How Asian Companies Use the Code to Collect Assets

October 2012 • Vol. XXXI, No. 9
The Essential Resource for Today’s Busy Insolvency Professional
Made in the U.S., Acquired by Asia:
How Asian Companies Use the
Code to Collect Assets page 14
By Edward E. Neiger, Joseph L. Steinfeld, Jr. and Dina Gielchinsky
On the Inside
KB Toys: Risk Allocation in Bankruptcy
Claims Trading page 24
By Bruce S. Nathan and Scott Cargill
Winter Leadership Conference
Schedule of Events page 62
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B
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Is wc ise /
s a r
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Meruelo Maddux: Terminating Automatic
Stay in SARE Proceedings page 34
By Steven D. Jerome and Andrew V. Hardenbrook
The Essential Resource for Today’s Busy Insolvency Professional
On the Edge
By Edward E. Neiger, Joseph L. Steinfeld, Jr. and Dina Gielchinsky1
Made in the U.S., Acquired by Asia
How Asian Companies Use the Code to Collect Assets
T
Edward E. Neiger
ASK LLP; New York
Joseph L. Steinfeld, Jr.
ASK LLP; St. Paul, Minn.
Dina Gielchinsky
ASK LLP; New York
Edward Neiger is a
managing partner
and Dina Gielchinsky
is Of Counsel at ASK
LLP in New York.
Joseph Steinfeld, Jr.
is a managing partner
in the firm’s St. Paul,
Minn., office.
he recent purchase of AMC Entertainment
Holdings by Chinese conglomerate Dalian
Wanda Group Company Ltd. for US$2.6 billion attracted worldwide attention. The blogosphere
lit up with speculation about the effects of China’s
increasing investments in the U.S. and the future of
U.S. industry.
The truth is that Asian companies, particularly
those based in China and Hong Kong, have been
collecting U.S. assets for several years, similar
to the Japanese acquisitions of U.S. assets in the
1980s. The latest trend seems to be Asian companies using Bankruptcy Code provisions to expand
their U.S. asset portfolios.
Bankrupt companies hold particular appeal for
foreign investors who are eager to benefit from the
advantages and safeguards that the Bankruptcy
Code affords acquirers and purchasers. For example, § 363(f) allows for the sale of assets “free and
clear of any interest in such property of an entity
other than the estate,” provided that the debtor
can satisfy any one of certain specified conditions.
These include, among other things, a showing that
applicable nonbankruptcy law permits the sale free
and clear, that the sale price exceeds the amount of
all liens encumbering the property, or that the interest being sold is in bona fide dispute.2 A reorganization plan may also provide for the sale or transfer
of the debtor’s assets free and clear of any other
interests, provided that secured creditors receive the
“indubitable equivalent” of the value of their liens
against the sold assets.3 One way to accomplish this
is to present the secured creditors with a cash payment on their claims.4
1 Mr. Neiger and Ms. Gielchinsky represented Haining Mengnu Group Company Ltd. in the
bankruptcy of Jennifer Convertibles Inc. and Royal Spirit Group Ltd. in the bankruptcy of
The Connaught Group Ltd.
2 See 11 U.S.C. § 363(f)(1)-(5).
3 See 11 U.S.C. § 1129(b)(2)(A)(iii).
4 See Bank of New York Trust Co. NA v. Official Unsecured Creditors’ Comm. (In re Pacific
Lumber Co.), 584 F.3d 229, 246-47 (5th Cir. 2009).
The recent bankruptcies of Jennifer Convertibles
Inc.5 and The Connaught Group Limited display
prime examples of Asian companies utilizing
the Bankruptcy Code to acquire U.S. assets. The
Chinese acquirer of Jennifer Convertibles’ equity
employed the Code’s reorganization plan provisions to achieve its purchase, while the joint venture
between a U.S. clothing retailer and a Hong Kongbased supplier purchased the Connaught Group’s
assets under § 363.
Chinese Furniture Supplier Swaps
Its Unsecured Debt for Ownership
Furniture retailer Jennifer Convertibles and
11 of its affiliates filed for bankruptcy on July 18,
2010, in the U.S. Bankruptcy Court for the Southern
District of New York. Jennifer Convertibles did not
have any secured creditors but had almost $35 million in unsecured debt. Of that amount, Jennifer
Convertibles owed more than $17 million to a
Chinese furniture supplier, Haining Mengnu Group
Company Ltd.
Mengnu was Jennifer Convertibles’ primary
supplier of furniture and played an active role in the
debtors’ reorganization. In fact, Mengnu signed a
plan-support agreement moments before the filing of
the cases pursuant to which Mengnu would convert
its debt into a controlling stake in the reorganized
Jennifer Convertibles. Through the reorganization
plan, which was confirmed just seven months after
the debtors filed their bankruptcy cases, Mengnu
recovered more than 87 percent of its claims plus
90.1 percent of the reorganized debtors’ new common stock. General unsecured creditors recovered
more than 22 percent of their claims plus 9.9 percent of the reorganized debtors’ new common stock.
5 See Edward E. Neiger and Dina Gielchinsky, “Converting Trade Debt to a Controlling
Stake: The Pragmatic Path to Jennifer Convertibles’ Unique Reorganization,” XXX ABI
Journal 6, 1, 64-65, July/August 2011.
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This debt-for-equity swap was unique, as it is one of the first
instances where foreign trade debt was converted into a controlling stake in a U.S. debtor.
There were no significant objections to Mengnu’s recovery, and no one demanded that Jennifer Convertibles hold
an auction to ensure that the Mengnu acquisition was the
best deal for the debtors’ estates. Creditors and even potential investors understood that the debtors’ sizeable debt to
Mengnu might dilute distributions to unsecured creditors to
mere pennies if Mengnu were not allowed to swap its debt
for equity.
Jennifer Convertibles’ most recent operating report 6
reflects that the Mengnu acquisition was a profitable one.
Revenue and net sales were up in June 2012 by more than
200 percent since the first operating report the debtors filed
in July 2010.7
Hong Kong-Based Company Forms Joint
Venture and Submits “Best” Bid
The Connaught Group and four affiliates filed for bankruptcy on Feb. 9, 2012, in the U.S. Bankruptcy Court for the
Southern District of New York, citing $12 million in outstanding secured lines of credit and almost $48 million in
unsecured debt. Tennessee-based Tom James Co., one of the
world’s largest manufacturers and retailers of custom men’s
clothing, expressed interest in purchasing the flailing debtors.
Tom James has operations across the U.S., Canada,
England, France, Australia and Dubai, but it sought to partner with a manufacturer and supplier who could produce a
consistent supply of high-quality clothing and textiles. The
most obvious choice was Royal Spirit Group Ltd., a Hong
Kong-based premium apparel supplier and one of the largest manufacturers of The Connaught Group’s designs. Royal
Spirit asserted significant claims against The Connaught
Group, including an administrative claim under § 503(b)(9)
of the Bankruptcy Code in the amount of $373,792.38 for
goods the debtors received from it within the 20 days prior
to their bankruptcy filings, and an administrative claim under
§ 503(b)(1)(A) in the amount of $148,103 for goods that it
provided to the debtors after their bankruptcy filings. Royal
Spirit also maintained that it could reclaim $1,377,388.28
worth of goods that the debtors received from it during the
45 days prior to their bankruptcy filings under § 546(c) of
the Bankruptcy Code. Finally, Royal Spirit asserted a general
unsecured claim of $4,668,033.45.
Tom James and Royal Spirit created a joint venture company called Carlisle Etcetera LLC8 for the purpose of acquiring The Connaught Group’s assets. The joint venture first
contemplated acquiring the assets through a reorganization
plan, which permits more complex financing techniques and
the issuance of new securities. A plan, however, also requires
time. Federal Rule of Bankruptcy Procedure 2002(b) requires
28 days’ notice before objections and a hearing to consider
the adequacy of a disclosure statement, and another 28 days’
notice before objections and a hearing on a chapter 11 plan.
During these periods, creditors and parties-in-interest are
6 See In re Jennifer Convertibles Inc., Case No. 10-13779 (ALG), Corporate Monthly Operating Report for
the Period 6/01/12-6/30/12 (Bankr. S.D.N.Y. Aug. 16, 2012) [Docket No. 822].
7 See In re Jennifer Convertibles Inc., Case No. 10-13779 (ALG), Corporate Monthly Operating Report for
the Period 7/18/10-8/31/10 (Bankr. S.D.N.Y. Sept. 27, 2010) [Docket No. 269].
8 At the time of the auction, Carlisle was named Forty-Three Eighty Company.
invited to object not only to the proposed sale of the debtor’s
assets through the reorganization plan, but also to any other
aspect of the plan that they find offensive.
The Connaught Group did not have time to sell its assets
under a plan for two reasons. First, any delay in finding a
purchaser would postpone the release of The Connaught
Group’s fall season line of clothing, causing a potentially
fatal blow to The Connaught Group’s future profits. Second,
the debtors were concerned that their network of “wardrobe
consultants,” which provided wardrobe consultations to customers showcasing the debtors’ clothes, would seek employment elsewhere if the debtors did not consummate a sale in
short order.
While Asian companies may face
some objections...particularly if
the U.S. company operates in the
defense or technology sectors,
the purchases of bankrupt U.S.
companies in retail sectors has
proved profitable for both U.S.
and Asian economies.
Accordingly, the debtors decided to conduct their sale
pursuant to § 363, which must be public, on notice to all
parties in interest and subject to “higher and better” offers.9
To comply with these requirements, judges often require
auctions, which may be conducted just three weeks after a
motion to sell the debtor’s property is filed.10
At the auction,11 The Worth Collection Ltd. and other
liquidators submitted a collective $21 million bid, which was
$1 million in excess of Carlisle’s $20 million bid. However,
the highest numerical bid is not always the “highest and
best bid” required by § 363.12 The debtors and the creditors’
committee determined that Carlisle’s bid was preferable to
the liquidators’ collective bid because accepting the collective bid would harm the debtors’ employees, most of whom
would be laid off. In addition, the liquidators did not intend
to assume the debtors’ leases and other contracts, which
would cause the debtors to incur rejection damages claims,
resulting in less recovery for each general unsecured creditor.
Carlisle, in contrast, agreed to assume various of the debtors’ employment contracts and the real property lease for
the debtors’ headquarters, which suggested continued operations and minimal reduction in forces. In order to assume the
employment contracts, Carlisle was required to cure deficiencies of more than $1 million. In order to assume the lease,
Carlisle agreed to pay a cure claim in the amount of approximately US$500,000. Had Carlisle not agreed to assume the
lease and employment contracts, the debtors’ estates would
have been liable for the resultant rejection damages claims
under § 502(b)(6) and (7) of the Bankruptcy Code at the
9 See Livore v. Hargrave (In re Livore), Adv. No. 10-1094, 2010 Bankr. LEXIS 1653, *10 (Bankr. D.N.J. May
6, 2010).
10See Fed. R. Bankr. P. 2002(a)(2).
11See In re The Connaught Group Ltd., Case No. 12-10512 (SMB), Transcript of the Auction Held on April 5,
2012 (Bankr. S.D.N.Y. April 11, 2012) [Docket No. 195].
12See In re Bakalis, 220 B.R. 525, 532-34 (Bankr. E.D.N.Y. 1998) (sale of debtor’s assets to second-highest
bidder approved based on court’s evaluation of risks inherent in conditions attached to highest dollar bid).
44 Canal Center Plaza, Suite 400 • Alexandria, VA 22314 • (703) 739-0800 • Fax (703) 739-1060 • www.abiworld.org
expense of unsecured creditors.13 Most importantly, Royal
Spirit agreed to waive its unsecured claim, resulting in a
greater recovery for the remaining unsecured creditors and
displaying another example of a company converting its
unsecured trade debt in order to acquire a U.S. debtor.
Asian Companies May Meet Resistance
in Technology or Defense Sectors
Not every proposed foreign acquisition of a U.S. company in bankruptcy is met with enthusiasm, particularly if the
U.S. company operates in the technology or defense sectors.
For example, after U.S. telecommunications giant Global
Crossing Ltd. filed for bankruptcy in the U.S. Bankruptcy
Court for the Southern District of New York on Jan. 28,
2002, it announced a proposed $750 million investment
from two major Asian telecommunications companies: Hong
Kong-based Hutchison Whampoa Limited and Singaporebased Singapore Technologies Telemedia Pte. Limited.
Immediately, U.S. authorities questioned whether the investment posed security risks. At issue was the debtor’s planetcircling fiber-optic network, which was used by government
agencies and major businesses in the United States.
The debtor and its potential investors mobilized trade and
telecom lawyers and lobbyists to persuade U.S. authorities
to sign off on the deal. Ultimately, Hutchison, which was
rumored to have ties to the Chinese government and its military, withdrew its bid. Although Global Crossing declared
more than $16 billion in assets when it went into bankruptcy,
Singapore Technologies, which is owned by the Singapore
government, was able to buy 61.5 percent of the company for
just $250 million. As part of winning U.S. approval for its
sale to Singapore Technologies, Global Crossing agreed to
create a national security committee on its board that would
be responsible for ensuring that government communications
on Global Crossing’s network remain secure.
A sale contemplated by Hawker Beechcraft Inc., a manufacturer of commercial and military aircraft, also caused
some concern. Hawker and its affiliates filed for bankruptcy
in the U.S. Bankruptcy Court for the Southern District of
New York on May 3, 2012. Hawker is the sole-source provider of the T-6, a military trainer aircraft, to the U.S. Air
Force and Navy.
Superior Aviation Beijing Co. Ltd. submitted a tentative
bid of $1.79 billion for Hawker’s assets, excluding Hawker’s
defense business. The parties moved for a court order giving Superior a 45-day exclusive period to negotiate a stalking-horse agreement with the debtors. In exchange for this
exclusivity, Superior offered to pay the debtors $50 million
to compensate them for the cost of keeping their commercial
business operational.
Little is known about Superior other than the information
that it included in the proposed sale agreement. According
to Superior, it is incorporated in the People’s Republic of
13See In re Pre-Press Graphics Co., 300 B.R. 902, 909 (Bankr. N.D. Ill. 2003) (“Rejection of an underlying
contract constitutes a breach of the contract, which usually results in a three-prong claim against the
estate: (1) a general unsecured claim for any accrued unpaid rent due under the lease or contract prior to
the bankruptcy filing under 11 U.S.C. § 502(b)(6)(B), (7)(B); (2) an administrative (and therefore a priority)
claim for rent amounting to either rent that accrued post-petition but prior to rejection or the reasonable
value of services or goods for that same time whichever the court finds appropriate under § 503(b)‌(1)‌(A)
and § 507(a)(1); and (3) a general unsecured claim for ‘rejection damages’ (amounts due under the
remaining term of the lease or contract) under § 502, subject to certain limitations on the maximum
amount a claimant may claim as rejection damages under § 502(b)(6)(A) and § 502(b)(7)(A).”).
China, and the Beijing municipal government owns 40 percent of its equity. Superior’s chairman and his wife purportedly own 100 percent of the entity that owns the other 60
percent of Superior. Superior also disclosed that the city of
Beijing intends to finance the proposed transaction.14
The U.S. government appeared in the case but did
not object to the debtors’ motion to enter into the exclusive negotiating period with Superior. The International
Associations of Machinists and Aerospace Workers AFLCIO (IAM), however, drew upon the dearth of information
known about Superior, and cautioned against allowing a
Chinese-controlled and -financed entity to procure an equitable interest in a business that is so intertwined with U.S.
national security.
Ultimately, the bankruptcy court permitted Superior and
the debtors to enter into the exclusive negotiating period.
This permission was granted upon two conditions: (1) any
deal reached would face a competitive auction, and (2)
the deal would be subject to scrutiny by the Committee
on Foreign Investments, a regulatory body chaired by the
Department of the Treasury that reviews the national security
implications of foreign investments in U.S. companies.
Aided by the Code, Asian Acquisitions
Expected to Increase
While Asian companies may face some objections when
acquiring U.S. companies in bankruptcy, particularly if the
U.S. company operates in the defense or technology sectors,
the purchases of bankrupt U.S. companies in retail sectors
has proved profitable for both U.S. and Asian economies.
Aided by the Bankruptcy Code’s promotion of asset sales and
its protections for acquirers and purchasers, Asian business
are expected to increase their portfolios of distressed U.S.
companies. abi
Reprinted with permission from the ABI Journal, Vol. XXXI, No. 9,
October 2012.
The American Bankruptcy Institute is a multi-disciplinary, nonpartisan organization devoted to bankruptcy issues. ABI has
more than 13,000 members, representing all facets of the
insolvency field. For more information, visit ABI World at www.
abiworld.org.
14See In re Hawker Beechcraft Inc., Case No. 12-11873 (SMB), Exhibit C to Debtor’s Motion for the Entry
of an Order Authorizing the Debtor’s to Enter into an Exclusive Negotiations Agreement and a Refund
Agreement (Bankr. S.D.N.Y. July 10, 2012) [Docket No. 324].
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