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.
Thursday, December 15th, 2011
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Nearly 16 months ago, this blog covered the story of Qimonda AG – a German chip manufacturer whose cross-border liquidation created waves on both sides of the Atlantic. As noted in that prior post, Qimonda’s insolvency proceeding illustrates what can happen when one country’s rules governing the treatment of an insolvent firm’s intellectual property assets collide with those of another.
But what can happen is not always what does happen.
As a liquidating entity, Qimonda’s primary assets were its portfolio of patents, licensed to other firms under a series of cross-licensing agreements. Though not completely settled law in Germany, patent cross-licenses are widely viewed by German practitioners as executory agreements. Such agreements are automatically unenforceable unless the insolvency administrator (the functional equivalent of a trustee under US bankruptcy law) affirmatively elects to perform the contracts. In practice, to avoid any implied election of performance, an insolvency administrator will usually send a letter of non-performance to the counter-party. Consistent with this practice, Qimonda’s administrator had issued non-performance letters to a number of licensees in connection with his proposed disposition with Qimonda’s patents, which were the company’s most valuable remaining asset following a decision to liquidate. The business strategy was to maximize the value of Qimonda’s patents by canceling, then re-negotiating, the company’s patent licenses with Qimonda’s original licensees.
In response, the licensees asserted rights with respect to Qimonda’s US patents under Bankruptcy Code section 365(n), which – contrary to German law – specifically protects the rights of patent licensees in the event of a licensor’s bankruptcy. Qimonda’s recognition under Chapter 15 of the Bankruptcy Code had made Section 365 “applicable” to the company’s ancillary proceedings in the US.
Qimonda’s administrator sought the Bankruptcy Court’s elimination or restriction of Section 365’s applicability to the company’s US patents, in light of his proposed disposition of the patents under conflicting German insolvency law. The Bankruptcy Court restricted 365(n)’s applicability, but the District Court remanded on appeal for a determination of whether doing so was “manifestly contrary to the public policy of the United States” and whether the licensees would be “sufficiently protected” if Section 365(n) did not apply.
After four days of evidentiary hearings and one day of argument, the Bankruptcy Court concluded that:
- Chapter 15 of the US Bankruptcy Code, which is rooted in considerations of comity and deference to the decisions of foreign tribunals, is nevertheless limited by the “sufficient protect[ion] of creditors’ interests.” Moreover, any relief requested by a foreign representative seeking recognition and relief in the US under this statute is further limited when granting such relief “would be manifestly contrary to the public policy of the United States.”
- The protections afforded patent licensees by Section 365(n) have their origins in Congressional reaction to the Fourth Circuit’s decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), a decision involving the debtor’s rejection of a fully paid-up license to a non-bankrupt licensee for use of the debtor’s metal coating technology. Most disturbingly for Congress, the Lubrizol court found that rejection under Section 365(a) effectively prohibited the licensee’s continued receipt of specific performance under the agreement, even if that remedy would otherwise be available under a breach of this type of contract. Congress’ answer to the Lubrizol decision was to pass the “Intellectual Property Licenses Act of 1987,” which included the licensee protections of Section 365(n). According to the Congressional history behind the statute, adoption of the legislation was intended to “immediately remove [the threat of license rejection] and its attendant threat to American [t]echnology and will further clarify that Congress never intended for Section 365 to be so applied.”
- Though the nature of patent cross-licensing made it difficult – if not impossible – for the parties to establish whether the cancellation of licenses for specific patents would put at risk the licensees’ investment in manufacturing or sales facilities in the US for products covered by US patents, the administrator’s threat of infringement litigation following cancellation of Qimonda’s patent licenses was as damaging to licensees as an actual finding of infringement of specific patents. This risk, balanced against the loss in value to Qimonda’s patent portfolio, warranted the application of Section 365(n) to the administrators disposition of the company’s US patents.
- Application of the German insolvency law as an exercise of comity would “severely impinge . . . a U.S. statutory . . . right such that deferring to German law would defeat ‘the most fundamental policies and purposes’ of such right.’” For the Bankruptcy Court, the question of whether or not Section 365(n) was intended to protect a “fundamental” US policy was an extremely close one. But “[a]lthough [technological] innovation [in the US] would obviously not come to a grinding halt if licenses to U.S. patents could e cancelled in a foreign insolvency proceeding, . . . the resulting uncertainty would nevertheless slow the pace of innovation, to the detriment of the U.S. economy.” As a result, the failure to apply Section 365(n) to Qimonda’s US patent portfolio “would ’severely impinge’ an important statutory protection accorded licensees of U.S. patents and thereby undermine a fundamental U.S. public policy promoting technological innovation” – and as such, deferring to German law would be “manifestly contrary to U.S. public policy.”
The Bankruptcy Court’s most recent decision is available here.
Saturday, June 25th, 2011
On Thursday, the US Supreme Court released its second decision in the long-runing battle between the estate of Vickie Lynn Marshall (aka Anna Nicole Smith) and her erstwhile son-in-law, Pierce Marshall.
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The 63-page slip opinion, available here, illustrates how the result of a high-profile celebrity bankruptcy can ultimately turn on arcane, esoteric matters of jurisdiction – and how such esoterica can be potentially ground-shifting for the US Bankruptcy Court system which has been in effect since its first constitutional challenge in 1984.
A small portion of the already considerable commentary evolving in conventional media and in the blogosphere appears below.
Sunday, June 12th, 2011
Personal liability for corporate debt has been all the rage in the Ninth Circuit. Within the last year, at least two appellate decisions (discussed here and here) have clarified the doctrine of alter ego liability – the idea that a corporate entity and its principals ought to be treated as one and the same, and therefore equally liable for corporate obligations.
It is easy to see why interest in alter ego liability has become so fashionable: When a business slips into insolvency and cannot pay its creditors in full, those creditors naturally go looking for other pockets from which to satisfy their claims.
Cover of Flushed Away (Widescreen Edition)
If creditors can show that the business’ officers effectively ran the business for personal economic purposes rather than as a separate and distinct corporate entity, the doctrine of alter ego permits creditors to hold the officers responsible for the business’ obligations. This is especially the case where it appears the officers used the business to perpetrate a fraud or some other inequity on creditors. One California court noted that “[t]he general purpose of the doctrine of alter ego is to look through the fiction of the corporation and to hold the individuals doing business in the name of the corporation liable for its debts in those cases where it should be so held in order to avoid fraud or injustice.”
Earlier this year, Judge Clarkson of California’s Central District followed this fashion trend by offering his view on a non-dischargeability claim based on alter ego liability.
The facts of In re Munson are relatively straightforward. Robert and Kimberly Munson were the owners – and corporate officers – of Munson Plumbing, Inc. (“MPI”), a plumbing subcontractor on several public works projects in the Los Angeles metropolitan area. As is typically required of public works contractors, MPI’s work was backed by surety bonds issued by SureTec Insurance Company (“SureTec”). As part of the consideration for the issuance of the surety bonds, the Munsons and MPI signed a General Agreement of Indemnity (“SureTec Indemnity Agreement”), in which the Munsons agreed to jointly and severally indemnify SureTec and to deposit collateral with SureTec upon its demand. The SureTec Indemnity Agreement contained language that all project funds received by MPI would be held in trust for the benefit of SureTec.
Eventually, MPI encountered financial difficulties and could not pay its own subcontractors – thereby requiring SureTec to make payments under the bonds and finish MPI’s work.
Concurrent with MPI’s demise, the Munsons commenced individual Chapter 7 proceedings. SureTec, which had been left with over $436,000 in losses related to various MPI projects, asserted claims against the Munsons individually. It also sought to have at least a portion of those losses deemed non-dischargeable in the Munsons’ Chapter 7 case. Specifically, it claimed:
- The SureTec Indemnity Agreement created an express trust which placed fiduciary duties upon the Munsons.
- Further, because the Munsons had allegedly defrauded SureTec by diverting at least $95,000 in progress payments on the projects to non-bonded expenses, including their own personal expenses, applicable fiduciary duties upon the Munsons arose by California statutes (including Business & Professions Code §7108 and Penal Code §§§ 484b, 484c and 506.)
- The Munsons were alter egos of MPI, and therefore were liable for MPI’s obligations under the surety bonds.
- The Munsons’ obligations were non-dischargeable because they arose as a result of the Munsons’ breach of their fiduciary duties.
The Debtors sought dismissal of SureTec’s lawsuit. In a brief, 9-page decision, Judge Clarkson found that:
- The SureTec Indemnity Agreement did not impose fiduciary duties upon the Munsons. “If a trust was created, it imposed the fiduciary duty obligations on the corporation, the receiver and disburser of the project funds. The [Munsons,] [in] signing the [SureTec Indemnity Agreement] were creating only a creditor-debtor relationship (and a contingent one at that) between SureTec and the [Munsons]. They were “indemnifying” SureTec, as SureTec accurately indicates . . . .”
- Any alleged trust relationship created on a constructive, resulting, or implied basis (i.e., arising legally as a result of the Munsons’ allegedly bad acts) is not the sort of trust relationship which gives rise to a non-dischargeable debt. “The core requirements [for asserting non-dischargeability based on breach of a fiduciary duty] are that the [fiduciary] relationship exhibit characteristics of the traditional trust relationship, and that the fiduciary duties be created before the act of wrongdoing and not as a result of the act of wrongdoing.”
- SureTec’s allegations of alter ego liability were likewise insufficient to tag the Munsons with the sort of fiduciary obligations that would give rise to a non-dischargeable claim. “If a finding of alter ego were to be considered as imposing fiduciary duties, any such imposition would be ex maleficio, i.e., trusts that arose by operation of law upon a wrongful act.”
Judge Clarkson also found that SureTec’s separate non-dischargeability claim for fraud had not been pleaded with the requisite particularity, and dismissed it with leave to amend.
The Munson decision is important in several respects:
- It emphasizes the relatively narrow scope of non-dischargeability claims based on breaches of fiduciary duty in the Ninth Circuit.
- It also emphasizes the similarly narrow scope of liability derived from alter ego status.
- It highlights the importance of the alter ego doctrine as a strategic tool for both creditors and trustees in bankruptcy litigation – as well as litigants’ varying success in using it. As detailed in other posts, alter ego liability has been employed (i) unsuccessfully as a “blocking device” in an attempt to capture recoveries for the corporation’s bankruptcy estate; and (ii) successfully to preserve recoveries from self-settled trusts to which the debtors attempted to convey assets out of the reach of creditors. Here, alter ego was employed (again, without success) to “bootstrap” a creditor’s claim into “non-dischargeable” status.
Monday, May 16th, 2011
When a retailer becomes insolvent, suppliers or vendors who have recently provided goods on credit typically have the ability to assert “reclamation” rights for the return of those goods. Retailers may respond to these rights by seeking the protection the federal bankruptcy laws – and, in particular, the automatic stay.
When a retailer files for bankruptcy while holding goods which are subject to creditors’ “reclamation” rights, what should “reclamation” creditors do?
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The Bankruptcy Code itself provides some protection for “reclamation” creditors by providing such creditors additional time in which to assert their claims, and by affording administrative priority for a certain portion for such claims even when they are not formally asserted.
But is merely asserting a reclamation claim under the Bankruptcy Code sufficient to protect a supplier once a retailer is in bankruptcy? A recent appellate decision from Virginia’s Eastern District serves as a reminder that merely speaking up about a reclamation claim isn’t enough.
When Circuit City sought bankruptcy protection in 2009, Paramount Home Entertainment was stuck with the tab for more than $11 million in goods. Though it didn’t object to blanket liens on Circuit City’s merchandise which came with the retailer’s debtor-in-possession financing, and stood by quietly while Circuit City later liquidated its merchandise throug a going-out-of-business sale, Paramount did file a timely reclamation demand as required by the Bankruptcy Code. It also complied with what it understood to be the Bankruptcy Court’s orders regarding administrative procedures for processing its reclamation claims in Circuit City’s case. It was therefore unpleasantly surprised when Circuit City objected to Paramount’s reclamation claim – and when the Bankruptcy Court sustained that objection – on the grounds that Paramount hadn’t done enough to establish or preserve its reclamation rights.
Paramount appealed the Bankruptcy Court’s ruling, claiming that it complied with what it understood to have been the Bankruptcy Court’s administrative procedures for processing reclamation claims. Paramount argued that to have done more (i.e., to have sought relief from the automatic stay to take back its goods or commenced litigation to preserve its rights to the proceeds of such goods) would have disrupted Circuit City’s bankruptcy case.
In affirming the Bankruptcy Court, US District Judge James Spencer held that the Bankruptcy Code, while protecting a creditor’s reclamation rights, doesn’t impose them on the debtor. Instead, a reclaiming creditor must take further steps consistent with the Bankruptcy Code and state law to preserve the remedies which reclamation claims afford. Merely asserting a reclamation claim under the Bankruptcy Code – or under a Bankruptcy Court’s administrative procedure – isn’t enough:
“Filing a demand, but then doing little else in the end likely creates more litigation and pressure on the Bankruptcy Court than seeking relief from the automatic stay. . . or seeking a [temporary restraining order] or initiating an adversary proceeding. In this case, Paramount filed its reclamation demand, but then failed to seek court intervention to perfect that right. As the Bankruptcy Court held, the Bankruptcy Code is not self-executing. Although [the Bankruptcy Code] does not explicitly state that a reclaiming seller must seek judicial intervention, that statute does not exist in a vacuum. The mandatory stay as well as the other sections of the Bankruptcy Code that protect and enforce the hierarchy of creditors create a statutory scheme that cannot be overlooked. Once Paramount learned that Circuit City planned to use the goods in connection with the post-petition [debtor-in-possession financing], it should have objected. It didn’t. To make matters worse, Paramount then failed to object to Circuit City’s liquidation of its entire inventory as part of the closing [going-out-of-business] [s]ales.”
Let the seller beware.
Tuesday, April 5th, 2011
It is axiomatic in American business bankruptcy practice that though they may disagree strenuously on the particulars, all parties to a Chapter 11 case are interested in the same basic goal: maximization of the debtor’s asset values.
Or are they?
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NYU Professor Sarah Woo has recently published an empirically-based analysis of this assumed common goal, and the results of that analysis are striking. As she describes her own research (presented in an article titled “Regulatory Bankruptcy: How Bank Regulation Causes Firesales“):
This Article demonstrates empirically that this assumption is inaccurate: the actions of banks in bankruptcy proceedings are not necessarily driven by value maximization. The findings in this Article have groundbreaking implications for bankruptcy policy which focuses on the debtor and overlooks exogenous creditor-specific factors. Where banks, which extend the bulk of the outstanding credit in the United States, are driven by financial regulatory policy to over-liquidation of their own borrowers, these actions lead to fire sales which potentially amplifyliquidity shocks and systemic risk.
Ms. Woo’s working hypothesis is that changes in the banking sector over the past decade, including increased consolidation and increased leverage, eventually pushed banks to pursue higher portfolio returns. As a result, many banks over-concentrated their portfolios in commercial real estate – a strategy which worked well during frothier times, but which proved disatrous in the aftermath of 2008’s economic collapse.
In the aftermath of the banking crisis, over-concentration by banks drew significant regulatory scrutiny – and, ultimately, significant new regulation designed to pressure banks to reduce their concentration risk. According to Professor Woo:
As with many episodes of financial instability which can be traced to misguided attempts to use regulatory power, pervasive regulatory pressure with capital adequacy as a centerpiece affected bank behavior in bankruptcy, interfering with investment expectations and diminishing asset values. In the case of IndyMac Bank, the bank shed more than a billion dollars of construction and development loans in the first six months of 2008 under regulatory pressure, partly through liquidations in bankruptcy. The actions of bank regulators thus had unintended but dire consequences of rendering the standard assumption of value maximization in bankruptcy policy obsolete by creating a different set of incentives dependent on the bank creditor’s own health. The phenomenon of regulatory bankruptcy thus demands a comprehensive reevaluation of current bankruptcy policy which has not kept up with these developments in the banking industry.
Professor Woo’s work is important, not only for the specific question of how and why banks behave the way they do in bankruptcy, but also as an example of how industry dynamics can mold and shape the bankruptcy process – and further, how empirical data can be marshalled for the benefit of informed legislative change and judicial decision-making.
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.
Monday, March 7th, 2011
Asset sales through bankruptcy are all the rage – they’re presumably [relatively] quick. And just as importantly, they’re perceived as clean – that is, they permit assets to be sold “free and clear” of an “interest” in the property.
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The term “interest” has been construed broadly, and has been interpreted to extend to successor liability claims – including often prohibitively expensive environmental liabilities. Indeed, one recent post on this blog (here) notes the potentially broad reach of bankruptcy court orders authorizing asset sales – and suggests the relief available in some circumstances may even be broader than the Chapter 11 discharge.
But not all courts agree with this conclusion . . . at least not entirely.
Late last month, the Southern District of New York (the same jurisdiction which authorized the “Section 363″ sale of General Motors free and clear of environmental liabilities) reached a different result in the case of In re Grumman Olson Industries, Inc.
Grumman Olson, an auto-body manufacturer whose primary customers were Ford and General Motors, commenced Chapter 11 proceedings nearly nine years ago and completed a “363 sale” of its assets to Morgan Olson, LLC about 6 months after filing. The sale order contained provisions which purported to release both Morgan Olson and the sold assets themselves from any successor liability claims which might arise.
Ms. Frederico, a FedEx employee, sustained serious injuries on October 15, 2008 when the FedEx truck she was driving hit a telephone pole. In a New Jersey lawsuit filed after the accident, the Fredericos claimed that the FedEx truck involved in the accident was manufactured, designed and/or sold by Grumman in 1994, and was defective for several reasons. The Fredericos claimed that Morgan Olson continued Grumman‘s product line, and was, therefore, liable to the Fredericos as a successor to Grumman under New Jersey law. In response, Morgan Olson requested that Bankruptcy Judge Stuart Bernstein re-open the [now closed] Grumman Olson case, then filed an adversary proceeding to determine that the Federico’s claim was barred by the prior sale order.
Both sides sought Judge Bernstein’s summary judgment regarding the Morgan Olson suit. In a 21-page decision, Judge Bernstein ruled (following a brief discussion addressing his continuing jurisdiction to interpret the prior sale order) that Morgan Olson was, indeed, a successor for purposes of the Fredericos’ suit. This was because the Fredericos’ claimed injuries arose not from the assets sold through bankruptcy, or from personal claims against Grumman Olson that arose prior to Grumman’s Chapter 11, but from Morgan Olson’s post-confirmation conduct:
the Fredericos are basing their claims on what Morgan [Olson] did after the sale. According to their state court Amended Complaint, Morgan [Olson] is liable as a successor under New Jersey law because it “continued the product line since the purchase,” “traded upon and benefited from the goodwill of the product line,” “held itself out to potential customers as continuing to manufacture the same product line of Grumman trucks” and “has continued to market the instant product line of trucks to Federal Express.” The Sale Order did not give Morgan [Olson] a free pass on future conduct, and the suggestion that it could is doubtful.
A good portion of Judge Bernstein’s decision is devoted to a discussion of what constitutes a “claim” for bankruptcy purposes – and the circumstances under which an anticipated “future tort claim” (i.e., claim based on a defective product manufactured by the debtor which hasn’t yet caused an injury, but which will at some point in the future) may be addressed through a “Section 363″ sale.
In permitting the Fredericos to proceed with their New Jersey law suit against Morgan Olson, Judge Bernstein’s analysis focused on three areas:
- the Fredericos’ lack of any meaningful “contact” with Grumman prior to the commencement of Grumman’s case or confirmation of Grumman’s Chapter 11 plan;
- the absence of any notice by the Fredericos of the Grumman/Morgan sale; and (though less important than the lack of contact and lack of notice)
- the absence of any provision for such anticipated “future claims” in Grumman’s Chapter 11 plan.
In the end, he observed that “every case. . . addressing this issue has concluded for reasons of practicality or due process, or both, that a person injured after the sale (or confirmation) by a defective product manufactured and sold prior to the bankruptcy does not hold a ‘claim’ in the bankruptcy case and is not affected by either the § 363(f) sale order or the discharge under 11 U.S.C. § 1141(d).”
Judge Bernstein’s Grumman Olson decision serves as an important reminder that “section 363 sales” – though undoubtedly a very powerful tool for disposing of distressed assets quickly and cleanly – do not provide “bullet-proof” protection for any type of liability which might be associated with the debtor’s assets, or with its general product line.