Hot Topics in Bankruptcy: Recent Commercial Bankruptcy Decisions Affecting Creditors and Lenders Rights

Transcription

1 Business Law Section Commercial Finance Committee Creditors Rights Sub-Committee BLS Summer Meeting September 2017 Hot Topics in Bankruptcy: Recent Commercial Bankruptcy Decisions Affecting Creditors and Lenders Rights Peter S. Munoz (Moderator) Reed Smith LLP San Francisco, CA T. Parker Griffin, Jr. (Co-Moderator) Bradley Arant Boult Cummings LLP Birmingham, AL Margaret ( Peg) M. Anderson Fox Swibel Levin & Carroll, LLP Chicago, IL Jonathan R. Doolittle Reed Smith LLP San Francisco, CA Caroline Reckler Latham & Watkins LLP Eunice Chay (Panel Coordinator) Renovate America San Diego, CA Chicago, Illinois September 15, 2017 US_ACTIVE

2 I. FRAUDULENT TRANSFER/AVOIDABLE TRANSACTIONS A. WEISFELNER V. HOFMANN (IN RE LYONDELL CHEM. CO.), 554 B.R. 635 (S.D.N.Y 2016). Summary: New York District Court held that a single corporate officer s fraudulent intent could be imputed to a corporation under Delaware law for purposes of an intentional fraudulent transfer claim. The Court also held that the standard for proving actual intent requires evidence that the actor desires to cause the consequences of his act, or that he believes that the consequences are substantially certain to result from it. Facts: Lyondell Chemical Company ( Lyondell ) was a publicly traded petrochemical company that was acquired in a leveraged buyout ( LBO ) transaction. Lyondell s board of directors ( Board ) included Dan Smith ( CEO ), Lyondell s CEO and board chairman, and ten outside directors. In August 2006, an initial buyout offer was made at a price of $26.50 to $28.50 per share. The CEO instructed the Board to reject this offer until he presented a strategic update in October 2006, and the Board rejected this initial offer. In October 2006, a strategic update was presented to the Board, which included projections of about $14.9 billion in EBITDA from 2007 to It is alleged by Lyondell s unsecured creditors that such projections were inflated by over $5 billion in order to justify a higher stock price in any future acquisition. In December 2006, the Board adopted these projections as part of Lyondell s 2007 long range plan ( Plan ). Lyondell s actual revenues for 2007 failed to meet the 2007 projection included in the Plan. In May 2007, upon a potential acquirer s further expression of interest, the CEO requested a set of refreshed EBITDA projections for 2007 to 2011 that added $2 billion of EBITDA at the direction of the CEO ( Refreshed Projections ). In June 2007, the CEO and potential acquirer engaged in a series of negotiations, during which time the CEO proposed a purchase price of $48 per share. The acquirer responded in early July with an offer of $40 to $48 per share. Later in July, the CEO reported to the Board on the proposed offer, and delivered the Refreshed Projections. The Board reviewed the Plan and the Refreshed Projections, and authorized the CEO to continue negotiations. With the Board s authorization, Lyondell s senior management made a single due diligence presentation to the acquirer. Lyondell s financial advisor also made a presentation to the Board concluding that the merger was fair to shareholders. The financial advisor adopted the Refreshed Projections without verification, and did not opine on their reasonableness. Thereafter, the parties entered into a merger agreement, and the transaction closed in December The LBO was financed entirely by debt secured by Lyondell. Lyondell assumed about $21 billion of secured debt, and distributed the loan proceeds as follows: (i) $12.5 billion was paid to Lyondell shareholders ( Shareholder Payments ), including $100 million to Lyondell officers and directors; (ii) $337 million was paid to Lyondell officers and employees pursuant to a variety of benefit and incentive plans; and (iii) $7.1 billion of was used to refinance existing debt. About a year after the LBO, Lyondell filed bankruptcy. Bankruptcy Court Ruling: Lyondell s unsecured creditors, acting through the trustee of a creditor trust, asserted intentional fraudulent claims against certain of Lyondell s selling shareholders based on Section 548 of the Bankruptcy Code or state fraudulent transfer law. The trustee alleged that the CEO knowingly presented false financial projections to the Board in order to urge approval of an LBO, and that the CEO had the actual intent to defraud Lyondell s creditor for his own benefit and the benefit of other shareholders. The Bankruptcy Court - 2 -

3 dismissed such actions on the grounds that the CEO s intent could not be imputed to Lyondell. The Bankruptcy Court held that because Delaware law requires Board approval for any merger or LBO, it was the intent of the Board, not the CEO that mattered. It further held that the trustee failed to prove that either a critical mass of Board members, or Board members with sufficient control to dispose of property, had the requisite intent. District Court Ruling: The District Court overruled the decision of the Bankruptcy Court and held that the CEO s fraudulent intent could be imputed to Lyondell. Applying Delaware law to the question of imputation, the Court explained that Delaware law holds corporations liable for the acts and knowledge of their agent even when the agent acts fraudulently or causes injury to third persons through illegal conduct. It further explained that such acts must be performed within the scope of employment. Based on the facts of this case, the Court concluded that the CEO s knowledge and intention in connection with the LBO could be imputed to Lyondell, because the CEO was an agent of the company, and the actions performed with respect to the supervision, preparation and presentation of the Refreshed Projections and the associated negotiations were all done as an officer of Lyondell. The Court further held that the standard for pleading intent requires proof of a person s mental apprehension of the consequences of his conduct. This standard was also described as the actor s desire to cause the consequences of his act, or the belief that the consequences are substantially certain to result from the act. Comment: Section 546(e) has been interpreted as limiting the avoidance of pre-bankruptcy transfers that occurred in connection with a securities contract as constructive fraudulent transfers. The second circuit has interpreted the term settlement payment for purposes of such provision broadly to mean any kind of payment that completes a transaction in securities. Section 546(e), however, does not insulate transfers from attack as intentional fraudulent transfers. As held in this case, the trustee of the creditors committee could pursue an intentional fraudulent transfer claim against the transferee (but not a constructive fraudulent transfer claim). B. FTI CONSULTING, INC., VS. MERIT MANAGEMENT GROUP, LP 2016 WL (7th Cir.). Summary: Settlement payment safe harbor defense under 546(e) safe harbor does not protect the recipient of cash transfers though conduit bank as part of leveraged acquisition. It does however protect the conduit bank. Facts: A racetrack entity acquired the shares of a competitor with more than $16 million in borrowed money. The money flowed from the lender to an intermediary bank as an escrow agent; the money was then disbursed to the former shareholders of the acquired entity. The acquiring entity filed a Chapter 11 petition and brought a fraudulent transfer action against one former shareholder of the acquired entity (i.e. the recipient of the cash). That shareholder invoked the settlement payment defense of 11 U.S.C.A. 546(e), on the theory that the use of the intermediary bank as an escrow agent created a safe harbor against avoidance. The bankruptcy court granted the defendants' motion for judgment on the pleadings, but the Seventh Circuit reversed. Analysis: The settlement payment defense provided under 11 U.S.C.A. 546(e) states that the trustee may not avoid certain transactions including a settlement payment made by or to or - 3 -

4 for the benefit of a broker financial institution, financial participant, or securities clearing agency that is a transfer made by or to or for the benefit of the foregoing. The settlement payment defense is an important defense that is regularly asserted by parties who have received payments through an escrow as part of a leveraged buyout. The Second, Third, Sixth, Eighth, and Tenth Circuits have held that the settlement payment defense protects the recipients. Only the Eleventh Circuit has previously held to the contrary. In FTI Consulting the Seventh Circuit joined the Eleventh Circuit and held: [W]hether the section 546(e) safe harbor protects transfers that are simply conducted through financial institutions (or the other entities named in section 546(e)), where the entity is neither the debtor nor the transferee but only the conduit. We hold that it does not. In response to the shareholder s argument that a ruling denying protection of the safe harbor would cause major repercussions in the financial markets, the Court held: We are not troubled by any potential ripple effect through the financial markets from returning the funds to [the estate]. The safe harbor addresses cases in which the debtor-transferor or transferee is a financial institution or other named entity.... [The acquiring entity's] bankruptcy will not trigger bankruptcies of any commodity or securities firms. C. CONT L CAS. CO. V. SYMONS, 817 F.3d 979 (7th Cir. 2016), cert. denied, Symons Int l Grp., Inc. v Cont l Cas. Co., 137 S. Ct. 493 (2016). Summary: Seventh Circuit held that the transfer of sales proceeds to the parent and affiliates of the seller constituted a constructive and intentional fraudulent transfer under Indiana state law; and that the publicly traded parent and affiliated entities and their individual officers and directors could be held liable for such transfers under an alter ego or veil piercing theory. Background: Continental Casualty Company ( Continental ) sold its crop insurance business ( Business ) to IGF Insurance Company ( IGF ) for $25 million ( Continental Purchase Obligation:). While the Continental Purchase Obligation remained outstanding, IGF resold the business to Acceptance Insurance Company ( AIG ) for $40 million, and structured the transaction for payment to be made: $16.5 million to IGF; $9 million to IGF parent companies ( IGF Parent ) in exchange for non-competition agreements; and $15 million to an IGF affiliate ( IGF Affiliate ) in exchange for a reinsurance treaty. IGF, IGF Parent, and IGF Affiliate had interlocking equity, boards, and officers. IGF Parent and IGF Affiliate were publicly traded companies with majority family ownership. Appellate Court Ruling: The Court held that the payments made to the IGF Parent and the IGF Affiliate constituted constructive and intentional fraudulent transfers under Indiana state law. The Court agreed with the lower court s determination that the elements of a constructive fraudulent transfer claim were met, because (i) Continental held a claim against IGF prior to the time of the transfer from IGF to AIG; (ii) AIG was insolvent at the time such transfer; and (iii) the purchase price for the sale to AIG was structured to prevent AIG from receiving reasonable equivalent value for such transfer. The Court also agreed with the lower court s determination that the elements of an intentional fraudulent transfer were met, because there were sufficient badges of fraud to infer fraudulent intent, including: (i) the transfer of property by a debtor during the pendency of a suit ; (ii) the transfer of property that renders the debtor insolvent or greatly reduces his estate ; (iii) a series of contemporaneous transactions which strip a debtor of all property available for - 4 -

5 execution ; (iv) any transaction conducted in a manner differing from customary methods ; (v) little or no consideration in return for the transfer ; and (vi) transfer of property between family members. In reaching this result, the Court agreed with the lower court s analysis that neither the non-competition agreement nor the reinsurance treaty insulated the transfer to the IGF Parent or IGF Affiliate, because neither agreement conferred material value. The Court also rejected the argument that the IGF Parent and IGF Affiliate could not be liable for such transfers, because such payments did not belong to IGF. The Court noted that the definition of transfer for purposes of the fraudulent transfer statute included both direct and indirect transfers of assets; and that the Court could look beyond the form of the transaction to its substance to assign liability, where the sale was structured to divert over half of the sales proceeds to the IGF Parent and IGF Affiliate for no material consideration. The Court also agreed that the officers and directors of the IGF Parent and IGF Affiliate could be held liable for the fraudulent transfers on an alter-ego theory, and such theory applied to publicly traded companies. Comment: The Court s decision (i) looks beyond the form of a transaction to its substance to assign liability for a fraudulent transfer and (ii) applies an alter ego analysis (including to a publicly traded company) to expand the scope of responsible parties for a fraudulent transfer where supported by the facts and equities. D. BASH V. TEXTRON FIN. CORP. (IN RE FAIR FIN. CO.), 834 F.3d 651 (6th Cir 2016), reh g denied, 2016 U.S App. LEXIS (6th Cir., Sept. 23, 2016). Summary: Sixth Circuit held that an amendment to loan documents may constitute a novation that created a new lien that could be challenged as a fraudulent transfer. Facts: Fair Finance Company ( Debtor ) was originally operated as a legitimate factoring business. In 2002, the Debtor was purchased in a leveraged buyout ( LBO ) by purchasers through a holding company ( Holding ) that operated the Debtor s business as a ponzi scheme. Holding financed the purchase by entering into a loan and security agreement ( Original Agreement ) with Textron and United Bank ( Lender ) in January Under the Original Agreement, Lender agreed to provide a $22 million revolver to Debtor and Holding, which was secured by certain property of Debtor and Holding. After the financing was established, the operations of Debtor and Holding s business and performance under the Agreement became a concern to Lender, in part due to the delivery of draft report of the companies financials that showed a number of irregularities. In 2004, the parties amended the Original Agreement (the Amended Agreement ) in a number of material respects, including to remove United Bank as lender. In 2007, Debtor and Holding obtained alternative financing and satisfied the obligations under the Amended Agreement. Two years after such obligations were satisfied, the FBI raided the Debtor s headquarters. Certain of the Debtor s owners and officers were indicted and convicted. After the FBI raid, certain of the Debtor s creditor filed an involuntary petition against the Debtor. The bankruptcy trustee filed an adversary proceeding against Textron, pursuant to which the trustee sought to recover the value of the property subject to the lien Amended Lien as actual and constructive fraudulent transfers. Textron moved to dismiss such action. District Court Ruling: The District Court concluded that the Amended Agreement was not a novation of the Original Agreement, but instead a mere refinancing that did not impact the validity of the security interests granted under the Original Agreement. Because such security interests remained valid, the District Court held that neither the Amended Agreement nor - 5 -

6 payments made thereunder could be deemed transfers for purposes of a fraudulent transfer claim. On this basis, the District Court granted Textron s motion to dismiss. Appellate Court Ruling: On appeal, the trustee contended that the Amended Agreement was a novation of the Original Agreement, and that when the Original Agreement was extinguished, the liens granted thereunder were also extinguished. In reviewing the language of the Amended Agreement and the circumstances surrounding its execution, the Appellate Court determined that genuine factual disputes existed regarding the nature of the Amended Agreement. The Appellate Court concluded that the District Court was in error in determining that the parties did not intend the Amended Agreement as a novation of the Original Agreement. On that basis the Appellate Court reversed the judgment of the District Court, and remanded for further proceedings. II. FRAUDULENT DEALINGS WITH CREDITORS A. U.S. EX REL. O'DONNELL V. COUNTRYWIDE HOME LOANS, INC., 2016 (2d Cir. 2016) 822 F.3d 650 Summary: The Second Circuit has held that a bank's knowing sale of risky and substandard mortgages to Freddie Mac and Fannie Mae was not fraudulent because the bank did not intend to commit fraud at the time that the master purchase agreement was earlier executed. In protecting the seller, the Second Circuit may have undermined the viability of continuing representations and warranties in revolving loan documents. Facts: The federal government intervened in a "whistleblower" case, claiming that Countrywide had engaged in fraudulent practices, in violation of federal mail and wire fraud statutes. The government contended that Countrywide had entered into purchase agreements with Fannie Mae and Freddie Mac, promising to sell high-quality home mortgages. Freddie Mac's selling guide, which was essentially incorporated into the terms of the agreement, contained a representation by Countrywide that all Mortgages sold to Freddie Mac have the characteristics of an investment quality mortgage." The representations concerning the quality of the loans were made "[a]s of" the date the loans were delivered. After entering into those agreements, Countrywide originated risky sub-prime mortgages and then sold them to the federal agencies without disclosing that those mortgages were not in compliance with the requirements of the original purchase agreements. No explicit additional representations were made by Countrywide at the time of each sale. The case was eventually tried to a jury, which found that Countrywide engaged in fraudulent behavior when it knowingly sold substandard mortgages to the two federal agencies. The trial court judge imposed penalties of over $1 billion. Appellate Court Ruling: The Second Circuit reversed, holding that the government had failed to prove that Countrywide had harbored fraudulent intent from the outset of its contractual relationship with the government. The court carefully distinguished between tortious promissory fraud, and an intentional breach, which is not tortious. The court noted that under both federal and common law, a representation is not fraudulent unless the defendant has a contemporaneous intent to defraud: It is emphatically the case and has been for more than a century that a representation is fraudulent only if made with the contemporaneous intent to defraud i.e., the statement was knowingly or recklessly false and made with the intent to induce harmful reliance

7 The court then held that since there was no proof that Countrywide had entered into the purchase agreements with the contemporaneous intent to defraud, the subsequent transfers of the substandard loans were not actionable. The government then argued that the representations in this case were made not only in the purchase contracts but also at the time that each substandard mortgage was transferred to the federal agencies. Construing the terms of the agreements, the court disagreed: In the relevant contractual provisions, Countrywide makes or warrants and represents certain statements (i.e., present-tense acts), including that the future transferred loan will be investment quality as of the transfer or delivery date.... The use of a present-tense verb in a contract indicates that the parties intend the act here, the making of the representation to occur at the time of contract execution, not in the future. Accordingly, the only reasonable interpretation of the contracts is that the date contained in the as of clause identifies the moment at which the promised fact will exist i.e., when the representation becomes effective. Where a party makes a contractual representation of quality that is effective as of a future date rather than the time of contract execution, the date of future effectiveness determines the date of performance (and, thus, breach)..., but the promisor's intent to perform on that promise is fixed as of contract execution. Comment: Although the O Donnell case does not involve a dischargeability issue under 11 USC 523, it could be very relevant to many dischargeabiilty disputes. Under 11 USC 523 a debt is not dischargeable as follows: a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt (2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor s or an insider s financial condition; (B) use of a statement in writing (i) that is materially false; (ii) respecting the debtor s or an insider s financial condition; (iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and (iv) that the debtor caused to be made or published with intent to deceive In the O Donnell case, the parties had expressly agreed that as to each loan to be subsequently transferred, the effective date of the representation would be the date that the advance on the loan was later delivered. The Second Circuit undermined what seems to be the clear meaning of the requirement of a continuing representation. Countrywide was released of liability despite the proof shown in the case of ongoing wrongful conduct. This is noteworthy because lenders regularly rely on continuing representations and warranties particularly in receivable financing, factoring, warehouse lines, etc. The O Donnell decision could open the door to borrowers denying the validity of continuing representation provisions in loan documents

8 III. BANKRUPTCY BLOCKING AND RELATED ISSUES. A. SOLUTION TRUST V. 211 GRAN LLC (IN RE AWTR LIQUIDATION INC.) 548 B.R. 300 (Bankr.C.D. Cal. 2016). Summary: A Bankruptcy Court in the Central District of California held that upon insolvency of a corporation, corporate directors owe a fiduciary duty to creditors that is similar to the fiduciary duty owed to stockholders and the corporation outside of insolvency: to exercise business judgment in an informed and good faith effort to preserve and grow the corporation s value. Facts: Rhythm & Hues, Inc., a California corporation ( Debtor ) confirmed a chapter 11 plan of reorganization that reserved all causes of action belonging to the Debtor or its estate for postconfirmation enforcement by a trust. After confirmation, the liquidating trustee under the Debtor s plan filed a complaint against the Debtor s directors ( Directors ) that Directors breached their fiduciary duties to creditors while the Debtor was insolvent, and that such breach caused the Debtor to lose over $70 million in value. The complaint alleged that certain Directors were involved in transactions marked by self-dealing that resulted in the transfer of corporate assets for little or no consideration, and at the same time, other Directors failed to oversee such transactions. The Directors sought to dismiss the complaint on the grounds, among others, that Directors owed no duties to creditors, or, in the alternative, that Directors are protected by the business judgment rule or stockholder ratification. Bankruptcy Court Ruling and Analysis: The Court determined that Directors were subject to the following corporate fiduciary duties under California law: (i) the duty to exercise reasonable prudence in making business judgments for the corporation, including gathering adequate information and undertaking due consideration of the relevant issues ( Duty of Care ); (ii) the duty to give primacy to the interest of the corporation, most typically contrasted with acting in self-interest ( Duty of Loyalty ); and (iii) the duty of good faith [,which] is generally considered part of the duty of loyalty, because directors or officers cannot act loyally towards the corporation unless they act in the good faith belief that their actions are in the corporation s best interest, and has been held to include a duty of oversight ( Duty of Good Faith ). In addition, although not expressly followed in any reported decision under California corporate law, based on its acceptance in other jurisdictions, the Court also held that a corporate director s obligations include the duty to attempt in good faith to assure that a corporate information and reporting system, which the board includes is adequate, exists, and the failure to do so.. [may] render a director liable for losses caused by non-compliance with applicable legal standards ( Duty of Oversight or Caremark Duties ). Outside of insolvency, these fiduciary duties run to the stockholders and the corporation. Upon insolvency, however, directors owe creditors substantially the same duties that directors owe to stockholders and the corporation outside of insolvency, because creditors are also risk bearers whose contract claims may be jeopardized by management s business decision. Both before and after insolvency, the court interpreted such fiduciary duties to mean: to exercise business judgment in an informed and good faith effort to preserve and grow the corporation s value. In an effort to address potential conflicts of interest that could arise between residual claimants of the corporation (including classes of investors and creditors), the court further explained that directors should exercise their business judgment in a good faith attempt to act in the best interests of the whole corporate enterprise, encompassing all its constituent groups, without undue preference to any, consistent with the goal of preserving and growing corporate value

9 The opinion also addressed the Directors potential protection under the business judgment rule. The Court explained that the business judgement rule does not insulate the Directors from liability where Directors process leading to the judgment fails to meet the business judgement rule requirements that reasonable diligence has been exercised. The Court highlighted the following as examples where such reasonable diligence has not be exercised: (i) Directors fail to establish any corporate information and reporting system; (ii) Directors fail to exercise their business judgment in determining that the system in adequate; (iii) Directors fail to use the system or ignore its flaws. The Court also noted that the business judgement rule does not apply to circumstance involving conflicts of interest, including self-dealing. Comment: This case provides a good exposition of the potential fiduciary duties that apply under California law. As such it is in line with the zone of insolvency cases in other circuits. The court s holding, that directors owe some fiduciary duty to creditors upon insolvency, makes sense, in view of the economic risk to creditors upon insolvency. B. IN RE INTERVENTION ENERGY HOLDINGS, LLC, 553 B.R. 258 (Bankr. D. Del. 2016) Summary: The Bankruptcy Court for the District of Delaware held void as contrary to public policy a provision in a debtor s operating agreement that granted debtor s secured creditor a single common unit the ability to block a debtor s bankruptcy filing in a situation where such interest and blocking right was granted as a concession in a loan forbearance. Background: In May 2106, Intervention Energy Holdings, LLC ( IE Holdings ) and its wholly owned subsidiary Intervention Energy LLC ( IE ; IE Holdings and IE Debtors ) filed bankruptcy. Prior to filing, Debtors and EIG Energy Fund XV-A, L.P. ( Lender ) entered into a Note Purchase Agreement ( NPA ) pursuant to which Lender provided up to $200 million in senior secured notes. In October 2015, Debtors defaulted under the NPA. In December 2015, Debtors and EIG entered into an amendment, forbearance and waiver agreement, which provided, among other things, that (i) IE Holdings amend its LLC agreement to admit Lender or its affiliate as a member of IE Holdings with one common unit, and (ii) amend such LLC agreement to require the approval of each common unit holder prior to any voluntary bankruptcy filing by IE Holdings. Thereafter, IE Holdings amended its LLC agreement to include the unanimous consent provision ( Consent Provision ), and to issue a single common unit to Lender. Other than the single common unit issued to Lender, IE Holdings issued 22 million common units. Shortly after the bankruptcy filing, Lender filed a motion to dismiss Debtors chapter 11 cases on the grounds that IE Holdings lacked authority to file a voluntary petition without Lender s consent under the IE Holdings LLC agreement. Bankruptcy Court Ruling and Analysis: The Bankruptcy Court held that the Consent Provision was tantamount to an absolute waiver of IE Holdings right to file bankruptcy, and that such waiver was void as contrary to public policy. The Court declined to address the LLC members freedom to contract under applicable state law, because it addressed the issue on public policy grounds. It explained that the federal public policy to be guarded... is to assure access to the right of a person, including a business entity, to seek federal bankruptcy relief as authorized by the Constitution and enacted by Congress. Comment: This case demonstrates the interplay of two competing legal principles: (i) the ability under state law for an entity to contract regarding the requisite approval to authorize a particular - 9 -

10 action (which the court did not address); and (ii) general public policy against the advance waiver of certain bankruptcy protections. The result is not entirely unexpected; the Bankruptcy Court refused to give effect to a structure that would effectively waive a debtor s right to file for bankruptcy. C. IN RE LAKE MICHIGAN BEACH POTTAWATTAMIE RESORT LLC, 547 B.R. 899 (Bankr. N.D. Ill. 2016) Summary: The Bankruptcy Court for the Northern District of Illinois held void as contrary to the Michigan Limited Liability Company Act a provision in a debtor s operating agreement that granted the debtor s secured creditor the ability to block a bankruptcy filing by the debtor in a situation where the blocking right was granted as a concession in a loan forbearance. Background: In December 2015, Lake Michigan Beach Pottawattamie Resort LLC (the Debtor ) filed a chapter 11 bankruptcy case. Prior to filing, the Debtor granted a mortgage and assignment of rents to BCL-Bridge Funding LLC ( BCL ) to secure a loan and line of credit provided by BCL to the Debtor. In July 2015, the Debtor defaulted on its monetary obligations to BCL. In exchange for BCL s promise to forbear from pursuing its remedies on account of the payment default until October 21, 2015, the Debtor signed an agreement on August 21, 2015, stipulating to the amount of the debt owed to BCL and promising to pay the full amount by October 21, The Debtor also agreed, among other things, to amend its operating agreement to add BCL as a member of the Debtor (the Special Member ) with the right to approve or disapprove any Material Action defined to include institution of bankruptcy proceedings by the Debtor. As a Special Member of the Debtor, BCL had no obligation to make capital contributions, no interest in the profits or losses of the Debtor, and no right to distributions. The operating agreement (as amended) limited BCL s duties as a Special Member to only such interests and factors as it desires, including its owns interests, and shall to the fullest extent permitted by applicable law, have no duty or obligation to give any consideration to any interests of or factors affecting the [Debtor]. Shortly after the bankruptcy filing, BCL filed a motion to dismiss the Debtor s chapter 11 case on the grounds that, among other things, the Debtor lacked authority to file a voluntary petition without BCL s consent under the terms of the Debtor s operating agreement. Bankruptcy Court Ruling and Analysis: The Bankruptcy Court held that BCL s consent to file bankruptcy under the terms of the Debtor s operating agreement (as amended) was an unenforceable blocking member structure, because, under Michigan law, members of a Michigan limited liability company have a duty to consider the interests of the entity and not only their own interests. The language of the Debtor s operating agreement resulted in BCL having no duties to the Debtor as a Special Member, contrary to the requirements under the Michigan Limited Liability Company Act. The Court explained that [t]he essential playbook for a successful blocking director structure is this: the director must be subject to normal director fiduciary duties and therefore in some circumstances vote in favor of a bankruptcy filing, even if it is not in the best interests of the creditor that they were chosen by. Id. at 913. Comment: The Court s decision was informed by two principles: (i) the affirmative duty of an LLC member under Michigan law to consider the interests of the LLC; and (ii) the public policy against the advance waiver of certain bankruptcy protections. In this case, the Court focused primarily on restrictions under applicable state law and less on considerations of bankruptcy policy. That the Special Member was a creditor with no economic rights may have influenced the Court s reasoning. BCL s Special Member interest was non-economic in nature and was viewed by the Court as intended solely for the purpose of blocking a bankruptcy filing by the

11 Debtor. The outcome could be different in a fact pattern where a creditor holds a more significant economic interest in a debtor, perhaps as an investment or for a purpose other than blocking rights. If that were the case, the creditor/member potentially could articulate reasons to block a bankruptcy filing that are related to its equity investment in the debtor and in the best interest of the debtor. D. IN RE BAY CLUB PARTNERS-472, LLC, No rld11, 2014 WL (Bankr. D. Or. 2014) Summary: The Bankruptcy Court for the District of Oregon held void as contrary to public policy a provision in a debtor s operating agreement that prohibited the debtor from instituting or consenting to bankruptcy proceedings until the indebtedness secured by a pledge on the debtor s apartment complex was paid in full. Background: Bay Club Partners-472, LLC (the Debtor ) was formed as a manager-managed Oregon limited liability company in 2005 to acquire, renovate and operate a large apartment complex. In November 2005, the predecessor of Legg Mason Real Estate CDO I, Ltd. ( Legg Mason ) loaned the Debtor $23,600,000 to finance the Debtor s acquisition of the property. Repayment of the loan was secured by a deed of trust on the property. On January 17, 2014, the Debtor defaulted on its obligations to Legg Mason, and on January 28, 2014, the Debtor filed a chapter 11 bankruptcy case. The Debtor s consent resolution accompanying its bankruptcy petition was signed by three of the Debtor s four members. Trail Ranch Partners, LLC ( Trail Ranch ), the non-consenting member and 20% owner of the Debtor, joined a motion to dismiss the bankruptcy case filed by Legg Mason for lack of authority to file the chapter 11 case. The Debtor s operating agreement, in a section entitled Special Purpose Entity Restrictions, provided that until such time as the debt owed to Legg Mason was paid in full, the Debtor was, among other things, prohibited from instituting or consenting to bankruptcy proceedings. The evidence showed that these restrictions were included at the request of Legg Mason. Bankruptcy Court Ruling and Analysis: The Bankruptcy Court held that the bankruptcy waiver provision in the Debtor s operating agreement was unenforceable as a matter of federal public policy. The Court viewed the restriction as no less [than] the maneuver of an astute creditor to preclude [the Debtor] from availing itself of the protections of the Bankruptcy Code prepetition..., relying on precedent in the Ninth Circuit holding that it is against public policy for a debtor to waive the prepetition protection of the Bankruptcy Code and reasoning that [t]his prohibition... has to be the law; otherwise, astute creditors would require their debtors to waive. Id. at *4-5. After holding the waiver provision to be unenforceable, the Court found that the Debtor s manager had the requisite authority to take all actions necessary to further the business interests of the Debtor, including the commencement of the chapter 11 case, and denied Legg Mason s motion to dismiss. Comment: Although the parties argument primarily focused on whether the restrictive provisions of the operating agreement were consistent with Oregon LLC law, the Court s decision was based entirely on the public policy against the advance waiver of bankruptcy protections. The Court viewed as cleverly insidious that Legg Mason requested the bankruptcy waiver in the Debtor s operating agreement as opposed to the underlying loan documents. Like the Bankruptcy Court in In re Intervention Energy Holdings, LLC, the Court in this case was focused solely on the violation of federal public policy as opposed to a reasoned analysis of applicable non-bankruptcy law or freedom-of-contract principles. Courts relying on federal public policy considerations don t take kindly to attempts by creditors to bankruptcy

12 proof their borrower entities, with this Court describing Legg Mason s conduct as the clever maneuvering of an astute creditor. Thus, a creditor s self-interestedness evidenced by the restrictive language itself does not play well in front of these courts. E. DB CAPITAL HOLDINGS, LLC v. ASPEN HH VENTURES, LLC (IN RE DB CAPITAL HOLDINGS, LLC), 463 B.R. 142 (B.A.P. 10th Cir. 2010) (unpublished) 1 Summary: The Bankruptcy Appellate Panel for the Tenth Circuit, affirming the bankruptcy court s order dismissing the bankruptcy case, held that, under Colorado s Limited Liability Company Act and the terms of the debtor s operating agreement, the debtor s manager did not have the authority to file a bankruptcy petition on behalf of the debtor. Background: DB Capital Holdings, LLC (the Debtor ) was formed as a manager-managed Colorado limited liability company to develop and sell a luxury condominium project. The Debtor had one Class A member, Aspen HH Ventures, LLC ( Aspen ), and one Class B member, Dancing Bear Development, LP ( DB Development ). The Debtor was managed by DB Development s general partner, Dancing Bear Management, LLC ( Manager ). After delays and budget overruns, the Debtor ran out of the funds to continue the project and defaulted under its loan agreement with its mortgage lender, WestLB AG, a German banking corporation ( WestLB ). After becoming embroiled in litigation over the appointment of a receiver requested by WestLB, on June 9, 2010, the Manager filed a chapter 11 bankruptcy case on the Debtor s behalf without obtaining Aspen s consent. A few years prior to the bankruptcy filing, however, the Debtor s operating agreement had been amended to expressly bar the Debtor from instituting or consenting to a bankruptcy filing. In addition, the operating agreement required the Manager (i) to conduct and operate its business as presently conducted, (ii) to cease operating as the Debtor s manager upon the dissolution or bankruptcy of the Debtor, and (iii) to not do any act that would make it impossible to carry on the ordinary business of the Debtor. Aspen filed a motion to dismiss the chapter 11 case, alleging that the Manager lacked the authority to file a bankruptcy petition on behalf of the Debtor. The Bankruptcy Court granted Aspen s motion to dismiss, and the Debtor appealed. Panel Ruling and Analysis: The panel held that the waiver provision in the Debtor s operating agreement (as amended) was enforceable as a matter of Colorado LLC law and under the express language of the Debtor s operating agreement. It declined to strike down the waiver provision on public policy grounds, basing its conclusion instead on a holistic reading of the operating agreement according to general principles of contract law. The panel stated that, even if the waiver provision were ineffective, the operating agreement, read as a whole, precluded the bankruptcy, because the bankruptcy filing meant that the Manager could no longer operate the business as presently conducted and constituted an act that made it impossible to carry on the ordinary business of the Debtor. To support this conclusion, the panel surveyed the various duties and burdens imposed on a debtor-in-possession operating in a chapter 11 case. Comment: The panel upheld an absolute bar on filing for bankruptcy that the Manager alleged was demanded by and for the sole benefit of WestLB. Unlike other cases, where there was clear evidence of waivers coerced by a creditor, the panel in this case observed that there was no evidence showing that the operating agreement amendment was coerced by WestLB. 1 This unpublished opinion may be cited for its persuasive value, but is not precedential, except under the doctrines of law of the case, claim preclusion, and issue preclusion. 10th Cir. BAP L.R

13 Notably, the panel declined to opine whether, under the right set of facts, an LLC operating agreement containing terms coerced by a creditor could be unenforceable. Absent evidence of coercion, it seems that the panel was comfortable with the LLC members agreeing among themselves not to file for bankruptcy. Other courts do not draw that distinction and hold that public policy dictates that advance waivers of the right to file for bankruptcy are unenforceable as a general matter. IV. PREFERENCE A. IN RE TENDERLOIN HEALTH V. BANK OF THE WEST 849 F.3d 1231 (9th Cir. 2017), The Court of Appeals for the Ninth Circuit addressed a bankruptcy trustee s challenge of a prepetition loan payment by a debtor to a bank. To succeed, the trustee must demonstrate that by virtue of this payment the bank received more than it otherwise would have in a hypothetical chapter 7 liquidation where the challenged transfer had not been made. 1. Factual and procedural background. In May 2009, Bank of the West ( Bank ) extended a $200, line of credit to Tenderloin Health ( Tenderloin ). Bank loaned another $100, two years later. The loans were secured through a blanket filing against Tenderloin by all of its personal property, including its deposit accounts with Bank. In late 2011, Tenderloin elected to wind up its affairs. Tenderloin entered into a contract of sale of its only real property for $1,295,000.00, established an escrow. The sale closed on June 13, Tenderloin used the escrow proceeds to complete two transactions that same day: (i) it paid Bank $190, to pay its loans; (ii) the remaining proceeds ($526,402.05) were transferred into its deposit account at Bank. On July 20, 2012, Tenderloin filed a chapter 7 bankruptcy petition. Ninety days prior to filing, its account contained $173, On the day that the loan was paid off the account had been reduced to $52,735.11, but increased to $576, immediately after the deposit. On the petition date Tenderloin the account held $564, If the sum of the disputed deposit were subtracted from the account balance of $564, on the petition date, the account would have only held $37, On December 12, 2012, in an action to recover the $526, the trustee in bankruptcy, filed an action against Bank alleging that a debt payment of $190, was preferential, and avoidable under 11 U.S.C. 547(b). The bankruptcy court granted Bank s motion for summary judgment, concluding that the Trustee could not show that Bank received more than it would have in a hypothetical liquidation assuming that the debt payment had not been made. On appeal the District Court affirmed. The Trustee appealed to the Ninth Circuit. 2. Analysis. Majority Opinion. The Ninth Circuit Court Bank provided a lengthy analysis of the improvement of position test within a hypothetical Chapter 7 liquidation, the legislative history behind 11 U.S.C. 547(b)(5), and Alvarado v. Walsh (In re LCO Enters.), 12 F.3d 938 (9th Cir. 1993), and the rights of a creditor holding a right of setoff under 11 U.S.C The majority held the Court must look at the assets of the bankrupt party as a whole. The majority concluded that the Bank had improved its position in the 90 days preceding the Borrower s filing for bankruptcy by virtue of the payment of the outstanding loan and by the transfer of the funds from the escrow to the bank account at the Bank and that such payments could be voided under 11 U.S.C. 547(b)(5). The Court also concluded that under 11 U.S.C. 553 the Bank (hypothetically if it had not been paid in full) would have been able to protect its right to setoff against only the sum of $37, and not the full $190, since that was the lowest

14 amount that the bank account had reached in the 90 days prior to bankruptcy (prior to the $526, deposit). The Court reversed the District Court s ruling and remanded the matter back to the District Court. Dissenting Opinion. The dissenting opinion agrees that under the circumstances of the case, applying 547(b)(5) s greater amount test requires the Court construct a hypothetical liquidation, and that in so doing, the Court may consider whether a reasonable trustee would bring and prevail in a preference action under the improvement of position test within the hypothetical Chapter 7 liquidation. The dissenting opinion also took into account the Bank s right of setoff in determining whether the Bank had improved its position. Nevertheless, the dissenting opinion does not agree that the Bank would have had the right of setoff against only the sum of $37, Instead the dissenting opinion focuses on the fact that the Bank had a floating lien on all personal property assets including without limitation the right to the money in the escrow owed to the Borrower. The dissenting opinion correctly interpreted 11 U.S.C. 553 to hold where a bank holding a exercises a right of set off against the assets of the Debtor in the 90 days prior to the bankruptcy, the trustee may recover from such creditor the amount so offset only to the extent that any insufficiency on the date of such setoff is less than the insufficiency on the later of (i) 90 days before the date of the filing of the petition; and (ii) the first date during the 90 days immediately preceding the date of the filing of the petition on which there is an insufficiency. The dissenting opinion concluded that if the Bank had exercised a right of setoff as opposed to simply accepting payment from the Borrower, the Bank would have been entitled to retain the sum of $173, Therefore applying the improvement of position test the dissenting opinion concluded that inasmuch as Bank received $190, during the ninety days prior to bankruptcy, but only would have received $173, in a hypothetical liquidation, the trustee has made out a prima facie case that the $ difference is voidable as a preference. 3. Possible flaws in the analysis. The Court s analysis may be flawed for the following reasons. a. Bank s blanket lien. As the dissenting opinion highlights, all of Tenderloin s assets were subject to a blanket lien through an all assets filing against it by Bank: All of Tenderloin s personal property was subject to the same floating lien, including general intangibles. Thus, Bank had a security interest in (i) all contracts for sale, (ii) all escrows, (iii) all proceeds therefrom, and (iv) all deposit accounts maintained by Bank even before the sale proceeds were deposited into a deposit account with Bank. This lien gave the Bank rights which were in addition to and separate from the Bank s rights of setoff. This lien affects the analysis of whether the Bank improved its position under 11 U.S.C. 547(b)(5). Yet the majority opinion does not address this analysis even though the dissenting opinion does. A simple analogy would be if, 90 days prior to bankruptcy, Tenderloin had held only two assets (i) $10,000 in the deposit account and (ii) $200,000 in accounts receivable; and if Tenderloin collected all accounts receivable and deposited the proceeds into its deposit account so that by the date of bankruptcy Tenderloin held (i) $210,000 in the deposit account and (ii) $0 in accounts receivable. The increase of the funds in the deposit account would not constitute a preference since the Bank would not have improved its overall collateral position. b. Amount of the avoidable preference. Bank received $190, from Tenderloin to pay off the loan obligations on June 13, Ninety days prior to filing, Tenderloin s deposit account contained approximately $173, Thus, in a hypothetical liquidation, the trustee has made out a prima facie case that only the $ difference is voidable as a preference, not the entire payoff sum. [Note: this analysis assumes that there were no other

15 personal property assets which were encumbered by the Bank which assumes a fact not evident from the statement of facts.] c. Ordinary course payment. A payment in the ordinary course is exempt from voiding under 11 U.S.C. 547 by virtue of an exclusion in 547(c)(2), with emphasis supplied: (c) The trustee may not avoid under this section a transfer-- (2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was-- (A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or (B) made according to ordinary business terms; In evaluating whether a transfer was made in the ordinary course of business the Ninth Circuit Court of Appeals apply an objective standard based upon what is ordinary in the course of business in the relevant industry. [See In re Kaypro 218 F.3d 1070 (9th Cir. 2000) which went so far as to hold that under appropriate circumstances payments made under a debt restructuring agreement might be insulated under Section 547(c)(2).] In the Tenderloin situation, Tenderloin s loan obligations to Bank appear to be lines of credit. Customarily lines of credit require only periodic payment of interest and payment of principal is optional at the borrower s discretion at any time and in any amount. There is no pre-payment penalty imposed if the borrower should decide to pay the full amount of the outstanding principal. When Tenderloin therefore paid off the entire loan obligation on June 13, 2012, this pay off could and should be viewed as a payment in the ordinary course of business and was therefore excluded under 547(c)(2) from voiding as a preference. d. Conclusion. The Court holds that a court may entertain a hypothetical preference action under 547(b)(5) hypothetical liquidation when such an inquiry is factually warranted, supported by appropriate evidence, and so long as the hypothetical preference action would not result in a direct conflict with another section of the Bankruptcy Code. This remarkable ruling appears to be a departure from commonly understood principles governing 11 U.S.C. 547(c) (5); further, for a lender, this result may violate the advice frequently advanced by lender s counsel, never turn down a preference payment. V. CREDITOR RIGHTS IN CRAM-DOWN A. WELLS FARGO BANK, N.A. V BELTWAY ONE DEV. GRP, LLC (In re Beltway One Dev. Grp., LLC), 547 B.R. 819 (B.A.P. 9th Cir. 2016). Summary: The Bankruptcy Appellate Panel ( BAP ) of the Ninth Circuit held that an over secured creditor is entitled to post-petition, pre-effective date default interest on its over secured claim under a plan of reorganization: (i) where the plan does not cure the pre-bankruptcy default, (ii) the underlying agreement provides for the payment of default interest and such agreement is enforceable under applicable law; and (iii) equitable considerations do not require a different result. The BAP rejected Section 1129(b) of the Bankruptcy Code as a potential basis for limiting the payment of such default interest, because such provision addresses the potential treatment of a claim, not its allowance, which is governed by Section 506(b). Facts: In May 2008, Beltway One Development Group, LLC ( Debtor ) entered into a loan agreement with Wells Fargo s predecessor in interest Wachovia Bank (collectively, Lender ) pursuant to which Lender provided a $10 million loan that was secured by a first priority lien on