Avoidance and Recovery
|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 ‘California’
Avoidance and Recovery
For those practitioners practicing locally here in SoCal – or for those who need to appear pro hac in one of the many Chapter 11’s pending in the nation’s largest bankruptcy district – the Central District has very recently collaborated with the local bankruptcy bar to produce a detailed list of individual judicial preferences.
In a District with nearly 30 sitting bankruptcy judges scattered overÂ five divisions, a “score-card” like this one is essential reading.Â A copy of the survey is available here.
Other Posts of Interest:
One of the historical attractions of the Bankruptcy Code as a vehicle for restructuring is the ability to sell the debtorâ€™s assets quickly, cleanly, and with finality pursuant to a sale under Section 363.
So-called â€śsection 363 salesâ€ť have been the subject of much recent interest and debate, as evidenced by the discussion surrounding 2009â€™s â€śsection 363 salesâ€ť of both Chrysler LLC and General Motors Corporation (see, for example, blog posts here and here).Â In California, the effectiveness of such sales has been limited where the assets are worth less than the aggregate liens against them, and a lienholder objects to the sale.
Earlier this month, â€śSection 363 salesâ€ť received yet another potential challenge in California, this time from the Federal Trade Commission, which sought to undo Laboratory Corporation of America (â€śLabCorpâ€ť)â€™s acquisition of Westcliff Medical Laboratories, Inc. (â€śWestcliffâ€ť).Â According to the agencyâ€™s December 1 complaint to enjoin furtherance of the merger, filed in Washington DC and transferred to Californiaâ€™s Central District (redacted copy available here), the merger will substantially lessen competition among providers of capitated clinical laboratory testing services to physician groups in southern California.
LabCorp and Westcliff are clinical laboratory testing companies serving physician groups here in Southern California.Â In May 2010, Westcliff agreed to sell substantially all of its business assets to LabCorp for $57.5 million.Â As part of the sale, Westcliff agreed to file a voluntary petition for relief under Chapter 11 of the US Bankruptcy Code.Â The transaction was therefore subject to the approval of the US Bankruptcy Court for the Central District of California.Â In June, after a hearing at which no other bidder emerged to top the LabCorp offer, the court approved the sale, the parties closed the deal, and life went on â€“ until the FTC stepped in.
Though after-the-fact challenges to mergers are not unknown, they have been â€“ at least until recently â€“ comparatively rare.Â Even rarer is the challenge to an acquisition completed with approval by the US Bankruptcy Court.Â The FTC claims Westcliff wasnâ€™t a â€śfailing firm,â€ť whose assets otherwise would have exited the market absent the merger (and would therefore be exempt from anti-trust enforcement).Â Instead, the FTC alleges Westcliff was generating operating profits at the time of its sale and that there were other potential buyers available to purchase the company.Â According to the FTC, the reason these buyers didnâ€™t show up was because none would have matched LabCorpâ€™s $60 million â€śstalking horseâ€ť bid.
Counsel for LabCorp attempted to preempt the FTCâ€™s action by filing an adversary complaint in Bankruptcy Court, seeking declaratory relief as well as an injunction against the FTC, arguing that the agencyâ€™s enforcement action constituted a â€ścollateral attackâ€ť on the Bankruptcy Courtâ€™sÂ prior sale order.Â The FTC responded with its own motion to dismiss and an argument that its enforcement action was limited merely to prospective violations of antitrust laws, and did not seek to disturb the bankruptcy sale.Â Bankruptcy Judge Theodor Albert abstained, and transferred the matter to the US District Court where the FTCâ€™s action remains pending.
Though the Bankruptcy Courtâ€™s order authorizing the Westcliff acquisition remains undisturbed, the FTCâ€™s action raises some important and often-overlooked questions about â€ś363 salesâ€ť:Â Does counsel advising on the sale or purchase of a distressed business need to conduct or provide due diligence on the potential anti-trust effect of the transaction, despite the transactionâ€™s failure to meet the Hart-Scott-Rodino reporting threshold?Â Is it necessary (or good practice) for bankruptcy counsel to obtain factual findings commensurate with the sale which would insulate the transaction from subsequent attack?
In any event, 363 sales in now carry another important caveat emptor.
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:Â 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.Â A series of lease amendments failed to rectifyÂ Big3D’s ongoing missed payments.Â PCLC sued Big3D for breach of contract in Fresno and obtained a prejudgment writ of possession regarding its equipment.Â Two days later, Big3D was in Chapter 11 protection in California’s Eastern District.Â Big3D’s bankruptcy schedulesÂ 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.Â Â Then, in March 2009,Â PCLC sought relief from the automatic stay – or, alternatively, adequate protection – in Big3D’s bankruptcy case.Â PCLC claimed the value ofÂ its equipment had remained constant at $380,000 from the time of its lawsuit through the date of Big3D’s Chapter 11 case,Â and thereafter had declined $45,000 in the first 6 months of Big3D’s case “because of adverseÂ economic conditions”Â – but as of the time of PCLC’s request, wasÂ depreciating at an estimated rate of approximately $3,350 monthly.
Though the facts weren’t in dispute, PCLC’s entitlement to adequate protection was.Â Big3D and PCLC agreed that, moving forward, PCLC should receive adequate protection payments of $3,500 monthly.Â Â But the parties were at odds over PCLC’s entitlement to adequate protection for the first 6 months of Big3D’s case, in whichÂ PCLC sat by and did nothing to protect itsÂ 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),Â for the proposition that adequate protection should be provided to a creditor as of the time fromÂ which the creditor could have obtained its state court remedies if bankruptcy had not intervened.Â According to PCLC, this was immediately prior to Big3D’s case, since PCLCÂ had already been awarded a writ of possession and was about to foreclose.Â Therefore, PCLC argued, its $3,500 month was perhaps a good start, but not enough – itÂ 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 sumÂ [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.”Â Â 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.Â It also expressed concern over PCLC’s apparent delay in getting around to seeking adequate protection.Â In the end, the Bankruptcy Court declined to award PCLC any adequate protection for the first 6 months of Big3D’s case.Â 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.Â Specifically, the Panel reckoned that to exercise its remedies, PCLC would have had to take possession of the equipment and sell it for cash.Â 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.”Â It also accorded weight to the Bankruptcy Court’s observation that PCLC hadn’t been prompt in seeking reliefÂ – 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:
As a result, Deico remains good law in the 9th Circuit.Â Courts continue to have wide discretion to fashion adequate protection remedies according to the particulars of the case before them.Â Debtors are without a “bright line” from which toÂ gauge the need to come up with adequate protection payments.Â 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 evidenceÂ detailing the loss of value in the creditor’s collateral; and (iii) on time.
Altered Egos – The Ninth Circuit Weighs in (Again) On Whether Individual Creditors Can Pursue Their Own “Alter Ego” Claims Against a Bankrupt Entity’s PrincipalsMonday, October 25th, 2010
Whenever a troubled business seeks bankruptcy protection, unsecured creditors are often left scrambling to find other sources of recoveries for their claims.
In addition to individual, contractually negotiatedÂ protections such as personal guarantees and letters of credit, alter ego claims against the debtor’s principals can provide such creditors with additional pockets from which to seek payment.Â To do so, however, such creditors must often address the objectionÂ that they are without standing to pursue such claims, becauseÂ alter ego claims are often “general” ones, by which all creditors were injured – and from which all creditors are entitled to benefit.Â As a result, goes the objection, only the trustee – and not individual creditors – may pursue alter ego claims against the debtor’s principals.
The idea that alter ego claims may be prosecuted only by the debtor’s bankruptcy trustee on behalf of all creditors has been endorsed by at least one Circuit Court of Appeals:Â The 11th Circuit has affirmed as much in Baille Lumber Company, LPÂ v. Thompson, 413 F.3d 1293 (11th Cir. 2005).
But this view is not universally held.Â In fact, the 9th Circuit has long held a contrary view, as has the 8th Circuit.Â See Williams v. California 1st Bank, 859 F.2d 664, 667 (9th Cir. 1988) (“[N]o trustee . . . has the power under . . . the [Bankruptcy] Code to assert general causes of action, such as [an] alter ego claim, on behalf of the bankrupt estate’s creditors.”).Â Â See alsoÂ In re Ozark Restaurant Equipment Co., Inc., 816 F.2d 1222, 1228 (8th Cir. 1987); Estate of Daily v. Title Guar. Escrow Services, Inc., 187 B.R. 837, 842-43 (D. Haw. 1995), aff’d. 81 F.3d 167 (9th Cir. 1996).
Despite the Ninth Circuit’s guidance, however, several lower courts in California have continued to permit bankruptcy trustees to “glom onto” alter ego claims.Â See, e.g., In re Advanced Packaging and Products Co., 2010 WL 234795 (C.D. Cal. 2010) (permitting a trustee in bankruptcy to settle an alter ego claim brought against the bankrupt corporation’s parent entity because the claim was “general” rather than “particularized”).
Last week – for what appears to be the third time in as many decades – theÂ Ninth Circuit revisited this issue in Ahcom, Ltd. v. Smeding.
Ahcom‘s facts are relatively straightforward:Â Ahcom, a UK-based corporation, contracted for almonds with California-based Nuttery Farms, Inc. (NFI).Â After NFI allegedly failed to deliver the almonds, Ahcom commenced arbitration in Europe, then sued in the US to collect on the arbitrator’s award – but not before NFI had filed for bankruptcy protection.Â Undeterred, Ahcom directly sued NFI’s non-debtor principals, Hendrik and Lettie Smeding, seeking to pierce NFI’s corporate veil.Â Â TheÂ SmedingsÂ removed the action to US District Court for the Northern District of California and successfully dismissed the action on the grounds that Ahcom’s alter ego claims were “general” in nature – and, therefore, property of NFI’s bankruptcy estate.
On appeal, the Ninth Circuit reversed, noting that in California, “there is no such thing as a substantive alter ego claim at all . . . .” (citing Hennessey’s Tavern, Inc. v. Am. Air Filter Co., 251 Cal.Rptr. 859, 863 (Ct. App. 1988)).Â The panel then went further to explain that California law on this issue has been misread by bankruptcy courts and by the Bankruptcy Appellate Panel for the Ninth Circuit.
As a result, “California law does not recognize an alter ego claim or case of action that will allow a corporation and its shareholders to be treated as alter egos for purposes of all the corporation’s debts.Â Just because NFI’s trustee could not bring such a claim against the Smedings under California law, there is no reason why Ahcom’s claims against the Smedings could not proceed.”
A circuit split worthy of resolution by the Supreme Court?Â Perhaps.Â An alternate means of recovery for unsecured creditors who can allege the right facts?Â Most definitely.
A New Type of Government Refund: Criminal Restitution Payments Recoverable as Preferential TransfersSunday, August 15th, 2010
From the 9th Circuit last week, aÂ decision providing creditors and their representatives with a potentially new source of preferential recoveries: pre-petition criminal restitution payments.
Jeffrey and Faye Silverman – electrical contractors – were indicted in 2005 for fraud and underpayment of workers’ compensation insurance premiums.Â In March of that year, they paid the California State Compensation Insurance Fund $101,531 in restitution as part of a plea agreement and their court-ordered sentence.Â Less than 60 days later, they sought relief under Chapter 7.
Their trustee sought recovery of the restitution payment from the State Fund under the theory that the payment was a preferential transfer under Section 547(b) of the Bankruptcy Code.
Both sides moved for summary judgment.Â For its part, the State Fund argued that Section 547(b) doesn’t apply to criminal restitution payments, citing Kelly v. Robinson, 479 U.S. 36 (1986) and Becker v. County of Santa Clara (In re Nelson), 91 B.R. 904 (N.D. Cal. 1988).Â Kelly held that criminal restitution payments are non-dischargeable under Section 523(a)(7).Â Â Nelson extended Kelly to hold that payments on such non-dischargeable obligations are not recoverable as preferences.
The Bankruptcy Court for the Central District of California was not persuaded – nor was the District Court, which heard the matter on appeal following entry of summary judgment in the trustee’s favor.
The Ninth Circuit agreed.Â Finding that criminal restitution payments are, in fact, subject to the preference statute, the Ninth Circuit held that State Fund enjoyed no “judicial exception” to Section 547(b)’s reach.Â In the 3-judge panel’s view, an obligation’s non-dischargeability is separate and distinct from recovery of its pre-petition payment as a preference.Â Further, the restitution payments to State Fund were “to or for the benefit of” State Fund within the contemplation of Section 547(b)(1) –Â State Fund’s arguments to the contrary notwithstanding.
The decision is an important one for creditors’ representatives and committees seeking possible additional sources of recovery where the debtor has been attempting to resolve criminal problems pre-petition.
In a globalized business environment, it should be no surprise that some of the more interesting – and better – economic reporting on the US economy now comes from offshore.
Last month, China’s Xinhua news agency reported that California leads the nation in small-business bankruptcies.Â The report – based on data reported by Equifax – covers small business filings under all applicable chapters of the Bankruptcy Code (i.e., Chapters 7, 11, and 13).Â The Xinhua report (it broke the story a day before the Orange County Register) is here.
Equifax’s reporting shows that California remains the most impacted state, with the Los Angeles andÂ Riverside/San Bernardino MSA’s leading the nation in small business bankruptcy flings by a significant margin.Â Â
The chart below provides a closer look at this trend.
# of MSA # of Bankruptcies Bankruptcies % of Increase Q1 2009 Q1 2010 Los Angeles-Long Beach-Glendale, CA 899 1035 15.13% Riverside-San Bernardino-Ontario, CA 663 736 11.01% Sacramento-Arden- Arcade-Roseville, CA 462 522 12.99% Houston-Sugar Land- Baytown, TX 365 399 9.32% San Diego-Carlsbad- San Marcos, CA 345 387 12.17% Portland-Vancouver- Beaverton, OR-WA 276 386 39.86% Denver-Aurora, CO 304 382 25.66% Santa Ana-Anaheim- Irvine, CA 359 370 3.06% California -Rest of State 233 335 43.78% Phoenix-Mesa- Scottsdale, AZ 234 327 39.74% Dallas-Plano- Irving, TX 348 323 -7.18% Chicago-Naperville- Joliet, IL 395 314 -20.51% Atlanta-Sandy Springs-Marietta, GA 336 304 -9.52% Oregon -Rest of State 235 299 27.23% --------------- --- --- ----- New York-White Plains-Wayne, NY- NJ 335 272 -18.80% ------------------ --- --- ------
Inc. Magazine picked up the story last week, commenting that “no area has been insulated from the recession and the economy clearly isnâ€™t rebounding quickly enough.”
Two prior posts on this blog (here and here) have traced the progress of an obscure – but potentially important – piece of California legislation designed to regulate the ability of local California governments to seek relief through the municipal debt adjustment process of Chapter 9.
Relatively little-known California StateÂ Assembly Bill 155 would, if voted and signed into law, require local public entities to first seek approval from the California Debt and Investment Advisory Commission (which operates under the auspices of the State Treasurer’s Office) prior to seeking the federal debt adjustment relief presently available to them by local government decision.
Though ostensibly addressing the “debt” and “investments” of local governments, the bill is in factÂ aimed squarely at protecting public employee unions who – unnerved by the 2008 Chapter 9 filing commenced by the City of Vallejo, California – haveÂ backed the legislation since its introduction into the California legislature nearly 18 months ago.Â According to analysis produced last July by the State Senate’s Local Government Committee, “labor unions and others want to require state oversight of local governments’ bankruptcy petitions.”
The reason?Â Public employee pensions and other employee benefits.
The details of public employees’ hiring and retention arrangements are typically governed by collective bargaining agreements (or “Memoranda of Understanding” in the context of public labor relations), brokered by the employees’ unions and their public employers.Â As presicently noted in an article on municipal collective bargaining agreements authored 3 years ago, “Public sector unions have successfully obtained comparatively generous compensation and benefits packages even as the fortunes of American labor have continued to decline. In particular, municipal pensions may jeopardize the fiscal survival of many public sector employers.”
With perrenial state and local budget deficits, declining property values and a shrinking tax base, and significantly reducedÂ revenues, many local governments are now in precisely the sort of “survival mode” suggested by this article . . . and the unions know it.Â As a result, AB 155 has quietly made its way through the State Assembly and now appears poised to go to the State Senate floor.
Is “bankruptcy by committee” an appropriate balance between state interests and local government control?Â Does it hamstring local govrenment officials from responding effectively to a local fiscal crisis?Â BecauseÂ municipal bankruptciesÂ have always beenÂ used very sparingly, andÂ only 2 such proceedings (including Vallejo’s) have filed statewide since 2008, isÂ committee approval truly necessary?Â Or is it merely a means by which public employee unions can improve their bargaining position outside of bankruptcy?Â And what happens if a local government in financial crisis can’t get committee approval?
These questions appear, to date, unanswered.
But last week, AB 155 took a step forward, clearing the Senate’s Local Government Committee.Â The bill will now go to the Senate Appropriations Committee for review.