Chapter 11 as a Safe Place
from January/February 2003
by John R. Engen
Troubled InterBank Funding Corp. may have hit upon an artful way to keep regulators at bay: head for U.S. bankruptcy court. The privately held investment company filed for Chapter 11 protection in June, when it became clear that the Securities and Exchange Commission was intent on turning an investigation of IBF into an enforcement action that could empower a trustee to liquidate its assets. The filing not only forestalled that possibility but has also given CEO Simon Hershon time to try to get IBF back on its feet.
Is this a strategy that other besieged companies might want to adopt? Lynn LoPucki, a UCLA law professor and bankruptcy expert, thinks so. He notes that Chapter 11 freezes other legal actions against a company and gives the bankruptcy court jurisdiction over its assets. Since bankruptcy courts rarely appoint trustees who might push to sell everything, he says, that “makes them a great refuge.”
It’s no surprise that IBF, which calls Washington, D.C., home, went to New York for protection. The New York court has made a name for itself as “management-friendly,” LoPucki says. Among the more notable examples: its denial of creditors’ motions to move the Enron case to a Houston court and to appoint a trustee. “You’re seeing companies flocking to New York from all over the U.S.,” says LoPucki.
IBF attorney Andrew Weissman, a Washington-based partner with Wilmer Cutler & Pickering, takes a different view. He says the New York court has the most experience in dealing with “sophisticated bankruptcies.” And bankruptcy court is where he’d like the case to stay. A fire-sale liquidation of IBF’s assets by a trustee would most likely net 20 cents on the dollar, Weissman says—a “disaster” for the firm’s 3,100 investors. Better, he argues, to let the experienced court oversee a reorganization, with Hershon’s input.
All of which doesn’t sit well with the SEC. In a civil suit filed in U.S. district court, it alleges a variety of misdeeds, including Hershon’s “routinely” moving “tens of millions of dollars” between IBF and related funds to meet cash-flow needs without disclosing that to investors. The Chapter 11 filings, the suit says, were a deliberate attempt “to avoid having a federal district court impose a trustee” on IBF’s operations. “I can’t say it was the primary purpose [of the bankruptcy filing],” counters Richard Kraut, a Washington partner with Dilworth Paxson who represents Hershon. “But it certainly was one of the effects.”
LoPucki says that even if a district court decides it has jurisdiction, it will often turn that over to the bankruptcy court, which he calls “a central clearinghouse” for solving messy situations. “It’s not just what can be legally done. It’s what the people in the system are likely to do,” he says.
The SEC could also persuade the bankruptcy court to order a trustee for IBF, as it could for any other company in Chapter 11. “But if it’s a close case, a New York bankruptcy judge is much more likely to side with management,” says LoPucki.
So far, no date has been set for the hearings.
