Court Looks to the Knowledge of the Transferees in Madoff

Maurice Horwitz reported on the latest decision to interpret fraudulent transfer law in the context of the Madoff Ponzi scheme in In Madoff Fraudulent Transfer Cases, Bankruptcy Court Focuses on Intent of the Transferees. In the context of actual fraud, the intent of the transferor determines whether the transfer is avoidable, and fraudulent intent is presumed in the context of Ponzi schemes. So, why was the bankruptcy court focusing on the knowledge of the transferees in its most recent decision? The transferee’s knowledge becomes important in defenses to constructive fraud and actual fraud cases. For example, the section 546(e) safe harbor that is available in constructive fraud cases is not available if the transferee had “actual knowledge that there were no actual securities transactions being conducted.” The section 548(c) defense is available to a transferee that takes “in good faith” to the extent the transferee gave value to the debtor in connection with the transfer. Although both of these are defenses to fraudulent transfer claims, the court held that the trustee had to plead that the transferee had actual knowledge or was “willfully blind,” i.e., had a subjective belief that there is a high probability that a fact exists and took deliberate actions to avoid learning, “that there were no actual securities transactions being conducted” to avoid the section 546(e) or 548(c) defense. In a victory for investors that received transfers, Judge Bernstein held that not only was the trustee required to have pled facts that would defeat these defenses, but he failed to adequately plead such facts in his complaint.

Writ of Mandamus Is No Path to the BAP

Prashant Rai wrote about a decision holding that bankruptcy appellate panels do not have authority to issue writs of mandamus in Ninth Circuit Reminds Us of Limits to Bankruptcy Jurisdiction.After the Ninth Circuit BAP summarily denied a party’s request to issue a writ of mandamus directing the bankruptcy court to hear his motion, the party appealed from that order to the Ninth Circuit. Instead of dismissing the appeal on its merits, the Ninth Circuit considered whether the BAP even had jurisdiction to adjudicate the writ petition. The court framed the issue as whether the All Writs Act authorizes BAPs to issue writs of mandamus directing bankruptcy courts to hear motions and held that it does not. The key issue was whether a bankruptcy appellate panel is a “court[] established by Act of Congress.” Because Congress’s enacting statute does not establish bankruptcy appellate panels, but, instead, requires a finding by the judicial council in each circuit that a panel would not unjustifiably drain the circuit’s judicial resources or result in undue delay and/or increased cost to parties filing for chapter 11 relief, the court held that bankruptcy appellate panels are not established by an Act of Congress. Moreover, parties to a bankruptcy appeal may opt out of BAP jurisdiction, whereas a petition for a writ mandamus does not trigger such opt-out rights. Accordingly, the hearing of a writ petition extended the BAP’s jurisdiction over a non-consenting party, an act that exceeded, rather than aided, its existing jurisdiction.

Centipede, Asteroids, and Missile Command Come Back to the Bankruptcy Court

If you don’t understand the title, then do you really understand the cultural impact of Atari? The Atari 2600 was released in North America in 1977, and it helped launch the video game craze that continues today. Unfortunately, in 2013, Atari, Inc. filed for bankruptcy protection, and it emerged later that year with the support of its French parent. As Brenda Funk detailed in Southern District of New York Reopens Atari’s Bankruptcy Cases, after Atari’s case was closed, troubles arose with a creditor having a security interest in Atari’s intellectual property and a pledge of the non-debtor parent’s intercompany claims against Atari. After the Atari entities filed suit in Paris to enjoin the creditor from foreclosing, the creditor sought to reopen Atari’s chapter 11 case to enjoin the French litigation and compel compliance with certain provisions of the plan, which contained a global settlement with the creditor. Applying section 350(b) of the Bankruptcy Code, the bankruptcy court reopened the case. Among other things, the court noted that the creditor had filed its motion promptly after the commencement of the French actions. Moreover, the global settlement that allegedly was being attacked in the French court was an integral part of the confirmed plan of reorganization, and the parties had agreed in the plan that the bankruptcy court would have exclusive jurisdiction to hear disputes related to the enforcement of the plan.

Try Getting Another Bankruptcy Court to Transfer a Case to Delaware

We typically hear complaints about too many chapter 11 cases being filed in Delaware and New York and have seen those courts grapple with requests to transfer cases out of those jurisdictions. Similar to the request made by Caesars Entertainment Operating Company, which asked the Delaware bankruptcy court to transfer its involuntary case to Chicago (the jurisdiction in which it had filed voluntary cases for itself and its affiliates), one of the Abengoa entities sought to transfer its involuntary case to Delaware, where the chapter 11 cases of its indirect parent and other affiliates were pending and where the debtor had filed its own voluntary chapter 11 petition. Katherine Doorley discussed the Kansas bankruptcy court’s denial of such request in Toto, We Are Staying in Kansas: Bankruptcy Court Declines to Transfer Related Case to Delaware. Applying the commonly used factors developed by the First Circuit in CORCO, the bankruptcy court found that the only known creditors of the debtor were either from Kansas or already had consented to its jurisdiction; the debtor was a Kansas LLC, and its managing officers and indirect parent were in St. Louis, Missouri and Washington, D.C.; the debtor’s assets were located in Kansas; and the debtor would still be able to benefit from financing approved in Delaware even if the case was not transferred. The court distinguished the case from Caesars on the ground that the involuntary petition was filed more than ten days before the voluntary case was filed, the debtor presented no evidence that the petitioning creditors had been aware of the plans to file in Delaware, the case was not particularly complex as the debtor had few assets that were encumbered by liens, and the validity of the mechanic’s lien claims against the debtor would be governed by Kansas law. Finally, the bankruptcy court noted that it had the time and expertise to reach those and any other necessary issues with dispatch.

Back to the More Typical Situation – a Requested Transfer Out of the SDNY

Courtney Stone addressed a variation of the more typical request, a transfer out of New York to another court, in What Are You Doing in This Court? SDNY Bankruptcy Court Transfers Post-Confirmation, State Law Dispute with Non-Debtors Back to the “Home” Bankruptcy Court. At least here, the transfer request was to go back to the Eastern District of Virginia, the jurisdiction of Patriot Coal’s chapter 11 case. A dispute arose between two non-debtors relating to one party’s alleged breach of a commitment to provide financing to the other in connection with that party’s acquisition of Patriot Coal assets. The dispute ended up in front of the SDNY bankruptcy court when one party filed suit in New York State court, and the other party removed the lawsuit to federal court and simultaneously sought to transfer the action to the Eastern District of Virginia. Although Bankruptcy Judge Glenn emphasized the breadth of bankruptcy court jurisdiction, including that the bankruptcy court may even have jurisdiction in certain cases to hear state law disputes between non-debtor parties after confirmation of the debtor’s plan, he decided to transfer the case back to Patriot Coal’s bankruptcy court, noting that such court was familiar with the facts and circumstances giving rise to the claims in the case and was best situated to resolve the litigation efficiently. The court also noted that the home bankruptcy court would be in the best position to consider the plaintiff’s request to remand the action back to state court.

Valuation Methodology May Be Within Bankruptcy Court’s Discretion

We are familiar with the different approaches to valuation, but what weight should an appellate court give a bankruptcy court’s decision to employ a particular valuation methodology? As Gabriel Morgan reported in Valuation Outside the Box: Southern District of Texas Affirms the Bankruptcy Court’s Discretion to Select Appropriate Valuation Methodologies, the choice of valuation methodology may be within the bankruptcy court’s discretion based upon the facts and circumstances of a particular case. In that case, the bankruptcy court was required to determine the value of the owners’ right to use the common amenities in an unbuilt phase of a luxury condominium. The bankruptcy court rejected the replacement cost approach (which had been used by both sides’ experts) and instead applied what it called a “modified income approach.” That approach valued the land and the amenities of the not-yet-built phase by (i) determining the likely sales price of the to-be-constructed units, (ii) determining the expected cost of building, financing, and marketing the phase without the amenities package, and (iii) subtracting the cost in (ii) from the sales price in (i). On appeal, the district court found that the bankruptcy court’s choice of valuation methodology was correct, noting that, in the Fifth Circuit, bankruptcy courts have “broad leeway” in selecting a valuation methodology. The district court also made clear that a bankruptcy court is not bound by an expert’s choice of method but, instead, should choose the appropriate methodology based on the purpose of the valuation.

Automatic Stay, Airplanes, and Administrative Expenses

Danielle Donovan won this Lookback Period’s award for most New York Post-worthy headline with BREAKING: Automatic Stay Releases Airplane Hostage and Shoots Down Landlord’s Administrative Expense.In her entry, Danielle pondered whether a landlord under a terminated lease of an airport hangar can refuse to release the debtor’s airplane but still collect as an administrative expense the cost of storing the airplane. The short (and probably obvious) answer is certainly not under the facts of In re Sussex SkyDive, LLC, a case that featured a landlord named When Pigs Fly, LLC. The court found that denying the debtor access to the premises in which the airplane was stored could not have resulted in any benefit to the estate, the landlord had not complied with the state law requirement to have the airplane determined to have been abandoned by the debtor prepetition, and the landlord’s refusal to turn over the airplane violated the automatic stay.

It May Seem Obvious, but 20/20 Hindsight Has no Place in Fraudulent Transfer Litigation

Jessica Liou discussed the ruling in the SemCrude cases on how “unreasonably small capital” should be assessed in Third Circuit Agrees That When it Comes to Fraudulent Transfers, There’s No Room for 20/20 Hindsight.At issue in this case was whether SemCrude had been left with “unreasonably small capital” following certain prepetition distributions it made to equity holders. Although SemCrude had significant availability under its credit facility at the time of the distributions, it also had undisclosed defaults under its credit agreement as a result of certain risky trading strategies in which it was engaged, so material questions of fact existed as to whether it was reasonably foreseeable that the lenders would have cut off access to the credit facility if they had known about the defaults at the time. The Third Circuit agreed with the lower courts’ rejection of this approach, noting that it would require “multiple levels of forecasting” regarding what would have been the lenders’ reaction to discovering the conduct and then the consequences of that reaction: “Absent the bias of hindsight, it simply cannot be said that SemGroup was likely to be denied access to a credit facility.”

If a Landlord Thinks a Lease Assumption Is Subject to Conditions, It Better Specify That in the Order Approving Assumption

Patrick Thompson discussed what happens to a landlord when a debtor has defaulted under its lease, the lease gets assumed with a promise to cure the defaults in the future, and then (you guessed it) the debtor doesn’t cure those defaults in Fifth Circuit Holds That Assumption of a Real Property Lease Is Effective Upon Entry of an Agreed Order. Under an agreed order between Bourbon Saloon (the debtor) and Absinthe Bar (the landlord) – this is New Orleans, after all – the landlord agreed to allow the debtor to assume its lease and agreed that the debtor would have about seven months to cure all nonmonetary defaults under the lease. The order was silent, though, on the consequences of the failure to cure those defaults. After the debtor failed to cure the outstanding defaults in accordance with the terms of the agreed order, the landlord sought to declare the lease rejected. The Fifth Circuit reasoned that the landlord could have required all of its conditions to be satisfied prior to entering into the agreed order, but it failed to do so. The Fifth Circuit rejected the landlord’s contention that the deadline imposed by the order to cure the defaults was a condition precedent to the assumption of the lease. Instead, “assumption occurred at the time the parties entered into the agreed order and…the remaining provisions of the order were conditions which Bourbon Saloon became legally obligated to meet under the supervision of the bankruptcy court.”

Student Loan Discharge Issues

To round out this Lookback Period’s focus on individual discharge issues, Alana Katz published The Battle of the Student Loan Discharge, which addressed a debtor’s discharge of student loan obligations under section 523(a)(8) of the Bankruptcy Code. Under this section, student loans are presumptively nondischargeable, but a debtor may overcome this presumption if he or she is able to show that repayment of the student loans will cause an “undue hardship.” Alana addressed the decisions of two courts, the District Court for the Middle District of Alabama and the Bankruptcy Court for the District of Idaho, that came to two very different conclusions on what constitutes “undue hardship,” although ostensibly applying the same standard for “undue hardship.” The test for undue hardship requires the debtor to establish (1) that he or she cannot maintain, based on current income and expenses, a “minimal standard of living for herself and her dependents if forced to repay the loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans.”The Alabama district court denied the debtor’s discharge of her loans, reasoning that the debtor chose to earn four degrees with a general understanding of the cost versus benefit analysis, and her multiple, marketable degrees enabled her to seek employment with a larger pay scale. As such, her future ability to earn extra income was a realistic possibility, negating the need to discharge her student loans. In Idaho, however, the court permitted a debtor to discharge her student loans even though she was steadily employed as a social worker and recently had taken a $6,000 trip to South America to attend training for a career switch to photography and had financed the purchase of a motorcycle for her ex-husband.What may have made the difference was the testimony of the Idaho debtor’s doctor that the debtor’s health was deteriorating, and it was likely that she would be unable to work in the near future.