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    Archive for November, 2010

    Altered Egos – Part 2: Trust Busters

    Monday, November 29th, 2010

    About a month ago, the Ninth Circuit clarified and restated the ability of individual creditors to pursue claims against debtors based on an alter ego theory, despite a bankruptcy trustee’s efforts to reach the same assets (discussion here).

    Last week, the Ninth Circuit further expanded the reach of alter ego liability to “asset protection” trusts established by debtors.  Along the way, and in dicta, it finessed earlier treatment of the same liability in the corporate context.

    U.S. Court of Appeals for the Ninth Circuit
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    The facts in In re Schwarzkopf are somewhat involved, but essentially reduce themselves to the following:  During the 1990′s, the debtors established two separate and allegedly irrevocable trusts – the “Apartment Trust” (to hold the debtors’ stock in a corporation which owned and operated an apartment building) and the “Grove Trust” (to hold four plots of land containing avocado groves).  The Apartment Trust was established to remove the debtors’ stock from the reach of creditors while the debtors contested a judgment obtained against the corporation.  The Grove Trust was subsequently established while the debtors were insolvent – and, likewise, was intended to move the debtors’ assets beyond the reach of their creditors.

    During the life of both trusts, the debtors routinely sought and obtained use of the trust assets for their personal benefit and for the benefit of family members.  The trustee administering the trusts apparently exercised no independent judgment regarding the debtors’ requests, commingled trust assets, and kept no books and records regarding either trust for several years after their establishment.

    The debtors filed a Chapter 7 case in 2003, seeking to discharge approximately $5.4 million in debt.  The appointed Chapter 7 trustee filed an adversary complaint seeking to recover approximately $4 million from the trusts.  The bankruptcy court initially concluded both trusts were valid and that neither is the alter ego of the debtors, but subsequently reversed the alter ego determination as to the Grove Trust.

    The District Court found that the trusts were not the debtors’ alter ego, reasoning that under SEC v. Hickey, 322 F.3d 1123 (9th Cir. 2003), legal ownership is a prerequisite for such liability in California.  It also found the Apartment Trust was not valid, but remanded so the Bankruptcy Court could determine whether or not the Trustee’s complaint was time-barred in the first instance.

    The Ninth Circuit quickly dispensed with the Apartment Trust, finding the statute of limitations for attacking the Apartment Trust did not begin to run until the trustee answered the avoidance complaint filed in the debtors’ Chapter 7 cases.

    It then turned to the Grove Trust, finding that despite its continuing existence as a trust, it was the nevertheless the debtors’ alter ego.  To reach this conclusion, it reasoned that despite its earlier decision in Hickey, which had concluded that actual ownership of stock was a prerequisite for alter ego liability in corporate cases, California law nevertheless suggested that equitable stock ownership was sufficient for alter ego liability after all . . . and that, in any event, an equitable ownership interest is “traditionally sufficient to confer ownership rights” in the trust context.

    Schwarzkopf‘s facts certainly suggest the Ninth Circuit was reaching to assist the trustee’s efforts to recover significant assets for the benefit of creditors.  However, its relaxed treatment of the “ownership threshold” for alter ego liability may prove useful for trustees or creditors in other contexts.

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    Fraudulent Transfers By The Numbers – Revisited

    Tuesday, November 16th, 2010

    Back in May, this blog featured a post on some preliminary research addressing the idea of “probability-based” fraudulent transfer analysis.  PBGC lawyer (and Cadwalader alum) John Ginsburg  has argued that rather than merely asking whether insolvency is “reasonably foreseeable,” courts ought to clarify “reasonable foreseeability” in probabalistic terms.  The basic idea underlying this argument is that it should be easier to attack (or to defend) a fraudulent transfer if it can be shown, for example, that the “probability” of insolvency at the time of an LBO was 50% – or 60%, or 75%.

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    Mr. Ginsberg argues further that courts ought to articulate what, for them, constitutes an acceptable margin of error (say, 40% risk of insolvency with a margin of error of +/- 15%).

    Following comments offered here and elsewhere, Mr. Ginsberg – and colleagues Zachary Caldwell, Daniel Czerwonka, and Mary Burgess – have gone through a number of revisions and have a final draft version of the article available for review prior to going to publication with ABI Law Review in March.

    A discussion is hosted at http://www.bulletinboards.com/view.cfm?comcode=LBO_FT, where anyone can critique and debate the paper, upload a rebuttal from a word-processor, or upload a handwritten mark-up in PDF.  In written comments to South Bay Law Firm, Mr. Ginsberg notes that the authors are particularly “interested in hearing from private equity fund managers, from the investment bankers who finance their deals, and from the lawyers, financial analysts and others who earn fees helping put those deals together.  The paper has significant implications for them.”

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    Clear as Mud

    Monday, November 8th, 2010

    Late last month, the 9th Circuit Bankrpuptcy Appellate Panel clarified earlier precedent and held that adequate protection determinations are entirely within a bankruptcy court’s discretion – and not, as suggested by a number of recent decisions, subject to a “bright line” test of the time when adequate protection was requested.

    The facts in People’s Cpaital and Leasing Corp. v. Big3D, Inc (In re Big3D) weren’t in dispute:  Big3D, which operated a commercial printing business and leased specialized equipment from People’s Capital (PCLC), encountered difficulties in making its equipment lease payments to PCLC.  A series of lease amendments failed to rectify Big3D’s ongoing missed payments.  PCLC sued Big3D for breach of contract in Fresno and obtained a prejudgment writ of possession regarding its equipment.  Two days later, Big3D was in Chapter 11 protection in California’s Eastern District.  Big3D’s bankruptcy schedules assigned PCLC’s equipment a value of $400,000 – about $50,000 more than the amount of Big3D’s debt to PCLC – and acknowledged that PCLC held a secured claim for this amount.

    About 6 months passed.  Then, in March 2009, PCLC sought relief from the automatic stay – or, alternatively, adequate protection – in Big3D’s bankruptcy case.  PCLC claimed the value of its equipment had remained constant at $380,000 from the time of its lawsuit through the date of Big3D’s Chapter 11 case, and thereafter had declined $45,000 in the first 6 months of Big3D’s case “because of adverse economic conditions” - but as of the time of PCLC’s request, was depreciating at an estimated rate of approximately $3,350 monthly.

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    Though the facts weren’t in dispute, PCLC’s entitlement to adequate protection was.  Big3D and PCLC agreed that, moving forward, PCLC should receive adequate protection payments of $3,500 monthly.  But the parties were at odds over PCLC’s entitlement to adequate protection for the first 6 months of Big3D’s case, in which PCLC sat by and did nothing to protect its rights.

    PCLC cited Paccom Leasing Corp. v. Deico Elect’s., Inc. (In re Deico Elect’s., Inc.), 139 B.R. 945 (9th Cir. BAP 1992), for the proposition that adequate protection should be provided to a creditor as of the time from which the creditor could have obtained its state court remedies if bankruptcy had not intervened.  According to PCLC, this was immediately prior to Big3D’s case, since PCLC had already been awarded a writ of possession and was about to foreclose.  Therefore, PCLC argued, its $3,500 month was perhaps a good start, but not enough – it should also receive adequate protection payments for the entire first 6 months of Big3D’s case.

    The Bankruptcy Court for the Eastern District of California disagreed, instead reading Deico as granting it “discretion to fix any initial lump sum [of adequate protection], the amount payable periodically, the frequency of payments, and the beginning date [of adequate protection], all as dictated by the circumstances of the case and the sound exercise of that discretion.”  The Bankruptcy Court focused on PCLC’s acknowledgment that depreciation of its equipment was related to economic conditions – and not to Big3D’s continued use during its Chapter 11 case.  It also expressed concern over PCLC’s apparent delay in getting around to seeking adequate protection.  In the end, the Bankruptcy Court declined to award PCLC any adequate protection for the first 6 months of Big3D’s case.  PCLC appealed, claiming the Bankruptcy Court had abused its discretion.

    An en banc Appellate Panel first determined that the Bankruptcy Court had not, in fact, abused its discretion.  Specifically, the Panel reckoned that to exercise its remedies, PCLC would have had to take possession of the equipment and sell it for cash.  It took issue with PCLC’s claim that a mere writ of possession was sufficient to entitle it to adequate protection all the way through Big3D’s case: “To be entitled to adequate protection, Deico requires that [the creditor] establish both a temporal point at which it would have ‘exercised’ its state law remedies outside of bankruptcy, and the amount the equipment declined in value after that time.”  It also accorded weight to the Bankruptcy Court’s observation that PCLC hadn’t been prompt in seeking relief - but had waited for 6 months before seeking adequate protection.

    The Panel further determined that, despite a gradual shift in the case law from an early focus on the petition date to a more recent emphasis on the date of the adequate protection request as the time from which adequate protection payments should apply, Deico provides bankruptcy courts with needed flexibility in determining adequate protection for specific creditors in specific cases:

    “When a creditor can or could exercise its statutory or contractual remedies to realize upon collateral is an inherently factual determination, but the fact that such a determination can be complicated does not make it unworkable.  The discretionary standard adopted by Deico gives bankrupcy courts the needed flexibility to make appropriate adequate protection determinations as provided for in the Bankruptcy Code, based upon the evidence presented by the parties.”

    As a result, Deico remains good law in the 9th Circuit.  Courts continue to have wide discretion to fashion adequate protection remedies according to the particulars of the case before them.  Debtors are without a “bright line” from which to gauge the need to come up with adequate protection payments.  And creditors are on notice: It is critical that any request for adequate protection be (i) supported by a thorough brief explaining when – but for the intervention of bankruptcy – state law remedies could have been exercised; (ii) backed by solid evidence detailing the loss of value in the creditor’s collateral; and (iii) on time.

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    Proposed Technical Amendments to BAPCPA

    Monday, November 1st, 2010

    The American Bar Association Section of Business Law provided comments last week to the Senate and House Judiciary Committees regarding proposed technical amendments to the Bankruptcy Code. The comments are designed to correct certain errors contained in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”).

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    Get a complete copy of the proposed amendments here.

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