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    Archive for January, 2012

    The Year in Bankruptcy – 2011

    Monday, January 30th, 2012

    JonesDay’s comprehensive and always-readable summary of notable bankruptcies, decisions, legislation, and economic events was released just over a week ago.  A copy is available here.

    As 2012 gets off to an uncertain start, some more recent headlines are accessible immediately below.

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    A Formula for Confusion

    Monday, January 23rd, 2012
    Inc

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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:

    Rent-Based Formula: Maximum Rejection Damages = (Rent x Remaining Term) x 0.15
       
    Term-Based Formula: Maximum Rejection Damages = Rent x (Remaining Term x 0.15)

    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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    Intercreditor Agreements: How Far Can They Reach?

    Tuesday, January 17th, 2012
    Creditor's Ledger, Holmes McDougall

    Image by edinburghcityofprint via Flickr

    Can a senior secured lender require, through an inter-creditor agreement, that a junior lender relinquish the junior’s rights under the Bankruptcy Code vis á vis a common debtor?

    Though the practice is a common one, the answer to this question is not clear-cut.  Bankruptcy Courts addressing this issue have come down on both sides, some holding “yea,” and others “nay.”  Late last year, the Massachusetts Bankruptcy Court sided with the “nays” in In re SW Boston Hotel Venture, LLC, 460 B.R. 38 (Bankr. D. Mass. 2011).

    The decision (available here) acknowledges and cites case law on either side of the issue.  It further highlights the reality that lenders employing the protective practice of an inter-creditor agreement as a “hedge” against the debtor’s potential future bankruptcy may not be as well-protected as they might otherwise believe.

    In light of this uncertainty, do lenders have other means of protection?  One suggested (but, as yet, untested) method is to take the senior lender’s bankruptcy-related protections out of the agreement, and provide instead that in the event of the debtor’s filing, the junior’s claim will be automatically assigned to the senior creditor, re-vesting in the junior creditor once the senior’s claim has been paid in full.

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    Getting to the “Core” of the Matter

    Friday, January 13th, 2012
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    Last year, the Supreme Court issued one of its more significant bankruptcy decisions in recent years with Stern v. Marshall (a very brief note concerning the Stern decision as reported on this blog is available here).  Stern, which addressed the limits of bankruptcy courts’ “core” jurisdiction, has been the focus of a considerable amount of academic and professional interest – primarily because of its possible fundamental effect on the administration of bankruptcy cases.

    Three weeks ago, the Seventh Circuit capped off 2011 with a decision – the first at an appellate level – discussing and applying Stern.

    The procedural history of In re Ortiz is straightforward.  Wisconsin medical provider Aurora Health Care, Inc. had filed proofs of claim in 3,200 individual debtors’ bankruptcy cases in the Eastern District of Wisconsin between 2003 and 2008.  Two groups of these debtors took issue with these filings, claiming Aurora violated a Wisconsin statute that allows individuals to sue if their health care records are disclosed without permission.  One group of debtors filed a class action adversary proceeding against Aurora in the Bankruptcy Court for Wisconsin’s Eastern District, while the other filed a similar class action complaint against Aurora in Wisconsin Superior Court.

    For all their differences, it appears neither the debtor-plaintiffs nor Aurora wanted to have these matters heard by the US Bankruptcy Court.  Aurora removed the Superior Court Action to the Bankruptcy Court, then immediately sought to have the US District Court for Wisconsin’s Eastern District withdraw the reference of these actions to the Bankruptcy Court and hear both matters itself.  Both groups of debtor-plaintiffs, on the other hand, sought to have their claims heard by the Wisconsin Superior Court by asking the Bankruptcy Court to abstain from hearing them, and remand them to the state tribunal.

    Both parties’ procedural jockeying for a forum other than the US Bankruptcy Court ultimately proved unfruitful:  The District Court denied Aurora’s request to hear the matters, and the Bankruptcy Court declined to remand them back to Wisconsin Superior Court or otherwise abstain from hearing them.  The District Court’s and the Bankruptcy Court’s reasoning was essentially the same – since the original “disclosure” of health records took place in the context of proofs of claim filed in individual debtors’ bankruptcy proceeding, both courts believed the matters were therefore “core” proceedings which Bankruptcy Courts were entitled to hear and determine on a final basis.

    Ultimately, the Bankruptcy Court granted summary judgment and dismissed the class actions because both groups of debtors had failed to establish actual damages as required under the Wisconsin statute.  Both the plaintiffs and Aurora requested, and were granted, a direct appeal to the Seventh Circuit Court of Appeals.

    But if Ortiz’ procedural history is straightforward, the Seventh Circuit’s disposition of the appeal was not.  After the case was argued on appeal in February 2011, the Supreme Court issued its decision in Stern v. Marshall.  In that decision, the high court called into question the viability of Congress’ statutory scheme in which bankruptcy courts were empowered to finally adjudicate “core” proceedings – i.e., those proceedings “arising in a bankruptcy case or under title 11″ of the US Code.  The Stern court held that a dispute – even if “core” – was nevertheless improper for final adjudication by a bankruptcy court if the dispute was not integral to the claims allowance process, and constituted a private, common-law action as recognized by the courts at Westminster in 1789.  Such matters were – and are – the province of Article III (i.e., US District Court) judges, and it was not up to Congress to “chip away” at federal courts’ authority by delegating such matters to other, non-Article III (i.e., Bankruptcy) courts.

    In order to resolve the Aurora class actions in a manner consistent with Stern, the Seventh Circuit requested supplemental briefing, and then undertook a lengthy analysis of that decision.  To isolate and identify the type of dispute that the Stern court found “off-limits” for final decisions by bankruptcy courts, it distinguished the Aurora class action disputes from those cases which:

    -        Involved  “public rights” or a government litigant;

    -        Flowed from a federal statutory scheme or a particularized area of law which Congress had determined best addressed through administrative proceedings; or

    -        Were “integral to the restructuring of the debtor-creditor relationship” or otherwise part of the process of allowance and disallowance of claims.

    Instead, the Aurora disputes had nothing to do with the original claims filed by Aurora in the debtors’ cases, was between private litigants, and was not a federal statutory claim or an administrative matter.  Consequently, the Bankruptcy Court had no jurisdiction to determine it on a final basis.  Consequently, the Seventh Circuit had no jurisdiction to hear the appeal.

    Ortiz, like Stern, has received a considerable amount of attention within the bankruptcy community.   Among some of the community’s immediate reactions to Ortiz:

    -        Despite the fact that the class actions arose out of Aurora’s filing proofs of claim in bankruptcy cases, the bankruptcy court could not decide those class actions.  More importantly, the Seventh Circuit suggested that a bankruptcy judge may not even have “authority to resolve disputes claiming that the way one party acted in the course of the court’s proceedings violated another party’s rights.”  In other words, it seems possible to argue, under Ortiz (and Stern), that though US District Courts have authority to police their own dockets, Bankruptcy Courts do not.

    -        The Seventh Circuit’s decision appears circular in some respects.  Specifically, the Seventh Circuit declined to hear the appeals from the bankruptcy court as proposed findings of fact and conclusions of law (rather than as a final judgment), because such recommendations from a bankruptcy court are available only in “non-core” proceedings – and since the Aurora class actions were “core,” an appellate review of such proposed findings and conclusions simply wasn’t available.  But if a “core” matter is outside a bankruptcy court’s jurisdiction, is it really “core”?  In other words, wouldn’t it have been easier for the Seventh Circuit to have simply sent the matter back to the bankruptcy court as a recommended resolution, not yet ripe for an appeal?

    As the results of Stern begin to percolate their way through the bankruptcy system and other circuits weigh in on the Supreme Court’s 2011 guidance, it appears the administration of bankruptcy cases faces some significant adjustment.

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