On July 22, 2008, the US Court of Appeals for the Second Circuit affirmed denial of the motion of Parmalat S.p.A. ("New Parmalat") to extend an injunction provided to its predecessor, Parmalat Finanziaria, S.p.A., under Bankruptcy Code section 304, against securities fraud actions.1 Although the appeal addressed the issue of injunction in the context of superseded Bankruptcy Code section 304, this decision and the underlying lower court opinion signify other issues of broader import, including the need for careful plan drafting and the complexities inherent in cross-border cases.

Background

In December 2003, Parmalat — an Italian dairy company — reported that €3.9 million in cash it was supposed to have did not actually exist. Amid charges of securities fraud, Parmalat Finanziaria, S.p.A. and several of its subsidiaries and affiliates ("Old Parmalat") filed for bankruptcy protection under Italy's Marzano insolvency laws. Shortly thereafter, purchasers of Old Parmalat's debt and equity securities filed securities fraud class action lawsuits in the District Court for the Southern District of New York against Old Parmalat and other financial entities.

In June 2004, the Italian Extraordinary Commissioner (akin to a Chapter 11 trustee) petitioned the Southern District of New York Bankruptcy Court to enjoin actions against the Old Parmalat estate with respect to any property involved in its Italian bankruptcy proceedings pursuant to Bankruptcy Code section 304, subsequently repealed in 2005. The court, pursuant to Bankruptcy Code section 304, permitted a representative of Old Parmalat to commence a bankruptcy case in the US and enjoined litigation against Old Parmalat in US courts by the securities fraud plaintiffs.

In July 2004, the Extraordinary Commissioner proposed a restructuring plan, the "Concordato," under which the assets of the 16 companies that composed Old Parmalat were transferred to a newly formed entity, New Parmalat. Under the Concordato, New Parmalat assumed all debts of the 16 entities. It undertook to discharge those debtsincluding court-verified pre-insolvency claims by unsecured creditors — through the process of converting — approved claims against Old Parmalat (even if late-filed) into equity interests in New Parmalat. Thus, under the Concordato, liquidated claims are discharged upon receipt of New Parmalat equity.

District Court Holding

Once New Parmalat was formed, the securities fraud plaintiffs sought leave to amend the securities fraud class action complaint (from which Old Parmalat was dropped as a defendant) to add claims against New Parmalat. The District Court granted the motion.

The District Court held that New Parmalat's assumption and discharge of Old Parmalat's debts meant that New Parmalat agreed to assume liability, if any, for the fraud alleged in the US securities fraud complaints under the doctrine of successor liability. The District Court thus permitted the securities fraud plaintiffs to amend their complaint to join New Parmalat as a defendant in the securities fraud actions as the successor to Old Parmalat.2 New Parmalat moved to expand the injunction to bar the securities fraud plaintiffs from bringing direct claims against New Parmalat.

While the expansion motion was pending, the District Court granted a separate motion, holding that, with respect to certain third-party claimants with contribution claims against New Parmalat based on Old Parmalat's securities fraud, they could use US judgments to set off liability to New Parmalat, but could not affirmatively collect money from New Parmalat until the Italian courts choose to enforce the American court's judgment.

In June 2007, the District Court denied the expansion motion based largely upon the following determinations: (1) the economical and expeditious administration of the Old Parmalat estate would be best served by liquidating liability in the US, where relevant facts were already being litigated in the securities fraud litigation in connection with the contribution claims; (2) the interests of comity and the just treatment of claimholders would be better served by allowing the claims to go forward because, although plaintiffs seek to liquidate their claims in the US, they could only be enforced (if at all) in Italy; and (3) settlement would be facilitated by having all potentially liable parties before the District Court.

New Parmalat appealed the order denying expansion of the injunction.

Second Circuit Holding

The Second Circuit affirmed the District Court's order denying expansion of the injunction, finding that the District Court did not abuse its discretion. However, the Second Circuit did not weigh in on whether granting the expansion motion would best assure an economical and expeditious administration of the Old Parmalat estate:

We cannot say with certainty what effect the Expansion Denial Order may have on the economy and expeditiousness with which the Old Parmalat estate will be administered. But we cannot conclude that the district court abused its discretion on that score. And our review of the record satisfies us that Judge Kaplan did not act inconsistently with any of the six considerations mandated by § 304(c).3 In making its determination, the Second Circuit first analyzed whether allowing the US securities fraud litigation to proceed before the District Court would best assure an economical and expeditious administration of the Old Parmalat bankruptcy estate. The Second Circuit noted that there were good reasons for both sides of this argument. The governing law of the securities fraud lawsuits is that of the US If such actions were to be litigated in Italy, the Italian insolvency court ("Parma Court") would confront a foreign legal and regulatory scheme to which there is no Italian analog, a large number of documents in a foreign language and conflicting expert affidavits on what American securities law requires. On the other hand, American litigation costs can be exorbitant. Further, there is no assurance that the securities fraud plaintiffs would proceed in Italy at all. The Second Circuit noted that, had it believed that the Parma Court would view the District Court as lacking jurisdiction, it would reverse the order denying expansion of the injunction. However, the Parma Court has made no such statement.

The Second Circuit also analyzed whether the order denying expansion of the injunction was inconsistent with just treatment of all claimholders and comity. In holding that it was not inconsistent with such factors, the Second Circuit found: (1) claimholders were not treated unjustly because a judgment in favor of the securities fraud plaintiffs would only result in the issuance of New Parmalat stock, and that "there is no cognizable injustice to one claimholder in the satisfaction of claims properly presented by another", and (2) international comity was respected because the courts of Italy will decide whether or not to enforce any judgment that the securities fraud plaintiffs win in their suits against New Parmalat.4

Based upon these factors, the Second Circuit concluded that the District Court did not abuse its discretion and it affirmed the District Court's order denying expansion of the injunction.

Comment

The US securities fraud class action lawsuits (described above) have reportedly been settled. Therefore, the Second Circuit's holding will likely not have an impact on New Parmalat.

However, this decision underlines the importance of careful plan drafting and the complexities inherent in cross-border cases. Here, Old Parmalat was granted an injunction against securities fraud class action lawsuits under Bankruptcy Code section 304 and was dropped as a defendant. However, the Concordato provided that New Parmalat would assume all debts of Old Parmalat, and would discharge those debts by allocating to each eligible creditor an amount of New Parmalat stock. New Parmalat claimed that the intended effect of this language was not to assume the pre-insolvency acts of Old Parmalat. The District Court disagreed and the Second Circuit affirmed. Under the doctrine of successor liability, when New Parmalat agreed to assume all debts and discharge them, New Parmalat also assumed Old Parmalat's liability for the fraud alleged in the US securities fraud class action lawsuits. Through the Concordato, the securities fraud plaintiffs' claims were revived, giving them leverage to negotiate and settle the US securities fraud class action lawsuits.