Arcapita Bank B.S.C.(C), et al. and Tadhamon Capital B.S.C.

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
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In re 	Chapter 11
ARCAPITA BANK B.S.C.(c), et al. 	Case No. 12-11076 (SHL)
Reorganized Debtors. 	(Jointly Administered)
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MEMORANDUM OF DECISION
A P P E A R A N C E S:
GIBSON, DUNN & CRUTCHER LLP
Counsel to the Debtors and Debtors-in-Possession
By: 	Michael A. Rosenthal, Esq.
Craig H. Millet, Esq.
Matthew K. Kelsey, Esq.
200 Park Avenue
New York, New York 10166-0193
MILBANK, TWEED, HADLEY & McCLOY LLP
Counsel for the Reorganized Debtors and the New Holding Companies
By: 	Dennis F. Dunne, Esq.
Evan R. Fleck, Esq.
Lena Mandel, Esq.
1 Chase Manhattan Plaza
New York, New York 10005
DLA PIPER LLP (US)
Counsel for National Bank of Bahrain B.S.C.
By: 	Daniel G. Egan, Esq.
1251 Avenue of the Americas
New York, New York 10020
-and-
By: 	Richard A. Chesley, Esq.
Daniel M. Simon, Esq.
203 N. LaSalle Street, Suite 1900
Chicago, Illinois 60601
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SEAN H. LANE
UNITED STATES BANKRUPTCY JUDGE
Before the Court is the objection of the above-captioned debtors and reorganized debtors
(collectively, the “Debtors”) to claim number 45 (the “Claim”), filed by National Bank of
Bahrain (“NBB”) against Arcapita Investment Holdings Limited (“AIHL”), one of the Debtors,
in the amount of US$10,000,000. The Debtors seek to expunge the Claim because it relates to a
call option on stock of a non-Debtor subsidiary under which NBB has suffered no loss. For the
following reasons, the Court grants the Debtors’ objection.
BACKGROUND
The Debtors operated as an investment bank headquartered in Bahrain and were a leading
global manager of Shari’ah-compliant alternative investments. On March 19, 2012 (the “Petition
Date”), the Debtors filed for relief under Chapter 11 of the Bankruptcy Code.
In 2007, NBB entered into a Master Murabaha Facility Agreement (the “Facility
Agreement”) with Riffa Views B.S.C.(c) (“Riffa Views”), a non-Debtor entity. Under the
Facility Agreement, NBB provided a loan to Riffa Views for the development of real estate
located in Bahrain. The Facility Agreement was amended several times to, among other things,
provide additional financing to Riffa Views. In connection with the Second Amendment to the
Facility Agreement in 2009, NBB and Arcapita Bank B.S.C.(c) (“Arcapita Bank”), one of the
Debtors, entered into an Irrevocable Guarantee to National Bank of Bahrain, under which
Arcapita Bank agreed to guarantee the payment of the Riffa Views loan in an amount up to
10,000,000 Bahraini Dinar (“BD”), which is approximately $26,595,745.
The Facility Agreement was again amended several times to provide additional financing
to Riffa Views and to extend the maturity date. Due to the increase in debts owed by Riffa
Views to NBB, Arcapita Bank and NBB subsequently entered into a new Irrevocable Guarantee
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to National Bank of Bahrain (the “Guarantee”) that by its terms superseded the original
guarantee and increased the amount to BD49,906,331, or approximately $132,729,604.
In connection with the Guarantee, NBB, Debtor AIHL and Waterwarf Holdings Limited,
a wholly owned indirect subsidiary of AIHL, entered into a Promise to Sell Shares Agreement in
2009 (the “Share Agreement”). The Share Agreement provided that if Arcapita Bank failed to
make payments under the Guarantee, NBB could exercise a right to purchase up to
US$10,000,000 in shares of Waterwarf Holdings Limited from AIHL. The Share Agreement
was meant to provide additional security for NBB in the event that Arcapita Bank failed to
perform under the Guarantee.
Section 4.2.2. of the Share Agreement further provided that NBB “may, at its sole
discretion, elect to deduct or set-off from the Purchase Price any amounts due by Arcapita Bank
to [NBB].” Agreement ¶ 4.2.2. Thus, if NBB elected to exercise its right to a deduction or set-
off, the transfer of the shares to NBB would serve as a partial payment of indebtedness owed by
Arcapita Bank to NBB.
In May 2012, NBB sent a notice of default to Riffa Views (with a copy to Arcapita Bank)
notifying them of an event of default under the Murabaha Facility Agreement and accelerating
the loan. NBB asserts that Arcapita Bank is liable under the Guarantee for the outstanding
balance of the loan in the amount of BD47,051,455, which is approximately $125,136,847. As a
result of Arcapita Bank’s failure to make payments under the Guarantee, NBB also filed the
Claim against AIHL in the amount of US$10,000,000 based upon its rights under the Share
Agreement. The Debtors objected only to the Claim against AIHL in the Debtors’ Second
Omnibus Objection to Claims [Docket No. 1050] and a hearing on the matter was held on
December 17, 2013.
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DISCUSSION
Fed. R. Bankr. P. 3001(f) provides that “a proof of claim executed and filed in
accordance with [the Bankruptcy Rules] constitutes prima facie evidence of the validity and
amount of the claim.” Thus, when a claim is properly filed, the objecting party bears the initial
burden of persuasion, and must produce “evidence equal in force to the prima facie case . . .
which, if believed, would refute at least one of the allegations that is essential to the claim’s legal
sufficiency.” In re Oneida, Ltd., 400 B.R. 384, 389 (Bankr. S.D.N.Y. 2009) (internal citations
and quotations omitted). The burden then shifts to the claimant, who must “prove by a
preponderance of the evidence that under applicable law the claim should be allowed.” Id.
Section 101(5) defines a “claim” as a
(A) right to payment, whether or not such right is reduced to judgment, liquidated,
unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed,
legal, equitable, secured, or unsecured; or . . .
(B) right to an equitable remedy for breach of performance if such breach gives
rise to a right to payment, whether or not such right to an equitable remedy is
reduced to judgment, fixed, contingent, matured, unmatured, disputed,
undisputed, secured, or unsecured.
11 U.S.C. 101(5). It is true that “Congress unquestionably expected this definition to have wide
scope. . . At the same time, however, the definitions reach is not infinite.” PBGC v. Oneida Ltd.,
562 F.3d 154, 156-67 (2d Cir. 2009).
The Debtors raise several arguments in their objection. They first argue that there is no
valid claim against AIHL because the Claim is based on a call option for the shares of a non-
Debtor subsidiary, Waterwarf Holdings Limited. The Court disagrees that there is no claim
simply because it involves the shares of a non-debtor. Section 541(a) of the Bankruptcy Code
provides that property of the estate includes “all legal or equitable interests of the debtor in
property as of the commencement of the case.” The definition of property of the estate is
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interpreted broadly, and “every conceivable interest of the debtor, future, nonpossessory,
contingent, speculative, and derivative, is within the reach of [Section] 541.” Chartschalaa v.
Nationwide Mut. Ins. Co., 538 F.3d 116, 122 (2d Cir. 2008). NBB notes (and the Debtors do not
deny) that AIHL currently holds shares in Waterwarf. 	The broad definition of property of the
estate clearly encompasses a debtor’s interest in another corporation’s stock. See Kolinsky v.
Russ (In re Kolinsky), 100 B.R. 695, 701 (Bankr. S.D.N.Y. 1989); In re Deak & Co, Inc., 63 B.R.
422, 427 (Bankr. S.D.N.Y. 1986). Thus, to the extent that NBB has a claim, there appears to be
no reason NBB cannot assert it against AIHL based upon AIHL’s ownership interest in the
Waterwarf Holdings shares.1
The Debtors next argue that NBB’s rights under the Share Agreement fail to qualify as a
claim because NBB has not suffered a loss that would give rise to a claim. The Debtors note that
the Share Agreement gives NBB the opportunity to purchase Waterwarf shares from AIHL at
fair market value. They argue that NBB would enjoy no gain upon consummation of the
transaction because the value of the Waterwarf shares purchased would be exactly the same as
their purchase price. The Court agrees that NBB’s contractual rights under the Share Agreement
do not constitute a claim, since those rights do not give rise to a right to payment.
The definition of “claim” includes both a “right to payment” and a “right to an equitable
remedy for breach of performance if such breach gives rise to a right to payment.” 11 U.S.C. §
101(b). (emphasis added). Thus, “[w]here the same breach gives the aggrieved party the
alternative of an equitable remedy or money damages, the resulting right is a ‘claim.’” In re
Mark IV Indus., Inc., 438 B.R. 460, 465 (Bankr. S.D.N.Y. 2010). But courts in this jurisdiction
have noted that “[c]onversely, where a creditor does not have the option to accept money in lieu
1 	Indeed, AIHL appeared to have dropped their objection to the Claim on this basis during the hearing on
December 17, 2013. But to the extent this argument was not abandoned by AIHL, the Court rejects it.
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of the equitable remedy, the equitable obligation is not a ‘claim’ and is not dischargeable in
bankruptcy.” Id. While the definition of what constitutes a ‘claim’ is interpreted broadly, “[a]s
enacted . . . Section 101[5][B] limits the definition of claims by excluding rights to an equitable
remedy for a breach of performance with respect to which such a breach does not give rise to a
right to payment. Such rights are not ‘claims’. . . .” 2-101 Collier on Bankruptcy ¶ 101.05[5]
(16th ed. 2014).
NBB counters that the right created in the Share Agreement is not a bare right to enforce
conveyance of the shares and cites to its contractual setoff right under the Share Agreement as an
alternative right to payment. NBB argues that its set-off right is “tantamount in substance to a
right to payment as required by section 101(5) of the Bankruptcy Code” since such election
would reduce the amount owed to NBB by up to $10 million. (NBB Objection, ¶ 16).
As a general matter, however, the setoff right asserted here is unenforceable in
bankruptcy. The type of setoff contemplated by the Share Agreement is commonly referred to as
a triangular setoff, which is the right to set off amounts owed to affiliates of a counterparty. Said
another way, NBB seeks to assert a right to offset against AIHL, although the debt in question is
owed by Arcapita Bank. As correctly noted by the Debtors, triangular setoffs are commonly
disallowed in bankruptcy due to a lack of mutuality. Section 553(a) of the Bankruptcy Code
provides that “this title does not affect any right of a creditor to offset a mutual debt owing by
such creditor to the debtor that arose before the commencement of the case under this title
against a claim of such creditor against the debtor that arouse before the commencement of the
case . . . .” 11 U.S.C. § 553(a) (emphasis added). Thus, “to be eligible for setoff under [S]ection
553, (1) the amount owed by the debtor must be a prepetition debt; (2) the debtor’s claim against
the creditor must also be prepetition; and (3) the debtor’s claim against the creditor and the debt
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owed the creditor must be mutual.” In re Lehman Bros., Inc., 458 B.R. 134, 139 (Bankr.
S.D.N.Y. 2011) (internal citations and quotations omitted). “[C]ourts consistently find debts to
be mutual only when they are in the same right and between the same parties.” Id. at 140
(internal citations and quotations omitted); see also In re SemCrude, 399 B.R. 388, 393 (Bankr.
D. Del. 2009).
The fact that the setoff was provided for by contract does not alter this conclusion. As
the court in Lehman observed:
Section 553 expressly preserves the “right of a creditor to offset a mutual debt
owing by such creditor to the debtor . . . against a claim of such creditor against
the debtor”. . . The clarity of this language is conclusive – mutuality quite literally
is tied to the identity of a particular creditor that owes an offsetting debt. The
right is personal, and there simply is no ability to get around this language.
Parties may freely contract for triangular setoff rights, but not in derogation of
these mandates of the Bankruptcy Code.
Lehman, 458 B.R. at 141 (quoting 11 U.S.C. § 553); see also SemCrude, 399 B.R. at 396-99
(“[M]utuality cannot be supplied by a multi-party agreement contemplating a triangular setoff.”).
Thus, the setoff relied upon by NBB does not create a right to payment that is recognizable under
the Code.
NBB reasons that it does not actually seek to effectuate a setoff, but rather that its right to
setoff was an alternative right to payment. It further contends that simply because a triangular
setoff was prohibited under the Bankruptcy Code, does not mean that a creditor could not make a
claim on that basis. The Court disagrees. While NBB is not seeking to enforce its setoff right, it
is invoking that right as the basis for the Claim. And the Court disagrees that a setoff constitutes
a right to payment. Rather, it is a right to pay less on the claimant’s own liability. “[A] right to
effect a setoff can never impose a ‘right to payment,’ it only can yield a right to pay less than one
would otherwise have to pay.” In re SemCrude, 399 B.R. at 398. 	So while a party “may be able
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to assert a state law right to the equitable remedy of setoff, this right is not based on a breach of
performance that gives rise to a ‘right to payment . . . .” A setoff agreement . . . only creates a
right to pay less or nothing, not a right to receive a payment.” Id.
At the hearing on the Debtors’ motion, counsel to NBB cited for the first time to various
other provisions of the Share Agreement that had not been raised in its pleadings. Counsel to
AIHL did not have prior notice or opportunity to respond to these new arguments. See, e.g.,
Unsecured Claims Estate Representative of Teligent, Inc. v. Cigna Healthcare, Inc. (In re
Teligent, Inc.), 326 B.R. 219, 229 (S.D.N.Y. 2005) (bankruptcy court has the discretion not to
consider argument raised for the first time in reply papers). In any event, these additional
provisions do not help NBB. Specifically, NBB argued that the right to acquire shares under
Sections 2 and 3.1 of the Share Agreement constituted a claim under Section 101(5)(b). Section
2 of the Share Agreement provides that
In consideration of the payment by NBB of US$10 to the Company (receipt of
which is hereby taken to be acknowledged) the Company grants to NBB the right,
but not the obligation, during the Purchase Period to acquire the Promised Shares
at the Purchase Price Per Share2 on the terms set out in this Agreement upon the
occurrence of a Trigger Event.
Section 3.1 of the Share Agreement provides
Upon the occurrence of a valid Trigger Event during the Purchase Period, NBB
may exercise its Purchase Right by servicing the Company and the Target with a
Promise to Sell Shares Notice specifying NB’s preferred date of Completion,
which must be a Business Day within the Purchase Period.
But NBB did not explain how these provisions constitute anything more than a bare
requirement to convey the property – that is, a right to equitable relief. Such right is not a claim:
[R]ights to an equitable remedy for breach of performance with respect to which
such breach does not give rise to a right to payment are not "claims" within the
2 	Purchase Price Per Share is defined in the Share Agreement as “an amount in [United States dollars] to be
determined on or around the Exercise Date which amount reflects the Fair Market Value of the Target’s shares on
the Exercise Date. (Share Agreement, § 1.1).
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Code's contemplation, and would not therefore be dischargeable in bankruptcy,
unless such obligations could be translated into a claim for damages if breached.
When there is no money damage alternative to state court ordered equitable
remedies such as resulting trust, partition in kind, or deed reformation, they do not
fit the definition of claim under [S]ection 101(5) . . . .
2-101 Collier on Bankruptcy ¶ 101.05[5] (16th ed. 2014); see also Route 21 Assoc. of Belleville,
Inc. v. MHC, Inc., 486 B.R. 75, 88-9 (S.D.N.Y. 2012) (noting that “[s]everal courts have held
that a claimant’s right to certain equitable remedies constitutes a ‘claim’ if an award of monetary
damages is a ‘viable alternative’ to the equitable remedy sought.”) (quoting In re Ben Franklin
Hotel Assocs., 186 F.3d 301, 305 (3d Cir. 1999)). 	Even to the extent that any equitable remedy
for breach of performance were available to NBB, such right could not be translated to a claim
for damages since NBB was only given the right to purchase the shares at fair market value in
any case. NBB would therefore simply be expending the same amount of money as the stock
was worth and would enjoy no gain upon consummation of the transaction because the value of
the Waterwarf shares purchased would be exactly the same as their purchase price.3 As noted
above, “[a]s enacted . . . Section 101[5][B] limits the definition of claims by excluding rights to
an equitable remedy for a breach of performance with respect to which such a breach does not
give rise to a right to payment. Such rights are not ‘claims’. . . .” 2-101 Collier on Bankruptcy ¶
101.05[5] (16th ed. 2014); see also In re Mark IV Indus., 438 B.R. at 465.
In its objection, NBB also requested that the Court, in the alternative, find that any
equitable right of NBB to enforce the Share Agreement would pass outside of bankruptcy and
not be subject to the automatic stay or discharge in bankruptcy. At the hearing held on
December 17, 2013, counsel clarified that these arguments were merely a reservation of rights,
3 	Indeed, neither party discusses where the value in an equitable remedy would be. One way to understand
the Share Agreement is that the value was in the setoff itself, which, as noted above, is unenforceable in this
bankruptcy.
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not an objection. (See Hr’g Tr. 24:1-3, Dec. 17, 2013). The Court therefore need not address
those arguments now on the merits. NBB’s rights outside of bankruptcy are what they are.4
CONCLUSION
For the reasons set forth above, the Debtors’ objection to the Claim is granted. The
Debtors are directed to submit an order on three days’ notice.
Dated: New York, New York
May 20, 2014
/s/ Sean H. Lane
UNITED STATES BANKRUPTCY JUDGE
4 	The Debtors also argued that, to the extent NBB’s rights under the Share Agreement did constitute a claim,
that claim would be subordinated under Section 510(b) of the Bankruptcy Code. But as the Court has ruled that
NBB does not have a claim, it is unnecessary to address the subordination argument. In any case, the Court could
not grant such relief on the current record as the Debtors raised their arguments on subordination in their reply brief,
without first filing an adversary proceeding as required under Bankruptcy Rules 3007 and 7001.
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