When Can a Subsidiary Be Liable for the Actions of Its Owners?

That is the question answered by Sara Coelho in Bad Children: How One Court Used Alter Ego Doctrine to Uphold Reverse Veil Piercing.Sara discussed a court decision that analyzes “reverse veil-piercing” claims and suggests that holding a subsidiary liable for certain obligations of its parent might be possible under the alter ego doctrine. The issue arose in the case of an individual who agreed to pay a fine in a consent judgment entered into with the SEC. After the individual defaulted on his payments, the SEC brought an action seeking to compel certain entities owned and controlled by the individual to disgorge their assets.As “reverse veil piercing” is a matter of state law, the Tenth Circuit considered what the Utah Supreme Court might hold (as no controlling law on point existed). Analyzing various statements and decisions, the circuit court found that Utah’s highest court had “expressed sympathy for reverse piercing” when the Utah court said the doctrine “follows logically from the basic premise of the alter ego rule and appears consistent with our case law.” Lower courts in Utah also have held corporate entities liable for the debts of the individuals who controlled them. Although the existing decisions tend to arise in the context of entities owned and controlled by individuals, it remains to be seen whether an aggressive claimant will seek to extend the principles to subsidiaries of a corporate debtor.

The Shoe Is on the Other Foot – When Can the Debtor Plead Excusable Neglect?

In A Twist on Excusable Neglect, Moshe Fink addressed what happens when the debtor needs to beg the mercy of the court and ask it to allow the debtor to file a late-filed objection to a claim. (Anyone who has read a debtor’s mantra about the importance of deadlines in an objection to a late-filed claim is chuckling now.). In In re Prucres, the debtor filed claims objections five days after the deadline established in the debtor’s confirmed plan. The debtor offered two explanations: (i) debtor’s counsel had failed to calendar the claim objection deadline, and (ii) debtor’s counsel had sustained a concussion in a car accident and was sidelined for several weeks, including at the time of the claim objection deadline. The court found that the claimant would not be surprised by the objection because the plan had listed the creditor’s claim as disputed. Although the court found as inexcusable the counsel’s failure to calendar the objection deadline, the court “reluctantly” held that the counsel’s car accident and concussion were circumstances beyond counsel’s control and that the creditor was not prejudiced by the delay. Accordingly, the court allowed the late-filed objection to stand.

The Ninth Circuit BAP Weighs in on the Prepetition Default vs. Non-Default Rate Debate

When is an oversecured creditor entitled to accrue postpetition interest at the default rate, and when is such creditor limited to accruing postpetition interest at the non-default rate? Scott Bowling discussed the Ninth Circuit BAP’s approach in Improper Calculation of Postpetition Interest Leads to Reversal of a Confirmation Order. In In re Beltway One Development Group, LLC, the debtor failed to repay its loan by the maturity date and commenced a chapter 11 case after the lender had begun the process of foreclosing on its collateral. All parties agreed that the lender was significantly oversecured and, therefore, entitled to include postpetition interest. The question was the rate. The Ninth Circuit BAP held that an oversecured claim presumptively is entitled to postpetition interest at the applicable prepetition nondefault rate where the claim is unimpaired under a plan because the claim essentially is treated as having been restored to its prepetition nondefault status. A holder of an oversecured claim that is impaired under a chapter 11 plan, however, is entitled “to default interest that reasonably compensates it for losses arising from the default.” Therefore, the Ninth Circuit BAP held that a rebuttable presumption exists in favor of allowing an impaired, oversecured creditor to accrue interest at the prepetition, contractual default rate.

Defalcation and Discharge

In an earlier Lookback Period summary, I mentioned the decision holding that trademark infringement constituted “willful and malicious injury” for purposes of the exception to an individual debtor’s discharge. In Defalcation and the Hazards of Board Membership – Lessons From the Fifth Circuit, Hannah Geller discussed a challenge to an individual’s bankruptcy discharge under section 523(a)(4)’s “defalcation” exception. Once again, the findings in a state court judgment proved sufficient to determine the key issue in the discharge dispute – whether the debt arises from defalcation by the debtor while acting in a fiduciary capacity. In In re Whitaker, the Fifth Circuit noted that Texas state law recognizes that the debtor, as a member of the board of his homeowners’ association, had a fiduciary relationship with the HOA. Based upon the state court’s findings, the Fifth Circuit also held that the debtor had committed a defalcation, or a knowing breach of a fiduciary duty, because the debtor had acted knowingly when he hired an attorney to improperly refuse a homeowner’s request, reimbursed his personal expenses with HOA money, and sought and received money personally from a third party contractor working for the HOA.

Well, at Least the Debtor Prevailed in This Discharge Objection

In case you are starting to believe that the debtor always loses in discharge objection cases, turn to Matthew Goren’s entry, Too Little, Too Late: Ninth Circuit Holds Confirmation Objection Insufficient to Revive Untimely Complaint Objecting to Dischargeability of Debt. Matt wrote about a Ninth Circuit decision, In re Lui, which held that a creditor’s announcement in her objection to confirmation of a debtor’s chapter 13 plan that she intended to object in the future to the dischargeability of her claim was not sufficient to save such objection when the creditor then filed her complaint about three weeks late. She argued that her complaint should be deemed timely because it related back to a confirmation objection she had (timely) filed, in which the judgment creditor stated that she believed the debt owed to her was incurred through fraud and that she “intends to file an adversary proceeding on this issue.” The Ninth Circuit concluded, though, that the creditor’s discharge complaint could not “relate back” to her confirmation objection because the statements made by the creditor in her confirmation objection not only failed to plead fraud with particularity (as required by FRCP 9(b)), but also failed to plead a plausible claim for relief under FRCP 8. Moreover, the announcement that the creditor intended to file a discharge complaint demonstrated to the Ninth Circuit that the creditor herself understood that she would need to file a separate, more complete complaint.

Bankruptcy Rules Take Precedence Over the Federal Rules of Civil Procedure

In Whose Rules Are They Anyway? Even in District Court, the Bankruptcy Rules Apply to Proceedings Arising Under Chapter 11, Candice Carson reminded us that the Federal Bankruptcy Rules govern all adversary proceedings brought in a bankruptcy case, even if those adversary proceedings are pending before the district court. Although the Bankruptcy Rules often incorporate the Federal Rules of Civil Procedures, the two sets of rules sometimes differ. At issue in Rosenberg v. DVI Receivables XIV, LLC was the difference between FRCP 50(b), which requires a motion for judgment as a matter of law after a jury trial to be filed within 28 days after the entry of a judgment, and Bankruptcy Rule 9015(c), which provides a 14-day deadline to file such a motion. Applying the plain language of the rules, the Eleventh Circuit found that it must read FRCP 50 through the lens of the Bankruptcy Rules with all the limitations that apply. In ruling that the 14-day deadline of the Bankruptcy Rules applied to the defendants’ motion, the Eleventh Circuit focused on the clear language of Bankruptcy Rule 1001, which provides, “The Bankruptcy Rules and Forms govern procedure in cases under title 11 of the United States Code.”

Use of Correspondent Bank Accounts in U.S. Creates Personal Jurisdiction in U.S.

Debora Hoehne addressed the issue of the effect of a foreign bank’s use of a correspondent bank account in New York on a federal court’s jurisdiction over the foreign bank in Asserting Personal Jurisdiction Over Foreign Banks.The case arises out of the chapter 11 case of Arcapita Bank B.S.C., a bank headquartered in Bahrain. Two other Bahraini banks that were defendants in preference actions brought in the Arcapita chapter 11 case argued that the federal court lacked personal jurisdiction over them. The district court held that the use of correspondent banks to effect transfers between Arcapita and the Bahraini banks, albeit a “transitory step,” was sufficient to subject the banks to personal jurisdiction. The district court reasoned that the banks’ use of correspondent bank accounts in New York was purposeful as the banks selected the New York correspondent bank accounts and actively directed U.S. funds received from Arcapita into those accounts. Had Arcapita made those choices, though, personal jurisdiction might not have existed over the Bahraini banks because the foreign banks’ contacts with New York would then have been merely “adventitious.”

Court Refuses to Dismiss Chapter 11 Case Filed Without Consent of “Blocking Director”

In a two-part series, Yvanna Custodio and Alex Condon discussed a decision by the United States Bankruptcy Court for the Northern District of Illinois that refused to dismiss a chapter 11 case even though the case had been filed without the requisite consent of the “Special Member” appointed by the debtor’s lender.

In Bankruptcy Court Rejects Use of Blocking Director to Prevent Bankruptcy Filing, Yvanna discussed the bankruptcy court’s analysis of the enforceability of the requirement that the “Special Member” consent to a bankruptcy filing. Although other courts have enforced provisions requiring the consent of shareholders or independent directors or members, the lender here made one fatal mistake – it required that the debtor’s amended operating agreement allow the Special Member to consider only the interests of the lender in making its decision. In finding that the provision violated Michigan LLC law, the bankruptcy court observed that the “blocking director” directly contravened a section of the Michigan Limited Liability Company Act that required each LLC member to, among other things, discharge its duties “in a manner [it] reasonably believes to be in the best interests of the limited liability company.” Although the court acknowledged the existence of a savings clause, which allowed the member to “consider only such interests and factors as it desires . . . to the fullest extent permitted by applicable law,” the savings clause could cure the provision “only by rendering it meaningless.” Consequently, the bankruptcy court held that the “blocking director” provision was void under Michigan corporate governance law.

In Lake Michigan Part II: Bad Faith Analysis, Alex discussed the portion of the court’s opinion that denied the lender’s alternative request to dismiss the chapter 11 filing as a bad faith filing. Because the debtor filed the petition on the eve of the mortgage lender’s non-judicial foreclosure of the debtor’s property, the lender argued that the filing was a bad faith litigation tactic to stall the foreclosure process. The court expressed little sympathy for this argument and even noted that it would have summarily dismissed the mortgagor’s motion if it did not also have to decide the blocking director issue. The court applied factors developed in In re Tekena USA, LLC to evaluate whether the filing was in bad faith. In ruling against the mortgage lender, the court found that the debtor had two (yes, two) other creditors, the debtor had not previously been a debtor in a bankruptcy case (and its out-of-court deal with the debtor did not qualify as such), and the timing of the filing did not, by itself, establish a bad faith filing. The court also placed little weight on the fact that the property was the debtor’s sole asset and rejected the lender’s argument that the debtor had no ongoing business because the debtor’s business was a seasonal vacation resort business (and the filing occurred off season). Finally, the court found that the mortgagor’s consent was not required for a reorganization because the debtors had those two other creditors and significant equity in the mortgaged property.

Reconciling the Interests of Two Debtor Counterparties in Assumption or Rejection of Contracts

We increasingly are seeing situations in which both parties to a contract find themselves in their own bankruptcy cases. In the recent high-profile dispute between Noranda Aluminum and Sherwin Alumina, this issue came to a head when Noranda filed a motion to reject its sales agreement with Sherwin, but Sherwin wanted to assume such contract. Jessica Liou discussed how Noranda’s bankruptcy court addressed the issue in Dueling Debtors: Missouri Bankruptcy Court Says Debtor Can Reject Contract That Counterparty (Who Is Also a Debtor) Sought to Assume. The Noranda bankruptcy court rejected Sherwin’s argument that, because both parties to the agreement were debtors, Noranda’s bankruptcy court should apply a “balancing of the equities test.” The Noranda bankruptcy court also rejected Sherwin’s argument that the court should apply the heightened rejection standard used in N.L.R.B. v. Bildisco & Bildisco and Mirant Corp. v. Potomac Elec. Power Co. (In re Mirant Corp.), reasoning that those decisions applied to situations in which section 365 of the Bankruptcy Code conflicted with policies designed to protect the national interest underlying other federal regulatory schemes. Accordingly, the court held that the appropriate test to apply was the business judgment test and found that that Noranda had met its burden of showing that rejection was in the best interest of its estate, and no evidence existed of bad faith or abuse of business discretion.