Posts Tagged ‘Chapter 11 Title 11 United States Code’
Thursday, February 9th, 2012
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:
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.
Sunday, July 10th, 2011
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.
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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?
Wednesday, July 6th, 2011
Guest-blogger Ray Clark of Valcor (whose prior posts appear here, here, and here) has recently completed a succinct but helpful piece on the valuation of firms in Chapter 11.
Ray’s piece focuses on the supportability of assumptions underlying valuations.¬† As he notes:
Over the last year, there have been a rash of bankruptcy cases and related lawsuits involving challenges to both debtor and creditor financial experts, wherein opposing parties successfully attacked the relevance and reliability of valuation evidence. In a number of cases, even traditional methodologies were disqualified for lack of supportable assumptions, which severely impacted recoveries for various stakeholders.
The piece is here.
Monday, June 20th, 2011
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.
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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 issues to be considered [in connection with efforts to introduce Shariah principles into secular bankruptcy and insolvency regimes throughout the world] are legion. Starting at the level of fundamental principle, will the contemplated regime provide for reorganization along the lines of Chapter 11 systems, or will liquidation be the essential thrust of the system?¬† If, in line with international trends, the system will incorporate reorganization concepts and principles, what is the Sharńę Ņah basis for this regime?¬† Even the fundamental questions are daunting.¬† For example, consideration will need to be given to debt rescheduling concepts, debt forgiveness concepts, delayed debt payment concepts, equity conversion concepts, asset sale concepts, and differential equity conceptions.¬† There will have to be consideration of whether voluntary bankruptcies can and will be permissible.¬† And after agreement is reached on the basic nature and parameters of the system, the long road of discovery and elucidation of specific Sharńę Ņah principles will have to be addressed.¬† That undertaking will wind through a great deal of new territory, from the Sharńę Ņah perspective, and will entail a comparative laws analyses, and a systemic comparison, unlike any in history.
The article is available¬†here.
Tuesday, June 7th, 2011
Chapter 11 practice ‚Äď like so many other professional service specialties ‚Äď is regrettably jargon-laden.¬† Businesses that need to get their financial affairs in order ‚Äúenter restructuring.‚ÄĚ¬† Those that must re-negotiate their debt obligations attempt to ‚Äúde-leverage.‚ÄĚ¬† And those facing resistance in doing so seek the aid of Bankruptcy Courts in ‚Äúcramming down‚ÄĚ their plans over creditor opposition.
Likewise, the Bankruptcy Code ‚Äď and, consequently, Bankruptcy Courts ‚Äď employ what can seem an entirely separate vocabulary for describing the means by which a successful ‚Äúcram-down‚ÄĚ 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‚Äôs apple, for example, the debtor may simply give the creditor the apple ‚Äď or may even attempt to replace the creditor‚Äôs interest in the apple with a similar¬†interest in the debtor‚Äôs 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 ‚Äúbankruptcy-ese‚ÄĚ as providing the creditor with the ‚Äúindubitable equivalent‚ÄĚ of its claim ‚Äď and it is a concept employed perhaps most frequently in cases involving real estate assets (though ‚Äúindubitable equivalence‚ÄĚ 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 ‚Äúdirt for debt‚ÄĚ plans.
A recent bankruptcy decision out of Georgia‚Äôs Northern District issued earlier this year illustrates the challenges of ‚Äúdirt for debt‚ÄĚ reorganizations based on the concept of ‚Äúindubitable equivalence.‚ÄĚ
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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‚Äôs proposed plan of reorganization, initially opposed by a number of his creditors, went through five iterations until only one objecting creditor ‚Äď Northside Bank ‚Äď 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 ‚ÄúHighway 411/Dodd Blvd Property,‚ÄĚ and a second-priority claim secured by a condominium unit generally referred to as the ‚ÄúHeritage Square Property.‚ÄĚ¬† It also held a judgment lien recorded against Mr. Riddle in Floyd County, Georgia.
A key feature of Mr. Riddle‚Äôs 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 ‚Äúindubitable equivalent,‚ÄĚ and in satisfaction, of all of Northside‚Äôs claims.
Northside Bank objected to this treatment, respectfully disagreeing with Mr. Riddle‚Äôs idea of ‚Äúindubitable equivalence.‚ÄĚ¬† Bankruptcy Judge Paul Bonapfel took evidence on the issue and ‚Äď in a brief, 9-page decision ‚Äď found that Mr. Riddle had the better end of the argument.
Judge Bonapfel‚Äôs decision highlights several key features of ‚Äúindubitable equivalent‚ÄĚ plans:
-¬†¬†¬†¬†¬†¬†¬†¬† The importance of valuation.¬† The real challenge of an ‚Äúindubitable equivalence‚ÄĚ plan is not its vocabulary.¬† It is valuing the property which will be given to the creditor so as to demonstrate that value is ‚Äútoo evident to be doubted.‚ÄĚ¬† 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‚Äôs claim, as Mr. Riddle did in his case.¬† In such circumstances, the valuation must be very conservative ‚Äď a consideration Judge Bonapfel and other courts recognized.
-¬†¬†¬†¬†¬†¬†¬†The importance of evidentiary standards.¬† Closely related to the idea of being ‚Äútoo evident to be doubted‚ÄĚ is the question of what evidentiary standards apply to the valuation.¬† Some courts have held that because the property‚Äôs value must be ‚Äútoo evident to be doubted,‚ÄĚ the evidence of value must be ‚Äúclear and convincing‚ÄĚ (the civil equivalent of ‚Äúbeyond a reasonable doubt‚ÄĚ).¬† More recent cases, however, weigh the ‚Äúpreponderance of evidence‚ÄĚ (i.e., does the evidence indicate something more than a 50% probability that the property is worth what it‚Äôs claimed to be?).¬† As one court (confusingly) put it: ‚ÄúThe level of proof to show ‚Äėindubitably‚Äô is not raised merely by the use of the word ‚Äėindubitable.‚Äô‚ÄĚ¬† 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 ‚Äúindubitable equivalent‚ÄĚ of its claim, it is up to the debtor to show that such treatment is for the good of all the creditors ‚Äď and not merely to disadvantage the creditor in question.¬† Judge Bonapfel put this issue front and center when he noted, in Mr. Riddle‚Äôs case:
[I]t is important to recognize that ¬ß 1129(b), the ‚Äúcram-down‚ÄĚ subsection, ‚Äúprovides 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.‚ÄĚ 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 ‚Äúfair and equitable,‚ÄĚ 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 ‚Äúprojected disposable income,‚ÄĚ 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).
Tuesday, May 10th, 2011
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.
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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 ‚Äô 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.¬† ‚ÄúInvestors‚ÄĚ 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 (‚ÄúSBIC‚ÄĚ) 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 (‚ÄúMoulton‚ÄĚ), 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. ¬ß 510(c), which provides, in pertinent part:
Notwithstanding subsections (a) and (b) of this section, after notice and a hearing, the court may‚ÄĒ (1) under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim …
“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.
Monday, May 2nd, 2011
From Florida’s Northern District comes a cautionary tale of what can go wrong when¬†distressed real estate requires restructuring.¬† A copy of the decision is available here.
Davis Heritage GP Holdings, LLC (‚ÄúDebtor‚ÄĚ) was a family-owned LLC formed in 2002 to ‚Äúhold, develop, and sell condominium development properties in Mississippi and Louisiana.‚ÄĚ¬† Its sole assets were membership interests in a series of single-member “middle-tier” LLC’s, which themselves held no assets except for interests in a series of single-member “lower-tier” LLC’s – each formed to hold separate parcels of real property.
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In December 2010, the Debtor sought protection under Chapter 11, ostensibly to deal with the adverse effects of a judgment entered against it.¬† None of the “middle-tier” or “lower-tier” LLC’s had sought bankruptcy protection.¬† Despite their separate,¬†three-tier structure, the Debtor’s management adminstered them as if they were a single business enterprise.¬† Until very shortly before the Debtor’s Chapter 11 filing, the expenses and income of the enterprise were processed through the Debtor’s bank account.¬† In fact, none of the “lower tier” LLCs held bank accounts in their names until after meeting with the Debtor’s bankruptcy counsel.¬† From at least January 2007 through August 2010, the Debtor’s bank accounts contained several millions of dollars, at one time exceeding $22 million.¬† The Debtor’s principals have used the Debtor’s accounts freely, to receive and disburse money to and from whomever the principals chose at any given time.¬† Despite this fact, the Debtor only disclosed one bank account in its Schedule B and did not disclose, but rather affirmatively denied, making any transfers to insiders within one year pre-petition.
Finally, the Debtor never disclosed the properties owned by the “lower tier” LLCs (or their income and expenses) in its Schedules or any other papers filed with the Court. Nevertheless, the Debtor’s Plan is based entirely upon the liquidation of some of those very properties.
The Debtor’s difficulties arose out of the purchase of land and subsequent construction of¬†the 21-story “Beau View” luxury condominium tower in Biloxi, Mississippi.¬† In exchange for the land, the Debtor had executed two junior-priority promissory notes to the seller, and obtained a senior-priority acquisition loan from Wells Fargo.¬† The Debtor then financed construction with a separate loan – also from Wells Fargo – and completed the tower.
Though it made considerable progress selling condominium units and repaying Wells Fargo’s construction loan, the Debtor made only sporadic payments on its purchase notes to the seller.¬† Eventually, the seller obtained a judgment on the note in Mississippi, then domesticated that note in Florida and sought to foreclose on all of the debtor’s membership interests in the “middle tier” LLC’s.
To avoid foreclosure on its “middle tier” LLC interests, the Debtor made a $200,000 payment in exchange for 60 days’ forbearance – then, promptly, sought Chapter 11 protection.¬† At the time of filing, the Wells Fargo¬†construction loan and acquisition loans¬†were current.¬† The Debtor had permitted two¬†mortgage loan actions filed against two of the “lower tier” LLC’s by Sun Trust Bank to go to default judgment.
Very shortly after filing, the seller of the Biloxi property sought relief from stay to continue its foreclosure on the “middle tier” LLC interests – or, in the alternative, dismissal of the Debtor’s Chapter 11 case.¬† The Debtor countered with an emergency motion for the sale of certain assets – and, a day prior to the hearing on the stay relief motion, a Chapter 11 Plan.
In reviewing the evidence and determining that dismissal of the Debtor’s case was appropriate, the court observed:
[W]hen determining whether to grant stay relief for cause or dismiss a chapter 11 case, . . . a number of factors may evidence an ‚Äúintent to abuse the judicial process and the purposes of the reorganizationprovisions‚ÄĚ . . . . . Those factors include:
a. the debtor has only one asset, the property;
b. the debtor has few unsecured creditors whose claims are small in relation to the claims of the secured creditors;
c. the debtor has few employees;
d. the property is the subject of a foreclosure action as a result of arrearages of the debt;
e. the debtor’s financial problems involve essentially a dispute between the debtor and the secured creditors which can be resolved in the pending state court action; and
f. the timing of the debtor’s filing evidences an intent to delay or frustrate the legitimate efforts of the debtor’s secured creditors to enforce their rights . . . . Once a court finds that the above factors are present, ‚Äú[t]he possibility of a successful reorganization cannot transform a bad faith filing into one undertaken in good faith.‚ÄĚ All of the [above-referenced] bad faith factors are present in this case, as are additional factors indicating bad faith. . . . The Debtor’s financial problems involve a two-party dispute between it and [the judgment creditor] that can be resolved in state court. Also, the timing of this petition shows an intent to delay or frustrate the legitimate collections efforts of [the judgment creditor]‚ÄĒwho is the only real direct creditor of the Debtor . . . .
The court then went on to explain why the essence of the Debtor’s Chapter 11 plan – essentially, an effort to pay Wells Fargo and Sun Trust at the expense of the seller of the Biloxi property – was a “sort of reverse marshalling” inappropriate for Chapter 11 under the facts of this case:
Unlike the traditional single asset case where a main creditor is stayed from collecting out of the debtor’s only asset, this case involves a three-tier corporate structure created by the Debtor and its principals whereby [the Biloxi land seller and judgment creditor] is the only creditor that is adversely affected by the automatic stay.¬† See 11 U.S.C. ¬ß 362(a).¬† All other creditors of the Debtor with claims to the properties owned by the “lower tier” LLCs are free to pursue those claims through foreclosure on those real properties, thereby diminishing the value of the Debtor’s only asset (membership in the “middle tier” LLCs), beyond the control of [the judgment creditor].¬† This fact is illustrated by Sun Trust’s pursuit of its post-petition mortgage foreclosure litigation against [two "lower-tier" LLC] properties, which has been unopposed by the Debtor and its principals.¬† Similarly, [the Debtor's] testimony states that in spite of the bankruptcy, and the way the enterprise has historically been managed, all of the “lower tier” LLCs are doing business as usual, renting units, offering units for sale, selling property, signing contracts for sale, and paying their bills.¬† After a history of treating all the entities as a single corporate enterprise, the Debtor now takes the position that it lacks control of its wholly-owned subsidiaries and only it, the Debtor, is subject to the rules and constraints of Chapter 11.
In reviewing Chapter 11 cases alleged to have been filed in bad faith, courts may look to all of the evidence and the totality of the circumstances to determine what is really happening, and the true intent and purpose behind the filing. . . .¬† Here, the true intent and effect of this case and the Debtor’s Plan are plain: the Debtor’s insiders seek to donate assets subject to [the judgment creditor's] judgment lien to Sun Trust and Wells Fargo in order to shield their own assets and money from those creditors.¬† This scheme, memorialized in the Debtor’s Chapter 11 Plan, amounts to a kind of reverse marshaling.¬† The Plan takes the only assets available to [the judgment creditor] (and subject to its levy), property owned not by the Debtor but by the “lower tier” LLCs, and shifts that property to Sun Trust and Wells Fargo, creditors with claims [are] secured by other assets owned by the insiders.¬† This Plan reduces the amount that [the judgment creditor] may collect and simultaneously reduces the guarantors’/insiders’ liability to Sun Trust and Wells Fargo.
The court’s discussion of what constitutes “bad faith” in filing a Chapter 11 case is instructive, as is its analysis of how “bankruptcy remote” entities can be treated in the absence of related Chapter 11 filings.
Sunday, April 24th, 2011
One of the most effective vehicles for the rescue and revitalization of troubled business and real estate to emerge in recent years of Chapter 11 practice has been the “363 sale.”
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Named for the Bankruptcy Code section where it is found, the “363 sale” essentially provides for the sale to a proposed purchaser, free and clear of any liens, claims, and other interests, of distressed assets and land.
The section has been used widely in bankruptcy courts in several jurisdictions to authorize property sales for “fair market value” . . . even when that value is below the “face value” of the liens encumbering the property.
In the Ninth Circuit, however, such sales are not permitted – unless (pursuant to Section 363(f)(5)) the lien holder “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”
A recent decision issued early this year by the Ninth Circuit Bankruptcy Panel and available here)¬†provides a glimpse of how California bankruptcy court are¬† employing this statutory exception to approve “363 sales.”
East Airport Development (EAD) was a residential development project in¬† San Luis Obispo which, due to the downturn of the housing market, never came completely to fruition.
Originally financed with a $9.7 million construction and development loan in 2006, EAD’s obligation was refinanced at $10.6 million in mid-2009.¬† By February 2010, the project found itself in Chapter 11 in order to stave off foreclosure.
A mere¬† two weeks after its Chapter 11 filing, EAD’s management requested court authorization to sell 2 of the 26 lots in the project free and clear of the bank’s lien, then to use the excess proceeds of the sale as cash collateral.
In support of this request, EAD claimed the parties had previously negotiated¬†a pre-petition release price agreement.¬† EAD argued the release price agreement was a ‚Äúbinding agreement that may be enforced by non-bankruptcy law, which would compel [the bank] to accept a money satisfaction,‚ÄĚ and also that the bank had consented to the sale of the lots.¬† A spreadsheet setting forth the release prices was appended to the motion.¬† The motion stated EAD’s intention to use the proceeds of sale to pay the bank the release prices and use any surplus funds to pay other costs of the case (including, inter alia, completion of a sewer system).
The bank objected strenuously to the sale.¬† It argued there was no such agreement – and EAD’s attachment of spreadsheets and e-mails from bank personnel referencing such release prices ought to be excluded on various evidentiary grounds.
The bankruptcy court approved the sale and cash collateral use over these objections.¬† The bank appealed.
On review, the Ninth Circuit Bankruptcy Appellant Panel found, first,¬†that the bankruptcy court was within the purview of its discretion to find that, in fact, a release price agreement did exist – and second, that such agreement was fully enforceable in California:
It is true that most release price agreements are the subject of a detailed and formal writing, while this agreement appears rather informal and was evidenced, as far as we can tell, by only a few short writings. However, this relative informality is not fatal. The bankruptcy court is entitled to construe the agreement in the context of and in connection with the loan documents, as well as the facts and circumstances of the case. Courts seeking to construe release price agreements may give consideration to the construction placed upon the agreement by the actions of the parties. . . . Here, the parties acted as though the release price agreement was valid and enforceable and, in fact, had already completed one such transaction before EAD filed for bankruptcy. On these facts, [EAD] had the right to require [the bank] to release its lien on the two lots upon payment of the specified release prices, even though [the bank] would not realize the full amount of its claim. More importantly, [EAD] could enforce this right in a specific performance action on the contract. For these reasons, the sale was proper under ¬ß 363(f)(5).
The Ninth Circuit Bankruptcy Appellate Panel’s East Airport decision provides an example of how bankruptcy courts in the Ninth Circuit are creatively finding ways around¬†legal hurdles to getting “363 sales” approved in a very difficult California real estate market.¬† It likewise demonstrates the level of care which lenders’ counsel must exercise in negotiating the work-out of troubled real estate projects.