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CR&B AlertCommercial Restructuring & Bankruptcy News
OCTOBER 2016, ISSUE 3
In This Issue:
• DelawareandNewYorkatOddsoverReclamationClaims—2
• SecondCircuitSetsOutStandardforDeterminingScopeofFreeandClearProvisioninSaleOrderUnderSection363(F)—2
• GoodFaithFilingRequirementAliveandWellinInvoluntaryBankruptcyCases—4
• UnpaidCompensationPayableExclusivelyinStockConstitutesEquity,NotanUnsecuredClaim—5
• BreachofFiduciaryDutyClaimsAreNotTime-BarredDuetoLender’sKnowledge—6
• PetitioningCreditorsBeware:BankruptcyCodeDoesNotPreemptStateLawClaimsofNon-Debtors—7
• NinthCircuitHoldsThatDefalcationRequiresMoreThanaContingentPartnershipAgreement—8
• TaxUpsetSaleHeldNotToBeConstructiveFraudulentTransfer—9
• CaliforniaBankruptcyCourtClarifiesOfficerandDirectorDutiestoCreditorsofInsolventCompany—9
• TexasBankruptcyCourtHoldsThatStructuredDismissalIsAuthorizedbytheBankruptcyCodeWhenCreditorRecoveryIsMaximizedbyLimitingAdministrativeClaims,andtheTermsoftheDismissalProvideFairandEquitableTreatmenttoCreditors—11
• Does“No-Asset”MeanNoJurisdiction?BankruptcyCourtConsidersJurisdictioninAdjudicatingClaimsinNo-AssetChapter7Case—12
• TimingIsEverything:BankruptcyCourtConsidersTimingIssuesRelatingtoWhenWARNActClaimsMayBeEligibleforTreatmentasAdministrativeExpenseClaims—13
• FurtherClarityinAnalyzing“Make-Whole”Provisions(orNot).IsItSimplyaMatterofContractInterpretation?—14
• TrusteeFailstoMeetBurdenofShowingThatProposedSaleofAssetsComplieswithSection363(F)oftheBankruptcyCode—15
• Pre-petitionBankruptcyWaiversbyAnotherName:CourtRefusestoDismissCaseFiledWithoutVoteofCreditor’sGoldenShare—15
• Pre-petitionRestructuringDidNotAlterSeniorLenders’RightsUnderanIntercreditorAgreement—16
• FirstCircuitDeclinestoOverturnChapter7Conversion,NotingLowerCourts’BroadDiscretion—17
• ClassCertificationandProofsofClaim;aMeasureofCaseEfficiency—18
• Counsel’sCorner:NewsfromReedSmith—18
Commercial Restructuring & Bankruptcy Newsletter – October 2016 2
DELAWARE AND NEW YORK AT ODDS OVER RECLAMATION CLAIMS
Avendormayreclaimgoodssoldoncredit
toaninsolventdebtorthathasfiledfor
bankruptcy.However,NewYorkBankruptcy
Courtshaveconsistentlyheldthatacreditor’s
reclamationrightsarecutoffbyaDIP
loanthatrefinancedapre-petitionloan.
Thesecourtstreatthetwoloans,andthe
lienssecuringtheloans,asan“integrated
transaction,”withtheDIPlender’srights
relatingbacktothepre-petitionloan.
ArecentdecisionbytheDelawareBankruptcyCourtconcludedotherwiseand
heldthatthepre-petitionloanandtheDIPloanwereseparatetransactions,and
thatthereclamationrightsofthevendorwerenotaffectedbytherepaymentof
thepre-petitionloan.Simplyput,theDelawareBankruptcyCourtfoundthatthe
vendor’sreclamationrightarosebeforetheDIPlender’sliensattached,sosuch
liensweresubjecttothepriorreclamationrightsofthevendor.In re Reichhold
Holdings US, Inc.,No.14-12237,(Bankr.D.Del.Aug.24,2016).
ClickheretosubscribetoourGlobal Restructuring Watchblog.
CONT INUEDONPAGE3
Peter S. Clark, II Firmwide Practice Group Leader, Philadelphia
SECOND CIRCuIT SETS OuT STANDARD fOR DETERMININg SCOpE Of fREE AND CLEAR pROVISION IN SALE ORDER uNDER SECTION 363(f)
Elliott v. General Motors LLC (In re Motors Liquidation Co.),829F.3d135,(2dCir.2016)
CASE SNAPSHOT
TheSecondCircuitCourtofAppealsrecently
articulatedastandardtodeterminewhich
claimsarebarredasagainstapurchaserof
assets“freeandclear”ofclaimspursuantto
section363(f)oftheBankruptcyCode.While
findingthatsomeoftheclaimsagainstthe
purchaserwerebarredbythesaleorder,the
courtalsofoundthatthefreeandclearprovisioncouldnotbeusedtoenjoin
allclaimsassertedbecausethepublicationnoticegiventoclaimantsdidnot
comportwithdueprocess.Instead,wherethedebtorkneworshouldhaveknown
ofthedesigndefectgivingrisetotheclaims,actualnoticebymailshouldhave
beengiven.
FACTUAL BACKGROUND
OnJune1,2009,amidcrushinglosses,GeneralMotorsCorp.(“OldGM”)filed
forbankruptcyintheUnitedStatesBankruptcyCourtfortheSouthernDistrictof
NewYork(the“BankruptcyCourt”).Onthesamedate,OldGMsoughtauthority
tosellsubstantiallyallofitsassetstoGeneralMotorsLLC(“NewGM”)ina
saleundersection363oftheBankruptcyCode.Thenextday,theBankruptcy
CourtorderedOldGMtoprovideactualnoticeoftheproposedsaleordertoall
knowncreditorsofOldGM,andinmajorpublicationssuchasThe Wall Street
JournalandThe New York Timestoallunknowncreditors.Afteraddressingand
dismissingsome850objections,theBankruptcyCourt,inJuly2009,approved
thesaleandenteredanorder(the“SaleOrder”)providingthatthesalewould
be“freeandclearofallliens,claims,encumbrances,andotherinterestsofany
kindornaturewhatsoever,includingrightsorclaimsbasedonanysuccessor
ortransfereeliability,”withtheexceptionofcertainliabilitiesthatNewGMhad
agreedtoassume.
StartinginFebruary2014,NewGMbeganrecallingcarsbuiltbetween2002and
2009becauseofanignitionswitchdefectthatcouldcausetheignitiontoturn
offand,asaresult,disablepowersteering,brakesandairbags.Congressional
testimonyandnumerouslawsuitssoonfollowed.Theplaintiffsfellintofour
categories:(i)pre-closingaccidentclaims,(ii)economiclossclaimsarisingfrom
theignitionswitchorotherdefects,(iii)independentclaimsrelatingsolelytoNew
GM’sconduct,and(iv)usedcarpurchasers’claims.NewGMsoughttoenforce
thefreeandclearprovisionintheSaleOrdertoenjoinallsuchclaimsagainst
NewGM.Theplaintiffsinthelawsuitshadreceivedpublication,butnotactual,
noticeoftheSaleOrder.
TheBankruptcyCourtfoundthat,withafewexceptions,thetermsoftheSale
OrderbarredtheclaimsassertedagainstNewGM.TheBankruptcyCourtalso
foundthatalthoughsomeoftheignitionswitchplaintiffshadnotreceivednotice
oftheSaleOrderconsistentwithproceduraldueprocess,theplaintiffs,withthe
exceptionofthosepersonswithindependentclaimsrelatingsolelytoNewGM’s
conduct,hadnotbeen“prejudiced”bythisinsufficientnotice.
COURT ANALYSIS
AddressingtheSaleOrder,theSecondCircuitheldthataBankruptcyCourt
mayapproveasection363(f)sale“freeandclear”ofsuccessorliabilityclaims
“ifthoseclaimsflowfromthedebtor’sownershipofthesoldassets”and(i)
arisefrom“arighttopayment”(ii)“thatarosebeforethefilingofthepetition
orresultedfrompre-petitionconductfairlygivingrisetotheclaim.”Inaddition,
“theremustbesomecontactorrelationshipbetweenthedebtorandtheclaimant
suchthattheclaimantisidentifiable.”
Christopher A. Lynch Associate, New York
Commercial Restructuring & Bankruptcy Newsletter – October 2016 3
Second Circuit Sets Out Standard for Determining Scope of free and Clear provision in Sale Order under Section 363(f)—continued from page 2
ApplyingthisstandardtothefourclassesofclaimsassertedagainstNewGM,the
SecondCircuitfoundthatpre-closingaccidentclaimsandeconomiclossclaims
arisingfromtheignitionswitchorotherdefectsfellwithinthescopeoftheSale
Orderandcouldbebarred.Theseclaimswerefoundto“flowfromtheoperation
ofOldGM’s”business.TheSecondCircuit,however,foundthattheso-called
independentclaims(i.e.,thosebasedonNewGM’sownpost-closingconduct)
andclaimsofusedcarpurchaser(i.e.,claimsheldbyindividualswhopurchased
carsmanufacturedbyOldGMafterclosingwithoutknowledgeofthedefect)fell
outsidethescopeoftheSaleOrder’s“freeandclear”provision.
TheSecondCircuitthenconsideredthedueprocessimplicationsofthenotice
giventotheclaimants.Thecourtnotedthatthegeneralruleisthatnoticeby
publicationisinsufficientwhereaperson’snameandaddressareknownorvery
easilyascertainable,andwherethatperson’slegallyprotectedinterestsare
directlyaffected.Here,theSecondCircuitagreedwiththeBankruptcyCourtthat
OldGMkneworreasonablyshouldhaveknownabouttheignitionswitchdefect
priortoclosing,andthereforeshouldhaveprovideddirectnoticetotheaffected
carowners.Moreover,becausefederallawrequirestheautomanufacturerto
keeprecordsoftheinitialownersoftheirvehiclestofacilitaterecallsandother
communications,OldGMhadwithinitspossessionthecontactinformationfora
significantnumberofaffectedowners.Accordingly,theclaimantswereentitled
toactualnoticeoftheproposedSaleOrder.TheSecondCircuitalsorejected
theBankruptcyCourt’sconclusionthattheseclaimantswerenotprejudiced
becausethesalewouldhavebeenapprovedanywaybecausethealternative,
liquidation,wasunacceptable.NotingthattheSaleOrderwastheproductof
negotiationswithmanyparties,includingstates’attorneysgeneral,failureto
givetheclaimantsnoticedeprivedthemtheopportunitytoparticipateinthose
negotiations.Thecourtthereforeruledthattheclaimantswerenotbarredfrom
assertingtheirclaimsagainstNewGM.
OnSeptember14,2016,theSecondCircuitdeniedNewGM’spetitionforpanel
rehearing,or,inthealternative,forrehearingenbanc.
PRACTICAL CONSIDERATIONS
TheSecondCircuit’sdecisionisacautionarytalefordebtorsseekingtosell,and
thosewishingtopurchase,assets“freeandclear”undersection363.Where
adebtorcanreasonablyknowofpotentialclaimants(eveniftheclaimsarenot
liquidated),actualnoticeoftheproposedsaleshouldbeprovided.
Commercial Restructuring & Bankruptcy Newsletter – October 2016 4
CONT INUEDONPAGE5
gOOD fAITh fILINg REquIREMENT ALIVE AND WELL IN INVOLuNTARY BANKRupTCY CASES
In re Diamondhead Casino Corporation,No.15-11647,slipop.(Bankr.D.Del.June7,2016)
CASE SNAPSHOT
Inthisinvoluntarybankruptcycase,afterfinding
thatasufficientnumberofthepetitioning
creditors’claimswerenotthesubjectofa
bonafidedispute,theDelawareBankruptcy
Courtconcluded–baseduponthetotality
ofthecircumstances–thattheinvoluntary
bankruptcycasehadbeenfiledinbadfaithby
thepetitioningcreditorswhentheevidencefailedtosupporttheconclusionthat
thedebtorwasinsolvent.Thecourtwentontonotetheevidencesupportedthe
conclusionthattheprimarypurposeofthebankruptcywastoeffectachangein
thedebtor’smanagementtobenefittheirinterestsasthedebtor’sequityholders.
Asecondarypurposewastoenablethepetitioningcreditorstocollectontheir
pre-petitionnotes.Thereafter,theBankruptcyCourtenteredjudgmentinfavorof
thedebtorandagainstthepetitioningcreditorsforfees,expensesandpunitive
damagesincurredbytheallegeddebtorinconnectionwiththismatter.
PROCEDURAL HISTORY
InAugust2016,threenoteholdersandstockholdersfiledaninvoluntarychapter
7bankruptcypetitionagainstDiamondheadCasinoCorporation.Threeadditional
creditorssubsequentlyjoinedinthepetition.Theallegeddebtormovedtodismiss
thebankruptcycase,assertingthat(i)eachofthepetitioningcreditors’claims
wasthesubjectofbonafidedispute;(ii)thepetitionwasfiledinbadfaith;and
(iii)abstentionwaswarranted.WhileDiamondhead’smotionwaspending,
thepetitioningcreditorssoughttheappointmentofachapter7trustee.The
BankruptcyCourtdeniedthepetitioningcreditors’motiontoappointachapter
7trustee,followinganevidentiaryhearing.Afterafurtherevidentiaryhearing
andpost-hearingbriefingbyDiamondheadandthepetitioningcreditors,the
BankruptcyCourtgrantedDiamondhead’smotiontodismissthebankruptcycase.
FACTUAL BACKGROUND
Forapproximately15yearspriortothepetitiondate,Diamondheadhadno
operations.Asofthepetitiondate,Diamondhead’sonlyassetwasawholly
ownedsubsidiarythatownscertainundevelopedrealproperty.Diamondhead’s
CEOtestifiedthattheappraisedvalueoftherealpropertywas$39,350,000.
Tofundthedevelopmentoftherealproperty,Diamondheadissuedvarious
promissorynotes,allofwhichhadmaturedandhadnotbeenpaid,priortothe
commencementofthebankruptcycase.Thepetitioningcreditorsheldsuchnotes
andalsoheldstockinDiamondhead.Accordingtoevidenceadducedduring
thehearingsinthiscase,asofDecember31,2014,Diamondhead’sbalance
sheetreflectedcurrentassetsofapproximately$6.5million,includingthereal
propertywithabookvalueofapproximately$5.3million,andliabilitiestotaling
approximately$9million.
Intheyearleadinguptothefilingoftheinvoluntarypetition,petitioningcreditors’
frustrationwithDiamondhead’smanagementgrewandthepetitioningcreditors
lostfaithinmanagementasaresultof,amongotherthings,petitioningcreditors’
disagreementwithcertainactiontakenbyDiamondheadfortheapparentbenefit
ofinsiders,andthedenialofcertainpetitioningcreditors’requeststoinstallnew
boardmembers.Additionally,Diamondheadandoneofitsnoteholders(who
purportedlyassigneditsinterestinsuchnotetooneofthepetitioningcreditors)
suedDiamondheadtorecoveramountsowedtoitunderthenote.Furthermore,
atDiamondhead’s2015annualmeeting,certainofthepetitioningcreditors
unsuccessfullyundertookaproxycontesttoreplaceDiamondhead’sincumbent
boardofdirectors.
COURT ANALYSIS
Asathresholdmatter,theBankruptcyCourtevaluatedwhetherthepetitioning
creditors’claimswerethesubjectofabonafidedispute.Thecourtconcluded
that,infiveofthesixpetitioningcreditors’claims,theclaimswerenotthesubject
ofabonafidedisputebecausetherewasnoobjectivebasisforeitherafactual
orlegaldisputeconcerningthevalidityofthedebt.Inreachingitsconclusion,the
courtanalyzedwhetherDiamondhead’saffirmativedefensestoliabilityunderthe
notespresentedameritoriouslegalargumentthatitwouldnotbeliabletopay
thenotes.Theremainingpetitioningcreditorfailedtopresentevidencesufficient
tocarryitsburdenthatnobonafidedisputeexisted,withrespecttoitsright
topaymentunderthenote,followinganallegedassignment.Notwithstanding
theexistenceofabonafidedisputewithonepetitioningcreditor’sclaim,the
fiveremainingpetitioningcreditors’claimsweresufficienttosatisfythethree
petitioningcreditoranddebtthresholdrequirementsinsection303ofthe
BankruptcyCode.Accordingly,thecourtwentontoconsiderwhetherthepetition
hadbeenfiledingoodfaith.
CourtsintheThirdCircuitmaydismissaninvoluntarycasethatwasfiledinbad
faith,evenifthestatutoryrequirementsaresatisfied.Inevaluatingthegood
faithrequirementininvoluntarycases,courtswithintheThirdCircuitexamine
thetotalityofthecircumstances,byconsideringvariousfactorsincluding:(i)
whetherthepetitioningcreditorsareusingthebankruptcyinanattemptto
obtainadisproportionateadvantageoverothercreditors;(ii)whetherthefiling
wasmotivatedbyaproperpurposeorsomeillwill,maliceoradesiretoharass
orembarrasstheallegeddebtor;and(iii)whatareasonablepersonwouldhave
doneinthepetitioningcreditors’situation.Thecourtconductedanadditional
inquiryastowhetherthepetitioningcreditorsweremotivatedbytheirstatusas
creditors,stockholdersorboth.
TheBankruptcyCourtconsideredtheevidenceintroducedandparties’arguments
inconnectionwitheachofthesefactor.TheBankruptcyCourtfoundthatthe
evidenceoverwhelminglyprovedthateachofthepetitioningcreditorssought
achangeinmanagement,believedtheinvoluntarybankruptcyproceedingwas
theonlymeansbywhichtoaccomplishsuchmanagerialchange,andexpressed
frustrationandalackoffaithinexistingmanagement.
TheBankruptcyCourtfoundthatcertainfactorstobeconsideredweighedin
favoroffindingthattheinvoluntarypetitionwasfiledinbadfaith,whileothers
didnot.Forinstance,thecourtfoundthatpetitioningcreditors’desiretoreplace
Jennifer P. Knox Associate, Philadelphia
Commercial Restructuring & Bankruptcy Newsletter – October 2016 5
existingmanagementandremedystockholderissuesthroughaninvoluntary
bankruptcyproceeding,isafactorwarrantingdismissal.Thecourtalsorejected
thepetitioningcreditors’argumentsthattheycommencedtheinvoluntary
bankruptcycasetopreserveandprotectthepropertyandpursuechapter5
avoidanceactions,citing,amongotherthings,“significanthurdles”toprovingthe
allegeddebtor’sinsolvencyatthetimeofsuchtransfers.TheBankruptcyCourt
furthernotedthatinvoluntarybankruptcycasesshouldnotbeusedascollection
devices.Ontheotherhand,theBankruptcyCourtconcludedthatseveral
factorsdidnotsuggestabadfaithfiling.Theseincludealackofillwilltoward
Diamondheadoritscurrentmanagement,despitethepetitioningcreditors’
frustrationwithboth,andalackofevidencetosupportafindingthatthecase
wascommencedtoobtainatacticallitigationadvantageoradvantageoverother
creditors.
Afterweighingallthefactors,thecourtconcluded,baseduponthetotalityofthe
circumstances,thatthepetitioningcreditorsfiledthebankruptcycaseinbad
faithbecausetheprimarypurposeofthebankruptcywastoeffectachangein
thedebtor’smanagementtobenefittheirinterestsasthedebtor’sequityholders;
asecondarypurposewastoenablethepetitioningcreditorstocollectontheir
pre-petitionnotes;andanymotivetopursueavoidanceactionswas“tertiary,at
best,andlikelyill-conceived.”Accordingly,thecourtdismissedthebankruptcy
case.Followingthedismissalofthecase,Diamondheadsuccessfullypetitioned
thecourtforanawardoffeesandcoststhatitincurredindefendingthemotion
toappointachapter7trusteeandinobtainingdismissalofthebankruptcycase.
PRACTICAL CONSIDERATIONS
Thecourtwascarefultolimititsdeterminationtotheparticularfactsand
circumstancesofthiscase;however,petitioningcreditorsshouldbemindfulof
thegoodfaithfilingrequirementinpursuinganinvoluntarybankruptcycase.In
consideringwhethertofileaninvoluntarypetition,creditorsshouldnotethat,a
desiretoeffectachangeinmanagementandcollectonpre-petitionobligations,
especiallywhenthedebtor’sinsolvencyisinquestion,maynotbesufficientto
sustainafindingthattheinvoluntarycasewasfiledingoodfaith.Moreover,in
evaluatingwhethertofileaninvoluntarypetition,creditorsshouldconsiderthat
thedismissalofaninvoluntarycase,whichisfoundtohavebeenfiledinbad
faith,couldresultintheimpositionofmonetarysanctionsagainstsuchcreditors
infavorofthedebtor.
good faith filing Requirement Alive and Well in Involuntary Bankruptcy Cases—continued from page 4
uNpAID COMpENSATION pAYABLE EXCLuSIVELY IN STOCK CONSTITuTES EquITY, NOT AN uNSECuRED CLAIM
GSE Environmental, Inc. v. Sorentino (In re GSE
Environmental, Inc.),Adv.Pro.No.16-50377,
(Bankr.D.Del.Jul.18,2016)
CASE SNAPSHOT
TheDelawareBankruptcyCourtrecently
foundthatemployeecompensation,which
waspayableincompanystock,shouldbe
characterizedasequityratherthandebt.
FACTUAL BACKGROUND
Priortothecommencementofthebankruptcycase,thedebtors’interim
presidentandCEO(“CEO”)enteredintoanemploymentagreementwiththe
debtors,pursuanttowhichthepartiesagreedthat$100,000oftheCEO’s
monthlycompensationwouldbepaidincashandtheremaining$86,000would
bepaidincompanystock.Asofthepetitiondate,theCEOhadreceivedallofthe
cashcompensationdueundertheemploymentagreement,buthadnotreceivedthe
compensationthatwaspayableintheformofcompanystock.
TheCEOfiledaproofofclaiminthedebtors’bankruptcycases,assertinga
generalunsecuredclaimintheamountof$260,886.67,onaccountofthe
unpaidcompanystockportionofhiscompensation.Thereafter,thedebtors
commencedanadversaryproceedingseekingadeclaratoryjudgmentthatthe
stock-basedcompensationconstitutedan“equityinterest,”asdefinedbythe
BankruptcyCode,notanunsecuredclaim;oralternatively,thatsuchclaimshould
besubordinatedpursuanttosection510(b)oftheBankruptcyCode.Afterthe
pleadingsclosed,thedebtors’movedthecourtforentryofjudgmentontheir
claimsagainsttheCEO.
COURT ANALYSIS
JudgeWalrathagreedwiththedebtorsandfoundthatthecompanystock
portionoftheCEO’scompensation“fitssquarelywithintheCode’sdefinition
ofequitysecurity.”Section101(16)oftheBankruptcyCodedefines“equity
security”toinclude,a“shareinacorporation,whetherornottransferableor
denominated‘stock’orsimilarsecurity...[ora]warrantorright,otherthan
arighttoconvert,topurchase,sellorsubscribeto[such]ashare,securityor
interest.”Thecourtheldthatthecommonstockgiveninexchangeforlabor
constitutesapurchaseandsaleofasecurity,undertheBankruptcyCode.Inso
holding,thecourtrejectedtheCEO’sargumentthat,becausethevalueofthe
stockowedtohimwascalculatedbaseduponadollaramount,ratherthanona
certainnumberofshares,theclaimshouldbetreatedasanunsecuredclaim.In
rejectingthisargument,thecourtnotedthattheemploymentagreemententitled
theCEOtoreceivecompanystockonly,notcash,onaccountoftheportionofthe
compensationthatremainedunpaid.
PRACTICAL CONSIDERATIONS
ThedecisionisthesubjectofanappealthatispendingbeforetheU.S.District
CourtfortheDistrictofDelaware,asCaseNo.16-616.ReedSmithrepresents
thedebtorsinthiscase.
Jennifer P. Knox Associate, Philadelphia
Commercial Restructuring & Bankruptcy Newsletter – October 2016 6
BREACh Of fIDuCIARY DuTY CLAIMS ARE NOT TIME-BARRED DuE TO LENDER’S KNOWLEDgE
Eugenia VI Venture Holdings, Ltd. v. MapleWood
Holdings LLC (In re AMC Investors, LLC),551
B.R.148(D.Del.2016)
CASE SNAPSHOT
Inthischapter7case,thedebtor’spre-petition
securedlender,andsolecreditor,obtained
derivativestandingtopursuebreachoffiduciary
dutyclaimsagainstprivateinvestmentfunds
thatcontrolledthedebtor.Thelenderalleged
thatthedefendantshadbreachedtheirfiduciary
dutiesofgoodfaith,duecare,andloyaltybyinstituting,directing,and/orfailing
todiscoverandpreventmassivefraudbytheboardandmanagementofthe
debtor.TheBankruptcyCourtheldthatsuchclaimsweretime-barredunder
theapplicableDelawarestatuteoflimitations.TheDistrictCourtreversedthat
decisiontotheextentthatitwasbasedsolelyonthelender’sknowledge.
FACTUAL BACKGROUND
Thedebtor–AMCComputerCorp.–wasahardwareandservicescompany.
In2000,thedefendants–privateinvestmentfundscollectivelyreferredtoas
MapleWood–investedinAMCinexchangeforequityshares.Pursuanttoa
January30,2003,creditagreement,thelender–Eugenia–extendedupto
$16millionofcredittoAMCsecuredbyworkingcapital.InMay2005,AMC
becameinsolvent,anditsboardofdirectorsvotedtoceaseoperationsandto
approveanassignmentforthebenefitofcreditors.
Eugenia–AMC’ssolecreditor–successfullybroughtaninvoluntarychapter7
bankruptcycaseagainstAMC.Inthebankruptcycase,Eugeniaallegedthat,at
allrelevanttimes,MapleWooddominatedandcontrolledAMC.Eugeniafurther
allegedthatMapleWood’sbreachesofitsfiduciarydutiesrenderedEugenia’s
loanunrecoverableandworthless.Onthesebases,Eugeniasought,and
obtained,derivativestandingtobringbreachoffiduciarydutyclaimsagainst
MapleWoodonbehalfofAMC.However,theBankruptcyCourtdismissedsuch
claimsasbeingtime-barredunderDelaware’sthree-yearstatuteoflimitations.
Onappeal,EugeniaarguedthattheBankruptcyCourterredwhenitfailedto
tollthestatuteoflimitations.UnderDelaware’stollingdoctrine,thestatuteof
limitationsbeginstorunuponthediscoveryoffactsconstitutingthebasisofthe
causeofactionortheexistenceoffactssufficienttoputapersonofordinary
intelligenceandprudenceoninquiry,which,ifpursued,wouldleadtothediscovery
ofsuchfacts.EugeniacontendedthattheBankruptcyCourterredwhenitheld
thatthestatuteoflimitationsbegantorunuponEugenia’sdiscoveryofthe
underlyingfactsbecauseEugeniawasbringingaderivativeclaimonbehalfof
AMC.AccordingtoEugenia,thecorrectinquirywaswhetherandwhenAMC
discoveredtheunderlyingfacts,andthestatuteoflimitationsonlybegantorun
uponthatdate.
COURT ANALYSIS
TheDistrictCourtagreedwithEugenia.TheDistrictCourtreasonedthatthe
discoveryinquiryshouldnothaveturnedonEugenia’sknowledge,butinsteadon
AMC’sabilitytodiscovertheclaims,becauseitwastheonlyentitywithadirect
breachoffiduciarydutyclaimagainstMapleWood.Thus,theDistrictCourtheld
thatDelawarelawrequiredtheBankruptcyCourttoevaluatewhenAMChad
discoveredfactsconstitutingthebasisforthebreachoffiduciarydutyclaims,or
theexistenceoffactssufficienttoputAMConinquirynotice.
PRACTICAL CONSIDERATIONS
HavingreversedtheBankruptcyCourttotheextentthatitsdecisionwasbased
solelyonEugenia’sknowledge,theDistrictCourtemphasizedthat“Eugenia’s
knowledgeatthecriticaltimeshouldnotbeimputedto”AMC.Thecorrectinquiry
wassolelyAMC’sknowledge.TheDistrictCourtacknowledgedthatsuchinquiry
wascomplicatedbythefactthatMapleWoodwasbothcontrollingAMCand
allegedlybreachingitsfiduciaryduties,andsuggestedthatthismaybeabasis
alonetotollthestatuteoflimitationssolongasEugeniawasreasonablyrelying
onMapleWood’scompetenceandgoodfaith.TheDistrictCourt,however,left
thatissuefortheBankruptcyCourttodetermine.
Brian M. Schenker Associate, Philadelphia
Commercial Restructuring & Bankruptcy Newsletter – October 2016 7
pETITIONINg CREDITORS BEWARE: BANKRupTCY CODE DOES NOT pREEMpT STATE LAW CLAIMS Of NON-DEBTORS
Rosenberg v. DVI Receivables XVII, LLC,
No.15–2622,2016WL4501675
(3dCir.Aug.29,2016)
CASE SNAPSHOT
Inthisopinion,theUnitedStatesCourtof
AppealsfortheThirdCircuitwaspresentedwith
thequestionofwhethersection303(i)ofthe
BankruptcyCodepreemptedanon-debtor’sstate
lawrightsofrecoveryfordamagesresultingfrom
animproperinvoluntarybankruptcypetition.
Thecourtheldthatbecausetheplaintiffseeking
damagesherewerenotthedebtorssubjectto
theinvoluntarypetitionand,becausesection303(i)oftheBankruptcyCodedid
notconstitutecompletefieldpreemptionofallremedies,non-debtorsinjuredby
improperlyfiledinvoluntarypetitionstillretainedtherighttoproceedwiththose
statelawclaims.
FACTUAL BACKGROUND
Thecasebeganthroughaninvoluntarypetitionthatwascommencedbycertain
leasecreditorsagainstvariouslesseesandoneoftheprincipals–MauryRosenberg–
intheEasternDistrictofPennsylvania.ThecaseagainstRosenbergwas
transferredtotheSouthernDistrictofFloridaandwassubsequentlydismissed
becausetheleasecreditorswerenotcreditorsofRosenberg.Ultimately,the
actionsagainsttheoriginallesseeswerealsodismissed.Rosenbergthereafter
filedanactionagainstthepetitioningcreditorsfortheimproperinvoluntary
petitionfilingpursuanttosection303(i)oftheBankruptcyCode.Aftervarious
proceduralmachinations,afinaljudgmentwasenteredinfavorofRosenbergin
theFloridacourtsfor$1.1millionincompensatorydamagesand$5millionin
punitivedamages.
WhilethepetitionswerependingintheFloridacourts,SarahRosenberg(Maury’s
wife)andvariousotheraffiliatedentitiesthatwerenotthesubjectofany
involuntarypetitionsbroughtaseparatesuitagainstthepetitioningcreditorsin
FloridafederalDistrictCourtforstatelawtortiousinterferencewithcontractual
relations.ThecasesweretransferredtotheEasternDistrictofPennsylvaniaand
werethereafterdismissed.Thedismissingcourtheldthatthecomplaintinvolved
statelawclaimsthatwerepreemptedbysection303(i)oftheBankruptcyCode.
Theappealfollowed.
COURT ANALYSIS
Thecourtbeganbyhighlightingthatsection303(i)oftheBankruptcyCode
expresslyprovidesaremedyfordebtorswhoarethesubjectofanimproperly
commencedinvoluntarypetition.TheBankruptcyCodeallowsputativedebtorsto
recoverattorneys’fees,costsanddamagesresultingfromtheimpropercase.The
courtalsonotedthatbecausetheplaintiffsinthecurrentactionwerenotdebtors,
theyarenotentitledtobringactionsundersection303(i)oftheBankruptcy
Code.Thecourtthenanalyzedwhethertheenactmentofsection303(i)ofthe
BankruptcyCodepreemptedanystatelawclaimsassertedbynon-debtors.
ThecourtfocusedonwhetherCongresshasoccupiedafieldthathasbeenset
forexclusivefederalregulationinordertodeterminewhetherthatactpreempted
statelawclaims.Thereisapresumptionagainstinferringpreemptionsoastonot
eliminateexistingrightsunlessCongressspecificallyattemptedtodoso.When
analyzingthetextofsection303(i)oftheBankruptcyCode,Congressspecifically
addressedaremedyfordebtorsbutdidnotprovideanyremedyfornon-debtors.
ThecourtheldthatCongressionalsilenceshouldbeinferredtoleaveintact
whateverrightsthosenon-debtorpartieswouldhave.
Thecourtnotedthatitsdecisionwascontrarytothe2005decisionoftheNinth
CircuitinIn re Miles.InIn re Miles,theNinthCircuitheldthatsection303(i)ofthe
BankruptcyCodeprovidedtheexclusiveremedyrelatingtothecommencement
ofanimproperbankruptcypetition.ThecourtherenotedthattheMilesdecision
wasinconsistentwitha1988decisionoftheThirdCircuit(whichwasprecedent
here)anddeclinedtofollowtheMilesreasoning.Thecourtfurtherreasoned
thatitwashardtorationalizehowthestatute’sexpresslanguagerelatedonly
todebtors–andhowitssilenceastotherightsofnon-debtorscouldresultin
preemption.
PRACTICAL CONSIDERATIONS
Involuntarybankruptcycasesaregenerallycautionarytales.Creditorscommencing
involuntarypetitionsmustengageinsignificantpre-filingdiligencejusttoensure
thattheyarenotexposedtoliabilitytotheputativedebtorundertheBankruptcy
Code.Thiscaseraisesthebarevenfurther–creditorsimproperlycommencing
aninvoluntarycasecouldalsobeliabletonon-debtorpartiesfortheiractionsif
separatestatelawclaimscanbeestablished.
Derek J. Baker Partner,
Philadelphia and Princeton
Commercial Restructuring & Bankruptcy Newsletter – October 2016 8
NINTh CIRCuIT hOLDS ThAT DEfALCATION REquIRES MORE ThAN A CONTINgENT pARTNERShIp AgREEMENT
Crull v. Utnehmer (In re Utnehmer),No.13-60113
(9thCir.June06,2016)
CASE SNAPSHOT
TheNinthCircuitheldthataloanagreementwith
acontingentpromisetoenterintoanoperating
agreementforapartnershipatsomepointinthe
futuredidnot,onitsown,formapartnership
underCalifornialaw.
FACTUAL BACKGROUND
Creditorsloaned$100,000tothedebtorsforpurposesofdevelopingaparcelof
realproperty.Theloanagreementgrantedthedebtorstherighttousethefunds
intheirdiscretionandsetforththetermsofrepaymentoftheloan.Althoughthe
partiesdiscussedtheloanbeingsecuredbytherealproperty,nodeedoftrust
waseverrecorded.Importantly,theloanagreementalsostatedthattheparties
intendedthat$50,000oftheloanberecharacterizedasequitypursuanttoan
operatingagreementnotyetdraftedoragreedupon.However,nosuchoperating
agreementwaseverfinalizedbetweentheparties.
Aftercreditorsmadethe$100,000loan,thedebtorsobtainedadditionalfinancing
fromothersourcesthatweresecuredbytherealpropertywithoutinforming
thecreditors,andafterfullydevelopingtherealproperty,thedebtorsrepaidall
oftheirlendersexceptforcreditors.Creditorssuedthedebtorsandobtained
defaultjudgment.Thedebtorsfiledachapter11case,atwhichtimecreditors
filedanadversarycaseagainstthedebtorsseekingtohavetheirjudgment
deemednondischargeableunder11U.S.C.section523.
TheBankruptcyCourtfoundnofraudintheinceptionoftheloan,butfoundthat
theloanagreementcreatedapartnershipbetweencreditorsandthedebtors,
andfoundthatthedebtors’failuretoaccountformissingfundsowedtocreditors
constituted“defalcation”toapartnerunder11U.S.C.section523(a)(4).On
appealtotheBankruptcyAppellatePanel(BAP)fortheNinthCircuit,theBAP
reversedtheBankruptcyCourt’sruling,findingthatacontingentpromiseina
loanagreementtoformapartnershipinthefuturewasnotenoughtoforma
currentpartnership.TheBAPdidnotremandthecaseforanyfurtherfindingsof
factonthepartnershipissues.CreditorsappealedtotheNinthCircuit.
COURT ANALYSIS
TheNinthCircuitagreedwiththeBAP’sanalysisthat,findingthattheloan
agreementrequiredthatthepartiesenterintoanoperatingagreementbefore
anypartnershipwasformed,andthefailuretosatisfythatcontingencyresulted
innopartnershipbeingformedundertheoperatingagreement.Onthatbasis,
theNinthCircuitreversedtheBankruptcyCourt’srulingthattheloanagreement
formedapartnership.Withoutsuchapartnershipbeingformed,therecouldbeno
“defalcation”under11U.S.C.section523(a)(4).
However,theNinthCircuitalsoheldthattheBAPerredbynotremandingthecase
forfurtherfindingsoffactregardingwhetherapartnershipwasformedoutsideof
thecontextoftheloanagreement,andwhethertherewasanydefalcationunder
thatpartnershiparrangement.IftheBankruptcyCourtweretodetermine
thatapartnershipwasformedoutsidetheloanagreement,theNinthCircuitalso
remandedontheissuewhetherdebtorshadtherequisiteculpablestateofmind
tocommitdefalcation,asrequiredbytheSupremeCourt’sdecisioninBullock v.
BankChampaign, N.A.,569U.S.___,133S.Ct.1754(2013),whichwasissued
aftertheBankruptcyCourt’sruling.
PRACTICAL CONSIDERATIONS
Sloppydraftinginaloanagreementcanwreakhavoconacreditor’sabilityto
collectonitsloanobligations,andbothlendersandborrowersshouldbevery
clearaboutwhethertheirlendingrelationshipisatruelendingrelationshipora
partnership.ThecreditorsinUtnehmerapparentlyrushedintotheloanagreement
withoutfinalizinganoperatingagreementorconsideringtheirenforcement
mechanisms.Creditorshadnumerousoptionsavailabletothematthetimethey
negotiatedtheloanagreementthatwouldhaveavoidedthedifficultiestheyfound
themselvesin,including:properlysecuringtheirloanobligationsbyrecordinga
deedoftrust;negotiatinganoperatingagreementbeforeenteringintotheloan
agreement;and,ifdraftingtheoperatingagreementwasunfeasibleatthetime,
atleastprovidingimmediateenforcementmechanismsforcreditorsuponthe
failuretotimelyenterintoanoperatingagreement.
Christopher O. Rivas Associate, Los Angeles
Commercial Restructuring & Bankruptcy Newsletter – October 2016 9
CONT INUEDONPAGE10
TAX upSET SALE hELD NOT TO BE CONSTRuCTIVE fRAuDuLENT TRANSfER
Crespo v. Immanuel (In re Crespo),Adv.No.
14-326,CaseNo.14-11629-REF,(Bankr.E.D.
Pa.May18,2016)
CASE SNAPSHOT
Inthischapter13case,thedebtorsoughtto
avoidataxupsetsaleofhispersonalresidence
onthebasisthatthetaxupsetsalewasa
constructivefraudulenttransferundersection
548(a)(1)(B)(i)oftheBankruptcyCode.The
BankruptcyCourtheldthat,asamatterof
law,ataxupsetsalecannotbeaconstructive
fraudulenttransferbecausethevaluepaidbythepurchaseratanysuchsale
mustbedeemedtobereasonablyequivalentvalue.Thus,adebtorcannotstate
anyclaimforconstructivefraudulenttransferinataxupsetsale.
FACTUAL BACKGROUND
Thefactsofthecasearesimple.Thedebtorpurchasedapersonalresidence
for$175,000.Thedebtorbecamedelinquentinpayingpropertytaxesonhis
personalresidencelocatedinLehighCounty,Pennsylvania.Ultimately,the
LehighCountyTaxClaimBureausoldthepropertyattaxupsetsale.Athird
partybid$27,000forthepropertyatthesale,wasthesuccessfulbidder,and
purchasedtheproperty.Thedebtorthenfiledachapter13bankruptcypetition
seekingtoundothetaxupsetsaleasaconstructivefraudulenttransfer.
Section548(a)(1)(B)(i)oftheBankruptcyCodeprovidesthatatransferofproperty
ofadebtormaybeavoidedifthedebtorwasinsolventatthetimeof,anddidnot
receivereasonablyequivalentvalueinexchangefor,thetransferofsuchproperty.
Here,thedebtorarguedthathewasinsolventatthetimeofthetaxupsetsale
andthe$27,000receivedforhispersonalresidencedidnotconstitutereasonably
equivalentvalue.
COURT ANALYSIS
TheBankruptcyCourtbeganitsanalysiswiththeUnitedStatesSupremeCourt’s
decisioninBFP v. Resolution Trust Corp.,511U.S.531,545(1994).InBFP,the
U.S.SupremeCourtheldthatthereasonablyequivalentvalueforforeclosedreal
propertyisthepricereceivedataforeclosuresaleiftheforeclosuresalewas
conductedinaccordancewithstatelawrequirements.TheBankruptcyCourt
disagreedwiththedebtor’sargumentthattheholdinginBFPshouldnotbe
extendedtotaxupsetsales.Instead,theBankruptcyCourtextendedtheholding
inBFPtotaxupsetsalesandnotedthatitjoinedmanyothercourtsindoingso.
TheBankruptcyCourtthenconcludedthatitwasboundbyastatecourt’sfinding
thatthetaxupsetsalehadbeenconductedinaccordancewithallPennsylvania
statelawrequirements.Consequently,the$27,000paidforthehomeconstituted
reasonablyequivalentvalueasamatteroflaw.Thus,thedebtor’sclaimfor
constructivefraudulenttransferfailedasamatteroflaw.
PRACTICAL CONSIDERATIONS
TheBankruptcyCourt’sdecisionconfirmstheapplicabilityoftheU.S.Supreme
Court’sdecisioninBFPtoPennsylvaniataxupsetsales.Thus,providedthat
allPennsylvaniastatelawrequirementsarecompliedwith,taxupsetsaleswill
notbeabletobechallengedasconstructivefraudulenttransfersinsubsequent
bankruptcycases.
CALIfORNIA BANKRupTCY COuRT CLARIfIES OffICER AND DIRECTOR DuTIES TO CREDITORS Of INSOLVENT COMpANY
AWTR Liquidation Trust v. 2100 Grand LLC
(In re AWTR Liquidation Inc.),548B.R.300
(Bankr.C.D.Cal.2016)
CASE SNAPSHOT
TheBankruptcyCourtheldthat,although
Californialawwasnotfullysettledontheissue,
directors’andofficers’fiduciarydutiesdidnot
changewhenacompanybecameinsolvent.
Rather,thesamedutiesowedbydirectorsand
officerstostockholderspre-insolvencyareowed
toallcreditorspost-insolvency.
FACTUAL BACKGROUND
TheliquidatingtrusteefordebtorRhythm&Hues,Inc.,suedthedebtor’sformer
directorsonbehalfofthedebtor’screditors,allegingthatthedirectorsbreached
theirfiduciarydutiestocreditorsatatimewhenthedebtorwasinsolvent,and
thatthetransfersweresubjecttoavoidanceasfraudulenttransfersunder11
U.S.C.section548.Thedebtorwasawell-knownvisualeffectsandcomputer-
generatedanimationproducer(knownmostrecentlyforthefilm“LifeofPi”).
Thetrusteeallegedthatthedebtor’sdirectorsdivertednearly$2millionof
thedebtor’scapitaltoabusinessfoundedbyoneofthedirector’sparents,
transferredawaycertainofthedebtor’simportantsoftwarerightswithout
consideration,advancedmillionsofdollarstothedirectors,andenteredinto
unfavorablestudiocontracts.
Brian M. Schenker Associate, Philadelphia
Christopher O. Rivas Associate, Los Angeles
Commercial Restructuring & Bankruptcy Newsletter – October 2016 10
Thedirectorsmovedtodismissthetrustee’scomplaint,allegingthatthedirectors
owednodutiestocreditors,evenduringthedebtor’sinsolvency,andthatthe
directors’decisionswereshieldedbythebusinessjudgmentrule.
COURT ANALYSIS
TheBankruptcyCourtobservedthat,withoutaCaliforniaSupremeCourtdecision
andwithsparseopinionsbyCaliforniacourtsofappeal,thatCalifornialawwas
largelyunsettledonissuesofofficers’anddirectors’fiduciarydutieswhena
companyisinsolvent,andtheprotectionsaffordedtothemunderthebusiness
judgmentrule.TheBankruptcyCourtfoundthatCalifornialawwaswellsettled
thatdirectors(andlikelyofficers)owedfiduciarydutiesofcare,loyaltyandgood
faithtotheirinvestors.
Firstaddressingthebusinessjudgmentrule,theBankruptcyCourtheldthat
underCalifornialaw,theruleoperatedtoshieldacompany’sdirectorsforbreach
offiduciarydutybasedonmerenegligence.Inotherwords,uponapplication
oftherule,adirectorcouldonlybeheldliableforhisorhergrossnegligence.
Critically,theBankruptcyCourtheld,indicta,thatCaliforniaCorporationsCode
section309andunpublishedCaliforniadecisionsdidnotextendthebusiness
judgmentruletoacompany’sofficers–onlytoitsdirectors.
RelyingprimarilyonDelawaredecisions,mostnotableIn re Caremark Int’l
Derivative Lit.,698A.2d959(Del.Ch.1996),theBankruptcyCourtheldthatthe
adirectorcouldinvokethebusinessjudgmentruleifthedirectorcouldestablish
thatheorsheworkedunderasystemreasonablydesignedtoprovidetimely,
accurateandsufficientinformationtothedirector;thatthedirectoractually
usedthesystem;andthatthedirectorexercisedhisorherbusinessjudgment
inusingthesystem.Forexample,adirectorcannotjustassumeothersonthe
boardarehandlingtheirresponsibilities,butshouldsetupasystem,suchas
subcommitteeswithregularreportingrequirements,toconfirmsuchmatters,
andmustproperlymonitorandoverseethesystem.Californialaw,likeDelaware
law,isclear,thatconflictsofinterestandself-dealingarenotprotectedbythe
businessjudgmentrule.
TheBankruptcyCourtthenturnedtotheissueofinsolvency.Adirectorordinarily
owesfiduciarydutiesonlytothecompany’sstockholders.Butwherethe
companybecomesinsolvent,certaindutiesextendtocreditorsaswell.Thescope
ofdutiesowedtocreditorshasnotbeensettledbytheCaliforniaSupremeCourt,
buttheBankruptcyCourtreliedprincipallyonthe“trustfunddoctrine”setforth
inBerg & Berg Enterprises, LLC v. Boyle,178Cal.App.4th1020(2009),which
requiresthatdirectorsandofficersavoidactionsthat“divert,dissipate,orunduly
riskcorporateassetsthatmightotherwisebeusedtopaycreditors[‘]claims.”
TheBankruptcyCourtreasonedthatthesedutieswere“essentially,ifnotexactly”
thesameasthedutiesowedbydirectorsandofficerstotheirstockholdersina
solventcorporation.Theonlychangebetweensolvencyandinsolvencyisthata
creditorjoinsthecompany’sstockholdersintheirstandingtosuedirectorsand
officersforbreachoffiduciaryduty.
Analyzingthecomplaintfiledbytheliquidatingtrustee,theBankruptcyCourtheld
thatitadequatelypleadedinsolvencyunderallthreeapplicabletests(balance
sheet,cashflow,andinadequatecapitalization).TheBankruptcyCourtfurther
determinedthatthecomplaintallegednotonlyordinarynegligence(whichcould
beshieldedbythebusinessjudgmentrule),butalsoallegedgrossnegligence
(whichcouldnot).Likewise,thecomplaintallegedself-dealingtransactions,
whichcouldalsonotbeshieldedbythebusinessjudgmentrule.
PRACTICAL CONSIDERATIONS
Californialawonfiduciaryduties,particularlyforinsolventcorporations,remains
unsettled.However,theAWTRdecisionprovidesvaluablepersuasiveguidanceto
officersanddirectorsintermsofhowtoexercisetheirpowers,particularlywhen
acompanymaybeinsolvent.Critically,theAWTRdecisionshouldprovidesome
comfort(althoughnon-binding),thatthedutiesthemselvesdonotchangewhen
acompanybecomesinsolvent;thedutiesmerelyextendfromstockholdersto
creditors.Nevertheless,giventheadditionalexposuretodirectorsandofficers
whenacompanyisinsolvent,theyoughttoerronthesideofexercisingtheir
businessjudgmentcautiouslysinceitisfarmorelikelythattheirdecisionswillbe
scrutinizedbyacourtifandwhencreditorsdosue.
California Bankruptcy Court Clarifies Officer and Director Duties to Creditors of Insolvent Company—continued from page 9
Commercial Restructuring & Bankruptcy Newsletter – October 2016 11
TEXAS BANKRupTCY COuRT hOLDS ThAT STRuCTuRED DISMISSAL IS AuThORIzED BY ThE BANKRupTCY CODE WhEN CREDITOR RECOVERY IS MAXIMIzED BY LIMITINg ADMINISTRATIVE CLAIMS, AND ThE TERMS Of ThE DISMISSAL pROVIDE fAIR AND EquITABLE TREATMENT TO CREDITORS
In re Olympic 1401 Elm Associates, LLC,No.
16-30130-hdh,slipop.(Bankr.N.D.Tex.,Dallas
Div.,Aug.26,2016)
CASE SNAPSHOT
TheUnitedStatesBankruptcyCourtforthe
NorthernDistrictofTexas,DallasDivision
(the“Court”),heldthatstructureddismissals
areauthorizedbytheBankruptcyCodeifthe
proposedstructureddismissal:(i)providesfair
andequitabletreatmenttocreditors;(ii)does
notconstituteasubrosaplan;and(iii)doesnot
violatedtheabsolutepriorityrule.Accordingly,theCourtgrantedtheDebtor’s
MotiontoDismiss.
FACTUAL BACKGROUND
Olympic1401ElmAssociates,LLC(the“Debtor”),asingleassetsrealestate
entitywhosesolepurposewastoownandmanageacommercialbuildingin
Dallas(the“Property”),filedamotiontoselltheProperty(the“MotiontoSell”)
for$65million.TheproposedsalespricewassufficienttopayalloftheDebtor’s
non-insidercreditorsinfull,andprovideaproratadistributiontotheDebtor’s
twoinsiderclaims.TheCourtenteredanorder(the“SalesOrder”)approvingthe
MotiontoSell,andthePropertywassubsequentlysoldfor$65million(the“Sales
Proceeds”)pursuanttothetermsoftheSalesOrder.
TheDebtorsubsequentlyfiledamotiontodismiss(the“MotiontoDismiss”)its
chapter11bankruptcycase(the“Case”).TheMotiontoDismissprovided,among
otherthings,that:(i)theCasewouldbydismissed;and(ii)theSalesProceeds
wouldbeusedto(a)paytheDebtor’sadministrativecreditorsandnon-insider
unsecuredcreditorsinfull,and(b)makeaproratadistributiontotheDebtor’s
insiderclaims.TheMotiontoDismissalsosoughttowaivetherequirementthat
theestate’sprofessionalsfilefeeapplicationstoobtainpaymentoftheirclaims.
TheDebtor’screditorsdidnotfileanobjectiontotheMotiontoDismiss;however,
theUnitedStatesTrusteefiledanobjectionasserting,amongotherthings,
thattheproposedstructureofthedismissalwasimproperbecause:(i)estate
professionalswerenotrequiredtofilefeeapplicationstoobtainpaymentoftheir
fees;(ii)creditors’statelawrightswerenotbeingrestored;and(iii)notimeframe
orcertificationrequirementrelatedtothepaymentofcreditorswasimposed.
PriortothehearingontheMotiontoDismiss,theDebtoragreedtobothatime
frameandcertificationrequirementsapplicabletothepaymentofcreditorclaims,
andthatthestatelawrightsofcreditorswouldbepreservedifcreditorswerenot
paidinfullfromtheSalesProceeds.Inlightofthesepre-hearingconcessions,the
CourtproceededtoanalyzewhethertheDebtor’sproposedstructureddismissal
isauthorizedbytheBankruptcyCode.
COURT ANALYSIS
IndeterminingwhethertheBankruptcyCodeauthorizesastructureddismissal,
theCourtnotedthatsection305(a)oftheBankruptcyCodeallowsitto“dismiss
acase…iftheinterestofcreditorsandthedebtorwouldbebetterserved”by
dismissal.Moreover,withregardtocasesproceedingunderchapter11,theCourt
notedthatsection1112(b)oftheBankruptcyCodeallowsittodismissacase
“whenever[dismissal]isinthebestinterestoftheestate.”Finally,theCourt
citedsection105(a)oftheBankruptcyCodeasauthorizingittoissueanyorderor
judgmentnecessaryorappropriatetocarryouttheprovisionsoftheBankruptcy
Code.
Relyingonthisstatutoryauthority,theCourtheldthatstructureddismissalsare
authorizedbytheBankruptcyCodeifthetermsofthedismissal:(i)arefairand
equitabletoallcreditorsgenerally;(ii)donotrisetothelevelofasubrosaplan;
and(iii)donotviolatetheabsolutepriorityrule.Thekeyrequirement,however,
isthatthetermsofstructureddismissalprovidefairandequitabletreatmentto
creditors.Infact,theCourtnotedthattheabovethreeelementscollapseintothe
fairandequitableanalysisbecauseifasubrosaplanhasnotbeenproposedand
theabsolutepriorityruleisnotviolated,astructureddismissalwillgenerallybe
foundtobefairandequitable.
InthisCase,thetermsofthestructureddismissalprovidedcreditorswithfair
andequitabletreatmentbecause:(i)non-insiderclaimswerebeingpaidin
fullfromtheSalesProceeds;(ii)thedebtorhasagreedtoatimeframeand
certificationrequirementsrelatedtothepaymentofcreditorclaims;and(iii)
creditorsretainedtheirstatelawrightstotheextentthattheirclaimswerenot
paidinfull.Furthermore,theproposedstructureddismissaldidnotconstitute
asubrosaplanbecause:(i)thePropertyhadbeensoldpriortothefilingonthe
MotiontoDismiss;(ii)theSalesOrderwasenteredaftercreditorsweregiven
anopportunitytoobjecttotheSalesMotion;and(iii)theDebtorhadnointent
tocircumventtheplanconfirmationprocess.WithregardtotheDebtor’sintent,
theCourtspecificallynotedthattheDebtor’sintentwastobenefitcreditors
byavoidingtheincurrenceofunnecessaryadministrativeclaims,andthatthe
avoidanceofsuchunnecessarycostsservesa“legitimatepurpose.”Finally,
becauseallnon-insiderclaimswerebeingpaidinfullandinsiderclaimswere
onlygettingpaidafterthepaymentofnon-insiderclaims,theabsolutepriority
rulewasnotviolated.TheCourt,therefore,grantedtheMotiontoDismissand
approvedthetermsofthestructureddismissal.
PRACTICAL CONSIDERATIONS
Structureddismissalscanserveavaluablepurposebyincreasingdistributions
tocreditorsthroughtheminimizationofadministrativeclaims.Toachievethis
legitimatepurpose,partiesseekingastructureddismissalshouldbemindfulthatthe
proposeddismissalstructuredoesnotviolatetheabsolutepriorityrulebyproviding
arecoverytoajuniorcreditorclassattheexpenseofaseniorclass.Partiesshould
alsonotseektodeliberativelysubverttheprotectionsprovidedtocreditorsbythe
BankruptcyCode,orattempttoimplementacourseofactionthroughastructured
dismissalthatwouldnotbeapprovedthroughtheplanconfirmationprocess.Ifthese
guidelinesarefollowed,partiesarelikelytofindcourtsreceptivetoproposed
structuredismissals.AstheCourtstatedinthisCase–“what’snottolike?”
Lloyd A. Lim Counsel, Houston
Commercial Restructuring & Bankruptcy Newsletter – October 2016 12
Lauren S. Zabel Associate, Philadelphia
DOES “NO-ASSET” MEAN NO JuRISDICTION? BANKRupTCY COuRT CONSIDERS JuRISDICTION IN ADJuDICATINg CLAIMS IN NO-ASSET ChApTER 7 CASE
Doctor’s Associates Inc. v. Desai a/k/a Patwari
(In re: Patwari),Adv.Pro.No.09-1022,slipop.
(Bankr.D.N.J.June10,2016)
CASE SNAPSHOT
TheBankruptcyCourtfortheDistrictofNew
Jerseyconsideredwhethercertainclaims
assertedbyacreditorinachapter7“no-asset”
casepresenteda“truecaseorcontroversy”
overwhichtheBankruptcyCourtcouldexercise
jurisdiction.Thecourtconcludedthatno
purposewouldbeservedbydeterminingthecreditor’soutstandingrequests
forreliefinlightofthefactthatthevariousdebtorshadnoassetsavailablefor
distributiontocreditors.Indecliningtoadjudicatetheissuespresentedbythe
creditor,however,thecourtmadeclearthat“iftheresolutionofthe[]claims
becomesmeaningful,”thecreditorwillhaveafullandfairopportunitytopresent
theclaims.
FACTUAL BACKGROUND
Priortothedebtor’sbankruptcy,thedebtorenteredintoseveralfranchise
agreementsforoperatingquickservesandwichshopsand(aspermittedbythe
franchiseagreements)createdoperatingentitiestooperatethesandwichshops.
Thefranchisorobtainedarbitrationawardsagainstthedebtorpre-petitionbased
uponvariousallegedbreachesofthefranchiseagreements.Separatelitigationwas
thereafterinitiated,whereinthedebtorassertedvariousclaimsagainstthe
franchisorandobtainedapreliminaryinjunctionenjoiningenforcementofthe
arbitrationawards,andthefranchisorassertedvariousadditionalclaimsagainst
thedebtoranditsoperatingentitiesarisingfromtheallegednon-compliancewith
thearbitrationawards.Thedebtorandtheoperatingentitiesthenfiledchapter11
bankruptcypetitions,andthependinglitigationwastransferredtotheBankruptcy
Court.
Thefranchisorfiledproofsofclaiminbankruptcycasesofthedebtorandthe
operatingentities,whichassertedclaimsbaseduponthearbitrationawardsand
theclaimsassertedinthesubsequentlitigation.Thebankruptcycaseswere
thereafterconvertedtochapter7,andthechapter7trusteefiledreportsindicating
thatthedebtor’sestateshadnoassetsavailablefordistributiontocreditors.
COURT ANALYSIS
Thecourtbeganitsanalysisbynotingthatthefranchisor’sproperlyfiledproofs
ofclaimwouldbedeemedallowedunlessanduntiltherespectivedebtorsobject
totheproofsofclaim.Inlightofthatfactandthelackofassetsavailablefor
distribution,thecourtconcludedthatnopurposewouldbeservedbyadjudicating
thefranchisor’soutstandingrequestsforrelief.Intheeventthatassetswere
broughtintoanyofthebankruptcyestates,thecourtnotedthatthefranchisor
wouldeitherreceiveadistributiononthefullamountofitsfiledclaims,orthe
courtwoulddeterminethevalidityand/oramountofitsclaimsinthecontextof
aclaimsobjectionfiledatthattime.Thecourtfurthernotedthatthefranchisor
wouldhavethefullandfairopportunitytopresentitsclaimsinotherproceedings
inthecourtifandwhenresolutionofthoseclaimsbecamemeaningful.
PRACTICAL CONSIDERATIONS
ThisdecisionemphasizesthatBankruptcyCourtsshouldconsiderwhetherissues
broughtbeforethecourtpresenta“truecaseorcontroversy”overwhichthe
BankruptcyCourtcouldexercisejurisdiction.Asaresult,inchapter7no-asset
cases,wherenoassetsareavailablefordistributiontocreditors,creditors
attemptingtoadjudicateclaims-relatedissuesintheBankruptcyCourtshould
beawarethatthecourtmaydeclinetoexercisejurisdictionbecausenopractical
purposewouldbeservedbyadjudicatingthoseissues.
Commercial Restructuring & Bankruptcy Newsletter – October 2016 13
TIMINg IS EVERYThINg: BANKRupTCY COuRT CONSIDERS TIMINg ISSuES RELATINg TO WhEN WARN ACT CLAIMS MAY BE ELIgIBLE fOR TREATMENT AS ADMINISTRATIVE EXpENSE CLAIMS
In re: Calumet Photographic, Inc.,No.14-08893,
2016WL3035468(Bankr.N.D.Ill.May19,
2016)
CASE SNAPSHOT
TheBankruptcyCourtfortheNorthernDistrict
ofIllinoisconsideredwhetheranallegedWARN
Actclaimarisingasaresultofapre-petition
terminationisentitledtoadministrativeexpense
priority.Thecourtconcludedthatundersection
503(b)(1)(A),onlyclaimsrelatingtoapost-
petitionperiodcouldbeentitledtoadministrative
priority,and,therefore,claimsarisingasaresultofapre-petitiontermination
wouldnotbeentitledtoadministrativepriority.
FACTUAL BACKGROUND
Thedebtorwasaspecialtyretailerofphotographyandvideoequipment.Earlier
inthedaythatthedebtorfileditsbankruptcypetition,thedebtorlaidoffmany
employees.Aparticularterminatedemployee(the“Claimant”)arguedthat,
amongotherthings,aWARNActclaimaroseoutofhertermination.
COURT ANALYSIS
TheprimaryissuebeforethecourtwaswhethertheClaimant’sallegedWARN
Actclaimwasentitledtoadministrativeexpensepriorityunderthebankruptcy
code.TheWARNActprovidesthat,withcertainexceptions,certain“affected
employees”areentitledtoatleast60days’noticeofabusinessclosingora
“coveredmasslayoff.”WhenappropriatenoticeisnotgivenundertheWARN
Act,“affectedemployees”areentitledtobackpayandbenefitsforupto60
days.TheClaimantarguedthatherWARNActclaimshouldbeconsidered
anadministrativeexpenseundersection503(b)(1)(A).Section503(b)(1)(A)
authorizesadministrativeexpensepriorityforpaymentsmadefortheactual,
necessarycostsandexpensesofpreservingtheestate,includingpost-petition
wagesandcertainbackpay“attributabletoanyperiodoftimeoccurringafter
commencementofthecaseunderthistitle.”Thecourtdeterminedthatthe
plainmeaningofsection503(b)(1)(A)requiredthecourttodeterminewhether
theclaimatissuerelatestoapost-petitiontimeperiod.Thecourtconcluded
thatbecausethedateofterminationwasbeforefiling,theClaimant’sWARNAct
claimwasnotentitledtoadministrativeexpenseentitlement.Thisconclusion,the
courtreasoned,wasalsoconsistentwiththerequirementthatsection501(b)(1)
(A)claimsbe“actual,necessarycostsofpreservingtheestate.”Importantly,the
courtdidnotdeterminewhether,infact,theClaimantandthefellowterminated
employeeshadvalidWARNActclaims.
ThecourtalsodeclinedtoaccepttheClaimant’sinvitationtoconsiderwhether
herallegedWARNActclaimshouldbeentitledtopriorityundersection507(a)(4).
Insoconcluding,thecourtstatedthatsuchdeterminationwouldnotberipefor
adjudicationuntilthedebtorobjectedtotheClaimant’sproofofclaim.
PRACTICAL CONSIDERATIONS
LiketheBankruptcyCourt’sdecisioninDoctor’s Associates,thisdecisionemphasizes
thatBankruptcyCourtsshouldconsiderwhetheracontroversyisripeforadjudication.
Inaddition,thisdecisionemphasizesthatthe2005amendmentstosection503(b)(1)(A)
didnotchangethepriorityofWARNclaimsthataccruebyvirtueofapre-petition
termination.
Lauren S. Zabel Associate, Philadelphia
Commercial Restructuring & Bankruptcy Newsletter – October 2016 14
fuRThER CLARITY IN ANALYzINg “MAKE-WhOLE” pROVISIONS (OR NOT). IS IT SIMpLY A MATTER Of CONTRACT INTERpRETATION?
Delaware Trust Company v. Computershare Trust
Company, et al. (In re Energy Future Holdings,
Corp.),551B.R.550(Bankr.D.Del.2016)
CASE SNAPSHOT
Thefirstliennoteholdersfiledadeclaratory
judgmentactionagainstthesecondlien
noteholdersseekingadeterminationthatthe
secondliennoteholderswerenotentitledtoa
distributionfromthebankruptcyestateuntilthe
firstliennoteholderswerepaidinfull.
FACTUAL BACKGROUND
Thedebtors’corporatestructurewassuchthatitenteredintoacollateraltrust
agreementgoverningtherelationshipofallindenturetrustees.Thecollateraltrust
agreementgovernstherightsandobligationsoftheindenturetrusteesforthe
firstliennoteholdersandthesecondliennoteholders.
TheBankruptcyCourtapprovedadistributiontothetrusteeforthesecondlien
noteholders,andthefirstliennoteholdersbroughtsuitallegingthatthetrustee
forthesecondliennoteholdersshouldholdthefundsitreceivedintrustforthe
benefitofthefirstliennoteholdersuntiltheywerepaidinfull.
COURT ANALYSIS
Inapriorproceedinginthebankruptcycase,thecourtheldthatthefirstlien
indenturedidnotprovideforpaymentofamake-wholepremiumuponthe
filingofthedebtors’bankruptcycases.Thecourt’srulingwasgroundedinits
determinationthatthedebtors’filingofthebankruptcycasestriggeredadefault
underthefirstlienindenture,whichinturncausedanautomaticaccelerationof
thefirstliennotes.Accordingly,repaymentafteraccelerationwasnotconsidered
voluntary,andthefirstliennoteholderscouldnotrescindtheautomatic
accelerationwithoutrelieffromtheautomaticstay,butstayreliefwasnot
warranted.
Inthedeclaratoryjudgmentactionagainstthesecondliennoteholders,thefirst
liennoteholderssoughtadeterminationthat,whiletheycouldnotenforcethe
make-wholepremiumagainstthedebtors,theycouldenforcetheprovision
againstthesecondliennoteholdersunderthecollateraltrustagreement.The
secondliennoteholdersfiledamotiontodismiss,arguingthatthecourthad
alreadydecidedthatthefirstlienobligationswereautomaticallyaccelerated,so
themake-wholepremiumwasnotpayable(eitherbythedebtorsorotherwise).
Thecourtthereforeanalyzedthetermsofthecollateraltrustagreement.The
courtnotedthatthecollateraltrustagreementcontainedthefullagreementof
theparties,andneitherpartywaschallengingthecompletenessofthecollateral
trusteeagreement.Infollowingestablishedcontractinterpretationcanonsthat
ambiguitywillnotbereadintoacontract,thecourtrefusedto“readintothe
‘Obligations’provisionthatanypremiumwouldbeowed…regardlessofwhether
itisallowedorisallowable”inabankruptcyproceeding.Restated,thecourt
refusedtoreadadditionallanguageintothedefinitionof“Obligations”inthe
collateraltrustagreementthatwouldhavesupportedthefirstliennoteholders’
argumentthatthesecondliennoteholderscouldberesponsibleforthemake-
wholepremiumevenifthedebtorswerenot.
Thecourtwentontonotethatsophisticatedpartiesarecapableofdrafting
thelanguagetheywantintocontracts.Thestrictreadingofthecollateraltrust
agreementdidnotsupportthefirstliennoteholders’position.
PRACTICAL CONSIDERATIONS
Courtsareunwillingtolookbeyondthefourcornersofaclearandunambiguous
contract.Duringdrafting,apartythatmaylaterrelyonamake-wholepremium
provisionshouldensurethecircumstancesunderwhichthepremiumistobepaid
areclearlyenumerated.
Jared S. Roach Associate, Pittsburgh
Commercial Restructuring & Bankruptcy Newsletter – October 2016 15
Sarah K. Kam Associate, New York
TRuSTEE fAILS TO MEET BuRDEN Of ShOWINg ThAT pROpOSED SALE Of ASSETS COMpLIES WITh SECTION 363(f) Of ThE BANKRupTCY CODE
In re Southern Mfg. Grp., LLC,No.15-931,2016
Bankr.LEXIS2306(Bankr.D.S.C.June8,2016)
CASE SNAPSHOT
TheUnitedStatesBankruptcyCourtforthe
DistrictofSouthCarolinaheldthatthetrustee
didnotmeethisburdenofshowingthatthe
proposedsaleofassetsfreeandclearofany
interestscomplieswithsection363(f)ofthe
BankruptcyCode.Therefore,theBankruptcy
Courtdeniedthetrustee’ssalemotion.
FACTUAL BACKGROUND
Thetrusteefiledamotiontosellsubstantiallyalloftheassetsofachapter
7debtorfreeandclearofallliensinexchangefor$635,000andother
considerationpursuanttosection363oftheBankruptcyCode.Thetrustee
proposedthatupontheclosingofthesale,thepurchaserwouldremitdirectly
tothesecuredcreditortheamountof$605,000inexchangeforsatisfactionof
thesecuredcreditor’sallowedsecuredclaimintheamountof$890,691.87.The
trusteefurtherproposedapaymentatclosingof$30,000fromthepurchase
pricetoberemittedtothedebtor’sestatefreeandclearofliens,alongwiththe
debtor’saccountsreceivable,estimatedtobeworth$40,000.Therefore,the
projectedvaluetothedebtor’sestatewas$70,000.Thesalemotionstatedthat
despitesubstantialeffortstolocateanalternatebuyer,thesalewasthehighest
offertheestatereceived.
Thesecuredcreditorandoneofseveraljuniorlienholderswerepresentatthe
hearingonthesalemotionandconsentedtotheproposedsale.Theotherjunior
lienholderswereservedwiththesalemotionviamailbutdidnotappearatthe
hearingonthesalemotion.
COURT ANALYSIS
Section363(b)(1)oftheBankruptcyCodeprovidesthat“[t]hetrustee,after
noticeandahearing,mayuse,sell,orlease,otherthanintheordinarycourse
ofbusiness,propertyoftheestate[.]”Thetrustee’sdecisiontoselladebtor’s
propertyoutsidetheordinarycourseofbusinessisreviewedbythecourtfor
compliancewiththebusinessjudgmentrule.Althoughthetrusteeappeared
tosatisfythebusinessjudgmentrule,thetrustee’sabilitytoconsummatethe
saleandgenerateabenefitfortheestatedependedontheBankruptcyCourt’s
entryofanorderapprovingthesalefreeandclearofanyliensorinterestsunder
section363(f)oftheBankruptcyCode.
Thetrusteearguedthatthesaleoftheassetsshouldbemadefreeandclearof
anyinterestsheldbyanentityotherthantheestatepursuanttosection363(f)of
theBankruptcyCodebecause:(i)applicablenon-bankruptcySouthCarolinalaw
permitsthesaleoftheassetsfreeandclearofsuchinterests,11U.S.C.§363(f)
(1);(ii)allpartieswithaninterestintheassetshaveconsentedtothesale,
11U.S.C.§363(f)(2);and/or(iii)thepartieswithaninterestintheassetscould
becompelled,inalegalorequitableproceeding,toacceptamoneysatisfaction
ofsuchinterest,11U.S.C.§363(f)(5).
TheBankruptcyCourtrejectedthetrustee’sarguments.First,thetrusteedidnot
demonstratehowSouthCarolinapermittedthesalestructureanddistribution
presentedinthesalemotion.Second,becausethejuniorlienholdersperfected
theirliens,theirsilencedidnotimplytheirconsenttotheproposedsale.Finally,
thetrusteedidnotpointtoanylegalorequitableproceedingthatwouldpermit
thesaleproceedstoberedirectedawayfromthejuniorlienholdersandtothe
estate.Accordingly,theBankruptcyCourtdeniedthetrustee’ssalemotion.
PRACTICAL CONSIDERATIONS
ABankruptcyCourt’sabilitytocleartitleisbothgrantedandconstrainedbythe
BankruptcyCodeTherefore,atrusteemustmeetitsburdenofshowingthata
proposedsaleofassetsfreeandclearofanyinterestscomplieswithsection
363(f)oftheBankruptcyCode.
pRE-pETITION BANKRupTCY WAIVERS BY ANOThER NAME: COuRT REfuSES TO DISMISS CASE fILED WIThOuT VOTE Of CREDITOR’S gOLDEN ShARE
In re Intervention Energy Holdings, LLC,553B.R.
258(Bankr.D.Del.2016)
CASE SNAPSHOT
InIn re Intervention Energy Holdings, LLC,the
BankruptcyCourtwasfacedwithamotionto
dismissbythelender,whoarguedthatthedebtor
didnothavepropercorporateauthoritytofilethe
case.
FACTUAL BACKGROUND
Thecaseessentiallyinvolvedatwo-partydisputebetweenthedebtorandthe
lender.Asaresultofvariousdefaults,thelenderenteredintoapre-petition
forbearanceagreementwiththedebtor.Aspartofthatforbearancearrangement,
thecreditorrequiredthatthedebtoramenditsoperatingagreementto(i)issuea
singleLCCunitinfavorofthelender,(ii)requireaunanimousvoteofallLCCunit
holdersinordertocommenceabankruptcycase,and(iii)eliminateanyfiduciary
dutiesthatwouldordinarilyneedtobeexercisedbythatsingleunitholderinthe
votingprocess.Derek J. Baker Partner,
Philadelphia and PrincetonCONT INUEDONPAGE16
Commercial Restructuring & Bankruptcy Newsletter – October 2016 16
pRE-pETITION RESTRuCTuRINg DID NOT ALTER SENIOR LENDERS’ RIghTS uNDER AN INTERCREDITOR AgREEMENT
Salus Capital Partners, LLC v. Standard Wireless
Inc. (In re RadioShack Corp.),550B.R.700
(Bankr.D.Del.2016)
CASE SNAPSHOT
TheUnitedStatesBankruptcyCourtforthe
DistrictofDelawareheldthatapre-petition
restructuringdidnotaltertheseniorlenders’
rightsunderanintercreditoragreement,which
requiredtheseniorlendertobepaidfirstfrom
theproceedsofcertaincollateral.
FACTUAL BACKGROUND
InDecember2013,14monthspriortothecommencementofthedebtors’
chapter11bankruptcycases,thedebtorsenteredintoanew$835million
financingarrangementwithtwodistinctsetsoflenders,namely(i)a$250million
termloanfromthe“SCPLenders,”and(ii)a$585millionfacilityfromthe“ABL
Lenders”consistingofa$50milliontermloanand$535millioninrevolvingloan
commitments.Alloftheseobligationsweresecuredbysubstantiallyallofthe
debtors’assets.Underanintercreditoragreement,thepartiesagreedthatthe
ABLLendersheldafirstlienon“liquidcollateral”andasecondlienon“fixed
assets.”Inturn,thepartiesagreedthattheSCPLendersheldafirstlienon“fixed
assets”andasecondlienon“liquidcollateral.”InearlyOctober2014,thecredit
agreementwiththeABLLenderswasrestructured.
Duringthedebtors’chapter11cases,aportionofthedebtors’businesswassold
asagoingconcernandtheremainderwasliquidated.Proceedsfromthesaleand
liquidationweredistributedinaccordancewiththeprovisionsandthepriorities
establishedintheintercreditoragreement.Accordingly,theABLLendersreceived
approximately$232millionbecauseofthedispositionoftheliquidcollateralin
whichtheyclaimedafirstlienposition.
InMarch2015,theSCPLenderscommencedanadversaryproceedingraising
ninecausesofaction.TheSCPLenderscontendedthattheOctober2014
restructuringalteredtheABLLenders’rightstobepaidfirstfromtheproceeds
oftheliquidcollateral.AccordingtotheSCPLenders,theproceedsfromthe
dispositionoftheliquidcollateralthatwerepaidtotheABLLendersmustbe
paidovertotheSCPLenders.TheABLLendersfiledmotionstodismisstheSCP
Lenders’complaint.
COURT ANALYSIS
TheBankruptcyCourtinterpretedandconstruedtheintercreditoragreementand
theamendedABLcreditagreementunderNewYorklaw.TheBankruptcyCourt
observedthatitsroleincontractinterpretationistogiveeffecttotheintentof
thepartiesasdefinedbytheprovisionsoftheiragreements.TheBankruptcy
Courtconcludedthattheunambiguousprovisionsoftheintercreditoragreement
permittedtheABLLenderstoenterintotheamendedABLcreditagreement.The
ABLLendersdidnotbreachtheintercreditoragreementandwerenotunjustly
enrichedbyreceivingtheproceedsoftheliquidcollateral.Furthermore,theABL
LendersdidnottortuouslyinterferewiththeSCPLenders’contractualrightsor
converttheSCPLenders’collateral.TheSCPLendersonlyheldjuniorrightsin
theliquidcollateralthatwerenotaffectedbytherestructuring.Accordingly,the
BankruptcyCourtgrantedtheABLLenders’motionstodismisstheSCPLenders’
complaint.
PRACTICAL CONSIDERATIONS
Ascourtswillgiveeffecttotheintentofthepartiesasdefinedbytheprovisions
oftheiragreements,carefulconsiderationmustbegiventodraftingclearand
unambiguousprovisionsinintercreditoragreements.
Sarah K. Kam Associate, New York
Afterfurtherdefaults,thedebtorcommencedabankruptcycasewithoutthe
affirmativevoteoftheoneunitissuedinfavorofthelender.Thelenderquickly
filedamotiontodismiss,arguingthatthecasewasnotproperlycommencedand
shouldbedismissedasa“badfaithfiling.”Thedebtoropposedthedismissal,
arguingthattheamendedprovisionsofitsoperatingagreementeffectively
constitutedapre-petitionwaiverofitsrighttocommenceabankruptcycase.
Sincesuchwaiversareagainstpublicpolicy,thedebtorarguedthecourtshould
denythemotiontodismiss.
COURT ANALYSIS
TheBankruptcyCourtbeganbynotingthat,absenttheamendedprovisions
oftheoperatingagreementinfavorofthelender,thedebtorwouldhavebeen
authorizedtofilethebankruptcycase.Thecourtnotedthatitwasdealingwith
theintersectionofstatelawfreedomofcontractinoperatingagreements,anda
federalpolicythatgenerallyprohibitspre-petitionwaiversofbankruptcyrights.
Citingsubstantialcaselawforthepropositionthatdebtorsareprohibitedfrom
contractingawaytheirBankruptcyCoderights,thecourtcitedadditionalcase
lawnotingthattransactionstructurescreatedthathavetheeffectofwaving
bankruptcyrightsshouldbeviewedsimilarly.Thecourtnotedspecificallythat
the“goldenshare”provisionoftheoperatingagreementherewasspecifically
negotiatedaspartofaforbearanceagreementasameanstoprohibitthe
commencementofthebankruptcycase,whichwouldbeadversetothecreditor’s
interest.Becausetheimpactofthatprovisionwastowaiveadebtor’sbankruptcy
right,thecourtrefusedtogiveeffecttothatprovisionasvoidagainstfederal
publicpolicy.Therefore,sincetheprovisionwasvoid,thecourtheldthatthe
bankruptcyfilingwasproper.
PRACTICAL CONSIDERATIONS
Thisdecisionisinlinewithanumberofotherbankruptcyandfederalcourt
decisionsthatholdthatprovisionsincludedincorporate“bankruptcyremote”
structureswithawaiveroffiduciarydutiesassociatedwithtraditionalownership
cannottrumptherightsoftheentitytoseekreliefunderfederalbankruptcylaw.
pre-petition Bankruptcy Waivers by Another Name: Court Refuses to Dismiss Case filed Without Vote of Creditor’s golden Share—continued from page 15
Commercial Restructuring & Bankruptcy Newsletter – October 2016 17
fIRST CIRCuIT DECLINES TO OVERTuRN ChApTER 7 CONVERSION, NOTINg LOWER COuRTS’ BROAD DISCRETION
In re Hoover,828F.3d5(1stCir.2016)
CASE SNAPSHOT
TheU.S.CourtofAppealsfortheFirstCircuit
affirmedtheU.S.DistrictCourtfortheDistrict
ofMassachusetts’holdingthattheBankruptcy
Courtdidnoterrinconvertingdebtor’schapter
11casetoachapter7proceeding.Insoholding,
theFirstCircuitemphasizedthatdebtor’sown
recordsandtestimony–whichshoweda
flounderingbusiness–fellfarshortofwhat
isrequiredtoovercomethebroaddiscretion
conferredonthelowercourts.
FACTUAL BACKGROUND
Debtor,asanindividualanddoingbusinessas“HalloweenCostumeWorld,”filed
avoluntarychapter11petition.Debtorcontinuedtooperatethebusinessby
sellinginventorywithoutreplacingtheitemssold.Hismonthlyoperatingreports
showedinsufficientprofitstoenabledebtortoreplaceinventoryandinsufficient
cashflowtopaycostsanddebts.TheU.S.trusteemovedtoconvertthecase
toachapter7liquidation,contendingthatcauseexistedunderthreeseparate
provisionsofsection1112(b)(4)oftheBankruptcyCode.
Specifically,thetrusteecontendedthatthecaseshouldbeconverted:(1)because
ofthe“substantialorcontinuinglosstoordiminutionoftheestateandthe
absenceofareasonablelikelihoodofrehabilitation”undersection1112(b)(4)
(A);(2)becausedebtor’s“unauthorizeduseofcashcollateral[was]substantially
harmfulto1ormorecreditors”undersection1112(b)(4)(D);and(3)becauseof
debtor’s“unexcusedfailuretosatisfytimelyany[pertinent]filingorreporting
requirement”undersection1112(b)(4)(F).
Atthehearingonthetrustee’smotion,debtorwasthesolewitness.Heconceded
hewassellinginventorywithoutreplacingit.Further,hisrecordsandmonthly
operatingreportsshowedinsufficientprofittoreplacethatinventory,andthathe
wasonlycontinuingoperationsbysellinginventoryandfailingtopaycreditors.
COURT ANALYSIS
TheBankruptcyCourtheldthatthecaseshouldbeconvertedonallthree
basescitedbythetrustee.TheDistrictCourtaffirmedonthegroundthatthe
BankruptcyCourtdidnoterrinitsfindingthattherewasa“substantialor
continuinglosstoordiminutionoftheestateandtheabsenceofareasonable
likelihoodofrehabilitation”undersection1112(b)(4)(A),anddidnotconsiderthe
twoalternativebasesforconversion,“becauseonecauseisenough.”
OnappealtotheFirstCircuit,debtorarguedthatconversionwasinappropriate
becausehedidnotreceiveadequatenoticeasrequiredbyFed.R.Bankr.P.
9014(a).Thecourtheldthatdebtor’sproceduralargumentlackedmerit,finding
thatthetrustee’sfilingsmadeclearthebasisonwhichthetrusteewasmoving
forconversion,andfurther,theBankruptcyCourttwicecontinuedthehearingon
thetrustee’smotiontoallowdebtorandhiscounseltimetogatherevidenceto
rebutthetrustee’sarguments.
Afteritdismisseddebtor’sproceduralargument,theFirstCircuit’sanalysis
focusedonwhethercauseexistedundersection1112(b)(4)(A),andifso,whether
conversionordismissalwasinthebestinterestsofthecreditorsandthe
estate.DebtorarguedthattheBankruptcyCourterredinconvertinghiscase
onthegroundsthathisproposedplanofreorganizationwasnot“patently
unconfirmable,”andthattaxauthoritiesmightwriteoffaportionofthedebtshe
owed.TheFirstCircuitnotedthatwhile“rehabilitationunder§1112(b)(4)(A)isnot
synonymouswithreorganization,…thedebtorstillmusthavesufficient‘business
prospects’…to‘justifycontinuanceof[a]reorganizationeffort.”
Relyingondebtor’sownrecordsandhistestimony,theFirstCircuitagreedwith
theDistrictCourtthattheBankruptcyCourtdidnotabuseits“broaddiscretion”
whenitfoundcauseexisted.NordidtheBankruptcyCourterrwhenitconcluded
conversionwasinthebestinterestsofthecreditors.TheFirstCircuitdidnot
considerdebtor’sargument–raisedforthefirsttimeonappeal–thatliquidation
wouldresultinlittletonothingbeingpaidtotheestate’screditors;however,the
FirstCircuitheldthattheuntimelyargumentnonethelesswouldfailbecausethe
DistrictCourt“hadamplediscretiontoconcludethatapromptconversionrather
thanfurtherdiminutionwasinthebestinterestsofcreditors,especiallywhereno
creditoropposedconversionashostiletoitsinterests.”
PRACTICAL CONSIDERATIONS
“Cause”forconversionfromchapter11tochapter7existswhenanyoneofthe
factorsundersection1112(b)(4)isshown.Onreview,theDistrictCourtforthe
DistrictofMassachusettsaffirmedconversionunder1112(b)(4)(A)(“substantial
orcontinuinglosstoordiminutionofthestateandtheabsenceofareasonable
likelihoodofrehabilitation”),anddidnotdelveintothetwoalternativebasesfor
findingcausetoconvert.IftherecordsupportstheBankruptcyCourt’sfindings
thatcauseexists,appellatecourtsintheFirstCircuitdefertotheBankruptcy
Court’s“broaddiscretion”infindingthatconversionordismissalisinthebest
interestsofthecreditorsandtheestate.Thisisparticularlytruewherecreditors
donotobjecttoconversionordismissal.
Alison Wickizer Toepp Associate, Richmond
Commercial Restructuring & Bankruptcy Newsletter – October 2016 18
COuNSEL’S CORNER: NEWS fROM REED SMIThMatt TashmanwasapanelistonTheKnowledgeGroup’sJune22,2016,webcast,“Bankruptcy&RestructuringintheOil&GasIndustriesin2016&Beyond.”
OnAugust22,2016,Derek BakerandJennifer KnoxmadeapresentationforamajorbankclientthatfocusedonFirstDayPleadingsandjudicialpracticesintheBankruptcyCourtsfortheEasternandMiddleDistrictsofPennsylvania.
Colin CochraneandElizabeth Mcgovernco-authoredanarticlepublishedSeptember5,2016,byCredit Strategy,“Judgetakesunusualsteponturnaroundcase,”whichdealtwitharecentcaseontheEnglishcourts’discretiontograntadministrationorders(Rowntree Ventures v Oak Property Partners).
OnSeptember8,2016,attheABABusinessLawSectionMeetinginBoston,Eric Schafferpresented,“CaughtintheCrossfire:RecentLitigationIssuesConfrontingIndentureTrustees.”
Bob Simons wasthechairpersonforthe39thAnnualPlattsCoalMarketingDaysConference.Theconference,heldinPittsburghSeptember20-21,2016,featuredexpertswhodiscussedtopicscriticallyimportanttothefutureofthecoalindustry–manyofwhichareequallyimportanttooilandgasproducers.
Andrea pincusandMatt Tashmanwereamongtheco-presentersof“NavigatingChoppyWatersintheEnergySector”atReedSmith’sU.S.EnergyandCommoditiesConferenceSeptember27,2016,inHouston.
OnSeptember27,2016,Mike Vendittopresented“FirstDayMotions”attheannualbankruptcyconferenceoftheNationalAssociationofAttorneysGeneralinSantaFe.
Mike Venditto,Andrea pincus,andSarah KamwereamongtheReedSmithco-authorsof“TroubledWaters:TheRagingStormoverSafeHarbors,”publishedintheOctober2016editionofPratt’s Journal of Bankruptcy Law.
Derek Bakerwillpresenton“TopCommercialCasesoftheYear”atPennsylvaniaBarInstitute’s21stAnnualBankruptcyInstitute,October20,2016.
CLASS CERTIfICATION AND pROOfS Of CLAIM; A MEASuRE Of CASE EffICIENCY
In re Pacific Sunwear of California, Inc.,No.
16-10882,slipop.(Bankr.D.Del.June22,2016)
CASE SNAPSHOT
Thecourtfirstheldthatanyclaimsfiledunder
theCaliforniaLaborCodePrivateAttorneys
GeneralActof2004(PAGA)canbefiledina
representativecapacitywithoutcourtapproval.
Thecourtthencertifiedaclassofclaimantsfor
purposesoftheclaimsprocess.
FACTUAL BACKGROUND
In2011,twoseparatelawsuitswerefiledagainstPacSunallegingviolationsofthe
Californialaborlawsrelatingtowagesandhours.Priortothepetitiondate,one
ofthelawsuitswasgrantedclasscertification.Onthedatethedebtorsfiledfor
bankruptcyprotection,theyalsofiledtheirplanofreorganizationanddisclosure
statement.Thedebtorsadditionallyfiledamotiontoestablishabardate,butthey
didnotservemembersofthecertifiedclass.
Theclassrepresentativessoughtcourtapprovaltofileproofsofclaimintheir
respectiverepresentativecapacities.
COURT ANALYSIS
Thecourtfirstheldthatarepresentativeseekingtofilehisclaimonlyunder
PAGAcouldfiletheclaimonbehalfofallsimilarlyaggrievedemployees,because
PAGAexpresslyallowedrepresentativestomakeclaimsonbehalfofother
similarlysituatedindividualswithoutfirstseekingclasscertification.Restated,
thebankruptcycodedeferstostatelawwithregardtowhomaybeanauthorized
representativeofacreditor.BecausePAGAgrantsagencyrightstoclaimants,
BankruptcyCourtapprovalwasnotrequiredtofileaproofofclaimonbehalfof
othersimilarlysituatedindividuals.
ThecourtthenanalyzedwhetheritshouldapplyFed.R.Bankr.P.7023tocertify
thepreviouslycertifiedclassforpurposesoffilingaproofofclaim.Thecourt’s
analysisincludedareviewofthefollowingfactors:“(1)whethertheclasswas
certifiedpre-petition;(2)whetherthemembersoftheputativeclassreceived
noticeofthebardate;and(3)whetherclasscertificationwilladverselyaffect
theadministrationoftheestate.”Thecourtconcludedthatthefirsttwofactors
weighedinfavorofcertifyingtheclassbecause:(i)theclasswascertifiedpre-
petition,and(ii)thedebtorsadmittedlylimitednoticeofthebardate,which
noticewaspotentiallynotsenttopotentialclassmembers.
Thethirdfactoralsosupportedclasscertificationbecauseasingleclaimwould
befiledinplaceofpotentiallythousandsofclaims.Thedebtors,ratherthan
objectingtothousandsofindividualclaims,couldfocusononeclaimfiledon
behalfoftheclass.
HavingdeterminedthatitshouldapplyFed.R.Bankr.P.7023tothepotentialclass,
thecourtundertookareviewofrelevantfactors.Thecourtdeterminedthat
thepotentialclassmetthenumerosity,commonality,andtypicalitythresholds.
Becausethedebtorsdidnotchallengetheexperienceandperformanceofclass
counsel,theadequacyofrepresentationthresholdwasalsomet.
Finally,thecourtdeterminedthatthepotentialclasssatisfiedFed.R.Bankr.P.
7023(b)becausecommonquestionsoflawandfactwerepervasiveintheclass.
WhiletouchingtherelevantprovisionsofFed.R.Bankr.P.7023,thetenorofthe
court’sopinionsoundedverymuchinjudicialefficiency.Itwasmoreefficientfor
allpartiesinvolvedtoaddressoneclaim,ratherthaneachclaimthatmaybefiled
byclassmembers.
PRACTICAL CONSIDERATIONS
Itisnotacommonoccurrencetoseeaputativeclasscertifiedinabankruptcy
case.InadditiontoaddressingtherequirementsofFed.R.Bankr.P.7023,aparty
opposingcertificationshouldbepreparedtoexplainwhyjudicialeconomydoes
notfavorclasscertification.Conversely,partiessupportingclasscertification
wouldbewellservedtodemonstratehowclasscertificationwillbenefitall
parties(includingthecourt)fromanadministrativeprospective.
Jared S. Roach Associate, Pittsburgh
PRACTICE LEADERPeterS.ClarkII+12158518142(Philadelphia)[email protected]
FALLS [email protected]
FRANKFURTDr.VolkerKammel+49(0)[email protected]
HONG [email protected]
LONDONHelenaClarke+44(0)[email protected]
JefferyDrew+44(0)[email protected]
ElizabethA.McGovern+44(0)[email protected]
CharlotteMøller+44(0)[email protected]
GeorgiaM.Quenby+44(0)[email protected]
VictoriaThompson+44(0)[email protected]
EstelleVictory+44(0)[email protected]
MUNICHDr.StefanKugler,LL.M.+49(0)[email protected]
Dr.EtienneRichthammer+49(0)[email protected]
CommercialRestructuring&BankruptcyAlertispublishedbyReedSmithtokeepothersinformedofdevelopmentsinthelaw.Itisnotintendedtoprovidelegaladvicetobeusedinaspecificfactsituation;thecontentsareforinformationalpurposesonly.
“ReedSmith”referstoReedSmithLLPandrelatedentities.©ReedSmithLLP2016.
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