Posts Tagged ‘creditor’
Tuesday, January 17th, 2012
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Can a senior secured lender require, through an inter-creditor agreement, that a junior lender relinquish the 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.
Tuesday, June 7th, 2011
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
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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. 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:
[I]t is important to recognize that Â§ 1129(b), the âcram-downâ subsection, âprovides 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.â 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 âfair and equitable,â 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).
Monday, May 16th, 2011
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?
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The Bankruptcy Code itself provides some protection for “reclamation” creditors by providing such creditors additional time in which to assert their claims, and by affording administrative priority for a certain 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:
“Filing a demand, but then doing little else in the end likely creates more litigation and pressure on the Bankruptcy Court than seeking relief from the automatic stay. . . or seeking a [temporary restraining order] or initiating an adversary proceeding.Â In this case, Paramount filed its reclamation demand, but then failed to seek court intervention to perfect that right.Â As the Bankruptcy Court held, the Bankruptcy Code is not self-executing.Â Although [the Bankruptcy Code] does not explicitly state that a reclaiming seller must seek judicial intervention, that statute does not exist in a vacuum.Â The mandatory stay as well as the other sections of the Bankruptcy Code that protect and enforce the hierarchy of creditors create a statutory scheme that cannot be overlooked.Â Once Paramount learned that Circuit City planned to use the goods in connection with the post-petition [debtor-in-possession financing], it should have objected.Â It didn’t.Â To make matters worse, Paramount then failed to object to Circuit City’s liquidation of its entire inventory as part of the closing [going-out-of-business] [s]ales.”
Let the seller beware.
Tuesday, 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.Â From Kansas, a recentÂ 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”),Â 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.Â The company converted its case to one under Chapter 11 and thereafter sought to reorganize its affairs.
QuVIS â debt was structured in an unusual way.Â 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.Â âInvestorsâ acquired these notes for cash and received a security interest, evidenced by a UCC-1 recorded in 2002.Â One of QuVIS’ “investors” was Seacoast Capital Partners II, L.P. (“Seacoast”), a Small Business Investment Company (âSBICâ) licensed by the United States Small Business Administration.Â Between 2005 and 2007, Seacoast lent approximately $4.25 million through a series of three separate promissory notes issued by QuVIS.Â 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 (âMoultonâ), 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.Â 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.Â Seacoast immediately filed a UCC-1 on its own behalf in order to protect its position.Â Some time after QuVIS found itself in Chapter 11 in 2009, the Committee of Unsecured Creditors (and other, less alertÂ ”investors”) sought to subordinate Seacoast’s position.
The Committee’s argument was based exclusively onÂ 11 U.S.C. Â§ 510(c), which provides, in pertinent part:
Notwithstanding subsections (a) and (b) of this section, after notice and a hearing, the court mayâ (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 -Â such asÂ fraud, illegality, or breach of fiduciary duties.Â 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.Â In granting Seacoast’s request, Judge Nugent of the Kansas Bankruptcy Court distinguishedÂ Seacoast’sÂ Managing DirectorÂ from Seacoast, finding that though Moulton was indeed an “insider,” Seacoast was not.Â Â Therefore, Seacoast’s claim was not subject to subordination for any “unfair conduct” which might be attributable to Moulton.Â 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.Â With this in mind, the facts of the QuVIS decisionÂ afford instructive reading for lenders whose lending arrangements may entitle them to designate one of the debtor’s directors.
Tuesday, April 19th, 2011
Title II of the Dodd-Frank Act provides âthe necessary authority to liquidate failing financial companies that pose a systemic risk to the financial stability of the United States in a manner that mitigates such risk and minimizes moral hazard.â
Under this authority, the government would have had the requisite authority to structure a resolution of Lehman Brothers Holdings Inc. – which, as readers are aware, was one of the marquis bankruptcy filings of the 2008 – 2009 financial crisis.
Readers are also aware that Dodd-Frank is an significant piece of legislation, designed to implement extensive reforms to the banking industry.Â But would it have done any better job of resolving Lehman’s difficulties than did Lehman’s Chapter 11?
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Predictably, the FDIC is convinced that a government rescue would have beenÂ more beneficialÂ - and in “The Orderly Liquidation of Lehman Brothers Holdings Inc. under the Dodd-Frank Act” (forthcoming in Vol. 5 of the FDIC Quarterly), FDIC staff explain why this is so.
The 19-page paper boils down to the following comparison between Chapter 11 and a hypothetical resolution under Dodd-Frank:
[U]nsecured creditors of LBHI are projected to incur substantial losses. Immediately prior to its bankruptcy filing, LBHI reported equity of approximately $20 billion; short-term and long-term indebtedness of approximately $100 billion, of which approximately $15 billion represented junior and subordinated indebtedness; and other liabilities in the amount of approximately $90 billion, of which approximately $88 billion were amounts due to affiliates. The modified Chapter 11 plan of reorganization filed by the debtors on January 25, 2011, estimates a 21.4 percent recovery for senior unsecured creditors. Subordinated debt holders and shareholders will receive nothing under the plan of reorganization, and other unsecured creditors will recover between 11.2 percent and 16.6 percent, depending on their status.
By contrast, under Dodd-Frank:
As mentioned earlier, by September of 2008, LBHIâs book equity was down to $20 billion and it had $15 billion of subordinated debt, $85 billion in other outstanding short- and long-term debt, and $90 billion of other liabilities, most of which represented intracompany funding. The equity and subordinated debt represented a buffer of $35 billion to absorb losses before other creditors took losses. Of the $210 billion in assets, potential acquirers had identified $50 to $70 billion as impaired or of questionable value. If losses on those assets had been $40 billion (which would represent a loss rate in the range of 60 to 80 percent), then the entire $35 billion buffer of equity and subordinated debt would have been eliminated and losses of $5 billion would have remained. The distribution of these losses would depend on the extent of collateralization and other features of the debt instruments.
If losses had been distributed equally among all of Lehmanâs remaining general unsecured creditors, the $5 billion in losses would have resulted in a recovery rate of approximately $0.97 for every claim of $1.00, assuming that no affiliate guarantee claims would be triggered. This is significantly more than what these creditors are expected to receive under the Lehman bankruptcy. This benefit to creditors derives primarily from the ability to plan, arrange due diligence, and conduct a well structured competitive bidding process.
Convinced?Â You decide.
Monday, November 29th, 2010
About a month ago, the Ninth Circuit clarified and restated the ability of individual creditors to pursue claims against debtors based on anÂ alter ego theory, despite a bankruptcy trustee’s efforts to reach the same assets (discussion here).
Last week, the Ninth Circuit further expanded the reach of alter ego liability to “asset protection” trusts established by debtors.Â Along the way, and in dicta, it finessed earlier treatment of the same liability in the corporate context.
The facts in In re Schwarzkopf are somewhat involved, but essentially reduce themselves to the following:Â During the 1990′s, the debtors established two separate and allegedly irrevocable trusts – the “Apartment Trust” (to hold the debtors’ stockÂ inÂ aÂ corporation which owned and operated anÂ apartment building) and the “Grove Trust” (to hold four plots of land containing avocado groves).Â The Apartment Trust was established to remove the debtors’ stock from the reach of creditors while the debtors contested a judgment obtained against the corporation.Â The Grove Trust was subsequently established while the debtors were insolvent – and, likewise, was intended to move the debtors’ assets beyond the reach of their creditors.
During the life of both trusts, the debtors routinely sought and obtained use of the trust assets for their personal benefit and for the benefit of familyÂ members.Â The trustee administering the trusts apparently exercised no independent judgment regarding the debtors’ requests, commingled trust assets, and kept no books and records regarding either trust for several years after their establishment.
The debtors filed a Chapter 7 case in 2003, seeking to discharge approximately $5.4 million in debt.Â The appointed Chapter 7 trustee filed an adversary complaint seeking to recover approximately $4 million from the trusts.Â The bankruptcy court initially concluded both trusts were valid and that neither is the alter ego of the debtors, but subsequently reversed the alter ego determination as to the Grove Trust.
The District Court found that the trusts were not the debtors’ alter ego, reasoning thatÂ under SEC v. Hickey, 322 F.3d 1123 (9th Cir. 2003), legal ownership is a prerequisite for such liability in California.Â It also found the Apartment Trust was not valid, but remanded so the Bankruptcy Court could determine whether or not the Trustee’s complaint was time-barred in the first instance.
The Ninth Circuit quickly dispensed with the Apartment Trust, finding the statute of limitations for attacking the Apartment Trust did not begin to run until the trusteeÂ answered the avoidance complaint filed in the debtors’ Chapter 7 cases.
It then turned to the Grove Trust, finding that despite its continuing existence as a trust, it was the nevertheless the debtors’ alter ego.Â To reach this conclusion, it reasoned that despite its earlier decision in Hickey, which had concluded that actual ownership of stock was a prerequisite for alter ego liability in corporate cases, California law nevertheless suggested that equitable stock ownership was sufficient for alter ego liability after allÂ . . . and that, in any event, an equitable ownership interest is “traditionally sufficient to confer ownership rights” in the trust context.
Schwarzkopf‘s factsÂ certainly suggest the Ninth Circuit was reaching to assist the trustee’s efforts to recover significant assets for the benefit of creditors.Â However, its relaxed treatment of the “ownership threshold” for alter ego liability may prove useful for trustees or creditors in other contexts.
Monday, November 8th, 2010
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:
“When a creditor can or could exercise its statutory or contractual remedies to realize upon collateral is an inherently factual determination, but the fact that such a determination can be complicated does not make it unworkable.Â The discretionary standard adopted by Deico gives bankrupcy courts the needed flexibility to make appropriate adequate protection determinations as provided for in the Bankruptcy Code, based upon the evidence presented by the parties.”
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.
Monday, 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.
Monday, October 11th, 2010
Most readers of this blog are aware that, under the Bankruptcy Code, a Chapter 11 debtor (or the trustee appointed in the debtor’s case)Â is entitled to seek âavoidanceâ of a limited set of pre-bankruptcy âpreferenceâ payments, providedÂ it can establish the payments were made:
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt . . . ;
(3) . . . while the debtor was insolvent;
(4) . . . on or within 90 days before the date of the filing of the [bankruptcy] petition; . . . and
(5) that enables [the] creditor to receive more than [its anticipated pro rata distribution in Chapter 7].
Even if all these elements are met, however, the Bankruptcy Code provides creditors with an affirmative âordinary course of businessâ defense.
Though articulated slightly differently by different courts,Â 11 U.S.C. Â§547(c)(2) essentially provides that the âordinary course of business exceptionâ permits a creditor to retain transfers made by a debtor to a creditor during the ninety days before the petition date if: (1) such transfers were made for a debt incurred in the âordinary course of businessâ of the parties; and either (2) the transfers were made in the âordinary course of businessâ of the parties; or (3) the transfers were made in accordance with âordinary business terms.â
Once an “ordinary course” relationship is established between the debtor and the creditor who received allegedly preferential payments, the focus shifts to showing whether or not the payments at issue complied with “ordinary course” timing and terms.
To show this, the preference defendant must demonstrate thatÂ the relevant payments did not differ from past payments in âamountâ or âform,â were not the result of âunusual collection or payment activit[ies],â or did not come as a result of the âcreditor [taking] advantage of the debtorâs deteriorating financial condition.â
Importantly, the emphasis is on the payments themselves – rather than on what the debtor and creditor may have otherwise considered or discussed.Â This distinction is illustrated in a recent decision issued by Judge Christopher Sontchi in Burtch v. Detroit Forming, Inc. (In re Archway Cookies) (available here).
In Burtch v. Detroit Forming, the Trustee in a Chapter 7 case (converted from one under Chapter 11) commenced an adversary proceeding against Detroit Forming, Inc. (âDFIâ) seeking to avoid as preferential six (6) transfers totaling $180,648.17.Â DFI asserted the “ordinary course” defense, arguing it had a two-year suppplier relationship with the debtors and that it had received the payments in question under the same timing and terms as those extant throughout this relationship.
DFI’s defense is typical of that offered under the “ordinary course” defense:Â It established a specific range of days-to-payment from invoicing, then showed that the payments in question were timed substantially similar to the days-to-payment average and under similar terms (i.e., by check rather than by wire transfer or COD).
Notably, the Court was not troubled by a letter sent by DFIâs CFO/Controller notifying the Debtors that no product would be shipped unless the accounts were current.Â For purposes of establishing “ordinary course,” it was the subjective relationship that existed between the debtor and the preference defendant which mattered – rather than the debtor’s relations with all its creditors.
Burtch v. Detroit Forming is instructive on what it takes to mount a successful “ordinary course” defense, as is the Ninth Circuit’s earlier decision in Sigma Micro v. Healthcentral.com (In re Healthcentral.com) (availabe here) – a similar case where the defendant’s “ordinary course” analysis was deemed sufficient to withstand a motion for summary judgment, and where the Ninth Circuit placed little stock in the debtor’s evidence of pre-petition “old school” cash management practices whereby the debtor’s management determined each week which creditors would be paid, and how much.
Monday, June 14th, 2010
The Advisory Committee on Bankruptcy Rules of the Administrative Office of the U.S. Courts has pulled back from its earlier position on the disclosure required of hedge fund and other distressed debt investors participating as ad hoc committees or other, loosely organized creditor groups in Chapter 11 cases.
An earlier version of proposed amendments to Federal Rule of Bankruptcy Procedure 2019 would have required such investors to disclose the dates and prices paid for their purchases of distressed securities.Â These changes were resisted by investor groups such as the Loan Syndications and Trading Association, and created some press coverage last year (an earlier post on the amendmentsÂ is available here).
That said, investors will still be required to reveal the âdisclosable economic interestâ they each hold in a company, including debt and derivatives. This includes the identity of specific investors and the date such investors acquired their interests.
Morever, Committee notes to the proposed rule indicate that the previously-contested disclosures of pricing and purchase dates may be compelled through discovery or by the Court acting under its own authority outside the proposed rule.
A copy of the proposed rule, along with a summary of comments received on earlier versions and the Committee’s advisory notes,Â is available here.