In the November 1, 2016 edition of the Delaware Business Court Insider, LRC partner Matt McGuire writes on how ‘Arctic Glacier’ Highlights Conflict Between Two Federal Regulations.
‘Arctic Glacier’ Highlights Conflict Between Two Federal Regulations
By Matthew B. McGuire
In Zardinovsky v. Arctic Glacier Income Fund (In re Arctic Glacier Int’l, Inc.), Case No, 12-10605 (KG) (Bankr. D. Del. July 1, 2016), Judge Kevin Gross of the U.S. Bankruptcy Court for the District of Delaware held that when a confirmed plan of reorganization’s distribution procedures to equity security holders conflicts with existing distribution protocols and rules promulgated by the Financial Industry Regulatory Authority (“FINRA”), the provisions of the confirmed plan supersede such existing FINRA regulations. In doing so, the Court in Artic Glacier highlighted a subtle, yet important, potential conflict between the provisions of two federal statutory and regulatory regimes designed to provide for the orderly distribution of a company’s dividend proceeds to its equity security holders.
- Contrast Between Distributions under the Bankruptcy Code and FINRA Rules
Federal Rule of Bankruptcy Procedure 3021 (“FRBP”) generally provides that following confirmation of a plan, distributions from a debtor’s estate will be made to creditors and security holders of record as of the date the distribution is made unless a different date is selected through a confirmed plan. As the advisory committee noted when drafting the 1997 amendments to FRBP 3021, “it may be impractical for the debtor to determine the holders of record with respect to publicly held securities and also to make distributions to those holders at the same time … [and as a result] the plan or the order confirming the plan may fix a record date for distributions that is earlier than the date on which distributions commence.” Fed. R. Bankr. P. 3021, advisory committee’s note to 1997 amendment.
Outside of a bankruptcy proceeding, distributions to equity security holders in the secondary securities markets are governed by the FINRA Uniform Practice Code (“UPC”). The UPC material differs from the FRBP 3021 concept of record date in that it defines two relevant milestone dates when determining the rights of security holders to receive distributions: the “Record Date” and “Ex-Dividend Date.” Under the UPC, the “Record Date” is the date established by the issuer of the underlying security (with FINRA approval) for determining which holders of securities are entitled to receive distributions. The “Ex-Dividend Date” is the date on and after which the security is traded without a specific dividend or distribution. See FINRA Uniform Practice Code 11120. As a result, beginning on the “Ex-Dividend Date” the underlying security will generally trade at a discount proportional to the amount of the distribution being paid to the holder by the issuer.
The UPC further delineates the distribution rights of equity security holders based upon the amount of the distribution relative to the value of the underlying security. In those instances where the value of the distribution is less than 25% of the value of the underlying security, the “Ex-Dividend Date” is two business days preceding the “Record Date.” However, if the value of the distribution is greater than 25% of the value of the underlying security, the “Ex-Dividend Date” is one day immediately following the date when the distribution is made and is not tied to the “Record Date.” In the later such scenario, when an owner of a security sells the security after the “Record Date” but prior to the “Ex-Dividend Date,” the seller will be entitled to receive the distribution and then be obligated to pay over to the party that acquired the security prior to the “Ex-Dividend Date.” NASD Notice to Members 00-54.
The distribution rules set forth in the FRBP and UPC generally allow for the orderly distribution of dividends and other rights to equity security holders in bankruptcy proceedings and the secondary securities markets, respectively. In some cases however, the Bankruptcy Code and UPC come into direct conflict. Judge Gross addressed just such an issue in Artic Glacier.
- Arctic Glacier Decision
In Artic Glacier, the Court considered the conflict between a bankruptcy plan set record date and the UPC in the context of a post-petition complaint initiated by investors against a debtor alleging, among other things, breach of fiduciary, negligent misrepresentation and violations of certain US securities laws for the failure to make property distributions to equity security holders under a confirmed plan of reorganization.
In February 2012, Artic Glacier Income Fund (the “Debtor”) initiated proceedings in Canada under the Companies’ Creditors Arrangement Act (the “CCAA”); the Debtor contemporaneously commenced ancillary proceedings under Chapter 15 of the Bankruptcy Code in the Bankruptcy Court. The Debtor obtained approval of its plan from the Canadian Court and the order approving the Debtor’s CCAA plan (the “Sanction Order”) was subsequently recognized by the Bankruptcy Court on September 16, 2014.
The Debtor’s plan did not contain a mechanism for making distributions to equity security holders based on the size of the distribution relative to the value of the Debtor’s equity securities then trading in the OTC market. Rather, the plan required the CCAA monitor to declare a “Unitholder Distribution Record Date” that was at least 21 days prior to the contemplated distribution to equity unitholders. The plan further provided that the CCAA monitor was exclusively authorized to administer the plan and distribute funds to the equity unitholders free of any interference from any person including governmental authorities and agencies.
The Court also recognized that the plan and UPC were fundamentally at odds with one another with respect to notification requirements. The plan contained no notice requirements, absent setting of the “Unitholder Distribution Record Date” and did not require the CCAA monitor to observe any authority other than the CCAA and plan. The UPC requires that issuers of securities notify FINRA of the proposed Record Date and seek approval of same.
The CCAA monitor set the Unitholder Distribution Record Date for December 18, 2014 and subsequently made distributions on January 22, 2015 to unitholders of record as of December 18, 2014. The plan monitor did not notify FINRA of the proposed record date nor did FINRA set an Ex-Dividend Date.
Plaintiffs began acquiring the Debtor’s equity securities through the OTC market shortly before the Unitholder Distribution Record Date and continued purchasing securities through the date the distributions were made pursuant to the plan. Among other things, the plaintiffs alleged that the Debtor and CCAA monitor could only pay dividends with FINRA approval and those dividends could only be paid to those holders FINRA would recognize as having the right to receive the distributions.
The Bankruptcy Court rejected all of plaintiffs’ arguments and granted the motion to dismiss the complaint. As a threshold matter, the Bankruptcy Court concluded that under principles of res judicata, a confirmed plan, unless procured by fraud, supersedes all other applicable law, including applicable non-bankruptcy law. As the Bankruptcy Court noted, “the Plan’s distribution procedure is an adjudication and to the extent that there is a conflict between that adjudication and the FINRA Rules, the plan will superseded.” Arctic Glacier, at *13.
The Bankruptcy Court also rejected several other proposals from the plaintiffs that they alleged would have harmonized the plan with the UPC. Because the distribution made by the Debtor amounted to 75% of the value of the securities, UPC Rule 11140(b)(2) – which would have provided for an “Ex-Dividend Date” of January 23, 2015, one day after the payable date of January 22, 2015 – was in direct conflict with the plan’s requirement that the Unitholder Distribution Record Date occur at least 21 days prior to the date of the distribution. To address this conflict, the plaintiffs argued that the Debtor and plan monitor could have separated the distribution into multiple tranches so as to avoid falling under the construct set forth in UPC Rule 11140(b)(2). The Bankruptcy Court rejected this approach and held that doing so would violate the terms of the plan because the plan had distribution procedures in effect without regard for the size of the distribution to be made. Accordingly, accepting such an alternative approach would have impermissibly modified the plan’s distribution procedures. Finally, the Bankruptcy Court rejected the plaintiffs’ proposal that the Debtor and plan monitor be required to make distributions under both the plan and applicable UPC Rules, even if that resulted in certain equity holders being paid twice. The Bankruptcy Court stated that any such requirement would result in an impermissible modification to the confirmed plan. The Bankruptcy Court concluded that, in this case, the UPC rules were not concurrent and additional obligations, but rather conflicting provisions and the plan monitor was “obligated to follow the Plan’s distribution procedures and eschew any conflicting procedure, such as that provided in the FINRA Rules.” Arctic Glacier, at *16.
Trading in securities of a distressed company is inherently a risk filed endeavor. Those who trade and speculate in the equity securities of companies involved in court supervised insolvency proceedings generally are afforded the comfort that their trades in the OTC market will be processed and settled in accordance with the applicable UPC rules and regulation. In this regard, the UPC and FINRA oversight of the secondary OTC markets provides a valuable benefit to the markets in that they provide for a structured venue for the trading and settlement of these sometime illiquid securities. Regardless, the holding in Arctic Glacier makes clear, to the extent that it was not already clear, that the usual ground rules for trading and capitalizing on these trades can be modified by a debtor with those new ground rules sanctioned and approved by the bankruptcy court.
Matthew B. McGuire is a partner at Landis Rath & Cobb where he concentrates his practice in the areas of corporate bankruptcy and restructuring. He can be contacted at 302-467-4416 or at firstname.lastname@example.org
Reprinted with permission from the November 1, 2016 issue of the Delaware Business Court Insider. © 2016 ALM Media Properties. Further duplication without permission is prohibited.