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.
 





 
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    Archive for June, 2011

    Stern v. Marshall – What a Long, Strange Trip It’s Been

    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.

    American actreess Anna Nicole Smith in the red...

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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.

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    When Shari’a Law Meets Chapter 11

    Monday, June 20th, 2011

    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.

    Countries with Sharia rule.

    Image via Wikipedia

     

    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.

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    Flushed Away

    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

    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.

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    A Lesson In Vocabulary: “Indubitable Equivalence”

    Tuesday, June 7th, 2011

    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.”

    Map of USA with Georgia highlighted

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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).

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