Tag: Bankruptcy

When Your Customer is In Bankruptcy, There Are Two Major No-Nos That You Must Remember.

First, don’t violate the automatic stay, which prevents a creditor from attempting to collect a debt while the debtor is in bankruptcy unless the creditor gets prior court approval.  Second, don’t violate the discharge injunction, which absolves a debtor of liability for those debts covered by the bankruptcy court’s discharge order.  The automatic stay takes effect when the debtor files bankruptcy, while the discharge injunction typically comes at the end of the case.

The United States Supreme Court recently decided a case involving the discharge injunction.  In Taggart v. Lorenzen, the issue was the legal standard for holding a creditor in civil contempt when the creditor violates the bankruptcy discharge order.  In a unanimous decision, the Supreme Court held that a court may hold a creditor in civil contempt for violating a discharge order if there is no fair ground of doubt as to whether the order barred the creditor’s conduct. In other words, civil contempt may be appropriate if there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful.

Bradley Taggart was a part owner of an Oregon company called Sherwood Park Business Center.  He got into a dispute with some of the other owners, and they sued him in state court for breach of Sherwood’s operating agreement.  During the lawsuit, Taggart filed a Chapter 7 bankruptcy. In Chapter 7, a debtor discharges his debts by liquidating assets to pay creditors.   Taggart ultimately obtained a discharge.  After the bankruptcy court entered the discharge order, the parties returned to the state court lawsuit.  The parties who had sued Taggart before he filed bankruptcy obtained an order from the state court requiring him to pay post-bankruptcy attorneys’ fees of $45,000.00.  Taggart contended this debt had been discharged and the parties’ actions violated his bankruptcy discharge.

Multiple appellate courts reached different conclusions as to whether – and why or why not – the parties had violated the discharge order.  One issue the courts struggled with was the standard to apply to the parties’ conduct.  Should the courts apply an objective test based solely on their conduct or should they consider their subjective beliefs and motivations?  Should the courts impose strict liability for discharge violations or should they let creditors off the hook if they didn’t realize their conduct was improper?  The Supreme Court agreed to resolve these questions.

In adopting the “no fair ground of doubt” standard, the Supreme Court noted that civil contempt is a severe remedy and basic fairness requires those enjoined know what conduct is outlawed before being held in contempt.  The standard is generally an objective one.  A party’s subjective belief he was complying with an order ordinarily will not insulate him from civil contempt if that belief was objectively unreasonable.  Bad faith conduct, and repeated or persistent violations can warrant civil contempt.  Good faith can mitigate against contempt and factor into the appropriate remedy.

Although a discharge order often has little detail, the Supreme Court pointed out that, under the Bankruptcy Code, all debts are discharged unless they are a debt listed as exempt from discharge under Section 523.  A domestic support obligation, for instance, is exempt from discharge.  (This recent article discusses how debts involving intentional, fraud-like conduct may be exempted from discharge.)  In other words, ignorance of the bankruptcy law is no excuse.

In adopting the “no fair ground of doubt standard,” the Supreme Court rejected two other standards, one more lenient and one more harsh.  First, the Supreme Court rejected a pure “good faith” test – a creditor’s good faith belief that its actions did not violate the discharge would absolve it of contempt. Second, the Supreme Court rejected a strict liability test – if a creditor violated the discharge, he would be in contempt regardless of his subjective beliefs about the scope of the discharge order or whether there was a reasonable basis for concluding that his conduct did not violate the discharge order.

The discharge injunction is no joke, and creditors violate it at their peril.  A debtor can be compensated for damages resulting from a discharge violation.  In this case, the bankruptcy court initially awarded Taggart over $100,000 for attorneys’ fees, emotional distress, and punitive damages.  Creditors with customers in bankruptcy, or who have filed bankruptcy in the past, should consult counsel who can advise them on what debts they can pursue.  And if a creditor finds itself accused of violating the discharge injunction, it should contact counsel to assess its chances of passing or failing the “no fair ground of doubt” test.

© 2019 Ward and Smith, P.A.. All Rights Reserved.

Mission Products v. Tempnology: SCOTUS Holds that Rejection of Trademark License in Bankruptcy Does Not Terminate the Right to Use the Mark

On May 20, 2019, the U.S. Supreme Court held by a vote of 8-1 that a trademark licensor’s rejection in bankruptcy of a trademark license does not terminate the licensee’s right to use the licensed mark.Mission Products Holdings, Inc. v. Tempnology, LLC, No. 17-1657, 587 U.S. ___ (2019). In so holding, the Court resolved a circuit split on the issue. The Court reversed the decision of the First Circuit, which held that Tempnology’s rejection of a trademark license under the Bankruptcy Code had the effect of terminating Mission Products’ right to use the licensed marks. The Court expressly affirmed the reasoning of the Seventh Circuit in Sunbeam Products, Inc. v. Chicago Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012), and held that rejection of a trademark license constitutes a pre-petition breach of the license agreement but does not otherwise terminate the licensor’s and licensee’s rights and obligations under the license agreement.

The Court’s opinion, authored by Justice Kagan, considered section 365 of the Bankruptcy Code, 11 U.S.C. §365. Specifically, the Court considered section 365(a), which permits a debtor in bankruptcy to reject any executory contract 1, and section 365(g), which provides that the debtor’s rejection “constitutes a breach of such contract.” 11 U.S.C. §365(a), (g).

In this case, the licensor, Tempnology, manufactured clothing and accessories designed to stay cool when used in exercise. Tempnology sold those products under the name “Coolcore” with related logos and labels. Tempnology entered into a license agreement with Mission Products, which granted, among other things, a non-exclusive license to use the Coolcore trademark in the United States and elsewhere. In 2015, less than a year before the license was to expire, Tempnology filed a petition for bankruptcy under Chapter 11 of the Bankruptcy Code. Tempnology exercised its option under section 365(a) to reject the license agreement, as it was still executory, and the Bankruptcy Court approved the rejection. The parties agreed that the rejection had two effects. First, Tempnology could stop performing under the license agreement, and second, Mission Products could assert a pre-bankruptcy petition claim for damages 2. 

Tempnology argued that its rejection of the license agreement also terminated the rights it previously granted Mission Products to use the Coolcore marks. Tempnology based its argument on a negative inference it drew from the fact that, over the years, Congress had adopted provisions in section 365 that allowed the other party in a rejected contract to continue exercising its contractual rights. Of particular relevance was section 365(n), which provides that if the licensor of certain intellectual property rights, such as patents, rejects the license, the licensee can continue to use the patented technology as long as it makes the payments required under the license. 11 U.S.C. §365(n).  Section 365(n) specifically excluded trademark licenses. See 11 U.S.C. §365(n). Tempnology argued that, because section 365(n) excludes trademark licenses, a negative inference should be drawn that Congress intended for trademark licenses to terminate upon rejection.

The Court rejected Tempnology’s arguments. In so doing, the Court first relied on the language in section 365(g), which provides that a rejection constitutes a breach. While a breaching debtor can stop performing its remaining obligations under the license, it cannot rescind the license. The Court went on to note that the section 365(n) provision allowing a licensee to continue using licensed intellectual property other than trademarks was a reaction to a Fourth Circuit decision – Lubrizol Enterprises v. Richmond Metal Finishers, 756 F.2d 1043 (4th Cir. 1985) – which held that a patent licensee’s rejection of an executory contract had the effect of revoking the grant of a patent license. The Court in Mission Products explained that “Congress’s repudiation of Lubrizol for patent contracts does not show any intent to ratify that decision’s approach for almost all others. Which is to say that no negative inference arises.” (emphasis in original).

The Court also rejected Tempnology’s arguments based on a trademark licensor’s duty to monitor and exercise quality control over licensed goods and services. Tempnology argued that if rejection does not terminate the license, the debtor-licensor is forced to choose between expending scarce resources on quality control, or forgoing expending such resources and thereby risking the loss of a valuable asset, presumably because use without quality control would lead to a naked license. The Court observed that these concerns, while possibly serious, “would allow the tail to wag the Doberman.” The Court explained that the ability to reject a contract under section 365 allows a debtor to escape its future contract obligations, but it does not exempt the debtor from all burdens that generally-applicable law, in this case the law on trademarks, imposes on the owner of the trademark.

Tempnology also argued that the case is moot because, it claimed, Mission Products could not recover damages.3The Court held that the case is not moot, as Mission Products would be able to recover damages. 

The Mission Products decision is important for several reasons.  First, it resolves the split that had developed between those courts holding that rejection results in a breach and those holding that rejection terminates the right to use a licensed mark. Second, resolving the split removes uncertainty faced by trademark licensors and licensees who are forced to consider what might happen if a licensor declares bankruptcy. Moreover, resolving this uncertainty avoids the need to use expensive and complex steps, such as placing licensed marks in a bankruptcy-remote entity, in order to avoid the effect of a licensor’s bankruptcy. 

[1] An executory contract refers to a contract that neither party has finished performing.[2] In its opinion, the Court noted that pre-petition creditors often receive only cents on the dollar of their bankruptcy claims.

[3]The lone dissent, by Justice Gorsuch, also argued mootness on the ground that the license had already expired by the time the bankruptcy court confirmed the rejection and declared that Mission Products could not use the mark.

© 2019 Brinks Gilson Lione. All Rights Reserved.

This post was written by David S. Fleming and Emily Kappers of Brinks Gilson Lione.

The Real Estate Problem of Retail

The retail sky is falling.  At least that is how it appears from recent and unprecedented number of retailers filing for bankruptcy. From iconic stores such as Sears and Toys ‘R’ Us, to department stores such as Bon Ton, to mall stores including Brookstone, The Rockport Company, Nine West, among others.  The reasons given for such filings vary as much as their products but one theme seems to be constant — the inability of retailers to maintain “brick and mortar” operating expenses in the era of online shopping.  Accordingly, it appears that what some retailers actually have is a real estate problem.

Another troubling theme of many retail filings is the use of bankruptcy courts to achieve a quick liquidation of the company, rather than a reorganization.  Chapter 11 filings over the past several years have shown a dramatic shift away from a process originally focused on giving a company a “fresh start” to one where bankruptcy courts are used for business liquidation.  The significant increase in retail Chapter 11 cases and the speed at which assets are sold in such cases is disturbing and provides a cautionary tale for developers and landlords alike.  Indeed, such parties need to be extremely diligent in protecting their rights during initial negotiations as well as when these cases are filed, starting from day one, lest they discover that their rights have been extinguished by the lightning speed of the sale process.

Recent statics suggest that the average time to complete a bankruptcy sale is only 45 days from the petition date.  Moreover, under the Bankruptcy Code, and arguably, best practices, the sale will close shortly after court approval thereby rendering any appeal likely moot.  This leaves little time for parties to protect their rights.

Bankruptcy Code Section 363(f) permits a debtor to sell property free and clear of interests in the property if certain conditions are met.  Unlike a traditional reorganization, which requires a more engaging process, including a disclosure statement containing “adequate information,” a sale under Section 363 is achieved by mere motion, even though it results in property interests being entirely wiped out.  Not only are property rights altered by motion, rather than by an adversary proceeding or a plan process, but these sale motions are being filed in retail cases as “first day motions” and concluded in as short as a month and half.

Even more alarming is that the notice accompanying such motions can be ambiguous as to how it will impact parties such as developers who have multiple interests in retail/multi-use properties.  Often, the reference to the developer and its property is buried in a 20+ page attachment in 8 point font, listed in an order only the debtor (or its professionals) understands.  If that was not concerning enough, these notices are being served by a third-party agent who may not have access to the most updated contact information necessary to ensure that non-debtors are actually receiving the notices in time to properly protect their rights.  It is not uncommon for these notices to be inaccurately addressed and not be received until after an order is entered; an order which will undoubtedly contain a provision that notice was proper.

Notably, despite Section 363(f)’s reference solely to “interests” (the group of things that an asset may be sold free and clear of), these sales are commonly referred to as sales free and clear of “claims and interests.”  Lacking an actual definition, courts have expansively interpreted “interests” to include “claims.”  Indeed, it is now the norm for bankruptcy courts to enter extensive findings of fact and conclusions of law supporting 363 sales that extinguish every imaginable potential claim (rather than merely “interests”).  While consistent with the overall spirit of the Bankruptcy Code to promote maximization of value through the alienability of property, it comes at the expense of those holding an interest in that property, such as a mall or shopping center developer.

Fortunately, there are certain well-accepted exceptions to the courts’ expansive application of “interest.”  Courts generally limit a debtor’s attempt to use Section 363 to strip off traditional in rem interests that run with the land.  When faced with such attempts, courts routinely constrain the interpretation of the statute to block the sale free and clear of an in rem interest.

The majority of state laws have long treated covenants, easements, and other in rem interests that are said to “run with the land” as property interests.  Although clearly falling within the common definition of “interests,” courts routinely hold them not to be strippable interests for purposes of a Section 363(f), as being so ingrained in the property itself that they cannot be severed from it, or, alternatively, that the in rem interests are not included in Section 363(f)’s use of the term “interests.”

The protection afforded to in rem interests should provide forward-thinking transactional attorneys with a valuable opportunity to insulate many rights and remedies for their developer clients.  A hypothetical real estate transaction is illustrative — consider a transaction in which a developer sells two parcels to a large retailer as part of a retail/mixed use shopping center and takes back a long-term ground lease for one of the parcels. There are a number of methods available to document this deal: a sale-leaseback agreement; a separate contract to convey in the future secured by a lien; entry into a partnership, joint venture, or similar agreement. When analyzed with respect to the risk of a potential retailer bankruptcy, these mechanisms are inferior to the use of a reciprocal easement agreement (“REA”) or similar devise that creates an in rem property interest that runs with the land in favor of the developer.

If traditional contractual methods are used, the documents run the risk of being construed as executory contracts in the retailer’s subsequent bankruptcy case, subject to rejection, leaving the developer with only a prepetition claim.  A lien in favor of the developer would only marginally improve its position, as any lien will likely be subordinated to the retailer’s development financing and therefore of little value.  But, based on the current state of the law, a non-severable REA or similar document recorded against the retailer’s property will not be stripped off the property absent consent or a bona fide dispute. Thus, rights incorporated into a properly drafted and recorded REA provide the developer with a level of “bankruptcy-proofing” against a potential future retailer bankruptcy. Further, as REAs in mixed-use developments are the norm in the industry, they are likely to be accepted, if not embraced, by the retailer’s construction lender, making their adoption that much more likely.

The lesson is be forward thinking and be diligent.

© Copyright 2019 Squire Patton Boggs (US) LLP.

Are You Ready for the Next Downturn? Ninth Circuit “Cramdown” Cases Affecting Real Estate Lenders

Plan Approval in a Multi-Debtor, Single-Plan Context

In In re Transwest Resort Properties, Inc., the Ninth Circuit addressed the Chapter 11 reorganization plan approval process where a single plan was proposed for multiple affiliated debtor entities whose cases were being administered jointly. Generally, for “cramdown” plans, the Bankruptcy Code requires that at least one class of impaired creditors vote in favor of a plan for it to be approved. In Transwest, a mezzanine lender who was the sole creditor for two of the five debtor entities and whose loan would be extinguished under the single, jointly administered plan, argued that impaired class approval had to occur on a per debtor basis, and that since it was the only impaired class member for two of the debtors, its votes against the plan in those debtor cases barred confirmation (as there were no impaired classes of creditors in those cases voting in favor of the plan). The bankruptcy court, the district court, and the Ninth Circuit rejected that position, holding instead that impaired class approval applied on a per plan basis, and that the votes of the impaired class of creditors of the other three debtors established consent from an impaired class across all debtors, and supported plan confirmation. The Ninth Circuit is the first circuit-level court to address this issue, and the lower bankruptcy courts remain split on the issue.

Potential Impact

Lenders, particularly mezzanine lenders, who lend to one or more isolated borrowing entities within a corporate group of debtor entities may not have the voting control in the plan confirmation process they assume exists to block “cramdown”, and should factor that reality into their risk assessments.

“Cramdown” Value = Replacement Value (even if it’s less than foreclosure value)

In In re Sunnyslope Housing Limited Partnership, the Ninth Circuit, in an en banc opinion, addressed how a secured creditor’s interest should be valued in the context of a “cramdown,” i.e. where the debtor seeks to retain and use creditor’s collateral in the reorganization plan and the value of that collateral is to be determined based on the proposed use of the property. Valuation of the property in the “cramdown” context was critical to how much the secured creditor would recover under the proposed plan, given that amount of its secured claim would be determined by the value of the property. The Sunnyslope case presented a highly unusual circumstance where the foreclosure value of the apartment complex collateral was significantly higher than its replacement or use value due to the existence of low-income housing covenants that would be extinguished in a prospective foreclosure.

Despite the higher foreclosure value supported by the secured creditor, the Ninth Circuit affirmed application of the replacement value standard for determining the secured creditor’s present value of its claim under the plan. In doing so, the Ninth Circuit affirmed prior precedent holding that only a property’s replacement value – to be determined in light of its “proposed disposition or use” – could be utilized for determining the amount of a secured claim in the cramdown context. In applying its replacement value standard in Sunnyslope, the Ninth Circuit confirmed that the highest and best use of collateral may not dictate the value of a creditor’s secured claim, even where the replacement value, as determined by the collateral’s anticipated use or disposition, is lower than its foreclosure value.

Potential Impact

Lenders facing a potential “cramdown” of its secured claim, based on present value of its claim against real property, should carefully analyze the potential difference between a property’s foreclosure value and its replacement value and adjust expectations accordingly.

© 2010-2018 Allen Matkins Leck Gamble Mallory & Natsis LLP

This post was written by Michael R. Farrell of Allen Matkins Leck Gamble Mallory & Natsis LLP.

University Wins Important Tuition Claw-Back Case

A federal bankruptcy court in Connecticut recently ruled in favor of Johnson & Wales University in a tuition claw-back case. Roumeliotis v. Johnson & Wales University (In re DeMauro), 2018 WL 3064231 (Bankr. D. Conn. June 19, 2018). Wiggin and Dana attorneys Aaron Bayer, Benjamin Daniels, and Sharyn Zuch had filed an amicus curiae brief in support of the University on behalf of the Connecticut Conference of Independent Colleges, the Association of Independent Colleges & Universities of Massachusetts, and the Association of Independent Colleges & Universities of Rhode Island.

The federal bankruptcy trustee in Roumeliotis sought to force the University to disgorge tuition payments that the parent-debtors had paid on behalf of their daughter. The trustee claimed that the payments were fraudulent transfers because the parents were insolvent at the time, and because the trustee believed that parents do not receive value when they pay for their adult children’s education. The trustee argued that the tuition should be returned to the debtors’ estate and be available for distribution to the parents’ creditors – even though the University was unaware of the parents’ financial circumstances when it received the payments and had long since provided the educational services to the daughter.

The bankruptcy court granted summary judgment dismissing the claim, finding that the tuition was never part of the parents’ assets. The decision turned, in large part, on the precise nature of the tuition payments at issue. The parents had used federal Direct PLUS Loans to pay the tuition. However, under that program, the proceeds of the loan were paid directly to the University and never held by the parents. Therefore, the loans were never technically the parents’ assets and never were held by the parents. To hold otherwise, the court concluded, would conflict with and undermine the purposes of the Direct PLUS Loan program. The trustee has not taken an appeal.

You can find the Bankruptcy Court decision here.  You can find the amicus brief here.

We continue to await a decision by the First Circuit in another very significant tuition claw-back case, DeGiacomo v. Sacred Heart University (In re Palladino), No. 17-1334 (1st Cir.). In that case, the Court is expected to rule on the question whether parents received “reasonably equivalent value” for tuition payments they made on behalf of their child. The bankruptcy trustee claims that they did not, because the child and not the parents received the education, and seeks to recover the tuition payments from the University.

© 1998-2018 Wiggin and Dana LLP

This post was written by Aaron Bayer and Benjamin Daniels of Wiggin and Dana LLP.

The Tail of a Dog with Two Hats: Fifth Circuit Upholds “Golden Share” Held by Creditor Affiliate

On May 22, 2018, the United States Court of Appeals for the Fifth Circuit issued its decision in Franchise Services of North America v. United States Trustees (In re Franchise Services of North America), 2018 U.S. App. LEXIS 13332 (5th Cir. May 22, 2018). That decision affirms the lower court’s holding that a “golden share” is valid and necessary to filing when held by a true investor, even if such investor is controlled by a creditor.

The backdrop of mergers and acquisitions leading up to this case need not be retold in detail to understand the holding’s significance, but some context is helpful. Franchise Services of North America, Inc. (“FSNA”), one of North America’s largest car rental companies, filed for chapter 11 bankruptcy without the required consent of its sole holder of preferred stock, Boketo, LLC (“Boketo”). Boketo was a minority shareholder that had invested $15 million in FSNA  making it FSNA’s single largest investor. Boketo is a wholly-owned subsidiary of investment bank Macquarie Capital (U.S.A.) (“Macquarie”), an unsecured creditor of FSNA’s by virtue of an alleged $3 million claim for fees incurred in connection with the aforementioned transactions. When Boketo invested $15 million in FSNA, it required FSNA to re-incorporate in Delaware and add a “golden share” provision to its corporate documents, i.e. Boketo’s affirmative vote of its preferred share was required for certain corporate events, such as filing bankruptcy. Nonetheless, FSNA eventually filed for chapter 11 in the Southern District of Mississippi without seeking Boketo’s consent, fearing that shareholder Boketo—controlled by creditor Macquarie—would not consent to filing.

Macquarie and Boketo filed motions to dismiss the case for a lack of corporate authority under FSNA’s amended corporate charter. In doing so, Macquarie donned two hats—that of a shareholder through Boketo and that of an unsecured creditor with a $3 million claim. FSNA asserted that Macquarie used Boketo as a “wolf in a sheep’s clothing” to equip a creditor with shareholders’ blocking rights under an allegedly unenforceable “blocking provision” or “golden share.” FSNA implied the tail had been wagging the dog—that Macquarie made the $15 million investment through Boketo to avoid the cost and inconvenience of trying to collect some portion of its $3 million claim in FSNA’s bankruptcy. The bankruptcy court denied Macquarie’s motion because case law and public policy forbid a creditor from preventing a debtor’s bankruptcy filing. However, it granted Boketo’s motion, given its status as a voting shareholder. The Fifth Circuit affirmed, and found FSNA’s theory that Macquarie chased $3 million with $15 million “strain[ed] credulity.”

FSNA’s various legal arguments each fell flat. First, FSNA sought a ruling that “blocking provisions” or “golden shares” (similar, but not identical, concepts), in general, are unenforceable under Delaware law. The Fifth Circuit declined to offer such an advisory opinion. Second, FSNA contended that even if Delaware law allowed these types of provisions, federal policy forbids them. This, too, failed to move the court, since the corporate charter did not eliminate FSNA’s ability to file bankruptcy. Instead, it specified which parties’ consent was necessary to authorize a bankruptcy filing, placing the decision with shareholders. Third, because authority to file bankruptcy is a matter of state law, FSNA argued that Boketo could not exercise its blocking right under Delaware law, and that Boketo had owed a fiduciary duty to facilitate the filing. The Fifth Circuit held that Delaware law, flexible by nature, allows a corporate charter to assign rights to shareholders that would ordinarily be assigned to directors/management, but declined to go so far as to determine whether such provision was valid under Delaware law. In addition, the court refuted FSNA’s fiduciary duty argument because only controlling minority shareholders owe fiduciary duties, and here, Boketo was a non-controlling minority shareholder. The court explained that the standard for minority control is a “steep one,” and that courts focus on control of the board—i.e., whether the minority shareholder can exert actual control over the company. While Boketo made a sizeable investment in FSNA, it only had the right to appoint 2 out of 5 directors and therefore could not exert actual control over the board. FSNA pointed to Boketo’s hypothetical ability to prevent bankruptcy as evidence of actual control, but the court distinguished such theoretical control from actual exertion thereof. The court keenly noted that FSNA defeated its own control argument when it filed bankruptcy without Boketo’s consent—if Boketo was a controlling shareholder, then once again the tail must have been wagging the dog.

Franchise Services highlights the potential for a creditor to essentially step into a shareholder’s shoes and assert shareholder rights pursuant to a corporate charter’s blocking provision or “golden share” by virtue of wearing two hats through a parent and subsidiary.

© 2018 Bracewell LLP.

This post was written by Logan Kotler and Jason G. Cohen of Bracewell LLP.

Supreme Court Bars Structured Dismissals of Bankruptcy Cases That Violate the Code’s Priority Distribution Scheme – Could it Affect Your Creditor Position?

supreme court structured dismissalsOn March 22, 2017 the Supreme Court issued its long-awaited ruling regarding the legality of structured dismissals of Chapter 11 bankruptcy cases that would make final distributions of estate assets to creditors in a manner that deviates from the Bankruptcy Code’s statutory priority distribution scheme.1 In Czyzewski v. Jevic Holding Corp., the Court held that such a structured dismissal was forbidden, absent the consent of the negatively affected parties. However, the Court did not bar all distributions of estate assets which violate the priority distribution scheme, suggesting that interim distributions that serve a broader Code objective such as enhancing the chances of a successful reorganization might be allowed, meaning that important bankruptcy tools like critical vendor orders and first-day employee wage orders are still viable.

In Jevic, the debtor was taken over by an investor in a leveraged buy-out (“LBO”), with money borrowed from a bank. The LBO added a significant and ultimately unsustainable level of the debt to the company. Shortly before the bankruptcy, Jevic ceased operations and fired all of its employees. A group of those laid-off employees (the truck drivers) filed a lawsuit against Jevic and the investor for violations of the federal WARN Act.2 The employees prevailed in the WARN Act litigation against Jevic and obtained a $12.4 million judgment, $8.3 million of which was entitled to priority status in Jevic’s bankruptcy case because it was for wages. As the holders of a priority claim, the truck drivers were entitled to be paid before any of the general unsecured creditors in the Jevic bankruptcy. The employees also had a WARN Act claim pending against the investor, the acquirer in the LBO. During the bankruptcy, the unsecured creditors’ committee sued the investor and the bank for fraudulent transfer claims arising from the LBO. While those cases were pending, and during the bankruptcy, several constituencies attempted to negotiate a resolution to the case with a plan of reorganization, but that effort failed. Ultimately everyone but the truck drivers agreed to a settlement regarding the fraudulent transfer claims and distribution of estate property and a structured dismissal of the bankruptcy case.3 The settlement excluded the truck drivers from any recovery, but did provide some recovery to consenting lower-priority unsecured creditors.

The truck drivers and the United States Trustee objected to the structured dismissal since it deviated from the Code’s priority rules. However the Bankruptcy Court approved it, and was affirmed by both the District Court and the Third Circuit Court of Appeals. Those courts reasoned that under the settlement and structured dismissal, there would be at least some recovery to some priority and general unsecured creditors—even if not to the bypassed truck drivers—whereas otherwise no one but the secured creditor would get anything.. The truck drivers could not really complain, those courts concluded, because they would have gotten nothing regardless. Furthermore, those courts did not believe that the absolute priority rule applied to a dismissal.

The Supreme Court, however, reversed the Third Circuit Court of Appeals, and concluded that in a final distribution of estate assets, by whatever mechanism, the Code’s priority rules must be respected, absent the consent of adversely affected parties.

However, the Court narrowly tailored its ruling, stating that strict compliance with the priority rules is only required in a final distribution of estate assets upon the conclusion of the bankruptcy case, whether via liquidation, plan confirmation, sale of assets, or dismissal. The Court noted that during a reorganization case, bankruptcy courts routinely approve interim distributions of estate assets in ways that violate the priority distribution scheme. For example, in almost every chapter 11 case, debtors seek the ability to pay their employees for pre-petition wages that are accrued but unpaid on the petition date. In some cases, debtors also seek critical vendor orders that allow them to pay certain key suppliers the pre-petition amounts due so that those suppliers will continue to ship goods or provide services during the bankruptcy case. The Court distinguished these interim priority-violating distributions from the one at issue in Jevic because the interim distributions served the goal of the bankruptcy system: the rehabilitation of debtors. Priority-violating final distributions made pursuant to structured dismissals do not serve that goal.

Jevic’s ruling will drastically curtail the growing trend of structured dismissals, eliminating some wiggle room bankruptcy stakeholders had in fashioning a resolution to a case outside a plan of reorganization. No longer can recalcitrant groups of creditors be threatened with being squeezed out of any distribution if they won’t cave in and agree to play ball; they can insist on their priority rights. However, the ruling still preserves the flexibility that has developed in chapter 11 cases to allow debtors to attempt to reorganize their business and protect parties that are willing to work with debtors during the bankruptcy.

ARTICLE BY Tamar N. Dolcourt & Gjina Lucaj of Foley & Lardner LLP
© 2017 Foley & Lardner LLP

1 Czyzewski v. Jevic Holding Corp., 580 U.S. ___ (2017); 2017 WL 1066259.

2 The WARN Act is the Worker Adjustment and Retraining Notification Act. Among other things, the WARN Act requires companies to give workers facing a mass layoff at least 60 days’ notice of the layoff, or pay their wages for the 60 day period. 29 U.S.C. 2102.

3 The truck drivers were excluded because they would not agree to drop their WARN Act claims against the investor, who was a party to the settlement.

Payless Expected to File for Bankruptcy in Next Few Weeks

payless bankruptcyAs I mentioned in my article from January, “11 Retailers to Watch for Possible Bankruptcy Filings in 2017,” it looks like Payless is on the verge of a bankruptcy filing.

Bloomberg reports that Kansas-based Payless, Inc. may be filing for bankruptcy protection as early as next week. The retail discount shoe chain has more than 4,000 stores in 30 countries. Speculation is that they will close about 10 to 15% of the stores as it reorganizes.

The company has had difficulties in the increasingly competitive online market. Last year the company attempted to increase revenue with a new master plan for opening more Payless Super Stores with a larger footprint, more in-stock footwear, and heightened shopping experience, according to Footwear News.

The company has about $665 million in debt, according to Reuters. In February, Moody’s downgraded the company debt rating, stating the company shown “weaker than anticipated operating performance.”

With the number stores, a Payless bankruptcy can raise questions for many landlords. If you are a landlord with a Payless it is important to know your rights, now.

ARTICLE BY Thomas S. Onder of Stark & Stark

COPYRIGHT © 2017, STARK & STARK

Bankruptcy News: Gander Mountain Shooting for Chapter 11 Bankruptcy

Gander Mountain Chapter 11 BankruptcyReuters reports Gander Mountain, the St. Paul based hunting and fishing chain, is preparing to file for bankruptcy. The bankruptcy is reportedly due to aggressive expansion that failed to draw new customers. Gander Mountain is known as America’s firearms superstore.

Gander has faced stiff competition from Bass Pro Shops, Cabela’s, and Dick’s Sporting Goods.

Currently, Gander Mountain has about 160 stores, with about 60 new stores opened or announced since 2012. According to Reuters, the company has a $30 million loan and revolving credit lines for $25 million and $500 million.

If Gander Mountain files, it will be the fifth outdoor retailer to file for bankruptcy in the last year. Others include Sports Chalet, Sports Authority, EMS, and Eastern Outfitters.

ARTICLE BY Thomas S. Onder of Stark & Stark

COPYRIGHT © 2017, STARK & STARK

The Road Ahead for 2017 – Restructuring & Insolvency in Australia

insolvency Australia Road to 2017It is anticipated that, by the middle of the year, Australia will see the most significant reform to the corporate and personal insolvency environment in two decades. The reforms, which appear likely to be supported by all sides of government, are designed to promote business preservation and allow greater flexibility in order to ‘turnaround’ distressed companies.

In 2014 the process of reform began with the Australian Productivity Commission’s release of an Issues Paper and subsequent Report on Business Set-Up, Transfer and Closure. In December 2015 the draft Insolvency Law Reform Bill (the Bill) was released.

The perception among the business community is that the existing insolvency landscape stifled entrepreneurship and forced distressed companies into insolvency at the expense of restructuring. While some commentators lament the missed opportunity to go further and adopt more comprehensive reforms, consensus is that the new legislation will resolve some of the market’s biggest concerns and will encourage a turnaround culture. It is also likely to generate increased interest in the domestic distressed debt market.

Key elements of the Insolvency Law Reform Act 2016 include:

  1. Reduction of the bankruptcy period from three to one year
  2. Introduction of a ‘safe harbour’ defence for directors. Directors will avoid personal liability for insolvent trading if they appoint an adviser to assist with business turnaround.
  3. Unenforceability of certain ipso facto clauses. The proposed new laws will prevent a party from terminating a contract based solely on an insolvency event. Certain contracts such as prescribed financial contracts may be excluded from this restriction.

One of the Productivity Commission’s more controversial recommendations (and which did not make it into the draft Bill) is the introduction of a duty of receivers “to not cause unnecessary harm to the interests of creditors as a whole.” This and other more substantive reforms will be subject to further consultation as the Government has committed to another review. The passage of the Bill will meanwhile continue to shine a spotlight on the more substantive reforms proposed.

In addition to the commencement of the Insolvency Law Reform Act 2016, certain class action proceedings in the Federal Court of Australia are likely to intensify in 2017 in the lead up to a hearing on common issues in 2018. Squire Patton Boggs advises the applicants and most group members in seven class action proceedings that have arisen out of the rating of several structured financial products by Standard & Poor’s (S&P) and Fitch Ratings (Fitch). These follow a successful settlement reached in similar proceedings against S&P, following a landmark win in the main proceedings and a further appeal to the Full Federal Court.

The majority of the claims in these proceedings arose following the global financial crisis and the collapse of underlying reference entities including Fanny Mae and/or the swap counterparty Lehman Brothers Australia (in liquidation) (LBA). As a large number of Australian organisations held these products, a number of insolvencies resulted from their collapse in value and/or wipe out and Squire Patton Boggs has acted for creditors of LBA in the insolvency proceedings that ensued to recover money for creditors with these claims.

The products that are the subject of these proceedings include a constant proportion portfolio insurance (CPPI) and synthetic collateralised debt obligations (SCDOs) which were assigned credit ratings by S&P or Fitch. The applicants allege that the ratings agencies were negligent and engaged in misleading and deceptive conduct in assigning high ratings to these products. They contend that had the products not received such high ratings, they would not have invested. S&P and Fitch deny these allegations.

These proceedings have had and will continue to have widespread domestic and international significance due to the number of structured financial products that were sold around the world and were rated by the large ratings agencies using similar methodology. Actions against S&P have been filed in other jurisdictions, including by European institutional investors in Amsterdam, setting a global trend that is likely to continue into 2017. This trend involves ensuring the accountability of credit rating agencies in their assignment of ratings to complex financial products, especially in areas where regulators have as yet failed to achieve similar outcomes. As a result, the continuing progress of these class actions in 2017 is likely to produce lasting implications, in particular further consideration as to the regulation of credit rating agencies.

Continue watching this blog throughout the year to come for updates about these and other topics from our offices across Australia, EU and Europe, UK and US.

ARTICLE BY Amanda Banton of Squire Patton Boggs (US) LLP

© Copyright 2017 Squire Patton Boggs (US) LLP