Category: Bankruptcy

Is Crypto Collapsing?

November 11, 2022, brought news of yet another massive crypto bankruptcy filing. One of the largest crypto exchanges, FTX, filed a petition for bankruptcy protection in Delaware. FTX, Alameda, and other affiliates estimated in their filings that they have more than 100,000 creditors. With their estimated range of between $10 and $50 billion worth of assets and liabilities, this could well be the largest crypto-related bankruptcy ever filed.

This follows a slew of other big names in crypto which have filed bankruptcy petitions recently, including lender Three Arrows Capital (3AC) and the Celsius crypto exchange. Others have sought similar protections overseas, such as Zipmex’s proceeding in Singapore.

Why are these companies filing bankruptcy? The reasons vary.

  • Business models built on unsustainable growth rates in cryptocurrency prices
  • Collapse in cryptocurrency prices, leading to “runs on the bank”
  • Financial irregularities

Is your crypto safe? That depends on what it is and where you park it. Some newer tokens and wallet software may not have been extensively tested, and so may have weak points that an attacker might exploit. Even “safe” currencies like Bitcoin can be hacked if stored in a hot wallet. Of particular interest, customers of a bankruptcy exchange may find it difficult to recover their crypto deposits because their investments may be treated as mere unsecured claims against the exchange, drastically reducing the odds of recovery.

Filings by crypto-based entities come with a host of thorny issues. The most obvious is whether a crypto exchange’s bankruptcy estate owns the tokens it holds for others. But there are many others, including privacy concerns with respect to what previously were anonymous transactions and questions about the propriety of large financial withdrawals by high-ranking individuals in the days surrounding the filing of bankruptcy petitions.

For More FinTech Legal News, click here to visit the National Law Review.

© 2022 Miller, Canfield, Paddock and Stone PLC

Large Corporate Bankruptcy Filings Continue to Decrease through First Half of 2022

Most industry groups saw bankruptcy filings decline from mid-2020 pandemic highs.

New York—Following the spike in large corporate bankruptcy filings triggered by the COVID-19 pandemic, filings in 2021 and the first half of 2022 fell to levels below historical averages, according to a Cornerstone Research report released today.

The report, Trends in Large Corporate Bankruptcy and Financial Distress—Midyear 2022 Update, examines trends in Chapter 7 and Chapter 11 bankruptcy filings by companies with assets of $100 million or higher. It finds that 70 large companies filed for bankruptcy in 2021, down significantly from 155 in 2020 and below the annual average of 78 filings since 2005. In the first half of 2022, only 20 large companies filed for bankruptcy, compared to midyear totals of 43 in 1H 2021 and 89 in 1H 2020. The 20 bankruptcies in 1H 2022 were the lowest midyear total since the second half of 2014.

“U.S. government stimulus programs, low borrowing rates, and high debt forbearance helped disrupt predictions of continued growth in the number of bankruptcy filings,” said Nick Yavorsky, a report coauthor and Cornerstone Research principal. “Looking ahead, however, there are some concerns that increased corporate debt levels, rising interest rates and inflation, and a potential global recession may contribute to an increase in bankruptcy filings.”

In 2021, there were 20 “mega bankruptcies”—bankruptcy filings among companies with over $1 billion in reported assets—a substantial decline from the 60 mega bankruptcy filings in 2020. The first half of 2022 saw four Chapter 11 mega bankruptcy filings, compared to nine in the first half of 2021 and at a pace significantly lower than the annual average of 22 filings in 2005–2021.

Most industry groups saw bankruptcy filings decrease in 2021 and the first half of 2022, including those industries with the highest number of filings following the pandemic’s onset: Mining, Oil, and Gas; Retail Trade; Manufacturing; and Services.

Read the full report here.

Article By Allie Schwartz, Joseph B. “J.B.” Doyle, Nicholas D. Yavorsky, and Diego Vega San Martin of Cornerstone Research

For more bankruptcy legal news, click here to visit the National Law Review.

Copyright ©2022 Cornerstone Research

The Unredeemable Debtor

The law is the witness and external deposit of our moral life. Its history is the history of the moral development of the race.

– Oliver Wendell Holmes

Bankruptcy law decisions are replete with references to the “worthy debtor.”  In re Carp, 340 F.3d 15, 25 (1st Cir. 2003); In re BankVest Capital Corp., 360 F.3d 291 (1st Cir.2004); In re Institute of Business and Professional Educ., Inc., 79 B.R. 948 (Bankr. S.D. Fla. 1987); In re Nickerson, 40 B.R. 693 (Bankr. N.D. Tex. 1984); In re Marble, (Bankr. W.D. Tex. 1984); In re Doherty, 219 B.R. 665 (Bankr. W.D. N.Y. 1998).

These decisions typically employ the “worthy debtor” nomenclature in the context of the entitlements that are afforded by the provisions of the Bankruptcy Code.  It is always the “worthy debtor” that is entitled to a discharge of debts, a “fresh start”,  or to reject cumbersome contracts. This usage bespeaks a universe that also contains the “unworthy debtor,” a party whose behavior does not merit the statutory benedictions of the Bankruptcy Code. The identity of these parties is most often examined in the context of the discharge of debts and the behavior or actions that merit a denial of discharge or the finding that a particular debt is non-dischargeable.

There is a larger and more amorphous question though that also merits consideration, namely are their industries, companies, enterprises whose function and purpose is so odious and inconsistent with the precepts of good citizenship and the “moral development of the race”, to quote Justice Holmes, that they should be denied the benefits of reorganization afforded by the Bankruptcy Code.

If there is an argument to be made to prevent such enterprises from receiving the benefits of the Bankruptcy Code, to deny them the colloquial label of “worthy debtor”, that recourse likely lies within the provisions of the Bankruptcy Code that require that a plan of reorganization be “proposed in good faith and not by any means forbidden by law.”  11 U.S.C. § 1129(a)(3).  The “not forbidden by law” requirement is of limited utility in situations where the behavior is recognizable as immoral or intrinsically evil to most but has not yet been sanctioned by any legislative authority. Notably, and perhaps inversely, enterprises engaged in the sale and growing of cannabis are without access to the Bankruptcy Code because they act in contravention of the federal Controlled Substances Act, 21 U.S.C. §§ 801 et seq., which has been found to take precedence over state laws allowing the sale of cannabis. See, Gonzales v. Raich, 545 U.S. 1, 12 (2005).  As a result, bankruptcy being a creature of federal law, cannabis cases are generally being dismissed at the outset for cause in accordance with 11 U.S.C. § 1112(b) and not making it as far as the confirmation standard. See, In re Way To Grow, Inc., 597 B.R. 111 (Bankr. D. Colo. 2018).

If “forbidden by law” is unavailable as a source of relief, the last best hope to prevent the sanctioned reorganization of the unworthy debtor lies within the requirement that a plan be proposed in “good faith.”

“Good faith” is not defined by the Bankruptcy Code, a fact that makes it more likely that our  understanding of good faith may be transitory and that as the ‘moral development of the race’ proceeds, so might our understanding of ‘good faith.’  In other words, what was good faith yesterday might not, in light of our communal experience and growth as citizens, be good faith today.

In the first instance, we can understand from the ordering of the words within section 1129(a)(3) that the good faith standard exists independently of the ‘forbidden by law’ standard.  A plan of reorganization may describe a course of action not forbidden by law, but may still not meet the ‘good faith’ standard.

The good faith standard as used within section 1129(a)(3) is most commonly described as proposing a plan that fulfills the purposes and objectives of the Bankruptcy Code.  Those purposes and objectives within the context of Chapter 11 are most commonly understood as being “to prevent a debtor from going into liquidation, with an attendant loss of jobs and possible misuse of economic resources.”  NLRB v. Bildisco & Bildisco, 465 U.S. 513, 528 (1983);  see also, Bank of Am. Nat. Trust & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 452 (1999) (“[T]he two recognized policies underlying Chapter 11 [are] preserving going concerns and maximizing property available to satisfy creditors”)

This case law, which is by far the most consistent usage of the term, emphasizes paying back creditors and preserving an ongoing enterprise. It does not suggest the existence of anything more amorphous beyond those standards and it supports the idea that the ‘good faith’ standard is not meant to be an existential inquiry into the moral worth of a particular industry.

Bankruptcy courts have, however, recognized that the absence of a definition of good faith leaves courts without “any precise formulae or measurements to be deployed in a mechanical good faith equation.”  Metro Emps. Credit Union v. Okoreeh–Baah (In re Okoreeh–Baah), 836 F.2d 1030, 1033–34 (6th Cir.1988) (interpreting good faith in context of Chapter 13).

Any successful collateral attack under section 1129(a)(3) on the ‘good faith’ of the immoral enterprise must likely follow the path of connecting the good faith standard to the “public good.”  Bankruptcy Courts have invoked the ‘public good’ in refusing to enforce certain contracts and have followed the dictates of some courts that “while violations of public policy must be determined through “definite indications in the law of the sovereignty,” courts must not be timid in voiding agreements which tend to injure the public good or contravene some established interest of society. Stamford Bd. of Educ. v. Stamford Educ. Ass’n., 697 F.2d 70, 73 (2d Cir.1982).

The concept of the ‘public good’ is not a foreign one in bankruptcy courts.  Seeking relief for debtors that are the only providers of a service within their geographic area is an immensely easier task, no court, and no bankruptcy judge, likes to see a business fail and when the business is important to the community, support for reorganization from the bench often works to make reorganization easier.  Bankruptcy courts, although restrained by a statutory scheme, are as a matter of practice courts of equity.  Employing those equitable arguments to support a reorganization is both achievable and a reality of present practice.

Whether equitable arguments can be inversely employed to graft a sense of the ‘public good’ onto the good faith requirement within section 1129(a)(3) is decidedly uncertain and is not directly supported by the case law as it exists.

Somewhere out there though in one of those small border towns between the places of unelected legislators and the judicious and novel application of historical precedent lies the “moral development of the race” and the bankruptcy court that finds that incumbent within the concept of good faith is fair consideration of the public good.

Article By Peter J. Haley of Nelson Mullins

For more bankruptcy and restructuring news, click here to visit the National Law Review.

Copyright ©2022 Nelson Mullins Riley & Scarborough LLP

“My Lawyer Made Me Do It” is Not an Absolute Defense to Bankruptcy Court Sanctions

Last year, we offered a lesson and a moral from a North Carolina district court decision reversing a $115,000 sanctions order by a North Carolina bankruptcy court.

The lesson from the case was that the bankruptcy court cannot sanction a creditor if there is an objectively reasonable basis for concluding that the creditor’s conduct is lawful.

The moral was that a creditor can avoid the time, expense, and risk associated with litigating contempt and sanctions issues by taking basic steps to ensure that confirmed Chapter 11 plans are clear and precise.  The moral is even more glaring now because a recent decision from the Fourth Circuit Court of Appeals reveals that the parties continue to fight in court over the easily-avoidable sanctions order.  The decision also clarifies when and why a bankruptcy court can sanction a creditor.

Factual Background

In 2009, the Beckharts filed Chapter 11.  At the time, they were almost a year behind on a loan secured by the property at Kure Beach.  The loan servicer objected to planning confirmation because it did not specify how post-petition mortgage payments would be applied to principal and interest.  The bankruptcy court confirmed the plan without clarifying the issue, but the servicer did not ask the court to reconsider its order, nor did it appeal.

The Beckharts paid for five years.  Shellpoint acquired the loan from the original servicer and treated it as in default based on unpaid accrued arrearages.  Periodically, Shellpoint sent default letters to the Beckharts, who disputed the default.  Counsel for Shellpoint advised that the confirmation order had not changed the loan contract terms and that the loan remained in default.  The matter escalated with the Beckharts filing complaints with the Consumer Financial Protection Bureau.  Shellpoint commenced foreclosure, then represented to the Beckharts that it was ceasing foreclosure, but then posted a foreclosure hearing notice on the Beckharts’ door (allegedly due to error).

Litigation

In January 2020, the Beckharts moved the bankruptcy court to find Shellpoint in contempt and award them monetary sanctions.  The court held a hearing in June and, in September 2020, found Shellpoint in contempt.  The court tagged Shellpoint with $115,000 in sanctions for lost wages, “loss of a fresh start,” attorney’s fees, and travel expenses.

Bankruptcy courts have the power to hold a party in civil contempt and to impose sanctions for violation of a confirmed plan.  The test for liability is based on a recent United States Supreme Court decision — Taggart v. Lorenzen.  The Taggart test prohibits sanctions if there was an “objectively reasonable basis for concluding that the creditor’s conduct might be lawful.” There can be contempt for violating the discharge injunction only “if there is no fair ground of doubt as to whether the order barred the creditor’s conduct.”

In reversing the bankruptcy court, the district court noted that the plan and confirmation order did not state how much the debtors would owe on confirmation, did not say how the $23,000 in arrears would be paid, and did not set the amount of the first payment.  Confusingly, the confirmation order also said that the original loan terms would remain in effect, except as modified.  Finally, the district court pointed out that Shellpoint was repeatedly advised by counsel that their behavior was authorized, and reliance on the advice of outside counsel is a sufficient defense to civil sanctions.  Based on all these facts, the district court found that Shellpoint acted in good faith and interpreted the confirmation order in a manner consistent with the contractual terms of the loan, and that was objectively reasonable.

Taggart was a Chapter 7 case involving a discharge violation, but the Fourth Circuit held that the “no fair ground of doubt” test applied broadly in bankruptcy – including in Chapter 11 cases.

But the Fourth Circuit disagreed with the district court’s decision to reverse the bankruptcy court because the creditor had requested and received legal advice from outside counsel.  The Fourth Circuit held that advice of counsel is not an absolute defense in civil contempt.   The Court suggested that, under the Taggart test, advice of counsel “may still be considered in appropriate circumstances as a relevant factor” and “a party’s reliance on guidance from outside counsel may be instructive, at least in part, when determining whether that party’s belief that she was complying with the order was objectively unreasonable.”

The Fourth Circuit held that both lower courts had made mistakes and sent the case back to the bankruptcy court to “reconsider the contempt motion under the correct legal standard, including any additional fact-finding that may be necessary.”

Creditors can take some comfort in the “no fair ground of doubt” test, which is more forgiving than a strict liability standard.  But creditors can’t blame their lawyer for perilous conduct and expect the court to exonerate them.

But the most important takeaway hasn’t changed:  Creditors should insist on clear and specific plan terms.  After over two years of litigation, Shellpoint remains in peril of sanctions.  All of this could have been avoided had the loan servicer insisted the plan specify how the Beckharts’ payments would be applied to satisfy the arrearage.

Article By Lance P. Martin of Ward and Smith, P.A.

For more bankruptcy legal news, click here to visit the National Law Review.

© 2022 Ward and Smith, P.A.. All Rights Reserved.

Debt Ceiling Shrinks for Small Business Bankruptcies

Subchapter V of Chapter 11 of the Bankruptcy Code, which took effect in February 2020, creates a more streamlined and less expensive Chapter 11 reorganization path for small business debtors.  Under the law as originally passed, to be eligible for Subchapter V, a debtor (whether an entity or an individual) had to be engaged in commercial activity and its total debts — secured and unsecured – had to be less than $2,725,625.  At least half of those debts must have come from business activity.

In March 2020, in response to the COVID-19 pandemic, Congress passed the CARES Act, which raised the Subchapter V debt ceiling to $7.5 million for one year.  Congress extended it to March 27, 2022.  A bipartisan Senate bill would make the Subchapter V debt limit permanent at $7.5 million and index it to inflation.  But Congress has not yet passed the legislation or sent it to President Biden for signature.  So, for now, the debt ceiling has shrunk to the original $2,725,625.

Subchapter V has proven popular, with over 3,100 cases filed in the last two years (78 in North Carolina).  Many of those cases could not have proceeded under Subchapter V but for the higher debt limits.  The American Bankruptcy Institute has reported that Subchapter V cases are experiencing higher plan-confirmation rates, speedier plan confirmation, more consensual plans, and improved cost-effectiveness than if those cases had been filed as a traditional Chapter 11.  Anecdotally, most debtors in North Carolina are filing under Subchapter V if they are eligible.

We will continue to monitor legislative activity and report if Congress passes a law to reinstate the $7.5 million debt ceiling.

Article By Lance P. Martin of Ward and Smith, P.A.

For more financial and business legal news, click here to visit the National Law Review.

© 2022 Ward and Smith, P.A.. All Rights Reserved.

Cannabis and District Courts: Are Those Courthouse Doors Closed Too?

We have written many times over the past few years about how the bankruptcy courts are off-limits to state-legalized cannabis businesses.  This past year brought no new relief to the cannabis industry, and the doors to the bankruptcy courts remain shut.  Are the other federal courts off-limits as well?  A recent district court decision from the Southern District of California sheds some light on this issue, and indicates that the district courts are at least partially open to participants in legal cannabis businesses.

Factual Background

The facts of Indian Hills Holdings, LLC v. Frye are relatively straightforward.  Plaintiff Indian Hills Holdings (“IHH”), Construction & Design Professional Corp. (“CDP”) and its principal Christopher Frye (“Frye” and, together with CDP, the “Defendants”) entered into a contract whereby IHH paid Defendants to purchase Cultivation “Adult” Extreme Cubes (the “Cubes”).  Defendants in turn contracted with ICT Centurion Investments, LLC (“ICT”) to purchase the Cubes.   The Cubes were marketed as a “fully integrated growing container system” used in indoor cannabis cultivation.  When ICT sold the Cubes to another party, Defendants were unable to deliver the Cubes to IHH.  Defendants refused to return the money, and IHH sued, asserting breach of contract, unjust enrichment and fraud claims.

A default judgment was entered against CDP for failing to respond to IHH’s complaint.  Frye, however, filed a motion to dismiss the complaint, arguing in part that IHH did not have standing to bring its claims.  Noting that Frye only “cursorily” raised the standing issue and that the “issue is a complex one”, the court reframed Frye’s argument as follows:

  • The contract is illegal under the Controlled Substances Act, 21 U.S.C. §§ 801, et seq.(the “CSA”);
  • Federal district courts will not enforce contracts that violate federal law;
  • Because federal district courts will not enforce contracts that violate federal law, IHH lacks an “actionable injury”; and
  • Because IHH lacks an actionable injury, the district court does not have subject matter jurisdiction.

Legal Analysis

The court began its analysis by considering whether the parties’ contract violated the CSA.  Section 863(a) of the CSA makes it unlawful to sell or offer for sale “drug paraphernalia,” which is defined to include “any equipment, product, or material of any kind which is primarily intended or designed for use in manufacturing … a controlled substance.”  Because the Cubes are used to grow cannabis, and because cannabis is a controlled substance, the sale of the Cubes would seemingly violate section 863(a) of the CSA.  However, the CSA contains an exemption, whereby section 863 does not apply to any person authorized by state law to manufacture, possess or distribute drug paraphernalia.  California allows the manufacturing of drug paraphernalia, which would include the Cubes.  As a result, the court wrote that the contract “may fall within the CSA exemption.” Additionally, the court noted that the U.S. Department of Justice has declined to enforce the CSA’s prohibition on the sale of marijuana when the marijuana is bought or sold in accordance with state law.  For these reasons, the court concluded that enforcing the parties’ contract would likely neither violate the CSA nor public policy.

While the contract may be legal, the court still had to consider whether assuming jurisdiction over the dispute would result in a violation of federal law.  After all, federal courts will not assume jurisdiction over a dispute where the court will be required to order a legal violation.  The question therefore became whether a plausible remedy existed for IHH that would not require the court to order such a legal violation.   The court held that it could fashion a remedy without violating the law by simply awarding IHH monetary damages.  A judgment for money damages, unlike an award of specific performance, would not result in IHH obtaining the Cubes and growing cannabis.  Instead, the result would be a return of the monies paid by IHH to Defendants for the Cubes.  The court’s ruling was consistent with prior cases involving state-legalized cannabis business, where the courts found ways to provide relief without violating the CSA.  E.g., Polk v. Gontmakher, 2021 U.S. Dist. LEXIS 53569 (W.D. Wash. Mar. 22, 2021) (noting that “recent case law involving cannabis-related business contracts does not espouse an absolute bar to the enforcement of such contracts”); Mann v. Gullickson, 2016 U.S. Dist. LEXIS 152125 (N.D. Cal. Nov. 2, 2016) (court may consider breach of contract claim arising from sale of cannabis business when “it is possible for the court to enforce [the] contract in a way that does not require illegal conduct”).

Takeaways

As the legalized cannabis industry continues to grow and develop, market participants will undoubtedly need access to courts.  The bankruptcy courts remain off-limit, thus requiring distressed cannabis businesses and their creditors to turn to state-law insolvency proceedings (e.g., assignments for the benefit of creditors; receiverships).  To those in the industry, it may be a welcome relief to know that at least some federal district courts have made themselves available to these parties and that these courts thus far have shown a willingness to adjudicate disputes arising from the cannabis industry.  However, any party seeking their day in federal court needs to ensure that they are not asking the court to grant relief that would violate federal law, including the CSA.  This means that while money damages should be available, specific performance of the contract is likely off the table.

Article By Mark A. Salzberg of Squire Patton Boggs (US) LLP

For more cannabis legal news, click here to visit the National Law Review.

© Copyright 2022 Squire Patton Boggs (US) LLP

Not So Fast! How Poor Planning Can Doom Your Chapter 11 Filing

A Texas bankruptcy court’s decision earlier this year to dismiss the National Rifle Association’s (“NRA”) chapter 11 bankruptcy case as a bad faith filing illustrates the perils of a poorly planned chapter 11 filing, and highlights the need, even in crisis situations, to establish solid objectives and develop a sound strategy prior to seeking relief under the Bankruptcy Code. In re Nat’l Rifle Ass’n of Am., 628 B.R. 262 (Bankr. N.D. Tex. 2021). Unique facts and circumstances notwithstanding, In re Nat’l Rifle Ass’n of Am. provides textbook examples of things you should not do when filing a corporate chapter 11 case.

In its opinion, the Northern District of Texas Bankruptcy Court highlighted recent events in the history of the NRA prior to the bankruptcy filing, including: (1) the New York Attorney General (“NYAG”) opening investigations into the NRA in 2017; (2) the New York Department of Financial Services urging insurers and financial institutions in April 2018, to evaluate whether their relationships with the NRA were harmful to their corporate reputations and jeopardized public safety; (3) multiple whistleblowers notifying the NRA Audit Committee in July 2018 about alleged misconduct by NRA management, including conflicts of interest of senior management and board members and improper reimbursement of living expenses for certain employees; and (4) the NYAG filing a complaint against the NRA in New York state court on August 6, 2020 seeking dissolution of the NRA (the “NYAG Action”).

Approximately 3 months after the NYAG Action, on November 23, 2020, the NRA retained counsel to advise them on bankruptcy and restructuring options. The very next day, the entity “Sea Girt, LLC” was formed, as “a transition vehicle to facilitate the NRA’s relocation to Texas.” Id at 267. At a board meeting on January 7, 2021, the NRA board approved the employment agreement of the NRA’s Executive Vice President Wayne LaPierre, which included language allowing Mr. LaPierre to “exercise corporate authority in furtherance of the mission and interests of the NRA, including without limitation to reorganize or restructure the affairs of the Association for the purposes of cost-minimization, regulatory compliance or otherwise.” Id. at 267-68. There was no discussion of bankruptcy or reorganization at the board meeting, and the board was never informed that the employment agreement authorized Mr. LaPierre to unilaterally file a bankruptcy petition for the NRA. A few days after the board meeting, on Jan. 15, 2021, the NRA and Sea Girt, LLC filed voluntary petitions for relief under Chapter 11.

Approximately one month into the bankruptcy case, multiple parties, including the NYAG, filed dispositive motions seeking various relief that the bankruptcy court categorized as generally falling into three buckets: (1) dismissal; (2) appointment of a chapter 11 trustee; or (3) appointment of an examiner. Id. at 270. In adjudicating the motions, the bankruptcy court adopted the Fifth Circuit’s flexible view that the term “cause” in Section 1112(b)(4) could include “a finding that the debtor’s filing for relief is not in good faith.” Id at 270.

The Court’s good faith analysis largely focused on the NRA’s reasons for filing bankruptcy. After evaluating the relevant arguments and evidence, the Court concluded that the real purpose for the bankruptcy filing was to avoid dissolution in the NYAG Action. The Court noted that although there was “some evidence that the NRA want[ed] to streamline litigation and control litigation costs,…” that did not appear to be “the real purpose” behind the bankruptcy filing. Id. at 278. On the contrary, there was testimony that the NRA could afford to pay its legal fees and there had not been any analysis done of the comparative cost of litigation outside of bankruptcy versus the cost of litigation within the bankruptcy case. While the question of “[w]hether the NRA’s desire to leave New York and reincorporate in Texas was a true reason for filing bankruptcy [was] a closer call,” the Court was not persuaded that the conditions faced by the NRA predating the NYAG Action were an existential threat and reason to file bankruptcy in order to move to Texas. Id. at 278. Testimony of the CFO, that “he was not aware of any reasons to file for bankruptcy” was also not supportive of the argument that the bankruptcy was filed for financial reasons. Id. at 279. In the Court’s view, the other reasons that the NRA gave for filing bankruptcy, such as “preserving the NRA as a going concern” could all be grouped under the general reason of avoiding the dissolution in the NYAG Action. Id. at 279.

For its subsequent analysis of whether avoiding the dissolution in the NYAG Action was a valid purpose, the Court conducted the 2-pronged inquiry used by the Third Circuit, namely: “(1) whether the petition serves a valid bankruptcy purpose and (2) whether the petition is filed merely to obtain a tactical litigation advantage.” Id. at 280. The Court reasoned that a lawsuit seeking a monetary judgment, which could be financially ruinous for a debtor, was different from a state enforcement action specifically seeking dissolution under that state’s laws that must satisfy certain requirements. The Court found the NRA case to be a bad faith filing because its purpose was (1) “to deprive the New York AG of the remedy of dissolution, which is a distinct litigation advantage” and “[to deprive] the state of New York of the ability to regulate not-for-profit corporations in accordance with its laws.” Id. at 281.

In considering whether appointment of a trustee or examiner was in the best interest of creditors, the Court noted “cringeworthy” facts such as the evidence of the NRA’s past misconduct, including deficiencies in financial disclosures by senior management. Id. at 283. Even more concerning to the Court was the “surreptitious manner in which Mr. LaPierre obtained and exercised authority to file bankruptcy for the NRA,” where he had excluded key people such as the CFO and the general counsel from the decision-making process. Id. at 284. The determination of whether or not to appoint a trustee or examiner was further complicated because the NRA’s mission was, “at times, political and polarizing” and because “[t]he NRA does not sell goods or services” it would be difficult to find the appropriate fiduciary to serve as trustee or examiner. Id. at 284. Touting progress the NRA had made in recent years resulting in more disclosure and self-reporting, the Court concluded that, “[o]utside of bankruptcy, the NRA can pay its creditors, continue to fulfill its mission, continue to improve its governance and internal controls, contest dissolution in the NYAG Enforcement Action, and pursue the legal steps necessary to leave New York.” Id. at 284-85.

In re Nat’l Rifle Ass’n of Am. vividly demonstrates the danger of hastily filing a chapter 11 case, and then formulating a narrative post-petition as to the reasons for the filing that are not supported by evidence. Profoundly damaging to the NRA’s position was the inconsistency between the NRA’s arguments in bankruptcy court and the NRA’s own publicly announced reasons for filing bankruptcy, including a posting on its NRA website which stated, “This action is necessitated primarily by one thing: the unhinged and political attack against the NRA by the New York Attorney General.” The Court also expressed frustration at the lack of clarity caused by conflicting testimony of witnesses about the purpose of the bankruptcy filing. When the CFO testifies there is no financial reason to file bankruptcy, how do you argue that the bankruptcy was filed to reorganize the debtor? Also detrimental to the NRA’s position were corporate governance failings where there was no vote or even any discussion by the Board about bankruptcy and restructuring options, and it was clear that the decision to file chapter 11 was made by one person. This case shows that, given the significant costs attendant to an imprudent bankruptcy filing that is later dismissed, it is essential to establish clear objectives, articulate a coherent strategy, and practice good corporate governance prior to filing a chapter 11 case.

Copyright ©2022 Nelson Mullins Riley & Scarborough LLP

Article By Zana Scarlett of Nelson Mullins

For more articles on Chapter 11, visit the NLR Bankruptcy & Restructuring section.

10 Retailers to Watch for a Bankruptcy Filing in the Second Half of 2021

The tide has turned from last year! Slowly, the global pandemic is coming to an end. In its wake, the retail industry has been forever changed with technological innovations and advancements, including online ordering and delivery/pickup, warehousing, automation, and mobile self-check-out. Although most landlords and tenants have worked together during the adversity, there are still a number of problem tenants that may not be able to recover or who may now use the bankruptcy process to get rid of debt and actually restructure.

Following is our top 10 retailers to watch for possible Chapter 11 filing(s) in the year ahead.

  1. AMC – Why Go to the Movies When You Can Stream? According to the Motley Fool, despite the more than $917 million in cash infusion from the investors at the beginning of the year, there is still numerous obstacles for the movie theater company. The rise in streaming services, slow return of consumers to theaters, as well as a significant portion of their current debt being nonconvertible are all signs that there is a high likelihood of a bankruptcy filing to restructure the debt.

  2. Nine West – Footwear Company Walking into a Chapter 22? The women’s footwear company owned by Premier Brands Group Holdings previously filed for bankruptcy in 2018. At the time it reduce debt and sold the Anne Klein trademark. However according to Business Insider, the pandemic is caused a significant drop in revenue. The company looks poised for a Chapter 22 filing – a second Chapter 11 bankruptcy within a few years of the first filing.

  3. LA Fitness – A Footprint Reduction? The Wall Street Journal reports that although gyms are now re-open, the pandemic upended the fitness industry. However, out of all the gyms that suffer through the pandemic, LA Fitness seems to be in the best position to use the bankruptcy process to reduce its footprint and renegotiate leases.

  4. Jo-Ann Stores – Private Equity Debt. According to USA Today, the private-equity owned company has significant debt. This scenario is a classic reason for filing for bankruptcy – remember Toys R’ Us.

  5. Regal Entertainment Group – Significant Rent Arrears. CNBC reports that Regal’s reopening of approximately 500 locations on April 2 to limited capacity was a significant decision for the theater chain. However, like AMC, its owner, Cineworld Group PLC faces significant debt, streaming services and slow return of customers. In addition, numerous outlets report significant rent arrears to landlords.

  6. Barnes and Noble – Can It Survive? The acquisition of Paper Source was meant to create synergies between the two. However, the company is heavily reliant on food concessions as well as in-store customers. Have buyer habits changed for good due to the Pandemic? Forbes still has it on its list of specialty retailers to watch for a Chapter 11 filing.

  7. Rite Aid – A Healthier Population Hurts Business. com notes that the US pharmacy chain with 2,500 stores in 19 states, had a rough go during the Pandemic, as fewer people came down with colds or coughs as they sheltered at home. According to Moody’s, the company is in danger of default as it holds $1.5 billion in outstanding high-risk debt.

  8. Equinox – Another Gym Filing? According to Crain’s New York, landlords are pursuing the private health club for more than $6 million in back rent. Bloomberg noted in February 2021 that the company reached a deal that released it from a limited guarantee of SoulCycle’s $265 million credit facility with lender HPS Investment Partners. Still, the heavy back rent, multiple locations and other debt issues make the gym a perfect candidate for a Chapter 11 restructuring.

  9. The Children’s Place – Losses Keep Piling Up. According to the Forbes, the pandemic accelerated apparel filings. One retailer listed at the top of the list for this year is The Children’s Place. The largest children apparel retailer is on track to close more than 300 stores. Although the company negotiated about $13 million in rent abatements in the fourth quarter 2020 for the COVID-closure period, it may not be enough to avoid a filing.

  10. The Gap – Fall Into Bankruptcy? S. News & World Report’s notes that the company’s long-term debt increased from 1.24 billion to 2.21 billion in 2000 due to the pandemic. Although its business is expected to recover as malls reopened and shoppers return, there is still a concern of the decline in mall traffic long-term.

COPYRIGHT © 2021, STARK & STARK
For more articles on bankruptcy, visit the NLRBankruptcy & Restructuring section.

Their Aim Wasn’t True – The NRA and Bad Faith Bankruptcy Filings

Bankruptcy offers a temporary sanctuary for parties seeking relief from a variety of problems – financial crisis, lawsuits, collection actions, repossessions, foreclosure, and pandemics.

Filing bankruptcy before a money judgment is entered or on the eve of a foreclosure sale is – often to the consternation of creditors – perfectly valid.  Creditors often complain that the debtor is acting in bad faith, and the bankruptcy court should toss the case.  Those arguments almost always fail.

But not all bankruptcy cases survive long enough for a debtor to reorganize.  When a case is truly filed in “bad faith,” the bankruptcy court can and often will dismiss it.  So when a Bankruptcy Court in Texas recently dismissed the Chapter 11 case filed by the National Rifle Association, it provided an opportunity to look at what constitutes a bad faith filing under the Bankruptcy Code.

The NRA was sued by the New York Attorney General, who alleged the NRA had committed a variety of illegal acts in violation of New York’s laws governing not-for-profits.  The New York Attorney General has the power to bring enforcement actions against charities like the NRA and, if successful, one of the potential remedies is the dissolution of the charity.  The NRA sought to avoid the enforcement action – and particularly the specter of dissolution – by filing bankruptcy and moving to Texas.

When a party files a bankruptcy petition, it must do so for a valid bankruptcy purpose; otherwise, it is a bad faith filing.  Valid bankruptcy purposes include avoiding foreclosure, avoiding having to shutter operations, reducing operating costs, addressing burdensome contracts and leases, streamlining and consolidating litigation, attempting to preserve a business as a going concern, or simply obtaining a breathing spell to deal with creditors.  A petition filed merely to obtain a tactical litigation advantage is a bad faith filing.

To determine good faith versus bad faith, the courts must consider the totality of the circumstances based on the debtor’s financial condition, motives, and the local financial realities.  No single factor is dispositive.  Since the court must evaluate and decide the issue, witness testimony – particularly from the parties who decided to file the case – is a critical factor.  The burden is on the party seeking dismissal to prove bad faith by the debtor.  If that party can muster enough evidence to suggest bad faith, then the burden shifts to the debtor to prove that it was acting in good faith.

After a 12-day trial with 23 witnesses, the Bankruptcy Court found that the NRA’s bankruptcy petition was not filed in good faith based on the totality of the circumstances. The NRA was not in financial distress and had funds to pay all their creditors in full.   The NRA filed their petition to gain an unfair litigation advantage in the New York Attorney General enforcement action.  New York might still be able to get a money judgment, but the NRA wanted to take dissolution off the table.  The enforcement action was different than a lawsuit by a disgruntled vendor.  It was to enforce New York’s regulatory scheme for charities, and the NRA was using bankruptcy to try to avoid that regulatory scheme.  This was not a legitimate bankruptcy purpose.

The lesson for creditors is that, although infrequent, there are circumstances when a bankruptcy court will dismiss a case.  If the debtor has filed a case for a patently improper purpose, you may get it dismissed.  But to pursue dismissal and succeed, you need to be prepared to go to trial and present compelling evidence of bad faith to the court through documents and witness testimony.

© 2021 Ward and Smith, P.A.. All Rights Reserved.
For more articles on bankruptcy, visit the NLR Bankruptcy & Restructuring section.

The Value of IP in Fashion/Retail Insolvencies

A strong brand creates a competitive edge; such a brand will often enhance consumer loyalty, not only because of the products offered, but also because of the name on the label. While a brand may have a strong customer base, in today’s climate it, unfortunately, does not mean that the business has enough financial security to withstand the struggles faced by the declining traditional bricks and mortar shopping in the United Kingdom or the global COVID-19 pandemic. In the first six months of 2020, more bricks and mortar retailers went into administration in the United Kingdom, compared with the whole of 2019. With the sad reality that many brands are facing financial struggles, it is important to consider the value of a brand’s intellectual property (IP) when such brands are facing insolvency.

A brand’s IP can be made up of registered trademarks, the associated goodwill with those marks, designs (registered and unregistered), copyright and trade secrets, to name just a few. The IP is how consumers identify one product from another. The value of a brand is likely to have huge appeal for anyone looking to step in and purchase a company going through administration, especially when it comes to fashion. Particularly where a brand has a strong reputation, it can often continue to thrive after going through the insolvency process. Many brands have ceased trading in retail units following administration but have adapted to create or maintain a strong online presence.

Many UK businesses have followed suit and this year have announced (following administration) that they are closing all of their bricks and mortar shops and will only continue to trade online. Such brands include the prestigious footwear company, Oliver Sweeney; TM Lewin, the 120-year-old British formal menswear brand; Antler, the luxury luggage company originally founded in 1914; and the retro fashion chain, Cath Kidston.

The timeline of buying a company that is in administration, and, therefore, the opportunity (if any) to carry out due diligence, is considerably shorter than the usual acquisition process. Additionally, any information provided by the administrators cannot be relied on, and no warranties or indemnities will typically be given. A buyer should, therefore, consider undertaking its own searches into the assets of a company. In relation to the IP, the following (at a minimum) should be considered:

  1. Identify the IP — what IP does the brand have? Does the brand have registered trademarks (words/logos), designs protected by copyright or perhaps a registration, the ‘get-up’ of its websites or stores, or any potential databases such as customers or suppliers?
  2. Ownership — it is important to consider whether the IP ownership sits with the correct party to ensure it will be validly transferred following completion of the acquisition. Any registrations should be in the name of the business, not an individual employee or contractor. If there are any discrepancies in ownership, steps should be taken to ensure a valid assignment could be put in place.
  3. Is it valid — for any registered IP, a buyer should ensure the registrations have been renewed, as required, and subsist. For any unregistered rights such as copyright or designs, if possible, calculations should be made as to when the expiration dates might arise. For copyright, protection ends at the end of the calendar year following 70 years after the author’s death and for unregistered designs, protection ends a maximum of 15 years after the first creation.

For those brands facing financial difficulty, the importance of validly holding IP assets cannot be understated. Having IP correctly and validly held could help in uncertain times when financial assistance may be needed, particularly where the brand is of interest to bankruptcy bidders.

Tegan Miller-McCormack, a trainee solicitor in the Mergers & Acquisitions/Private Equity practice, contributed to this article.

©2021 Katten Muchin Rosenman LLP

ARTICLE BY Sarah Simpson, Prav Reddy and Mark Johnson of
Katten
For more articles on fashion insolvencies, visit the NLR Bankruptcy & Restructuring section.