Distressed and special situations investors should take note of the U.S. Bankruptcy Court’s recent decision in Oi’s Chapter 15 case. We present our takeaways for investors.

The U.S. Bankruptcy Court refused to recognise the precedence of a Dutch bankruptcy of a Dutch entity, having previously recognised a Brazilian restructuring proceeding under Chapter 15 of the U.S. Bankruptcy Code. The Bankruptcy Court’s deference to the Brazilian proceeding is significant because it exemplifies the U.S. Court’s view of Chapter 15 as an endorsement of global and practical restructuring proceedings and it suggests that the U.S. Court will reprimand opportunistic creditor conduct that disturbs those proceedings. The opinion is long and nuanced, but the perception of bad behaviour drove the outcome.

Oi has Dutch subsidiaries and a disparate capital structure

Oi is one of the largest telecommunications companies in Brazil. It has raised billions of euros from debt capital markets through two Dutch subsidiaries as well as billions in other currencies from issuances by Brazilian entities. The issuer and guarantee structure is not uniform, creditors under one debt issuance might expect to realise more or less than creditors under other issuances.

Oi and the Dutch subsidiaries enter a Brazilian restructuring proceeding

Oi and several of its subsidiaries (including the two Dutch subsidiaries) filed for a Brazilian judicial reorganisation proceeding in mid-2016. That debtor-in-possession proceeding has similarities to a U.S. Chapter 11 proceeding in that the Brazilian proceeding leads to a creditor vote on a plan of reorganisation. However, unlike most other jurisdictions across the world, the Brazilian proceeding permits substantive consolidation of the entities within the corporate group. This would pool all the assets and liabilities of all of the entities giving a pari passu distribution to creditors of the same class. This is controversial in the case of the Oi entities as it fundamentally subverts the non-uniform issuer and guarantee structure and therefore changes the outcome for the creditors of the various debt issuances.

Oi and the Dutch subsidiaries obtain Chapter 15 recognition for the Brazilian restructuring proceeding without opposition

U.S. hedge fund Aurelius sought to put the Dutch subsidiaries into bankruptcy in the Netherlands. Before it managed to achieve this objective, the Oi entities in the Brazilian proceeding sought and obtained Chapter 15 recognition of the Brazilian proceeding in the United States as a foreign main proceeding. The effect of this would give the Oi entities an avenue to have the U.S. courts endorse a plan of reorganisation approved in the Brazilian proceeding. One of the matters an applicant must establish to obtain Chapter 15 recognition of a foreign main proceeding is that each debtor’s centre of main interests (COMI) is (at the time the petition for Chapter 15 relief is filed) in the jurisdiction where the proceeding has been commenced. So, in the case of the Oi entities (including the two Dutch subsidiaries), the evidence put before the U.S. Bankruptcy Court was that their COMI was in Brazil. This was proved to the satisfaction of the U.S. Bankruptcy Court which made a Chapter 15 recognition order of the Brazilian proceeding.

Insolvency trustee of one of the Dutch subsidiaries belatedly challenged Chapter 15 recognition for that subsidiary

The Dutch subsidiaries entered into a Dutch bankruptcy proceeding. The insolvency trustee for one of the entities applied for various relief from the U.S. Bankruptcy Court with the aim of overturning the Chapter 15 recognition order of the Brazilian proceeding and obtaining Chapter 15 recognition of that entity’s Dutch bankruptcy proceeding. This would seem to close the avenue through which the Oi entities might seek the U.S. court’s endorsement of any plan of reorganisation approved in the Brazilian proceeding.

The U.S. court rejects the challenge – allowing the Brazilian restructuring proceeding a chance to proceed

Judge Sean H. Lane of the U.S. Bankruptcy Court Southern District of New York refused the requested relief. Of broad interest are two of his principal reasons for refusing the relief (sought under § 1517(d) of the U.S. Bankruptcy Code): First, that the Dutch insolvency trustee would have technical authority, but no practical power, to implement a restructuring of the Oi entities. This is because the Oi entities’ assets were in Brazil and the Brazilian court has ordered that the insolvency trustee “did not have the power to represent or act as the managing body of Coop” [the Dutch subsidiary]. Secondly, that the tactics of Aurelius were considered and summarised by the Judge (remembering that this was an application filed by the Dutch insolvency trustee) as: “a disturbing picture: a creditor unhappy with Brazilian insolvency proceedings decided to strategically remain silent through a Chapter 15 recognition of those proceedings by this Court while planning—and eventually executing—a strategy designed to reverse that recognition and block any restructuring in the Brazilian proceeding.” Ultimately, the Judge found that Aurelius’s conduct “undermines the goals of maximizing the Chapter 15 Debtors’ assets and assisting in the rescue of their financially troubled business… In sum, the strategy pursued by Aurelius in these cases is a troubling one that the Court refuses to countenance.”

The Oi saga will continue with disquiet and uncertainty surrounding the development of a plan of reorganisation; and even if a plan is approved in Brazil, the Judge has confirmed that its recognition within the U.S. may yet be challenged.

Takeaways

1. Creditors should conduct themselves in good faith throughout formal restructuring proceedings.
2. Act early if you want to oppose recognition of a foreign main proceeding under Chapter 15 of the U.S. Bankruptcy Code.
3. A creditor strategy to optimise personal returns which risks implementation of a broader restructuring can expect significant judicial scrutiny.