Shipping Company Bankruptcies: Impact of US Law on International Lenders and Other Non-US Creditors

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1 June 9, 2014 Shipping Company Bankruptcies: Impact of US Law on International Lenders and Other By Rick Hyman, Charles S. Kelley and Michael F. Lotito Rick Hyman Charles S. Kelley Michael F. Lotito The resurgence of US bankruptcy filings by international shipping companies requires a heightened appreciation of the risks and available options to lenders and other non-us creditors. As a policy matter, US bankruptcy law is intended to provide a breathing spell for a distressed business, allowing for an orderly restructuring or sale, while promoting the equality of treatment to similarly situated creditors and to create the best chance for the reorganization and rehabilitation of businesses as going concerns. To achieve these objectives, US bankruptcy law enables a distressed entity to file a Chapter 11 case with relative ease and grants debtors-inpossession significant rights and protections, including the imposition of a worldwide stay that prevents all creditors from taking any further steps in pursuit of any claims, lawsuits or remedies against the debtor and its property. A US bankruptcy filing, therefore, dramatically changes the landscape for all creditors, in particular for creditors who provided services or loaned monies to the business without contemplating that US laws might apply. A tension arises when debtors take advantage of the well-intentioned policies of the US Bankruptcy Code and use the US courts to address, and one might argue to disrupt, overwhelmingly foreign operations and relationships. US bankruptcy law, for example, has trended toward an open door policy, even for debtors with negligible, immaterial US contacts. This has enabled debtors to impose US laws on matters having entirely foreign relationships, often precluding foreign creditors and counterparties from exercising otherwise lawful remedies and arguably disrupting their reasonable expectations. Frequently, this can lead to inequitable results as large lending institutions will likely abide by the rule of law of foreign jurisdictions, such as US laws, and recognize the automatic stay once it is put in place, while much smaller creditors that operate entirely outside of US territories may ignore US laws. A recent shipping case filed in Houston, Texas, provides the best demonstrative example of these types of issues. In particular, the bankruptcy cases of TMT Procurement Corporation and its affiliated debtors highlight this tension and demonstrate the disruption that foreign debtors might inflict upon their

2 Article creditors and the inequitable impact that may result. This article examines the impact of TMT, discusses how US bankruptcy law can protect creditors rights even under the most adversarial of circumstances, and concludes with a brief discussion on how US bankruptcy law is designed encourage a consensual rehabilitation of a borrower in distress. This article shall also broadly identify steps and protections that lenders and non-us creditors should take to improve and protect their rights in respect of a potential or existing US bankruptcy proceeding. Ease of Access to US Bankruptcy Courts The Bankruptcy Code provides a minimum threshold for debtor eligibility. In general, only a person that resides or has a domicile, a place of business, or property in the United States may be a debtor under the Bankruptcy Code. Bankruptcy courts have interpreted property in the United States very broadly. In Marco Polo, 1 for example, a bankruptcy court found that the debtors interests in their US professionals retainers, along with other negligible property interests, constituted property in the United States to satisfy the eligibility requirements of the Bankruptcy Code. In regards to the TMT case, the property interest was tenuous. TMT demonstrates the extent to which foreign debtors might manufacture a place of business or even a purported property interest in the United States simply to satisfy the statutory threshold and gain access to US courts. TMT, a Taiwanese shipping enterprise founded in 1958 with no historical business in the United States whatsoever, operated a fleet of approximately 30 vessels. In June 2013, 23 related entities under the TMT enterprise including 17 special purpose entities, each owning a separate or unique vessel filed voluntary petitions under Chapter 11 of the Bankruptcy Code in Houston, Texas. All debtors were organized under foreign law, and their respective vessels were registered and sailed under flags of various foreign nations, none of which were US. The debtors principal and ultimate equity owner was a Taiwanese national. As of the petition date, the debtor s operations and major parties in interest were all foreign in identity and nature. TMT s secured creditors were principally syndicated or club bank facilities, led by Taiwanese agent banks. In all, the prepetition first priority mortgage lenders held more than an aggregate $850 million in pre-petition secured debt under bilateral and syndicated loan facilities governed by foreign laws. There were no US employees, no US creditors, no US-based indebtedness, and no physical assets located in the United States. Not surprisingly, due to the foreign nature of their operations, each of the debtors top 30 unsecured creditors were also foreign entities. The majority of the 17 vessels had not even stopped at a US port of call at any time in their operational history. Notwithstanding years of exclusively foreign operations, TMT undertook great lengths to manufacture a place of business and assets in the United States in the week or two leading up to the June 20, 2013 petition date. For a place of business, certain of the TMT debtors entered into a commercial lease for nominal office space in Houston. TMT also organized a US limited liability corporation purportedly to promote and market the TMT enterprise in the United States. As of, and well after, the petition date, however, TMT s Houston office space remained empty, unfurnished and with no employees or business operations. The lease itself was signed only days before the bankruptcy filing. For property in the United States, TMT relied upon its nominal interests in retainers held by its US attorneys and financial advisers, citing Marco Polo and similar precedent. TMT s interests in the retainers, however, were particularly tenuous. A nondebtor affiliate of the TMT debtors funded the retainers by wire transfer to TMT s professional advisers in the days before the bankruptcy filing. TMT s professionals wrote-off significant portions of the amounts due and payable on existing invoices in order to ensure that the retainer accounts held positive, although nominal, balances as of the petition date. TMT s financial adviser had not yet finalized its engagement letter until after the petition date (and after the issue of the retainer was raised in open court), and its retainer was wire-transferred to the financial adviser s firm shortly before the bankruptcy case was filed. The bankruptcy court nevertheless 2 Mayer Brown Shipping Company Bankruptcies: Impact of US Law on International Lenders and Other

3 found that TMT s retainers constituted sufficient (and the only) assets located in the United States to sustain debtor-eligibility and allow the bankruptcy cases to remain in the United States. Cases May Be Dismissed for Cause Of course, not every eligible debtor may remain in bankruptcy. A bankruptcy case may be dismissed for cause, including for lack of good faith in the filing of a Chapter 11 bankruptcy petition. TMT s senior secured lenders moved to dismiss TMT s bankruptcy cases for lack of good faith in their commencement. The secured lenders argued that the debtors Houston lease and retainers were manufactured for the sole purposes of establishing jurisdiction, venue and eligibility for a select few entities within the TMT enterprise. The lenders argued that TMT s selective filing of certain but not all of its enterprise demonstrated TMT s intent to frustrate the Taiwanese lenders reasonable efforts to enforce their lawful rights and remedies. Importantly, of TMT s 17 vessels financed by Taiwanese banks, 6 of the vessels had been arrested in maritime proceedings in jurisdictions around the world on or before TMT filed for bankruptcy in the US. The remaining ships had turned off their AIS systems and were hiding at or around ports whose outer limits were known as sanctuaries for vessels that wish to remain unbothered by local officials. The lenders asserted that TMT had filed for bankruptcy in order to stop the pending arrest sales, prevent further arrests, and to allow TMT to use US court orders to direct the lenders permit TMT to access collateral and retention accounts held by the Taiwanese banks to pay its professional advisers and other bankruptcy expenses, as there was no hope that the resources available would permit a successful restructuring. In further support of dismissal, the secured lenders argued that TMT had no reasonable likelihood of rehabilitation. The lenders noted that commercial and technical management over the debtors vessels remained with nondebtor affiliates located in Taiwan. Certain of the vessels also were bareboat or time chartered to nondebtor affiliates. The lenders thus argued that TMT s selective filing of passive, shipowning entities and not the affiliates in possession or control of the vessels severely limited the bankruptcy court s ability to oversee the reorganization of these debtors, much less the control of the vessels. After a heated three-day trial in July 2013, the bankruptcy court concluded that all but two of TMT s cases were filed in good faith (one of which was the leaseholder on the Houston lease and the other owned a vessel that had been arrested and sold in an arrest proceeding prior to the bankruptcy case), allowing the other cases to stand. The bankruptcy court concluded that the cases were filed for a reorganizational purpose, mainly relying on the surprise commitment of TMT s principal (offered in court while testifying under oath) to post $40 million of stock in a publicly traded company and held by another non-debtor affiliate as good faith collateral to provide a means of adequate protection to the secured lenders and to facilitate debtor-in-possession financing, among other things. The secured lenders appealed from the bankruptcy court s order denying the lenders motion to dismiss. As a result, the district court withdrew its general order of reference to the bankruptcy court, effectively seizing control of TMT s cases from the bankruptcy court, and reconsidered the lenders motion to dismiss. After some delay, in October 2013, the district court judge indicated he would agree with the bankruptcy judge that TMT had filed its remaining bankruptcy cases in good faith, and denied the lenders request for permission to appeal further and referred the cases back to the bankruptcy court for all remaining proceedings. Use of Cash Collateral and Post-Petition Financing In the United States, a pre-petition secured lender familiar with US bankruptcy laws will often provide post-petition financing and authorize the use of cash collateral to ensure the proper maintenance of, and control over, its collateral. Often the terms of such financing are agreed prior to commencement of the case to allow for a smooth transition into bankruptcy. That becomes considerably more difficult to accomplish in the context of a case unexpectedly filed 3 Mayer Brown Shipping Company Bankruptcies: Impact of US Law on International Lenders and Other

4 by a foreign borrower and involving foreign banks inexperienced in US bankruptcy. It became evident at the outset of the TMT cases that the lenders were unwilling to provide post-petition financing or consensually agree to the use of cash collateral. Notwithstanding the lenders protestations, the bankruptcy court also granted the debtors limited authority to use the lenders cash collateral from the outset of the cases. Importantly, however, the lenders were able to point out certain issues with regard to the role of non-debtor entities that allowed the lenders to insist upon certain protections in those orders, namely that payments would only be made to vendors and for vessel expenses approved by the lenders and would not be used to pay the debtors professional advisers, like their lawyers, financial advisers or the unsecured creditors committee s counsel and their advisers. Absent such a ruling allowing the debtors to use this money for operating expenses of the vessels, the court effectively would have been dismissing the cases because no other source of financing was then present and the ships had no other access to money. The cash collateral took the form of funds held in retention accounts and maintained as additional collateral for many of the vessels. In particular, at the time the loans were made, the lenders had required as additional collateral that the various borrowers fund the equivalent of two quarterly payments into a retention account, which accounts were held in the name of the particular borrower. While the various lenders had access to these accounts prior to the commencement of the cases for purposes of exercising their remedies and paying the considerable costs of the vessels, the accounts remained in the debtors names on the petition date. As a result, the monies remained property of the estate under US law and the debtors were permitted to seek authority to use to such amounts. The debtors, however, were required to provide adequate protection of the lenders interests in their cash collateral. Adequate protection can take a variety of forms, including periodic cash payments, payment of professionals, and replacement liens in the same or other collateral. In TMT, the bankruptcy court granted the prepetition lenders replacement liens on the good faith property, junior to the post-petition lender s liens. To ensure that the vessels operations remained lawful and transparent, the adequate protection ultimately included an order requiring the debtors to replace then-existing non-debtor affiliate technical and commercial management with third-party technical and commercial management, and an order requiring the vessels to keep their AIS systems operating at all times. 2 With access to cash collateral and postpetition financing, the debtors were able to operate their vessels. In short, this cash became the critical tool in TMT s efforts of releasing vessels from arrest and employing them under time charter or spotmarket vessel charter agreements. Additionally, the debtors were ultimately able to obtain a modest amount of post-petition financing from a new lender. For the most part, these loans were used to pay escalating professional fees with little available to pay the release and maintenance costs of the many idle vessels. The post-petition loans were secured by first priority liens on the good faith stock and other property pledged to the bankruptcy estates and junior or second mortgages on the debtors vessels, among other things. Automatic Stay US bankruptcy law imposes an immediate statutory injunction effective upon the debtor s filing of a bankruptcy petition. This is the automatic stay of Section 362 of the Bankruptcy Code. The automatic stay precludes almost every action against a debtor and its property, including any action to collect a prepetition debt, any continuation of a lawsuit to collect a debt, and any action to exercise control over property of the debtor s bankruptcy estate, which the Bankruptcy Code defines to include virtually all property of the debtor, wherever located and by whomever held. In the international shipping context, debtors have raised concerns about the enforceability of the Section 362 automatic stay, especially in nations that have not 4 Mayer Brown Shipping Company Bankruptcies: Impact of US Law on International Lenders and Other

5 adopted the Model Law on Cross-Border Insolvency, currently embodied in Chapter 15 of the US Bankruptcy Code. Debtors with substantial international operations often seek the entry of a comfort order by a bankruptcy court, which simply restates the statutory provisions of the automatic stay and is available to present to foreign creditors and courts not otherwise familiar with US bankruptcy law in an attempt to preclude actions that could otherwise be in violation of that statutory provision. Still, a US bankruptcy court might not have the requisite jurisdiction to enforce the automatic stay against a foreign creditor, and foreign courts similarly might not recognize or enforce such orders of US courts. Indeed, in TMT s case, there was concern that that certain foreign courts might fail to recognize or honor the US bankruptcy court s orders, and further that foreign creditors having no contacts to the US would ignore the automatic stay and continuing to join or initiating their own arrest proceedings. In fact, one of the vessels was arrested by the crew and other parties in Malta even after its bankruptcy case was filed. Enforcement of the automatic stay can become even more complicated when a foreign court has concurrent jurisdiction over property of a debtor s US bankruptcy estate. In TMT, several of the vessels were under arrest and subject to admiralty proceedings in foreign nations. TMT sought to enforce the automatic stay with respect to those vessels and argued that the lenders who had arrested the vessels not only must discontinue the foreign arrest proceedings but also must release and return the vessels to the debtors. In one instance, the bankruptcy court concluded that a pre-petition lender had an affirmative duty to release its vessel from arrest (rather than simply take a passive role in the foreign action). The bankruptcy court supported its conclusion with reference to US precedent concerning automobile repossessions. While a single non-descript ruling in the context of a lengthy case, the bankruptcy court s decision to require a lender to take affirmative actions in furtherance of release of a vessel under arrest should stand out to foreign secured lenders. Further, the consequences of refusing to take those affirmative steps could be quite devastating to any lender that refused such a court order. In those instances, a court has broad discretion to issue sanctions, including stripping a creditor of its claims, invalidating a mortgage, or imposing such other economic and punitive damages to ensure compliance. Relief from the Automatic Stay Creditors may move for relief from the automatic stay, which otherwise remains in effect for the entire duration of the bankruptcy case. A bankruptcy court shall lift the automatic stay and allow a creditor to exercise its remedies outside bankruptcy (i) for cause, including for lack of adequate protection, violation of court orders, or such other acts that the court may feel are not supportive or respective of the restructuring process or (ii) when a debtor has no equity in its property and such property is not necessary to an effective reorganization. In TMT, every pre-petition lender eventually moved for relief from the automatic stay for cause, and certain lenders moved for relief from the automatic stay on the basis that the respective ship-owning debtor had no equity in its vessel and that the vessel was not necessary to an effective reorganization. The lenders argued that cause existed to lift the stay because the debtors, among other things, failed to replace management in accordance with the bankruptcy court s prior order. The lenders also argued that TMT failed to obtain profitable employment of the vessels and that no practical restructuring was feasible (in some instances, TMT had depleted the retention bank account and left without sufficient funds to operate the vessel). The automatic stay lifted on many of the vessels and the lenders were able to negotiate orders that permitted an orderly sale process through the US courts in a shorter time frame than the foreign proceedings for arrest would have permitted. The stipulations also permitted the lenders to credit bid the amount, in whole or in part, of the secured claims for the purchase of the vessels, which right is otherwise protected under US bankruptcy law, even when the ships were located in jurisdictions where 5 Mayer Brown Shipping Company Bankruptcies: Impact of US Law on International Lenders and Other

6 bidding the debt to buy the vessel was not permitted. Specifically, credit bidding allows the lender to bid its debt for the vessel in the event the lender believes that the next best offer does not sufficiently reflect the value of its collateral or if the lender simply wishes to acquire the collateral itself in order to maximize its ability to monetize that vessel and pay down the existing debt. In the event that no offer exceeded the lenders debt, the stipulations allowed the lenders alternatively to arrest the vessels and exercise other non-bankruptcy remedies if they were to conclude a sheriff s deed is more valuable than a US bankruptcy court order authorizing the sale of the vessel free and clear of all liens, claims and encumbrances. Concluding Thoughts on TMT TMT is a prime example of why lenders must prepare for a protective Chapter 11 filing by their borrowers. To thwart a borrower s ability to fund a potential Chapter 11 case, lenders might consider sweeping cash held in collateral accounts upon a material default of the borrower. If the borrower nevertheless files for bankruptcy, lenders could use that swept cash to fund post-petition financing to the borrower, which would enable the lender to exert some greater control over the bankruptcy process. Alternatively, monies could be maintained in accounts held in the name of the lender from the outset of the loan. Of course, a lender should ensure that all mortgages are properly filed and documented and all other collateral is otherwise property perfected. Another significant issue is priming maritime liens incurred by a vessel in an insolvent situation in relation to expenses for essentials or necessities. As unpaid debts owed to typical venders and suppliers on vessels may, depending on the nature of the expense and the jurisdiction in which it has been incurred, prime or come ahead of the claims of first priority mortgage-holders with respect to payment from any proceeds of the ship sale, it is extremely important that these priming claims be kept to a minimum or prevented as their presence has an effect on various key issues in a US bankruptcy case, such as adequate protection, release of an arrested vessel, the implementation of a sister-ship arrest in a jurisdiction permitting such actions, the automatic stay, and the ability to secure ongoing charters. On a related note, a pre-petition lender s liens on after-acquired property generally do not encumber a borrower s post-petition earnings. The Bankruptcy Code, however, provides an exception to the rule for rents. Although there is scant precedent on the issue, bareboat charterhire arguably could be sufficiently similar to rents and fall within the exception. A shipping lender, therefore, might improve its collateral position by ensuring that its vessel is under bareboat charter and that its collateral package includes all after-acquired charterhire. Furthermore, while it may not be possible to prevent a foreign borrower from establishing jurisdiction in the United States, restrictions in credit facilities that prevent borrowers from holding assets in the United States might provide an opportunity for greater insight into a borrower s strategy planning and allow a lender an earlier opportunity to consider defensive measures. TMT also demonstrates how a debtor could disrupt a lender s lawful exercise of remedies. If a borrower files for bankruptcy while its vessel is under arrest, lenders should seek judicial clarity of their rights and obligations. Lenders could move for limited relief from the automatic stay to protect their interests in the event third parties exercise rights against vessels notwithstanding the application of the automatic stay. Lenders should also understand that the filing of a bankruptcy case does not preclude, for example, the exercise of remedies against nondebtor guarantors. In TMT, the debtors principal personally guaranteed the pre-petition lenders claims. Certain of those lenders began enforcement their remedies under the guarantees during the pendency of the bankruptcy cases which had, at times, certain helpful effects. Although TMT represents an example of foreign debtors using Chapter 11 in an adversarial manner to frustrate and disadvantage their creditor constituencies, Chapter 11 also may be used to effectuate a negotiated restructuring on an expedited time frame. 6 Mayer Brown Shipping Company Bankruptcies: Impact of US Law on International Lenders and Other

7 Article Chapter 11 enables lenders and borrowers to develop and solicit plans of reorganization even before the borrower files for bankruptcy protection. These plans are known as prepackaged plans of reorganization, and a notable example includes the recent bankruptcy filing of Genco Shipping & Trading Limited in the Southern District of New York. In other instances, a borrower may enter into a restructuring support agreement with its principal creditors in advance of filing for bankruptcy protection. Such prepackaged and prenegotiated plans can be confirmed within three months. In all, bankruptcy courts generally are convenient forums for quickly implementing complex restructurings, even if to the disadvantage junior creditors and equity holders. u Endnotes 1 In re Marco Polo Seatrade B.V., Case No (Bankr. S.D.N.Y. Oct. 21, 2011). 2 These protections were offered to the pre-petition lenders because a vessel, while under nondebtor-affiliate management and under sub-charter to secretive entities during the pendency of the bankruptcy cases, had transacted with a black-listed Iranian vessel in potential violation of US and other foreign sanctions. The vessel s AIS system was not active during such transaction. Upon discovery of the transaction, the pre-petition lenders filed renewed motions to dismiss the bankruptcy cases, or, in the alternative, to appoint a Chapter 11 trustee, which would effectively displace nondebtor-affiliate management. The debtors offered to transition the vessels to third-party management voluntarily in order to resolve the renewed motions, and the court thereafter ordered the replacement of management expeditiously and in good faith. Mayer Brown is a leading global law firm serving many of the world s largest companies, including a significant portion of the Fortune 100, FTSE 100, DAX and Hang Seng Index companies and more than half of the world s largest investment banks. We provide legal services in areas such as Supreme Court and appellate; litigation; corporate and securities; finance; real estate; tax; intellectual property; government and global trade; restructuring, bankruptcy and insolvency; and environmental. Please visit our web site for comprehensive contact information for all Mayer Brown offices: IRS Circular 230 Notice. Any advice expressed herein as to tax matters was neither written nor intended by Mayer Brown LLP to be used and cannot be used by any taxpayer for the purpose of avoiding tax penalties that may be imposed under US tax law. If any person uses or refers to any such tax advice in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to any taxpayer, then (i) the advice was written to support the promotion or marketing (by a person other than Mayer Brown LLP) of that transaction or matter, and (ii) such taxpayer should seek advice based on the taxpayer s particular circumstances from an independent tax advisor. Mayer Brown is a global legal services organization comprising legal practices that are separate entities (the Mayer Brown Practices). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; Mayer Brown JSM, a Hong Kong partnership, and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. Mayer Brown and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions. This Mayer Brown publication provides information and comments on legal issues and developments of interest to our clients and friends. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein The Mayer Brown Practices. All rights reserved. 0614