Rendering Structured Finance Opinions of Counsel: Substantive...
Transcript of Rendering Structured Finance Opinions of Counsel: Substantive...
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Presenting a live 90-minute webinar with interactive Q&A
Rendering Structured Finance Opinions
of Counsel: Substantive Consolidation,
Authority to File Bankruptcy and More Navigating Assumptions, Qualifications, Limitations and
Use of Letters; Reducing Risks for Opinion Givers
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
TUESDAY, JULY 12, 2016
Scott J. Gordon, Partner, Kirkland & Ellis LLP, New York
Michelle P. Quinn, Partner, Berger Harris LLP, Wilmington, Del.
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Right to File Bankruptcy
• Pre-petition waivers of the right to file a bankruptcy petition, whether by
contract or in charter documents, have repeatedly been held to be void on the
basis that they are against public policy.
• Most recently, in In Re BAY CLUB PARTNERS–472, LLC, Debtor (No. 14-
30394, 2014 WL 1796688 (Bankr. D. Or. May 6, 2014)), the court
characterized as “cleverly insidious” a restriction on filing that was
placed in the debtor’s operating agreement at a lender’s request
rather than being placed in the loan agreement. The court held the
provision to be void.
5
Right to File Bankruptcy (Cont’d)
• In the circumstances underlying the 1997 case of In Re Kingston Square
Associates, 214 B.R. 713, the owner/manager of property owning SPEs solicited
creditors to make involuntary bankruptcy filings in respect of the SPEs, thereby
seeking to thwart the “bankruptcy-remote” provisions of the SPEs charters,
which contained a requirement for the unanimous vote of directors, including
an ID, for a voluntary filing. Lenders that had relied on the “bankruptcy-
remote” provisions argued for dismissal on grounds of bad faith through
collusion to file. The court found that the debtors had orchestrated the
involuntary filings but that the filings did not further a wrongful purpose,
which is a necessary element of collusion; also noting that the failure of the
ID, who had been selected by one of the lenders, to participate in the
governance of the SPEs eliminated the potential for proper consideration of a
unanimous voluntary filing.
6
Right to File Bankruptcy (Cont’d)
• In 2009, General Growth Properties, Inc. replaced existing independent
directors (ID) with seasoned restructuring professionals that satisfied the ID
requirements and the newly appointed IDs voted with the “inside” directors to
place the SPEs, which were solvent and in varying states of financial health,
into bankruptcy, supporting their votes as consistent with their fiduciary duty
to creditors and shareholders as established by the LLC Agreements by
reference to Delaware General Corporation Law (DGCL), which provides that
the directors of a solvent corporation are required to consider the interests of
shareholders in exercising their fiduciary duties. In re Gen. Growth Props.,
Inc., 409 B.R. 43 (Bankr. S.D.N.Y. 2009).
7
Right to File Bankruptcy (Cont’d)
• Delaware Limited Liability Company Act §18-1101(c):
To the extent that, at law or in equity, a member or manager or other
person has duties (including fiduciary duties) to a limited liability company
or to another member or manager or to another person that is a party to or
is otherwise bound by a limited liability company agreement, the member's
or manager's or other person's duties may be expanded or restricted or
eliminated by provisions in the limited liability company agreement;
provided, that the limited liability company agreement may not eliminate
the implied contractual covenant of good faith and fair dealing.
• Fiduciary duties should be explicitly addressed in the LLC Agreement.
8
Delaware LLCs
The Delaware Limited Liability Company Act
• Increase of use of LLCs in the mid-1990s
As of March 29, 2013 from the
Delaware Division of Corporations
9
Delaware LLCs - Easy Administrative Procedures
• Online Services
• Expedited and same day service
• Filing of UCC documents
• Payment of franchise taxes
• Access to relevant provisions of the Delaware Code
• Help with finding a registered agent
• Name reservations
• Status check for Delaware entities
10
Delaware LLCs - Expertise of Judiciary in Business Matters
• Delaware's Court of Chancery
• Limited jurisdiction
• High volume of corporate and LLC matters
• Corporations Section of the Delaware State Bar Association
• Generates legislation after careful study of case law and business
trends
• Easy access to elected and appointed officials due to the small size of the state
11
Delaware LLCs - Contract Flexibility
• Section 18-1101(b) of the DE LLC Act: “It is the policy of this chapter to give
the maximum effect to the principle of freedom of contract and to the
enforceability of limited liability company agreements.”
• "Except as provided in a limited liability company agreement“ or similar
language is found in most provisions of the DE LLC Act.
• Delaware LLC Act is friendly to the SPV structure.
12
Delaware Opinions - the “Authority to File” Bankruptcy Opinion
• Reasoned opinion that addresses whether a federal bankruptcy court would
look to federal or state law to determine the parties with authority to file a
bankruptcy petition on behalf of the LLC.
• Required because federal bankruptcy law does not specifically address LLCs.
13
Delaware Opinions – the LLC Opinion Letter
• The Company has been duly formed and is validly existing in good standing as a
limited liability company under the laws of the State of Delaware.
• In Delaware, this requires an LLC Agreement and a Certificate of
Formation. Should not be based solely on a good standing certificate.
• The LLC Agreement constitutes a legal, valid and binding agreement of the
Member, and is enforceable against the Member, in accordance with its terms.
• Given with standard enforceability carve-outs, including bankruptcy
• Sometimes drafted to cover only the Special Member provisions
14
Delaware Opinions – the LLC Opinion Letter (Cont’d)
• If properly presented to a Delaware court, a Delaware court applying Delaware
law, would conclude that (i) [so long as any Obligation is outstanding,] in order
for a Person to file a voluntary bankruptcy petition on behalf of the Company,
the prior unanimous written consent of the Member and all Independent
Managers, as provided for in Section ___ of the LLC Agreement, is required,
and (ii) such provision, contained in Section ___ of the LLC Agreement, that
requires, [so long as any Obligation is outstanding,] the prior unanimous
written consent of the Member and all Independent Managers in order for a
Person to file a voluntary bankruptcy petition on behalf of the Company,
constitutes a legal, valid and binding agreement of the Member, and is
enforceable against the Member, in accordance with its terms.
• Given with only an equitable principles carve-out. No bankruptcy
carve-out.
• Should track language of LLC Agreement.
• LLC Agreement should not prohibit a bankruptcy filing or require
lender consent for a bankruptcy filing
15
Delaware Opinions – the LLC Opinion Letter (Cont’d)
• While under the Delaware Limited Liability Company Act, 6 Del. C. § 18-101, et
seq.) (the "LLC Act"), on application to a court of competent jurisdiction, a
judgment creditor of the Member may be able to charge the Member's share of
any profits and losses of the Company and the Member's right to receive
distributions of the Company's assets (the "Member's Interest"), to the extent so
charged, the judgment creditor has only the right to receive any distribution or
distributions to which the Member would otherwise have been entitled in
respect of the Member's Interest. Under the LLC Act, no creditor of the
Member shall have any right to obtain possession of, or otherwise exercise
legal or equitable remedies with respect to, the property of the Company.
Thus, under the LLC Act, a judgment creditor of the Member may not satisfy its
claims against the Member by asserting a claim against the assets of the
Company.
• Under the LLC Act (i) the Company is a separate legal entity, and (ii) the
existence of the Company as a separate legal entity shall continue until the
cancellation of the LLC Certificate.
16
Delaware Opinions – the LLC Opinion Letter (Cont’d)
• Under the LLC Act and the LLC Agreement, the Bankruptcy or dissolution of the
Member will not, by itself, cause the Company to be dissolved or its affairs to
be wound up.
• LLC Agreement should override LLC Act regarding bankruptcy of a
member
• Mandatory Events Dissolution
1. As specified in the limited liability company agreement
2. At such time as there are no remaining members
3. When ordered by the Court of Chancery
17
Delaware Opinions – the LLC Opinion Letter (Cont’d)
• Under the LLC Act and the LLC Agreement, the Company has all necessary
limited liability company power and authority to execute and deliver the Loan
Documents to which it is a party, and to perform its obligations thereunder.
• Under the LLC Act and the LLC Agreement, the execution and delivery by the
Company of the Loan Documents to which it is a party, and the performance by
the Company of its obligations thereunder, have been duly authorized by all
necessary limited liability company action on the part of the Company.
18
Delaware Opinions – the LLC Opinion Letter (Cont’d)
• No authorization, consent, approval or order of any Delaware court or any
Delaware governmental or administrative body is required to be obtained by
the Company solely as a result of the execution and delivery by the Company
of the Loan Documents to which it is a party, or the performance by the
Company of its obligations thereunder.
• The execution, delivery and performance by the Company of the Loan
Documents to which it is a party do not violate (i) any Delaware law, rule or
regulation, or (ii) the LLC Agreement or the LLC Certificate.
• For both opinions, assume no assets or activities in Delaware
19
Delaware Opinions - the UCC Opinion
• The Financing Statement is in an appropriate form for filing with the Division.
• Insofar as Article 9 of the Uniform Commercial Code as in effect in the State of
Delaware on the date hereof (the "Delaware UCC") is applicable (without
regard to conflict of laws principles), upon the filing of the Financing
Statement with the Division, the Lender will have a perfected security interest
in the Company's rights in that portion of the Property described in the
Financing Statement in which a security interest may be perfected by the filing
of a UCC financing statement with the Division and the proceeds (as defined in
Section 9-102(a)(64) of the Delaware UCC) thereof.
20
Bankruptcy Estate
• Estate includes all legal and equitable rights of debtor
• Imposes automatic stay, which prohibits:
• judicial proceedings against debtor
• enforcement of pre-petition judgments
• actions to possess or control debtor’s property
• enforcement of liens against debtor’s property
• actions to collect pre-petition debts
• set-offs of pre-petition debts
21
Effects of Bankruptcy
• Debtor may use collateral, despite security interest, if creditor has adequate
protection
• Debtor may substitute for collateral if new property is indubitable equivalent
• Debtor may give collateral to other parties if creditor is over-secured
• Debtor may reject obligations under executory contracts and leases
22
Bankruptcy Remote Structures – 3 Key Attributes of Isolation
• Structure purchaser as bankruptcy-remote
• minimize likelihood of purchaser independently filing for BK due to
unforeseen problems
• Effect true sale of assets by originator
• keep assets out of BK estate of originator
• Minimize risk of substantive consolidation
• avoid consolidation of purchaser’s assets and liabilities with those of
originator
23
Independent Manager/Director
• SPE charter documents contain requirements that there be at least one
“independent” person represented among those whose vote is required to
approve the voluntary filing of a bankruptcy petition and that the authorizing
vote be unanimous (the “Independent Director Requirement”).
• Often serves as the special member
• Lender limits on identity and replacement
• Designate as a “manager” within the meaning of the LLC Act.
• While the Independent Director Requirement has been respected and not found
to be an unreasonable restraint on the right to file a bankruptcy petition,
courts have viewed the application of the Independent Director Requirement in
a manner consistent with preservation of the right to file.
• Disinterested third party granted authority to vote on bankruptcy of the LLC
24
The Special Member
• A special member/springing member becomes a member of the LLC upon
occurrence of any event that would causes the last remaining equity member
to cease to be a member by operation of law or contract
• Provisions:
• May not resign or transfer its rights unless a successor Special Member has
been admitted
• Has no interest in the profits, losses and capital of the Company
• Has no right to receive any distributions of Company assets
• Is not required to make any capital contributions to the Company, 6
Del. C. § 18-301(d)
• May not bind the Company except as required by any mandatory
provision of the LLC Act
• Has no right to vote on, approve or otherwise consent to any action
by, or matter relating to, the Company, including, without limitation,
the merger, consolidation or conversion of the Company
25
The Personal Representative
• “Unless otherwise provided in a limited liability company agreement, within 90
days or such other period as is provided for in the limited liability company
agreement after the occurrence of the event that terminated the continued
membership of the last remaining member, the personal representative of the
last remaining member agrees in writing to continue the limited liability
company and to the admission of the personal representative of such member or
its nominee or designee to the limited liability company as a member, effective
as of the occurrence of the event that terminated the continued membership of
the last remaining member; provided, that a limited liability company
agreement may provide that the personal representative of the last remaining
member shall be obligated to agree in writing to continue the limited liability
company and to the admission of the personal representative of such member or
its nominee or designee to the limited liability company as a member, effective
as of the occurrence of the event that terminated the continued membership of
the last remaining member.” Section 18-801(a)(4) of the DE LLC Act
• Provision works with the Special Member provision to continue the LLC
in the event of a dissolution.
26
In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016)
Background
In December 2014, BCL-Bridge Funding LLC (“BCL”) made a loan to Lake Michigan
Pottawattamie Resort LLC (“Pottawattamie”). After defaulting on its loan
payments to BCL, Pottawattamie and BCL entered into a forbearance agreement
and amended Pottawattamie’s operating agreement to install BCL as a “Special
Member” of Pottawattamie.
Pottawattamie again defaulted on its loan from BCL and filed a petition for relief
under Chapter 11 of the Bankruptcy Code. While all other members of
Pottawattamie consented to the petition, BCL did not. BCL filed a motion to
dismiss Pottawattamie’s petition, contending that Pottawattamie's bankruptcy
filing was invalid because BCL did not consent.
27
In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016) (Cont’d)
The Court stated that the public policy prohibiting direct, absolute waivers of
one’s right to file for bankruptcy relief applies not only to individual persons, but
to corporations as well. The Court was careful to note, however, that bankruptcy
law requires that corporate formalities and state corporate law also must be
satisfied in commencing a bankruptcy case.
The Court then explained that, generally speaking, a blocking director is
permissible to the extent that such a director is subject to, and adheres to, its
normal fiduciary duties to the debtor. Under those circumstances a blocking
director does not serve as an absolute prohibition on petitioning for bankruptcy
relief and is therefore permissible. In other words, a valid and enforceable
blocking director provision must envision “at least theoretically, . . . situations
where the blocking director will vote in favor of a bankruptcy filing, even if in so
doing he or she acts contrary to purpose of the secured creditor for whom he or
she serves.”
28
In re Lake Michigan Beach Pottawattamie Resort LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016) (Cont’d)
Unauthorized Filing
The Court went on to explain that under Michigan corporate law, members of an
LLC have a duty to consider the interests of the LLC, rather than only their
individual interests. Therefore, the Court held that the Special Member provision
in Pottawattamie’s amended operating agreement permitting BCL to disregard
Pottawattamie’s interests “expressly eliminated the only redeeming factor that
permits the blocking director/member construct.”
As a result, the Court then held that the blocking director provision was void and
unenforceable under both Michigan state corporate law and federal bankruptcy
law, and that under Pottawattamie’s remaining corporate governance provision,
Pottawattamie’s bankruptcy petition was valid.
29
In re Intervention Energy Holdings, LLC, 2016 WL 3185576 (Bankr. D. Del. June 3, 2016)
In In re Intervention Energy Holdings, LLC, 2016 WL 3185576 (Bankr. D. Del. June
3, 2016), the Bankruptcy Court for the District of Delaware denied a motion to
dismiss in a bankruptcy case involving a secured lender holding a “golden share”
of a bankruptcy-remote special purpose entity. Intervention Energy Holdings, LLC
(“IEH”) and Intervention Energy, LLC (“IE”; together the “Debtors”) are Delaware
LLCs. IEH is owned approximately 85% by Intervention Energy Investment Holdings
(“IEIH”) and the remaining 15% is owned by various entities.
On January 6, 2012, the Debtors entered into a $200 million Note Purchase
Agreement with EIG Energy Fund XV-A, L.P. (“EIG”), their senior secured lender.
Following a default, the Debtors and EIG entered into a forbearance agreement
IEH's operating agreement was also amended to include EIG as a member and
issued EIG a single “golden share” in return for a $1.00 capital contribution.
Pursuant to the forbearance agreement, IEH needed to secure unanimous consent
of “all Common Members” in order to validly petition for bankruptcy relief.
30
In re Intervention Energy Holdings, LLC, 2016 WL 3185576 (Bankr. D. Del. June 3, 2016) (Cont’d)
In In re Intervention Energy Holdings, LLC, 2016 WL 3185576 (Bankr. D. Del. June
3, 2016), the Bankruptcy Court for the District of Delaware denied a motion to
dismiss in a bankruptcy case involving a secured lender holding a “golden share”
of a bankruptcy-remote special purpose entity. Intervention Energy Holdings, LLC
(“IEH”) and Intervention Energy, LLC (“IE”; together with IEH, the “Debtors”) are
Delaware LLCs. IEH is owned approximately 85% by Intervention Energy
Investment Holdings (“IEIH”) and the remaining 15% is owned by various entities.
On January 6, 2012, the Debtors entered into a $200 million Note Purchase
Agreement with EIG Energy Fund XV-A, L.P. (“EIG”), their senior secured lender.
Following a default, the Debtors and EIG entered into a forbearance agreement.
IEH's operating agreement was also amended to include EIG as a member and IEH
issued EIG a single “golden share” in return for a $1.00 capital contribution.
Pursuant to the forbearance agreement, IEH needed to secure unanimous consent
of “all Common Members” in order to validly petition for bankruptcy relief.
31
In re Intervention Energy Holdings, LLC, 2016 WL 3185576 (Bankr. D. Del. June 3, 2016) (Cont’d)
On May 20, 2016, each of the Debtors filed voluntary bankruptcy petitions in
Delaware. In return, EIG filed a motion to dismiss the jointly administered
bankruptcy cases, asserting that IEH did not have authority to file a bankruptcy
petition because it did not obtain EIG’s consent to do so. At the time of the
petition IEH had 22,000,001 common units. IEIH owned 22,000,000. EIG owned 1.
Though declining to consider the parties’ arguments regarding the extent to which
Delaware LLCs may limit an LLC’s ability to file for bankruptcy (and also noting
that these arguments may well be an issue of first impression of Delaware state
law), the Court held that the unanimous consent provision in IEH’s forbearance
agreement was unenforceable because it violated the well-established federal
public policy that a debtor may not waive its right to seek bankruptcy relief,
despite the clear intent of IEH and EIG to give EIG a veto right with respect to the
filing of a voluntary bankruptcy case.
32
True Sale Opinion
• Supports key structured finance principle of isolation of assets in SPE
• Is one of two “creditor’s rights” opinions (along with the Non-Consolidation
Opinion) key to supporting the legal isolation of the SPE’s assets from creditors
of the SPE’s affiliates
• Although speaks to outcome in Bankruptcy, is based on state law principles
• Is relied upon by accountants for accounting sale treatment
33
What Constitutes True Sale
• Keys to “True Sale” are
• Risk transfer / recourse
• Intent
• Securitization Statutes
• Delaware, ("ABSFA” (2002)), Texas, Ohio
• Attempt (largely ineffective) to create true sale safe harbor
• Most transfers under securitizations continue to be governed by New
York law
34
True Sale – Applicable Law
• Property interests are created and defined by state law, including in
bankruptcy, unless federal interest requires otherwise Butner v. United States,
440 U.S. 48, 55 (1979)
35
True Sale – Indicia of Sale
• Purchase price = fmv
• Buyer keeps all collections
• Buyer services receivables
• Obligors notified of sale
• Seller makes representations regarding nature of receivables
• Buyer takes interest rate risk
• Buyer takes obligor credit risk
36
True Sale – Indicia of Secured Loan
• Overcollateralization of loan
• Lender receives P + I only
• Debtor services receivables
• Obligors not notified of sale
• Seller makes reps re nature of receivables
• Debtor retains interest rate risk
• Debtor retains obligor credit risk
37
True Sale – Recourse
• “[T]here may be a true sale of accounts or chattel paper although recourse
exists.” UCC section 9-502, comment 4
• “Castle required Major’s to retain all conceivable risks of uncollectibility of
these accounts. . . Guaranties of quality alone, or even guarantees of
collectibility alone, might be consistent with a true sale, but Castle attempted
to shift all risks to Major’s, and incur none of the risks or obligations of
ownership.” Castle’s Furniture Mart, 602 F.2d At 545
38
True Sale – Recourse – How Much is OK?
• Loss-based
• e.g., Equal to historical losses
• Percentage-based
• X% of pool size
• Dodd-Frank Act risk retention requirements
• Ratings-based
• e.g., Seller retains only investment grade risk
39
Two-Step Transfer
40
True Sale Opinion
• You have requested our opinion whether, in a properly presented proceeding
under Title 11 of the United States Code, the bankruptcy court with
jurisdiction over the case would:
• compel the turnover of the [relevant property] or proceeds thereof to
the bankruptcy trustee under Section 542 of the Bankruptcy Code
based on a determination that the [relevant property] is property of
the originator’s/transferor’s bankruptcy estate under Section 541 of
the Bankruptcy Code; or
• prohibit the SPE from enforcing its rights under the [relevant
property] pursuant to the automatic stay provisions of Section 362(a)
of the Bankruptcy Code.
41
True Sale Cases – Intent
• One line of cases relies substantially upon the intent of the parties. Provided
that the characterization of the transaction by the parties is supported by the
facts, where commercially sophisticated parties have characterized a
transaction as a sale and have acted consistently with that characterization,
courts have been unwilling to recharacterize the transaction even though it
may also bear certain attributes of a secured loan. Kassuba v. Realty Income
Trust (In re Kassuba), 562 F.2d 511, 514 (7th Cir. 1977) ("If the parties actually
intended to effect an absolute transfer of ownership, a court of equity will not
ignore that intent and make another contract for them").
42
True Sale Cases – True Nature of Transfer
• The other line of cases looks beyond the stated intent of the parties and seek
to ascertain the "true nature" of a transaction, regarding the parties' intent as
only one factor in analyzing a transaction, and weighing those characteristics
of a transaction indicative of a true sale against those indicative of a secured
loan to determine whether the transaction most resembles one or the other.
In Major's Furniture Mart, Inc. v. Castle Credit Corp., Inc., 602 F.2d 538, 544
(3rd Cir. 1979) the court asked "whether the nature of the recourse, and the
true nature of the transaction, are such that the legal rights and economic
consequences of the agreement bear a greater similarity to a financing
transaction or to a sale."
43
True Sale Cases – Conduct Matters
• In a series of decisions between 2007 and 2013, the Bankruptcy Court for the
Northern District of Illinois, the District Court for the Northern District of
Illinois and the Seventh Circuit Court of Appeals considered matters relating to
the purported sale of a hospital’s accounts receivable to an affiliate of the
hospital that was structured to be an SPE.
• While ultimately, on remand, the Bankruptcy Court found that a “true-sale”
existed, the Seventh Circuit noted that the SPE “lacked the usual attributes of
a bankruptcy-remote vehicle” and that “the [Bankruptcy] Code allows the
[bankruptcy] trustee to look out for the interests of these other creditors, who
may not appreciate that they should have charged extra to offset the effects
of a bankruptcy-remote vehicle that was hidden in the weeds.”
44
Substantive Consolidation – Derivation/Foundation
• The power of a bankruptcy court to consolidate the assets and liabilities of
separate, but related, entities
• Judicially created doctrine; not codified; based on equitable jurisdiction
• Derives from the U.S. Supreme Court’s decision in Sampsell v. Imperial Paper &
Color Corp. , 313 U.S. 215 (1941)
• Remedial action
• Extraordinary remedy
• Determination made on case-by-case basis
• Distinct from procedural consolidation
45
Substantive Consolidation – Dead or Deadly
• “Grupo Mexicano and the Death of Substantive Consolidation” was as article
that appeared in the American Bankruptcy Institute Law Review in 2000 (8Am.
Bankr. Inst. L. Rev. 427 (2000)). The Grupo Mexicano decision suggested that
federal courts look to 18th Century English legal practice to determine
whether the equitable remedy of substantive consolidation may be granted
• Six years later, the American Bankruptcy Institute Law Review published an
article titled “Substantive Consolidation – A Post-Modern Trend” in which the
author, Timothy E. Graulich, argued that “[n]otwithstanding the appellate
courts' repeated admonitions that substantive consolidation should be used
only "sparingly," other decisions – mostly bankruptcy court cases citing to
unreported bankruptcy court decisions—have announced a "liberal" or "modern"
trend that would make substantive consolidation the rule, rather than the
sparingly used exception described by the appellate decisions.”
46
Substantive Consolidation – Dead or Deadly (Cont’d)
• In their article titled “The Sum and Substance of Substantive Consolidation”
published in the Annual Survey of Bankruptcy Law in 2005, Kirkland bankruptcy
practitioners James H.M. Sprayregen, Jonathan P. Friedland, and Jeffrey W.
Gettleman began, “Substantive consolidation jurisprudence, perhaps more
than many other areas of bankruptcy law, is highly unpredictable.”
47
Substantive Consolidation – Framework
• Courts consider:
• The corporate structure and conduct of the entities proposed to be
consolidated and their relationship with their creditors and other
third parties
• The impact upon creditors and whether they would be unfairly
prejudiced or treated more fairly by substantive consolidation
48
Substantive Consolidation – Framework (Cont’d)
• Consideration of many factors; none dispositive:
• In In re Vecco Construction Industries, Inc., 4 B.R. 407, 409 (Bankr.
E.D. Va. 1980) the court considered the following seven factors:
(1) degree of difficulty in segregating assets and liabilities;
(2) presence of consolidated financial statements; (3)
increased profitability due to consolidation at a single
physical location; (4) commingling of assets and business
functions; (5) unity of interests and ownership; (6) existence
of intercorporate guaranties or loans; and (7) transfer of
assets without observance of corporate formalities
49
Substantive Consolidation – Framework (Cont’d)
• Other courts have added additional factors:
• (1) the parent owning the majority of the subsidiary’s stock; (2) the
entities having common officers or directors; (3) the subsidiary being
grossly undercapitalized; (4) the subsidiary transacting business solely
with the parent; and (5) both entities disregarding the legal
requirements of the subsidiary as a separate organization
• Subsequently, courts have created tests from the foregoing factors
50
Substantive Consolidation – Auto Train
• In Drabkin v. Midland-Ross Corp. (In re Auto Train Corp.), 810 F.2d 270
(D.C.Cir. 1987), the court laid out a winding path of analysis that started with
applying factors, as set forth in Vecco, to determine whether “substantial
identity existed,” which, if it did exist, would require the proponent of
substantive consolidation to establish a prima facie case, which if established
would shift the burden to opponents of substantive consolidation to
demonstrate harm, which, if established would shift the burden back to the
proponent to demonstrate that the benefits of substantive consolidation
“heavily” outweigh the harm.
51
Substantive Consolidation – Augie/Restivo
• In Union Savings Bank v. Augie/Restivo Baking Co. (In re Augie Restivo Baking
Co., Inc.), 860 F.2d 515, 518 (2d Cir. 1988), the court stated that the factual
predicates used by courts (such as the Vecco variables) to determine whether
to order substantive consolidation of entities are “merely variants of two
critical factors: (i) whether creditors dealt with the entities as a single
economic unit and did not rely on their separate identity in extending credit
(citations omitted) or (ii) whether the affairs of the debtors are so entangled
that consolidation will benefit all creditors.”
52
Substantive Consolidation – Augie/Restivo (cont’d)
• Augie/Restivo Emphasizes whether creditors have been harmed based on their
expectations and reliance in extending credit
• Augie/Restivo concluded that the course of dealing and the expectations of
the parties did not justify consolidation
• Coupled with the court’s general reluctance to grant substantive consolidation
except where estates are “hopelessly” entangled, Augie/Restivo represents a
conservative approach to substantive consolidation
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Substantive Consolidation – Eastgroup
• In Eastgroup Properties v. Southern Motel Assoc., Ltd. 935 F.2d 245, 250 (11th
Cir. 1991), the court stated that the essential analysis is whether “the
economic prejudice of continued debtor separateness” outweighs “the
economic prejudice of consolidation”
• The Eastgroup court upheld the lower courts’ substantive consolidation orders
• Both the lower courts and the 11th Circuit Court considered the relative
recoveries of the proponent and objecting creditors
• Eastgroup styled itself as the “liberal” approach to substantive consolidation
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Substantive Consolidation – Owens Corning
• In In re Owens Corning, 419 F.3d 195 (3d Cir. 2005), 419 F.3d 195, cert. denied
sub nom. McMonagle v. Credit Suisse First Boston, 126 S. Ct. 1910 (2006), the
court stated, “What must be proven (absent consent) concerning the entities
whom substantive consolidation is sought is that (i) prepetition they
disregarded separateness so significantly their creditors relied on the
breakdown of entity borders and treated them as one legal entity, or (ii)
postpetition their assets and liabilities are so scrambled that separating them
is prohibitive and hurts all creditors.”
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Substantive Consolidation – Owens Corning (Cont’d)
• The Owens Corning court:
• criticized the mere recitation of factors as omitting analysis and
failing to separate the important from the unimportant
• discounted the mere presence of a parent guarantee of a subsidiary
SPE’s obligations as evidence of lack of separateness
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Substantive Consolidation – Opinion
• You have requested our opinion whether, in a properly presented proceeding
under Title 11 of the United States Code in which [the transferor of receivables
that is an affiliate of the SPE and an eligible debtor under the bankruptcy code
(the “Code Debtors”)] is the debtor, the bankruptcy court with jurisdiction
over the case would, under applicable federal bankruptcy law, apply the
doctrine of substantive consolidation to consolidate the assets and liabilities of
the SPE with the assets and liabilities of the Code Debtors.
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Creditors’ Rights Opinions – Reasoned Opinions
• True Sale and Non-Consolidation Opinions are reasoned opinions
• Reasoning:
• Sets forth:
legal precedent, including facts, holdings and principles
derived therefrom
facts of transaction and parties covered by the opinion
• Conveys lack of certainty based on absence of
precedent with identical facts
codified legal principles
• The conclusion, and the reasoning upon which the conclusion is based, link the
facts at hand to precedent cases that have established tests, albeit in the
context of different facts
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Creditors’ Rights Opinions – Diligence
• As with all legal opinions, reasoned opinions require diligence
• Review all relevant contracts
• Assure that transactions contemplated
maintain arms-length relationship between the SPE and its
affiliates
contain covenants of reliance by the SPEs counterparties
and creditors on the separateness of the SPE
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Creditors’ Rights Opinions – Diligence (Cont’d)
• Review certified copies of formation documents of the SPE
• Assure presence of requirements for SPE to, among other things:
establish and maintain its separate identity and present
itself to creditors accordingly
pay its own bills from its own funds
not incur indebtedness other than as contemplated in the
transaction documents or become liable for the debt of
others
not act as agent for its members or affiliates or permit them
to act as agent for it
not commingle its assets with those of any other person
Appoint and at all times maintain at least one Independent
Director (or manager) whose consent is required to file
Bankruptcy and take other “Material Actions” that could
jeopardize the entity’s status as an SPE
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Creditors’ Rights Opinions – Diligence (Cont’d)
• Identify any guarantees of the SPEs obligations by any affiliate
• Receive Officer’s Certificates certifying as to the intended operation of the SPE
in a manner consistent with the separateness and solvency of the SPE, and, to
the extent the SPE is not a newly-formed entity, addressing the conduct of the
SPE from the time of its formation through the date of the opinion
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Creditors’ Rights Opinions – Other Considerations
• Purpose of opinion
• Doesn’t assure outcome
• Hopefully assures thorough consideration of relevant factors in
forming SPE structuring/documenting transactions to which SPE is a
party
• Opinion shopping
• Appropriate pairings for Non-Consolidation opinions
• Appropriate assumptions for counsel reliance
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FDIC Safe–Harbor
• Federal Deposit Insurance Act (“FDIA”) governs insolvencies of banks and other
insured depository institutions (“IDIs”)
• stay for up to 90 days following FDIC’s appointment and up to 6 mos
to decide claims against estate
• FDIC can “repudiate” obligations under burdensome executory
contracts and challenge “true sales” and separateness of IDI
subsidiaries
• 2000 Safe-Harbor based on legal isolation or GAAP sale
• FAS 166/167 made GAAP sale very difficult
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FDIC Safe–Harbor (Cont’d)
• 2010 Safe-Harbor
• Conditions include:
Conformity with payment and capital structure requirements
Disclosure obligations to all potential investors
Documentary provisions regarding rights and obligations of the
parties
Risk retention (to conform to Dodd-Frank)
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FDIC Safe–Harbor (Cont’d)
• If GAAP sale and all key conditions satisfied:
• FDIC will not seek to recover or re-characterize the transferred
financial assets as property of the IDI
• If not a GAAP sale and all key conditions satisfied:
• Trustee can take possession of the financial assets 10 business days
after monetary default with notice to FDIC
• If FDIC repudiates IDI’s obligations, FDIC must, within 10 business
days, pay principal and interest owing on asset-back securities at
date of repudiation or let trustee take possession of the financial
assets
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FDIC Safe–Harbor Opinion
• You have requested our opinion whether, if the FDIC were to be appointed as a
conservator or receiver for [the IDI] pursuant to Section 11(c) of the FDIA, a
court of applicable jurisdiction, exercising reasonable judgment after fully
considering all relevant factors, would hold that paragraphs (d)(4) and (e) of
the FDIC regulation entitled “Treatment of financial assets transferred in
connection with a securitization or participation,” 12 CFR § 360.6 (as amended
through the date of this opinion letter) (the “Rule”) would apply to the
[transactions covered by this opinion].
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FDIC Safe–Harbor Opinion (Cont’d)
• Certain key assumptions contained in the opinion letter:
• Receivables convert into cash within a finite period of time
• Investors are relying on collections on the financial assets and not on
external credit support, other than as permitted by the Rule
• transfers do not qualify for GAAP sale treatment
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FDIC Safe–Harbor Opinion (Cont’d)
• Certain key conclusions supported by reasoning set forth in the opinion letter:
• The transactions constitute a “securitization” as defined in the Rule:
The issuance by an issuing entity of obligations for which the
investors are relying on the cash flow or market value characteristics
and the credit quality of the transferred financial assets (together
with any external credit support permitted by [the Rule] to repay the
obligations.
Receivables constitute “financial assets” under the Rule
The notes being issued constitute “obligations” as defined in
the Rule
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Series LLCs
• Provide for isolated assets in separate series within one LLC
• Require only one filing with the DE Secretary of State and one annual tax
• Series are not separate legal entities under DE law
• Cannot provide standard structured finance opinions on a series
• Not recognized in every state or under federal bankruptcy law
• Concern over whether a series can hold title to real estate in other
jurisdictions
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Thank You
Scott J. Gordon
Kirkland & Ellis LLP
Michelle P. Quinn
Berger Harris LLP
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