In a recent decision, the United States Bankruptcy Court for the Southern District of New York found that a relatively small retainer placed in the trust account of the foreign liquidators’ U.S. counsel constituted “property” sufficient to satisfy the requirements of section 109(a) of the Bankruptcy Code in a chapter 15 proceeding.[1] The decision elucidates the parameters of the “property” requirement of section 109, which the Second Circuit has applied even in the chapter 15 context.[2]

In August 2014, B.C.I. Finances Pty Limited, Binqld Finances Pty Limited, E.G.L. Development (Canberra) Pty Limited, and Ligon 268 Pty Limited (the “Debtors”), a group of companies controlled and operated by the Binetter family, were placed into Australian liquidation proceedings after allegations of fraud and tax evasion arose.[3] John Sheahan and Ian Russell Lock were appointed as joint liquidators (the “Liquidators”).[4] Following their appointment, the Liquidators brought suit against the Debtors’ corporate directors, including Andrew and Michael Binetter, in Australia, alleging that the corporate directors had breached their fiduciary duties, and that their breaches caused “significant losses” to the Debtors.[5] The trial judge in Australia ultimately ruled in the Liquidators’ favor, but did not come to a determination on the issue of damages.[6]

In 2017, the Liquidators sought chapter 15 recognition of the Australian liquidation proceedings in order to conduct discovery of Andrew and Michael Binetter, who had moved to New York City during the pendency of the trial in Australia.[7] Andrew Binetter, along with another party (together, the “Objecting Parties”), opposed the Liquidators’ chapter 15 petition.

The Objecting Parties claimed that the Debtors were ineligible for chapter 15 relief because they did not have sufficient “property” in the United States to satisfy section 109(a) of the Bankruptcy Code. Section 109(a) states that “only a person that resides or has a domicile, a place of business, or property in the United States . . . may be a debtor under this title.”[8] The Second Circuit has held that this requirement must also be satisfied in the context of chapter 15 proceedings.[9] However, the Second Circuit did not specify a threshold for the amount of “property” sufficient to satisfy this requirement in the chapter 15 context.

In response, the Liquidators argued that (1) a $1,250 retainer placed in the trust account of the Liquidators’ counsel (the “Retainer”) and (2) the Debtors’ fiduciary duty claims against Andrew and Michael Binetter (the “Fiduciary Duty Claims”) constituted “property in the United States” sufficient for section 109(a) eligibility.[10]

The Bankruptcy Court held that the Retainer and the Fiduciary Duty Claims each independently satisfied the section 109(a) requirement.[11] Before concluding that even a $1,250 retainer may satisfy section 109(a), the Court noted that “it is well established that ‘[a] debtor’s funds held in a retainer account in the possession of counsel to a foreign representative constitute property of the debtor in the United States and satisfy the eligibility requirements of section 109.’”[12] Furthermore, the court emphasized that the “property” requirement in section 109(a) is satisfied even by a “minimal amount of property” in the United States.[13] The court then rejected the Objecting Parties’ argument that the Debtors’ deposit was made in order to “manufacture eligibility under Section 109.”[14]

The court next addressed whether the Fiduciary Duty Claims were located in the United States, since it was undisputed that the Fiduciary Duty Claims were property of the Debtors. Using a multi-step analysis, the court first applied New York’s “greatest interest test,” holding that the situs of the Fiduciary Duty Claims should be determined according to Australian law.[15] Then, after considering expert testimony on the issue, the court determined that, under Australian law, claims “are situated where they are properly recoverable and are properly recoverable where the debtor resides.”[16] Therefore, the court concluded that, because the Binetters lived in New York, the situs of the Fiduciary Duty Claims was New York and qualified as “property in the United States.”

Although the Barnet decision imposed an additional eligibility requirement for foreign representatives seeking chapter 15 protections,[17] the Bankruptcy Courts have consistently lowered the barrier, ensuring that foreign representatives are afforded easy access to the protections offered in chapter 15. With this low barrier, even a de minimis amount of funds deposited in a trust account for the purpose of retaining counsel may satisfy the eligibility requirement. In addition, claims that situated in the United States under applicable laws may also satisfy the requirement.

-Hillary McDonnell assisted with the preparation of this post.

 

[1] In re B.C.I. Finances Pty Limited, 583 B.R. 288 (Bankr. S.D.N.Y. 2018).

[2] See Drawbridge Special Opportunities Fund LP v. Barnet (In re Barnet), 737 F.3d 238 (2d Cir. 2013).

[3] Id. at 290.

[4] Id.

[5] Id. at 291.

[6] Id.

[7] Id.

[8] Id. at 292; 11 U.S.C. § 109(a).

[9] See Barnet, 737 F.3d at 247; see also In re Forge Grp. Power Pty Ltd., No. 17-CV-02045-PJH, 2018 WL 827913, at *9 (N.D. Cal. Feb. 12, 2018) (adopting the Second Circuit’s reasoning to hold that Section 109(a) applies to chapter 15 proceedings). But see Transcript of Hearing at 8-9, In re Bemarmara Consulting A.S., No. 13-13037 (KG) (Bankr. D. Del. Dec. 17, 2013) (holding that section 109(a) does not apply to chapter 15 proceedings).

[10] B.C.I. Finances, 583 B.R. at 291.

[11] Id. at 290.

[12] Id. at 293 (quoting In re Poymanov, 571 B.R. 24, 29 (Bankr. S.D.N.Y. 2017)).

[13] Id. at 294.

[14] Id. at 295.

[15] Id. at 297.

[16] Id. at 300.

[17] Barnet, 737 F.3d at 251 (holding that a debtor within a foreign proceeding seeking recognition under chapter 15 must satisfy the section 109(a) requirement of residing or having a domicile, place of business, or property in the United States).

In what may become a precedential analysis of the cardinal principles of Delaware corporate and bankruptcy law, the Delaware Court of Chancery recently issued a decision in Quadrant Structured Products Co., Ltd. v. Vertin, extensively discussing the rights of an insolvent company’s creditors to pursue derivative claims against the company’s directors and provided guidance to directors of distressed companies on the fiduciary duties they owe to the corporation and its stakeholders.

As a result of the financial crisis, Athilon Capital Corp, which guaranteed credit default swaps on collateralized debt obligations, suffered severe financial distress and became insolvent. A former note holder, EBF & Associates LP, subsequently acquired all of Athilon’s equity and as a result also gained control of Athilon’s board. Following this acquisition, Quadrant Structured Products Company, a creditor and note holder of Athilon, filed a derivative lawsuit in the Delaware Court of Chancery against Athilon’s directors alleging that they had breached their fiduciary duties by adopting a high risk investment strategy for the sole benefit of EBF at the expense of Athilon’s other creditors. After the filing, Athilon structured several financial transactions with EBF, which, according to the defendants, returned Athilon to balance-sheet solvency. The directors then moved for summary judgment and argued that Quadrant could only have standing to bring a derivative lawsuit if it could show that (i) Athilon was insolvent at the time the lawsuit was commenced and continuously thereafter, and (ii) Athilon was “irretrievably insolvent,” i.e., with no reasonable prospect of returning to solvency.

Noting that the question was one of first impression under Delaware law, the court rejected continuous insolvency as a requirement for creditor standing. The court explained that a continuous insolvency requirement was ill-advised because, during the course of litigation, “a troubled firm could move back and forth across the insolvency line such that a continuing insolvency requirement would cause creditor standing to arise, disappear, and reappear again.” Further, to require continuing insolvency for creditor standing would allow conflicted directors to prevent the corporation and its creditors from pursuing valid claims by restoring the corporation back to solvency and would result in a “failure of justice.” Therefore, to have standing to sue derivatively, a creditor need only establish that a corporation was insolvent at the time the creditor filed suit; whether the corporation was continuously insolvent thereafter is irrelevant.[1] The court also rejected the more onerous “irretrievable insolvency” requirement because the great weight of Delaware authority uses the traditional “balance sheet test,” which deems an entity insolvent when it has liabilities in excess of a reasonable market value of assets. The court noted that the balance sheet test was also consistent with both the test under the Bankruptcy Code for recovery of allegedly preferential or fraudulent transfers,[2] and Delaware’s statutory standard for determining whether a Delaware corporation has a cause of action against its directors for declaring an improper dividend or improperly repurchasing stock.[3]

The ruling in Quadrant Structured Products Co., Ltd. v. Vertin should be of interest for board members whose company is already, or faces the prospect of, insolvency. Although the Delaware Court of Chancery rejected the continuous insolvency and “irretrievable insolvency” requirements, the ruling does not significantly expand derivative plaintiffs’ rights—they still may not bring direct claims to enforce fiduciary duties against an insolvent corporation, do not have a “deepening insolvency” cause of action, may only gain standing to derivatively sue the board when the corporation is insolvent rather than in the “zone of insolvency” and enjoy the broad protections of the business judgment rule. Quadrant may have removed a single arrow from the quiver of a director defending against derivative suits, but the quiver still remains full.

[1]       In reaching these conclusions, Vice Chancellor Laster elaborated on the legal principles underpinning the regime for creditor-derivative litigation in light of the Delaware Supreme Court’s 2007 decision in North American Catholic Educational Programming Foundation v. Gheewalla, 930 A.2d 92 (Del. 2007), and its progeny, namely that:

  • Creditors do not gain derivative standing when a corporation operates in a “zone of insolvency.” The corporation’s “insolvency itself” is the only factor conferring standing to creditors.
  • Regardless of the corporation’s solvency or insolvency, creditors may only bring derivative claims – as opposed to direct claims – to enforce fiduciary duties.
  • The directors of an insolvent corporation do not owe any particular duties to creditors and continue to owe fiduciary duties to the corporation for the benefit of its residual claimants, which includes creditors. Therefore, the directors (a) may continue to operate the insolvent entity and refuse to transfer or distribute all of its assets to the creditors, and (b) may exercise their good faith judgment to favor non-insider creditors over other creditors of similar priority.
  • There is no theory of “deepening insolvency” in Delaware. Directors may continue to operate an insolvent entity in the good faith belief that they may achieve profitability even if their decisions ultimately lead to greater losses for creditors.

[2]       See 11 U.S.C. § 101(32)(A) (defining insolvency as a “financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation, exclusive of–(i) property transferred, concealed, or removed with intent to hinder, delay, or defraud such entity’s creditors; and (ii) property that may be exempted from property of the estate under section 522 of [the Bankruptcy Code].”).

[3]       See 8 Del. C. § 160(a)(1); SV Inv. P’rs, LLC v. ThoughtWorks, Inc., 7 A.3d 973, 982 (Del. Ch. 2010) (“[T]he [net assets] test operates roughly to prohibit distributions to stockholders that would render the company balance-sheet insolvent, but instead of using insolvency as the cut-off, the line is drawn at the amount of the corporation’s capital.”), aff’d, 37 A.3d 205 (Del. 2011).