Theodore A. Cohen, Special Counsel, Sheppard Mullin Richter & Hampton, Los Angeles Zachary G. Newman, Partner, Hahn & Hessen, New York

Transcription

1 Presenting a live 90 minute webinar with interactive Q&A Bankruptcy Risks for Secured Lenders Minimizing Claims Involving Fraudulent Transfer, Preference Challenges, Equitable Subordination and Recharacterization, and Other Risks for Secured Lenders TUESDAY, FEBRUARY 26, pm Eastern 12pm Central 11am Mountain 10am Pacific Td Today s faculty features: Theodore A. Cohen, Special Counsel, Sheppard Mullin Richter & Hampton, Los Angeles Zachary G. Newman, Partner, Hahn & Hessen, New York The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 Bankruptcy and Lender Liability Risks for Secured Lenders and Recent Developments February 26, 2013 Theodore A. Cohen, Sheppard Mullin Zachary G. Newman, Hahn & Hessen

6 Overview: Recent Developments Affecting Secured Lenders I. The last 2 years have been a mixed bag for secured lenders II. III. Some issues have been resolved A. Credit bidding under a plan US Supreme Court Some issues have a split in authority A. Separate classification of similar claims B. Application of absolute priority rule in individual chapter 11 cases IV. Some decisions have favored secured lenders V. Some decisions have favored debtors and debtor-related parties VI. We ll cover many issues that affect secured lenders A. Recent cases and their holdings B. Best practices and how to minimize risk and exposure 6

7 Topics Covered Topics Covered I. Gerrymandering deficiency claims to control voting II. Credit bidding under a bankruptcy plan III. Determining lack of confirmability of plan at disclosure statement stage IV. Admissibility of parol evidence to contradict unambiguous loan documents when promissory fraud is alleged V. Equitable Subordination and Recharacterization VI. Setting aside pre-petition credit bid as a preference 7

8 Topics Covered Topics Covered VII. Applicability of absolute priority rule in individual chapter 11 cases VIII.363 sales free and clear of junior liens without consent of junior lienholders Clear Channel IX. Interpretation of single asset real estate case X. Standard for reasonable reliance on misrepresentations as to financial condition for dischargeability analysis XI. Fraudulent transfers and reasonably equivalent value 8

9 Gerrymandering deficiency claims to control voting Gerrymandering Claims I. Background A. Classification i Requirements: A plan may place a claim in a particular class only if such claim is substantially similar to the other claims of such class. 11 U.S.C. 1122(a). To separately classify similar claims, the plan proponent must show there is a legitimate business or economic reason to do so. In re Barakat, 99 F.3d 1520, 1526 (9th Cir. 1996). B. Vti Voting Requirements: When secured lender has a dfii deficiency claim li large enough to control unsecured class under 11 U.S.C. 1126(c) [2/3 in amount; ½ in number], debtor cannot confirm plan over secured lender s objection if only impaired class is unsecured creditors because at least one class of impaired claims must vote in favor of a plan for the plan to be confirmed. 11 U.S.C. 1129(a)(10). C. To obtain the required class of impaired claims accepting the plan, debtors may attempt to separately classify similarly situated claimants. The Ninth Circuit, and a majority of other circuits, have ruled that this type of gerrymandering is impermissible. In re Barakat, 99 F.3d at BUT... 9

10 Gerrymandering deficiency claims to control voting Gerrymandering Claims I. Recent case law has held that a secured lender s unsecured deficiency claim can be classified separately from unsecured claims A. Wells Fargo Bank, N.A. v. LOOP 76, LLC (In re LOOP 76, LLC), 465 B.R. 525 (B.A.P. 9th Cir. 2012): A partially secured creditor s deficiency claim was properly classified separately because the creditor had a third-party source a guarantor -- for repayment of its claim. In this single asset real estate case, the lender could have vetoed the debtor s plan by voting to reject it if the lender s deficiency claim had been included in the class of unsecured claims. B. Loop has been criticized, including in In re 4 th Street East Investors, Inc., 2012 Bankr. LEXIS 2144 (C.D. Cal. 5/15/12). The court disagreed with Loop, and also distinguished the case on the grounds that the guarantor was insolvent C. In re Red Mt. Mach. Co., 448 B.R. 1 (Bankr. D. Ariz. 2011): Partially secured lender's deficiency claim was separately classified because, unlike other unsecured claims, (1) lender held personal guarantees on its claim; (2) lender s deficiency claim was embroiled in an adversary proceeding with the Debtor; and (3) lender s deficiency claim could have been paid in full and/or differently than all other unsecured claims, because the plan provided that the claim was to be paid in accordance with any final order in the adversary proceeding. 10

11 Credit Bidding Under a Chapter 11 Plan Credit Bidding Under Plan I. Issue: Whether a plan providing for the sale of a debtor s assets free and clear of liens must include a provision allowing an objecting secured creditor to credit bid at the sale. II. Background Law A. Free and Clear Sale: When a debtor sells its assets out of bankruptcy, it can sell them "free and clear" of all liens. B. If a secured creditor (often placed in its own class) objects to a plan proposing a free and clear sale, the plan must nonetheless be "fair and equitable" with respect to that class. 11

12 Credit Bidding Under a Chapter 11 Plan Credit Bidding Under Plan I. Split of Authority A. Until early 2012, whether fair and equitable treatment under a free and clear sale required the plan to allow the secured creditor to credit bid was unresolved. There was a conflict among the circuits. II. B. Some courts had held that credit bidding was not required because any free and clear sale would give the secured creditor the "indubitable equivalent" of its claim, thereby satisfying the fair and equitable rule. C. Other courts had held that allowing credit bidding was statutorily mandated under the fair and equitable rules. Split Resolved Secured Lender s Right to Credit Bid is Required A. In 2012, the US Supreme Court held that any plan providing for a sale of assets free and clear of liens must allow for an objecting secured lender to credit bid at the sale for it to be fair and equitable. RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065, 2073 (2012). 12

13 Determining Lack of Confirmability at Disclosure Statement Stage Confirmation Issues at Disclosure Statement Stage I. Typically, requirements of confirmation under 11 U.S.C are addressed and determined at confirmation stage, after disclosure statement has already been approved and votes have been solicited II. Under what circumstances can the court determine that a plan is not confirmable at the disclosure statement stage III. In re American Capital Equipment, 688 F.3d 145 (3d Cir. 2012) A. Facts: Case had been pending 5 years. Debtor had previously proposed 5 amended plans. At disclosure statement stage, court considered whether cause existed to convert case to chapter 7 for debtor s inability to propose a confirmable plan to date. B. Holding: Cause to convert exists. Court could determine at disclosure statement stage that plan is patently unconfirmable and convert case. Confirmation hearing is not necessary. Plan is patently unconfirmable where defects cannot be overcome by voting and there are no material factual disputes. 13

14 Determining Lack of Confirmability at Disclosure Statement Stage Confirmation Issues at Disclosure Statement Stage I. Notice must be given that confirmability will be considered at disclosure statement hearing. 688 F.3d at 154, n. 6 II. A. Secured lender should request court to give notice to plan proponents that confirmability will be considered at disclosure statement hearing If appropriate, disclosure statement hearing can be an evidentiary hearing. III. Take away: While the court found case to be unconfirmable based on feasibility under 1129(a)(11) and good faith under 1129(a)(3), this case supports denial of approval of a disclosure statement when secured lender controls the only unimpaired class because the plan is patently unconfirmable based on voting acceptance requirements under 1129(a)(10). 14

15 Admissibility of Parol Evidence to Avoid Enforcement of Loan Documents When Allegations of Fraud Are Involved I. Issue: Whether extrinsic evidence may be introduced to avoid the enforcement of an integrated writing when fraud or fraudulent inducement is alleged? II. Some Courts Seem To Say Yes A. Background: 1. The parol evidence rule holds that when parties enter an integrated written agreement, extrinsic evidence of a prior or contemporaneous agreement is not admissible to alter or add to the terms of a writing. B. Example (the state of the law in California): 1. Bank of America Nat l Trust and Savings Ass n v. Pendergrass, 4 Cal. 2d. 258 (1935): Held that evidence offered to prove fraud is only admissible if it tend[s] to establish some independent fact or representation, some fraud in the procurement of the instrument or some breach of confidence concerning its use, and not a promise directly at variance with the promise or writing. Id. at Since 1935, Pendergrass was relied upon by lenders as a defense to borrower claims alleging g misrepresentations (oral and written) that are at odds with the final written agreement of the parties. 15

16 Admissibility of Parol Evidence to Contradict Loan Documents When Promissory Fraud is Alleged Shift in the Law? Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Ass n, No. S190581, 2013 Cal. LEXIS 253 (Jan. 14, 2013) (California Supreme Court) A. Facts: Commercial borrowers sued a lender over a forbearance agreement, claiming that the workout officer orally promised them that the bank would extend the loan for two years in exchange for two additional properties as collateral. The integrated forbearance agreement, which the borrowers claimed they did not read, provided for a three-month forbearance and eight additional properties as collateral. B. Holding: Evidence of the oral agreement was admissible to prove promissory fraud, despite the fact it was directly at variance with the terms of the integrated writing. 16

17 Admissibility of Parol Evidence to Contradict Loan Documents When Promissory Fraud is Alleged Other states differ in their treatment of fraudulent inducement claims: I. See Allen v. Overturf, 234 Ark. 612, 353 S.W.2d 343 (1962). When a party is induced by false representations to enter into a contract, the contract is utterly invalid. Id. This is so even if the contract is a written one containing a merger clause. Id. In order to prove fraud, a plaintiff must prove five elements under Arkansas law: (1) that the defendant made a false representation of material fact; (2) that the defendant knew that the representation was false or that there was insufficient evidence upon which to make the representation; (3) that the defendant intended to induce action or inaction by the plaintiff in reliance upon the representation; (4) that the plaintiff justifiably relied on the representation; and (5) that the plaintiff suffered damage as a result of the false representation. Wal-Mart Stores, Inc. v. Coughlin, 369 Ark. 365, 255 S.W.3d 424 (2007). II. In New York, the Court of Appeals ruled that if facts represented are not matters peculiarly l within the party s knowledge, and the other party has the means available to him of knowing, by exercising ordinary intelligence, the truth or the real quality of the subject of the representations, he must make use of those means, or he will not be heard to complain that he was induced to enter into the transaction by misrepresentations. DDL Mgmt., LLC v. Thone Group LLC, 15 N.Y.3d 147, 155, 931 N.E.2d 87, 91 (2010) 17

18 Admissibility of Parol Evidence to Contradict Loan Documents When Promissory Fraud is Alleged Comparing Other NY Decisions: I. First articulated in 1892 in the case of Schumaker v. Mather, 133 N.Y. 590, 596, 30 N.E. 755 (1982), the rule holds that sophisticated parties must conduct an investigation of their counterparty s representations before blindly relying on them. II. III. See Dannan, 5 N.Y.2d at (noting that stipulation not to rely on any representations destroys allegations in complaint that the agreement was executed in reliance upon the contrary oral representations). Citibank, N.A., v. Plapinger, 66 N.Y.2d 90, 485 N.E.2d 974 (1985) (although it found sufficient evidence to raise a triable fact that there was fraud, held that the specific merger clause in the guarantee foreclosed the guarantors reliance on the claim that they were fraudulently induced to sign the guarantee by the banks oral promise of an additional line of credit). 18

19 Admissibility of Parol Evidence to Contradict Loan Documents When Promissory Fraud is Alleged Wrap Up: A. For California venued matters, Riverisland explicitly overrules Pendergrass and its progeny. Riverisland may expose a lender s reliance on its commercial loan agreements and jeopardize the efficacy of merger and integration clauses, and may perhaps result in an uptick in fraud and/or fraudulent inducement claims. Takeaways: A. Parol evidence rule and integration ti and merger clauses do not necessarily and automatically bar fraud and fraudulent inducement claims. B. Borrowers still must meet their proof hurdles, by alleging and proving promises that were made (which will depend on the particular jurisdiction s evidentiary rules and decisions). C. Be aware of your jurisdiction s decisional authority. 19

20 Admissibility of Parol Evidence to Contradict Loan Documents When Promissory Fraud is Alleged What To Look For In These Types Of Disputes: A. Promises or representations inconsistent with the terms of the agreement, or statements that may be construed as such B. Integration clauses stating that the borrower has not relied on any promises outside of agreement, and merger clauses to foreclose reliance on prior agreements C. conversations between the counterparties and don t make promises D. Obtain written statements that the counterparties have: 1. Read and acknowledge understanding the agreement 2. Consulted with counsel 3. Not relied on any promises other than in the agreement E. Examine whether the parties conducted their own inquiries and investigation into any promises or proposals not contained in the final writing, and explore the interaction with counsel and other professional advisors F. Obtain prenegotiation agreements prior to talking with the borrower 20

21 Equitable Subordination Purpose: Effect: Relied upon by debtors, trustees, and/or unsecured creditors to subordinate claims or interests for distribution purposes. The creditor engaging in inequitable conduct may be relegated to a more subordinate position, and could receive a payout after other competing creditors. Remedial Not Penal: Claims are typically subordinated only to the extent necessary to offset the harm caused by the inequitable conduct. See In re Mobile Steel Co., 563 F.2d 692, (5th Cir. 1977). 21

22 Equitable Subordination Under 11 U.S.C. 510(c):... the court may (1) under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of another all or part of an allowed interest to all or part of another allowed interest; or (2) order than any lien securing such asubordinated d claim be transferred to the estate. 22

23 Equitable Subordination Most widely used 3-part test is found in In re Mobile Steel Co., 563 F.2d 692, (5th Cir. 1977): The claimant must have engaged in some type of inequitable conduct: Fraud, illegality or breach of fiduciary duty; Undercapitalization; and/or Control of the debtor through use of the debtor as the creditor s alter ego or instrumentality. See also In re Hedged-Investments Assocs., Inc., 380 F.3d 1292, 1301 (10th Cir. 2004). The misconduct must have resulted in injury to the creditors of the bankrupt or conferred an unfair advantage on the claimant; and equitable subordination of the claim must not be inconsistent with the provisions of the Bankruptcy Code. 23

24 Equitable Subordination Insiders vs. Non-Insiders I. Insiders: If a claimant is an insider, less egregious conduct may support equitable subordination. In re Autostyle Plastics, Inc., 269 F.3d 726, (6th Cir. 2001). II. Non-Insider: If the claimant is not an insider id or fiduciary i... the party seeking subordination must demonstrate even more egregious conduct such as gross misconduct tantamount to fraud, misrepresentation, overreaching or spoliation. In re Hedged-Investments Assocs., Inc., 380 F.3d 1292, 1301 (10th Cir. 2004). III. IV. Test: [W]here a lender s influence on a debtor s actions merely arises by operat[ion] of bargained for rights under a credit agreement, those reasonable financial controls negotiated at arms length between the lender and borrower do not transform a lender into an insider. Official Comm. of Unsecured Creditors v. Credit Suisse (In re Champion Enters.), Case No , Adv. No , 2010 Bankr. LEXIS 2720 at *21 (Bankr. D. Del., Sept. 1, 2011) (quotations omitted). Equitable subordination may be more difficult to obtain if the creditor is a non- insider. 24

25 Equitable Subordination Credit Suisse v. Official Committee of Unsecured Creditors (In re Yellowstone Mountain Club), Case No , Adv. No , 2009 Bankr. LEXIS 2047 (D. Mo. May 13, 2009) Facts: With respect to loans targeted for property developers, CS sought to make a $375MM loan to Yellowstone, a high end property development. CS intended to sell participation positions. In connection therewith, CS would be paid origination fees. Initial valuation of the property at market value was $420MM, making the loanto-value ratio too high for CS underwriting criteria. CS relies on a Total Net Value valuation method, applies a discount rate of zero to Yellowstone s cash-flows, and originates the loan through an offshore subsidiary to avoid compliance with Financial Institutions Reform Act of 1989 methodology. CS collects $7.5M in fees and sells off the loan to other investors. 25

26 Equitable Subordination In re Yellowstone continued A. Yellowstone files for Chapter 11 because of continuing liquidity problems and the Official Committee of Unsecured Creditors brings adversary proceeding against CS. B. The court found that CS s non-insider status and arms length nature of transaction notwithstanding, CS s actions in this case were so far overreaching and self-serving they shocked the conscience of the Court. Id. At *25. C. CS s first lien position subordinated to that of DIP financier and allowed claims of unsecured creditors. 26

27 Equitable Subordination In re Yellowstone continued What did the court find to be inequitable? 1. CS encouraged Yellowstone to take larger loans purportedly just to increase transaction fees, and then sold the loan to third parties. 2. CS purportedly ignored Yellowstone s historical performance in its valuations and conducted close to no due diligence. 3. The transaction was structured purportedly so that all risks were borne by creditors subordinate to CS s first lien while enriching the creditor with fees. 27

28 Recharacterization I. Under what circumstances may a court recharacterize an outside lender s loan to the debtor as an equity interest? A. Recharacterization is a remedy grounded in a bankruptcy court s equitable authority to ensure that substance will not give way to form, that technical considerations will not prevent substantial justice from being done. Cohen v. KB Mezzanine Find II, LP (In re SubMicron Sys. Corp.), 432 F.3d 448, 454 (3d Cir. 2006). B. Focus is on whether the circumstances surrounding the purported debt transaction reveal that it was actually an equity contribution ab initio. Bayer Corp. v. Masco Tech, Inc. (In re Autostyle Plastics, Inc.), 296 F.3d 726, (6 th Cir. 2001). II. No Specific Provision Under the Bankruptcy Code: A. Bankruptcy courts recharacterize claims based on their inherent equitable powers sourced from 11 U.S.C. 105(a). See In re Autostyle Plastics, Inc., 296 F.3d 726, 748 (6th Cir. 2001). B. Other courts have relied upon 502(b), the court s authority to disallow claims. See In re Lothian Oil, Inc., 650 F.3d 539, 542 (5th Cir. 2011). 28

29 Recharacterization Distinguished from Equitable Subordination: A. Equitable Subordination: Recognizes that the loan is in fact a debt position, but subordinates it to remedy the lender s inequitable conduct. B. Recharacterization: Applies when a court finds that there was no loan in the first place, but based on the facts, the transaction was an equity investment. See Cohen v. KB Mezzanine Fund II, LP (In re SubMicron Sys. Corp.), 432 F.3d 448, 454 (3d Cir. 2006) 29

30 Recharacterization Court s Generally Use a Multi-Factor Test: Most court s employ some variation of the test first articulated in Roth Steel Tube Co. v. Comm'r, 800 F.2d 625 (6th Cir. 1986): 1. The names given to the instruments; 2. The presence or absence of a fixed maturity date and schedule of payments; 3. The presence or absence of a fixed rate of interest and interest payments; 4. The source of repayments; 5. The adequacy or inadequacy of capitalization; 6. The identity of interest between the creditor and stockholders; 7. The security, if any, for the advances; 8. The corporation s ability to obtain financing from outside lending institutions; 9. The extent to which the advances were subordinated to claims of outside creditors; 10. The extent to which the advances were used to acquire capital assets; and 11. The presence or absence of a sinking fund provision to provide repayments. 30

31 Recharacterization Application to Non-Insiders: In re Lothian Oil, Inc., 650 F.3d 539, 542 (5th Cir. 2011) Facts: Grossman, an outsider, loaned Lothian Oil $200,000 in exchange for a percentage of its royalties and proceeds from an equity placement. Lothian filed for chapter 11, and Grossman filed numerous proofs of claim, many of which were denied as common equity interest. On appeal, the District Court reversed the Bankruptcy Court s refusal to recharacterize the non-insiders claim. Holding: Recharacterization was appropriate and the fact that Grossman was a non-insider is irrelevant. The authority to allow and disallow claims arises under 11 U.S.C Turning to Texas state law, the Federal Appeals Court characterized Grossman s contribution as equity because even though the documents termed the deal as a loan : 1. The source of repayment was from royalties and equity placements, which depended on the success of Lothian s business, and not on a rate of interest; 2. There was no specified interest rate, maturity, or term of repayment. 31

32 Setting Aside Pre Petition Credit Bid as a Preference Pre-Petition P Credit Bid as Preference Issue: Whether a prepetition foreclosure at which a creditor credit bids on the property can be set aside as a preferential transfer. While a Properly Conducted Non-Collusive Foreclosure Sale Cannot Be a Fraudulent Transfer Under 548 (BFP v. Resolution Trust Corp., 511 U.S. 531, (1994)), it May Be a Preferential Transfer Under 547 per one court. A bankruptcy court in Texas denied a motion to dismiss a preference claim based on a non-collusive foreclosure sale conducted in accordance with state law under 547 because it found that the creditor may have received more from the sale than it otherwise would have under a Chapter 7 liquidation. Whittle Dev., Inc. v. Branch Banking Trust Co. (In re Whittle Dev., Inc.), 463 B.R. 796, (Bankr. N.D. Tex. 2011). 32

33 Setting Aside Pre Petition Credit Bid as a Preference Pre-Petition Petition Credit Bid as Preference One month prior to the petition date, secured lender foreclosed on the debtor's real property. The lender s subsidiary bought the property for $1.2 million, apparently with $1 million going to the lender after costs of sale. The lender then asserted a $1.2 million deficiency claim in the debtor's bankruptcy proceedings based on the secured lender s claim of $2.2 million. Id. at 800. The debtor asserted that the property s actual value was $3.3 3 million, so the lender received more than the $2.2 million amount of its claim that it would have received in a Chapter 7 liquidation. The court held that since the lender received more through the foreclosure than it would have received in a Chapter 7 liquidation, id the sale was potentially avoidable as a preference, and the court denied the lender s motion to dismiss. Id. 33

34 Setting Aside Pre Petition Credit Bid as a Preference Pre-Petition Credit Bid as Preference The court held that the amount the lender would have received at a liquidation is an issue of ff fact,, different from the presumed "reasonably equivalent value" under Section 548, which is an issue of law. See id. at 801. This appears to be a unique holding as a number of decisions has deemed that the amount received at a foreclosure sale is the amount that would have been obtained in a hypothetical liquidation. Chase Manhattan Bank v. Pulcini (In re Pulcini), 261 B.R. 836 (Bankr. W.D. Pa. 2001); In re FIBSA Forwarding, Inc., 230 B.R. 334 (Bankr. S.D. Tex., 1999) aff'd, 244 B.R. 94 (S.D. Tex. 1999). Query how Whittle impacts secured lender credit bids. Does it matter if the lender credit bids and then transfers the property to a buyer as opposed to a buyer acquiring the property for cash at the sale? 34

35 Applicability of Absolute Priority Rule in Individual Chapter 11 Cases Absolute Priority Rule in Individual Chapter 11s I. Issue: Whether the absolute priority rule applies to individual debtors in possession proceeding under Chapter 11 post-bapcpa. II. III. Rule: Pursuant to BAPCPA, the absolute priority rule of Section 1129(b)(2)(B)(ii) was amended to state that in a case in which the debtor is an individual, the debtor may retain property included in the estate under Section 1115 of the Bankruptcy Code, which includes reference to Section 541, the section of the Bankruptcy Code defining the assets that are property of the bankruptcy estate. Split in Authority Broad View: The reference to Section 541 in Section 1115 meant that Congress intended to include the entirety of the bankruptcy estate (i.e., all pre- and postii property) as property that the individual diid debtor could retain as not subject to petition the absolute priority rule, thereby abolishing the absolute priority rule for individual debtors. Friedman v. P+P, LLC (In re Friedman), 466 B.R. 471, 482 (B.A.P. 9th Cir. 2012); SPCP Group, LLC v. Biggins, 465 B.R. 316, (M.D. Fla. 2011); In re Tgd Tegeder, 369 B.R. 477, 480 (Bankr. D. Neb. 2007). 35

36 Applicability of Absolute Priority Rule in Individual Chapter 11 Cases Absolute Priority Rule in Individual Chapter 11 IV. Other Justifications for the Broad View : A. Congress intended to make the Chapter 11 process for individuals more similar to the Chapter 13 process, which h the "broad view" facilitates. In re Shat, 424 B.R. 854, 868 (Bankr. D. Nev. 2010). B. The "narrow view" would have little impact on most individual debtors ability to reorganize under Chapter 11, and Congress did not intend to draft a law that would be ineffective. In re Roedemeier, 374 B.R. 264, 275 (Bankr. D. Kan. 2007). V. Narrow View: Congress did not intend to abolish the absolute priority rule for individual debtors, but rather merely intended to subject only pre-petition p property p to the absolute priority rule while exempting from the rule the post-petition property and earnings enumerated in Section 1115(a)(1)-(2). Maharaj v. Stubbs & Perdue, P.A. (In re Maharaj), 681 F.3d 558, 568 (4th Cir. 2012); In re Gdadebo, 431 B.R. 222, 229 (Bankr. N.D. Cal. 2010). 36

37 Applicability of Absolute Priority Rule in Individual Chapter 11 Cases Absolute Priority Rule in Individual Chapter 11s Other justifications for the Narrow View 1. Congress easily could have abolished the absolute priority rule for individual debtors with simple language, which it did not do. Therefore, Congress did not intend to abolish it. In re Kamell, 451 B.R. 505, 508 (Bankr. C.D. Cal. 2011); In re Karlovich, 456 B.R. 677, 682 (Bankr. S.D. Cal. 2010). 2. Congress could have harmonized Chapter 11 and Chapter 13 by amending the Chapter 13 debt ceilings instead of modifying many aspects of Chapter 11, including abolishing the absolute priority rule. In re Karlovich, 465 B.R. at 682; In re Lindsey, 453 B.R. 886, 900 (Bankr. E.D. Tenn. 2011). 37

38 363 Sales Free and Clear of Junior Liens Without Consent of Junior Secured Lender Clear Channel Issue I. Under 11 U.S.C. 363(f), court can order sale of property free and clear of liens and encumbrances if certain conditions are established. II. III. In Clear Channel v. Knupfer (In Re PW, LLC), 391 B.R. 25 (9 th Cir. BAP 2008), an appellate court held that property could not be sold free and clear of a junior lien that was not paid in full from the proceeds because the lender objected to the sale. The court also held that 363(m) did not render the appeal moot and actually found that Clear Channel s junior lien was not stripped under 363 given the court s interpretation of the language in section (f)(3), the aggregate value of all liens. Clear Channel is not gospel: A. In re Nashville Senior Living, LLC, 407 B.R. 222 (9 th Cir. BAP 2009) (court rejected Clear Channel, concluding that 363(m) applies to free and clear aspect of 363(f)). 38

39 363 Sales Free and Clear of Junior Liens Without Consent of Junior Secured Lender Clear Channel Continued A. In re Jolan, 403 B.R. 866 (Bankr. W.D. Wash 2009) (under 363(f)(5), state legal and equitable proceedings exist where junior lienholder can be compelled to accept money satisfaction) B. In Re Boston Generating, 440 B.R. 302, 333 (Bankr. SDNY 2010) (foreclosure actions under state law satisfy 363(f)(5)) C. In Re NAMCO Capital Group, Inc., 2011 U.S. Dist. LEXIS (Bankr. C.D. Cal. 2011) (notwithstanding Clear Channel,, 363(m) renders moot free and clear sale under 363(f)) Additional thoughts: 1. Where do you stand? 2. Should 363(f)(1) permit a sale free and clear of all junior liens regardless of the aggregate value of the liens? 3. Should it hinge on state foreclosure law? 4. Will title or insurance companies protect the good faith purchasers from Clear Channel type claims? 39

40 Interpretation of Single Asset Real Estate Case Interpretation of Single Asset Real Estate Case Section 101(51B): The term single asset real estate means real property p constituting a single property or project... which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto. Allows expedited stay relief under Section 362(d)(3) Is it a black and white test? The Ninth Circuit recently considered whether there is a whole enterprise exception to allow consideration of the operations of the debtor s affiliates in determining whether 101(51B) applies. 40

41 Interpretation of Single Asset Real Estate Case Interpretation t ti of Single Asset Real Estate t Case In Re Meruelo Maddux, 667 F.3d 1072 (9 th Cir. 2012). A. The debtor had consolidated, interrelated business operations with its parent and siblings. Debtor, however, was a separate entity with its own single real estate asset. Debtor argued that under the whole enterprise exception, the court considers not only the operations of the debtor, but also of the debtor s affiliates, and therefore, the debtor did not fall under 101(51B). B. The court rejected the debtor s arguments and found that the debtor was a single asset real estate debtor. Even though there was centralized management among all the entities, without substantive consolidation, the court looks only to the debtor s assets, income and real estate for purposes of 101(51B). 41

42 Standards for Reasonable Reliance under 523 Standards for Reasonable Reliance Under Section 523 I. Under Section 523(a)(2)(B)(iii), to object to dischargeability, a lender needs to establish the guaranty obligation was, for example, based on a false writing relating to the guarantor s financial condition and the lender must demonstrate reasonable reliance on the false writing. II. In In Re Machuca, 483 B.R. 726 (9 th Cir. BAP 2012), after the lender s obligor filed bankruptcy, the lender brought a 523 action based on the obligor s misrepresentation of income in his loan application. Because the lender had not verified the obligor s income prior to making the loan, the lender was not found to have reasonably relied on the misrepresentation, and the debt was discharged. 42

43 Standards for Reasonable Reliance under 523 Standards d for Reasonable Reliance Under Section 523 Moreover, because the lender could not establish reasonable reliance, the court concluded that the lender could not establish substantial justification to bring the 523 action. The court ordered the lender under Section 523(d), which applies to consumer debts, to pay the debtor s attorneys fees in defending against the 523 action A. Recognizing Machuca was a consumer debt case, could the substantive analysis apply to commercial loans? B. How can lenders document in their files reasonable reliance? 43

44 Fraudulent Transfers Reasonably Equivalent Value I. Discussion Issues: II. A. Does a subsidiary receive reasonably equivalent value by granting a lien on their assets to its parent in exchange for a loan used to pay a debt owed to the parent? B. Did the lending group benefit from the lien? Fraudulent Transfer Basic Refresher: A. 11 U.S.C. 548(a)(1)(B) allows the avoidance of any transfer of an interest of the debtor in property, or any obligation i incurred by the debtor, that was made or incurred within two years before the date of filing if the debtor (1) was insolvent on the date of the transfer or became insolvent because of it; (2) there was unreasonably small capital for the transaction the debtor was engaged in, or (3) intended to incur, or believed it would incur, debts beyond its ability to pay. B. If a transfer is avoided as a fraudulent conveyance, 11 U.S.C. 550(a)(1) allows recovery of the property or its value from an initial transferee or from an entity for whose benefit the transfer was made. 44

45 Fraudulent Transfers Reasonably Equivalent Value Senior Transeastern Lenders v. Official Comm. Of Unsecured Creditors (In re TOUSA, Inc.), 680 F.3d 1298 (11th Cir. 2012) Facts: TOUSA, a homebuilder, enters a joint-venture to acquire assets of another homebuilder, and finances the acquisition by borrowing from the Transeastern Lenders. Due to decline in housing market, TOUSA defaults on obligations, and after litigation, settles for $421M with the Transeastern Lenders. To finance the settlement, TOUSA obtained first and second lien loans from a syndicate of new lenders secured by the upstream guarantees by the subsidiaries. Six months later, TOUSA and the subsidiaries filed for Chapter 11 relief. Adversary Proceeding: Creditors Committee files adversary proceeding against the new lenders and Transeastern Lenders to avoid, as a fraudulent transfer, the transfer of the liens to the New Lenders, and recover the value of the liens from the Transeastern Lenders. 45

46 Fraudulent Transfers Reasonably Equivalent Value In re TOUSA continued A. Grant of liens by the subsidiaries to the New Lenders was found to be constructively fraudulent as to the subsidiaries because (i) the proceeds of the loans were used to repay debt for which the subsidiaries had no liability and (ii) the indirect benefit of avoiding bankruptcy was not reasonable equivalent value in exchange for such liens when bankruptcy was inevitable. B. The Transeastern Lenders were entities for whose benefit the transfer was made because even though the liens were granted to the new lenders. C. The new lenders expressly required their loan proceeds to be paid directly to the Transeastern Lenders and the settlement contemplated the same. 46

47 Fraudulent Transfers Reasonably Equivalent Value In re TOUSA aftermath: A. Reasonably equivalent value is a highly factual question and the bankruptcy court s determination is entitled to deference unless clearly erroneous. B. While the indirect value of avoiding bankruptcy may constitute reasonably equivalent value, it was not in this case because bankruptcy was inevitable at the time of the transaction. C. Creditors may choose to exercise caution when receiving payment towards a struggling debtor s debt that is paid from other sources. 47