Some of the week’s top bankruptcy and restructuring headlines:
And Still More:
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Posts Tagged ‘Chapter 11 Title 11 United States Code’
Some of the week’s top bankruptcy and restructuring headlines:
And Still More:
An old and well-known proverb warns: “It is better to remain silent and be thought a fool than to speak and remove all doubt.” Over against this timeless advice, however, a very recent Second Circuit offers more specific guidance for creditors of a bankrupt debtor:
“The squeaky wheel gets the grease.”
In Adelphia Recovery Trust v. Goldman, Sachs & Co., et al., a creditors’ trust established to recover transfers under Adelphia Communications’ confirmed Chapter 11 plan of reorganization sought unsuccessfully to recover “margin call” payments made to Goldman, Sachs & Co. The Second Circuit Court of Appeals agreed with the lower courts in determining that the commingled funds used to make the payments had been taken from a “concentration account” scheduled as property of one of Adelphia Communications’ subsidiaries; consequently the funds were not Adelphia Communications’ to recover, and the trust could not belatedly be re-characterized them as such. A copy of the decision is available here.
In 2002, Adelphia Communications Corporation and related subsidiaries entered Chapter 11 bankruptcy following the disclosure of fraudulently concealed, off-balance sheet debt on Adelphia Communications’ books. The companies were ultimately liquidated and their secured creditors paid in full. In addition, all of the unsecured debt of Adelphia Communications’ subsidiaries was paid in full, with interest, and Adelphia Communications’ general creditors were paid in part. Under Adelphia Communications’ Chapter 11 Plan (confirmed in early 2007 – about 2½ years after the company entered bankruptcy), those same unsecured creditors were to receive the proceeds of the Adelphia Recovery Trust. The Trust was charged with recovery of, among other things, fraudulent transfers made by Adelphia Communications prior to the commencement of the Adelphia cases.
It was not until 2009 that the Trust identified as funds belonging to Adelphia Communications certain commingled funds held in a “concentration account” of one of Adelphia Communications’ subsidiaries. Those funds, it was alleged, were used to cover “margin calls” made by Goldman Sachs & Co. in connection with margin loans previously made to Adelphia Communications’ founders and primary stockholders and collateralized by Adelphia Communications stock. Goldman Sachs had issued the margin calls as the value of Adelphia Commutations stock declined amidst revelations of Adelphia Communications’ off-balance sheet debt.
Goldman Sachs sought, and obtained, summary judgment in the District Court on the basis that the funds in question had been paid by Adelphia Communications’ subsidiary – and not by Adelphia Communications. The Recovery Trust appealed, arguing that the funds in question were, in fact, owned by Adelphia Communications. The Second Circuit Court of Appeals disagreed and affirmed the District Court’s ruling.
The Second Circuit explained that the commencement of a bankruptcy case triggers a number of requirements for a debtor. Among these is the mandatory requirement that the debtor must submit a schedule of all its interests in any property, wherever situated. Ultimately, the debtor must propose a plan which distributes this property within a defined priority scheme, and in the manner most advantageous for the greatest number of creditors.
The plan must also designate classes of claims and classes of interests and specify how the debtor will attend to these classes. Once the relevant parties, including the creditors, approve the debtor’s plan, the court confirms the plan and binds all parties. It is therefore crucial that all claims and interests must be settled before the plan is finalized and within the time frame allotted by the Bankruptcy Code.
The Second Circuit found that the commingled funds sought by the Adelphia Recovery Trust were claimed by one of Adelphia Communications’ subsidiaries during the bankruptcy proceeding. Those claims were asserted without objection from Adelphia Communications’ creditors. The Trust’s subsequent claim to those assets in a subsequent proceeding was therefore inconsistent with creditors’ earlier stance. Under the doctrine of judicial estoppel, parties (and their successors) cannot be allowed to change their positions at their convenience. Consistent with this doctrine, disturbing claims and distributions at such an advanced stage of the proceedings to address the creditors’ changed position would undermine the administration of Adelphia Communications’ and its subsidiaries’ related cases. It would also threaten the integrity and stability of the bankruptcy process by encouraging parties to alter their positions at their whim, as and whenever convenient.
Adelphia Recovery Trust highlights three important realities of bankruptcy practice:
- First, the filing of a debtor’s bankruptcy schedules is more than a merely a perfunctory act. It is a preliminary statement, made to the best of the debtor’s belief and under penalty of perjury, of the debtor’s assets (including all of its ownership interests in any property, anywhere) and its liabilities. Ultimately, creditors and other interested parties – and the court itself – rely upon those schedules in determining the debtor’s compliance with the reorganization requirements of Bankruptcy Code section 1129.
- Second, related debtors are commonly related in much more than name or ownership. In addition to inter-company transfers and claims between debtors, it is common for such enterprises to separate functional asset ownership from legal asset ownership. This distinction may be an important one for various groups of creditors seeking additional sources of recovery.
- Third (and finally), creditors – and the professionals who represent them – should thoroughly investigate any and all “control,” commingling, and other aspects of the relationships between related debtors which may give rise to indirect ownership of assets. Where doubt or conflicting claims exist as to specific assets, it is important for parties with competing claims to reserve their rights early and clearly – thereby making themselves the “squeaky wheel” in the event of any future “grease.”
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 over five divisions, a “score-card” like this one is essential reading. A copy of the survey is available here.
Other Posts of Interest:
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.
One of the time-honored attractions of US bankruptcy practice is the set of tools provided for the purchase and sale of distressed firms, assets and real estate. In recent years, the so-called “363 sale” has been a favorite mechanism for such transactions – its popularity owing primarily to the speed with which they can be accomplished, as well as to the comparatively limited liability which follows the assets through such sales.
But “363 sales” have their limits: In such a sale, a secured creditor is permitted to “credit bid” against the assets securing its lien – often permitting that creditor to obtain a “blocking” position with respect to sale of the assets.
Until very recently, many practitioners believed these “credit bid” protections also applied whenever assets were being sold through a Chapter 11 plan. In 2009 and again in 2010, however, the Fifth and Third Circuit Courts of Appeal held, respectively, that a sale through a Chapter 11 Plan didn’t require credit bidding and could be approved over the objection of a secured lender, so long as the lienholder received the “indubitable equivalent” of its interest in the assets (for more on the meaning of “indubitable equivalence,” see this recent post).
Lenders, understandably concerned about the implications of this rule for their bargaining positions vis a vis their collateral in bankruptcy, were relieved when, about 10 days ago, the Seventh Circuit Court of Appeals respectfully disagreed – and held that “credit bidding” protections still apply whenever a sale is proposed through a Chapter 11 Plan.
The Circuit’s decision in In re River Road Hotel Partners (available here) sets up a split in the circuits – and the possibility of Supreme Court review. In the meanwhile, lenders may rest a little easier, at least in the Seventh Circuit.
Or can they?
It has been observed that the Seventh Circuit’s River Road Hotel Partners decision and the Third Circuit’s earlier decision both involved competitive auctions – i.e., bidding – in which the only “bid” not permitted was the lender’s credit bid. The Fifth Circuit’s earlier decision, however, involved a sale following a judicial valuation of the collateral at issue.
Is it possible to accomplish a sale without credit bidding – even in the Seventh Circuit – so long as the sale does not involve an auction, and is instead preceded by a judicial valuation?
Ray’s piece focuses on the supportability of assumptions underlying valuations. As he notes:
The piece is here.
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.
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 article is available here.
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.”
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:
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 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.
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:
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).
Most insolvency practitioners are familiar with the fighting which often ensues when creditors jockey for position over a troubled firm’s capital structure. From Kansas, a recent decision issued in February highlights the standards which apply to claims that a senior creditor’s claim ought to be “subordinated” to those of more junior creditors or equity-holders.
QuVIS, Inc. (“QuVIS”), a provider of digital motion imaging technology solutions in a number of industries, found itself the target of an involuntary Chapter 7 filing in 2oo9. The company converted its case to one under Chapter 11 and thereafter sought to reorganize its affairs.
QuVIS ’ debt was structured in an unusual way. When presented with some growth opportunities in the early 2000′s, the company issued secured notes under a credit agreement that capped its lending at $30,000,000. “Investors” acquired these notes for cash and received a security interest, evidenced by a UCC-1 recorded in 2002. One of QuVIS’ “investors” was Seacoast Capital Partners II, L.P. (“Seacoast”), a Small Business Investment Company (“SBIC”) licensed by the United States Small Business Administration. Between 2005 and 2007, Seacoast lent approximately $4.25 million through a series of three separate promissory notes issued by QuVIS. In 2006, and consistent with the purposes of the Small Business Investment Act of 1958, under which licensed SBICs are expected to provide management support to the small business ventures in which they invest, Seacoast’s Managing Director, Eben S. Moulton (“Moulton”), was designated as an outside director to QuVIS’ board.
In 2007, it came to Seacoast’s attention that, despite its belief to the contrary, a UCC-1 had never been filed on Seacoast’s behalf regarding its loans to QuVIS. Nor had the earlier (and now lapsed) UCC-1 filed regarding QuVIS’ other “investors” ever been modified to reflect Seacoast’s participation in the company’s loan structure. Seacoast immediately filed a UCC-1 on its own behalf in order to protect its position. Some time after QuVIS found itself in Chapter 11 in 2009, the Committee of Unsecured Creditors (and other, less alert “investors”) sought to subordinate Seacoast’s position.
The Committee’s argument was based exclusively on 11 U.S.C. § 510(c), which provides, in pertinent part:
“Equitable” subordination is based on the idea of “inequitable” conduct - such as fraud, illegality, or breach of fiduciary duties. Where an “insider” or a fiduciary of the debtor is the target of a subordination claim, however, the party seeking subordination need only show some unfair conduct, and a degree of culpability, on the part of the insider.
Seacoast sought summary judgment denying the subordination claim. In granting Seacoast’s request, Judge Nugent of the Kansas Bankruptcy Court distinguished Seacoast’s Managing Director from Seacoast, finding that though Moulton was indeed an “insider,” Seacoast was not. Therefore, Seacoast’s claim was not subject to subordination for any “unfair conduct” which might be attributable to Moulton. To that end, Judge Nugent also appeared to go to some lengths to demostrate that Mr. Moulton’s conduct was not in any way “unfair” or detrimental to the interests of other creditors.
Subordination claims are highly fact-specific. With this in mind, the facts of the QuVIS decision afford instructive reading for lenders whose lending arrangements may entitle them to designate one of the debtor’s directors.