Monday, July 1st, 2013
A very recent decision out of California’s Central District Bankruptcy Court highlights the boundaries of “commercial reason” and “diligence” where distressed asset sales are concerned.
In re 1617 Westcliff, LLC (Case No. 8:12-bk-19326-MW) involved the court-approved sale of the debtor’s real property under a purchase agreement in which the debtor and the purchaser agreed to use their “commercially reasonable and diligent efforts” to obtain the approval of the debtor’s mortgage lender for the assumption of the mortgage debt by the buyer. If the approval was not obtainable, the buyer had the right to terminate the transaction. The buyer also had the right to terminate the deal if the assumption required payment of more than a 1% assumption fee.
As is sometimes the case where due diligence remains while a deal is approved, things didn’t quite work out as planned. Unfortunately, the bank proved less cooperative than the parties had anticipated. More importantly, however, the buyer notified the debtor-seller 4 days prior to closing that it would not proceed with the transaction as structured, but might be willing to proceed if the transaction was framed as a tax deferred exchange.
The debtor was, understandably, somewhat less than receptive to restructuring the deal at the 11th hour. It insisted that the buyer proceed with the transaction as originally agreed and as approved by the court. In response, the buyer effectively walked away. The parties then made competing demands on the escrow company regarding the buyer’s $200,000 deposit, and filed cross-motions with Bankruptcy Judge Mark Wallace to enforce them.
In a brief, 11-page decision, Judge Wallace found that the buyer’s renunciation of the deal 4 days before closing was a material breach of the buyer’s obligation to use “commercially reasonable and diligent efforts” to obtain assumption consent:
The Purchase Agreement required [the buyer] to keep working in good faith for an assumption until the close of business on May 10, 2013, not to throw up its hands and to propose – at the eleventh hour – a wholesale restructuring of the purchase transaction in a manner completely foreign to the Purchase Agreement. On [the date of the proposal] there were still four days left to reach agreement with the Bank, but [the buyer] chose (five months into the deal) to abandon the assumption. It was not commercially reasonable nor was it diligent for [the buyer] to cease negotiations with the Bank relating to the assumption of the loan under these circumstances.
Judge Wallace found that due to this breach the debtor was entitled to retain the $200,000 deposit. He found further that the buyer, by offering to purchase the property in a restructured transaction, had failed to effectively terminate the deal. Instead, the buyer had indicated that it was “eager to keep the Purchase Agreement in force (on terms other than those agreed to).” Since the deal had not terminated, the buyer remained under a duty to continue to use reasonable efforts to obtain the bank’s consent. Its failure to do so caused the loss of its deposit.
Bill of sale sedan 1927 (Photo credit: dlofink)
The 1617 Westcliff decision (the unpublished slip copy is available here) serves as a reminder to buyer’s counsel of the unique nature of distressed asset purchases. The Bankruptcy Court which originally approved the purchase remains available and prepared to resolve any issues which may arise prior to closing, often at a fraction of what it would cost to get a Superior Court involved in connection with an unraveled private sale. And conditions and contingencies to the sale must be carefully drafted and observed. This applies even to common asset-purchase “boilerplate” such as “commercial reasonableness” and “diligence.”
Friday, June 14th, 2013
In a 23-page memorandum decision issued yesterday, New York Bankruptcy Judge Stewart Bernstein ruled that the debtor and a third party were parties to a master agreement that allowed the debtor to issue purchase orders that the counter-party was required to fill. Judge Bernstein held that the debtor could assume the master agreement but could reject individual purchase orders. The purchase orders were divisible from the master agreement.
English: Sketch of Richard Mentor Johnson freeing a man from debtors' prison. Johnson was an advocate of ending the practice of debt imprisonment throughout his political career. (Photo credit: Wikipedia)
The decision (available here) provides a thorough analysis of when – and under what circumstances – an executory agreement may be “divisible” into separate, individual agreements . . . which can then be selectively assumed or rejected by a debtor or trustee.
Monday, January 23rd, 2012
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Thanks to an active lobby in Congress, commercial landlords have historically enjoyed a number of lease protections under the Bankruptcy Code. Even so, those same landlords nevertheless face limits on the damages they can assert whenever a tenant elects to reject a commercial lease.
Section 502(b)(6) limits landlords’ lease rejection claims pursuant to a statutory formula, calculated as “the [non-accelerated] rent reserved by [the] lease . . . for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease . . . .”
This complicated and somewhat ambiguous language leaves some question as to whether or not the phrase “rent reserved for . . . 15 percent . . . of the remaining term of such lease” is a reference to time or to money: That is, does the specified 15 percent refer to the “rent reserved?” Or to the “remaining term?”
Many courts apply the formula with respect to the “rent reserved.” See. e.g., In re USinternetworking, Inc., 291 B.R. 378, 380 (Bankr.D.Md.2003) (citing In re Today’s Woman of Florida, Inc., 195 B.R. 506 (Bankr.M.D.Fl.1996); In re Gantos, 176 B.R. 793 (Bankr.W.D.Mich.1995); In re Financial News Network, Inc., 149 B.R. 348 (Bankr.S.D.N.Y.1993); In re Communicall Cent., Inc., 106 B.R. 540 (Bankr.N.D.Ill.1989); In re McLean Enter., Inc., 105 B.R. 928 (Bank.W.D.Mo.1989)). These courts calculate the amount of rent due over the remaining term of the lease and multiply that amount times 15%.
Other courts calculate lease rejection damages based on 15% of the “remaining term” of the lease. See, e.g., In re Iron–Oak Supply Corp., 169 B.R. 414, 419 n. 8 (Bankr.E.D.Cal.1994); In re Allegheny Intern., Inc., 145 B.R. 823 (W.D.Pa.1992); In re PPI Enterprises, Inc., 324 F.3d 197, 207 (3rd Cir.2003).
For more mathematically-minded readers, the differently-applied formulas appear as follows:
||Maximum Rejection Damages = (Rent x Remaining Term) x 0.15
||Maximum Rejection Damages = Rent x (Remaining Term x 0.15)
Earlier this month, a Colorado bankruptcy judge, addressing the issue for the first time in that state, sided with those courts who read the statutory 15% in terms of time:
“In practice, by reading the 15% limitation consistently with the remainder of § 502(b)(6)(A) as a reference to a period of time, any lease with a remaining term of 80 months or less is subject to a cap of one year of rent [i.e.,15% of 80 months equals 12 months] and any lease with a remaining term of 240 months or more will be subject to a cap of three years rent [i.e., 15% of 240 months equals 36 months]. Those in between are capped at the rent due for 15% of the remaining lease term.”
In re Shane Co., 2012 WL 12700 (Bkrtcy. D.Colo., January 4, 2012).
The decision also addresses a related question: To what “rent” should the formula apply – the contractual rent applicable for the term? Or the unpaid rent remaining after the landlord has mitigated its damages? Under the statute, “rents reserved” refers to contractual rents, and not to those remaining unpaid after the landlord has found a new tenant or otherwise mitigated.
Colorado Bankruptcy Judge Tallman’s decision, which cites a number of earlier cases on both sides of the formula, is available here.
Monday, December 19th, 2011
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Outside of bankruptcy, a creditor whose loan is secured by collateral typically has the right to payment in full when that collateral is sold – or, if the collateral is sold at an auction, to “credit bid” the face amount of the debt against the auction price of the collateral.
Inside bankruptcy, however, the right to “credit bid” is not always guaranteed.
In July, this blog predicted Supreme Court review of a Seventh Circuit case addressing the question of whether a bankruptcy court may confirm a plan of reorganization that proposes to sell substantially all of the debtor’s assets without permitting secured creditors to bid with credit. The courts of appeals are divided two to one over the question, with the Third and Fifth Circuits holding that creditors are not entitled to credit bid and the Seventh Circuit holding to the contrary (for a review of the more recent, Seventh Circuit decision, click here).
The question is one of great significance for commercial restructuring practice, with several bankruptcy law scholars suggesting the answer “holds billions of dollars in the balance.”
Apparently, the Supreme Court agrees. Last week, the justices granted review of the Seventh Circuit decision. For the petitioners’ brief, respondent’s opposition, and amicus briefs, click here.
Sunday, August 21st, 2011
After a brief hiatus, we’re back – and just in time to discuss a recent decision of some import to trademark owners and licensors.
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For many years, insolvency practitioners have recognized the value of the Bankruptcy Code in permitting a reorganizing firm to assign contractual rights to a third party, even where the contract itself prohibits assignment. That power is limited, however, where “applicable [non-bankruptcy] law” prohibits the assignment without the non-bankrupt party’s consent.
In recent years, the “anti-assignment” provisions of federal copyright and patent law have limited the transfer of patent and copyright licenses through bankruptcy. Whether the transfer of trademark licenses is likewise limited has been an open question, at least amongst the Circuit Courts of Appeal.
In late July, the Seventh Circuit Court of Appeals found in In re XMH Corp. that trademarks were not assignable.
XMH Corp. involved the former Hartmarx clothing company’s Chapter 11, along with the related filings of several subsidiaries. XMH ultimately sold its assets and assigned contracts to a group of third-party purchasers. Those assets included certain trademark licenses for jeans held by one of the XMH subsidiaries. The trademarks were owned by a Canadian firm.
The Canadian firm objected to the trademark assignment, and the bankruptcy court agreed. The District Court reversed, and the licensor appealed to the Seventh Circuit.
In a succinct, 15-page decision, Judge Posner found that where “applicable law” prohibits the assignment of a trademark, it cannot be assigned through a bankruptcy proceeding absent the trademark owner’s consent.
Judge Posner apparently reached this decision despite a lack of either party to articulate which “applicable law” actually prohibited the assignment:
Unfortunately the parties haven’t told us whether the applicable trademark law is federal or state, or if the latter which state’s law is applicable (the contract does not contain a choice of law provision)—or for that matter which nation’s, since [the licensor] is a Canadian firm. ([The licensee's] headquarters are in the State of Washington.) None of this matters, though, because as far as we’ve been able to determine, the universal rule is that trademark licenses are not assignable in the absence of a clause expressly authorizing assignment. Miller v. Glenn Miller Productions, Inc., 454 F.3d 975, 988 (9th Cir. 2006) (per curiam); In re N.C.P. Marketing Group, Inc., 337 B.R. 230, 235-36 (D. Nev. 2005); 3 McCarthy on Trademarks § 18:43, pp. 18-92 to 18-93 (4th ed. 2010).
But the Seventh Circuit then turned to the question of whether the contract actually contained a valid trademark license - and found that though the agreement appeared to provide a relatively short-term license of the trademark, what remained at the time of the proposed assignment was merely a contract for services.
Despite its brevity, XMH Corp. is instructive in two respects:
- Trademarks cannot be assigned – at least not in the 7th Circuit.
- Contract drafters and negotiators must be careful to identify and preserve the trademark rights at issue.
Sunday, July 10th, 2011
One of the time-honored attractions of US bankruptcy practice is the set of tools provided for the purchase and sale of distressed firms, assets and real estate. In recent years, the so-called “363 sale” has been a favorite mechanism for such transactions – its popularity owing primarily to the speed with which they can be accomplished, as well as to the comparatively limited liability which follows the assets through such sales.
But “363 sales” have their limits: In such a sale, a secured creditor is permitted to “credit bid” against the assets securing its lien – often permitting that creditor to obtain a “blocking” position with respect to sale of the assets.
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Until very recently, many practitioners believed these “credit bid” protections also applied whenever assets were being sold through a Chapter 11 plan. In 2009 and again in 2010, however, the Fifth and Third Circuit Courts of Appeal held, respectively, that a sale through a Chapter 11 Plan didn’t require credit bidding and could be approved over the objection of a secured lender, so long as the lienholder received the “indubitable equivalent” of its interest in the assets (for more on the meaning of “indubitable equivalence,” see this recent post).
Lenders, understandably concerned about the implications of this rule for their bargaining positions vis a vis their collateral in bankruptcy, were relieved when, about 10 days ago, the Seventh Circuit Court of Appeals respectfully disagreed – and held that “credit bidding” protections still apply whenever a sale is proposed through a Chapter 11 Plan.
The Circuit’s decision in In re River Road Hotel Partners (available here) sets up a split in the circuits – and the possibility of Supreme Court review. In the meanwhile, lenders may rest a little easier, at least in the Seventh Circuit.
Or can they?
It has been observed that the Seventh Circuit’s River Road Hotel Partners decision and the Third Circuit’s earlier decision both involved competitive auctions – i.e., bidding – in which the only “bid” not permitted was the lender’s credit bid. The Fifth Circuit’s earlier decision, however, involved a sale following a judicial valuation of the collateral at issue.
Is it possible to accomplish a sale without credit bidding – even in the Seventh Circuit – so long as the sale does not involve an auction, and is instead preceded by a judicial valuation?
Wednesday, July 6th, 2011
Guest-blogger Ray Clark of Valcor (whose prior posts appear here, here, and here) has recently completed a succinct but helpful piece on the valuation of firms in Chapter 11.
Ray’s piece focuses on the supportability of assumptions underlying valuations. As he notes:
Over the last year, there have been a rash of bankruptcy cases and related lawsuits involving challenges to both debtor and creditor financial experts, wherein opposing parties successfully attacked the relevance and reliability of valuation evidence. In a number of cases, even traditional methodologies were disqualified for lack of supportable assumptions, which severely impacted recoveries for various stakeholders.
The piece is here.
Sunday, April 24th, 2011
One of the most effective vehicles for the rescue and revitalization of troubled business and real estate to emerge in recent years of Chapter 11 practice has been the “363 sale.”
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Named for the Bankruptcy Code section where it is found, the “363 sale” essentially provides for the sale to a proposed purchaser, free and clear of any liens, claims, and other interests, of distressed assets and land.
The section has been used widely in bankruptcy courts in several jurisdictions to authorize property sales for “fair market value” . . . even when that value is below the “face value” of the liens encumbering the property.
In the Ninth Circuit, however, such sales are not permitted – unless (pursuant to Section 363(f)(5)) the lien holder “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”
A recent decision issued early this year by the Ninth Circuit Bankruptcy Panel and available here) provides a glimpse of how California bankruptcy court are employing this statutory exception to approve “363 sales.”
East Airport Development (EAD) was a residential development project in San Luis Obispo which, due to the downturn of the housing market, never came completely to fruition.
Originally financed with a $9.7 million construction and development loan in 2006, EAD’s obligation was refinanced at $10.6 million in mid-2009. By February 2010, the project found itself in Chapter 11 in order to stave off foreclosure.
A mere two weeks after its Chapter 11 filing, EAD’s management requested court authorization to sell 2 of the 26 lots in the project free and clear of the bank’s lien, then to use the excess proceeds of the sale as cash collateral.
In support of this request, EAD claimed the parties had previously negotiated a pre-petition release price agreement. EAD argued the release price agreement was a “binding agreement that may be enforced by non-bankruptcy law, which would compel [the bank] to accept a money satisfaction,” and also that the bank had consented to the sale of the lots. A spreadsheet setting forth the release prices was appended to the motion. The motion stated EAD’s intention to use the proceeds of sale to pay the bank the release prices and use any surplus funds to pay other costs of the case (including, inter alia, completion of a sewer system).
The bank objected strenuously to the sale. It argued there was no such agreement – and EAD’s attachment of spreadsheets and e-mails from bank personnel referencing such release prices ought to be excluded on various evidentiary grounds.
The bankruptcy court approved the sale and cash collateral use over these objections. The bank appealed.
On review, the Ninth Circuit Bankruptcy Appellant Panel found, first, that the bankruptcy court was within the purview of its discretion to find that, in fact, a release price agreement did exist – and second, that such agreement was fully enforceable in California:
It is true that most release price agreements are the subject of a detailed and formal writing, while this agreement appears rather informal and was evidenced, as far as we can tell, by only a few short writings. However, this relative informality is not fatal. The bankruptcy court is entitled to construe the agreement in the context of and in connection with the loan documents, as well as the facts and circumstances of the case. Courts seeking to construe release price agreements may give consideration to the construction placed upon the agreement by the actions of the parties. . . . Here, the parties acted as though the release price agreement was valid and enforceable and, in fact, had already completed one such transaction before EAD filed for bankruptcy. On these facts, [EAD] had the right to require [the bank] to release its lien on the two lots upon payment of the specified release prices, even though [the bank] would not realize the full amount of its claim. More importantly, [EAD] could enforce this right in a specific performance action on the contract. For these reasons, the sale was proper under § 363(f)(5).
The Ninth Circuit Bankruptcy Appellate Panel’s East Airport decision provides an example of how bankruptcy courts in the Ninth Circuit are creatively finding ways around legal hurdles to getting “363 sales” approved in a very difficult California real estate market. It likewise demonstrates the level of care which lenders’ counsel must exercise in negotiating the work-out of troubled real estate projects.
Tuesday, March 22nd, 2011
Last month, the Delaware Bankruptcy Court offered an interesting look at the preemptive effect of federal aircraft registration statutes on state law recordation requirements under the UCC.
Eclipse Aircraft Corporation (“Aircraft”), an aircraft manufacturer, filed a 2008 Chapter 11 proceeding in Delaware with about 26 aircraft orders unfinished, and in various stages of production. Aircraft’s efforts to sell its business assets through a “Section 363” sale ultimately proved unfruitful, and the case was converted to a Chapter 7. The appointed Chapter 7 trustee immediately sought authorization for another “Section 363” sale, this time to Eclipse Aerospace Inc. (“Aerospace”).
Aircraft’s customers holding pending but unfilled orders (the WIP Customers”) didn’t oppose the trustee’s sale per se, but did seek a determination that they held property interests in their respective, partially completed planes and parts which were superior to any interests and rights held by Aircraft’s bankruptcy estate, and that these rights entitled them to various equitable remedies such as replevin and specific performance, as well as the imposition of equitable liens and constructive trusts on the unfinished planes and parts.
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Aerospace moved for summary judgment on theory that the WIP Customers’ imposition of a constructive trust required a showing of fraudulent conduct – and that Aircraft had never acted improperly.
Aerospace argued further that the Federal Aviation Administration (FAA) registration statute preempted the Uniform Commercial Code (UCC) (on which a number of the WIP Customers’ claims were based), thereby preventing them from asserting interests in partially completed planes based on their UCC filings.
In a brief decision, Bankruptcy Judge Mary Walrath reasoned that Aerospace’s “preemption” argument involved the impact of two decisions – Philko Aviation, Inc. v. Shacket, 462 U.S. 406 (1983) and Stanziale v. Pratt & Whitney (In re Tower Air, Inc.), 319 B.R. 88 (Bankr.D.Del.2004) – on the federal “registration” requirements applicable to any “aircraft.”
According to Judge Walrath, Philko stands for the broad proposition that “every aircraft transfer must be evidenced by an instrument, and every such instrument must be recorded [thereby preempting state law recordation statutes], before the rights of innocent third parties can be affected.” See 462 U.S. at 409-10. Therefore, it would not be enough for the WIP Customers to argue, as they did, that the mere failure to register a plane with the FAA (and to record that registration) meant it wasn’t an “aircraft.”
But what Philko might have taken away from the WIP Customers, Tower Air returned: Tower Air, according to Judge Walrath, held that Philko and its following decisions applied only to complete aircraft – and not to aircraft components or parts. See 319 B.R. at 95 (finding that Philko and its progeny “involved the conveyance of aircraft in their entirety, and neither involved or made any reference whatsoever to engines or components separate and apart from the aircraft.”).
Consequently, an unfinished plane isn’t really a plane – at least not for purposes of federal preemption.
Judge Walrath made comparatively short work of Aerospace’s other theories. She noted that, despite Aerospace’s arguments to the contrary, applicable state law did not require fraudulent or wrongful conduct for the imposition of a constructive trust, but rather the mere “breach of any legal or equitable duty” or the “commission of a wrong.” Aerospace’s further argument that the WIP Customers were unsecured creditors as a result of Aircraft’s insolvency wasn’t properly raised in its initial request for summary judgment – and therefore wouldn’t serve as the basis for such a judgment.
Saturday, March 12th, 2011
Chapter 15 of the US Bankruptcy Code, enacted in 2005, was Congress’ effort to make cross-border insolvency proceedings just a little more predictable.
Specifically, the statute’s policy objective was to ”recognize” the efforts of foreign insolvency administrators and trustees to administer their debtors’ US-based assets – thereby helping to “standardize” the way assets and claims are treated in non-US insolvency proceedings.
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Chapter 15 reflects a strong Congressional preference for what has been described as a “universalist” (rather than a “territorial”) approach to cross-border insolvency administration. But have US Bankruptcy Courts actually followed through on this “universalist” policy?
That is the question behind an empirical study on Chapter 15 recently published by Jeremy Leong, an advocate and solicitor with Singapore’s Wong Partnership. According to Mr. Leong, the study (entitled IS CHAPTER 15 UNIVERSALIST OR TERRITORIALIST? EMPIRICAL EVIDENCE FROM UNITED STATES BANKRUPTCY COURT CASES, and forthcoming in the Wisconsin International Law Journal) and its results indicate that, despite its ostensibly “universalist” objectives:
United States courts applying Chapter 15 have not unconditionally turned over [the] debtor’s assets in the United States to foreign main proceedings. The results of the study show that while United States courts recognized foreign proceedings in almost every Chapter 15 case, courts entrusted United States assets to foreign proceedings for distribution in only 45.5% of cases where foreign proceedings were recognized. When such entrustment was granted, 31.8% of cases were accompanied by qualifying factors[,] including orders which protected United States creditors by allowing them to be paid according to the priority scheme under United States bankruptcy law[,] or assurances that certain United States creditors would be paid in full or in priority. In only 9.1% of cases, entrustment of assets for distribution was ordered without any qualifications and where there were US creditors and assets at stake.
Based on this data, Mr. Leong goes on to conclude that “when deciding Chapter 15 cases, United States courts seldom grant entrustment [of assets for foreign distributions] without [protective] qualifications when United States creditors may be adversely affected.” Consequently, ”Chapter 15 is not as universalist as its proponents claim it to be and exposes the inability of Chapter 15 to resolve conflicting priority rules between the United States and foreign proceedings.”
Mr. Leong’s study is commendable as one of the earliest pieces of empirical work on how Chapter 15 is actually applied. But it raises some questions along the way. For example:
- Is a 45.5% “entrustment” rate really accurate? Mr. Leong’s claim that “courts entrusted United States assets to foreign proceedings for distribution in only 45.5% of cases where foreign proceedings were recognized” does not really compare apples to apples. That is, it measures the “entrustment” of assets across all recognized foreign proceedings – and not the smaller subset of proceedings where entrustment was actually requested.
According to Mr. Leong’s study results, “of the 88 cases where recognition was granted, the [US bankruptcy] court made orders for [e]ntrustment in only 40 cases. Of the remaining 48 cases where [e]ntrustment was not granted, [e]ntrustment had been requested by foreign representatives in 25 of these cases.” In other words, “entrustment” of assets was requested in 65 of the cases in Mr. Leong’s sample – and in those cases, it was granted in 40, providing a 61.5% success rate for the “entrustment” of assets, rather than the study’s advertised 45.5% success rate.
- Is a 45.5% “entrustment” rate really all that bad? Success rates – like many other statistics – are significant only by virtue of their relative comparison to other success rates. Assuming for the moment that the 45.5% “entrustment” rate observed where US courts apply Chapter 15 was indeed accurate, how does that rate compare against similar requests in the insolvency courts of other sophisticated business jurisdictions applying their own recognition statutes?
Without such benchmarks or relative rankings, the conclusion that US courts are not “universal” seems premature.
- Is “asset entrustment” really the true measure of “universalism?” Finally, and perhaps most fundamentally, Mr. Leong’s focus on the “entrustment” of assets – i.e., the turnover of US-based assets for distribution in a foreign insolvency case – seems to neglect the other reasons for which a US bankruptcy court’s recognition of cross-border insolvency might be sought. Such reasons include the “automatic stay” of US-initiated litigation against the debtor, access to US courts for the purpose of gaining personal jurisdiction over US-based defendants and the recovery of assets, and access to the “asset sale” provisions of the US Bankruptcy Code which automatically apply along with recognition under Chapter 15.
Given the breadth of strategic reasons for seeking recognition of a foreign insolvency in the United States (many of which are unrelated, at least directly, to the ultimate distribution of assets), the study’s focus on “entrustment” as a measure of “universalism” may be over-narrow.
These questions aside, however, Mr. Leong’s study asks thought-provoking and empirically-grounded questions about the true nature of “universalism” as applied in US bankruptcy courts. It is an important initial step in framing the proper assessment of cross-border insolvencies in coming years.