Loan Market Breathes a Sigh of Relief As SDNY District Court Finds Loan Are NOT Securities

 

On May 22, 2020, the loan market let out a collective sigh of relief as Judge Gardephe dismissed the Millennium Lender Claim Trust’s complaint alleging securities law violations related to the sale of loans. The central question considered was whether loan trading should be subject to securities laws. The loan market operates on the assumption that loans are not securities, and the LSTA and Bank Policy Institute sought authority for leave to file briefs as amicus curiae to support that position. The motion for leave to file was denied, thus heightening concern over the outcome. But the concerns turned out to be unwarranted. Rather than redefining the leveraged loan market, Judge Gardephe stuck with the status quo finding that the loans were not securities after applying the four prong Reves test, which considers: (i) the motivations of Seller and Buyer; (ii) the distribution plan for the loans; (iii) the reasonable expectations of the investing public and (iv) the existence of another regulatory scheme. The Court pointed to the fact that the documents used the terms “loan documents,” “loan,” and “lender” consistently throughout, instead of “investor” which “would lead a reasonable investor to believe that the Notes constitute loans, and not securities.” The Court also noted in light of the Banco Español case, where the Second Circuit affirmed the district court’s finding that because “the Office of the Comptroller of the Currency has issued specific policy guidelines addressing the sale of loan participations,” application of securities laws is unnecessary as another regulatory scheme exists. (Order at 21, citing Banco Español de Credito v. Sec. Pac. Nat. Bank, 973 F.2d 51 (2d Cir. 1992)). The Plaintiff has until June 5, 2020 to amend the complaint.

COVID-19-Related Defaults in European Leveraged Loans Could Create Opportunities for Distressed Investors

 

Since the last financial crisis, borrowers and private equity sponsors have cut distressed investors out of most European leveraged loan deals. According to Reorg Debt Explained about 66% of European leveraged loans in 2019 restricted transfers to distressed investors.[1] But the recent economic turmoil created by the COVID-19 pandemic could create opportunities for distressed investors to return to the market. Fitch Ratings recently forecast a 4% default rate for European leveraged loans in 2020 and a 7% default rate in 2020.[2] In a severe downside scenario, Fitch projected that default rates could reach as high as 14% next year. In some European leveraged loan deals, the transfer restrictions that have kept distressed investors out of lending syndicates may fall away if events of default (or certain specific events of default) occur and continue. Read our key takeaways here.

CARES Act Update: Small Business Administration Releases Paycheck Protection Program Regulations

 

On April 2, 2020, six days after the CARES Act was enacted, the Small Business Administration (“SBA”) released an interim final rule (the “Interim Final Rule”) implementing the Paycheck Protection Program (“PPP”). For an overview of the PPP sections of the CARES Act, see our previous alert, which is available here.

Read our discussion of the key provisions of the Interim Final Rule, along with a brief discussion of the revised Borrower Application Form and related guidance from the Treasury Department and the SBA, here. Significantly, the Interim Final Rule states that the SBA also intends to promptly issue additional guidance regarding the applicability of its affiliation rules to PPP loans.[1]

Secondary Trading As Usual?

 

In a very short time, the COVID-19 pandemic has spread frightening levels of uncertainty all around the world. While many schools, businesses, and houses of worship have closed, the financial markets remain open. Like other markets, the secondary market for syndicated loans has experienced stomach-churning volatility and steep declines in asset prices in recent weeks. If you aren’t thinking about how COVID-19 could affect liquidity and settlements, you should be. Fortunately, the standard trading documents published by the Loan Syndications & Trading Association (the “LSTA”) already contain important concepts and tools aimed at promoting liquidity and pushing trades toward settlement, even during times as uncertain as these.

Click here for a brief refresher on some of the provisions that could prove critical in the months ahead.

The Coronavirus Aid, Relief and Economic Security (CARES) Act Becomes Law – With Major Enhancements

 

By voice vote on March 27, the House of Representatives passed the Coronavirus Aid, Relief and Economic Security Act (the “Act”), a version of which the Senate passed on a 96-0 vote two days earlier. President Trump promptly signed the Act into law. The Act includes significant amendments to the Senate bill resulting from legislative negotiations that took place since we last analyzed it here. The final version of the Act increases funding for loans to small and large businesses, increases oversight on the Department of the Treasury’s loans and grants to businesses, and adds funding for struggling state, tribal and local governments, individuals and healthcare providers. We summarize key changes here.

Congress Has Passed Phase III of the Federal Coronavirus Relief Legislation: Here’s What You Need to Know about the Legislation’s COVID-19-related Small Business Administration Loan Resources

 

The Coronavirus Aid, Relief, and Economic Security (CARES) Act – the third phase of Congress’s response to COVID-19, which was enacted on March 27, 2020 – includes a Paycheck Protection Program. The proposed program would, among other things, expand the scope of the Small Business Administration’s available 7(a) loans during a “covered period” beginning on February 15, 2020 and ending on June 30, 2020. (The Small Business Administration (SBA) provides 7(a) loan guarantees for certain loans made by participating lending institutions to qualifying small businesses.) Certain key elements of the Paycheck Protection Program are described here, followed by a discussion of various other SBA loan resources. The final version of the bill reflects substantial changes from the version introduced into the Senate on March 19, 2020.

CARES Act Inches Closer, but Terms for Economic Relief Still Uncertain

 

When we last wrote, we advised that the CARES Act’s provisions granting extraordinary power to the Secretary of the Treasury to determine those businesses’ eligible for financial relief without legislative oversight was likely to be a significant point of contention during legislative negotiations over approval of the Senate Bill. Our prediction proved correct, with passage of the Bill being delayed for several days through procedural measures. Recent reports have indicated that Secretary Mnuchin has agreed to strict legislative oversight over his authority to designate eligible businesses entitled to receive funding, which has increased in the aggregate from $150 billion to $500 billion in aid for corporations and municipalities. The agreement purportedly also includes hundreds of billions of dollars in funding for hospitals – a significant increase from the Bill’s initial allocation. Read our key takeaways here.

What You Need to Know About Proposed and Existing COVID-19-related Small Business Administration Loan Resources

 

The Coronavirus Aid, Relief, and Economic Security (CARES) Act – which was introduced into the Senate on March 19, 2020, as the third phase of Congress’s response to COVID-19 – includes a Small Business Interruption Loan program. The proposed program would, among other things, expand the scope of the Small Business Administration’s available 7(a) loan guarantees during a “covered period” beginning on March 1, 2020 and ending on December 31, 2020. (The Small Business Administration (SBA) provides 7(a) loan guarantees for certain loans made by participating lending institutions to qualifying small businesses.) Read our key takeaways here.

What You Need to Know About the Proposed Senate Coronavirus Aid, Relief and Economic Security (CARES) Act

 

The goal of the trillion-dollar Coronavirus Aid, Relief and Economic Security Act (CARES Act) introduced yesterday in the Senate is the quick distribution of cash to individuals, small businesses and critical economic sectors such as the airline industry, providing financial assistance to students, expediting coronavirus testing and easing shortages of medical supplies and personnel. While the bill as drafted has met with resistance from Democratic leaders, we expect a version of this bill to be enacted soon. The CARES Act is 247 pages long and seeks to address many critical problems. We summarize below some key provisions here.

Second Circuit Affirms Dismissal of Chapter 15 Appeal by Purported Shareholder on Standing Grounds

 

In a March 19, 2019 summary order, the U.S. Court of Appeals for the Second Circuit affirmed the district court’s dismissal of a purported shareholder’s appeal challenging the chapter 15 recognition of a Cayman Islands restructuring of an offshore drilling contractor. See In re Ocean Rig UDW Inc., No. 18-1374, 2019 WL 1276205 (2d Cir. Mar. 19, 2019). The Court of Appeals affirmed the district court’s dismissal of that appeal for lack of appellate standing. An Orrick team handled the chapter 15 proceedings in the bankruptcy court, as well as the appellate proceedings in the district court and Court of Appeals.

Background

The appeal was brought by a self-described shareholder of debtor Ocean Rig UDW Inc. (“UDW”). The appellant sought review of an order issued by U.S. Bankruptcy Judge Martin Glenn granting recognition of provisional liquidation and scheme of arrangement proceedings in the Cayman Islands of UDW and three of its subsidiaries as “foreign main proceedings” under section 1517 of the Bankruptcy Code. That recognition order gave rise to various forms of relief, including an automatic stay with respect to the Debtors and their property within the territorial jurisdiction of the United States.

In the ancillary proceedings in the bankruptcy court, the appellant had opposed the Debtors’ petition for recognition on numerous grounds, including on the basis that venue was improper in the Southern District of New York, that the Debtors failed to meet their burden of proving that their center of main interests (“COMI”) was in the Cayman Islands, that the Debtors improperly manipulated their COMI, and that granting recognition would violate the public policy objectives of chapter 15. The bankruptcy court overruled those objections and granted recognition and other related relief under sections 1520 and 1521 of the Bankruptcy Code. See In re Ocean Rig UDW Inc., 570 B.R. 687 (Bankr. S.D.N.Y. 2017).

Appellant timely noticed an appeal to the district court, but did not seek a stay of the recognition order. Thus, the Debtors moved forward with their restructuring via four interrelated schemes of arrangement under Cayman Islands law (the “Schemes”). The Schemes involved the exchange of more than $3.7 billion of existing financial indebtedness for $450 million in new secured debt, approximately $288 million in cash, and new equity in UDW. Under the Schemes, existing shareholders of UDW retained a nominal amount of equity in the reorganized UDW (0.02%), but this token amount was provided solely to facilitate UDW’s ability to maintain its NASDAQ listing and was not an indication of UDW’s solvency. In fact, the indicative value of the consideration distributed to the creditors under the Schemes was significantly less than the face amount of their claims.

Appellant did not object to the provisional liquidation proceedings or the Schemes, which were later sanctioned (i.e., approved) by the Grand Court of the Cayman Islands. Similarly, appellant did not object to a motion in the chapter 15 proceedings for entry of an order granting comity and giving full force and effect to the Schemes and Cayman court’s ruling in the United States, which the bankruptcy court subsequently granted. Promptly upon the bankruptcy court’s issuance of this “enforcement order,” the Debtors consummated the restructuring in accordance with the Schemes.

Thereafter, in the district court, before U.S. District Judge John G. Koeltl, the Debtors and their authorized foreign representative moved to dismiss the appeal, arguing that the appellant’s purported shareholder status was insufficient to give her appellate standing, and that in any event, her appeal had been rendered equitably moot by the consummation of the restructuring. The district court granted the motion on both alternative grounds. See In re Ocean Rig UDW Inc., 585 B.R. 31 (S.D.N.Y. 2018).

Appellant then sought review of the district court’s dismissal in the Second Circuit. While that appeal was pending, a third-party company (Transocean Ltd.) acquired UDW in a cash and stock transaction valued at approximately $2.7 billion.

The Second Circuit’s Ruling

The Second Circuit affirmed the district court’s dismissal of the appeal for lack of standing. The Court of Appeals began its analysis by reiterating the settled legal standard for bankruptcy appellate standing: “To have standing to appeal from a bankruptcy court ruling in this Circuit, an appellant must be an ‘aggrieved person,’ a person directly and adversely affected pecuniarily by the challenged order of the bankruptcy court.” 2019 WL 1276205 at *1 (quoting In re Gucci, 126 F.3d 380, 388 (2d Cir. 1997)). “The stringency of our rule,” the Court explained, “is rooted in a concern that freely granting open‐ended appeals to those persons affected by bankruptcy court orders will sound the death knell of the orderly disposition of bankruptcy matters.” Id.

Applying that standard, the Second Circuit readily concluded that the appellant was not an “aggrieved person.” Although the appellant was subject to injunctions set forth in the bankruptcy court’s recognition order, she had not “pursued any action against UDW that has been stayed because of the injunctive relief, and her brief [did] not identify any action that she plans to pursue.” Id. Relatedly, the Second Circuit noted that the district court had found UDW was significantly insolvent at the time the Debtors initiated the Cayman proceedings, a finding which appellant had not challenged. Because Cayman Islands law provides that creditors must be made whole before shareholders can recover in a “winding up” proceeding, the Second Circuit concluded that shareholders, including appellant, lacked any pecuniary interest in those proceedings and the U.S. order recognizing those proceedings. Id. (citing Cayman Islands Companies Law § 140(1)).

The Second Circuit also treated as inapposite a prior chapter 15 decision invoked by appellant, Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.), 714 F.3d 127 (2d Cir. 2013). That decision arose from an appeal brought by shareholders of a feeder fund that invested in the Madoff fraud. The shareholders there challenged the bankruptcy court’s chapter 15 recognition of liquidation proceedings that were ongoing in the British Virgin Islands. But as the Second Circuit’s summary order here explained, standing was not at issue in that case, and the facts were distinguishable. The shareholders in Fairfield Sentry had filed a New York shareholder derivative suit that was stayed as a result of chapter 15 recognition, whereas here, the appellant could not identify any way that recognition caused her to be aggrieved.

The Second Circuit did not explicitly address the district court’s alternative basis for dismissal: i.e., that the consummation of the Debtors’ restructuring, combined with the appellant’s failure to seek a stay, rendered the appeal equitably moot. In re Ocean Rig UDW Inc., 585 B.R. at 39-41. Noting simply that it had considered the appellant’s remaining arguments and concluded that they were without merit, the Court of Appeals did not discuss the appellant’s contention that the equitable mootness doctrine is inapplicable to chapter 15 proceedings. The district court had previously rejected appellant’s arguments that equitable mootness did not apply under chapter 15, concluding that the same “principles of finality and fairness” that pertain to “domestic reorganizations” and the same “concerns of comity” that animated former section 304 of the Bankruptcy Code apply in the chapter 15 context. Id. at 41.


If you have any questions about any of the topics discussed in this opinion, please contact your Orrick attorney or any of the following attorneys:

Evan Hollander

Daniel Rubens

Emmanuel Fua