Can An Entity Qualify as a Chapter 15 Debtor Without Ever Filing for Bankruptcy?

by Dechert LLP
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Chapter 15 of the Bankruptcy Code provides a framework through which representatives of foreign insolvency proceedings can commence ancillary U.S. proceedings and obtain relief from U.S. courts in aid of foreign restructurings. For a foreign insolvency proceeding to be recognized by a U.S. bankruptcy court under Chapter 15, the proceeding must, among other things, involve a “debtor” whose assets or affairs are subject to the control of the foreign court. The term “debtor” is defined in Chapter 15, somewhat vaguely, as “an entity that is the subject of a foreign proceeding.”

Recently, in In re Mood Media Corp., 596 B.R. 556 (Bankr. S.D.N.Y. June 28, 2017), a Chapter 15 petitioner attempted to obtain recognition of “foreign proceedings” for fourteen U.S. subsidiaries of Mood Media Corporation, a Canadian parent company that was an applicant in a Canadian insolvency proceeding, even though none of the U.S. subsidiaries were, or could be, applicants in Canada themselves. The petitioner’s main theory was that the U.S. subsidiaries each met the definition of “debtor” because the Canadian plan of arrangement purported to affect the U.S. subsidiaries’ guaranties of the Canadian entity’s funded debt, thereby making the subsidiaries “the subject of a foreign proceeding.” Judge Michael Wiles of the Southern District of New York bankruptcy court rejected that theory, holding that only an entity whose restructuring or liquidation is the subject of the foreign proceeding, i.e. the petitioner or applicant in the foreign proceeding, may be considered a Chapter 15 “debtor.”

Background

Mood Media and its affiliates are providers of audio, visual, and other forms of media and marketing services for use in their customers’ stores. Due to new competition, increased costs of securing music rights, and media piracy, Mood Media became unable to meet its funded debt obligations, including with respect to the US$350 million of senior unsecured notes issued by Mood Media and guaranteed by some or all of its U.S. subsidiaries.

On May 18, 2017, Mood Media commenced an insolvency proceeding under section 192 of the Canada Business Corporations Act, which allows companies to propose a plan of arrangement for the reorganization of its capital structure with the approval of affected stakeholders. Mood Media’s U.S. subsidiaries, however, did not commence Canadian insolvency proceedings because, under Canadian law, only Canadian companies can do so. Mood Media’s application to commence the Canadian proceedings, however, stated that the matter related to a proposed plan of arrangement “involving” the U.S. subsidiaries. Moreover, on the date the Canadian proceedings commenced, the Canadian court issued an interim order staying all actions to enforce the obligations under the senior unsecured notes, including against the U.S. subsidiaries.

The proposed plan of arrangement provided for an exchange of the existing senior unsecured notes for new notes and common stock. In addition, the plan provided for the release of the U.S. subsidiaries’ guaranties of the existing senior unsecured notes.

In its Chapter 15 petition, the petitioner sought recognition of “foreign nonmain proceedings” for the U.S. subsidiaries. The petitioner argued that the U.S. subsidiaries were “the subject of” the Canadian proceeding, and thus met the Chapter 15 definition of “debtor,” because Canadian law allowed the Canadian court to exercise jurisdiction over an arrangement that involved the U.S. subsidiaries, those subsidiaries’ guarantee obligations were affected by the plan of arrangement, and the Canadian court’s interim order protected the U.S. subsidiaries from adverse collection actions.

The petitioner further asserted that the U.S. subsidiaries’ assets and affairs were under the control of the Canadian court because Canadian law allows the Canadian court to enter any order it sees fit and to adjudicate the rights of all parties in the Canadian proceeding. Thus, the petitioner reasoned, the Canadian court’s powers extended to control of the U.S. subsidiaries’ assets and affairs because the proceedings “involved” the U.S. subsidiaries.

The Decision

The court was unpersuaded by the petitioner’s rationale, noting a litany of circumstances that cut against the petitioner’s arguments. The U.S. subsidiaries were not listed as applicants on Mood Media’s application for commencement of the Canadian proceeding. The Canadian court’s interim order did not authorize or direct the U.S. subsidiaries to do anything. For example, the order authorized Mood Media to arrange meetings of its stakeholders to vote on the plan of arrangement, but did not authorize the U.S. subsidiaries to do so.

The Canadian interim order contained no explicit statement that the petitioner was authorized to act on behalf of the U.S. subsidiaries. The plan of arrangement affected the U.S. subsidiaries’ obligations to guarantee the senior unsecured notes, but did not purport to affect any of their other obligations, assets, or business operations. Accordingly, although the U.S. subsidiaries were beneficiaries of orders that related to the restructuring of the parent company’s obligations, the evidence contradicted the argument that the Canadian court exercised any control over the U.S. subsidiaries’ assets or dealings with stakeholders.

To drive its point home, the court analogized the U.S. subsidiaries’ status in the Canadian proceeding to situations that often arise with respect to parties “involved” in Chapter 11 cases. The court noted that parties in Chapter 11 cases routinely offer to buy assets of or propose mergers with debtors, and the court can take jurisdiction over such parties to enforce their obligations. The court’s limited control over those parties, however, does not mean that they become Chapter 11 “debtors.”

The court then pointed out, most pertinently to the petitioner’s main argument, that Chapter 11 plans often result in releases of claims against non-debtor third parties, including officers, directors, and indenture trustees. The court noted that while its ability to release such claims means that the parties are “subject to the proceedings,” no one would reasonably argue that a release makes them “debtors” in the proceedings.

The court further highlighted the awkwardness of the petitioner’s argument by noting that a court in a Chapter 11 proceeding has the right to cancel or restructure a creditor’s claim, and therefore has a measure of control over the creditor’s asset. Authority over that asset, however, cannot conceivably turn a run-of-the-mill creditor into a “debtor” for Chapter 11 purposes.

Given these observations, the court rejected the petitioner’s arguments and found that the U.S. subsidiaries were not “debtors” eligible for Chapter 15 relief.

Despite the court’s ruling regarding the U.S. subsidiaries’ eligibility for Chapter 15 relief, the court went on to provide substantive relief that accomplished the petitioner’s goal, i.e. the recognition in the U.S. of the discharge of the U.S. subsidiaries’ guarantees under the Canadian plan of arrangement. The court recognized Mood Media’s Canadian parent proceedings as foreign main proceedings, and stated that it could, and would, enforce the guarantee discharge and bar the U.S. subsidiaries’ counterparties from invoking ipso facto clauses in their contracts with the U.S. subsidiaries based on their “involvement” with the Canadian proceedings.

Implications

Insolvency laws across countries vary in their use of terminology. Chapter 15, however, is designed to apply to proceedings from any foreign jurisdiction. Thus, perhaps because of the drafters' intent to accommodate varying terms for similar concepts, certain of Chapter 15’s provisions are vaguely or broadly drafted. This lends itself to creative technical arguments based on imprecise language. The Mood Media decision demonstrates that, when faced with such arguments, and in absence of definitive guidance, bankruptcy courts are likely to take a common sense approach based on concepts that make sense under U.S. bankruptcy law.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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