Under section 550(a) of the Bankruptcy Code, a trustee or debtor in possession may recover property (or its value) that has been fraudulently transferred “from the initial transferee or the entity for whose benefit the avoided transfer was made.” While the trustee’s right to recover from an initial transferee is absolute once a transfer is deemed fraudulent, a subsequent transferee may assert affirmative defenses that could prevent recovery by the estate of an otherwise avoidable transfer. As a result, defendants in fraudulent transfer litigations often take great pains to characterize themselves as subsequent transferees as opposed to initial transferees. Continue reading
Author Archives: Michael Klein
The Ninth Circuit Rejects the “Dominion and Control Test” for Determining the Initial Transferee in Fraudulent Conveyance Actions
On December 8, 2014, the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 issued an extensive report detailing hundreds of recommended changes to the Bankruptcy Code to address significant economic and financial developments since the enactment of the Bankruptcy Code in 1978. The recommendations aim to reduce the cost of chapter 11, increase the predictability of disputes by resolving ambiguous and divergent case law, provide more flexibility for debtor in possession financing, curb the power of senior lenders, and increase protections for creditors when a debtor sells its business under section 363. Among some of the Commission’s important recommendations are:
- Appointment of “Estate Neutral”: Under the current Code, the Court can appoint an examiner to investigate claims only if it makes the determination that appointment of an examiner would be in the best interest of all parties. The Commission suggests that, rather than an examiner, an “estate neutral” should be appointed by the Court when doing so would be in the interest of the estate—appointment need not serve the interest of all parties. The estate neutral would have a flexible role that would be tailored by each bankruptcy court.
- Restrictions on DIP Financing Terms: The Commission’s proposals seek to reduce the level of control secured lenders currently enjoy over chapter 11 cases without disrupting the market for debtor in possession (DIP) financing, which is often vital to successful reorganizations. Collectively, these changes would give more power to debtors and junior creditors vis-à-vis DIP lenders, but such significant changes have the potential to discourage lenders from providing DIP loans or to substantially increase the cost of such loans. The Commission recommendations regarding DIP financing are:
- Courts should not permit DIP financing provisions that grant DIP lenders liens on avoidance actions or subject the debtors to milestones or benchmarks within 60 days of filing.
- Courts should not approve certain provisions on an interim basis: directing the debtor to satisfy certain conditions, stipulate that liens are valid, or “roll-ups” in which DIP financing is used to pay off prepetition secured debt, in effect converting it to postpetition debt. The report further recommends tightening the standards for roll-ups when the debtor’s prepetition lenders provide DIP financing.
- Judges should reject roll-ups in DIP financing provided by prepetition lenders except where DIP financing repays the prepetition debt in cash and provides “substantial” new credit on better terms than any alternative.
- Debtors should be prohibited from waiving their right under 506(c) to surcharge a secured lender’s collateral for the costs and expenses of preserving that collateral. Debtors often waive that right, making the estate, rather than the secured lender, responsible for professional fees and certain administrative claims that the secured lender does not expressly agree to pay.
- Courts should allow junior lenders to offer debtors DIP financing, even if prohibited from doing so by an intercreditor agreement with a senior lender, so long as the proposed financing does not prime the loans of senior lenders and the senior lender is given the opportunity to offer financing on the same terms. Encouraging competition between junior and senior lenders could enhance debtors’ negotiating position when seeking DIP financing.
- 60-Day Breathing Room Period: In recent years, expedited sales under section 363 of substantially all of the debtor’s assets have become increasingly common. The Commission expressed concern that excessively fast 363 sales risk reducing the value of the estate. In particular, the Commission was sensitive to the harm to junior creditors when a senior lender demands that a debtor rush through a bankruptcy sale quickly in order to pay its senior secured loans without regard to whether the sale will maximize the value of the debtor’s assets for all of its stakeholders. To correct the problem, the Commission proposes a 60-day moratorium on sales of substantially all assets under section 363, unless clear and convincing evidence establishes that the debtor’s circumstances are extraordinary.
- Protection for Creditors in 363 Sales: Because 363 sales of substantially all assets generally affect creditors’ rights to the same degree as reorganization under a chapter 11 plan, the Commission suggests that creditors should have the same level of substantive and procedural protection as they would in connection with the confirmation of a chapter 11 plan.
- “Redemption Value Rule” to Provide a Return to Junior Creditors: The Commission expressed concern that cases are often run for the benefit of senior creditors, who receive full payment on their claims while junior creditors receive nothing. In many bankruptcies, the debtor is at a low point in value when its case is commenced, and immediately junior creditors—those ranking directly below the senior creditors in priority—could have received a distribution if the debtor had sold or reorganized at some later date. The Commission suggests a “redemption value rule” that would, in short, provide a distribution to junior creditors in cases where the senior class receives full or nearly full payment. Junior creditors would receive a distribution from the estate based on the hypothetical option to purchase the reorganized debtor within three years of the petition date, which would compensate them for value lost due to the timing of the bankruptcy. The “redemption value rule” would apply for both reorganizations and 363 sales.
- Intellectual Property under the Bankruptcy Code: While some courts have prohibited a debtor in possession from assuming a license when that license prevents assignment to a third party, the Commission recommends allowing assumption, and allowing Debtors to freely assign such licenses to third parties unless the licensor could demonstrate that the hardship imposed by the assignment would significantly outweigh the benefit to the estate. The report also recommends changing the Code’s definition of intellectual property to include trademarks, service marks, and trade names.
- Curbing Unwarranted Preference Actions: The Commission recommends changing the Code to require a trustee to perform reasonable due diligence before bringing a preference action. Preference complaints would have to properly plead facts supporting each element of a preference. The Commission also recommended barring preference actions for less than $25,000.
- A New Scheme for Smaller Companies: The Commission also outlines an alternative restructuring scheme for small and medium-sized companies.
The above represent only a small portion of the many suggested changes. Among other things, the Commission also recommends approval of alternative fee arrangements with estate professionals, the alteration of the valuation method used to calculate adequate protection, removal of 546(e) safe harbor protections for some leveraged buyouts, changes to the treatment of executory contracts and real estate leases, clarification as to which vendors will be entitled to administrative claims under section 503(b)(9), and elimination the requirement that some impaired creditors vote to accept a non-consensual plan. It remains to be seen which of the Commissions suggestions, if any, will make it into the next iteration of the Bankruptcy Code.
The full report can be found here: [https://abiworld.app.box.com/s/vvircv5xv83aavl4dp4h]
Boardwalk Empire in Decline – A Recap on the Shuttering of Atlantic City Casinos and What’s Next for the Struggling City
Atlantic City has been struggling in recent years, and it remains unclear how the city’s problems will improve in the face of a deteriorating tax base. According to the Update Report of Governor’s Advisory Commission on New Jersey Gaming, Sports and Entertainment, total Atlantic City casino revenues fell from a peak of $5.2 billion in 2006 to just $2.9 billion in 2013, and are projected to be approximately $2.5 billion in 2014. Continue reading
Ninth Circuit Expands the Limits of Post-Confirmation Injunctions and Non-Debtor Releases Under A Chapter 11 Plan
For years, it has been the rule in the Ninth Circuit that a chapter 11 plan cannot discharge or otherwise affect the obligation of a non-debtor owed to a third party. Continue reading
United States Bankruptcy Courts, particularly in New York and Delaware, are already a destination for multinational corporate bankruptcy filings, but a recent study co-authored by Stephen J. Lubben, a Seton Hall Law School professor and frequent contributor to The New York Times’ DealBook blog, suggests that the current volume of foreign debtors filing in the U.S. may just be the tip of the iceberg. Lubben suggests that the dramatic increase in bond debt issued by foreign corporations, particularly in Europe, will lead to a commensurate surge in U.S. bankruptcy filings by foreign issuers looking to restructure debt held by investors around the world. Continue reading
Nevada is one of many states that adopted some iteration of the Uniform Common Interest Ownership Act, an act designed in part to aid homeowners’ associations (“HOAs”) in recovering delinquent fees from their members. As codified in Nevada under NRS Chapter 116, Nevada law affords HOAs a super-priority lien for nine months worth of unpaid fees and maintenance charges. Continue reading
Should Attorneys Be Paid for Litigating Their Fee Requests? Supreme Court to Decide if Fee Defense Is a ‘Cost of Doing Business’
In a decision that will have profound implications for insolvency professionals of all types, the U.S. Supreme Court has agreed to hear an appeal of the 5th U.S. Circuit Court of Appeals’ decision that Section 330 of the U.S. Bankruptcy Code does not allow applicants to seek compensation in connection with successful defenses to objections to fee applications. Continue reading
California Bankruptcy Judge Rules that State Law Does Not Protect Pension Fund from Municipal Bankruptcies
On October 1, a bankruptcy judge ruled that the pension agreement between Stockton, California and Calpers, California’s massive state-run pension fund for public employees, is an executory contract that can be rejected in bankruptcy. Judge Christopher Klein of the Eastern District of California found that California laws designed to protect Calpers from municipal bankruptcies could not be enforced once a city entered bankruptcy. Continue reading
When Are Goods “Received” by the Debtor? Establishing International Suppliers’ Entitlement to 503(b)(9) Administrative Expense Claim
Section 503(b)(9) of the Bankruptcy Code provides creditors with an administrative expense priority claim for value of goods that were received by the debtor in the ordinary course within the 20 days prior to the bankruptcy filing Because section 503(b)(9) affords administrative priority status to an otherwise unsecured prepetition claim, it is strictly construed by courts. Nowhere was this more apparent than in the bankruptcy court’s recent decision in In re World Imports, Ltd.,
In World Imports, the court denied the 503(b)(9) claims of two Chinese companies, notwithstanding the fact that the debtor admitted to having taken physical possession of the goods within the 20-day pre-bankruptcy filing period, because the Chinese vendors had loaded their goods onto ships for delivery to the debtor outside of the 20-day period. The court concluded that the key factor in determining whether an international shipment of goods is entitled to 503(b)(9) claim status is the date on which title passed from the vendor to the debtor, not the date on which the debtor took physical possession of the shipment.
The court first noted that it was obliged to look to non-bankruptcy law to determine when the goods were “received” by the debtor because the Bankruptcy Code does not define that term in section 503(b)(9). The court then determined that the standard trade definitions used in international sales contracts under the United Nations Convention on Contracts for the International Sale of Goods (the “CISG”) (which the court determined was applicable in lieu of the Uniform Commercial Code by operation of the US Constitution’s supremacy clause and the failure of the parties to opt out of the CISG in their contract) controlled when the subject goods were received. Under the CISG, goods shipped “FOB from port of origin” (like the goods in this case) are delivered by the seller (and “perforce constructively received” by the buyer) when the seller places the goods on the ship and the “risk of loss or damage passes to the buyer.” Because the goods were placed by the Chinese vendors on the ship prior to the 20-day period, they were not eligible for 503(b)(9) treatment.
The holding in World Imports, which is currently under appeal, applies in only limited circumstances. Purely domestic transactions are governed by the UCC (which defines “receipt” as the taking of physical possession). Moreover, international suppliers can circumvent the result in World Imports by specifically writing into their purchase and sale agreements that the UCC, and not the CISG, applies with respect to the definition of “receipt” in connection with the sale and shipment of goods. It is important to note that, in order to opt out of the CISG, it is not enough to simply reference the applicable state law. Parties must explicitly state that the CISG does not apply.
Of course, suppliers with the requisite bargaining power can avoid the bankruptcy claims process altogether and be insulated from the risk of a clawback of any payments made by a debtor on the eve of bankruptcy by demanding payment in advance for all goods shipped or by requiring the purchaser to obtain a letter of credit from its bank against which the supplier can draw down at the same time it delivers the goods “FOB from point of origin.”
In a recent decision from the Delaware bankruptcy court, Judge Christopher S. Sontchi joined the debate over the interpretation of section 547(c)(4)(B) of the Bankruptcy Code, which sets forth the new value defense to a preference claim. Continue reading