An old and well-known proverb warns:Â â€śIt is better to remain silent and be thought a fool than to speak and remove all doubt.â€ťÂ Over against this timeless advice, however, a very recent Second Circuit offers more specific guidance for creditors of a bankrupt debtor:
â€śThe squeaky wheel gets the grease.â€ť
In Adelphia Recovery Trust v. Goldman, Sachs & Co., et al., a creditorsâ€™ trust established to recover transfers under Adelphia Communicationsâ€™ confirmed Chapter 11 plan of reorganization sought unsuccessfully to recover â€śmargin callâ€ť payments made to Goldman, Sachs & Co.Â 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 â€śconcentration accountâ€ť scheduled as property of one of Adelphia Communicationsâ€™ subsidiaries; consequently the funds were not Adelphia Communicationsâ€™ to recover, and the trust could not belatedly be re-characterized them as such.Â 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 Communicationsâ€™ books.Â The companies were ultimately liquidated and their secured creditors paid in full.Â In addition, all of the unsecured debt of Adelphia Communicationsâ€™ subsidiaries was paid in full, with interest, and Adelphia Communicationsâ€™ general creditors were paid in part.Â Under Adelphia Communicationsâ€™ Chapter 11 Plan (confirmed in early 2007 â€“ about 2Â˝ years after the company entered bankruptcy), those same unsecured creditors were to receive the proceeds of the Adelphia Recovery Trust.Â 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 â€śconcentration accountâ€ť of one of Adelphia Communicationsâ€™ subsidiaries.Â Those funds, it was alleged, were used to cover â€śmargin callsâ€ť made by Goldman Sachs & Co. in connection with margin loans previously made to Adelphia Communicationsâ€™ founders and primary stockholders and collateralized by Adelphia Communications stock.Â Goldman Sachs had issued the margin calls as the value of Adelphia Commutations stock declined amidst revelations of Adelphia Communicationsâ€™ 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 Communicationsâ€™ subsidiary â€“ and not by Adelphia Communications.Â The Recovery Trust appealed, arguing that the funds in question were, in fact, owned by Adelphia Communications.Â 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.Â Among these is the mandatory requirement that the debtor must submit a schedule of all its interests in any property, wherever situated.Â 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. Â Once the relevant parties, including the creditors, approve the debtor’s plan, the court confirms the plan and binds all parties. Â 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. Â Those claims were asserted without objection from Adelphia Communications’ creditors. Â The Trust’s subsequent claim to those assets in a subsequent proceeding was therefore inconsistent with creditors’ earlier stance. Â Under the doctrine of judicial estoppel, parties (and their successors) cannot be allowed to change their positions at their convenience. Â 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 Communicationsâ€™ and its subsidiariesâ€™ related cases. Â 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:
–Â First, the filing of a debtorâ€™s bankruptcy schedules is more than a merely a perfunctory act. Â It is a preliminary statement, made to the best of the debtorâ€™s belief and under penalty of perjury, of the debtorâ€™s assets (including all of its ownership interests in any property, anywhere) and its liabilities.Â Ultimately, creditors and other interested parties â€“ and the court itself â€“ rely upon those schedules in determining the debtorâ€™s compliance with the reorganization requirements of Bankruptcy Code section 1129.
– Second, related debtors are commonly related in much more than name or ownership.Â 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.Â This distinction may be an important one for various groups of creditors seeking additional sources of recovery.
–Â Third (and finally), creditors â€“ and the professionals who represent them â€“ should thoroughly investigate any and all â€ścontrol,â€ť commingling, and other aspects of the relationships between related debtors which may give rise to indirect ownership of assets.Â 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 â€“ thereby making themselves the â€śsqueaky wheelâ€ť in the event of any future â€śgrease.â€ť