More on Hedge Funds and the U.S. Bankruptcy Process

Bear Stearns Funds

The denial of recognition under Chapter 15 of the Bankruptcy Code of the Cayman Islands liquidations of the Bear Stearns High-Grade Structured Credit Strategies Master Fund and the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund (the “Funds”) was affirmed last week. Judge Robert Sweet of the U.S. District Court for the Southern District of New York affirmed the decision last September of Bankruptcy Judge Burton Lifland that the Funds’ centers of main interest (COMI) were in the United States, rather than the Cayman Islands. Although there was no opposition to the requested relief, Judge Sweet strongly validated Judge Lifland’s view that the Joint Official Liquidators of the Funds failed to meet their burden of establishing the Funds’ COMI outside of the United States.

Many hedge funds are domiciled outside of the United States. For such a fund that fails, commencing a case in its jurisdiction of formation, and then utilizing Chapter 15 of the Bankruptcy Code to protect assets located in the U.S., can offer a flexible, lower-cost alternative to the commencement of a Chapter 11 case. However, what may be in the best interests of a fund’s sponsors and managers may not coincide with the interests of its investors and creditors. Considering the substantial amounts (nearly $2 trillion) currently entrusted to hedge funds, Judge Sweet aptly noted:

The process by which the financial problems of insolvent hedge funds are resolved appears to be of transcendent importance to the investment community and perhaps even to the society at large.

For now, it is clear that the parties entrusted with the liquidation of such funds will need to establish that the fund’s business is truly centered outside of the U.S. (or, at the very least, that it has significant operations outside of the U.S.). Otherwise, they will need to resort to the more burdensome requirements of a Chapter 11 case.

Rule 2019 Disclosure

Rule 2019 of the Federal Rules of Bankruptcy Procedure requires certain disclosures by “every entity or committee representing more than one creditor or equity security holder[.]” As noted in an earlier post, the question 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 a very hot issue right now. For a hedge fund, such information can be tantamount to disclosing a proprietary trading strategy. Unquestionably, some debtors and other interested parties are requesting such disclosures as a way to seek to neutralize aggressive groups of hedge funds.

Last year, in the Northwest Airlines case, SDNY Judge Alan Gropper held that a group of hedge fund equity holders represented by common counsel constituted a “committee” for purposes of Rule 2019. The equity holders were therefore required to provide information setting forth “the amount of claims or interests owned by the members of the committee, the times acquired, the amounts paid therefor, and any sales or dispositions thereof[.]” Judge Richard Schmidt in the Pacific Lumber Chapter 11 case subsequently reached the opposite conclusion on this question, and refused to require an ad hoc group of bondholders to disclose details of their trades of Pacific Lumber debt securities.

Judge Kevin Carey in the highly influential Delaware bankruptcy court has now weighed in. Ruling on a Rule 2019 request in the Sea Containers Chapter 11 case, Judge Carey agreed that the ad hoc bondholders did constitute a “committee” for purposes of Rule 2019. However, he did not require disclosure of the amounts paid in specific trades. The outcome is probably a positive one for the Sea Containers bondholders, but will almost certain engender more Rule 2019 disclosure requests in other major Chapter 11 cases.


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