U.S. Recognition of International Financial Restructurings

Multicanal is a cable operator headquartered in Argentina. To raise more than $500 million in debt, Multicanal came to the U.S. in the late 1990s. Using U.S. agents, bankers, lawyers, and the protections of the U.S. securities market, Multicanal sold five series of bonds, more than 80% to U.S. investors. The bonds are governed by New York law and provide for New York jurisdiction. Multicanal took advantage of the lower cost of funds available for borrowings made under “New York Indentures” and broadened investor appeal by qualifying the issues under the Federal Trust Indenture Act, registering some of them with the SEC under the Securities Exchange Act. The evidence at trial included: 1) the bonds would not have had the market they had without having given these protections to creditors; and 2) there was no disclosure of any intention of trying to restructure the bonds by use of any proceeding other than a U.S. bankruptcy, should that ever become necessary.

Multicanal experienced financial difficulties after the devaluation of the Argentine peso in early 2002. It defaulted on all its financial debt and did not make even partial payments of interest. Multicanal's cash position then improved considerably, and it became clear that the company, with free cash flow exceeding $60 million annually, could repay all or substantial amounts of its overdue principal and interest. It did not need to extinguish its existing debt.

Multicanal did not propose that sort of a workout. Instead, its proposed restructuring would replace $527 million in debt with $220 million in debt, eradicating between 56% and 70% of the value of bondholder investment (depending on which of the options they receive). The equity available to bondholders is capped at 35%. None of the equity is available to retail U.S. holders — ie, those who are not Qualified Institutional Buyers under the U.S. securities laws; nor are the replacement debt securities being offered to the retail sector. Multicanal's parent retains 65% of the equity in return for a mere $15 million contribution. There was no market test or other fairness valuation of the $15 million.

There is little doubt that, had the company's creditors had the protections written into the bonds and provided by U.S. federal and state law, any workout would have included making creditors whole (or nearly so) or required equity to forego all or a very substantial portion of its ownership and control in favor of giving creditors equity in lieu of repaying the debt. None of that occurred, however.

The Argentine APE

Instead of adjusting its debts in the U.S., Multicanal invoked a new and untested Argentine out-of-court restructuring mechanism called an “Acuerdo Preventivo Extrajudicial” or “APE.” The APE rules being relied on were not even in existence when the bonds were sold.

The Argentine APE accords creditors very different substantive and procedural rights from what they would have under U.S. law. As a result, creditors lack any significant amount of negotiating leverage and thus, predictably, “support” economic restructurings that would be unheard of in a system of rights and protections analogous to those promised when the money was borrowed. Thus, for example, Multicanal held that the APE could impair a creditor's absolute right to the repayment of principal and interest just like a U.S. bankruptcy could — yet, as summarized below, the court also held that the APE did not have to give creditors the same protections as U.S. bankruptcy law does. Under an APE, the restructuring company is not obliged to provide creditors with a liquidation analysis; or give more value to creditors than they would get in a liquidation; or provide projections of its income and expenses so that creditors can assess what kind of a deal they are being faced with. Multicanal also designed a voting procedure that facilitated “yes” votes while it excluded and minimized “no” votes.

The APE does not give creditors the protections of a trustee, creditors committee, or other person or entity with fiduciary duties to creditors. The grounds for creditor objection are extremely limited by statute to whether the proposed restructuring misstated assets or liabilities or whether the company counted the votes correctly. (The hope for a broader role by the reviewing court was characterized by Multicanal's own trial expert as one “enormously far from the idea of guaranteed justice”). Ex parte communications between the “reviewing” court and the debtor are the norm, not the exception, and the APE court admittedly does not evaluate the economic fairness of the transaction (indeed, the debtor provides no information from which that court could make that evaluation). There is no right to discovery or hearing (in the Multicanal APE creditors sought both and were given neither). Finally, because Multicanal did not wish to undergo the SEC scrutiny entailed in registering its proposed replacement securities, it did not make any offer to U.S. retail creditors of anything but cash.

The Decision of the U.S. Bankruptcy Court

Multicanal turned to the U.S. Bankruptcy Court for “recognition” of its foreign APE. The court read ' 304 and the prior case law as entailing a narrower scope of review than that urged by the objecting creditors, not one examining the substantive or procedural fairness of the transaction under U.S. standards. The court stated that its primary function was to determine the most “economical and expeditious administration of the estate” — not whether U.S. bondholders' reasonable expectations were being frustrated by Multicanal's post-hoc refusal to accord creditors the protections it promised when it borrowed the money. Finding “comity” to the foreign regime to be an overriding factor, the court believed that it was sufficient that, in satisfying the ' 304 factors, certain aspects of the APE were, in the court's view, similar to U.S. pre-packs. The court found it important that many creditors voted in favor of the APE, although it acknowledged that there were voting irregularities in the APE (irregularities that would not have been tolerated in a U.S. proceeding). Even the court's finding that there was indeed disparity in the procedures for obtaining “yes” and “no” votes was insufficient to withhold recognition. (The court may have been motivated by the fact that the reviewing court in Argentina had found that Multicanal had discriminated against “no” voters. But the Argentine court did not require a re-vote to remedy the discrimination, and the U.S. Court held that it would not be appropriate for it to order that relief in a ' 304 proceeding. Said the court, “the question here is not whether the APE should be confirmed as a U.S. Chapter 11 plan, but whether it is entitled to recognition under ' 304 and fundamental principles of due process.”) The court, however, did hold that ' 304 permitted it to draw the line in two places:

• First, it found that Multicanal discriminated against U.S. retail creditors, who were not able to exercise the vote that other creditors were and were being forced to accept a type of consideration (cash) that the court found was worth substantially less than the other consideration (new notes and equity). The court rejected Mulitcanal's many excuses for the discrimination and has required Multicanal to remedy the discrimination before according the restructuring any U.S. recognition.
• Second, the court reacted to the fact that, in Argentina, Multicanal caused criminal accusations to be initiated against individual employees of a vocal dissenting U.S. creditor. The court gave no weight to the incredible testimony of the Multicanal director who portrayed the incident as one he pursued in his personal capacity rather than as a director and officer of Multicanal. The court has required Multicanal to prove the “substantial justification” for its conduct, which for all appearances looked like rank intimidation.

Remarks

The promise of predictability as well as clear procedural and substantive rules protecting U.S. investors/ creditors have led to the extraordinary success of U.S. capital markets over the last seven decades. Building on Congressionally inspired protections passed during the 1930s — the Securities Exchange Act of 1934, the Trust Indenture Act of 1939 – America has developed the world's most efficient capital market system — a market that has benefited not only U.S. companies and investors but foreign companies desirous of raising capital as economically as possible too, and, indirectly, the foreign nations and citizens where these foreign issuers of debt are domiciled.

When U.S. companies face severe and enduring economic hardship, U.S. courts have observed that these fundamental rules of the game might change. The U.S. Bankruptcy Code embodies these changes. But the Code also accords creditors a valuable set of substantive and procedural protections in their place, including three worthy of brief mention here:

1. The U.S. Code promotes the importance of predictability (which has as its corollary being suspicious of retroactively applied changes in law);

2. The U.S. Code provides procedural due process (eg. a system of full disclosure; the ability of the creditor to participate in the process of restructuring; the existence of a neutral and independent third party with fiduciary duties to all creditors (be it a committee, trustee, debtor-in-possession); the important role of the reviewing court, before whom creditors have broad and meaningful rights to obtain discovery, object, cross-examine, and be heard; the general resistance to ex parte communications between debtor and the reviewing court); and

3.The U.S. Code (or the Constitution) establishes certain unalterable, inalienable substantive rights (eg, contract rights may not be impaired by the government; even a majority of creditors may not impair a creditor's right to the return of principle and interest absent a Bankruptcy Court's determination that the transaction is fair; similarly situated creditors must be treated nondiscriminatorily; the creditor must be shown projections so that it can be in a better position to assess the bona fides of the debtor's constant refrain, “We can't pay more”; the creditor must receive at least what it would get in a liquidation irrespective of how many other creditors, for whatever reason, are willing to take less).

In the case of a U.S. company, these protections create a framework in which both debtor and creditor appreciate the rules of the game and exercise such leverage as the system gives them. However, when a foreign company invokes a wholly different set of post-hoc rules, the complex mosaic morphs into something quite different. Does the mere fact of the debtor's foreign incorporation justify the magnitude of the changes in the rules and the magnitude of the differences in economic results given those changed rules? Does it matter that the debtor deliberately came to U.S. to raise the funds in the first place? Does it matter how many times the foreign company promised to treat creditors just like a U.S. company would?

When a company comes to the U.S. to raise debt, then invokes a foreign restructuring system when it can't or doesn't wish to pay the debt, and then seeks to return to the U.S. for recognition and extinguishment of the claims of U.S. creditors, two fundamental questions remain: First, is this a proper use of ' 304? See In re Koreag, Controle et Revision S.A., 961 F.2d 341, 348 (2d Cir. 1992) (“The purpose of a ' 304 petition is to prevent the piecemeal distribution of assets in the United States”). Second, should the law permit, require, or, alternatively, condemn the practice? Would it be fair to describe the predictability and substantive and procedural protections embodied in the U.S. Bankruptcy Code as reflecting American notions of due process? When a foreign restructuring regime consistently falls short of providing those protections, can it be said nonetheless to satisfy the standard for recognition by a U.S. court under ' 304? And once the case is here, should the Court have the authority to remedy a wrong that it finds?

Multicanal is based on a reading of ' 304 under which a foreign issuer may provide far fewer creditor protections than a U.S. company would have to. The decision also stands for the propositions that there are limits to what a foreign company can do and that there remain some protections that U.S. creditors can insist on. Future development of the law will undoubtedly occur.

There has been a significant increase in litigation in the U.S. under Section 304 of the U.S. Bankruptcy Code. It is through that statutory mechanism that foreign issuers, having sold debt in the U.S., restructure the debt under foreign restructuring regimes and then return to the U.S. for “recognition.” Recognition under ' 304 has been read to cut off claims and litigation by U.S. creditors in U.S. courts, avoid U.S. judgments for collection, and hence can pave the way for the foreign company to access the U.S. capital markets in the future.

The influential U.S. Bankruptcy Court for the Southern District of New York has recently rendered a significant post-trial decision under ' 304. In re Multicanal, Dkt No. 04-10280. The decision extends a line of Bankruptcy Court decisions approving foreign restructurings notwithstanding their ever-increasing deviations from the U.S. creditor protections that bondholders might be said to have bargained for when they loaned money to the foreign issuer. The decision also, however, shows how a prejudiced minority creditor might get a U.S. court to draw the line between permissible and impermissible foreign restructuring regimes, for the decision withholds recognition in the face of clear and unexplained discrimination against a subset of U.S. creditors (retail investors). The decision also signals a warning to foreign issuers against utilizing threats and intimidation tactics against U.S. creditors to secure their majorities.

Background

Multicanal is a cable operator headquartered in Argentina. To raise more than $500 million in debt, Multicanal came to the U.S. in the late 1990s. Using U.S. agents, bankers, lawyers, and the protections of the U.S. securities market, Multicanal sold five series of bonds, more than 80% to U.S. investors. The bonds are governed by New York law and provide for New York jurisdiction. Multicanal took advantage of the lower cost of funds available for borrowings made under “New York Indentures” and broadened investor appeal by qualifying the issues under the Federal Trust Indenture Act, registering some of them with the SEC under the Securities Exchange Act. The evidence at trial included: 1) the bonds would not have had the market they had without having given these protections to creditors; and 2) there was no disclosure of any intention of trying to restructure the bonds by use of any proceeding other than a U.S. bankruptcy, should that ever become necessary.

Multicanal experienced financial difficulties after the devaluation of the Argentine peso in early 2002. It defaulted on all its financial debt and did not make even partial payments of interest. Multicanal's cash position then improved considerably, and it became clear that the company, with free cash flow exceeding $60 million annually, could repay all or substantial amounts of its overdue principal and interest. It did not need to extinguish its existing debt.

Multicanal did not propose that sort of a workout. Instead, its proposed restructuring would replace $527 million in debt with $220 million in debt, eradicating between 56% and 70% of the value of bondholder investment (depending on which of the options they receive). The equity available to bondholders is capped at 35%. None of the equity is available to retail U.S. holders — ie, those who are not Qualified Institutional Buyers under the U.S. securities laws; nor are the replacement debt securities being offered to the retail sector. Multicanal's parent retains 65% of the equity in return for a mere $15 million contribution. There was no market test or other fairness valuation of the $15 million.

There is little doubt that, had the company's creditors had the protections written into the bonds and provided by U.S. federal and state law, any workout would have included making creditors whole (or nearly so) or required equity to forego all or a very substantial portion of its ownership and control in favor of giving creditors equity in lieu of repaying the debt. None of that occurred, however.

The Argentine APE

Instead of adjusting its debts in the U.S., Multicanal invoked a new and untested Argentine out-of-court restructuring mechanism called an “Acuerdo Preventivo Extrajudicial” or “APE.” The APE rules being relied on were not even in existence when the bonds were sold.

The Argentine APE accords creditors very different substantive and procedural rights from what they would have under U.S. law. As a result, creditors lack any significant amount of negotiating leverage and thus, predictably, “support” economic restructurings that would be unheard of in a system of rights and protections analogous to those promised when the money was borrowed. Thus, for example, Multicanal held that the APE could impair a creditor's absolute right to the repayment of principal and interest just like a U.S. bankruptcy could — yet, as summarized below, the court also held that the APE did not have to give creditors the same protections as U.S. bankruptcy law does. Under an APE, the restructuring company is not obliged to provide creditors with a liquidation analysis; or give more value to creditors than they would get in a liquidation; or provide projections of its income and expenses so that creditors can assess what kind of a deal they are being faced with. Multicanal also designed a voting procedure that facilitated “yes” votes while it excluded and minimized “no” votes.

The APE does not give creditors the protections of a trustee, creditors committee, or other person or entity with fiduciary duties to creditors. The grounds for creditor objection are extremely limited by statute to whether the proposed restructuring misstated assets or liabilities or whether the company counted the votes correctly. (The hope for a broader role by the reviewing court was characterized by Multicanal's own trial expert as one “enormously far from the idea of guaranteed justice”). Ex parte communications between the “reviewing” court and the debtor are the norm, not the exception, and the APE court admittedly does not evaluate the economic fairness of the transaction (indeed, the debtor provides no information from which that court could make that evaluation). There is no right to discovery or hearing (in the Multicanal APE creditors sought both and were given neither). Finally, because Multicanal did not wish to undergo the SEC scrutiny entailed in registering its proposed replacement securities, it did not make any offer to U.S. retail creditors of anything but cash.

The Decision of the U.S. Bankruptcy Court

Multicanal turned to the U.S. Bankruptcy Court for “recognition” of its foreign APE. The court read ' 304 and the prior case law as entailing a narrower scope of review than that urged by the objecting creditors, not one examining the substantive or procedural fairness of the transaction under U.S. standards. The court stated that its primary function was to determine the most “economical and expeditious administration of the estate” — not whether U.S. bondholders' reasonable expectations were being frustrated by Multicanal's post-hoc refusal to accord creditors the protections it promised when it borrowed the money. Finding “comity” to the foreign regime to be an overriding factor, the court believed that it was sufficient that, in satisfying the ' 304 factors, certain aspects of the APE were, in the court's view, similar to U.S. pre-packs. The court found it important that many creditors voted in favor of the APE, although it acknowledged that there were voting irregularities in the APE (irregularities that would not have been tolerated in a U.S. proceeding). Even the court's finding that there was indeed disparity in the procedures for obtaining “yes” and “no” votes was insufficient to withhold recognition. (The court may have been motivated by the fact that the reviewing court in Argentina had found that Multicanal had discriminated against “no” voters. But the Argentine court did not require a re-vote to remedy the discrimination, and the U.S. Court held that it would not be appropriate for it to order that relief in a ' 304 proceeding. Said the court, “the question here is not whether the APE should be confirmed as a U.S. Chapter 11 plan, but whether it is entitled to recognition under ' 304 and fundamental principles of due process.”) The court, however, did hold that ' 304 permitted it to draw the line in two places:

• First, it found that Multicanal discriminated against U.S. retail creditors, who were not able to exercise the vote that other creditors were and were being forced to accept a type of consideration (cash) that the court found was worth substantially less than the other consideration (new notes and equity). The court rejected Mulitcanal's many excuses for the discrimination and has required Multicanal to remedy the discrimination before according the restructuring any U.S. recognition.
• Second, the court reacted to the fact that, in Argentina, Multicanal caused criminal accusations to be initiated against individual employees of a vocal dissenting U.S. creditor. The court gave no weight to the incredible testimony of the Multicanal director who portrayed the incident as one he pursued in his personal capacity rather than as a director and officer of Multicanal. The court has required Multicanal to prove the “substantial justification” for its conduct, which for all appearances looked like rank intimidation.

Remarks

The promise of predictability as well as clear procedural and substantive rules protecting U.S. investors/ creditors have led to the extraordinary success of U.S. capital markets over the last seven decades. Building on Congressionally inspired protections passed during the 1930s — the Securities Exchange Act of 1934, the Trust Indenture Act of 1939 – America has developed the world's most efficient capital market system — a market that has benefited not only U.S. companies and investors but foreign companies desirous of raising capital as economically as possible too, and, indirectly, the foreign nations and citizens where these foreign issuers of debt are domiciled.

When U.S. companies face severe and enduring economic hardship, U.S. courts have observed that these fundamental rules of the game might change. The U.S. Bankruptcy Code embodies these changes. But the Code also accords creditors a valuable set of substantive and procedural protections in their place, including three worthy of brief mention here:

1. The U.S. Code promotes the importance of predictability (which has as its corollary being suspicious of retroactively applied changes in law);

2. The U.S. Code provides procedural due process (eg. a system of full disclosure; the ability of the creditor to participate in the process of restructuring; the existence of a neutral and independent third party with fiduciary duties to all creditors (be it a committee, trustee, debtor-in-possession); the important role of the reviewing court, before whom creditors have broad and meaningful rights to obtain discovery, object, cross-examine, and be heard; the general resistance to ex parte communications between debtor and the reviewing court); and

3.The U.S. Code (or the Constitution) establishes certain unalterable, inalienable substantive rights (eg, contract rights may not be impaired by the government; even a majority of creditors may not impair a creditor's right to the return of principle and interest absent a Bankruptcy Court's determination that the transaction is fair; similarly situated creditors must be treated nondiscriminatorily; the creditor must be shown projections so that it can be in a better position to assess the bona fides of the debtor's constant refrain, “We can't pay more”; the creditor must receive at least what it would get in a liquidation irrespective of how many other creditors, for whatever reason, are willing to take less).

In the case of a U.S. company, these protections create a framework in which both debtor and creditor appreciate the rules of the game and exercise such leverage as the system gives them. However, when a foreign company invokes a wholly different set of post-hoc rules, the complex mosaic morphs into something quite different. Does the mere fact of the debtor's foreign incorporation justify the magnitude of the changes in the rules and the magnitude of the differences in economic results given those changed rules? Does it matter that the debtor deliberately came to U.S. to raise the funds in the first place? Does it matter how many times the foreign company promised to treat creditors just like a U.S. company would?

When a company comes to the U.S. to raise debt, then invokes a foreign restructuring system when it can't or doesn't wish to pay the debt, and then seeks to return to the U.S. for recognition and extinguishment of the claims of U.S. creditors, two fundamental questions remain: First, is this a proper use of ' 304? See In re Koreag, Controle et Revision S.A., 961 F.2d 341, 348 (2d Cir. 1992) (“The purpose of a ' 304 petition is to prevent the piecemeal distribution of assets in the United States”). Second, should the law permit, require, or, alternatively, condemn the practice? Would it be fair to describe the predictability and substantive and procedural protections embodied in the U.S. Bankruptcy Code as reflecting American notions of due process? When a foreign restructuring regime consistently falls short of providing those protections, can it be said nonetheless to satisfy the standard for recognition by a U.S. court under ' 304? And once the case is here, should the Court have the authority to remedy a wrong that it finds?

Multicanal is based on a reading of ' 304 under which a foreign issuer may provide far fewer creditor protections than a U.S. company would have to. The decision also stands for the propositions that there are limits to what a foreign company can do and that there remain some protections that U.S. creditors can insist on. Future development of the law will undoubtedly occur.