Archive for October, 2010
Monday, October 25th, 2010
Whenever a troubled business seeks bankruptcy protection, unsecured creditors are often left scrambling to find other sources of recoveries for their claims.
In addition to individual, contractually negotiated protections such as personal guarantees and letters of credit, alter ego claims against the debtor’s principals can provide such creditors with additional pockets from which to seek payment. To do so, however, such creditors must often address the objection that they are without standing to pursue such claims, because alter ego claims are often “general” ones, by which all creditors were injured – and from which all creditors are entitled to benefit. As a result, goes the objection, only the trustee – and not individual creditors – may pursue alter ego claims against the debtor’s principals.
The idea that alter ego claims may be prosecuted only by the debtor’s bankruptcy trustee on behalf of all creditors has been endorsed by at least one Circuit Court of Appeals: The 11th Circuit has affirmed as much in Baille Lumber Company, LP v. Thompson, 413 F.3d 1293 (11th Cir. 2005).
But this view is not universally held. In fact, the 9th Circuit has long held a contrary view, as has the 8th Circuit. See Williams v. California 1st Bank, 859 F.2d 664, 667 (9th Cir. 1988) (“[N]o trustee . . . has the power under . . . the [Bankruptcy] Code to assert general causes of action, such as [an] alter ego claim, on behalf of the bankrupt estate’s creditors.”). See also In re Ozark Restaurant Equipment Co., Inc., 816 F.2d 1222, 1228 (8th Cir. 1987); Estate of Daily v. Title Guar. Escrow Services, Inc., 187 B.R. 837, 842-43 (D. Haw. 1995), aff’d. 81 F.3d 167 (9th Cir. 1996).
Despite the Ninth Circuit’s guidance, however, several lower courts in California have continued to permit bankruptcy trustees to “glom onto” alter ego claims. See, e.g., In re Advanced Packaging and Products Co., 2010 WL 234795 (C.D. Cal. 2010) (permitting a trustee in bankruptcy to settle an alter ego claim brought against the bankrupt corporation’s parent entity because the claim was “general” rather than “particularized”).
Last week – for what appears to be the third time in as many decades – the Ninth Circuit revisited this issue in Ahcom, Ltd. v. Smeding.
Ahcom‘s facts are relatively straightforward: Ahcom, a UK-based corporation, contracted for almonds with California-based Nuttery Farms, Inc. (NFI). After NFI allegedly failed to deliver the almonds, Ahcom commenced arbitration in Europe, then sued in the US to collect on the arbitrator’s award – but not before NFI had filed for bankruptcy protection. Undeterred, Ahcom directly sued NFI’s non-debtor principals, Hendrik and Lettie Smeding, seeking to pierce NFI’s corporate veil. The Smedings removed the action to US District Court for the Northern District of California and successfully dismissed the action on the grounds that Ahcom’s alter ego claims were “general” in nature – and, therefore, property of NFI’s bankruptcy estate.
On appeal, the Ninth Circuit reversed, noting that in California, “there is no such thing as a substantive alter ego claim at all . . . .” (citing Hennessey’s Tavern, Inc. v. Am. Air Filter Co., 251 Cal.Rptr. 859, 863 (Ct. App. 1988)). The panel then went further to explain that California law on this issue has been misread by bankruptcy courts and by the Bankruptcy Appellate Panel for the Ninth Circuit.
As a result, “California law does not recognize an alter ego claim or case of action that will allow a corporation and its shareholders to be treated as alter egos for purposes of all the corporation’s debts. Just because NFI’s trustee could not bring such a claim against the Smedings under California law, there is no reason why Ahcom’s claims against the Smedings could not proceed.”
A circuit split worthy of resolution by the Supreme Court? Perhaps. An alternate means of recovery for unsecured creditors who can allege the right facts? Most definitely.
Monday, October 18th, 2010
In a well-known quote, Depression-era author Thurmond Arnold once described the inside of a corporate reorganization as:
a combination of a municipal election, a historical pageant, an antivice crusade, a graduate school seminar, a judicial proceeding, and a series of horse trades, all rolled into one — thoroughly buttered with learning and frosted with distinguished names. Here the union of law and economics is celebrated by one of the wildest ideological orgies in intellectual history. Men work all night preparing endless documents in answer to other endless documents . . . . At the same time practical politicians utilize every resource of patronage, demagoguery, and coercion beneath the solemn smoke screen.
Most litigators understand the compelling power of story as a means to rationalize and persuade. In bankruptcy, a debtor’s “first day motions” are the initial means by which counsel has to weave the “wild orgy” of corporate restructuring into a cohesive narrative that will serve the client’s interests.
Because business insolvency and its resolution typically follow a well-understood process with a predictable set of possible outcomes, the “first day” narratives describing a debtor’s demise – and setting forth its “exit strategy” – likewise often follow familiar patterns. These patterns have been adapted over the decades to suit the capital structure of distressed firms and the economic conditions they face. But in the end, they remain . . . familiar patterns.
Penn Law Professor David Skeel, Jr. has recently taken up an engaging, non-empirical analysis of these patterns as they have appeared in US bankruptcy law. In Competing Narratives in Corporate Bankruptcy: Debtor in Control vs. No Time To Spare (published most recently as Research Paper No. 10-20 under the auspices of Penn Law’s Institute for Law and Economics and previously in the Winter 2009 issue of Michigan State Law Review) Skeel argues that such narratives have been utilized historically to justify and obtain judicial sanction for what, at the time, may be innovative, even controversial, reorganization techniques attempted within the strictures of a fixed bankruptcy legal structure. In bankruptcy, he suggests, the power of narrative grows out of the innovation employed to restructure a firm, and is then used to strengthen and further extend the innovation.
Skeel – who earlier authored Debt’s Dominion: A History Of Bankruptcy Law In America – traces this narrative and its variations from the early “equity receiverships” utilized to reorganize railroads through the early cases filed in the wake of the 1978 Bankruptcy Code, and to the more recent 2008-09 “headline” cases of Lehman Brothers, Chrysler, and General Motors. Observing that reorganizations proposed over the last 30 years have been explained using one of two predominant narratives – “Debtor in Control” (used most commonly to justify the debtor’s further prosecution of an ongoing reorganization) or “No Time to Spare” (often used to justify the sale of the debtor’s business assets) – he then circles back to ask whether the “innovations” proposed are justifiable under either narrative.
Skeel’s treatment of narrative – particularly, in questioning whether there was truly “no time to spare” in the Lehman, Chrysler, and GM bankruptcies – is insightful. As he sees it:
Bankruptcy’s master narratives have always been closely intertwined with the underlying legal structures, which suggests that bankruptcy judges and bankruptcy law will determine the future of . . . current, competing narratives.
Though his work covers narrative in the domestic bankruptcy context, the same complexity and requests for emergency, interim relief that require narrative explanation also arise in cross-border insolvencies.
As these “master narratives” become intertwined with multiple (and potentially conflicting) “legal structures,” their continued evolution bears close watching.
Monday, October 11th, 2010
Most readers of this blog are aware that, under the Bankruptcy Code, a Chapter 11 debtor (or the trustee appointed in the debtor’s case) is entitled to seek “avoidance” of a limited set of pre-bankruptcy “preference” payments, provided it can establish the payments were made:
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt . . . ;
(3) . . . while the debtor was insolvent;
(4) . . . on or within 90 days before the date of the filing of the [bankruptcy] petition; . . . and
(5) that enables [the] creditor to receive more than [its anticipated pro rata distribution in Chapter 7].
Even if all these elements are met, however, the Bankruptcy Code provides creditors with an affirmative “ordinary course of business” defense.
Though articulated slightly differently by different courts, 11 U.S.C. §547(c)(2) essentially provides that the “ordinary course of business exception” permits a creditor to retain transfers made by a debtor to a creditor during the ninety days before the petition date if: (1) such transfers were made for a debt incurred in the “ordinary course of business” of the parties; and either (2) the transfers were made in the “ordinary course of business” of the parties; or (3) the transfers were made in accordance with “ordinary business terms.”
Once an “ordinary course” relationship is established between the debtor and the creditor who received allegedly preferential payments, the focus shifts to showing whether or not the payments at issue complied with “ordinary course” timing and terms.
To show this, the preference defendant must demonstrate that the relevant payments did not differ from past payments in “amount” or “form,” were not the result of “unusual collection or payment activit[ies],” or did not come as a result of the “creditor [taking] advantage of the debtor’s deteriorating financial condition.”
Importantly, the emphasis is on the payments themselves – rather than on what the debtor and creditor may have otherwise considered or discussed. This distinction is illustrated in a recent decision issued by Judge Christopher Sontchi in Burtch v. Detroit Forming, Inc. (In re Archway Cookies) (available here).
In Burtch v. Detroit Forming, the Trustee in a Chapter 7 case (converted from one under Chapter 11) commenced an adversary proceeding against Detroit Forming, Inc. (“DFI”) seeking to avoid as preferential six (6) transfers totaling $180,648.17. DFI asserted the “ordinary course” defense, arguing it had a two-year suppplier relationship with the debtors and that it had received the payments in question under the same timing and terms as those extant throughout this relationship.
DFI’s defense is typical of that offered under the “ordinary course” defense: It established a specific range of days-to-payment from invoicing, then showed that the payments in question were timed substantially similar to the days-to-payment average and under similar terms (i.e., by check rather than by wire transfer or COD).
Notably, the Court was not troubled by a letter sent by DFI’s CFO/Controller notifying the Debtors that no product would be shipped unless the accounts were current. For purposes of establishing “ordinary course,” it was the subjective relationship that existed between the debtor and the preference defendant which mattered – rather than the debtor’s relations with all its creditors.
Burtch v. Detroit Forming is instructive on what it takes to mount a successful “ordinary course” defense, as is the Ninth Circuit’s earlier decision in Sigma Micro v. Healthcentral.com (In re Healthcentral.com) (availabe here) – a similar case where the defendant’s “ordinary course” analysis was deemed sufficient to withstand a motion for summary judgment, and where the Ninth Circuit placed little stock in the debtor’s evidence of pre-petition “old school” cash management practices whereby the debtor’s management determined each week which creditors would be paid, and how much.
Monday, October 4th, 2010
In April, this blog highlighted research done by Seton Hall‘s Stephen Lubben and York University‘s Stephanie Ben-Ishai on similarities and differences between asset sales conducted under the US Bankruptcy Code and those proceeding under the Canadian Companies Creditors’ Arrangement Act (“CCAA”).
Last week, the authors offered a revised version of their earlier work, available here. As noted by the authors’ abstract:
Ultimately, . . . questions of speed and certainty mark the biggest difference between [asset sales in the US and Canada], as the American approach [to asset sales] offers greater flexibility, which is apt to facilitate quicker . . . sales. However, . . . the Canadian approach also provides significant benefits, particularly in the realm of employee protection and the ability of the monitor to act as an independent check on quick sales proceedings. . . . [W]hile the American approach is advantageous in situations with exceptional time constraints, the Canadian approach under the . . . CCAA is more beneficial for a typical corporate reorganization, insofar as the role of the monitor and other limitations of the CCAA will prevent overuse of the quick sales process.