S.D.N.Y. Dismisses Chapter 15 Appeal By Purported Shareholder On Standing And Equitable Mootness Grounds

by Orrick, Herrington & Sutcliffe LLP
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In an April 6, 2018 memorandum opinion and order, U.S. District Judge John G. Koeltl dismissed an appeal challenging the Chapter 15 recognition of a Cayman Islands restructuring of an offshore drilling contractor, holding that the appellant lacked standing and that the appeal was equitably moot. See In re Ocean Rig UDW Inc., No. 17-cv-7222 (JGK), 2018 WL 1725223 (S.D.N.Y. Apr. 6, 2018).

The appeal was brought by a purported shareholder of debtor Ocean Rig UDW Inc. (“UDW”). The purported shareholder 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 (Drill Rigs Holdings Inc. (“DRH”), Drillships Financing Holding Inc. (“DFH”), and Drillships Ocean Ventures Inc. (“DOV”), collectively the “Debtors”) as “foreign main proceedings” under section 1517 of the Bankruptcy Code.

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 the objections of the purported shareholder 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 noticed an appeal 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 payments, 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 scheme creditors 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 the request in the Chapter 15 proceedings for entry of an enforcement order, and the Bankruptcy Court ultimately issued an order giving full force and effect to the Schemes in the United States. Promptly upon the Bankruptcy Court’s issuance of the enforcement order, the Debtors consummated the restructuring in accordance with the Schemes.

Meanwhile, in the District Court, 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 grounds.

Standing

As to standing, the District Court reiterated the two-pronged standard that the appellant in a bankruptcy case (1) must be an “aggrieved person” whose pecuniary interests are directly affected by the order at issue; and (2) must have “prudential standing,” in that he or she is asserting his or her “own legal rights and interests and not those of third parties.” Ocean Rig, 2018 WL 1725223, at *3. In discussing the latter prong, the District Court observed that “[p]rudential standing is particularly important in a bankruptcy context where one party may seek to challenge the plan based on the rights of third parties who favor the plan.” Id.

The District Court held that the appellant, a purported shareholder, was not an “aggrieved person” because she “did not stand to lose anything” from UDW’s restructuring. Id. The District Court reasoned that UDW was insolvent prior to initiating restructuring proceedings in the Cayman Islands, and that UDW’s Cayman Scheme had the effect of sending the “total value of UDW, represented by the new equity” to “UDW’s creditors pro rata, with no value left for its pre-restructuring shareholders.” Id. Thus, the appellant lacked the requisite pecuniary interest. Id.

Additionally, the District Court rejected the appellant’s argument that she had a pecuniary interest in the restructuring because UDW’s Scheme gave 0.02% of UDW’s newly issued equity to pre-restructuring shareholders. Id. at *4. Upon observing that UDW’s Scheme was constructed in that manner “in an effort to avoid having to re-register UDW’s shares on the NASDAQ, which would have ‘adversely affected’ the newly issued shares”—rather than because the pre-restructuring shareholders were actually entitled to the newly issued shares on account of their pre-restructuring holdings—the District Court held that the shares were merely “gifts” from UDW’s creditors. Id. The District Court then concluded that the nominal distribution of new equity to preexisting shareholders did not suggest that the Debtors were solvent, and did “not change the fact that the appellant was not entitled to receive anything as part of the debtors’ restructuring because the debtors’ creditors had not received the full portion of their claims.” Id.

The District Court further observed that while under the Second Circuit’s decision in In re DBSD N. Am., Inc., 634 F.3d 79, 95 (2d Cir. 2011), a dissenting class of unsecured creditors in a Chapter 11 case “may have standing to challenge such ‘gifts’ to shareholders,” appellant had provided no authority that the receipt of such a gift “provide[d] the recipient shareholders with standing to contest the restructuring.” Ocean Rig, 2018 WL 1725223, at *4.

Equitable Mootness

The District Court also held that dismissal was warranted on equitable mootness grounds, which it considered an independent and “additional reason” for dismissal. Id. Although the District Court recognized that the doctrine of equitable mootness originated in Chapter 11 of the Bankruptcy Code, it noted that the doctrine had since been imported and applied in cases under Chapters 7, 9, and 13, as well as in a case involving former Bankruptcy Code section 304, the predecessor statute to Chapter 15. Id. (citing, e.g., Allstate Ins. Co. v. Hughes, 174 B.R. 884 (S.D.N.Y. 1994) (Sotomayor, J.)). The District Court found “unpersuasive” appellant’s argument that equitable mootness cases under Chapter 11 former Bankruptcy Code section 304 have no force in the Chapter 15 context, reasoning that the same “principles of finality and fairness” that pertain to “domestic organizations” and the same “concerns of comity” that animated former section 304 apply in the chapter 15 context. Id. at *6.

The District Court thus applied Second Circuit’s established equitable mootness standard to this Chapter 15 appeal. Id. at *5. Under that standard, “when a reorganization has been substantially consummated, there is a ‘strong presumption’ that an appeal of an unstayed order is moot.” Id. (collecting cases). Such presumption may only be overcome if five circumstances are present:

(a) the court can still order some effective relief; (b) such relief will not affect the re-emergence of the debtor as a revitalized corporate entity; (c) such relief will not unravel intricate transactions so as to knock the props out from under the authorization for every transaction that has taken place and create an unmanageable, uncontrollable situation for the Bankruptcy Court; (d) the parties who would be adversely affected by the modification have notice of the appeal and an opportunity to participate in the proceedings; and (e) the appellant pursue with diligence all available remedies to obtain a stay of execution of the objectionable order . . . if the failure to do so creates a situation rendering it inequitable to reverse the orders appealed from.

Id. (quoting Frito-Lay, Inc. v. LTV Steel Co. (In re Chateaugay, Corp.), 10 F.3d 944, 952-53 (2d Cir. 1993)).

In setting forth the Chateaugay standard, the District Court emphasized the importance of the appellant seeking a stay of the order at issue, citing “fairness concerns” that arise from attempts to undo a reorganization that has already been substantially completed. Id.

In applying this standard, the District Court first observed that the appellant did not seek a stay of the Bankruptcy Court’s recognition order. Id. It then found that appellees had “argue[d] persuasively” that, on their restructuring effective date, their positions “comprehensively changed” and their “Cayman reorganization ha[d] been substantially completed.” Id. In particular, the District Court noted that the Debtors had “issued new equity and made cash distributions to creditors and entered into a new secured debt facility, as well as a long-term management services agreement.” Id. Given this change of circumstances, the District Court held there was a “strong presumption” that the appeal was moot on the ground that “the debtors’ reorganization has already been substantially completed.” Id. As the appellant failed to persuade the District Court that this “strong presumption” was overcome, the District Court dismissed her appeal as equitably moot. Id. at *6.

 

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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