Distressed debt investors need strong stomachs. Consider the
events of Wednesday afternoon, in cases in opposite corners of
the country that featured big-money claims by Elliott Capital
and Aurelius Capital. In New York, the 2nd Circuit Court of
Appeals stepped in to save Argentina from economic catastrophe,
staying a ruling by U.S. District Judge Thomas Griesa that would
have required the country to cough up $1.3 billion for the hedge
funds if it wanted to make good on payments to bondholders who
participated in Argentina's debt restructuring. That was a huge
blow to Elliott and Aurelius, which had hoped the injunction
would finally break Argentine defiance of U.S. judgments. But
perhaps the pain was dulled by a ruling from the 5th Circuit in
New Orleans, which affirmed U.S. Bankruptcy Judge Harlin Hale's
decision that the Mexican glassmaker Vitro can't use the Mexican
bankruptcy process to block Elliott and Aurelius from pursuing
more than $1 billion in claims against Vitro subsidiaries.
The long-running Argentine debt saga is still the ultimate
example of the risks of litigating for a return on defaulted
bonds, but in the Vitro case, the hedge funds confronted
similarly delicate foreign relations issues, since they were
challenging the propriety of a Mexican court's judgment in a
matter that the Mexican government joined as an amicus. The 5th
Circuit's ruling Wednesday, as my Reuters colleague Tom Hals was
the first to report, should embolden distressed-debt investors.
It stands for the principle that foreign debtors can't rely on
international comity to shaft U.S. creditors, whoever those
creditors might be.
Vitro's bankruptcy plan was particularly brazen. After its
revenues went into steep decline in 2008, the company went
through an extremely complicated restructuring that converted
its biggest creditor into an ally and several of its
subsidiaries into creditors. It subsequently underwent
bankruptcy in the Mexican courts. A group of noteholders led by
Elliott and Aurelius opposed the reorganization plan, which left
them in the hole but preserved $500 million in Vitro equity. But
because the pre-bankruptcy restructuring made Vitro subsidiaries
into creditors, insiders had enough votes to push the bankruptcy
through the Mexican courts despite noteholders' objections.
Vitro then sought recognition and enforcement of its Mexican
bankruptcy through Chapter 15 of the federal Bankruptcy Code, a
device enacted in 2005 to permit debtors to translate foreign
insolvency proceedings into relief in U.S. courts. Vitro
asserted that the Mexican proceeding extinguished claims by its
hedge fund creditors. The hedge funds, represented principally
by Dechert, set up a howl of protest, since they had previously
obtained a declaratory judgment in New York State Supreme Court
upholding their rights. Vitro, they argued, was improperly
attempting to use Chapter 15 to stop them from proceeding with
their billion-dollar claims against its subsidiaries. Judge Hale
agreed. The Dallas judge ruled that the Mexican bankruptcy plan
was contrary to U.S. public policy and refused to enforce it.
In Vitro's appeal, the company's lawyers at Thompson &
Knight and Milbank, Tweed, Hadley & McCloy told a three-judge
5th Circuit panel (Judges Carol King and Jerry Smith and Senior
Judge Rhesa Barksdale) that Hale had not paid sufficient
deference to the concept of international comity. Chapter 15
acknowledges that foreign bankruptcies may not produce the same
results as U.S. procedures. So U.S. bankruptcy courts, Vitro
argued, are bound to enforce the legitimate judgments of their
foreign counterparts. (Hale had specifically declined to accept
claims by Elliott and Aurelius that Vitro's Mexican bankruptcy
process was corrupt.) Comity, according to Vitro, should
outweigh concerns about the specifics of its plan.
The Mexican government expounded on that point in an amicus brief filed late in the U.S. appeals process by Goldstein &
Russell. "A contrary result would signal to dissatisfied parties
(creditors and debtors alike) that they may seize upon any
deviation from U.S. bankruptcy law as a basis to challenge the
enforcement of a foreign plan, and comity shall be reduced from
a strong norm of international cooperation to mere rhetoric,"
the Mexican brief said.
The painstaking 50-page opinion that the 5th Circuit issued
Wednesday acknowledges Chapter 15's profound interest in
international comity. But the law, wrote Judge King for the
panel, "does impose certain requirements and considerations that
act as a brake or limitation on comity." Much of the court's
discussion of the limits on relief available to foreign debtors
through Chapter 15 is too technical to be of interest to anyone
who isn't paid by the hour to parse it. For the rest of us,
suffice to say that the appeals court considered the extremely
broad relief Vitro would receive through Chapter 15 --
nullifying judgments against it and its subsidiaries,
permanently barring pending and future enforcement actions and
releasing Vitro from liability in connection with the Mexican
bankruptcy -- and concluded that the company could not have
obtained it through a U.S. bankruptcy proceeding.
The 5th Circuit said its precedent explicitly holds that
U.S. debtors can't obtain the release of claims against
non-bankruptcy subsidiaries through the Chapter 11 process. The
law in other circuits is less black-and-white, the panel said,
but even those circuits that permit such releases only do so in
extraordinary circumstance. The same standard, the court
suggested, should apply to Chapter 15 debtors. Indeed, according
to the 5th Circuit, the only Chapter 15 that approved a release
of claims against someone other than the debtor was a Canadian
case in which the creditors supported the release. Here, by
contrast, creditors other than Vitro insiders vehemently opposed
it.
And besides, the 5th Circuit said, Vitro could hardly
complain about a lack of international comity when Mexico's own
courts hadn't shown deference to the New York state court
judgments obtained by the hedge funds. Comity is the rule of
Chapter 15, the court said, but the circumstances of the Vitro
case are exceptional.
"Many of the factors that might sway us in favor of granting
comity and reversing the bankruptcy court to that end are absent
here," the 5th Circuit said. "Vitro has not shown that there
existed truly unusual circumstances necessitating the release.
To the contrary, the evidence shows that equity retained
substantial value. The creditors also did not receive a
distribution close to what they were originally owed. Moreover,
the affected creditors did not consent to the plan, but were
grouped together into a class with insider voters who only
existed by virtue of Vitro reshuffling its financial obligations
between it and its subsidiaries."
Ironically, a Mexican appeals court issued its affirmation
of Vitro's bankruptcy plan on Tuesday, the day before the 5th
Circuit ruling. But that won't help the company block actions by
the hedge funds in the United States. In a press release on the
U.S. appellate ruling, Vitro said its restructuring was "fully
consistent with Mexican law, which has been consistently
recognized and respected in the U.S. legal system." The company
said it is analyzing the 5th Circuit ruling and considering its
options.
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