Business Bankruptcy Blog

With Revisions To Bankruptcy Rule 2019 Under Review, A Second Delaware Bankruptcy Decision Goes The Other Way On Whether The Rule Requires Informal Committees To Disclose Their Trades

Bob Eisenbach — Wed, 27 Jan 2010 07:12:58 -0800

Last month, I reported on a decision from Delaware Bankruptcy Judge Mary Walrath in the In re Washington Mutual, Inc. case ("WaMu") holding that informal creditor groups must disclose details of their trades under Federal Rule of Bankruptcy Procedure 2019. The WaMu ruling, a first from Delaware, came nearly three years after rulings from the Southern District of New York in the Northwest Airlines case, and the Southern District of Texas in the Scotia Pacific case, took different sides on the issue.

A New Decision And Proposed Revision To Rule 2019. Now, little more than a month later, a second Delaware Bankruptcy Court judge has issued an opinion on the same issue -- and has forcefully come out the other way. These decisions are playing out against the backdrop of a proposed revision of Rule 2019 which, if adopted, would expand disclosures by ad hoc committees and other groups of creditors and equity security holders as discussed in more detail near the end of this post.

Before turning to the new decision, here are several links to follow for more about the earlier Rule 2019 decisions and the overall context:

The New Delaware Decision. On January 20, 2010, Delaware Bankruptcy Judge Christopher Sontchi issued an opinion in In re Premier International Holdings, Inc., more commonly known as the Six Flags case, explaining his reasons for denying a motion to compel an informal committee of noteholders, known as the SFO Noteholders Informal Committee, from complying with Rule 2019. Follow the link in this sentence for a copy of Judge Sontchi's new 34-page Six Flags opinion.

The Six Flag Court's Plain Meaning Analysis. In his opinion, Judge Sontchi discussed but respectfully declined to follow the Northwest Airlines and WaMu decisions referenced above. Instead, he held that under the plain meaning of Rule 2019, an informal committee of noteholders was not a "committee representing more than one creditor" described in the current Rule 2019. In reaching this conclusion, Judge Sontchi explained as follows:

    The question here is whether the SFO Noteholders Informal Committee is 'a committee representing more than one creditor.' If so, its members are subject to Rule 2019. The starting point of the analysis or 'default entrance' is plain meaning.

    A committee” is a 'body of two or more people appointed for some special function by, and usu. out of a (usu. larger) body.' The use of the word 'appointed' clearly contemplates some action be taken by the larger body. Thus, a self-appointed subset of a larger group - whether it calls itself an informal committee, an ad hoc committee, or by some other name – simply does not constitute a committee under the plain meaning of the word. In order for a group to constitute a committee under Rule 2019 it would need to be formed by a larger group either by consent, contract or applicable law -- not by 'self-help.' This construct is supported by the rule’s applicability to indenture trustees, which are delegated with certain rights and obligations on behalf of all holders of the debt by operation of contract, i.e., the indenture. Similarly, official committees under section 1102 of the Bankruptcy Code (although exempted from Rule 2019) receive their authority from federal law, i.e., the Bankruptcy Code.

    The meaning of 'represent' is: 'take the place of (another); be a substitute in some capacity for; act or speak for another by a deputed right.' A deputed right is one that is assigned to another person. Thus, the plain meaning of 'represent' contemplates an active appointment of an agent to assert deputed rights. It is black letter law that a person cannot establish itself as another’s agent such that it may bind the purported principal without that principal’s consent unless the principal ratifies the agent’s actions. Thus, under the plain meaning of the phrase 'a committee representing more than one creditor,' a committee must consist of a group representing the interests of a larger group with that larger group’s consent or by operation of law. As the SFO Noteholders Informal Committee does not represent any persons other than its members either by consent or operation of law, it is not a 'committee' under Rule 2019 and, thus, its members need not make the disclosures required under the rule.

(Footnotes omitted; emphasis in original.)

The Six Flag Court's Review Of Legislative History. After concluding that the plain meaning of Rule 2019 did not require disclosures by the SFO Noteholders Informal Committee, the Court then examined the legislative history of the rule at some length as a "reality check" on the plain meaning decision. In this part of the opinion, Judge Sontchi traced the legislative history back to the Chandler Act of 1938 and subsequent rule making creating Rule 10-211, which later became Rule 2019. The Court then placed the Chandler Act in context by reviewing the perceived abuses of "protective committees" and "reorganization committees" involved in pre-1930s railroad reorganizations through equity receiverships. Judge Sontchi then concluded that the purposes for which Rule 2019 was adopted do not apply to today's informal committees:

    The nub of the question is how the legislative history of Rules 10-211 and 2019 applies to the informal and ad hoc committees of today and, more specifically, the Informal Committee of SFO Noteholders. Certainly there are parallels between the 'protective committees' under equity receivership and the informal committees of today. For example, both are usually composed of Wall Street banks and institutional investors. Both are formed for the purpose of obtaining leverage in the reorganization that would not be available to disparate creditors. Both are involved in the negotiation and formulation of a plan of reorganization.

    The differences, however, far outweigh the similarities. The 'protective committees' that were the target of the reforms under the Chandler Act were able to control completely the entire reorganization – from inception to formulation to solicitation to implementation. They were granted the authority to negotiate on behalf of and to bind creditors through the use of deposit agreements. They were so intimately involved with management so as to be virtually in control of the business. They could force disparate treatment of similarly situated creditors. Finally, they were able 'to steal' the company for an inadequate 'upset price' at a foreclosure sale by credit bidding their debt.

    The informal and ad hoc committees of today have none of these expansive powers. Indeed, the Chandler Act so effectively curbed the power of protective committees that they virtually ceased to exist within a few years of the Act’s passage. Rule 10-211 was, for all intents and purposes, superfluous almost immediately after its passage. There was nothing left to regulate.

    The Bankruptcy Code continues to limit the powers of committees, albeit in other ways. For example, the debtor is given exclusive authority to propose and to solicit a plan of reorganization; claims and interests may only be classified with substantially similar creditors; creditors in the same class must be treated equally; a trustee or examiner can be appointed for cause. Even if an informal committee were to try to exercise the powers formerly available to protective committees, it would be prevented by the Bankruptcy Code. Thus, Rule 2019 is also, for all intents and purpose, superfluous – the problem it was designed to address by requiring certain disclosures simply no longer exists.

    In any event, the Informal Committee of SFO Noteholders has not attempted to invoke the powers previously wielded by protective committees. Certainly, the committee has actively participated in the reorganization process both pre-petition and post-petition. The committee vigorously opposed the Debtors’ Initial Plan and now vigorously supports the Revised Plan that it negotiated post-petition. But, the Informal Committee of SFO Noteholders has gone no farther. It doesn’t have the ability to bind its members – they can vote any way they please. It cannot force disparate treatment of the SFO creditors. The list goes on. Based upon the legislative history, Rule 2019 is not intended to nor does it apply to the Informal Committee of SFO Noteholders in this case.

(Footnotes omitted; emphasis in original.) Finally, Judge Sontchi considered the analysis in the Northwest Airlines and WaMu decisions and declined to follow those rulings for a number of reasons detailed in the Six Flags opinion.

The Proposed Revisions To Rule 2019. The core holding of the Six Flags opinion -- that under the plain meaning of Rule 2019 the term "committee" applies only to a committee that is appointed by or represents a larger group -- could be rendered moot by a proposed revision to Rule 2019 now under consideration by the Advisory Committee.

The proposed amendment to Rule 2019 would change the language of the rule to include not only representative committees but also "every entity, group, or committee that consists of or represents more than one creditor or equity security holder." (Emphasis added.)
Follow the link in this sentence for a copy of the proposed Federal Rules of Bankruptcy Procedure amendments under active consideration by the Advisory Committee, including proposed Rule 2019.
The proposed version of Rule 2019 would require these newly defined groups or committees to disclose each "disclosable economic interest." That term would be defined to mean "any claim, interest, pledge, lien, option, participation, derivative instrument, or any other right or derivative right that grants the holder an economic interest that is affected by the value, acquisition, or disposition of a claim or interest."
The bankruptcy court would also have the authority to order the disclosure of amounts paid for these positions, but pricing disclosure would not be required absent a court order.
The proposed rule has now gotten the attention of the financial media, and it will be the subject of a hearing in early February with testimony expected from various interested parties.

Conclusion. To say the least, a lot is going on in the world of Rule 2019, informal committees and creditor groups, and the potential for disclosure of trading data by hedge funds and other distressed investors. It's likely that more courts will be asked to decide these issues in the months ahead, and advocates on both sides of the issue now have new Delaware opinions to cite for their position. On top of that, if ultimately adopted, a proposed -- and significantly revised -- Rule 2019 could resolve some of these questions. For now, however, the final language of any revised Rule 2019, like the application of the current Rule 2019, remains unclear.

When Worlds Collide: Do Section 365(n) IP Licensee Rights Work In A Chapter 15 Cross-Border Bankruptcy?

Bob Eisenbach — Tue, 19 Jan 2010 07:28:10 -0800

Section 365(n) And Licensee Rights. I have discussed in the past how Section 365(n) was added to the Bankruptcy Code to protect licensees of intellectual property in the event the licensor files bankruptcy.

Under Section 365(n), if the debtor or trustee rejects a license, a licensee can elect to retain its rights to the licensed intellectual property, including a right to enforce an exclusivity provision. In return, the licensee must continue to make any required royalty payment.
The licensee also can retain rights under any agreement supplementary to the license, which should include source code or other forms of technology escrow agreements.
Taken together, these provisions protect a licensee from being stripped of its rights to continue to use the licensed intellectual property.
To read more about Section 365(n)'s benefits and protections, follow the link in this sentence.

Limits Of Section 365(n). These protections, however, have their limits. One limitation comes from the fact that the Bankruptcy Code's special definition of "intellectual property" excludes trademarks from the scope of Section 365(n)'s protections. Another major limitation is that since Section 365(n) is a U.S. Bankruptcy Code provision, it only applies in a U.S. bankruptcy case.

What Happens To Section 365(n) In Chapter 15 Cases? One issue that was less clear was what would happen if a foreign licensor were the subject of a case under Chapter 15 of the U.S. Bankruptcy Code. Would Section 365(n) apply to protect licensees in a Chapter 15 proceeding?

Chapter 15 allows an entity's foreign representative to obtain U.S. bankruptcy protection for assets and interests in the United States. It was was added to the Bankruptcy Code a few years ago to implement certain cross-border insolvency procedures when corporations had assets and interests in more than one country. To read more on Chapter 15 bankruptcy, follow the link in this sentence.
Section 365(n) and Chapter 15 recently collided in the Chapter 15 case of Qimonda AG, and led to a decision by Judge Robert G. Mayer of the United States Bankruptcy Court for the Eastern District of Virginia on that very issue.
The Bankruptcy Court's decision, discussed below, is available by following the link in this sentence.

The Qimonda Chapter 15 Case. In the Qimonda AG Chapter 15 case, the Bankruptcy Court had previously recognized the pending German insolvency proceeding as a "foreign main proceeding" under Chapter 15 of the U.S. Bankruptcy Code. As part of the Chapter 15 proceeding, the Bankruptcy Court had entered a supplemental order providing, among other things, that Section 365 of the U.S. Bankruptcy Code would apply to the Chapter 15 case.

U.S. Licensees Invoke Section 365(n). Following the Bankruptcy Court's supplemental order, certain U.S. licensees asserted Section 365(n) rights in an attempt to retain their rights to intellectual property that Qimonda AG had licensed them.

In response, Qimonda AG's foreign representative, who had brought the Chapter 15 case in the first place, filed a motion in the U.S. Bankruptcy Court for an order that Section 365(n) not apply in the Chapter 15 case and that instead Section 103 of the German Insolvency Code, which governs executory contracts under German law, be left to control the licenses and any rights of the licensees.
Certain licensees objected to the motion, arguing that they should have the benefit of Section 365(n)'s protections in the Chapter 15 case, having in some cases paid millions of dollars to obtain those licenses.

The Bankruptcy Court's Decision. After considering the motion and opposition, Judge Mayer issued a decision agreeing with Qimonda AG's foreign representative and he modified the prior supplemental order to exclude the effect of Section 365(n) by providing that it would apply only if the foreign representative "rejects an executory contract pursuant to Section 365 (rather than simply exercising the rights granted to the Foreign Representative pursuant to the German Insolvency Code)." In reaching this decision, the Bankruptcy Court considered the effect of its recognition of the German insolvency proceeding given the purpose of Chapter 15:

The principal idea behind chapter 15 is that the bankruptcy proceeding be governed in accordance with the bankruptcy laws of the nation in which the main case is pending. In this case, that would be the German Insolvency Code. Ancillary proceedings such as the chapter 15 proceeding pending in this court should supplement, but not supplant, the German proceeding.

That objective is particularly relevant in this case where there are many international patents. The patents themselves are issued under the laws of various nations. While there may be multiple international patents, the multiple international patents protect the same idea, process or invention in the country that issued the patent. If the patents and patent licenses are dealt with in accordance with the bankruptcy laws of the various nations in which the licensees or licensors may be located or operating, there will be many inconsistent results. In fact, the same idea, process or invention may be dealt with differently depending on which country the particular ancillary proceeding is brought. Rather than having a coherent resolution to Qimonda’s patent portfolio, the portfolio may be shattered into many pieces that can never be reconstructed. In this case, Qimonda licensed its patents to companies that are operating in various nations. It is clear that the patent rights are not being exploited solely, and even possibly principally, in the United States. In fact, they are being utilized throughout the world. If the laws of the various nations in which the patents are being used would be applicable, there will be many different treatments of the patents that have been licensed by Qimonda AG and many different and inconsistent results throughout the world. This is detrimental to a systematic bankruptcy proceeding and detrimental to the resolution of the German bankruptcy proceeding itself. It diminishes the value of these assets. It results in an inefficient insolvency administration. It may well be detrimental to parties who are or wish to license the patents. It is not difficult to envision that if the patent portfolio is splintered without overall administration or control, some parties may be left with incomplete patent protection. Holding an American patent without holding a patent enforceable in the Europe may significantly restrict its use and utility. This is at odds with the Congressionally stated purposes in §1501.

* * *

All the patents should be treated the same. There should not be disparate results simply because of the location of a factory or research facility or corporate office. This would be the result if the supplemental order were left in place. It is clear that the inclusion of §365 in the supplemental order was improvident. It had unintended consequences that significantly and adversely affect the main proceeding in Germany.

Conclusion. The Qimonda AG decision underscores that although Section 365(n) of the Bankruptcy Code offers significant protection to licensees, its benefits frequently stop at the water's edge. When the licensor is based outside of the United States, Section 365(n) will be of little help, even if the license covers U.S. issued patents and the foreign licensor obtains protection for its U.S. assets and interests under Chapter 15 of the Bankruptcy Code. Licensees must continue to keep the limits of Section 365(n) in mind when negotiating licenses of intellectual property from foreign licensors.

The Return Of The Rule 2019 Question: Delaware Bankruptcy Court Weighs In On Whether Creditor Groups Must Disclose Trading Data

Bob Eisenbach — Wed, 09 Dec 2009 07:31:53 -0800

It's been a few years since decisions from the United States Bankruptcy Courts for the Southern District of New York, and later from the Southern District of Texas, examined whether hedge funds and other investors could be required to disclose the details of their trades when they form an ad hoc committee or group in a Chapter 11 case. Last week, Judge Mary Walrath of the United States Bankruptcy Court for the District of Delaware issued a decision in the Washington Mutual, Inc. Chapter 11 case, for the first time giving us a Delaware bankruptcy judge's views on the subject. Before turning to the new decision, a copy of which is available below, let's first put the issue in context.

Ad Hoc Committees and Groups. In recent years, hedge funds and other investors in distressed debt or the equity securities of bankrupt companies have taken active roles in Chapter 11 bankruptcy cases. Often, these investors form unofficial or "ad hoc" committees.

Much like official committees of unsecured creditors, equity security holders, retirees, or other constituencies, unofficial or ad hoc committees typically hire counsel and file motions and other pleadings during the course of a bankruptcy case.
Sometimes these creditors call themselves a committee but more recently the more informal term "group" has been used.
By acting as a committee or group, the creditors not only share the costs of participating in the bankruptcy case but also have the ability to wield greater influence by acting collectively instead of on an individual basis.

The Rule 2019(a) Statement. After making an appearance in a bankruptcy case, these groups or committees, their counsel, or both will typically file what's known as a "Rule 2019(a) Statement." This is a public filing required by Rule 2019(a) of the Federal Rules of Bankruptcy Procedure, the set of procedural rules which, together with the United States Bankruptcy Code itself, govern the conduct of bankruptcy cases. Rule 2019(a) provides, in part, as follows:

[E]very entity or committee representing more than one creditor or equity security holder . . . shall file a verified statement setting forth (1) the name and address of the creditor or equity security holder; (2) the nature and amount of the claim or interest and the time of acquisition thereof unless it is alleged to have been acquired more than one year prior to the filing of the petition; (3) a recital of the pertinent facts and circumstances in connection with the employment of the entity . . . ; and (4) . . . the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof.

The Northwest Airlines And Scotia Pacific Decisions. In early 2007, first in the Northwest Airlines case, and then in the Scotia Pacific Company LLC ("Scotia Development") case, two bankruptcy judges reached opposite conclusions on the question of whether groups of investors had to comply with Rule 2019.

In February and March of 2007, Judge Allan L. Gropper of the U.S. Bankruptcy Court for the Southern District of New York, presiding over the Northwest Airlines Chapter 11 case, required an ad hoc committee of hedge funds and other stockholders to disclose publicly full details of their trades in Northwest Airlines claims and stock. This was big news because hedge funds and other distressed debt investors carefully guard their trading data. Follow the links in this sentence for copies of Judge Gropper's first decision requiring the disclosure and second decision ordering that the trading data not be filed under seal. You can find earlier posts on these decisions and their aftermath here, here, here, here, and here.
Then in April 2007, Judge Richard S. Schmidt of the U.S. Bankruptcy Court for the Southern District of Texas issued an order denying Scopac's motion to compel disclosure of the details of trades in Scotia Development's secured timber notes. In his two-page order, Judge Schmidt ruled that a noteholder group that had formed in the Scopac case was not a "committee" within the meaning of Rule 2019 and, as such, the disclosure requirements of that rule did not apply. Following the links in this sentence will lead you to a copy of Judge Schmidt's two-page order in the Scotia Development case and to an earlier post on the case.

The Delaware Bankruptcy Court's Decision In The Washington Mutual Case. On December 2, 2009, more than two and a half years since the Scotia Development decision, Judge Walrath of the Delaware bankruptcy court faced the same issue in the Washington Mutual, Inc. case. J. P. Morgan Chase Bank moved to compel a group of creditors calling themselves the "Washington Mutual, Inc. Noteholders Group" ("WMI Noteholders Group") to provide trading and other information required by Rule 2019. The WMI Noteholders Group argued, among other points, that they were not an ad hoc committee but only a loose affiliation of creditors who came together on at at-will basis to share the cost of advisory services as a matter of efficiency.

In her decision, Judge Walrath rejected that argument, siding with Judge Gropper's analysis in Northwest Airlines and declining to follow the two-page order issued by Judge Schmidt in the Scotia Development case. Specifically, she held:

Here, the WMI Noteholders Group possesses virtually all the characteristics typically found in an ad hoc committee, save the name. The WMI Noteholders Group consists of multiple creditors holding similar claims. The members of the WMI Noteholders Group filed pleadings and appeared in these chapter 11 cases collectively, not individually. The WMI Noteholders Group retained counsel, which takes its instructions from the Group as a whole. While counsel contends that it speaks only for the members of the WMI Noteholders Group that agree with the filing of each pleading or position taken in each appearance, counsel for the Group has never advised this Court that it is representing less than all the Group. Rather the pleadings and appearances by counsel demonstrate that the Group and counsel represent not each individual member in its individual capacity, but rather the Group as a whole. In fact, it is the collective $1.1 billion in holdings of the members of the Group that counsel uses to argue in favor of the Group’s position, not each individual’s separate holding.

Under the plain language of Rule 2019, therefore, the Court finds that although the WMI Noteholders Group call themselves a Group, they are in fact acting as an ad hoc committee or entity representing more than one creditor. The WMI Noteholders Group, therefore, must comply with Rule 2019.

Follow the link for a copy of Judge Walrath's 20 page Washington Mutual decision.

Another Issue: Do Groups Owe Fiduciary Duties? One of the most interesting parts of Judge Walrath's decision came in response to the WMI Noteholders Group's argument that Rule 2019 was not intended to apply to the Group because it does not speak for other noteholders. Judge Walrath not only rejected this argument but in doing so also suggested that creditor or shareholder groups may owe fiduciary duties to others in the same class:

The WMI Noteholders Group contends, however, that the Rule was only intended to apply to 'a body that purports to speak on behalf of an entire class or broader group of stakeholders in a fiduciary capacity with the power to bind the stakeholders that are members of such a committee.' The WMI Noteholders Group’s argument is premised on the erroneous assumption that the Group owes no fiduciary duties to other similarly situated creditors, either in or outside the Group. The case law, however, suggests that members of a class of creditors may, in fact, owe fiduciary duties to other members of the class.

Judge Walrath, however, deferred any further decision on the issue, noting:

It is not necessary, at this stage, to determine the precise extent of fiduciary duties owed but only to recognize that collective action by creditors in a class implies some obligation to other members of that class.

With this decision, ad hoc committees and other groups are on notice that, at least in Delaware, they may be found to owe duties to other members of their respective class of creditors or investors.

Conclusion. This new decision means that Delaware now joins the Southern District of New York in holding that ad hoc committees and investor groups will be required to comply fully with Rule 2019, including the requirement to disclose details of their trades in the debtor's claims or interests. In addition, the Washington Mutual decision goes another step and suggests that these groups may be held to owe fiduciary duties to other members of their class, whether or not they have joined the group or ad hoc committee. With judges in the two most active jurisdictions for Chapter 11 bankruptcy cases now applying Rule 2019 more broadly, it will be interesting to see how creditors, investors, and debtors react in future cases.

Bankruptcy Judge's Research Binder Now Updated And Available

Bob Eisenbach — Wed, 02 Dec 2009 07:32:45 -0800

I have posted in the past about the helpful research binder that Chief Judge Randall J. Newsome of the United States Bankruptcy Court for the Northern District of California makes available to bankruptcy professionals and the public. Fortunately, Chief Judge Newsome has again updated his binder as of December 1, 2009, covering cases through Volume 410 of Bankruptcy Reports. Follow the links in this sentence to access the entire binder in PDF format and the HTML version organized by topic. The PDF version is capable of being searched using a key word or phrase.

The primary focus of the research binder is on Ninth Circuit law, as Chief Judge Newsome presides in the Northern District of California, but some out-of-circuit law is also included. The disclaimer Chief Judge Newsome includes puts the binder's use in context:

The following list of cases and supplemental information is presented for informational and educational purposes only. Though it represents the aggregation of 19 years of research, the Court makes no claims as to its current level of accuracy. Some of the cases set forth may very well have been superseded, reversed, or otherwise may no longer be good law. The Court has posted it with the intention to educate and assist those who may find it helpful. Accordingly, users should consider it a first, but by no means final, research tool, and should cite check all cases listed herein for continued viability prior to relying on such cases in practice.

With those caveats, and especially when used in combination with the new Google Scholar legal research tool, the binder is a helpful place to start when researching bankruptcy law issues in Ninth Circuit.

Powerful, Free Legal Research Tool Now Available

Bob Eisenbach — Mon, 23 Nov 2009 12:57:20 -0800

Last week, Google launched a new feature on its Google Scholar specialized search engine that enables full-text searching of published federal and state court opinions, as well as articles in certain legal journals. Users can access the new features by selecting the "Legal opinions and journals" bullet on the Google Scholar main search page. The cases in the Google Scholar database generally include official reporter citation page numbers throughout the decision. The other main search category available is "Articles," including or excluding patents.

By using the Advanced Scholar Search feature, you can engage in more tailored searches, such as within just federal court decisions, decisions from one or more individual states, or articles by specific authors, or in designated journals, date ranges, or subject matter fields. Google's official blog post on the new search feature gives additional information.

At the moment, it appears that not all unpublished decisions are available in Google Scholar search results, and Google's disclaimer states that it does not represent that results are complete or accurate. In addition, among other features, Google Scholar lacks the key number system, headnotes, cite-checking ability (although the "How Cited" link gives some information on follow-on citations), and access to a full range of legal journals available from long-standing legal search services such as LexisNexis and Westlaw. Still, as a supplement to Google's standard web search, the Google Scholar legal opinion and journal search engine is a powerful new -- and free -- place to start when doing bankruptcy or other legal research.

Second Circuit Decides Whether Unsecured Creditors Can Recover Post-Petition Attorney's Fees

Bob Eisenbach — Tue, 10 Nov 2009 08:57:01 -0800

On November 5, 2009, the U.S. Court of Appeals for the Second Circuit became the second court of appeals to answer the question left open in the U.S. Supreme Court's March 2007 decision in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 549 U.S. 443 (2007): Can unsecured creditors recover post-petition attorney's fees as part of their unsecured claims? For more on the Travelers decision, follow the link to this earlier post.

The Ninth Circuit's Earlier SNTL Corp. Decision. In June 2009, the Ninth Circuit, in a per curiam decision in In re SNTL Corp., 571 F.3d 826 (9th Cir. 2009), held that post-petition attorney’s fees were allowable as part of an unsecured prepetition contract claim. The Ninth Circuit adopted the December 2007 opinion of the Ninth Circuit Bankruptcy Appellate Panel, In re SNTL Corp., 380 B.R. 204 (9th Cir. BAP 2007), which is available by following the link in this sentence. You may find this earlier post on the SNTL Corp. case of interest as well.

The Second Circuit’s New Decision. In its November 5, 2009 opinion in Ogle v. Fidelity & Deposit Company of Maryland, the Second Circuit held -- as the Ninth Circuit did in the SNTL Corp. case -- that an unsecured creditor can include post-petition attorney’s fees authorized under a prepetition contract valid under state law. In Ogle, the Second Circuit extended its holding in United Merchants & Manufacturers, Inc. v. Equitable Life Assurance Society of the United States, 674 F.2d 134 (2d Cir. 1982), a case decided under the Bankruptcy Act, and concluded that United Merchants survived both the statutory revisions made by the Bankruptcy Code and the Supreme Court’s Travelers decision.

In reaching this result, the Second Circuit analyzed the issues presented, in part, as follows:

All of the fees at issue in Travelers were incurred post-petition; so the amount was necessarily unknown when the bankruptcy petition was filed. It follows that if an unsecured claim for post-petition fees was for that reason unrecoverable, the Travelers Court could have disposed of the claim on that simple, available ground alone. Travelers, therefore, proceeds along lines that, reasonably extended, would suggest (notwithstanding the Court’s express disclaimer) that section 502(b)’s requirement--that the court “shall determine the amount of such claim . . . as of the date of the filing of the petition”--does not bar recovery of post-petition attorneys’ fees.

In the present appeal, as in Travelers: The underlying contract is valid as a matter of state substantive law; none of the section 502(b)(2)-(9) exceptions apply; and the Code is silent as to the particular question presented--in Travelers, whether the Code allows “unsecured claims for contractual attorney’s fees incurred while litigating issues of bankruptcy law,” 549 U.S. at 453; and here, whether the Code allows unsecured claims for “fees incurred while litigating issues of” contract law more generally.

Accordingly, we hold that an unsecured claim for post-petition fees, authorized by a valid pre-petition contract, is allowable under section 502(b) and is deemed to have
arisen pre-petition. Accord SNTL, 571 F.3d at 844 (“[W]e reject the position . . . that section 502(b) precludes such fees.”).

The Court then turned to the question of whether Section 506(b) of the Bankruptcy Code expressly disallows the recovery of attorney's fees as part of an unsecured claim:

As Travelers makes clear, the question is whether the Code disallows post-petition attorneys’ fees, and does so expressly. It was therefore decisive in Travelers that “the Code says nothing about unsecured claims for contractual attorney’s fees incurred while litigating issues of bankruptcy law.” 459 U.S. at 453 (emphasis in original). And while Travelers declined to address section 506(b) (because the parties had not raised the issue below), see id. at 454-56, it is decisive here that the Code says nothing about such fees incurred litigating things other than issues of bankruptcy law. The teaching of Travelers is therefore fully consonant with our decision in United Merchants.

Accordingly, we hold that section 506(b) does not implicate unsecured claims for post-petition attorneys’ fees, and it therefore interposes no bar to recovery.

Finally, the Second Circuit rejected arguments that (1) Section 502(b)(2)'s disallowance of unmatured interest bars claims for post-petition attorney's fees, (2) Section 502(e)(2) regarding claims for reimbursement or contribution implicitly forecloses post-petition attorney's fees, and (3) as a policy matter it would be unfair to allow contract creditors to recover post-petition attorney's fees when tort claimants and many trade creditors cannot.

Conclusion. We now have two U.S. Court of Appeals decisions this year holding that, after Travelers, post-petition attorney's fees are allowable as part of an unsecured claim if otherwise recoverable under a prepetition contract. Particularly given the major bankruptcy cases filed in the Southern District of New York, within the Second Circuit, unsecured creditors may make a point of including post-petition attorney's fees as part of their claims when their contracts so provide. This decision raises questions as well:

Will the potential allowance of post-petition attorney's fees for bankruptcy-related issues impact a debtor's reorganization prospects?
What procedures will debtors propose for managing the process as unsecured creditors amend their claims to add attorney's fees incurred in protecting their rights during the course of a bankruptcy case?
Will individual unsecured creditors become more active in Chapter 11 cases, particularly in those cases in which a large distribution is likely?
What standards will bankruptcy courts use to assess the reasonableness of an unsecured creditor's post-petition attorney's fees for bankruptcy-related issues?
Will claims buyers pay more for unsecured claims based on contracts providing for recovery of post-petition attorney's fees now that bankruptcy-related fees are recoverable?
Will creditors be more insistent on including attorney's fees provisions in contracts?

Not every unsecured creditor will have the right to attorney's fees, and most may not incur significant fees after a bankruptcy is filed. However, those that do now have another important arrow in their quiver when seeking to add those fees to their unsecured claims. It will be interesting to see how these issues play out in the months ahead.

A Matter Of Time: Important Amendments To The Bankruptcy Rules Are Coming December 1st

Bob Eisenbach — Mon, 02 Nov 2009 08:45:08 -0800

Nearly every year, changes are made to the set of rules that govern how bankruptcy cases are managed -- the Federal Rules of Bankruptcy Procedure. Normally, the changes address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others. This year, the amendments to the national bankruptcy rules are mainly the result of statutory changes enacted by Congress. The new amendments will take effect on December 1, 2009.

Timing Changes Across The Board. For years, the standard time periods for many actions in bankruptcy cases have been measured in round numbers -- 10 days for some, 20 days for others. Sometimes this has led to confusion about deadlines, especially when time periods straddle weekends or holidays. To simplify the calculation of bankruptcy time periods, and those in other non-bankruptcy laws, earlier this year Congress enacted the Statutory Time-Periods Technical Amendments Act of 2009. The main purpose of the Act is to switch to 7, 14, 21, and 28 day intervals for most bankruptcy procedures. Here's how the changes will be implemented in the Federal Rules of Bankruptcy Procedure:

5 day periods become 7 day periods;
10 day periods become 14 day periods;
15 day periods become 14 day periods;
20 day periods become 21 day periods;
25 day periods become 28 day periods.

For example, a motion set for hearing on a Friday will now have objection and reply deadlines fall on Fridays. It also means that the era of the "20 day notice" in bankruptcy is over -- but it's just being replaced with the era of the "21 day notice." The change should make calculating due dates easier, although be aware that it will shorten or lengthen most of the previously standard notice periods under prior law. Rule 9006 is being revised extensively to reflect the new way of accounting for weekends and holidays. Periods that were 30 days or longer are essentially unchanged.

A Longer Appeal Period. So where is this going to have the biggest effect in the business bankruptcy realm? I think the impact will be felt most in the time to file an appeal from a bankruptcy court order. Amendments to Rule 8001 will extend the time for filing a notice of appeal by four days -- from 10 days to 14 days. This means that an order approving a settlement under Rule 9019, authorizing a Section 363 sale of assets, or confirming a plan of reorganization, among others, will not become final and no longer appealable until the 15th day following entry compared to the 11th day following entry under current law. After years of counting on bankruptcy court orders being final after only 10 days, parties will need to adjust their expectations on the finality of orders.

How To Access The Amended Rules. Bankruptcy attorneys and other professionals should review the amended rules to see the full range of the changes.

For a copy of the "clean" set of the amended rules, click on the link in this sentence.
For a copy of a "redline" of the amended rules against the current rules, as well as Advisory Committee comments, click on the link in this sentence.

Local Rule Changes Are Also Coming. Expect to see bankruptcy courts around the country adopt conforming changes to their local rules. Two examples: the Northern District of California has already done so and the Southern District of New York is proposing to do so.

Conclusion. Although these timing changes are not as significant as amendments made a few years ago, they will affect virtually all time periods in the national, and in time local, bankruptcy rules that are currently less than 30 days. With under a month to go before they take effect, now is a good time to get on top of these amendments.

Major Amendments To The CCAA, Canada's Reorganization Law, Are Now In Force

Bob Eisenbach — Mon, 21 Sep 2009 22:46:15 -0800

In a post last year entitled "North Of The Border: Reorganization Under Canada's Companies' Creditors Arrangement Act," I discussed the various types of bankruptcy and insolvency proceedings available under Canadian law. Included in the discussion was the Companies' Creditors Arrangement Act, known as the CCAA, used by many Canadian companies to reorganize. At that time, although significant amendments had been enacted to the CCAA and other Canadian bankruptcy laws, those amendments had not "come into force," the final act necessary under the Canadian system before the changes in the law would become effective.

That changed on September 18, 2009, when these revisions to the CCAA and to the Bankruptcy and Insolvency Act, or BIA, finally came into force (joining a few other changes that came into force in July 2008). Canadian bankruptcy law has now been modified in a number of important ways, applicable to cases filed going forward.

Although the revisions are too numerous to describe here, fortunately the Canadian government has prepared a very helpful summary of the biggest changes, available at the link in this sentence.
As amended, the CCAA now resembles the Chapter 11 bankruptcy process in more ways than before, including post-filing financing, sales of assets, and preferences, yet with a distinctly Canadian approach.
A provision protecting the rights of licensees of intellectual property has also been added, similar to Section 365(n) of the U.S. Bankruptcy Code, an important benefit to those licensing IP from Canadian companies.
In addition, Canada has now adopted the Model Law on Cross-Border Insolvency, as the United States did with the enactment of Chapter 15 of the U.S. Bankruptcy Code, governing the recognition of foreign insolvency proceedings.

For more on the new law, and Canadian bankruptcy issues generally, be sure to check out the website of the Office of the Superintendent of Bankruptcy Canada.

Fall 2009 Edition Of Absolute Priority Now Available

Bob Eisenbach — Sun, 20 Sep 2009 21:30:54 -0800

The Fall 2009 edition of the Absolute Priority newsletter, published by the Cooley Godward Kronish LLP Bankruptcy & Restructuring group, of which I am a member, has just been released. The newsletter gives updates on current developments and trends in the bankruptcy and workout area. Follow the links in this sentence to access a copy of the newsletter or to register to receive future editions. You can also subscribe to the blog to learn when future editions of the Absolute Priority newsletter are published, as well as to get updates on other bankruptcy topics.

The latest edition of Absolute Priority covers a range of cutting edge topics, including:

Developments in the General Growth Chapter 11 cases;
Updates on the General Motors and Chrysler bankruptcies;
Efforts in Congress to repeal certain of BAPCPA's business bankruptcy provisions; and
The "settlement payment" defense to fraudulent transfer claims against shareholders in leveraged buyouts.

This edition also reports on some of our recent representations, including debtors Pacific Ethanol Holding Co. and Crabtree & Evelyn, Ltd., and our work for official committees of unsecured creditors in Chapter 11 bankruptcy cases involving major retailers. Recent committee cases include Eddie Bauer, Ritz Camera, Filene's Basement, BT Tires Group, Boscov's, Gottschalk's, KB Toys, BTWW Retail, and G.I. Joe's, among others. Also discussed is our work for Levi Strauss & Co. in purchasing 73 outlet stores from the Anchor Blue Retail Group case and for Rackable Systems, Inc. (now known as Silicon Graphics International) in purchasing substantially all of the assets of Silicon Graphics, Inc. in its recent Chapter 11 case.

In addition, a note from my colleague, Jeffrey Cohen, the editor of Absolute Priority, discusses how Section 363 asset sales have become the chief means for companies to restructure in bankruptcy, and how the number of "going concern" sales has grown over the past few months compared to the period following the bankruptcy of Lehman Brothers in September 2008.

I hope you find this Fall's edition of Absolute Priority to be of interest.

New Site Features Free Insolvency Charts And Information

Bob Eisenbach — Thu, 03 Sep 2009 16:57:09 -0800

The American Bankruptcy Institute has launched a new site called "ABI's Chart of the Day," featuring a new insolvency-related economic or financial chart daily, plus a collection of prior charts. The topics covered range from FDIC information showing potentially troubled financial institutions, to the percentage of real estate owned properties sold in certain markets, to economic statistics in comparison to past recessions.

ABI describes the site as follows:

This resource is provided to give insolvency professionals a daily visual peek at the state of the economy.

The charts include links to related news items and other data, covering trends in retailing, housing, commercial real estate, personal income, employment and other indicators important to insolvency professionals.

Please visit abiworld.org for a full suite of tools to stay informed.

This site joins other helpful, free offerings from ABI, such as the Bankruptcy Code Wiki, with the entire current Bankruptcy Code, and a Bankruptcy Rules site, with a handy search feature enabling you to search all of the Federal Rules of Bankruptcy Procedure using key words.

Protecting IP Rights From A Licensor's Bankruptcy: What You Need To Know About Section 365(n)

Bob Eisenbach — Thu, 30 Jul 2009 23:15:16 -0800

Many companies rely on in-bound licenses of intellectual property, especially those involving patents or trade secrets, and spend millions of dollars on research, development, and ultimately commercialization of drugs or products incorporating the licensed IP. With so much at stake, licensees frequently ask a critical question: Can our license rights be terminated if the licensor files bankruptcy?

Assumption Or Rejection. A license is typically held to be an executory contract. This means that a licensor in bankruptcy (or its bankruptcy trustee) has the option of assuming or rejecting the license. Generally, a debtor licensor can assume a license if it meets the same tests (cures defaults and provides adequate assurance of future performance) required to assume other executory contracts. Most licensees will not object to the assumption of their license as long as the debtor can actually continue to perform. Instead, the real concern for licensees is whether they risk losing their rights to the licensed IP if the license is rejected.

Bankruptcy Code Section 365(n). To address this concern, in 1988 Congress added Section 365(n) to the Bankruptcy Code to give licensees special protections. If the debtor or trustee rejects a license, under Section 365(n) a licensee can elect to retain its rights to the licensed intellectual property, including a right to enforce an exclusivity provision. In return, the licensee must continue to make any required royalty payment. The licensee also can retain rights under any agreement supplementary to the license, which should include source code or other forms of technology escrow agreements. Taken together, these provisions protect a licensee from being stripped of its rights to continue to use the licensed intellectual property.

Some Important Limitations. If the license is rejected, however, the licensor will no longer have to perform under the license. This means the licensor will not have to update or continue to develop the IP, and will not have to make available any updates later developed. In addition, Section 365(n) only applies in a U.S. bankruptcy case. It generally will not be of any help in a bankruptcy or insolvency of a non-U.S. licensor under applicable foreign law.

No Protection For Trademark Licensees. Many people expect intellectual property to include trademarks, but when Section 365(n) was enacted a special, limited definition of "intellectual property" was also added to the Bankruptcy Code. The bankruptcy definition includes trade secrets, U.S. patents and patent applications (less clear as to foreign patents), copyrights, and mask works, but it does not include trademarks. This distinction means that a trademark licensee enjoys none of Section 365(n)'s special protections and is at risk of losing its trademark license rights if the licensor files bankruptcy. For more on the special bankruptcy risk facing trademark licensees, follow the link in this sentence.

Getting The Most Out Of Section 365(n). Although Section 365(n) gives licensees significant comfort within limits, there are a number of approaches a licensee can take to maximize the statute's benefits while avoiding its pitfalls. Here are a few to consider:

Make sure you actually have a granted license. Section 365(n) only applies to actual license rights as they existed at the time the bankruptcy case was commenced. This means that an agreement by the licensor to grant a license to IP at some later date, including a springing license grant on a bankruptcy filing, will likely be unenforceable if a bankruptcy is filed. Get a present grant of a license to any important IP or risk not having a license to it at all.
Consider a technology escrow. Licensees sometimes forget that Section 365(n) is not self-executing. This means that Section 365(n) doesn't require the licensor to deliver the embodiment of the licensed intellectual property to the licensee unless the license or an agreement supplementary to the license expressly provides for such a right. One solution is to include this delivery provision in the license itself. Another common approach is to establish a technology (often a source code) escrow into which the embodiment and updated versions of the embodiment are in fact deposited, to be released to the licensee on specified conditions.
Refer to Section 365(n) in the license. Section 365(n) applies to licenses of bankruptcy-defined intellectual property whether it is mentioned in the license or not. That said, including an express reference that the license involves such IP, as the old saying goes, "wouldn't hurt." A provision in the license that the agreement involves IP covered by Section 365(n), although not binding on the bankruptcy court, may be helpful in persuading a bankruptcy trustee -- or the bankruptcy judge -- that the IP involved is indeed subject to Section 365(n)'s protections.
Save the election until later. If you do include a Section 365(n) reference in the license, it's usually better to state that no Section 365(n) election is then being made. Things change, and there is always a chance that the IP will turn out to be less important in future years, meaning you might elect to treat a rejected license as terminated.
Get bankruptcy advice before you sign the license. As the points above illustrate, even with Section 365(n), protecting your IP license can be tricky if a bankruptcy is later filed. Be sure to seek advice from bankruptcy counsel knowledgeable about IP licenses when the license is being drafted, not just after the licensor gets in financial trouble.

Conclusion. Section 365(n) of the Bankruptcy Code can provide valuable protections for licensees of intellectual property, but those protections have their limitations. Taking steps to maximize your rights when the license is being drafted can make a big difference if the licensor later files bankruptcy.

First Court Of Appeals Decision Addresses Question Left Open In The Supreme Court's Travelers Opinion: Can Unsecured Creditors Recover Post-Petition Attorney's Fees?

Bob Eisenbach — Sun, 28 Jun 2009 21:23:02 -0800

On June 23, 2009, the U.S. Court of Appeals for the Ninth Circuit became the first Court of Appeals to answer the question left open in the U.S. Supreme Court's March 2007 decision in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. -- whether post-petition attorney's fees can be added to unsecured claims.

The Ninth Circuit had before it an appeal from the December 2007 decision by the Ninth Circuit Bankruptcy Appellate Panel ("BAP") in the In re SNTL Corp. case, which in turn had been the first appellate decision to address that unresolved question.
The decision also addressed the interesting, albeit unrelated, question of whether a guarantor of a debt can become liable if the payment of the debt by the primary obligor later is returned in a preference settlement.

The Travelers Case. Before turning to the SNTL Corp. case itself, let's look back at the Supreme Court's decision. In March 2007, the U.S. Supreme Court overruled the Ninth Circuit's so-called Fobian rule in the Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. decision. However, it did not decide whether unsecured creditors could recover, as part of their unsecured claims, post-petition attorney's fees incurred during the course of the bankruptcy case. For more on the Travelers decision, follow the link in this sentence.

The SNTL Corp. BAP Decision. In the December 2007 BAP decision, Bankruptcy Judge Dennis Montali, writing for the unanimous BAP panel, held that that "claims for postpetition attorneys' fees cannot be disallowed simply because the claim of the creditor is unsecured." On the unrelated issue, the BAP held that a guarantor's liability was revived after a preference settlement.

The Ninth Circuit Rules In The SNTL Corp. Case. On June 23, 2009, the Ninth Circuit decided the appeal, issuing a brief, per curiam decision, stating as follows:

The Bankruptcy Appellate Panel decision is AFFIRMED for the reasons stated in its opinion in this case sub nom. We adopt the BAP opinion, In re SNTL Corp., 380 B.R. 204 (B.A.P. 9th Cir. 2007), as our own and attach it as an appendix to this opinion. See Appendix, infra.

A Second Look At The BAP's Decision. Given that the Ninth Circuit affirmed and adopted as its own the BAP opinion in its entirety, further review of the BAP's analysis is merited. In reaching its decision, the BAP carefully reviewed two earlier decisions by bankruptcy courts that had taken up the open "Travelers" issue, In re Qmect, Inc. (see earlier post on the Qmect decision) and In re Electric Machinery Enterprises, Inc. (see prior post on the Electric Machinery decision), as well as pre-Travelers law, and first explained its analysis of the interplay between Sections 502 and 506(b):

We are not persuaded by the approach of the Electric Machinery court and, like Qmect, we reject the argument that section 506(b) preempts postpetition attorneys’ fees for all except oversecured creditors. While we cannot predict how the Ninth Circuit will decide this issue in Travelers, we do find a clue in Joseph F. Sanson Inv. Co. v. 268 Ltd. (In re 268 Ltd.), 789 F.2d 674, 678 (9th Cir. 1986), where the Ninth Circuit observed that section 506(b) defines secured claims and does not limit unsecured claims:

When read literally, subsection (b) arguably limits the fees available to the oversecured creditor. When read in conjunction with § 506(a), however, it may be understood to define the portion of the fees which shall be afforded secured status. We adopt the latter reading.

268 Ltd., 789 F.2d at 678.

Next, the BAP discussed Section 502(b)(1)'s requirement that the court determine the amount of an unsecured claim as of the petition date:

The Electric Machinery court, like the bankruptcy court here and many of the pre-Travelers majority courts, disallowed the postpetition fees of an unsecured creditor because section 502(b)(1) provides that a bankruptcy court “shall determine the amount of such claim . . . as of the date of the filing of the petition” and the postpetition fees did not exist as of that date. Elec. Mach., 371 B.R. at 551; Pride Cos., 285 B.R. at 373. Because the amount of fees incurred postpetition cannot be determined or calculated as of the petition date, section 502(b) purportedly precludes their allowance. Id. We disagree with this approach, as it is inconsistent with the Bankruptcy Code’s broad definition of “claim,” which -- as discussed previously -- includes any right to payment, whether or not that right is contingent and unliquidated. See 11 U.S.C. § 101(5)(A); Qmect, 368 B.R. at 884.

The BAP then held that the Supreme Court's 1988 Timbers decision did not apply:

We believe that Electric Machinery’s reliance on Timbers is misplaced. Timbers provided that an undersecured creditor could not receive postpetition interest on the unsecured portion of its debt. Timbers, 484 U.S. at 380. This holding is consistent with section 502(b)(2), which specifically disallows claims for unmatured interest. Inasmuch as section 502(b) does not contain a similar prohibition against attorneys’ fees, the comparison between the current issue and that presented in Timbers is not persuasive.

Finally, the BAP held that it was unnecessary to reconcile the competing public policy considerations advanced by the Electric Machinery and Qmect decisions:

Because we find that the Bankruptcy Code itself provides the answer to this issue (by not specifically disallowing postpetition fees), we do not attempt to reconcile these policy concerns. In the end, it is the province of Congress to correct statutory dysfunctions and to resolve difficult policy questions embedded in the statute.

For more on this decision, as well as the BAP's discussion (now adopted by the Ninth Circuit) on the revival of a guarantor's liability after a preference settlement, this earlier post on the BAP's In re SNTL Corp. decision may be of interest.

On Remand From The Supreme Court's Travelers Decision. One interesting side note involves the BAP's December 2007 comment in the In re SNTL Corp. decision about being unable to predict how the Ninth Circuit would decide this issue in the Travelers case on remand from the U.S. Supreme Court. Months later, in May 2008, the Ninth Circuit issued this brief order in the Travelers case, effectively remanding the case for "consideration of the bankruptcy court in the first instance." The bankruptcy judge to whom the decision was remanded? Bankruptcy Judge Dennis Montali, who wrote the BAP opinion in In re SNTL Corp.

Impact On Unsecured Creditors? As the first ruling by a U.S. Court of Appeals on this open issue, the Ninth Circuit's decision may lead unsecured creditors to include post-petition attorney's fees as part of their allowed unsecured claims when their contracts or a statute provides for them outside of bankruptcy. It will be interesting to see whether the decision has a significant impact on how unsecured creditors in the Ninth Circuit and other jurisdictions pursue claims in bankruptcy cases, and how bankruptcy estates react to such claims for post-petition attorney's fees.

Section 363 Sales And Beyond: An M&A Lawyer's Perspective On Purchasing Assets From Distressed Companies

Bob Eisenbach — Sun, 21 Jun 2009 23:40:10 -0800

With the economy suffering through the longest recession since the 1930s, it's little wonder that much of the merger and acquisition ("M&A") activity these days has been focused on distressed companies. The Chrysler and General Motors cases may be the best-known examples, but Chapter 11 bankruptcy is frequently used by companies large and small to sell assets through Section 363 sales. The important intersection between bankruptcy and M&A deals in today's business climate was recently made the focus of an article in the Wall Street Journal, aptly called "Barbarians in Bankruptcy Court."

Although Section 363 sales are quite common, some distressed companies are able to complete an asset sale outside of bankruptcy. The sale may be made directly by the company, or the seller may actually be a lender foreclosing on its collateral under the Uniform Commercial Code. In still other situations, the seller may be an assignee acting through a general assignment for the benefit of creditors under state law.

Regardless of the path chosen, the landscape of distressed asset purchases can be significantly different from that traversed by many traditional M&A lawyers and, most importantly, their clients. Fortunately, one of my M&A partners at Cooley Godward Kronish LLP with significant experience in distressed acquisitions, Jennifer Fonner DiNucci, has recently written an insightful article on the subject. Entitled "Balancing the Risks and Benefits of Transactions Involving Distressed Companies," the article discusses the unique challenges -- and opportunities -- posed by distressed asset acquisitions. It also highlights some of the major issues that potential asset buyers encounter when dealing with a distressed seller, and points out key differences between distressed transactions and more traditional M&A deals with solvent companies.

The article makes for interesting -- and timely -- reading for anyone considering a purchase of assets from a distressed company.

General Motors Files Chapter 11 Bankruptcy In New York

Bob Eisenbach — Mon, 01 Jun 2009 06:33:14 -0800

General Motors Corp. filed for Chapter 11 bankruptcy protection this morning in the U.S. Bankruptcy Court for the Southern District of New York. Judge Robert E. Gerber has been assigned to preside over the case.

A copy of GM's bankruptcy petition is available here. The petition listed approximately $82 billion in assets and $172 billion in liabilities. A copy of GM's press release regarding its bankruptcy can be found at the link in this sentence. GM has also created a restructuring website where additional information for customers, suppliers, and others can be found.

Spring 2009 Edition Of Bankruptcy Resource Is Now Available

Bob Eisenbach — Tue, 14 Apr 2009 18:44:23 -0800

The Spring 2009 edition of the Absolute Priority newsletter, published by the Cooley Godward Kronish LLP Bankruptcy & Restructuring group, of which I am a member, has just been released. The newsletter gives updates on current developments and trends in the bankruptcy and workout area. Follow the links in this sentence to access a copy of the newsletter or to register to receive future editions. You can also subscribe to the blog to learn when future editions of the Absolute Priority newsletter are published, as well as to get updates on other bankruptcy topics.

The latest edition of Absolute Priority covers a range of cutting edge topics, including:

Claim issues involving the Madoff SIPA proceeding;
How new Bankruptcy Code provisions involving swap agreements and swap participants are being interpreted;
The importance of the mutuality requirement in setoffs;
Post-petition rent and Section 503(b)(9) "20 day goods" claims; and
The use of a trademark after a bankruptcy petition is filed.

This edition also reports on some of our recent representations of official committees of unsecured creditors in Chapter 11 bankruptcy cases involving major retailers. These include Mervyn's, Boscov's, Gottschalk's, Lenox Sales, Goody's, KB Toys, BTWW Retail, and Innovative Luggage, among others. In addition, a note from my colleague, Jeffrey Cohen, the editor of Absolute Priority, discusses the current economic climate and the impact it continues to have on how debtors and creditors have been approaching bankruptcies and restructurings.

I hope you find this latest edition of Absolute Priority to be a helpful resource.

Text Of Legislation To Repeal Certain Of BAPCPA's Business Bankruptcy Changes Affecting Retailers Now Available

Bob Eisenbach — Wed, 08 Apr 2009 12:35:31 -0800

As reported in a post on the blog earlier this week, on April 2, 2009, Representative Jerrold Nadler (D-NY) introduced a bill entitled the "Business Reorganization and Job Protection Act of 2009." At that time the official text of the legislation was not available.

The full text of the legislation, which has been referred to the Committee on the Judiciary, is now available. You can download a copy of the legislation by clicking here.
For those who reviewed the draft bill from the National Association of Credit Management (NACM) website, it appears that the official text of the legislation is identical to the earlier draft.

The bill would repeal changes made by BAPCPA relating to (1) the deadline to assume or reject non-residential real property leases, (2) utility deposits, (3) the Section 503(b)(9) administrative claim, and (4) reclamation. These BAPCPA provisions are among those that have had a significant impact on retailers. For a discussion of the bill's provisions, you can read this blog's earlier post on the legislation or the explanation of the bill by the NACM. It will be interesting to follow the bill as it makes its way through the legislative process in Congress.

Legislation Introduced To Repeal Certain Business Bankruptcy Changes Made By BAPCPA's 2005 Amendments

Bob Eisenbach — Sun, 05 Apr 2009 22:23:30 -0800

On April 2, 2009, Representative Jerrold Nadler (D-NY) introduced a bill entitled the "Business Reorganization and Job Protection Act of 2009." The bill has been co-sponsored by Representative Steve Cohen (D-TN), the Chairman of the Subcommittee on Commercial and Administrative Law of the United States House of Representatives Committee on the Judiciary. As of the date of this post, the bill's official text has not been printed but the National Association of Credit Management has made available on its website what appears to be a final or near-final draft of the legislation, which you can access by clicking here. I plan to provide an update on the blog once the official version of the bill as introduced becomes available.

Introduction of the bill follows testimony before the Subcommittee on Commercial and Administrative Law by a number of bankruptcy professionals and law professors, including my partner and the Chair of Cooley Godward Kronish LLP's Bankruptcy & Restructuring Group, Lawrence Gottlieb. Click here for a prior post about his September 26, 2008 testimony, which focused on the disappearance of reorganizations of retailers since the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (known as "BAPCPA"). A link to Representative Nadler's press release on the bill's introduction can be found here.

The Legislation's Proposed Changes. The Business Reorganization and Job Protection Act of 2009, introduced as H.R. 1942, would make several major amendments to the Bankruptcy Code. The common theme is that the proposed bill would repeal certain changes made by BAPCPA and restore the statutory language that was in place before BAPCPA was enacted in 2005. The four principal changes are as follows:

Real Estate Leases. The bill would change Section 365(d)(4) of the Bankruptcy Code by repealing the maximum 210-day period within which debtors could assume or reject non-residential real property leases. Instead of the current 120-day initial period and up to a 90-day extension, the statute would revert back to the initial 60-day period under the prior law but, more importantly, would allow the bankruptcy court, for cause, to grant further extensions without any time limit.
Utilities. Similarly, the bill would repeal Section 366(c) of the Bankruptcy Code, which now requires a deposit of cash or certain cash equivalents to provide adequate assurance of payment to utilities. If enacted, the bill would allow debtors to establish adequate assurance of payment with something short of a monetary deposit, as had been the case under the pre-BAPCPA law.
20-Day Goods Administrative Claim. The bill would also make changes to the law relating to shipments by vendors prior to a bankruptcy filing. It would repeal Section 503(b)(9) of the Bankruptcy Code, added by BAPCPA, which gives an administrative claim to vendors for the value of goods received by a debtor in the ordinary course of business during the 20 days before the bankruptcy petition.
Reclamation. Another change the bill proposes to make is to go back to the pre-BAPCPA language in Section 546(c) of the Bankruptcy Code governing reclamation claims, specifically to repeal language that had expanded the potential reclamation claim for vendors to the 45 days before a bankruptcy petition. The bill would reinstate the pre-BAPCPA provisions restricting reclamation to that provided for under the Uniform Commercial Code (generally only a 10 day period) and permitting an administrative claim or secured claim to be provided to a reclaiming vendor in lieu of a return of the goods pursuant to a valid reclamation claim.
Effective Date. Finally, the bill proposes that its changes would apply to cases commenced on or after the date of its enactment, meaning it would apply to cases filed after the bill became law but not to cases filed before it became law.

Conclusion. If the Business Reorganization and Job Protection Act of 2009 were enacted, it could have a major impact on Chapter 11 bankruptcy cases, in particular those involving retailers. As explained in a recent article by several of my colleagues, the cumulative changes made by BAPCPA have had a profound impact on retail Chapter 11 cases. Repealing them could enable retailers the opportunity to emerge from Chapter 11 -- the way they often did in the years before the BAPCPA amendments were adopted. Otherwise, we are likely to continue to see more retailers forced into going of out business sales in Chapter 11.

U.S. Supreme Court Shows Interest In Deciding Whether The Hypothetical Test Or The Actual Test Should Be Used To Determine If IP Licenses Can Be Assumed In Bankruptcy

Bob Eisenbach — Thu, 26 Mar 2009 00:36:38 -0800

It looks like the U.S. Supreme Court, or at least two of the Justices, is interested in deciding whether the "hypothetical test" or the "actual test" should be used in determining whether an intellectual property license can be assumed by a debtor in possession under Section 365(c)(1) of the Bankruptcy Code. That was the clear message from the somewhat unusual statement by Justice Kennedy, with whom Justice Breyer joined, issued on March 23, 2009, in connection with the Supreme Court's denial of a writ of certiorari in the N.C.P. Marketing Group, Inc. case. You can read a copy of the entire statement by following the link in the prior sentence.

The N.C.P. Marketing Case. As a refresher, in 2005, the U.S. District Court for the District of Nevada issued its first of a kind decision, In re: N.C.P. Marketing Group, Inc., 337 B.R. 230 (D.Nev. 2005), holding that trademark licenses are personal and nonassignable in bankruptcy absent a provision in the trademark license to the contrary. Click here for a copy of the N.C.P Marketing Group decision and here, here, and here to read earlier posts on the case. Last May, the Ninth Circuit affirmed the District Court's judgment "for the reasons provided by that court" in an order designed as "not for publication."

Assumption And Assignment. A key basis for the District Court's decision in the N.C.P. Marketing Group case was the way the Ninth Circuit has interpreted Section 365(c)(1), specifically on the question of whether a debtor in possession can assume an intellectual property license. In bankruptcy parlance, assumption means that the debtor gets to keep the license. Usually, debtors are allowed to exercise their business judgment when deciding whether to assume or reject (read: breach and stop performing) an executory contract, as well as to assume and assign one to a third party. However, Section 365(c)(1) of the Bankruptcy Code puts a limit on a debtor's ability to assign executory contracts, and perhaps even to assume them, when "applicable law" gives the non-debtor party to the contract the right to refuse to deal with someone else. In the N.C.P. Marketing Group decision, the District Court held that federal trademark law under the Lanham Act was such "applicable law" and rendered non-exclusive trademark licenses nonassignable.

The Key Bankruptcy Code Section. Section 365(c)(1) is so important to this debate that it bears careful review. Here's what it says:

(c) The trustee may not assume or assign any executory contract or unexpired lease of the debtor, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties, if—

(1)(A) applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties; and

(B) such party does not consent to such assumption or assignment.

Hypothetical Versus Actual Test. If a debtor cannot assign an IP license without consent of the licensor, can it at least assume the license? That question has led courts to examine ever so closely the first seven words of Section 365(c): "The trustee may not assume or assign..."

When the statute says that the trustee may not assume or assign an IP license, does the word "or" really mean "and" too?
Put differently, what happens when a debtor is only trying to assume (keep) an IP license and is not actually trying to assign it? Does the Bankruptcy Code language mean that it can neither assume nor assign the license or does it only mean that the debtor cannot assign the license?
That, in a nutshell, is the difference between the so-called "hypothetical test" (which reads Section 365(c)(1)'s language as asking whether the debtor hypothetically could assign the license even if it's only proposing to assume it) and the "actual test" (which interprets the statute's language as asking only what the debtor is actually proposing to do).
The U.S. Courts of Appeals for at least three circuits have adopted the hypothetical test. The Ninth Circuit (covering California, Nevada, Arizona, and a number of other Western states), the Third Circuit (which includes Delaware, the venue of many Chapter 11 cases), and the Fourth Circuit (covering Virginia, West Virginia, Maryland, and North and South Carolina), have held that Section 365(c)(1) gives most IP licensors a veto right over proposals by a Chapter 11 debtor to assign -- and even to assume -- IP licenses.
For a more complete discussion of these issues, take a look at this earlier post, entitled "Assumption of Intellectual Property Licenses in Bankruptcy: Are Recent Cases Tilting Toward Debtors?"

Justice Kennedy's Statement. N.C.P. Marketing Group petitioned the U.S. Supreme Court for a writ of certiorari, seeking review of the decision denying it the ability to assume the trademark license. Although also voting to deny review, Justice Kennedy issued a three-page statement on that decision to express his view, joined in by Justice Breyer, that the Supreme Court should considering granting certiorari in a future case on the "significant question" of whether the hypothetical test or the actual test should be applied in interpreting Section 365(c)(1) of the Bankruptcy Code. Justice Kennedy summed up his analysis this way:

The division in the courts over the meaning of §365(c)(1) is an important one to resolve for Bankruptcy Courts and for businesses that seek reorganization. This petition for certiorari, however, is not the most suitable case for our resolution of the conflict. Addressing the issue here might first require us to resolve issues that may turn on the correct interpretation of antecedent questions under state law and trademark-protection principles. For those and other reasons, I reluctantly agree with the Court’s decision to deny certiorari. In a different case the Court should consider granting certiorari on this significant question.

Justice Kennedy's discussion of the two tests suggests that he (and perhaps Justice Breyer) may be leaning toward the actual test. Although noting that the actual test "may present problems of its own," including that it aligns Section 365 "with sound bankruptcy policy only at the cost of departing from at least one interpretation of the plain text of the law," Justice Kennedy aimed most of his criticism in the statement at the hypothetical test.

Specifically, Justice Kennedy commented that one "arguable criticism of the hypothetical approach is that it purchases fidelity to the Bankruptcy Code's text by sacrificing sound bankruptcy policy." He stated that the hypothetical test "may prevent debtors-in-possession from continuing to exercise their rights under nonassignable contracts, such as patent and copyright licenses." Continuing, he noted that without these licenses, "some debtors-in-possession may be unable to effect the successful reorganization that Chapter 11 was designed to promote."
He also remarked on what he perceived as a "windfall" to nondebtor parties to valuable executory contracts. While outside of bankruptcy the nondebtor cannot renege on its agreement, if the debtor files bankruptcy "then the nondebtor obtains the power to reclaim--and resell at the prevailing, potentially higher market rate--the rights it sold to the debtor." Although most non-exclusive licenses are not treated as a sale of intellectual property, Justice Kennedy appears to view the potential loss of IP license rights due to a bankruptcy filing as an unfair result.

Conclusion. In denying review in the N.C.P. Marketing Group case, the Supreme Court has let stand the decision of the courts below that, where the hypothetical test applies as it does in the Ninth Circuit, a non-exclusive trademark license cannot be assumed by a debtor in possession. However, given the detailed statement issued by Justice Kennedy, and joined in by Justice Breyer, it appears that the chances of the Supreme Court granting certiorari in a future IP license assumption case have increased. If such a case reaches the Supreme Court, the current split in the circuits on this important intersection between bankruptcy and intellectual property law may finally be resolved.

If Madoff Investors Are Sued By The SIPA Trustee And Pay Money Back, Can They File Proofs Of Claim After The Bar Date?

Bob Eisenbach — Tue, 03 Mar 2009 07:20:23 -0800

Recently, I posted about SIPA liquidations of brokerage firms, prompted by the Securities Investor Protection Act (known as SIPA) liquidations of Lehman Brothers, Inc. and Bernard L. Madoff Investment Securities LLC. An interesting issue has come up in the Madoff case involving investors who redeemed their accounts before the Madoff bankruptcy was filed. In other alleged Ponzi scheme cases, trustees have sued such investors asserting fraudulent transfer or other claims. The investors in turn often raise defenses, including that they redeemed their accounts in good faith and without any knowledge of the alleged fraud, and lengthy and complex litigation usually results.

Resolution of such litigation can come long after the deadline set for filing proofs of claim (known as a "bar date"). This raises a question: if investors end up paying money back to the estate as a result of the trustee's litigation, will they be able to file proofs of claim -- after the bar date -- for the amounts they have to return? Before turning to that question, let's take a look at how such post-bar date claims are dealt with in non-SIPA bankruptcy cases.

Section 502(h) Of The Bankruptcy Code. Under the Bankruptcy Code, if a person or entity is sued by the bankruptcy estate (usually by a trustee, the debtor in possession, or a creditors' committee) for receipt of an alleged preference or fraudulent transfer, they will be able to file a proof of claim if they end up paying money back to the bankruptcy estate in settlement or as a result of a judgment. Bankruptcy Code section 502(h) expressly covers this situation:

(h) A claim arising from the recovery of property under section 522, 550, or 553 of this title shall be determined, and shall be allowed under subsection (a), (b), or (c) of this section, or disallowed under subsection (d) or (e) of this section, the same as if such claim had arisen before the date of the filing of the petition.

Section 502(h) recognizes that resolution of avoidance actions may come long after the original bar date for filing proofs of claim has past and allows holders of these later-arising claims to share in the estate along with other creditors. The Bankruptcy Code treats these claims as having arisen at the time of the payment back to the bankruptcy estate and allows proofs of claim to be filed months or even years after the bar date.

The Claims Bar Date In SIPA Liquidations. In a SIPA liquidation, there are generally two claims bar dates. The first bar date set is for customer claims, in which customers of the failed brokerage firm seek to recover the securities in their accounts (or more likely in the Madoff case, the securities that were supposed to have been in their accounts). The Securities Investor Protection Corporation insurance of up to $500,000 applies to customer claims. A second bar date, usually a few months later, is for general claims. General creditors may include customers with claims in excess of the $500,000 SIPC protection or those who have more traditional trade creditor or other claims.

The Madoff Case. In the Madoff case, last month several investors filed a motion seeking to have the bar date order clarified with regard to their potential claims in the event that the Madoff trustee later sued them and they were forced to return funds under a fraudulent transfer or other avoidance (sometimes called a "clawback") cause of action after the general claims bar date.

These investors had previously redeemed some or all of their investments, and were seeking an order holding that claims arising from avoidance actions could be filed within 30 days after the judgment giving rise to the claim became final, a provision common in non-SIPA bankruptcy bar date orders due to Bankruptcy Code section 502(h).
The moving parties were concerned that without this clarification, any such claims they filed after the bar date might be held to be barred. On the other hand, if they were forced to file a protective claim before the bar date, they would submit to the court's equitable jurisdiction and may be held to have waived their right to a jury trial in any avoidance action brought against them.
The Madoff trustee filed an opposition to the motion (copy available at the prior link) arguing, among other things, that these investors were not creditors, had not been sued, and as a result did not present an actual case or controversy ripe for adjudication. In addition, the trustee argued that Section 502(h) of the Bankruptcy Code was inapplicable, contending that it was inconsistent with an absolute bar date provision under SIPA. (The SIPA statute provides that Bankruptcy Code provisions are generally applicable in SIPA cases to the extent consistent with SIPA.)
The SIPC also filed a response to the motion (copy available at the prior link) making arguments similar to those advanced by the trustee. In particular, the SIPC argued that Section 502(h) was inconsistent with what the SIPC called SIPA's "immutable" bar date.

The Court's Decision. In a five-page decision issued on February 24, 2009, U.S. Bankruptcy Judge Burton R. Lifland denied the motion, first holding that the Court did not have the discretion to extend the bar dates involved. (A copy of the decision is available by clicking on the link in the prior sentence.) The Court then stated that the motion essentially sought a determination of whether Section 502(h) of the Bankruptcy Code was applicable in SIPA liquidations. Because no avoidance action had yet been filed, the Court held that the requested relief, if granted, would amount to an improper advisory opinion.

As a result, the Court refused to decide whether Bankruptcy Code Section 502(h) applies in SIPA cases, commenting as follows: "Although section 78fff(b) of SIPA specifies that the provisions of the Bankruptcy Code shall apply in SIPA liquidation proceedings, to the extent that they are consistent with SIPA, it is unclear whether section 502(h) of the Code would apply. 15 U.S.C. § 78fff(b) (1981)."
The Court concluded by noting that the investors could file a protective proof of claim before the general claims bar date, although that would subject them to the Court's equitable jurisdiction.

An Open Question. Although the Court denied the motion, it left open the ultimate issue involved -- whether Section 502(h) of the Bankruptcy Code applies in SIPA liquidations and permits parties to file proofs of claim after the bar date if they are sued by a trustee and later have to return funds or other property. With the issue undecided for now, some investors may choose to file a protective proof of claim before the bar date passes.

New Article Looks At BAPCPA's Impact On Retailers In Chapter 11

Bob Eisenbach — Mon, 23 Feb 2009 21:52:47 -0800

My colleagues Lawrence C. Gottlieb, Michael Klein, and Ronald R. Sussman recently authored an article entitled "BAPCPA's Effects on Retail Chapter 11s Are Profound," in the February 2009 edition of the The Journal of Corporate Renewal, published by the Turnaround Management Association. You can access a copy of the article by clicking on its title in the prior sentence.

What's their assessment of the impact of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (known as BAPCPA) on retailer Chapter 11 bankruptcies? Here's an excerpt:

BAPCPA’s numerous creditor-friendly amendments and modifications have profoundly impacted the Chapter 11 process, to the point that it is nearly impossible for retailers to reorganize, regardless of the prevailing national and international economic conditions.

Time and again in the three years since its enactment, BAPCPA has significantly impaired the ability of retailers to obtain the necessary post-petition financing and breathing room from creditors to test and implement a reorganization strategy, regardless of the debtor’s capital structure, the fluctuating state of the credit markets, or the extent to which they compete with large discount retailers like WalMart or online retailers like Amazon.

The article details several of the critical changes BAPCPA made, their effect on retailers, and how the timing of a bankruptcy filing is often critical for a retailer to have any chance of trying for a going concern sale to avoid complete liquidation through going out of business sales.

The Cooley Bankruptcy & Restructuring Group, which Lawrence Gottlieb chairs, is representing official committees of unsecured creditors in many high-profile national and regional retail bankruptcies, including Steve & Barry’s, The Bombay Company, Hancock Fabrics, Lillian Vernon, The Sharper Image, Mervyns, Shoe Pavilion, Boscov’s and Goody’s. The article, drawn from these recent experiences, is important reading for retailers, creditors, and insolvency professionals alike.