March 9, 2012: Publication of Dynegy Examiner’s Report

On March 9, 2012, Susheel Kirplani, the Court-appointed examiner in Dynegy Holdings, LLC’s bankruptcy case, issued a report setting forth his findings and conclusions concerning potential claims and causes of action arising from Dynegy Holdings’ pre-bankruptcy restructuring. Among other things, the examiner’s report found that Dynegy Holdings, acting at the direction of its parent, Dynegy Inc., transferred its coal assets to Dynegy Inc. with the actual intent to hinder and delay, but not necessarily defraud, Dynegy Holdings’ creditors. The report found that the transfer of the coal assets was in exchange for less than reasonably equivalent value, and thus a constructive fraudulent transfer. Additionally, the report found that, assuming Dynegy Holdings was insolvent, its board of directors had breached its fiduciary duties to Dynegy Holdings by approving the transfer. Lastly, the examiner’s report cautioned that in light of the conduct of all but one of the members of Dynegy Inc.’s board, four of whom constituted the majority of Dynegy Holdings’ board, any bankruptcy plan that provided for those individuals to continue as directors would not be consistent with the interests of creditors and with public policy.

The issuance of the examiner’s report had several major effects on Dynegy Holdings’ bankruptcy case. Shortly after the report was released, the Bankruptcy Court asked that the examiner serve as mediator over Dynegy Holdings’ plan negotiations and ensure that Dynegy Holdings had an independent principal that participated in the negotiations. Ultimately, as a result of the examiner’s report, Dynegy Holdings was forced to abandon its original bankruptcy plan that would have restructured Dynegy Holdings’ debts while leaving Dynegy Inc.’s shareholders with 100% ownership of the company, and would have left in place the Dynegy board that was the architect of the pre-bankruptcy asset transfers. After mediation, a new deal was announced that included the following: (a) the return of the transferred assets, (b) Dynegy Holdings’ creditors receiving 99% of Dynegy Inc.’s equity, $200 million in cash, and a portion of the proceeds from the sale of two power generation facilities, and (c) a new board of directors selected by Dynegy Holdings’ major creditor constituencies.

March 29, 2012: SDNY Rules That 363 Sales May Not Be Free and Clear of Future Claims

In re Grumman Olson Industries Inc., the U.S. District Court for the Southern District of New York held that a party was not barred from asserting successor liability claims against the purchaser of assets in a 363 sale, where the claims at issue arose after the conclusion of a bankruptcy case and a basis for successor liability was available under state law. In re Grumman Olson Industries Inc., 2012 WL 1038672 (S.D.N.Y. Mar. 29, 2012). While the Southern District’s holding in Grumman explicitly declined to enforce a sale order against a future claimant that lacked notice of and was not afforded the opportunity to participant in a prior bankruptcy proceeding, the court limited its holding to the facts at issue in Grumman and declined to answer the broader question of whether and under what circumstances a debtor could transfer assets under section 363 free and clear of future claims. However, the decision clearly suggests that despite the plain language of section 363(f), sales in the Southern District of New York do necessarily transfer assets free and clear of all future claims. Read in conjunction with Judge Stein’s recent decision in Hispanic Independent Television Sales LLC v. Kaza Azteca America Inc., 10 Civ. 932 (SHS), 2012 U.S. Dist. LEXIS 46239 (S.D.N.Y. Mar. 30, 2012), where the court found that a claimant’s affirmative defense of recoupment was not extinguished by operation of section 363(f), courts in the Southern District are beginning to articulate limitations on section 363(f) that all parties in interest should consider before proceeding with a section 363 sale.

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May 15, 2102: Eleventh Circuit Rules in TOUSA that Refinanced Lenders Can Be “Pulled Back In” and Held Liable if a Replacement Loan is a Fraudulent Transfer

The Eleventh Circuit Court of Appeals’ decision in In re TOUSA, Inc. raised significant questions regarding a lender’s exposure to fraudulent transfer liability. Senior Transeastern Lenders v. Official Committee of Unsecured Creditors (In re TOUSA, Inc.), Case No. 11-11071 (11th Cir. May 15, 2012). In TOUSA, the Eleventh Circuit overturned the District Court’s ruling that temporarily forestalling bankruptcy can constitute reasonably equivalent value under section 548 of the Bankruptcy Code. This ruling increases the risk that a lender that extends credit to a financially distressed company to forestall or avoid bankruptcy will have the transaction clawed back as a constructively fraudulent transfer if the distressed company ultimately files for bankruptcy protection.

The Eleventh Circuit also ruled that the Transeastern Lenders could be held liable as initial transferees under section 550 of the Bankruptcy Code because certain of TOUSA’s subsidiaries granted liens to the New Lenders in exchange for cash, and TOUSA used that cash to satisfy the debts owed to the Transeastern Lenders. Importantly, the court did not find that the structure of the refinancing was influenced or designed by the Transeastern Lenders.

This conclusion is troubling for lenders because companies often obtain secured debt to refinance unsecured holding company debt that is maturing at a time when the company cannot refinance on an unsecured basis. Under the Eleventh Circuit’s decision, the existing holding company lenders may be at risk of liability if, even years after the refinancing, the company files a chapter 11 case and the refinancing loan is deemed to be a fraudulent transfer.

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May 18, 2012: Third Circuit Prohibits Retroactive Application of Grossman’s Decision to Unknown Future Claims in Wright v. Owens Corning.

In May 2012 the Third Circuit issued an important decision clarifying the appropriate standard to apply in determining when a “claim” arises. In determining the universe of debts eligible for discharge, Third Circuit courts labored for many years under Avellino v. M. Frenville Co. (In re M. Frenville Co.), 744 F.2d 332 (3d Cir. 1984), which held that a claim arises when a right to payment accrues under applicable nonbankruptcy law. Courts in other jurisdictions almost unanimously rejected Frenville’s “accrual” test because it seemed to be at odds with the Bankruptcy Code’s broad definition of “claim”. On June 2, 2010, in Jeld-Wen, Inc. v. Van Brunt (In re Grossman’s Inc.), 607 F.3d 114 (3d Cir. 2010), the Third Circuit reversed course on the highly criticized accrual test, overruling Frenville and adopting an amalgam of the “conduct” test and “prepetition relationship” test used by other courts to determine when a claim arises for purposes of the Bankruptcy Code. Under the Third Circuit’s new test, a claim arises when an individual is exposed prepetition to a product or other conduct giving rise to an injury, which underlies a right to payment under the Bankruptcy Code. Grossman’s expanded the range of debts that could be discharged in bankruptcy, and arguably signaled a new, more debtor-friendly era in the Third Circuit. However, on May 18, 2012, the Third Circuit issued a decision in Wright v. Owens Corning, Case No. 11-2026 (3d Cir. May 18, 2012) holding that due process concerns may preclude retroactive application of Grossman’s to certain unknown future claims and, accordingly, the debts on account of such claims may survive a chapter 11 discharge. Owens Corning indicates that the fresh starts received by some reorganized debtors may not be quite as fresh as originally anticipated.

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May 29, 2012: Radlax: The Supreme Court Affirms Secured Creditors’ Right to Credit Bid at Plan Sales

In a widely anticipated opinion, the U.S. Supreme Court affirmed secured creditors’ right to credit bid when collateral is sold pursuant to a plan of reorganization. RadLAX Gateway Hotel v. Amalgamated Bank, 566 U.S. __ (2012). The decision resolved a circuit split on the issue and reversed prior rulings of the Third and Fifth Circuits allowing debtors to sell collateral pursuant to a plan of reorganization so long as the secured creditor received the “indubitable equivalent” of its claim.

Writing for a unanimous court, Justice Scalia relied almost exclusively on a textual analysis of section 1129(b)(2)(A) of the Bankruptcy Code and rejected the argument that if a plan that contemplated the sale of assets provided a secured creditor with the “indubitable equivalent” of its claim, the plan could be confirmed even if the secured creditor was not allowed to credit bid. The court found that a common sense reading of this section and canons of statutory construction only authorized the provision of the indubitable equivalent of a claim in circumstances where collateral was not sold pursuant to a plan of reorganization or the secured creditor retained its lien on the collateral.

Although RadLAX vindicated secured lenders’ rights, by relying primarily on textual analysis, the court did not endorse the broader policy interests favoring a right to credit bid.

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