Posts Tagged ‘Bankruptcy in the United States’
Tuesday, January 17th, 2012
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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.
Sunday, August 21st, 2011
After a brief hiatus, we’re back – and just in time to discuss a recent decision of some import to trademark owners and licensors.
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For many years, insolvency practitioners have recognized the value of the Bankruptcy Code in permitting a reorganizing firm to assign contractual rights to a third party, even where the contract itself prohibits assignment. That power is limited, however, where “applicable [non-bankruptcy] law” prohibits the assignment without the non-bankrupt party’s consent.
In recent years, the “anti-assignment” provisions of federal copyright and patent law have limited the transfer of patent and copyright licenses through bankruptcy. Whether the transfer of trademark licenses is likewise limited has been an open question, at least amongst the Circuit Courts of Appeal.
In late July, the Seventh Circuit Court of Appeals found in In re XMH Corp. that trademarks were not assignable.
XMH Corp. involved the former Hartmarx clothing company’s Chapter 11, along with the related filings of several subsidiaries. XMH ultimately sold its assets and assigned contracts to a group of third-party purchasers. Those assets included certain trademark licenses for jeans held by one of the XMH subsidiaries. The trademarks were owned by a Canadian firm.
The Canadian firm objected to the trademark assignment, and the bankruptcy court agreed. The District Court reversed, and the licensor appealed to the Seventh Circuit.
In a succinct, 15-page decision, Judge Posner found that where “applicable law” prohibits the assignment of a trademark, it cannot be assigned through a bankruptcy proceeding absent the trademark owner’s consent.
Judge Posner apparently reached this decision despite a lack of either party to articulate which “applicable law” actually prohibited the assignment:
Unfortunately the parties haven’t told us whether the applicable trademark law is federal or state, or if the latter which state’s law is applicable (the contract does not contain a choice of law provision)—or for that matter which nation’s, since [the licensor] is a Canadian firm. ([The licensee's] headquarters are in the State of Washington.) None of this matters, though, because as far as we’ve been able to determine, the universal rule is that trademark licenses are not assignable in the absence of a clause expressly authorizing assignment. Miller v. Glenn Miller Productions, Inc., 454 F.3d 975, 988 (9th Cir. 2006) (per curiam); In re N.C.P. Marketing Group, Inc., 337 B.R. 230, 235-36 (D. Nev. 2005); 3 McCarthy on Trademarks § 18:43, pp. 18-92 to 18-93 (4th ed. 2010).
But the Seventh Circuit then turned to the question of whether the contract actually contained a valid trademark license - and found that though the agreement appeared to provide a relatively short-term license of the trademark, what remained at the time of the proposed assignment was merely a contract for services.
Despite its brevity, XMH Corp. is instructive in two respects:
- Trademarks cannot be assigned – at least not in the 7th Circuit.
- Contract drafters and negotiators must be careful to identify and preserve the trademark rights at issue.
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.”
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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).
Tuesday, May 31st, 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).
Monday, May 16th, 2011
When a retailer becomes insolvent, suppliers or vendors who have recently provided goods on credit typically have the ability to assert “reclamation” rights for the return of those goods. Retailers may respond to these rights by seeking the protection the federal bankruptcy laws – and, in particular, the automatic stay.
When a retailer files for bankruptcy while holding goods which are subject to creditors’ “reclamation” rights, what should “reclamation” creditors do?
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The Bankruptcy Code itself provides some protection for “reclamation” creditors by providing such creditors additional time in which to assert their claims, and by affording administrative priority for a certain portion for such claims even when they are not formally asserted.
But is merely asserting a reclamation claim under the Bankruptcy Code sufficient to protect a supplier once a retailer is in bankruptcy? A recent appellate decision from Virginia’s Eastern District serves as a reminder that merely speaking up about a reclamation claim isn’t enough.
When Circuit City sought bankruptcy protection in 2009, Paramount Home Entertainment was stuck with the tab for more than $11 million in goods. Though it didn’t object to blanket liens on Circuit City’s merchandise which came with the retailer’s debtor-in-possession financing, and stood by quietly while Circuit City later liquidated its merchandise throug a going-out-of-business sale, Paramount did file a timely reclamation demand as required by the Bankruptcy Code. It also complied with what it understood to be the Bankruptcy Court’s orders regarding administrative procedures for processing its reclamation claims in Circuit City’s case. It was therefore unpleasantly surprised when Circuit City objected to Paramount’s reclamation claim – and when the Bankruptcy Court sustained that objection – on the grounds that Paramount hadn’t done enough to establish or preserve its reclamation rights.
Paramount appealed the Bankruptcy Court’s ruling, claiming that it complied with what it understood to have been the Bankruptcy Court’s administrative procedures for processing reclamation claims. Paramount argued that to have done more (i.e., to have sought relief from the automatic stay to take back its goods or commenced litigation to preserve its rights to the proceeds of such goods) would have disrupted Circuit City’s bankruptcy case.
In affirming the Bankruptcy Court, US District Judge James Spencer held that the Bankruptcy Code, while protecting a creditor’s reclamation rights, doesn’t impose them on the debtor. Instead, a reclaiming creditor must take further steps consistent with the Bankruptcy Code and state law to preserve the remedies which reclamation claims afford. Merely asserting a reclamation claim under the Bankruptcy Code – or under a Bankruptcy Court’s administrative procedure – isn’t enough:
“Filing a demand, but then doing little else in the end likely creates more litigation and pressure on the Bankruptcy Court than seeking relief from the automatic stay. . . or seeking a [temporary restraining order] or initiating an adversary proceeding. In this case, Paramount filed its reclamation demand, but then failed to seek court intervention to perfect that right. As the Bankruptcy Court held, the Bankruptcy Code is not self-executing. Although [the Bankruptcy Code] does not explicitly state that a reclaiming seller must seek judicial intervention, that statute does not exist in a vacuum. The mandatory stay as well as the other sections of the Bankruptcy Code that protect and enforce the hierarchy of creditors create a statutory scheme that cannot be overlooked. Once Paramount learned that Circuit City planned to use the goods in connection with the post-petition [debtor-in-possession financing], it should have objected. It didn’t. To make matters worse, Paramount then failed to object to Circuit City’s liquidation of its entire inventory as part of the closing [going-out-of-business] [s]ales.”
Let the seller beware.
Tuesday, April 12th, 2011
When a municipality faces municipal distress, who ultimately picks up the tab? More importantly, who should pick up the tab?
That’s the issue taken up by Clayton P. Gillette, NYU’s Max E. Greenberg Professor of Contract Law, in a recent paper titled “POLITICAL WILL AND FISCAL FEDERALISM IN MUNICIPAL BANKRUPTCY.” Though the academic prose doesn’t read quite like the Economist, Professor Gillette’s discussion is a timely and important one for observers of US municipalities and their current financial troubles.
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In essence, Professor Gillette argues that Chapter 9 of the Bankruptcy Code (municipal bankruptcy) is often perceived as a “dumping ground” for governmental entities who could raise taxes, but simply don’t have the political gumption to do so. Historically, municipal debtors have attempted to utilize Chapter 9 as a means of shifting the burden of imprudent debt onto creditors. But Gillette argues that in an age of government bailout and centralized governmental assistance for failing municipalities, Chapter 9 also effectively acts as a “bargaining chip” for municipal debtors dealing with federal and state agencies who would prefer to address municipal financial distress outside of bankruptcy – albeit at a moderate cost to local officials.
In support of this argument, Gillette explains that the structure of Chapter 9 offers municipalities a shot at having it both ways: They can run up a tab, then determine whom (other than themselves or their taxpayers – i.e., private creditors or states and federal agencies) they’d prefer to pick it up.
What’s the answer to this perceived recipe for irresponsibility? For Professor Gillette, it involves giving bankruptcy courts the power to impose affordable tax increases:
As a general proposition, fiscal federalism requires each level of government to internalize both the costs and the benefits of its activities. Centralized governments should, therefore, subsidize decentralized governments only to control negative spillovers of local activity or to induce activities that generate positive spillovers. Concomitantly, decentralized governments should be discouraged from engaging in activities that impose adverse external effects. In at least some cases of fiscal distress, however, – primarily those involving localities that have substantial state or national importance – municipalities can externalize some costs of idiosyncratic choices or local public goods onto more centralized levels of government or creditors. As a result, municipalities have tendencies both to overgraze on the commons of more centralized budgets and to avoid the exercise of political will to satisfy the debts they incur. The current legal structure for addressing municipal fiscal distress may interfere with, rather than advance the objectives of fiscal federalism insofar as it insulates local decisions from centralized influence and reduces the need for distressed localities to internalize the consequences of fiscal decisions. The result is that while theories of federalism typically focus on the security that decentralization confers against an onerous centralized government, the capacity of sub-national governments to exploit the financial strength of more central governments raises the possibility that the latter requires protection from the former. The claim of this Article is that judicially imposed tax increases may be used as a means of providing such protection by reducing the incentives of municipalities to [strategically] exploit bankruptcy proceedings . . . .
Whatever readers may think of the constitutionality of his idea, Professor Gillette’s article is an intriguing contribution to evolving thought on municipal distress.
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.