We know you’ve been spending a lot of time trying to figure out how to translate “Absolute Priority Rule,” “Equitable Mootness,” and “Make-Wholes” (not to mention “Cramdown”) into Halloween costumes, so you may have missed out on some of the entries the Weil Bankruptcy Blog has posted over the past six weeks.  For our treats to you, we are handing out these entries in convenient (Count Dracula) bite-sized servings.  You can indulge a little today, and we will have more for you next week. 

Sometimes, What a Creditor “Needs” Is Not Enough to Support Its Proof of Claim

Handshake deals and conflicting witness testimony make for shaky support for a proof of claim, as discussed by Charlie Chen in his piece, Think You Got a Blank Check? Think Again.  Charlie wrote about a case in which the debtor’s principal handed a creditor a blank security agreement and (according to the creditor) said, “whatever you need Jerry, write it in there.”  The $2 million amount filled in by a creditor (who worked for two years on the debtor’s project with no agreement on how he would be compensated) was insufficient to support his proof of claim.  Although all parties made mistakes that the court characterized as “foolish,” it was the creditor who failed to meet his burden of establishing his claim and saw his claim amount reduced to $108,000.

A Judge’s Harsh Appraisal of the Debtor Does Not Warrant Recusal

No debtor wants to be called a “crook,” “dirty bird,” or a “skillful manipulator,” especially by the bankruptcy judge overseeing his chapter 7 case.  As Melissa Siegel noted, though, in The Annoyed Adjudicator:  When Recusal Is Unnecessary, the judge’s opinions were grounded in his experience during the course of the bankruptcy case.  Accordingly, because the opinion was based upon knowledge properly acquired during the course of the case, the bankruptcy judge was not required to recuse himself.

When Religious Proceedings and Bankruptcy Collide

Doron Kenter’s entry, Yom Kippur, Kim Davis, the Automatic Stay, and Religious Adjudication of Disputed Involving Parties in Bankruptcy, discussed a somewhat controversial case – the decision by Bankruptcy Judge Drain that the automatic stay prevented litigants from proceeding with an action against a chapter 11 debtor’s principals in a Jewish beit din.  Doron’s entry showed how Judge Drain attacked a thorny issue with the same detailed level of analysis he brought to Momentive.  After the debtor, an Orthodox Jewish congregation, commenced an action against a religious school and certain individuals accusing them of looting the congregation, the defendants invoked a beit din against the debtor’s principals, which also purported to enjoin them from pursuing the bankruptcy action. Judge Drain concluded that, even though the action was nominally directed at the debtor’s principals and not the debtor, the beit din was convened specifically for the purpose of taking control of the adversary proceeding.  Judge Drain also concluded that the automatic stay, on its face and as applied, did not violate the Constitution’s free exercise clause or the establishment clause.

Emotional Distress Is Not Always Personal Injury

Claims for personal injury and wrongful death are afforded special status in bankruptcy as they are the only claims for which a party may file a proof of claim and preserve his or her jury trial right and for which the district court where the bankruptcy case is pending has the right to decide where they are tried.  One might think this issue would not have come up in the ResCap case, but creditors who alleged that ResCap wrongfully foreclosed on their home asserted claims that included intentional infliction of emotional distress.  Danielle Donovan covered the decision in Can’t Control Your Emotions?  Well, Maybe the Bankruptcy Court Can.  Because the underlying claim was for the allegedly wrongful foreclosure, the physical effects of the emotional distress did not rise to the level of bodily trauma, and the emotional distress claim did not fall within the traditional notions of a personal injury tort, Bankruptcy Judge Glenn held that he had jurisdiction to adjudicate the claims.

Back and Forth on the MCK 546(e) Safe Harbor Decision

The broad scope of the section 546(e) safe harbor seemed to narrow a bit last month when the Bankruptcy Court for the Northern District of Illinois revisited its earlier decision that protected certain payments from avoidance as preferences or fraudulent transfers on the ground that they were made by or to a “financial institution” in connection with a securities contract.  Debora Hoehne addressed the bankruptcy court’s new ruling in Safe No More?  Court Vacates Opinion Safe Harboring REMIC Payments.  The trustee sought reconsideration of the bankruptcy court’s initial ruling after the trustee learned that the recipient of the payments at issue was not a bank, but an affiliate that was not a “financial institution” within the meaning of section 101(22) of the Bankruptcy Code.  As a result, the bankruptcy court vacated its earlier opinion and order and granted the trustee leave to file an amended complaint.

The Ninth Circuit Isn’t That Flexible When It Comes to Appeals

In Ninth Circuit on Finality:  “It ain’t over ‘til It’s over,” Ben Farrow reminded us that circuit courts can be sticklers when it comes to finality and the right to appeal from orders.  On appeal from a bankruptcy court order addressing the merits of wage claims, the district court remanded the proceeding to the bankruptcy court to apply a different legal standard for wages spent traveling to and from public worksites.  Unhappy with the district court’s order, the employees attempted to appeal from that order to the Ninth Circuit.  The Ninth Circuit held that even its flexible test for finality was not flexible enough to consider an order that directs the bankruptcy court to reassess the evidence to be a final order.

Another Interesting Indenture Decision, This Time Involving the Express Violation of an Indenture

Although a lot of attention is being paid to the federal courts for decisions on indenture issues, the Weil Bankruptcy Blog recently came across a New York state court decision in which the court held that bondholders could collect compensatory damages as a result of a tender offer, redemption, and total return swap that violated the indenture.  The fairly complicated fact pattern is described by Debra McElligott in Does Your Bond Deal Seem Too Good to Be True?  Maybe It Violates the Indenture.  In short, after the issuer tendered for bonds in order to use the tendered bonds in a total return swap, the court held that the issuer had violated the indenture by redeeming less than 100% of the bonds in a non-random fashion, and the issuer also could not use the bonds in the total return swap because its purchase of the bonds required the issuer to retire the bonds.  Because of the issuer’s improper legal maneuvering, the court held that the bondholder plaintiffs could be awarded damages commensurate with the harm they suffered by selling their bonds back to the issuer below the market rate (which was in excess of the bonds’ redemption price).

Which Requires Proof of “Worse” Conduct – Constructive Fraudulent Transfers by Insiders or Piercing the Corporate Veil?

Yvanna Custodio reviewed a case in which judgment creditors attempted to hold the owners of the LLC judgment debtors and an affiliated corporation liable when the LLCs were unable to pay their judgment debts, but did manage to scrape together enough funds to pay management fees owed to an affiliated corporation as well as repay loans owed to the LLCs’ insiders.  In The Interesting Relationship Between Veil Piercing and Fraudulent Transfer Law, Yvanna explained the court’s ruling that proof of a constructively fraudulent transfer (unlike proof of actual intent to defraud) was not sufficient to satisfy the higher standard for piercing the corporate veil under New York law.  Even though the plaintiffs had accused the defendants of “purposeful asset-stripping,” the court noted that the plaintiffs had failed to prove that the defendants had completely dominated the debtors and compelled them to perform actions amounting to a “sustained effort to siphon assets.”

Section 363 Provides a Means of Skirting Absolute Priority, Even in the Third Circuit

Although the Third Circuit rejected “gifting” in Armstrong, it recently showed that it has not foreclosed all possibilities of making distributions outside the strict constructs of the absolute priority rule.  Chris Hopkins discussed the Third Circuit’s ICL Holding Co., Inc. most recent decision in Third Circuit Rules That If It’s Not Estate Property, There’s No Need to Respect Priority.  In ICL, the creditors’ committee objected to a sale by credit bid of all of debtors’ assets to their (undersecured) secured creditors.  The committee argued that the bankruptcy sale was being pursued exclusively for the benefit of the secured creditors and would leave the debtors’ estates administratively insolvent.  That objection, however, disappeared in exchange for a $3.5 million payment by the secured creditors/purchasers towards a fund to pay unsecured claims.  The purchasers also agreed to fund certain professional fees and wind-down costs and placed funds into escrow to cover such expenses.  As is often the case in these absolute priority stories, the government stepped in and asserted that it had an administrative expense for tax liability in connection with the sale and that the $3.5 million and the separate escrows constituted property of the debtors’ estates that should be used to pay its administrative expenses.  The Third Circuit, however, disagreed and held that the $3.5 million settlement payment never went through the debtors’ estates and was, therefore, not property of the estate.  With respect to the escrows, it found that, because the purchasers acquired all estate assets in the sale, no estate property remained following the closing.

LSTA Responds That Not Everyone Believes Bankruptcy Reform Is Necessary

The LSTA responded to the ABI Commission’s report on bankruptcy reform and treated the Weil Bankruptcy Blog to an advance copy.  David Griffiths and Doron Kenter reviewed the LSTA’s response in LSTA to ABI Commission on Chapter 11 Reform:  No Way, José.  As David and Doron pointed out, the following were the principal arguments raised by the LSTA in its response:

  • No reliable empirical evidence shows that increased secured creditor control has undermined the Bankruptcy Code’s effectiveness.
  • The proposed reforms will increase the costs of secured credit, while reducing the availability thereof. Moreover, chapter 11 cases will last longer and will be more complicated and expensive.
  • By proposing to scale back chapter 11’s existing protections for secured creditors, the ABI Commission undermines one of the conceptual foundations of the Bankruptcy Code – namely, that of maximizing the value of enterprises and the distribution of that value in accordance with nonbankruptcy priorities.
  • The changes proposed by the ABI Commission will have material adverse effects on the leveraged loan and DIP markets.

Why Stop at 9 or 11?  Creditors May Make Substantial Contributions in Chapter 7 Cases Too

Even though section 503(b)(3)(D) of the Bankruptcy Code only purports to grant a right to seek a substantial contribution claim in chapter 9 or 11 cases, the Sixth Circuit recently extended that right to chapter 7 cases.  Abigail Lerner discussed the Sixth Circuit’s reasoning in Sixth Circuit “Contributes” to Section 503(b)(3)(D) Debate – Holds Substantial Contribution Claim Is Available in a Chapter 7 Case.  Abby explained that certain unsecured creditors succeeded in removing a chapter 7 trustee whose gross negligence resulted in the dismissal of an action brought by the chapter 7 trustee.  The successor trustee then obtained a significant damages award against the first chapter 7 trustee.  The Sixth Circuit, in a split decision, reasoned that the use of “including” in the general lead-in to the list of administrative expenses meant that it could ignore the specific statutory language on substantial contribution and allow a substantial contribution claim in favor of the creditors that had sought removal of the first chapter 7 trustee.

Can Dismissal Bring a Rejected Lease Back From the Dead?

No, says the Delaware Bankruptcy Court.  Kevin Bostel explained the decision in Bankruptcy Court Sheds Light on Effect of Section 1112(b) Case Dismissal on Section 365 Lease Rejection Order – Section 349 Answers the Question.  Following dismissal of its chapter 11 case under section 1112(b) of the Bankruptcy Code, the debtor tried to argue that it could revive the lease it had rejected during the course of its chapter 11 case.  Because deemed rejection of a lease terminates a debtor’s possessory right, that possessory right is no longer property of the estate at the time of dismissal.  Moreover, section 365 is not on of the enumerated sections that section 349(b) states are affected by dismissal of a case.