Recent Developments in Bankruptcy and Restructuring
Volume 13 l No. 3 l May–June 2014 JONES DAY
Eighth Circuit Expands Subsequent New Value
Preference Defense in Cases Involving Three-Party
Charles M Oellermann and Mark G. Douglas
A bankruptcy trustee or chapter 11 debtor-in-possession has the power under section
547 of the Bankruptcy Code to avoid a transfer made immediately prior to
bankruptcy if the transfer unfairly prefers one or more creditors over the rest of
the creditor body. However, not every payment made by a debtor on the eve of
bankruptcy can be avoided merely because it appears to be preferential. Indeed,
section 547 provides several statutory defenses to preference liability. The Eighth
Circuit Court of Appeals recently addressed one such defense to preference
avoidance—the “subsequent new value” exception. In Stoebner v. San Diego Gas
& Electric Co. (In re LGI Energy Solutions, Inc.), 2014 BL 76796 (8th Cir. Mar. 20,
2014), the court, in a matter of first impression, ruled that “new value” (either contemporaneous
or subsequent) for purposes of section 547(c) can be provided by
an entity other than the transferee.
Avoidance of Preferential Transfers
A fundamental goal underlying U.S. bankruptcy law is equality of distribution
among similarly situated creditors. To that end, the automatic stay generally
prevents creditors from acting to collect on their debts after a debtor files
for bankruptcy. In addition, section 547(b) of the Bankruptcy Code provides for
avoidance of transfers made by an insolvent debtor within 90 days of a bankruptcy
petition filing (or up to one year, if the transferee is an insider) to or for
the benefit of a creditor on account of an antecedent debt where the creditor, by
reason of the transfer, receives more than it would have received if, assuming the
transfer had not been made, the debtor were liquidated in chapter 7.
Section 547(c) contains nine exceptions to avoidance of a preference. Of these,
the three defenses most commonly invoked by commercial creditors are the
“contemporaneous exchange” defense (section 547(c)(1)), the “ordinary course
payment” defense (section 547(c)(2)), and the “subsequent new value” defense
in this issue
1 E ighth Circuit Expands Subsequent
New Value Preference Defense
in Cases Involving Three-Party
5 N ewsworthy
6 F ourth Circuit Weighs In on Good-
Faith Defense to Avoidance of
10 I n Brief: Debt Purchaser’s Credit
Bid Limited Post-Fisker
11 T aking Sides—Lyondell Limits the
Use of the Section 546(e) Safe
Harbor in Fraudulent Transfer
14 I n Brief: Chapter 11 Plan
Payment of Official Committee
Members’ Legal Fees Disallowed
Absent Showing of Substantial
16 C laims Traders Alert
Section 547(c)(4) provides as follows with respect to the
subsequent new value defense:
The trustee may not avoid under this section a transfer
. . . (4) to or for the benefit of a creditor, to the extent
that, after such transfer, such creditor gave new value
to or for the benefit of the debtor—
(A) not secured by an otherwise unavoidable security
(B) on account of which new value the debtor did not
make an otherwise unavoidable transfer to or for the
benefit of such creditor[.]
Thus, even where a creditor has received a preferential transfer,
the transferee may offset against the preference claim any subsequent
unsecured credit that was extended to the debtor. The
purpose of the exception is to encourage creditors to continue
working with troubled businesses. See Jones Truck Lines, Inc.
v. Full Serv. Leasing Corp., 83 F.3d 253, 257 n.3 (8th Cir. 1996).
“It recognizes that the ‘new value’ effectively repays the earlier
preference, and offsets the harm to the debtor’s other creditors.
. . . Accordingly, ‘the relevant inquiry under section 547(c)
(4) is whether the new value replenishes the estate.’ ” Savage &
Assoc., P.C. v. Level (3) Communications (In re Teligent, Inc.), 315
B.R. 308, 315 (Bankr. S.D.N.Y. 2004) (internal citations omitted).
“New value” is defined in section 547(a)(2) of the Bankruptcy
Code to include, among other things, “money or money’s worth
in goods, services, or new credit.” In other words, a creditor
must establish that it provided the debtor with “something new
that is of tangible value.” In re Fuel Oil Supply & Terminaling, Inc.,
837 F.2d 224, 230 (5th Cir. 1988).
The issue addressed by the Eighth Circuit in LGI Energy is
whether the language “such creditor gave new value” in section
547(c)(4) means that, in order to shield a transfer from avoidance,
the “new value” provided to the debtor following the
transfer must have come from the recipient of the challenged
transfer, as distinguished from a third party.
LGI Energy Solutions, Inc., and an affiliate (collectively, “LGI”)
performed bill payment services for clients that were large
utility customers. Pursuant to contracts between LGI and its
customers, LGI periodically sent each customer a spreadsheet
detailing its payment obligations under invoices that LGI
received from the utilities that provided services to the customer.
After the customer sent a check payable to LGI for the
aggregate amount due, LGI deposited the funds into its own
commingled bank accounts and then sent checks drawn on
those accounts to the utility companies. Even though the utilities
sent bills for LGI’s customers to LGI, the utilities had no contracts
Over a three-week period in November 2008, LGI paid two utility
providers approximately $258,000 for utility services provided
to LGI customers. After those transfers, the utilities continued to
provide services to the customers and sent new invoices to LGI.
LGI continued to bill the customers, which sent checks totaling
$297,000 to LGI for the payment of the invoices. LGI never paid
any of those funds to the utilities.
LGI ceased operating in December 2008. Shortly afterward, involuntary
chapter 7 petitions were filed against LGI in Minnesota.
After entry of orders for relief in the consolidated cases, the
chapter 7 trustee sued the utility providers to avoid as preferential
the $258,000 in payments made by LGI. Although the
challenged transfers were made to satisfy LGI’s antecedent obligations
to its utility customers—the transfers were made “for
the benefit” of the customers—the trustee elected not to sue
these primary creditor beneficiaries. The utilities invoked section
547(c)(4)’s subsequent new value defense.
The bankruptcy court concluded that the utilities were “creditors”
under third-party and trust beneficiary principles, even though
no contractual relationship existed between the providers and
LGI. In addition, the court construed the language “such creditor”
in section 547(c)(4) to mean that new value for purposes of the
exception must have been provided to, or for the benefit of, LGI
by the utilities, rather than to LGI’s customers. Accordingly, the
bankruptcy court ruled that the $297,000 in services provided by
the utilities to LGI’s customers did not qualify as new value furnished
to LGI subsequent to the $258,000 in payments LGI made
to the utilities within 90 days of the bankruptcy petition date.
A bankruptcy appellate panel reversed the ruling in part on
appeal. The appellate panel agreed with the bankruptcy court’s
conclusion that the utilities were creditors despite the absence
of a contract with LGI. However, relying on Jones Truck Lines,
the court disagreed with the bankruptcy court’s reading of
“such creditor” to preclude new value provided to a debtor by
a third party:
Jones Truck Lines can be harmonized with the [reference
to “such creditor” in section 547(c)(4)] by
interpreting it as a recognition that in tripartite relationships
where the [preferential] transfer to a third
party [here, the utility] benefits the primary creditor
[here, the utility customer], new value can come
from that [primary] creditor, even if the third party is a
creditor in its own right.
The trustee appealed to the Eighth Circuit.
The Eighth Circuit’s Ruling
A three-judge panel of the Eighth Circuit affirmed.
At the outset, the court severely criticized the trustee’s approach
in suing the utilities instead of LGI’s customers, who could have
warded off any liability by means of section 547(c)(4) because
they clearly provided post-transfer value to LGI. According to the
court, “This approach does fundamental violence to the ‘prime
bankruptcy policy of equality of distribution among creditors.’ ” If
the utilities were required to return the preferential payments to
LGI, the Eighth Circuit wrote, “the estate is ‘doubly replenished’
entirely at the expense of only two creditors, [LGI’s customers],
who got no benefit for their subsequent new value and will continue
to be liable to the utilities for their unpaid invoices.”
The Eighth Circuit distanced itself from the lower courts’ determination
that the utilities were “creditors” who received a
transfer or its benefit within the meaning of section 547(b)(1).
Because the utilities did not raise this issue on appeal, however,
the Eighth Circuit noted merely that “it seems open to serious
question . . . and [the ruling] should not be considered Eighth
The court faulted the trustee’s reliance on In re Musicland Holding
Corp., 462 B.R. 66 (Bankr. S.D.N.Y. 2011), for the proposition that
“such creditor” in section 547(c)(4) must “in all circumstances” be
construed as “limiting subsequent new value to that personally
provided by the creditor the trustee elects to sue to recover the
preferential transfer.” In Musicland, the Eighth Circuit explained,
the court denied the preference defendant’s claim of an offset for
subsequent new value provided by another creditor who, unlike
in LGI Energy, “neither received nor benefitted [sic] from the preferential
transfer.” Here, the Eighth Circuit emphasized, both LGI’s
customers and the utilities benefited from LGI’s preferential payments
to the utilities.
LGI Energy is a positive development for those doing
business with financially troubled entities because
it expands the scope of the subsequent new value
defense to encompass payment relationships involving
The Eighth Circuit agreed with the bankruptcy appellate panel
that Jones Truck Lines adequately refuted the trustee’s position.
In Jones Truck Lines, the Eighth Circuit ruled that payments made
by a debtor-employer to benefit plans to satisfy its obligations to
pay pension and welfare benefits were excepted from preference
liability to the extent that the employees provided the debtor with
post-transfer new value in the form of services. The court’s analysis
was directed principally toward new value in the context of the
contemporaneous exchange defense in section 547(c)(1). Even
so, the Jones Truck Lines court went on to address the related
subsequent new value defense under section 547(c)(4). The
court wrote that “[i]f [the debtor] received no contemporaneous
new value for the weekly payments [to the benefit funds], then
it necessarily received subsequent new value for each payment
(except the last one) because its employees continued working.”
Jones Truck Lines, 130 F.3d at 327.
In LGI Energy, the Eighth Circuit concluded that, even if not controlling,
Jones Truck Lines provides persuasive authority contradicting
the trustee’s “inequitable” interpretation of the term
“such creditor” in section 547(c)(4):
Our decision is limited to the circumstances presented
by this case, for the statute is complex. We hold that,
in three-party relationships where the debtor’s preferential
transfer to a third party benefits the debtor’s primary
creditor, new value (either contemporaneous or
subsequent) can come from the primary creditor, even
if the third party is a creditor in its own right and is the
only defendant against whom the debtor has asserted
a claim for preference liability. As § 547(b) makes
avoidable a transfer “for the benefit of a creditor,” it
both serves the purposes of § 547 and honors the statute’s
text to construe “such creditor” in the § 547(c)(4)
exception as including a creditor who benefitted [sic]
from the preferential transfer and subsequently replenished
the bankruptcy estate with new value.
LGI Energy is a positive development for those doing business
with financially troubled entities because it expands the scope
of the subsequent new value defense to encompass payment
relationships involving multiple parties. In one sense, the ruling
can be viewed as an instance of judicial activism directed
at harmonizing the Bankruptcy Code with the realities of complex
financial transactions. A handful of other courts have
similarly concluded that new value provided by a third party
in similar three-party transactions is adequate for the transaction
at issue to fall within the exceptions provided by sections
547(c)(1) and 547(c)(4). See, e.g., In re H&S Transp. Co., 939
F.2d 355, 358–60 (6th Cir. 1991); Fuel Oil Supply, 837 F.2d at 231;
Holmes Environmental, Inc. v. Suntrust Banks, Inc. (In re Holmes
Environmental, Inc.), 287 B.R. 363, 386 (Bankr. E.D. Va. 2002).
However, it could be argued that the Eighth Circuit’s decision
was motivated more by equitable and policy considerations
than by a careful examination of the plain meaning of section
547(c)(4). The court stated in no uncertain terms that it
viewed the trustee’s preference litigation strategy as “do[ing]
fundamental violence” to the policy of equality of distribution.
The problem with the court’s approach is that, even though
the result may have been seen as fair, it glosses over the
specific language of section 547(c)(4) and related provisions
in the statute. Section 547(c)(1) and section 547(c)(4) share
the concept of “new value” as a defense to preference liability.
The former exempts from avoidance a transfer made as
“a contemporaneous exchange for new value given to the
debtor,” whereas the latter shields a transfer to the extent that
“after such transfer, such creditor gave new value” (emphasis
added). Thus, section 547(c)(1) does not specify by whom new
value can be provided, but section 547(c)(4) clearly provides
that “such creditor”—i.e., the transferee—must be the source.
When Congress makes a distinction of this nature between
two subsections of the same statute, it is presumed to have
intended that they be implemented differently. Other courts
have reached this conclusion with respect to sections 547(c)(1)
and 547(c)(4), ruling that only the former allows new value to be
provided by a third party. See, e.g., Manchester v. First Bank &
Trust Co. (In re Moses), 256 B.R. 641, 652 (B.A.P. 10th Cir. 2000);
Gray v. Chace (In re Boston Publishing Co.), 209 B.R. 157, 174
(Bankr. D. Mass. 1997) (same).
In LGI Energy, the Eighth Circuit did not conclude that the language
of section 547(c)(4) is ambiguous and therefore did
not offer a rationale for declining to apply it literally. Nor, in its
opinion, did the court examine the legislative history of section
547(c) in an effort to discern why lawmakers chose to use
different wording in sections 547(c)(1) and 547(c)(4). As such,
even though the outcome may have been fair, the ruling does
not provide an ideal road map for invoking the subsequent new
value defense in other cases involving three-party relationships.
The court in this case could have elected a pathway more consonant
with the literal terms of section 547(c)(4) that nevertheless
reached the same result. As the Eighth Circuit noted, the ruling
below that the utilities were “creditors” of LGI was “open to
serious question.” A conclusion that the utilities were not in fact
creditors of LGI—given that the parties had no contractual relationship—
would have resulted in no preference liability, while simplifying
the resolution of the case considerably.
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Fourth Circuit Weighs In on Good-Faith
Defense to Av oidance of Fraudulent
Charles M Oellermann and Mark G. Douglas
An important defense in litigation brought by a bankruptcy
trustee or chapter 1 1 debtor-in-possession (“DIP”) to avoid
a fraudulent transfer is that the recipient provided value in
exchange for the transfer and acted in “good faith.” Because the
Bankruptcy Code does not define “good faith,” courts assessing
the viability of a good-faith defense typically examine whether,
on the basis of the specific circumstances, a transferee knew or
should have known that a transfer was actually or constructively
fraudulent. Although most courts agree that this test is an objective
one, a ruling recently handed down by the Fourth Circuit
Court of Appeals may have introduced an element of subjectivity
into the analysis. In Gold v. First Tenn. Bank N.A. (In re Taneja),
2014 BL 47157 (4th Cir. Feb. 21, 2014), a Fourth Circuit panel
ruled in a split decision that: (i) the same standard applies in
assessing good faith under sections 548(c) and 550(b) of the
Bankruptcy Code; and (ii) a transferee bank met its burden
of demonstrating good faith without introducing evidence of
standard practices in the mortgage warehousing industry.
Good-Fa ith Defense to Avoidance of Fraudulent
Section 548(a)(1) of the Bankruptcy Code authorizes a trustee or
DIP to avoid any transfer of an interest of the debtor in property
or any obligation incurred by the debtor within the two years
preceding a bankruptcy filing if: (i) the transfer was made, or
the obligation was incurred, “with actual intent to hinder, delay,
or defraud” any creditor; or (ii) the debtor received “less than
a reasonably equivalent value in exchange for such transfer or
obligation” and was, among other things, insolvent, undercapitalized,
or unable to pay its debts as such debts matured.
Section 548(c) provides a defense to avoidance of a fraudulent
transfer for a “good faith” transferee or obligee who gives
“value” in exchange for a transfer or obligation:
Except to the extent that a transfer or obligation voidable
under this section is voidable under section 544,
545, or 547 of this title [dealing with a trustee’s power
to avoid, respectively, transfers that are voidable under
state law, statutory liens, and preferential transfers], a
transferee or obligee of such a transfer or obligation
that takes for value and in good faith has a lien on or
may retain any interest transferred or may enforce any
obligation incurred, as the case may be, to the extent
that such transferee or obligee gave value to the
debtor in exchange for such transfer or obligation.
Thus, the ability of a transferee or obligee to rely on section
548(c) as a defense depends upon whether: (i) the transferee
or obligee takes “for value”; (ii) the transferee or obligee acts
in “good faith”; and (iii) the transfer or obligation is not otherwise
avoidable. Section 550(b) of the Bankruptcy Code similarly
provides that, after avoidance of a transfer, the trustee may not
recover the property transferred or its value from any transferee
“that takes for value, including satisfaction or securing of a present
or antecedent debt, in good faith, and without knowledge of
the voidability of the transfer avoided.”
What Is “Good Fa ith”?
The Bankruptcy Code defines “value” for purposes of section
548. Section 548(d)(2)(A) states that “ ‘value’ means property, or
satisfaction or securing of a present or antecedent debt of the
debtor, but does not include an unperformed promise to furnish
support to the debtor or to a relative of the debtor.”
“Good faith,” however, is not defined by the Bankruptcy Code,
and courts have sometimes struggled to find a reliable standard
to apply in assessing whether it exists under a wide range of circumstances.
See generally Jimmy Swaggart Ministries v. Hayes
(In re Hannover Corp.), 310 F.3d 796, 800 (5th Cir. 2002) (“[T]here
is little agreement among courts as to what conditions ought to
allow a transferee [the good-faith] defense. This is not surprising,
as the variables are manifold.”). For example, in Hayes v.
Palm Seedlings Partners-A (In re Agric. Research & Tech. Group,
Inc.), 916 F.2d 528 (9th Cir. 1990), the Ninth Circuit explained that
the standard is an objective one—namely, in gauging good
faith, a court should examine what a transferee knew or should
have known, rather than what the transferee actually knew from
a subjective standpoint. Accord Brown v. Third Nat’l Bank (In re
Sherman), 67 F.3d 1348 (8th Cir. 1995); Leonard v. Coolidge (In re
Nat’l Audit Defense Network), 367 B.R. 207 (Bankr. D. Nev. 2007).
Other courts have refined this standard into a two-part analysis,
examining: (i) whether the transferee was on inquiry notice of
suspicious facts amounting to “red flags”; and (ii) if so, whether
the transferee reasonably followed up with due diligence to
determine whether a transaction may not have been bona fide.
See, e.g., Horton v. O’Cheskey (In re Am. Hous. Found.), 2013
BL 307573 (5th Cir. Nov. 5, 2013); Christian Bros. High School
Endowment v. Bayou No Leverage Fund LLC (In re Bayou Group,
LLC), 439 B.R. 284 (S.D.N.Y. 2010); Bear Stearns Securities Corp. v.
Gredd (In re Manhattan Inv. Fund Ltd.), 397 B.R. 1 (S.D.N.Y. 2007);
Soifer v. Bozarth (In re Lydia Cladek, Inc.), 494 B.R. 555 (Bankr.
M.D. Fla. 2013). Whether a transferee has acted in good faith is a
fact-intensive inquiry that must be determined on a case-by-case
basis. See Sherman, 67 F.3d at 1355; Wagner v. Ultima Homes, Inc.
(In re Vaughan Co. Realtors), 493 B.R. 597 (Bankr. D.N.M. 2013).
The Fourth Circuit’s ruling in Taneja has already been
criticized by some commentators and industry professionals
for corrupting the objective element of the test
for good faith.
In Taneja, the Fourth Circuit examined the meaning of “good
faith” as used in section 548(c).
Beginning in the 1990s, Vijay K. Taneja (“Taneja”) owned and operated
Financial Mortgage, Inc. (“FMI”), a business engaged in
originating home mortgages and selling the loans to secondary
purchasers who aggregated the mortgage loans and securitized
them for sale to investors. As part of that business, FMI worked
with several financial institutions known as “warehouse lenders.”
Those lenders advanced funds to FMI under lines of credit so
that FMI could originate mortgages. Under those arrangements,
FMI was obligated to sell the mortgage loans to secondary purchasers
within a certain period of time, after which the lines of
credit were replenished.
At some point after 1999, FMI had difficulty selling mortgage
loans and, under Taneja’s control, began engaging
in fraudulent conduct. The fraud included selling the same
mortgage loans to several different secondary purchasers and
conspiring with other affiliated entities controlled by Taneja to
have those entities serve as intermediaries as a way to conceal
the fraud. This scheme continued through 2007–08, when
the market for mortgage-backed securities began to implode
as part of the financial crisis. The fraudulent scheme resulted
in losses of nearly $14 million to warehouse lenders, approximately
$19 million to secondary purchasers, and unspecified
millions to investors.
One of FMI’s warehouse lenders was First Tennessee Bank N.A.
(“FTB”). In July 2007, FTB agreed to provide FMI with a $15 million
line of credit. Before doing so, FTB analyzed financial statements
and tax records provided by FMI and Taneja, checked
FMI’s references, and examined FMI’s “quality control plan.”
The bank also conducted due diligence, using a “private mortgage
database” that contained information regarding mortgage
irregularities and reports of fraud or suspected fraud. FTB’s
investigation did not reveal any negative business information
regarding either FMI or Taneja.
The lending agreement obligated FTB to send funds directly to
an insured title agent. After each mortgage transaction closed,
FMI was required to send the loan documentation, including the
promissory note, to the bank within two business days.
From September 2007 to March 2008, FMI made payments to
FTB aggregating nearly $4 million, but the payments were often
untimely. FTB loan officers met with Taneja and other FMI representatives
twice during that period. The loan officers later testified
that: (a) Taneja claimed that FMI’s failure to produce loan
documentation in a timely fashion was caused by the unexpected
departure of one of its loan processors; (b) FMI’s chief
secondary purchaser confirmed that it had not bought FMI’s
outstanding loans due to the lack of supporting documentation;
and (c) Taneja’s lawyer assured the officers that the mortgages
were “good” and represented “arms-length transactions.”
In April 2008, FTB learned that the mortgages originated by
FMI had been falsified. The bank immediately declared FMI in
default under the lending agreement.
In June 2008, Taneja (who was later convicted and imprisoned
for the fraud), FMI, and various affiliates filed for chapter
11 protection in the Eastern District of Virginia. A bankruptcy
trustee appointed for all of the debtors sued FTB in the bankruptcy
court to avoid the $4 million in payments made by FMI
to the bank as fraudulent transfers under section 548(a) and to
recover the funds under section 550(a). FTB invoked the goodfaith
defense under section 548(c).
At trial, the bankruptcy court heard the testimony of the FTB officers
who had been in charge of the lending relationship with FMI.
Although the witnesses had considerable experience in warehouse
lending, they were not qualified as experts in the industry.
Both testified that during the “market meltdown” of 2007–08,
banks spent more time analyzing mortgage loans, such loans
were more difficult to sell, and more loans remained outstanding
on the bank’s warehouse lines of credit than in previous years.
The bankruptcy court, relying on the loan officers’ testimony,
ruled that FTB had established its good-faith affirmative
defense under section 548(c) and dismissed the avoidance proceeding.
Among other things, the court found that, although the
bank was concerned about FMI’s failure to sell its loans quickly
in 2007, the bank reasonably thought that the lagging secondary
mortgage market, rather than any misconduct, caused the
delay. The court concluded that FTB “did not have any information
that would [reasonably] have led it to investigate further,
and the bank’s actions were in accord with the bank’s and the
industry’s usual practices.”
A district court affirmed the ruling, and the trustee appealed to
the Fourth Circuit.
The Fourth Circuit’s Ruling
A three-judge panel of the Fourth Circuit affirmed in a split
decision. Both the majority and dissenting opinions discussed
whether the bankruptcy court had erred in: (i) misapplying the
good-faith standard; and (ii) concluding that FTB presented
sufficient objective evidence to prove that it had accepted the
payments from FMI in good faith.
The majority explained that the Fourth Circuit recently interpreted
the term “good faith” in the context of section 550(b)(1)
of the Bankruptcy Code in Goldman v. City Capital Mortg. Corp.
(In re Nieves), 648 F.3d 232 (4th Cir. 2011). In Nieves, the Fourth
Circuit ruled that the proper focus in evaluating good faith in
the context of section 550(b)(1) is determining “what the transferee
[actually] knew or should have known” when it accepted
the transfer. In addition, the court determined that good faith
has components that are both subjective (honesty in fact) and
objective (observance of reasonable commercial standards):
Under the subjective prong, a court looks to “the honesty”
and “state of mind” of the party acquiring the
property. Under the objective prong, a party acts without
good faith by failing to abide by routine business
practices. We therefore arrive at the conclusion that the
objective good-faith standard probes what the transferee
knew or should have known taking into consideration
the customary practices of the industry in which
the transferee operates.
Id. at 239–40 (citation omitted). In Taneja, the majority concluded
that the good-faith standard adopted in Nieves should
apply in determining good faith under section 548(c).
The trustee did not allege that FTB had actual knowledge of
FMI’s fraudulent conduct at the time of the transfers. Thus, under
Nieves, the Taneja panel’s inquiry concerned whether the bank
should have known about the fraud in keeping with customary
practices in the industry.
The majority rejected the trustee’s argument that FTB could
not prove good faith without showing that “each and every act
taken and belief held” by the bank constituted “reasonably prudent
conduct by a mortgage warehouse lender.” The majority
also rejected the trustee’s contention that such evidence should
have been presented in the form of third-party expert testimony.
“We decline,” the majority wrote, “to adopt a bright-line rule
requiring that a party asserting a good-faith defense present
evidence that his every action concerning the relevant transfers
was objectively reasonable in light of industry standards.”
Rather, the court emphasized, “our inquiry regarding industry
standards serves to establish the correct context in which to
consider what the transferee knew or should have known.”
The majority was similarly loath to adopt an “inflexible rule” that
expert testimony must be presented in every case to prove good
faith. Such a rule, the court wrote, “unreasonably would restrict the
presentation of a defense that ordinarily is based on the facts and
circumstances of each case and on a particular witness’ knowledge
of the significance of such evidence.”
Having laid the groundwork regarding the appropriate standard
and the nature of the evidence necessary to satisfy it, the
majority ruled that: (i) the bankruptcy court applied the correct
legal standard in evaluating whether FTB proved its good-faith
defense; and (ii) the bankruptcy court did not err in concluding
that, on the basis of testimony by FTB’s officers regarding their
experience in mortgage warehousing and their efforts to investigate
Taneja, FMI, and the circumstances surrounding FMI’s failure
to timely submit mortgage loan documentation, FTB should not
necessarily have known of FMI’s fraudulent conduct. According to
the majority, “[W]hen considered as a whole, the circumstances
relied on by the trustee indicated only that FMI had financial difficulties,
which was not uncommon in the warehouse lending
industry during 2007 and 2008.”
Fourth Circuit Judge James A. Wynn, Jr., dissented. In his
opinion, Judge Wynn explained that good faith has not just a
subjective component, but also an objective “observance of
reasonable commercial standards” element. FTB, the judge
wrote, “failed to proffer any evidence to support a finding that it
received transfers from FMI with objective good faith in the face
of several alleged red flags.”
Judge Wynn agreed with the majority’s conclusion that FTB
could meet its burden as to the objective element of the test
without presenting expert testimony on prevailing industry
standards. However, he argued that FTB failed to elicit such
testimony from its (nonexpert) witnesses, relying instead on
“generalities from those witnesses such as having read the
Wall Street Journal and having worked in the industry for many
years.” Such generalities, Judge Wynn posited, constitute evidence
of commercially reasonable standards in the warehouse
lending industry that is inadequate to satisfy the objective component
of the good-faith defense. Moreover, he questioned
whether FTB’s response to the red flags raised by FMI’s conduct
comported “with that of a reasonable warehouse lender.”
Finally, Judge Wynn discounted FMI’s reliance on what it portrayed
as a reasonable response in the face of the turmoil in
the economy and the mortgage industry during the financial
crisis, rather than demonstrating how, in the face of red flags,
its conduct comported with industry practices and standards.
According to the judge:
If economic turmoil gives businesses a free pass on
needing to prove objective good faith, even businesses
falling far short of industry standards but rather
“wil[l]ful[ly] ignoran[t] in the face of facts which cried out
for investigation[,]” In re Nieves, 648 F.3d at 241, could
succeed with a good faith defense so long as their
implosion coincided with an economic downturn. This is
not, and should not be, the law.
The Fourth Circuit’s ruling in Taneja has already been criticized
by some commentators and industry professionals for corrupting
the objective element of the test for good faith. Under existing
case law, if a DIP or trustee claims that a transferee “should have
known” of a transferor’s fraud, a two-part analysis is required.
First, the court must examine whether red flags existed that
should have alerted a reasonably prudent transferee to potential
fraud. If the court concludes that the transferee had “inquiry
notice” due to the existence of red flags, the transferee can still
establish a good-faith defense under section 548(c) if it can
demonstrate that a reasonably diligent inquiry would not have
revealed the fraud. Both the inquiry notice and diligent inquiry
elements are objective tests.
Taneja muddies the waters by injecting an element of subjectivity
into this analysis. The Fourth Circuit majority did not require
FTB to demonstrate that a reasonably prudent warehouse
lender would not have been alerted to the fraud. Instead, the
majority ruled that the bank’s nonexpert witnesses adequately
demonstrated that FTB received the transfers in good faith and
without knowledge that should have alerted the bank that the
transfers were fraudulent. As noted in the dissent, an objective
inquiry would have required FTB to present evidence demonstrating
that its conduct followed routine industry standards
and that its response to the red flags (e.g., late payments,
inadequate loan documentation) would not have alerted a reasonably
prudent mortgage warehouse lender to FMI’s fraud.
In Brief: Debt Purchaser’s Credit Bid
In the March/April 2014 edition of the Business Restructuring
Review, we discussed an important ruling from a Delaware
bankruptcy court restricting a creditor’s right to credit bid an
acquired claim in bankruptcy sale of the underlying collateral.
In In re Fisker Automotive Holdings, Inc., 2014 BL 13998 (Bankr.
D. Del. Jan. 17, 2014), leave to app. denied, 2014 BL 33749 (D. Del.
Feb. 7, 2014), certification denied, 2014 BL 37766 (D. Del. Feb. 12,
2014), the bankruptcy court limited the amount of the credit bid
to the discounted purchase price actually paid for the debt.
In concluding that the right to credit bid under section 363(k)
of the Bankruptcy Code is not absolute and may be limited
“for cause,” the court relied on a controversial ruling handed
down in 2010 by the Third Circuit Court of Appeals. In In re
Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010), the
Third Circuit observed in a footnote that imposing a limit on
credit bidding “for cause” does not require the secured creditor
to “engage in inequitable conduct.” On the contrary, according
to the Third Circuit, “[a] court may deny a lender the right to
credit bid in the interest of any policy advanced by the Code,
such as to ensure the success of the reorganization or to foster
a competitive bidding environment.”
In Fisker, the bankruptcy court held that limiting the amount of
the credit bid was warranted because an unrestricted credit bid
would chill bidding and because the full scope of the underlying
lien was as yet undetermined. The court also expressed
concern as to the expedited nature of the proposed sale under
section 363(b) of the Bankruptcy Code, which in the court’s view
was never satisfactorily explained. As a postscript, although the
debt purchaser was outbid at the ensuing auction of Fisker’s
assets, the losing bidder and Fisker’s other creditors reached
a settlement in mid-April whereby the loser will receive as much
as $90 million of the $149.2 million sale proceeds—a significant
return on its $25 million investment to acquire the debt from the
Given the importance of credit bidding as a distressed acquisition
tool, along with the court’s ruling limiting the credit bid to
the amount paid for the debt, distressed debt purchasers have
kept a close watch on the way subsequent courts have interpreted
and applied Fisker.
A Virginia bankruptcy court, in a published April ruling, was
apparently the first to do so. In In re The Free Lance-Star
Publishing Co. of Fredericksburg, Va., 2014 BL 103869 (Bankr.
E.D. Va. Apr. 14, 2014), leave to appeal denied, 2014 BL 130156
(E.D. Va. May 7, 2014), the court found “cause” under section
363(k) to limit a credit bid by an entity that purchased
$39 million in face amount of debt with the intention of acquiring
ownership of the debtors, which owned various radio stations
The court limited the credit bid in connection with a sale of the
debtors’ assets under section 363(b) on the basis of its findings
that: (i) the creditor’s liens on a portion of the assets to be
sold had been improperly perfected; (ii) the creditor engaged in
inequitable conduct by forcing the debtor into bankruptcy and
an expedited section 363 sale process in pursuing its clearly
identified “loan to own” strategy; and (iii) the creditor actively
“frustrate[d] the competitive bidding process” and attempted
“to depress the sales price of the Debtors’ assets.” The court
accordingly limited the debt purchaser’s credit bid to $14 million.
Although the capped amount appears to correspond to the
approximate value of the collateral that was subject to the creditor’s
valid and perfected liens, the court stated at a March 25,
2014, hearing that it “wishes it had more information with regard
to the amount . . . that the lender paid . . . for the loan.” Transcript
of Mar. 25, 2014, Hearing at 197:1–198:10 (quoted in Doc. No. 177).
On May 8, 2014, a Virginia district court denied the creditor’s
motion for leave to appeal the interlocutory ruling. See
DSP Acquisition, LLC v. Free Lance-Star Publishing Co. of
Fredericksburg, VA, 2014 BL 130156 (E.D. Va. May 7, 2014). In its
motion, the creditor argued that the credit-bidding issue is at
the heart of the sale process and an anticipated May 15, 2014,
auction and that the issue must therefore be resolved prior to
the auction. It also contended that, absent immediate appellate
review, the integrity of the sale process would be jeopardized.
Relying on the Delaware district court’s ruling denying a motion
for leave to appeal the credit bid limitation in Fisker, the district
court rejected the creditor’s arguments:
[T]here is no risk of irreparable harm if the issues
are not resolved before the auction because there
is no pending issue regarding the assets subject to
sale and the Bankruptcy Court will determine who
receives the proceeds (and how much) after the
sale. Thus, if the Bankruptcy Court determines that
the amount of [the] credit bid was incorrect, it can
accordingly adjust the payment to [the creditor] at a
later stage of the proceedings.
Id. at *2.
Most recently, the bankruptcy court in In re Charles Street African
Methodist Episcopal Church of Boston, 2014 BL 134241 (Bankr. D.
Mass. May 14, 2014), denied in part a chapter 11 debtor’s motion to
limit a credit bid on the basis that the secured creditor’s claims
were subject to bona fide dispute because the debtor had filed
counterclaims against the creditor which, by way of setoff, could
have reduced the amount of the claims to zero. The debtor, in
an attempt to auction its assets, had sought an expedited “up or
down” decision on credit-bidding rights without the need for an
evidentiary hearing. It explicitly disavowed reliance on Fisker and
the alternative theories limiting credit bids articulated in the ruling
(e.g., bid chilling and bidding for an improper purpose or with an
In finding that “cause” was lacking under section 363(k) to limit
the credit bid, the court explained that: (i) despite the debtor’s
counterclaims, which did not relate to the validity of the secured
creditor’s claims or liens, the claims were “allowed” (a designation
that the debtor did not dispute); and (ii) the claims were not
likely to be consumed entirely in a credit bid for the assets.
The court rejected the debtor’s argument that “credit risk”
associated with collecting on its counterclaims was a valid
reason under the circumstances to limit credit-bidding rights.
According to the court, “[The debtor] would be using a denial of
credit bidding as, in essence, a form of prejudgment security, a
purpose that I doubt it was intended to serve.” Id. at *7.
However, the court ruled that, because the terms of the auction
included the payment of a $50,000 breakup fee if the stalkinghorse
bidder did not prevail, the secured creditor was required
to include at least $50,000 in cash as part of its bid. Thus, the
court did partially limit the credit bid.
Taking Sides—Lyondell Limits the Use of the
Section 546(e) Safe Harbor in Fraudulent
In Weisfelner v. Fund 1 (In re Lyondell Chem. Co.), 503 B.R. 348
(Bankr. S.D.N.Y. 2014), the U.S. Bankruptcy Court for the Southern
District of New York held that the “safe harbor” under section
546(e) of the Bankruptcy Code for settlement payments made
in connection with securities contracts does not preclude
claims brought by a chapter 11 plan litigation trustee on behalf
of creditors under state law to avoid as fraudulent transfers
pre-bankruptcy payments to shareholders in a leveraged buyout
(“LBO”) of the debtor. By its ruling, the Lyondell court contributed
to a split among the courts in the Southern District of
New York, aligning itself with the district court in In re Tribune
Co. Fraudulent Conveyance Litig., 499 B.R. 310 (S.D.N.Y. 2013),
and against the district court in Whyte v. Barclays Bank PLC,
494 B.R. 196 (S.D.N.Y. 2013). Lyondell and Tribune appear to signal
that even in the Second Circuit, where courts have liberally
interpreted the scope of the Bankruptcy Code’s financial safe
harbors, the reach of section 546(e) is not without bounds.
Bankruptcy Avoidance Powers and Limitations
The Bankruptcy Code gives a bankruptcy trustee or chapter 11
debtor-in-possession (“DIP”) the power to avoid, for the benefit
of the estate, certain transfers made or obligations incurred by
a debtor, including fraudulent transfers, within a specified time
prior to a bankruptcy filing. Fraudulent transfers include transfers
that were made with “actual” fraudulent intent—the intent to
hinder, delay, or defraud creditors—as well as transfers that were
“constructively” fraudulent, because the debtor received less than
“reasonably equivalent value” in exchange and, at the time of
the transfer, was insolvent, undercapitalized, or unable to pay its
debts as such debts matured.
Fraudulent transfers can be avoided by a bankruptcy trustee or
DIP for the benefit of the estate under either: (i) section 548 of
the Bankruptcy Code, which creates a federal cause of action
for avoidance of transfers made or obligations incurred up to
two years before a bankruptcy filing; or (ii) section 544, which
gives the trustee or DIP the power to avoid transfers or obligations
that may be avoided by creditors under applicable nonbankruptcy
law. Some state fraudulent transfer laws that may
be utilized under section 544 have a reach-back period longer
than two years.
Section 546 of the Bankruptcy Code imposes a number of limitations
on these avoidance powers. Specifically, section 546(e)
prohibits, with certain exceptions, avoidance of transfers that
are margin or settlement payments made in connection with
securities, commodity, or forward contracts. The purpose of section
546(e) and other financially focused “safe harbors” in the
Bankruptcy Code is to minimize “systemic risk” to the securities
and commodities markets that could be caused by a financial
contract counterparty’s bankruptcy filing. Like sections 544 and
548, section 546(e) is expressly directed at a bankruptcy trustee
or, pursuant to section 1107(a), a DIP: “Notwithstanding sections
544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may
not avoid a transfer that is a margin payment . . . or settlement
payment . . . .” (emphasis added).
The Bankruptcy Clause of the U.S. Constitution grants authority
to Congress to establish a uniform federal law of bankruptcy.
U.S. CONST., art. I, cl. 8. The Supremacy Clause of the
Constitution mandates that federal laws, such as those concerning
bankruptcy, “shall be the supreme Law of the Land; . . . [the]
Laws of any State to the Contrary notwithstanding.” U.S. CONST.,
art. VI, cl. 2. Thus, under the doctrine of preemption, “state laws
that interfere with or are contrary to federal law are preempted
and are without effect pursuant to the Supremacy Clause.” In
re Loranger Mfg. Corp., 324 B.R. 575, 582 (Bankr. W.D. Pa. 2005);
accord Hillsborough County v. Automated Medical Labs, Inc.,
471 U.S. 707, 712 (1985). Through the years, three types of federal-
law preemption over state law have been developed by the
courts: (i) express preemption; (ii) field preemption; and (iii) conflict
preemption. In re Nickels Midway Pier, LLC, 332 B.R. 262, 273
(Bankr. D.N.J. 2005). Express preemption applies “when there is
an explicit statutory command that state law be displaced.” Id.
Field preemption applies when federal law “is sufficiently comprehensive
to warrant an inference that Congress ‘left no room’
for state regulation.” In re Miles, 294 B.R. 756, 759 (B.A.P. 9th Cir.
2003); Hillsborough County, 471 U.S. at 713. Conflict preemption
applies if state law conflicts with federal law such that: “(1) it is
impossible to comply with both state law and federal law; or
(2) the state law stands as an obstacle to the accomplishment
and execution of the full purposes and objectives of Congress.”
Nickels Midway Pier, 332 B.R. at 273.
Lyondell contributes to a split of authority in the
Southern District of New York on the application of
section 546(e). Whereas Barclays continued the trend
of liberally applying the safe harbor consistent with its
purpose to protect financial markets against systemic
risk, Tribune and Lyondell have departed from this
approach, limiting the reach of section 546(e) by tempering
the need to protect markets with other important
bankruptcy principles, such as the protection of
In Lyondell, the court considered, among other things, whether
section 546(e), either by its own terms or under preemption
principles, bars state-law fraudulent transfer claims with respect
to a prepetition LBO, which claims were assigned as part of a
chapter 11 plan to a post-bankruptcy litigation trust established
for the benefit of creditors.
In December 2007, Basell AF S.C.A. acquired Lyondell Chemical
Company (“Lyondell”) through an LBO. The transaction was
financed entirely by debt and was secured by the assets of the
target company rather than the acquirer. As a result of the LBO,
Lyondell took on approximately $21 billion of secured indebtedness.
About $12.5 billion of the amount borrowed was paid to
Lyondell stockholders, many of which were investment banking
houses, brokerage firms, or other financial institutions.
In early January 2009, just 13 months after the LBO, Lyondell and
numerous affiliates filed for chapter 11 protection in the Southern
District of New York. Ultimately, the bankruptcy court confirmed a
chapter 11 plan for Lyondell that provided for, among other things:
(i) the creation of a litigation trust (the “Creditor Trust”) to which
certain estate causes of action were abandoned; and (ii) the
assignment by creditors of their state-law claims, including statelaw
fraudulent transfer actions, to the Creditor Trust. After the
effective date of the plan, the trustee of the Creditor Trust sued
all Lyondell shareholders who had received more than $100,000
in connection with the LBO, alleging that the payments were actually
or constructively fraudulent and therefore avoidable under
state law. The defendants moved to dismiss, asserting, among
other things, that the claims were: (i) barred by the terms of the
section 546(e) safe harbor; and (ii) preempted by section 546(e).
The Decision: Creditor Trust Claims Are Not Barred by
546(e) or Preemption Principles
The bankruptcy court denied the defendants’ motion to dismiss
on the basis of section 546(e). The court concluded that, by its
terms, section 546(e) does not apply to claims asserted by or
on behalf of creditors; rather, it applies only to claims brought
by a bankruptcy trustee or DIP. Furthermore, the court ruled
that the state-law claims were not preempted by either section
546(e) or other federal law.
The defendants argued that, even though section 546(e)
expressly bars only actions brought by a “trustee” to avoid certain
financial transactions as constructively fraudulent transfers,
the provision also bars similar state-law claims asserted
on behalf of creditors. The court flatly rejected this argument,
admonishing that “[w]hile the Movants spend 10 pages in their
brief arguing the matter as if sections 544 and 548—and hence
section 546(e)—apply to this case, this is not a case about sections
544 and 548.” The claims at issue, the court explained,
were being asserted not on behalf of the estate, but on behalf
of individual creditors. Thus, the court wrote, “there is no statutory
text making section 546(e) applicable to claims brought on
behalf of individual creditors, or displacing their state law rights,
by plain meaning analysis or otherwise.” Quoting Tribune, the
court emphasized that “if Congress intended section 546(e) to
be more broadly applicable, ‘it could simply have said so.’ ”
Also following the reasoning of Tribune, the court rejected the
defendants’ position that, under all three types of preemption
doctrine, the absence of a safe harbor similar to section 546(e)
in state fraudulent transfer laws should mean that the states’
“similar but not congruent” constructive fraudulent transfer
avoidance statutes are preempted by section 546(e) and therefore
invalid. In this regard, the court initially determined that
Congress had not expressly preempted any state-law causes of
action for fraudulent transfers.
The bankruptcy court also concluded that there was no “field
preemption” because “Congress has not evidenced any intention
to wholly occupy the fields of avoidance or recovery of
fraudulent transfers.” Rather, the court explained, the history
of state and federal fraudulent transfer law has long demonstrated
a shared interest with the states in protecting creditors
from constructively fraudulent transfers. Indeed, the court noted,
state fraudulent transfer laws predate the federal equivalents,
with no subsequent attempt by Congress to preclude enforcement
of existing state laws.
Finally, the court found no “conflict preemption.” The defendants
argued that the congressional policy underlying the enactment
of section 546(e) would be undermined by allowing the statelaw
fraudulent transfer action to proceed. In response, the court
concluded that it is not impossible for a party to comply with
both federal and state fraudulent transfer laws. The court similarly
determined that, considering lawmakers’ intent with respect
to section 546(e) in the context of general bankruptcy policy:
[A]t least in the context of an action against cashed out
beneficial holders of stock, at the end of the asset dissipation
chain, state law fraudulent transfer laws do not
“stand as an obstacle” to the “purposes and objectives
of Congress”—even if one were to ignore the remainder
of bankruptcy policy and focus solely on the protection
against the “ripple effects” that caused section 546(e) to
come into being.
Accordingly, following much of the reasoning in Tribune, the
Lyondell court ruled that the state-law fraudulent transfer laws
were not preempted by section 546(e) or any other federal law.
The Lyondell court determined that the defendants’ reliance on
Barclays, in which the court granted a motion to dismiss state
constructive fraudulent transfer claims brought by a litigation
trust, was misplaced. According to the Lyondell court, Barclays is
factually distinguishable—in Barclays, the same trust prosecuted
both estate and individual creditor claims, whereas in Lyondell,
the Creditor Trust held only claims assigned by creditors, and the
estate specifically abandoned its section 544 rights.
The Lyondell court also faulted both the Barclays court’s ultimate
judgment and its reasoning, particularly with respect to
preemption. The Lyondell court appeared to be particularly
troubled by the Barclays court’s focus on the congressional
objective of protecting the financial markets and the court’s
failure to consider other congressional bankruptcy objectives,
such as the “longstanding and fundamental principles
that insolvent debtors cannot give away their assets to the
prejudice of their creditors.” According to the Lyondell court,
this narrow focus prevented the Barclays court from drawing
the proper conclusion that “[p]rotecting market participants is
not the same thing as protecting markets.” Characterizing the
analysis in Barclays as “flawed” and “less thorough than that of
Tribune,” the Lyondell court ruled that nothing in section 546(e)
demands that state-law fraudulent transfer claims be either
expressly or impliedly preempted.
Lyondell contributes to a split of authority in the Southern District
of New York on the application of section 546(e). Whereas
Barclays continued the trend of liberally applying the safe harbor
consistent with its purpose to protect financial markets against
systemic risk, Tribune and Lyondell have departed from this
approach, limiting the reach of section 546(e) by tempering the
need to protect markets with other important bankruptcy principles,
such as the protection of creditors’ rights. Although Tribune
and Lyondell both involved specific, somewhat narrow circumstances
in which the claims at issue were clearly state-law claims
that were not being asserted by the bankruptcy trustee or DIP, the
two opinions signal that, even in the Second Circuit (where courts
are known for liberally construing the safe harbor), the scope of
section 546(e) is not without limits. Furthermore, in the preemption
context, Tribune and Lyondell suggest that protection of the
financial markets will not always trump other bankruptcy policies.
Both Barclays and Tribune have been appealed to the Second
Circuit, which will hear the appeals in tandem and is expected to
weigh in on these important issues later this year.
In Brief: Chapter 11 Plan Payment of
Official Committee Members’ Legal Fees
Disallowed Absent Showing of Substantial
In the March/April 2014 issue of Business Restructuring Review,
we discussed a recent trend among bankruptcy courts in the
Southern District of New York confirming chapter 11 plans containing
provisions that treat the fees and expenses of unofficial
committees or individual official committee members
as administrative expenses without the need to demonstrate
that the applicants made a “substantial contribution” to the
estate, as required by sections 503(b)(3)(D) and 503(b)(4) of the
Bankruptcy Code. See, e.g., In re AMR Corp., 497 B.R. 690 (Bankr.
S.D.N.Y. 2013); In re Lehman Brothers Holdings Inc., 487 B.R. 181
(Bankr. S.D.N.Y. 2013); In re Adelphia Communications Corp.,
441 B.R. 6 (Bankr. S.D.N.Y. 2010).
Prior to 2005, section 503(b) of the Bankruptcy Code authorized
the payment of legal fees incurred in chapter 11 cases
by ad hoc committees and individual official or unofficial committee
members as administrative expenses. Section 503(b)(3)
confers administrative-expense status on “the actual, necessary
expenses, other than compensation and reimbursement specified
in” section 503(b)(4) (emphasis added), incurred by six categories
of creditors or custodians.
Of these six categories, the fourth in subparagraph (D) consists
of “a creditor, an indenture trustee, an equity security
holder, or a committee representing creditors or equity security
holders other than [an official committee], in making a
substantial contribution in a case under chapter 9 or 11 of this
title.” Subparagraph (F) covers the sixth category, “a member
of [an official committee], if such expenses are incurred in the
performance of the duties of the committee.”
Before 2005, section 503(b)(4) provided that allowed administrative
expenses included “reasonable compensation for professional
services rendered by an attorney or an accountant of
an entity whose expense is allowable under” section 503(b)(3).
Thus, allowed administrative expenses formerly included legal
fees incurred by an unofficial committee in making a substantial
contribution, as well as a member of an official committee.
However, section 503(b)(4) was amended in 2005. It now provides
for the payment as an administrative expense of fees
“rendered by an attorney or an accountant of an entity whose
expense is allowable under subparagraph (A), (B), (C), (D), or (E)”
of section 503(b)(3). Thus, subparagraph (F)—pertaining to legal
fees of official committee members—is no longer included. By
excluding subparagraph (F), the amendment “make[s] it clear
that a committee member is not entitled to reimbursement as
an administrative expense for professional fees incurred by
the committee member.” 4 Collier on Bankruptcy ¶ 503LH
(16th ed. 2014); see also H.R. Rep. No. 109-31, pt. 1, at 142 (2005)
(“Expenses for attorneys or accountants incurred by individual
members of creditors’ or equity security holders’ committees
are not recoverable, but expenses incurred for such professional
services . . . by such committees themselves would be.”).
The AMR, Lehman, and Adelphia bankruptcy courts concluded
that section 503(b) is not the exclusive source of authority for
the payment by a bankruptcy estate of the fees and expenses
of unofficial committees or individual official committee
members. Instead, those courts reasoned, fees may also be
authorized under: (i) section 1123(b)(6), which provides that a
chapter 11 plan may include any provision “not inconsistent” with
applicable provisions of the Bankruptcy Code; and (ii) section
1129(a)(4), which provides that a court shall confirm a plan only
if payments made under the plan for services or for costs and
expenses in connection with a chapter 11 case are “reasonable.”
The bankruptcy court’s ruling in Lehman was recently vacated
on appeal. In Davis v. Elliot Mgmt. Corp. (In re Lehman Bros.
Holdings, Inc.), 2014 BL 92862 (S.D.N.Y. Mar. 31, 2014), U.S. District
Court Judge Richard Sullivan construed the lack of explicit
authority in section 503(b) to mean that the fees and expenses
of individual official committee members may not be paid as
Relevant here, official committee members’ professional
fee expenses are not included in § 503(b). The
problem is not that such expenses are not listed—the
list is not exhaustive—but instead that the structure of
§ 503(b)(3) and (4) glaringly exclude [sic] professional
fee expenses for official committee members.
Thus, Judge Sullivan concluded, “because § 503(b)—the
sole source of administrative expenses—excludes paying
professional fee expenses on the basis of committee membership,”
individual committee members “cannot have their professional
fee expenses paid as administrative expenses solely on
the basis of their committee membership.”
Moreover, the judge ruled that the requirements of section 503(b)
may not be circumvented by characterizing the payment of such
fees as “permissive plan payments” authorized under sections
1123(b)(6) and 1129(a)(4). According to Judge Sullivan, “[N]either
the need for flexibility in bankruptcy cases, the consensual nature
of [the plan provision] nor a bankruptcy court’s approval of a payment
as ‘reasonable’ can justify a plan provision that is merely
a backdoor to administrative expenses that § 503 has clearly
excluded.” If an official committee member “perform[s] extraordinary
work to benefit the estate, above and beyond normal committee
duties,” Judge Sullivan wrote, the committee member may
“seek to be reimbursed under § 503(b)(3)(D) and 503(b)(4), which
provide for payment of the professional fees incurred by entities
that have made a ‘substantial contribution in a case.’ ” He accordingly
vacated the ruling below and remanded the case for factual
findings on the issue of substantial contribution.
Business Restructuring Review is a publication
of the Business Restructuring & Reorganization
Practice of Jones Day.
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interpretation, the court wrote, would allow assignment to any entity
that “has some remote connection to the management of money”
and would drain any force from the limitation inherent in the Eligible
Assignees provision. The court also reasoned that the remaining
language in the loan agreement’s assignment limitation (“commercial
bank, insurance company, . . . or institutional lender”) would
have no meaning if the term “financial institution” were as broad as
the Funds suggested.
The district court concluded that the parties knew of the materiality
of the Eligible Assignees limitation in the loan agreement and had
intentionally limited the term to exclude assignment to “distressed
asset hedge funds who candidly admit they seek to ‘obtain outright
control’ of assets.” The court ruled that “the Loan Agreement permitted
only ‘Eligible Assignees’ to vote on the plan, and thus the Funds
were rightfully precluded from voting.”
The district court also held that, even if the Funds had been permitted
to vote, the three entities comprising the Funds would be entitled
to one collective vote only (as distinguished from three). According
to the court, a creditor-assignor cannot split up a claim in a way that
artificially creates or enhances voting power that the original assignor
never had. Permitting the Funds to have three votes, the court reasoned,
would arbitrarily increase the voting power of their claim and
violate the majority voting requirements of the Bankruptcy Code by
preventing the remaining members of the class from accepting a
chapter 11 plan without the Funds’ cooperation.
Claims Traders Alert
A decision recently handed down by the U.S. District Court for the
Western District of Washington should be of interest to lenders and
distressed debt purchasers. In Meridian Sunrise Village, LLC v. NB
Distressed Debt Investment Fund Ltd. (In re Meridian Sunrise Village,
LLC), 2014 BL 62646 (W.D. Wash. Mar. 6, 2014), a lender group had
provided $75 million in financing to a company for the purpose of
constructing a shopping center. The loan agreement provided that
the lenders were prohibited from selling, transferring, or assigning
any portion of the loan to entities other than “Eligible Assignees.”
The term “Eligible Assignees” was defined as “any Lender, Affiliate
of a Lender or any commercial bank, insurance company, financial
institution or institutional lender approved by Agent in writing and,
so long as there exists no Event of Default, approved by Borrower in
writing, which approval shall not be unreasonably withheld.”
After a nonmonetary default in 2012 triggered liability under the
loan agreement for default interest and other penalties, the debtor
filed for chapter 11 protection in the Western District of Washington
on January 18, 2013. Over the debtor’s objection, one of the lenders
then sold its debt to a hedge fund that later resold a portion of
the debt to two other distressed investors (collectively, the “Funds”).
Shortly afterward, the debtor sought an order from the bankruptcy
court enjoining the Funds from exercising any rights that Eligible
Assignees would have under the loan agreement, including the right
to vote on the debtor’s proposed chapter 11 plan.
The debtor argued that it had negotiated those limitations specifically
to avoid assignments of the debt to “predatory investors—
investors who purchase distressed loans in the hope of obtaining
control of the underlying collateral in order to liquidate for rapid
repayment.” The bankruptcy court granted the injunction. After the
Funds’ request for a stay pending appeal was denied, the court
confirmed the debtor’s chapter 11 plan on the basis, in part, of votes
cast in favor of the plan by the prepetition lenders that had not sold
their claims. The Funds appealed the confirmation order as well
as the injunction, claiming that the bankruptcy court erroneously
denied them the right to vote on the plan when it concluded that
they were not “financial institutions.”
On appeal, the debtor argued that, under the terms of the loan
agreement, “hedge funds that acquire distressed debt and engage
in predatory lending” do not fall within the meaning of “financial
institutions” and should therefore not be included in the definition of
“Eligible Assignees.” The district court agreed.
The court rejected as overly broad the Funds’ reading of “financial
institution” to encompass any entity that manages money. This