copyright 2002. dgb/rcp1 american college of bankruptcy october 2, 2002 the implications of enron...

Copyright 2002. DGB/RCP 1

American College of BankruptcyAmerican College of BankruptcyOctober 2, 2002October 2, 2002

The Implications of EnronThe Implications of Enron

Douglas G. BairdDouglas G. BairdHarry Bigelow Harry Bigelow

Distinguished Service Distinguished Service Professor of LawProfessor of Law

Randal C. PickerRandal C. PickerPaul & Theo Leffmann Paul & Theo Leffmann

Professor of Commercial LawProfessor of Commercial Law

The Law School, The University of ChicagoThe Law School, The University of Chicago


Four IssuesFour Issues

Corporate Information, Disclosure and Corporate Information, Disclosure and GovernanceGovernance

Entity Fragility and Liquid MarketsEntity Fragility and Liquid Markets Understanding Enron’s TransactionsUnderstanding Enron’s Transactions The Law of Deodands and SPEsThe Law of Deodands and SPEs


Corporate Information, Disclosure and Governance


Ann Report 2000: Page 1Ann Report 2000: Page 1



Enron has built unique and strong businesses that have tremendous opportunities for growth. These businesses — wholesale services, retail energy services, broadband services and transportation services — can be significantly expanded within their very large existing markets and extended to new markets with enormous growth potential. At a minimum, we see our market opportunities company-wide tripling over the next five years.



Enron is laser-focused on earnings per share, and we expect to continue strong earnings performance. We will leverage our extensive business networks, market knowledge and logistical expertise to produce high-value bundled products for an increasing number of global customers.



Guarantees of liabilities of unconsolidated entities and residual value guarantees have no carrying value and fair values which are not readily determinable (see Note 15).


4/17/01: 14/17/01: 1stst Quarter Earnings Quarter Earnings ReportReport

“Enron’s wholesale business continues to generate outstanding results. Transaction and volume growth are translating into increased profitability,” said Jeff Skilling, Enron’s president and CEO. “In addition, our retail energy services and broadband intermediation activities are rapidly accelerating.”


5/15/01: Files 1Q ‘01 10-Q: 5/15/01: Files 1Q ‘01 10-Q: Related Deals DiscussionRelated Deals Discussion

““During the first quarter of 2001, Enron entered into During the first quarter of 2001, Enron entered into transactions with limited partnerships (the Related transactions with limited partnerships (the Related Party), whose general partner is a senior officer of Party), whose general partner is a senior officer of Enron. The limited partners of the Related Party are Enron. The limited partners of the Related Party are unrelated to Enron. All transactions with the Related unrelated to Enron. All transactions with the Related Party are approved by Enron’s senior risk officers as Party are approved by Enron’s senior risk officers as well as reviewed annually by the Board of Directors. well as reviewed annually by the Board of Directors. Management believes that the terms of the Management believes that the terms of the transactions with the Related Party were reasonable transactions with the Related Party were reasonable compared to those which could have been negotiated compared to those which could have been negotiated with unrelated third parties.”with unrelated third parties.”


7/12/01: 27/12/01: 2ndnd Quarter Earnings Quarter Earnings ReportReport

“Enron completed another quarter of exceptional performance. Our wholesale and retail energy businesses continue to dramatically expand business activity and increase profitability. In addition, Enron is distinct in developing a leading role in the European energy markets and in other high potential wholesale markets,” said Jeff Skilling, Enron president and CEO.


8/14/01: Skilling Resigns8/14/01: Skilling Resigns

“I am resigning for personal reasons. I want to thank Ken Lay for his understanding of this purely personal decision, and I want to thank the board and all of my colleagues at Enron,” said Skilling.

“We regret Jeff’s decision to resign, as he has been a big part of our success for over eleven years,” said Lay. “But, we have the strongest and deepest talent we have ever had in the organization, our business is extremely strong, and our growth prospects have never been better.”


8/14/01: Files 2Q ‘01 10-Q8/14/01: Files 2Q ‘01 10-Q

““During the second quarter of 2001, Enron did not During the second quarter of 2001, Enron did not recognize any material revenues or income from recognize any material revenues or income from transactions with the limited partnerships transactions with the limited partnerships discussed below. Additionally, the senior officer, discussed below. Additionally, the senior officer, who previously was the general partner of these who previously was the general partner of these partnerships, sold all of his financial interests as of partnerships, sold all of his financial interests as of July 31, 2001, and no longer has any management July 31, 2001, and no longer has any management responsibilities for these entities. Accordingly, responsibilities for these entities. Accordingly, such partnerships are no longer related parties to such partnerships are no longer related parties to Enron.”Enron.”


8/14/01: Files 2Q ‘01 10-Q8/14/01: Files 2Q ‘01 10-Q

““All transactions with these partnerships (the All transactions with these partnerships (the Partnerships) have been approved by Enron’s Partnerships) have been approved by Enron’s senior risk officers as well as reviewed annually senior risk officers as well as reviewed annually by the Board of Directors. Management believes by the Board of Directors. Management believes that the terms of the transactions were reasonable that the terms of the transactions were reasonable compared to those which could have been compared to those which could have been negotiated with unrelated third parties.”negotiated with unrelated third parties.”

““In the first quarter of 2001, Enron entered into In the first quarter of 2001, Enron entered into transactions with the Partnerships, now unrelated, transactions with the Partnerships, now unrelated, to hedge certain merchant investments and other to hedge certain merchant investments and other assets.” assets.”


8/15/01: Watkins Letter to Ken Lay8/15/01: Watkins Letter to Ken Lay

Has Enron become a risky place to work? For those of us who didn’t get rich over the last few years, can we afford to stay?

Skilling’s abrupt departure will raise suspicions of accounting improprieties and valuation issues. Enron has been very aggressive in its accounting—most notably the Raptor transactions and the Condor vehicle.

The spotlight will be on us, the market just can’t accept that Skilling is leaving his dream job.


8/15/01: Watkins Letter to Ken Lay8/15/01: Watkins Letter to Ken Lay

I am incredibly nervous that we will implode in a wave of accounting scandals. My eight years of Enron work history will be worth nothing on my resume, the business world will consider the past successes as nothing but an elaborate accounting hoax. Skilling is resigning now for “personal reasons” but I would think he wasn’t having fun, looked down the road and knew this stuff was unfixable and would rather abandon ship now than resign in shame in two years.


10/16/01: 310/16/01: 3rdrd Quarter Earnings Quarter Earnings ReportReport

ENRON REPORTS RECURRING THIRD QUARTER EARNINGS OF $0.43 PERDILUTED SHARE; REPORTS NON-RECURRING CHARGES OF $1.01 BILLIONAFTER-TAX; REAFFIRMS RECURRING EARNINGS ESTIMATES OF $1.80 FOR2001 AND $2.15 FOR 2002; AND EXPANDS FINANCIAL REPORTING



“Our 26 percent increase in recurring earnings per diluted share shows the very strong results of our core wholesale and retail energy businesses and our natural gas pipelines,” said Kenneth L. Lay, Enron chairman and CEO. “The continued excellent prospects in these businesses and Enron’s leading market position make us very confident in our strong earnings outlook.”



“$544 million related to losses associated with certain investments, principally Enron’s interest in The New Power Company, broadband and technology investments, and early termination during the third quarter of certain structured finance arrangements with a previously disclosed entity.”


TimelineTimeline

10/24/01: Fastow, Enron CFO, placed on leave10/24/01: Fastow, Enron CFO, placed on leave 11/8/01: 8-K Filing with SEC11/8/01: 8-K Filing with SEC

– A required restatement of prior period financial A required restatement of prior period financial statements to reflect the previously disclosed $1.2 statements to reflect the previously disclosed $1.2 billion reduction to shareholders’ equity, as well as billion reduction to shareholders’ equity, as well as various income statement and balance sheet various income statement and balance sheet adjustments required as the result of a adjustments required as the result of a determination by Enron and its auditors, based on determination by Enron and its auditors, based on current information, that certain off-balance sheet current information, that certain off-balance sheet entities should have been included in Enron’s entities should have been included in Enron’s consolidated financial statements pursuant to consolidated financial statements pursuant to generally accepted accounting principles;generally accepted accounting principles;


TimelineTimeline

– the restatement of its financial statements for the restatement of its financial statements for 1997 through 2000 and the first two quarters of 1997 through 2000 and the first two quarters of 2001. As a result, financial statements for these 2001. As a result, financial statements for these periods and the audit reports relating to the periods and the audit reports relating to the year-end financial statements for 1997 through year-end financial statements for 1997 through 2000 should not be relied upon; 2000 should not be relied upon;

11/19/01: Files 3Q 2001 10-Q with SEC11/19/01: Files 3Q 2001 10-Q with SEC– Extensive follow-on discussion to 11/8 8-K Extensive follow-on discussion to 11/8 8-K

regarding LJM transactionsregarding LJM transactions


12/2/01: Enron Files for Chapter 12/2/01: Enron Files for Chapter 1111


Sarbanes-OxleySarbanes-Oxley

P.L. 107-204, July 30, 2002: Sarbanes-Oxley Act of 2002

Creates new Public Company Accounting Oversight Board, with broad authority to set accounting standards for public companies and their auditors

Mandatory lead audit partner rotation after 5 years

New requirement for signing officer liability for reported financial information


Andy Grove, CEO of Intel, Andy Grove, CEO of Intel, Fortune, 9/16/02Fortune, 9/16/02

What's your view of the new regulations What's your view of the new regulations coming out of Washington?coming out of Washington?– Well, one part--attestation of financial reports--is Well, one part--attestation of financial reports--is

a real pain in the ass. At Intel, we had an 11-hour a real pain in the ass. At Intel, we had an 11-hour financial meeting. I sat through it and learned a financial meeting. I sat through it and learned a bunch of things about how we put together a bunch of things about how we put together a statement. I met a bunch of the people responsible statement. I met a bunch of the people responsible for the actual work; not the comptrollers, whom for the actual work; not the comptrollers, whom we normally deal with. It was very useful. we normally deal with. It was very useful. Would Would we have done that without the SEC regulations? we have done that without the SEC regulations? No. Should we have done it? Yes.No. Should we have done it? Yes.


Entity Fragility and Liquid Markets


Fragility and LiquidityFragility and Liquidity

““Liquidating” An EntityLiquidating” An Entity– ““Our most important assets walk out the door Our most important assets walk out the door

each day.”each day.”– Human capital is highly mobile on its ownHuman capital is highly mobile on its own– Physical capital is increasing mobile with liquid Physical capital is increasing mobile with liquid

asset marketsasset markets Entities Are FragileEntities Are Fragile

– Trademarks can depreciate quicklyTrademarks can depreciate quickly– People can leave, assets can be soldPeople can leave, assets can be sold


Fragile EnronFragile Enron

Much of what has occupied the first part of Much of what has occupied the first part of Enron’s Chapter 11 has been a sale of assetsEnron’s Chapter 11 has been a sale of assets– Enron’s trading operation and many of its gas Enron’s trading operation and many of its gas

pipelines and other businesses have been sold. pipelines and other businesses have been sold. – Any firm that emerges will have little in Any firm that emerges will have little in

common with the firm that was seventh on the common with the firm that was seventh on the list of the Fortune 500 list of the Fortune 500

This is typical of large, modern Chapter 11sThis is typical of large, modern Chapter 11s


Fragile AndersenFragile Andersen

12/12/01: Berardino testifies in Congress12/12/01: Berardino testifies in Congress– ““If there is one thing you take away from my If there is one thing you take away from my

testimony, I hope it is this: Andersen will not hide testimony, I hope it is this: Andersen will not hide from its responsibilities. That’s why I’m here today. from its responsibilities. That’s why I’m here today. The public’s confidence is of paramount importance. The public’s confidence is of paramount importance. If my firm has made errors of judgment, we will If my firm has made errors of judgment, we will acknowledge them. We will make the changes acknowledge them. We will make the changes needed to restore confidence.”needed to restore confidence.”

1/10/02: AA announces “significant but 1/10/02: AA announces “significant but undetermined number of Enron-related documents undetermined number of Enron-related documents were disposed of”were disposed of”

1/15/02: AA fires David Duncan1/15/02: AA fires David Duncan


3/14/02: Andersen Indictment3/14/02: Andersen Indictment


Fragile AndersenFragile Andersen

Law Can Limit Human Capital MobilityLaw Can Limit Human Capital Mobility– Status of covenants not to competeStatus of covenants not to compete– Fears of acquired liability as large chunks of Fears of acquired liability as large chunks of

Andersen move to new firmsAndersen move to new firms Trademark ImplosionTrademark Implosion

– From valuable brand to The Tonight Show From valuable brand to The Tonight Show monologue in 60 secondsmonologue in 60 seconds

ReceivablesReceivables– Collect quickly or vanishCollect quickly or vanish


18 USC 1512(b)(2) 18 USC 1512(b)(2)

§ 1512. Tampering with a witness, victim, or an § 1512. Tampering with a witness, victim, or an informant informant – (b) Whoever knowingly uses intimidation or physical (b) Whoever knowingly uses intimidation or physical

force, threatens, or corruptly persuades another person, or force, threatens, or corruptly persuades another person, or attempts to do so, or engages in misleading conduct attempts to do so, or engages in misleading conduct toward another person, with intent to—toward another person, with intent to—

» ……» (2) cause or induce any person to— (2) cause or induce any person to—

(A) withhold testimony, or withhold a record, document, or other (A) withhold testimony, or withhold a record, document, or other object, from an official proceeding;object, from an official proceeding;

(B) alter, destroy, mutilate, or conceal an object with intent to (B) alter, destroy, mutilate, or conceal an object with intent to impair the object’s integrity or availability for use in an official impair the object’s integrity or availability for use in an official proceeding;proceeding;

……

– shall be fined under this title or imprisoned not more than shall be fined under this title or imprisoned not more than ten years, or both. ten years, or both.


10/12/01: Andersen Emails: 10/12/01: Andersen Emails: Temple to Odom to DuncanTemple to Odom to Duncan

To: David Duncan

From: Michael C. Odom

Forwarding email from Nancy Temple

Mike-

It might be useful to consider reminding the engagement team of our document and retention policy. It will be helpful to make sure that we have complied with the policy. Let me know if you have any questions.

Nancy


Duncan’s Draft Memo to File Duncan’s Draft Memo to File (10-15-01)(10-15-01)


Temple’s Email (10-16-01)Temple’s Email (10-16-01)

Dave – Here are a few suggested comments for consideration.

I recommend deleting reference to consultation with the legal group and deleting my name on the memo. Reference to the legal group consultation arguably is a waiver of attorney-client privileged advice and if my name is mentioned it increases the chances that I might be a witness, which I prefer to avoid.


Temple’s Email (10-16-01)Temple’s Email (10-16-01)

I suggested deleting some language that might suggest that we have concluded that the release is misleading.

In light o the “non-recurring” characterization, the lack of any suggestion that this characterization is not in accordance with GAAP, and the lack of income statements in accordance with GAAP, I will consult further within the legal group as to whether we should do anything more to protect ourselves from potential Section 10A issues.


Understanding Enron’s Transactions


Enron’sEnron’s Place in the Pantheon Place in the Pantheon

Two notable bankruptcies provide a good baselineTwo notable bankruptcies provide a good baseline– Crazy EddieCrazy Eddie

– Equity FundingEquity Funding

Basic LessonsBasic Lessons– Don’t obsess too much about who did and did not Don’t obsess too much about who did and did not

engage in fraudengage in fraud

– Those who commit frauds are usually judgmentproofThose who commit frauds are usually judgmentproof

– You often can recover from others, You often can recover from others, even if they knew even if they knew nothing about the fraudnothing about the fraud


Crazy EddieCrazy Eddie

Crazy Eddie’s prices were insaneCrazy Eddie’s prices were insane– But he also inflated the stock price, sold stock, But he also inflated the stock price, sold stock,

and took the cash with himand took the cash with him——in suitcasesin suitcases– He went to jail, and the investors were left He went to jail, and the investors were left

unpaidunpaid– He is now back in businessHe is now back in business


Lessons of Lessons of Crazy EddieCrazy Eddie

The litigation was largely over bringing The litigation was largely over bringing securities and other actions against those securities and other actions against those (such as accountants) with money(such as accountants) with money

Willie Sutton principle (and its corollary)Willie Sutton principle (and its corollary)– You go to where the money isYou go to where the money is– But there is usually an inverse corollation But there is usually an inverse corollation

between the amount of money and the strength between the amount of money and the strength of your cause of actionof your cause of action


Crazy Eddie Crazy Eddie andand Enron Enron

In chasing after solvent third parties, In chasing after solvent third parties, nonbankruptcy law is what mattersnonbankruptcy law is what matters

Recently, we’ve narrowed third-party liabilityRecently, we’ve narrowed third-party liability– Central Bank of Denver v. First Interstate Bank of Central Bank of Denver v. First Interstate Bank of

Denver, 511 U.S. 164 (1994)Denver, 511 U.S. 164 (1994)

– Private plaintiffs cannot bring Rule 10b-5 actions Private plaintiffs cannot bring Rule 10b-5 actions against those who merely aided and abetted violations against those who merely aided and abetted violations of the securities lawof the securities law

– But there are lots of other theories that may be But there are lots of other theories that may be sufficient to get past a motion for summary judgmentsufficient to get past a motion for summary judgment


Bankruptcy and Third-Party Bankruptcy and Third-Party LiabilityLiability

When can the bankruptcy trustee bring the cause When can the bankruptcy trustee bring the cause of action?of action?– If the firm could bring the action outside of bankruptcy, If the firm could bring the action outside of bankruptcy,

the cause of action is property of the estate under §541the cause of action is property of the estate under §541

– The trustee has the power to avoid liens and recover The trustee has the power to avoid liens and recover transfers under §544 and the other avoiding powerstransfers under §544 and the other avoiding powers

But the trustee cannot bring ordinary damage But the trustee cannot bring ordinary damage actions, even if the creditors as a group couldactions, even if the creditors as a group could


The The CaplinCaplin Principle Principle

Caplin v. Marine Midland Grace Trust Company, Caplin v. Marine Midland Grace Trust Company, 406 U.S. 416 (1972), sharply limits the trustee’s 406 U.S. 416 (1972), sharply limits the trustee’s freedom of movement herefreedom of movement here

Warning!Warning!– The case law here about what is “property of The case law here about what is “property of

the estate” is unreliable and confusedthe estate” is unreliable and confused– Be cautious about taking appellate opinions at Be cautious about taking appellate opinions at

face valueface value– E.g., they can be reversed by subsequent state E.g., they can be reversed by subsequent state

court decisionscourt decisions


Equity Funding’sEquity Funding’s Business Plan Business Plan

We are in the 1960s, and we have learned We are in the 1960s, and we have learned that bull markets last foreverthat bull markets last forever

Investors get the tax benefits of life Investors get the tax benefits of life insurance and the growth potential of a insurance and the growth potential of a mutual fundmutual fund– Investors buy our mutual fund, and we lend Investors buy our mutual fund, and we lend

them the money (with their shares as collateral) them the money (with their shares as collateral) to buy insuranceto buy insurance

– They pay off the loan with the appreciated They pay off the loan with the appreciated mutual fund sharesmutual fund shares


Equity Funding’sEquity Funding’s Problem Problem

The 1960s bull market endsThe 1960s bull market ends Investors start to withdraw their funds and Investors start to withdraw their funds and

are less inclined to invest in the first placeare less inclined to invest in the first place– How do we maintain our stock price? How do we maintain our stock price? – We turn to aggressive accountingWe turn to aggressive accounting


Aggressive AccountingAggressive Accounting

Treat as cash receivedTreat as cash received– revenues that will come when an identified revenues that will come when an identified

person makes the first payment on a policy person makes the first payment on a policy already issuedalready issued

– revenues that will come if an identified person revenues that will come if an identified person we have solicited agrees to buy a policy, passes we have solicited agrees to buy a policy, passes the medical test, etc.the medical test, etc.

– revenues that would come if a fictitious person revenues that would come if a fictitious person actually existed, was solicited by us, agreed to actually existed, was solicited by us, agreed to buy our policy, passed the medical test, etc. buy our policy, passed the medical test, etc.


Equity Funding’sEquity Funding’s Problem Problem

Reinsurers expect us to turn over premiums Reinsurers expect us to turn over premiums from all living insureds, even if they are from all living insureds, even if they are fictitious fictitious

Fictitous people don’t pay premiumsFictitous people don’t pay premiums– Some can die youngSome can die young– But reinsurers get suspicious if too many But reinsurers get suspicious if too many

people die youngpeople die young Proving fictitious people both lived and Proving fictitious people both lived and

died is hard workdied is hard work


Equity FundingEquity Funding Lessons Lessons

Sliding slowly from corner-cutting to Sliding slowly from corner-cutting to outright fraud is commonplace in outright fraud is commonplace in bankruptcy, especially in small Chapter 11s bankruptcy, especially in small Chapter 11s

Many of the Many of the Equity FundingEquity Funding people who people who end up engaging in outright fraud (forging end up engaging in outright fraud (forging medical histories) aren’t even getting paid a medical histories) aren’t even getting paid a lot of moneylot of money


Equity FundingEquity Funding Lessons Lessons

Uncovering fraud after the fact is easy, but Uncovering fraud after the fact is easy, but beforehand it’s hardbeforehand it’s hard

WWARNINGARNING!!– Be alert to departures from past practiceBe alert to departures from past practice– Be aware of slippery slopesBe aware of slippery slopes– Don’t sign off on transactions you don’t Don’t sign off on transactions you don’t

understand understand


What happens in What happens in EnronEnron now? now?

EnronEnron is harder than is harder than Crazy EddieCrazy Eddie, , Equity Equity FundingFunding, or , or WorldComWorldCom

The complex structure hid the extent of the The complex structure hid the extent of the failure of the businessfailure of the business– Outright fraud and self-dealing is a problem, Outright fraud and self-dealing is a problem,

but the law is easy and recoveries smallbut the law is easy and recoveries small– What remedies do creditors have against those What remedies do creditors have against those

who help a debtor keep them in the dark?who help a debtor keep them in the dark?


What happens in What happens in EnronEnron now? now?

Can the estate recover Enron assets parked Can the estate recover Enron assets parked in various SPEs and transferred out of SPEs in various SPEs and transferred out of SPEs to investors?to investors?

The challenge is to filter out what doesn’t The challenge is to filter out what doesn’t mattermatter– Identify the basic transaction behind the SPEsIdentify the basic transaction behind the SPEs– Don’t get hung up on whether the transaction Don’t get hung up on whether the transaction

complied with GAAP or securities regulationscomplied with GAAP or securities regulations


White ElephantPlaza

$800

OfficeCo


White ElephantPlaza

$800

CFO

CFO Partners

GP

LimitedPartners

OfficeCo

$198

$2


White ElephantPlaza

CFO PartnersOffice

Co

White Elephant Co.

$200 cash & $800 note


White ElephantPlaza

CFO Partners

OfficeCo

White Elephant Co.$800 note


White ElephantPlaza

OfficeCo

Elephant Co.$800 note

Bank

Security Interest

$250


White ElephantPlaza

OfficeCo

Elephant Co.$800 note

Bank

Security Interest

CFOPartners

$250 dividend


What’s Really Going On?What’s Really Going On?

OfficeCo is spending real resources OfficeCo is spending real resources merely to give outsiders the illusion of merely to give outsiders the illusion of financial stabilityfinancial stability

CFOPartners is the big winnerCFOPartners is the big winner– It put nothing at risk, and ended up with It put nothing at risk, and ended up with

$50 in cash$50 in cash– All the upside in the event that Plaza ever is All the upside in the event that Plaza ever is

worth more than $1000worth more than $1000


White Elephant Plaza and Willie White Elephant Plaza and Willie SuttonSutton

Potential AssetsPotential Assets– White Elephant Plaza no longer belongs to White Elephant Plaza no longer belongs to

OfficeCo, but it has valueOfficeCo, but it has value

– Funds were transferred out of White Elephant to Funds were transferred out of White Elephant to CFOPartnersCFOPartners

Possible RecoveriesPossible Recoveries– Bring White Elephant back into the estate, stripped Bring White Elephant back into the estate, stripped

of Bank’s liens and CFOPartners claimsof Bank’s liens and CFOPartners claims

– Recover transfers made to CFOPartnersRecover transfers made to CFOPartners


Recovering White Elephant PlazaRecovering White Elephant Plaza

Potential Theories of RecoveryPotential Theories of Recovery– Veil-piercing and alter ego actionsVeil-piercing and alter ego actions

– Substantive consolidationSubstantive consolidation

– Absence of a “true sale”Absence of a “true sale”

ProblemsProblems– Each of these theories has serious weaknessesEach of these theories has serious weaknesses

– In any event, they don’t rid us of Bank’s security In any event, they don’t rid us of Bank’s security interest or allow us to recover from CFOPartnersinterest or allow us to recover from CFOPartners


Fraudulent Conveyance Fraudulent Conveyance Recovery from CFOPartnersRecovery from CFOPartners

Step-transaction doctrine appliesStep-transaction doctrine applies– Multiple layers of entities irrelevantMultiple layers of entities irrelevant

– Orr v. Kinderhill Corp., 991 F.2d 31 (2d Cir. 1993) Orr v. Kinderhill Corp., 991 F.2d 31 (2d Cir. 1993)

We may be able to show insolvency and lack of We may be able to show insolvency and lack of reasonably equivalent valuereasonably equivalent value– Dividends of insolvent firm are fraudulent Dividends of insolvent firm are fraudulent

conveyancesconveyances

– Insolvency can be defined broadly. See In re W.R. Insolvency can be defined broadly. See In re W.R. Grace & Co., 2002 WL 1767221 (Bankr. D. Del. Grace & Co., 2002 WL 1767221 (Bankr. D. Del. 2002)2002)


Fraudulent Conveyance Fraudulent Conveyance Recovery from CFOPartnersRecovery from CFOPartners

““Badges of fraud” fraudulent conveyanceBadges of fraud” fraudulent conveyance– Proving actual fraud is unnecessaryProving actual fraud is unnecessary– Proving GAAP or violation of securities laws is Proving GAAP or violation of securities laws is

irrelevantirrelevant Potential BadgesPotential Badges

– Closeness of relationship Closeness of relationship – Retention of controlRetention of control– ConcealmentConcealment– No business justificationNo business justification


Fraudulent Conveyance Fraudulent Conveyance Recovery from BankRecovery from Bank

If a fraudulent conveyance theory can be made If a fraudulent conveyance theory can be made out against CFOPartners, history suggests that out against CFOPartners, history suggests that Bank is similarly at riskBank is similarly at risk

Mere knowledge of the transaction may be Mere knowledge of the transaction may be enough and giving reasonably equivalent value enough and giving reasonably equivalent value isn’t a defenseisn’t a defense– We can recharacterize as a transaction in which We can recharacterize as a transaction in which

Debtor gave Bank a security interest in White Debtor gave Bank a security interest in White Elephant and received nothing in returnElephant and received nothing in return

– Form of the transaction may be a one-way ratchet. Form of the transaction may be a one-way ratchet. See See In re W.R. GraceIn re W.R. Grace


The Law of Deodands and SPEs


Exodus 21:28Exodus 21:28

““If a bull gores a man or a woman to death, If a bull gores a man or a woman to death, the bull must be stoned to death, and its the bull must be stoned to death, and its meat must not be eaten. But the owner of meat must not be eaten. But the owner of the bull will not be held responsible.”the bull will not be held responsible.”


Blackstone on DeodandBlackstone on Deodand

““ByBy this is meant whatever personal chattel is the this is meant whatever personal chattel is the immediate occasion of the death of any reasonable immediate occasion of the death of any reasonable creature: which is forfeited to the king, to be applied to creature: which is forfeited to the king, to be applied to pious uses, and distributed in alms by his high almoner; pious uses, and distributed in alms by his high almoner; though formerly destined to a more superstitious purpose.though formerly destined to a more superstitious purpose.

* * * Wherever the thing is in motion, not only that part * * * Wherever the thing is in motion, not only that part which immediately gives the wounds (as the wheel which which immediately gives the wounds (as the wheel which runs over his body,) but all things which move with it and runs over his body,) but all things which move with it and help to make the wound more dangerous, (as the cart and help to make the wound more dangerous, (as the cart and loading, which increase the pressure of the wheel) are loading, which increase the pressure of the wheel) are forfeited.” forfeited.” Blackstone, Book 1, Chap. 8, XVI.Blackstone, Book 1, Chap. 8, XVI.


HR 833 (July 17, 2001)HR 833 (July 17, 2001)

Sec. 912. Asset-Backed Securitizations.


Transferred?Transferred?

‘‘‘‘(5) the term ‘transferred’ means the debtor, under a written (5) the term ‘transferred’ means the debtor, under a written agreement, agreement, represented and warranted that eligible assets were represented and warranted that eligible assets were soldsold, contributed, or otherwise conveyed , contributed, or otherwise conveyed with the intention of with the intention of removing them from the estate of the debtor pursuant to removing them from the estate of the debtor pursuant to subsection (b)(8)subsection (b)(8) (whether or not reference is made to this title (whether or not reference is made to this title or any section hereof), or any section hereof), irrespectiveirrespective and without limitation of— and without limitation of— – (A) whether the debtor directly or indirectly obtained or held an (A) whether the debtor directly or indirectly obtained or held an

interest in the issuer or in any securities issued by the issuer;interest in the issuer or in any securities issued by the issuer;– (B) whether the debtor had an obligation to repurchase or to service (B) whether the debtor had an obligation to repurchase or to service

or supervise the servicing of all or any portion of such eligible or supervise the servicing of all or any portion of such eligible assets; orassets; or

– (C) (C) the characterization of such sale, contribution, or other the characterization of such sale, contribution, or other conveyance for tax, accounting, regulatory reporting, or other conveyance for tax, accounting, regulatory reporting, or other purposes.’’purposes.’’


CommentaryCommentary

Respect True SalesRespect True Sales– True sales that are not otherwise subject to True sales that are not otherwise subject to

avoidance under the fraudulent transfer avoidance under the fraudulent transfer provisions should be respected in bankruptcy.provisions should be respected in bankruptcy.

– This is true whether the sold asset is real estate This is true whether the sold asset is real estate or a car, securities or accounts receivable.or a car, securities or accounts receivable.



Assessing Whether a True Sale Has Taken Assessing Whether a True Sale Has Taken PlacePlace– The problem that arises—and here is where asset The problem that arises—and here is where asset

securitization comes in—is that for some assets, securitization comes in—is that for some assets, the basic notion of sale can be quite tricky.the basic notion of sale can be quite tricky.

– In some versions, true sales take place, in others, In some versions, true sales take place, in others, this is much less obvious, and the essential point this is much less obvious, and the essential point here is that the basic notion of sale in these here is that the basic notion of sale in these contexts is quite difficult to apply. contexts is quite difficult to apply.



Managing UncertaintyManaging Uncertainty– How should we deal with that uncertainty, that How should we deal with that uncertainty, that

is, the uncertainty about whether the structure is, the uncertainty about whether the structure of a particular asset securitization is or is not a of a particular asset securitization is or is not a true sale?true sale?

– Current law appropriately leaves these Current law appropriately leaves these questions to judges, to be resolved under state questions to judges, to be resolved under state law, if and when a particular transaction is law, if and when a particular transaction is challenged.challenged.


HR 333 Conf Rep (7-26-02)HR 333 Conf Rep (7-26-02)

Sec. 912 Completely gone.


S. 2798/H.R. 5221 (7-25-02)S. 2798/H.R. 5221 (7-25-02)

Employee Abuse Prevention Act of 2002

To protect employees from corporate practices that deprive them of their earnings and retirement savings when a business files for bankruptcy under title 11


SecuritizationSecuritization

New Sec. 105(e)(1): “Notwithstanding any otherwise applicable provision of law, the court may recharacterize as a secured loan, a sale, lease, or transaction if the material characteristics of the sale, lease, or transaction are substantially similar to the characteristics of a secured loan.”

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