legal notes: THE LEGAL SIDE OF ABL & FACTORING [Secured Lender, The]

he cases we have selected for this issue address the enforceability of a general release given by a Chapter 11 debtor upon a subsequently appointed Chapter 7 trustee, Canadian pension plan liabilities that prime secured lenders and the enforcement of foreign insolvency judgments in United Kingdom courts.

In re Managed Storage International, Inc., 2012 WL 5921723 (Bankr. Del. 2012) (Bankruptcy Court holds that a general release given by a Chapter 11 debtor is binding upon a subsequently appointed Chapter 7 trustee.)

Shortly after filing for Chapter 11 bankruptcy, Managed Storage International, Inc. and its related affiliates (the "Debtors") sold all of their assets free and clear of liens in a sale under §363 of the Bankruptcy Code. In connection with the sale, the Debtors and Avnet, Inc. ("Avnet"), a creditor of the Debtors, entered into a stipulation pursuant to which Avnet and the Debtors exchanged mutual releases (the "Release").

After the sale, the Bankruptcy Court converted the Debtors' Chapter 11 cases to Chapter 7 cases and appointed a Chapter 7 trustee (the "Trustee"). The Trustee then promptly filed a complaint against Avnet seeking to avoid and recover over $5 million as an alleged preferential transfer. Avnet responded by moving to dismiss the preference action on the basis of the prior Release granted to it by the Debtors.

The Trustee argued, among other things, that a release by a Chapter 11 debtor is not binding on a Chapter 7 trustee. Moreover, according to the Trustee, even if such a release is binding on a Chapter 7 trustee, the preference action commenced by the Trustee against Avnet was beyond the scope of the Release. The Bankruptcy Court rejected both of these arguments and dismissed the complaint.

The Bankruptcy Court first discussed the Trustee's argument that it was not bound by the Release. While the Release did not expressly state that it would bind a subsequently appointed Chapter 7 trustee, the Release expressly provided that it would bind all of the Debtors' successors and assigns. Reasoning that the Trustee was the successor in interest to the Debtors, the Bankruptcy Court held that the Trustee was bound by the Release.

The Bankruptcy Court next addressed the Trustee's argument that the preference action was beyond the scope of the Release. The Release granted by the Debtors to Avnet was a general release in that it covered "any and all ... claims and demands relating to the Debtors and their Chapter 11 cases." While the Release did not expressly reference preference actions, the Bankruptcy Court stated that a general release does not need to explicitly reference all possible claims and causes of action intended to be covered by the release. As such, the Bankruptcy Court held that the Trustee's preference action was covered by the Release.

Managed Store International should provide secured lenders with some measure of comfort that, at least in the United States Bankruptcy Court for the District of Delaware, a general release obtained from a Chapter 11 debtor will be binding upon a subsequently appointed Chapter 7 trustee.

Sun Indalex Finance, LLC v. United Steelworkers, 2013 SCC 6 (Supr. Ct. of Canada, Feb. 1, 2013) (Supreme Court of Canada holds that pension plan "wind-up deficiencies" maintain priority over the debtor's pre-petition secured lenders, but unfunded pension liabilities do not enjoy priority over the debtor's DIP lenders.)

In light of the recent trend toward increased cross-border secured lending, it is important for U.S. lenders engaged in, or contemplating, cross-border loans to be aware of developments on priming liens under the laws of the country in which they are lending. A recent opinion of the Supreme Court of Canada (SCC) addressed whether defined pension plan "wind-up deficiencies" enjoy priority over secured creditors' claims under the Companies' Creditors Arrangement Act of Canada (CCAA), which is the Canadian version of Chapter 11. In this case, the court held that, although a priority for such deficiencies exists as against pre-petition lenders, the priority does not trump lenders providing debtor-inpossession financing.

Indalex Limited sponsored and administered two pension plans - one for salaried employees and one for executives - at the time it entered an insolvency proceeding under the CCAA in 2009. Both plans had solvency deficiencies, but only the salaried plan was in the process of being wound up at the time of the insolvency proceeding.

In the CCAA proceeding, Indalex secured DIP financing to continue operations during the restructuring process and subsequently sold its operations as agoing concern. A portion of the sale proceeds was paid to the DIP lenders and a portion was set aside in reserve for possible distribution to pension plan members, subject to further litigation concerning what rights, if any, they had to the proceeds.

The pension plan members sought a declaration from the CCAA court that a deemed trust, with priority over Indalex's other creditors, equal to the unfunded pension liabilities existed under the Pension Benefits Act (Ontario). The CCAA court dismissed the plan members' claim. However, on appeal, the Ontario Court of Appeal agreed with the plan members and held that they enjoyed priority over all creditors, including the DIP lenders.

The SCC reversed the appellate court and held that the deemed trust under the provincial Ontario pension law did not have priority over the security interest granted to the DIP lenders. The SCC reasoned that, under the doctrine of federal law paramountcy, the priority granted to a DIP secured creditor under the CCAA supersedes provincial deemed trusts. However, the SCC did settle an open question as to which categories of pension liabilities have priority status over pre-petition lenders. Specifically, the court held that the deemed trust extends to both (i) the total amount of payments due or accrued that have not been paid (known as the "current service costs") and (ii) the additional amounts necessary to cover insufficiency of the pension fund to cover the value of all immediately vested and accelerated benefits (known as the "wind-up deficiency"). Prior to this case, it was generally understood that the deemed trust (and related priming position) only applied to unfunded pension liabilities in respect of current service costs.

As a result of the possibility of pension liability priming liens in favor of plan members, U.S. secured lenders thinking about lending in Canada should understand the nature of any Canadian defined pension benefit plans of their borrowers. Moreover, when documenting loans to Canadian borrowers, lenders should consider ongoing reporting obligations with respect to such pension plans and the possibility of establishing reserves against the borrowing base to cover potential pension claims.

Rubin v. Eurofinance, [2012] UKSC 46 (U.K. Supreme Court, Oct. 24, 2012) (United Kingdom Supreme Court reverses controversial decision and holds that enforcement of foreign insolvency judgments is subject to traditional analysis regarding the court's jurisdiction over the defendant.)

In this highly anticipated decision, the U.K. Supreme Court recently reversed a controversial decision of the Court of Appeals and held that avoidance action (i.e., preferences, fraudulent transfers) judgments entered in foreign (i.e., non-English) insolvency proceedings are not enforceable in English courts when the defendant was not subject to personal jurisdiction in the foreign court. The decision, which confirms settled common law regarding enforcement of judgments, is a welcome relief to secured lenders.

Procedurally, the Supreme Court addressed two appeals in this case, Rubin v. Eurofinance, [2010] EWCA Civ 895, and New Cap Reinsurance Corporation v. Grant, [2011] EWCA Civ 971, which raised the same issue: to what extent would an English court recognize and enforce insolvency orders under common law when the English defendant had not submitted to the jurisdiction of the foreign proceeding and was not subject to in personam (personal) jurisdiction in the foreign court.

In Rubin, an English law trust, which was managed in the U.S. and engaged in a Ponzi scheme involving rebates, encountered financial difficulty and sought protection under a U.S. bankruptcy proceeding in New York. A court-appointed representative for the trust then commenced adversary proceedings against certain defendants, who were the alleged perpetrators of the underlying Ponzi scheme, seeking to avoid certain preferential transfers. The defendants, who were not residents of New York and had not submitted to the New York court's jurisdiction, did not defend the proceedings. As a result, default and summary judgments were entered against them.

In New Cap, an Australian reinsurer made payments to a Lloyd's insurance syndicate and subsequently went into liquidation. The trustee for the reinsurer sought to avoid the transfers as unfair preferences and, after the insurance syndicate did not enter an appearance challenging the avoidance, a judgment was entered in favor of the reinsurer.

In each of Rubin and New Cap, the applicable trustee then sought to enforce the judgments in English courts. The Court of Appeals held that the foreign judgments could be enforced. Prior to that decision, the long-standing rule in respect of such conflict of laws issues was that a court would not enforce a foreign judgment in personam if the defendant had not submitted to the foreign jurisdiction. In reaching its decision, the Court of Appeals determined that judgments arising only in the context of an insolvency proceeding were a special category of judgment, which fell outside of traditional principles of in personam jurisdiction. Specifically, in reliance upon the concept of "modified universalisai," the court held that such insolvency judgments were neither in personam nor in rem (against the property) matters, but rather a separate category of judgment whose purpose was to establish a mechanism for executing against property of the debtor inherent in the insolvency process. As a result, according to the Court of Appeals, enforcement of such judgments by English courts is an appropriate exercise of their common law powers.

The U.K. Supreme Court reversed the Court of Appeals and held that the insolvency judgments subject to the appeals were in personam judgments that should be treated the same as other in personam foreign judgments.

Ever since the Court of Appeals decision was handed down, lenders have been closely watching this case. Prior to the U.K. Supreme Court decision, any U.K. lender was at risk that, having failed to participate in a foreign insolvency proceeding, a judgment rendered in its absence would be enforced in domestic courts. This decision settles that uncertainty in favor of the traditional rules and expectations with respect to jurisdiction over a defendant subject to an insolvencyrelated judgment. However, it should be noted that the specific appeal in the New Cap case was denied because the court determined that the insurance syndicate, by submitting proofs of debt and participating in creditor meetings, had in fact submitted to the Australian court's jurisdiction. Thus, what constitutes submission to a foreign jurisdiction sufficient to establish jurisdiction may be the source of further litigation.

JONATHAN HELFAT AND RICHARD KOHN

CFA CO-GENERAL COUNSEL

Jonathan N. Helfat, partner, Otterbourg Steindler Houston & Rosen, PC, and Richard M. Kohn, partner, Goldberg Kohn, are CFA co-general counsel.