Recent Developments in Bankruptcy Law, October 2015
(Covering cases reported through 536 B.R. 350 and 794 F.3d 1326)
RICHARD LEVIN Partner +1 (212) 891-1601 [email protected]
© Copyright 2015 Jenner & Block LLP. 353 North Clark Street Chicago, IL 60654-3456. Jenner & Block is an Illinois Limited Liability Partnership including professional corporations. Attorney Advertising. Prior results do not guarantee a similar outcome. Recent Developments in Bankruptcy Law, October 2015
TABLE OF CONTENTS
1. AUTOMATIC STAY ______3 10.3 Exemptions ______10 1.1 Covered Activities ______3 10.4 Reaffirmations and Redemption ______10 1.2 Effect of Stay ______4 1.3 Remedies ______5 11. JURISDICTION AND POWERS OF THE COURT ______11 2. AVOIDING POWERS ______5 11.1 Jurisdiction ______11 2.1 Fraudulent Transfers ______5 11.2 Sanctions______13 2.2 Preferences ______5 11.3 Appeals ______13 2.3 Postpetition Transfers ______5 11.4 Sovereign Immunity ______16 2.4 Setoff ______5 2.5 Statutory Liens ______5 12. PROPERTY OF THE ESTATE17 2.6 Strong-arm Power ______5 12.1 Property of the Estate ______17 2.7 Recovery ______6 12.2 Turnover ______18 12.3 Sales ______18 3. BANKRUPTCY RULES ______6 13. TRUSTEES, COMMITTEES, 4. CASE COMMENCEMENT AND AND PROFESSIONALS ______19 ELIGIBILITY ______6 13.1 Trustees ______19 4.1 Eligibility ______6 13.2 Attorneys ______19 4.2 Involuntary Petitions ______7 13.3 Committees ______19 4.3 Dismissal ______7 13.4 Other Professionals ______19 13.5 United States Trustee ______19 5. CHAPTER 11 ______7 5.1 Officers and Adminisration ______7 14. TAXES ______20 5.2 Exclusivity ______8 5.3 Classification ______8 15. CHAPTER 15—CROSS- 5.4 Disclosure Statement and Voting ______8 BORDER INSOLVENCIES ______20 5.5 Confirmation, Absolute Priority ______8 6. CLAIMS AND PRIORITIES ___ 9 6.1 Claims ______9 6.2 Priorities ______9
7. CRIMES ______10
8. DISCHARGE ______10 8.1 General ______10 8.2 Third-Party Releases ______10 8.3 Environmental and Mass Tort Liabilities 10
9. EXECUTORY CONTRACTS _ 10
10. INDIVIDUAL DEBTORS ____ 10 10.1 Chapter 13 ______10 10.2 Dischargeability ______10
Recent Developments in Bankruptcy Law, October 2015
1. AUTOMATIC STAY
1.1 Covered Activities 1.1.a Seventh Circuit adopts “conduct” test to determine when a claim arises and stay applies. The state adopted a law in April 2011 that imposed on all operating hospitals a fee to create a fund from which to reimburse the hospitals for the treatment of Medicaid patients. The fee period was from July 2011 to June 2013, payable in two installments, and the fee was based on a hospital’s cost reports from May 2010 to April 2011. The state did not receive required federal approval to collect the fee until May 2012 and immediately began assessing the fee. It sent the debtor hospital a bill for the 2012 fiscal year on May 29, 2012 and began withholding Medicaid reimbursements from the hospital as a setoff against the fee. The hospital filed its chapter 11 petition on June 19, 2012. The state continued withholding reimbursements. The automatic stay prohibits any attempt to collect or offset a claim that arises prepetition. A definition of when a claim arises that contemplates the earliest possible time best serves the Code’s underlying policy goal of giving a debtor complete relief. The court therefore adopts the conduct test, holding that a claim arises when the conduct giving rise to the claim occurs. Here, the conduct was the state’s enactment and imposition of the fee well before the petition date, and the fee amount was based on the debtor’s prepetition cost report. Therefore, the fee claim arose prepetition, and the state’s offset of postpetition reimbursement amounts violated the automatic stay. The court does not address whether a prepetition relationship between the debtor and the claimant is also required, because such a relationship existed here. St. Catherine Hosp. v. Ind. Family and Soc. Servs. Admin., ___ F.3d ___, 2015 U.S. App. LEXIS 15212 (7th Cir. Aug. 28, 2015).
1.1.b Seizure under the Mandatory Victims Restitution Act is not subject to the automatic stay. After confirmation of the debtor’s chapter plan, the government seized the debtor’s pension and retirement benefits under the Mandatory Victims Restitution Act (MVRA) on account of a prepetition criminal restitution award against the debtor. The automatic stay prohibits any act to collect or recover on a prepetition claim. The MVRA, enacted in 1996, permits the government, “[n]otwithstanding any other Federal law,” to enforce a judgment imposing a criminal fine “against all property or rights to property of the person fined.” 18 U.S.C. § 3613(a). The MVRA’s later enactment and its broad “notwithstanding” clause supersedes any other federal enactment, including the automatic stay. Therefore, the seizure did not violate the automatic stay. Partida v. U.S. (In re Partida), 531 B.R. 811 (9th Cir. B.A.P. 2015).
1.1.c Automatic stay applies to Jewish religious court proceeding. The debtor in possession, a synagogue, commenced an adversary proceeding in the bankruptcy court against another synagogue for fraud, breach of fiduciary duty, and looting of the debtor’s assets. The other synagogue and its principals invoked a beis din, a Jewish rabbinical court, against the debtor’s principals, though not against the debtor itself, to enjoin the prosecution of the adversary proceeding. The beis din issued both a “summons” to the debtor’s principals and an “injunction” ordering them to discontinue pursuing the adversary proceeding and threatened them with a form of shunning or excommunication from the Orthodox Jewish community if they did not comply. The automatic stay prohibits “the commencement or continuation of a judicial, administrative or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case” and “any act … to exercise control over property of the estate.” The automatic stay protects the debtor’s principals when the challenged action attempts to control the principals’ conduct of the bankruptcy case. Here, the beis din’s purpose was to prevent the DIP from pursuing the adversary proceeding, which sought to collect property of the estate, and the other synagogue’s invocation of the beis din was therefore an act to exercise control over property of the estate. The First Amendment prohibits the government from interfering with the free exercise of religion. However, the Free Exercise clause does not prohibit government action or law that is neutral on its face and as applied and generally applicable in practice. The automatic stay meets those requirements, especially where, as here, the dispute is secular, does
Recent Developments in Bankruptcy Law, October 2015
not involve religious observance, and promotes only the Congressional policy to prohibit self-help and to funnel all covered activity through the bankruptcy court. Therefore, the court enjoins further prosecution of the beis din and requires those who invoked it to request it to terminate its proceedings and revoke the summons, the injunction, and the threat of shunning. In re Congregation Birchos Yosef, 535 B.R. 629 (Bankr. S.D.N.Y. 2015).
1.1.d Automatic stay does not protect nondebtors alleged to be the debtor’s alter ego. Before the debtor’s bankruptcy, a union and an ERISA plan administrator sued the debtor and three affiliates in the district court for unpaid plan contributions, alleging that all four defendants were each other’s alter egos. After the debtor filed its bankruptcy case, the other three defendants asked the district court to stay the litigation based on the automatic stay. The automatic stay protects only the debtor and its estate. An alter ego claim, even if successful, does not make the other defendants debtors; it only renders them liable for the debtor’s debts. It therefore does not enlarge the scope of the stay’s protection to encompass the other defendants. However, if necessary to the debtor’s, the estate’s, or creditors’ protection, the bankruptcy court may issue an injunction to protect the affiliates. Pavers & Road Builders District Council Welfare Fund v. Core Contracting of N.Y., LLC, 536 B.R. 48 (E.D.N.Y. 2015).
1.1.e Court denies motion to enforce automatic stay against union’s boycott promotion activities. The debtor’s contract with its union expired a few days after the petition date. After the debtor in possession attempted unsuccessfully to negotiate a new contract, it rejected the contract. Before rejection, the union contacted the debtor’s customers to encourage a boycott. Claiming such action violated the automatic stay, the DIP moved to enforce the stay. Section 362(a)(3) prohibits any act to exercise control over property of the estate. A debtor’s customer relationships are property of the estate. However, the Norris-LaGuardia Act deprives federal courts of jurisdiction to enjoin certain union activities, including promoting a boycott. Although the automatic stay arises automatically and does not depend on a federal court order, applying the stay to protected union activities would require court involvement, through stay relief or enforcement motions, contrary to Congress’s intent that federal courts not interfere in unions’ exercise of economic leverage in labor disputes. To harmonize the two statutes, courts should consider the nexus between the conduct at issue and the estate’s property interests, the conduct’s impact on the estate, and the competing legal interests of the non-debtor party. Here, because of Congress’s protection of union activities under the Norris-LaGuardia Act, the third factor weighs heavily against application of the stay to prohibit the union’s exercise of economic leverage in its negotiations. The DIP may not use the automatic stay to shift bargaining power. The court denies the motion to enforce the stay against the union. In re Trump Entertainment Resorts, Inc., 534 B.R. 93 (Bankr. D. Del. 2015).
1.1.f Termination payment assignee under terminated swap is not a swap participant. The debtor entered into a loan agreement and an interest rate swap with the bank and granted the bank a security interest in its assets to secure its obligations under both. Upon early swap termination for the debtor’s default, the bank determines the amount payable, which, if payable by the debtor, is secured by the collateral. The swap provides that neither the swap nor any interest or obligation under the swap may be transferred without the other party’s consent, but a party may transfer its interest in a termination payment. The debtor defaulted under the swap and the loan agreement, and the bank fixed a termination payment amount, which it added to the loan amount. It did not seek enforcement against the collateral but instead sold its position. Later, the debtor filed a chapter 11 petition. The automatic stay prohibits any attempt to collect a prepetition debt but excepts from the stay a swap participant’s exercise of a contractual right under a security agreement to offset or net out any termination payment amount. By the time the bank assigned its termination payment right, the swap had been terminated, and the swap was not assignable without consent. Therefore, the bank assigned only the right to collect, not the swap. As a result, the buyer was not a swap participant that was protected by the automatic stay exception. A62 Equities LLC v. Chohan (In re Chohan), 532 B.R. 130 (C.D. Cal. 2015).
1.2 Effect of Stay
Recent Developments in Bankruptcy Law, October 2015
1.3 Remedies
2. AVOIDING POWERS
2.1 Fraudulent Transfers 2.1.a Section 546(e) may protect loan payments that are deposited into a securitization trust. Another corporation that the debtor’s shareholders owned borrowed under a promissory note that provided it was to be transferred to a commercial mortgage backed securitization trust under a pooling and servicing agreement (PSA). The trust issued notes to fund the affiliate’s loan. The debtor made payments on the note to a bank that serviced the securitization trust under the PSA. The trustee sued to avoid and recover the payments as fraudulent transfers. Section 546(e) prohibits the trustee from avoiding “a transfer made by or to … a financial institution … in connection with a securities contract.” The provision protects a transfer to a financial institution, whether or not the institution holds a beneficial interest in the payments. A securities contract is a contract for the purchase or sale of a security. The PSA provided for the sale of the trust’s notes. A transfer is made in connection with a securities contract if the transfer is related to the securities contract, whether or not the transfer is made for the purchase or sale of the securities. Therefore, the loan payments were transfers to a financial institution in connection with a securities contract and were protected from avoidance. The bankruptcy court recommends that the district court dismiss the action. Krol v. Key Bank N.A. (In re MCK Millennium Centre Parking, LLC), 532 B.R. 716 (Bankr. N.D. Ill. 2015).
2.2 Preferences 2.2.a DePrizio waiver insulates insider guarantor from preference liability. The debtor’s principal guaranteed the debtor’s secured loan. In the guarantee, the principal waived all indemnification rights against the debtor that might arise from his payment on the guarantee. When the debtor encountered financial trouble, it sold its assets and turned over the proceeds to the lender. The principal paid the balance under his guarantee. The debtor filed bankruptcy more than 90 days but less than one year later. The trustee sued the principal to recover as a preference the amount the debtor paid the lender from the sale proceeds. Preference liability requires a transfer to or for the benefit of a creditor. Under In re DePrizio, 874 F.2d 1186 (7th Cir. 1989), the debtor’s payment of an insider-guaranteed debt within one year before bankruptcy is a preference to the insider because the insider ordinarily has a reimbursement claim against the debtor on account of the payment, making the insider a creditor. If the insider waives any reimbursement claim against the debtor, then the insider would not be a creditor and is not liable for a preference. Some courts have refused to enforce such a “DePrizio waiver” on the ground that it does not effectively waive the claim, because instead of paying on the guarantee, the insider can purchase the full claim from the lender, effectively satisfying the guarantee obligation and preserving a claim against the debtor. In the first court of appeals decision on the enforceability of a DePrizio waiver, the court upholds the waiver’s effectiveness in a 2-1 decision, relying on what actually happened in this case, rather than on the policy question based on what could happen. Stahl v. Simon (In re Adamson Apparel, Inc.), 785 F.3d 1285 (9th Cir. 2015).
2.3 Postpetition Transfers 2.4 Setoff 2.5 Statutory Liens 2.6 Strong-arm Power 2.6.a Article 9 does not apply to a claim payment under an insurance policy. The lender took a security interest in “all accounts and other rights to payment (including payment intangibles)” and timely filed a UCC-1 financing statement in the proper filing office. The debtor suffered a catastrophic loss that resulted in business interruption and its chapter 11 filing. The trustee asserted a claim against the debtor’s business interruption insurance carrier, which he settled.
Recent Developments in Bankruptcy Law, October 2015
The lender asserted a claim to the proceeds. U.C.C. Article 9 applies to any transaction, “regardless of its form, that creates a security interest in personal property” but excludes “the transfer of an interest in or an assignment of a claim under a policy of insurance.” The exclusion applies broadly to any rights under an insurance policy (with specific statutory exceptions). The lender’s various attempts to distinguish the claim payment here from Article 9’s exclusion do not succeed. Therefore, the UCC-1 filing does not perfect the lender’s security interest in the claim payment. Applicable nonbankruptcy law, here Maine’s, requires something more than just the security agreement to perfect the lender’s interest against the trustee and judicial lien creditors. The lender did nothing other than file the UCC-1. Therefore, its security interest is not perfected, and the trustee is entitled to the claim payment. Wheeling & L.E. Ry. Co. v. Keach (In re Montreal, Me. & Atl. Ry., Ltd.), 799 F.3d 1 (1st Cir. 2015).
2.6.b Trustee avoids unperfected interest of buyer of debtor’s accounts. The debtor sold specific accounts to a buyer. The buyer did not perfect its interest in the accounts by filing a UCC-1 financing statement. The buyer collected some but not all of the accounts before the debtor’s bankruptcy. Section 544(a)(1) grants the trustee the rights of a hypothetical judicial lien creditor as of the commencement of the case. Under U.C.C. section 9-318(1), a debtor that has sold an account does not retain any legal or equitable interest in the account. Section 9-318(2) provides that for purposes of determining creditors’ rights, the debtor is nevertheless deemed to have rights and title to the accounts (that is, treated the same as if the debtor had not sold the account, even though it had sold) while the buyer’s interest is unperfected. Section 9-317 subordinates the right and title of an unperfected purchaser of an account to the right and title of a judicial lien creditor. Therefore, the trustee may avoid the buyer’s interest in the accounts. However, a judicial lien creditor does not obtain any interest in assets that the debtor does not own as of the petition date. Therefore, the trustee does not have any rights under section 544(a)(1) to payments that the purchaser received on the accounts from the debtor’s customers before bankruptcy. Jubber v. Defendants re C.W. Mining Co. Coal Proceeds (In re C.W. Mining Co.), 530 B.R. 878 (Bankr. D. Utah 2015).
2.7 Recovery
3. BANKRUPTCY RULES
4. CASE COMMENCEMENT AND ELIGIBILITY
4.1 Eligibility 4.1.a Section 903(1) prohibition on state composition procedures bars Puerto Rico’s Recovery Act. Puerto Rico adopted a statute that permits a composition of some of its agencies’ debts. Bondholders challenged the statute on numerous constitutional grounds and on the ground that Congress prohibited such a statute in the Bankruptcy Code. Section 109(c) permits a “municipality” to be a debtor under chapter 9. Section 101 defines “municipality” as a political subdivision or agency or instrumentality of a State and “State” as including the District of Columbia and Puerto Rico “except for purpose of defining who may be a debtor under chapter 9,” so Puerto Rico municipalities are not eligible for chapter 9. Section 903(1) provides “a State law prescribing a method of composition of indebtedness of such [sic] municipality may not bind any creditor that does not consent.” This provision bars any state composition proceeding, preempting Puerto Rico’s composition statute. The court does not address any of the constitutional objections to the Puerto Rico statute. Franklin Calif. Tax-Free Trust v. Commonwealth of Puerto Rico, ___ F.3d ___, 2015 U.S. App. LEXIS 11594 (1st Cir. July 6, 2015).
4.1.b Court denies marijuana grower’s chapter 13 conversion motion and dismisses chapter 7 case. The debtor operated a marijuana growing business, which was legal in Colorado but illegal under federal law. He filed a chapter 7 case and then moved to convert the case to chapter 13. His income other than from the marijuana business was insufficient to fund a chapter 13 plan. A
Recent Developments in Bankruptcy Law, October 2015
debtor may convert a case to chapter 13 only if the debtor is eligible for chapter 13. Chapter 13 eligibility requires the debtor’s good faith in filing the case, based on the totality of the circumstances, which include the debtor’s ability to fund a plan, the burden a plan’s administration would place on the trustee, and the debtor’s motivation and sincerity in seeking chapter 13 relief. Here, the debtor would not be able to fund a plan except with the proceeds of his marijuana business. Using those proceeds would place an intolerable risk on the trustee by requiring him to violate federal law. Therefore, despite the debtor’s sincere motivation, he did not seek chapter 13 relief in good faith, and the court denies his motion to convert. Section 707(a) permits the court to dismiss a chapter 7 case for cause. The trustee’s administration of the estate’s assets would violate federal law, which suffices as cause for dismissal. Therefore, the court dismisses the chapter 7 case. Arenas v. U.S. Trustee (In re Arenas), 535 B.R. 845 (10th Cir. B.A.P. 2015).
4.1.c Court allows a chapter 13 debtor who operates a medical marijuana business the option of exiting the business and remaining in chapter 13. The chapter 13 debtor had social security income and income from a medical marijuana business that was legal and fully compliant under state law. The debtor was in financial distress and, but for the source of some of his income, was clearly eligible for chapter 13. The federal Controlled Substances Act makes the debtor’s marijuana business criminal and makes the assets used in the business contraband and subject to forfeiture. Federal officers, including the bankruptcy judge and the chapter 13 trustee, take an oath to uphold federal law. The debtor’s conduct of his business is subject to the court’s acquiescence. Section 959(b) of title 28 requires the trustee to comply with federal and state law. As a result, the trustee may not hold contraband or handle proceeds of criminal activity. Therefore, the court will not permit the debtor to remain in chapter 13 while he conducts his medical marijuana business. However, rather than dismissing the case, the court gives the debtor the choice of remaining in chapter 13 if he discontinues the business and destroys all contraband. In re Johnson, 532 B.R. 53 (Bankr. W.D. Mich. 2015).
4.2 Involuntary Petitions 4.3 Dismissal
5. CHAPTER 11
5.1 Officers and Administration 5.1.a Court denies injunction to protect debtor’s parent where claim against parent differs from claim against debtor. The debtor issued unsecured notes under an indenture, which the debtor’s parent guaranteed. The debtor and its parent entered into a series of transactions under which the debtor transferred substantial assets to the parent and attempted to void the guarantees. After the transactions, some of the unsecured noteholders sued the parent in federal district court for declaratory relief that the guarantees remained in effect and for damages. While the actions were pending, the debtor and some of its secured lenders entered into a restructuring support agreement to provide for a restructuring under chapter 11, and the debtor filed its chapter 11 case. In the chapter 11 case, the debtor in possession filed an adversary proceeding to enjoin the noteholders’ actions against the parent. Under section 105(a), if there is a likelihood of a successful reorganization, then in limited circumstances, the bankruptcy court may enjoin nonbankruptcy litigation that would defeat or impair the bankruptcy court’s jurisdiction. In the Seventh Circuit, the limited circumstances are those in which the estate’s claims and the third-party litigation seek recovery from the same assets in possession of the same defendants and both arise out of the same set of facts. In this case, the noteholders’ litigation seeks recovery from the same assets as the estate’s claims—the parent’s assets—and although the underlying transactions challenged in each claim are the same, the noteholders’ claims arise out of the breach of the indentures, while the estate’s claims arise under the bankruptcy avoiding powers. Therefore, the court denies the injunction. Caesars Entertainment Op. Co., Inc. v. BOKF, N.A. (In re Caesars Entertainment Op. Co., Inc.), 533 B.R. 714 (Bankr. N.D. Ill. 2015).
Recent Developments in Bankruptcy Law, October 2015
5.1.b Court denies enforcement to free and clear sale order to remedy due process violation. The debtor automobile manufacturer filed its chapter 11 case and sold substantially all its assets under section 363 40 days after the petition date, when its financing ran out and it would have had to cease operations if the sale had not closed. Over the objections of numerous contract and tort creditors, the sale order authorized a sale free and clear of all claims and interests and specifically protected the purchaser from successor liability claims. The purchaser expressly assumed some obligations, including product liability and warranty claims for cars manufactured before the chapter 11 case, but expressly excluded other tort liabilities resulting from issues with those cars. Five years after the sale, the purchaser revealed a previously concealed design defect in about 27 million prepetition cars, which had resulted in injury or death to numerous individuals and which were the subject to federal mandatory safety recall requirements and notices. At least 24 engineers, managers, and internal lawyers knew of the defect prepetition. The debtor in possession had not sent notice to the 27 million car owners but relied on broad publication notice. After the purchaser revealed the defect, several class actions were initiated against the purchaser on successor liability theories, among others. The purchaser moved to enforce the sale order provision prohibiting successor liability claims. Due process requires the best notice practical under the circumstances, reasonably calculated to apprise people of the pendency of an action and to permit them to assert objections. Publication may suffice for unknown creditors, but direct notice is required for creditors whose identity the debtor in possession knows or can ascertain with reasonable effort. If notice to a creditor is inadequate, the creditor must show prejudice from the lack of notice to obtain relief from the order. Because of the debtor’s internal knowledge of the defect, its danger, and the recall notice obligation, owners of the affected cars were known creditors; failure to give them notice violated their due process rights. However, they were not prejudiced, because they were well represented by numerous other objectors in similar positions, who made similar arguments against release of successor liability claims, which the court overruled. They should not be absolved of an adverse ruling that was fully litigated because of the due process violation. However, other creditors did not object to a sale order provision that appeared to protect the purchaser from claims for its own actions. A constitutional due process violation allows the court to revise or deny enforcement to a provision in an otherwise final order to remedy the violation, despite a non-severability clause in the sale order. The court therefore denies enforcement to the overly broad provision that protected the purchaser from claims for its own actions. In re Motors Liquidation Co., 529 B.R. 510 (Bankr. S.D.N.Y. 2015).
5.2 Exclusivity 5.3 Classification 5.4 Disclosure Statement and Voting 5.5 Confirmation, Absolute Priority 5.5.a Court approves Till-based cramdown interest rate. The debtor’s plan provided that if the first lien lenders accepted the plan, the lenders would be paid in cash in full, without any make-whole premium; if not, they would receive new seven-year notes in the full allowed claim amounts with an interest rate determined under the formula approach of Till v. SCS Credit Corp., 541 U.S. 465 (2004). The lenders did not accept the plan. Section 1129(b) permits a court to confirm a plan despite a secured claim class’s rejection if the plan is fair and equitable, which permits the plan to provide deferred cash payments on account of the claim with a value as of the plan’s effective date equal to the claim’s allowed amount. Deferred cash payments will have such a value if they include an interest component that compensates the creditor for the decrease in value caused by the delayed payments. In Till, to determine the appropriate interest rate for payments under a chapter 13 plan, the plurality opinion approved a “formula approach,” which uses a risk-free rate plus an addition to account for non-payment risk. The formula approach makes the creditor whole rather than ensuring that the payments have a present value equal to the allowed claim amount and prevents overcompensating the creditor by covering facts such as transaction costs and profits that are not relevant in the court-supervised cramdown context. It puts “the creditor in the same economic position that it would have been in had it received the value of its claim
Recent Developments in Bankruptcy Law, October 2015
immediately [rather than if] it arranged a ‘new’ loan.” In re Valenti, 105 F.3d 55, 63-64 (2d Cir. 1997). The same reasoning applies in a chapter 11 case. For a base rate, Till used the prime rate, which is appropriate for short term loans. The plan here uses the seven-year Treasury note rate as the base rate, which is appropriate because the new notes’ tenor was seven years. Therefore, the court confirms the plan. U.S. Bank N.A. v. Wilmington Savings Fund Soc., FSB (In re MPM Silicones, LLC), 531 B.R. 321 (S.D.N.Y. 2015).
5.5.b Cure and reinstatement requires payment of default rate interest. The debtor defaulted on a real estate mortgage. The lender asserted a claim for default rate interest and began foreclosure proceedings. Before foreclosure, the debtor filed a chapter 11 case. The debtor filed a plan under which it proposed to cure and reinstate the lender’s mortgage and loan but without paying default rate interest. Section 1123(a)(5)(G) permits a plan to cure a default. Section 1123(d) requires determination of the cure “in accordance with the underlying agreement and applicable nonbankruptcy law.” The agreement provided for default rate interest, and applicable law enforces such a provision. Therefore, the plan must pay default rate interest to effect the cure and reinstatement. JPMCC 2006-LDP7 Miami Beach Lodging, LLC v. Sagamore P’ners, Ltd. (In re Sagamore P’ners, Ltd.), 610 Fed. Appx. 922, modified at 2015 U.S. App. LEXIS 15382 (11th Cir. Aug. 31, 2015).
6. CLAIMS AND PRIORITIES
6.1 Claims 6.2 Priorities 6.2.a Involuntary gap rent claims are entitled to section 507(a)(3) priority. Creditors filed an involuntary petition against the debtor. The debtor consented to an order for relief and converted the case to chapter 11 two months later. The debtor did not pay rent under its real property leases during the involuntary gap. Section 502(f) requires allowance of claims incurred in the ordinary course of business during the gap. Section 507(a)(3) grants second priority to claims allowed under section 502(f). Rent accrues each month as the debtor occupies the premises, not once when the debtor signs the lease. Therefore, the landlords’ gap rent claims are entitled to priority. In re Howrey LLP, 534 B.R. 373 (Bankr. N.D. Cal. 2015).
6.2.b Section 510(b) subordinates shareholder claim for breach of fiduciary duty. The debtor entered into a plan support agreement with is principal noteholders, which provided for the filing of a chapter 11 petition and a sale of the debtor’s assets. The process failed to produce a going concern sale, so the debtor in possession liquidated its assets at an auction that the bankruptcy court approved. The liquidating plan provided no equity recovery. A shareholder filed a claim in the case alleging the debtor breached its fiduciary duty to him by agreeing to the bankruptcy and the sale, which he claimed were unnecessary and imprudent and harmed shareholders. Section 510(b) subordinates a claim for damages “arising from the purchase or sale” of a security of the debtor. The section’s policy is to prevent a wronged shareholder, who took equity risk, from elevating his interest to a claim. Accordingly, “arising from” should be given a broad reading and cover any claim that has a nexus or causal relationship to a purchase or sale. As applied here, the shareholder would not have his claim unless he had purchased the shares. Therefore, even though his claim arose long after his purchase, his claim arises from his purchase of the debtor’s securities and must be subordinated. The court does not address whether the claim for breach of fiduciary duty belongs to the corporation rather than to the shareholders. Murphy v. Madden, 532 B.R. 286 (E.D. Mich. 2015).
6.2.c Repo creates only a contractual, not a fiduciary, relationship. A bank entered into a securities repo transaction with a broker-dealer. The repo agreement gave the debtor broker- dealer full legal title to the securities and permitted the debtor to transfer the securities for any purpose. The agreement gave the bank the right to any principal or interest payments generated by the securities during the repo period. Before the bank repurchased the securities from the
Recent Developments in Bankruptcy Law, October 2015
debtor, the debtor became subject to a SIPA proceeding. SIPA requires the SIPA trustee to return customer property to a customer. SIPA defines “customer” as a person “who has a claim on account of securities received, acquired, or held by the debtor … from or for the securities accounts of such person for safekeeping, with a view to sale, to cover consummated sales, pursuant to purchases, as collateral, security, or for purposes of effecting transfer.” Thus, a customer is one who entrusts cash or securities to a broker-dealer in a fiduciary relationship. Delivery is not entrustment; the broker-dealer must hold the securities on the customer’s behalf and deal with the securities for the customer. Here, the relationship between the bank and the debtor was strictly contractual, not fiduciary. Despite the bank’s continuing economic interest in the securities, the debtor had full legal and equitable title and was not constrained in its use of the securities. Therefore, the bank was not a customer of the debtor with respect to the repo. CarVal UK Ltd. v. Giddens (In re Lehman Brothers, Inc.), 791 F.3d 277 (2d Cir. 2015).
7. CRIMES
8. DISCHARGE
8.1 General 8.2 Third-Party Releases 8.3 Environmental and Mass Tort Liabilities
9. EXECUTORY CONTRACTS
9.1.a Section 502(b)(6) lease termination damages cap does not apply to amounts that would have been owing had the lease not been terminated. The lessee breached the lease before bankruptcy. The landlord obtained a judgment in state court against the lessee and the guarantor for unpaid rent, pre- and post-judgment interest, and attorneys’ fees. The landlord obtained an additional judgment against the guarantor for recovery of a fraudulent transfer from the lessee. The guarantor filed a chapter 11 case. The landlord file a proof of claim for amounts owing on the lease judgment and on the fraudulent transfer judgment. Section 502(b)(6) caps a landlord’s claim “for damages resulting from the termination of a lease of real property.” To determine whether a claim arising from a prepetition lease termination is subject to the cap, the court should ask whether, assuming all other conditions remain constant, the landlord would have the same claim against the tenant if the lease had not been terminated. If so, then the claim does not arise from termination. Here, the landlord would have a claim for pre-termination rent and interest and for attorneys’ fees related to prepetition rent, even if the lease had not been terminated. The landlord would not have had a claim for post-termination future rent or for interest on that amount. The fraudulent transfer claim amount duplicates the breach of lease judgment amount and is separately disallowed for that reason. Lariat Cos., Inc. v. Wigley (In re Wigley), 533 B.R. 267 (8th Cir. B.A.P. 2015).
10. INDIVIDUAL DEBTORS
10.1 Chapter 13 10.2 Dischargeability 10.3 Exemptions 10.4 Reaffirmations and Redemption
Recent Developments in Bankruptcy Law, October 2015
11. JURISDICTION AND POWERS OF THE COURT
11.1 Jurisdiction 11.1.a District court may refer proceeding over which it has diversity jurisdiction to bankruptcy court. The chapter 7 trustee (a lawyer) advised a client that it might acquire property that the estate had forfeited. Later, the trustee learned that the estate had not forfeited the property and so advised the other client not to pursue its acquisition. The other client refused. The trustee sued the other client in bankruptcy court to prevent it from proceeding. The other client then sued the trustee for malpractice in federal court under diversity jurisdiction. The district court referred the matter to the bankruptcy judge to hear and determine under 28 U.S.C. § 157(a), which permits the district court to refer a proceeding that arises under title 11 or arises in or relates to a case under title 11. A bankruptcy judge may not constitutionally hear and determine a claim that is not a public rights claim. Although the line between a public rights and private rights claim is unclear, a claim that arises under nonbankruptcy law and is “not necessarily resolvable by a ruling on the creditor’s proof of claim in bankruptcy,” Stern, 131 S. Ct. at 2611, is not a public rights claim, and the bankruptcy court may not determine it without the parties’ consent, even if the claim is factually intertwined with proceedings in the bankruptcy case. The malpractice claim arises under state law and will not be resolved by a ruling on the plaintiff’s proof of claim, because the plaintiff is not a creditor and did not file a proof of claim. Therefore, the district court may not refer this action to the bankruptcy judge to hear and determine. Section 157(a) does not implicate the bankruptcy judge’s jurisdiction, only the allocation of responsibility between the district court and the bankruptcy judge, so it does not matter whether the proceeding is “related to” the bankruptcy case. Section 1334(b) does not provide the district court jurisdiction if the proceeding is not related to the bankruptcy case, but the district court has diversity jurisdiction in this proceeding and, having jurisdiction, may refer the proceeding to the bankruptcy judge for a report and recommendation. Loveridge v. Hall (In re Renewable Energy Dev. Corp.), 792 F.3d 1274 (10th Cir. 2015).
11.1.b Bankruptcy court may exercise in rem jurisdiction to hear adversary proceeding claiming automatic stay violation by foreign defendant. The debtor issued a credit default swap in connection with a complex synthetic collateralized debt obligation transaction. As part of the transaction, the swap counterparty issued notes and used the proceeds to post collateral with a collateral trustee to secure the counterparty’s obligation under the swap. Upon termination of the swap, the trustee was to liquidate and distribute the collateral to the debtor, if the counterparty’s default terminated the swap, or to the counterparty’s noteholders, if the debtor’s or its parent guarantor’s default terminated the swap. U.K. law governed all transaction documents, all transaction parties other than the debtor and its parent guarantor and the collateral were all located in England or Ireland, and all parties consented to U.K. jurisdiction to resolve disputes under the documents. The parent’s bankruptcy defaulted the swap. The counterparty gave a swap termination notice and required the trustee to liquidate and distribute the collateral to the counterparty, which it did. The debtor in possession sued to recover the collateral, claiming that its distribution to the counterparty violated the automatic stay. The counterparty moved to dismiss for lack of personal jurisdiction. Personal jurisdiction requires that the defendant have minimum contacts with the forum related to the transaction and that the exercise of jurisdiction be reasonable. Simply dealing with a citizen or resident of the forum is generally not sufficient minimum contacts, nor is taking action that will have an effect in the forum. In addition, the court may not base a personal jurisdiction finding on a stay violation, which is the ultimate finding the action seeks. The court therefore concludes that it does not have personal jurisdiction over the counterparty defendant. A bankruptcy court has exclusive jurisdiction of all property of the debtor and property of the estate, wherever located, as of the commencement of the case. A debtor’s security interest in collateral and its interest in an executory contract is property of the estate. Therefore, the court may exercise in rem jurisdiction to resolve the action. The court does not resolve what authority in rem jurisdiction gives it in the particular circumstances of the case. Lehman Bros. Special Financing Inc. v. Bank of America N.A. (In re Lehman Bros. Holdings Inc.), 535 B.R. 608 (Bankr. S.D.N.Y. 2015).
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11.1.c Trial court relies on equitable mootness to deny motions to share in plan distributions. The debtor automobile manufacturer filed its chapter 11 case and sold substantially all its assets under section 363 40 days after the petition date, when its financing ran out and it would have had to cease operations if the sale had not closed. Over the objections of numerous contract and tort creditors, the sale order authorized a sale free and clear of all claims and interests and specifically protected the purchaser from successor liability claims. The purchaser expressly assumed some obligations, including product liability and warranty claims for cars manufactured before the chapter 11 case, but expressly excluded other tort liabilities resulting from issues with those cars. Five years after the sale, the purchaser revealed a previously concealed design defect in about 27 million prepetition cars, which had resulted in injury or death to numerous individuals and which were the subject to federal mandatory safety recall requirements and notices. At least 24 engineers, managers, and internal lawyers knew of the defect prepetition. The debtor in possession had not sent notice to the 27 million car owners but relied on broad publication notice. After the purchaser revealed the defect, several class actions were initiated against the purchaser on successor liability theories, among others, and the plaintiffs sought leave to file late proofs of claims and to share in the trust established to distribute estate assets to prepetition creditors. The trust reserved only enough assets for distribution on disputed claims and had distributed the balance. In addition, trust interests had already been distributed, and many had been traded in the market. For strategic reasons, the plaintiffs did not seek to stay any further distributions from the trust pending the hearing on their claims. Due process requires the best notice practicable under the circumstances, reasonably calculated to apprise people of the pendency of an action and to permit them to assert objections. Publication may suffice for unknown creditors, but direct notice is required for creditors whose identity the debtor in possession knows or can ascertain with reasonable effort. If notice to a creditor is inadequate, the creditor must show prejudice from the lack of notice to obtain relief from the order. Because of the debtor’s internal knowledge of the defect, its danger, and the recall notice obligation, owners of the affected cars were known creditors; failure to give them notice violated their due process rights, so the court permits the late claims filings. Equitable mootness permits a court to deny relief whose implementation would be impractical, imprudent, or inequitable. The doctrine is not limited to appeals; it also applies at the trial court level to any request for relief that would upset settled expectations arising from an earlier order in the case. In the Second Circuit, a court should apply equitable mootness unless the court can still order effective relief, the relief will not affect the debtor’s re-emergence as a revitalized corporate entity nor unravel complex transactions so as to knock the prop out from under the reorganization or create an unmanageable or uncontrollable situation for the court, the potentially affected parties had a chance to participate in the proceeding, and the party seeking relief pursued a stay or other remedy to prevent execution of the objectionable order. Here, the court could permit the new claimants to share in the trust, but the trust had no unallocated assets, so such relief would be impossible without taking distributions or potential distributions away from other claimants who had relied on the trust’s terms. If it were possible, the relief would not affect the liquidating debtor’s re-emergence as a revitalized corporate entity. However, it would knock the props out from under the bargain underlying the trust, its reserves, and the distribution of trust assets. The potentially affected parties did not receive notice of the proceedings, though their interests were protected by similarly situated parties who effectively articulated the mootness argument, preventing any prejudice to parties who did not receive notice. Finally, the plaintiffs chose not to protect their position by seeking a stay. Therefore, the court denies relief on equitable mootness grounds. In re Motors Liquidation Co., 529 B.R. 510 (Bankr. S.D.N.Y. 2015).
11.1.d Section 105(a) permits the court to fashion a remedy where the Code and applicable agreements do not provide an answer. The multinational debtor filed chapter 11 case in the U.S., a CCCA proceeding in Canada, and for administration in England. The consolidated enterprise owned a substantial patent portfolio, which it sold in an auction that was coordinated between the Canadian and U.S. courts. None of the agreements among the debtors’ affiliates allocated the portfolio’s value or the beneficial ownership among the subsidiaries, and because the assets spanned different jurisdictions, there was no controlling law allocating the sale proceeds among the estates. Section 105(a) provides that the court may “issue any order,
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process or judgment that is necessary or appropriate to carry out the provisions” of the Bankruptcy Code. Under the circumstances, fashioning an allocation among the various estates was within the court’s authority under section 105(a). (The court rejects all parties’ proposed allocation methods and, in agreement with the Canadian court, allocates instead pro rata based on the amount of allowed unsecured claims at each estate, without double counting, leaving to each estate the means of dividing and distributing the proceeds among their separate creditors.) In re Nortel Networks, Inc., 532 B.R. 494 (Bankr. D. Del. 2015).
11.2 Sanctions 11.2.a Bankruptcy court has inherent power to issue non-contempt punitive sanction. The chapter 13 debtor inadvertently failed to send the trustee a copy of his tax return, as required by his plan confirmation order. The trustee moved for sanctions, seeking a punitive award of $200. The debtor sent the trustee the information before the hearing, but the bankruptcy court imposed a $100 sanction. A court has inherent power, in addition to its power to sanction for contempt, to impose a punitive sanction for violation of its order. Factors that distinguish a criminal contempt sanction from an inherent-power punitive sanction are whether the court makes an express contempt finding, whether the sanctioned conduct evidences a criminal mens rea, and whether the order falls within a recognized inherent power of the court. Here, the court did not find a contempt of court, the debtor’s conduct was inadvertent and not reflective of criminal intent, and a punitive award such as the bankruptcy court imposed here is within its inherent power to impose. A non-Article III bankruptcy court has inherent power to award sanctions to manage its own affairs. Therefore, it was a proper sanction. Charbono v. Sumski (In re Charbono), 790 F.3d 80 (1st Cir. 2015).
11.3 Appeals 11.3.a Court of appeals has jurisdiction over an appeal from an abstention order that does not rely on section 1334(c) grounds. The state court defendant removed an action to the district court as related to a chapter 11 case. While the plaintiff’s remand motion was pending, the liquidators for entities related to the chapter 11 debtor filed chapter 15 cases for those entities. The district court permissively abstained under section 1334(c)(1) and ordered remand under section 1452(b) of title 28. Section 1334(c)(1) permits abstention in the interest of justice or of comity with State courts, except with respect to a case under chapter 15. Section 1334(d) provides that a decision to abstain or not to abstain under section 1334(c) is not reviewable by appeal or otherwise by the courts of appeal. However, if the district court bases its decision on a ground that section 1334(c)(1) does not authorize, then the decision is not “under section 1334(c),” and the courts of appeals may review whether the abstention ground was proper. Because the appellant’s challenge to the abstention and remand order was that sections 1334(c)(1) and 1452 did not apply, rather than to the district court’s reason for abstention and remand, the court of appeals has jurisdiction under section 158(d). Firefighters Retirement System v. Citco Group Ltd., 788 F.3d 425 (5th Cir. 2015).
11.3.b In a thoughtful opinion considering equitable mootness and its underlying policies, Third Circuit dismisses confirmation appeal as moot. A failed LBO pushed the debtor into chapter 11. Creditors asserted substantial claims against the LBO sponsors and lenders. Ultimately, two plans were proposed that differed primarily in their treatment of the LBO claims: one settled them, the other preserved them for a litigation trust. Nearly all creditor classes rejected the litigation plan. The court confirmed the settlement plan. The litigation plan proponent appealed, seeking a ruling that would preserve the litigation and requesting a stay pending appeal. The bankruptcy court required a $1.5 billion supersedeas bond as a condition to a stay pending appeal, and the district court did not set aside that ruling. The appellant opposed any bond at all, choosing not to argue for a smaller bond amount. The plan was then consummated with a new equity investment. Under Third Circuit precedent, an appeal may be dismissed as equitably moot if the plan has been substantially consummated and if so, whether granting the appellate relief requested will either fatally scramble the plan or significantly harm third parties who have justifiably relied on confirmation and consummation. Some third partieshave reliance
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interests more worthy of protection than others. For example, new equity investors are most worthy of protection to encourage new investment to rescue companies from bankruptcy. Parties who have received plan distributions to which they are not entitled are least worthy of protection, as long as recovering the distributions will not unravel the plan. Those who participated in the plan process and negotiated settlements and plan terms and those who deal with the reorganized debtor fall somewhere in between. Here, the remedy the appellant seeks would upset the entire plan settlement and undermine the equity investor’s investment in the reorganized debtor. Finally, equitable mootness is an equitable doctrine. It would be inequitable to reward the appellant’s decision to risk mootness rather than propose and justify a reasonable bond amount. Therefore, the court dismisses the appeal. However, the court does not dismiss a related appeal in which an indenture trustee argued that the plan misinterpreted a subordination agreement and distributed $30 million to the wrong class, because the amount was small in relation to the entire plan (so recovery would not scramble the plan), and the recipients could not justifiably rely on the confirmation order if they were not entitled under the documents to the funds. In re Tribune Media Co., 799 F.3d 272 (3d Cir. 2015).
11.3.c Equitable mootness does not apply to an appeal of sale proceeds distribution order, and the appeal is not moot under section 363(m). The debtor in possession sold all its assets, including its cash, to its secured lender under a credit bid of about 90% of the secured debt. The secured lender agreed to put funds into escrow to pay the DIP’s professional and to fund into escrow a small distribution to unsecured creditors. The sale resulted in a large, adminstrative priority capital gain tax. The government objected to the sale and to the distribution of the escrowed funds to professionals and unsecured creditors and appealed the sale order, seeking payment of its tax claim from the escrowed funds. Section 363(m) provides that the reversal or modification on appeal of an order authorizing a sale does not affect the validity of the sale to a good faith purchaser. It applies only to an appellate order that affect the validity of the sale itself, not one that grants ancillary relief, such as an order to redistribute sale proceeds. In addition, the equitable mootness doctrine applies only to an appeal from a plan confirmation order. Therefore, the appeal is not moot. In re ICL Holding Co., Inc., ___ F.3d ___, 2015 U.S. App. LEXIS 16306 (3d Cir. Sept. 14, 2015).
11.3.d Appeal is not moot where the court may modify plan without affecting innocent third parties. The debtor comprised two operating hotel entities, two mezzanine entities, and a holding company. The operating debtors’ lender purchased the mezzanine debtors’ loans. The debtor proposed a plan to sell the hotels to a third party and to restructure the operating debtors’ loan. The lender made the section 1111(b) election, so the plan proposed to pay the lender total cash payments equal to the lender’s $247 million claim over 21 years, with interest only and a full principal balloon payment at the end. If the purchaser sold the property, the full principal would be payable immediately, unless the purchaser sold between years five and fifteen, in which case the purchaser’s purchaser could assume the restructured loan. Creditor classes of the operating debtors accepted the plan, but no mezzanine debtor creditor classes did. The bankruptcy court confirmed the plan, finding the restructured loan met section 1129(b)(2)(A)’s cramdown requirements and that section 1129(a)(10)’s “impaired accepting class” rule applies on a per-plan basis. The lender appealed from the bankruptcy court’s ruling on both issues and sought a stay from the bankruptcy court and from the district court, both of which denied the stay request. The debtor consummated the plan and transferred the hotels to the purchaser. The district court dismissed the appeal as equitably moot. An appellate court may dismiss an appeal as equitably moot based upon four considerations: whether the appellant has fully pursued its rights, whether the plan has been substantially consummated, an appellate remedy’s effect on innocent third parties, and whether the bankruptcy court can fashion effective relief without knocking the props out from under the plan and thereby creating an uncontrollable situation. Here, the appellant pursued its rights by seeking a stay, but an appellate court should not penalize the appellant for failure to obtain one, assuming the other considerations counsel against mootness. The plan was substantially consummated, but that alone does not require dismissal. The relief the lender sought might affect the purchaser, but not necessarily other parties. The court could, for example, modify the terms of the loan assumption provisions or the allocation of value to the mezzanine
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lender. Neither remedy would affect third parties; the purchaser is not an innocent third party, having fully participated in the plan process. Finally, fashioning such a remedy would not necessarily knock the props out from under the plan, though the bankruptcy court should be careful in fashioning a remedy. Based on these considerations, the appeal is not moot. The court of appeals remands to the district court to hear the appeal. JPMCC 2007-C1 Grasslawn Lodging, LLC v. Transwest Resort Props. Inc. (In re Transwest Resort Props. Inc.), 791 F.3d 1140 (9th Cir. 2015).
11.3.e Appeal from fee award under section 303(i) based on unreviewable abstention under section 305 is not moot. The creditors filed an involuntary petition against the debtor. The bankruptcy court dismissed the petition on the grounds that the claimed debts were subject to bona fide dispute and that the court should abstain under section 305 because the disputes were the subject of ongoing litigation in other courts. The bankruptcy court then awarded attorneys’ fees against the creditors under section 303(i). The creditors appealed to the district court, which affirmed all rulings. The creditors appealed to the court of appeals but then argued that the appeal was moot and should be dismissed, because the court of appeals does not have jurisdiction over an appeal from an abstention ruling under section 305. The creditors sought an order vacating the fees award based on the mootness of the appeal, which prevented them from obtaining review of the dismissal order. An award of money damages presents a live controversy, even if the underlying issues resulting in the award are moot and not subject to appeal. Therefore, the court of appeals has jurisdiction to hear the appeal from the attorneys’ fee award. Crest One SpA v. TPC Troy, LLC (In re TPG Troy, LLC), 793 F.3d 228 (2d Cir. 2015).
11.3.f Court dismisses as equitably moot an appeal from a structured dismissal. The debtor’s lessor sued the debtor to terminate its lease. One of its two shareholders asserted his claims were secured, which the other shareholder disputed. A judicial lien creditor had levied on the debtor’s accounts, which were now frozen. After bankruptcy court litigation over the validity of the lessor’s lease termination and over a reorganization plan, the lessor, the shareholder with the disputed secured claim, and the other secured creditor settled. The settlement provided for the lessor to pay into the estate $4 million and to receive a lease termination and clear title to the real property, for the non-claimant shareholder to receive all the debtor’s equipment, worth over $2 million, for the full payment of administrative claims, for a distribution of approximately 40% to the general unsecured creditors, for distribution of the balance of the $4 million cash payment to the claimant shareholder, and for dismissal of the case. The court approved the settlement, including the dismissal; the parties consummated the entire settlement. The non-claiming shareholder appealed, asking the court to reverse the distribution to the claimant shareholder on the ground that the shareholder’s claim was not secured. A court must dismiss an appeal as equitably moot when the court cannot grant effective relief, such as when the court lacks power to rescind transactions that are the subject of the appeal. The equitable mootness doctrine is not limited to appeals from plan confirmation orders. Here, the settlement was an integrated transaction. Reversing the distribution to the claimant shareholder would effectively break the settlement into two parts, which would arbitrarily reform the parties’ agreement. Therefore, the court could not grant effective relief and so dismisses the appeal. Musilino v. Ala. Marble Co., Inc., 534 B.R. 820 (N.D. Ala. 2015).
11.3.g Denial of a stay pending appeal of a sale order is a final order for purposes of appeal. The debtor in possession moved to sell property free and clear of a leasehold interest on the ground that the leasehold interest was subject to a bona fide dispute. The lessee objected on the ground, among others, that the DIP had not shown a bona fide dispute. The bankruptcy court granted the free and clear sale motion and denied a stay pending appeal, as did the district court. Under section 158(d) of title 28, the court of appeals has “jurisdiction of appeals from all final decisions, judgments, orders, and decrees” of the district court in bankruptcy proceedings. Section 363(m) prohibits an appellate order from affecting a sale’s validity to a good faith purchaser. Therefore, if the sale closed, the lessee would be without a remedy; the district court’s denial of the stay effectively foreclosed the lessee from further relief. Under the circumstances, the stay denial
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operated as a final order, so the court of appeals had jurisdiction under section 158(d). In re Revel AC, Inc., ___ F.3d ___ (3d Cir. Sept. 30, 2015).
11.3.h Third Circuit describes standard for stay pending appeal. A lessee brought an action seeking a declaratory judgment that it was entitled to the protections of section 365(h), which permits a lessee to retain its interest even after lease rejection. The debtor in possession then moved to sell property free and clear of a leasehold interest on the ground that the leasehold interest was subject to a bona fide dispute. The lessee objected on the ground, among others, that the DIP had not shown a bona fide dispute. The bankruptcy court granted the free and clear sale motion and denied a stay pending appeal, as did the district court. To obtain a stay pending appeal, an appellant must make a strong showing of likelihood of success on the merits, show irreparable injury that outweighs the expected injury to the appellee, and show that a stay is in the public interest. The appellant need not show that merits success is more likely than not; rather, a reasonable chance or probability of winning is adequate. The appellant must show that irreparable injury is likely, not merely possible. These first two factors are the most important. After that, the court should consider the balance of potential harms to the parties from denying or granting a stay in conjunction with the public interest consideration. In cases between the extremes or where all factors do not point in the same direction, the court should use a sliding scale in considering the factors: the stronger the likelihood of merits success, the less weight to be accorded to irreparable injury, balancing harms, and the public interest. Conversely, if the likely harm to the appellant would be substantial, and the balance of harms tips decidedly in its favor, then a weaker showing, though still well above negligible, of likelihood of success might suffice for a stay. Thus, the appellant need not necessarily prevail on each of the four factors. Here, likely statutory mootness of the appeal under section 363(m) establishes irreparable harm to the appellant/lessee, and DIP did not show that it would likely lose the sale absent a stay. The public interest factor slightly favored the DIP, but not enough to overcome the near certainty of merits success. The declaratory judgment action sought only confirmation that section 365(h) protections applied and did not suggest any dispute at all over whether the lease was in fact a lease. Therefore, the court grants the stay pending appeal. In re Revel AC, Inc., ___ F.3d ___, 2015 U.S. App. LEXIS 17192 (3d Cir. Sept. 30, 2015).
11.3.i Avoiding power defendant does not have standing to appeal substantive consolidation order. The bankruptcy court granted the trustee’s motion to consolidate the estates of a Ponzi scheme debtor and its wholly owned special purpose entities while the trustee’s avoiding power actions against net winner investors in the subsidiaries were pending. The consolidation order facilitated the trustee’s avoiding power actions by making the investors initial transferees rather than subsequent transferees. The investors objected to consolidation and appealed the bankruptcy court’s ruling. Only a “person aggrieved” has standing to appeal a bankruptcy court’s order. A person aggrieved is one who has a pecuniary interest directly affected by the order, one whose property is diminished, burdens increased, or rights impaired by the bankruptcy court’s order. A person is not aggrieved by an order that merely requires the person to defend litigation or deprives a person of a defense in an adversary proceeding, nor is a person aggrieved whose interest is not protected by the Bankruptcy Code. An adversary defendant’s interest in defending an action is an interest the Bankruptcy Code does not protect. Therefore, the investors are not persons aggrieved by the substantive consolidation order. That the investors have a contingent claim against the estate that might arise from the trustee’s successful pursuit of the avoiding power action does not change the result. The claim is speculative, and the argument amounts only to another way to assert their interest as defendants. The court dismisses the appeal. WestLB AG v. Kelley, 531 B.R. 783 (D. Minn. 2015).
11.4 Sovereign Immunity 11.4.a Section 106’s sovereign immunity abrogation does not apply to Indian tribes. The trustee sued an Indian tribe to avoid and recover a fraudulent transfer. Common law grants Indian tribes sovereign immunity. Congress may abrogate a tribe’s sovereign immunity but only by a clear and unequivocal statement in the legislation itself. Inference or implication from legislative language
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does not suffice. And in every instance in which the courts have found abrogation of an Indian tribe’s sovereign immunity, Congress has referred expressly to Indians or tribes. Section 106(a) abrogates sovereign immunity of governmental units. Section 101 defines “governmental unit” as the “United States; State; Commonwealth; … foreign state; … or other foreign or domestic government.” A tribe is domestic and it is a government. Syllogistically, therefore, it is a domestic government. However, no prior Supreme Court case has referred to an Indian tribe as a “domestic government.” Moreover, the Constitution distinguishes in Art. III, sec. 1 among the States, foreign governments, and Indian tribes, yet section 106(a) does not mention Indian tribes. Therefore, including Indian tribes within the phrase “domestic government” would require inference or implication, which would be inadequate to bring them within the section’s scope. The court dismisses the avoiding power action against the tribe. Buchwald Cap. Advisors, LLC v. Papas (In re Greektown Holdings, LLC), 532 B.R. 680 (E.D. Mich. 2015).
12. PROPERTY OF THE ESTATE
12.1 Property of the Estate 12.1.a Malpractice claim against individual chapter 11 debtor’s attorney is property of the estate under the “accrual” test. An inexperienced attorney represented the individual chapter 11 debtor. The attorney’s inexperience led to several failures, including failure to list valuable assets on the debtor’s schedules, to obtain permission to use cash collateral, and to file a confirmable plan. The debtor also improperly transferred property of the estate during the chapter 11 case. The court awarded the attorney fees during the case but eventually converted the case to chapter 7. After conversion, both the debtor and the trustee sued the attorney for malpractice. Section 1115(a)(1) provides that property acquired during an individual chapter 11 case and before conversion is property of the estate; by implication, property acquired upon or after conversion is property of the post-bankruptcy debtor. A malpractice claim is property of the estate if it arises before conversion. In a bankruptcy case, to determine when a claim arises, courts have used the “accrual” test, measuring when the claim accrues; the “conduct” test, based on when the wrongful conduct that ultimately causes harm occurred; and the “prepetition relationship” test, which modifies the conduct test to require a prepetition relationship to permit the debtor to identify and notify potential claimants. The issue typically comes up in the context of a claim against the debtor, because determining when a claim arises matters for the automatic stay and discharge. The policies behind those provisions counsel for a broad reading of when a claim arises, making the accrual test less appropriate. But in determining when a claim by the debtor or the estate arises, those policies do not predominate. The accrual test is an appropriate means to determine when property becomes property of the estate, because it focuses on whether the alleged wrongful conduct harmed the estate. A tort claim typically accrues when the defendant’s wrongful conduct causes harm. Here, the loss of assets, the payment of the attorney’s fees, and the failure of plan confirmation all harmed the chapter 11 case before conversion, so the malpractice claim is property of the estate. Cantu v. Schmidt (In re Cantu), 784 F.3d 253 (5th Cir. 2015).
12.1.b Escrowed funds for professionals and unsecured creditors from a credit-bidding secured creditor are not property of the estate. All the debtor’s assets, including its cash, were subject to the secured lender’s lien. The debtor in possession sold all its assets, including its cash, to the secured lender under a credit bid of about 90% of the secured debt. The secured lender agreed before bankruptcy to put funds into escrow to pay the DIP’s professional and, to settle an unsecured creditors committee objection to the sale, to fund into escrow a small distribution to unsecured creditors. The sale resulted in a large, administrative priority capital gain tax. The government objected to the sale and to the distribution of the escrowed funds to professionals and unsecured creditors and appealed the sale order, seeking payment of its tax claim from the escrowed funds. If the escrowed funds are property of the estate, section 507(a)’s priority rules might apply to their distribution. Section 541(a)(6) includes as property of the estate “proceeds … of or from property of the estate.” Because the purchase resulted in all the estate’s cash being transferred to the secured creditor, and because the payments were not given as consideration
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for the purchased assets, the cash the secured creditor placed into escrow for the sole benefit of the professionals and the unsecured creditors was not proceeds of the sale or property of the estate. ICL Holding Co., Inc., ___ F.3d ___, 2015 U.S. App. LEXIS 16306 (3d Cir. Sept. 14, 2015).
12.1.c Court denies claim for deepening insolvency but permits claim for asset diversion that increased the debtor’s liabilities without corresponding asset value increase. The principals had loaned the debtor money, which had been used to fund the debtor’s sole asset, a German subsidiary that manufactured the debtor’s product. When the debtor encountered financial trouble, the principals offered to loan more and raise equity. Management preferred a third-party proposal, but that would have required the principals to subordinate their existing loans, which they refused to do. Ultimately, the debtor accepted the principals’ proposal. One of the principals funded the full amount he had promised; the other did not. And they raised only additional debt financing, not equity. The debtor transferred the loaned funds to the insolvent German subsidiary to keep it afloat. The funding principal owned a potential customer of the debtor and used his position with the debtor to divert inventory of the German subsidiary for the benefit of the customer. Ultimately, the debtor and its German subsidiary failed. The trustee sued the debtor’s principals for breach of fiduciary duty, alleging that the debtor lost enterprise value and incurred debt as a result of these events and that the debtor suffered from the principal’s asset diversions. A fiduciary duty breach claim requires proof of causation and damages. A loss in enterprise value, even for an insolvent debtor, might constitute damages, because it might reduce amounts available for creditors or prevent a successful reorganization. Here, however, the principals’ loan proposal did not breach their fiduciary duty and cause loss of enterprise value, because they had no duty, fiduciary or otherwise, to subordinate their existing loans to permit the third-party transaction, so the debtor had no alternative. Incurrence of additional debt does not constitute damages, because upon incurring the debt, the debtor typically receives assets (usually cash) of equal value. Therefore, the new loan does not deepen the debtor’s insolvency or cause damage. However, diversion or waste of assets can breach fiduciary duty and cause damages. Here, the trustee adequately alleged that the lending principal caused the diversion and waste of assets. Therefore, the court denies the principals’ motion to dismiss the trustee’s complaint. Wirum v. Goel (In re Signet Solar, Inc.), 532 B.R. 70 (N.D. Cal. 2015).
12.2 Turnover 12.3 Sales 12.3.a Section 363(n) action proceeds are not proceeds of the underlying sold property. The debtor in possession sold all its encumbered assets in a section 363 sale and paid the sale proceeds to the secured lender. The sale proceeds were less than half the lender’s secured claim amount. After the case was converted to chapter 7, the trustee hired counsel to sue the purchaser for collusion under section 363(n), seeking actual and punitive damages equal to the balance of the secured lender’s claim plus the amount of allowed unsecured claims. The purchaser prevailed. Counsel sought allowance of its fees. Section 330 does not permit allowance of compensation for professional services that were not reasonably likely to benefit the estate. The fee objector, who was the section 363(n) defendant, argued that if the secured lender was entitled to all the proceeds of the trustee’s lawsuit, then the action would not have been reasonably likely to benefit the estate. A section 363(n) claim vests solely in the trustee and so is property acquired by the estate after the commencement of the case. Under section 552, property acquired after commencement is not subject to a prepetition lien except to the extent the property is proceeds of the petition-date collateral. “Proceeds” is what is acquired upon sale or other disposition of property or from loss or damage. Proceeds of the trustee’s avoiding powers are not proceeds of petition-date property of the estate; the avoiding power claims arise only upon and because of the bankruptcy and are therefore independent of the underlying property from which they arise. Similarly, the trustee’s section 363(n) claim was not proceeds of the lender’s petition- date collateral, so counsel’s services were reasonably likely to benefit the estate at the time they were rendered. Arlington Cap. LLC v. Bainton McCarthy LLC, 534 B.R. 337 (N.D. Ind. 2015).
Recent Developments in Bankruptcy Law, October 2015
13. TRUSTEES, COMMITTEES, AND PROFESSIONALS
13.1 Trustees 13.2 Attorneys 13.2.a Barton doctrine protects debtor in possession’s general counsel and subsidiary director. The debtor in possession’s chief restructuring officer asked the company’s general counsel to continue to serve as such, and the court approved an “Executive Service Agreement” between the DIP and the general counsel. The CRO then elected the general counsel to the board of the DIP’s principal subsidiary to facilitate the subsidiary’s sale. The board issued an SEC Form 8-K shortly after the general counsel’s appointment, which an attorney claimed was defamatory. After plan confirmation, the attorney sought the court’s permission to sue the general counsel in federal district court. Under Barbour v. Barton, 104 U.S. 126 (1881), a plaintiff must obtain leave of the bankruptcy court to sue a trustee or other court-approved officer, including an attorney or investigator that the trustee hires. The general counsel, acting as a director of the subsidiary, was a court-approved officer, even though the court approved only his employment agreement, not him personally, and is therefore protected by Barton. Section 959(a) is an exception to the Barton doctrine for acts committed in carrying on the estate’s business. It does not apply here because the general counsel’s actions were in furtherance of administering the estate, not operating the business. The court denies permission to sue. Coen v. Stutz (In re CDC Corp.), ___ F. Appx. ___ (11th Cir. June 11, 2015).
13.2.b Barton v. Barbour does not apply to an action against the trustee arising from an order in a withdrawn adversary proceeding. The trustee sued the debtors and their children in bankruptcy court to avoid and recover fraudulently transferred property. The district court withdrew the reference of the adversary proceeding. It then authorized the trustee to seize certain property from the debtors’ home. The debtors and their daughter claimed the trustee seized more than authorized and sued the trustee in the district court for a Fourth Amendment violation. Under Barton v. Barbour, 104 U.S. 126 (1881), a federal court does not have jurisdiction over an action against a court-appointed officer unless the appointing court has given leave to the plaintiff to proceed. Barton protects the officer and the appointing court from another court’s usurping its control over the officer and the underlying proceeding and protects the officer from unjustified personal liability for acts taken within the scope of official duties. Generally, Barton applies to prevent a suit in the district court against a trustee appointed by the bankruptcy court in the same district. However, here, the suit concerned an order the district court had issued, giving the district court the interest in protecting its proceeding and trustee. Therefore, Barton does not apply. Carroll v. Abide, 788 F.3d 502 (5th Cir. 2015).
13.2.c Barton v. Barbour requires leave to sue a state court-appointed trustee. The state court appointed a trustee to sell the debtor’s marital home to collect the amount owed to the debtor’s ex-wife. The debtor took several steps to frustrate the sale and then filed a bankruptcy case. The state court found the debtor in contempt for failing to cooperate with the trustee and imposed sanctions. Without leave of the state court, the debtor filed an adversary proceeding against the trustee for violation of the stay. Under Barton v. Barbour, 104 U.S. 126 (1881), a federal court does not have jurisdiction over an action against a court-appointed officer unless the appointing court has given leave to the plaintiff to proceed. The doctrine applies in federal court equally to actions against an officer appointed by a state court. Because the debtor did not obtain leave of the state court before bringing the action, the bankruptcy court does not have jurisdiction to hear it. Tshiani v. Monahan, 533 B.R. 506 (D. Md. 2015).
13.3 Committees 13.4 Other Professionals 13.5 United States Trustee
Recent Developments in Bankruptcy Law, October 2015
14. TAXES
14.1.a Section 502(b)(3) does not apply to secured water and sewer charges but limits secured property tax claim to the property’s value and disallows any deficiency claim. The county asserted two secured claims against the debtor’s hotel, one for delinquent property taxes for about $1.9 million, the other for unpaid water and sewer charges also for about $1.9 million. The hotel was worth only about $700,000. Section 502(b)(3) requires the court to disallow a claim for property taxes to the extent that the claim exceeds the value of the debtor’s interest in the property. The water and sewer charges are for actual usage. If unpaid, state law provides that the delinquent charges shall be entered as a lien on the tax roll and “be enforced in the same manner as provided for the collection of taxes.” The requirement that they be collected in the same manner as taxes does not convert them into a tax claim, so section 502(b)(3) does not apply. The Tax Injunction Act, 28 U.S.C. § 1341, prohibits a district court from enjoining, suspending, or “restraining the assessment, levy, or collection of any tax under State law where a plain, speedy and efficient remedy many be had in the courts of such State.” But it does not prevent enforcement of the Bankruptcy Code’s provisions governing allowance of tax claims against an estate. Therefore, the county’s secured property tax claim is limited to the hotel’s value. Because section 502(b)(3) limits the claim’s allowed amount, not just the allowed secured claim amount, the county does not have a deficiency claim under section 506(a) to which section 1111(b) would apply. Shefa, LLC v. Oakland County Treasurer (In re Shefa, LLC), 535 B.R. 165 (E.D. Mich. 2015).
14.1.b Trustee may pay administrative tax liability only “after notice and a hearing.” The debtor filed its chapter 11 petition in January 2005. The case converted to chapter 7 in October 2005. In May 2009, the chapter 7 trustee filed a federal income tax return for the estate’s 2005 income tax liability and paid the tax owing on the return. In May 2012, the trustee filed his final report and account. A creditor objected on the ground that the trustee should have given notice of his intent to file the return and pay the tax. Section 503(b) provides that administrative expenses shall be allowed “after notice and a hearing.” The estate’s tax liability is an administrative expense, and the Internal Revenue Code requires the trustee to file a return for the estate’s liability and pay the tax owing even if the IRS does not file an administrative expense claim. Section 503(b)’s requirement of notice and a hearing is mandatory and does not conflict with the IRC’s filing and payment requirement. Therefore, the court may not approve the trustee’s final report without providing an opportunity to determine the estate’s tax liability. Dreyfuss v. Cory (In re Cloobeck), 788 F.3d 1243 (9th Cir. 2015).
15. CHAPTER 15—CROSS-BORDER INSOLVENCIES
15.1.a A special purpose finance subsidiary’s COMI may be at its parent’s headquarters. A Brazilian group of companies commenced reorganization cases in Brazil, including for the holding company and several principal operating subsidiaries, which maintained their registered offices in Brazil, and a special purpose finance company, which maintained its registered office in Austria but had no actual operations in Austria. In fact, all finance company decisions were made by its Brazilian directors in Brazil. The finance company had issued U.S.-dollar denominated notes. The note proceeds were loaned to other subsidiaries, who guaranteed the notes. The notes were governed by New York law, and the parties consented to New York jurisdiction. A foreign representative of the finance subsidiary petitioned for recognition of its Brazilian reorganization case under chapter 15. Chapter 15 permits recognition of a foreign proceeding as a foreign main proceeding if, among other things, the foreign proceeding is at the foreign debtor’s center of main interests (COMI). Absent contrary evidence, a debtor’s COMI is presumed to be at the location of the debtor’s registered office. The debtor may show that it actually operated at a different location, based on, among other things, the location of its headquarters or its principal management (its “nerve center) or of its primary assets or a majority of its creditors. Here, the finance subsidiary’s sole business was the repayment of the notes, which could be accomplished only by the repayment to the subsidiary from the other companies to which it loaned the note
Recent Developments in Bankruptcy Law, October 2015
proceeds. Under the circumstances, Brazil is the finance subsidiary’s COMI. In re OAS S.A., 533 B.R. 8 (Bankr. S.D.N.Y. 2015).
15.1.b An officer authorized by the debtor’s board of directors may serve as a foreign representative to seek chapter 15 recognition. A Brazilian group of companies commenced reorganization cases in Brazil, including for the holding company and several principal operating subsidiaries that maintain their registered offices in Brazil. Under Brazilian reorganization law, the court appoints a judicial administrator, but his role is limited. The debtor retains authority to operate the business and propose a reorganization plan. The debtors’ boards of directors authorized the group’s chief legal officer as agent and attorney-in-fact to seek relief available under chapter 15 as a foreign representative. The CLO petitioned for chapter 15 recognition for the foreign proceedings. Under section 1517, only a foreign representative may petition for recognition. Under section 101(24), a “foreign representative” is a person “authorized in a foreign proceeding to administer the reorganization or liquidation of the debtor’s assets or affairs or to act as a representative of such foreign proceeding.” Judicial authorization is not required. All that is required is that the authorization occurs in the context of a foreign proceeding. Authorization from a debtor holding the power to administer the proceedings is adequate, even if those powers are not co-extensive with the powers of a chapter 11 debtor in possession. Here, Brazilian law provides adequate powers and authority to the reorganizing debtors, and their appointment of the CLO to act as the representative of the foreign proceeding was adequate. In re OAS S.A., 533 B.R. 8 (Bankr. S.D.N.Y. 2015).
15.1.c Court may not permissively abstain from a proceeding in a chapter 15 case. The state court defendant removed an action to the district court as related to a chapter 11 case. While the plaintiff’s remand motion was pending, the liquidators for entities related to the chapter 11 debtor filed chapter 15 cases for those entities. The district court permissively abstained under section 1334(c)(1) and ordered remand under section 1452(b) of title 28. Section 1334(c)(1) permits abstention in the interest of justice or of comity with State courts, “except with respect to a case under chapter 15.” Section 1334(c)(1) distinguishes between cases and proceedings, so “case” should not be read to mean “proceeding.” Therefore, the “except” clause means that a court may not permissively abstain from anything in a chapter 15 case. Section 1452 refers to section 1334(c) and so should be read in pari materia with it. The filing of the chapter 15 case after removal does not change the result. Section 1334(c)(1) applies at the time of abstention, not at the time of removal. Therefore, the court reverses the abstention and remand order. Firefighters Retirement System v. Citco Group Ltd., 788 F.3d 425 (5th Cir. 2015).