Just when you thought it was safe to cross the pond.. Selinda A Melnik takes a look at the US court's view of UK solvent schemes of arrangement.
With increased frequency, US bankruptcy courts have agreed to grant requests to enjoin US parties from taking actions that might impair the viability of UK solvent schemes of arrangement.
Authorised under section 425 of the UK Companies Act 1985, solvent schemes seek to more rapidly and efficiently, and with greater finality and certainty, resolve otherwise protracted and costly re/insurance run-offs. US judicial assistance, therefore, often is vital where significant US policyholder and asset exposure are involved.
Despite greater acceptance, US assistance of foreign schemes by no means is guaranteed and, thus, should not be presumed. Predicate criteria under the US Bankruptcy Code must be met before a US court initially may recognise the UK scheme and, thereafter, order relief to facilitate the scheme or shield it from being undermined from within the US.
The law that must be applied in this process, however, while highly advanced, remains ambiguous, subject to the court's subjective interpretation, or to its discretionary application.
The resultant lack of certainty and predictability presents numerous challenges for those requiring swift and comprehensive US judicial intervention.
The risk of uncertain outcome increases where the US court is presented with previously unexamined forms of schemes or related business arrangements.
It, therefore, is not surprising that requests for such US assistance remain open to attack, particularly in high profile cases, those involving significant US exposure, and those concerning innovative or nontraditional schemes and related arrangements. With both US bankruptcy law and the UK run-off industry operating in dynamic and evolving landscapes, the risk of unanticipated objection criteria is inevitable. Indeed, two very recent US court decisions, discussed below, raise one previously unconsidered concern and revive another thought firmly resolved.
Accordingly, one seeking to obtain US assistance in aid of a solvent scheme must, at a minimum: refrain from assuming that (re)insurance scheme equals automatic relief; eschew relying on recycled court pleadings; comprehensively understand the terrain to be traversed; conduct thorough and informed due diligence; attempt to identify and account for potential lurking obstacles, objections and objectors; build in as much lead time as possible to the process; and carefully craft and prosecute requests for assistance and relief that simultaneously are both offensive and defensive.
Predicates for US assistance
US judicial assistance in aid of a UK scheme most frequently is sought through Section 304 of the US Bankruptcy Code. Section 304 provides a mechanism through which a duly authorised 'foreign representative' of a non-US debtor in a pending 'foreign proceeding' may commence a limited form of a US insolvency proceeding ancillary to the 'foreign proceeding' to obtain from a US bankruptcy court orders granting certain relief in aid of the 'foreign proceeding".
A successful Section 304 proceeding filed in aid of a Section 425 scheme typically stays actions by US creditors of the scheme company and actions against the company's US-based assets, providing the time and protections necessary to progress the proposed scheme through the requisite stages of solicitation, approval, UK High Court of Justice sanction, and implementation.
The predicate challenge in obtaining Section 304 relief in aid of a UK scheme is to successfully establish that the UK scheme is eligible to be recognised as a 'foreign proceeding' and that the proponent of the Section 304 relief is a duly authorised 'foreign representative' of that 'foreign proceeding'. While both of these terms are defined in Bankruptcy Code sections 101(23) and (24), their definitions are imprecise and ambiguous.
Accordingly, it is critical that the documents filed to commence the Section 304 proceeding be protectively and persuasively drafted.
Even if the initial recognition hurdle is scaled successfully and the Section 304 proceeding permitted to proceed, that does not ensure that the relief sought by commencing the case will be granted. While the Bankruptcy Code affords broad discretion to the bankruptcy court to determine the nature of the relief it might grant in aid of the foreign proceeding, the Code fails to provide the court adequate and sufficiently precise instruction for determining whether such relief may be granted under the circumstances presented.
The Code merely commands that the court "be guided by what will best assure an economical and expeditious administration of the (foreign) estate" and do so consistent with six unfortunately ambiguous factors set forth in Section 304(c). This directive and the factors required to be considered have spawned extensive litigation and wide-ranging decisions.
Thus, to best ensure that requested relief will be granted, it is crucial that the assertions and pleas in the document seeking relief be the product of well-informed appreciation of the issues coupled with comprehensive investigation and analysis of the facts and circumstances related to the scheme, the subject company, its assets and its creditors.
A frequent obstacle to obtaining expeditious Section 304 relief in aid of a UK scheme is an objection asserting that the proposed scheme disenfranchises or otherwise impairs the rights of US creditors. The section 304(c) criteria require the US court to consider whether the foreign law it is asked to aid would be anathema to US policy, improperly discriminate against US creditors, or otherwise unjustifiably impair the ability of US creditors to assert and enforce their rights.
Thus, for example, a US court may determine that it lacks the power to order injunctive or other requested relief in aid of the foreign scheme because the procedures approved under the foreign law do not provide all US creditors adequate and timely notice of the scheme, its terms and scope, voting deadlines and requisites, or claims submission and adjudication procedures.
The proponent of a scheme whose viability depends upon US judicial assistance therefore must frame key elements of the scheme in a manner that will empower the US court to grant the requisite relief.
Two recent US court decisions raise additional issues to be considered in fashioning requests for relief under section 304 related to run-off schemes.
Recognisable run-off schemes: In re Petition of David Rose, as director of the legal entity closedown project for Aviva plc, et al, _BR _ 2004 WL 3058305 (Bankr SDNY December 29, 2004). One day before December 30, 2004 effective date of a UK run-off transfer scheme, a US bankruptcy court determined that the scheme did not fit the definition of a 'foreign proceeding' under the US Bankruptcy Code and the court therefore lacked the power to sustain the Section 304 petition filed in support of the scheme.
The transfer scheme had been approved by the High Court of Justice of England and Wales pursuant to Part VII of the UK's Financial Services and Markets Act 2000. The Section 304 case had been commenced to obtain a US nationwide injunction without which the petitioner claimed the sanctioned transfer scheme would likely fail. The scheme proposed to transfer the majority of assets and liabilities of 12 solvent British insurers and reinsurers to a 13th company that would administer the run-off insurance liabilities of the transferring companies.
The US bankruptcy court determined that the scheme proposed was not related to any foreign insolvency proceeding and did not effect the kind of "reorganisation" contemplated by the definition of "foreign proceeding" in the US Bankruptcy Code.
The decision currently is on appeal. If upheld, the Rose decision obviously may impact the sustainability of other current and future re/insurance business forms whose viability may be dependent upon US injunctive relief.
Solvency: US bankruptcy law traditionally has not required that a debtor be insolvent to be eligible for relief under the Bankruptcy Code. Accordingly, to date, the fact that the subject company of a proposed UK scheme of arrangement is solvent has not prevented US bankruptcy court recognition of such UK schemes nor precluded granting assistance.
However, a recent US appellate court decision unrelated either to section 304 or UK schemes has raised concerns within the US bankruptcy community that a debtor's solvency may be a factor a US bankruptcy court may consider in determining whether a case has been commenced in good faith, thus entitling the debtor to Bankruptcy Code protection and relief.
In re Integrated Telecom Express, Inc, 384 F.3d 108 (3d Cir. 2004), the US Court of Appeals for the Third Circuit found that a Chapter 11 case filed solely to take advantage of a single 'debtor-friendly' provision of the US Bankruptcy Code by a solvent debtor having no intention of reorganising or liquidating had not been filed in good faith and therefore must be dismissed.
Given the current US Bankruptcy Code and established precedent, it appears highly unlikely that an insolvency test will be required for US Chapter 11 reorganisations or Chapter 7 liquidations presenting facts different from those which occasioned the Integrated Telecom decision.
Even were such a test universally adopted, it does not necessarily follow that a foreign debtor's solvency would preclude a US bankruptcy court from recognising such debtor's foreign proceeding or aiding it through Section 304 relief. This would appear to be particularly true in the case of solvent companies in run-off whose ultimate goal is resolution of creditor claims, winding-up, and release of invested capital.
The greater concern for Section 304 cases commenced to facilitate UK schemes is that Integrated Telecom may provide yet another ring for a determined objector to grasp and exploit in an attempt to obstacle or delay US relief in aid of a UK solvent scheme.
Intelligent positioning is key
Industry musings envision that schemes will become more prevalent, take on new forms, and concern entities having increasing US exposure. If this prediction is correct, doing all possible to enhance the odds of obtaining timely and successful access to section 304 relief will be crucial.
- Selinda A Melnik is a partner in the finance practice group and the creditors' rights, bankruptcy and insolvency group of US law firm Edwards & Angell LLP.