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Nondisclosure of Planned Corporate Bankruptcy Does Not Violate Federal Securities Law Contributing Editor: Richard J. Corbi Proskauer Rose LLP; New York


s the financial crisis that began in 2007 continues to rage on with no end in sight, many companies have to file bankruptcy to escape their crushing debt. The latest trend in this process is when companies announce that they are going to file for bankruptcy, something unheard of until the recent onslaught of bankruptcies. 1 Distressed companies that buck this trend of announcing imminent bankruptcy may find themselves defending a lawsuit. This is what happened in the recent case of Beleson v. Schwartz. 2 In Beleson, the U.S. District Court for the Southern District of New York ultimately resolved the disclosure issue in the debtor’s favor, holding that failure to disclose its negotiations of sale terms requiring a bankruptcy filing did not violate the federal securities laws.3

Factual Background

In Beleson, the lead plaintiffs, Robert Beleson and Harvey Matcovsky, brought a class action against Bernard Schwartz for alleged violations of §§10(b) and 20(a) of the Securities and Exchange Act of 1934 (the 1934 Act) and Securities and Exchange Commissions Rule 10b-5.4 The lead plaintiffs represented a group of investors that purchased securities of Loral Space & Communications Ltd. (the debtor) from June 30, 2003, to July 15, 2003 (the class period).5 The debtor was a satellite communications company, and Schwartz was the debtor’s CEO and chairman of the board of directors in 2002 and 2003.6 In 2003, Loral was experiencing financial difficulties and had $2.2 billion of debt, and as a result sought a variety of ways to improve its financial circumstances.7 That same year, Intelsat Ltd. emerged as a possible buyer of some of Loral’s assets.8 By May 2003, Intelsat demanded that Loral file bankruptcy in order to complete the sale 1 See Jeffrey McCracken, “New Chapter in Bankruptcy: More Firms Open Up Early,” Wall St. J., March 25, 2009, at C1. 2 599 F.Supp.2d 519 (S.D.N.Y. 2009). 3 Id. at 520. 4 Id. 5 Id. 6 Id. at 520-21. 7 Id. at 521. 8 Id.

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About the Author Richard Corbi is an associate in the Bankruptcy & Restructuring Group of the New York office of Proskauer Rose LLP. so that title to Loral’s satellites would safely pass to Intelsat.9 Since the sale to Intelsat required a bankruptcy filing, Schwartz held a meeting of Loral’s board of directors on May 27, 2003, in order to discuss the sale to Intelsat as part of a prepackaged bankruptcy.10 On May 30, 2003, Intelsat and Loral agreed that a sale would be completed through §363 of the Bankruptcy Code, although Loral hoped to avoid bankruptcy and actively pursue other alternatives out of distress.11 On June 24, 2003, Loral provided its lenders with a cash flow-forecast on the assumption that it would file for bankruptcy within 30 days and that Loral had settled arbitration claims with Alcatel

to Intelsat and its chapter 11 bankruptcy filing.19 As a result, the lead plaintiffs alleged that during that two-day period, Loral’s stock price went from $3.01 to 30 cents per share on July 16, 2003.20 On Aug. 11, 2003, the lead plaintiffs filed a class action asserting 1934 Act and Rule 10b-5 violations, asserting that four fraudulent statements were made during the class period, giving rise to the securities law violations. Loral issued the following: (1) a June 30, 2003, press release announcing that it had reached an overall settlement of the Alcatel arbitration claims; (2) a June 30, 2003, press release in which Loral stated it had collected $55 million from Intelsat representing an acceleration of a receivable for agreed-upon performance payments; (3) a July 1, 2003, article that quoted Schwartz as saying that Loral was on schedule to have $65 million in cash at the end of the year; and (4) a July 8, 2003, press release stating that a Loral

Code to Code Space Industries and Alcatel Space.12 As of June 30, 2003, the first day of the class period, the lead plaintiffs alleged that due diligence items remained.13 During the class period, Intelsat raised questions about Loral’s assets and sought to change the price it would pay for Loral’s assets.14 Intelsat reduced its initial offer of $1.1 billion to $950 million for Loral’s assets.15 On July 12-13, 2003, Loral and Intelsat concluded negotiations in which Intelsat raised its offer price to more than $1 billion.16 On July 14, 2003, Loral’s board of directors approved the sale to Intelsat as well as the bankruptcy filing.17 On July 15, 2003, Loral and Intelsat signed an asset-purchase agreement in which Intelsat would pay $1.06 billion for Loral’s assets and Loral would file for chapter 11.18 Before the markets opened that same day, Loral announced its sale 9 Id. 10 Id. 11 Id. 12 Id. 13 Id. at 521-22. 14 Id. at 522. 15 Id. 16 Id. 17 Id.

subsidiary had won a contract from Boeing to build 40 replacement batteries for the International Space Station.21 The truth of the four statements was not disputed by the parties. Rather, the lead plaintiffs alleged that these statements were misleading as to Loral’s viability because Loral failed to disclose a deal with Intelsat that required it to file for bankruptcy.22 The lead plaintiffs also alleged that because of Schwartz’s position of control at Loral, he controlled the contents of the press releases at issue in the securities lawsuit. 23 The lead plaintiffs alleged that Schwartz: (1) deceived the investing public by making false statements and omissions of material fact; (2) artificially inflated the market price of Loral’s securities; and (3) caused the lead plaintiffs to purchase securities at an artificially inflated price and to suffer damages after Loral filed for bankruptcy.24 18 Id. 19 Id. 20 Id. 21 Id. at 522-23. 22 Id. at 523. 23 Id.

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Both parties moved for summary judgment on the lead plaintiffs’ claims under §10(b) of the 1934 Act and Rule 10b-5.25 Section 10(b) makes it unlawful to “use or employ, in connection with the purchase and sale of any security... any manipulative or deceptive device or contrivance of such rules and regulations as the Commission may prescribe.”26 Rule 10b-5 prohibits making any untrue statement of a material fact or omitting to state a material fact necessary in order to make the statement not misleading.27 In order to establish liability for §10(b) and Rule 10b-5, the plaintiffs must establish that the defendant (1) in connection with the purchase or sale of securities, (2) made a materially false statement or omitted a material fact, (3) with scienter, and (4) the plaintiff’s reliance on the defendant’s action caused injury to the plaintiff.28 The court continued to explain that an “omitted fact is material if there is a ‘substantial likelihood that [its disclosure] would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”29 The “total mix” of information includes information “reasonably available” to investors.30 The lead plaintiffs did not dispute the truth of the four statements made during the class period. Rather, they asserted that the statements were misleading because Loral failed to disclose that it was negotiating a sale of the company that required it to file for bankruptcy.31 The court noted that a corporation is not required to disclose every fact merely because an investor would like to have known it.32 Instead, “an omission is actionable only when the corporation is subject to a duty to disclose information, which arises when it is necessary to make prior disclosed statements not misleading.33 The court found that Loral’s failure to disclose its bankruptcy planning did not render the class period statements misleading as to Loral’s viability 24 Id. 25 Id. at 524. 26 Id. quoting 15 U.S.C. §78j(b). 27 Id. relying on 17 C.F.R. 240.10b-5. 28 Id. (quotations omitted) (citations omitted). 29 Id. (citations omitted). 30 Id. (citations omitted). 31 Id. 32 Id. at 524-25 (quotations and citations omitted). 33 Id. at 525.

for several reasons. 34 First, Schwartz submitted evidence that the world was on notice of Loral’s dire financial situation35 and its SEC filings revealed continuous yearly cash losses and declining cash reserves. 36 Loral attempted a 1-to-10 reverse stock split, which still left it with significant debt obligations of $2.2 billion.37 Second, the SEC filings revealed that Loral’s common stock was worth $111 million and its debt was 20 times its equity value. 38 Third, Loral had warned that its stock price would continue to drop and that it might not have enough cash to pay its obligations.39 Fourth, the stock was trading at all-time lows and the Wall Street Journal noted that the company’s bonds were rated as “junk.”40 Fifth, relevant trade publications reported that analysts had predicted that Loral would file for chapter 11.41 The court distinguished all the cases relied on by the lead plaintiffs that found statements regarding a company’s financial condition materially misleading because the company failed to disclose a bankruptcy filing.42 First, the court found that cases relied on by the lead plaintiffs were not controlling because they were outside of the Southern District of New York.43 Second, the statements in this case were not in dispute whereas the statements were disputed in the cases relied on by the lead plaintiffs.44 Third there was extensive information available in the marketplace regarding Loral’s deteriorating financial condition during the class period.45 Fourth, in this case, Loral and Intelsat were considering other alternatives besides bankruptcy, whereas bankruptcy was the only option available to the parties in the cases relied upon by the lead plaintiffs.46 The court relied on a similar case, In re Tower Auto Secs. Litig., 483 F.Supp.2d 327 (S.D.N.Y. 2007), to find that the company’s failure to disclose its bankruptcy planning did not make 34 Id. 35 Id. 36 Id. 37 Id. 38 Id. 39 Id. 40 Id. at 525-26. 41 Id. at 526. 42 Id. 43 Id. 44 Id. 45 Id. 46 Id.

other statements misleading because the company’s liquidity problems provided enough disclosure to the market regarding its deteriorating financial condition.47 Like the company in Tower, Loral’s deteriorating financial condition was available in the market through the company’s 10-K filings, media coverage and analyst reports, which was enough to put investors on notice that bankruptcy was a real possibility.48 Similarly, Loral’s failure to disclose its imminent bankruptcy planning did not render the statements during the class period misleading because enough information was available in the market to put investors on notice of its bankruptcy filing.49 The court explained that a ruling requiring every company considering a bankruptcy filing to disclose it to the public “would put an unacceptable burden on corporations and their officers.”50 The court continued: “[s]uch a standard might amount to a self-fulfilling prophecy that all companies that begin contingent preparations for bankruptcy would inevitably go bankrupt because, upon disclosure of the plans, investors would immediately lose confidence in the company and close the capital markets.”51 In addition, the court added that “a rule requiring disclosure of bankruptcy plans might prematurely foreclose other options the company may be contemplating that could restore its financial viability and thus avert bankruptcy.”52


Beleson provides protection from liability for companies contemplating bankruptcy as part of their overall corporate strategy. Although no appeal has been taken as of yet by the plaintiffs in Beleson, the lasting effects of the Beleson decision may ease the fears of any repercussions and future lawsuits by angry investors against companies who plan to file for bankruptcy protection. n 47 Id. at 526-27 (relying on In re Tower Auto Secs. Litig., 483 F.Supp.2d 327, 348 (S.D.N.Y. 2007)). 48 Id. at 527. 49 Id. 50 Id. 51 Id. 52 Id.

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