Harvard Business Law Review (HBLR)

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Bankruptcy

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Why The Lack of Interest in Interest? Another Look at Preferences and Secured Creditors

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Samuel D. Krawiecz*

I.          Introduction

The Bankruptcy Code (sometimes referred to herein as the Code) disallows preferential payments made to creditors.[1] Bankruptcy preference law “ha[s] been hailed as ‘the single greatest contribution of the Bankruptcy Act to the field of commercial law.’”[2] Preference law is “designed to prohibit insolvent debtors, on the eve of filing for bankruptcy, from paying off their debts held by ‘preferred’ creditors—those creditors whom the soon-to-be bankrupts wish to favor.”[3] One purpose the preference provisions serve is that of “facilitat[ing] the prime bankruptcy policy of equality of distribution among creditors of the debtor.”[4] The other purpose of preference law is to discourage creditors “from racing to the courthouse to dismember the debtor during his slide into bankruptcy.”[5] This gives the debtor an opportunity to rescue his business and remove it from insolvency.[6]

The preference rule has five elements.[7] The payment must be (1) a transfer to a creditor, (2) for the benefit of an antecedent debt, (3) while the debtor was insolvent, (4) within ninety days of the filing of the petition (unless the creditor is an insider), and (5) the payment must “enable[] such creditor to receive more than such creditor would receive” in a Chapter 7 liquidation.[8] This Article will analyze how the fifth and last element is applied, particularly with regard to fully secured creditors.

II.         The Hypothetical Liquidation Test

The fifth element is sometimes called the “hypothetical liquidation test.”[9] The full text of paragraph 547(b)(5) reads:

[T]he trustee may avoid any transfer of an interest of the debtor in property . . .
(5) that enables such creditor to receive more than such creditor would receive if—
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the provisions of this title.[10]

A court must “construct a hypothetical chapter 7 case and determine what the creditor would have received if the case proceeded under chapter 7.”[11]

A.         Secured v. Unsecured Creditors

Generally, an unsecured creditor receiving a prepetition payment will have received more than in a chapter 7 liquidation.[12] This is true because, in a typical bankruptcy, the distribution made to unsecured creditors is less than 100% of their outstanding debt. Therefore, “any payment . . . will enable [an unsecured] creditor to receive more than” in a liquidation.[13]

The opposite rule holds true for secured creditors.[14] Prepetition payments to a fully secured creditor “generally ‘will not be considered preferential because the creditor would not receive more than in a chapter 7 liquidation.’”[15] This rule seems appropriate because the underlying rationale for preference law “appl[ies] to a lesser degree to creditors with fully secured claims.”[16] The fairness rationale does not apply in the case of a fully secured creditor because a fully secured creditor “is not required to share with other creditors on a pro rata basis” due to his security interest and there is less fear of a fully secured creditor “dismember[ing] a financially unsound debtor” because he is certain of his payment to the extent of his security interest.[17]

B.       Application of the Hypothetical Liquidation Test

When applying the hypothetical liquidation test, courts construct a counterfactual in which (1) there was a Chapter 7 liquidation proceeding, (2) the transfer was not made, and (3) the debtor’s debt was discharged pursuant to the Bankruptcy Code.[18] The court then estimates how much the creditor would receive in the hypothetical case, which I will refer to as Scenario B, for the debt that was repaid with the allegedly preferential payment.[19] If this amount is lower than the amount of the prepetition payment, what we will call Scenario A, then the fifth prong of the preference analysis is satisfied.[20]

The hypothetical is not “conducted in a vacuum.”[21] For example, when a creditor has a contract with the debtor, a court must estimate whether the contract would be assumed or rejected before concluding whether the prepetition payment benefitted the creditor.[22] When making this assessment, courts do not mechanically construct and apply a Chapter 7 liquidation model, but take into account the “actual facts of the case.”[23] The hypothetical “assume[s] that [all] persons would act in a commercially reasonable and businesslike manner.”[24]

III.      Post-Petition Interest and the Hypothetical Liquidation Test: Why Secured Creditors Are Usually “Preferenced”

Although courts consider issues such as liquidation costs and contract assumption, they do not consider post-petition interest when performing the hypothetical liquidation test.[25] For example, consider the effect of post-petition interest[26] on a fully secured creditor with a $1 million debt, a $1 million security interest in the debtor, and the ability to receive a semi-annual interest rate of 4%. In Scenario A, he receives a $1 million cash payment on January 1 and the debtor files for bankruptcy on February 1 of the same year. Because the money is in the creditor’s hands and not subject to the automatic stay, he will employ this cash and receive a semi-annual interest rate of 4%. This will result in him earning forty thousand dollars every six months.

In Scenario B, a court would hypothesize either that the money was returned before February 1 or never paid to the creditor and the debtor then files for Chapter 7 on February 1. The creditor will then submit a claim for $1 million. However, even though he is fully secured, he will not receive interest until the conclusion of the Chapter 7 proceedings. In a liquidation proceeding with “extensive or complex litigation”, the case can take years.[27] Supposing it takes half a year, he will receive $1 million in six months’ time in Scenario B; in Scenario A, he will have $1.04 million.[28]

Another way of analyzing this is by comparing the present value of the payments in Scenario A and B.  In Scenario A, the payment is today and the present value would therefore equal the payment, or one million dollars.  In Scenario B, supposing the Chapter 7 takes six months, the present value of the million dollars is only $961,538.[29]  Secured creditors seem to “flunk” the hypothetical liquidation test. This analysis runs counter to the legal dogma that secured creditors are not preferenced by prepetition payments.[30]

A.         This Analysis Fits with the Statutory Text of Bankruptcy Code § 547(b)

The statutory language of the hypothetical liquidation test requires only that the prepetition payment “enable” the creditor “to receive more” than in hypothetical liquidation.[31] The term enable indicates that the analysis should encompass more than the prepetition payment itself. If Congress meant to limit the court’s consideration to the actual payment, it could have stated “(5) that is greater than such creditor would receive if . . . ” Additionally, the text of § 547 does not require that the benefit from the preference derive from the debtor themselves.[32]

B.         This Analysis Follows the “Not Conducted in a Vacuum” and “Commercially Reasonable and Businesslike Manner” Approaches Taken by Courts

Preference case law also supports a contextual approach to constructing the hypothetical liquidation.[33] In In re LCO Enterprises,[34] the question of whether a creditor benefitted from a prepetition payment depended on whether the creditor’s contract with the debtor would be assumed or rejected in Scenario B.[35] If assumed, the debtor would be obligated to cure any default,[36] the creditor would therefore be paid in full, and the payment would not be a preference.[37] In the actual facts of that case, the contract was assumed but the question the court was considering was whether that fact should affect the hypothetical test.[38]

The court began its analysis by invoking the Supreme Court’s ruling in Palmer Clay Products Co. v. Brown[39] that:

The preferential effect of the payment must be determined “not by what the situation would have been if the debtor’s assets had been liquidated and distributed among his creditors at the time the alleged preferential payment was made, but by the actual effect of the payment as determined when bankruptcy results.”[40]

This principle was applied in In re Tenna Corp.[41] to disregard a post-petition development of a super-priority in constructing the hypothetical liquidation.[42] Both cases seem to indicate that in a hypothetical liquidation, the court can only look at events as of the day of the filing.[43]

Despite this, the court in In re LCO Enterprises stressed that “the hypothetical liquidation . . . should not . . . be conducted in a vacuum,”[44] and that it “must be based on the actual facts of the case.”[45] The court therefore ruled that, because the contract was assumed, there was a legal obligation on the debtor to repay the debt in full and therefore there was no benefit to the creditor due to the prepetition payment.[46]

Just as a court can consider post-petition events such as a contract assumption,[47] so too it can consider the length of a hypothetical liquidation in determining the amount that would be received in that proceeding, relative to what a prepetition payment “enabled” a creditor to receive.

C.         Applying Preference Law to Payments to Secured Creditors Fits with the Rationale for Preference Law

Allowing secured creditors to receive prepetition payments and ignoring the practical benefits accruing to them due to the time value of money runs counter to the policy rationales underlying preference law. These reasons are described in the legislative history of section 547:

The purpose of the preference section is two-fold. First, by permitting the trustee to avoid prebankruptcy transfers that occur within a short period before bankruptcy, creditors are discouraged from racing to the courthouse to dismember the debtor during his slide into bankruptcy. The protection thus afforded the debtor often enables him to work his way out of a difficult financial situation through cooperation with all of his creditors. Second, and more important, the preference provisions facilitate the prime bankruptcy policy of equality of distribution among creditors of the debtor. Any creditor that received a greater payment than others of his class is required to disgorge so that all may share equally.[48]

Payments to secured creditors should be avoided pursuant to both of these reasons.

1.         The dismemberment fear

As noted in In re Fuel Oil Supply & Terminaling, Inc., there is an incentive, albeit reduced, even for secured creditors to obtain prepetition payments due to the time value of money.[49] If a bank has knowledge that a debtor is having financial difficulties and may need to enter bankruptcy, there is a very real incentive for them to try to force the debtor to use whatever cash is available to pay their debts. Their alternative, in the real world, is to wait for the conclusion of a Chapter 11 proceeding. Although Congress is attempting to shorten the duration of Chapter 11 cases by limiting the period of exclusivity for debtors to file plans of reorganization,[50] even a secured creditor must fear that his money will be tied up for the duration of the proceedings. If there are many creditors, the case can take a long time.[51] Thus, the first rationale for preferences applies to secured creditors as well.

2.         The fairness concern

Additionally, fairness should dictate that payments to secured creditors are avoidable preferences. First, as the Ninth Circuit formulated the fairness argument, preference law was meant to “prohibit insolvent debtors, on the eve of filing for bankruptcy, from paying off their debts held by ‘preferred’ creditors—those creditors whom the soon-to-be bankrupts wish to favor.”[52] Given the interest of a creditor in avoiding having his money tied up in a bankruptcy, this consideration is very real even for secured creditors. Supposing a debtor has several secured creditors with claims of one million dollars, and the debtor has only one million in cash, he can favor a “preferred” creditor by paying them the cash and allowing them to avoid waiting out the ensuing bankruptcy.

Additionally, there is a fairness concern that prepetition payment to a secured creditor will result in less money for the other creditors, secured or otherwise. Allowing the debtor to keep its cash means that the debtor, and not the secured creditor, will capture the benefit of the time value of money. This value can be obtained either by lending out the money, or, as is more likely, if the debtor needs the cash to operate in bankruptcy, keeping its cash allows the debtor to avoid obtaining expensive debtor-in-possession financing. Thus, avoiding prepetition payments for secured creditors “facilitate[s] the prime bankruptcy policy of equality of distribution among creditors of the debtor.”[53]

IV.         Conclusion

Current case law clearly holds that payments made to a secured creditor are not voidable because the creditor was guaranteed to be repaid that amount, due to his security. However, this does not account for the real world practicality that receiving a prepetition payment is greatly beneficial to the secured creditor as it allows him to receive interest on that money during the pendency of the Chapter 11 proceedings.

The statutory text seems to allow for this consideration, as it states that a prepetition payment need only “enable” the creditor to receive more. Additionally, current bankruptcy doctrine has other instances where courts create a hypothetical scenario (such as would need to be created to account for post-petition interest) in analyzing if a creditor is better off.[54]

The underlying preference law rationale militates for such a rule as well. Allowing secured creditors to keep prepetition payments will lead to such creditors rushing the debtor and actually causing a filing, which is precisely the result preference law was meant to prevent.

 

Preferred citation: Samuel D. Krawiecz, Why The Lack of Interest in Interest? Another Look at Preferences and Secured Creditors, 5 Harv. Bus. L. Rev. Online 107 (2015), https://www.hblr.org//?p=4024.

* J.D., Harvard Law School, 2015. I am especially grateful to Professor Mark J. Roe for his thoughtful guidance and feedback.

[1] See 11 U.S.C. § 547 (2012).

[2] Isaac Nutovic, The Bankruptcy Preference Laws: Interpreting Code Sections 547(c)(2, 550(a)(1), and 546(a)(1), 41 Bus. Law. 175, 175 (1985) (quoting Maclachlan, Bankruptcy 284 (1956)).

[3] In re Taylor, 599 F.3d 880, 888 (9th Cir. 2010).

[4] Union Bank v. Wolas, 502 U.S. 151, 161 (1991) (quoting H.R. Rep. No. 95-595, at 177–78 (1977), reprinted in 1978 U.S.C.C.N. 5963, 6138).

[5] Union Bank, 502 U.S. at 161 (quoting H.R. Rep. No. 95-595, at 177–78 (1977), reprinted in 1978 U.S.C.C.N. 5963, 6138).

[6] See Union Bank, 502 U.S. at 161.

[7] See 11 U.S.C. § 547(b) (2012).

[8] See id.

[9] E.g., In re Friedman’s Inc., 738 F.3d 547, 555–56 (3d Cir. 2013).

[10] 11 U.S.C. § 547(b)(5).

[11] In re LCO Enters., 12 F.3d 938, 941 (9th Cir. 1993).

[12] See e.g., In re Powerine Oil Co., 59 F.3d 969, 972 (9th Cir. 1995).

[13] Id. This is because for the portion of debt that is paid prepetition, the unsecured creditor is being repaid at rate of 100%, as opposed to during a bankruptcy where unsecured creditors receive less than 100% for the entirety of their loan.

[14] See id.

[15] Id. (quoting 4 Collier on Bankruptcy ¶ 547.08, at 547–45 (Lawrence P. King ed., 15th ed. 1995)).

[16] See In re Fuel Oil Supply & Terminaling, Inc., 837 F.2d 224, 227 (5th Cir. 1988).

[17] See id.

[18] See e.g., In re Friedman’s, 738 F.3d at 556; In re Smith’s Home Furnishings, Inc., 265 F.3d 959, 963 (9th Cir. 2001).

[19] See In re Smith’s Home Furnishings 265 F.3d at 963.

[20] See id.

[21] In re LCO, 12 F.3d at 942.

[22] See id. at 941.

[23] See id. at 942–43.

[24] See In re ML & Assocs., Inc., 301 B.R. 195, 202 (Bankr. N.D. Tex. 2003).

[25] See e.g., In re LCO Enters., 12 F.3d at 942–44;  In re ML & Assocs., 301 B.R.  at 202–03. But see In re Fuel Oil Supply & Terminaling, Inc., 837 F.2d at 227 n.10 (noting that a fully secured creditor’s incentive to obtain prepetition payments is merely “reduced” but still present, partly because he “forgoes earning interest on the retained collateral during bankruptcy”).

[26] This argument applies only to the interest that could be earned after the filing. With regard to the interest between the preference and the filing though, there is no argument to say that there is a benefit. This is because the creditor’s claim is accruing interest even in Scenario B, which means that on the day of the filing, there is no difference between Scenarios A and B. In both cases, he will have a right to the one million dollars with its accompanying interest for January 1st through February 1st.

[27] See William J. Factor, When is Chapter 7 the Best Option for Liquidating a Business?, in Chapter 7 Commercial Bankruptcy Strategies 91, 97 (2010), available at 2010 WL 895211 (noting that “it can take longer than a decade to administer a case involving extensive or complex litigation claims”).

[28] This is equal to the one million dollars paid prepetition and an additional forty thousand dollars earned as interest over six months (1,000,000 x 1.04).

[29] This is equal to one million divided by 1.04.

[30] See e.g., In re Smith’s, 265 F.3d at 964.

[31] 11 U.S.C. § 547(b)(5).

[32] See id.

[33] A contextual approach, as opposed to a mechanical one, is crucial to this analysis. Most of the cases cited use this approach when constructing Scenario B (for example, by assessing if a contract will be assumed) while in this Essay’s analysis the main effect is in Scenario A. Just as courts look beyond the petition date when constructing Scenario B, this analysis looks at the length of the proceedings after the petition date to either discount the payment in Scenario B or to calculate interest that can be earned in Scenario A.

[34] 12 F.3d 938 (9th Cir. 1993).

[35] See id. at 941.

[36] See id. (citing 11 U.S.C. § 365(b)).

[37] See In re LCO Enters., 12 F.3d  at 941.

[38] See id. at 942.

[39] 297 U.S. 227 (1936).

[40] In re LCO Enters., 12 F.3d at 942 (quoting Palmer Clay, 297 U.S. at 229).

[41] 801 F.2d 819 (6th Cir. 1986).

[42] See id. at 823.

[43] See In re LCO, 12 F.3d at 942.

[44] See id. (quoting In re LCO Enters., 137 B.R. 955, 959 (B.A.P. 9th Cir. 1992)).

[45] See In re LCO, 12 F.3d at 940.

[46] See id. at 942.

[47] See id.

[48] H.R. Rep. No. 95-595, at 177–78 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6138.

[49] 837 F.2d at 227 n.10.

[50] See Bankruptcy Abuse Protection and Consumer Protection Act of 2005 § 411, 11 U.S.C. § 1121(d)(2) (2012).

[51] See M. Todd Henderson, Paying CEOs in Bankruptcy: Executive Compensation When Agency Costs are Low, 101 Nw. U. L. Rev. 1543, 1607 n.327 (“The average time a firm spends in Chapter 11 is about 18 months.”).

[52] In re Taylor, 599 F.3d at 888.

[53] H.R. Rep. No. 95-595, at 177–78 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6138.

[54] See supra, note 18.

By

Losing Momentive: A Roadmap to Higher Cramdown Interest Rates

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Evan D. Flaschen, David L. Lawton & Mark E. Dendinger*

I.         Introduction

There has been a lot of press regarding the lengthy Momentive[1], bench ruling delivered in late 2014.[2] In Momentive, the Bankruptcy Court for the Southern District of New York held that debtors could satisfy the “cramdown” requirements of section 1129(b) of the Bankruptcy Code by distributing to secured creditors replacement notes paying below-market interest rates based on small margins.[3] Several months later, the Ninth Circuit Bankruptcy Appellate Panel (“BAP”) issued an unpublished decision in which it took a more nuanced approach to cramdown interest rate calculation.[4] Instead of identifying a defined range for acceptable margins, as was the case in Momentive, the Ninth Circuit BAP concluded that creditors should shoulder the evidentiary burden to prove the risk factors used to determine the appropriate cramdown rate.[5] In the wake of Momentive, the Ninth Circuit BAP has offered undersecured creditors a roadmap to higher cramdown interest rates under the right circumstances.[6]

II.        Till Sets the Cramdown Interest Stage

A chapter 11 plan of reorganization may be confirmed without the consent of an impaired class of secured creditors if the plan satisfies the conditions set out in section 1129(b) of the Bankruptcy Code.[7] Such conditions include a requirement that the plan be fair and equitable with respect to the objecting class, which, in the case of secured creditors, is satisfied when creditors in the class retain the lien securing their claims and receive deferred cash payments with a present value at least equal to the value of their secured claims.[8] The present value is determined as of the effective date of the plan, and the deferred cash payments must consist of an appropriate cramdown interest rate and amortization of principal.[9]

The Bankruptcy Code is silent as to how bankruptcy courts should calculate the appropriate cramdown interest rate.[10] In the absence of a clear statutory directive, “[c]ourts have used a wide variety of different rates as benchmarks in computing the appropriate interest rate (or discount rate as it is frequently termed) for the specific risk level in their cases.”[11] Among these methods are the formula rate, the coerced loan rate, the presumptive contract rate, and the cost of funds rate.[12]

Till v. SCS Credit Corp. is the leading case on cramdown interest rates. Under Till, the United States Supreme Court eschewed a market interest rate and held instead that the cramdown rate should be determined by a “formula” approach: taking the national prime rate and adjusting it by a margin that takes into consideration “the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan.”[13] However, the Supreme Court noted specifically that, in a chapter 13 case, “there is no free market of willing cramdown lenders,” and that “the same is not true in the Chapter 11 context, as numerous lenders advertise financing for Chapter 11 debtors in possession.”[14] Nevertheless, since Till, many courts have been persuaded by Till‘s reasoning and have adopted its formula approach in cases under chapters 13 and 11.[15]

III.       Along Comes Momentive

In 2012, Momentive Performance Materials Inc. and its affiliates (collectively, “Momentive”) issued $1.1 billion of first-lien notes and $250 million of “1.5-lien” notes due 2020 under indentures with substantially similar terms governed by New York law. In April 2014, Momentive filed a chapter 11 petition and subsequently proposed a death-trap plan to pay noteholders either (i) in full in cash, without a make-whole premium, if the noteholders voted in favor of the plan, or (ii) seven-year replacement notes in the amount of their allowed claims at a below-market rate and the right to litigate their make-whole claims, if they did not vote in favor of the plan.[16] The noteholders did not vote in favor of the plan, and they objected to confirmation of the plan on grounds that the treatment of their claims was not fair and reasonable under applicable cramdown standards.[17]

Because secured noteholders rejected the debtors’ proposed plan, the debtors were required to satisfy the cramdown requirements of section 1129(b)(2) of the Bankruptcy Code, as described above.[18] At issue was whether the secured noteholders would receive deferred cash payments totaling at least the value of the secured portion of their claim as of the effective date of the plan under section 1129(b)(2) of the Bankruptcy Code and, more specifically, whether the cramdown rate on the replacement notes to be issued under the plan was sufficient.[19] The debtors argued that their plan provided sufficient present value to satisfy the cramdown requirements standard enumerated in Till and by the Second Circuit in In re Valenti, 105 F.3d 55 (2d Cir. 1997), in which the respective courts applied a “formula” approach under an analogous chapter 13 provision to determine a proper interest rate by taking a risk-free base rate, such as the prime rate or the Treasury rate, and adding a margin to account for debtor-specific risk of non-payment.[20] The secured noteholders argued that (i) the formula approach was only relevant in the absence of a clear market rate, and (ii) the higher rate in the debtors’ exit financing commitment clearly evidenced a market rate.[21]

In August 2014, the Bankruptcy Court for the Southern District of New York issued a lengthy bench ruling, which was later corrected and re-issued in September 2014.[22] The Bankruptcy Court rejected market-based approaches (such as the “coerced loan” approach) used by other courts, whereby the cramdown interest rate is determined based on the rates for similar loans in similar circumstances, the cost of funds, and other conditions, assuming a market exists.[23] Instead, the Bankruptcy Court held, inter alia, that the debtors could cram down their plan of reorganization on the secured lenders under section 1129(b)(2)(A)(i) of the Bankruptcy Code by providing them with replacement notes paying below-market interest rates, limiting the interest rate determined by the formula approach to the prime rate plus a margin of 1 to 3 percent depending on the risk of nonpayment.[24] The Bankruptcy Court reasoned that the formula approach meets the objective of section 1129(b)(2)(A)(i)(II) by putting the creditor in the same economic position as it would have been in if it immediately received the value of its allowed claim[25]—and that such value should not include any degree of profit.[26] The Bankruptcy Court ultimately found that (i) the elements of profit and transaction cost considered in the market approach are not to be considered in calculating present value with respect to cramdown rates, and, moreover, such market approach requires costly evidentiary hearings that involve issues unfamiliar to bankruptcy judges; and (ii) the formula approach should start with a riskless rate and be adjusted upward (1 to 3 percent) for debtor-specific risks (i.e., “based on the circumstances of the debtor’s estate, the nature of the collateral security and the terms of the cramdown note itself, and the duration and feasibility of the plan”).[27] The Bankruptcy Court reiterated that application of an appropriate risk premium is not a means to achieve a market rate, finding that up to 1 to 3 percent per annum is appropriate in the absence of “extreme risk.”[28]

In determining the appropriate risk premium for the Momentive noteholders, the Bankruptcy Court looked to the market testimony of the debtors and the parties’ investment bankers.[29] The Bankruptcy Court relied almost exclusively on the debtors’ financials, projections, and budgets to conclude that the noteholders’ investment bankers engaged in no independent analysis and failed to engage in a rigorous testing of the debtors’ projections.[30]  The Bankruptcy Court found that repayment was very likely given a healthy asset coverage ratio under the plan (closer to 50 percent than 75 percent), a much-reduced total debt leverage (with debt reduced from $4.4 billion to $1.3 billion), and a committed $600 million equity investment.[31] Accordingly, the Bankruptcy Court concluded that the risk of non-payment (as opposed to the risk of default) was relatively low and that the 1.5 and 2 percent risk premiums, for the first and 1.5-lien replacement notes established by the debtors under the plan, were appropriate.[32] The Bankruptcy Court disagreed only with the debtors’ selection of the Treasury rate as the base rate because the Treasury rate assumes virtually no risk of payment by the United States—whereas a rate closer to the prime rate more accurately accounts for the risk of the debtors’ performance.[33]

The decision in Momentive provides both debtors and secured creditors clear guidance as to how Judge Drain views the calculation of the appropriate interest rate in a secured creditor cramdown situation. While the result was disappointing to secured creditors, the decision bolsters the body of law applying the Till formula approach.

IV.        Dunlap Oil to the Rescue?

Creditors winced after reading the Momentive decision’s interpretation of the Till cramdown rate formula, but they may take a little comfort in the fact that other courts are not strictly limiting the maximum risk margin applied in the formula approach to only 3 percent. In a recent decision, the Ninth Circuit BAP held that the bankruptcy court below did not err in applying a 1.75 percent margin to the 3.25 percent prime rate.[34] Although the secured creditor appellant argued that the rate was still unreasonably low, the Ninth Circuit BAP did not identify a percentage to serve as a cap in all cases, as Judge Drain did in dicta in Momentive.[35] Instead, the Ninth Circuit BAP emphasized Till‘s language in placing the burden on secured creditors to submit evidence to prove that the risks under a particular plan warrant a higher cramdown interest rate: “[S]tarting from a concededly low estimate and adjusting upward places the evidentiary burden squarely on creditors, who are likely to have readier access to any information absent from the debtor’s filing . . . .”[36]

In In re Dunlap Oil Co., Inc., the secured creditors argued that the only evidence on the record that the risk factors required a 4 percent adjustment to the prime rate was testimony from the debtor’s financial consultant.[37] While not eliminating the possibility of such a higher margin, the Ninth Circuit BAP held that the burden of proof rests squarely on the creditors to provide such evidence and that the bankruptcy court had not abused its discretion in selecting a lower rate, noting that the bankruptcy court had properly considered the feasibility of the plan, the market conditions, and the absence of evidence that the collateral would decline in value over the term of the plan.[38]

Whereas Momentive’s approach to the Till rate limited the applicable cramdown rate, Dunlap Oil illustrates adherence to precedent in allowing the facts and circumstances in each case to dictate the rate. The flexibility of Till and Dunlap Oil grants secured creditors their day in court instead of foreclosing higher rates where they might be warranted. Nonetheless, that day in court—and the evidence it requires—can have a significant cost. Without clear evidence of an established market for the secured claim in question, evidence of comparable rates under similar circumstances and the likelihood of nonpayment in each case may not be readily available, apart from evidence created by advisors of the debtor or its creditors; accordingly, the dispute as to the appropriate rate may be costly. To avoid indecision in the absence of probative evidence, a court may consider eschewing the flexibility of Till’s formula approach, as followed by Dunlap Oil, in favor of a more rigid standard. However, such rigidity should result in judicial economies, e.g., where costly, time-consuming analyses consistently reach the same conclusion. Although it is unlikely that the market rate and risk of non-payment would consistently be the same in wholly different circumstances, the United States Bankruptcy Courts for the Northern and Southern Districts of Mississippi issued a standing order setting the current presumptive Till rate at 5.0 percent.[39] A presumptive rate is particularly useful where evidence is lacking and a rate must still be set, as long as the presumptive rate remains only a presumption, rebuttable by contrary evidence. But a fixed interest cap used in Momentive offers neither presumption nor efficiency. Enforcing a cap still requires the court to consider evidence in setting the cramdown rate—it merely limits the effect of such evidence, regardless of its probative value. Therefore, it is encouraging that Momentive’s establishment of a maximum cramdown rate threshold remains an isolated, case-specific approach that, to date, has failed to gather momentum.

V.         Conclusion

While the Momentive decision sent ripples throughout the lending market,[40] its application is limited by the facts of the case. Moreover, while other courts may yet find its reasoning persuasive, the establishment of a judicial cramdown interest rate cap is not gaining widespread traction. As explained above, the Ninth Circuit BAP, in a post-Momentive decision, eschewed a clearly defined range for acceptable margins and focused instead on the evidentiary burden creditors have to overcome to prove that higher risks warrant a higher interest rate. Such a “proof-of-risk” approach requires a probative inquiry without foreclosing appropriately higher rates where greater risk exists.

 

Preferred citation: Evan D. Flaschen, Mark E. Dendinger & David L. Lawton, Losing Momentive: A Roadmap to Higher Cramdown Interest Rates, 5 Harv. Bus. L. Rev. Online 100 (2015), https://www.hblr.org//?p=4003.

* Evan D. Flaschen is the chair of the Financial Restructuring Group at Bracewell & Giuliani LLP. Mark E. Dendinger and David L. Lawton are associates in that group.

[1] In re MPM Silicones, LLC, No. 14-22503, 2014 WL 4436335 at *34 (Bankr. S.D.N.Y. Sept. 9, 2014). MPM stands for “Momentive Performance Materials”, and we refer to the case as “Momentive” throughout.

[2] See e.g., Matt Wirz, Momentive Ruling Shakes Up Debt Markets, MoneyBeat (Aug. 28, 2014), http://blogs.wsj.com/moneybeat/2014/08/28/momentive-ruling-shakes-up-debt-markets/; Adam C. Harris & Karen S. Park, Bankruptcy Court Approves Non-Market Cramdown Rate on Momentive Secured Creditors, Harvard Law School Bankruptcy Roundtable (Mar. 17, 2015), http://blogs.law.harvard.edu/bankruptcyroundtable/2015/03/17/bankruptcy-court-approves-non-market-cramdown-rate-on-momentive-secured-creditors/; Mark I. Bane, Bankruptcy Court Holds Secured Creditors Can Be “Crammed Down” With Below-Market Replacement Notes, Harvard Law School Forum on Corporate Governance and Financial Regulation (Sept. 6, 2014), http://corpgov.law.harvard.edu/2014/09/06/bankruptcy-court-holds-secured-creditors-can-be-crammed-down-with-below-market-replacement-notes/; Alan Zimmerman, Bankruptcy: In Cram-Down Fight, Momentive Loses the Battle, but Wins the War, HighYieldBond.com (Aug. 27, 2014, 10:24 AM), http://www.highyieldbond.com/in-cram-down-fight-momentive-loses-the-battle-but-wins-the-war/.

[3] In re MPM Silicones, LLC, No. 14-22503, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014).

[4] In re Dunlap Oil Co., Inc., No. AZ-14-1172-JuKiD, 2014 WL 6883069 (B.A.P. 9th Cir. Dec. 5, 2014).

[5] Id. at *20.

[6] See Dunlap Oil, 2014 WL 6883069.

[7] See 11 U.S.C. § 1129(b) (2010).

[8] See 11 U.S.C. § 1129(b)(1); In re Dynamic Brokers, Inc., 293 B.R. 489, 499 (B.A.P. 9th Cir. 2003); In re Arnold & Baker Farms, 85 F.3d 1415, 1420 (9th Cir. 1996).

[9]See Matter of Briscoe Enterprises, Ltd., II, 994 F.2d 1160, 1169 (5th Cir. 1993).

[10] See In re Am. HomePatient, Inc., 420 F.3d 559, 565 (6th Cir. 2005).

[11] Briscoe, 994 F.2d at 1169.

[12] See Till v. SCS Credit Corp., 541 U.S. 465, 473 (2004) (discussing methods of calculating cramdown interest rates in analogous chapter 13 cases).

[13] Id. at 479.

[14] Id. at 476 n.14.

[15] See In re Texas Grand Prairie Hotel Realty, L.L.C., 710 F.3d 324, 331 (5th Cir. 2013) (discussing the persuasive, yet non-binding, nature of the “splintered” Till decision); In re Blanton, No. 10-60160, 2010 WL 4503188 at *2 (Bankr. N.D. Ohio Oct. 29, 2010) (critiquing the precedential value of Till and its formula approach); see also, e.g., In re Toso, No. BAP EC-05-1290, 2007 WL 7540985 at *8–9 (B.A.P. 9th Cir. Jan. 10, 2007); Mercury Capital Corp. v. Milford Conn. Assocs., L.P., 354 B.R. 1, 12 (D. Conn. 2006). But see, e.g., Am. HomePatient, 420 F.3d at 566–68 (refusing to fully adopt the Till formula approach in a chapter 11 case).

[16] Voluntary Petition, In re MPM Silicones, LLC, No. 14-22503, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014); Joint Chapter 11 Plan of Reorganization for Momentive Performance Materials Inc. and Its Affiliated Debtors, In re MPM Silicones, LLC, No. 14-22503, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014).

[17] Cramdown Objection of Wilmington Trust, National Association, as Indenture Trustee, to Confirmation of Debtors’ Proposed Joint Chapter 11 Plan of Reorganization, In re MPM Silicones, LLC, No. 14-22503, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014); Objection of Wilmington Trust, National Association, as Indenture Trustee, to Confirmation of Debtors’ Proposed Joint Chapter 11 Plan of Reorganization, In re MPM Silicones, LLC, No. 14-22503, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014).

[18] See 11 U.S.C. § 1129(b) (2010).

[19] In re MPM Silicones, LLC, No. 14-22503, 2014 WL 4436335, at *23 (Bankr. S.D.N.Y. Sept. 9, 2014).

[20] Id. at *24-*25.

[21] Id. at *24, *25.

[22] In re MPM Silicones, LLC, No. 14-22503, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014).

[23] See id. at *25.

[24] Id. at *29.

[25] The Bankruptcy Court found no reason to distinguish between the statutory objectives of analogous provisions regarding plan confirmation under chapters 13 and 11 and therefore found Valenti’s conclusion that the formula approach satisfies section 1325(a)(5)(B)(ii) wholly supportive of the argument that it likewise satisfies the requirement for plan confirmation under section 1129(b)(2)(A)(i)(II). Id. at *25.

[26] Id..

[27] Id. at *26.

[28] See id. at *31.

[29] See id. at *30.

[30] Id.

[31] Id. at *30–31.

[32] Id. at *31.

[33] Id.

[34] In re Dunlap Oil Co., Inc., No. AZ-14-1172-JuKiD, 2014 WL 6883069, at *20 (B.A.P. 9th Cir. Dec. 5, 2014).

[35] Id.

[36] Id. (quoting Till v. SCS Credit Corp., 541 U.S. 465, 479 (2004)); see also In re Tapang, No. 11-59479-ASW, 2014 WL 7212959, at *2 (Bankr. N.D. Ca. Dec. 17, 2014) (likewise concluding that the creditors—not the debtor—bear the burden of proof on the issue of the appropriate cramdown interest rate under chapter 11).

[37] Dunlap Oil, at *20; see also In re Chardon, LLC, 519 B.R. 211, 221 (Bankr. N.D. Ill. 2014) (The court there was forced to rely on the debtor’s financial advisor, who was not “a particularly compelling witness,” in the absence of any evidence of a market rate for debtor-in-possession financing, the current prime rate, or an appropriate risk adjustment).

[38] Dunlap Oil, at *20.

[39] See In re Fortenberry, No. 14-50768, 2014 WL 7407515, at *5 (Bankr. S.D. Miss. Dec. 30, 2014) (examining cramdown interest rates in the chapter 13 context).

[40]See, e.g., Matt Wirz, Momentive Ruling Shakes Up Debt Markets, MoneyBeat (Aug. 28, 2014), http://blogs.wsj.com/moneybeat/2014/08/28/momentive-ruling-shakes-up-debt-markets/.

By

Fatally Foreign: Extraterritorial Recovery of Avoidable Transfers and Principles of Comity in the Madoff Securities SIPA Liquidation Proceeding

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Timothy Graulich, Brian M. Resnick, and Kevin J. Coco*

Bernie Madoff’s investment firm, Bernard L. Madoff Investment Securities LLC (Madoff Securities), famously imploded in December 2008 under the weight of the largest Ponzi scheme in U.S. history.[1] Some of Madoff’s largest customers were offshore “feeder funds” that pooled capital from various investors around the world principally in order to “feed” investments into Madoff Securities. In many cases the vast majority, or all, of the capital in the feeder funds was channeled directly to, and as investments in, Madoff Securities. When feeder funds received distributions from Madoff Securities, they would often in turn distribute assets to their own customers, many of whom were foreign institutions and individuals. In an important recent decision from the United States District Court for the Southern District of New York, the court dismissed recovery claims asserted by the Madoff Securities trustee against foreign subsequent transferees that had received distributions from foreign Madoff feeder funds on the basis that section 550(a)(2) of the Bankruptcy Code[2] does not apply extraterritorially under the circumstances and, alternatively, international comity considerations prohibit recovery from these foreign entities.

I.         Cross-Border Clawbacks

The trustee appointed under the Securities Investor Protection Act (SIPA) to administer the Madoff Securities estate has engaged in a multiyear global effort to recoup funds for the estate’s customers and creditors using the powers of SIPA and the Bankruptcy Code.[3] This effort extended to several offshore feeder funds that received distributions from Madoff Securities, many of which are subject to liquidation proceedings in their respective foreign jurisdictions. In addition to claims against the feeder funds themselves, the Trustee brought avoidance and recovery actions against the foreign customers of the funds that had received subsequent distributions. As a statutory matter, the Trustee pursued clawbacks against these foreign subsequent transferees under section 550(a)(2),[4] which allows a trustee to recover property that is the subject of an avoided transfer from “any immediate or mediate transferee” of an initial transferee. The foreign subsequent transferees moved to withdraw the reference to the bankruptcy court, and the U.S. District Court for the Southern District of New York granted their request and consolidated the cases with respect to the issue of whether section 550(a)(2), as incorporated into SIPA, applies extraterritorially such that the Trustee can recover transfers made from foreign feeder funds to foreign investors in those funds.[5]

II.         Extraterritorial Applications

The foreign subsequent transferees moved to dismiss the Trustee’s complaints on the basis that section 550(a)(2) does not apply extraterritorially and therefore cannot be used by the Trustee to claw back transfers made abroad by a foreign feeder fund to its foreign customer. In the consolidated case, Securities Investor Corp. v. Bernard L. Madoff Investment Securities LLC,[6] Judge Jed S. Rakoff granted the motion to dismiss, holding that (i) the application of 550(a)(2) to the particular facts of the case would constitute an extraterritorial application of the statute,[7] (ii) Congress did not clearly intend such an application,[8] and (iii) even if the statute could be applied extraterritorially, principals of international comity would preclude such an application under the circumstances.[9]

Judge Rakoff began his opinion by recalling the longstanding presumption that congressional legislation is meant to apply only within the United States in the absence of contrary intent.[10] Citing the recent Supreme Court decision in Morrison v. Nat’l Australia Bank Ltd.,[11] Judge Rakoff wrote that the court must first determine whether the factual circumstances of the case require extraterritorial (as opposed to domestic) application of the relevant statute.[12] In answering “yes” to this inquiry, Judge Rakoff evaluated the “focus” of the transactions that section 550(a) seeks to regulate.[13] For their part, the Trustee and the Securities Investor Protection Corporation (SIPC) interpreted the inquiry broadly by arguing that the focus in a SIPA liquidation is the domestic broker-dealer and the maximization of its assets, meaning that any application of section 550(a) and other Bankruptcy Code provisions incorporated into SIPA is inherently domestic.[14] Judge Rakoff rejected this approach in favor of the more specific interpretation advocated by the defendants, which analyzes the regulatory focus of section 550(a).[15] The statute focuses on the nature of the transactions at issue – here, transfers between foreign parties abroad, rather than the U.S. debtor more generally, leading the court to conclude that the Trustee’s attempted recovery of the “predominantly foreign” transactions would require an extraterritorial application of section 550(a).[16] The court repeatedly highlighted the foreign-to-foreign aspect of the transfers and the fact that they did not come directly from the U.S. debtor.[17]

III.         Congressional Intent

The second step of the Morrison analysis is whether Congress intended the statute to apply extraterritorially. Under Morrison, the congressional intent must be affirmative and clear in order to overcome the presumption.[18] The Trustee and SIPC had argued that, although extraterritorial intent is not present in the plain language of section 550(a), the court should look to section 541(a)[19] for statutory context, which provides that “property of the estate” is estate property “wherever located and by whomever held,” and is understood generally to apply regardless of whether the property is present in the United States.[20] According to the Trustee and SIPC, the words “wherever located and by whomever held” are incorporated into the Bankruptcy Code’s avoidance and recovery provisions, meaning that Congress intended section 550(a) to apply extraterritorially.[21] The court dismissed this argument as “clever [but] neither logical nor persuasive” and cited Supreme Court and Second Circuit precedent to explain that “fraudulently transferred property becomes property of the estate only after it has been recovered by the Trustee.”[22] Responding to the Trustee’s policy-based contention that refusing to apply section 550(a) extraterritorially would permit a U.S. debtor to transfer its assets abroad and then retransfer them to another foreign entity, thus escaping liability, the court noted that such concerns “must be balanced against the presumption against extraterritoriality[,]” which is intended to avoid international conflict.[23] The court ultimately held that the Trustee had not adequately rebutted the presumption against extraterritoriality and was therefore prohibited from utilizing section 550(a) to recover transfers to the foreign investors of the offshore feeder funds.[24]

IV.         Comity Matters

In an alternative ruling, Judge Rakoff determined that even if the Trustee were to overcome the presumption against extraterritoriality, recovery from the foreign subsequent transferees in this case would be prohibited by considerations of international comity.[25] International comity is “the recognition which one nation allows within its territory to the legislative, executive, or judicial acts of another nation.”[26] In the United States, comity requires a comparison of U.S. interests against foreign interests. Here, the court recognized that many of the other Madoff feeder funds are subject to liquidation proceedings in their home countries where their own avoidance and recovery statutes govern.[27] As the defendants noted in their briefing, the British Virgin Islands trial court and appellate court had already addressed, and rejected, one feeder fund liquidator’s attempt to recover these same transfers pursuant to local common law.[28] The defendants criticized the Trustee’s approach as seeking a type of unfair double recovery, arguing that the Trustee should not be permitted to first recover initial transfers to the feeder funds and then recover subsequent transfers to the feeder fund’s customers, but rather should be required to stand in line alongside the feeder fund customers and share as a creditor of the feeder fund’s estate.[29] On the other hand, SIPC focused on U.S. interests in stating that comity is not implicated where the Trustee attempts to recover property stolen from investors in a U.S. broker-dealer as part of a Ponzi scheme with its “center of gravity” in the U.S.[30] In the end, Judge Rakoff agreed with the defendants with respect to the comity issue, describing the proceedings before him as an attempt by the Trustee to “reach around” the foreign proceedings and pull in foreign investors with no direct relationship to the U.S. estate and no reason to expect that U.S. law would apply to distributions received from foreign investment funds.[31]

V.         International Deference

Comity is an influential thread woven throughout Judge Rakoff’s opinion. Indeed, the longstanding presumption against extraterritoriality, which the Madoff court established as its analytical starting point, is itself a comity-based rule that was recognized more than twenty years ago by the Supreme Court as an effort to “protect against unintended clashes between our laws and those of other nations which could result in international discord.”[32] Judge Rakoff repeated this principle in finding that section 550(a)(2) does not apply extraterritorially, further commenting that the Trustee’s proposed actions “could raise serious issues of international comity.”[33]

More broadly, the Madoff decision illustrates a growing (albeit not universal) trend in both U.S. and non-U.S. courts’ willingness to employ comity principles to address cross-border insolvency disputes. Beginning with the 1996 In re Maxwell Communications Corp.[34] case, in which the U.S. bankruptcy judge cooperated effectively with her U.K. counterpart to improvise and implement a cross-border protocol between simultaneous bankruptcy cases,[35] courts in many countries have moved toward a practice that substantially defers to the insolvency laws of the home country. This trend follows the Second Circuit’s observation in the Maxwell decision that “[c]omity is especially important in the context of the Bankruptcy Code.”[36] The Maxwell case initiated a series of discussions and decisions endorsing the doctrine of universalism, which posits that a single set of governing rules promotes market symmetry, or that, since modern markets are global, the same legal rules should apply in a consistent manner across borders.[37] Eventually, in 1997, the United Nations Commission on International Trade Law promulgated the Model Law on cross-border insolvency, which employs universalism and comity as its guiding principles.[38] Since then, more than twenty countries have adopted some version of the Model Law, including the United States Congress when it passed chapter 15 of the Bankruptcy Code in 2005.[39]

The Madoff decision reflects a universalist approach and courts’ growing hesitation to reach over international borders where competing insolvency regimes govern. Universalism seeks not only to defer to the laws of the country with the greater interest but also recognizes that economic actors, when transacting, have a right to rely on their expectation that the “home” jurisdiction’s laws will govern.[40] Otherwise, global markets may suffer from unpredictability, inefficiency and, some would argue, unfairness.

VI.         Further Applications

The Madoff ruling should give a measure of comfort to foreign customers of foreign investment funds regarding the ability of a U.S. trustee to utilize U.S. bankruptcy law to claw back their distributions. However, in exploring potential future applications of Judge Rakoff’s Madoff decision, it is useful to consider whether a slight change in circumstances would lead to a different outcome. For instance, consider a situation where an offshore feeder fund is created by a U.S. broker-dealer for the purpose of helping investors avoid U.S. taxes. In that case, a trustee could argue that the feeder fund is a “sham entity” and seek a ruling from the U.S. bankruptcy court that the offshore entity and U.S. entity should be treated together as a single estate pursuant to a substantive consolidation or alter ego theory. Accordingly, if the offshore fund made distributions to its foreign customers, the trustee may argue that such transfers were not foreign-to-foreign transactions as in Madoff but instead U.S.-to-foreign transfers that are recoverable under a purely domestic application of section 550(a).[41]

Just three days prior to the Madoff decision, the Ninth Circuit addressed a similar scenario in Kismet Acquisition, LLC v. Icenhower.[42] In Icenhower, a U.S. debtor transferred a Mexican coastal villa to a Nevada shell company during the pre-petition period and then, post-petition, the shell company sold the asset to a Mexican couple.[43] The Ninth Circuit upheld the rulings of both lower courts, confirming that the shell company was the alter ego of the debtor and should be substantively consolidated with the bankruptcy estate.[44] Section 549(a) of the Bankruptcy Code,[45] which permits a trustee to avoid post-petition transfers of property of the estate, applied in this case. As a result of the substantive consolidation finding, property of the debtor’s estate as of the petition date included the villa in the hands of the shell company and the successor to the trustee was able to claw back the villa into the estate.[46] The court explained that, under Morrison and applicable Ninth Circuit precedent, Congress intended an extraterritorial application of the Bankruptcy Code as it applies to property of the estate, including with respect to section 549(a).[47]

The Icenhower decision suggests that Madoff may have been decided differently if the feeder funds were consolidated into the Madoff Securities estate, even considering the fact that section 548(a) uses the term “interest of the debtor in property” rather than “property of the estate.”[48] The Trustee may have found more success if, for example, he was able to show that Madoff Securities and the feeder funds colluded to defraud other Madoff customers by distributing assets to the foreign subsequent transferees. In an alternative scenario, the defendants’ arguments may have been stronger if the feeder funds at issue invested a smaller portion of their assets in Madoff Securities (say 5% rather than 95% or 100%). Under those facts, as a due process matter, it would seem even less appropriate to bring the foreign subsequent transferees into the Madoff Securities bankruptcy case.

With respect to comity, it is important to note that the doctrine requires a comparison of jurisdictional interests that does not always result in deference. In a recent chapter 15 case, In re Elpida Memory Inc.,[49]the bankruptcy court conducted a de novo review of a sale transaction that had been previously approved by the Japanese bankruptcy court in the main proceeding, stating that comity “is not the end all be all of the [Chapter 15] statute.”[50] In Madoff, the court found persuasive the fact that many of the feeder funds were undergoing liquidation proceedings in their respective home countries.[51] Consequently, the Trustee could seek recovery from subsequent transferees pursuant to the laws of the feeder funds’ home countries.[52] Without those facts, or if the feeder funds’ home jurisdictions had been ones with undeveloped insolvency laws such that the U.S. retained a stronger interest in seeing the subsequent transfers recovered from the feeder funds’ customers, the result may have been different.

Ultimately, extraterritorial application of the Bankruptcy Code and international comity require courts to examine congressional intent while balancing the competing interests of different jurisdictions. Absent contrary intent within the statute, debtors and trustees in cases under both SIPA and the Bankruptcy Code likely face an uphill battle in overcoming the presumption against extraterritoriality. The recent gravitation toward universalism and respect for foreign laws reinforces that presumption and seeks to establish international deference as the governing baseline.

 

Preferred citation: Timothy Graulich, Brian M. Resnick, & Kevin J. Coco, Fatally Foreign: Extraterritorial Recovery of Avoidable Transfers and Principals of Comity in the Madoff Securities SIPA Liquidation Proceeding, 5 Harv. Bus. L. Rev. Online 53 (2015), https://www.hblr.org//?p=3971.

* Timothy Graulich and Brian M. Resnick are partners in the Insolvency and Restructuring Group of Davis Polk & Wardwell LLP, and Kevin J. Coco is an associate in that group.

[1] See Robert Frank, Madoff Jailed After Admitting Epic Scam, Wsj.com (Mar. 13, 2009), http://www.wsj.com/articles/SB123685693449906551.

[2] 11 U.S.C § 550(a)(2) (2012).

[3] See generally The Madoff Recovery Initiative: Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC & Bernard L. Madoff, http://www.madofftrustee.com (last visited Mar. 2, 2015).

[4] 11 U.S.C § 550(a)(2).

[5] See Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 513 B.R. 222, 225 (S.D.N.Y. July 28, 2014).

[6] Id.

[7] Id. at 228.

[8] Id. at 231.

[9] Id.

[10] Id. at 226.

[11] 561 U.S. 247 (2010).

[12] See Sec. Investor Prot. Corp., 513 B.R. at 226 (citing Morrison, 561 U.S. at 264–73).

[13] See id. at 226.

[14] Id.

[15] Id.

[16] Id.

[17] Id. at 225, 232.

[18] 561 U.S. at 255 (quoting E.E.O.C. v. Arabian Am. Oil Co., 499 U.S. 244, 248 (1991)).

[19] 11 U.S.C. § 541(a).

[20] Sec. Investor Prot. Corp., 513 B.R. at 228.

[21] Id. at 228–29.

[22] Id. at 229.

[23] Id. at 231 (quotingIn re Midland Euro Exch. Inc., 347 B.R. 708, 718 (Bankr. C.D. Cal. 2006)).

[24] Id.

[25] Id. at 232.

[26] JPMorgan Chase Bank v. Altos Hornos de Mexico, S.A. de C.V., 412 F.3d 418, 423 (2d Cir. 2005) (quoting Hilton v. Guyot, 159 U.S. 113, 164 (1895)).

[27] See Sec. Investor Prot. Corp., 513 B.R.at 232.

[28] Id. (quoting Decl. of Marco E. Schnabl dated July 13, 2012, Ex. C., No. 12 Misc. 115, ECF No. 236 (S.D.N.Y. filed July 13, 2012)).

[29] Transcript of Oral Argument. at 29 (Sept. 28, 2012), Sec. Investor Prot. Corp., 513 B.R. 222.

[30] Id. at 15-16.

[31] See Sec. Investor Prot. Corp., 513 B.R.at 232.

[32] EEOC v. Arabian American Oil Co., 499 U.S. 244, 248 (1991).

[33] Sec. Investor Prot. Corp., 513 B.R. at 227.

[34] 93 F.3d 1036 (2d Cir. 1996).

[35] Id. at 1054-55.

[36] Id. at 1048.

[37] Law Business Research Ltd, The International Insolvency Review 2 (Donald S. Bernstein ed., 2d ed.  2014).

[38] See United Nations Commission On International Trade Law, UNCITRAL Model Law on Cross-Border Insolvency with Guide to Enactment and Interpretation 109 (2014), available at www.uncitral.org/uncitral/en/uncitral_texts/insolvency/1997Model.html.

[39] 11 U.S.C. § 1501 (2005); Status – UNCITRAL Model Law on Cross-Border Insolvency (1997), http://www.uncitral.org/uncitral/en/uncitral_texts/insolvency/1997Model_status.html (last visited Mar. 2, 2015).

[40] See, e.g., Jay Lawrence Westbrook, Theory and Pragmatism in Global Insolvencies: Choice of Laws and Choice of Forum, 65 Am. Bankr. L.J. 457, 461 (1991).

[41] 11 U.S.C. § 550(a).

[42] 757 F.3d 1044 (9th Cir. 2014).

[43] Id. at 1048.

[44] Id. at 1053.

[45] 11 U.S.C. § 549(a) (2012).

[46] Icenhower, 757 F.3d at 1051.

[47] Id. at 1050.

[48] See 11 U.S. Code § 548(a) (2012).

[49] No. 12-10947 CSS, 2012 WL 6090194 (Bankr. D. Del. Nov. 20, 2012).

[50] Id. at *8.

[51] See Sec. Investor Prot. Corp., 513 B.R.at 232.

[52] Id.