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Judge Denies US Bankruptcy Protection To Bear Stearns Funds

August 30, 2007 4:54 p.m.
By Patrick Fitzgerald

A federal judge on Thursday denied a bid by two Bear Stearns (BSC) hedge funds for protection under Chapter 15 of U.S. bankruptcy law, although he said their U.S. assets can't be seized by creditors for another 30 days.

Judge Burton Lifland of the U.S. Bankruptcy Court in Manhattan rejected a request from the Cayman-Islands-registered funds to recognize their Cayman bankruptcy case as having "main jurisdiction" because the funds main business operations are conducted in the U.S.

Lifland likened the Bear Stearns hedge funds' presence in the Caymans to little more than a "letter-box," noting that the funds had no employees or managers in the Cayman Islands. He said all of the funds liquid assets are in the U.S.

"The only adhesive connection with the Cayman Islands that the funds have is the fact that they are registered there," said Lifland in his ruling.

The judge's decision means the Bear Stearns funds can't take advantage of protections available under Chapter 15, including the automatic stay that blocks lawsuits and the seizure of assets.

Under Chapter 15, added to the Bankruptcy Code in 2005, a company or court-appointed administrator may seek a U.S. court's recognition of a foreign bankruptcy case as the main, or controlling, proceeding. Recognition would have allowed the funds to enjoy bankruptcy-law protection in the U.S. while liquidating in the Cayman Islands.

However the judge left the door open for the hedge funds to file for bankruptcy under Chapter 11 or Chapter 7 of the U.S. Bankruptcy Code. He said his Aug. 9 preliminary injunction, which barred creditors and investors from taking action in the U.S. against the funds, would remain in place for another 30 days.

Lifland's decision also raises questions about ability of offshore hedge funds to gain U.S. bankruptcy protection under Chapter 15.

Last year, another New York bankruptcy judge, Robert Drain, rejected the Chapter 15 filing Sphinx Funds, a Cayman-Islands-registered group of hedge funds that collapsed following the meltdown of commodities brokerage Refco Inc. (RFXCQ).

In that case, Drain said that since Sphinx conducted no business and had no employees on the island-- while most of the funds more than $500 million in assets were in the U.S. -- he didn't have to defer to the Cayman courts.

The Bear Stearns hedge funds bet heavily on subprime mortgage loans and as defaults increased, creditors began to clamor for their collateral, leaving the funds short on cash. The funds were placed into liquidation in the Cayman Islands in July and their Cayman liquidators the filed for U.S. bankruptcy protection on Aug. 1.

Bear Stearns stepped in and bought out investors' positions after big Wall Street firms started fleeing the funds earlier this year.

The liquidators have estimated that the one of the funds - High-Grade Structured Credit Strategies Master Fund - could see recoveries of $25 million. The smaller High-Grade Structured Credit Strategies Enhanced Leverage Master Fund could see recoveries of less than $50 million.
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