role of the lead investor.  Question: If you will be a minority shareholder in the newly restructured company, what rights should you expect, and what can you get?  Some lenders will approach this type of scenario with the view “I’m getting x¢ on the dollar in new debt more than I paid, and the equity is just the icing on the cake.”  Others will make the (usually incorrect) assumption that they will be able to freely trade their new equity in the same way as the debt they previously held or the new debt they are receiving.  In a guest article, Jahangier Sharifi and Catherine Rossouw, Partner and Associate, respectively, at Richards Kibbe & Orbe LLP, provide lenders who are being offered minority shareholder positions in restructured companies with a checklist of rights to look for and of pitfalls to avoid when negotiating the terms of these equity documents.  Their article has three parts.  Section 1 discusses possible restrictions on liquidity that may limit your ability to get the most value out of your new equity.  Section 2 outlines the basic protections and control rights that you should ask for in your equity documents as a minority shareholder.  Section 3 highlights the key takeaways for lenders when negotiating equity documents.

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  • From Vol. 3 No.10 (Mar. 11, 2010)

    Should Hedge Funds Include Automatic Termination as a Term of Bank Debt Trades on the New Loan Market Association Forms?

    On January 25, 2010, the Loan Market Association (LMA) – the European trade association for the syndicated loan market – launched a combined set of standard terms and conditions for par and distressed trading documentation (Combined Terms and Conditions).  One of the key additions to the form loan documentation is a termination upon insolvency provision.  Specifically, the new provision creates a default rule whereby the non-insolvent party to a bank debt trade may terminate the trade upon notice to the insolvent party.  The parties may also revise the default rule to provide for automatic termination upon the insolvency of either party.  In addition, the provision provides a mechanism for calculating damages upon a termination occasioned by insolvency of one of the parties.  The inclusion of the termination upon insolvency provision is widely perceived as a direct response to the experience of loan market participants in the Lehman Brothers bankruptcy.  In that case, absent a termination right on the part of Lehman’s non-insolvent bank debt trade counterparties (many of whom were hedge funds), Lehman generally had the right to (and in many cases did) keep open trades for which it was in the money, and cancel trades for which it was out of the money.  In short, the rules as they existed at the end of 2008 and through 2009 permitted Lehman entities to “cherry pick” favorable trades.  Part of the policy behind the new provision is to prevent parties trading in bank debt from using bankruptcy (or, in the U.K., administration) to obtain a trading advantage.  For hedge funds, one of the key questions raised by the new provision is whether to include automatic termination provisions in bank debt trade documentation.  This article explores that question, and in doing so discusses: the details of the new LMA Combined Terms and Conditions; the specifics of the termination on insolvency provision (including the default rule requiring notice of termination and permitted alterations to the default rule); the mechanism for calculating early termination payments; the disadvantages of providing for automatic termination, highlighting the different relevant bankruptcy rules in the U.K. and the U.S.; the advantages of providing for automatic termination, also highlighting the variations in analysis between the U.K. and the U.S.; the extent to which automatic termination can harmonize bank debt and derivatives documentation, at least in the U.K.; the effect of automatic termination on bank debt trade pricing; and relevant differences between LMA and LSTA documentation.

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  • From Vol. 3 No.9 (Mar. 4, 2010)

    Due Diligence Considerations for Hedge Funds That Invest in the Equities of Bankrupt Companies: Lessons of the Energy Partners, Ltd. Bankruptcy

    Hedge funds are recognizing with increasing frequency that the common stock of bankrupt companies or companies in the zone of insolvency may have post-reorganization value.  See “Interview with Mark Dalton, Alex Sorokin and Neil Wessan of Halsey Lane Holdings: Key Considerations for Distressed Debt Hedge Funds that become ‘Unnatural Owners’ of Equity Following a Reorganization,” The Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).  While investing in bankruptcy equities involves considerable risk – notably, the tangible likelihood of a complete loss of value – such investments also, in the right circumstances, offer the prospect of considerable upside.  In particular, bankruptcy equities may be attractive in at least three circumstances: (1) where creditors undervalue the assets of the debtor; (2) when an event (such as a lawsuit in which the debtor is a plaintiff) can act as a catalyst for value creation; and (3) where conditions in the relevant industry or credit markets may enable a debtor to emerge from reorganization while its bankrupt competitors do not.  See “Equities of Bankrupt Companies Offer Hedge Funds a High Risk, Potentially High Return Method of Investing in Restructurings,” The Hedge Fund Law Report, Vol. 2, No. 27 (Jul 8, 2009).  However, beyond the well-known financial risk of investing in bankruptcy equities, hedge funds should be cognizant of additional legal and structural risks that can adversely affect investment outcomes, or at least complicate the process of value creation.  In this article, Gregory C. White, an Associate at business valuation and litigation consulting firm Hill Schwartz Spilker Keller LLC, tells the story of hedge funds’ participation on the equity committee in the Chapter 11 bankruptcy of Energy Partners, Ltd. (EPL), a Louisiana-based exploration and production company.  In particular, this article outlines the facts of the case as they relate to the equity committee’s involvement in the valuation of EPL, focusing on relevant terms of the debtor’s engagement letter with its financial adviser.  The article then discusses two key lessons highlighted by the EPL case for hedge funds considering purchases of bankruptcy equities.

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  • From Vol. 3 No.7 (Feb. 17, 2010)

    Federal Judge Approves Settlement Agreements Arising out of Marc Dreier’s Criminal Fraud; Hedge Fund Victims “Squabble” Over Proposed Recovery

    On February 5, 2010, the United States District Court for the Southern District of New York approved proposed settlement agreements and reconfirmed a restitution order for the distribution of assets from the estates of convicted swindler Marc Dreier and his law firm, Dreier LLP.  The court order responded to objections by certain hedge fund victims to those agreements, which had been reached between the United States Attorney’s Office for the Southern District of New York, the Securities and Exchange Commission, the Trustees in Bankruptcy overseeing the estates of Dreier and his firm, and two entities that had obtained proceeds and suffered losses from investing in Dreier’s fictitious notes: hedge funds GSO Capital Partners and its affiliates, and Fortress Investment Group LLC and its affiliates.  See “Affiliates of Hedge Fund Manager Fortress Investment Group Sue Dechert Over Opinion Letter Endorsing Marc Dreier,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).  We discuss the background of the various related actions – including the dispute over the disposition of Dreier’s art collection – and the court’s legal analysis.

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  • From Vol. 3 No.6 (Feb. 11, 2010)

    Video Interview with Mark Dalton, Alex Sorokin and Neil Wessan of Halsey Lane Holdings: Key Considerations for Distressed Debt Hedge Funds that become “Unnatural Owners” of Equity Following a Reorganization

    When a hedge fund is set up – in terms of structure, strategy and managerial experience – to invest in secured debt, and the issuer of that debt defaults, the hedge fund and its manager often wind up in the unnatural position of owning equity or assets.  See “Hedge Funds Employing Loan-to-Own Strategies Face (and Resolve) Ownership Dilemmas,” The Hedge Fund Law Report, Vol. 2, No. 35 (Sep. 2, 2009).  How can such “unnatural owners” maximize the value of their post-reorganization investments?  In our inaugural video interview, The Hedge Fund Law Report discussed this and related questions with Mark Dalton, Alex Sorokin and Neil Wessan, founding principals of Halsey Lane Holdings.  In particular, we discussed issues including: circumstances in which hedge funds become unnatural owners; why such unnatural owners may be ill-equipped to maximize value following a restructuring; how Halsey Lane manages concerns relating to material, non-public information when advising unnatural owners; how hedge fund managers can negotiate the potential liquidity mismatch between their fund lock-ups and the time required to implement a strategic plan at a restructured company; how hedge funds with a debt strategy can remain faithful to that strategy while owning and managing post-reorganization equity; and more.

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  • From Vol. 3 No.6 (Feb. 11, 2010)

    Delaware Bankruptcy Court Recognizes Cayman Islands Proceeding as “Foreign Main Proceeding” Under Chapter 15 of the U.S. Bankruptcy Code

    On December 17, 2010, the U.S. Bankruptcy Court for the District of Delaware granted protection over U.S. assets in a Cayman Islands exempted company in liquidation, finding it to be a foreign main proceeding under Chapter 15 of the U.S. Bankruptcy Code (Code).  This case diverges from other courts that have denied or limited Chapter 15 protection for liquidating Cayman Islands exempted companies in recent years.  See, e.g., “Cayman Islands Liquidations of Failed Bear Stearns Hedge Funds Denied Access to US Bankruptcy Court,” The Hedge Fund Law Report, Vol. 1, No. 13 (May 30, 2008).  The petitioners were duly authorized foreign representatives and joint official liquidators in the debtors’ liquidation and winding up proceeding before the Grand Court of the Cayman Islands.  In granting the petition for recognition and protection under the Code, the Delaware Bankruptcy Court specifically found that the debtor, Saad Investments Finance Company (No. 5) Limited, had its “center of main interests” in the Cayman Islands.  This article summarizes the background of the case and the petitioners’ arguments, and examines how this case is distinguishable from foreign proceedings that were refused similar protection under the Code.  The case has particular relevance for hedge funds that are organized in the Cayman Islands, face winding up proceedings there and have U.S. investors.

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  • From Vol. 3 No.6 (Feb. 11, 2010)

    Bankruptcy Court Denies Philadelphia Newspapers’ Motion to Force Disclosure from Steering Group Pursuant to Rule 2019

    On February 3, 2010, Judge Stephen Raslavich of the U.S. Bankruptcy Court for the Eastern District of Pennsylvania denied a motion by Chapter 11 debtors Philadelphia Newspapers LLC, et al., seeking to compel the company’s largest creditors, who had formed a Steering Group, to disclose the value and amount of the debt each owns pursuant to Federal Rule of Bankruptcy Procedure 2019.  Its decision that Rule 2019 does not apply to ad hoc committees deepens the case law split on that issue.  At present, a battle exists between Chapter 11 debtors and the hedge fund industry over the scope and application of Rule 2019.  Debtors advocate applying the rule to ad hoc committees to promote transparency in the reorganization process.  Hedge funds, guarded from disclosing their trading secrets in reorganizations, argue that compelling disclosure will adversely affect their business, and may deter non-traditional lender participation in reorganization cases.  Yet, recently, the debtors in many cases appear to be filing the motions to compel as litigation tactics to intimidate and divide their hedge fund creditors, and to gain leverage in disputes among different classes of creditors or between debtors and certain of its creditors.  For instance, in this action, the Steering Group maintained that the debtors did not file their motion until right before the U.S. Court of Appeals for the Third Circuit appeared ready to decide an important issue in this case having to do with the right of these lenders to “credit bid” at a forthcoming auction of the debtors’ assets.

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  • From Vol. 3 No.5 (Feb. 4, 2010)

    Bankruptcy Court Finds Unenforceable CDO Provisions Subordinating Swap Termination Payments to Swap Counterparty Lehman Brothers as a Result of Its Bankruptcy

    On January 25, 2010, the United States Bankruptcy Court for the Southern District of New York ruled that the automatic stay and ipso facto clauses of the Bankruptcy Code forbid enforcement of structured finance provisions which alter the priority in bankruptcy of swap termination payments upon a default.  The court’s decision – a declaratory judgment on behalf of Lehman Brothers Special Financing, Inc. (LBSF) that these swap payment alteration provisions were unenforceable against it – casts doubt upon the enforceability of these market-standard provisions in other structured finance transactions in which hedge funds may engage.  We detail the background of the action, the court’s intricate legal analysis and the practical implications of the decision.

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  • From Vol. 3 No.4 (Jan. 27, 2010)

    Delaware Bankruptcy Court Disagrees with WaMu Decision, Finding that Rule 2019 Does Not Apply to Ad Hoc Committees in Six Flags Chapter 11 Proceeding

    As increasing numbers of hedge funds compete for investment opportunities, it has become even more critical for fund managers to keep their holdings and investment strategies close to the vest.  For instance, many hedge funds that focus on distressed investments more actively participate in bankruptcy proceedings, but remain loath to disclose sensitive information about the precise nature of their holdings.  As a result, Federal Rule of Bankruptcy Procedure 2019 – a seemingly ministerial rule mandating disclosures by creditors in specified circumstances – has become a source of hotly-contested litigation for these funds.  According to Rule 2019, “every entity or committee representing more than one creditor” must file a verified statement disclosing certain information about its claims.  That information includes, among other things, (i) the nature and amount of its claims or interests, (ii) the date of acquisition of its claims or interests acquired in the year before filing of the bankruptcy cases, (iii) the amount paid, and (iv) any subsequent sales of claims or interests.  For more background on Rule 2019, see “Would the Expanded Disclosures Required by Proposed Amendments to Federal Rule of Bankruptcy Procedure 2019 Deter Hedge Funds from Investing in Distressed Debt? (Part Three of Three),” Vol. 2, No. 39 (Oct. 1, 2009); “How Can Hedge Funds that Invest in Distressed Debt Keep their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)?,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009); and “How Can Hedge Funds that Invest in Distressed Debt Keep Their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)? (Part Two of Three),” The Hedge Fund Law Report, Vol. 2, No. 36 (Sep. 9, 2009).  In an abrupt change of course from the December 2, 2009 Washington Mutual decision, on January 9, 2010, the Delaware Bankruptcy Court held that the members of an ad hoc committee of noteholders did not have to comply with the disclosure requirements of Bankruptcy Rule 2019.  See In re Premier International Holdings, Inc. Case No. 09-12019 (Bankr. D. Del. Jan. 9, 2010); see also “As Debate over Amendment of Bankruptcy Rule 2019 Continues, Delaware Bankruptcy Court Finds that Current Rule 2019(a) Mandates Disclosure of Economic Interest of ‘Loose Affiliation’ of Washington Mutual Creditors,” The Hedge Fund Law Report, Vol. 2, No. 49 (Dec. 10, 2009).  Judge Christopher S. Sontchi reasoned that the plain meaning and legislative history of Rule 2019 does not contemplate ad hoc committees.  This article details the background of the action, the court’s legal analysis and its potential implications for the hedge fund community.

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  • From Vol. 3 No.4 (Jan. 27, 2010)

    Delaware Bankruptcy Court Bars Ad Hoc Noteholder Group from Participating in Accuride Chapter 11 Proceedings Until the Group Complies with Rule 2019

    On January 22, 2010, Judge Brendan L. Shannon, hearing In re Accuride Corporation, No. 09-13449 (Bankr. D. Del. January 22, 2010), issued an order compelling the Ad Hoc Noteholder Group in that matter to comply with Rule 2019(a).  Judge Shannon also prohibited further participation in these cases by the Ad Hoc Noteholder Group pending compliance, and directed the debtors in that case to withhold further payments to or on behalf of such group pending compliance.  Though Judge Shannon has not yet issued a memorandum explaining this decision, it would seem that he sides with Judge Mary F. Walrath, also of the Delaware Bankruptcy Court, who issued an opinion in the Washington Mutual Inc. Chapter 11 reorganization on December 2, 2009, likewise holding that Rule 2019 applies to the “ad hoc committees” of which hedge funds are often members.  See “As Debate over Amendment of Bankruptcy Rule 2019 Continues, Delaware Bankruptcy Court Finds that Current Rule 2019(a) Mandates Disclosure of Economic Interest of ‘Loose Affiliation’ of Washington Mutual Creditors,” The Hedge Fund Law Report, Vol. 2, No. 49 (Dec. 10, 2009).  This article details the factual background of and the court’s legal analysis in the Accuride decision.

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  • From Vol. 2 No.51 (Dec. 23, 2009)

    Creditors’ Rights in the United Arab Emirates

    The recent announcement by the government of Dubai that it would be seeking a stand-still on debt repayments by Dubai World and its subsidiary Nakheel PJSC has sent shock waves around the globe and raises questions regarding the rights of creditors in the United Arab Emirates (UAE).  In a guest article, Paul de Cordova, Dr. Sabine Konrad, Tony Griffiths and Jeffrey Rich, all partners at K&L Gates, highlight some key features of UAE federal insolvency law that may be relevant to hedge funds and others who have dealings with debtors in the UAE.  In particular, the K&L Gates partners address questions including: What are the insolvency laws in Dubai?  What constitutes bankruptcy under the insolvency laws?  Who is subject to the insolvency laws?  Who can commence bankruptcy proceedings?  Can a creditor sue the bankrupt business?  How are creditors ranked in insolvency?  Can a trader seek protection from its creditors?  Can transactions be set aside in bankruptcy proceedings?  And could the government be responsible for the debts of its controlled entities?

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  • From Vol. 2 No.49 (Dec. 10, 2009)

    As Debate over Amendment of Bankruptcy Rule 2019 Continues, Delaware Bankruptcy Court Finds that Current Rule 2019(a) Mandates Disclosure of Economic Interests of “Loose Affiliation” of Washington Mutual Creditors

    Following a run on Washington Mutual Bank (WaMu), WaMu was seized by the Office of Thrift Supervision.  The Federal Deposit Insurance Company, acting as receiver, sold “substantially all” of WaMu’s assets to JPMorgan Chase, Inc. (JPMC).  Simultaneously, WaMu’s holding company, Washington Mutual, Inc. (WMI), filed for bankruptcy protection.  As we have previously reported, certain entities, including several hedge fund managers, that held WMI debt (WMI Noteholders Group) intervened in the WMI bankruptcy proceeding to argue for a narrow construction of what assets had actually been sold to JPMC (which would have the effect of increasing the value of the WMI bankruptcy estate and, by extension, the value of the WMI Noteholders Group interests in WMI).  JPMC sought full disclosure of all information called for by Bankruptcy Rule 2019(a), not just the names of the members of the WMI Noteholders Group and the aggregate value of their interests.  Following the 2005 decision of the United States District Court for the Southern District of New York in In Re Northwest Airlines Corp., the court granted JPMC’s motion and ordered full compliance.  We discuss the court’s reasoning and the implications for investors in distressed debt.

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  • From Vol. 2 No.44 (Nov. 5, 2009)

    Investors Win Court-Imposed Liquidation of Cayman Islands Hedge Fund of Funds Matador Investments

    Matador Investments Ltd. (Matador or the Fund) is a fund of funds organized under the laws of the Cayman Islands.  Following a request by investors for redemption of their interests in Matador, the Fund first imposed a “gate” on redemptions (to stretch out redemption payments over time), and later imposed a complete freeze on redemptions.  The investors brought an action against the Fund seeking a judicial liquidation of the Fund on the ground that, following their redemption requests, they had become unpaid “creditors” of the Fund.  See “How Will the New Cayman Islands Insolvency Regime Affect the Winding-Up of Cayman Islands Hedge Funds?,” The Hedge Fund Law Report, Vol. 2, No. 42 (Oct. 21, 2009).  Matador, relying on the recent Strategic Turnaround decision, argued that until the redemptions were paid in full, the investors were still bound by the Fund’s governing documents, which permitted both gates and freezes on redemptions.  The court disagreed, appointed a liquidator, and directed the Fund to commence winding up its affairs.  We explain the parties’ arguments and how the court distinguished the Matador investors from those in the Strategic Turnaround case.

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  • From Vol. 2 No.42 (Oct. 21, 2009)

    How Will the New Cayman Islands Insolvency Regime Affect the Winding-Up of Cayman Islands Hedge Funds?

    On March 1, 2009, the Cayman Islands Legislative Assembly implemented a new insolvency regime applicable to, among others, hedge funds organized there.  Market participants surveyed by The Hedge Fund Law Report agree that the new regime does not dramatically change the insolvency regime applicable to hedge funds, but may empower liquidators and courts to pursue claims by insolvent companies of fraudulent pre-petition trading.  This article reviews the mechanics of the new insolvency regime that are relevant to hedge funds (including providing statutory language); the new regime’s effect on the powers of liquidators and courts; whether the outcome in the case In the Matter of Strategic Turnaround Master Partnership Limited (12 December 2008) would have been different had the new regime been in effect in December 2008, when the case was decided; the “cash flow” definition of insolvency in the Cayman Islands; when a Cayman Islands hedge fund investor becomes a creditor of the hedge fund from which the investor has redeemed; the anticipated impact of the legal changes on the number of hedge funds domiciled in the Caymans; the effect of the law on in-kind redemptions; and the likelihood that the Caymans will impose an income or capital gains tax on hedge funds or their managers to make up a budget shortfall.

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  • From Vol. 2 No.41 (Oct. 15, 2009)

    Will the Proposed Out-of-Court Plan Help or Hinder Efforts of Hedge Fund Creditors to Recover Assets from Lehman Brothers International Europe?

    The administrators of Lehman Brothers International Europe (LBIE), PricewaterhouseCoopers (PwC), continue to try to formulate a speedy and viable process for returning hedge fund client assets.  After a proposed scheme of arrangement (Scheme) was rejected by the High Court in London, PwC unveiled a contractual solution (Solution) as an alternative to the proposed Scheme.  PwC said in a statement that the Solution would allow them to distribute “a very significant portion” of the $8.9 billion in assets currently under their control directly to creditors.  According to PwC, the Solution offers substantially the same terms to investors as the Scheme.  The key difference is that the contracts by which the Solution would be effectuated do not need court approval.  LBIE is the U.K. broker-dealer affiliate of Lehman Brothers Holdings Inc., and served as a prime broker to various hedge funds.  On September 15, 2008, LBIE was placed into administration in the U.K.  The U.K. court appointed several PwC partners as joint administrators of the LBIE estate.  When LBIE collapsed, the assets of its hedge fund clients were frozen.  In the intervening year and change, those hedge funds clients have endured a long and tortuous process in an effort to retrieve their assets.  For more on the LBIE Scheme, see “How Can Hedge Funds Get Their Money Out of Lehman Brothers International Europe?,” The Hedge Fund Law Report, Vol. 2, No. 31 (Aug. 5, 2009).  This article aims to help hedge fund managers with assets tied up in the LBIE administration determine whether or not to participate in the Solution.  To do so, the article examines: the mechanics of the Solution; the mechanics of the Scheme; how net equity claims would be computed and valued under both the Solution and the Scheme; recourse available to LBIE clients that participate in the Solution but disagree with valuations of claims; timing and mechanics of distribution of assets under the Solution; effect of the Solution on non-participating creditors; and the primary benefits and drawbacks to hedge funds of participating in the Solution.

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  • From Vol. 2 No.39 (Oct. 1, 2009)

    Would the Expanded Disclosures Required by Proposed Amendments to Federal Rule of Bankruptcy Procedure 2019 Deter Hedge Funds from Investing in Distressed Debt? (Part Three of Three)

    On August 12, 2009, the Advisory Committee on the Federal Rules of Bankruptcy Procedure (Advisory Committee) proposed a significant revision of Federal Rule of Bankruptcy Procedure 2019 (Rule 2019), the rule that in its current form requires disclosure by an “entity or committee representing more than one creditor” of the identity of each creditor involved, the nature and amount of its interest, the times when the entity’s interests were acquired and the amounts paid for them.  The proposed amendment would clarify that every entity that plays an active part in a bankruptcy proceeding is at least potentially subject to a requirement to disclose a wide range of information of the sort that distressed debt hedge funds and other bankruptcy investors have long sought to keep proprietary.  Comments on the proposed revision are due by February 16, 2010.  The proposed rule revision would change the bankruptcy investing game in three principal ways: (1) it would widen the scope of who must disclose under Rule 2019; (2) it would widen the scope of what must be disclosed; and (3) it would give bankruptcy courts wider discretion to relieve or abridge disclosure obligations, especially disclosure regarding the prices of assets purchased in secondary market trading.  This article discusses the proposed revision in depth, focusing on the potential consequences for hedge funds that invest in and around bankruptcies.  This article is the third in a three-part series on Rule 2019, and its impact on hedge fund strategies.  For the two previous installments in the series, see “How Can Hedge Funds that Invest in Distressed Debt Keep their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)?,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009); and “How Can Hedge Funds that Invest in Distressed Debt Keep Their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)? (Part Two of Three),” The Hedge Fund Law Report, Vol. 2, No. 36 (Sep. 9, 2009).

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  • From Vol. 2 No.37 (Sep. 17, 2009)

    Motion of the Law Debenture Trust Company May Lead to Additional Recovery for Hedge Funds that Hold Various Categories of Unsecured Tribune Company Debt

    The Law Debenture Trust Company (LDTC), representing several groups of prepetition unsecured bondholders in media corporation Tribune Company (Tribune), has filed a motion in federal bankruptcy court seeking additional discovery to investigate the company’s 2007 sale to billionaire investor Samuel Zell, which the creditors claim led to Tribune’s bankruptcy filing in December 2008.  According to the motion, at this point in time, nine months after the bankruptcy filing, there still has not yet been an investigation of the fraudulent conveyance claims nor have any actions been brought.  The delay has made some creditors suspicious and the motion makes several claims of conflicts of interest among the creditors’ committee members and lenders and other parties involved in the buyout.  Legal experts who spoke with The Hedge Fund Law Report noted that because of the rapid collapse of Tribune it is likely that the LBO and related lending transactions will be challenged as fraudulent conveyances.  If such claims are successful, the liens that the LBO banks have would be voided and unsecured creditors would stand to receive a significantly greater recovery in the reorganization than they are currently poised to recover.  In this article, we provide background on the Tribune LBO and subsequent bankruptcy, and detail LDTC’s motion for additional discovery; what fraudulent conveyance claims are generally and what they are in this case; potential subordination of secured creditors; goals of fraudulent conveyance or transfer claims; additional forms of relief that may be available to Tribune’s unsecured creditors; the likelihood of success of LDTC’s claims; the potential impact of LDTC’s action on various categories of unsecured creditors, including hedge funds that purchased Tribune debt subsequent to the Chapter 11 filing; and the impact on recovery by unsecured creditors of the suit by employees of the Los Angeles Times.

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  • From Vol. 2 No.36 (Sep. 9, 2009)

    How Can Hedge Funds that Invest in Distressed Debt Keep Their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)? (Part Two of Three)

    An article in the August 7, 2009 issue of The Hedge Fund Law Report examined recent decisions that shed light on the scope of disclosure required under Federal Rule of Bankruptcy Procedure 2019(a) (Rule 2019(a)).  See “How Can Hedge Funds that Invest in Distressed Debt Keep Their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)?,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009).  This article further analyzes the issues that arise from those cases – issue that are currently under deliberation by the U.S. Bankruptcy Court for the District of Delaware in the matter of the reorganization of Washington Mutual Inc., the former holding company of failed Washington Mutual Bank.  This article draws on the views of leading practitioners in bankruptcy and other relevant legal areas to illustrate three points, among others: (1) relevant bankruptcy practice has not changed significantly since 2005, when the U.S. Bankruptcy Court for the Southern District of New York, in cases arising out of the bankruptcy of Northwest Airlines, required certain disclosures (e.g., the price and timing of securities purchases) by members of an ad hoc equity committee and refused to permit the disclosures to be made under seal; (2) the Northwest precedent has given litigants a new weapon that may be used against hedge funds that purchase distressed debt, though the effectiveness of that weapon remains to be determined; and (3) the hedge fund industry, and even some bankruptcy court judges, are looking to the Committee on Rules of Practice and Procedure of the Judicial Conference of the United States to resolve the uncertainty created by the Northwest decisions.

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  • From Vol. 2 No.36 (Sep. 9, 2009)

    Junior Creditors Suffer Setback at the Carwash: U.K. High Court Approves IMO Carwash Group Scheme, Wiping Out IMO’s Senior Debt Without Junior Creditors’ Approval

    On August 11, 2009, the United Kingdom High Court of Justice, Chancery Division, approved the terms of related restructuring schemes in which the bankrupt IMO (UK) Ltd. (IMO), the world’s largest dedicated carwash company, would release its senior debt, subject to a subsequent transfer of its assets to certain new companies.  Because a group of IMO’s junior creditors, the mezzanine lenders, did not join the schemes prior to their approval, the court’s ruling effectively granted control of IMO to senior lenders, the holders of the senior debt and, in the process, shut out the mezzanine lenders and any potential for them to challenge the fairness of the schemes.  The court also confirmed that a U.K. company has discretion to determine the creditors with whom it wishes to enter into a debt restructuring arrangement and need not include creditors whose economic interests will not be affected by that arrangement.  We discuss the factual background of the action, the mezzanine lenders’ argument and the High Court’s legal analysis.

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  • From Vol. 2 No.34 (Aug. 27, 2009)

    How Can Hedge Funds that Invest in Distressed Debt Keep Their Strategies and Positions Confidential in Light of the Disclosures Required by Federal Rule of Bankruptcy Procedure 2019(a)?

    Federal Rule of Bankruptcy Procedure 2019(a) (Rule 2019(a)) generally requires disclosure by an “entity or committee representing more than one creditor” of the identity of each creditor involved, the nature and amount of its interest, the times when the entity’s interests were acquired and the amounts paid for them.  This rule has relevance for hedge funds that invest in distressed debt because the timing of an acquisition of such debt and the amounts paid for it may provide insight into the fund’s trading strategy – information that can be used by other market participants to the detriment of the disclosing fund in debt transactions and bankruptcy negotiations.  The scope of disclosure required under Rule 2019(a) has been in doubt since two decisions by the U.S. Bankruptcy Court for the Southern District of New York in the Northwest Airlines bankruptcy in 2007, and another decision shortly thereafter by the U.S. Bankruptcy Court for the Southern District of Texas in the Scotia Pacific Company (Scopac) matter.  The issue has come to the fore again recently in the bankruptcy of Washington Mutual Inc. (WMI).  This article examines the caselaw on the subject as it relates to distressed debt trading by hedge funds, and the disclosures required in connection with such trading.  In particular, we offer a detailed examination of the relevant points from the WMI bankruptcy, the Northwest Airlines cases, the Scopac case and the May 2008 Sea Containers case in the U.S. Bankruptcy Court for the District of Delaware.  This article is part one of a two-part series, and focuses primarily on the cases.  Part two will focus on analysis of the cases and issues, incorporating the views of leading practitioners in bankruptcy and other relevant legal areas.

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  • From Vol. 2 No.33 (Aug. 19, 2009)

    Second Circuit Reaffirms Flexible Standards Governing Section 363 Sales in Chrysler Decision

    On August 5, 2009, the United States Court of Appeals for the Second Circuit issued an opinion setting forth the reasoning behind its June 2009 approval of the $2 billion sale of substantially all assets of Chrysler LLC to a newly-formed entity, backed by the United States Treasury Department and managed by the automobile manufacturer Fiat, under Section 363 of the Bankruptcy Code.  This decision reaffirms precedent which established that a flexible standard which meets the needs of individual situations should govern Section 363 sale transactions.  We discuss the factual background of the case and the court’s legal analysis.

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  • From Vol. 2 No.33 (Aug. 19, 2009)

    Lehman Brothers Claims that Withholding of Payments under Swap Agreement Violates the Automatic Stay of Bankruptcy Code

    On June 24, 2009, Lehman Brothers Holdings Inc. (LBH) filed a motion in the United States Bankruptcy Court in the Southern District of New York requesting that the court compel Metavante Corporation to perform its obligations under a swap agreement it had entered with Lehman Brothers Special Financing Inc. (LBSF).  LBH claims that Metavante’s attempt to suspend its regularly scheduled contractual payments violates the automatic stay provisions of the Bankruptcy Code.  Metavante responds that the Bankruptcy Code does not dictate a specific timeframe in which a non-debtor party must terminate a swap contract to preserve the protections afforded by the Code’s safe harbor provisions.  Also, it asserts that their swap agreement specifically permits a swap counterparty to suspend its payment obligations under swap transactions if an “event of default,” such as a bankruptcy, has occurred and is continuing with respect to its counterparty.  We discuss the factual background of the case and the court’s legal analysis.  The case is particularly important in offering guidance to hedge funds about the law that will govern the increasingly important intersection of bankruptcy and derivatives laws.

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  • From Vol. 2 No.27 (Jul. 8, 2009)

    Equities of Bankrupt Companies Offer Hedge Funds a High Risk, Potentially High Return Method of Investing in Restructurings

    Common wisdom holds that common stock is invariably wiped out in a chapter 11 reorganization.  Experience, however, has taught that sometimes common stock retains some value in a reorganization, and in light of the perception that equity will have no value, equities of companies in or near bankruptcy can often be picked up at a major discount.  Even a little recovery, therefore, can yield a lot of return (with, of course, a lot of risk).  Indeed, hedge funds of various stripes, including historic bankruptcy investors and others, have been purchasing bankruptcy equities in the conviction that the issuer will survive a chapter 11 reorganization, and emerge stronger than when it entered.  Many such investments are predicated on one or more of three ideas: (1) that the debt investors are greatly undervaluing the assets of the company; (2) that a major event, such as a lawsuit, will significantly expand the value of the estate; or (3) that industry-wide conditions will improve dramatically (e.g., that many players went into bankruptcy but only few, including the issuer of the subject equity, will emerge).  On the second point, see “Should Hedge Funds Purchase Unsecured Debt of Lehman Brothers Holdings Inc.? Key Legal Issues Impacting Returns,” The Hedge Fund Law Report, Vol. 2, No. 26 (Jul. 2, 2009).  We discuss the risks inherent in such investments; reasons (some of which may be surprising) why equity may not be wiped out in a bankruptcy; ways to mitigate the risk of investments in bankruptcy equities; and the formation, purpose and downside of equity committees.

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  • From Vol. 2 No.23 (Jun. 10, 2009)

    Legal Considerations for Investors In and Around the General Motors Bankruptcy, And Similar Distressed Situations Involving Politically Important Stakeholders

    On June 1, 2009, troubled automaker General Motors filed for Chapter 11 bankruptcy protection, leaving many lenders – both secured and unsecured – uncertain about how the bankruptcy process will play out, especially in light of the contentious negotiations leading up to and during the Chapter 11 filing by rival automaker Chrysler last month.  GM’s bankruptcy advisers announced that the automaker would be divided into two entities – the “new GM” and the “old GM.”  The latter will house the excess plants and equipment that will eventually be sold off.  The “new GM” will be a nationalized entity.  The automaker would then sell the bulk of its assets to a new company, called Vehicle Acquisitions Holding LLC.  The U.S. government has agreed to provide GM with $30 billion in aid, in addition to the $20 billion the car company already has borrowed from the government, to see it through its restructuring and exit from bankruptcy.  The U.S. government will own a 60 percent equity stake in the new company.  In addition, the Canadian government will put in $9.5 billion for a 12 percent stake.  A majority of the unsecured bondholders in the company have agreed to swap their debt for a 10 percent equity share.  The United Auto Workers Union also has reached an agreement that will give it a 17.5 percent stake.  We explain how the GM bankruptcy is unique, the government’s involvement as a participant in the bankruptcy, considerations for secured, unsecured and debtor-in-possession lenders, consequences of overpayments to secured lenders, cram down risk, dealer litigation and lessons to be drawn from the GM bankruptcy.

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  • From Vol. 2 No.18 (May 7, 2009)

    When Hedge Funds Initiate the Bidding on Bankruptcy Assets then Get Outbid, Can They Collect Break-Up Fees or Expense Reimbursements?

    Section 363 of the Bankruptcy Code (the Code) provides a mechanism whereby distressed debt investors can purchase unencumbered assets out of bankruptcy.  Specifically, Code Section 363(b)(1) authorizes a “trustee” (in a Chapter 11 cases, this usually refers to the debtor itself) to sell “property of the estate” other than in the ordinary course of business after notice and a hearing.  Section 363(f) provides that, subject to satisfying certain conditions, the trustee may sell property under Section 363(b) “free and clear of any interest in such property” that a third party may claim.  The ability to purchase assets “free and clear” can be a tremendous benefit to distressed debt investors.  Among other things, it permits greater certainty of ownership and valuation of assets, and easier resale, versus a purchase outside of bankruptcy.  On the downside, however, 363 sales can take a significant amount of time.  Moreover, 363 sales generally proceed as auctions, meaning that the first bidder – known colloquially as the “stalking horse” – can be outbid.  To address this possibility, the stalking horse can provide in the purchase agreement relating to its bid for expense reimbursement, and/or a break-up fee and/or so-called “overbid protection”  Yet the inclusion of such protections in purchase agreements typically provoke challenges from trustees or creditors’ committees, and the law governing such challenges remains unsettled.  The core principle emerging from the relevant cases is that the bankruptcy court (or any appellate court) will only uphold the validity of a break-up fee to the extent the fee benefits the bankruptcy estate.  This article examines the potential pitfalls of participating in 363 sales – an important topic for hedge funds, especially those with a strategy that involves investing in and around bankruptcies, as more and more interesting assets wind up on the bankruptcy auction block.

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  • From Vol. 2 No.16 (Apr. 23, 2009)

    Delphi Drops Fraud Claim against Appaloosa Management in Adversary Proceeding Arising Out of Alleged Breach of Bankruptcy Exit Financing Agreement

    On April 17, 2009, Judge Robert Drain of the U.S. Bankruptcy Court for the Southern District of New York ruled that Delphi Corporation (Delphi), the Troy, Michigan-based auto parts supplier that filed for chapter 11 bankruptcy protection in October 2005, may amend its complaint against Appaloosa Management LP (Appaloosa), a hedge fund manager that in April 2008 allegedly refused to participate in a funding that would have led to Delphi’s exit from bankruptcy.  As a result of that alleged refusal, Delphi sued Appaloosa, alleging, among other things, fraud.  Judge Drain’s decision will permit Delphi to remove fraud claims from its complaint while continuing with an adversary proceeding against Appaloosa.  On April 22, 2009, Appaloosa and affiliate A-D Acquisition Holdings LLC filed a Notice of Motion for Summary Judgment, asking for a hearing on that Motion on June 5, “or as soon thereafter as counsel can be heard.”  We offer a detailed review of the pleadings in the adversary proceeding – a cautionary tale for any hedge fund contemplating a DIP loan or other bankruptcy lending.

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  • From Vol. 2 No.9 (Mar. 4, 2009)

    Update on the Petters Fraud: Polaroid Bankruptcy Trustee Sues to Void Hedge Fund’s Pre-Bankruptcy Receipt of Polaroid Assets

    On February 12, 2009, the trustee in the bankruptcy proceeding of Polaroid Corporation, the camera and film company owned by Thomas J. Petters, filed lawsuits in the United States Bankruptcy Court for the District of Minnesota against two hedge fund managers, Acorn Capital Group, LLC and Ritchie Capital Management, LLC, claiming that they exploited Polaroid to extract value from the company shortly before Petters’ alleged fraud was uncovered.  In the actions against Acorn and Ritchie, the trustee asserted that both hedge fund firms used their positions as creditors to conceal losses at Petters’ businesses and to divest Polaroid of assets in the form of liens or other guarantees shortly before the Ponzi scheme collapsed.  We detail the complex allegations in the trustee’s complaints, and in the process offer insight into considerations relevant to hedge funds that have or may obtain investments in or claims with respect to companies in the zone of insolvency.

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  • From Vol. 2 No.7 (Feb. 19, 2009)

    Delaware Bankruptcy Court Decision Precludes Triangular Setoff

    A “setoff,” in the bankruptcy context, refers to the ability of entities that owe each other money to apply their debts against one another.  According to the United States Supreme Court, this avoids “the absurdity of making A pay B when B owes A.”  Citizens Bank of Maryland v. Strumpf, 516 U.S. 16 (1995).  Although the Bankruptcy Code does not create any setoff rights per se, it recognizes setoff rights if they otherwise exist under applicable non-bankruptcy law and satisfy the conditions set forth in section 553 of the Code. Section 553 limits setoffs to mutual obligations between a debtor and creditor.  It has four conditions; most significantly, it requires “mutuality,” meaning that the offsetting claim and debt must be owed between the same parties acting in the same capacity.  On January 9, 2009, in In re SemCrude, L.P., the United States Bankruptcy Court for the District of Delaware held that a creditor in bankruptcy cannot effect a “triangular” setoff of the amounts owed between it and three affiliated debtors, despite pre-petition contracts that expressly contemplated multiparty setoff.  We explain the facts and holding of a case that can have profound implications for hedge funds’ rights vis-à-vis bankrupt counterparties.

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  • From Vol. 1 No.21 (Sep. 22, 2008)

    SageCrest Files for Chapter 11 Bankruptcy, a Rare Move by a Hedge Fund

    In what legal experts have called a rare move by a hedge fund, troubled Greenwich, CT hedge fund SageCrest II has filed for bankruptcy protection in an effort to head off a forced asset sale. In a letter to investors, a copy of which was obtained by The Hedge Fund Law Report, SageCrest said that Deutsche Bank’s recent refusal to allow the fund to draw on a $400 million line of credit was one of the reasons for the bankruptcy filing. Liquidity of fund assets may play a role in whether bankruptcy is within the range of considerations in distressed situation. For example, in the midst of a wave of redemption requests, a fund with a substantial percentage of illiquid assets may consider a bankruptcy filing as one method of preserving the value of those assets. However, experts caution that even for funds in distress, a bankruptcy filing should only be considered once other options have been exhausted, since a filing diminishes the control of the fund manager over the disposition of assets.

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  • From Vol. 1 No.13 (May 30, 2008)

    Cayman Islands Liquidations of Failed Bear Stearns Hedge Funds Denied Access to US Bankruptcy Court

    In an opinion filed on May 27, 2008, Judge Sweet of the US District Court for the Southern District of New York affirmed a Bankruptcy Court decision holding that the official Cayman Islands liquidations of two failed Bear Stearns hedge funds were not entitled to recognition by the US Bankruptcy Court as either “main” or “nonmain” proceedings under Chapter 15 of the Bankruptcy Code.

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