Seller Beware: Yet Another Cautionary Tale For Distressed-Debt Traders
Participants in the multibillion-dollar market for
distressed claims and securities had ample reason to keep a
watchful eye on developments in the bankruptcy courts during
each of the last three years. Controversial rulings handed down
in 2005 and 2006 by the bankruptcy court overseeing the chapter
11 cases of failed energy broker Enron Corporation and its
affiliates had traders scrambling for cover due to the
potential that acquired claims/debt could be equitably
subordinated or even disallowed, based upon the seller's
misconduct. Although the severity of the cautionary tale writ
large in the bankruptcy court's Enron decisions
was ultimately ameliorated on appeal in the late summer of 2007
by district court judge Shira A. Scheindlin, the 20-month
ordeal (and the uncertainty it spawned) left a bad taste in the
mouths of market participants. 2008 has so far proved to be
little better in providing traders with any degree of comfort
with respect to claim or debt assignments involving bankrupt
obligors. This time, moreover, the trouble concerns standard
provisions contained in nearly every bank loan-transfer
agreement, which have rarely been subject to challenge or
analysis in the courts. In In re M. Fabrikant & Sons,
Inc., a New York bankruptcy court recently took a hard
look at the standard transfer forms and definitions to
determine whether a seller's reimbursement rights were
transferred along with the debt.
Distressed Claims/Debt Trading
Although the distressed-securities market is largely
unregulated, industry participants and trade
consortia—such as the Loan Syndications and Trading
Association ("LSTA"); the Securities Industry
Association; the International Swaps and Derivatives
Association, Inc.; and the Bond Market Association—have
implemented standards, forms, and procedures to govern purchase
and sale transactions. LSTA's standardized Purchase and
Sale Agreement for Distressed Trades, LSTA Standard Terms and
Conditions (the "LSTA Standards"), provides a fairly
comprehensive boilerplate for most sale/assignment
transactions. Even so, as demonstrated by the bankruptcy
court's ruling in In re M. Fabrikant & Sons,
Inc., parties relying on the LSTA Standards must be
vigilant to ensure that transfer documentation unambiguously
distinguishes between rights that are being transferred and
rights that are to be retained by the seller/assignor.
Background
M. Fabrikant & Sons, once one of the world's largest
manufacturers and distributors of diamonds, filed for chapter
11 protection together with its subsidiary Fabrikant-Leer
International, Ltd. (collectively referred to as
"Fabrikant"), in New York on November 17, 2006.
Shortly thereafter, the bankruptcy court entered an order
authorizing Fabrikant to use cash collateral pledged to a
consortium of bank lenders (collectively, the "original
lenders") as security for nearly $162 million in
pre-petition loans. The cash collateral order, which conferred
administrative-priority status upon claims asserted by the
original lenders for reimbursement of certain expenses (the
...
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