Restructuring and Insolvency Bulletin

July 11, 2017

This issue of Dechert's Restructuring and Insolvency Bulletin provides news and analysis from Dechert’s award winning global financial restructuring team, including:

  • Cross border restructuring landscape continues to evolve - EU and Singapore reform and modernize while the UK assesses the impact of Brexit
  • United States: D&O Insurance Policies - a cautionary tale: the Peril of Prior Act Exclusion
  • United Kingdom: New Insolvency Rules streamline communication with creditors
  • Supreme Court Lehman Waterfall I decision - foreign currency creditors lose over £1.6 billion in failed Lehman Brothers currency conversion claims


Legal Updates: Hot Topics


Cross border restructuring landscape continues to evolve - EU and Singapore reform and modernize while the UK assesses the impact of Brexit

Legislative changes in Singapore and the EU introduce pre-insolvency processes facilitating non-consensual debt restructurings or cram downs comparable to those already available in London and New York. In particular, the EU Recast Insolvency Regulation (the "Recast Regulation") came into effect on June 26, 2017, enhancing cross-border co-operation for applicable insolvency proceedings starting in the EU after that date.* 

The Recast Regulation will apply to insolvency proceedings against debtors with their center of main interests in the EU (excluding Denmark). This provides a framework for co-operation between office holders and, for the first time, gives protection to pre-insolvency proceedings (such as those in France and Spain). 

The European Commission released proposals for further ambitious reforms in November 2016, aiming to establish a common preventative restructuring process, which would see the debtor continuing its business as a going concern, with the benefit of a statutory moratorium on insolvency processes, while a restructuring plan was developed and voted on. 

Moreover, at the member state level, there has been a market trend across the Europe Union towards the introduction of pre-insolvency rescue procedures. The latest to join the fray is The Netherlands, which is about to introduce a mechanism that will allow debt cram down. 

Reforms in EU jurisdictions raise the question whether post-Brexit new centers of international debt restructuring may emerge to compete with London’s pre-eminent position as a hub for cross-border restructuring work (alongside New York). 

Singapore has also made a major push into the international restructuring arena with significant reforms underway to make it a more attractive landscape for cross-border restructuring and insolvency, including the adoption of the UNCITRAL model law. The Singaporean measures are modelled on the UK scheme of arrangement but also incorporate key Chapter 11 concepts such as DIP financing, worldwide moratoriums and cram down provisions. 

*Dechert assisted AIMA with their response to the proposal for the Recast Regulation.


United States: D&O Insurance Policies – a cautionary tale: the Peril of Prior Act Exclusion

Directors and officers (D&Os) of troubled companies should be highly sensitive to D&O insurance policies with Prior Act Exclusion. While policies with such exclusion may be cheaper, a recent decision by the U.S. Court of Appeal for the Eleventh Circuit raises the spectre that a court may hold a loss to have more than a coincidental causal connection with the officer’s conduct pre-policy period and make the (cheaper) coverage worthless. 

As the financial condition of Bank United Financial Corp. (the “Parent”) and its subsidiary Bank United FSB (the “Bank”) was deteriorating, in September 2008 the Parent was seeking to renew its D&O insurance policy. The insurer refused to renew. A new insurer agreed to provide coverage. The annual premium for a policy with Prior Act Exclusion was US$350,000 and without the exclusion, US$650,000. The Parent elected for the policy containing the Prior Act Exclusion. In September 2008, prior to the binding of the new policy (November 10, 2008), investors filed a class action against certain officers of the Parent and Bank for violation of securities laws. Also in September, the Parent and Bank entered into agreements with the Office of Thrift Supervision (“OTS”) acknowledging that they engaged in unsafe and unsound practices that resulted in the Bank’s unsatisfactory financial condition. 

In early 2009 the Parent transferred to the Bank US$46 million in tax refunds it received. Subsequently, in May 2009, the OTS closed the Bank and appointed the FDIC receiver and a day later the Bank filed for Chapter 11. In the Chapter 11 case, the unsecured creditor committee (later substituted by the Chapter 11 Plan Administrator) commenced an action against the Parent’s former executives for: 

(a) breaches of fiduciary duties, which resulted in the company’s insolvency; 

(b) the infusion of US$80 million into the Bank to avoid its seizure by regulators; and 

(c) the approval of the tax refunds transfers. 

The litigation was submitted to the insurer who denied coverage based on the Prior Act Exclusion. The District Court agreed and the Chapter 11 Plan Administrator appealed. The Eleventh Circuit U.S. Courts of Appeal affirmed. 

The Prior Act Exclusion provided that the insurer is not liable for any loss “in connection with a Claim arising out of, based upon or attributable to any Wrongful Act committed or allegedly committed … prior to [November 10.2008].” Wrongful Act was defined as any “act, error, misstatement, misleading statement, omission or breach of duty” by an insured person with respect of Securities Claims, or claims against insured person for acts in his capacity as an insured person. The Plan Administrator argued that the tax refunds transfers were made in 2009, after the effective date of the policy and that insolvency is not a wrongful act. But the Court of Appeals agreed with the insurer that the insolvency, although not a wrongful act, resulted from the officers’ pre-November 2008 alleged conduct, and thus is captured by the Prior Act Exclusion: “[W]e conclude that the Parent Bank’s insolvency ‘arose out of’ wrongful acts that occurred before November 10, 2008….[T]he Parent Bank’s insolvency has a connection to some prior wrongful acts of Parent Bank’s officers and directors that occurred before the policy’s effective date.” 

The opinion: Zucker v. U.S. Specialty Ins. Co. 

The Dechert financial restructuring teams in the United States, Europe and Asia have extensive experience advising clients on D&O insurance policies.


United Kingdom: New Insolvency Rules streamline communication with creditors 

The existing insolvency rules in the UK have been recast with the aim to "modernize and consolidate" the procedural framework for insolvency processes in the UK and promote efficiency. The Insolvency (England and Wales) Rules 2016 (the “New Rules”) came into force on April 6, 2017. 

A key feature of the New Rules is a welcome overhaul of the provisions regarding communication with creditors, to allow for electronic communications instead of paper documents and physical meetings. 

Previously, an officeholder could only communicate with a creditor by email where the creditor has given written consent. Under the New Rules, a creditor who communicated with the debtor by email prior to the insolvency proceedings commenced is deemed to have consented to receive documents by email from the officeholder (unless such consent is revoked). 

The New Rules also change the requirements relating to holding physical meetings of creditors. Going forwards, in most circumstances an officeholder is not required to hold a physical meeting to obtain decisions from creditors. Instead, the officeholder can obtain a decision using a "qualifying decision procedure" or by "deemed consent". We have briefly summarized both these processes below: 

  • Qualifying decision procedure: A physical meeting can, generally speaking, only be held if requested by 10 creditors, 10% of creditors by number or 10% of creditors by value. Alternative methods available to an officeholder include organizing a virtual meeting or arranging a decision using qualifying voting. 

  • Deemed consent: Where the officeholder gives notice to creditors of a proposed decision for which deemed consent is sought, the decision will be treated as having been made unless 10% (or more) in value of creditors object to it. 

Furthermore, creditors are able to opt out of receiving further correspondence from an officeholder, except for notices relating to the payment of dividends or where the rules require notice to all creditors. 

The New Rules also greatly facilitate the use of websites to provide creditors with improved access to documentation. Previously a court order was needed before an officeholder had the right to upload any case documents to a website (unless the officeholder also sent a notice to creditors that the relevant documents was available to view on the website). Under the New Rules an officeholder can deliver a notice to every potential recipient of such documents that all future documents (other than documents for which personal delivery is required or that detail an intention to declare a dividend) will be put on a specified website without further separate notice. 

The New Rules cover both corporate and personal insolvency proceedings across England and Wales.


In Depth


Supreme Court Lehman Waterfall I decision - foreign currency creditors lose over £1.6 billion in failed Lehman Brothers currency conversion claims 

98% of the liabilities of Lehman Brothers International (Europe) (in administration) (“LBIE”) were denominated in non-sterling currencies. The fall in sterling after LBIE entered administration resulted in significant paper losses for creditors, which they sought to recover from the LBIE estate. The recent decision of the UK Supreme Court in Waterfall I refused to recognize such claims.* 

The main Lehman Brothers trading company in the UK and Europe was LBIE. LBIE has been in administration since September 2008. At that time, approximately 98% of LBIE’s liabilities were denominated in non-sterling currencies including US dollars and Euros (the so-called foreign currency creditors). 

The Insolvency Rules in the UK provide that foreign currency debts are to be converted into sterling at the official exchange rate prevailing on the date LBIE entered administration (not at the date of payment). 

The value of sterling had fallen between the date of LBIE entering into the administration and the date of payment, causing foreign currency creditors to receive less value for their claims against LBIE than they would otherwise have been contractually entitled to receive. There is a large surplus in the LBIE estate and one of the claims before the court as part of the Waterfall I litigation was that foreign currency creditors should be entitled to recover such contractual shortfall as a non-provable debt (being the "Currency Conversion Claims"). The amount at stake for LBIE’s foreign currency creditors exceeded £1.6 billion and it was estimated that there was sufficient surplus to pay that amount in full. 

Non-provable debts are liabilities arising after the commencement of the administration, but which are not expenses of the administration. The classic example of a non-provable liability is a personal injury claim arising after the commencement of administration – the injured party can make a claim against the estate but such claim does not constitute an expense of the administration. 

While not expressly referenced in UK insolvency legislation, non-provable liabilities continue to be judicially recognized based on the fundamental principle that the assets of a company may not be returned to shareholders while there remains an outstanding unsatisfied liability. 

In Lord Neuberger’s judgment in In re Nortel GmbH [2014] AC 209 the description of the ranking of distributions in an insolvency, known as the ‘waterfall’, included non-provable liabilities (which ranked after unsecured provable debts and statutory interest but before shareholders). 

On May 17, 2017 the Supreme Court handed down its judgment overturning the decision of both lower courts and ruled that foreign currency creditors did not have non-provable claims to recover losses arising from currency fluctuations following the start of LBIE’s administration. 

Lord Neuberger, giving the primary judgement, concluded that the relevant statutory provisions did not allow for the Currency Conversion Claims to exist as a separate claim in the insolvent estate. His Lordship observed that two reports produced in the lead up to the enactment of the Insolvency Act 1986 (a 1981 working paper by the Law Commission and the 1982 Cork Report) each carefully reviewed and addressed the issue of currency conversion claims. In particular, the Cork Report recommended that “any future Insolvency Act should expressly provide that the conversion of debts in foreign currencies should be effected as at the date of the commencement of the relevant insolvency proceedings”. 

It also weighed on the court that Currency Conversion Claims would provide the foreign currency creditors with a “one way” option on the currency markets as there would be no repayment to the insolvent estate in the event that sterling appreciated to the benefit of the foreign currency creditors. 

Lord Sumption supported Lord Neuberger’s judgment, by concluding that the relevant statutory provisions provide a complete code for foreign currency debts and did not allow for Currency Conversion Claims to exist as a separate claim in the insolvent estate. 

In obiter comments Lord Sumption also considered whether insolvency proceedings provide an administrative procedure for distributing a debtor’s assets where there is a deficiency rather than discharging a creditor’s contractual rights and replacing them with a right to receive a distribution out of the insolvent estate. 

Lord Sumption suggested that a creditor’s pre-existing legal rights survive a debtor entering into an insolvency process and are only altered as provided by the applicable legislation. In this way, any residual contractual claims would remain enforceable against any surplus “unless the legislation otherwise provides”. 

Unfortunately for the holders of foreign currency claims, the Supreme Court decided that the legislation does codify their position and does not permit them to make Currency Conversion Claims against the surplus in LBIE’s estate. 

* The Dechert financial restructuring team in the United Kingdom acts for Lehman Brothers Limited (in administration) with respect to the Waterfall III proceedings in which billions of pounds of claims are the subject of a complex dispute.

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