Timing and Process in Crystallex v. PDVSA

[Updated with Crystallex's brief opposing the stay.]

In an earlier post, I noted some open questions that had to be answered before Crystallex could execute on PDVSA’s 100% ownership stake in PDV Holding (PDV-H). To recap: The federal district judge in Delaware let Crystallex attach the PDV-H shares on the theory that PDVSA is the Venezuelan government’s alter ego. The open questions relate both to timing (e.g., should there be a stay of execution pending appeal?) and process (how should an execution sale proceed)? A lot turns on the answers to these questions, as I’ll discuss below. First, however, here’s a simplified figure showing PDVSA’s corporate structure for readers who haven’t been following the dispute closely.

A few things to note:

• Formally, Venezuela has no U.S. assets related to CITGO; PDVSA owns the PDV-H shares. The court’s alter ego determination lets Crystallex attach these shares as if they belonged to Venezuela.
• PDV-H's only asset is a 100% stake in CITGO Holding, which is itself a holding company for CITGO and other operating subsidiaries. The CITGO Holding shares have already been pledged as collateral for other PDVSA debt: 50.1% to holders of the infamous PDVSA 2020 bonds and 49.9% to Rosneft in connection with a Nov. 2016 loan.
• Crystallex has filed a separate lawsuit seeking to invalidate these collateral pledges as fraudulent transfers. If it does not succeed, then a PDVSA default on the 2020 bonds and Rosneft loan might prompt foreclosure on the CITGO Holding shares. If that happens, PDV-H might wind up an empty shell. That doesn’t necessarily make PDV-H worthless to Crystallex. If Venezuela wants to retain control of CITGO, it will have some incentive to strike a deal (though any deal would at that point have to encompass multiple creditors). But it is a complicating factor.
• Finally, if the execution process results in the sale of more than 50% of PDV-H, this would seem to violate covenants in PDVSA’s 2020 bonds and constitute a change of control triggering repurchase obligations under separate notes issued by CITGO and CITGO Holding. Even if PDVSA kept current on the 2020 bonds and its obligations to Rosneft, the sale of a majority stake in PDV-H might entitle these creditors to force a sale of Citgo Holding shares--again leaving Crystallex with shares in a holding company that holds nothing. Similarly, an execution sale involving more than 50% of PDV-H might prompt holders of CITGO Holding and CITGO notes to foreclose on these entities' assets--a result that would impair the value of the collateral pledged to the 2020 bondholders and to Rosneft.

Timing:   

PDVSA has appealed the district court’s order allowing Crystallex to attach its interest in PDV-H. An appeal doesn’t normally stop the prevailing party from executing on its judgment. PDVSA claims the rule is different here, because its appeal challenges the district court’s rejection of its claim to sovereign immunity, but the district judge has rejected that argument. So, unless PDVSA gets a stay of execution, it risks losing control of PDV-H, and therefore CITGO, before its appeal is heard.

Normally, a party who wants to stay execution posts a supersedeas bond. However, as the Wall Street Journal notes, PDVSA doesn’t want to do that; possibly it can’t. It’s not (or not just) that the amount of the bond would be too large; the district judge has discretion over the amount. Instead, PDVSA argues that no bond is necessary. PDVSA argues that Crystallex needn’t worry that it will transfer its stake in PDV-H to a new entity. The attachment, combined with U.S. sanctions forbidding U.S. parties to participate in such a transfer, effectively eliminate this risk. But even if that is so, the argument doesn’t fully address the purpose of the bond requirement, which is to preserve the status quo during appeal. From Crystallex’s perspective, an additional risk of delay is that the PDV-H shares will decline in value. The attachment doesn’t protect against that risk. Perhaps a better argument for PDVSA is that the sanctions also forbid most new financing transactions involving PDVSA. Because of this, it might not even be possible for PDVSA to find a U.S. surety willing to provide the bond. In any event, here is PDVSA's brief asking the district judge to grant a stay of execution pending appeal. Crystallex has yet to respond.

The stay issue is important enough that PDVSA has separately asked the Third Circuit to issue a writ of mandamus requiring the district judge to stay execution on the PDV-H shares.

Process

What should an execution process look like? Remember that Crystallex isn’t entitled to the PDV-H shares; it is simply owed the amount of its $1.2 billion judgment plus interest. The execution process is the tool for getting it paid. Depending on the nature of that process, Crystallex could wind up holding none, some, or all of PDV-H. PDVSA could conceivably retain a majority interest in PDV-H; conversely, it could lose a majority stake. As noted above, the latter outcome also might cause defaults on other PDVSA, CITGO Holding, and CITGO debt, prompting various creditors to foreclose on these entities’ assets.

Delaware law (sec. 324) appears to envision a relatively informal procedure when a creditor executes on shares in a corporation. The sale will be conducted by the sheriff (here, the U.S. Marshals) after publishing notice of the sale in the newspaper for two consecutive weeks. Crystallex proposes to make the process more robust by “identifying and notifying” unspecified potential buyers and publishing additional notice of the sale in “national (and potentially international) publications” (pp. 3-4).

I guess that's one way to sell an oil company. I mean, Craigslist might be better, but this is, like, a way to do it. Viewed cynically, the process envisioned by Crystallex looks designed to deter competing buyers and to allow Crystallex (which has signaled it plans to credit bid) to obtain full control of PDV-H. What that control is worth will depend, as noted above, on whether Crystallex also succeeds in invalidating the pledge of CITGO Holding shares to Rosneft and the holders of PDVSA’s 2020 bonds, as well as on how creditors react to the triggering of change of control provisions in CITGO Holding and CITGO debt.

Not surprisingly, a range of other parties are now asking to intervene, either to support PDVSA’s request for a stay, to express views on the sale process, or both. Here are briefs by BlackRock and other holders of PDVSA 2020 bonds, by Rosneft, and by Citgo. The CITGO brief envisions an execution process managed by financial advisors, designed to identify the number of shares that must be sold to satisfy Crystallex’s judgment. Of course, if that winds up being a minority stake, PDVSA and its subsidiaries avoid many of the adverse consequences of a change in control. And Crystallex winds up locked into a minority ownership position.

In one sense, the dispute here is simply a high-dollar-value example of a common problem. State laws governing execution sales are poorly-designed to maximize asset value, can be exploited by creditors, and can have unfortunate spillover effects for third parties. That's true whether the asset is a family's home or a multi-billion dollar oil company. (Consider the implications for neighborhoods of cheap, hasty home foreclosure sales.) The problems are compounded for complex assets, which are more typically sold--for better or worse--in bankruptcy. Time will tell whether bankruptcy is in the cards for CITGO. For the moment, I hope the district judge will put the breaks on the execution process--if not until PDVSA's appeal is resolved, then at least until the judge can gather enough information to understand how each party is trying to exploit the process and to oversee a reasonable sale procedure.