INSIDE

1. AUTOMATIC STAY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

2. AVOIDING POWERS . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

3. BANKRUPTCY RULES . . . . . . . . . . . . . . . . . . . . . . . . . . 4

4. CASE COMMENCEMENT AND ELIGIBILITY . . . . . . . . 4

5. CHAPTER 11 PLANS . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

6. CLAIMS AND PRIORITIES. . . . . . . . . . . . . . . . . . . . . . . 6

7. CRIMES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

8. DISCHARGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

9. EXECUTORY CONTRACTS . . . . . . . . . . . . . . . . . . . . . . 8

10. INDIVIDUAL DEBTORS . . . . . . . . . . . . . . . . . . . . . . . . 10

11. JURISDICTION AND POWERS OF THE COURT . . . . . 11

12. PROPERTY OF THE ESTATE . . . . . . . . . . . . . . . . . . . . 13

13. TRUSTEES, COMMITTEES AND PROFESSIONALS . . 17

14. TAXES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Bankruptcy Law Update

This update is provided by Skadden, Arps,Slate, Meagher & Flom LLP & Affiliates foreducational and informational purposes onlyand is not intended and should not be con-strued as legal advice. This update may beconsidered advertising under applicable statelaws.

WWW.SKADDEN.COM

SkaddenSkadden, Arps, Slate, Meagher & Flom LLP

& Affi l iatesJuly 2005

RecentDevelopments inBankruptcy Law

(Covering cases reported through July 2005)

by Richard B. Levin, Esq.Partner

Corporate RestructuringLos Angeles Office

300 South Grand AvenueLos Angeles, California 90071

direct dial: 213.687.5940facisimile: 213.621.5940

e-mail: rlevin@skadden.com

TABLE OF CONTENTS

1. AUTOMATIC STAY . . . . . . . . . . . . . . . . . . 1

1.1 Covered Activities. . . . . . . . . . . . . . . 1

1.2 Effect of Stay . . . . . . . . . . . . . . . . . . 1

1.3 Remedies . . . . . . . . . . . . . . . . . . . . . 1

2. AVOIDING POWERS . . . . . . . . . . . . . . . . 1

2.1 Fraudulent Transfers . . . . . . . . . . . . . 1

2.2 Preferences . . . . . . . . . . . . . . . . . . . 2

2.3 Post-Petition Transfers . . . . . . . . . . . 2

2.4 Setoff . . . . . . . . . . . . . . . . . . . . . . . . 3

2.5 Statutory Liens. . . . . . . . . . . . . . . . . 3

2.6 Strong-arm Power . . . . . . . . . . . . . . 3

2.7 Recovery . . . . . . . . . . . . . . . . . . . . . 4

3. BANKRUPTCY RULES . . . . . . . . . . . . . . . 4

4. CASE COMMENCEMENT AND ELIGIBILITY. . . . . . . . . . . . . . . . . . . . . 4

4.1 Eligibility . . . . . . . . . . . . . . . . . . . . . . 4

4.2 Involuntary Petitions . . . . . . . . . . . . 4

4.3 Dismissal . . . . . . . . . . . . . . . . . . . . . 4

5. CHAPTER 11 PLANS . . . . . . . . . . . . . . . . 5

5.1 Officers and Administration . . . . . . . 5

5.2 Exclusivity . . . . . . . . . . . . . . . . . . . . 6

5.3 Classification . . . . . . . . . . . . . . . . . . 6

5.4 Disclosure Statements and Voting. . 6

5.5 Confirmation, Absolute Priority . . . . 6

6. CLAIMS AND PRIORITIES . . . . . . . . . . . 6

6.1 Claims . . . . . . . . . . . . . . . . . . . . . . . 6

6.2 Priorities . . . . . . . . . . . . . . . . . . . . . . 6

7. CRIMES . . . . . . . . . . . . . . . . . . . . . . . . . . 7

8. DISCHARGE . . . . . . . . . . . . . . . . . . . . . . 7

8.1 General. . . . . . . . . . . . . . . . . . . . . . . 7

8.2 Third Party Releases. . . . . . . . . . . . . 7

8.3 Environmental and Mass Tort Liabilities . . . . . . . . . . . . . . . . . . . 7

9. EXECUTORY CONTRACTS . . . . . . . . . . . 8

10. INDIVIDUAL DEBTORS. . . . . . . . . . . . . . 10

10.1 Chapter 13. . . . . . . . . . . . . . . . . . . . 10

10.2 Dischargeability . . . . . . . . . . . . . . . . 10

10.3 Exemptions . . . . . . . . . . . . . . . . . . . 10

10.4 Reaffirmation and Redemption . . . . 11

11. JURISDICTION AND POWERS OF THE COURT . . . . . . . . . . . . . . . . . . . . . . . . 11

11.1 Jurisdiction . . . . . . . . . . . . . . . . . . . . 11

11.2 Sanctions . . . . . . . . . . . . . . . . . . . . . 12

11.3 Appeals . . . . . . . . . . . . . . . . . . . . . . 12

11.4 Sovereign Immunity. . . . . . . . . . . . . 12

12. PROPERTY OF THE ESTATE. . . . . . . . . . 13

12.1 Property of the Estate. . . . . . . . . . . 13

12.2 Turnover . . . . . . . . . . . . . . . . . . . . . . 15

12.3 Sales . . . . . . . . . . . . . . . . . . . . . . . . 15

13. TRUSTEES, COMMITTEES AND PROFESSIONALS . . . . . . . . . . . . . . . . 17

13.1 Trustees . . . . . . . . . . . . . . . . . . . . . . 17

13.2 Attorneys . . . . . . . . . . . . . . . . . . . . . 17

13.3 Committees. . . . . . . . . . . . . . . . . . . 18

13.4 Other Professionals. . . . . . . . . . . . . 18

13.5 United States Trustee . . . . . . . . . . . 19

14. TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Skadden

i

1

Skadden

1. AUTOMATIC STAY

1.1 Covered Activities

1.2 Effect of Stay

1.3 Remedies

2. AVOIDING POWERS

2.1 Fraudulent Transfers

2.1.a. Change in form of ownership interest may result in lack of reasonably equiva-lent value. Before bankruptcy, the general partners in a partnership debtor had transferred theirassets to family limited partnerships, at least in part to shield their assets from creditors. Thetransfers were therefore likely to be actually fraudulent transfers. In dictum, the court statesthey might also be constructively fraudulent transfers. Although the partners received limitedpartnership interests in the family limited partnerships, those interests did not provide reason-ably equivalent value for the assets transferred, and the transfers rendered them insolvent,because creditors could no longer reach the transferred property to satisfy the partners' debts.Bezanson v. Thomas, 402 F.3d 257 (1st Cir. 2005).

2.1.b. Forgiveness of note may be a fraudulent transfer. The debtor forgave $200,000owing on a $561,000 note. Although the forgiveness agreement stated that the forgiveness wasin settlement of disputes between the debtor and the note's maker, there was no evidence of anydispute or any claims that the maker had against the debtor. The forgiveness constituted a"transfer" for purposes of section 548, because it disposed of an interest of the debtor in prop-erty-the claim against the maker-that would have become property of the estate if the debtorhad not forgiven it. Grochocinski v. Reliant Interactive Media Corp. (In re GeneralSearch.com), 322 B.R. 836 (Bankr. N.D. Ill. 2005).

2.1.c. Knowledge of the debtor's fraud to a third party does not defeat "good faith"for purposes of determining "fair consideration." When the lender suspected that the debtorwas engaged in fraudulent accounting practices, inflating sales, receivables and inventory, andthat the principals were looting the company, it did not call a default or accelerate the loan, butit put pressure on the debtor to refinance. The debtor did so, but ultimately failed. Although thenew lenders asked the old lender for information about the debtor, the old lender did notrespond. After bankruptcy, the new lenders sued the old lender under New York's UniformFraudulent Conveyance Law for recovery of the repayment as a constructively fraudulent trans-fer. The UFCA allows avoidance of a transfer that was not made for "fair consideration," whichrequires that the transfer be an exchange of a fair equivalent value, which must be made in goodfaith. Knowledge of the transferor's fraudulent conduct toward third parties (the new lenders)does not defeat the good faith of the old loan repayment, because a preference as between out-sider creditors does not constitute bad faith. Sharp Int'l Corp. v. State St. Bank & Trust Co. (Inre Sharp Int'l Corp.), 403 F.3d 43 (2d Cir. 2005).

2

Skadden

2.2 Preferences

2.2.a. Payments on illegal securities contracts are not "settlement payments." Thedebtor ran a Ponzi scheme. The investment interests were issued in violation of the securitieslaws. Shortly before bankruptcy, one of the investors withdrew a significant portion of hisinvestment. The investor defended against the trustee's preference action by arguing that thepayment was a "settlement payment." The Bankruptcy Appellate Panel concludes the paymentdoes not meet the definition of "settlement payment." The definition lists various kinds of set-tlement payments and concludes, "or any other similar payment commonly used in the securi-ties trade." That phrase defines the scope of the definition. Payments on illegal securities arenot commonly used in the securities trade. Congress enacted the Bankruptcy Code's settlementpayments provisions to protect the proper functioning of the securities markets, to assure theirintegrity, and to enhance enforcement of the securities laws. Recognizing payments on illegalsecurities as settlement payments would undermine that purpose. The payment here was notmade on a public market and did not involve the process of clearing trades. Therefore, the pay-ments are not protected. Kipperman v. Circle Trust F.B.O. (In re Grafton Partners, L.P.), 321B.R. 527 (B.A.P. 9th Cir. 2005).

2.2.b. Financial contract safe harbor does not protect illegal transaction. The debtorhad entered into a contract in the form of a swap, on an ISDA form, to purchase its own sharesat a fixed price at a future date. The contract could be settled in cash or in kind. The debtor wasinsolvent at the time. The transaction was illegal under Oregon law, which prohibits a corpora-tion from purchasing its own shares while insolvent, and makes the directors liable to the cor-poration for the amount paid. The debtor filed bankruptcy within a year after the purchase, andthe trustee sought recovery as a fraudulent transfer or illegal dividend of the payment to thecounterparty, who moved to dismiss on the ground that the payment was protected by the set-tlement payment provision in section 546(e) and the financial contract safe harbor in section546(g). Although those sections are designed to protect settlement payments and swaps toensure the smooth functioning of the financial markets, they do not protect an illegal transac-tion. Protecting such a transaction does not protect the financial markets; it does just the oppo-site. The payment was therefore not a "settlement payment," and the defendant's motion to dis-miss is denied. Enron Corp. v. Bear, Stearns Int'l, Ltd. (In re Enron Corp.), 323 B.R. 857(Bankr. S.D.N.Y. 2005).

2.3 Postpetition Transfers

2.3.a. A policy loan is not a "transfer"; an interest payment is. The debtor maintainedwhole life insurance policies on its executives to fund their supplemental retirement benefits.After bankruptcy, without court approval, the debtor in possession borrowed the entire loan val-ues under the policies and thereafter paid interest to the insurance company on the loanamounts. The trustee sued the insurer for recovery of both transfers as unauthorized postpeti-tion transfers. The policy loan was not a "transfer," because it was only an advance to the pol-icyholder of the reserve value to which the policyholder was absolutely entitled. The interestpayments, however, were transfers, because they decreased the value of the estate and disposedof the estate's property in favor of the insurer and allowed the insurer to earn a return on thepolicy's cash value. The court did not consider whether the insurer had a valid defense or off-set to the recovery to the extent that the interest payment increased the cash surrender value ofthe policy. Devan v. Phoenix Am. Life Ins. Co. (In re Merry-Go-Round Enters., Inc.), 400 F.3d219 (4th Cir. 2005).

3

Skadden

2.4 Setoff

2.5 Statutory Liens

2.6 Strong-arm Power

2.6.a. Lender is not liable for not warning take-out lender of debtor's fraud. Whenthe lender suspected that the debtor was engaged in fraudulent accounting practices, inflatingsales, receivables and inventory, and that the principals were looting the company, it did not calla default or accelerate the loan, but it put pressure on the debtor to refinance. The debtor didso, but ultimately failed. Although the new lenders asked the old lender for information aboutthe debtor, the old lender did not respond. After bankruptcy, the new lenders sued the old lenderfor aiding and abetting the fraud and sought recovery of the amount of their new loan plus theamount that the principals had looted after the new loan was made. A claim for aiding and abet-ting under New York law requires that the defendant had actual knowledge of a fiduciary'sbreach of obligations and actively induced or participated in the breach. Here, the mere knowl-edge or suspicion of the breach, even coupled with the pressure to refinance the old loan, didnot amount to active inducement or participation in the breach. The breach had existed beforeold lender learned of it and continued thereafter. The old lender therefore did not induce. Inaddition, the old lender had no duty to the new lenders, and it did not make any misrepresenta-tions to the new lenders. It merely refused to reveal what it knew. It was fully entitled to pro-tect its own interests in seeing its loan repaid and is not liable for aiding and abetting. SharpInt'l Corp. v. State St. Bank & Trust Co. (In re Sharp Int'l Corp.), 403 F.3d 43 (2d Cir. 2005).

2.6.b. Lender is not liable for not warning the banking regulator or other creditorsof the debtor's fraud. The debtor's principal embezzled substantial funds from the debtor. Itsbank lender suspected a problem, stopped advancing, and collected all of its outstanding loans,without advising either its banking regulators or the debtor's other lenders of its suspicions ofthe crimes afoot or of the potential uncollectability of the loans. Because the bank was underno duty to warn other lenders and neither participated in the borrower's embezzlement normade any fraudulent statements to its regulators or to any of the other lenders, it is not liable tothe other lenders for their losses. It received a preference, no more, which is not recoverableoutside of bankruptcy. B.E.L.T. Inc. v. Wachovia Corp., 403 F.3d 474 (7th Cir. 2005).

2.6.c. Settlement proceeds are payment intangibles or, alternatively, proceeds. Thedebtor's dairy cows were destroyed by a faulty electric fence. The debtor sued and recovered asettlement payment from the fencing company. The bank had a security interest in the cows andin all after-acquired property, including payment intangibles. The debtor argued that that actionagainst the fencing company sounded in tort and therefore was not subject to the bank's secu-rity interest. Under UCC Revised Article 9 § 9-204(b)(2), an after-acquired property clausecannot reach a future commercial tort claim, which is not a general intangible under UCCRevised Article 9 § 9-102(a)(42). However, once the action settles and the defendant becomescontractually obligated to pay, the obligation becomes a payment intangible that is subject tothe bank's after-acquired property clause. Alternatively, the settlement payment was collateral

4

Skadden

proceeds, which includes rights arising from loss or damage to collateral, under UCC § 9-102(a)(64)(D). Wiersma v. O.H. Kruse Grain & Milling (In re Wiersma), 324 B.R. 92 (B.A.P.9th Cir. 2005).

2.7 Recovery

2.7.a. Section 550(a)(1) requires direct benefit for liability. The debtors sold theirassets to a financing entity. The proceeds were used to pay off existing loans and to buy out oneof the shareholders for $100,000. A new entity, 100% owned by the other shareholder, leasedthe assets back from the financing entity. After the debtors later filed bankruptcy, the trusteesought recovery of the $100,000 as a fraudulent transfer from the new entity's shareholder onthe ground that by becoming the sole shareholder of the new entity, which controlled thedebtor's former assets and business, the sole shareholder had received a benefit from thedebtor's $100,000 transfer to the selling shareholder. The benefit was, however, indirect, inci-dental, and unquantifiable, unlike the paradigm case of the benefit to a guarantor when a debtorpays a guaranteed loan. The transfer could not be recovered from the sole shareholder, becauseit was not direct, ascertainable, and quantifiable. Reily v. Kapila, 399 F.3d 1288 (11th Cir.2005).

3. BANKRUPTCY RULES

3.1.a. Objection to claim may be served on attorney designated in "notice" box ofclaim form. A creditor asserted a personal injury claim against the debtor based on an accidentthat occurred only a month before the bankruptcy. The proof of claim form listed the creditor'sattorney in the box on the proof of claim form (Official Form 10B) that asks where noticesregarding the claim should be sent. The creditor signed the form and put her own address in thesignature block. The debtor in possession objected to the claim but mailed the objection onlyto the attorney, who claimed not to have received the objection. Service was adequate, becauseRule 9014, which governs contested matters "not otherwise provided for by these Rules" andrequires service in accordance with Rule 7004, does not apply, because Rule 3007 governsobjections to claims. Rule 3007 requires only notice to the claimant, not service. Jorgenson v.State Line Hotel, Inc. (In re State Line Hotel, Inc.), 323 B.R. 703 (B.A.P. 9th Cir. 2005).

3.1.b. Notice to creditor's attorney is not necessarily adequate notice to the creditor.The debtor sent notice of the claims filing bar date to the creditor's law firm, without identify-ing the firm's client in the notice. The notice was insufficient, because it was not reasonablycalculated to reach the creditor. The law firm is not required to search its client files when itreceives such a notice to determine who the creditor might be, if the law firm is not a creditor.In re Greater Southeast Comty. Hosp., 324 B.R. 162 (Bankr. D.D.C. 2005).

4. CASE COMMENCEMENT AND ELIGIBILITY

4.1 Eligibility

4.2 Involuntary Petitions

4.3 Dismissal

5

Skadden

4.3.a. Russian oil company's chapter 11 case is dismissed under "totality of circum-stances" test. Yukos Oil Co., Russia's largest oil company with very limited U.S. contacts orassets, filed a chapter 11 case in Texas to stay the Russian government's seizure of assets to payclaimed tax debts. The bankruptcy court rejects dismissal on jurisdictional grounds, holdingthat Yukos's U.S. property is sufficient to confer jurisdiction. It rejects dismissal on forum nonconveniens grounds, holding that doctrine inapplicable to an entire bankruptcy case (as opposedto a proceeding within the case). It similarly concludes that comity is not a ground to dismissan entire case and that despite the involvement of the Russian government, the act of state doc-trine does not apply. However, based on the totality of the circumstances, the court dismissesunder section 1112(b). The assets that created jurisdiction were transferred to the U.S. only daysbefore the filing. The proposed reorganization is not a financial reorganization, and since mostof its assets were oil and gas assets located in Russia, a reorganization without Russian govern-ment cooperation would have been futile. Yukos sought to substitute U.S. law for Russian andinternational arbitration laws in its dispute with the Russian government. Under the circum-stances, the court dismisses the case. In re Yukos Oil Co., 321 B.R. 396 (Bankr. S.D. Tex. 2005).

5. CHAPTER 11

5.1 Officers and Administration

5.1.a. An examiner's report should not be sealed. Section 107(b)(2) permits the courtto seal a document that contains scandalous or defamatory matter. The authority should be usedsparingly because of the importance of public access to court papers, and the burden on therequesting party is high. Bankruptcy Rule 9018 does not expand the court's authority. Materialthat is scandalous or defamatory is "material that would cause a reasonable person to alter their[sic] opinion of [a party] based on the statement therein." True information cannot qualify asscandalous or defamatory. The fact that the report might embarrass some individuals or harmtheir reputations is not adequate grounds to seal the report, as long as the information is true orappropriately described as preliminary investigatory results. The report met those requirementshere and should not be sealed. In re Gitto/Global Corp., 321 B.R. 367 (Bankr. D. Mass. 2005).

5.1.b. DIP financing agreement restriction on plan filing is permissible. Some but notall of the debtor's prepetition secured lenders provided debtor in possession financing, securedby a priming lien. The DIP financing agreement required the debtor to file a plan by a speci-fied date that was acceptable to two-thirds in amount and a majority in number of the prepeti-tion secured lenders. The court approves the requirement. It is not an improper lock-up agree-ment and is not an improper postpetition solicitation without a disclosure statement, because itdoes not commit the prepetition lenders to vote for a particular plan. It does not eliminate theability of the debtor to cram down the prepetition lenders, because as written, it permits the DIPlenders only to stop funding the DIP loan if the debtor does not comply with the provision. Itdoes not violate the "deemed acceptance" provision of section 1126(f) as applied to a class thatis not impaired, for the same reason. Finally, it does not prevent the debtor in possession fromcarrying out its fiduciary duties. It does not require the debtor in possession to cede control overits operations, plan formulation, or general chapter 11 case management to the lenders. Thecourt finds that the provision was intensely negotiated and critical to the DIP lenders' willing-ness to lend and should not be upset. Official Comm. of Unsecured Creditors v. New WorldPasta Co., 322 B.R. 560 (M.D. Pa. 2005).

6

Skadden

5.2 Exclusivity

5.3 Classification

5.4 Disclosure Statements and Voting

5.5 Confirmation, Absolute Priority

5.5.a. Cows are not the indubitable equivalent of cash. The debtor's dairy cows weredestroyed by a faulty electric fence, and the debtor's operation failed. The debtor in possessionrecovered from the fencing company and proposed a plan that would use the cash recovery topurchase replacement cows and restart the operation. The bank, who had a security interest inthe cash proceeds of the settlement, objected that the plan did not meet the requirements of sec-tion 1129(b)(2)(A)(iii), which requires that a plan that crams down a secured creditor providethe creditor the indubitable equivalent of its claim and lien. Because the creditor's collateral hadbeen converted to cash, the creditor was entitled to the cash. A lien on cows would be too riskybecause, among other things, there would be no equity cushion in case of adverse businessevents. The court therefore denies plan confirmation. Wiersma v. O.H. Kruse Grain & Milling(In re Wiersma), 324 B.R. 92 (B.A.P. 9th Cir. 2005).

6. CLAIMS AND PRIORITIES

6.1 Claims

6.1.a. Administrative claims are not entitled to interest in a surplus chapter 7 case.The trustee sought interest on his fees in a surplus chapter 7 case. Section 726(a)(5) requires"payment of interest at the legal rate from the date of the filing of the petition, on any claimpaid under paragraph (1)." Section 726(a)(1) provides for payment of claims described in sec-tion 507. The majority view permits interest only from the date the fees are allowed, despite theliteral language of the statute. The minority view follows the literal language and permits inter-est from the petition date on administrative claims. However, section 726(a)(1) applies only toa claim, "proof of which is timely filed under section 501." Because section 501 does not applyto administrative claims, which are filed under section 503, section 726(a)(5) does not apply,and interest is not payable at all. Tarbox v. United States Trustee (In re Reed), 405 F.3d 338 (5thCir. 2005).

6.2 Priorities

6.2.a. Workers compensation carrier's premium claim is entitled to priority undersection 507(a)(4). In a per curiam decision, the Fourth Circuit follows the Ninth Circuit anddisagrees with the Sixth, Eighth, and Tenth Circuits in ruling that unpaid workers compensa-tion insurance premiums incurred in the 180-day period before bankruptcy are entitled to the"contribution to an employee benefit plan" priority of section 507(a)(4). The 2-1 decision pro-duced three opinions. One concludes that the phrase "contribution to an employee benefit plan"unambiguously includes workers compensation insurance premiums because the insurance isfor the benefit of the employees. The other two conclude that the phrase is ambiguous and crit-icize the first opinion for selective review of dictionaries to find otherwise. They both reviewthe legislative history but reach opposite conclusions on whether the premiums are included.One relies in part on an analogy to ERISA to conclude that workers compensation insurance isan employee benefit plan. The other argues that priorities are to be narrowly construed and that

7

Skadden

the insurance protects the employers from statutory workers compensation liability, not theemployee. Howard Delivery Serv., Inc. v. Zurich Am. Ins. Co. (In re Howard Delivery Serv.,Inc.), 403 F.3d 228 (4th Cir. 2005).

6.2.b. Unpaid health insurance premiums for COBRA coverage are entitled to pri-ority. The debtor had terminated numerous employees well before bankruptcy. Many of themmaintained COBRA coverage after termination through the debtor's health insurance providerand paid the debtor for their coverage. The health insurance provider was unpaid at the time ofthe debtor's bankruptcy for coverage within the 180 days before bankruptcy. Based on theFourth Circuit's recent decision granting section 507(a)(4) priority to workers compensationinsurance claims, the court grants priority to the health insurance provider's claim. The courtconstrues "for services provided within 180 days before" bankruptcy as applying to theprovider's, not the just employees', services. Ivey v. Great-West Life & Annuity Ins. Co. (In reJ.G. Furniture Group, Inc.), 405 F.3d 191 (4th Cir. 2005).

6.2.c. Disappointed bidder's expenses are not limited by break-up fee standard. Adisappointed bidder sought reimbursement of its expenses (attorney's fees and expenses) undersection 503(b)(1) as an administrative expense claim because its activities conferred a benefiton the estate. The allowable amount is limited only by the reasonableness of the expenses, notby the typical percentage analysis that is applied to a break-up fee. AgriProcessors, Inc. v.Fokkena (In re Tama Beef Packing, Inc.), 321 B.R. 496 (B.A.P. 8th Cir. 2005).

7. CRIMES

8. DISCHARGE

8.1 General

8.1.a. Post-confirmation loan is dischargeable upon conversion to chapter 7. Thecreditor loaned the debtor money to consummate the chapter 11 plan. The plan ultimatelyfailed, and the creditor successfully moved to convert the case to chapter 7. The creditor alsosued the debtor in state court to collect the loan. The debtor asked the bankruptcy court toenjoin the creditor from suing on the debt, arguing that it was discharged in the chapter 7 case.The injunction was proper. Because section 348(d) treats post-chapter 11, pre-conversion debts(other than for purposes of section 503) as though they arose before the date of the filing of thepetition, the debt is discharged. The chapter 11 trustee had abandoned some property to thedebtor during the chapter 11 case. The property was not dealt with in the chapter 11 plan andwas therefore not available for distribution in the subsequent chapter 7. The fact that less thanall of the debtor's property was available for creditors in the chapter 7 case does not change theresult on the discharge issue. Murdock v. Holquin, 323 B.R. 275 (N.D. Cal. 2005).

8.2 Third-Party Releases

8.3 Environmental and Mass Tort Liabilities

8

Skadden

9. EXECUTORY CONTRACTS

9.1.a. Whether a contract is executory is not necessarily determined as of the peti-tion date. The debtor had entered into an agreement with a developer for the construction andsale-leaseback of a retail store. After bankruptcy, the developer completed construction and ten-dered the purchase price and the previously agreed form of lease to the debtor in possession.The debtor in possession moved to reject the contract. Although the contract may have beenexecutory as of the commencement of the case, whether it was an executory contract that couldbe rejected under section 365 should be determined as of the date of the motion to reject. Bythen, the only remaining performance was the debtor in possession's, not the developers.Although the developer had remaining obligations — it had not yet actually paid the purchaseprice or leased the property to the debtor — it had been prevented from doing so only by thedebtor in possession's refusal. Under contract law, a party may not deprive another of contrac-tual rights by virtue of its own breach. Under the Countryman test, a contract is executory if itis so far unperformed that the nonperformance by one party would excuse performance by theother. Because of the debtor in possession's refusal to perform was a breach of the contract, thedeveloper's nonperformance did not excuse the debtor's nonperformance, because it was thedebtor in possession that prevented the developer from performing. Therefore, the contract wasnot executory and could not be rejected. In re Penn Traffic Co., 322 B.R. 63 (Bankr. S.D.N.Y.2005).

9.1.b. The "hypothetical test" does not apply to a debtor in possession's assumptionof a contract or lease. The debtor's lease contained a standard ipso facto clause, allowing thelessor to terminate upon the lessee/debtor's bankruptcy filing. The debtor in possession movedto assume the lease. Section 365(c)(1) provides that "a trustee may not assume or assign" anexecutory contract or unexpired lease if applicable law excuses the non-debtor party "fromaccepting performance from . . . an entity other than the debtor or the debtor in possession."This limitation does not apply to a debtor in possession's assumption of a contract of lease.Although section 1107(a) grants a debtor in possession all of the rights and powers of a trustee,"subject to any limitations on a trustee," a debtor in possession is not the equivalent of a trustee.Because a trustee is an entity other than the debtor in possession, section 365(c)(1) must be readdifferently when a debtor in possession moves to assume (although not to assign) a contract orlease. Otherwise, the section 365(c)(1) limitation would effectively read "a debtor in possessionmay not assign a contract if the counterparty is excused from accepting performance from anentity other than the debtor in possession." Such a reading would be nonsensical. Therefore, thedebtor in possession may assume a contract, despite an ipso facto clause. In re Footstar, Inc.,323 B.R. 566 (Bankr. S.D.N.Y. 2005). By the same reasoning, the non-debtor counterparty maynot terminate the contract or lease, despite section 365(e)(2). Although section 365(e)(2) wasnot amended in 1984 in parallel with the amendment to section 365(c)(1), the result is the same.The lessor cannot be excused from accepting performance from the trustee (as provided in sec-tion 365(e)(2)). Section 365(e)(2) does not apply because there is no trustee, and the sectioncannot be applied hypothetically without confounding Congress' intent to prevent enforcementof ipso facto clauses. In re Footstar, Inc., Case No. 04 B 22350 (ASH) (Bankr. S.D.N.Y. May10, 2005).

9

Skadden

9.1.c. Federal law determines that section 365 applies only to true leases; state lawdetermines whether a lease is a true lease. The debtor leased facilities from the city for a rentthat equaled the debt service on the municipal bonds that the city issued to finance the con-struction of the facilities. The debtor in possession challenged the lease, claiming it was a dis-guised financing, and that section 365 therefore does not apply. Whether the word "lease" insection 365 applies to transactions that are leases in form or only in substance is a question offederal law. Congress intended section 365 to apply only to true leases, that is, leases that havethe economic substance of a lease, not just the form. However, state law determines whether theeconomic substance of a particular lease is of a true lease or of a secured financing (unless statelaw looked only to form, because that would conflict with Congressional policy in section 365).California law applies to this transaction. It should be determined by state court decisions,rather than bankruptcy court decisions. Under California law, the lease is a secured financing:The rent is measured by the amount borrowed and is payable whether or not the tenant contin-ues to occupy the facility. The payment includes interest only during the term of the lease anda balloon payment at the end. The debtor acquired the facility at the end of the lease for no addi-tional consideration, and the lease terminates early if the debtor pays off the entire loan amount.United Air Lines, Inc. v. HSBC Bank USA, No. 04-4209 (7th Cir. July 26, 2005).

9.1.d. "Economic realities" test does not apply to determination of true lease. Thedebtor leased facilities from the city for a rent that equaled the debt service on the municipalbonds that the city issued to finance the construction of the facilities. The debtor in possessionchallenged the lease, claiming it was a disguised financing. The district court overrules thebankruptcy court's application of the economic realities test to determine whether the transac-tion is a true lease or a disguised financing. Instead, applicable nonbankruptcy law applies.Under applicable Colorado law here, the intent of the parties at the time of the transaction deter-mines the characterization of the transaction. The most important factor is whether the lesseeobtains any equity in the leased property, such as through a below-market or nominal price pur-chase option. Here, the debtor/lessee had no such equity, so the transaction was a true lease.United Air Lines, Inc. v. HSBC Bank USA, 322 B.R. 347 (N.D. Ill. 2005), but see United AirLines, Inc. v. HSBC Bank USA, No. 04-4209 (7th Cir. July 26, 2005).

9.1.e. Personal property lessor's postpetition claim under the lease is an administra-tive expense. The debtor leased a telephone system. The debtor in possession stopped payingon the lease after the chapter 11 filing and stopped using the system during the chapter 11 case.The lessor did not seek payment until 13 months after the filing. The lessor was entitled to aclaim under section 365(d)(10) for the entire period during the chapter 11 case commencing 61days after the order for relief, even though it did not seek payment earlier. The lessor nowsought immediate payment of the amount owing. The court notes the majority view, whichholds that a personal property lessor is entitled to an administrative expense claim that arisesdirectly under section 365(d), not under section 503(b), because section 365(d) says that the les-sor is entitled to a claim "notwithstanding section 503(b)(1)," and the minority view, whichholds that the lessor does not have an administrative expense claim, but only an obligation ofthe trustee, which the lessor must either seek to enforce or lose. The court tracks a middlecourse, finding that the lessor has an administrative expense claim under section 503(b), notunder section 503(b)(1) which bases the claim on "use and occupancy" of leased premises.Otherwise, the lessor could not be paid under the Bankruptcy Code's priority scheme, becausesection 507 provides for first priority only for administrative expenses allowed under section503. The lessor is therefore to be treated to the same as other administrative expense claimants.Its claim is not necessarily entitled to immediate payment during the case, because a general

10

Skadden

administrative expense claim is not entitled to superpriority, and the claim is subordinated tochapter 7 administrative expenses under section 726(b). In addition, the bankruptcy court maynot make an equitable adjustment under section 365(d)(10) of the lessor's claim when thetrustee fails to perform. The court may modify only the trustee's actual performance, includingthe trustee's ongoing payment obligation. CIT Communications Fin. Corp. v. Midway AirlinesCorp. (In re Midway Airlines Corp.), 406 F.3d 229 (4th Cir. 2005).

9.1.f. Lessor collaboration to collect postpetition aircraft lease payments under sec-tion 1110 does not violate the antitrust laws. The bankruptcy judge enjoined aircraft lessorsfrom taking possession of aircraft under section 1110, because the debtor in possession assert-ed that by acting in concert to collect amounts owing, the lessors violated the antitrust laws.Characterizing that claim as "thin to the point of invisibility," the court concludes that compe-tition occurs at the time credit is extended and would continue during the chapter 11 case byallowing the debtor in possession and the lessor to compete in the market for leasing aircraft.Allowing the debtor in possession to assert an antitrust claim here would result in a monopsony,by prohibiting the lessor from dealing with any other potential lessees for the aircraft. UnitedAirlines, Inc. v. U.S. Bank N.A., 406 F.3d 918 (7th Cir. 2005).

10. INDIVIDUAL DEBTORS

10.1 Chapter 13

10.1.a. Rents are real property collateral for purposes of the section 1322(b)(2) anti-modification clause. Section 1322(b)(2) prohibits modification under a chapter 13 plan of amortgage that is secured solely by real property that is the debtor's principal residence. In thiscase, the lender took a second mortgage on the debtor's principal residence and on rents. Underapplicable New Jersey law, rents are real property. They therefore do not disqualify the mort-gage from the anti-modification provision of section 1322(b)(2). In addition, an escrow that thelender maintains for taxes and insurance does not disqualify the mortgage from protection,because the debtor retains no interest in the escrowed property, and it is therefore not collater-al for the loan. In re Ferandos, 402 F.3d 147 (3d Cir. 2005).

10.2 Dischargeability

10.3 Exemptions

10.3.a. An IRA is exempt. The debtors had interests in IRAs, which they attempted toexempt under section 522(b)(10)(D), which exempts "a right to receive a payment under a stockbonus, pension, profitsharing, annuity, or similar plan or contract on account of illness, disabil-ity, death, age or length of service." The trustee argued that the debtors could withdraw fundsfrom their IRAs at any time, subject only to a 10% tax penalty, so withdrawals from an IRA arenot based on age. The Supreme Court rules that the tax penalty is a substantial restriction onearly withdrawal, so that the right to receive payment under the plan is on account of age. AnIRA is "similar" to a pension plan for the same reason. It is intended as income replacementafter retirement. Therefore, the IRAs are exempt. Rousey v. Jacoway, 125 S. Ct. 1561 (2005).

10.3.b. Florida homestead withstands attack from creditor asserting sanctions claimunder section 303(i); judicial lien may be avoided. The debtor had filed an involuntary peti-tion in bad faith against JRH in Michigan. The Michigan bankruptcy court dismissed the peti-tion and awarded over $4 million in sanctions against the debtor under section 303(i). The

11

Skadden

debtor promptly bought a homestead in Florida for $2.8 million. The Michigan bankruptcycourt found that the Florida property did not qualify as a homestead, because the sanctionsorder under section 303(i) preempted Florida homestead law, and ordered the debtor to sell theproperty to satisfy the sanctions award. When the debtor could not obtain a stay pending appealof the Michigan order, he filed a chapter 11 case in Florida. The Florida bankruptcy courtupholds the exemption claim despite the Michigan court's prior ruling, because the sanctionsorder is no different from an ordinary money judgment, which would not preempt the home-stead law. In re Adell, 321 B.R. 562 (Bankr. M.D. Fla. 2005). In addition, JRH had obtained ajudgment lien against the real property under Florida law. The debtor sought to avoid it undersection 522(f)(1). The debtor may avoid the lien, no matter what its source or the nature of theunderlying claim, for example, even if the claim were nondischargeable. Therefore, the lienmay be avoided under section 522(f)(1). In re Adell, 321 B.R. 573 (Bankr. M.D. Fla. 2005).

10.4 Reaffirmation and Redemption

11. JURISDICTION AND POWERS OF THE COURT

11.1 Jurisdiction

11.1.a. Bankruptcy jurisdiction does not extend to action by a tort victim against adebtor's insurer on a prepetition insurance settlement. A tort victim sued the debtor beforebankruptcy. The debtor's insurer defended and, before bankruptcy, settled and agreed to pay thevictim. Before payment was made, the debtor filed chapter 11. The insurer then refused to pay,arguing that the tort action was stayed. The victim sued in state court. The insurer removed thesuit to the United States district court. The district court remanded because it does not havejurisdiction. The action does not arise under title 11, because it existed independently of thebankruptcy case before the case was filed. It does not arise in the title 11 case, because it doesnot arise during the bankruptcy case and concern the administration of the estate. Finally, theaction is not related to the title 11 case. Although an insurance policy and its proceeds are nor-mally property of the estate, in this case, it appears that the settlement amount was less than thedebtor's self-insured retention under the policy, so the insurer's payment of the settlementamount does not implicate the policy at all. Moreover, the insurance company's obligation tothe tort victim under the settlement agreement is independent of any obligation the debtor mayhave to the victim. Wetzel v. Lumberman's Mut. Cas. Co., 324 B.R. 333 (S.D. Ind. 2005).

11.1.b. Mandatory abstention applies in a removed action. Section 1334(c)(2) requiresa district court to abstain from hearing a non-core proceeding if, among other things, "an actionis commenced, and can be timely adjudicated, in a State forum of appropriate jurisdiction."Once an action is removed, it is no longer pending in the state court. However, the action waspreviously "commenced," even though not currently pending, so section 1334(c)(2) mandatoryabstention applies to removed actions. This conclusion follows decisions from the Fifth, Sixth,and Eleventh Circuits and splits with the Ninth Circuit. Mt. McKinley Ins. Co. v. Corning Inc.,399 F.3d 436 (2d Cir. 2005).

11.1.c. Arbitration clause is enforceable in a non-core proceeding. The debtor was adistributor of medical products. The trustee sued the debtor's former supplier in the RhodeIsland bankruptcy court for breach of the distribution agreement, which provided for arbitra-

12

Skadden

tion in Tennessee, claiming that arbitration in Tennessee would be inconvenient and expensive.The bankruptcy court ordered arbitration, but in Rhode Island. The supplier appealed. In thisnon-core proceeding, the trustee stands in the debtor's shoes and is bound by the arbitrationclause. Inconvenience and expense are not adequate reasons to disregard a forum selectionclause. Therefore, arbitration must proceed in Tennessee. Furness v. Wright Med. Tech., Inc. (Inre Mercurio), 402 F.3d 62 (1st Cir. 2005).

11.1.d. A core proceeding need not be arbitrated. The debtor and its principals, some ofwhom were foreign, had entered into international arbitration agreements for any dispute aris-ing out of their relationships. After bankruptcy, the foreign principals initiated an arbitrationproceeding in London. The U.S. principal, who had advanced substantial funds to the debtor,filed an adversary proceeding in the bankruptcy court to establish his claim and to enjoin thearbitration. The Convention on Recognition and Enforcement of Foreign Arbitral Awards, Dec.29, 1970, 21 U.S.T. 2517, implemented by the federal Arbitration Act, 9 U.S.C. § 1 et seq.,requires that the dispute be arbitrated unless Congress determined that the kind of disputeshould be heard in the courts. An inherent conflict between domestic law and the Conventionis a ground for refusing arbitration. The bankruptcy law contemplates centralization of all dis-putes relating to claims against a debtor's assets in the bankruptcy court as core proceedings.Arbitration would conflict with this policy. Therefore, enjoining the arbitration proceeding andhearing the dispute in the bankruptcy court is proper. Mowbay, L.L.C. v. White Mtn. Mining Co.(In re White Mtn. Mining Co.), 403 F.3d 164 (4th Cir. 2005).

11.1.e. Tax Court may properly defer to the bankruptcy court on automatic stayissue. The IRS applied a payment from the debtor's wife's property on dischargeable taxes. Thedebtor sought internal IRS review, claiming, among other things, that the application of the pay-ment violated the automatic stay. Although the Tax Court may determine whether the automat-ic stay applies in particular cases, this case presented an especially complex set of facts. TheTax Court believed that the bankruptcy court would have better expertise on the issue anddeferred. Deferral under these circumstances is not an abuse of discretion. Meadows v. Comm'r,405 F.3d 949 (11th Cir. 2005).

11.2 Sanctions

11.3 Appeals

11.3.a. Denial of mandatory abstention is reviewable, even in the context of a refusalto remand. Under section 1452(b), a district court's decision on a motion to remand is notreviewable, by appeal or otherwise. Under section 1334(d), a district court's decision on amotion to abstain is similarly not reviewable, except that an order denying mandatory absten-tion under section 1334(c)(2) is reviewable. What if the district court denies remand on theground that mandatory abstention is not required? The Second Circuit rules that to give effectto both provisions, the order is reviewable. It reasons that after a reversal of a decision not toabstain, the district court might decide to remand. The appellate court's review would have beenonly of the abstention decision, not of the remand, so the appellate review does not violate sec-tion 1452(b). Mt. McKinley Ins. Co. v. Corning Inc., 399 F.3d 436 (2d Cir. 2005).

11.4 Sovereign Immunity

11.4.a. Section 106(b) does not impose a claim "maturity" requirement to qualify asa compulsory counterclaim for sovereign immunity waiver purposes. The debtor's non-

13

Skadden

debtor subsidiary contracted to build a steel mill. The debtor guaranteed completion, posted aletter of credit to secure the guarantee, and posted cash collateral with the letter of credit issuerto secure the reimbursement obligation under the letter of credit. A dispute arose over comple-tion before the debtor's bankruptcy. Once the debtor filed chapter 11, the letter of credit issuerfiled a proof of claim. Sometime later, the debtor's customer drew the letter of credit. Thedebtor in possession sued, based on the allegedly improper letter of credit draw, to recover thecollateral. The issuer, International Finance Corp., an entity that is immune under theInternational Organizations Immunity Act, asserted sovereign immunity as a defense to theclaim and claimed that the waiver effected by its earlier filing of a proof of claim related to thistransaction did not meet the "compulsory counterclaim" requirement of section 106(b) for awaiver, because the debtor in possession's claim did not exist at the time IFC filed its proof ofclaim. Rule 13(b) of the Fed. R. Civ. P. requires the filing of any counterclaim "which at thetime of serving the pleading the pleader has against any opposing party, if it arises out of thetransaction or occurrence that is the subject matter of the opposing party's claim." However,section 106(b) does not impose a similar "maturity" requirement, so it applies even where, ashere, the counterclaim arose after the filing of the proof of claim. Int'l Fin. Corp. v. KaiserGroup Int'l, Inc. (In re Kaiser Group Int'l, Inc.), 399 F.3d 558 (3d Cir. 2005).

12. PROPERTY OF THE ESTATE

12.1 Property of the Estate

12.1.a. Claim related to improper letter of credit draw may be property of the estate.The debtor's non-debtor subsidiary contracted to build a steel mill. The debtor guaranteed com-pletion, posted a letter of credit to secure the guarantee, and posted cash collateral with the let-ter of credit issuer to secure the reimbursement obligation under the letter of credit. A disputearose over completion, the customer drew the letter of credit, and the issuer applied the collat-eral to the debtor's reimbursement obligation. The debtor in possession sued to recover the col-lateral. The claim is property of the estate. Although the letter of credit and its proceeds are notproperty of the estate, the collateral, which the debtor posted, and the claim to recover it basedon the improper draw are property of the estate over which the bankruptcy court has jurisdic-tion. Int'l Fin. Corp. v. Kaiser Group Int'l, Inc. (In re Kaiser Group Int'l, Inc.), 399 F.3d 558 (3dCir. 2005).

12.1.b. Funds were not property of the debtor where the debtor had only possession,not dominion or control. The debtor provided a service for freight shippers. It accumulatedbills from their carriers each week, allowing its customer the shipper to make only one paymenteach week to the debtor, who would issue separate checks to each of the carriers. Under thedebtor's contract with the shipper, the shipper would wire transfer the funds to the debtor eachMonday, and the debtor would issue and mail checks to the carriers Monday evening. Thedebtor was not prohibited under the contracts from commingling shippers' funds. Shortlybefore bankruptcy, the debtor started taking advantage of the float and not issuing or mailingchecks for up to 3 weeks, unless the shipper complained. One shipper did so, and the debtorissued and mailed $4.5 million of checks for this shipper within 90 days before bankruptcy. Thepayments were not a preference to the shipper, however, because the funds that the shipperadvanced were never "property of the debtor," as section 547(b) requires for preference liabil-ity. Although the debtor could (and did) divert shippers' funds to its own uses, it did so withoutauthority. It did not properly have dominion and control over the funds but was more like abailee, who has only a possessory interest. In a footnote, the court questions whether the ship-

14

Skadden

per is even a creditor, musing that because the debtor had used the shipper's funds to pay thecarriers on time, a debt (which arises only when an obligation is part due) had not arisen. Lyonv. Contech Constr. Prods., Inc. (In re Computrex, Inc.), 403 F.3d 807 (6th Cir. 2005).

12.1.c. Controlling customers may be liable for breach of fiduciary duty and relatedclaims. The debtor supplied parts to the automotive industry. When its costs of goods rose andits customer contracts became unprofitable, its three major customers asserted substantial con-trol over its operations, brought in a turnaround management firm, which operated the debtor'sbusiness for the benefit of the customers, caused the debtor to enter into an AccommodationAgreement with the debtor's lender that resulted in the reduction of the lender's exposure, thelender's forbearance from exercising remedies, and a substantial increase in the customers' ownaccounts receivable from the debtor. The debtor's sole shareholder cooperated in the processand before the debtor's bankruptcy established a new corporation that subsequently took overthe debtor's assets and customers. Within about 6 months, the debtor filed a chapter 7 case.After bankruptcy, the new corporation sold its assets to an unrelated third party in a transactionthat the customers arranged, and the proceeds were used to pay the customers' accounts receiv-able from the debtor. The debtor's trustee sued the controlling customers, the debtor's soleshareholder, and the turnaround firm on numerous theories. In ruling on the defendants'motions to dismiss the complaint, the court made the following rulings. Being an "insider"under the Bankruptcy Code does not impose any fiduciary duties. However, under Tennesseelaw, a defendant that actually exercises domination and control over a corporation may owefiduciary duties to the corporation the same as the directors or a majority shareholder. A defen-dant who owes a fiduciary duty to a corporation may be liable for the tort of deepening insol-vency under Tennessee law, which is an actionable breach of fiduciary duty when it results indissipation of assets that would otherwise be available for creditors, when debts are inflatedwithout regard to the best interest of the corporation, and when the controlling defendants'debts are selectively paid. A claim for breach of fiduciary duty belongs to the corporation, sothe trustee has standing under section 541 to bring the claim, to the exclusion of creditors. Thein pari delicto defense is not available where the defendants so dominated and controlled thedebtor that the debtor was not the principal wrongdoer but the controlling defendants causedthe wrongs that the debtor may have perpetrated. The debtor's payment of its law firm's fees inconnection with the Accommodation Agreement was for the benefit of the customers and sowas potentially recoverable as a preference from the customers. Finally, under Tennessee law, acorporation may not assert a claim against its shareholder under an alter ego theory, so thetrustee may not assert such a claim under section 541, nor is it a claim sufficiently common toall creditors that the trustee may assert it under section 544(a). Limor v. Buerger (In re Del-MetCorp.), 322 B.R. 781 (Bankr. M.D. Tenn. 2005).

12.1.d. In pari delicto defense does not apply where only two of three directors partic-ipated in the breach of duty. The closely held debtor had three directors. Two of them formeda new corporation and diverted corporate opportunities and allowed the new corporation to usethe debtor's assets for less than reasonably equivalent value. The trustee sued the two directorsand the new corporation, who pleaded an in pari delicto defense, arguing that the debtor hadcaused the transfer of opportunities and assets. However, because fewer than all of the directorswere involved in the breach of duty, the adverse interest exception applies, rebutting the pre-sumption that the action of the debtor's agent should be imputed to the debtor. O'Neil v. NewEngland Road, Inc. (In re NERI Bros. Constr.), 323 B.R. 540 (Bankr. D. Conn. 2005).

15

Skadden

12.1.e. The in pari delicto defense is available against a bankruptcy trustee. All of thedebtor's principals were convicted for operating a fraudulent business scheme. The trusteealleged that a stockbroker assisted in the scheme and thereby harmed creditors. The trustee suedand sought damages. The stockbroker moved to dismiss based on an in pari delicto defense. Onappeal, the district court concluded that the First Circuit would allow that defense against atrustee in bankruptcy, who was not involved in the fraud, because the action against the stock-broker was property of the debtor that vested in the estate under section 541. It was thereforesubject to all of the defenses that would be available if the debtor had brought the action beforebankruptcy. The action was therefore dismissed. Creditors were not precluded, however, frompursuing individual actions against the stockbroker for any damages that they may have suf-fered. Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Nickless (In re Advanced RISC Corp.), 324B.R. 10 (D. Mass. 2005).

12.1.f. The in pari delicto defense and its exceptions apply in a partnership case.Where the plaintiff participated in the wrongdoing of which it complains, the defendant mayassert the in pari delicto defense against liability. When the defendant was an agent of the plain-tiff, the adverse interest exception may apply: when the agent is acting in a manner adverse tothe interests of the principal, the normal rule that an agent's knowledge is imputed to the prin-cipal might not apply. The Revised Uniform Partnership Act codifies this rule in section 102(f).The sole actor doctrine is an exception to the adverse interest exception: when the agent andthe principal are one and the same, the agent's knowledge is imputed to the principal, despitethe adverse interest exception. RUPA does not codify the sole actor doctrine, but it appliesunder RUPA section 104, which permits supplementing of RUPA's provisions with "principlesof law and equity." In this case, the sole individual who controlled the sole general partner innumerous investment limited partnerships defrauded the limited partners and their partnerships.In their bankruptcy case, the general partner and the investment partnerships were substantive-ly consolidated. When the trustee sued a third party who had facilitated the fraud, the third partysuccessfully argued that the in pari delicto doctrine applied, because the general partner mas-terminded the fraud. He also successfully argued that the sole actor doctrine applied, because,among other things, the individual in control of the general partner was the sole actor on behalfof the general partner and the investment limited partnerships, as the bankruptcy court hadunderscored by ordering substantive consolidation of the estates. Grassmueck v. Am. ShorthornAss'n., 402 F.3d 833 (8th Cir. 2005).

12.2 Turnover

12.3 Sales

12.3.a. Reorganized debtor may not sell assets free and clear after plan confirmation.After the effective date of the debtor's plan, the reorganized debtor sought to sell its assets freeand clear of liens under section 363(f). Although the plan provided for post-confirmation reten-tion of jurisdiction to "hear and determine any and all pending or future applications forapproval of the sale of the Assets or any portion thereof, free and clear of all liens pursuant to§ 363 of the Bankruptcy Code," the plan did not itself provide for the sale of assets free andclear of liens. The court refuses to approve the sale, "because Section 363(f) is not operationalonce the plan is confirmed." It is not clear whether the court would have permitted the sale ifthe plan had been more explicit in providing for the post-confirmation asset sale. In re Golf,L.L.C., 322 B.R. 874 (Bankr. D. Neb. 2005).

16

Skadden

12.3.b. Lien holder has standing to object to section 363 sale. Adverse parties, includ-ing a lien holder, disputed the trustee's claim that the debtor owned real property. The trusteecommenced an adversary proceeding to determine title. Then, after 18 months of marketing theproperty, the trustee found a buyer and sought court approval by motion of a sale free and clearof the lien. The lien holder opposed the motion on essentially the same grounds as were beinglitigated in the adversary proceeding, but the court determined that the debtor "had some inter-est in the property" and authorized the sale. The lien holder has standing to object to thetrustee's motion to approve the sale, even though the holder does not claim any ownership inter-est in the property. Because an unsecured creditor may object to the disposition of estate assets,a secured creditor may surely do so, especially where the sale is to be free and clear of thesecured creditor's lien. The secured creditor is not limited to a challenge based only on thegrounds set forth in section 363(f), which lists the circumstances under which property may besold free and clear of a lien. Darby v. Zimmerman (In re Popp), 323 B.R. 260 (B.A.P. 9th Cir.2005).

12.3.c. Bankruptcy court must determine property ownership before it may author-ize a sale under section 363. Adverse parties disputed the trustee's claim that the debtor ownedreal property. The trustee commenced an adversary proceeding to determine title. Then, after18 months of marketing the property, the trustee found a buyer and filed a motion for courtapproval of the sale. The adversary proceeding defendants opposed the motion on essentiallythe same grounds as were being litigated in the adversary proceeding, but the court determinedthat the debtor "had some interest in the property" and authorized the sale. Under In re RodeoCanon Dev. Corp., 362 F.3d 603 (9th Cir. 2004), opinion withdrawn, 2005 U.S. App. LEXIS3786 (9th Cir. Mar. 8, 2005), if the estate's title to the property is in dispute and has not beendetermined, section 363 does not apply. Rodeo Canon states a prudential rule of efficient dis-pute resolution, not a rule prohibiting a bankruptcy court from determining ownership in a con-tested matter. Because the court here made no such determination, despite the pendency of theadversary proceeding for over 18 months, and found in the contested matter only that the debtorhad "some interest in the property," a finding that ultimately could be inconsistent with theadversary proceeding outcome, it was improper for the court to authorize the sale. However, theNinth Circuit withdrew its opinion two weeks after the BAP's decision, so whether the BAP'sdecision on this point will have any more than persuasive effect is unclear. Darby v. Zimmerman(In re Popp), 323 B.R. 260 (B.A.P. 9th Cir. 2005).

12.3.d. Mootness rule does not apply to sale to which section 363 does not apply.Adverse parties, including a lien holder, disputed the trustee's claim that the debtor owned realproperty. The trustee commenced an adversary proceeding to determine title. Then, after 18months of marketing the property, the trustee found a buyer and sought court approval of thesale by motion. The adversary proceeding defendants opposed the motion on essentially thesame grounds as were being litigated in the adversary proceeding, but the court determined thatthe debtor "had some interest in the property" and authorized the sale. Under In re RodeoCanon Dev. Corp., 362 F.3d 603 (9th Cir. 2004), if the estate's title to the property is in disputeand has not been determined, section 363 does not apply. Therefore, section 363(m) does notapply, and the appellate court may hear an appeal from the order approving the sale. In addi-tion, the buyer expressly took the risk in the sale contract that the estate might not have title tothe property, so equitable considerations did not require a mootness finding. Darby v.Zimmerman (In re Popp), 323 B.R. 260 (B.A.P. 9th Cir. 2005).

17

Skadden

13. TRUSTEES, COMMITTEES, AND PROFESSIONALS

13.1 Trustees

13.2 Attorneys

13.2.a. Attorney may be employed under section 327(e) even for core functions ofchapter 11. The debtor's law firm had represented the creditors committee in the debtor's priorchapter 11 case and was therefore not disinterested and was disqualified for employment undersection 327(a). Nevertheless, the court could approve the law firm's employment under section327(e) for the purposes of negotiating and implementing a cash collateral agreement with thelender, conducting the debtor's "going out of business" asset sale, and negotiating a keyemployee retention plan. Although these functions were central to the conduct of the chapter 11case, they did not constitute "represent[ing] the trustee in conducting the case," which section327(e) prohibits special counsel from doing. The court does not, however, provide a definitionof the quoted clause or a general test to determine whether it has been met. Stapleton v.Woodworkers Warehouse, Inc. (In re Woodworkers Warehouse, Inc.), 323 B.R. 403 (D. Del.2005).

13.2.b. Attorney with unpaid prepetition bill, secured by a cash retainer, is not disin-terested. The debtor's attorney took an adequate prepetition retainer to cover prepetition serv-ices and some postpetition services. He did not, however, withdraw funds from the retainer topay for all outstanding amounts immediately before bankruptcy, but allowed the retainer to sitpending final fee applications in the case. The court strictly follows United States Trustee v.Price Waterhouse, 19 F.3d 138 (3d Cir. 1994) (unsecured prepetition claim for nonbankruptcyservices) and determines that the attorney's status as a secured creditor, despite the contrary Inre Martin, 817 F.2d 175 (1st Cir. 1987) (secured claim for prepetition bankruptcy services), dis-qualifies the attorney from representing the debtor in possession. As a sanction, the court dis-allows the attorney's claim for prepetition services. In re Lackawanna Med. Group, P.C., 323B.R. 626 (Bankr. M.D. Pa. 2005).

13.2.c. Security retainer cannot be applied to a chapter 7 debtor's attorney's postpe-tition fees without court approval of the attorney's employment. The debtor's attorney tooka prepetition retainer and placed it in his client trust account. Before bankruptcy, he drew a por-tion of the retainer, representing the billed amount but not including incurred but unbilled prep-etition fees. He performed postpetition services as well. Upon his final application for fees inthe case, he was entitled to apply the retainer to the unbilled prepetition fees. The retainerbecame property of the estate upon the filing, and the attorney retained a lien on it to securethe prepetition fees, which could be paid from the retainer. However, the retainer could not beused to pay for the attorney's postpetition services. Property of the estate may not be used topay a debtor's attorney unless his employment has previously been approved by the court.Fiegen Law Firm, P.C. v. Fokkena (In re On-Line Servs. Ltd.), 324 B.R. 342 (B.A.P. 8th Cir.2005).

13.2.d. Liquidating chapter 11 corporation retains attorney-client relationship withformer counsel. The debtor sold all its assets in its chapter 11 case and then confirmed a liq-uidating plan. The plan authorized the creditors committee to bring the estate's avoiding poweractions on behalf of the debtor in possession. In one such action, the committee moved to dis-qualify defendants' counsel, who had previously represented the debtor on related matters.Because the beneficial owner of the actions was the same entity that counsel had previously

18

Skadden

represented, counsel was disqualified from representing the defendants in the avoiding poweractions, even though the debtor had been completely liquidated, no longer had any businessoperations, and had changed its name. It was the same corporate entity and therefore retainedthe attorney-client relationship and privilege that underlie the conflicts rules. Post-Confirmation Committee v. The Feld Group (In re I Successor Corp.), 321 B.R. 640 (Bankr.S.D.N.Y. 2005).

13.2.e. Use of company email does not necessarily waive personal attorney-client priv-ilege. Before bankruptcy, individual officers of the debtor communicated over the company'semail system with their personal attorneys. A trustee was appointed immediately upon the fil-ing of the bankruptcy petition and ordered the officers not to return to their offices and to turnover their keys immediately to the trustee. The trustee later sued the officers on various causesof action and sought discovery, including copies of the individual emails between the officersand their personal attorneys. The fact that the emails were transmitted unencrypted over thecompany's email system did not per se waive any attorney-client privilege. However, if the com-pany had an express policy denying confidentiality to email traffic on the company's system,the privilege would not apply. In re Asia Global Crossing, Ltd., 322 B.R. 247 (Bankr. S.D.N.Y.2005).

13.2.f. General partnership debtor in possession's lawyer may owe duty to pursueactions against debtor's general partners. Counsel for the general partnership chapter 11debtor and debtor in possession also represented the partnership's two individual general part-ners. Before bankruptcy, counsel had assisted the general partners in transferring their assets tofamily limited partnerships, at least in part to shield their assets from creditors, but counsel didnot disclose the representation in its employment application. The partnership's sole asset wasreal property that declined in value rapidly after the chapter 11 case was filed. After bankrupt-cy, counsel represented to the court that the property had declined in value, that the debtor couldbe reorganized without significant capital contributions from the general partners, and that thegeneral partners were able to answer any necessary capital calls. Counsel did not conduct anyinvestigation of the latter two representations, both of which counsel should have known, basedon the nature of the debtor's assets and counsel's work in setting up the family limited partner-ships, were false. Counsel was liable to the trustee for malpractice. Although the debtor in pos-session had ceased to exist, the cause of action belonged to the estate, not to the debtor in pos-session, and the chapter 7 trustee was the proper estate representative to bring the action.Counsel had a duty to the partnership debtor in possession, including the duty to maximize thevalue of the estate and the recovery of property for the estate. Counsel breached the duty by notrendering its services free of any conflict of interest — the simultaneous representation of apartnership and its general partners "almost invariably entails a plain conflict of interest" — andby not filing or threatening to file a contribution action against the general partners. The courtcomes close to imposing a duty on counsel for a debtor in possession to make decisions aboutwhom to sue on behalf of the estate, thus transferring to counsel the apparent duty to act as theclient, although the court may have suggested such a duty only in a case such as this, where aconflict of interest may have effectively prevented the debtor in possession from making thedecision on its own. Bezanson v. Thomas, 402 F.3d 257 (1st Cir. 2005).

13.3 Committees

13.4 Other Professionals

19

Skadden

13.4.a. Financial advisor's transaction fee is limited, based on amount of debt restruc-tured. The debtor engaged a financial advisor's prepetition, who obtained investors for arestructuring plan. After bankruptcy, the debtor in possession moved for court approval of theengagement, with a fixed transaction fee if the plan were consummated and a reasonable fee tobe determined if an alternative, stand-alone plan that did not involve a new money investmentwere consummated instead. The court granted the application under section 328. Upon con-summation of the latter plan, the advisor sought a transaction fee equal to the fee approved forthe new money plan. The court approves a lower transaction fee, based on a percentage of theamount of debt actually restructured — that is, that received a recovery under the plan — ratherthan on the total amount of the debtor's debts. In doing so, the court notes that "success" is notrequired to support a transaction fee; the market should determine reasonableness. In re XOCommunications, Inc., 323 B.R. 330 (Bankr. S.D.N.Y. 2005).

13.5 United States Trustees

14. TAXES