Recent Developments in Bankruptcy Law

Transcription

1 BANKRUPTCY UPDATE July 2012 Recent Developments in Bankruptcy Law (Covering cases reported through 470 B.R. 944 and 676 F.3d 1202) CRAVATH, SWAINE & MOORE LLP This update relates to general information only and does not constitute legal advice. Facts and circumstances vary. We make no undertaking to advise recipients of any legal changes or developments. Richard B. Levin Cravath, Swaine & Moore LLP Worldwide Plaza 825 Eighth Avenue New York, NY (212)

2 1. AUTOMATIC STAY Covered Activities Effect of Stay Remedies 1 2. AVOIDING POWERS Fraudulent Transfers Preferences Postpetition Transfers Setoff Statutory Liens Strong-arm Power Recovery 3 3. BANKRUPTCY RULES 4 4. CASE COMMENCEMENT AND ELIGIBILITY Eligibility Involuntary Petitions Dismissal 6 5. CHAPTER Officers and Administration Exclusivity Classification Disclosure Statements and Voting Confirmation, Absolute Priority 7 6. CLAIMS AND PRIORITIES Claims Priorities 9 9. EXECUTORY CONTRACTS INDIVIDUAL DEBTORS Chapter Dischargeability Exemptions Reaffirmation and Redemption JURISDICTION AND POWERS OF THE COURT Jurisdiction Sanctions Appeals Sovereign Immunity PROPERTY OF THE ESTATE Property of the Estate Turnover Sales TRUSTEES, COMMITTEES, AND PROFESSIONALS Trustees Attorneys Committees Other Professionals United States Trustees TAXES CHAPTER 15 CROSS-BORDER INSOLVENCIES CRIMES 9 8. DISCHARGE General Third-Party Releases Environmental and Mass Tort Liabilities 9

3 1. AUTOMATIC STAY 1.1 Covered Activities 1.1.a. Police and regulatory exception applies to action that private party commences. The debtor operated wireless service under a wireless license granted by the FCC. Several wireline carriers initiated actions before various state PUCs complaining that the debtor was in fact operating a wireline service and, in doing so, violating either state regulatory law or an interconnection agreement with the wireline carrier. In most of the PUC proceedings, the PUC staff becomes a party to the proceedings, and some of the actions are similar to those that the PUC itself might initiate. Section 362(b)(4) excepts from the automatic stay, the commencement or continuation of an action or proceeding by a governmental unit to enforce such governmental unit s police and regulatory power. This exception includes a proceeding that is not commenced by a governmental unit but is continued by a governmental unit, such as the participation in the proceedings by the PUC staffs. Therefore, the proceedings may be excepted from the automatic stay, even though not commenced by a governmental unit. Halo Wireless, Inc. v. Alenco Comm ns Inc. (In re Halo Wireless, Inc.), F.3d, 2012 U.S. App. LEXIS (5th Cir. June 18, 2012). 1.1.b. State PUC proceeding to enforce interconnection agreement is within the police and regulatory power exception to the automatic stay. The debtor operated wireless service under a wireless license granted by the FCC. Several wireline carriers initiated actions before various state PUCs complaining that the debtor was in fact operating a wireline service and, in doing so, violating either state regulatory law or an interconnection agreement (ICA) with the wireline carrier. In most of the PUC proceedings, the PUC staff becomes a party to the proceedings, and some of the actions are similar to those that the PUC itself might initiate. Section 362(b)(4) excepts from the automatic stay the commencement or continuation of an action or proceeding by a governmental unit to enforce such governmental unit s police and regulatory power. A proceeding comes within the exception if it does not primarily seek to protect a pecuniary governmental interest, as opposed to the public safety and health and attempts to effectuate public policy rather than adjudicate private rights. The PUCs role in ensuring that ICA rates are just and reasonable and that there is nondiscriminatory access to telecommunications services are public purposes and meet the public policy test. By limiting the PUCs ability to enforce any monetary judgment, the bankruptcy court ensures that the proceedings meet the pecuniary purpose test. Therefore, the police and regulatory exception to the automatic stay applies. Halo Wireless, Inc. v. Alenco Comm ns Inc. (In re Halo Wireless, Inc.), F.3d, 2012 U.S. App. LEXIS (5th Cir. June 18, 2012). 1.2 Effect of Stay 1.3 Remedies 2. AVOIDING POWERS 2.1 Fraudulent Transfers 2.1.a. Granting a lien to secure a borrowing to pay an affiliate s creditor is a fraudulent transfer to the affiliate s creditor. The debtor was a housing developer. Its subsidiary had entered into a joint venture to develop houses. The joint venture borrowed heavily and then failed. The debtor had guaranteed the loans. A default on the loans would have cross-defaulted the debtor s bonds and its bank revolving credit line, both of which were guaranteed by its other subsidiaries, who were not liable on the joint venture s obligations. After the joint venture failed, the debtor and its other subsidiaries borrowed from different lenders to pay the joint venture s lenders. The other subsidiaries granted security interests in substantially all their assets to secure the new loans. The borrowed funds, less fees incurred, were disbursed through another of the debtor s (nondebtor) subsidiaries to the joint venture lenders. The new loans increased the subsidiaries liabilities above the value of their assets and prevented them from accessing needed additional capital as their markets and businesses continued to decline. But the transaction prevented the cross-default and might have given the debtor and the other subsidiaries the chance to avert a bankruptcy. Despite the momentary respite, the housing market was collapsing both

4 2 before and after the transaction, and the debtor could not recover. The debtor and the subsidiaries filed bankruptcy seven months after the transaction. A transfer is fraudulent and avoidable if the debtor had unreasonably small capital or was insolvent at the time of or was rendered insolvent by the transfer and did not receive reasonably equivalent value in exchange. A bankruptcy court has wide latitude to determine what constitutes reasonably equivalent value, which is a question of fact. The chance to avert bankruptcy is not an unqualified benefit for which a company may pay any price; its value must be weighed against the alternative. Here, the benefit was not reasonably equivalent to the value the other subsidiaries transferred. The other subsidiaries did not receive any direct or indirect benefit from the transfers because they were not liable on preexisting obligations to the joint venture lenders, they did not receive the borrowed funds and the payments did not preserve value for the corporate group. Therefore, the payments to the old lenders were avoidable as constructive fraudulent transfers. Sr. Transeastern Lenders v. Official Comm. of Unsecured Creditors (In re TOUSA, Inc.), 680 F.3d 1298 (11th Cir. 2012). 2.1.b. Proceeds of loan that is transferred directly to third party is a transfer of property of the debtor. As part of an acquisition and leveraged recapitalization, the debtor borrowed enough not only to buy the target corporation but also to pay a dividend to its shareholders. All of the debtor s subsidiaries (as well as the target) guaranteed the loan and granted security interests in their assets to secure the guarantees. A second tier subsidiary (which became a debtor) declared the dividend to the debtor s first tier subsidiary, which declared a dividend to the debtor, which declared a dividend to its nondebtor parent. The loan agreement provided that a portion of the funds equal to the dividend amount would be paid directly to the nondebtor parent, and at closing, funds were disbursed as provided in the loan agreement. The trustee sought recovery from the nondebtor parent of the dividend payment as a fraudulent transfer. The trustee may recover a transfer of property of the debtor if the transfer is actually or constructively fraudulent. Property of the debtor includes property that would have become property of the estate if it had not been transferred. Despite the lender s direct transfer to the nondebtor parent, the funds were property of the second tier subsidiary, because the funds would have remained with the debtor second tier subsidiary if the transfer had not been made. Therefore, the complaint adequately states a claim that the debtor transferred property of the debtor. Michaelson v. Farmer (In re Appleseed s Intermediate Holdings, LLC), 470 B.R. 289 (D. Del. 2012). 2.1.c. Trustee may recover property that the debtor held in trust only for the benefit of the trust beneficiaries. The debtor operated a Ponzi scheme through a loan servicing business. It maintained an operating account and a servicing account. It paid its operating expenses only from the operating account. It used the servicing account to receive and disburse loan funds and also to fund the Ponzi scheme. A lender transferred funds to the debtor to fund a loan, who, at the lender s direction, deposited the funds directly into a servicing account and later paid the funds to the borrower. The debtor received payments from the borrower, which, at the lender s direction, the debtor also deposited into the servicing account and paid out to the lender. The debtor followed the same procedure for other lenders and borrowers. A trustee may avoid a transfer of property as a fraudulent transfer if, among other things, the property was property of the debtor. Property was property of the debtor if it would have become property of the estate upon the filing of the petition had it not been transferred. The debtor holds only legal title, not an equitable interest, in property that the debtor holds in trust for another. Based on applicable nonbankruptcy law, the debtor held the servicing account funds in trust for the lenders, because, even though the debtor skimmed funds from the servicing account to perpetuate the Ponzi scheme, the parties expressed their intention that the lender s funds be used solely to fund the specific loan to the borrower and that the borrower s funds be used solely to repay the lender. However, the lender may defend against avoidance only to the extent that the lender can trace its own funds into and out of the servicing account. It may not assert that funds were not property of the debtor on the ground that the debtor held them in trust for another. Where the debtor holds bare legal title to trust funds, a trustee s avoidance action may recover only legal title to, not an equitable interest in, the funds, and any recoveries from lenders would still be held in trust for the benefit of lenders, not for the benefit of the estate or the general creditors. Notinger v. Migliaccio (In re Fin. Res. Mortgage, Inc.), 468 B.R. 487 (Bankr. D.N.H. 2012). 2.1.d. Court applies state limited partnership law to determine fraudulent transfer reach-back period. The Delaware limited partnership debtor agreed with an investor that he could receive a refund of his limited partnership investment if the debtor s president left the debtor s employ. The president left 3-1/2 years before bankruptcy, and the debtor promptly refunded the investment. The debtor conducted business

5 3 only in California, but the debtor s limited partnership agreement had a Delaware choice of law provision. The trustee sued the investor to recover the payment under section 544(b) as a fraudulent transfer and under the Delaware Revised Uniform Limited Partnership Act as an unlawful distribution. The statute of limitations for a fraudulent transfer action depends on the choice of law. A federal court with exclusive jurisdiction over an action, such as in bankruptcy, should apply federal choice of law rules, which follow the Restatement. Restatement section 6(1) requires a court to apply its own state s statutory choice of law rules. Here, state law points to the law of the partnership s organization. Restatement section 187(1) points to the parties contract if the matter at issue could have been resolved by an express contract provision. Therefore, Delaware law applies to disputes regarding the transfer. A statute of limitations differs from a statute of repose in that the former is procedural, while the latter is substantive and defeats the cause of action after its expiration. DRULPA section (c) provides that a limited partner who receives a distribution from the partnership shall have no liability under this chapter or under applicable law for the amount of the distribution after the expiration of 3 years from the date of the distribution. It is a statute of repose, because it cuts off liability after 3 years. Moreover, because it precludes liability under other applicable law, it therefore precludes liability under Delaware s fraudulent transfer statute, which otherwise would have a four-year statute of limitations. Because the choice of law rules apply Delaware law to the action to avoid and recover the transfer, the trustee is barred from recovering it. Diamond v. Friedman (In re Century City Doctors Hosp., LLC), 466 B.R. 1 (Bankr. C.D. Cal. 2012). 2.2 Preferences 2.2.a. Reimbursement of a letter of credit draw that was used to redeem bonds is not a settlement payment. The debtor was indirectly liable on industrial revenue bonds. The bank had issued an annually renewable letter of credit to the bond indenture trustee, which the indenture trustee could draw if the debtor defaulted on its obligations or if the bank refused to renew the LC. The bank gave the indenture trustee notice of non-renewal. The debtor then directed the indenture trustee to redeem the bonds and deposited the amount of the redemption payment in its account at the bank. The indenture trustee sent bondholders a redemption notice, and when they tendered the bonds, drew on the LC for funds to redeem the bonds. After the draw, the bank debited the debtor s account to reimburse itself for the LC draw. The debtor filed bankruptcy less than 90 days later. The trustee sued the bank to avoid the debtor s deposit into its account and the bank s account debit as a preference. Section 546(e) prohibits the trustee from avoiding as a preference a settlement payment or a payment in connection with a securities contract. Settlement payment is broadly defined as a payment to complete a securities transaction. The court must examine each transaction in a series to determine whether it is a settlement payment, even if the series results in a securities transaction. Here, the debtor s payment to the bank was to fulfill an obligation to reimburse the bank for the LC draw, which is a transaction that was independent from the bond redemption. Therefore, neither the deposit nor the debit was a settlement payment. EPLG I, LLC v. Citibank, N.A. (In re Qimonda Richmond, LLC), 467 B.R. 318 (Bankr. D. Del. 2012). 2.3 Postpetition Transfers 2.4 Setoff 2.5 Statutory Liens 2.6 Strong-arm Power 2.7 Recovery 2.7.a. Direct payee of proceeds of a secured loan to an affiliate is an entity for whose benefit the liens were transferred. The debtor was a housing developer. Its subsidiary had entered into a joint venture to develop houses. The joint venture borrowed heavily and then failed. The debtor had guaranteed the loans. A default on the loans would have cross-defaulted the debtor s bonds and its bank revolving credit line, both of which were guaranteed by its other subsidiaries, who were not liable on the joint venture s obligations. After the joint venture failed, the debtor and its other subsidiaries borrowed from different lenders to pay the joint venture s lenders. The other subsidiaries granted security interests in substantially all their assets to secure the new loans. The new loan agreements required that the loan proceeds be transferred to the joint venture lenders. The borrowed funds, less fees incurred, were disbursed through another of the debtor s (nondebtor) subsidiaries to the joint venture lenders. The debtor and the subsidiaries filed bankruptcy seven months after the transaction. The transfers of security interests

6 4 to the new lenders and the payment of the borrowed funds to the joint venture lenders were avoided as constructive fraudulent transfers. Section 550 permits recovery of an avoided transfer from the initial transferee or from the entity for whose benefit the transfer was made. The joint venture lenders received the proceeds of the loans. Therefore, they were the entities for whose benefit the initial transfers of security interests to the new lenders were made. They were not beneficiaries of a subsequent transfer of cash from the paying subsidiary, because the new loan agreements required that the paying subsidiary wire the proceeds directly to them, so the subsidiary never had control over the funds. Such a ruling does not put all recipients of payments from a distressed subsidiary at risk or impose a heavy due diligence duty on them. But it is not a drastic obligation to expect some diligence from a creditor when it is being repaid hundreds of millions of dollars by someone other than its debtor. Sr. Transeastern Lenders v. Official Comm. of Unsecured Creditors (In re TOUSA, Inc.), 680 F.3d 1298 (11th Cir. 2012). 3. BANKRUPTCY RULES 3.1.a. Fourth Circuit establishes procedures for class proofs of claim. Before bankruptcy, the debtor was subject to an uncertified class action on behalf of several hundred former employees for overtime pay. After bankruptcy and before the bar date, the putative class representatives filed a class proof of claim. After the trustee objected, the claimants filed a motion under Rule 9014 to make Rule 7023 (Class Actions) apply. Rule 3001(a) requires a creditor or the creditor s authorized agent to file a proof of claim. In an ordinary class action, before class certification, the class representative is the class members putative agent. If the court certifies the class, the class representative s agency relates back to the date of the filing of the action. Similarly, when a creditor files a class proof of claim, it acts as putative agent for class members, and a later certification of the class and designation of the representative will relate back to the claim filing date. Therefore, Rule 3001(a) does not prohibit a class proof of claim. The court may certify the class only under rule 7023, which, under Rule 9014, applies in a contested matter only if the court so orders. A proof of claim does not initiate a contested matter, but an objection to claim does. The claimant may move under Rule 9014 to apply Rule 7023 to the contested matter only once an objection is filed. If the court grants the Rule 9014 motion, then Rule 7023 procedures would apply, and the court would then have to determine whether to certify the class. If the court denies the Rule 9014 motion, the court should give class members who did not file a proof of claim a reasonable time to file, because the commencement of a class action, and therefore the filing of a class proof of claim, tolls the statute of limitations, and therefore the bar date, for filing a claim. In determining whether to grant the Rule 9014 motion, the bankruptcy court may consider both systemic concerns and specific facts. In general, the bankruptcy process permits all claims to be consolidated in a single forum, permits filing claims without counsel at almost no cost, provides established mechanisms for notice and for managing large numbers of claims, centralizes proceedings in one court and prevents a race to judgment by competing class members. By contrast, class action procedures are cumbersome and protracted. Therefore, systemic concerns may counsel against applying Rule In this case, because the class members numbered only in the hundreds (compared with 15,000 other proof of claims filed), requiring class members to file individual proofs of claim would not unduly complicate the claims resolution process. Therefore, the bankruptcy court properly denied the Rule 9014 motion to apply Rule Gentry v. Siegel, 668 F.3d 83 (4th Cir. 2012). 3.1.b. A retroactive change in the law can prevent effective notice of a claims bar date. A consumer purchased the debtor s product before the debtor filed its chapter 11 case. The product manifested a defect three years after plan confirmation. The debtor in possession mailed notices of the claims bar date, of the disclosure statement hearing and of the confirmation hearing to all known claimants and published the notices widely to reach unknown claimants. When the court confirmed the plan, the applicable law under In re M. Frenville & Co., 744 F.2d 332 (3d Cir. 1984), was that the consumer did not have a claim, because the product defect had not yet become manifest. In re Grossman s Inc., 607 F.3d 114 (3d Cir. 2010), overruled Frenville four years after plan confirmation in this case, stating the rule that a claim arises upon prepetition exposure to a product or upon conduct that gives rise to an injury, so the consumer s claim against the debtor would have been a cognizable claim in the chapter 11 case. To discharge a claim requires that the claimant be given due process, which includes adequate notice to permit the claimant to participate meaningfully in the bankruptcy case. Because of

7 5 Frenville, the consumer did not have a cognizable claim during the chapter 11 case. So despite the broad notice, the consumer could not participate meaningfully in the case. Thus, where a claim arises from retroactive application of a change in the law, the claim is not discharged when the notice is given based on the understanding that the claimant does not have a claim. Wright v. Owens Corning, 679 F.3d 101 (3d Cir. 2012). 3.1.c. Due process may require the debtor to give notice of the nature of the creditor s claim. Law enforcement raids exposed the debtor s participation in an anti-trust conspiracy shortly after the debtor confirmed its plan. The creditor later brought an anti-trust action against the reorganized debtor, who pleaded the chapter 11 discharge as a defense. The debtor had given the creditor notice of the chapter 11 case but not of any possible anti-trust claims. A chapter 11 discharge operates on all claims that arise before plan confirmation. The Code defines claim broadly to include contingent, disputed and unliquidated claims. A claim arises when there is a relationship between the debtor and the creditor that allowed them to contemplate contingencies that might result in a claim. Here, the debtor and the creditor had a pre-confirmation relationship the creditor was the debtor s customer but not in a manner that allowed the creditor to contemplate the existence of a claim. Still, the creditor admitted that the discharge by its terms would apply to its claim. However, due process principles limit the discharge s scope. Due process requires reasonable notice of a proceeding in which a creditor s rights will be affected. Given chapter 11 s broad discharge and fresh start policy, what is practicable and fairness to claimants affect what notice is reasonable. A debtor need not provide notice of the nature of the creditor s claim if the creditor knew or should have known of its claim once it has notice of the chapter 11 case or if the debtor is unable to discover through reasonably diligent effort the nature of the creditor s claims. Here, the debtor was aware of the alleged conspiracy, and the creditor could not have known of it, because it was secret. Therefore, the debtor did not give the creditor sufficient notice so as to bring the creditor s anti-trust claim within the discharge s scope. DPWN Holdings (USA), Inc. v. United Air Lines, Inc., 2012 U.S. Dist. LEXIS (E.D.N.Y. May 18, 2012). 3.1.d. The burden of proof of the extent of a secured claim under section 506(a) ultimately lies with the creditor. Section 506(a) allows a claim for which the creditor has collateral as a secured claim to the extent of the collateral s value and as unsecured for the balance. Under Rule 3001(f), a proof of claim is prima facie valid. To challenge a proof of claim, an objector must come forward with sufficient evidence to overcome its prima facie validity. Once the objector does so, the burden of persuasion then shifts to the creditor to establish the validity and amount of the claim. The same process applies in determining the amount of an allowed secured claim under section 506(a). Thus, where the creditors committee (on behalf of the estate) introduced an appraisal that showed the collateral s value was less than the amount of the first lien debt, the second lien creditor bore the burden of producing evidence that the property was worth more. Because it did not, the court properly found that the second lien creditor was wholly unsecured. In re Heritage Highgate, Inc., 679 F.3d 132 (3d Cir. 2012). 3.1.e. Court denies motion to seal settlement agreement as contrary to open access policy. The chapter 11 plan liquidating trust settled a claim that the debtor had against a customer. The settlement agreement required that it be filed with the bankruptcy court under seal. There is a strong federal public policy favoring public access to court records, even more so when one of the parties is acting as a fiduciary. Section 107 implements that policy in a bankruptcy case. Ordinarily, a civil action settlement is a private matter. But where a bankruptcy estate (or its successor) is a party and requires court approval of the settlement, the open access public policy applies. Settlements are not entitled to any greater protection against disclosure than any other court-filed information. Because the parties did not present any reason sufficient to overcome the open access policy, the court denies the motion to seal. In re Oldco M Corp., 466 B.R. 234 (Bankr. S.D.N.Y. 2012). 4. CASE COMMENCEMENT AND ELIGIBILITY 4.1 Eligibility 4.2 Involuntary Petitions

8 6 4.3 Dismissal 5. CHAPTER Officers and Administration 5.1.a. Cash collateral order expires upon case dismissal. With the court s approval in periodic orders, the secured creditor and the real estate debtor in possession agreed that rents and other proceeds were cash collateral and could be used for certain property maintenance and related expenses. Before the last order expired, the court dismissed the case. Promptly after dismissal, the debtor transferred cash to third parties who had guaranteed the loan from the secured creditor. The creditor sought a temporary restraining order in district court against dissipation of the funds, on the grounds that they remained cash collateral even after dismissal of the chapter 11 case. Section 363(a) defines cash collateral as cash in which the estate and an entity other than the estate have an interest. Section 363(c)(2) prohibits a trustee s or debtor in possession s use of cash collateral without the other entity s consent or a court order. The statutory language negates any reading that the restrictions survive dismissal, because there is no longer an estate that could have an interest in the cash, nor a trustee or debtor in possession. In addition, a cash collateral order does not determine any rights; it operates only as an interim regulatory measure during the case, similar to a preliminary injunction. Therefore, section 363 s restrictions do not survive dismissal. Jefferson-Pilot Invs., Inc. v. Cap. First Realty, Inc., 2012 U.S. Dist. LEXIS (N.D. Ill. May 29, 2012). 5.2 Exclusivity 5.3 Classification 5.3.a. Guaranteed claim might not be substantially similar to other unsecured claims. The debtor bifurcated the real estate secured creditor s claim and classified the unsecured portion separately from other unsecured claims. A nondebtor entity had guaranteed the secured claim. Chapter XI of the Bankruptcy Act addressed only unsecured claims. It permitted separate classification of claims but did not provide a statutory standard. By contrast, Chapter X of the Act addressed secured and unsecured claims and permitted separate classification based on the nature of the claims. The rights a claim gives its holder against the debtor, typically priority and security, determine the nature of the claim. Section 1122(a) prohibits classification together only of claims that are not substantially similar. The absence of nature from section 1122(a) suggests Congress intended a different classification regime, not based entirely on the holder s right against the debtor. Therefore, a general unsecured claim for which the creditor has an alternative source of repayment, whether a guarantee or collateral, creates a special circumstance that accords the creditor a different status and might actually require separate classification of its claim from other general unsecured claims. In re Loop 76, LLC, 465 B.R. 525 (9th Cir. B.A.P. 2012). 5.4 Disclosure Statements and Voting 5.4.a. Preplan settlement may not bind and unimpair a bondholder class. The debtor s bond indenture trustee re-perfected a lapsed security interest within 90 days before bankruptcy. The debtor in possession sued to avoid the re-perfection as a preference. The debtor in possession and the indenture trustee settled the litigation by allowance of the bonds as secured claims in a substantially reduced amount. The settlement provided for the indenture trustee s release of its contractual indemnification claims against the debtor and for a third party release of the bondholders claims against the indenture trustee. However, the settlement was contingent upon confirmation of a plan that incorporated its terms. The debtor proposed such a plan, designating the bondholder class as unimpaired. The court approved the settlement. An indenture trustee s settlement of an adversary proceeding may not bind bondholders unless the indenture authorizes the indenture trustee to do so. Here, the indenture did not do so. A class of claims is impaired unless the plan does not alter the legal, contractual or equitable rights of holders of claims in the class. Because the settlement did not alter bondholders rights, the plan would do so, and the bondholder claim class is therefore impaired. In re Lower Bucks Hosp., 2012 Bankr. LEXIS 2098 (Bankr. E.D. Pa. May 10, 2012).

9 7 5.4.b. Approval of a third party release requires adequate disclosure. The debtor s bond indenture trustee re-perfected a lapsed security interest within 90 days before bankruptcy. The debtor in possession sued to avoid the re-perfection as a preference. The debtor in possession and the indenture trustee settled the litigation by allowance of the bonds as secured claim in a substantially reduced amount. The settlement provided for the indenture trustee s release of its contractual indemnification claims against the debtor and for a third party release of the bondholders claims against the indenture trustee. However, the settlement was contingent upon confirmation of a plan that incorporated its terms. The court approved the settlement and later approved a disclosure statement that did not clearly describe the third party release. The bondholders overwhelmingly accepted the plan, but one bondholder objected to confirmation based on the third party release. A court may approve a third party release in a plan if the third party has made an important contribution to the reorganization, the release is essential to confirmation, a large majority of creditors accept the plan, there is a close connection between the claims against the third party and the debtor and the plan provides for payment of substantially all affected claims. Rule 3016(c) requires a disclosure statement to describe in specific and conspicuous language any injunction the plan proposes. A third party release has the same effect as an injunction, so the Rule s requirements apply equally. Here, because the disclosure was inadequate, the disclosure statement did not comply with the Rule. More importantly, the plan s acceptance by a large majority of bondholders was inadequately informed and therefore did not satisfy the third requirement for approval of a third party release. In re Lower Bucks Hosp., 2012 Bankr. LEXIS 2098 (Bankr. E.D. Pa. May 10, 2012). 5.5 Confirmation, Absolute Priority 5.5.a. Plan that proposes collateral sale may not deprive a secured creditor of the right to credit bid its claim. The lender had a lien on substantially all of the debtor s assets, which were worth less than the claim amount. The debtor s plan proposed a sale of all assets, with the sale proceeds paid to the lender, according to sale and bid procedures that prohibited the lender from credit bidding its secured claim. The lender objected to confirmation. The court may confirm a plan without the acceptance of a class of claims if the plan is fair and equitable as to that class. Under section 1129(b)(ii)(A), a plan is fair and equitable to a class of secured claims if it proposes (i) that the holders of a secured claim retain their lien and receive payments with a present value equal to the amount of the secured claims, (ii) for the sale, subject to section 363(k), of the encumbered property free and clear of the lien or (iii) for the realization by such holders of the indubitable equivalent of such claims. Section 363(k) authorizes the holder of a secured claim to credit bid its claim, unless the court for cause orders otherwise. In construing a statute, the specific governs the general, so as to give effect to every provision. Clause (ii) is a specific provision that governs the general catch-all provision of clause (iii). Therefore, even if the result of a sale would be to provide the secured creditor the indubitable equivalent of its claim, the plan must satisfy clause (ii). To do so, section 363(k) must apply, and the secured creditor must be permitted to credit bid, unless the court for cause orders otherwise. Because the debtor did not point to any such cause, the plan does not meet section 1129(b)(2) s requirements and may not be confirmed. RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S., 132 S. Ct (2012). 5.5.b. Section 1123(a) preempts a private contract restriction, including an anti-assignment provision. The debtor s liability insurance policies each contained an anti-assignment provision. To fund in part an asbestos trust created under section 524(g), the debtor s chapter 11 plan provided for the assignment, over the insurers objections, of all its rights under the policies to the trust. Section 1123(a) provides that, Notwithstanding any otherwise applicable nonbankruptcy law, a plan shall (5) provide adequate means for the plan s implementation, such as (B) transfer of all or any part of the property of the estate to one or more entities. Congress may preempt state law by express language or by implication, either by occupying the legislative field or because of a conflict between state and federal law. There is a general presumption, which also applies in bankruptcy, against preemption, but ultimately, Congress s purpose is the guide. The use of notwithstanding is a clear indication of Congressional intent to preempt. The phrase any otherwise applicable law includes private contracts, which are implemented and enforced under state law. Therefore, section 1123(a)(5)(B) preempts state law that would enforce the policies anti-assignment provisions, and the plan may provide for the assignment of the policies to the trust. In re Federal-Mogul Global Inc., F.3d, 2012 U.S. App. LEXIS 8814 (3d Cir. May 1, 2012).

10 8 5.5.c. Secured claim valuation for plan confirmation purpose is based on present fair market value, not future prospects. At a cash collateral hearing at the beginning of the case, the real estate developer debtor in possession produced an appraisal that showed that the real property collateral securing the first and second lien debt was worth less than the amount secured by the first lien. To support plan confirmation, the debtor prepared a budget and projections showing that over time, the collateral, when developed and sold, would generate net cash proceeds in excess of the first lien debt plus interest. Yet based on the prior appraisal, adjusted downward for sales during the case, the debtor valued the collateral at less than the first lien debt and so proposed to treat the second lien creditor as wholly unsecured. Section 506(a) requires that the court value property to determine the extent of a creditor s secured claim. The court must determine the value in light of the purpose of the valuation and of the proposed disposition or use of such property. The plan proposed that the debtor retain the property, develop it and sell it in the ordinary course of its business as a developer, so the court must use the property s fair market value as of the plan confirmation date, rather than a foreclosure or liquidation value. The court rejects a wait-and-see approach that would base the value on cash collections over time. The projections do not determine value, as they contemplate the reorganized debtor s investment of labor and capital into producing the returns. The court must not determine future value, under which a junior secured creditor could retain its lien to see how the property performs and collect anything after a senior lien creditor is fully paid, but must determine current value. Based on the collateral s current fair market value, the second lien creditor was out of the money and should be treated as the holder of an unsecured claim. In re Heritage Highgate, Inc., 679 F.3d 132 (3d Cir. 2012). 5.5.d. A chapter 11 plan may strip an underwater lien. The court determined at plan confirmation that the present fair market value of a real estate developer s property was less than the amount of the first lien secured by the property. Under section 506(a), the holder of the second lien had only an unsecured claim. Section 506(d) avoids a lien to the extent it does not secure an allowed secured claim. However, Dewsnup v. Timm, 502 U.S. 410 (1992), prohibited avoiding such a lien in a chapter 7 case in which the collateral was being was abandoned to a foreclosure sale outside of the case. By contrast, a chapter 11 plan involves the retention of collateral to use in a reorganized business, and chapter 11, in provisions such as sections 1129(b) and 1111(b), expressly contemplates stripping an underwater lien. Therefore, the plan may properly treat the claim as an unsecured claim under section 506(a) and avoid the lien under section 506(d). In re Heritage Highgate, Inc., 679 F.3d 132 (3d Cir. 2012). 6. CLAIMS AND PRIORITIES 6.1 Claims 6.1.a. Third Circuit extends Grossman s to postpetition, pre-confirmation claims. A consumer purchased the debtor s product during the debtor s chapter 11 case. The product manifested a defect three years after plan confirmation. Under In re M. Frenville & Co., 744 F.2d 332 (3d Cir. 1984), the consumer did not have a claim as of plan confirmation, because the product defect had not yet become manifest. Determining when a claim arises requires balancing the goals of giving a reorganizing debtor a fresh start with protecting individuals who might not know yet that they have suffered injury. Based on such a balancing, In re Grossman s Inc., 607 F.3d 114 (3d Cir. 2010), overruled Frenville four years after plan confirmation in this case, stating the rule that a claim arises upon the exposure to a product or upon conduct that gives rise to an injury. Section 1141(d) discharges a debtor from all claims that arose before plan confirmation. Applying Grossman s only to claims that arise before bankruptcy would defeat the fresh start goal for a debtor who otherwise receives a discharge of all claims that arise before confirmation. The court therefore extends Grossman s to apply to a claim that arises upon the pre-confirmation exposure to a product or conduct that gives rise to an injury. Wright v. Owens Corning, 679 F.3d 101 (3d Cir. 2012). 6.1.b. Section 502(d) may disallow a transferred claim. In its statement of financial affairs, the debtor had listed a creditor, among others, as a recipient of a payment within 90 days before bankruptcy. The creditor transferred its claim during the debtor s bankruptcy. After plan confirmation, the liquidating trustee brought a preference avoidance action against the creditor and obtained a judgment. The trustee then objected under section 502(d) to the claim in the transferee s hands. Section 502(d) requires the court to disallow any claim of any entity that is a transferee of a transfer avoidable under section

11 9 [547], unless such entity or transferee has paid the amount, or turned over such property, for which such entity or transferee is liable. The language focuses on the claim, not the holder. Section 502(d) provides the estate with an affirmative defense, which is not destroyed by a transfer of the claim. A transfer does not change the claim s nature, only the holder. A different rule would permit a creditor who had received a voidable transfer to wash its claim by transfer, and a transferee can protect itself by obtaining an indemnity. Finally, in this case, the statement of affairs put all potential transferees on notice of which claims transferors might be subject to avoidance actions. Therefore, section 502(d) applies equally to a transferred claim even though the claim transferor is liable to return an avoidance transfer, and the court disallows the claim. In re KB Toys, Inc., 470 B.R. 331 (Bankr. D. Del. 2012). 6.2 Priorities 7. CRIMES 8. DISCHARGE 8.1 General 8.1.a. Only the bankruptcy court that grants the discharge may enforce it. The debtor emerged from a chapter 11 case in Delaware and received its discharge. Years later, some claimants brought a class action against the debtor in Florida state court based on pre-confirmation conduct. The reorganized debtor promptly brought an action in the Florida bankruptcy court for a declaration that the claims had been discharged and to enjoin the claimants from continuing the state court action. A bankruptcy court has in rem jurisdiction to issue the discharge and the discharge injunction. Under 28 U.S.C. 1334(e), only the court in which the bankruptcy case is pending has the in rem jurisdiction. A creditor who attempts to collect a discharged debt violates the court s discharge order. A bankruptcy court may enforce its own order. The court may enforce a discharge against anyone, whether or not within the territorial jurisdiction of the issuing court, because the order is based on the court s in rem jurisdiction and therefore extends to the whole world, as long as the bankruptcy notice complies with Constitutional due process requirements. Moreover, the issuing court may enforce its order only by a contempt citation, not by issuing a another injunction to order compliance with an existing injunction. However, only the issuing court may enforce the order. Other courts are without jurisdiction to do so. A reorganized debtor may assert the discharge as an affirmative defense in the state court action, may remove the case to the local bankruptcy court and seek transfer to the home bankruptcy court or may reopen the bankruptcy case to obtain relief to enforce the injunction. But the Florida bankruptcy court did not have jurisdiction to grant any of the relief that the reorganized debtor sought there. In the interest of justice, the court transfers the debtor s action to the Delaware bankruptcy court. Alderwoods Group, Inc. v. Garcia, F.3d, 2012 U.S. App. LEXIS (11th Cir. May 30, 2012). 8.2 Third-Party Releases 8.3 Environmental and Mass Tort Liabilities 9. EXECUTORY CONTRACTS 9.1.a. Trademark license rejection does not deprive the licensee of the right to use. The debtor contracted with a manufacturer to produce the debtor s product for sale to the debtor s customers. It licensed its trademark to the manufacturer. The license permitted the manufacturer to sell the product on its own if the debtor did not itself purchase the product. Three months later, creditors filed an involuntary petition against the debtor. The trustee sold the debtor s business and rejected the manufacturing and license agreement. Section 365(a) permits a trustee to reject an executory contract. Section 365(g) provides, the rejection of an executory contract constitutes a breach of such contract. Outside

12 10 bankruptcy, a breach does not terminate the non-breaching party s rights under a contract. Section 365(g) transports that result into bankruptcy, while protecting the debtor from specific performance as a remedy. Rejection is not the functional equivalent of rescission, nor is it an avoiding power. Section 365(n) protects a licensee s right to use intellectual property, as defined. The definition does not include trademarks. The omission is just an omission. It does not create an implication that trademarks, unprotected under section 365(n), are vulnerable under section 365 generally. Section 365 s general principles apply to trademark licenses as they do to all other executory contracts. Therefore, the trustee s rejection does not prevent the manufacturer from using the licensed trademark. Sunbeam Prods., Inc. v. Chicago Am. Mfg, LLC, F.3d, 2012 U.S. App. LEXIS (7th Cir. July 9, 2012). 9.1.b. Debtor s prepetition breach does not make a contract non-executory. The debtor entered into a technology license agreement with a licensee that required substantial continuing performance from both parties as of the petition date. The debtor committed material breaches of the agreement before bankruptcy. Under applicable nonbankruptcy law, the breaches excused the licensee from further performance under the agreement. Under the Countryman definition, for purposes of section 365, an executory contract is one under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other. Outside of bankruptcy, where one party has committed a material breach, the other party is excused from performance. Accordingly, a court might conclude that where the debtor has breached, the nondebtor party is excused from performance, so that the nondebtor party no longer has any obligations under the contract. However, such a reading would render all breached contracts non-executory, essentially eviscerating section 365. Importantly, Countryman observed that a contract in which the nondebtor party had no further obligation should not be considered an executory contract, because the estate has whatever benefit it was entitled to under the contract, and the only remaining performance is a liability of the debtor, as to which assumption would serve no purpose other than to elevate a general unsecured claim s priority. Thus, the Countryman definition should be read to exempt from the definition only those contracts under which the debtor has already received the full benefit of the nondebtor party s performance before bankruptcy. Under that interpretation, the license agreement here remained executory. In re Kemeta, LLC, 470 B.R. 304 (Bankr. D. Del. 2012). 10. INDIVIDUAL DEBTORS 10.1 Chapter Dischargeability 10.3 Exemptions 10.4 Reaffirmation and Redemption 11. JURISDICTION AND POWERS OF THE COURT 11.1 Jurisdiction 11.1.a. Bankruptcy court may enjoin extraterritorial automatic stay violation. The trustee sued a Cayman fund to recover a preference and a fraudulent transfer. The fund appeared and obtained an extension of time to respond to the complaint. On the same day that the fund answered, it brought an action against the trustee in the Cayman court for a declaration that it was not liable to the trustee. The automatic stay prohibits any action to obtain or exercise control over property of the estate. Property of the estate includes the debtor s property, wherever located. The bankruptcy court has in rem jurisdiction over all estate property, regardless of its location. The automatic stay applies to all entities, to protect the debtor s property and the court s jurisdiction. Still, the bankruptcy court s ability to enforce the automatic stay against an entity depends on the court s in personam jurisdiction over the entity. Here, the defendant had appeared in the bankruptcy court, so the court had jurisdiction over it. It therefore could enjoin the defendant s action, wherever it occurred, to recover property of the estate, wherever located.

13 11 Picard v. Maxam Absolute Return Fund, L.P. (In re Bernard L. Madoff Inv. Secs. LLC), B.R U.S. Dist. LEXIS (S.D.N.Y. May 4, 2012) b. Court has subject matter jurisdiction to grant third party release in plan, even after confirmation. The debtor s bond indenture trustee re-perfected a lapsed security interest within 90 days before bankruptcy. The debtor in possession sued to avoid the re-perfection as a preference. The debtor in possession and the indenture trustee settled the litigation by allowance of the bonds as secured claim in a substantially reduced amount. The settlement provided for the indenture trustee s release of its contractual indemnification claims against the debtor and for a third party release of the bondholders claims against the indenture trustee. However, the settlement was contingent upon confirmation of a plan that incorporated its terms. The court approved the settlement and later approved a disclosure statement that did not clearly describe the third party release. The bondholders overwhelmingly accepted the plan, but one bondholder objected to confirmation based on the third party release. To permit confirmation, all parties stipulated to address the third party release objection after confirmation, as a stand-alone issue, that would rise or fall independently of confirmation, and to allow confirmation to proceed. A bankruptcy court has jurisdiction over core proceedings (arising under title 11 or arising in the case) and over noncore proceedings (related to the case). A proceeding is related to a case if its outcome could have any conceivable effect on the estate. A creditor s contractual indemnification claim can make the proceeding on a nondebtor s claim against the creditor related to the case, so the court has jurisdiction to grant a third party release of a contractually indemnified claim. However, after confirmation, the claim will not have an effect on the estate. But once a court acquires jurisdiction, it may retain it even if later events eliminate the basis for jurisdiction. Here, the court exercises its discretion to retain jurisdiction because the parties agreed to defer litigation until after confirmation. In re Lower Bucks Hosp., B.R., 2012 Bankr. LEXIS 2098 (Bankr. E.D. Pa. May 10, 2012) Sanctions 11.3 Appeals 11.3.a. An administrative claimant does not have standing to appeal denial of derivative standing to another. After the case converted from chapter 11 to chapter 7, the debtor s chapter 11 lawyer asserted a claim for administrative expenses and demanded that the chapter 7 trustee pursue an avoiding power claim against a judicial lien creditor. When the trustee refused, the lawyer commenced an adversary proceeding against the creditor and sought derivative standing. The former chapter 11 examiner moved to substitute in as plaintiff, but the court denied the motion. The lawyer appealed. Only a person aggrieved, that is, someone whose property is diminished, burdens increased or rights impaired by the underlying order, has standing to appeal. The effect must be direct, not too remote or contingent. Here, the denial of the former examiner s derivative standing would have an effect on the lawyer only if the examiner prevailed in the avoiding power action and then only if the lawyer s administrative claim were allowed. The effect on him was too remote, so the lawyer did not have standing to appeal. Robert F. Craig, P.C. v. Greenlight Cap. Qualified, L.P. (In re Prosser), 469 B.R. 228 (D.V.I. 2012) Sovereign Immunity 11.4.a. An Indian tribe is a governmental unit for which the Bankruptcy Code waives sovereign immunity. The debtor in a prior case confirmed a plan that provided for assignment to a third party of a lease from an Indian tribe of mineral rights on Indian land. The plan specified the obligations under the lease for which the assignee would be liable. The Indian tribe was a party in the prior case. In the assignee s later chapter 11 case, the tribe objected to the lease s assumption on the ground that sovereign immunity protected it against the bankruptcy court s orders and the application of section 1141(d) in the prior case. An Indian tribe generally has sovereign immunity, subject to Congressional abrogation, which must be clear and unequivocal to be effective. Section 106(a) abrogates sovereign immunity as to a governmental unit with respect to section 1141, among other sections. A governmental unit includes, in addition to a State and its municipalities, a foreign state and its municipalities, and other foreign or domestic government. The latter phrase includes Indian tribes. Therefore, Congress has abrogated Indian tribes sovereign immunity in bankruptcy cases, and the tribe is bound by the order in the prior case. In re Platinum Oil Props., LLC, 465 B.R. 621 (Bankr. D.N.M. 2011).