U.S Court of Appeals for the Second Circuit

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

Momentive: Where does it stand?

On September 9, 2014, following a hotly contested four-day confirmation hearing, Robert Drain, U.S. Bankruptcy Judge for the Southern District of New York, issued a bench ruling approving Momentive’s chapter 11 plan.  See In re MPM Silicones, LLC, No. 14-22503-rdd, 2014 Bankr. LEXIS 3926 (Bankr. S.D.N.Y. Sept. 9, 2014).  Momentive’s plan provided for the company’s first and 1.5 lien noteholders to receive new notes with extended maturities at a reduced interest rate, while fully equitizing the second lien noteholders.  Holders of senior subordinated notes did not receive any recovery.  At the heart of the plan was a $600 million rights offering backstopped by the second lien noteholders.

In approving the plan, Judge Drain overruled objections filed by trustees for the first and 1.5 lien noteholders who argued that the plan was not “fair and equitable” because the proposed cramdown interest rate for each of the new notes was below the applicable market rate.  The first and 1.5 lien noteholders also asserted that a make-whole premium would have been due upon a repayment of the debt  pursuant to language in the first and 1.5 lien note indentures.  The trustee representing holders of senior subordinated notes also objected to the plan on the grounds that it impermissibly subordinated the claims of senior subordinated noteholders to the deficiency claims of second lien noteholders, which resulted in the senior subordinated noteholders not receiving any recovery.  The trustee for the senior subordinated notes also argued that the plan violated the absolute priority rule because Momentive and its debtor-subsidiaries retained intercompany interests even though the senior subordinated notes were not paid in full.

Although Judge Drain’s bench decision touched on several important confirmation topics, the ruling was controversial because it explicitly rejected a market-based approach to calculating the cramdown interest rate and endorsed the “formula approach” espoused in the chapter 13 cases Till v. SCS Credit Corp., 541 U.S. 465 (2004) and In re Valenti, 105 F.3d 55 (2d Cir. 1997).  Under the formula approach, the debtor must, in a cram-down scenario, provide a secured creditor with new notes bearing interest equal to a “risk free” base rate (such as the prime rate) plus a risk adjustment of 1-3%.  Importantly, he found while market pricing includes an element of profit, the Bankruptcy Code has no such requirement and thus the risk adjustment should be just that – an adjustment that reflects the ultimate risk of nonpayment, and not a mechanism to recover opportunity costs.  Judge Drain’s decision conflicts with decisions issued by the U.S. Court of Appeals for the Fifth and Sixth Circuits as well as some lower court opinions.  In economic terms, Momentive’s oversecured first and 1.5 lien noteholders lost nearly $100 million in trading value for their existing notes because the cramdown interest rate was calculated using the formula approach versus a market rate.

Following his confirmation decision, Judge Drain denied the creditors’ immediate request for a stay of consummation of the plan pending appeal.  Whether a stay pending appeal is granted is committed to the discretion of the judge after considering the following factors:  (i) whether the movant will suffer irreparable injury absent a stay, (ii) whether a party will suffer substantial injury if a stay is issued, (iii) whether the movant has demonstrated a substantial possibility of success on appeal, and (iv) the public interest that may be affected.  On September 11, 2014, Judge Drain formally entered an order confirming Momentive’s plan, prompting the trustees for the first and 1.5 lien noteholders as well as the trustee for the senior subordinated noteholders to file an appeal with the district court and once again seek a stay pending appeal.

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