On August 28, 2012, the United States District Court for the Northern District of Texas vacated a series of bankruptcy court rulings that had blocked Vitro SAB’s noteholders from filing involuntary bankruptcy petitions against Vitro’s non-debtor subsidiary guarantors. In a decision authored by Chief Judge Sidney A. Fitzwater, the District Court struck down two of the subsidiary guarantors’ most important affirmative defenses to the involuntary bankruptcy, holding that petitioning creditors’ guaranty claims were not contingent and the subsidiary guarantors were not generally paying their debts as they came due. Knighthead Master Fund, L.P. v. Vitro Packaging LLC (In re Vitro Asset Corp.), No. 3:11-CV-263-D (N.D. Tex. Aug. 28, 2012). This marks another major victory for Vitro noteholders, who – as reported by Restructuring Review here – just weeks ago persuaded the Bankruptcy Court for the Northern District of Texas not to enforce a Mexican plan of reorganization that purported to release Vitro’s non-debtor subsidiaries of the same guaranties at issue in the District Court’s decision.
Like almost every important decision in the Vitro cases, the District Court’s ruling on the noteholders’ involuntary bankruptcy petitions was the product of a complex procedural history involving many twists and turns.
The main debtor in the case, Vitro SAB, is a holding company organized under the laws of Mexico that conducts substantially all of its multinational operations through various subsidiaries. Together with its subsidiaries, Vitro serves as the largest manufacturer of glass containers and flat glass in Mexico. In 2008, in the wake of the global financial crisis, Vitro became unable to service the interest payments on several series of notes it had issued in 2003 and 2007. All of Vitro’s wholly-owned direct and indirect subsidiaries had guarantied the notes. On November 17, 2010, a number of United States-based investment funds that held Vitro notes filed involuntary chapter 11 petitions against fifteen of Vitro’s United States subsidiaries in the Bankruptcy Court for the Northern District of Texas. Several of these subsidiaries ultimately consented to chapter 11 relief, but the remaining subsidiaries continued to resist the involuntary petitions.
The remaining subsidiary guarantors answered the involuntary petitions and asserted a number of affirmative defenses rooted in section 303 of the Bankruptcy Code, which establishes the requirements for commencing an involuntary chapter 11 case. Under section 303, a creditor bringing an involuntary petition must generally hold a non-contingent claim that is not the subject of a bona fide dispute (section 303(b)(1)) and must usually satisfy at least one of two enumerated grounds for relief, the first being that the alleged debtor is generally not paying its debts as they come due (section 303(h)(1)). The subsidiary guarantors argued that the noteholders failed to satisfy sections 303(b)(1) and (h)(1). Specifically, the subsidiary guarantors contended that the noteholders’ claims were contingent because, under the terms of the governing indentures, the subsidiaries’ guaranty obligations did not arise until the noteholders made a demand for payment. Additionally, the subsidiary guarantors argued that, notwithstanding their failure to honor the guaranty obligations, they were generally paying their debts as they came due because they were continuing to pay their trade creditors in the ordinary course of business.
In March and April 2011, Judge Russell F. Nelms of the Bankruptcy Court for the Northern District of Texas held a trial on the involuntary petitions. At the beginning of the trial, Judge Nelms ruled against the subsidiary guarantors on the contingent liability issue, finding that the indentures expressly waived any requirement that the noteholders make a demand for payment. The subsidiary guarantors objected to this ruling on due process grounds, asserting that in addition to filing their own pretrial brief, they should have been given an opportunity to respond to the noteholders’ pretrial brief. In response to these objections, Judge Nelms declared his findings on the contingent liability issue to be “preliminary” and allowed the subsidiary guarantors to address the issue at length during the trial. Apparently believing that Judge Nelms would not depart from his preliminary ruling, the noteholders did not present extensive arguments on the contingent liability issue at trial. To the noteholders’ surprise, however, Judge Nelms reversed his initial ruling in response to the subsidiary guarantors’ subsequent arguments, and also ruled for the subsidiary guarantors with respect to their section 303(h)(1) affirmative defense. Accordingly, the Bankruptcy Court denied the noteholders’ involuntary bankruptcy petitions.
Shortly after the trial, Judge Nelms became ill, and the case was transferred to Judge Harlin D. Hale, the same judge who would later refuse to enforce Vitro’s Mexican plan of reorganization. The noteholders subsequently brought motions to alter Judge Nelm’s rulings. Judge Hale issued an order implying that he would have reached a different result than Judge Nelms. However, to overturn Judge Nelms’ rulings at this procedural stage, Judge Hale would have needed to find that the rulings constituted a “manifest error of law.” Judge Hale could not make this finding based on the record before him, and accordingly, denied the motions to alter. The noteholders then appealed to the District Court.
The District Court confronted two issues on appeal – whether Judge Nelms had committed clear error in finding that (i) the subsidiaries’ guaranty obligations were contingent as to liability and (ii) the subsidiaries were generally paying their debts as they came due. The District Court ultimately concluded that Judge Nelms had, in fact, clearly erred on both issues.
With respect to the contingency of liability issue, the court found that the guaranty obligations established by the governing indentures were unconditional and absolute. The Court began by acknowledging that one provision in the indentures, which stated that “[u]pon failure by [Vitro] to pay . . . , each Guarantor shall forthwith on demand pay the amount not so paid at the place and in the manner specified in the Indenture,” could be interpreted as creating a demand requirement. However, the Court ultimately concluded that this language did not give rise to a demand requirement, finding instead that the language merely required the subsidiary guarantors to pay upon demand but did not make demand a precondition to payment.
The Court also analyzed the effect of a waiver provision in the indentures. Applying a standard rule of contract interpretation known as the “last antecedent rule,” the Court determined that the waiver provision overrode any demand requirement the indentures might otherwise contain. The last antecedent rule provides that a limiting clause or phrase should ordinarily be read as modifying only the noun or phrase that it immediately follows. An exception to this rule occurs when a modifier is set off from a whole series of antecedents by a comma, in which case the modifier should be read to apply to each of those antecedents. Where a comma is not used to set off the modifier, however, the lack of a comma constitutes confirmation that the modifier applies only to the last antecedent. The waiver provision in the indentures was punctuated as follows:
Each Guarantor irrevocably waives acceptance hereof, presentment, demand, protest and any notice not provided for herein, as well as any requirement that at any time any action be taken by any Person against [Vitro SAB] or any other Person.
The limiting phrase at issue was “not provided for herein,” and the question before the Court was whether this phrase applied to all of the preceding nouns, including “demand,” in which case the subsidiary guarantors would have waived only a demand requirement not provided for in the indentures themselves, or whether the phrase instead applied only to its immediate antecedent, “notice,” in which case the guarantors would have waived all demand requirements, including those contained elsewhere in the indentures. Because the limiting phrase “not provided for herein” was not set off from its antecedents by a comma, the last antecedent rule dictated that this phrase applied only to its immediate antecedent, “notice,” and not to the earlier antecedent “demand.” Accordingly, the Court concluded that the subsidiary guarantors had waived all demand requirements, including any demand requirement supposedly contained in the indentures. Because the indentures waived demand, the District Court ruled that the Bankruptcy Court had erred in finding that the subsidiaries’ guaranty obligations were contingent.
With respect to the issue of whether the subsidiary guarantors were generally paying their debts as they came due, the District Court applied a four-factor test from In re Moss, 249 B.R. 411, 422 (Bankr. N.D. Tex. 2000). Pursuant to Moss, courts must consider (i) the number of unpaid claims, (ii) the amount of such claims, (iii) the materiality of the non-payments, and (iv) the alleged debtor’s overall conduct of its financial affairs. Applying this test to the subsidiary guarantors, the Court found it significant that the guaranty obligations under the Vitro notes constituted approximately 99.9% of the total debt for each subsidiary guarantor. The Court cited to recent persuasive authority for the proposition that an alleged debtor may not be generally paying its debts as they come due if it is “not paying one hundred percent of [its] debts to only one creditor, or paying most of [its] debts in number to small recurring creditors, but is not paying a few creditors that make up the bulk of [its] debts,” and concluded that the subsidiary guarantors “easily fell within the second category.” Accordingly, the District Court held that the subsidiaries were not generally paying their debts as they came due, vacated Judge Nelms’ rulings, and remanded to the Bankruptcy Court for further proceedings consistent with its opinion.
Although the District Court did not go so far as to grant the Vitro noteholders’ involuntary petitions, the Court struck down two of the subsidiary guarantors’ most powerful affirmative defenses to the petitions. Therefore, it seems increasingly likely that the Bankruptcy Court will eventually enter involuntary orders for relief. If this happens, the Vitro noteholders will gain a great deal of leverage over the subsidiary guarantors, who will be required to manage their estates in the noteholders’ and other creditors’ best interests and will no longer be able to transfer significant assets or engage in transactions outside the ordinary course of business without bankruptcy court approval.
In view of this latest defeat, Vitro’s best hope of keeping its subsidiaries’ assets out of the reach of its noteholders may be to convince the Fifth Circuit Court of Appeals to enforce the non-debtor releases contained in its Mexican plan of reorganization. The District Court’s decision with respect to the involuntary petitions thus further raises the stakes in Vitro’s pending appeal of the Bankruptcy Court’s prior decision refusing to enforce the Mexican plan of reorganization. Oral arguments before the Fifth Circuit Court of Appeals are scheduled to begin on October 3, 2012