Legislation and Rules
Avoidance and Recovery
|The South Bay Law Firm Law Blog highlights developing trends in bankruptcy law and practice. Our aim is to provide general commentary on this evolving practice specialty.|
Legislation and Rules
Avoidance and Recovery
Proofs of Claim
Avoidance and Recovery
Bankruptcy and Insolvency News and Analysis – Week of June 16 – 20, 2014:
Secured Lending and Claims:
Executory Contracts and Intellectual Property:
Jurisdiction and Bellingham Analysis:
And Still More:
Some of the week’s top bankruptcy and restructuring headlines:
And Still More:
An old and well-known proverb warns: “It is better to remain silent and be thought a fool than to speak and remove all doubt.” Over against this timeless advice, however, a very recent Second Circuit offers more specific guidance for creditors of a bankrupt debtor:
“The squeaky wheel gets the grease.”
In Adelphia Recovery Trust v. Goldman, Sachs & Co., et al., a creditors’ trust established to recover transfers under Adelphia Communications’ confirmed Chapter 11 plan of reorganization sought unsuccessfully to recover “margin call” payments made to Goldman, Sachs & Co. The Second Circuit Court of Appeals agreed with the lower courts in determining that the commingled funds used to make the payments had been taken from a “concentration account” scheduled as property of one of Adelphia Communications’ subsidiaries; consequently the funds were not Adelphia Communications’ to recover, and the trust could not belatedly be re-characterized them as such. A copy of the decision is available here.
In 2002, Adelphia Communications Corporation and related subsidiaries entered Chapter 11 bankruptcy following the disclosure of fraudulently concealed, off-balance sheet debt on Adelphia Communications’ books. The companies were ultimately liquidated and their secured creditors paid in full. In addition, all of the unsecured debt of Adelphia Communications’ subsidiaries was paid in full, with interest, and Adelphia Communications’ general creditors were paid in part. Under Adelphia Communications’ Chapter 11 Plan (confirmed in early 2007 – about 2½ years after the company entered bankruptcy), those same unsecured creditors were to receive the proceeds of the Adelphia Recovery Trust. The Trust was charged with recovery of, among other things, fraudulent transfers made by Adelphia Communications prior to the commencement of the Adelphia cases.
It was not until 2009 that the Trust identified as funds belonging to Adelphia Communications certain commingled funds held in a “concentration account” of one of Adelphia Communications’ subsidiaries. Those funds, it was alleged, were used to cover “margin calls” made by Goldman Sachs & Co. in connection with margin loans previously made to Adelphia Communications’ founders and primary stockholders and collateralized by Adelphia Communications stock. Goldman Sachs had issued the margin calls as the value of Adelphia Commutations stock declined amidst revelations of Adelphia Communications’ off-balance sheet debt.
Goldman Sachs sought, and obtained, summary judgment in the District Court on the basis that the funds in question had been paid by Adelphia Communications’ subsidiary – and not by Adelphia Communications. The Recovery Trust appealed, arguing that the funds in question were, in fact, owned by Adelphia Communications. The Second Circuit Court of Appeals disagreed and affirmed the District Court’s ruling.
The Second Circuit explained that the commencement of a bankruptcy case triggers a number of requirements for a debtor. Among these is the mandatory requirement that the debtor must submit a schedule of all its interests in any property, wherever situated. Ultimately, the debtor must propose a plan which distributes this property within a defined priority scheme, and in the manner most advantageous for the greatest number of creditors.
The plan must also designate classes of claims and classes of interests and specify how the debtor will attend to these classes. Once the relevant parties, including the creditors, approve the debtor’s plan, the court confirms the plan and binds all parties. It is therefore crucial that all claims and interests must be settled before the plan is finalized and within the time frame allotted by the Bankruptcy Code.
The Second Circuit found that the commingled funds sought by the Adelphia Recovery Trust were claimed by one of Adelphia Communications’ subsidiaries during the bankruptcy proceeding. Those claims were asserted without objection from Adelphia Communications’ creditors. The Trust’s subsequent claim to those assets in a subsequent proceeding was therefore inconsistent with creditors’ earlier stance. Under the doctrine of judicial estoppel, parties (and their successors) cannot be allowed to change their positions at their convenience. Consistent with this doctrine, disturbing claims and distributions at such an advanced stage of the proceedings to address the creditors’ changed position would undermine the administration of Adelphia Communications’ and its subsidiaries’ related cases. It would also threaten the integrity and stability of the bankruptcy process by encouraging parties to alter their positions at their whim, as and whenever convenient.
Adelphia Recovery Trust highlights three important realities of bankruptcy practice:
- First, the filing of a debtor’s bankruptcy schedules is more than a merely a perfunctory act. It is a preliminary statement, made to the best of the debtor’s belief and under penalty of perjury, of the debtor’s assets (including all of its ownership interests in any property, anywhere) and its liabilities. Ultimately, creditors and other interested parties – and the court itself – rely upon those schedules in determining the debtor’s compliance with the reorganization requirements of Bankruptcy Code section 1129.
– Second, related debtors are commonly related in much more than name or ownership. In addition to inter-company transfers and claims between debtors, it is common for such enterprises to separate functional asset ownership from legal asset ownership. This distinction may be an important one for various groups of creditors seeking additional sources of recovery.
– Third (and finally), creditors – and the professionals who represent them – should thoroughly investigate any and all “control,” commingling, and other aspects of the relationships between related debtors which may give rise to indirect ownership of assets. Where doubt or conflicting claims exist as to specific assets, it is important for parties with competing claims to reserve their rights early and clearly – thereby making themselves the “squeaky wheel” in the event of any future “grease.”
It often happens that, upon commencement of a bankruptcy case, property which is part of the debtor’s bankruptcy estate is not held or controlled by the trustee (or debtor-in-possession). To recover that property, Bankruptcy Code section 542 permits the trustee to seek its turnover from the party holding it.
Until very recently, Ninth Circuit law left unanswered the question of whether a party who at one point may have held estate property could remain liable for its turnover even after that property had been transferred elsewhere. Shapiro v. Henson answers that question in the affirmative.
In a case of first impression, the Ninth Circuit Court of Appeals expanded the trustee’s ability to seek turnover of estate property. In its analysis, the Court took cues from Section 542’s language which suggests that possession of property may not necessarily be mandatory for turnover. To support its interpretation of S. 542(a), the Court also reviewed turnover practices before the Bankruptcy Code was promulgated. Among these, the Court noted that ‘plenary proceedings’ did not require the present possession of property. The pre-Code possibility of a turnover of property of the bankruptcy estate without possession strengthened the Court’s similar reading of the present statute.
The Ninth Circuit Court also examined Section 550(a), which empowers trustees to recover from initial and intermediate transferees. Under the Ninth Circuit’s analysis, this section would be redundant if “present possession” was always a requirement for such recovery. Further, if possession or property was a must for seeking the property’s turnover, merely transferring the property in question would be an easy way to avoid the trustee’s reach. Finally, the Court considered (but rejected) the analysis behind Eighth Circuit rulings, which designate possession as a pre-requisite to turnover recovery.
In a nutshell Shapiro v. Henson‘s result means:
Shapiro v. Henson protects bankruptcy trustees from having to “chase” estate property through multiple transferees. But it does so at the cost of an added level of risk imposed on those initial holders of estate property who may not have notice of the debtor’s bankruptcy – or may be unable to prevent transfer of the property.
“The humorist Douglas Adams was fond of saying, ‘I love deadlines. I love the whooshing sound they make as they fly by.’ But the law more often follows Benjamin Franklin’s stern admonition: ‘You may delay, but time will not.’ To paraphrase Émile Zola, deadlines are often the terrible anvil on which a legal result is forged.”
With these words, Ninth Circuit Court of Appeals last week declined to retroactively extend Federal Rule of Bankruptcy Procedure 4007(c)’s deadline to file a non-dischargeability complaint. That deadline permits creditors only 60 days following an individual debtor’s initial meeting of creditors (otherwise known as the debtor’s “section 341(a) meeting”) to file a complaint to have certain types of debt determined non-dischargeable, unless a request for extension of the deadline is filed within the same, initial 60-day period.
The case before the 3-judge panel involved a creditor who had, in fact, previously obtained an extension to file a non-dischargeability complaint – but who, due to internal word-processing difficulties with conversion to the “Portable Document Format” (*.pdf) format now required for electronic filings with federal bankruptcy courts, missed the extended deadline by less than an hour.
The brief, 14-page decision (available here) upheld prior rulings in the same matter by both the Bankruptcy Court and the District Court. It raised, but did not answer, the question of what happens when a missed deadline is due to external problems (e.g., technical difficulties with the Bankruptcy Court’s filing system), rather than problems with counsel’s IT configuration or office procedures. But it also declined to recognize an “equitable exception” to the rule in the absence of a Supreme Court directive to the contrary:
We acknowledge that the U.S. Supreme Court has not expressly addressed whether FRBP 4007(c)’s filing deadline admits of any equitable exceptions and that lower courts are divided on the issue. See Kontrick v. Ryan, 540 U.S. 443, 457 & nn.11–12 (2004) (declining to decide question and noting circuit split). We need not, and do not, reach the question of whether external forces that prevented any filings—such as emergency situations, the loss of the court’s own electronic filing capacity, or the court’s affirmative misleading of a party—would warrant such an exception. See, e.g., In re Kennerley, 995 F.2d at 147–48; see also Ticknor v. Choice Hotels Intern., Inc., 275 F.3d 1164, 1165 (9th Cir. 2002). . . . In short, absent unique and exceptional circumstances not present here, we do not inquire into the reason a party failed to file on time in assessing whether she is entitled to an equitable exception from FRBP 4007(c)’s filing deadline; under the plain language of the rules and our controlling precedent, there is no such exception.
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.
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.”