Debt Dialogue: May 2017

This month’s issue of Debt Dialogue addresses cases and issues of interest to investors, issuers, trustees and others, that run the gamut from structuring and issuance to bankruptcy and reorganization.

Topics covered in this issue include:

• Supreme Court to Hear Circuit Split over Bankruptcy Safe Harbor Provision 
  Section 546(e) of the Bankruptcy Code provides that certain transfers “by or to” a financial institution are exempt from avoidance under the fraudulent transfer and preference provisions of the Bankruptcy Code. The circuits are split on whether this safe harbor applies to payments made through a financial institution whose only role is as an intermediary. For several decades, the majority position has been that it does. The Supreme Court will be deciding the issue next term, following a forceful opinion of the Seventh Circuit taking the minority position.
• Lyondell Chemical Company: Litigation Trust’s Fraudulent Conveyance Claims Fail
  Just one year after Lyondell Chemical Company and Basell AF consummated a nearly $20 billion merger, the merged business “failed in a colossal manner.” In the ensuing bankruptcy, a litigation trust sued on behalf of unsecured creditors, claiming, among other things, actual and constructive fraud. After trial, in a 173-page opinion, Judge Glenn of the SDNY bankruptcy court rejected the claims of the trust. The decision offers important lessons for parties attempting a post-transactional attack on solvency based on a failed outcome.
• The 2016 IRS Regulations Regarding Partnership Liabilities and Disguised Sale Rules
  Under the disguised sale rules, when a partner receives cash or other property from the partnership in connection with a contribution of property, the IRS may aggregate the contribution and distribution and treat them as a disguised sale. Recently, the IRS issued regulations altering the disguised sale rules. On the one hand, the new rules severely restrict structures that the IRS considers noncommercial or abusive. On the other, the rules expand the safe harbor for transactions in which the partnership assumes a liability.
• Ambac v. Countrywide: New York’s First Department Raises the Bar for RMBS Fraud Claims by Monoline Insurers 
  The Appellate Division, First Department, of the New York Supreme Court recently ruled that monoline insurance companies pursuing fraud claims against participants in failed RMBS trusts cannot take advantage of the lower bar for fraud claims available under New York’s Insurance Law. Instead, the court held, the insurer must satisfy all of the black letter fraud requirements, including that it justifiably relied on the defendant’s fraudulent misrepresentations and that its losses were caused by those misrepresentations. This ruling was a departure from First Department precedent, and it remains to be seen how faithfully other New York courts will follow it.
• Fiduciary Duty of Collateral Manager Bars Side Deal to Recover Expenses
  Trustees and other agents owe contractual and fiduciary duties to debt holders in structured finance vehicles. In a recent case, the New York Supreme Court held that a collateral manager could not condition its foreclosure on collateral upon the reimbursement of its expenses, which were capped by the relevant indenture and collateral management agreement. The case raises the interesting question of whether agents in debt deals have an obligation to go out-of-pocket in order to fulfill their fiduciary duties where the documentation is silent on the issue.
• Follow-up: Second Circuit Affirms Dismissal of Action on Ecuador Debt Based on Expansive No-Action Clause
  The Second Circuit recently upheld a lower court decision requiring a holder of Ecuadorian sovereign debt to abide by a no-action clause in order to collect overdue interest. The no-action provision was unusual in that it permitted individual noteholders to only bring suit to collect “payment of the principal of and interest on ... its Bonds on the stated maturity.” The courts read this phrase to mean that noteholders could not even sue on overdue interest until the maturity of principal on the notes. This is consistent with New York case law that reads contracts literally, even where the results are seemingly unfair or counterintuitive.