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The Constellation Experience

Ring-fencing after the subprime meltdown.

Fortnightly Magazine - August 2010

a bankruptcy filing because of the desires of a secured creditor[ is] mistaken.” 19 The General Growth Properties court rejected an argument that the subsidiary had filed for bankruptcy in bad faith because an independent manager had voted in favor of the filing notwithstanding that the governing subsidiary operating agreement required the independent manager to consider only the interests of the subsidiary, including its creditors, in casting his vote. The court found that the independent director also had fiduciary obligations of loyalty under Delaware law to shareholders and those shareholder interests extended to concerns relating to the corporate group as a whole. In short, golden share ring-fencing measures give rise to an entity that is bankruptcy remote, 20 but not bankruptcy removed.

General Growth Properties shows that the independent director might have multiple fiduciary obligations to different entities. The testimony of Charles Atkins, Constellation’s ring-fencing expert in the BGE case, was to like effect: “independent directors have a combination of fiduciary duties, they have a set of fiduciary duties to their particular entity. [There] is a set of fiduciary duties to the creditors and a set of fiduciary duties to the shareholders.”  21 How this can or should play out in a given circumstance is unclear. But arguably these conflicting obligations and the associated uncertainty of any dictated outcome give the golden vote its power of promoting bankruptcy remoteness. Just as the secured creditors were unsuccessful in arguing that the independent director had to vote “no,” it is entirely possible that shareholders would be unsuccessful in a given case in arguing for the specific relief that an independent director must vote “yes.”

Ring-fencing also can help protect against a bankruptcy court involuntarily consolidating a subsidiary into a parent bankruptcy. Consolidation is a judicially created remedy, it is not expressly provided for under the bankruptcy code. Where consolidation is ordered, the assets and liabilities of the consolidated entities are treated as combined assets and liabilities of the single, bankrupt entity. There are two different generally recognized tests for consolidation. Under the more creditor-protective approach, consolidation can be had where: 22

A proponent proves corporate disregard creating contractual expectations of creditors that they were dealing with debtors as one indistinguishable entity… Proponents who are creditors must also show that, in their prepetition course of dealing, they actually and reasonably relied on debtors’ supposed unity… Creditor opponents of consolidation can nonetheless defeat a prima facie showing under the first rationale if they can prove they are adversely affected and actually relied on debtors’ separate existence.

The second, more consolidation-friendly approach entails a multi-factor analysis of whether “‘the economic prejudice of continued debtor separateness’ outweighs ‘the economic prejudice of consolidation.’”  23 A central consideration under the balancing approach is the extent to which creditors have relied upon the separate credit of one of the entities and the extent to which they will be prejudiced by consolidation.

A single, substantial linkage between the parent and subsidiary could prove problematic, such as cross-default provisions in parent and subsidiary financings ( i.e, a default on one parent borrowing