Restructuring

Contributed by Sunny Singh
The United States Bankruptcy Court for the Southern District of New York was recently presented in In re Rede Energia, S.A. with the question of whether a confirmed Brazilian reorganization plan for Rede Energia, S.A. should be enforced in the United States. Rede, one of the largest power companies in Brazil, filed a reorganization proceeding in Brazil after the operations of its regulated subsidiaries were seized. After an auction process for investments in Rede was completed, the Rede debtors proposed and confirmed a reorganization plan in accordance with Brazilian law. Thereafter, Rede’s foreign administrator commenced a chapter 15 proceeding in the United States and sought an order granting, among other things, full faith and credit to Rede’s confirmed Brazilian reorganization plan. An ad hoc group of noteholders—who rejected the plan in Brazil but were crammed down—objected to the U.S. bankruptcy court’s recognition of Rede’s plan, arguing that the plan and Rede’s Brazilian reorganization proceeding were a “wholesale trampling of their rights that was conceived of and executed by the Brazilian government and rubberstamped by the Brazilian bankruptcy court.” The New York bankruptcy court granted the relief requested over the ad hoc group’s objection.
Chapter 15 Rewind
A quick primer of chapter 15 may be helpful. Chapter 15 of the Bankruptcy Code provides a framework for recognizing and giving effect in the United States to foreign insolvency proceedings. It is premised on principles of comity. Generally, upon the commencement of a chapter 15 case and recognition as a foreign main proceeding, certain relief automatically goes into effect, as provided in section 1520 of the Bankruptcy Code. For example, the automatic stay immediately applies with respect to the property of the debtor that is within the territorial jurisdiction of the United States. In addition, sections 1507 and 1521 of the Bankruptcy Code authorize a bankruptcy court to provide “additional assistance” to a foreign representative or to grant “any appropriate relief” to effectuate the purpose of chapter 15. Recognition assistance of the types available under these sections is largely discretionary and turns on principles of comity. All relief available under chapter 15 of the Bankruptcy Code, however, is subject to the limitation in section 1506, which permits a court to decline to take any action that would be “manifestly contrary to the public policy of this country.”
Back to Brazil
As stated, after the regulatory seizure of its eight operating subsidiaries that distribute electricity to millions of customers throughout Brazil, Rede and certain of its subsidiaries (generally holding companies) filed for bankruptcy protection in Brazil. The regulated subsidiaries did not file. After the filing, Rede solicited offers of investment and received two competing bids. One of the bids providing for a substantial cash investment to be used to fund Rede’s regulated subsidiaries and also to pay the creditors of the Rede debtors was selected and incorporated into a reorganization plan.
The plan provided for three categories of unsecured creditors. One category was “Concessionarie Creditor Claims,” which were comprised of unsecured guaranty, surety or joint claims against Rede on account of a primary claim against a regulated subsidiary.   A second category was the “Subsidiary Concessionaire Claims,” which were comprised of intercompany claims of the non-debtor regulated Rede affiliates. The third category included other general unsecured claims, primarily the claims of noteholders, including the ad hoc group, holding approximately $500 million in 11.125% perpetual notes issued by Rede. The plan provided that categories 1 and 2—the “Concessionaire Creditor Claims” and the “Subsidiary Concessionaire Claims”—would be paid in full. The noteholders, however, would receive a 25% cash payment on account of their claims. In addition, the Brazilian plan was premised on the substantive consolidation of assets and liabilities of the Rede debtors for voting and distribution purposes. The Brazilian court found that substantive consolidation was appropriate because the Rede group was “in fact organized as a corporate group, with a common controlling company and credit inter-dependence, as loans exist between the companies that comprise the group.”
The class of noteholder claims, which included the ad hoc group, did not accept the plan by the requisite majority. The plan was therefore confirmed by Brazilian bankruptcy court over the objection of the ad hoc group pursuant to the cram down provisions of Brazilian bankruptcy law (which are not the same as the cram-down provisions of U.S. bankruptcy law). When Rede’s administrator moved for recognition and enforcement of the plan in the U.S., the ad hoc group objected. The ad hoc group primarily relied on section 1506 and argued that enforcement of the Brazilian plan would be inconsistent with U.S. public policy because, among other things, similarly situated creditors were disparately treated and the substantive consolidation of the Rede debtors was improper.
The ad hoc group argued that substantive consolidation of the Rede debtors should not be recognized because a U.S. court would not have found that the standard for substantive consolidation in the Second Circuit—the familiar Augie/Restivo factors—was met. Although the facts in Rede Energia probably do not merit substantive consolidation under Augie/Restivo (and, in fact, seem to resemble typical operations of many corporations in the U.S.), the court overruled the objection. The bankruptcy court reasoned that chapter 15 does not require that the laws of Brazil be identical to the laws of the United States. Instead, it focuses on the process and whether creditors were given full access to information and a fair opportunity to be heard in the foreign proceeding. The court found that the record was clear that the ad hoc group was afforded due process and a full opportunity to object to the substantive consolidation before the Brazilian bankruptcy court, which the group exercised. The court, therefore, overruled the objection even though the Brazilian bankruptcy court did not consider factors that “ordinarily” would be considered by a U.S. court presented with substantive consolidation. The court stated that it would be inappropriate for a U.S. court to superimpose U.S. law on a case in Brazil. Not only would that be inefficient, but it would give creditors an unwarranted “second bite at the apple” by transforming a U.S. court into a foreign appellate court.
The ad hoc group also objected on the basis that similarly situated creditors were disparately treated under the Brazilian plan. Two classes of general unsecured creditors were being paid in full while the noteholders were only being paid 25% of their claims. Notwithstanding the differing treatment, the objection was overruled. As stated by the court, the issue presented was whether the treatment was wholly at odds with U.S. public policy, which the court found it was not. The court stated that the claims of the regulated affiliates and creditors with primary claims against the regulated entities had to be paid in full in order to lift the regulatory restrictions, thereby justifying the different treatment. The court cited U.S. chapter 11 cases where similarly situated creditors had been treated differently and even received drastically different recoveries when such treatment was justified.
Conclusion
The decision is a reminder that a U.S. court will not superimpose U.S. law or policy over a foreign administration. Creditors of foreign entities need to be prepared to play by the rules of the jurisdiction in which they chose to invest and should not count on a second bite at the apple in the U.S.