A View From The Bench And Bar: A Discussion Of Current Hot...

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A View From The Bench And Bar: A Discussion Of Current Hot Bankruptcy

Issues Facing Trade Creditors And The Future Of Chapter 11 Following

BAPCPA’S 10TH

Anniversary

Speakers: Honorable Laurel Davis,

UNITED STATES

BANKRUPTCY JUDGE, DISTRICT OF NEVADA

Wanda Borges, Esq.BORGES & ASSOCIATES, LLC

Bruce S. Nathan, Esq.LOWENSTEIN SANDLER

LLP

Date: June 14, 2016

Time: 2:00 pm – 5:00 pm

Session Number: 25056

BORGES & ASSOCIATES, LLC

Section 503(b)(9) “20 Day” Administrative Priority Claims

1

• Administrative Claim for the Value of Goods Debtor Received Within 20 Days of Bankruptcy Filing

• 20 Day Goods Must be Sold to the Debtor in the Ordinary Course of Debtor’s Business

• Safety Net for Trade Creditors that Supply Goods Not Services!

– Replaces reclamation as effective trade creditor remedy


How To Assert “20 Day” Goods Administrative Claims And Timing Of Payment?

2

• General Rule – Section 503(b)(9) Requests/Allowance Require Notice and a Hearing

– No automatic administrative claim without court approval; cannot just file a proof of claim form (subject to the below caveats)

• No Uniform Rule Specifying Manner In Which To Assert Section 503(b)(9) Priority Claims

• No Deadline to Assert Section 503(b)(9) Claim in Statute

– Local Bankruptcy Rules May Create Deadline

• Timing of Payment - Most Courts Have Rejected Immediate Payment Over Debtor’s Objection


Court-Approved Provisions re Assertion Of “20 day” Priority Claims

3

• Courts Are Setting Deadlines for Asserting Section 503(b)(9) Priority Claims

• Deadline Set to Assert (1) All Claims, Including Section 503(b)(9) Claims or (2) Solely Section 503(b)(9) Claims

– Allows for assertion of Section 503(b)(9) priority claim either

• (1) on the same claim form as the creditor’s general unsecured claim, or

• (2) on a special proof of claim form solely related to Section 503(b)(9) claims


One Of Section 503(b)(9)’s Litigated Issues: Meaning Of Receipt Of Goods

4

• Section 503(b)(9) does not define “Receipt”

• Actual Possession (UCC)?

– UCC-2(103)(1)(c)

• “Receipt of goods means taking physical possession of them”

• Constructive Possession Through Receipt of Goods by Third Party


One Of Section 503(b)(9)’s Litigated Issues: Meaning Of Receipt Of Goods

5

• Drop Shipment?

– Creditor ships goods to third party at Debtor’s instruction

• Debtor’s agent

• Debtor’s customer

– Debtor lacks actual physical possession of goods


Receipt Of Goods: Drop Shipment

6

• In re Plastech Engineered Products, Inc.; Drop Ship Case

– Section 503(b)(9) requires that a Debtor receive the goods and not just the value of such goods

– Court did not decide whether receipt includes Debtor ’s “constructive receipt” of goods through receipt by third party

– Parties subsequently settled on terms favorable to seller



7

• In re Momenta, Inc. – U.S. District Court New Hampshire affirming U.S. Bankruptcy Court Decision–

– Receipt includes buyer’s physical or constructive possession of goods

– Buyer does not obtain constructive possession of goods that are delivered to buyer’s customer under drop shipment arrangement

– Constructive possession narrowly interpreted to occur upon proof of receipt of goods by buyer’s agent

– Adopted Black’s Law Dictionary definition of “drop shipment delivery” as a “manufacturer’s shipment of goods directly to the consumer rather than initially to a wholesaler”



8

• In re World Imports – U.S. Bankruptcy Court, Eastern District of Pennsylvania

– Creditor “drop shipped” goods to debtor’s customers

– Followed Momenta decision in holding that debtor did not receive drop shipped goods

– Creditor’s section 503(b)(9) priority claim for drop shipped goods denied



9

• Can “Receipt” Be Defined in Parties’ Agreement to Occur Upon Buyer’s Customer’s Receipt of the Goods?

• Suggested Language: “Receipt of any product by buyer shall immediately occur when buyer, buyer’s bailee or other agent or designee receives either actual or constructive possession of such product. Constructive possession shall include, without limitation, receipt by an entity or individual (including, without limitation, buyer's customer) pursuant to a drop ship instruction or other delivery instructions from buyer. Constructive possession specifically does not require actual possession by the buyer.”


Is There A Different Meaning For Receipt Re International Sales?

10

• In re World Imports, Ltd. – District Court, Eastern District of Pennsylvania – 2016 Decision

• Court Held Receipt Occurs When Goods Are Loaded On Carrier

• Court Relied on

– CISG – Convention on Contracts for International Sale of Goods

– Incoterms

• One of Incoterms is FOB – Free on Board


Is There A Different Meaning For Receipt Re Goods Shipped From Abroad?

11

• Court Held Buyer Received Goods When They Were Loaded on the Carrier More than 20 Days Before Bankruptcy Filing Based on FOB Port of Origin Terms

• Court Relied on Definition of FOB– “means that the seller delivers the goods on board the vessel

nominated by the buyer at the named port of shipment or procures the goods already so delivered. The risk of loss of or damage to

the goods passes when the goods are on board the vessel, and the buyer bears all costs from that moment onwards.”

• Once Seller Delivers the Goods, Risk of Loss or Damage Passes to Buyer and Buyer Has Constructively Received the Goods


Another Litigated Issue: Debtor’s Setoff Rights As A Defense To Section 503(b)(9) Priority Claims

12

• Chapter 11 Debtors Have Successfully Offset Pre-Petition Credits, Deductions, Chargebacks, Overpayments, Rebates, and Similar Claims Against a Creditor First In Reduction of the Amount Owing to Creditors on their More Valuable Section 503(b)(9) Priority Claims Instead of their Less Valuable General Unsecured Claims


Debtor’s Setoff Rights As A Defense To Section 503(b)(9) Priority Claims

13

• Circuit City Stores (Eastern District of Virginia) and

very recent AWI (District of Delaware) Decisions

– Debtor permitted to setoff pre-petition credits claims in reduction of Section 503(b)(9) priority claims

– The courts invoked a little known Bankruptcy Code Section 558:

• “The estate shall have the benefit of any defense available to the debtor…”

– The Debtor could offset pre-petition credits claims against creditors’ unpaid post-petition administrative claims — VERY DANGEROUS!

BORGES & ASSOCIATES, LLC 14

• Proposed Contractual Fixes

– “Buyer waives right to assert pre-petition credits, deductions, chargebacks, overpayments, rebates and similar claims if buyer is “not in good standing” with Seller (i.e., Buyer is past due or otherwise in default; out of business)”

– “Buyer waives the right to assert any right of setoff, recoupment or any other defense with respect to any credits, deductions, chargebacks, overpayments, rebates and similar claims that Seller owes Buyer to reduce Buyer’s indebtedness to Seller”



• Proposed Contractual Fixes (continued)– “Seller shall be permitted to apply all credits, deductions,

chargebacks, overpayments, rebates and similar claims owed to the Buyer in reduction of indebtedness owing by the Buyer to Seller as determined by Seller at its sole discretion.” [e.g., apply credits against oldest invoices first]

– Enforceability of proposed provisions on screens 14 and 15 in bankruptcy?

• Note following caveat in AWI opinion:

“…I conclude that there is a presumption that the claimants’ prior course of dealing, industry standards and contract do not operate as a waiver of the Debtors’ equitable remedies. However, if a claimant believes that its course of dealing or contractual language provide a good faith basis for arguing that the Debtors have waived their equitable remedies, then the claimant shall have the right to a hearing on the merits of their claim to rebut the presumption.”



Another Litigated Issue: Preference Claim As a Defense to Administrative Claim

16

• Is a Preference Claim Grounds For Disallowing An Administrative Claim?

• Majority View: Administrative Claim Not Subject to Disallowance Based on Preference Risk

– Ames Department Stores – U.S. 2d Circuit Court of Appeals• Did not address Section 503(b)(9) priority claims

– Delaware: In re CM Holdings and In re Lids Corporation

• Contrary Minority View: Administrative Claims Subject to Disallowance Based on Preference Exposure

– In re MicroAge – 9th Circuit Bankruptcy Appellate Panel• Did not address Section 503(b)(9) priority claims


• Preference Claim Not Grounds for Disallowance of Section 503(b)(9) Priority Claim– In re Energy Conversion Devices, Inc. and Plastech Engineered

Products, Inc. – Bankruptcy Eastern District of Michigan decisions

– In re TI Acquisition LLC – U.S. Bankruptcy Court, Northern District of Georgia

– In re Momenta, Inc. – U.S. Bankruptcy Court, New Hampshire

• Contrary View: Debtor could assert preference claim as basis for temporarily disallowing Section 503(b)(9) priority claim– In re Circuit City – U.S. Bankruptcy Court, Eastern District,

Virginia

Another Litigated Issue: Preference Claim As a Defense to Section 503(b)(9) Administrative Priority Claim


Preference: Elements Of Claim

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• Any Transfer of an Interest of the Debtor in Property;

• To or for the Benefit of a Creditor;

• For or on Account of an Antecedent Debt Owed by the Debtor Before Such Transfer Was Made;

• Made While the Debtor was Insolvent;– On or within 90 days before bankruptcy filing; or

– Between 90 days and one year before bankruptcy filing for transfers to insider creditors; and

• That Enables Such Creditor to Receive More Than Such Creditor Would Receive if: – The case were a Chapter 7 case

– The transfer had not been made

– Such creditor received payment to the extent provided by other provisions of Title 11

– The greater than liquidation recovery requirement


Preference Elements

19

• Any Transfer of an Interest of the Debtor in Property;

– Trust Funds not property of estate

• Tracing obligation?


TRANSVANTAGE SOLUTIONS, INC.Delaware Bankruptcy Court

• Trustee Sued More Than 500 Companies, Mainly Transportation Carriers For a Combined Total of Almost $1/2 Billion

• Suits Were Brought Under Three Statutes

– 11 USC 547 for preference recoveries

– 11 USC 548 for fraudulent transfers under the Bankruptcy Code

– New Jersey State Statute for fraudulent transfers

• Resulted in substantially higher claims because the claw back period was extended from 2 years to 4 years

20


Transvantage Current Activity

• Defendants Joined in a Motion to Dismiss the Complaint on Multiple Grounds

• Most Cases Have Been Settled For a Very Small Percentage of the Original Claimed Amount

– Most recent round of settlements is 2%

• Only a Handful of Defendants Remain Who Refuse to Settle on Principle

– Oral argument is set for June 21st

21


Transvantage Bases For Dismissal Motion

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• Property Received By Carriers Was Not Property of the Estate

• Carriers are Trust Beneficiaries

• Claims are Preempted and Time-Barred Under Federal Law


Preference Elements – Greater Than Liquidation Recovery Requirement

23

• Creditor Whose Executory Contract Was Assumed by Debtor or Assigned by Debtor Is Not Subject to Preference Risk

– Caution – Trustee may still assert a preference • Quebecor

• NewPage


Preference Defenses: New Value

24

• Creditor Extending Unsecured Credit to Debtor AfterPayment Not Paid by Otherwise Unavoidable Transfer

• New Value Cannot Be Applied to Subsequent Payments

• Paid New Value –

– Courts are divided on applicability

– Recent Delaware decision – AFA Investment –paid new value counts

– Recent Delaware decision – AE Liquidation, Inc. –post-petition new value does not count


Hot New Value Issue: Critical Vendor

25

• Does Critical Vendor’s Receipt of Post-Petition Payment of Pre-Petition Claim Result in Loss of Section 547(c)(4) New Value Defense to Preference Claim?

– Yes and No!

– U.S. Court of Appeals 3rd Circuit Decision – In re Friedman’s counts new value paid post-petition pursuant to court order because new value is determined as of bankruptcy filing date

– Other courts have disqualified new value paid post-petition

– Suggestion: Critical vendor order should either release preference claims against vendor or preserve new value defense


Ordinary Course Of Business Preference Defense

26

• Transfer Was in Payment of a Debt Incurred by the Debtor in the Ordinary Course of Business or Financial Affairs of the Debtor and the Creditor; and

• Subjective Test – Made in the Ordinary Course of Business or Financial Affairs of the Debtor and the Creditor; OR

• Objective Test – Made According to Ordinary Business Terms

• Creditor Can Choose Most Beneficial (Subjective or Objective) Prong of Ordinary Course of Business Defense


• Range of Views– How long of a payment history?

• 1 Year?

• 2 Years? U.S. Bankruptcy Court, Southern District, New York decision: Quebecor World

• Longer?

Ordinary Course of Business: Subjective – Litigated Issues


• Range of Payments

– All payments? [American Home Mortgage Bankruptcy Court decision in Delaware]

– Modified range? [Philadelphia Newspapers Bankruptcy Court decision in Eastern District, Pennsylvania]

– Payments only when Debtor is healthy? [Circuit CityBankruptcy Court decision in Eastern District, Virginia]

• Bucket Analysis – Examining Payments by Grouping –Accepted – Quebecor World, U.S. Bankruptcy Court, Southern District of New York

– Risk of skewed analysis

Ordinary Course of Business: Subjective – Baseline for Comparing Preference vs. Prior Payments


• Comparison of Average Days to Pay/Days Late Prior to and During Preference Period

• Archway Cookies Bankruptcy and District Court decisions in Delaware –– Payments subject to subjective ordinary course defense,

notwithstanding approximately 5 day difference in average days to payment during historical period (42.3 days) compared to preference period (47.2 days)

• Quebecor World, U.S. Bankruptcy Court, Southern District of New York -– 30 days off average [27.56 average days outstanding prior

to preference period vs. 57.16 average days outstanding during preference period] too much

Ordinary Course of Business: Subjective – Baseline for Comparing Preference vs. Prior Payments


• Summary Judgment Dismissing Preference Complaint Based on Subjective Ordinary Course Defense

• Okayed 16 Month Payment History Prior To Preference Period

• Okayed 7 Day Difference in Average Days to Pay [61 Days Prior to Preference Period vs. 54 Days During Preference Period] When Including All Historical Payments Prior To Preference Period

• Court Rejected Trustee’s Weighted Average Analysis Showing 79 Days Prior To Preference Period vs. 60.6 Days During Preference Period

– Contrary view: In re Sparrer Sausage Co. – Bankruptcy, Northern District Illinois relied on weighted average days to payment

Recent Ordinary Course of Business Defense –Subjective Component Decision: In re Conex Holdings LLC Bankruptcy Court Delaware


• Relied on 16 Month Historical Payment Period When Debtor Had Adequate Capital – Average days to pay – 14.6 days

• Average Days to Pay During Preference Period –22.5 Days – Almost 50% increase – Did Not Support Subjective Ordinary Course Defense

• Court Did not Consider Additional 8 Month Payment History Immediately Prior to the Preference Period – Average Days to Pay Increased to Approximately 112 Days

• Court Limited Historical Payment Period to When Debtor was Adequately Capitalized

• Shades of Circuit City?

Recent Ordinary Course of Business Defense –Subjective Component Decision: Candy Fleet LLC v. Goodman, United States District Court, Western District Louisiana


• Summary Judgment Dismissing Preference Claim Based on Subjective Ordinary Course Defense

• Length of Time Parties Did Business– 2 years prior to preference period (rejecting 1 year period)

– Period could vary by case

• Consistency of Timing of Payments – Preference vs Prior Payments– Days to pay from invoice date

– Preference Payment – 26 days from invoice date consistent with 35.43 average days to pay prior to the preference period

Recent Ordinary Course of Business Defense –Subjective Component Decision: In re Affiliated Foods Southwest Inc. (U.S. 8th Circuit Court of Appeals)


• Defendant Proved Subjective Ordinary Course of Business Defense After Trial

– Did not matter that debtor paid invoices 27.9 days faster during preference period

• Average days-to-pay prior to preference period was 55.22 days

• Average days-to-pay during preference period was 27.3 days

Very Recent Ordinary Course of Business Defense –Subjective Component Decision: In re Sierra Concrete Design Inc.; United States Bankruptcy Court, Delaware


• Defendant Did Not Prove Subjective Ordinary Course of Business Defense on Summary Judgment Motion based on expert testimony

– Average days-to-pay prior to preference period was 22.43 days

– Average days-to-pay during preference period was 43.95 days

– Court found for the Debtors because payments during preference period were made twice as late as pre-preference period payments

– The Court awarded pre-judgment interest to Debtors

Very Recent Ordinary Course of Business Defense –Subjective Component Decision: In re AFA Investment, Inc.; United States Bankruptcy Court, Delaware


First Time Transactions May Fall Within Subjective Ordinary Course of Business Defense

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• Recent Decision of U.S. Court of Appeals for 10th Circuit – In re C.W. Mining Co.

– Payment on account of first time transaction between debtor and creditor might satisfy the subjective part of ordinary course of business defense

• Payment made 2 days before due date (within terms)

• No evidence of creditor collection activity

• 6th, 7th and 9th Circuits Agree


• Consistency In Timing of Payments Prior to and During Preference Period Alone Might Not Be Sufficient to Prove Subjective Component of Ordinary Course of Business Defense

• Threats to Subjective Component– Change in the form of payment during preference period

(regular check to wire)

– Change in method of invoicing (electronic to paper)

– Change in credit terms

– Imposition of credit limit/enforcement of existing credit limit

– Threats to stop shipment; imposition of credit holds

– Change in mode of delivery (regular mail to Federal Express)

Subjective Ordinary Course of Business Preference Defense – Facts That Defeat Subjective Ordinary Course of Business On the Numbers


Ordinary Course Of Business Preference Defense –Ordinary Business Terms Alternative: Objective Component

37

• Transfer Not Unusual or Idiosyncratic In The Relevant Industry

• Which Industry to Consider?

– Creditor’s? Debtor’s?

– Industry based on companies similar to creditor selling to companies similar to Debtor?

• Includes Range of Industry Terms

– No need to prove single set of business terms within an industry

– Ordinary Business Terms may vary widely across industries

• Creditor’s Changing of Business Terms Does Not Necessarily Result in Loss of Objective Ordinary Course of Business Defense

– Are new terms frequently used in industry?


Ordinary Course Of Business: Objective (Ordinary Business Terms)

38

• Proper Methodology For Determining A Payment’s Consistency with Industry Practices is Evolving

• Example: In re Waterford Wedgewood, Inc.

(Bankruptcy Court, Southern District of New York)

– Proper method for determining whether a payment is made in accordance with ordinary business terms: whether payment occurred within one standard deviation of the industry average

• Contrast with Hayes Lemmerz International Inc.

(Bankruptcy Court Delaware)

– Court rejected expert testimony proffered by Trustee limiting industry practice to median range of payments for middle 50% of surveyed companies


State Law Preference Claims

39

• Prerequisites Vary From State to State

• Some States (e.g., California) Have Preference Statutes Like Section 547

• Some States (e.g., Wisconsin, New Jersey, New York) Have Preference Statutes Like Bankruptcy Act of 1898

– 4 month reachback

– Intent to prefer

– No new value/ordinary course of business defense

• Some States Have No Preference Statute at All


Use Of State Laws To Pursue Preferences and Fraudulent Transfers

40

• New Trick being used by Trustees

• Generally expands the time frame for the claw back period

• May also eliminate new value and ordinary course of business defenses


JORDAN-CHILES, INC.Kentucky Bankruptcy Court

41

• Trustee sued multiple defendants for preference recoveries

• Suits were brought under three statutes

– 11 USC 547 for preference recoveries

– Kentucky State Law Preference Claims

• Alleged the payments were transfers in contemplation of insolvency

• Alleged intention was to prefer payment recipients


JORDAN-CHILES, INC.547 Defenses were asserted

42

• Defendants asserted new value defense anyway

– The continued extension of credit disproves the trustee’s theory that the transfers were intentional preferences

• Debtor’s records indicated that payments were made because creditor pushed debtor to pay it before others

• Case was settled for about 25% of the preference demand


Consignment Issues

43

• Since the 2001 revisions of UCC Article 9, Consignments treated under Article 9 in addition to Article 2 of the UCC


Consignment Definition – UCC Article 9

44

• A Transaction, Regardless of Form, in Which a Person Delivers Goods to a Merchant For the Purpose of Sale and:

– The merchant deals in goods of that kind under a name other than the person making delivery, is not an auctioneer; and is not generally known by its creditors to be substantially engaged in selling the goods of others;


Consignment Definition (cont’d)

45

• With respect to each delivery, the aggregate value of the goods is $1,000 or more at the time of delivery

• The goods are not consumer goods

• The transaction does not create a security interest that secures an obligation


Article 2 of the UCC

46

• UCC § 2-401(a): Any retention or reservation by the seller of the title (property) in goods shipped or delivered to the buyer is limited in effect to reservation of a security interest.

• UCC § 2-326: If goods conforming to contract are subject to return by buyer, the transaction is a “Sale or return” if the goods are delivered primarily for resale and the goods are subject to the claims of buyer’s creditors while in buyer’s possession.


Necessary Steps To Perfect And Obtain PriorityRe A Consignment Interest

47

• Enter into a properly written consignment agreement with customer

• Run a UCC search to determine any UCC liens against the goods to be sold under consignment

• File a UCC Financing Statement to perfect the consignment interest.

• Notify each prior secured party of the intended consignment


Recent Consignment Issues In Bankruptcy

• Sports Authority Case has Challenged Validity of Consignments

• Most of Inventory is Consigned Goods

• 170 Consignment Vendors

• Only a Handful of Consignment Vendors Have Validly Perfected Priority “Security Interests” in the Consigned Goods

• Adversary Proceedings Commenced Against Each Consignment Vendor To Void Alleged Consignment Interest

– Term Lender has intervened in each adversary proceeding

48


• Debtors Sought to Sell Consigned Goods and Escrow Payments for Consignment Vendors

– Consignment Vendors Objected insisting that Consignment Vendors were to be paid from sale proceeds

– Objection by Term Lender

• Court Granted Debtors’ Motion to Sell Consigned Goods and Directed Payment to Consignment Vendors Pursuant to terms of Consignment Agreements

• Term Lender has Appealed and Sought Stay of the “Consignment Order”

• Both Bankruptcy Court and United States District Court have Denied Term Lender’s Request for a Stay

• Consignment Vendors have Appealed as Well

Sports Authority Consignment Issues Ongoing

49


• Sale Under 11 U.S.C. 363 of Debtors’ Assets is Proceeding but Appeals by Term Lender and Consignment Vendors are ongoing

• Appeals will be sent to Mediation

Sports Authority Consignment Issues Ongoing

50


Piercing The Corporate Veil

51

• Generally the owner(s) of a business will adhere strictly to the corporate structure specifically in order not to be sued individually

• The requirements to be proven in order to have the court Pierce the Corporate Veil are numerous and complex. It is not common that the appropriate facts will be able to be proved


Requirements To Pierce The Corporate Veil

52

• Owner of the corporation “exercised complete domination of the corporation in respect to the transaction attacked”

• “such domination was used to commit a fraud or wrong against the plaintiff which resulted in injury.”

• “The party seeking to pierce the corporate veil must establish that the owners, through their domination, abused the privilege of doing business in the corporate form to perpetrate a wrong or injustice against that party such that a court of equity will intervene.”


• Defendant breached his duties of good faith and fair dealing with Plaintiff

• Defendant improperly used Plaintiff’s money for his personal benefit

• Defendant exercised unauthorized dominion over Plaintiff’s money

• Defendant’s breach proximately caused monetary harm to Plaintiff

• These, taken together, constituted a tort of conversion



• Absence of the formalities and paraphernalia that are part and parcel of the corporate existence i.e.,

issuance of stock, election of directors, keeping of

the Corporate records and the like,

• Inadequate capitalization,

• Whether funds are put in and taken out of the corporation for personal rather than corporate purposes



• Overlap in ownership, officers, directors, and personnel,

• Common office space, address and telephone numbers of corporate entities,

• The amount of business discretion displayed by the allegedly dominated corporation,

• Whether any related corporations or principals deal with the dominated corporation at arm’s length,



• Section 1129 Contains 16 Requirements For Confirmation of Plan

– All requirements must be satisfied

• Confirmation Requirements Include the Following With Respect to Each Class of Claims:

– Such class has accepted the plan or

– Such class is not impaired under the plan

– If neither requirement is satisfied, cramdown requirements must be satisfied: the plan does not discriminate unfairly and is not fair and equitable with respect to each non-consenting impaired class of claims

• Unsecured Creditor Cramdown Requirement: A Chapter 11 Plan is Fair and Equitable With Respect to a Class of Unsecured Creditors if

– The plan provides that each unsecured creditor in the class receives property with a value equal to the allowed amount of the creditor’s unsecured claim on the effective date of the plan or

– No lower class gets paid unless unsecured creditors are paid in full (Absolute Priority Rule)

Plan Confirmation and Cramdown Requirements – Re Unsecured Claims


• Special Plan Confirmation Requirement in an Individual Chapter 11 Case: Section 1129(a)(15) Where the Holder of an Allowed Unsecured Claim Objects to the Confirmation of the Plan:

– The value, as of the effective date of the plan, of the property to be distributed under the plan on account of such claim is not less than the amount of such claim; or

– The value of the property to be distributed under the plan is not less than the projected disposable income of the debtor (as defined in section 1325(b)(2) to be received during the 5-year period beginning on the date that the first payment is due under the plan, or during the period for which the plan provides payments, whichever is longer

Special Plan Confirmation Requirements In Individual Chapter 11 Cases


• General Cramdown Rules Apply to Unsecured Claims, Except As Follows:

– Section 1129(b)(2)(B): An individual debtor cramming down a plan over the objections of unsecured creditors may retain property included in the estate under Section 1115

– Section 1115(a) says that if the debtor is an individual, “property of the estate includes, in addition to the property specified in section 541 — (all property as of commencement of case) (1) all property…the debtor acquires after the commencement of the case…and (2) earnings from services performed by the debtor after the commencement of the case….”

– Does absolute priority rule apply to individual chapter 11’s?

Special Plan Confirmation Cramdown Requirements In Individual Chapter 11 Cases


• Majority View

– Based on Section 1129(b)(2)(B), Modified Absolute Priority Rule applies to individual Debtors

– An individual debtor can retain post-petition earnings and property acquired post petition, included in Section 1115, but NOT pre-petition property of the Estate included in Section 541

– Followed by 4th, 5th, 6th, (most recently) 9th, and 10th Circuit Courts of Appeal

• Minority View

– Absolute Priority Rule does not apply to individual chapter 11 debtors

– Individual debtors can retain most pre-petition and post-petition property

Does Absolute Priority Rule Apply To Individual Chapter 11’s?


Chapter 11 Trends: Speedier Chapter 11s

• Increased Frequency of:

– Section 363 sales

• Sale of business

• Liquidation vehicle

– Prepackaged chapter 11s

– Prenegotiated chapter 11s

– Traditional chapter 11 restructurings

• Exception rather than the norm

• Fix business/operational problems first

• Followed by Chapter 11 Plan Process

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Reasons For Speedier Chapter 11s

• Change in Nature of Lenders

– In the past, primarily money center banks and asset-based lenders

– Increase in hedge fund/private equity lending, less patient

– Increased desire for loan to own

• Less Costly

– Quicker chapter 11 process

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“Prepackaged” Chapter 11 Cases

• Debtor Files Chapter 11

• Prior to Filing, Debtor Has Agreement In Place with Creditors, Usually Holders of Significant Amount of Secured and/or Bond Debt

• Creditors Solicited and Vote on Prepackaged Plan Pre-petition

• Combined Hearing on Prepackaged Plan and Disclosure Statement Between 30 – 60 Days After Chapter 11 Filing

• Trade Creditors Usually Paid in Full Upon Approval of Plan or Earlier Pursuant to Court Order in Exchange for Trade Credit

• Recent Example:

– Fairway Market

62


“Pre-negotiated” Chapter 11 Cases• Bankruptcy Filed Before Plan Negotiations Concluded

– Debtor reached agreement with certain stakeholders (e.g., largest secured creditor(s)) on treatment of their claim(s) to be included in chapter 11 plan • Plan support agreement spells out treatment and binds

stakeholder(s) to vote for plan

– No agreement with other creditor classes, such as trade creditors

• How are Trade Creditors Treated?

– Payment in full of pre-petition claims?

– No or de minimis recovery on unsecured claims?

– Critical vendors treated better than other trade creditors?

– Are preference claims preserved or waived?

• Recent Example:

– Caesars Entertainment Operating Company

63


Advantages and Disadvantages of Chapter 11 Sale over Chapter 11 Plan

64

• Advantages

– Generally faster than Plan

– Free and clear/not subject to liens, security interests, creditors’ claims, fraudulent conveyance risk

– “no shop” protections

– Assign leases/contracts

– Similar to M&A deal

– Generally does not have to address resolution of claims

• Disadvantages

– Plan is best protection from successor liability

– Bankruptcy sale might be subject to attack as sub rosa plan

– Cannot generally deal with resolution of claims or equity interests


Quickie Section 363 Sales

65

• Debtor Uses Section 363 to Sell (Subject to Bankruptcy Court Approval)

– Entire Business

– Groups of Assets

– Business Lines

– Liquidation vehicle – All Assets Through Going Out of Business Sales (“GOB’s”)

• No Requirement For a Plan or Solicitation of Votes for Sale Approval


• Proposed Sale Negotiated Between Debtor and “Stalking Horse” Buyer Before or After Bankruptcy

– Increased frequency of acquisition by stakeholder via “loan to own”

• Debtor and Stalking Horse Bidder Sign Asset Purchase Agreement

• Buyer Purchases Specific Assets and Assumes Certain Liabilities

– Leaves estate with assets not purchased and liabilities not assumed

• Asset Purchase Agreement Usually Contains Schedule of Contracts/Liabilities to be Assumed

• Standard for Court Approval – Easy to Satisfy Business Judgment

Quickie Section 363 Sales

66


Assignment For The Benefit Of Creditors (“ABC”) – Overview

• Formal Out-of-Court Liquidation – State Alternative to Chapter 7 Bankruptcy

– Governed by state law

– Statutory authority and common law

– ABC procedures vary from state to state

• Increasingly Used As An Alternative to Liquidating Chapter 11 Case

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ABC’s – Overview

• ABC Arises by Contract

– Agreement between Debtor/Assignor and Assignee

– Assignee is selected by Debtor/Assignor

• Assignee bias in favor of Debtor/principal?

• Assignee bias in favor of secured lender?

• Sometimes, unsecured creditors have a role in selecting assignee

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• An ABC Vests Title to All Debtor’s/ Assignor’s Property to an Assignee

– All personal property

– All real property

– All causes of action

– Creditors share based on priority status

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• Assignee is a Fiduciary for All of Debtor’s/Assignor’s Creditors

– Liquidates Debtor’s/Assignor’s property

– Notifies creditors of ABC; claims bar date; other matters

– Investigates/pursues claims vs. third parties

– Reconciles claims vs. Debtor/Assignor

– Distributes cash proceeds to Assignor’s creditors according to recognized state law priorities

– Provides final accounting at conclusion of case


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• Court Supervision

– Some states provide for court supervision of the ABC and assignee

– Other states provide little, if any, oversight

• No court supervision

• Assignee could follow state law applicable to liquidating business/assets


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ABC’s – Assignee’s Avoidance Powers

• UCC § 9-309 Gives Assignee Rights of a Perfected Secured Creditor as of Date of Assignment

– Similar to Chapter 7 trustee’s status as a hypothetical lien creditor

• Creditors Cannot Enforce Unperfected Security/Lien Interest Against Debtor’s/Assignor’s Assets

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ABC’s – Claims Priorities

• Similar to Bankruptcy

• First in Priority: Properly Perfected Secured Creditor Gets First Position on Collateral

• Next In Line: Costs of Administering ABC

• State Law Priorities are Next Level in Priority

• Bottom of Claims Priority Ladder: General Unsecured Claims

– No distribution to unsecured creditors until all secured administrative claims, taxes, priority wage and other claims with priority have been paid in full

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• Assignee Required to Establish Claims Bar Date by Which Creditors May Assert Claims Against Debtor/Assignor and Provide Notice to Creditors

– Creditors that fail to timely file proof of claim may not share in distribution

– Assignee can question any filed claim that exceeds amount reflected in Debtor’s/ Assignor’s books and records

• No right to interest accruing during ABC of insolvent debtor

ABC’s – Claim Reconciliation

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• State or federal

• Commenced by court proceeding

– e.g., Secured creditor seeking to protect collateral

– Generally unavailable to trade creditors

• Receiver is Fiduciary Appointed to Administer and/or Liquidate a Business or Specific Asset

Receiverships

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• Receiver’s Duties Prescribed by Statute or Court Order

– Take possession of and dispose of/sell Debtor’s assets

– Collect accounts and other sums due the Debtor

– Manage and operate the Debtor’s business and property to the extent necessary until sold

– Employ, compensate and discharge employees necessary to manage or control the Debtor’s assets

• Most Frequently Used by Mortgage Lenders to Protect Real Property Prior to Foreclosure

Receiverships

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Receiverships – What Trade Creditors Should Look For

• Check For Court Order Granting Injunction Preventing Creditor Collection Activity

• Check For Claims Bar Date and Method for Asserting Proof of Claim, Which is Determined by

– Statute or

– Court Order

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• Some States Refer to Assignee in an ABC as a “Receiver” – Different From Court Appointed Receiver

– Example: Wisconsin

• Role of Receiver Is Often More Limited Than Assignee in ABC

– Scope of Receivership often limited to specific assets

– Receiver’s actions more closely monitored by court

Receiverships

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Other State Law Non-Bankruptcy Alternatives

• Uniform Commercial Code Article 9 Sale

• Debtor’s Announcement to Close Its Doors Without Fully Paying Claims

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Creditor Response

• Demand Transparency

• Otherwise, Solicit Creditor Participation in an Involuntary Petition

• Formation of Out of Court Creditors’ Committee

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QUESTIONS?

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Wanda Borges, Esq.BORGES & ASSOCIATES, LLCTelephone: (516) 677-8200, x 225E-Mail: [email protected]

Speaker Contact Information

Bruce S. Nathan, Esq.LOWENSTEIN SANDLER LLPTelephone: (212) 204-8686E-mail: [email protected]

Honorable Laurel Davis,United States Bankruptcy JudgeDISTRICT OF NEVADA

A View From The Bench And Bar: A Discussion Of Current Hot...

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