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
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COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 3
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
ChristopherO.Rivas Associate LosAngeles
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COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 4
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….”
ChristopherO.Rivas Associate LosAngeles
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.
PRACTICAL CONSIDERATIONS
Althoughcompaniesconsideringfilingforbankruptcyoftenthinkthatsection
365’srejectionprovisionsareapanacea,theyshouldanalyze—withan
experiencedbankruptcyattorney’shelp—whetherkeycontractscanactuallybe
rejectedbeforefilingforbankruptcy.
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COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 5
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
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COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 6
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.
PRACTICAL CONSIDERATIONS
Ifacompanyfindsitselfinafinancialpositionwhereitcanwaittounilaterally
terminatebenefitsafterconfirmation(aftersection1114isnolongerabar),the
companyshouldbecarefultonotmodifyretireebenefitsduringthependency
ofbankruptcyproceedingsinsuchawaythatitlosesthecontractualrightto
terminatepost-bankruptcyundersection1129(a)(13).
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COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 7
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.
PRACTICAL CONSIDERATIONS
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
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COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 8
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.
PRACTICAL CONSIDERATIONS
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
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 9
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
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 10
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.)
PRACTICAL CONSIDERATIONS
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
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 11
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.
PRACTICAL CONSIDERATIONS
Byholdingthatknowingandfraudulentmisstatementsofcorporatefinancial
informationbyacorporation’sofficersdonot,asamatteroflaw,provide
abenefittothecorporation,thePennsylvaniaSupremeCourthascurtailed
thecircumstancesinwhichthosefraudulentmisstatementscanbeimputed
tothecorporation.Thisholdingtherebyincreasesthelikelihoodthatthe
corporationitself,oranotherpartystandinginitsstead,canrecoverdamages
fromaccountantsorotherprofessionalsforthedamagesresultingfromthose
misstatedfinancialrecords.
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 12
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’
AnnE.Pille Associate Chicago
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 13
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.
PRACTICAL CONSIDERATIONS
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
AnnE.Pille Associate Chicago
PRACTICAL CONSIDERATIONS
Generallyspeaking,courtsareaversetoawardingsanctions,seekingtoavoid
anychillingeffectsanctionsmayhaveonvigorouslegalrepresentation.Where,
however,conductissoegregiousandabusiveofthelegalprocess,courtsare
willingtoimposesanctions.Parties,andtheircounsel,mustbeawarethatacourt
hasseveralweaponsatitsdisposaltoawardsanctions,astheBankruptcyCourtin
thiscaseimposedsanctionsunderanon-bankruptcyprovisionoffederallaw.
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 14
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
AnnE.Pille Associate Chicago
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 15
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.
PRACTICAL CONSIDERATIONS
Apartythathasacloserelationshipwithadebtorcompanymaybedeemedto
bean“insider,”regardlessofthenameortitlethepartyhas.Thiscaseillustrates
thatacreditordoesnothavetobea“director,”oranothertermsetforthinthe
BankruptcyCode,inordertobean“insider.”Courtswillsubstantivelyexamine
relationships,statelaws,andotherrelevantfacts,inordertodrawinferencesand
reachconclusions,especiallywheretheremaybesomegapintheBankruptcy
Code.Acreditororotherpartydeemedtobean“insider”standstoloseany
transfersmadetoitbyadebtorwithinoneyearpriortobankruptcy.
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 16
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
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 17
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.”
PRACTICAL CONSIDERATIONS
Overreachingandresultinglenderliabilityarerealconcernsofanylender,and
carefulconsiderationshouldbegiventoallactionstakenduringthelender’s
relationshipwithaborrower;inparticular,whentheloanentersworkout.
Thiscasegiveslenderssomeassurancethatliabilitywon’tbeimposedona
lenderfortakingstepsthatarecommonplaceinthecurrenteconomicclimate.
Nevertheless,thelinebetweenprotectinginterestsandoverreachingisonethat
mustbecarefullytreaded.
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 18
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.
PRACTICAL CONSIDERATIONS
Inanapparentattempttoprovidehelpfulinformationinitsfinancingstatement,
thefirstprioritysecuredlenderhereendedupatthebackofthelineofsecured
creditors.Thiscaseteachesaclearlesson-itisimperativethatacreditorseek
legaladviceastothespecificfilingrequirements,includingthesearchlogic,ina
particularjurisdiction,inordertoprotectthecreditor’ssecurityinterestandpriority.
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 19
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.
COMMERCIAL RESTRUCTURING & BANKRUPTCY NEWSLETTER –SEPTEMBER2010 20
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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