|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.|
Posts Tagged ‘Bankruptcy in the United States’
Can a senior secured lender require, through an inter-creditor agreement, that a junior lender relinquish the juniorâs rights under the Bankruptcy Code vis ĂĄ vis a common debtor?
Though the practice is a common one, the answer to this question is not clear-cut.Â Bankruptcy Courts addressing this issue have come down on both sides, some holding âyea,â and others ânay.âÂ Late last year, the Massachusetts Bankruptcy Court sided with the ânaysâ in In re SW Boston Hotel Venture, LLC,Â 460 B.R. 38 (Bankr. D. Mass. 2011).
The decision (available here) acknowledges and cites case law on either side of the issue.Â It further highlights the reality that lenders employing the protective practice of an inter-creditor agreement as a âhedgeâ against the debtorâs 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?Â One suggested (but, as yet, untested) method is to take the senior lenderâs bankruptcy-related protections out of the agreement, and provide instead that in the event of the debtorâs filing, the juniorâs claim will be automatically assigned to the senior creditor, re-vesting in the junior creditor once the seniorâs claim has been paid in full.
After a brief hiatus, we’re back – and just in time to discuss a recent decision of some import to trademark owners and licensors.
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.Â 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.Â Â 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.Â XMH ultimately sold its assets and assigned contracts to a group of third-party purchasers.Â Those assets included certain trademark licenses for jeans held by one of the XMH subsidiaries.Â The trademarks were owned by a Canadian firm.
The Canadian firm objected to the trademark assignment, and the bankruptcy court agreed.Â 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:
But the Seventh Circuit then turned to the question of whether the contract actually contained a valid trademark licenseÂ – 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:
Chapter 11 practice â like so many other professional service specialties â is regrettably jargon-laden.Â Businesses that need to get their financial affairs in order âenter restructuring.âÂ Those that must re-negotiate their debt obligations attempt to âde-leverage.âÂ And those facing resistance in doing so seek the aid of Bankruptcy Courts in âcramming downâ their plans over creditor opposition.
Likewise, the Bankruptcy Code â and, consequently, Bankruptcy Courts â employ what can seem an entirely separate vocabulary for describing the means by which a successful âcram-downâ is achieved.Â 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 debtorâs apple, for example, the debtor may simply give the creditor the apple â or may even attempt to replace the creditorâs interest in the apple with a similarÂ interest in the debtorâs 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 âbankruptcy-eseâ as providing the creditor with the âindubitable equivalentâ of its claim â and it is a concept employed perhaps most frequently in cases involving real estate assets (though âindubitable equivalenceâ is not limited to interests in real estate).Â For this reason, plans employing this concept in the real estate context are sometimes referred to as âdirt for debtâ plans.
A recent bankruptcy decision out of Georgiaâs Northern District issued earlier this year illustrates the challenges of âdirt for debtâ reorganizations based on the concept of âindubitable equivalence.â
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. Riddleâs proposed plan of reorganization, initially opposed by a number of his creditors, went through five iterations until only one objecting creditor â Northside Bank â remained.Â 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 âHighway 411/Dodd Blvd Property,â and a second-priority claim secured by a condominium unit generally referred to as the âHeritage Square Property.âÂ It also held a judgment lien recorded against Mr. Riddle in Floyd County, Georgia.
A key feature of Mr. Riddleâs plan involved freeing up the Heritage Square Property in order refinance one of his companies, thereby generating additional payments for his creditors.Â To do this, Mr. Riddle proposed to give Northside Bank his Highway 411/Dodd Blvd Property as the âindubitable equivalent,â and in satisfaction, of all of Northsideâs claims.
Northside Bank objected to this treatment, respectfully disagreeing with Mr. Riddleâs idea of âindubitable equivalence.âÂ Bankruptcy Judge Paul Bonapfel took evidence on the issue and â in a brief, 9-page decision â found that Mr. Riddle had the better end of the argument.
Judge Bonapfelâs decision highlights several key features of âindubitable equivalentâ plans:
–Â Â Â Â Â Â Â Â The importance of valuation.Â The real challenge of an âindubitable equivalenceâ plan is not its vocabulary.Â It is valuing the property which will be given to the creditor so as to demonstrate that value is âtoo evident to be doubted.âÂ As anyone familiar with valuation work is aware, this is far more easily said than done.Â Valuation becomes especially important where the debtor is proposing to give the creditor something less than all of the collateral securing the creditorâs claim, as Mr. Riddle did in his case.Â In such circumstances, the valuation must be very conservative â a consideration Judge Bonapfel and other courts recognized.
–Â Â Â Â Â Â Â The importance of evidentiary standards.Â Closely related to the idea of being âtoo evident to be doubtedâ is the question of what evidentiary standards apply to the valuation.Â Some courts have held that because the propertyâs value must be âtoo evident to be doubted,â the evidence of value must be âclear and convincingâ (the civil equivalent of âbeyond a reasonable doubtâ).Â More recent cases, however, weigh the âpreponderance of evidenceâ (i.e., does the evidence indicate something more than a 50% probability that the property is worth what itâs claimed to be?).Â As one court (confusingly) put it: âThe level of proof to show âindubitablyâ is not raised merely by the use of the word âindubitable.ââÂ Rather than require more or better evidence, many courts seem to focus instead on the conservative nature of the valuation and its assumptions.
–Â Â Â Â Â Â Â The importance of a legitimate reorganization purpose.Â Again, where a creditor is receiving something less than the entirety of its collateral as the âindubitable equivalentâ of its claim, it is up to the debtor to show that such treatment is for the good of all the creditors â and not merely to disadvantage the creditor in question.Â Judge Bonapfel put this issue front and center when he noted, in Mr. Riddleâs case:
In re Riddle, 444 B.R. 681, 686 (Bankr. N.D. Ga. 2011).
Many insolvency practitioners are familiar with the “high-asset” individual debtor – often a business owner or owner of rental property or otherÂ 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.Â These individuals typically have obligations matching the size of their assets:Â Â Their restructuring needs are too large for treatment through an “individual”Â 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.Â 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.Â 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.”Â But in Chapter 11 – at least until 2005 – theÂ answer has historically been “no.”Â This is because Chapter 11,Â oriented as it is toward business reorganization, prohibits a reorganizing debtor from retaining any property while anÂ objecting class of unsecured creditors is paid something less than the entirety of its claims.Â Known as the “absolute priority rule,” this prohibition has been a mainstay of Chapter 11 business practice for decades.
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%.Â Â For instance,Â an individualÂ debtor may retain certain wages and earnings earned after the commencement of the debtor’s case.Â 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).Â 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.Â 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:
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).
When a retailerÂ becomes insolvent, suppliers or vendors who have recently provided goods on credit typicallyÂ have the ability toÂ assert “reclamation” rights for the return of those goods.Â Retailers may respond to theseÂ 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?
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 portionÂ 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?Â 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.Â 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 laterÂ liquidated its merchandise througÂ a going-out-of-business sale, Paramount did file a timely reclamation demand as required by the Bankruptcy Code.Â 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.Â 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.Â Â 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.Â Instead, a reclaiming creditor must take further steps consistent with the Bankruptcy Code and state law to preserve the remedies which reclamation claims afford.Â Merely asserting a reclamation claim under the Bankruptcy Code – or under a Bankruptcy Court’s administrative procedure – isn’t enough:
Let the seller beware.
When a municipality faces municipal distress, who ultimately picks up the tab?Â More importantly, who should pick up the tab?
Thatâs the issue taken up by Clayton P. Gillette, NYUâs Max E. Greenberg Professor of Contract Law, in a recent paper titled âPOLITICAL WILL AND FISCAL FEDERALISM IN MUNICIPAL BANKRUPTCY.âÂ Though the academic prose doesnât read quite like the Economist, Professor Gilletteâs discussion is a timely and important one for observers of US municipalities and their current financial troubles.
In essence, Professor Gillette argues that Chapter 9 of the Bankruptcy Code (municipal bankruptcy) is often perceived as a âdumping groundâ for governmental entities who could raise taxes, but simply donât have the political gumption to do so.Â Historically, municipal debtors have attempted to utilize Chapter 9 as a means of shifting the burden of imprudent debt onto creditors.Â But Gillette argues that in an age of government bailout and centralized governmental assistance for failing municipalities, Chapter 9 also effectively acts as a âbargaining chipâ for municipal debtors dealing with federal and state agencies who would prefer to address municipal financial distress outside of bankruptcy â 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:Â They can run up a tab, then determine whom (other than themselves or their taxpayers â i.e., private creditors or states and federal agencies) theyâd prefer to pick it up.
Whatâs the answer to this perceived recipe for irresponsibility?Â For Professor Gillette, it involves giving bankruptcy courts the power to impose affordable tax increases:
Whatever readers may think of the constitutionality of his idea, Professor Gilletteâs article is an intriguing contribution to evolving thought on municipal distress.
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 Creditorsâ Arrangement Act (“CCAA”).
Last week, the authors offered a revised version of their earlier work, available here.Â As noted by the authors’ abstract: