Judge Robert Gerber of the U.S. Bankruptcy Court for the Southern District of New York signed an order yesterday dismissing the Chapter 15 case of Basis Yield Alpha Fund. The dismissal was made at the request of the Cayman Island Joint Provisional Liquidators (JPLs) of the Fund, following Judge Gerber’s refusal to recognize the Fund’s Cayman liquidation proceeding as a “foreign main proceeding” under Chapter 15 of the U.S. Bankruptcy Code.
As described in an earlier post on this site, the Fund commenced the Cayman liquidation proceeding in August, 2007 and the JPLs shortly afterwards filed a petition for recognition under Chapter 15 in the Southern District of New York. Although no objections to the requested relief were made, Judge Gerber denied Chapter 15 recognition to the Fund, citing an absence of evidence sufficient to convince the court that the Fund’s “center of main interest” (COMI) was in fact in the Caymans. The JPLs were subsequently directed to show detailed information not only about the Fund’s assets, creditors and employees, but also the number and location of the Fund’s equity investors and the relative percentages of the applicable equity that investors in each locale hold. Rather than presenting the information requested, the JPLs contended in a subsequent motion that, as a matter of law, the Fund was entitled to recognition in the Caymans, citing a provision of Chapter 15 that sets forth a presumption that a petitioning debtor’s COMI is based on the location of its registered office. Judge Gerber disagreed, however, and reiterated his request for the information. The JPLs instead asked to have the case dismissed.
The struggle to reconcile the often secretive nature of hedge funds with the open process mandated by the U.S. Bankruptcy Code has been building for some time. The issue of whether Bankruptcy Rule 2019 can be used to require members of ad hoc committees (which often consist of hedge funds) in Chapter 11 cases to disclose the amount that they paid to acquire their claims or interests remains highly contentious. Last year, Judge Alan Gropper in the Northwest Airlines case and Judge Richard Schmidt in the Pacific Lumber case reached opposite conclusions on this question. Now, Judge Kevin Carey in the highly influential Delaware bankruptcy court is expected shortly to issue a ruling on a Rule 2019 request in the Sea Containers Chapter 11 case.
The proliferation of credit default swaps (CDSs) will likely accelerate this controversy. For example, in an attempted out of court workout or restructuring, if certain debt holders have hedged their exposures to the borrower through the purchase of CDSs, their interests may well be better served by the failure of the negotiations and the commencement of a bankruptcy case, particularly if the CDSs were set to expire. Although it is arguable that Rule 2019 and other current disclosure requirements, under both the Bankruptcy Code and Rules and applicable non-bankruptcy laws, are inadequate to address this dynamic, as CDSs are contractual agreements with third parties and not claims against the debtor, it is unlikely that bankruptcy courts are going to stand by passively if they believe that a creditor has a greater interest in seeing a troubled enterprise fail than succeed. The battles so far over the scope and purpose of Rule 2019 will probably seem like minor skirmishes, as compared to the fights that will take place regarding disclosure with respect to CDS positions.