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Restricting Corporate Authority to File Bankruptcy

A dramatic recreation of the fight over corporate authority to file bankruptcy.

The Fifth Circuit recently issued an opinion that federal bankruptcy law does not prohibit a bona fide shareholder from exercising its right to vote against a bankruptcy filing notwithstanding that such shareholder was also an unsecured creditor. This represents the latest successful attempt to preclude bankruptcy through golden shares or bankruptcy blocking provisions in corporate authority documents.

In this post on the Bankruptcy Cave, Bryan Cave Leighton Paisner attorney, Jay Krystinik, analyzes how the Fifth Circuit Affirms Dismissal of Bankruptcy Case Due to Lack of Corporate Authority to File (and potentially provides a blueprint for veto powers over bankruptcy filings).

“There is no prohibition in federal bankruptcy law against granting a preferred shareholder the right to prevent a voluntary bankruptcy filing just because the shareholder also happens to be an unsecured creditor by virtue of an unpaid consulting bill. . . . In sum, there is no compelling federal law rationale for depriving a bona fide equity holder of its voting rights just because it is also a creditor of the corporation.”

The Fifth Circuit was careful to limit its holding to the facts of this case. “A different result might be warranted if a creditor with no stake in the company held the right. So too might a different result be warranted if there were evidence that a creditor took an equity stake simply as a ruse to guarantee a debt. We leave those questions for another day.”

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The Magic of Mt. Gox

The Magic of Mt. Gox

November 27, 2017

Authored by: Bryce Suzuki and Justin Sabin

How Bitcoin Is Confounding Insolvency Law

Arthur C. Clarke famously observed: “Any sufficiently advanced technology is indistinguishable from magic.” Our regulatory, legislative, and judicial systems illustrate this principle whenever new technology exceeds the limits of our existing legal framework and collective legal imagination.  Cryptocurrency, such as bitcoin, has proven particularly “magical” in the existing framework of bankruptcy law, which has not yet determined quite what bitcoin is—a currency, an intangible asset, a commodity contract, or something else entirely.

The answer to that question matters, because capturing the value of highly-volatile cryptocurrency often determines winners and losers in bankruptcy cases where cryptocurrency is a significant asset. The recently-publicized revelation that the bankruptcy trustee of failed bitcoin exchange Mt. Gox is holding more than $1.9 billion worth of previously lost or stolen bitcoins highlights the issue.

The Mt. Gox Case:  Timing is Everything

In 2013, Mt. Gox[1] was the world’s largest bitcoin exchange.  By some estimates, it accounted for more than 80% of all bitcoin exchange activity.  By February 2014, Mt. Gox had shut down its website, frozen customer accounts, and ceased trading.  A leaked internal document indicated that hackers had gained access to Mt. Gox’s online wallets and stolen nearly 850,000 bitcoins, each then worth approximately $550.  That same month, Mt. Gox commenced insolvency proceedings in Japan, and thereafter filed a corresponding chapter 15 bankruptcy in the United States.  Mt. Gox eventually “found” approximately 200,000 bitcoins previously believed to be among those lost or stolen.

When it became clear that Mt. Gox could not reorganize and would proceed with liquidation, the Japanese court appointed a trustee over Mt. Gox’s assets.  A former Mt. Gox exchange customer then filed a lawsuit against the trustee seeking the return of the customer’s purchased bitcoins.  The Japanese court, however, ruled that the bitcoins at issue were not capable of ownership under Japanese law and dismissed the lawsuit.  Article 85 of the Civil Code of Japan provides that an object of ownership must be a tangible “thing,” in contrast to intangible rights (like contract or tort claims) or natural forces (like sunlight or electricity).  Bitcoin, the court ruled, does not meet the definition of a “thing” under the statute and, therefore, does not qualify for private ownership.

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Supreme Court to Address Whether Collection of Time-Barred Debts Violate FDCPA

Our colleagues at The Bankruptcy Cave, Bryan Cave’s Bankruptcy & Restructuring Blog, recently published a blog post on the Supreme Court agreeing to to hear the issue of whether a debt collector that buys old, charged off debt which is beyond the statute of limitations violations the Fair Debt Collection practices Act when it files a proof of claim on that debt in a Chapter 13 bankruptcy (which they all do, as no one has an incentive to object to the claim, and they often collect far more on the debt than what they paid).

[On October 11, 2016,] the Supreme Court granted certiorari on an issue that (a) is pretty important in the world of consumer debt collection, and (b) makes some folks pretty darn furious. The issue is this:  if you file a proof of claim in a bankruptcy case, and you know such claim is barred by the applicable statute of limitations, are you committing a “misleading” or “unfair” practice under the Fair Debt Collection Practices Act (FDCPA)?

Read more on The Bankruptcy Cave for further insights on the competing interests at play, and how the Court may ultimately rule.  And if you haven’t seen John Oliver’s take on the practice of buying uncollectible medical debt, the post contains a link to the video.

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Forming a Game Plan for TruPS

Forming a Game Plan for TruPS

November 14, 2014

Authored by: Ken Achenbach and Michael Shumaker

For the past 15 years, trust preferred securities (TruPS) have constituted a significant percentage of the capital of many financial institutions, mostly bank holding companies.Their ubiquity, both as a source of capital and as a common investment for banks, made them a quiet constant for many financial institutions. Even in the chaos of the Great Recession, standard TruPS terms allowed for the deferral of interest payments for up to five years, easing institutions’ cash-flow burdens during those volatile times. However, with industry observers estimating that approximately $2.6 billion in deferred TruPS obligations will come due in the coming years, many institutions are now considering alternatives to avoid a potential default.

Unfortunately, many of the obstacles that caused institutions to commence the deferral period have not gone away, such as an enforcement action with the Federal Reserve that limits the ability to pay dividends or interest. It is unclear if regulators will relax these restrictions for companies facing a default.

So what happens if a financial institution defaults on its TruPS obligations? It is early in the cycle, but some data points are emerging. In two cases, TruPS interests have exercised the so-called nuclear option, and have moved to push the bank holding company into involuntary bankruptcy. While these cases have not yet been resolved, the bankruptcy process could result in the liquidation or sale of the companies’ subsidiary banks. Should these potential sales result in the realization of substantial value for creditors, it is likely that we will see more bankruptcy filings in the future.

Considering the high stakes of managing a potential TruPS default, directors must be fully engaged in charting a path for their financial institutions. While there may not be any silver bullets, a sound board process incorporates many of these components:

Consider potential conflicts of interest.
In a potential TruPS default scenario, the interests of a bank holding company and its subsidiary bank may diverge, particularly if a holding company bankruptcy looms. Allegations of conflict can undercut a board’s ability to rely on the business judgment rule in the event that decisions are later challenged. Boards should be sensitive to potential conflicts, and may want to consider using committees or other structures to ensure proper independence in decision-making.

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Bankruptcy Judge Allows Involuntary Bankruptcy to Move Forward

On August 29, 2014, Judge John T. Laney, III, the Chief United States Bankruptcy Judge for the Middle District of Georgia, issued an order denying FMB Bancshares’ motion to dismiss the involuntary bankruptcy petition filed by its TruPS creditor, Trapeza CDO XII.  Among other conclusions, Judge Lacey found that the restrictions contained in FMB Bancshares’ written agreement with the Federal Reserve constituted a a restriction on the company’s ability to pay, rather than its legal duty to pay.  While detrimental to FMB Bancshares’ motion to dismiss, this conclusion should reinforce the ability of third parties to enter binding contractual arrangements with bank holding companies, which should be of great relief to those willing to lend to bank holding companies.

As reflected in the opinion and other court documents, FMB Bancshares issued $12 million in Trust Preferred Securities to Trapeza CDO XII in 2006.  Starting in March 30, 2009, FMB Bancshares elected to defer payments under its TruPS, and on March 30, 2014, FMB Bancshares exhausted the twenty consecutive quarter deferral period.  Trapeza has alleged that FMB Bancshares was non-responsive to Trapeza’s efforts to find an out-of-court solution, and declared the TruPS in default on April 7, 2014, causing an acceleration of all principal and interest.  On June 9, 2014, Trapeza filed an involuntary bankruptcy petition for FMB Bancshares, indicating that it believed an auction under Section 363 of the Bankruptcy Code would maximize its return.  On July 3, 2014, FMB Bancshares filed a motion to dismiss the bankruptcy petition, arguing (1) that Trapeza did not have the right (or standing) to institute an involuntary bankruptcy under the terms of the TruPS, (2) that FMB Bancshares was unable to pay because of its regulatory obligations with the Federal Reserve Bank of Atlanta, resulting in the debt being legally contingent, and (3) that the bankruptcy court was not the right venue for the disagreement.

In a 20-page opinion, Judge Laney succinctly rejected each of FMB Bancshares’ arguments.

With regard to Trapeza’s standing to institute the involuntary bankruptcy filing, Judge Laney found that the terms of both the Indenture and Amended Trust Agreement provided Trapeza CDO, as the the holders of the Trust Preferred Securities, with broad powers to enforce their rights against FMB Bancshares directly following the event of default (the occurrence of which was conceded by FMB Bancshares).  Specifically, both the Indenture and Amended Trust Agreement provided, following an event of default, that any holder of TruPS had a contractual right to institute a suit or proceeding directly against FMB Bancshares for enforcement of payment.  Judge Laney found that  an involuntary bankruptcy case could be properly construed as a suit for enforcement of payment, noting that bankruptcy cases in other jurisdictions reached the same conclusion.

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TruPS and Involuntary Bankruptcy

One of the most dramatic tools a lender can use in the collection of a loan is the involuntary bankruptcy case.  It is dramatic because of the implications for both the debtor and the lender who files the case. If a bankruptcy court determine that the petitioning creditor has not met the statutory requirements it may require the creditor to pay the debtor’s costs and attorneys fees in defending the petition and if the court finds that the petition was filed in bad faith it can award compensatory and punitive damages.  The consequences for the debtor are that if the creditor is successful, the debtor’s business and assets are now subject to disposition under a frameworks found in the Bankruptcy Code which may involve the appointment, at least initially,  of a bankruptcy trustee to administer the debtor’s estate.  Even if the debtor is successful in fighting off the petition it may suffer dramatic reputational risks that might affect its continued viability. Think of it then as the “nuclear” option.

This tool has now been used at least twice in connection with the enforcement by holders of Trust Preferred Securities (“TruPS”) against bank holding companies (“BHCs”). TruPS are hybrid securities that are included in regulatory tier 1 capital for BHCs and whose dividend payments are tax deductible for the issuer. In 1996 the Federal Reserve Board’s decided that TruPS could be used to meet a portion of BHCs’ tier 1 capital requirements. Following that decision many BHCs found these instruments attractive because of their tax-deductible status and because the increased leverage provided from their issuance can boost return on equity.

Smaller BHC’s typically did not bring TruPS to the market themselves, rather they were issued into a collateralized debt obligation (“CDO”) which in turn purchased TruPS from many different BHCs. According to Fitch since 2000 over 1,800 entities issued roughly $38 billion of TruPS that were purchased by CDO’s. In addition, many federally insured institutions held TruPS themselves once the banking regulators determined that TruPS were an acceptable investment.

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The Upcoming Trust Preferred Interest Deferral Cliff

While we continue to emerge from the Great Recession, we are also approaching another cliff that could have significant ramifications for many community banks that continue to defer interest payments under their Trust Preferred securities.  Under the terms of such Trust Preferred, issuers are generally allowed to defer interest payments for up to twenty consecutive quarters (or five years) without triggering a default.  Many institutions began deferring interest payments about four and half years ago, both to preserve capital generally and in reaction to Federal Reserve Bank enforcement actions that limited the ability of banks to pay interest on the subordinated debt supporting the Trust Preferred.  As we approach the end of the permitted five-year deferral period, we are now assisting a number of clients, on all sides of the equation, in addressing the ramifications of approaching, and potentially ultimately exceeding, the five-year deferral period.

One issue we have looked at is whether the Federal Reserve will permit a bank holding company subject to an enforcement action to bring its Trust Preferred current when failure to do so would result in default.

We’ve looked at the language in a number of agreements hoping that it would prohibit bank holding companies from paying interest only when such interest can be contractually deferred.  Unfortunately, all the enforcement actions that we reviewed have a blanket prohibition on interest payments without regard to the permissibility of the deferral under the indenture.  We understand that the Federal Reserve Banks are looking closely at the issue but have not yet provided any guidance as to the ultimate position on payment.  In addition, most bank holding companies seeking to pay interest will need a dividend from their subsidiary bank to fund such payment; accordingly, the bank level regulator(s) will likely need to be involved as well.

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August 2011 Client Alerts

U.S. Supreme Court Upholds Arizona’s Employment Verification Law

On May 26, 2011, the U.S. Supreme Court upheld the Arizona law that sanctions employers for hiring unauthorized aliens and endorsed Arizona’s requirement that employers use the federal E-Verify screening program.  A 5-3 majority of the Court found that language in the Immigration Reform and Control Act of 1986 did not pre-empt the Arizona Law.  For the answers to frequently asked questions about the Arizona law, please click here to read the Client Alert published by the Labor & Employment Client Service Group on August 4, 2011.

Employers Should Consider Expressly Prohibiting FMLA Fraud

Many employers have updated their FMLA policies to reflect recent amendments to the law and revisions to the regulations.  Another aspect of an FMLA policy that merits attention is ensuring that the policy expressly prohibits FMLA fraud and specifies the penalty for the offense.  The United States Court of Appeals for the Ninth Circuit issued an unpublished opinion earlier this year that reinforces the need for express fraud prohibition.  To learn more about the implications of the opinion, please click here to read the Client Alert published by the Labor & Employment Client Service Group on August 19, 2011.

SEC Proxy Access Rule Vacated by Federal Court

The U.S. Court of Appeals for the District of Columbia Circuit recently set aside and vacated Exchange Act Rule 14a-11 concerning shareholder proxy access, adopted by the SEC on August 25, 2010.  On a petition for review, a panel held that the SEC had “failed adequately to consider the rule’s effect upon efficiency, competition and capital formation,” as the SEC was required to do under its enabling statutes.  Thus, the Court held that adoption of the Rule was “arbitrary and capricious” and vacated the Rule.  To read more about the decision, please click here to read the Alert published by the Corporate Finance and Securities Client Service Group published August 4, 2011.

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June 2011 Client Alerts

The Implications for FCPA Enforcement of the SEC’s New Whistleblower Rules

The SEC’s recent adoption of rules to implement the whistleblower program mandated by the Dodd-Frank Act has particular significance for enforcement of the Foreign Corrupt Practices Act.  For a discussion of the overall SEC enforcement context for the new whistleblower rules, a summary of the rules,  and a discussion of the key issues for FCPA enforcement, including recommendations that companies should take now, please click here to read the Alert published by the Global Anti-Corruption Team of the Securities Litigation and Enforcement  and International Trade Groups on June 22, 2011.

Supreme Court De-Certifies Largest Employment Discrimination Class Action In History

In Wal-Mart Stores, Inc. v. Dukes, the Supreme Court reversed a lower court’s decision to certify a nationwide class pursuing employment discrimination claims against the nation’s largest employer.  A 5-4 majority of the Court concluded that the class of 1.5 million current and former female employees could not satisfy the commonality requirement.  For a discussion of the decision, please click here to read the Alert published by the Class and Derivative Actions section of the Labor & Employment Client Service Group on June 21, 2011.

Supreme Court Draws Bright Line Barring Securities Fraud Claims Against Advisers to Companies Who Do Not “Make” Statements At Issue

In June the U.S. Supreme Court issued a significant decision restricting the ability of plaintiffs to bring securities fraud actions against adviser defendants who play a role in preparing statements actually made by companies they are advising.  In Janus Group, et al. v. First Derivative Traders, the court held that an investment adviser to a mutual fund could not be sued in a private securities fraud action for false statements made in mutual fund prospectuses.  To read more, please click here for the Alert published by the Securities Litigation and Enforcement practice group on June 16, 2011.

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February 2011 Client Alerts

February 2011 Client Alerts

March 1, 2011

Authored by: Jeannie Osborne

CPSC Opens Business Registration for New Consumer Product Safety Information Database

The new Consumer Product Safety Information Database is now available online on a trial basis, and will launch officially in March at www.SaferProducts.gov.  The Database allows a broad range of people to file so-called “reports of harm” informing the CPSC about an incident or concern that the submitter believes is an indication a product is unsafe or potentially hazardous.  To read more the database, please click here to see the Alert published by the Retail Team on February 3, 2011.

IRS Reverses Course — Breast Pumps and Other Lactation Supplies are Now Deductible Medical Expenses Subject to Reimbursement under FSAs, HRAs and HSAs

In Announcement 2011-14, the Internal Revenue Service concluded that breast pumps and supplies that assist lactation are medical care under Section 213(d) of the Internal Revenue Code and can therefore be reimbursed under a health flexible spending arrangement.  To learn more about this announcement, please click here to read the Feburary 22, 2011 Alert published by the Employee Benefits & Executive Compensation Client Service Group.

Patent Reform Act of 2011

On January 25, 2011, The Patent Reform Act of 2011 was introduced by Senator Leahy (D-VT) with bipartisan support.  The Bill is the latest installment of Congress’ attempts to pass patent legislation reform, following the Patent Reform Act of 2009 and other bills in recent years, all of which died in Congress.  To learn more, please click here to read the February 22, 2011 Bulletin published by the Intellectual Property Client Service Group.

Wide-Open House Budget Debate Moves Toward Finish Line

The House continues to work towards completing a major budget bill to fund the federal government for the remainder of the 2011 fiscal year.  Of the hundreds of amendments which have been offered and voted upon, major energy and environment-related amendments would reverse a law that requires the federal government to pay the legal costs of some environmental plaintiffs, de-fund the White House climate czar’s office, prevent an EPA appeals board from revoking air permits for oil exploration in the Arctic, and de-fund the EPA’s greenhouse gas emissions registry.  To read more about the proposed amendments and other energy updates, please click here to see the February 18, 2011 Energy Update.

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