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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:

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.

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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.

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• Supreme Court to Weigh ‘Meaty and Sexy’ Corporate-Bankruptcy Case (blogs.wsj.com)
• Appeals Courts Split on Creditors’ Right to Bid in Auction Sales (dealbook.nytimes.com)

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?

Stay tuned.

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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.

A prior post on this blog featured an article highlighting some of the basic principles from Shari’a law which apply to insolvent individuals and businesses.

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Another, more recent article explores the intriguing question of what happens when an investment structured according to Shari’a law needs to be restructured in a non-Shari’a forum – such as a United States Bankruptcy Court.  The University of Pennsylvania’s Michael J.T. McMillen uses the recent Chapter 11 filing of In re East Cameron Partners, LP as a case study to highlight some of the issues.

According to McMillen:

The issues to be considered [in connection with efforts to introduce Shariah principles into secular bankruptcy and insolvency regimes throughout the world] are legion. Starting at the level of fundamental principle, will the contemplated regime provide for reorganization along the lines of Chapter 11 systems, or will liquidation be the essential thrust of the system?  If, in line with international trends, the system will incorporate reorganization concepts and principles, what is the Sharīʿah basis for this regime?  Even the fundamental questions are daunting.  For example, consideration will need to be given to debt rescheduling concepts, debt forgiveness concepts, delayed debt payment concepts, equity conversion concepts, asset sale concepts, and differential equity conceptions.  There will have to be consideration of whether voluntary bankruptcies can and will be permissible.  And after agreement is reached on the basic nature and parameters of the system, the long road of discovery and elucidation of specific Sharīʿah principles will have to be addressed.  That undertaking will wind through a great deal of new territory, from the Sharīʿah perspective, and will entail a comparative laws analyses, and a systemic comparison, unlike any in history.

The article is available here.

Chapter 11 practice – like so many other professional service specialties – is regrettably jargon-laden.  Businesses that need to get their financial affairs in order “enter restructuring.”  Those that must re-negotiate their debt obligations attempt to “de-leverage.”  And those facing resistance in doing so seek the aid of Bankruptcy Courts in “cramming down” their plans over creditor opposition.

Likewise, the Bankruptcy Code – and, consequently, Bankruptcy Courts – employ what can seem an entirely separate vocabulary for describing the means by which a successful “cram-down” is achieved.  One such means involves providing the secured creditor with something which equals the value of its secured claim: If the secured creditor holds a security interest in the debtor’s apple, for example, the debtor may simply give the creditor the apple – or may even attempt to replace the creditor’s interest in the apple with a similar interest in the debtor’s orange (provided, of course, that the orange is worth as much as the original apple).

The concept of replacing something of value belonging to a secured creditor with something else of equivalent value is known in “bankruptcy-ese” as providing the creditor with the “indubitable equivalent” of its claim – and it is a concept employed perhaps most frequently in cases involving real estate assets (though “indubitable equivalence” is not limited to interests in real estate).  For this reason, plans employing this concept in the real estate context are sometimes referred to as “dirt for debt” plans.

A recent bankruptcy decision out of Georgia’s Northern District issued earlier this year illustrates the challenges of “dirt for debt” reorganizations based on the concept of “indubitable equivalence.”

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Green Hobson Riddle, Jr., a Georgia businessman, farmer, and real estate investor, sought protection in Chapter 11 after economic difficulties left him embroiled in litigation and unable to service his obligations.

Mr. Riddle’s proposed plan of reorganization, initially opposed by a number of his creditors, went through five iterations until only one objecting creditor – Northside Bank – remained.  Northside Bank held a first-priority secured claim worth approximately $907,000 secured by approximately 36 acres of real property generally referred to as the “Highway 411/Dodd Blvd Property,” and a second-priority claim secured by a condominium unit generally referred to as the “Heritage Square Property.”  It also held a judgment lien recorded against Mr. Riddle in Floyd County, Georgia.

A key feature of Mr. Riddle’s plan involved freeing up the Heritage Square Property in order refinance one of his companies, thereby generating additional payments for his creditors.  To do this, Mr. Riddle proposed to give Northside Bank his Highway 411/Dodd Blvd Property as the “indubitable equivalent,” and in satisfaction, of all of Northside’s claims.

Northside Bank objected to this treatment, respectfully disagreeing with Mr. Riddle’s idea of “indubitable equivalence.”  Bankruptcy Judge Paul Bonapfel took evidence on the issue and – in a brief, 9-page decision – found that Mr. Riddle had the better end of the argument.

Judge Bonapfel’s decision highlights several key features of “indubitable equivalent” plans:

-         The importance of valuation.  The real challenge of an “indubitable equivalence” plan is not its vocabulary.  It is valuing the property which will be given to the creditor so as to demonstrate that value is “too evident to be doubted.”  As anyone familiar with valuation work is aware, this is far more easily said than done.  Valuation becomes especially important where the debtor is proposing to give the creditor something less than all of the collateral securing the creditor’s claim, as Mr. Riddle did in his case.  In such circumstances, the valuation must be very conservative – a consideration Judge Bonapfel and other courts recognized.

-       The importance of evidentiary standards.  Closely related to the idea of being “too evident to be doubted” is the question of what evidentiary standards apply to the valuation.  Some courts have held that because the property’s value must be “too evident to be doubted,” the evidence of value must be “clear and convincing” (the civil equivalent of “beyond a reasonable doubt”).  More recent cases, however, weigh the “preponderance of evidence” (i.e., does the evidence indicate something more than a 50% probability that the property is worth what it’s claimed to be?).  As one court (confusingly) put it: “The level of proof to show ‘indubitably’ is not raised merely by the use of the word ‘indubitable.’”  Rather than require more or better evidence, many courts seem to focus instead on the conservative nature of the valuation and its assumptions.

-       The importance of a legitimate reorganization purpose.  Again, where a creditor is receiving something less than the entirety of its collateral as the “indubitable equivalent” of its claim, it is up to the debtor to show that such treatment is for the good of all the creditors – and not merely to disadvantage the creditor in question.  Judge Bonapfel put this issue front and center when he noted, in Mr. Riddle’s case:

[I]t is important to recognize that § 1129(b), the “cram-down” subsection, “provides only a minimum requirement for confirmation … so a court may decide that a plan is not fair and equitable even if it is in technical compliance with the Code’s requirements.” E.g., Atlanta Southern Business Park, 173 B.R. at 448. In this regard, it could be inequitable to conclude that a plan provision such as the one under consideration here is “fair and equitable,” if the provision serves no reorganization purpose. See Freymiller Trucking, 190 B.R. at 916. But in this case, the evidence shows that elimination of the Bank’s lien on other collateral is necessary for the reorganization of the Debtor and his ability to deal with all of the claims of other creditors who have accepted the Plan. No evidence demonstrates that the Plan is inequitable or unfair

In re Riddle, 444 B.R. 681, 686 (Bankr. N.D. Ga. 2011).

Many insolvency practitioners are familiar with the “high-asset” individual debtor – often a business owner or owner of rental property or other significant business and personal assets – whose financial problems are too large for standard “individual debtor” treatment.

Such debtors are a prominent feature of commercial insolvency practice in California and other western states.  These individuals typically have obligations matching the size of their assets:  Their restructuring needs are too large for treatment through an “individual” Chapter 13 reorganization, and must instead be handled through the “business” reorganization provisions of a Chapter 11.

When Congress amended the Bankruptcy Code in 2005, it recognized the need of some individuals to use the reorganization provisions of Chapter 11.  It provided certain amendments to Chapter 11 which parallel the “individual” reorganzation provisions of Chapter 13.

But certain “individual” reorganization concepts do not translate clearly into Chapter 11’s “business” provisions.  Among the most troublesome of these is the question of whether an individual debtor can reorganize by paying objecting unsecured creditors less than 100% while continuing to retain existing property or assets for him- or herself.

In Chapter 13, the answer to this question is “yes.”  But in Chapter 11 – at least until 2005 – the answer has historically been “no.”  This is because Chapter 11, oriented as it is toward business reorganization, prohibits a reorganizing debtor from retaining any property while an objecting class of unsecured creditors is paid something less than the entirety of its claims.  Known as the “absolute priority rule,” this prohibition has been a mainstay of Chapter 11 business practice for decades.

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In 2005, Congress amended Chapter 11’s “absolute priority rule” provisions to provide that despite the “absolute priority” rule, individual Chapter 11 debtors could nevertheless retain certain types of property, even when objecting unsecured creditors are paid less than 100%.  For instance, an individual debtor may retain certain wages and earnings earned after the commencement of the debtor’s case.  But can the individual debtor retain other types of property (for example, a rental property or closely held stock in a business), while paying objecting creditors less than 100%?

Congress’ “absolute priority rule” amendments for individual debtors are ambiguous – as is the language of a section which expands the definition of “property” included within the individual Chapter 11 debtor’s estate (paralleling similar treatment of individual Chapter 13 debtors).  As a result, Bankruptcy Courts are split on the question of whether or not the “absolute priority rule” applies to individual Chapter 11 debtors.

Until very recently, the Central District of California – one of the nation’s largest, and a frequent filing destination for individual Chapter 11 cases – had been silent on the issue.  This month, however, Judge Theodor Albert of Santa Ana joined a growing number of courts which conclude that Congress’ 2005 “absolute priority rule” amendments apply only to individual wages and earnings, and that individuals cannot retain other types of property where objecting creditors are paid less than 100%.

In a careful, 13-page decision issued for publication, Judge Albert collected and examined cases on both sides of this question and concluded:

After BAPCPA, the debtor facing opposition of any one unsecured creditor must devote 5 years worth of “projected disposable income,” at a minimum (or longer if the plan is longer).  But [the] debtor is not compelled to give also his additional earnings or after-acquired property net of living expenses beyond five years unless the plan is proposed for a period longer than five years.  But there is no compelling reason to also conclude that prepetition property need not be pledged under the plan as the price for cram down, just as it has always been.

Judge Albert’s decision joins several other very recent ones going the same direction, including In re Walsh, 2011 WL 867046 (Bkrtcy.D.Mass., Judge Hillman); In re Stephens, 2011 WL 719485 (Bkrtcy.S.D.Tex., Judge Paul); and In re Draiman, 2011 WL 1486128 (Bkrtcy.N.D.Ill., Judge Squires).

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From Florida’s Northern District comes a cautionary tale of what can go wrong when distressed real estate requires restructuring.  A copy of the decision is available here.

Davis Heritage GP Holdings, LLC (“Debtor”) was a family-owned LLC formed in 2002 to “hold, develop, and sell condominium development properties in Mississippi and Louisiana.”  Its sole assets were membership interests in a series of single-member “middle-tier” LLC’s, which themselves held no assets except for interests in a series of single-member “lower-tier” LLC’s – each formed to hold separate parcels of real property.

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In December 2010, the Debtor sought protection under Chapter 11, ostensibly to deal with the adverse effects of a judgment entered against it.  None of the “middle-tier” or “lower-tier” LLC’s had sought bankruptcy protection.  Despite their separate, three-tier structure, the Debtor’s management adminstered them as if they were a single business enterprise.  Until very shortly before the Debtor’s Chapter 11 filing, the expenses and income of the enterprise were processed through the Debtor’s bank account.  In fact, none of the “lower tier” LLCs held bank accounts in their names until after meeting with the Debtor’s bankruptcy counsel.  From at least January 2007 through August 2010, the Debtor’s bank accounts contained several millions of dollars, at one time exceeding $22 million.  The Debtor’s principals have used the Debtor’s accounts freely, to receive and disburse money to and from whomever the principals chose at any given time.  Despite this fact, the Debtor only disclosed one bank account in its Schedule B and did not disclose, but rather affirmatively denied, making any transfers to insiders within one year pre-petition.

Finally, the Debtor never disclosed the properties owned by the “lower tier” LLCs (or their income and expenses) in its Schedules or any other papers filed with the Court. Nevertheless, the Debtor’s Plan is based entirely upon the liquidation of some of those very properties.

The Debtor’s difficulties arose out of the purchase of land and subsequent construction of the 21-story “Beau View” luxury condominium tower in Biloxi, Mississippi.  In exchange for the land, the Debtor had executed two junior-priority promissory notes to the seller, and obtained a senior-priority acquisition loan from Wells Fargo.  The Debtor then financed construction with a separate loan – also from Wells Fargo – and completed the tower.

Though it made considerable progress selling condominium units and repaying Wells Fargo’s construction loan, the Debtor made only sporadic payments on its purchase notes to the seller.  Eventually, the seller obtained a judgment on the note in Mississippi, then domesticated that note in Florida and sought to foreclose on all of the debtor’s membership interests in the “middle tier” LLC’s.

To avoid foreclosure on its “middle tier” LLC interests, the Debtor made a $200,000 payment in exchange for 60 days’ forbearance – then, promptly, sought Chapter 11 protection.  At the time of filing, the Wells Fargo construction loan and acquisition loans were current.  The Debtor had permitted two mortgage loan actions filed against two of the “lower tier” LLC’s by Sun Trust Bank to go to default judgment.

Very shortly after filing, the seller of the Biloxi property sought relief from stay to continue its foreclosure on the “middle tier” LLC interests – or, in the alternative, dismissal of the Debtor’s Chapter 11 case.  The Debtor countered with an emergency motion for the sale of certain assets – and, a day prior to the hearing on the stay relief motion, a Chapter 11 Plan.

In reviewing the evidence and determining that dismissal of the Debtor’s case was appropriate, the court observed:

[W]hen determining whether to grant stay relief for cause or dismiss a chapter 11 case, . . . a number of factors may evidence an “intent to abuse the judicial process and the purposes of the reorganizationprovisions” . . . . . Those factors include:

a. the debtor has only one asset, the property;

b. the debtor has few unsecured creditors whose claims are small in relation to the claims of the secured creditors;

c. the debtor has few employees;

d. the property is the subject of a foreclosure action as a result of arrearages of the debt;

e. the debtor’s financial problems involve essentially a dispute between the debtor and the secured creditors which can be resolved in the pending state court action; and

f. the timing of the debtor’s filing evidences an intent to delay or frustrate the legitimate efforts of the debtor’s secured creditors to enforce their rights . . . . Once a court finds that the above factors are present, “[t]he possibility of a successful reorganization cannot transform a bad faith filing into one undertaken in good faith.” All of the [above-referenced] bad faith factors are present in this case, as are additional factors indicating bad faith. . . . The Debtor’s financial problems involve a two-party dispute between it and [the judgment creditor] that can be resolved in state court. Also, the timing of this petition shows an intent to delay or frustrate the legitimate collections efforts of [the judgment creditor]—who is the only real direct creditor of the Debtor . . . .

The court then went on to explain why the essence of the Debtor’s Chapter 11 plan – essentially, an effort to pay Wells Fargo and Sun Trust at the expense of the seller of the Biloxi property – was a “sort of reverse marshalling” inappropriate for Chapter 11 under the facts of this case:

Unlike the traditional single asset case where a main creditor is stayed from collecting out of the debtor’s only asset, this case involves a three-tier corporate structure created by the Debtor and its principals whereby [the Biloxi land seller and judgment creditor] is the only creditor that is adversely affected by the automatic stay.  See 11 U.S.C. § 362(a).  All other creditors of the Debtor with claims to the properties owned by the “lower tier” LLCs are free to pursue those claims through foreclosure on those real properties, thereby diminishing the value of the Debtor’s only asset (membership in the “middle tier” LLCs), beyond the control of [the judgment creditor].  This fact is illustrated by Sun Trust’s pursuit of its post-petition mortgage foreclosure litigation against [two "lower-tier" LLC] properties, which has been unopposed by the Debtor and its principals.  Similarly, [the Debtor's] testimony states that in spite of the bankruptcy, and the way the enterprise has historically been managed, all of the “lower tier” LLCs are doing business as usual, renting units, offering units for sale, selling property, signing contracts for sale, and paying their bills.  After a history of treating all the entities as a single corporate enterprise, the Debtor now takes the position that it lacks control of its wholly-owned subsidiaries and only it, the Debtor, is subject to the rules and constraints of Chapter 11.

In reviewing Chapter 11 cases alleged to have been filed in bad faith, courts may look to all of the evidence and the totality of the circumstances to determine what is really happening, and the true intent and purpose behind the filing. . . .  Here, the true intent and effect of this case and the Debtor’s Plan are plain: the Debtor’s insiders seek to donate assets subject to [the judgment creditor's] judgment lien to Sun Trust and Wells Fargo in order to shield their own assets and money from those creditors.  This scheme, memorialized in the Debtor’s Chapter 11 Plan, amounts to a kind of reverse marshaling.  The Plan takes the only assets available to [the judgment creditor] (and subject to its levy), property owned not by the Debtor but by the “lower tier” LLCs, and shifts that property to Sun Trust and Wells Fargo, creditors with claims [are] secured by other assets owned by the insiders.  This Plan reduces the amount that [the judgment creditor] may collect and simultaneously reduces the guarantors’/insiders’ liability to Sun Trust and Wells Fargo.

The court’s discussion of what constitutes “bad faith” in filing a Chapter 11 case is instructive, as is its analysis of how “bankruptcy remote” entities can be treated in the absence of related Chapter 11 filings.

A South Carolina bankruptcy court decision issued earlier this month highlights and illustrates the perils facing individual sole proprietors who struggle to reorganize their financial affairs through the Chapter 11 process.

The debtors – a husband and wife who owned a business and several pieces of rental property – filed a Chapter 11 in November 2009, but the case was dismissed approximately 10 months later.  In February this year, while their appeal of that dismissal was pending, they filed a second Chapter 11.

When an individual debtor seeks bankruptcy protection for a second time within 12 months, Section 362(c)(3) (added in connection with the 2005 BAPCPA amendments) terminates the automatic stay by default unless, within 30 days, the debtor can demonstrate that their second attempt is in “good faith.”

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Put another way, an individual debtor’s second attempt at bankruptcy protection is presumptively in “bad faith” – and the automatic stay will self-terminate – unless the debtor can demonstrate otherwise.

Demonstrating otherwise is what the debtors attempted to do in In re Washington.

So what does it take for an individual to establish “clear and convincing” evidence of “good faith” in these circumstances?

Apparently, a good deal of personal organization – and evidence of consistent, clearly documented efforts to reorganize, with clearly documented results to show for it.

In Washington, the debtors produced evidence regarding their business income and rental receipts which the Court characterized as “inconsistent and confusing.”  The Court took issue with the debtors’ estimates of present income, found holes in their testimony regarding decreased expenses, and found the debtors’ revenue projections to be “unjustifiably rosy.”

In sum, although Debtors claim that their financial circumstances have changed substantially, it appears to the Court that, with minor exceptions, Debtors have the same debt, same business, same properties, and same financial circumstances as they did in their previous case. The Court finds that there has not been a substantial change in Debtors’ financial circumstances and therefore, a presumption arises under section 362(c)(3)(C)(i)(III) that Debtors’ case was not filed in good faith.

The Court found that the same result applied under section 362(c)(3)(i)(III)(bb). That subsection imposes a presumption that a debtor’s second case was not filed in good faith if the court finds reason to conclude that the current case will not be concluded “with a confirmed plan that will be fully performed.”

But if Washington provides a cautionary tale for individual debtors who are struggling through the bankruptcy process, it also emphasizes the touchstone for every successful reorganization, no matter how small:  A viable business strategy.

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.

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