CR&B Alert · instruments, deposit accounts, and other cash equivalents ... turned out to be covertly created bank accounts ... the deceptively simple theory that the post

CR&B AlertCOMMERCIAL RESTRUCTURING & BANKRUPTCY NEWS – SEPTEMBER 2010, ISSUE 3

IN THIS ISSUE:

• SellersBeware—UnauthorizedPaymentsfrom‘CashCollateral’WillbeAvoided—page2

• TheThirdCircuitExpandstheSubstantial-PerformanceTesttoDetermineifaTrademarkLicenseContractisExecutory—page3

• CourtBreaksfromMajorityRule,GrantingRetireesPost-PetitionRightsGreaterthanPre-PetitionRights—page 4

• LandlordsSuccessfulinObtainingStubRentasanAdministrativeExpenseUnderSection503—page6

• DelawareBankruptcyCourtFindsAppointmentofExaminerNotRequiredEveryTimetheStatutoryDebtThresholdisExceeded—page7

• TheThirdCircuitOverrulesaLong-StandingCase,ChangingtheAbilityofPersonalInjuryPlaintiffstoBringSuitAgainstDebtors—page9

• DefenseofImputationofanAgent’sBadConducttoitsPrincipalClarifiedinPennsylvania;IndependentAuditoratRiskfor$1BillioninDamages—page10

• SanctionsAwardedUndertheBankruptcyCourt’s‘InherentAuthority’—page12

• TexasDistrictCourtAffirmstheContractualDefaultInterestRateWheretheDebtorisSolvent—page13

• AnLLCMember/Managerisan‘Insider,’sothatPaymentsArePreferentialTransfersSubjecttoAvoidanceUptoOneYearPriortoBankruptcyFiling—page14

• BroaderEconomicWoesMayHavePlayedaPartintheCourt’sDecisiontoDismissAllegationsofLenderOverreaching—page15

• RiskLosingYourFirstPriorityLienifYouProvideSuperfluousInformationintheUCCFinancingStatement—page17

• Landlord’sCorner—page18

• Counsel’sCorner—page20

COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 2

SELLERS BEWARE—UNAUTHORIZED PAYMENTS FROM ‘CASH COLLATERAL’ WILL BE AVOIDED

Marathon Petroleum Co., LLC v. Cohen (In

re DELCO Oil, Inc.), 599 F.3d 1255 (11th Cir.

March 16, 2010)

CASE SNAPSHOT

Supplierstochapter11debtors-in-possession

shouldalwaysensurethattheyarenotbeingpaid

fromthedebtor’s“cashcollateral”withoutcourt

approval.MarathonPetroleumCompanysupplied

productstodebtorDelcoOilintheordinary

courseofitsbusinessduringthebankruptcy

case,butwasforcedtoreturnallofthepost-

petitionpaymentsitreceivedfromDelco,pursuant

tosection549oftheBankruptcyCode.Marathonwasrequiredtoreturnthese

paymentsbecausetheyweredeemedpartofthecashcollateralthatwassecured

byDelco’spre-petitioncreditor,CapitalSourceFinance.Marathonprovided

valuablegoodstoDelcoinexchangeforpayment,andwasunawarethatDelco

wasusingcashcollateraltomakepayment.UnfortunatelyforMarathon,section

549strictlymandatesthereturnofunauthorizedpost-petitionpayments.Further,

UCC9-332(b)(whichoutsideofbankruptcycasesordinarilyprotectsinnocent

transfereesofdepositaccountsfromclaimsbypriorlienclaimants)didnotapply

becausetheissuewasnotoneoflienpriority,butofunauthorizedtransfers.

FACTUAL BACKGROUND

OnOctober16,2007,DelcoOil,Inc.filedforchapter11bankruptcyprotection,

andwaspermittedbythecourttocontinueoperatingitsbusinessasa

debtor-in-possession.Delcomovedforapprovaltouseitscashcollateral,

whichwassecuredbyproperlyperfectedUCC-1filingsbyCapitalSource,but

thecourtdeniedthemotiononCapitalSource’sobjection.(Section363(a)of

theBankruptcyCodedefines“cashcollateral”toincludecash,negotiable

instruments,depositaccounts,andothercashequivalents,whetherexisting

beforeorafterthefilingofabankruptcypetition.)

Marathon,whichsuppliedproductstoDelcopre-petition,continuedtodosoafter

thebankruptcyfiling.Afteritsbankruptcyfiling,butbeforethecourtruledon

itsmotiontouseitscashcollateral,Delcopaid$1.9millionincashtoMarathon

inexchangefortheproducts.(Thefundsforthesepaymentscamefromwhat

turnedouttobecovertlycreatedbankaccountshiddenfromCapitalSource.

MarathonwasnotawareofDelco’smachinations.)Ultimately,Delcovoluntarily

converteditscasetochapter7,andthenewlyappointedchapter7trustee

initiatedactionsagainstMarathontoavoidthepaymentsundersection549(a)of

theBankruptcyCode.Thebankruptcytrusteesuccessfullyrecoveredthepost-

petitionpaymentstoMarathon,andMarathonappealed.

COURT ANALYSIS

TheBankruptcyCodeprohibitsthepost-petitionuseofcashcollateralbya

debtor-in-possessionoratrustee,unlessthesecuredpartyorthebankruptcy

courtauthorizestheuseofthecashcollateral.Aspartofitsdecisiontoauthorize

theuseofcashcollateral,thebankruptcycourtmustfindthatthesecuredparty’s

interestinthecashcollateralisadequatelyprotected.

Section549(a)oftheBankruptcyCodeallowsatrusteetorecoverunauthorized

post-petitiontransfersofproperty.Toavoidsuchatransfer,thetrusteeneedonly

showthatatransferofpropertyofthedebtor’sestatewasmadefollowingthefiling

forbankruptcy,andthatthetransferwasnotauthorizedbytheCodeorthecourt.

Thechapter7trusteesuccessfullyavoidedthepaymentstoMarathonunder

thedeceptivelysimpletheorythatthepost-petitionpaymentstoMarathon

weremadefromDelco’scashcollateralwithoutthecourt’sorCapitalSource’s

approval,andwerethusnotauthorizedundersection363(a).Becausethe

transferswerenotauthorized,section549(a)mandatedtheirreturn.

Marathonraisedseveralfailedargumentsinitsattempttokeepthe$1.9million.

First,MarathonarguedthatthefundswerenotcashcollateralunderstateUCC

law.Specifically,UCCsection9-332(b)providedthattransfereestakefunds

fromdepositaccountsfreeofasecurityinterest,solongasthetransfereedid

notcolludetoviolatetherightsofthesecuredparty.Thecourtdisposedof

theargumentasirrelevant.TheissuewasnotwhetherCapitalSourcehada

prioritylienoverthecashundertheUCC,butwhetherthedebtorwaspermitted

totransferthecashinthefirstplace.Becausethedebtorclearlydidnothave

therequisiteauthorization,thetransferstoMarathonfellsquarelywithinthe

prohibitionsofsection549(a).

Marathonalsoarguedthatamaterialquestionoffactexistedastowhetherthe

fundsitreceivedwereidentifiableproceedsofCapitalSource’ssecuredcollateral.

Marathonsuggestedthatthecashmayhavecomefromsomeothersource,

butfailedtoprovidesufficientevidencetocontraveneCapitalSource’sblanket

securityinterest.Althoughtheissuewasnotaddressedintheopinion,itisironic

(andunfortunateforMarathon)thatthesourceofthecashfundsintheaccounts

mayverywellhavecomefromDelco’ssaleofMarathon’sproducts.

Marathonalsoarguedthat,becauseithadgivenDelcoinventoryinexchange

forthemoney,ithadgivenequivalentvalue,andthusnoharmhadbeendoneto

thebankruptestateorCapitalSource.Thecourtrejectedthisargumentaswell,

pointingoutthattherewasno“equivalentvalue”defenseundersection549.

TheCircuitCourtdeniedeachofMarathon’sarguments,andheldthatthetrustee

couldavoidandrecoverthepaymentsmadetoMarathon.

PRACTICAL CONSIDERATIONS

Creditorsandsupplierstodebtors-in-possessionmustbeextracautiousabout

thesourceofpost-petitionpaymentscomingfromthedebtor.Bankruptcy

courtstypicallypermitadebtor-in-possessiontouseitscashandotherassets

tocontinueoperating.Afterall,oneofthepurposesofchapter11istoallowa

debtorachancetoreorganizeitsaffairsthroughthecontinuedoperationsofits

businesses.Nevertheless,itisclearthatadebtorcannotusecashcollateralthat

issecuredbyoneofitscreditors,topayitssuppliersorothercreditors,unless

ChristopherO.Rivas Associate LosAngeles

CONT INUEDONPAGE3


thedebtorobtainseitherthesecuredcreditor’spermissionoracourtorder

allowingittodoso.

Thelessonisquiteclear:anypartythatplanstosupplyproductstoadebtor-in-

possessionshouldgetassurancesandshouldindependentlyinvestigatewhether

thedebtorispayingfromitscashcollateral.InMarathon’scase,thefactthat

CapitalSourcehadobjectedtoDelco’srequesttouseitscashcollateral,andthe

factthatCapitalSourcehadablanketlienonDelco’sassets,wereredflagsthat

warrantedextrainvestigation.

Sellers Beware – Unauthorized Payments from ‘Cash Collateral’ Will be Avoided—continued from page 2

THE THIRD CIRCUIT EXPANDS THE SUBSTANTIAL-PERFORMANCE TEST TO DETERMINE IF A TRADEMARK LICENSE CONTRACT IS EXECUTORY

In re Exide Technologies, 607 F.3d 957 (3rd Cir. June 1, 2010)

CASE SNAPSHOT

Thisisaninterestingcaseofseller’sremorse.

DebtorExidesoughttotakebackitsbattery

trademarkfromEnerSysbyrejectingthe

licensingagreementundersection365ofthe

BankruptcyCode.Exideattemptedtodothis

eventhoughEnerSyshadlongsincepurchased

Exide’sbatterybusinessandexclusivelyused

thetrademarkfor10yearsundertheparties’

agreements.TheBankruptcyCourtandDistrict

Courtruledthattheagreementwasexecutory

and,therefore,subjecttorejectionunder

section365.TheThirdCircuitCourtofAppeals

disagreed,andfoundthatEnerSyshadsubstantiallyperformeditsobligations

undertheagreements;thus,theagreementswerenotexecutoryandcouldnotbe

rejectedbyExide.Thecourtfurtherheldthatitwasexpandingthesubstantial-

performancetestbeyondconstructionandemploymentlawcases.

FACTUAL BACKGROUND

In1991,ExideagreedtosellitsindustrialbatterybusinesstoEnerSysDelaware,

Inc.,for$135million.Theassetssoldincludedmanufacturingplants,inventory,

and,atissuehere,aperpetual,exclusive,royalty-freelicensetousethe“Exide”

trademarkinthebatterybusiness.

Exidecontinuedtooperateitsotherbusinesslinesunderitsowntrademark,and

EnerSysmadeandsoldbatteriesundertheExidenameandtrademark.In2000,

Exidedesiredtore-enterthebatterybusiness,andattemptedtoregainitsname

andtrademarkfromEnerSysaspartofastrategicgoaltounifyitscorporate

image,anduseitsnameandtrademarkonallproductsthatitproduced.EnerSys

agreedtoshortenthenon-competitionprovisionsintheagreementstopermit

Exidetore-enterthebusiness,butrefusedtosellthe“Exide”trademarkbackto

Exide.Exidepurchasedabatterycompany,andbegansellingbatteriesundera

differentname.ThisputExideindirectcompetitionwithEnerSysproductssold

as“Exide”batteries.Thisendeavordidnotsucceed,andExidefiledforchapter

11bankruptcyprotectionin2002.

Seeinganopportunitytotakebackthedeal,Exidefiledamotiontorejectits

agreementwithEnerSysundersection365(a)oftheBankruptcyCode,arguing

thatthecontractwasexecutory,andthatrejectionoftheagreementterminated

EnerSys’rightsundertheagreement.TheBankruptcyCourtandtheDistrictCourt

agreed,andheldforExide.EnerSysappealedtotheCircuitCourtofAppeals.

COURT ANALYSIS

TheBankruptcyCodedoesnotdefine“executorycontract.”Courtshavedefined

thetermtomeanacontractunderwhichtheobligationsofboththebankrupt

andtheotherpartyaresofarunderperformedthatthefailureofeitherpartyto

completeperformanceconstitutesamaterialbreach,excusingtheperformance

oftheotherparty.

Conversely,ifeitherpartyhassubstantiallyperformed—inotherwords,ifneither

partyhadanymaterialobligationsremaining—theagreementcouldnotbe

executory.Todeterminewhethersubstantialperformancehadbeenrendered

here,thecourtconsideredseveralfactors:

Q Theratioofperformancerenderedtothatnotrendered

Q Thequantitativecharacterofthedefault

Q Thedegreetowhichthepurposebehindthecontracthadbeenfrustrated

Q Thewillfulnessofthedefault

Q Theextenttowhichtheaggrievedpartyhadalreadyreceivedthesubstantial

benefitofthepromisedperformance

TheCourtofAppealsdidnotbuyExide’sargumentsthatthecontracthadnot

yetbeensubstantiallyperformed.EnerSyspaidthe$135millionpurchaseprice

infull,usedalloftheassetstransferred,assumedExide’sliabilities,andhad

usedtheExidetrademarkconsistentlyfor10years.Indeed,thecourtruled

thatbothpartieshadalreadysubstantiallybenefittedfromtheirperformance.

Theremainingtermsoftheagreementwereminor,i.e.,userestrictions,quality

standardsprovisions,indemnityobligations,andfurtherassurancesobligations,

andhadeitherexpiredorhadbeentreatedbyExideasunimportantterms.As

such,thefactswereclearthatthecontracthadsubstantiallybeenperformed.

Exidealsoarguedthatthesubstantial-performancetestwasirrelevant,because

ithadpreviouslyappliedonlyinconstructionandemploymentcases.The

CourtofAppealsdisagreed,identifyinga2007casefromtheSecondCircuit

thathadappliedthetestinanothercontext.Moreover,theCourtofAppeals


CONT INUEDONPAGE4


COURT BREAKS FROM MAJORITY RULE, GRANTING RETIREES POST-PETITION RIGHTS GREATER THAN PRE-PETITION RIGHTS

IUE-CWA v. Visteon Corporation, 2010 WL 2735715 (3rd Cir. July 13, 2010)

CASE SNAPSHOT

TheThirdCircuitCourtofAppealsbrokefrom

theSecondCircuit,andamajorityoflowercourt

decisions,togiveunionandnon-unionretirees

moreprotectionsinbankruptcyundertheirbenefit

plansthanwereprovidedforinthebenefitplans

themselves.TheCourtofAppealsheldthatsection

1114oftheBankruptcyCode,whichsetsforth

strictproceduresforobtainingmodificationof

retireebenefitplans,requiresthedebtortoabide

bythoseproceduresbeforecancellingretiree

healthandlifeinsurancebenefits.Thisdecision

prohibitsadebtor-employerfromunilaterallyterminatingsuchbenefits,evenif

thebenefitplanitselfpermitsthedebtortodoso.Althoughthemajorityofcourts

inothercircuitshaveruledthatCongresscouldnothaveintendedtogivemore

benefitspost-petitiontoretireesthantheyhadundertheircontractspre-petition,

theCourtofAppealsdisagreed,holdingthatthebroadlanguageinsection1114

isunambiguousonitsfaceandthatCongressdidindeedintendtogiveretirees

additionalprotectionsfromthedebtoranditsothercreditors.

FACTUAL BACKGROUND

TheIndustrialDivisionoftheCommunicationWorkersofAmericaunion

representedhourlyworkersatmanufacturingplantsownedbyVisteon

Corporation.Visteonprovidedhealthandlifeinsurancebenefitstoretirees,asset

forthinthecollectivebargainingagreementsandthesummaryplandescriptions.

Intheplandescriptions,Visteonreserved“therighttosuspend,amendor

terminatethePlan…atanytime….”

OnMay28,2009,Visteonfiledapetitionforchapter11bankruptcy.Visteon

continuedtooperateasadebtor-in-possession,restructuringwiththegoalof

successfullyemergingfrombankruptcy.

Withinweeksofthefiling,VisteonmovedtheBankruptcyCourtundersection

363(b)(1)(whichhasfarlessonerousrestrictionsthansection1114)for

permissiontoterminateallretireebenefits.ThecourtgrantedVisteon’smotion.

Thisaffectedsome8,000peopleinall,2,100ofwhomwererepresentedbythis

union.TheunionappealedtotheDistrictCourt,whichaffirmedthetermination.

TheunionthenappealedtotheThirdCircuitCourtofAppeals.

Section 1114

Section1114providesproceduralandsubstantiveprotectionsforretireebenefits

duringachapter11case.Theprimarysubsectionatissue,1114(e),provides:“[n]

otwithstandinganyotherprovisionofthistitle,the[trusteeordebtor]shall timely

pay and shall not modify any retiree benefits”unlessthecourtorders,orthetrustee

andtheauthorizedrepresentativeoftheretireesagreeto,themodificationofsuch

benefits(emphasisadded).Section1114requiresadebtortomakeamodification

proposaltoretirees,discloseitsfinancialinformation,andtomeetandconferwith

retireesingoodfaithdiscussions.Ifsucheffortsfail,thecourtwillonlygranta

motiontomodifybenefitsoverretireeobjectionsiftheretireesrefusedtoacceptthe

proposalwithout“goodcause,”andthe“modificationisnecessarytopermitthe

reorganizationofthedebtorandassuresthatallcreditors,thedebtor,andallofthe

affectedpartiesaretreatedfairlyandequitably….”


The Third Circuit Expands the Substantial-Performance Test to Determine if a Trademark License Contract is Executory —continued from page 3

also“conclude[d]thatwewillnotconfinethedoctrinetoconstructionand

employmentcontractcases.”

Accordingly,becausetheagreementdidnotcontainatleastoneongoingmaterial

obligation,itwasnotanexecutorycontractandcouldnotberejectedbyExide.

CONCURRING OPINION DISCUSSES THE REJECTION OF TRADEMARKS

CircuitJudgeAmbrowroteseparatelytoaddresstheBankruptcyCourt’s

determinationthat“[r]ejectionoftheAgreementleavesEnerSyswithouttheright

tousetheExidemark.”JudgeAmbroreasonedthattherejectionofatrademark

licenseagreementdidnotdeprivethenon-debtorpartyofitsuseofthe

trademark.Thedebtor’srejectionwouldpermitittousethetrademark,asbefore,

butitdidnottakeawaytheotherparty’scontractualrightstousethetrademark.

JudgeAmbrocitedastringofdecisionsinothercircuitsholdingthattherejection

ofacontractwasnotthesameasarescissionofthecontract.Althoughrejection

relievedthedebtorofitsburdensunderthecontract,itdidnot,per se,take

awaythebenefitsofthecontractfromanon-debtorparty.(Interestingly,section

365(n)oftheBankruptcyCodecreatessimilarprotectionsfornon-debtorparties

forintellectualproperty,butdoesnotincludetrademarksinitsdefinitionof

“intellectualproperty.”)

Thisconcurringopinioncannotberelieduponasprecedent,sinceitisnotpart

ofthecentralholdingofthecase.Itisinformative,however,andcouldbeuseful

inatrademarklicensee’sargumentthattrademarklicenserejectionshouldnot

beusedtofreelyallowalicensortotakebacktrademarkrightsitbargainedaway.


Althoughcompaniesconsideringfilingforbankruptcyoftenthinkthatsection

365’srejectionprovisionsareapanacea,theyshouldanalyze—withan

experiencedbankruptcyattorney’shelp—whetherkeycontractscanactuallybe

rejectedbeforefilingforbankruptcy.

CONT INUEDONPAGE5


TheBankruptcyandDistrictCourtsbothconcluded—consistentwiththemajority

ofcourtsthathaveruledontheissue—thatsinceVisteonhadtherightto

terminatethebenefitsat-willoutsideofbankruptcy,itcontinuedtohavethat

rightduringbankruptcy.Essentially,thosecourtsheldthatrestrictingVisteon’s

contractualrighttoterminatebenefitsduringbankruptcywouldgivetheunion

greaterrightsinbankruptcythantheunionhadoutsideoftheprocess,which

wouldservenobankruptcypurpose.Therefore,thesecourtsconcluded,section

1114wasinoperablehere.

Theunionappealed,arguingthattheplain,unambiguouslanguageofsection

1114madenoexceptionsforbenefitplansthatpermittedunilateraltermination.

Theretireesarguedthatsection1114wasenacted,alongwithitscounterpart

section1129(a)(13),astheprimarycomponentsoftheRetireeBenefits

BankruptcyProtectionActof1988.Theunionnotedalsothatthislegislationwas

thedirectresultofpublicandCongress’dismayregardingtheactionsofLTV

Corporation,whichduringits1986bankruptcy,terminatedthehealthandlife

insurancebenefitsof78,000retireeswithoutnotice.

COURT HOLDING

TheCourtofAppealsheld“thatsection1114isunambiguousandclearlyapplies

toanyandallretireebenefits,includingtheonesatissuehere.Moreover,

despiteargumentstothecontrary,theplainlanguageofsection1114produces

aresultwhichisneitheratoddswithlegislativeintent,norabsurd.Accordingly,

disregardingthetextofthatstatuteistantamounttoajudicialrepealofthevery

protectionsCongressintendedtoaffordinthesecircumstances.”

However,theCourtofAppealsalsoruledthattheseprotectionsweresomewhat

fleeting,andthatupontheentryofaplanconfirmationorder,section1129

permittedthedebtortounilaterallyterminatebenefitsundertheexpresslanguage

ofitsagreements—assumingthatthedebtordidnotmodifyretireerightsunder

1114beforeentryoftheconfirmationorder.

COURT ANALYSIS

TheCourtofAppealsacknowledgedthatitsdecisionwasatoddswiththemajority

ofbankruptcyanddistrictcourtsthathadaddressedthisissue,andwasseemingly

intensionwithaSecondCircuitopinionaswell.“Weareconvincedthatinreaching

thesecontraryconclusionsastothescopeofsection1114,thesecourtsmistakenly

reliedontheirownviewsaboutsensiblepolicy,ratherthanonthecongressional

policychoicereflectedintheunambiguouslanguageofthestatute.”TheCourt

ofAppealssupporteditsdecisiononthreegrounds:thelanguageofthestatute;

legislativeintent;and,lackofabsurdityinthisstatutoryinterpretation.

Plain Statutory Language

Thecourtbeganbyanalyzingthelanguageofthestatute.Thesectionstates

thatthebankruptcytrustee“shalltimelypayandshallnotmodifyanyretiree

benefits,”exceptthroughtheproceduressetforthinthestatute.Theonly

subsectionof1114thatlimitsthisrequirementdealswithhigh-incomeretirees.

Otherwise,section1114doesnotallowadebtorortrusteetoterminateormodify

retireebenefitsoutsideoftheproceduressetforthinthestatute—notevenifthe

benefitagreementpermitsunilateraltermination.

TheCourtofAppealsruledthatothercourtsweremistakenintheirfindingsthat

section1114wasrenderedambiguousbythelanguageof1129(a)(13).Unlike

section1114,section1129(a)(13)requiresthatadebtor’sreorganizationplan

providefor“thecontinuationafteritseffectivedateofpaymentofallretireebenefits

…forthedurationoftheperiod the debtor has obligated itself toprovidesuch

benefits(emphasisadded).”Inotherwords,section1129(a)(13)recognizesthata

debtormaynothaveobligateditselftoprovidesuchbenefits.Basedontheseeming

inconsistencies,themajorityofcourtshaveruledthatCongressmusthaveintended

section1114tohaveasimilar“carve-out.”TheCourtofAppealsdisagreed,holding

thatCongresssaidwhatitmeant,andmeantwhatitsaid,andthatthedifferences

betweenthetwostatutorysectionsmusthavebeenintentional.

Thecourtalsoaddressedarelativelyrecentamendmenttosection1114;namely,

1114(l).Thissubsectionrequiresacourttoreinstateretireebenefitstothestatus

thebenefitshadjustpriortoanymodificationthatadebtormadeinthe180-day

periodbeforefilingabankruptcypetition.Thecourtbelievedthatthissubsection

strengtheneditsreadingofsection1114(e),andprovided“additionalevidenceof

thecoherenceofthestatutoryschemeCongresshascreatedhere....Although

wethinkthatthelanguageofsection1114wasalwaysunambiguous,this

subsectioncertainlyreinforcesourviewofthetext.”

Legislative History

Second,theCourtofAppealsrejectedVisteon’s“cherry-pickingfavorable

snippetsoflegislativehistory.”Thecourtcitedthecommentsofseveral

representativesandsenatorsinvolvedindraftingthelegislation,aswellas

conferencereports,insupportofitsreadingofthestatute.Forexample,thecourt

citedtheSenateConferenceReport:“Section1114makesitclearthatwhena

Chapter11petitionisfiledretireebenefitpaymentsmust be continued without

change until and unlessamodificationisagreedtobythepartiesororderedby

thecourt.Section1114rejects any other basis fortrusteestoceaseormodify

retireebenefitpayments.”(Emphasisaddedintheopinion.)

Thecourtevenspenttimereviewingtheimpetusbehindtheenactmentofsection

1114,theLTVCorporationbankruptcyandterminationofbenefitsfor78,000

retirees.LTV’sactionsaffectedunionandnon-unionemployees.“Congress

accordinglywasfullycommittedtoensuringthatbothunionandnon-union

employeeswouldbeequallyprotectedbytheRetireeBenefitsBankruptcy

ProtectionAct.”

Absurdity

Lastly,thecourtrejectedVisteon’sargumentthatitwouldbeabsurdtointerpret

“section1114togiveretireesmorerightsunderChapter11thantheywouldhave

outsideofbankruptcy.”TheCourtofAppealsruledthatCongressclearlyintended

togiveadditionalprotectionstoretireesduringthependencyofabankruptcy

case,preciselywhenthedebtorfeltthemostintensepressurefromitscreditors

toterminatethebenefitsofitsretirees.Thecourtruledthatitwasforthisvery

Court Breaks from Majority Rule, Granting Retirees Post-Petition Rights Greater than Pre-Petition Rights—continued from page 4

CONT INUEDONPAGE6


LANDLORDS SUCCESSFUL IN OBTAINING STUB RENT AS AN ADMINISTRATIVE EXPENSE UNDER SECTION 503

In re Goody’s Family Clothing, Inc. - F.3d – 2010 WL 2671929 (3d. Cir.

June 29, 2010)

CASE SNAPSHOT

TheUnitedStatesCourtofAppealsfortheThird

Circuitheldthatthelandlordsarenotprecluded

fromseekingpaymentof“stubrent.”Debtors

oftenmanipulatetheirbankruptcyfilingdateso

thattheycantakeadvantageofexistingcaselaw

interpretingsection365(d)(3)oftheBankruptcy

Code,whichholdsthatrentalpaymentsthat

are“due”priortothefilingofbankruptcy(even

ifthepaymentrelatestooccupancyafterthe

bankruptcyfiling)arenotobligationsthatare

requiredtobepaidpursuanttothetermsofthe

BankruptcyCode.Thus,formany“first-day-of-the-month”leases,adebtorwill

fileonadayafterthefirstdayofthemonth,arguingthattherentalpayment

wasduepre-petitionandthereforethedebtorcanoccupythepremisesforthe

remainderofthemonthpost-petitionwithoutthepaymentofanyrent.Thisperiod

isoftenreferredtoasthe“stubperiod.”

FACTUAL BACKGROUND

Goody’sFamilyClothingmanipulateditsbankruptcyfilinginthismanner.Goody’s

didnotpayanyrentforthemonthinwhichitfiledforbankruptcy;however,

itcommencedpayingregularleasepaymentsonthefirstdayofthemonth

immediatelyfollowingthebankruptcyfiling.Duringthestubperiod,Goody’s

conductedgoing-out-of-businesssales,securingasubstantialreturnonthe

inventorysoldand,intheprocess,obtainedpaymentfromtheliquidationagent,

fortheagent’soccupationofthespaceduringthatstubperiod.

Variouslandlordsarguedthattheyshouldbeentitledtoreceivecompensationfor

thedebtor’soccupationofthespaceduringthestubperiod.Sincethelandlords

couldnotseekrecoveryundersection365(d)(3)oftheBankruptcyCode(the

sectionthatgovernsthelandlord’srighttopayment),thelandlordssought

recoveryundersection503,themoretraditionalsectionoftheBankruptcyCode

whichgovernsallowanceofadministrativeclaims.Thelandlordsarguedthat

theongoingoccupationofthespaceduringthestubperiodconferredan“actual

necessarybenefitontheestate,”andthattheexpenseassociatedwiththat

occupationshouldbepaidtothelandlords.Thedebtorarguedthatsection

365(d)(3)oftheBankruptcyCodewastheexclusiverightofrecoveryforlandlords

forpost-petitionoccupation,andthereforenopaymentforthestubperiodcould

bemade.TheBankruptcyCourtgrantedthelandlords’claimsfortheamounts

dueduringthestubperiodandtheDistrictCourtaffirmed.Goody’stookan

ultimateappealtotheUnitedStatesCourtofAppealsfortheThirdCircuit.

COURT ANALYSIS

TheThirdCircuitbeganbyunderscoringitspriorholdingsthatsection

365(d)(3)oftheBankruptcyCodeprovidesamechanismforpaymenttolandlords

fortheoccupationofspaceduringthepost-petitionperiod.Thecourtnoted,

however,thatthelandlordswerenotseekingpaymentpursuanttosection

365(d)(3);rather,thelandlordswereseekingauthorityunderaseparateand

distinctsectionoftheBankruptcyCodeforthestubperiod.Thecourtquickly

dismissedthedebtor’sargumentthatsection365(d)(3)wastheexclusiveremedy

forpost-petitionoccupation.Whilesection365(d)(3)referencessection503

oftheBankruptcyCode,365(d)(3)simplyexcusesalandlord’sobligationsto

DerekJ.Baker Partner Philadelphia

Court Breaks from Majority Rule, Granting Retirees Post-Petition Rights Greater than Pre-Petition Rights—continued from page 5

reasonthat,afterentryofanorderconfirmingaplanofreorganization,andafter

thesepressureswerealleviated,section1129(a)(13)onceagainpermittedthe

debtortounilaterallyterminatethesebenefitsiftheagreementssoprovided

(assumingnosection1114modificationsweremadebeforeconfirmation).

“Farfrombeing‘absurd,’aliteralinterpretationofsection1114revealsaremedial

andequitablestatutoryschemethat,consistentwithCongress’concernswhen

enactingtheRBBPA,attemptstopreventthehumandimensionofterminating

retireebenefitsfrombeingobscuredbythebusinessofbankruptcy.”

CONCLUSION

TheThirdCircuitCourtofAppealsheldthatsection1114isclearand

unambiguousonitsface.Visteoncouldnotunilaterallyterminatetheretiree

benefitswithoutabidingbytheproceduressetforthinsection1114,eventhough

Visteonhadthecontractualrighttoterminatethebenefitsoutsideofbankruptcy.

“Weneednot,andshouldnot,beconcernedwithwhetherretireebenefitsshould

beextendedgreaterprotectionduringbankruptcythanotherwise;thatisajobfor

Congress.WeneedonlygiveeffecttothelawCongresshasenacted.”

However,solongasadebtordoesnotmodifythesubjectagreementsduring

thecaseundersection1114,itcanregainitscontractualrightstounilaterally

terminatesuchbenefitsafterthecourtapprovesitsplanofreorganization.


Ifacompanyfindsitselfinafinancialpositionwhereitcanwaittounilaterally

terminatebenefitsafterconfirmation(aftersection1114isnolongerabar),the

companyshouldbecarefultonotmodifyretireebenefitsduringthependency

ofbankruptcyproceedingsinsuchawaythatitlosesthecontractualrightto

terminatepost-bankruptcyundersection1129(a)(13).

CONT INUEDONPAGE7


DELAWARE BANKRUPTCY COURT FINDS APPOINTMENT OF EXAMINER NOT REQUIRED EVERY TIME THE STATUTORY DEBT THRESHOLD IS EXCEEDED

In re Spansion, Inc., 426 B.R. 114 (Bankr. Del. April 1, 2010)

CASE SNAPSHOT

Attheconfirmationhearingregardinga

chapter11debtor’splanofreorganization,

theBankruptcyCourtconsideredanad hoc

committeeofconvertiblenoteholders’motion

tovacatetheorderapprovingthedebtors’

disclosurestatement.Themotionwasbased

onallegationsthatthedebtorshadengaged

inmisconductandmisrepresentation.Inits

motion,thead hoccommitteealsomovedfor

theappointmentofanexaminerundersection

1104(c)(2)oftheBankruptcyCode,which

providesfortheappointmentofanexaminerwhenadebtor’sdebtsexceed

$5million.Despitetheexpresslanguageof1104(c)(2),theBankruptcyCourt

deniedthe ad hoccommittee’smotion,findingthatthestatutorylanguagedoes

notrequiretheappointmentofanexaminerineveryinstancewhenthedebt

thresholdisexceeded.

FACTUAL BACKGROUND

Spansion,Inc.designedandmanufacturedsemiconductordevices.Whenthe

economytookaseveredownturnin2008,demandforSpansion’sproducts

didaswell.Spansion(andseveralsubsidiaries)filedchapter11bankruptcy

petitionsinMarch2009.Overthecourseofseveralmonths,Spansionnegotiated

withdifferentcreditorsandinterestholders,includingtheunsecuredcreditors

committee,seniorsecurednoteholders,juniornoteholders,andunsecuredand

equityholders,attemptingtofinalizeitsreorganizationplan.Itwasundisputed

thatSpansion’sdebtexceeded$5million.

Overvariousobjections,Spansion’sdisclosurestatementwasapprovedbythe

BankruptcyCourt,anditsplanofreorganizationwasscheduledforaconfirmation

hearing.Spansion’sreorganizationplanincludedvariousdistributionoptions

forcreditors,aswellasvarioussourcesforthefundingoftheplan.Spansion

intendedtomakearightsofferingofnewcommonstocktoseveralclassesof

creditors,anda“backstop”rightsofferingtoaspecificinvestor.

PriortosubmissionoftheplantotheBankruptcyCourt,thead hoccommittee

ofconvertiblenoteholdersmadeanalternativeequityfinancingproposalto

Spansion,whichSpansionrejected,andwhichwasnotincorporatedintoitsplan.

Dayspriortothescheduledconfirmationhearing,the ad hoccommitteefiled

amotionseekingtovacatetheorderapprovingthedisclosurestatementand

seekingtheappointmentofanexaminerortrusteeundersection1104(c)(2)ofthe

BankruptcyCode.

COURT ANALYSIS

Thead hoccommitteeallegedthatthedisclosurestatementcontained

intentionallymisleadinginformation,andthatSpansionhadengagedinfraud

orothermisconduct.Primarily,thead hoc committeearguedthatSpansion

hadmisrepresenteditsfinancialforecasts,utilizingunreasonablyconservative

projections,therebyunder-valuingthecompanyandunfairlyimpactingunsecured

creditors.The ad hoccommitteearguedthatanexaminershouldbeappointed

undersection1104(c)(2)toinvestigatetheseallegedmisrepresentations.

ElizabethA.McGovern Associate Philadelphia

complywiththeotherwiseextensiveevidentiaryburdensofsection503toobtain

administrativeexpensestatus.TheBankruptcyCodedoesnotmakesection

365(d)(3)theexclusiveavenueforpayment,nordoesitpreemptorsupplant

section503.Therefore,alandlordisnotprohibitedfromseekingpaymentunder

the“morestringent”section503standards.

Afterholdingthatalandlordcouldseekaclaimforthestubperiodunder

section503(b)(1),thecourtwentontoexplainthat,tosuccessfullyobtainan

administrativeclaim,thelandlordmustprovethattheoccupationofthespace

conferredan“actualandnecessarybenefit”tothedebtorintheoperationof

itsbusiness.Notingthatmereoccupancywillnotalwaysconfer“anactualand

necessarybenefit”ontheestate,thecourtstatedthatthedebtorhereenjoyeda

clearbenefitbeyondmereoccupancy.Goody’sconductedsubstantialgoing-out-

of-businesssalesduringthestubperiod,andcollectedanoccupancyfeefrom

itsgoing-out-of-businesssalesagent.Therefore,itwasclearthattheoccupation

ofthespaceduringthatstubperiodresultedinaneasilyidentifiablebenefit

toGoody’s,bothintheconductofthesalesandintherecoupingofexpenses

associatedwithoccupation.


ThiscaseconfirmstheholdingsofseverallowercourtswithintheThirdJudicial

Circuit,andconfirmsthatlandlordswhoserentisnotpaidforthestubperiodcan

seekredress.However,theopportunitytoseekredressinvolvesasubstantial

evidentiaryundertakingforthelandlord.Often,the“one-month”rentassociated

withthedebtor’sfilingmanipulationdoesnotjustifyseekingtheincreasedburden

toestablishtheallowanceofaclaimundersection503(b)(1)oftheBankruptcy

Code;however,wherethedebtorhassoclearlyobtainedabenefitfromthe

occupationofthespaceduringthestubperiod,thiscaseconfirmsthelandlord’s

entitlementtoseektheclaimsolongasitcanmeetitsrequisiteevidentiaryburden.

Landlords Successful in Obtaining Stub Rent as an Administrative Expense Under Section 503—continued from page 6

CONT INUEDONPAGE8


Appointment of an Examiner

Section1104(c)(2)oftheBankruptcyCodeprovidesthat,afternoticeanda

hearing,“thecourtshallordertheappointmentofanexaminertoconductan

investigationofthedebtorasisappropriate,includinganinvestigationofany

allegationsoffraud…if…thedebtor’sfixed,liquidated,unsecureddebts,other

thandebtsforgoods,services,ortaxes…exceed$5,000,000.”

BecauseSpansion’sdebtsexceeded$5million,thead hoccommitteeargued

thatthestatuterequiredtheBankruptcyCourttoappointanexaminer.The

BankruptcyCourtdisagreed,however,baseduponitsinterpretationofthe

languageoftheprovisionanditsreviewofdecisionsreachedbyothercourts.

TheBankruptcyCourtnotedthatsomecourtsfoundthatthelanguageof

1104(c)(2)mandatesanexaminerbeappointedwhenthedebtthresholdis

met,regardlessofwhethertheexaminerwasneededtoperformanytasksor

functions.Infact,somecourtshadgonesofarastoappointanexaminerwithout

assigninganydutiestotheexaminer.Thosecourtsreasonedthatthestatute

requiredappointment,butthatthephrase,“asisappropriate,”gavethecourt

discretiontoassign–ornotassign-dutiestotheexaminerasitdeemedfit.

Othercourts,however,decidedthatsincebankruptcycourtshaveconsiderable

discretionindealingwithexaminerissues,andsincetheprovisioncontainsthe

phrase,“asisappropriate,”acourtcoulddecidenottoappointanexaminerin

appropriatecircumstances.

Appointment Neither Mandatory Nor Warranted

Here,theBankruptcyCourtfocuseditsanalysisonthephrase“asisappropriate,”

andreviewedotherdecisionsinwhichthecourtsfoundthattheappointment

ofanexaminerwasnotmandatory.Inparticular,theBankruptcyCourtcited

In re Winston Indus., Inc.,35B.R.304(Bankr.N.D.Ohio1983),whichfound

thatappointmentofanexaminerwasnotrequiredininstanceswheresuchan

appointmentis“needless,costlyandnon-productiveandwouldimposeagrave

injusticeonallpartiesherein.”

Ultimately,theBankruptcyCourtfoundthattherecordbeforeitdidnotcontain

sufficientevidenceof“conductthatwouldmakeaninvestigationoftheDebtors

appropriate,butratherrevealsdeepheateddifferencesofopinionaboutthevalue

oftheDebtors’companies.”Allpartieshadbeenvigorouslyrepresentedand

hadconductedextensivediscovery,andthecourtfoundnofraudormisconduct

inthevaluationmethodologies.Basedonthesefindings,theBankruptcyCourt

foundthatnoinvestigationwasappropriate,anddeniedthemotiontoappointan

examiner,onthebasisthatanexaminerinthiscasewouldnothavesubstantive

dutiesandwouldbewasteful.Thead hoccommittee’sallegationthatSpansion’s

rejectionofitsalternativeequityfinancingconstitutedmisconductwasmerely

a“classicconfirmationdispute,”ratherthangroundsfortheappointmentofan

examiner.Assuch,thecourtdeniedthead hoc committee’smotion.


ThecourtinSpansionfoundthat1104(c)(2)doesnotrequireacourttoappointan

examinerifthedebtorhasassetsinexcessof$5million,unlessthereisevidence

thatthereisanappropriateandsufficientbasistowarrantaninvestigationbyan

examiner.Incontrast,othercourtsview1104(c)(2)asrequiringtheappointment

ofanexaminer,regardlessofthecircumstancesofthecase.Whilethereisno

definitivestandard,theDelawareBankruptcyCourtinSpansionindicatedthat

itwasappropriateforcourtstoperformananalysisofthefactsofeachcase

whenconsideringtheappointmentofanexaminerunder1104(c)(2).Furthermore,

wherethepartieshavealreadyconductedextensivediscovery,andtherehasnot

beenaclearshowingoffraud,acourtmaywellconcludethatappointmentof

anexaminerwouldservenousefulpurpose,andrefusetoappointanexaminer

undersection1104(c)(2).

Delaware Bankruptcy Court Finds Appointment of Examiner Not Required Every Time the Statutory Debt Threshold is Exceeded —continued from page 7


THE THIRD CIRCUIT OVERRULES A LONG-STANDING CASE, CHANGING THE ABILITY OF PERSONAL INJURY PLAINTIFFS TO BRING SUIT AGAINST DEBTORS

JELD-WEN, Inc. v. Van Brunt (In re Grossman’s Inc.), (3d Cir. No. 09-1563,

June 2, 2010)

CASE SNAPSHOT

TheruleshavechangedintheThirdCircuit

forpersonalinjuryplaintiffsseekingrecovery

frombankruptandreorganizeddebtors.After

morethan25years,theThirdCircuitCourtof

AppealsrecentlyoverturnedAvellino & Bienes v.

M. Frenville Co. (Frenville),whichlongstoodfor

thepropositionthata“claim,”asdefinedinthe

BankruptcyCode,ariseswhentheunderlying

causeofactionaccrues,asdeterminedbystate

law.InGrossman’s,theThirdCircuitheldthat

abankruptcy“claim”ariseswhenaperson

isexposedtoaproductorconductpriortothefilingofadebtor’sbankruptcy

petition,andsuchproductorconductgivesrisetoaninjuryunderlyingaright

topaymentundertheBankruptcyCode.Consequently,latentproducts-liability

injuriesthatariseafteraThirdCircuitdebtor’sreorganizationarenowmore

likelytofallwithintheBankruptcyCode’sbroaddefinitionof“claim,”rendering

themcapableofbeingdischargedthroughadebtor’splanofreorganization.The

courtcautioned,however,thatthedischargeabilityofsuchaclaimdependsupon

satisfactionoftheclaimant’sfundamentaldueprocessrights,includingadequate

noticeofthebankruptcycaseandkeydeadlinestherein.

FACTUAL BACKGROUND

In1977,GloriaVanBruntpurchasedasbestos-containingproductsfromaretail

companycalledGrossman’s.Grossman’sfiledforbankruptcyinApril1997.

Ms.VanBruntfirstmanifestedsymptomsofmesothelioma(acancercausedby

asbestosexposure)in2006andwasdiagnosedin2007.Grossman’sprovided

noticebypublicationofthedeadlinetofileproofsofclaiminitsbankruptcycase;

Ms.VanBruntdidnotfileaproofofclaim.Grossman’splanofreorganization,

whichwasconfirmedbytheBankruptcyCourtinDecember1997,purportedto

dischargeallclaimsthatarosepriortotheplan’seffectivedate.

Soonafterherdiagnosis,Ms.VanBruntfiledsuitinNewYorkstatecourtagainst

JELD-WEN,Grossman’ssuccessor-in-interest.JELD-WENmovedtoreopen

Grossman’sbankruptcycase,seekingadeterminationthatMs.VanBrunt’sclaims

hadbeendischargedbytheplanofreorganizationconfirmed10yearsearlier.

IndeterminingwhetherMs.VanBrunt’sclaimsweredischargedbyGrossman’s

planofreorganization,boththebankruptcyanddistrictcourtsfollowedthe

ThirdCircuitCourtofAppeals’holdinginFrenville—aclaimariseswhenacause

ofactionaccruesunderstatelaw.UnderNewYorklaw,acauseofactionfor

asbestos-relatedinjuryaccrueswhentheinjurymanifestsitself.Since

Ms.VanBruntdidnotexperiencesymptomsuntilnearly10yearsafter

confirmationofGrossman’sreorganizationplan,boththebankruptcyanddistrict

courtsconcludedthatMs.VanBruntdidnothavea“claim”againstGrossman’s

withinthemeaningoftheBankruptcyCode.Therefore,Ms.VanBrunt’sproducts-

liabilityclaimswerenotdischargedbyGrossman’splanofreorganization.JELD-

WENappealedfromthedistrictcourt’sholding.

THE COURT ADOPTS A NEW TEST

TheCourtofAppealsacknowledgedthatthebankruptcyanddistrictcourts

correctlyappliedFrenville’s“accrualtest”inholdingthatMs.VanBruntdidnot

havea“claim”capableofbeingdischargedbyGrossman’sbankruptcyplan.

Beingawareofsignificantcontraryauthority,however,theThirdCircuitCourtof

AppealselectedtoconsiderwhetherFrenvilleshouldbeoverruled.Inthiscase,

theThirdCircuitCourtofAppealsfoundthattheaccrualtestimposestoonarrow

aninterpretationoftheterm“claim,”andoverruledFrenville.

InconsideringwhethertooverruleFrenville,thecourtrecognizedtherefusalof

othercourts,includingvariouscircuitcourts,tofollowtheaccrualtestbecauseit

resultsinamorenarrowinterpretationoftheterm“claim”thantheBankruptcy

Code’sdefinitionrequires.Section105(8)oftheBankruptcyCodedefines“claim”

as“[a]righttopayment,whetherornotsuchrightisreducedtojudgment,

liquidated,unliquidated,fixed,contingent,mature,unmatured,disputed,

undisputed,legal,equitable,secured,orunsecured....”OverrulingFrenville

thusenabledtheThirdCircuittoreconciletheinherentconflictbetweenthe

accrualtestandtheBankruptcyCode’sbroaddefinitionof“claim,”whichenables

bankruptcycourtstoaddressallofadebtor’slegalobligations,includingthose

thatareremoteorcontingent.

Inestablishingthenewtest,thecourtconsideredtheapproachofitssister

courtsinvariouscircuitsthathaddeclinedtoadoptFrenvilleindecidingtheissue

ofwhena“claim”arises.Althoughthesespecifictestsvary,theThirdCircuit

notedacommonalitythatitdescribedas“approachingconsensus...thata

prerequisiteforrecognizinga‘claim’isthattheclaimant’sexposuretoaproduct

givingrisetothe‘claim’occurredpre-petition,eventhoughtheinjurymanifested

afterthereorganization.”

Afterextensivelyconsideringtheexistingcaselawinthevariouscircuits,thecourt

overruledFrenvilleinfavorofanewtestthatprovides“thata‘claim’ariseswhen

anindividualisexposedpre-petitiontoaproductorotherconductgivingrisetoan

injury,whichunderliesa‘righttopayment’undertheBankruptcyCode.”

APPLICATION OF THE NEW TEST TO MS. VAN BRUNT

TheThirdCircuitwentontoapplythistesttoMs.VanBrunt.Underthenewly

establishedtest,thecourtfoundthatMs.VanBrunt’sclaimsarosein1977when

shewasexposedtotheasbestos-containingproducts.Thecourtnotedthat

thisdidnotnecessarilymeanthatMs.VanBrunt’sclaimhadbeendischarged,

however.

TheCourtofAppealsremandedthiscasetotheDistrictCourt,instructingthe

lowercourttodeterminewhetherMs.VanBrunt’sclaimsweredischargedby

Grossman’splanofreorganization.TheThirdCircuitinstructedthatwhether

Ms.VanBrunt’sclaimwasdischargedthroughGrossman’splanofreorganization

CONT INUEDONPAGE10

JenniferP.Knox Associate Philadelphia


woulddependuponsatisfactionbyGrossman’sofherdueprocessrights,

includingreceiptofadequatenoticeofthebankruptcycasesufficienttoprotect

herclaim.

TheThirdCircuitthenenumeratedseveralfactorsthatthelowercourtsmay

considerwhenevaluatingtheadequacyofthenoticeprovidedclaimants,including

Ms.VanBrunt.Thesefactorsinclude:thecircumstancesoftheinitialexposure

toasbestos;whetherand/orwhentheclaimantswereawareoftheirvulnerability

toasbestos;whetherthenoticeoftheclaimsbardateofthedebtorcametothe

claimants’attention;whethertheclaimantswereknownorunknowncreditors;

whethertheclaimantshadaplausibleclaimatthetimeofthebardate;andother

circumstancesspecifictotheparties,includingwhetheritwasreasonableor

possibleforthedebtortoestablishatrustundersection524(g)oftheBankruptcy

Codeforfutureclaimants.(Section524(g)wasenactedspecificallytoestablish

proceduresforasbestosclaims,suchastheoneinthiscase.)


Products-liabilitycasesillustratetheinherenttensionbetweenadebtor’sability

toachieveafreshstartthroughthebankruptcyprocess,andaninjuredparty’s

abilitytorecoverdamagesfromadebtorwhensuchinjuriesdonotmanifest

themselvesformanyyears.ByoverrulingFrenville,thecourtaffordsdebtors

intheThirdCircuitwithcomfortthatlatentinjuriesarisingpost-reorganization

constitutea“claim”withinthemeaningoftheBankruptcyCode,iftheexposure

orconductgivingrisetosuchinjuriesoccurredpriortotheinceptionofadebtor’s

bankruptcycase.

NotwithstandingtheThirdCircuit’sholdinginGrossman’s,however,debtors

arecautionedthatwhetheradischargeofsuchclaimswilloccurthroughaplan

ofreorganizationmustbedeterminedonacase-by-casebasis.Accordingly,

tomaximizethelikelihoodofobtainingadischargeofclaimsthatresultfrom

products-liabilityinjuriesthatareasymptomaticatthetimeofreorganization,

debtorswhoanticipatesuchclaimsarecautionedtocarefullyconsiderwhether

theiractionsduringthebankruptcycasearecapableofsatisfyingapotential

claimant’sconstitutionaldueprocessrights,whichincludeprovidingadequate

noticeofthebankruptcycaseandkeydeadlines.

The Third Circuit Overrules a Long-Standing Case, Changing the Ability of Personal Injury Plaintiffs to Bring Suit Against Debtors —continued from page 9

CONT INUEDONPAGE11

Official Committee of Unsecured Creditors of Allegheny Health,

Education and Research Foundation v. PricewaterhouseCoopers, LLP (3d.

Cir. No. 07-1397, May 28, 2010)

CASE SNAPSHOT

Anindependentauditorwassuedbyanonprofit

corporation’sofficialcommitteeofunsecured

creditors,forbreachofcontract,professional

negligence,andaidingandabettingabreachof

fiduciaryduty.Thecommitteeclaimeddamages

inexcessof$1billionresultingfromtheauditor’s

allegedcollusionwiththecorporation’sofficers

tofraudulentlymisstatethecorporation’s

finances.Atthelowercourtlevel,theauditor

prevailedonitsargumentthatthefraudofthe

officersshouldbeimputedtothecorporation,

thuspreventingthecorporation—andthe

committeestandinginitsstead—fromcollectingagainsttheauditorbecause

thecorporationwasasmuchatfaultastheauditor.Afterobtaininganadvisory

opinionfromthePennsylvaniaSupremeCourt,theCourtofAppealsvacatedthe

DistrictCourt’sjudgmentandremandedthecasetotheDistrictCourtforfurther

findingsoffact.

FACTUAL BACKGROUND

ThedebtoristheAlleghenyHealth,EducationandResearchFoundation(AHERF),

anonprofitcorporationthatprovidedhealthcareservicesthrough14hospitals,

twomedicalschoolsandhundredsofphysicians’practices.Throughoutthe

1980s,AHERFgrewthroughaprogramofacquisitions.Unfortunately,AHERFwas

unabletodelivercostsavingsandefficiencygainsasenvisioned,andby1996,

AHERFwassufferingsubstantialoperatinglosses.Duringthistime,independent

auditingserviceswereprovidedbyPricewaterhouseCoopers(PWC).

AgroupofAHERFofficers,ledbythechieffinancialofficerandoperatingwith

theapprovalofthepresidentandchiefexecutiveofficer,wasallegedtohave

knowinglymisstatedAHERF’sfinancesinthefigurestheyprovidedtoPWCfor

the1996audit.ThesemisstatementswereintendedtoshowAHERFasenjoying

positivefinancialconditions,ratherthanthedireconditionsthecompanywas

suffering.PWC’sauditfailedtorevealthemisstatements,andsoPWCissueda

cleanopiniontotheBoardofDirectorsofAHERFastothefinancialconditionof

thecompany.Thesesamecircumstanceswereallegedlyrepeatedin1997.

Byearly1998,thepoorfinancialconditionofAHERFbecamewidelyknown,as

supplierscomplaineddirectlytoboardmembers,anddoctorsthreatenedtoquit

becauseofalackofhospitalresources.Thefinancialdamagewastoodeep,and

inJuly1998,AHERFfiledachapter11petitionforbankruptcy.

DEFENSE OF IMPUTATION OF AN AGENT’S BAD CONDUCT TO ITS PRINCIPAL CLARIFIED IN PENNSYLVANIA; INDEPENDENT AUDITOR AT RISK FOR $1 BILLION IN DAMAGES

AnnE.Pille Associate Chicago


Defense of Imputation of an Agent’s Bad Conduct to its Principal Clarified in Pennsylvania; Independent Auditor at Risk for $1 Billion in Damages—continued from page 10

Inanadversaryproceeding,theOfficialCommitteeofUnsecuredCreditorsof

AHERFassertedthreecausesofactionagainstPWC:(1)breachofcontract;(2)

professionalnegligence;and(3)aidingandabettingabreachoffiduciaryduty.

PWCmovedforsummaryjudgment,raisingsevenargumentsinitsdefense.The

DistrictCourtgrantedPWC’smotiononthesolegroundthatthedoctrineofin

pari delicto—adoctrinethatpreventscourtsfromfindingforaplaintiffwhenthat

plaintiffisasequallyatfaultasthedefendantforthedamagesincurred—barred

theCommittee’sclaims.Specifically,applyingprinciplesofagencylaw,the

DistrictCourtfoundthatthewrongdoingofAHERF’sseniormanagementcouldbe

imputedtoAHERF,andthat,becauseAHERFwasalsoatfaultforthemisstated

financialstatements,thedoctrineofin pari delictobarredtheCommittee’s

claims.TheCommitteeappealedtotheCircuitCourt.

Becausequestionswereraisedconcerningtheinteractionbetweenthedoctrine

ofin pari delictoandtheimputationofanagent’sfraudtohisprincipalunder

Pennsylvanialaw,theCircuitCourtcertifiedtwoquestionstothestateSupreme

Court.ThiscasediscussesthefindingsofthePennsylvaniaSupremeCourt,and

theCircuitCourt’sdecisioninlightofthosefindings.

IMPUTING THE OFFICERS’ WRONGDOING TO AHERF

ThefirstquestioncertifiedtotheSupremeCourtofPennsylvaniawas:“[w]hatisthe

propertestunderPennsylvanialawfordeterminingwhetheranagent’sfraudshould

beimputedtotheprincipalwhenitisanallegedlynon-innocentthird-partythat

seekstoinvokethelawofimputationinordertoshielditselffromliability?”

ThePennsylvaniaSupremeCourtrespondedthatthekeywaswhetherthe

defendantdealtwiththeprincipalingoodfaith.ThePennsylvaniaSupremeCourt

noted,however,thatthisunderlyingprinciplehaddifferentapplicationsdepending

onwhethertheplaintiffwasproceedingagainsttheauditorunderatheoryof

negligenceorcollusion.

Inthenegligencecontext,thePennsylvaniaSupremeCourtdeclaredthatathird

partywouldgenerallybeabletoimputeanagent’sbadfaithtotheprincipalif

thatconductbenefittedtheprincipal,butwouldnotbeabletoimputetheagent’s

conducttotheprincipalifthebadactswereonlyintheagent’sself-interest.

Inthecollusioncontext,thePennsylvaniaSupremeCourtdeclaredthatifthe

auditorknewoftheagent’sbadorunsanctionedacts,theauditorcannotclaimto

havejustifiablyreliedontheagent’sstatements,andnoconductcanbeimputed

totheprincipal.

Inreachingtheseholdings,thePennsylvaniaSupremeCourtexpresslyrejected

theauditor’sassertionthatsecretivefalsificationofcorporatefinancial

informationbyrogueofficerscanberegardedasabenefittothecorporation,

insteadfindingthatitisinthebestinterestsofacorporationforthegoverning

structuretohaveaccurate(orattheveryleasthonest)financialinformation.

Basedontheforegoing,theCourtofAppealsrejectedtheDistrictCourt’sholding

that“anybenefit”receivedbyAHERFasaresultoftheofficer’sconductwould

resultinimputationofthatconducttoAHERF.Instead,theCourtofAppealsheld

that,underthenewdirectivesprovidedbythePennsylvaniaSupremeCourt:(i)“a

peppercornofbenefitcannotprovidetotaldispensationtodefendantsknowingly

andsubstantiallyassistinginsidermisconductthatisoverwhelminglyadverse

tothecorporation,”and(ii)asamatteroflaw,“aknowing,secretive,fraudulent

misstatementofcorporatefinancialinformationisnotofbenefittoacompany.”

IN PARI DELICTO

ThesecondquestionaskedoftheSupremeCourtwas,“doesthedoctrineofin

pari delictopreventacorporationfromrecoveringagainstitsaccountantsfor

breachofcontract,professionalnegligence,oraidingandabettingabreachof

fiduciaryduty,ifthoseaccountantsconspiredwithofficersofthecorporationto

misstatethecorporation’sfinancestothecorporation’sdetriment?”Thecourt

repliedthat,asageneralmatter,thedefenseisavailabletoauditors.Thecourt

pointedout,however,thatsinceimputationisnotavailableasadefensetoan

auditorthathasnotdealtingoodfaithwiththeprincipal,collusionbetweenthe

auditorandcorporateofficerseffectivelyforeclosesthedefenseofin pari delicto.

CIRCUIT COURT REMANDS THE CASE

InaccordwiththeguidancefromthePennsylvaniaSupremeCourt,theCircuit

Courtvacatedthegrantofsummaryjudgment,andremandedthecasetothe

DistrictCourtforfurtherproceedings.Specifically,theCircuitCourtinstructed

thattheDistrictCourtdeterminewhethertheauditordealtwithAHERFingood

faith.Furthermore,theDistrictCourtwasinstructedtore-examinetheextentof

benefittheagents’conductconferredtoAHERF,andtore-examinethebenefit

questioninlightofthePennsylvaniaSupremeCourt’sholdingthatsecretive,

fraudulentmisstatementsarenotabenefitatalltoaprincipal.


Byholdingthatknowingandfraudulentmisstatementsofcorporatefinancial

informationbyacorporation’sofficersdonot,asamatteroflaw,provide

abenefittothecorporation,thePennsylvaniaSupremeCourthascurtailed

thecircumstancesinwhichthosefraudulentmisstatementscanbeimputed

tothecorporation.Thisholdingtherebyincreasesthelikelihoodthatthe

corporationitself,oranotherpartystandinginitsstead,canrecoverdamages

fromaccountantsorotherprofessionalsforthedamagesresultingfromthose

misstatedfinancialrecords.


CONT INUEDONPAGE13

In re 15375 Memorial Corporation, et al., 430 B.R. 142 (Bankr. D. Del.

May 17, 2010)

CASE SNAPSHOT

TheBankruptcyCourtsanctionedtheindirect

parentcorporationofthechapter11debtorsand

theindirectparentcorporation’scounselunder

its“inherentauthority”and28U.S.C.section

1927–butnotRule9011–afterfindingthat

theparentcorporationabusedthebankruptcy

processbycausingtwoofitssubsidiariesto

filebankruptcypetitionsasalitigationtacticto

shielditselffroma$189millionliabilityinan

environmentaldamagecase.

FACTUAL BACKGROUND

Thiscaseconcernedseveralcorporateparties,allinvolvedinoilandgas

exploration.BassEnterprisesProductionCompany(Bass)andSantaFeMinerals,

Inc.(SantaFe)wereeachinthechainoftitleforamineralleaseoflandthatwas

laterfoundtobecontaminated.15375MemorialCorporation(Memorial)wasa

holdingcompanyandimmediateparentofSantaFe.EntitiesHoldings,Inc.(EHI)

wasaholdingcompanyandthesoleshareholderofMemorial.GlobalSantaFe

Corporation(GSF)wasthedirectparentofEHI,andtheindirectownerofboth

MemorialandSantaFe.BasswasnotaffiliatedwithSantaFe,Memorial,EHI,

GSF,oranyotherpartyinthiscase.

Individualsaffectedbythecontaminationoftherealpropertyfiledastatecourt

complaintagainstBassandSantaFe.Duringdiscoveryinthissuit,theparties

learnedthatSantaFe,notBass,wasresponsibleforthecontamination,and

thatitwouldtake$189milliontoremediatetheproperty.Further,theindividual

plaintiffsmadeitknownthatifanydefendantfiledforbankruptcy,thatdefendant

wouldbedismissedfromthesuit.Inaddition,aspartofthestatecourtsuit,Bass

assertedthird-partyclaimsagainstSantaFefordamagesdonetotheproperty,

andassertedalter-egoclaimsagainstGSF.

InAugust2006,EHIissuedademandnotetoMemorial,pursuanttowhichEHI

providedarevolvinglineofcredittoMemorialinexchangeforMemorial’s:(i)

acceptanceofallliabilities;and(ii)agreementtodefendandindemnifyGSFfrom

allclaimsrelatingtoSantaFe’soperations,regardlessofwhetherthoseclaims

werebasedonalter-egotheoriesorotherprinciples.Thereafter,Memorialand

SantaFefiledchapter11petitions,andtheindividuals’claimsagainsttheminthe

statecourtsuitweredismissed.

Ultimately,Basssettledtheclaimsagainstitinthestatecourtsuitformore

than$20million.Aspartofthissettlement,Basswasassignedthestatecourt

plaintiffs’claimsandrightsagainstSantaFeandGSF.Bassthenfiledproofsof

claimagainstSantaFeforassignment,contribution,indemnityandcontamination

oftheproperty.Bassalsosoughtrelieffromtheautomaticstaytopursueits

alter-egoclaimsagainstGSF,butwasdeniedthisreliefbythebankruptcy

courtonthetheorythatthealter-egoclaimsmightconstitutepropertyofthe

bankruptcyestates.

COURT ANALYSIS

AfteryearsoflitigationintheBankruptcyCourtbetweenBass,GSFandthe

debtors(withappealsuptotheThirdCircuitCourtofAppeals,whichresultedin

thedismissalofthebankruptcypetitionsforlackofgoodfaithintheirfiling),Bass

ultimatelyfiledamotionforsanctionsunderRule9011oftheFederalRulesof

BankruptcyProcedure.TheBankruptcyCourtdeniedthismotiononthebasisthat

thestringentstandardofRule9011requires“proofbythemovantbyclearand

convincingevidencethatnoreasonableattorneycouldconcludethatadebtorfiled

thecaseingoodfaith.”Notingthat:(i)itwasunawareofanymisrepresentations

thathadbeenmadebyanyparty;and(ii)itisnotaper seviolationofRule9011to

fileachapter11petitionlackingingoodfaith,theBankruptcyCourtfoundthatthe

highbarforRule9011sanctionshadnotbeenmet.

This,however,didnotendthecourt’sinquiry.AlthoughtheRule9011request

wasdeniedbytheBankruptcyCourt,thecourtdidgrantsanctionsinexcess

of$2million,onajointandseveralbasis,againstGSF,EHIandtheircounsel.

Specifically,thecourtrecognizedthatithadinherentauthoritytoimpose

sanctionsforabusesinbankruptcycases.Inaddition,itreliedupon28U.S.C.

secition1927,whichprovidesthat“anyattorney…whosomultipliesthe

proceedinginanycaseunreasonablyandvexatiouslymayberequired…tosatisfy

personallytheexcesscosts,expensesandattorneys’feesreasonablyincurred

becauseofsuchconduct.”

Inimposingthesesanctions,theBankruptcyCourtheldthatitwasclearthat

thesanctionedentitieswereincomplete,directcontrolofMemorialandSanta

Fe,andweredictatingthefilingandcourseofthebankruptcycases.Further,

theBankruptcyCourtheldthatGSF,EHIandtheircounselimproperlyand

intentionallyusedthebankruptcyprocesstothwartBass’effortsforreliefinthe

bankruptcycases,andthat“ateveryturn[they]manipulatedandside-tracked

thebankruptcyprocessfortheirownbenefit,asnon-debtors,tokeep[Bass]

onthedefensive.”ThecourtfoundthatGSFanditssubsidiaries(whichthe

courtreferredtoasthe“villainsinthesecases”)hadmisusedthebankruptcy

process,“whichresultedinsignificant,foreseeableandintendedharmto[Bass],”

compellingthecourttoimposesanctions.

Ingrantingthe$2millioninsanctions,thecourtdeniedtherequestsofthe

sanctionedentitiestotakediscoveryfromBass’attorneysregardingthe

attorneys’feesandexpensesincurred.Instead,theBankruptcyCourtreliedon

itsownexperienceinapprovingattorneys’feesrequests,anddeterminedthat

theattorneys’feesincurredwerefair,reasonable,andappropriatetothework

necessary.Inaddition,theBankruptcyCourtnoteditsdesiretopreventa“second

majorlitigation”overthereasonablenessofBass’fees.Itdid,however,reduce

thesanctionsawardbyanamountequaltoBass’feesonthevariousappeals

pursuedbytheparties,findingthatsanctionsrelatedtothoseappealsmustbe

heardbythecourtsthatheardtheappeals.

SANCTIONS AWARDED UNDER THE BANKRUPTCY COURT’S ‘INHERENT AUTHORITY’



Sanctions Awarded Under the Bankruptcy Court’s ‘Inherent Authority’—continued from page 12

Good v. RMR Investments, Inc., 428 B.R. 249 (E.D. Texas, March 31, 2010)

CASE SNAPSHOT

Asecuredcreditorinachapter11caseobjected

totheconfirmationofthereorganizationplanof

thedebtor,arguingthattheproper“cramdown”

interestrate(court-modifiedrate)wasthe

pre-petitioncontractualdefaultrate,ratherthan

thesignificantlylowercramdownrate.Afterthe

debtorappealed,theDistrictCourtaffirmed,

holdingthatutilizingthecontractrateofinterest

wasappropriatebecausethedebtorwassolvent.

FACTUAL BACKGROUND

LegacyCapitalInvestments,LLC,wasinthe

businessofrealestatedevelopment.RMRInvestments,Inc.enteredintoa

promissorynotewithLegacy,wherebyRMRloaned$7.8milliontoLegacy.As

partofthistransaction,LegacyexecutedadeedoftrustinfavorofRMR,granting

afirstprioritysecurityinterestincertainpropertyandmineralrights.

Theinterestrateunderthenotewasthehigheroftheprimerateplus

2.75percentor11percentperannum.Intheeventofadefault,theinterestrate

wouldincreaseby4percent.Thematuritydateofthenotewastheearlierofone

yearafterthedateofthenoteoruponaneventofdefault.

Legacyfileditschapter11petitioninJune2008,andshortlythereafter,Legacy

fileditsplanofreorganization.Theplanproposedthatthepost-confirmation

interestratebesetaccordingtotheprimerate.Theplanalsoproposedthatall

Legacycreditorswouldbepaidinfullattheendoffouryears,andthatLegacy

wouldhaveanequitybalanceofroughly$85millionatthattime.

Earlyin2009,theBankruptcyCourtenteredanorderconfirmingLegacy’s

reorganizationplan,overtheobjectionsofRMR.Inthatorder,thecourtheldthat

thepropercramdownrateofinterestpayabletoRMRwastheprimerateplus

2percent(5.25percentatthattime),andthattheproperlengthofpaymentswas

fouryearsfromthedateofconfirmation.

RMRfiledamotionforreconsideration,arguingthat–becauseLegacywas

solvent–theproperinterestratewasthecontractualdefaultrateof15percent,

andthatthepropertermofpaymentwasnomorethanthreeyears.Aftera

hearing,theBankruptcyCourtgrantedRMR’smotion,amendingtheinterestrate

to15percentandtherepaymenttermtonomorethanthreeyears.Legacythen

fileditsownmotionforreconsideration,whichtheBankruptcyCourtdenied.

LegacyappealedtotheDistrictCourt.

COURT ANALYSIS

WhiletheBankruptcyCodedoespermitcourtstoapproveplantermsoverthe

objectionsofcreditors,itdoesnotsetforthanymethodologiesforcalculatingthe

appropriatecramdowninterestrate.Intheabsenceofstatutorydirection,courts

haveusedawidevarietyofmethodsinthesecalculations.Whilesomecourts

requirespecificmethodsforcalculationofinterestratesinchapter11cases,

theFifthCircuithasdeclinedtodoso.TheFifthCircuithasexplainedthatsuch

calculationsrequirefact-specific,case-by-casedeterminationtoestablishthe

appropriateinterestrate.Giventhislatitude,thebankruptcycourt’sdetermination

willnotbeoverturned,absentclearerror.

Here,theBankruptcyCourtappliedthe“presumptivecontract”method,which

issometimesusedincaseswherethedebtorissolvent,andisbaseduponthe

presumptionthatthecourt’sroleis“merelytoenforcethecontractualrightsof

theparties.”Thecourtnoted,however,thattheFifthCircuithasalsoapproved

usageofthepresumptivecontractmethodincasesofinsolventdebtors.

ThecourtfoundthatLegacywasindefaultofthetermsofthenoteatthetime

itfileditspetition,andthatLegacywassolvent.Further,thecourtnotedthat

paymenttoRMRatthecontractualdefaultratewouldnotreducethepayment

thatanyothercreditorwouldreceiveundertheplan;itwouldsimplyreducethe

$85millioninequitythatwouldbeavailabletoLegacyattheendoffouryears.

Assuch,theDistrictCourtaffirmedtheBankruptcyCourt’srulingandheldthat

thedefaultrateofinterestundertheloandocumentswastheappropriaterateof

interestdueRMRundertheplan.


Althoughfullofunusualfactualcircumstances(i.e.,paymentofallcreditors

infull,solventdebtor,$85millionanticipatedequitycushion),thisopinion

demonstratesthatanumberoffactorscanbetakenintoconsiderationwhen

arguingforahigherrateofinterestunderaplanofreorganization.Further,

althoughunusual,itisnotunprecedentedforasecuredcreditortobepaidits

contractualdefaultinterestinthecontextofachapter11planofreorganization.

TEXAS DISTRICT COURT AFFIRMS THE CONTRACTUAL DEFAULT INTEREST RATE WHERE THE DEBTOR IS SOLVENT



Generallyspeaking,courtsareaversetoawardingsanctions,seekingtoavoid

anychillingeffectsanctionsmayhaveonvigorouslegalrepresentation.Where,

however,conductissoegregiousandabusiveofthelegalprocess,courtsare

willingtoimposesanctions.Parties,andtheircounsel,mustbeawarethatacourt

hasseveralweaponsatitsdisposaltoawardsanctions,astheBankruptcyCourtin

thiscaseimposedsanctionsunderanon-bankruptcyprovisionoffederallaw.


CONT INUEDONPAGE15

Longview Aluminum, LLC v. Brandt (In re Longview Aluminum, LLC), 2010

WL 2635787 (N.D. Ill., June 28, 2010)

CASE SNAPSHOT

AmemberoftheBoardofManagersofalimited

liabilitycompanysettledalawsuitagainstthe

LLC,receivingpartialpaymentfourmonths

priortotheLLCfilingitspetitionforchapter

11bankruptcy.Thebankruptcytrusteesought

torecoverthepaymenttothememberas

apreferentialtransfertoan“insider.”The

BankruptcyCourtheldthat,despitehavingbeen

strippedofmanyofhismembershiprightsprior

tothepayment,thememberwasan“insider”

oftheLLCwithinthemeaningoftheBankruptcy

Code,andthepaymentwasapreferentialtransferthatcouldbeavoidedand

recoveredbythetrustee.

FACTUAL BACKGROUND

LongviewAluminumwasorganizedinDelawareasalimitedliabilitycompany.

ItwasgovernedbyaLimitedLiabilityCompanyAgreement,whichlistedfive

memberscomprisingitsBoardofManagers.Amongthesememberswas

Mr.Forte.TheLLCAgreementprovidedthatLongviewwouldbemanagedby

theBoard,andthatLongviewwasrequiredtopromptlyfurnishmemberswith

relevantfinancialdata.Memberswerealsoaffordedtherighttoinspectthe

company’sbooksandrecords.

Onseveraloccasions,ForterequestedthatLongviewfurnishbusinessrecords

andallowhimtoreviewtherecords;allofhisrequestsweredenied.Forte

eventuallysuedoneofhisfellowmembersoftheBoard,allegingthatthemember

wasusinghiscontrollinginteresttoexcludeFortefromanymanagement

decisionsandanyreviewofrecords.Longviewintervenedinthataction,andwas

namedasanadditionaldefendant.TheothermembersoftheBoardadopteda

resolutionthatformallytookawayForte’srighttoaccessLongview’srecords.

Forteandthedefendantsreachedasettlement,wherebyLongviewwouldpay

Forte$400,000plusattorney’sfeesandcosts,inexchangeforForte’sagreement

toleavetheBoard.OnNovember7,2002,Longviewdelivered$200,000toForte

asaninitialpayment.OnJanuary16,2003,Longviewpaid$15,000toForte

asreimbursementforhisattorney’sfees.OnMarch4,2003,Longviewfileda

chapter11petition.

WilliamBrandtwasappointedthetrusteeinthebankruptcyproceedings,and

hefiledanadversaryactionagainstForte,seekingtoavoidthepaymentsof

$200,000and$15,000,aspreferentialtransfers.Sincethe$15,000payment

wasmadewithinthreemonthsofthebankruptcypetition,Forteconcededthat

itwasapreferentialtransfer,andhereturnedthatmoneytotheestate.The

BankruptcyCourtfoundthatFortewasan“insider”withinthemeaningofthe

BankruptcyCode,andorderedFortetoreturnthe$200,000.Forteappealedthat

decisiontotheDistrictCourt.

COURT ANALYSIS

Abankruptcytrustee,undersection547(b)(4)oftheBankruptcyCode,has

thepowertoavoidanytransferadebtormakesinthe90daysprecedingthe

bankruptcypetitionfiling.Further,thetrusteehasthepowertoavoidanytransfer

madetoan“insider”ofthedebtor,ifthetransferoccursbetween90daysand

oneyearpriortothepetitionfiling.

TheBankruptcyCodedoesnotdefinepersonsdeemedtobean“insider”with

respecttoalimitedliabilitycompany.Section101(31)(B)providesthat,ifthe

debtorisacorporation,an“insider”isdeemedtoincludeadirectorofthedebtor,

anofficerofthedebtor,andapersonincontrolofthedebtor.

Fortearguedthathewasnotan“insider”oftheLLCsinceneithertheterm

“manager”nor“member”isincludedinsection101(31)(B).Fortefurtherargued

thathewasnotaninsiderbecausehewasnotapersonincontrolofthedebtor.

Thus,Fortecontendedthatsincethe$200,000paymenttohimoccurredmore

than90dayspriortoLongview’sbankruptcyfiling,thetrusteeshouldnotbeable

toavoidthepayment.

ThecourtlookedtoaSeventhCircuitcaseforthepropositionthattheterm

“insider”encompassesanyonewitha“sufficientlycloserelationshipwiththe

debtorthathisconductismadesubjecttocloserscrutinythanthosedealing

atarm’slengthwiththedebtor.”ThecourtthenlookedtoDelawarelaw,which

requiresthatacorporationgenerallymustbemanagedbyaboardofdirectors.

“Thus,inreferencingadirector,section101(31)(B)wasintendedtorefertothe

partythat‘managed’thedebtorcorporation.”Further,Delawarelawregarding

LLCsstatesthatthemanagementofalimitedliabilitycompanyshallbevestedin

itsmembers.Puttingallofthistogether,thecourtfoundthatamemberofanLLC

isanalogoustoadirectorofacorporationunderDelawarelaw,andthatForte

was,therefore,an“insider”underbankruptcylaw.

Fortearguedthat,asearlyas2001,hewasnolongereffectivelyamanaging

memberofLongviewsincehewasdeniedaccesstoitsbooksandrecords.

Further,heargued,theAugust2002,Boardconsenteffectivelystrippedhim

ofhisstatusasamember.Thecourtsubstantivelyexaminedthiscontention.

First,thesettlementagreementprovidedthatFortewouldremainamember

ofLongviewuntiltheentire$400,000waspaid.Fortehadnotreceivedfull

payment,sohewasstillformallyamemberoftheBoard.Thecourtalso

examinedtheBoardconsent,andconcludedthat,whiletheconsentdidstrip

Forteofhisrightstoexaminethebooksandrecords,itdidnotstripForteof

anyotherrights,nordiditstripForteofhisstatusasamemberoftheBoardof

ManagersofLongview.

Therefore,thecourtconcluded,atthetimeofthe$200,000payment,Fortewas

stillamemberofLongviewandamemberoftheBoardofManagers,andthat

hewasan“insider.”Becausethepaymenthadbeenmadetoaninsider,andhad

AN LLC MEMBER/MANAGER IS AN ‘INSIDER,’ SO THAT PAYMENTS ARE PREFERENTIAL TRANSFERS SUBJECT TO AVOIDANCE UP TO ONE YEAR PRIOR TO BANKRUPTCY FILING



An LLC Member/Manager is an ‘Insider,’ so that Payments Are Preferential Transfers Subject to Avoidance Up to One Year Prior to Bankruptcy Filing—continued from page 14

CONT INUEDONPAGE16

American Consolidated Transportation Companies, Inc. v. RBS Citizens

N.A. (In re American Consolidated Transportation Companies, Inc.),

Adversary No. 10-00154, Bankruptcy No. 09-26062 (Bankr. N.D. Ill.

July 13, 2010)

CASE SNAPSHOT

Achapter11debtorsueditsprincipalsecured

lenderoverwhetherthelenderhadengagedin

overreachingbehaviorwiththedebtorbeforethe

bankruptcyfiling.Thesuitessentiallyallegedthat

thelenderhadinducedthedebtortoenterintoa

loancontainingprovisionsthelenderknewthe

debtorcouldnotmeet,andthenusedadefault

bythedebtortotakecontrolofandattemptto

sellthedebtor’sbusinessinordertorecoupits

loan.TheBankruptcyCourtdismissedallbuttwo

ofthedebtor’scounts,primarilyonthebasisthat

thedebtorfailedtoplausiblypleadaclaim.Thecourtultimatelyconcludedthat

thelenderhaddonenothingmorethantakehardstepstoprotectitsinterests.

FACTUAL BACKGROUND

AmericanConsolidatedTransportationCompaniesprovidedbusandtravel

services.ThoughawareofproblemswithAmerican’sbusiness,RBSCitizens

enteredintoabankingrelationshipwithAmericananditssubsidiaries,expecting

thatitwouldbeabletocollectsubstantialfeesandotherrevenuefromAmerican

byprovidingancillaryservices,suchascommercialdepositoryaccountservices,

lettersofcreditservices,andmerchantbusinessservices.

RBSandoneoftheAmericansubsidiariesexecutedavariableratetermnote

intheprincipalamountof$4million.Shortlythereafter,RBSandtheAmerican

subsidiaryexecutedaninterestrateswapagreement,wherebythesubsidiary

wouldpayafixedrateofinterest,ratherthanavariablerate.RBSandother

Americansubsidiariesenteredintoaloanandsecurityagreement,involvinga

$1milliontermnoteanda$1millionrevolvinglineofcredit.Thesetransactions

closedinSeptemberandOctober2006.

Thetransactiondocumentscontainedanumberofcovenantsregardingdefault,

twoofwhicharemostrelevanttothiscase.ThefirstcovenantrequiredAmerican

tomaintainacombinedtangiblenetworthofatleast$100,000asof

December31,2006,withspecificannualincreases.Thesecondcovenant

requiredAmericantomaintainaminimumcashflowsothattheratioofearnings

topaymentsontheloanswasalwaysatleast1.20to1.00.

InJune2008,RBSsentAmericanadefaultandaccelerationletter,statingthat

Americanwasindefaultofthenetworthandcashflowcovenants.Atthetimeof

thisletter,Americanwascurrentonitsloanpaymentsandnotindefaultofany

otherloanprovision.

RBSandAmericanthenenteredintoaforbearanceagreementthat,among

otherthings,requiredAmericantopledgeadditionalassetsascollateral,retain

arestructuringconsultantofRBS’choosing,andtakeanactiveroleinsellingits

ownbusiness.Aftertheforbearanceperiodended,Americanfiledapetitionfor

chapter11bankruptcy,andRBSfiledaproofofclaimformorethan$6million.

COURT ANALYSIS

Americanalleged,andRBSinternaldocumentsshowed,thatRBSknewof

materialbusinessproblemswithinAmericanevenbeforetheloantransactions

closed.Americanhadlostamajoraccount,reducingitsannualrevenuesby

25percent,andRBSinternalreportscalledintoquestionseveralassumptions

RBShadmadeaboutAmerican’sabilitytoincreasesales,reducecosts,and

increasepricesinordertooffsettherevenueloss.RBSconsideredAmerican’s

profitabilitytobe“consistentlybelowaverage”anditsliquidity“weak.”Because

ofthelostaccount,Americanwasactuallyindefaultofthecashflowcovenantat

thetimetheloandocumentswereexecuted.

TheforbearanceagreementrequiredAmericantohireachiefrestructuring

consultant.Theconsultantwasgivenextensivemanagerialresponsibility

inconnectionwithAmerican’soperationsandbusinesses,andtheprimary

responsibilityofsellingthosebusinesses.AlthoughAmericanwishedtoremain

inbusiness,theforbearanceagreementrequiredAmericantouseitsbestefforts

toenterintoasaleorrefinancingtransactionthatwouldrepayRBSinfull,and

todeliveratleastonebonafideletterofintentorsimilardocumentnolaterthan

May29,2009.RBSitselfwasactivelyseekingproposalstoliquidateAmerican,

BROADER ECONOMIC WOES MAY HAVE PLAYED A PART IN THE COURT’S DECISION TO DISMISS ALLEGATIONS OF LENDER OVERREACHING

BrianM.Schenker Associate Philadelphia

occurredwithinoneyearofthebankruptcyfiling,thetrusteecouldavoidthe

paymentmadetoForte.


Apartythathasacloserelationshipwithadebtorcompanymaybedeemedto

bean“insider,”regardlessofthenameortitlethepartyhas.Thiscaseillustrates

thatacreditordoesnothavetobea“director,”oranothertermsetforthinthe

BankruptcyCode,inordertobean“insider.”Courtswillsubstantivelyexamine

relationships,statelaws,andotherrelevantfacts,inordertodrawinferencesand

reachconclusions,especiallywheretheremaybesomegapintheBankruptcy

Code.Acreditororotherpartydeemedtobean“insider”standstoloseany

transfersmadetoitbyadebtorwithinoneyearpriortobankruptcy.


Broader Economic Woes May Have Played a Part in the Court’s Decision to Dismiss Allegations of Lender Overreaching —continued from page 15

CONT INUEDONPAGE17

andwouldhaveengagedaliquidationcompanyhadAmericannotfiledits

bankruptcypetition.

Americanarguedthatthesefactssupportedclaimsforequitablesubordination

oftheRBSloanclaim(CountI),damagesforviolationsoftheIllinoisConsumer

FraudandDeceptiveBusinessPracticesAct(CountII),breachoffiduciaryduty

(CountIII),breachofdutyofgoodfaithandfairdealing(CountIV),duress(Count

V),subordinationoftheRBSswapclaim(CountVI),andtheundoingofthe

perfectionofcertainofRBS’securityinterests(CountVIIandCountVIII).

InitsmotiontodismisssevenofAmerican’sclaims,RBSmadeargumentsfalling

intothreecategories:challengestotheplausibilityofAmerican’spleadings;

assertionsthatsomecountsrepresentaffirmativedefensesandnotcausesof

actionunderstatelaw;andRBS’assertionsofitsownaffirmativedefenses.

Plausibility of Claims/Inadequacy of Pleadings

RBSarguedthatAmericandidnotadequatelypleadfourofitsclaims.In

examiningtheplausibilityofAmerican’sallegations,thecourtnotedthata

complaintmustcontain“sufficientfactualmatter,acceptedastrue,tostatea

claimtoreliefthatisplausibleonitsface.”Acomplaintisplausiblewhen“the

plaintiffpleadsfactualcontentthatallowsthecourttodrawthereasonable

inferencethatthedefendantisliableforthemisconductalleged.”Claimssetforth

inacomplaintmustbemorethan“conceivable,”butnotnecessarily“probable.”

ThefirstcountinAmerican’scomplaintpleadedequitablesubordination.Under

section510(c)oftheBankruptcyCode,aclaimmaybesubordinatedtoanother

claim,andanyliensecuringasubordinatedclaimmaybetransferredtothe

debtor’sestate.Tosubordinateaclaim,Americanmustshow:(1)RBSengaged

insometypeofinequitableconduct;(2)themisconducteitherresultedininjury

toothercreditorsorconferredanunfairadvantageonRBS;and(3)subordination

isconsistentwithotherprovisionsoftheBankruptcyCode.Undertheholdings

ofotherbankruptcycases,typesofinequitableconductgenerallyincludefraud,

illegality,orbreachoffiduciaryduties.

Thelegalrelationshipbetweenthepartiesisakeycomponentindetermining

whetherconductwastrulyinequitable.IfRBSwasafiduciarywithrespectto

American,thenequitablesubordinationwouldbeappropriate,unlessRBScould

showthatthecontestedtransactionwasconductedatarm’s-length.IfRBS

wasnotafiduciary,thenAmericanwouldhavetoshowthatRBS’conductwas

egregious,“grossmisconducttantamounttofraudoroverreaching.”

Thecourtcitedseveralcasesinnotingthatadebtor-creditorrelationshipdoes

not,inandofitself,causethecreditortobeafiduciary.Thecreditormust

exertoperatingcontrolofthedebtor’sbusinessinordertoestablishafiduciary

relationship.“Controlmustbesooverwhelmingthatthereisamergerofidentity

oradominationoftheborrower’swill.”ThecourtfoundthatRBSneverexerted

thathighlevelofcontroloverAmerican.Eventheextensiveresponsibilitiesgiven

totherestructuringconsultantdidnotrisetotherequisitelevelofcontrol,since

theconsultantwasnotempoweredtomakeunilateraloperationaldecisions.

SinceAmericandidnotplausiblypleadthatRBSwasafiduciary,thecourt

examinedwhetherAmericanhadpleadedfactsshowingegregiousconduct.

Americancitedsixinstancesofsupposedegregiousconduct,noneofwhichthe

courtacceptedastantamounttofraud.Ineachassertion,thecourtfoundeither

thatAmerican’sreasoningwassimplynotplausibleornotsufficientlypleadedin

thecomplaintsoastopermitthecourttodrawinferencesthatRBShadengaged

insuchmisconduct.

Here,thecourtconcluded,“theComplaintshowslittlemorethan[RBS]taking

hardstepstoprotectitselfduringyearswhentherealestatemarketgenerally

wasincollapse.”

Illinois Consumer Fraud and Deceptive Business Practices Act

ToestablishviolationofthisAct,Americanmustshowthat:RBSengagedina

deceptiveact;RBSintendedthatAmericanrelyonitsdeception;thedeception

occurredinthecourseofcommerce;actualdamagetoAmericanoccurred;and

thedamagewascausedbyRBS’deception.

AmericanallegedthatRBSusedits2008defaultletterasapretexttoliquidate

Americanandregainthebank’scapital,eventhoughRBSknewthatAmerican

wasindefaultofthosecovenantsbeforetheloantransactionswereclosedin

2006.Thecourtstatedthat,“itisnotplausibleonthefaceofthesesparseand

conclusorypleadingsthattheBankusedAmerican’sdefaultasapretextto

controlAmericanandrecoupitscapital.”

IneachinstancethatAmericanofferedasproofofRBS’deceptiveactions,the

courtrepliedthatAmerican’spleadingswereeithersparse,ornotplausible.The

courtdismissedfourcountsofthecomplaintforAmerican’sfailuretosufficiently

pleadacauseofaction.

Dismissal of Other Claims

Thecourtalsodismissedtwocounts,breachofthecovenantofgoodfaithand

fairdealing,andduress,onthegroundsthatneitherconstitutesanindependent

claimunderIllinoislaw.Thecourtdidnote,however,thattheymaystandas

defensestoanyclaimRBSmaymakeagainstAmerican.

Broad Economic Context Counts

Morethanonceinitsopinion,theBankruptcyCourtmentionsbroadereconomic

woes.IndiscussingAmerican’sallegationsofdeceptiveacts,thecourtstates,

“[t]heUnitedStateseconomyandrealestatemarketsufferedfromahistoric

deeprecessionwhiletheeventscomplainedofherewereunfolding.Adequate

pleadingwouldhavetoshowmorethanacreditorprotectingitselfduringthat

period.”ThoughthecourtreferencedRBS’superiornegotiatingpositionwith

respecttotheforbearanceagreementanditsimpositionoftherestructuring

consultantonAmerican,italsostatedthat“Americanseemsrathertohavebeen

facinga‘Hobson’schoice’betweenfinancialcollapseandforbearanceonthe

Bank’sterms,achoicenotunusualinthepresenteconomy.”Asnotedabove,the

courtfoundthat,ratherthanengaginginfraudulentoroverreachingconduct,RBS


Broader Economic Woes May Have Played a Part in the Court’s Decision to Dismiss Allegations of Lender Overreaching —continued from page 16

CONT INUEDONPAGE18

In re EDM Corporation, 2010 WL 1929772 (8th Cir. BAP May 14, 2010)

CASE SNAPSHOT

Afirst-in-timesecuredlenderismovedtothe

endofthecreditorlinewhenafieldinthe

financingstatementfiledbythelendercontains

toomuchinformation.Thecourtheldthat

addingthedebtor’stradenametotheregistered

corporatenameinthe“name”fieldofafinancing

statementrenderedthestatement“seriously

misleading”andthereforeineffective.Toavoid

thispitfall,afinancingstatementfiledagainsta

registeredorganizationshouldonlyprovide“the

nameofthedebtorindicatedonthepublicrecord

ofthedebtor’sjurisdictionoforganization–nothingmoreandnothingless.”

FACTUAL BACKGROUND

Thecaseinvolvedthreelenderswithliensagainstcommoncollateralofthe

debtor,EDMCorporation.Thedebtor’sofficialnameregisteredwithitsstate

ofincorporation(Nebraska)was“EDMCorporation,”althoughitused“EDM

Equipment”asatradename.(EDMhadneverregistereditstradename).The

first-in-timelender,HastingsStateBank,filedafinancingstatementidentifying

thedebtoras“EDMCorporationd/b/aEDMEquipment.”

Subsequently,thedebtorgrantedliensinthesamecollateraltoTierOneBank.

TierOneranUCCsearches,usingtheNebraskastandardsearchlogic,underthe

debtorname“EDMCorporation.”However,noneofthesearchesrevealedHastings’

priorfinancingstatement.TierOnefiledafinancingstatementtoperfectits

perceivedfirstprioritylien.EDMsubsequentlygrantedliensinthesamecollateral

toHuntingtonNationalBank.HuntingtonranthesameUCCsearchasTierOne

had,usingtheNebraskastandardsearchlogic;thissearchdidnotrevealHastings’

financingstatement,althoughitdidrevealTierOne’sfinancingstatement.

EDMthenfiledavoluntarychapter7bankruptcycase,sparkingapriority

disputeamongthethreebanksholdingcompetingliensinthesamecollateral.

TheBankruptcyCourtheldthatHastings’financingstatementwasnotvalidly

perfected,becauseasearchfor“EDMCorporation”utilizingthestandardsearch

logicdidnotrevealthestatementidentifyingthedebtoras“EDMCorporation

d/b/a/EDMEquipment.”

COURT ANALYSIS

Onappeal,theBankruptcyAppellatePanelnotedthatRevisedArticle9ofthe

UniformCommercialCodeprovidesthat“afinancingstatementsufficiently

providesthenameofthedebtor...ifthedebtorisaregisteredorganization,

onlyifthefinancingstatementprovidesthenameofthedebtorindicatedonthe

publicrecordofthedebtor’sjurisdictionoforganization....”RevisedArticle9

alsoprovidesasafeharborprovisionwherebyafinancingstatementisdeemed

“notseriouslymisleading”ifasearchoftherecordsofthefilingofficeunder

thedebtor’scorrectlegalname,usingthatoffice’sstandardsearchlogic,would

disclosethefinancingstatement.

Thecourtalsonotedthepurposeoffilingafinancingstatement:toput

subsequentcreditorsonnoticethatthedebtor’spropertyisencumbered.The

courtstatedthatthe“veryfirststepofthatprocessforcreditorsisfinding

theUCCstatementinthefirstplace,andthewaytodothatisbysearching

therecordsunderthedebtor’sorganizationalname.Inotherwords,complete

accuracyisevenmoreimportantwiththedebtor’snamethanitiswiththe

descriptionofthecollateral.”(Emphasisinopinion.)

ThecourtemphasizedthatRevisedArticle9“evidencedanintenttoshiftthe

responsibilityofgettingthedebtor’snamerighttothepartyfilingthefinancing

statement.Thisapproachwouldenableasearchertorelyonthatnameand

eliminatetheneedformultiplesearchesusingvariantsofthedebtor’sname,all

leadingtocommercialcertainty.”

Thecourtconcludedthat,becauseHastings’statementcontainedsuperfluous

informationintheparticularfieldofthestatement,itdidnot“sufficiently

providethenameofthedebtor.”Ifthedebtorisaregisteredorganization,then

afinancingstatementsufficiently“providesthenameofthedebtor”onlyifit

providestheexactlegalnameofthedebtorindicatedonthepublicrecordof

thedebtor’sjurisdictionoforganization-nothingmoreandnothingless.The

courtstatedthat“itsimplycannotbetherulethatafinancingstatementshould

bedeemedeffectiveaslongaswordsconstitutingthelegalnameofthedebtor

RISK LOSING YOUR FIRST PRIORITY LIEN IF YOU PROVIDE SUPERFLUOUS INFORMATION IN THE UCC FINANCING STATEMENT

J.CoryFalgowski Associate Wilmington

wassimply“takinghardstepstoprotectitselfduringyearswhentherealestate

marketgenerallywasincollapse.”


Overreachingandresultinglenderliabilityarerealconcernsofanylender,and

carefulconsiderationshouldbegiventoallactionstakenduringthelender’s

relationshipwithaborrower;inparticular,whentheloanentersworkout.

Thiscasegiveslenderssomeassurancethatliabilitywon’tbeimposedona

lenderfortakingstepsthatarecommonplaceinthecurrenteconomicclimate.

Nevertheless,thelinebetweenprotectinginterestsandoverreachingisonethat

mustbecarefullytreaded.


DerekJ.Baker Partner Philadelphia

Risk Losing Your First Priority Lien if You Provide Superfluous Information in the UCC Financing Statement—continued from page 17

CONT INUEDONPAGE19

InthiseditionoftheLandlord’sCorner,we

reviewvariouscasesthataddressthe(i)rightsof

landlordstorecovertheirpropertypost-rejection,

(ii)whetherpaymentspursuanttoatermination

ofleaseagreementconstitutepreferential

transfersand(iii)whetheraleasecouldbe

retroactivelyrejectedintheabsenceofaformal

motiontoreject.

InIn re Deli Den, LLC,425B.R.725(Bankr.S.D.

Fla.2010),thecourtconstruedhowquickly

andthroughwhichjudicialprocessthedebtor

wasrequiredtoreturnpropertytothelandlord

afterrejectionoftheleaseconsistentwiththeprovisionsofsection365(d)(4)

oftheBankruptcyCode.Section365(d)(4)providesprotectionsforcommercial

landlords,requiringatrusteeordebtor-in-possessionto“immediatelysurrender”

thepremisesuponrejectionofthelease.Ifthetrusteeordebtordoesnotaccept

orrejectaleasewithin120daysofthebankruptcypetitionfiling,theleasewillbe

deemedtoberejected.InDeli Den,thedebtorhadfailedtoactwithin120days;

thus,theleasewasdeemedrejected.Ratherthansurrenderingthepremises,

however,thedebtorarguedthatthelandlordwasrequiredtoseekanunlawful

detainer/recoveryinstatecourt,providedthatthelandlordultimatelyobtained

relieffromtheautomaticstaytodoso.Inotherwords,thedebtorassertedthat,

despiteexercisingthebenefitsofabankruptcycaseandrejectingthelease,

thedebtorcouldremaininpossessionuntilsuchtimeasthelandlordotherwise

soughttoexerciseitsstatelawrightstorecoverthepremises.

Inresponse,thelandlordarguedthattheplainlanguageofsection365(d)(4)

oftheBankruptcyCoderequiredthedebtorto“immediatelysurrender”the

propertytothelandlorduponrejectionofthelease.Thecourtsidedwiththe

landlord,notingthatthelanguageoftheBankruptcyCodeclearlyprovidesforthe

“immediatesurrender”oftheproperty,andthelandlordshouldnotberequiredto

resorttostatecourtstorecoveritsproperty.Moreover,bankruptcycourtsshould

exercisetheirbroadequitypowersinfavorofgrantingasurrenderordertoa

lessorwho,underthetermsoftheBankruptcyCode,clearlydeservesone.

Thiscasefurthersupportslandlordsintheirattempttoimmediatelyrecover

propertyuponitsrejectionbyadebtorinabankruptcycase.

InMcHale v. Publix Supermarkets, Inc. (In re Luxury Ventures LLC), 425B.R.680

(Bankr.M.D.Fla.2010),theBankruptcyCourtconsideredwhetherpayments

madepursuanttoaterminationagreementcouldotherwisebeexceptedfromthe

preferencestatute.Mostlandlordsareawarethatpaymentsmadebyadebtor

inthe90dayspriortothebankruptcycasecanberecoupedtothedebtor’s

estatetotheextentthatthosepaymentsaremadeonaccountofapre-existing

indebtedness.Whilethestatuteimposesthe“strict”liabilitytoreturncertain

pre-petitionpayments,thosepaymentscanbedefendedtotheextentthatthe

paymentsweremade“intheordinarycourseofbusiness.”

Inthiscase,thedebtorandthelandlordenteredintoapre-petitionagreement

pursuanttowhichthelandlordagreedtoallowthedebtortoterminatethelease,

providedthatthedebtorpaytheupcomingmonthlyrentalpaymentasandwhen

due.Inthesucceedingmonth,thedebtormadethepaymentasrequiredunder

theleaseandtheterminationagreementand,attheconclusionofthemonth,

tenderedthekeystothelandlord,therebyterminatingtheleaseinaccordance

withtheterminationagreement.

Afterthebankruptcyfiling,arepresentativeofthedebtor’sestatesoughtto

recoverthefinalpayment,assertingthatthepaymentwasapreference.The

landlordarguedthatthepaymentwasmadeintheordinarycourseofbusiness

andthereforewassubjecttothatdefenseasamatteroflaw.Afterhearing

arguments,thecourtconcludedthatthepaymentwasmadepursuanttothe

termsoftheleaseandtheterminationagreement.Asaresult,thepaymentwas

onordinarybusinesstermsinaccordancewithordinarybusinesspractices.

Therefore,thepaymentwasimmunefromanyrecoveryasastatutorypreference.

LANDLORD’S CORNER

appearedsomewhereinthestringofwordslistedasthedebtor’sname,and

regardlessofwhateveradditionalwordsaretackedontotheend.”

Havingdeterminedthatthedebtor’snameassetforthinthefinancingstatement

wasinsufficient,thecourtthenconsideredwhethertheerrorrenderedthefiling

“seriouslymisleading.”Hadthesubsequentlenders’UCCsearchesdisclosed

Hastings’erroneousfinancingstatement,theerrorwouldnothavebeenseriously

misleadingunderRevisedArticle9’ssafeharborprovision.However,sincethose

standardsearchesdidnotrevealHastings’lien,thesafeharbordidnotapply.

Thecourtconcludedthatthefinancingstatementwas,therefore,seriously

misleading,sothatHastingslostitsprioritylien,andthejuniorlienswere

elevatedinpriority.


Inanapparentattempttoprovidehelpfulinformationinitsfinancingstatement,

thefirstprioritysecuredlenderhereendedupatthebackofthelineofsecured

creditors.Thiscaseteachesaclearlesson-itisimperativethatacreditorseek

legaladviceastothespecificfilingrequirements,includingthesearchlogic,ina

particularjurisdiction,inordertoprotectthecreditor’ssecurityinterestandpriority.


Landlord’s Corner—continued from page 18

Thiscaseisunique,inthesensethattheterminationagreementrequiredthe

debtortocontinuetomakeleasepaymentspursuanttothetermsoftheexisting

leaseagreementforasetperiodoftime.Therefore,intheeventthatlandlords

arenegotiatingwithtenantsaboutpossibleterminations–andseektoinsert

“preferenceprotections”insuchagreements–thebettercoursemaybetolink

theterminationtotheongoingcompliancewithleasetermsforaspecificperiod

oftime,ensuringthecontinuityoftheordinarybusinesspracticesandthereby

possiblyinsulatingthepaymentsfromasubsequentpreferenceattack.

InTenucp Property, LLC v. Riley (In re GCP CT Sch. Acquis., LLC),No.MB09-065,

2010WL2044871(Bankr.1stCir.May24,2010),thecourtreviewedtheauthority

ofabankruptcycourttopermittherejectionofaleaseretroactivelyandits

effectontheclaimofalandlordforpost-petition,pre-rejectionrent.Inthiscase,

thedebtor,whichoperatedanumberofbroadcastingschools,commencedthe

bankruptcycaseafteraliquidityeventclosetotheendofasemester.Immediately

uponthechapter7filing,thechapter7trusteesoughtauthoritytooperatethe

businessonaninterimbasis.Asaresultofthe“teachout,”thestudentsofthe

schoolswouldbepermittedtofinishandearntheircompletioncertificates,andthe

trusteewouldbeabletomarketthebusinessforsale.Aspartofthemotionseeking

authoritytooperatethebusinessonaninterimbasis,thetrusteeadvisedthecourt

thatthe“teachout”wouldbeforaveryshortperiodoftime.

Shortlythereafter,thetrusteewasabletoidentifyapotentialbuyerforthe

majorityofthebusiness;however,thebuyerwasnotinterestedinassuming

certainleaseholdinterests.Thetrusteefiledamotionseekingauthorizationto

concludethesaleand,aspartofthatmotion,enumeratedthoseleasesthatthe

buyerdidnotwant.Thereafter,thetrusteefiledamotiontoextendtheperiod

toassumeorrejectunexpirednon-residentialrealpropertyleasesandnoted

thatanyleasenototherwiseassumedasaresultofthesalewouldbedeemed

rejectedJune4,2009.

Thesaleclosedandimmediatelyaftertheclosing,thetrusteesentanemail

tothelandlord(TenucpProperty,LLC)advisingthatalloftheassetsatthe

landlord’slocationhadbeenremovedasofMay23,2009.Thetrusteeprovided

anaccountingofthetrustee’scalculationoftheaggregateobligationsdue.

Thereafter,thetrusteesentalettertothelandlordenclosingapaymentforthe

occupationofthepremisesthroughMay23,2009.Thepaymentwasalleged

tobe“inaccordandsatisfactionofalladministrativerentandexpenses4/4-

5/23/09.”ThelandlordreceivedandthereaftercashedthecheckJune9,2009.

ThelandlordsubsequentlyfiledamotionseekingpaymentofrentthroughJuly

13,2009(thestatutorydatetheleasewouldbedeemedrejected).

Thecourtnotedthatnon-residentialrealpropertyleasesreceivespecial

treatmentundertheBankruptcyCode.Atrusteeisobligatedtoassumeorreject

aleasewithinaspecifiedperiodoftime.Also,thetrusteeisrequiredtotimely

performalltheobligationsunderthatlease–includingtheobligationtopayrent

atthecontractrate–untiltheleaseisrejected.Thecourtnotedthatthemain

issueconcerned“theeffectivedateofrejection,”sincethatdatedetermines

whentheobligationtopayrentceasespursuanttotheBankruptcyCode.In

reviewingothercaseholdings,thecourtnotedthatbankruptcycourtapprovalis

aconditionprecedenttotherejectionofanynon-residentialrealpropertylease.

Whilenotingthatrejectionmaynottakeeffectuntiljudicialapprovalissecured,

theapprovingcourtnonethelesshastheequitablepowertoorderthatthe

rejectionoperateretroactively.

Thelandlordfirstarguedthatnorejectionwasobtainedbecausenoformal

motionseekingrejectionhadbeenfiled.Thecourtheldthataformalmotion

torejecttheleasewasnotnecessary.Rather,theBankruptcyCoderequires

onlypriornoticeofthetrustee’sintenttoreject.Thecourtreviewedtheseries

ofmotionsfiledbythetrustee–includingthemotiontoextendtheperiodto

assumeorrejectleases–whichthecourtheldputthelandlordonnoticethatthe

trusteeintendedtoreject.Further,thecourtconcludedthatoncethelandlordhad

noticeofthetrustee’sintenttosellthebusiness,thelandlordwasonnoticethat

itsleasemightbeaffected.Thecourtconcludedthatwhilenoformalrejection

motionwasfiled,alltheothermotionsfiledinthecase–allofwhichwereserved

onthelandlord–hadtheeffectofprovidingthelandlordwithsufficientnoticeof

thetrustee’sintenttorejectthelandlord’slease.

Thelandlordfurthercontendedthatevenifappropriatenoticeofrejectionwas

found,theBankruptcyCourtcouldonlyallow“retroactive”rejectiontotakeeffect

asofthemotion“filingdate”orthe“orderdate.”Thecourtconcludedthatall

priorprecedentestablishesthatbankruptcycourtshavetheequitablepower

toretroactivelydeterminetheappropriateeffectivedateofrejection.Thecourt

alsoconcludedthattherewasnolegalbasistolimitthedatethatcouldbethe

appropriateeffectivedate.Rather,theBankruptcyCourtcouldtakeintoaccount

allthefactsandcircumstancestodeterminetheappropriatedate,oncethecourt

hadconcludedthatappropriatenoticewasgivenofthelease’srejection.The

courtconcluded,however,thattheBankruptcyCourtdiderrbyselectingthedate

itchosefortheeffectiverejectiondate,andremandedthecaseto“re-determine”

theappropriateleaserejectiondate.

Thiscasemakesclearthatlandlordsmustremainvigilantintheirreviewoftheir

tenant’sbankruptcydockets.Landlordsmustmonitoractionsintheirtenant’s

bankruptcycasetodeterminewhethertomakeaninquiryastoanypossible

impactonthelandlord’slease.Whilethiscaseplacesaburdenonthelandlords

toengageinmorevigorousreviewandinquiry,italsomakesclearthatthecourt

maynotarbitrarilydeterminewhenarejectionisdeemedeffective.Rather,the

courtmusttakeintoaccountallthefactsnecessarytoensurethattherehasbeen

propernoticeoftherejectionpriortobeingeffective,andthattherejectionwill

notbeeffectiveuntiltheestaterepresentativehasappropriatelyevidencedintent

torelinquishanyrightsinconnectionwiththeproperty,andhascompliedwithits

bankruptcyobligationsofsurrender.


COUNSEL’S CORNER: NEWS FROM REED SMITH

Presentations

Stephen BobospokeMay26aspartofapanelpresentationentitled,“LeveragedBuyoutTransactionsUnderHeightenedScrutinyinBankruptcy:WithstandingCreditorChallengestoFraudulentTransferClaims.”

StephenalsospokeJuly28aspartofapanelpresentationentitled,“MezzanineLoanForeclosureinRealEstateTransactions:ProtectingBorrowers’andLenders’InterestsUnderUCCArticle9.”Bothwereon-linepresentations.

Mark Silverschotz, Mike VendittoandAndrea Pincusarescheduledtopresentthe“LehmanUpdate”inSantaFe,N.M.,Sept.15,attheannualconferenceoftheNationalAssociationofAttorneysGeneral/StatesAssociationofBankruptcyAttorneys.Thisconferenceisattendedbyseveralhundredgovernmentalbankruptcyattorneysfromvirtuallyall50states.

CommercialRestructuring&BankruptcyAlertispublishedbyReedSmithtokeepothersinformedofdevelopmentsinthelaw.Itisnotintendedtoprovidelegaladvicetobeusedinaspecificfactsituation;thecontentsareforinformationalpurposesonly.

“ReedSmith”referstoReedSmithLLPandrelatedentities.©ReedSmithLLP2010.

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Documents

CR&B Alert · instruments, deposit accounts, and other cash equivalents ... turned out to be covertly created bank accounts ... the deceptively simple theory that the post