Senate Bill No. 908 - Buchalter Law Firm - Buchalter Law Firm
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ALTERNATIVES TO BANKRUPTCY & RELATED TOPICS2014 UPDATE
Presented by:
Benjamin S. Seigel, Esq.of Buchalter Nemer,
a Professional Corporation
March 12, 2014
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DISCLAIMER
This presentation is intended to inform those in attendance regarding general concepts of bankruptcy and certain alternatives to bankruptcy proceedings. It is not intended to constitute legal advice nor does it necessarily express the opinion of Buchalter Nemer regarding its contents. Legal advice should be obtained from an attorney of your selection and nothing contained in this presentation should be considered such advice.
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HISTORY OF BANKRUPTCY
• Deuteronomy‐Verse 15
• Chapter 11 enacted in 1978
• BAPCPA enacted in 2005
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TOPICS NOT FOR DISCUSSION
• Chapter 13 (individuals with regular income)
• Chapter 12 (family farmers and fishermen)
• Chapter 9 (municipalities)
• Chapter 15 (ancillary and cross border bankruptcies
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TOPICS FOR DISCUSSION
• Liquidation (Chapter 7)• Reorganization (Chapter 11) • Single Asset Real Estate Bankruptcies – Article Attached• Bankruptcy Code §363 & 1129• Stern v. Marshall and Bellingham Insurance – Article Attached• Receiverships• Bulk Sales• Foreclosures• Orderly Liquidation• Assignments for the Benefit of Creditors• Mediation
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PURPOSE OF BANKRUPTCY
• Give an honest debtor a fresh start
‐ Reorganization
‐ Liquidation
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LIQUIDATION
• PETITION
• TRUSTEE
• LIQUIDATION
• PAYMENT
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REORGANIZATION
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ONE JUDGE’S VIEW ON CHAPTER 11
In Re: Miners Oil Company:
“This decision recounts a cautionary tale about the inherent risks associated with a Chapter 11 case and the recriminations which fly when rosy expectations of a successful resolution of a multitude of serious interrelated financial issues are shattered and the businessman who started the process is left astounded by how quickly he has learned that one’s attempt to control events can come to grief in a reorganization case without the support of creditors. Filing a Chapter 11 case is something like a very sick man taking very potent medicine; it may restore him to health if it doesn’t kill him.”
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WHAT’S THE PROBLEM?
• Takes too long (most of the time)
• Costs too much
• Too many professionals
• Law is complicated
• Different districts; different results
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HOT AREAS
• Section 363 Sales – Article Attached
• Section 1129 Sales – Article Attached
• Pre‐packaged plans
• Bellingham Insurance
• Crowdfunding
• Bitcoins
• Supply Chain Finance11
RECEIVERSHIPS
• State or Federal Court proceeding
• Court appointed receiver operates the business
• Can be initiated by secured creditor
• Can be initiated by unsecured creditors
• Receiver must post a bond
• Court order defines the duties
• Consider impact on business12
INFORMAL WORKOUT COMPOSITIONS
• Workout plan‐like a Chapter 11 Plan
• Needs 90%+ approval
• Needs secured creditors cooperation
• Consider security interest for consenting creditors
• Consider a meeting and the dangers
• Consider an advisory committee
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BULK SALES
•Article 6 of California UCC
•Deleted by most states
•Difficult to administer
•Could lead to involuntary bankruptcy
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FRIENDLY FORECLOSURE
•Secured creditor forecloses on assets
•Sale to buyer‐relationship concerns
•Continuity of business
•Unsecured creditors not happy
•Risk of involuntary bankruptcy
•Risk of litigation, injunction, etc.15
ORDERLY SELF‐LIQUIDATION
•Self administered
•Secured creditor needs to cooperate
•Normally over an extended time period
•Good if very few assets and few unsecured creditors or few buyers
•Could lead to involuntary bankruptcy16
ASSIGNMENTS FOR THE BENEFIT OF CREDITORS
• Recover fraudulent transfers and preferences
• Enjoin eviction of Assignor
• Prosecute and defend claims
• Void personal property transfers
• Set aside unperfected security interests
• Terminate attachments and TPOs
• Avoid post‐assignment judgment liens
• Transfer liquor licenses
• Exempt from Bulk Sales law
• Article Attached 17
ASSIGNMENT & IMMEDIATE SALE
• FIRST THINGS TO DO: Get a lawyer, a buyer and an appraisal‐maybe two of them
• Get an Asset Purchase Agreement
• Get cooperation of secured creditor
• Get cooperation of prospective Assignee
• Right, title and interest, as is, where is without reps or warranties and with all faults
• Not free and clear; due diligence required
• Potential involuntary bankruptcy…but there is a great safety net to allow abstention and dismissal 18
MEDIATION
•Different than Arbitration
•Secured Lender/Borrower Negotiations
•Fast and Inexpensive (Relatively)
•Benefit of experienced mediator (if you select the right one)
•Why Mediation Works & Why It Doesn’t19
QUESTIONS?
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Why Mediation Works...And Why It Doesn’t: One Mediator’s Perspective Benjamin S. Seigel, Esq.
My 36 years of practicing law have included both civil and criminal litigation and engagements across many practice areas including; corporate, bankruptcy, probate, real estate, tax, intellectual property and family law. I have used that experience of late to act in a wide variety of matters as a mediator. Looking back over those years and the matters that I have been privileged to mediate, I noted that when a matter settled in the course of a mediation I spent little time to analyze why it settled. I was just happy that it did. However, when a matter did not settle in mediation I struggled with why I could not get the parties to come to an agreement. What did I do, or fail to do as the mediator? I have published several articles on mediation. After the recent publication of “Meltdown Mediation,”1 a reader asked why some cases settle and others don’t. Fortunately, more of my mediated matters settled than didn’t. In attempting to answer that question, I came up with my own personal laundry list of “why” and “why not.” When Mediation Works: the “Why It Does” Factors Preparation: Clients who have not been properly introduced to the mediation process in most instances cannot know what to expect when attending the mediation conference. Some think it will be like a court proceeding complete with someone in a black robe and a court reporter sitting in front of a shorthand machine. Others think they might be called upon to testify, as in a deposition. Still others are unnecessarily nervous and intimidated by the process. Attorneys unfamiliar with the process, to some degree, often feel as their clients do. They either have not had the opportunity to participate in a mediation, or have had a bad experience with an untrained and inexperienced mediator. One of the most important aspects of a successful mediation is the pre‐mediation preparation of both attorney and client. An attorney with little or no mediation experience is wise to consult with a colleague with such experience, read an article or two on the process, and speak with a friend who serves as a mediator. A pre‐mediation meeting with the client is essential. The client needs to be briefed on the mediator’s instructions, the presentation that will be made by the attorney—and
possibly the client—and the approach to settlement that the mediator is likely to take. Mediation is the exploration of settlement options. Both client and attorney should feel free to set forth and explore as many options as can be created. Options should not be limited to payment of money or turning over property. Solutions that are outside of the box often compel settlement. These may be an apology printed in a newspaper, a gift to the other side’s favorite charity, the purchase of goods at a special discount in contemplation of future business—anything one might imagine. Developing options for settlement requires preparation by both the client and the attorney. Experience: The level of experience of the selected mediator is also an important factor. With all due respect to mediators fresh from judicial retirement who have not had mediation training, one should carefully select the mediator who has had a degree of formal mediation training and a track record of experience. Mediation is not an arbitration in which the arbitrator makes a decision. Nor is mediation a judicial settlement conference in which a judge often makes a settlement recommendation and attempts to force the parties to agree. The ideal mediator has formal mediation training and experience as a mediator. The mediator need not have experience regarding the particular dispute nor be an expert on the law involved. Mediation skills apply to all disputes because the goal is to reach a settlement; not to decide on who is right or wrong under the law. Attitude & Motivation: When both client and counsel participate in mediation with the idea of reaching an agreement that resolves the dispute, the chances of a resolution are far greater than when they approach the mediation with the proverbial “chip” on their shoulders. Often a court will recommend, or, in some cases, order the parties to mediation. If the mediation is approached as merely attending in compliance with such a recommendation or order, the mediation session is over before it begins. Focusing on the legal issues to the exclusion of the practicalities of achieving a settlement can cloud the vision of the participants. A positive attitude that a settlement will be achieved, with both client and counsel motivated to accomplish that goal, will go a long way toward reaching it.
Risk Analysis: An important aspect of litigation is the cost involved. Beyond real costs for attorneys, expert witnesses, court reporters, court fees, jury fees and the other costs involved with litigation, are the human costs involved as well. The time involved by the parties, the emotional attributes of litigation, and the effect on family members and friends, should all be considered. Clients who take these parameters into consideration and weigh the costs of continuing litigation against the costs of settlement will achieve an appropriate result in mediation. Forgive & Forget: Louis Smedes, a theologian, wrote a book titled, “Forgive & Forget,” in which he presented numerous illustrations about the advantages of getting past the disputes that one faces in life. Clients who understand the advantage of getting on with their lives and getting the litigation behind them are able to approach mediation with an attitude that leads to a resolution of the matter at hand. I often recommend the book to parties to mediation that I believe need the impetus the book provides. Clients who are willing to approach mediation with the idea of forgiving their adversaries and getting on with their lives will have a much better chance of resolving the dispute than those who are unable to make forgiveness a part of their mediation preparation. Perseverance: One element that frustrates mediators in many instances is the unwillingness of clients and attorneys to press on even though settlement appears to be impossible. After several hours of private and group discussions when everyone is starting to feel that no resolution is possible, those participants who want to give it one more chance are more likely to come to a resolution than those who want to pack up and go home. Taking a break, going for a walk, having a bite to eat, or even a cold beer, can change the atmosphere. The parties who persevere and continue to explore ways to resolve the dispute find their efforts rewarded. Pursuing every avenue that can lead to a resolution takes time and effort, but it pays off in achieving a solution to the matter. When Mediation Doesn’t Work: the “Why Not” Factors As a starting point, if the foregoing elements are missing—the parties are not prepared, they have selected an inexperienced mediator, they have a negative attitude or lack motivation to settle, have not done a risk analysis, they are unwilling to forgive and forget, or lack the desire to persevere—the mediation is doomed at the outset. Even when some “Why” factors are present there are other reasons a mediation may not be successful. The five “Why Not” factors that I believe result in a failed mediation are:
1. Ego, 2. Misunderstanding of the facts, 3. Misunderstanding of the law, 4. There being no incentive for settlement, and 5. Telephonic and video conferences Ego: A significant “Why Not” factor for achieving resolution in mediation is the ego of the parties. Sometimes it is one party, or one lawyer. Other times, it is everyone in the room. Even when every element of the “Why” factors points toward resolution, when ego comes into play, the settlement prospects become severely diminished. When a party thinks that she will not allow her opponent to get the best of her or that a settlement might make her look foolish to her peers or she has a fixation on getting the matter to trial so a jury can decide that she is right and her opponent is wrong, mediation will not work. One of the tasks that attorneys must undertake is to detect the ego factor early on, and take steps to eliminate it, if mediation is to be successful. Misunderstanding of the Facts or the Law: Attorneys who represent clients in mediation sometimes have a disconnect between what the attorney understands to be the facts and the law and the understanding of the client. On occasion, in the initial mediation conference when each side makes an opening presentation, a client will turn to his attorney and whisper, “I never knew about that!” Or on other occasions, the mediation briefs of the parties will discuss a case as being controlling when the case was recently overruled. There may have been reliance by a party that the case was not only controlling but good law. The lesson here is that clients need to spend some time with their attorneys to review the facts and be certain that both the client and the attorney know all of the facts and that every effort has been made to determine the facts known to the opponent. Knowing the controlling law is helpful as well. However, one of the unique advantages of mediation is that settlements are often made notwithstanding the law and who is right or who is wrong. The attorney needs to be certain that the advice being given to the client as to the applicable law is not “off‐the‐cuff,” but is well researched so that embarrassment can be avoided. No Incentive to Settle: There are occasions when the parties have been “encouraged” by a judge to go to mediation, or mediation is a contractual pre‐requisite to litigation. Since mediation is not binding unless a signed agreement is achieved, some clients and their attorneys will go through the motions of attending a mediation conference with no interest in working toward a resolution. In many court‐sponsored programs the
mediators are unpaid volunteers. The participants have no financial investment in getting their money’s worth. When the mediator is paid, normally in advance, there is a financial investment in the activity and a greater incentive in seeing that the investment pays off by moving toward a settlement. There are those mediations sessions when the client and her counsel sit and stare out the window, having no interest in what is being said; they are there to demonstrate that they have participated in the mediation to satisfy the court or a mediation clause in a contract. No matter how hard a mediator may try to motivate the parties, when one or both parties has no incentive to participate and reach an agreement, the mediation simply ends with a frustrated mediator lying awake that night trying to analyze what could have been done to incentivize the parties. Telephonic and Videoconference Issues: When the mediation is set for a location that is at a great distance from one of the parties and a request is made to conduct the mediation by telephone conference call or by videoconference the chances of success are greatly diminished. Face‐to‐face mediations work best because the mediator can caucus individually with the parties, look at the them in the eye and use all manner and means of persuasion to achieve a settlement. That is not to say that long‐distance mediations never work, but they present a significant roadblock to negotiations when the mediator cannot take a participant aside for a confidential discussion, or take the lawyers into an adjacent room and explain the facts of life in a persuasive manner. Conclusion There are certainly other factors that might influence why a particular mediation doesn’t result in an agreement: the mediation took place too early in the litigation when the facts had not been fully ascertained, or it took place too late when positions had hardened to the point of no compromise, or the room was too hot, or it was too cold, or it started too early in the day or too late. Many factors influence the outcome of any dispute. However, the “Why” and “Why Not” factors discussed above play a significant part in whether or not any mediation will be successful. 1 Seigel, Ben, “Meltdown Mediation,” Dispute Resolution Magazine, American Bar Association, Winter 2010, Volume 16, Number 2, ADR and the Financial Crisis
Benjamin S. Seigel is a Shareholder in the Firm’s Insolvency and Financial Solutions Practice Group in Los Angeles. He serves as a mediator for the Central District Bankruptcy Court and as a panel mediator for Judicate West and the American Mediation Association, Inc. He can be reached at 213.891.5006 or [email protected].
IMAGINATIVE SOLUTIONS IN MEDIATION: AVOIDING THE RISKS OF CLEAR CHANNEL AND PHILADELPHIA NEWSPAPERS
BENJAMIN S. SEIGEL We all know that litigation can be a costly process, especially if the dispute involves difficult issues that may require resolution by an appellate court. In contrast, mediation can be a cost effective and efficient vehicle for resolving disputes—and has the added benefit of being able to provide imaginative resolutions that courts cannot: an apology printed in a newspaper, a donation to a favorite charity, a cost price accommodation on future orders, or just about anything else one can think of. More and more, courts are encouraging disputing parties to engage in mediation, and it’s working. Approximately two‐thirds of matters submitted to California’s Central District Bankruptcy Court mediation program were settled, generally in less than one full day of mediation. Two recent decisions arising out of bankruptcy cases prompted me to imagine a case that might lend itself perfectly to the mediation process. The case law is unsettled and to litigate the imagined issues could prove to be highly unsatisfactory for all concerned. In 2008, the Bankruptcy Appellate Panel of the 9th Circuit Court of Appeals (“BAP”) affirmed an order of the bankruptcy court that allowed the holder of a first lien on real property to credit bid the amount of its debt in the course of a sale of the property pursuant to section 363 of the Bankruptcy Code. However, the BAP also reversed part of the bankruptcy court’s decision that authorized the sale of the property free and clear of the junior creditor’s lien. The case is Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC) 391 B.R. 25 (9TH Cir. BAP 2008) (“Clear Channel”). Clear Channel has been severely criticized as spelling the end of so‐called “363 sales” in those cases where the senior lien holder intends to credit bid the amount of its debt and there is a junior lien holder in place on the property to be purchased. (See for example, Lawrence Peitzman, Clear Channel: An Appeal for Reinterpretation, 30 Cal. Bankr. J 287.) With Clear Channel being the law in the 9th Circuit, if a secured creditor is concerned about a debtor using the Section 363 vehicle to sell an asset of the estate, selling the asset through a plan of reorganization under Section 1129 of the Bankruptcy
Code might be the way to proceed. The secured creditor just needs to convince the debtor to propose a plan of reorganization where the asset will be sold and the senior secured creditor will credit bid its debt and get the property free and clear of junior liens. Along comes the 3rd Circuit 2010 opinion in In re: Philadelphia Newspapers, LLC 599 F.3d 298 (3d Cir. Mar 22, 2010), where the court held that because Section 1129 of the Bankruptcy Code permits a debtor to proceed with any plan that provides secured lenders with the “indubitable equivalent” of their secured interest in the assets and contains no statutory right to credit bid, the secured lender would be required to place a cash bid and would not be permitted to credit bid. Although a similar holding was made in 2009 by the 5th Circuit in In re: Pacific Lumber Co., 584 F3d 229 (5th Cir. 2009) the Philadelphia Newspapers decision has also been severely criticized as being improperly decided. A senior secured creditor wishing to credit bid under Section 363 with a junior lien holder in place, and not being able to under a plan because of the purported Section 1129 language, has a problem. Thus we have a dilemma; under Clear Channel, a senior secured creditor cannot credit bid in a 363 sale. Under Philadelphia Newspapers, a senior secured creditor cannot credit bid in a sale pursuant to a plan of reorganization; it must come up with cash. Although in In re: Jolan, Inc., 403 B.R. 928, a United States Bankruptcy Court for the Western District of Washington held that neither the Clear Channel rule nor Section 363 precluded a sale free and clear of all junior liens, claims and encumbrances in the circumstances presented in that case, a secured creditor would be fearful that another court might not be so accommodating. In Re: Nashville Senior Living, 407 B.R. 222 (6th Cir. B.A.P. 2009), held that Clear Channel was an aberration.1 Other courts might not agree. So what’s a secured creditor to do to avoid the Clear Channel/Philadelphia Newspapers dilemma and avoid the risk of having to be required to put up all cash in order to be a bidder? Consider the following situation drawn from the facts in several unrelated cases and the author’s imagination:
M & E Properties, LLC owns a shopping center in Los Angeles, California. The first trust deed is held by Banco Grande with an outstanding principal balance of $4 million. Harry’s Loan Company (“HLC”) holds the second deed of trust with a principal balance of $600,000. The center is anchored by an upscale market and a national chain drug store. Five of the remaining tenants are in place and current on their rent. Three former tenants defaulted on the rent and have vacated. The remaining seven retail tenants are struggling and have requested rent reductions. Each of the seven leases has four years remaining with various renewal options. M & E is three months behind on its payments to Banco Grande and HLC. M & E is current on all of its other obligations. Banco Grande recorded a Notice of Default. M & E filed Chapter 11. Banco Grande has offered to purchase the property through a 363 sale by credit bidding its $4 million debt. The value of the property based on a recent appraisal is $3.9 million. However, Banco Grande is concerned about the consequences of Clear Channel which might result in the credit bid being accepted but not free and clear of the HLC debt. And although M & E is willing to file a plan of reorganization allowing Banco Grande to credit bid its claim, Banco Grande is fearful that HLC will object based on Philadelphia Newspapers. M & E’s lawyer suggested that all of the parties go through a mediation process in an effort to restructure the 1st and the 2nd trust deeds, and work out something with the struggling tenants to keep them in place. An ambitious project for all concerned! The parties agree on a mediator and after two days of intense mediation, the parties reach the following agreement: 1. M & E would make interest only payments on both the 1st and 2nd trust deeds for one year with the missed principal payments being added to the loans and the maturity dates extended for one year. The principals of M & E would personally guaranty the amount of the missed principal payments. 2. The seven struggling tenants would be given temporary rent reductions so they would pay 60% of the rent under the existing leases for four months, 70% for the next four months and 80% for next four months with the amount of the short payments added to the end of their respective leases. The shortfall would be personally guaranteed by the principals of each respective tenant.
3. The Notice of Default would be rescinded and the bankruptcy case would be dismissed. This resolution allows for the shopping center to remain in business with a nearly full complement of tenants and Banco Grande avoids the possible consequences of Clear Channel and Philadelphia Newspapers. Though perhaps not ideal, with the cooperation of everyone involved, a reasonable resolution was reached through mediation. The key point is that no court could issue an order that would provide the results achieved through mediation in this case. Until Congress addresses this problem by amendments to the Bankruptcy Code, which most observers believe is not likely to happen soon, lenders and borrowers must come up with imaginative solutions. Often the services of a trained and experienced mediator can help craft a practical resolution for all concerned. Tomorrow I will think of a way to resolve the problems in the Middle East.
Benjamin S. Seigel is a Shareholder in the Insolvency & Financial Solutions Practice Group in Los Angeles. He can be reached at (213) 891‐5006 or [email protected].
1. Also, two 8th Circuit cases held similarly: In Re Polaroid Corporation (2010 WL 2696748) and United States v. Asset Based Resource Group, LLC (2010 WL 2791364).
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ANNA NICOLE SMITH STRIPS BANKRUPTCY COURT JURISDICTION Benjamin S. Seigel, Esq. Who is Anna Nicole Smith? Anna Nicole Smith was born in 1967 and died in 2007. After a troubled childhood, among other activities, she worked as a waitress in a fried chicken restaurant and held jobs at Wal‐Mart and Red Lobster. She became a stripper in 1991, was Playmate of the Year in 1993 and a model for Guess Jeans. Little did she know that she would gain notoriety for initiating legal proceedings that would result in what some legal pundits and scholars believe to be a significant change in one aspect of our country’s bankruptcy laws. Did her actions strip the Bankruptcy Courts of jurisdiction over matters that they had traditionally decided? The Litigation History On June 23, 2011, in a 5/4 decision, the United States Supreme Court decided the case of Stern, Executor of the Estate of Marshall v. Marshall, Executrix of the Estate of Marshall, 546 U.S. _____ (2011), or simply, Stern v. Marshall. It involved a long running dispute between Vickie Lynn Marshall, better known to the world as Anna Nicole Smith, and her deceased husband’s son, Pierce Marshall over a purported trust that Vickie claimed was promised to her by her late billionaire husband, J. Howard Marshall. The marriage took place approximately one year prior to J. Marshall’s death. The litigation against Pierce was commenced by Vickie prior to the death of J. Howard at age 90 and worked its way through the State and Federal courts in Louisiana, Texas and California. Two of those courts, a Texas state probate court and the Bankruptcy Court for the Central District of California, reached contrary decisions on the merits. Vicky and Pierce both died in the course of the litigation so the litigation continued between the representatives of their respective estates. Stern v. Marshall was the second time that the Supreme Court was faced with adjudicating the rights of Vickie and Pierce. The issue before the Supreme Court this time was whether a Bankruptcy Court had the authority to enter a final judgment on a counterclaim filed by Vickie against Pierce in Vickie’s California bankruptcy case. Pierce had filed a proof of claim in the bankruptcy proceedings, claiming that she had defamed him, and Vickie filed a counterclaim against Pierce for tortious interference with her rights to receive the purported trust. The Bankruptcy Court held that it could hear and decide the counter claim and awarded Vickie a bit under $450 million. The award
was reduced to $88 million by a District Court Judge. The 9th Circuit Court of Appeals overruled the District Court reasoning that the federal courts lacked jurisdiction to overrule the Texas state court decision in favor of Pierce. The issue eventually came before the Supreme Court. What the Supreme Court Decided In a 38‐page opinion the majority held that although the Bankruptcy Court had the statutory authority to enter judgment on Vickie’s counterclaim, it lacked the constitutional authority to do so. In a separate 2‐page concurring opinion, Justice Scalia stated, “The sheer surfeit of factors that the court was required to consider in this case should arouse the suspicion that something is seriously amiss with our jurisprudence in this area.” In a 17‐page dissenting opinion, Justice Breyer, joined by Justices Ginsburg, Sotomayor and Kagan, disagreed with the majority’s constitutional interpretation and predicted dire consequences stating, “[A] constutionally required game of ping‐pong between the courts would lead to inefficiency, increased cost, delay and needless additional suffering among those faced with bankruptcy.” So What? So, what’s it all about? Well, first of all, Bankruptcy Courts are created under Article I of the constitution, the administrative branch of government. Those courts get their power and authority from the Article 3 courts, or the judicial branch of government. Some matters that come before a bankruptcy court are called “core” matters and are defined in the Bankruptcy Code. If a matter comes before the bankruptcy court that is not a core matter, there are arguments both in favor and against the jurisdiction of the bankruptcy court to decide the matter. In Stern v. Marshall, the Supreme Court held that the counterclaim brought by Vicky against Pierce was based on his tortious interference with her right to receive the trust purportedly promised to her by Pierce’s father, the late J. Howard Marshall, was not a core proceeding and could not be decided by the bankruptcy court. Looking at the Law The law at issue is found in 28 USC §157(b) (2) (C) which states in pertinent part, “Core proceedings include, but are not limited to…counterclaims by the estate against persons filing claims
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against the estate.” The Supreme Court majority opinion held that although the Bankruptcy Court had the statutory authority to enter judgment on Vicky’s counterclaim, it lacked the constitutional authority to do so. That decision was supported by a lengthy dissertation on what powers had been given to the Bankruptcy Courts and what powers had not been so granted. Some Comments Professor Dan Schechter of Loyola Law School, commenting on the Supreme Court opinion, indicated that the effect of the opinion is to delete §157(b) (2) (C) from the statute and that Bankruptcy courts will still be able to hear and decide counterclaims under another statutory provision, §157(c) (1) by issuing proposed findings and conclusions which will then be routinely rubber‐stamped by a district court judge—the only change being the additional paper, expense and time delay. Schechter also raised the long debated issue of whether or not the opinion continued what some believe to be the “…continuing and inexplicable hostility of some judges toward the bankruptcy bench….I think that some federal judges are simply worried about encroachments on their turf.” Adam A. Lewis, Esq., a bankruptcy lawyer with the San Francisco office of Morrison & Forrester commented that the decision did not resolve the compulsory counterclaim issue and how it should be procedurally resolved. He asks, “Does the decision mean that the claim objection remains with the Bankruptcy Court, but that the debtor has to bring her ‘compulsory’ counterclaim in the District Court? Could the debtor bring the compulsory counterclaim with the claim objection and ask the District Court to withdraw the reference?” (A term used to describe the referral of bankruptcy cases by the District Court to the Bankruptcy Court.) Conclusion As is the case with all controversial decisions of our Supreme Court, only time will tell if this decision is much ado about nothing or a true and significant stripping of bankruptcy court jurisdiction.
Benjamin S. Seigel is a Shareholder in the Firm’s Insolvency & Financial Solutions Practice Group in Los Angeles. He can be reached at 213.891.5006 or [email protected].
Real Estate Alert
Single Asset Real Estate Bankruptcies Revisited Benjamin S. Seigel, Esq., Michael A. Williamson, Esq., and Anthony Napolitano, Esq.
In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act made substantial changes to the administration of bankruptcy cases that involve single asset real estate (“SARE”) matters. Most notably, the 2005 Act greatly expanded the applicability of the SARE rules. Before the 2005 Act, the SARE provisions did not apply if the property’s value exceeded $4 million. The 2005 Act eliminated this $4 million cap and, as a result, the SARE provisions are now applicable to a larger number of real estate cases. The elimination of this cap coupled with the economic downturn of 2007 to 2009 has increased the importance of the SARE provisions in bankruptcy cases. Classifying a debtor’s bankruptcy case as a SARE case greatly favors lenders by reducing the amount of time the debtor can spend in chapter 11. This Alert summarizes the key SARE provisions and provides a framework for dealing with issues that arise in SARE bankruptcy cases. WHAT IS “SINGLE ASSET REAL ESTATE”? Real property constitutes “single asset real estate” when it is a single property or project, which generates substantially all of the debtor’s gross income. SARE generally includes shopping centers, office buildings, industrial and warehouse properties, and apartment complexes, provided that the debtor’s only business is operating the property and that the property generates substantially all of the debtor’s income. SARE does not include family farmers, residential complexes with less than four units, or operating businesses that have revenues streams independent from the operation of the property. For example, hotels, resorts, hospitals or other types of real estate with independent revenue streams (e.g., restaurants, spas, and casinos) typically do not qualify for SARE status. Whether a particular real estate interest constitutes a single “property” or “project” is frequently disputed in bankruptcy cases. Most bankruptcy courts have held that the SARE provisions can apply to a debtor with multiple properties where the properties are linked together in some fashion, such as a common plan or scheme involving their use. For example, courts have held that a debtor in the business of acquiring multiple parcels of land with the intent of constructing and selling homes is a SARE debtor. Courts have
also held that the properties do not need to be contiguous or even geographically proximate. Multiple related properties will not defeat the applicability of the SARE rules. THE BENEFIT OF A “SINGLE ASSET REAL ESTATE” CLASSIFICATION Determination of SARE status benefits secured lenders by significantly shortening the amount of time for the debtor to reorganize. Within 90 days of the petition date or 30 days after determination of SARE status by the court, the debtor must either (i) file a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable period of time or (ii) commence monthly payments to the secured lender in an amount equal to interest at the then applicable nondefault contract rate of interest on the value of the creditor’s interest in the real estate. These payments can be made from rents or other income generated by the property. If the debtor fails to do either, the court shall grant the secured lender relief from the automatic stay so that the lender may exercise its rights and remedies with respect to its collateral. STRATEGIES FOR LENDERS DEALING WITH SARE CASES Most debtors seeking to reorganize want to stay in chapter 11 for as long as possible. Their primary motivation is that the local real estate market will improve or that rents or other income derived from the property will increase thereby facilitating their reorganization. Accordingly, it is not uncommon for a debtor to willfully fail to check the “single asset real estate” box on their bankruptcy petition, even if there is no legitimate basis to assert that the SARE rules do not apply. In that event, the SARE provisions do not come into play unless an interested party seeks a determination from the court that the bankruptcy case should be administered as a SARE case. If the debtor fails to check the SARE box, the secured lender should promptly file a motion requesting that the court determine whether the debtor’s case is a SARE case. This motion should be brought promptly unless additional evidentiary support is required. Such evidence can be obtained at the 341(a) Meeting of Creditors which is an opportunity for any creditor to question the debtor’s representative under oath. Additionally, lenders should consider including within their loan documents representations and warranties where the borrower confirms
Real Estate Alert
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that its asset(s) constitute “single asset real estate” within the meaning of Section 101(51B) of the Bankruptcy Code. Lenders should also include a covenant that the borrower will consent to SARE treatment in a bankruptcy case. Further, real estate lenders will want to carefully consider the structure of their debtors and assets in order to take advantage of the SARE provisions in bankruptcy. While most borrowers will establish special‐purpose entities to hold a single property for tax or liability reasons, if a borrower does not plan on using such a structure, the lender may want to insist on it in the event that the borrower ends up in bankruptcy. A debtor with a number of disparate properties may be able to stretch its bankruptcy case out for 12 to 15 months longer than a comparable SARE bankruptcy case. Ultimately, if the court determines that the SARE provisions apply, then the debtor will have 30 days to file its plan or commence making interest payments. Since the interest payments are based on the nondefault contract rate of interest on the value of the creditor’s interest in the property, some debtors have valued their properties substantially below the current fair market value in order to decrease the amount that the debtor has to pay to the secured lender. This can buy the debtor additional time if the debtor is not ready to proceed with the plan confirmation process. To avoid this inequitable result, secured lenders can seek a valuation of the collateral under the Bankruptcy Code at any time, which will result in an increase in the monthly payment that the debtor is required to pay. Such an increase may be too much for the debtor to bear resulting in a post‐petition default and ideally relief from the automatic stay. Finally, the debtor’s failure to comply with the SARE provisions is just one means for obtaining relief from the automatic stay. Secured lenders may also seek relief from the automatic stay at any time during the bankruptcy case for “cause,” which includes lack of adequate protection, bad faith, or waste. Lenders may also seek relief from the automatic stay if there is no equity in the property and the property is not necessary for an effective reorganization. CONCLUSION The 2005 Act’s elimination of the $4 million cap for SARE cases and the recent economic downturn have brought single asset real estate cases into the forefront of recent reorganization attempts. With proper planning, a lender can take advantage of the SARE provisions to minimize the amount of time to administer the bankruptcy case. While this Alert highlights some of the key aspects of SARE cases, it is not a complete dissertation on the subject and
should not be construed as the provision of legal advice. Please contact us with any questions or if you would like more information.
Ben Seigel, Shareholder Insolvency & Financial Solutions Practice Group 213.891.5006 [email protected].
Michael Williamson, Shareholder Real Estate Practice Group 213.891.5074 [email protected].
Anthony Napolitano, Senior Counsel Insolvency & Financial Solutions Practice Group 213.891.5109 [email protected].
ASSIGNMENTS FOR THE BENEFIT OF CREDITORS: AN ALTERNATIVE TO BANKRUPTCY Benjamin S. Seigel, Esq. INTRODUCTION In good economic times as well as bad some businesses prosper while others falter and close their doors. It is the latter group that often seeks to liquidate by resorting to bankruptcy proceedings under Chapter 7 of Title 11 of the United States Code (referred to in this article simply as the “code”). Federal bankruptcy law requires that individuals and entities follow the provisions established by the Code, the Rules of Bankruptcy Procedure, local bankruptcy court rules, guidelines of the United States Trustee, and the procedural rules established by individual bankruptcy judges. The “debtor” entity must complete lengthy detailed schedules, a complex statement of financial affairs and appear and testify, under oath, at an examination by the bankruptcy trustee responsible for administering the case. Although individual debtors in bankruptcy cases will be able to discharge their unsecured debts, corporate debtors do not obtain a discharge.
AN ALTERNATIVE TO BANKRUPTCY If liquidation of the business is the goal, there is a faster, more efficient and less expensive process known as a common law general assignment for the benefit of creditors (which we will refer to simply as an “Assignment”.) Each state has different laws regulating Assignments. This article will address Assignments under California law. An Assignment is a business liquidation device available to insolvent debtors as an alternative to formal bankruptcy proceedings. It is analogous to a Chapter 7 liquidation proceeding under the Code. An Assignment vests title to all of the debtor's assets in an Assignee who liquidates the debtor's property for cash and then distributes the cash to the debtor's creditors in accordance with priorities established by California law.
ECONOMIC CONSIDERATIONS The filing of a bankruptcy petition requires the payment of a filing fee. No filing fee is paid in an Assignment. Business debtors will generally retain the services of an attorney to guide them through the bankruptcy process. Fees charged by attorneys representing debtors in Chapter 7 cases vary greatly and can run from a few hundred dollars in the simplest cases to several thousand dollars in cases involving the preparation of extensive and complex documentation to support the schedules and statement of financial affairs that must be filed with the court. Fees paid to attorneys for guidance in an Assignment also vary widely. However, after the payment of a modest retainer, there is no
further out‐of‐pocket expense incurred; any fees over the retainer will, in most cases, be paid from the proceeds of the liquidation of the Assignment estate.
ROLE OF THE ASSIGNEE An Assignment is administered by an “Assignee” who may be an individual or an institutional entity. The Assignee is charged with the responsibility of gathering all of the debtor's assets and selling the debtor's right, title and interest in those assets. The debtor, also known as the “Assignor” must turn over and assign all right, title and interest in its assets to the Assignee together with a complete listing of all creditors, their addresses and the amount of indebtedness shown on the debtor's books and records. The Assignee is required to give notice of the Assignment to the creditors and invite each creditor to file a claim in the Assignment estate. The notice must provide a “bar” date, by which all claims must be filed. After the bar date, the Assignee will reconcile the claims and object to those deemed to be improper.
POWERS OF AN ASSIGNEE The Assignee may recover preferential transfers made within 90 days preceding the Assignment and may recover insider preferences made within one year of the assignment in accordance with California law fashioned after similar provisions found in the Code. However, the Ninth Circuit Court of Appeals recently held that preference recovery under California law had been pre‐empted by the federal bankruptcy law. The case has been severely criticized and the California courts recognize and follow the preference recovery provisions of California law. California case law has established that Bankruptcy case law can be used as precedent in Assignment cases. California Assignees have the benefit of laws that will assist them in carrying out their obligations. For example, an Assignee can:
• recover fraudulent transfers in accordance with California law
• enjoin an eviction and is given the right to occupy the debtor's business premises for a period of ninety (90) days after the assignment provided that the monthly rent is paid,
• prosecute and defend claims, as the successor in interest to the Assignor,
• void transfers of personal property of the Assignor which were made without the immediate delivery or change of possession of the property,
• set aside unperfected security interests in personal property,
• terminate attachments and temporary protective orders
made within 90 days of the Assignment,
• avoid a judgment lien obtained after the Assignment,
• transfer a liquor license without violating the rules restricting such transfers,
• avoid compliance with the California Bulk Sales Law found in the California Uniform Commercial Code, as Assignments are specifically exempt.
RISK FACTORS One of the risks inherent in an Assignment is that three unsecured creditors of the debtor might file an involuntary bankruptcy proceeding. In most cases the bankruptcy court will abstain from exercising jurisdiction over the case and will dismiss it if the Assignee can establish that the Assignee's administration of the estate is competent and continued administration by the Assignee will best serve the interests of the creditors.
LIQUIDATION OF ASSETS As a general rule, the Assignee will assemble the Assignor's assets and advertise an auction sale. The assets will be liquidated either piecemeal or in bulk; whichever will yield the highest price. The proceeds are then distributed in accordance with applicable provisions of California law.
ASSIGNMENT‐AND‐IMMEDIATE SALE OF ASSETS Circumstances may arise when a buyer exists for the entire asset pool and the Assignee is convinced that the price the buyer is willing to pay reasonably exceeds that which can be obtained at auction or in a bankruptcy trustee's sale. A prudent Assignee will obtain at least one liquidation appraisal by a recognized appraiser and if the sale price being offered exceeds the appraised liquidation value by a reasonable amount, the Assignment and immediate sale of the assets will go forward. This process often results in the continuation of the assignor’s operations as a going business, continued employment for the employees of the business, continued source of supply to customers and a continued outlet for suppliers.
FEES AND COSTS OF AN ASSIGNMENT Although the fees and costs to the Assignor in an Assignment proceeding are minimal when compared to those that are associated with a Chapter 7 bankruptcy case, an attorney experienced in insolvency matters should be retained by the Debtor to evaluate the financial situation of the business and consider the various options available. If an Assignment is to be the course of action, an Assignee is selected and Assignment documents are prepared, generally by the Assignee. The Assignee's fees and costs are paid from the proceeds of the sale of the assets.
RIGHT, TITLE AND INTEREST The purchaser of the assets will receive an Assignee's bill of sale establishing that the purchaser has received the Assignee's right, title and interest in the purchased assets. The purchaser at an Assignee's sale is best advised to obtain a thorough lien search before consummating such a purchase because the sale is not free and clear of liens, claims and encumbrances as is the case when assets are purchased in a bankruptcy sale.
CONCLUSION Although an Assignment is an economical alternative to a bankruptcy liquidation, not every insolvency situation calls for an Assignment proceeding. Each case must be judged based on the particular facts and circumstances that exist at the time. A trained and experienced insolvency attorney should be retained to perform the required financial analysis and explore all available options.
Mr. Seigel is a Shareholder in Buchalter Nemer's Insolvency and Financial Solutions practice group. He is a frequent writer and lecturer to accountants and attorneys on the subject matter of this article. He is the principal draftsman of legislation enacted in California in 1992 and 1999 regarding Assignments for the Benefit of Creditors.