Friday, August 17, 2007

Bear Stearns Hedge Funds File Cayman Insolvency Proceedings and U.S. Chapter 15 Cases

On July 31, 2007, two Bear Stearn's hedge funds filed insolvency petitions in the Grand Court of the Cayman Islands. The two funds, which were limited liability companies organized and incorporated in the Cayman Islands, were the Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd. ("High-Grade Fund") and the Bear Sterns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd. ("Enhanced Fund"). In their petitions to the court, they pled that they were insolvent and unable to pay their debts as they fell due. They requested that they be "wound up" by the court under the provisions of the Cayman Island's Companies Law. The court appointed Joint Provisional Liquidators ("JPLs") with various powers, including to take control of the funds' assets and books and records. Some commentators have expressed concern that the proceedings of the Cayman Court will prove less transparent than would a proceeding in a U.S. Court and that the Cayman Judges have a track record highly favorable to incumbent management.

The hedge funds were open-ended investment companies and intended to invest in various investments, including asset-backed securities, synthetic asset-backed securities, mortgage-backed securities, derivatives, options, swaps, and futures. Bear Stearns Asset Management, Inc. ("BSAM") was the investment manager of the funds. Following volatility in the U.S. subprime lending market in early 2007, the funds began to suffer a significant devaluation of their asset portfolios which led to margin calls from many of its trading counterparties which the funds were unable to meet. This led to default notices by these counterparties and their exercise of rights to seize and/or sell assets that were subject of repurchase agreement or over which they held security agreements. Subsequent events led to further downward pressures and deterioration.

On July 17, 2007, the funds were reported to have sent a letter to their investors advising them of the "increasingly difficult market conditions." On July 25, 2007, the JPLs of the High-Grade Fund and Enhanced Fund filed Chapter 15 petitions pursuant to section 1504 and 1515 commencing Chapter 15 cases in the U.S. Bankruptcy Court for the Southern District of New York in cases 07-12383 and 07-12384 respectively. These Chapter 15 cases were ancillary to the Cayman Island's proceedings and sought recognition of the Cayman proceedings as a "foreign main proceeding" pursuant to section 1502(4). The effect of the Chapter 15 cases will be based on whether the Cayman foreign proceedings are each determined to be a "foreign main proceeding" or a "foreign nonmain proceeding." This is based on a determination by the court whether the debtor's "center of main interests" ("COMI") is in the jurisdiction where the foreign proceeding was commenced. There is a presumption that a debtor's COMI is its place of incorporation, but this presumption can be rebutted.

Chapter 15 is the U.S. adoption of the model law on cross-border bankruptcies proposed by the United Nations Commission on International Trade Law. The law generally mandates the cooperation of the U.S. bankruptcy courts with those of foreign jurisdictions.

The funds both filed motions for a temporary restraining orders and preliminary injunctions staying execution and litigation against the funds and further sought to entrust the funds assets to the JPLs. The funds pled to the court that the relief sought would avoid piecemeal distribution of its assets and provide "breathing-room" necessary to conduct an orderly review and wind-up of the funds' affairs so that their creditors would receive equitable treatment.
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