Stillwater Asset Backed Offshore Fund Ltd.

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
__________________________________________
:
In re: 	: 	Chapter 11 (Involuntary)
:
STILLWATER ASSET BACKED 	:
OFFSHORE FUND LTD. 	: 	Case No. 12-14140 (ALG)
:
Alleged Debtor. 	:
__________________________________________:
MEMORANDUM OF DECISION
APPEARANCES:
HERRICK, FEINSTEIN LLP
2 Park Avenue
New York, New York 10016
By: Arthur G. Jakoby, Esq.
Paul A. Rubin, Esq.
Frederick E. Schmidt, Jr., Esq.
Justin B. Singer, Esq.
Attorneys for Alleged Debtor,
Stillwater Asset Backed Offshore Fund, Ltd.
FOLEY & LARDNER LLP
90 Park Avenue
New York, New York 10016
By: Douglas E. Spelfogel, Esq.
Richard Bernard, Esq.
Mark J. Wolfson, Esq.
Katherine R. Catanese, Esq.
Attorneys for Petitioning Creditors
ALLAN L. GROPPER
UNITED STATES BANKRUPTCY JUDGE
On October 3, 2012, Eden Rock Finance Master Limited, f/k/a Fortis Prime Fund
Solutions Custodial Services (Ire) Ltd re KBC as G1 (ERFF) (“ERFML”), Eden Rock
Unleveraged Finance Master Limited f/k/a Fortis Prime Fund Solutions Custodial Services (Ire)
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Ltd re KBC as G1 (“ERUFML”, and together with ERFML, the “Eden Rock Petitioners”), ARP
Structural Alpha Fund, f/k/a Fortis (Isle of Man) Nominees Limited a/c 80 000 323
(“ARPSAF”), and ARP Private Finance Fund, f/k/a Fortis (Isle of Man) Nominees Limited a/c
80 000 357 (“ARPPFF”, together with ARPSAF, the Absolute Petitioners”, and collectively with
the Eden Rock Petitioners, the “Petitioning Creditors”) filed an involuntary Chapter 11 case
against Stillwater Asset Backed Offshore Fund Ltd. (“Stillwater” or the “Alleged Debtor”). On
November 7, 2012, the Petitioning Creditors filed an emergency motion, pursuant to § 303(g) of
the Bankruptcy Code, seeking the immediate appointment of a trustee to manage the Alleged
Debtor pending the entry of an order for relief. A hearing was conducted on October 12, 2012.
The motion was denied on the ground, among others, that the Alleged Debtor had not had any
ongoing business or operations for several years, and there was no showing of the need for
extraordinary relief. An order was entered on October 30, 2012, denying the motion for the
appointment of a trustee but confirming that no action out of the ordinary course would be taken
by current management without notice to the Petitioners.
The Alleged Debtor thereafter contested the involuntary petition, seeking an order,
pursuant to 11 U.S.C. §§ 105(a), 303, and 305, (i) dismissing the petition, (ii) imposing sanctions
against the Petitioning Creditors, and (iii) scheduling a damages hearing and directing the
Petitioning Creditors to post a bond pending such hearing. The Petitioning Creditors oppose this
relief, and both parties have filed voluminous papers in support of their positions. An
evidentiary hearing on the matter was conducted on December 18, 2012. Two other creditors,
who go by the name Cannonball and Cannonball II, claim to be similarly situated, and purport to
be funds holding in excess of $8.2 million of redemption claims, have filed a joinder to the
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opposition to the dismissal motion and state that they support the involuntary petition.
FACTS
The following facts were either stipulated by the parties or appear from the record of the
hearing held on December 18, 2012, and the documents admitted into evidence.
Stillwater and the Petitioning Creditors’ Investments and Redemptions
Stillwater was organized under the laws of the Cayman Islands as an offshore
“exempted” investment company. It was originally formed to invest in securities and financial
instruments, with a primary focus on loan participations consisting of the following: loans
secured by residential and commercial properties; loans to law firms working on a contingency
fee basis, secured by an interest in the potential recovery; insurance premium financial loans;
and miscellaneous loans, including corporate loans.
All of Stillwater’s investments were in the form of participation interests in assets held by
another fund, Stillwater Asset Backed Fund LP (the “Onshore Fund”), a Delaware limited
partnership also managed by Stillwater Capital Partners, Inc. (the “Asset Manager”). The Asset
Manager made all management decisions for both Stillwater and the Onshore Fund; its principals
are Jack Doueck and Richard Rudy. Stillwater’s participation interests in the investments made
by the Onshore Fund were documented in a series of substantially identical Master Loan
Participation Agreements (the “Master Loan Participation Agreements”) between Stillwater and
the Onshore Fund. All of the investments were illiquid and most required active management
and/or additional capital to maintain value.
The Eden Rock Petitioners invested more than $24 million with the Alleged Debtor and
the Absolute Petitioners invested more that $9 million. In connection with their investments, the
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1 The Certificates each confirmed that “the holder hereof is the owner of the Fund assets identified on
Schedule A hereto and assigned to you pursuant to the terms hereof.” The Share Transfer Forms each stated that
Stillwater “in satisfaction of a redemption in kind does hereby . . . transfer to the investor . . . the number of shares in
the capital of [a special purpose vehicle].”
4
Petitioning Creditors received copies of a Confidential Private Placement Memorandum (the
“PPM”), amended as of May 2005, and Stillwater’s Memorandum and Articles of Association,
amended and restated by Special Resolution dated 10 June 2005 (the “Articles”).
Like many other funds, particularly those that invested in real estate, Stillwater was hard
hit by the financial collapse in 2008. Starting in June 2008, the Petitioning Creditors, along with
many other investors, redeemed all of their investments in Stillwater (the “Redemptions). The
Petitioning Creditors’ redemptions aggregated $35,934,811.74, divided among them as follows:
$23,009,320 to ERFML; $3,603,080 to ERUFML; $5,433,318.26 to ARPSAL; and
$3,899,093.48 to ARPPFF. Stillwater does not dispute that after redemption, the Petitioning
Creditors became creditors of the Alleged Debtor in the amount of the redemptions and that,
absent payment by Stillwater, either in cash or in kind, the Petitioning Creditors would be
creditors of Stillwater with standing to commence an involuntary bankruptcy case.
The Alleged Payment to the Petitioning Creditors
Stillwater was unable to pay cash to the Petitioning Creditors or many other investors
who redeemed their shares in the aftermath of the financial crisis. On December 18, 2009,
Stillwater issued to each of the Petitioning Creditors documents, each entitled Assignment and
Participation Certificate (the “Certificates”) and Share Transfer Forms (the “Share Transfer
Forms”) on account of the Redemptions.1 It is Stillwater’s position that this constituted a
distribution in kind (“DIK”) to the Petitioning Creditors of their proportionate interest in the
participations that Stillwater, in turn, owned in the Onshore Fund’s investments. It is
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uncontested that the Certificates and the Share Transfer Forms were the only documents issued
by Stillwater in connection with the DIK. It is uncontested that the Onshore Fund never
executed or issued any documents in connection with the DIK, and the record does not disclose
that the Onshore Fund has ever recognized any rights that any of the Petitioning Creditors may
have had under the Master Loan Participation Agreements.
Notwithstanding the alleged “distribution in kind” to the Petitioning Creditors, about a
month later, on January 20, 2010, Stillwater entered into an “asset purchase agreement” with
another fund named Gerova Financial Group Ltd. (“Gerova”), a Bermuda corporation. Stillwater
sold all of its assets to or merged into Gerova (the “Gerova Transaction”) but its creditors
received no cash or other property in return (except that a substantial fee was paid to the Asset
Manager). The purpose of this transaction, according to the Alleged Debtor, was to provide
liquidity to Stillwater’s investors in the form of restricted Gerova stock that would convert, over
a six-month period, to unrestricted common shares of Gerova tradable on a public exchange.
Subsequent to the Gerova Transaction, each of the Petitioning Creditors was offered an interest
in Gerova in exchange for the assets that they had purportedly been issued in the DIK; although
it appears that many or most of the other redeeming investors accepted this proposal, the offer
was never accepted by the Petitioning Creditors. It is the Alleged Debtor’s position that
Stillwater did not sell Gerova the participation interests that had been distributed to the
redeeming creditors, or at least to the redeeming creditors like Petitioners who refused to accept
the Gerova novation; however, there is no evidence that Gerova has ever recognized the
purported interest of the minority.
According to Mr. Rudy, one of the principals of the Asset Manager, the Gerova
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2 Subsequent to the Gerova Transaction, Gerova transferred all of the real estate investment assets
previously owned by the Alleged Debtor to a Gerova affiliate, Net Five at South Beach LLC (“Net Five”) (Stip. of
Facts #31). There is no evidence Net Five has ever recognized or is even aware of the Petitioning Creditors’ alleged
ownership of an interest in those holdings, whether as a “participation in a participation” or as SPV shareholders.
Needless to say, Petitioners have never received an accounting or any proceeds related to those transactions.
3 In those proceedings, the JPL has complained that he had not received any cooperation from Gerova’s
management and had been unable to take control of Gerova’s books and records.
6
Transaction left the creditors who did not accept the novation with an illiquid participation
interest in investments once owned by the Stillwater Onshore Fund but now owned by Gerova,
but he also explained at length that he, as the Asset Manager of Stillwater, has never – despite
years of effort – been able to obtain substantial information from Gerova’s principals about the
status of the transferred investments.2 It is not disputed that the Gerova Transaction left
Stillwater without any assets whatsoever, and approximately one year after the Gerova
Transaction, Stillwater’s independent directors resigned.
The Gerova Transaction was such a fiasco in producing for Stillwater investors either
cash or a liquid security that, eventually, the Asset Manager (on behalf of itself and related
entities) and Gerova executed a Letter of Intent dated as of April 20, 2011 to unwind it (the
“Unwind”). However, the transactions related to the Unwind have never taken place, and the
possibility of a closing has been complicated by the fact that Gerova is currently subject to a
winding up proceeding in Bermuda and is ostensibly controlled by a joint provisional liquidator
(the “JPL”) appointed by the Bermuda Court. On October 22, 2012, this Court granted the JPL’s
Petition seeking recognition of the Bermuda proceedings as foreign main proceedings under
chapter 15 of the Bankruptcy Code. See In re Gerova Financial Group, Ltd., 482 B.R. 86, 96
(Bankr. S.D.N.Y. 2012). 3
On March 8, 2011, prior to the execution of the Letter of Intent for the Unwind, the Eden
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4 Eden Rock Finance Fund L.P. et al. v. Gerova Financial Group, LTD., Index No. 650613/2011.
5 In re Stillwater Capital Partners Inc. Litigation, Case No. 11 Civ. 737 (SAS), and Maurice Hanan, Albert
Chehebar, Isaac Shehebar, and Prudent Partners, LP v. Gerova Financial Group, Ltd., Stillwater Capital Partners,
LLC, Stillwater Capital Parnters, Inc., Jach Doueck, Richard Rudy, Gary T. Hirst, Michael Hlavsa, Tore Nag, Keith
Laslop, and Arie van Roon, Case No. 11 Civ. 07107 (SAS).
7
Rock Petitioners filed a lawsuit in New York state court against several defendants, including
Gerova and Stillwater (the “State Court Lawsuit”).4 On May 3, 2011, the defendants filed a
motion to dismiss the State Court Lawsuit that was denied in part and granted in part by decision
of that Court dated December 22, 2011. Separately, on March 22 and April 21, 2011, class
actions charging securities fraud were filed in the United States District Court for the Southern
District of New York against, among others, Stillwater, the Investment Manager and Gerova (the
“Stillwater Class Actions”).5 A third federal class action brought by investors in Gerova with no
connection to Stillwater has been consolidated with the Stillwater Class Actions. The parties to
the securities litigation and some of Stillwater’s and Gerova’s creditors agreed to mediate, and a
mediation before JAMS was commenced on September 20, 2011 and has been ongoing.
A mediation session was scheduled for October 4, 2012 and, prior to that date, a proposal
was distributed by the mediator to the parties. On that date, the Petitioning Creditors filed this
chapter 11 involuntary petition against Stillwater but the Eden Rock Petitioners nevertheless
participated. As of the hearing on the Involuntary Petition, the mediation was ongoing and the
parties had not come to agreement.
DISCUSSION
There is no question that the Alleged Debtor is not paying its debts as they mature. For
the purpose of the current motion, the parties stipulated that the Alleged Debtor is generally not
paying its debts as they come due (Stipulation of Facts #40), which is one of the conditions to
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6 See § 303(h), which provides, in relevant part, that where an involuntary petition is controverted, relief
can be ordered only if, among other things
(1) the debtor is generally not paying such debtor’s debts as such debts become due unless such
debts are the subject of a bona fide dispute as to liability or amount.
7 Richard Rudy, one of the two principals of the Asset Manager, testified that the goal of the ongoing
mediation is to recover Stillwater’s investments from Gerova and liquidate them with the assistance of Kinetic
Partners, which he believes is acceptable to creditors as a reputable administrator of these types of investments. The
record is not clear as to how much control Kinetics or a creditors’ committee would have over the liquidation.
8
relief under an involuntary bankruptcy petition pursuant to § 303 of the Bankruptcy Code.6 In
fact, its financial condition is far worse. It has no ongoing business, having transferred its
property to another fund named Gerova. Its only apparent goal is to unwind the Gerova
Transaction and recover its former assets from Gerova, a possibility that Gerova’s management
may have once contemplated but that is more problematic as a consequence of Gerova’s having
been placed in an involuntary liquidation proceeding in Bermuda. In any event, even if the
Alleged Debtor is successful in recovering any of its assets from Gerova, its only goal is to
liquidate them for the benefit of Stillwater’s creditors. A third party, Kinetic Partners, will have
duties of an uncertain nature, but the liquidation will seemingly be carried out by the Asset
Manager, subject to the review of a committee of creditors.7
Nevertheless, although the Alleged Debtor is defunct as an ongoing enterprise and its
only goal is to carry out an asset liquidation, its current managers vigorously resist a court-
supervised liquidation under the aegis of the U.S. Bankruptcy Code. They have raised two
defenses to the involuntary petition. First, although they admit for purposes of the instant
proceeding that the Alleged Debtor was not, on the petition date, generally paying its debts as
they come due, they assert that the debts to the Petitioning Creditors were paid in full by a
distribution to them of an alleged “distribution in kind.” This implicates the second clause of §
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303(h)(1), which provides that an entity cannot be forced into an involuntary proceeding if the
debts it is generally not paying are “subject to bona fide dispute as to liability or amount.” It
also implicates § 303(b)(1) of the Code, which provides that an involuntary petition can only be
filed, in the case of a non-partnership debtor with more than 12 creditors, “by three or more
entities, each of which is either the holder of a claim against such person that is not contingent as
to liability or the subject of a bona fide dispute as to liability or amount.” Second, it is asserted
that the Alleged Debtor is in the midst of an out-of-court workout acceptable to the “vast
majority” of its creditors, and that this Court should abstain or dismiss this case in favor of a
non-judicial alternative. For the reasons stated below, neither of these defenses can withstand
scrutiny.
Debt Subject to Bona Fide Dispute
As quoted above, § 303(b)(1) requires that a petitioning creditor hold a non-contingent
claim that is not “the subject of a bona fide dispute as to liability or amount,” and § 303(h)
provides that an entity can be placed into involuntary bankruptcy proceedings if it is not paying
its debts as they come due, “unless such debts are the subject of a bona fide dispute as to liability
or amount.” In the case at bar, it is stipulated that the Alleged Debtor is not paying its debts
generally as they come due, but it is claimed by the Alleged Debtor that the debts of the
Petitioning Creditors are the subject of a bona fide dispute. An objective test is applied to
determine whether there is a bona fide dispute. Key Mechanical Inc. v. BDC 56 LLC (In re BDC
56 LLC), 330 F.3d 111, 117 (2d Cir. 2003), abrogated on other grounds by Adams v. Zarnel (In
re Zarnel), 619 F.3d 156 (2d Cir. 2010). This formulation requires a court to “determine
whether there is an objective basis for either a factual or a legal dispute as to the validity of the
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debt.” BDC 56 LLC, 330 F.3d at 117, citing In re Busick, 831 F.2d 745, 750 (7th Cir. 1987). A
debtor’s subjective belief or intent does not satisfy its burden. Id. A bona fide dispute,
therefore, is present if “there is either a genuine issue of material fact that bears upon the
debtor’s liability or a meritorious contention as to the application of law to undisputed facts.”
Id., citing In re Lough, 57 B.R. 993, 997 (Bankr. E.D. Mich. 1986). The rationale for the
objective standard, as made clear by the legislative history, is “to disqualify a creditor whenever
there is any legitimate basis for the debtor not paying the debt, whether that basis is factual or
legal.” Id. A debtor should not be forced to pay a legitimately disputed debt or be pressured to
pay that debt by the commencement of an involuntary bankruptcy case. Id.
While a court is called upon to determine the presence of a bona fide dispute, it is not
called on to resolve such dispute. Id. This does not preclude a court, however, from addressing
the merits of a dispute, and it “may be required to conduct a limited analysis of the legal issues in
order to ascertain whether an objective legal basis for the dispute exists.” In re Rimell, 946 F.2d
1363, 1365 (8th Cir. 1991). A court may, in its discretion, hold an evidentiary hearing. BDC 56
LLC, 330 F.3d at 119. The burden of proof shifts in that the petitioning creditors must first
establish a prima facie case that there is no bona fide dispute; then the burden shifts to the
putative debtor to show the existence of such a dispute. Id. at 118.
The foregoing principles may be applied to the facts of this matter as follows. The
Alleged Debtor admits that the Petitioners, each of whom redeemed its units in the Alleged
Debtor years ago, became creditors rather than equity holders in the amounts set forth above.
See Stipulation of Facts #17 (“Absent payment by the Alleged Debtor, either in cash or in kind,
the Petitioning Creditors would be creditors of the Alleged Debtor in the foregoing amounts.”).
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There is thus no question as to “the validity of the debt.” In re BDC 56 LLC, 330 F.3d at 117.
According to the Alleged Debtor, the bona fide dispute arises out of the transmittal to these
creditors of “Assignment and Participation Certificates,” dated December 18, 2009. The
Certificates “confirmed” that the holder was the holder of the Fund assets listed on an attached
Schedule A, namely (i) 24 loan participations in investments made by the Onshore Fund and
(ii) certain shares of a new special purpose vehicle, called Stillwater AB Offshore Funding, Ltd.
(the “SPV”), “which owns membership interests in Stillwater Funding LLC (the “Law Firm
SPV”) and indirectly participates in certain loans and loan participations held by the Law Firm
SPV. . . . ” It is not contested that this document and another piece of paper that purported to be a
“Share Transfer Form” transferring to the Petitioning Creditors a certain percentage of the stock
of the SPV “were the only documents issued by the Alleged Debtor in order to effectuate the
DIK [Distribution in Kind].” Stipulation of Facts #20.
The Alleged Debtor asserts that the distribution to the Petitioning Creditors of these two
documents was authorized under the Alleged Debtor’s Articles and the governing law, and
satisfied its debt to them in full. Neither contention can be sustained.
A. The Stillwater Articles, the PPM, and Cayman law.
According to the PPM, redemptions of shares are governed by the Articles and Cayman
Island law. See PPM, p. 33 (providing that redemptions of shares were to be “in accordance with
and subject to the applicable provisions of [the Articles] and the laws of the Cayman Islands.”).
The PPM explained the right to substitute “assets in specie” for cash as follows:
The Fund may redeem Shares in cash or, in the sole discretion of the Board of
Directors, through in-kind distribution of portfolio securities, the fair market
value of which would satisfy the redemption request. PPM, p. 34.
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In the section of the Articles concerning “Redemptions,” article 46 provided:
Amounts payable to a Redeeming Shareholder in connection with the redemption
of Shares will be paid in cash (unless the Directors determine to pay the
Redemption Price (or any amount thereof) by way of delivery of assets in specie)
and normally will be posted or sent by wire transfer upon the Redeeming
Shareholder’s request and at his expense.
The PPM thus authorized the Board to redeem with “portfolio securities,” and the Articles
authorized the Directors to pay “by way of delivery of assets in specie” instead of in cash.
“Portfolio” as used in connection with “securities” has been defined as “the various
securities or other investments held by an investor at any given time.” B LACK ’ S LAW
DICTIONARY (9th ed. 2009). The “delivery of assets in specie” means delivery “in the same or
like form” or “in kind.” BLACK ’ S LAW DICTIONARY , 867 (9th ed. 2009). See also WEBSTER ’ S
THIRD NEW I NTERNATIONAL DICTIONARY 2187 (1st ed. 1981) (defining the phrase “in specie” as
“in the identical form and without alteration or substitution”). Instead of the delivery of a
security that the Alleged Debtor held in its portfolio, or even something that could be called an
“asset in specie,” the Petitioning Creditors received an equity interest in (i) a new fund set up to
hold some of the investments made by the Alleged Debtor and (ii) an undivided interest in the
Alleged Debtor’s participations in some of the investments made by the Onshore Fund.
As to the interest in the SPV, the Petitioning Creditors had, at most, no more than they
had before – a claim against assets of the Alleged Debtor for amounts owed them on account of
their redemptions. In a letter to redeeming investors in July 2009, Stillwater management
described a proposed payment in kind option then being discussed (the creation of a special
purpose vehicle to hold all of Stillwater’s assets) and admitted: “[i]t will resemble and feel like
being invested in the main fund (just like you originally were), except that the PIK vehicle will
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return any and all money (after loan servicing and protection of existing collateral) to redeemed
investors as capital comes back in.” Pet. Ex. 38, p.2. The creation of a SPV to liquidate assets is
merely the dedication by an existing debtor of its assets to the payment of debts, not an actual
payment of debt by way of “portfolio securities, the fair market value of which would satisfy the
redemption request,” or the “delivery of assets in specie.”
Similarly, the proposition cannot be sustained that the Petitioning Creditors received
portfolio securities or “a distribution in kind” by the transmittal of a piece of paper that
purported to give them a slice of some of the Alleged Debtor’s investments. Indeed, as holders
of a purported investment slice, the Petitioning Creditors seemingly had less than they would
have had as creditors of Stillwater. In a letter to Redeeming Creditors dated December 11, 2009
(the “December 2009 Letter”), seven days before the so-called distribution, Mr. Rudy wrote that
creditors who did not choose the alternative “SPV Option” would receive “a pro rata interest in
such Fund assets equal to the aggregate redemption payment due to such Redeemer.” Pet. Ex.
33, p. 2. It warned, however, that
Fund Assets distributed pursuant to the Direct Asset Option will not be managed
by the Investment Manager, and, as such, Redeemers choosing this option . . . will
be responsible for all administrative and management functions with respect to
such Fund Assets.
. . . Redeemers will have to make their own decision whether to fund additional
advances to preserve the value of assets and underlying collateral without the
benefit of the Investment Manager’s expertise and of the potential availability of
reserves attributable to management of the SPV. If Redeemers electing the Direct
Asset Option do not make such additional follow on advances required from time
to time to preserve asset values and to meet anticipated and actual expenses and
liabilities associated with distributed Fund Assets, such Redeemers may see their
ultimate realization from those assets decline. . . .
Pet. Ex. 33, pp. 2-3.
The December 2009 Letter informed redeemers of some of the problems with the
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distribution but apparently did not inform the Redeeming Creditors that the Alleged Debtor had
no authority in any event to distribute a slice of its investments in the Onshore Fund. The Master
Loan Participation Agreements between the Alleged Debtor and the Onshore Fund provided that
the Alleged Debtor’s participations could “not be divided, sub-participated or fractionalized by
the Participant [the Alleged Debtor] in any manner.” Pet. Ex. 4, § 2.2. Section 7.5 of the Master
Agreement provided that “any disposition of any interest in this Agreement or in the
Participation Interest in violation of any of the provisions hereof shall confer no rights on the
transferee.” Taking the documents at face, after the alleged “distribution in kind” of a slice of
Stillwater’s investments in the Onshore Fund, the Petitioning Creditors had no rights at all in the
allegedly transferred assets.
Furthermore, within a month of the purported “distribution in kind,” the Petitioning
Creditors’ position was further undermined. On January 20, 2010, about a month after the
alleged DIK, Stillwater merged with and transferred control over its assets to Gerova, previously
known as Asia Special Situation Acquisition Corp. Although many of Stillwater’s redeeming
creditors accepted an offer to become holders of a Gerova security, the Petitioning Creditors did
not. At best, therefore, they became holders of (i) a minority putative equity interest in
investments now controlled by another entity that, according to Mr. Rudy, has refused to provide
information about the investments even to Stillwater management; and/or (ii) a slice of
investments previously owned by the Onshore Fund and now owned by Gerova, which slice was
assigned in violation of the Onshore Funds’ Master Participation Agreement and has never been
recognized by Gerova. According to the Alleged Debtor, the foregoing legerdemain paid the
Petitioning Creditors in full and has left them only with a claim against Gerova. The Alleged
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Debtor states in its papers to this Court
It is indeed unfortunate that the Petitioning Creditors have not yet received any
proceeds from the DIK Asset Slices. But, to the extent that any proceeds of those
assets have been converted, as suggested by the Petitioning Creditors, their claim
would likely be against Gerova, whose chapter 15 case is currently pending
before this Court, not the Alleged Debtor.
Alleged Debtor’s Reply Memo (¶ 58).
The question is thus whether the transmittal of a piece of paper that purports to pay a
redeeming creditor an undivided percentage of some of the debtor’s assets collected into a
special purpose fund, and a slice of other assets that could not by their terms be further sub-
divided, satisfied, under Cayman law, a requirement that the creditor receive payment in full in
portfolio securities or in specie. In another case in which a Cayman fund attempted to carry out
a similar scheme, the answer was clearly in the negative. In In re FIA Leveraged Fund, (April
18, 2012) No. FSD 0013 of 2012 at p. 26-28 (ASCJ) (Cayman Is.), another Cayman-based fund
disputed an involuntary petition filed by redeeming creditors and claimed that the creditors had
been paid in specie as permitted under the Articles, or at least that there was a “genuine” dispute
regarding payment that would constitute a defense to the involuntary petition under Cayman law.
Even though the Articles of the fund in that case gave the fund’s board “sole discretion” to
determine the value of the assets to be distributed, the Cayman Chief Justice determined that the
redeeming creditors had not received a distribution of securities “in specie” or indeed any value
at all by the transfer of a wholly illiquid, purported interest in other assets of the fund. The Court
held that the offering memorandum there did not give the directors the absolute right to redeem
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8 The FIA Leveraged Fund decision is Ex. R to Docket entry No. 38, Exhibits to Petitioning Creditors’
Objection to Motion to Dismiss. The decision is apparently now on appeal.
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with assets that were commercially worthless. 8 The Alleged Debtor attempts to distinguish FIA
on the ground that, in that case, the distribution was of an interest in an option that would be
worthless absent the payment of a costly exercise price, and that the FIA fund cherry-picked
assets. Reply ¶ 72. There is ample evidence in this case that the assets allegedly distributed to
the Petitioning Creditors require substantial investment and management to have or retain any
value. Moreover, although the Alleged Debtor may not have cherry picked assets, it divested
itself of all of its assets within a month of its distribution to redeeming creditors, thereby
purporting to leave the Petitioning Creditors as creditors of Gerova whom Gerova has never
recognized.
The Petitioning Creditors have adequately borne their burden of demonstrating that the
alleged distribution in kind was not effective, under governing Cayman law, in satisfying the
debt to the Petitioners, in whole or in part, by transmittal of portfolio securities or assets in
specie.
B. The Bankruptcy Code
Under these circumstances, there is no objective basis for concluding, under U.S. law,
that the debt to the Petitioning Creditors is subject to bona fide dispute within the meaning of
§ 303 of the Bankruptcy Code. The conclusion here is the same as in In re Paper I Partners,
L.P., 283 B.R. 661 (Bankr. S.D.N.Y. 2002), where involuntary petitions were filed in New York
against limited partnerships, one of which was formed under the laws of the Turks and Caicos
Islands, B.W.I. The putative debtors asserted that their debts to the petitioning creditors had
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9 It is also irrelevant that the New York Court denied Eden Rock’s motion for a temporary receiver of
Gerova’s business and assets on the ground that it had not made a clear “evidentiary showing” that such “drastic”
relief was “necessary for the protection of the parties” and avoidance of “irreparable loss.” Decision of Hon.
Bernard J. Fried, Eden Rock Fin. Fund L.P. et al. v. Gerova Financial Group Ltd, et al. As mentioned above, this
Court also denied Petitioners’ motion for an interim trustee on the ground they had not shown the need for such
extraordinary relief. Neither decision is probative of the question whether there is a bona fide dispute as to
17
been satisfied by the issuance of a “promissory security” entitling the creditors to a future
payment, and that this was authorized by the debtors’ charters. The Court rejected the
contention that a bona fide dispute as to payment could be created under § 303 by the transfer of
an illiquid promissory security that gave the creditor no more than it already had – its
proportionate share of an interest in the debtor’s assets.
The Alleged Debtor also observes that the Eden Rock Petitioners brought a lawsuit in
New York State court, individually and derivatively, against Stillwater, Gerova and certain of
their principals, and that judgment has never been entered for the Eden Rock Petitioners against
Stillwater. The fact that litigation is ongoing related “to a petitioning creditor’s claim is
insufficient to rebut its prima facie validity.” See In re Vitaminspice, 472 B.R. 282, 293 (Bankr.
E.D. Pa. 2012), citing In re Red Rock Rig 101, Ltd., 397 B.R. 545 (10th Cir. BAP 2008); see also
In re AMC Investors, LLC., 406 B.R. 478, 486 (Bankr. D. Del 2009) (holding that there is no
requirement that a petitioning creditor obtain a state-court judgment in order to have standing to
file an involuntary petition under § 303 of the Bankruptcy Code). Moreover, the Eden Rock
lawsuit asserted claims sounding in fraud as well as contract, and the principal action bearing on
the instant case was the New York court’s refusal to dismiss the contract action brought by the
Eden Rock Petitioners against Stillwater. The failure of the Petitioning Creditors to obtain
judgments against Stillwater does not, alone, provide an objective basis for concluding that their
debts are subject to bona fide dispute.9
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Stillwater’s payment of its debt to Petitioners.
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Abstention
The Alleged Debtor also maintains that the Court should exercise its discretion to abstain
or dismiss the involuntary petition pursuant to § 305(a)(1) of the Bankruptcy Code. Section
305(a)(1) of the Bankruptcy Code provides that
[t]he court, after notice and a hearing, may dismiss a case under this title, or may
suspend all proceedings in a case under this title, at any time if –
(1) the interests of creditors and the debtor would be better served
by such dismissal or suspension.
There is no question that § 305(a)(1) “was designed to be utilized where, for example, a few
recalcitrant creditors attempted to interfere with an out-of-court restructuring that had the
support of a significant percentage of the debtor’s creditors.” See In re Board of Directors of
Multicanal S.A., 314 B.R. 486, 522 (Bankr. S.D.N.Y. 2004), citing H.R.Rep. No. 95-595, 95th
Cong., 1st Sess. 325 (1977); S.Rep. No. 95-989, 95th Cong. 2d Sess. 35 (1979); and In re Wine
& Spirits Specialties of Kansas City, Inc. 142 B.R. 345, 347 (Bankr. W.D. Mo. 1992). There is
also no question that abstention may be proper where, as here, the debtor is an entity formed
under the laws of, or doing business in, a foreign country. See GMAM Investment Funds Trust I
v. Globo Comunicacoes e Participacoes S.A. (In re Globo Comunicacoes e Paricpiacoes S.A.),
317 B.R. 235, 255-257 (S.D.N.Y. 2004) (where the court sustained the involuntary petition
against a foreign entity but suggested that abstention pursuant to § 305 might be proper if it
would further the interests of debtor and creditors and it were established that there was an out of
court restructuring satisfactory to the vast majority of creditors).
The record on these motions does not establish that these salutary provisions should be
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19
applied in this case. In the case at bar, the workout relied upon by the debtor is a mediation,
conducted in connection with class action litigation that may be most deeply concerned with
rights to existing insurance policies. There has been no proof that the mediation is nearing a
conclusion, or that the Gerova liquidator or the court in Bermuda with jurisdiction over the
Gerova liquidation will accept its results, if there ever are any results. The Alleged Debtor
asserts that the “vast majority” of its creditors are supportive of the mediation, but it also claims
that all or nearly all of its creditors except the Petitioners and Cannonball accepted the proposal
to become creditors of Gerova. The only remaining creditors of Stillwater may be those
supportive of the instant involuntary petition. In any event, one goal of the mediation appears to
be the Unwind of the Gerova Transaction, and if this is to take place, it would be very useful for
the Stillwater estate representative to be armed with the avoidance and related powers of a U.S.
bankruptcy trustee.
Both parties appear to assume that after an order for relief, there would be the
appointment of an independent trustee for Stillwater – the Petitioners assume that one is
necessary and the Alleged Debtor argues that a trustee would impede or preclude a workout of
the type contemplated by the mediation. However, the Petitioners filed an involuntary chapter
11 case. The appointment of a trustee in an involuntary chapter 11 case does not appear to be
automatic even after the entry of an order for relief. See 2 COLLIER ON BANKRUPTCY ¶ 330.29
(16th ed. 2012). The parties have leave to argue this issue further; however, there is no reason to
conclude that the appointment of a trustee for the Stillwater creditors would necessarily make the
mediation more problematic, rather than providing the Stillwater creditors the same type of
independent representation that the Gerova creditors already have.
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Other Relief
It follows from the above that the Alleged Debtor is not entitled to sanctions against the
Petitioning Creditors or to damages on account of the filing of an improvident involuntary
petition.
CONCLUSION
The Petition is granted. The Petitioning Creditors are directed to settle an order on five
days’ notice to the Alleged Debtor’s counsel and to the United States Trustee. The parties
should address the type of relief sought in connection with the form of order to be settled,
including the question of the appointment of a chapter 11 trustee. The Court will hold a further
hearing on this issue if requested by either party.
Dated: New York, New York
January 17, 2013
s/Allan L. Gropper
UNITED STATES BANKRUPTCY JUDGE
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