Navigating distressed M&A
Investors and advisers have been poised for a flood of distressed M&A transactions since the early days of the pandemic.
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Chapter 15 of the United States Bankruptcy Code provides a mechanism for a foreign debtor or a foreign representative (e.g., trustee or administrator) to seek recognition of a foreign insolvency, liquidation, or debt restructuring proceeding (known as a foreign proceeding) in the US. To be eligible for Chapter 15 recognition, a foreign proceeding must be either (1) a foreign main proceeding, which is one pending where the debtor has the center of its main interests, or (2) a foreign nonmain proceeding, which is one pending where the debtor has an establishment (i.e., “any place of operations where the debtor carries out a nontransitory economic activity”).
Upon recognition of a foreign main or nonmain proceeding, a foreign representative will have access to the US courts to sue and seek other relief. Moreover, upon recognition of a foreign main proceeding, creditors and other parties will be automatically stayed from taking any action to collect a debt against the debtor or its assets in the US. Recognition, however, does not result in the automatic enforcement of a debtor’s foreign debt restructuring or liquidating plan. Nevertheless, a US court may, upon recognition, issue an order enforcing such a plan in the US. This article discusses two recent instances in which a US court enforced a plan, including the release provisions, approved by a Canadian court.
Mood Media Corporation, a Canadian corporation, and its affiliates provide in-store audio, visual, and other forms of media and marketing solutions throughout the world. Mood Media issued USD $350 million of 9.25% senior unsecured notes due 2020. Certain US subsidiaries of Mood Media guaranteed the obligations on the notes. Faced with near-term debt maturities, Mood Media and its affiliates entered into an agreement in April 2017 with certain significant holders of the 9.25% notes, under which, among other things, the notes would be exchanged for new notes and new common stock and the existing common stock of Mood Media would be redeemed for CAD $0.17 per unit. In addition, the subsidiary guarantees would be released.
On May 18, 2017, Mood Media commenced a proceeding under section 192 of the Canada Business Corporations Act (the “CBCA”) in the Ontario Superior Court of Justice (Commercial List) to effectuate the proposed restructuring under a “Plan of Arrangement.” On the same day, the Canadian court issued an order authorizing Mood Media to hold a special meeting of the noteholders and shareholders on June 15, 2017 to consider and vote on the Plan of Arrangement. In addition, the order provided that the Plan of Arrangement must be approved by %) of the votes cast by shareholders before the Plan of Arrangement could be submitted to the Canadian court for final approval.
On May 22, 2017, Mood Media and fourteen of its US subsidiaries filed petitions under Chapter 15 of the United States Bankruptcy Code seeking recognition of the Canadian proceeding under the CBCA as foreign nonmain proceedings as well as orders enforcing the Plan of Arrangement in the US. Mood Media and the subsidiaries commenced the Chapter 15 cases prior to the special meetings of the noteholders and the shareholders to expedite the implementation of the Plan of Arrangement by minimizing the time between the approval of the Plan of Arrangement in Canada and the issuance of an order enforcing it in the US.
Following approval of the Plan of Arrangement by the Canadian court, the United States Bankruptcy Court held a hearing to consider the request for recognition of the Canadian proceeding and entry of an order enforcing the Plan of Arrangement in the US. As an initial matter, the bankruptcy court noted that the request raised two fundamental issues. First, the court had to determine whether the US subsidiaries were “debtors” for purposes of Chapter 15. Second, assuming they were debtors, the court had to determine whether the US subsidiaries had an establishment in Canada. The bankruptcy court did not question whether Mood Media was a debtor or if it had an establishment in Canada.
A necessary element for a foreign proceeding is the existence of a “debtor.” Absent a debtor, there is no foreign proceeding to be recognized. For purposes of Chapter 15, a debtor is defined as “an entity that is the subject of a foreign proceeding.” In this instance, the bankruptcy court concluded that Mood Media, a Canadian corporation, was the only “debtor” in the Canadian proceeding. Mood Media commenced the Canadian proceeding. In accordance with the Canadian court’s order, Mood Media convened the meetings of noteholders and shareholders. In addition, the Canadian court’s order approving the Plan of Arrangement (the “Approval Order”) clearly referred to Mood Media and the Plan of Arrangement as being “of” Mood Media. In contrast, the Canadian court did not authorize or direct the US subsidiaries “do anything.” Indeed, the US subsidiaries were not among the parties authorized to speak at the meetings. Moreover, the US subsidiaries could not have commenced their own proceeding under the CBCA, which is available only to Canadian corporations. According to the bankruptcy court, the US subsidiaries “were just there as beneficiaries of orders that related to the restructuring of the parent company’s obligations.”
The US subsidiaries argued that they were debtors because the Plan of Arrangement and the Approval Order released the subsidiaries’ guarantees and enjoined US creditors from taking certain actions against the US subsidiaries or their assets. The bankruptcy court easily dismissed this argument, finding that the mere fact that the Canadian court has jurisdiction over (and could compel creditors to release the guarantees of) the US subsidiaries did not make the subsidiaries debtors. By way of example, the bankruptcy court noted that there are many instances in a chapter 11 case where a plan results in a release of claims against officers and directors, indenture trustees, or other parties, “but nobody would reasonably argue that the ability of a court to release those claims means that the releasees are persons who are subject to the proceedings, and subject to the jurisdiction of the court, in a way that makes them ‘debtors’ in the proceedings.”
Moreover, the US subsidiaries did not have an establishment in Canada. According to the bankruptcy court, establishment “contemplates the existence of a place of business in the foreign country from which market-facing activities are conducted.” The evidence demonstrated that the US subsidiaries were subject to oversight by and shared internal enterprise functions (e.g., cash management, accounting, legal, human resources) with Mood Media, retained service providers in Canada, and had contracts with other parties in Canada. But the US subsidiaries did not have an office or a physical presence in Canada. According to the bankruptcy court, the subsidiaries’ contacts with Canada in this instance were not sufficient to support a finding that the subsidiaries had an establishment in Canada. Consequently, the Canadian proceeding could not be recognized under Chapter 15 as to the US subsidiaries.
As discussed above, the bankruptcy court found that Mood Media was a debtor. It also concluded that there was no question that Mood Media had its center of main interest in Canada. Accordingly, it recognized Mood Media’s Canadian proceeding as a foreign main proceeding. Moreover, the bankruptcy court decided to enforce the Plan of Arrangement, which contained the releases of the US affiliates from their guarantee obligations. The bankruptcy court also enforced a provision contained in the Plan of Arrangement and Approval Order enjoining counterparties to contracts or debt instruments with the US subsidiaries from terminating such contract because of the subsidiaries’ involvement in the Canadian proceedings or the Plan of Adjustment. Because such provisions were contained in the Plan of Arrangement and the Approval Order, the US subsidiaries were able to obtain the releases and other protections they wanted upon enforcement of the Plan of Arrangement under Chapter 15 notwithstanding the lack of recognition of the Canadian proceedings as to the US subsidiaries themselves.
Artic Glacier Income Fund (“AGIF”) is an income trust based in Canada that owns a group of packaged ice manufacturers and distributors. AGIF trust units are listed on the Canadian Securities Exchange and publicly traded in the US on the “Over-The-Counter” market. In February 2012, AGIF and its affiliates commenced insolvency proceedings in Canada under the Companies’ Creditors Arrangement Act (the “CCAA”) before the Court of Queen’s Bench of Winnipeg Centre. On the same day, the Canadian court appointed a monitor, who commenced cases under Chapter 15 to obtain recognition of the Canadian proceedings in the US.
On September 5, 2014, the Canadian court issued an order (the “Sanction Order”) approving AFIG’s plan of arrangement under the CCAA. AFIG’s plan provided detailed procedures for distribution to unitholders registered as of a particular date to be declared by the monitor (i.e., the record date). The plan further provided that once approved it was binding on all unitholders and their successors and assigns. Moreover, AFIG’s plan provided for the release of liability against AFIG and certain insiders for any actions or omissions related to, arising out of, or in connection with the plan. On September 16, 2014, the United States Bankruptcy Court for the District of Delaware entered an order enforcing the Sanction Order in the US (the “Enforcement Order”).
In November 2014, the monitor issued a report predicting that the plan would be implemented on or about January 8, 2015. Thereafter, AGIF issued a press release, which was posted on SEDAR (the electronic filing system for disclosure documents of investment funds in Canada), and published notice that unitholders of the fund as of December 18, 2014 would be entitled to a distribution under the plan. Because of a three-day processing period for sales, only purchasers of units on or before December 15, 2014 would have been identified as registered holders as of the December 18, 2014 record date. During the period of December 16, 2014 through and including January 22, 2015, Eldar Brodski Zardinovsky and others purchased AGIF trust units.
On January 22, 2015, AGIF distributed approximately USD $0.16 per unit to the unitholders of record as of December 18, 2014 in accordance with plan. Zardinovsky and the other buyers did not receive a distribution from AGIF under the plan because they were not identified as registered unitholders as of December 18, 2014. In a complaint filed with the United States Bankruptcy Court for the District of Delaware, Zardinovsky and the other buyers (collectively, the plaintiffs) asserted that they (and not the prior unitholders) were entitled to a distribution under certain rules and regulations governing Over-The-Counter market transactions adopted and administered by the Financial Industry Regulatory Authority (“FINRA”).
Under FINRA rules, there are two key dates for distribution purposes: (1) the record date, which is set by the issuer for the purpose of determining which holders of equity securities should receive dividends, and (2) the ex-dividend date, which is set by FINRA and determines which holders are legally entitled to dividends. “The fact that an individual is the holder of record on the record date, however, does not necessarily mean that such person is entitled to retain the dividend.” According to the plaintiffs, the dividend paid by AGIF was 25% or greater than the value of the units and thus under FINRA rules, the ex-dividend date should have been January 23, 2015, the first day following the payable date. However, FINRA never set the ex-dividend date because AGIF did not, as required by FINRA rules, notify FINRA of the record date or inform and obtain approval from FINRA of the date and amount of the distribution. Consequently, the plaintiffs did not receive a dividend from AGIF as required under FINRA rules. They therefore sued AGIF and certain insiders in the Bankruptcy Court, alleging that AGIF’s distribution violated US securities laws.
The bankruptcy court dismissed the plaintiffs’ complaint finding that (1) AGIF’s plan’s distribution procedure superseded any conflicting obligations, including FINRA rules, and (2) the releases contained in AGIF’s plan were binding on the buyers and barred their claims. On appeal, the United States District Court for the District of Delaware affirmed the bankruptcy court’s findings.
In arguing that AFIG’s distributions violated US securities laws, the plaintiffs did not deny that AFIG made the distributions in accordance with AFIG’s plan. Instead, they asserted that the AFIG and its fellow defendants had “concurrent and additional obligations,” including those under FINRA rules, not set forth in the plan. According to the plaintiffs, the plan did not excuse the defendants from their FINRA obligations.
In rejecting the plaintiffs’ arguments, the district court emphasized that the plan provided an exclusive procedure for distribution to unitholders and did not impose an obligation on AFIG to make distributions in accordance with FINRA rules. Consequently, AFIG’s distributions were not subject to FINRA rules. Moreover, distributions under FINRA rules, as advocated by the plaintiffs, would have conflicted with the terms of AFIG’s plan, the Sanction Order, and the bankruptcy court’s Enforcement Order. In particular, application of FINRA rules in this instance could have resulted in multiple smaller distributions to unitholders or in duplicative payments--one to plaintiffs and one to the selling unitholders. The district court found that AFIG’s plan did not contemplate or provide for multiple distributions. Moreover, there was no support in AFIG’s plan or otherwise for making additional separate distributions to the plaintiffs, as purchasers of the trust units. According to the court, such separate distributions to plaintiffs would violate the terms of AFIG’s plan and the Sanction Order.
The district court further noted that AFIG’s plan was approved by a final order on the merits. The district court cited existing precedent from the Court of Appeals for the Third Circuit (which includes Delaware) and concluded that the plaintiffs were barred from “re-litigating any aspect of the Plan, including its distribution procedure” by attacking, after the fact, the distributions made in accordance with AFIG’s plan. “Absent the Plan being procured by fraud, or plaintiffs establishing a due process violation, the doctrine of res judicata bars plaintiffs from now contesting the Plan’s distribution procedure.”
After having found that AFIG’s plan, including its distribution procedure, was binding on AFIG and the plaintiffs, the district court analyzed the releases contained in the plan, the Sanction Order and the Enforcement Order. The plaintiffs acknowledged that the releases protected the defendants from liability for acts taken in accordance with AFIG’s plan. But they argued that the releases did not preclude a finding of liability based upon the “defendants’ disregard” of their obligations under US law.
The district court concluded that the releases were broad and encompassed the plaintiffs’ claims for not having received a distribution under AFIG’s plan. In particular, the releases prohibited (1) all claims against the defendants “in any way related to, or arising out of or in connection with” AFIG’s business and affairs, AFIG’s plan, or the Canadian proceedings, and (2) “any liability as a result of payments and distributions to Unitholders,” including omissions. Irrespective of the terms of the releases, the plaintiffs argued that they were not bound by the releases and that enforcement of the releases against them would violate their due process rights. The district court disagreed with the plaintiffs.
According to the plaintiffs, they were not bound by the releases because they purchased the units after approval of AFIG’s plan. The district court found that the plaintiffs “stepped into the shoes of the selling unitholders, and acquired no greater rights than the selling unitholders.” Indeed, AFIG’s plan and the Sanction and Enforcement Orders expressly provided that all unitholders and their successors and assigns are bound to the releases. The plaintiffs, as successors and assigns of the selling unitholders, acquired the rights of the unitholders as of the date of the sale, which did not include the right to a distribution from AFIG, and were bound to the releases. In addition, the releases, by their terms, were binding on “any Person,” which would include the plaintiffs, in connection with any distribution under AFIG’s plan. Moreover, “to rule that a party that buys a bankruptcy claim after plan confirmation is not bound by the terms of the plan would completely undermine the certainty and finality a plan must provide in order to be effective.”
In general, a release will be ineffective if it is procured in violation of a party’s due process rights. Here, the plaintiffs argued that the releases should not be enforced as against them because they did not have notice of and their interests were not represented in the Canadian proceedings. According to the plaintiffs, the Canadian court should have appointed someone to represent the interests of purchasers of unitholders. The district court, however, found that the plaintiffs’ due process rights were not violated. The plaintiffs bought claims from unitholders who had notice of and who participated in the Canadian proceedings, and who overwhelmingly voted in favor of AFIG’s plan. Therefore, the district court rejected the plaintiffs’ due process challenge.
Absent a showing that a Canadian plan was procured by fraud or raised serious due process concerns, a US court will, upon recognition of a Canadian proceeding, generally enforce a Canadian plan under Chapter 15 of the US Bankruptcy Code. US courts have typically not been troubled by releases contained in Canadian plans and have enforced them without much fanfare. Indeed, the court in Mood Media enforced the releases contained in a plan for the benefit of non-debtor US subsidiaries without undertaking a lengthy analysis. However, a US court will typically enforce a plan only in accordance with its terms and related orders. A US court is unlikely to interpret a Canadian plan beyond its stated terms. Therefore, parties should understand the terms of a plan and the relevant orders before taking any action. Had the buyers of AGIF’s unitholders been mindful of the terms of AGIF’s plan before purchasing the units, they may have been able to avoid the negative consequences of their transaction in the US.
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