Business Bankruptcy Blog

Winter 2012 Edition Of Bankruptcy Resource Now Available

Bob Eisenbach — Mon, 13 Feb 2012 08:42:21 -0800

The Winter 2012 edition of the Absolute Priority newsletter, published by the Bankruptcy & Restructuring group at Cooley LLP, of which I am a member, has recently 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. 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 and insolvency topics.

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

The Supreme Court's recent Stern v. Marshall decision and its impact on the ability of bankruptcy courts to enter final judgments in certain cases;
Recent decisions on the ability of secured creditors to credit bid their debt in bankruptcy asset sales;
Issues involving the recharacterization of debt as equity; and
The ability of directors and officers to obtain coverage under a D&O liability policy purchased by a bankrupt company.

This edition also reports on some of our recent representations, including our work for official committees of unsecured creditors in Chapter 11 cases involving major retailers and others. Recent committee cases include Blockbuster, Orchard Brands, Alexander Gallo Holdings, Claim Jumper, Signature Styles, Urban Brands, and Mervyn's Holdings, among others.

I hope you find the latest edition of Absolute Priority to be of interest.

Amendments To Federal Bankruptcy Rules, Official Forms, And Federal Rules Of Evidence Are Now In Effect

Bob Eisenbach — Thu, 01 Dec 2011 07:20:24 -0800

Bankruptcy Rule Amendments. As reported in a post last month, this year's amendments to the Federal Rules of Bankruptcy Procedure have now taken effect today, December 1, 2011.

For a discussion of the amended rules, follow the link in this sentence.
For the Advisory Committee's report on the amendments, together with a redline showing the changes made, follow the link in this sentence.

Amended Official Bankruptcy Forms. In addition to the national bankruptcy rules, revisions have been made to a number of the official bankruptcy forms. This sentence contains a link to a set of these updated official forms.

Amended Federal Rules Of Evidence. Finally, a restyled edition of the Federal Rules of Evidence also goes into effect today; follow the link in this sentence for the revised evidence rules. Although the substance of the rules of evidence has not changed, revisions in the numbering of some subsections and the style of how the rules are phrased have been implemented.

Amendments To The Federal Bankruptcy Rules, Including Rule 2019, To Take Effect December 1, 2011

Bob Eisenbach — Wed, 16 Nov 2011 09:46:28 -0800

Almost every year, changes are made to the set of rules that govern how bankruptcy cases are managed -- the Federal Rules of Bankruptcy Procedure. The changes address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others. There are seven amendments to the national bankruptcy rules this year. Some affect bankruptcy cases involving individuals but major revisions have been made to Rule 2019, which governs disclosures by ad hoc committees and groups of creditors or equity security holders in Chapter 11 business bankruptcy cases and in Chapter 9 municipality cases. All of the new amendments will take effect on December 1, 2011, barring unlikely action by Congress.

Read All About It. A copy of the Advisory Committee's report, together with a redline of the new rule amendments, is available by following the link in this sentence. The report also includes the Advisory Committee's notes on each new or amended rule.

Significant Revisions to Rule 2019: Controversy Resolved? Over the past several years, Rule 2019, the national bankruptcy rule regarding disclosure by unofficial committees and groups of hedge fund and other investors, has been the subject of much litigation and a number of conflicting court decisions, including opposite views from different bankruptcy judges in Delaware. Follow the link in this sentence for a collection of previous posts on the blog discussing those past decisions and the controversy surrounding old Rule 2019.

In an attempt to put the controversy to rest, the Advisory Committee drafted, and the Supreme Court has approved, a new Rule 2019, which will take effect on December 1, 2011. It requires disclosure in Chapter 11 and Chapter 9 cases by unofficial committees, groups and entities consisting of or representing multiple creditors or equity security holders that are (1) acting in concert to advance common interests, and (2) not composed entirely of affiliates or insiders of each other, and which take a position before the court or solicit votes on confirmation of a plan.

The new rule focuses on the nature and purpose of the committee or group, rather than how it names itself. In contrast, old Rule 2019 covered entities and committees, leading to disputes over whether a self-designated "group" had to make disclosures. Also dropped from the final version of new Rule 2019 was language from the initial proposed rule amendments that would have permitted the court to require disclosure of the amount paid for a disclosable economic interest, another topic of much prior controversy.

Disclosable Economic Interest. Amended Rule 2019 is built around the defined term "disclosable economic interest," which is defined to mean the following:

Any claim, interest, pledge, lien, option, participation, derivative instrument, or any other right or derivative right granting the holder an economic interest that is affected by the value, acquisition, or disposition of a claim or interest.

Required Disclosures Under Rule 2019. A covered group or committee will be required to file a verified statement disclosing facts and circumstances on the following topics listed in new Rule 2019(c):

The group or committee's formation;
Any entity's employment and the party at whose instance the employment was arranged;
Each member's and entity's name, address, and nature and amount of their disclosable economic interest;
For each member of a group or committee claiming to represent any entity beyond the group's members, the date of acquisition by quarter and year of each disclosable economic interest, unless acquired more than a year before the bankruptcy petition was filed; and
Where applicable, a copy of any instrument authorizing the entity, group, or committee to act on behalf of creditors or equity security holders.

If any material changes have occurred since the group or committee's last statement, a supplemental statement must be filed whenever the group or committee takes a position before the court or solicits votes on confirmation of a plan.

Consequences of Non-Compliance With Rule 2019. A party in interest or the court on its own motion can determine whether there has been any failure to comply with the new Rule 2019's requirements. If so, the court may refuse to permit the group or committee from being heard in the case and/or hold invalid any authority, objection, or plan votes made or obtained by the non-complying entity, group or committee, as well as grant any other appropriate relief.

Other Business Bankruptcy Rule Amendments. In addition to Rule 2019, three of the other new amendments directly impact business bankruptcy cases.

New Rule 1004.2 applies in Chapter 15 cross-border bankruptcy cases. It requires that any petition for recognition of a foreign proceeding under Chapter 15 of the Bankruptcy Code state the center of the debtor's main interests (aka, "COMI"), as well as each country in which a foreign proceeding involving the debtor is pending. The rule is designed to help identify whether the foreign proceeding is a foreign main or nonmain proceeding.
Amended Rule 2003(e) will require the United States Trustee or designee to file a statement specifying the date and time to which any Section 341(a) meeting of creditors has been adjourned. This rule amendment was included to be sure that creditors who did not attend a meeting of creditors could learn when the continued meeting will take place, information that sometimes was known only to those who attended the original meeting.
Rule 6003, discussed in this prior blog post on the 2007 rule amendments, has been amended to clarify that although a court cannot, absent immediate and irreparable harm, enter an order during the 21 days after a petition has been filed on certain matters, including employment of professionals, it can enter an order after those first 21 days that grants relief effective as of a date prior to entry of the order, i.e., as of the petition date.

Rule Amendments for Individual Bankruptcy Cases. The balance of the new rule amendments involve cases in which the debtor is an individual.

Amended Rule 3001(c), governing proofs of claim, requires in an individual debtor's case that an itemized statement of interest, fees, expenses or other charges be filed with the proof of claim. If a security interest is claimed in the debtor's property, a statement must also be included giving the amount required to cure any default. If the property involved is the debtor's principal residence, the proof of claim must attach, and give the information required by, a new official form addressing this rule change, and also must include information related to any escrow account. Penalties for non-compliance can include barring the claimant from presenting the omitted information in any contested matter or adversary proceeding, and an award of reasonable attorney's fees and expenses caused by the failure.
New Rule 3002.1, related to claims secured by a Chapter 13 debtor's principal residence, sets forth a number of additional requirements when the claim is provided for under Section 1322(b)(5) of the Bankruptcy Code. The new rule details required information related to post-petition fees, expenses, and charges, as well as procedures for determining those amounts and the final cure amount.
Rule 4004(b) has been amended to allow a party in interest, under certain circumstances, to seek an extension of time to file an objection to a debtor's discharge after the deadline for filing such objections to discharge has already expired.

Updated Official Forms. As mentioned, some of the pending amended rules will require revisions in official bankruptcy forms. You can find the proposed revised forms, which will be formally released on December 1, 2011 (unless Congress surprises us and prevents the amendments from taking effect), by following the link in this sentence.

Conclusion. For business bankruptcy professionals, and companies and investors involved in Chapter 11 bankruptcy cases, the most important change to the Federal Rules of Bankruptcy Procedure this year is the newly revised Rule 2019. However, several of the other amendments also will impact Chapter 11 cases, and all are worthy of note.

Delaware Supreme Court Affirms Ruling Protecting Managers Of Insolvent LLCs

Bob Eisenbach — Wed, 14 Sep 2011 10:31:40 -0800

Creditor Derivative Claims Against Fiduciaries Of Insolvent Corporate Entities. In a 2007 decision in North American Catholic Educational Programming, Inc. v. Gheewalla, et al., 930 A.2d 92 (Del. 2007), the Delaware Supreme Court held that directors of an insolvent Delaware corporation could be sued derivatively by creditors for breaches of fiduciary duty. For a discussion of the case, you may find this earlier post of interest: "Delaware Supreme Court Addresses, For The First Time, Whether Creditors Can Sue Directors For Breach Of Fiduciary Duty When The Corporation Is Insolvent Or In The Zone Of Insolvency."

What About LLCs? The Gheewalla decision clarified that creditors of a Delaware corporation that is insolvent (but not one only in the "zone of insolvency") can assert derivative claims against the corporation's directors. That led many to wonder whether the same ruling would be extended to managers of Delaware limited liability companies ("LLCs"), the LLC equivalent of a corporation's directors.

The Chancery Court's Decision. In November 2010, the Delaware Chancery Court answered the question, somewhat surprisingly, with a decisive "no." In CML V, LLC v. Bax, 6 A.3d 238 (Del.Ch. 2010), the Chancery Court held that creditors could not bring derivative actions for breach of fiduciary duty against managers of insolvent LLCs, chiefly because the relevant Delaware LLC Act provision limited standing to bring such suits only to LLC members and their assignees. For a discussion of the Chancery Court decision, follow the link to a November 2010 post on the blog entitled "New Ruling Finds Important Protection For Managers Of Insolvent Delaware LLCs."

The Delaware Supreme Court Decision. The decision was appealed to the Delaware Supreme Court. On September 2, 2011, the Delaware Supreme Court issued an opinion analyzing the Delaware LLC Act and affirming the Chancery Court's decision. A copy of the Delaware Supreme Court's opinion is available through this link.

The Delaware Supreme Court held that the literal terms of the Delaware LLC Act, specifically 6 Del. C. section 18-1002, limits standing to bring derivative claims only to LLC members and their assignees because the LLC Act provides that only they are "proper plaintiffs." The Delaware Supreme Court held that this statute was unambiguous and expressly limits standing only to LLC members and their assignees. The creditor plaintiff argued that it was "absurd" for the result to be different as between a corporation and LLC, but the Delaware Supreme Court held that the Delaware General Assembly "was well suited to make that policy choice and we must honor that choice."
The plaintiff also claimed that by limiting standing, the statute violated the Delaware Constitution's prohibition against curtailing the Chancery Court's jurisdiction to less than the general equity jurisdiction of the High Court of Chancery of Great Britain as it existed in 1792, when Delaware ratified its first constitution. The Delaware Supreme Court rejected the argument holding that, among other reasons, Delaware limited liability companies, unlike corporations, came into existence only in 1992 and therefore did not exist in 1792. In addition, the LLC statute was properly able to both grant and limit derivative standing.

Creditor Options. Recognizing that this standing provision could limit creditor remedies in the event of insolvency, the Delaware Supreme Court discussed one remedial option available to creditors. In footnote 20 of the opinion, the Court stated:

Admittedly, this approach is not the only option the General Assembly had, and we make no normative comment on the General Assembly's policy choice. Our only purpose here is to explain that limiting derivative standing to members and assignees in a contractual entity like an LLC is not absurd because other interest holders--like creditors--have other options--as, for example, negotiating automatic assignment of membership interests upon insolvency clauses into the credit agreement and requiring the members and governing board to amend the LLC agreement accordingly.

Key Observations. As the Delaware Supreme Court noted, certain creditors may require that the LLC agreement be amended to provide for automatic assignment of membership interests to the creditors upon insolvency. If so, those creditors would then have standing to bring derivative claims. However, absent such provisions, under the Delaware Supreme Court's decision:

Managers of a Delaware LLC will not be subject to derivative claims by creditors if the entity becomes insolvent, although it is far less certain that the standing statute would preclude a bankruptcy trustee from bringing claims on behalf of the LLC itself;
An insolvent LLC's creditors will not have derivative standing to bring potential D&O type claims; and
These creditors will be limited to contractual remedies against the LLC to protect themselves.

Although Delaware LLCs and corporations share many common features, this new Delaware Supreme Court decision makes clear that the automatic derivative standing of creditors upon insolvency is one important distinction.

Summer 2011 Edition Of Bankruptcy Resource Now Available

Bob Eisenbach — Mon, 29 Aug 2011 10:29:07 -0800

The Summer 2011 edition of the Absolute Priority newsletter, published by the Bankruptcy & Restructuring group at Cooley LLP, 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. 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 and insolvency topics.

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

Recent case law on the impact of a confirmed plan on a second bankruptcy filing by a successor to the original debtor;
The Second Circuit's recent decision limiting "gifting" in a Chapter 11 plan;
The reach of the Section 546(e) securities transaction safe harbor defense in avoidance actions; and
An update on litigation by the Madoff trustee against feeder funds and its broader implications.

This edition also reports on some of our recent representations, including the Chapter 11 bankruptcy case for our client Metropark USA, Inc., and our work for official committees of unsecured creditors in Chapter 11 cases involving major retailers and others. Recent committee cases include Blockbuster, Orchard Brands, ArchBrook Laguna Holdings, Signature Styles, Claim Jumper Restaurants, OTC Holding Corp., Urban Brands, Mervyn's Holdings, Sierra Snowboard, Trade Secrets, Mt. Diablo YMCA, and Pacific Metro, among others.

I hope you find the latest edition of Absolute Priority to be of interest.

First Published Court Of Appeals Opinion Issued Answering Whether Trademark Licenses Are Assignable In Bankruptcy

Bob Eisenbach — Tue, 02 Aug 2011 07:11:24 -0800

It's been a long wait, but we finally have a published decision from a U.S. Court of Appeals answering whether a trademark license is assignable in bankruptcy without the licensor's consent. On July 26, 2011, the U.S. Court of Appeals for the Seventh Circuit issued an opinion in In re: XMH Corp., written by Circuit Judge Richard A. Posner, and a copy of the opinion is available by following the link in this sentence. Until now, the closest we had come to a Court of Appeals decision on this issue was an unpublished affirmance by the U.S. Court of Appeals for the Ninth Circuit of the district court's decision in In re N.C.P. Marketing Group, Inc., 337 B.R. 230 (D. Nev. 2005). For more on the Ninth Circuit case including the Supreme Court's interest in one of the issues in the case, take a look at these earlier posts on the blog, here, here, and here.

The Context. The dispute that led to the Seventh Circuit's decision arose in the Chapter 11 bankruptcy case of Hartmarx Corporation (which later changed its name to "XMH"). One of its subsidiaries, Simply Blue ("Blue"), which was also in bankruptcy, sold its assets in a Section 363 sale to two buyers (the "purchasers").

Among Blue's assets was an executory contract with Western Glove Works ("Western"), which Blue sought to assign to the purchasers. Western objected, arguing that the contract could not be assigned because it was a sublicense to Blue of a trademark licensed by Western. The bankruptcy court agreed with Western and XMH appealed.
That's when things got a little complicated. While XMH's appeal was pending, Blue and the purchasers amended the contract. Under the amendment, title to the contract was left with Blue but the purchasers assumed all of Blue's contractual duties, together with the right to receive all fees to which Blue was otherwise entitled. The bankruptcy court approved the amendment and Western appealed from that decision.
In the meantime, the district court reversed the bankruptcy court's original decision holding that the contract could not be assigned, effectively allowing the original contract to be assigned. Western appealed the district court's decision and that brought the case to the Seventh Circuit.

The Court's Decision. After disposing of a few jurisdictional issues springing from the complicated way the case had played out, the Seventh Circuit reached the merits. The Court first looked to Section 365(c)(1) of the Bankruptcy Code, which limits assignment of an executory contract if "applicable law" permits the non-debtor party to the contract to refuse to accept performance from an assignee, regardless of whether the contract prohibits or restricts assignment. In the XMH Corp. case, the contract did not prohibit or restrict assignment (but neither did it permit it). Western argued that "applicable law" was trademark law because the contract stated that Western was a licensee of a trademark for "Jag Jeans." The Court noted that "Jag" is a federally registered trademark, although "Jag Jeans" is not.

The Court held that if the contract included a trademark sublicense when XMH attempted to assign the contract, it was not assignable. This was true regardless of whether federal trademark law applied, any particular state's trademark law applied, and also, apparently, even if Canadian law applied (Western is a Canadian company). The Seventh Circuit put it this way:

None of this matters, though, because as far as we've been able to determine, the universal rule is that trademark licenses are not assignable in the absence of a clause expressly authorizing assignment. Miller v. Glenn Miller Productions, Inc., 454 F.3d 975, 988 (9th Cir. 2006)(per curiam); In re N.C.P. Marketing Group, Inc., 337 B.R. 230, 235-36 (D. Nev. 2005); 3 McCarthy on Trademarks § 18:43, pp. 18-92 to 18-93 (4th ed. 2010).

After describing how consumers rely on a trademark as an indicator of a good's quality, the Court explained that if a trademark owner (or licensee sublicensing the mark) allows another company to produce the trademarked goods, it

will not want the licensee to be allowed to assign the license (that is, sublicense the trademark) without the owner's consent, because while the owner will have picked his licensee because of confidence that he will not degrade the quality of the trademarked product he can have no similar assurance with respect to some unknown future sublicensee.

Because this is the normal reaction of a trademark owner, it makes sense to make the rule that a trademark license is not assignable without the owner's express permission a rule of contract law--what is called a 'default' rule because it is the rule if the parties do not provide otherwise (as they are allowed to do).

Ultimately, the Seventh Circuit held that although the contract included a trademark sublicense, the sublicense had expired and the parties had not designated the contract, post-expiration, as a trademark sublicense. Further, the Court held that the balance of the contract was only a service agreement and not an implied trademark license. The Court also refused to go down the "dark path" of whether a contract could be a trademark license for some purposes but not others. As such, with no actual trademark sublicense in existence at the time of assignment, the default rule discussed above did not apply and the executory contract could be assigned. The Seventh Circuit affirmed the lower courts' decisions approving the assignment of the contract as amended.

An IP Attorney's Observations. For the perspective of an in-house intellectual property attorney on the Seventh Circuit's decision, including helpful links to the trademark and the parties' underlying agreements, you may find Pamela Chestek's discussion of the case on her "Property, intangible" blog, interesting reading.

Good News For Trademark Owners. With the Seventh Circuit's XMH Corp. decision, we now have two Courts of Appeals (the Seventh and Ninth Circuits) on record holding that trademark licenses are not assignable in bankruptcy absent the consent of the trademark owner or sublicensor. While the full force of a decision depends on whether other courts follow its holding, trademark owners will likely find the guidance provided by this decision meaningful, especially given the Seventh Circuit's observation that the non-assignability of trademark licenses is "the universal rule." That said, how the decision is viewed in other circuits, particularly in Delaware and New York where many large Chapter 11 cases are filed, remains to be seen, so stay tuned.

Bankruptcy Judge's Free Online Research Binder Now Updated

Bob Eisenbach — Tue, 21 Jun 2011 10:42:55 -0800

I have posted in the past about the helpful research binder that former Judge Randall J. Newsome of the United States Bankruptcy Court for the Northern District of California had made available on the Bankruptcy Court's website. Although Judge Newsome has retired from the bench, fortunately Judge Charles Novack, also of the U.S. Bankruptcy Court for the Northern District of California, has picked up the mantle and has continued to update the research binder. Judge Novack recently released the updated version covering cases through Volume 436 of Bankruptcy Reports. Follow the link in this sentence to access the entire binder in PDF format, which is capable of being searched using a key word or phrase.

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

I have the privilege of continuing Judge Randall Newsome's research binder. Although this represents the aggregation of his 22 years of research (and my own several months of work), I make no claim as to its current level of accuracy. Some of the cases may well have been superseded, reversed or otherwise no longer be good law. I, like Judge Newsome, post it with the intention of assisting those who are researching bankruptcy matters within the 9th Circuit. Users should consider it a first, but not final research tool, and should cite check all cases before relying on them.

With those caveats, and with Judge Novack's continuing work, the binder remains a good place to start when researching bankruptcy law issues in Ninth Circuit.

Spring 2011 Edition Of Bankruptcy Resource Now Available

Bob Eisenbach — Tue, 22 Mar 2011 10:14:22 -0800

The Spring 2011 edition of the Absolute Priority newsletter, published by the Cooley 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. 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 and insolvency topics.

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

Recent case law on third-party releases in bankruptcy plans;
Treatment of make-whole and no-call provisions in bankruptcy;
Breach of fiduciary duty claims against managers of insolvent Delaware LLCs; and
Ordinary course of business defense to preferences.

This edition also reports on some of our recent representations, including the successful Chapter 11 reorganization of our client, retailer Crabtree & Evelyn, Ltd., and our work for official committees of unsecured creditors in Chapter 11 bankruptcy cases involving major retailers and others. Recent committee cases include Blockbuster, Orchard Brands, Ultimate Electronics, Claim Jumper Restaurants, OTC Holdings, Urban Brands, Mervyn's Holdings, Sierra Snowboard, Trade Secrets, Mt. Diablo YMCA, and Pacific Metro, among others.

I hope you find the latest edition of Absolute Priority to be of interest.

Blast From The Past: Website Provides Quick Access To Older Bankruptcy Code Sections

Bob Eisenbach — Wed, 01 Dec 2010 07:19:01 -0800

Thanks to Professor Robert Lawless of the University of Illinois College of Law, also of the Credit Slips blog, you can now save yourself from combing through dusty old books to find the language of Bankruptcy Code provisions going back as far as 1980. Need to find how Section 547 was worded prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA"), or interested in tracing the evolution of exceptions to the automatic stay of Section 362? Then navigate over to the BankrLaw Project site. Once there, select a date and the site will provide you with the Bankruptcy Code in effect at that time, free of charge. This promises to be a very useful research tool when the text of older Bankruptcy Code provisions is in issue.

New Ruling Finds Important Protection For Managers Of Insolvent Delaware LLCs

Bob Eisenbach — Tue, 16 Nov 2010 07:25:57 -0800

Derivative Claims Against Directors Of An Insolvent Delaware Corporation. With its 2007 decision in North American Catholic Educational Programming, Inc. v. Gheewalla, et al., 930 A.2d 92 (Del. 2007), the Delaware Supreme Court held that directors of an insolvent Delaware corporation could be sued derivatively by creditors for breaches of fiduciary duty. To read that decision, click on the case name in the prior sentence. For a discussion of the case, you may find this earlier post of interest: "Delaware Supreme Court Addresses, For The First Time, Whether Creditors Can Sue Directors For Breach Of Fiduciary Duty When The Corporation Is Insolvent Or In The Zone Of Insolvency."

What About LLCs? The Gheewalla decision clarified that creditors of a Delaware corporation that is insolvent (but not one only in the "zone of insolvency") can assert derivative claims against the corporation's directors, but a question remained: Would that same ruling extend to managers of Delaware limited liability companies, the LLC equivalent of a corporation's directors. Although a number of commentators and some court decisions assumed that it would, a recent Delaware Chancery Court decision has answered the question, somewhat surprisingly, with a decisive "no."

New Chancery Court Ruling. In the new decision, CML V, LLC v. Bax, C.A. No. 5373-VCL (Del.Ch. Nov. 3, 2010), the Delaware Chancery Court undertook an extensive analysis of the Delaware LLC Act and also examined the issue more broadly.

The Court held that under the literal terms of the Delaware LLC Act, specifically 6 Del. C. section 18-1002, only LLC members and their assignees have standing to bring derivative claims because the LLC Act provides that only they are "proper plaintiffs." The LLC Act does not give an insolvent LLC's creditors standing to bring derivative claims. The situation is different for creditors of insolvent corporations because the governing Delaware corporation statutes do not impose exclusive derivative standing provisions.
Although the Chancery Court acknowledged that arguments could be made for allowing creditors to bring derivative actions against managers of an insolvent LLC, the Court saw no reason to set aside the literal reading of the LLC Act's standing provision. The Court also noted that the Delaware Limited Partnership Act has a similar exclusive standing provision.

For a full discussion of the decision, including a link to the opinion itself, be sure to read Francis G.X. Pileggi's excellent post entitled "Chancery Bars Derivative Claim of Creditor Against Insolvent LLC, Based on LLC Act."

Impact On An Insolvent LLC's Creditors. So where does this new decision leave creditors of an insolvent Delaware LLC?

Under the Chancery Court decision, unlike directors of a Delaware corporation, managers of a Delaware LLC are not be subject to derivative claims by creditors if the entity becomes insolvent.
If the decision is followed by other courts -- specifically including bankruptcy courts where claims involving managers of bankrupt LLCs may more often be litigated -- then an insolvent LLC's creditors will not have access to potential D&O type claims. Instead, those creditors will have to rely on contractual remedies against the LLC to protect themselves.

Stay Tuned. As noted, the bankruptcy court is often the forum where insolvency-related matters are litigated. Should these claims be pursued outside of the Chancery Court, it will be interesting to see how other courts interpret the Delaware LLC Act's provisions.

Fall 2010 Edition Of Bankruptcy Resource Now Available

Bob Eisenbach — Thu, 23 Sep 2010 07:50:00 -0800

The Fall 2010 edition of the Absolute Priority newsletter, published by the Cooley 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:

The Third Circuit's decision barring secured creditors from credit bidding under a plan;
The ability of landlords to recover "stub rent" as an administrative claim;
Whether preference defendants can use Section 503(b)(9) claims as a new value defense; and
Proposed changes to Rule 2019 governing disclosures by ad hoc groups and committees.

This edition also reports on some of our recent representations, including the successful Chapter 11 reorganization of our client, retailer Crabtree & Evelyn, Ltd., and our work for official committees of unsecured creditors in Chapter 11 bankruptcy cases involving major retailers and others. Recent committee cases include Eddie Bauer, Uno Restaurant Holdings, Ritz Camera, Filene's Basement, BT Tires Group, Gottschalk's, G.I. Joe's, Trade Secret, Pacific Metro, Mervyn's Holdings, The Ski Market, and Michael Anthony Management, among others.

I hope you find the latest edition of Absolute Priority to be of interest.

Third Circuit Decision Suggests Another Way For Trademark Licensees To Protect Against License Rejection In Bankruptcy

Bob Eisenbach — Wed, 30 Jun 2010 23:38:33 -0800

Trademark licensees have long faced the serious risk of losing all license rights to a trademark if the licensor files bankruptcy and rejects the trademark license as an executory contract. However, a recent decision from the U.S. Court of Appeals for the Third Circuit in the In re: Exide Technologies case may give some trademark licensees new hope of retaining their license rights even in bankruptcy.

Limited protection of Section 365(n). It can be devastating for a licensee to lose access to licensed intellectual property. Often a licensee will build in licensed technology into its products or develop an entire business line or brand around a licensed trademark. Recognizing how important in-licensed IP can be, in 1988 Congress added Section 365(n) of the Bankruptcy Code, giving licensees of certain types of intellectual property special protections in bankruptcy. These protections allow licensees to retain their rights to the licensed intellectual property – but there’s a catch. The Bankruptcy Code’s definition of “intellectual property” includes, among other things, patents, patent applications, copyrights, and trade secrets, but unfortunately for trademark licensees, it does not include trademarks. Follow the link in this sentence for more on Section 365(n)'s licensee protections other than in the trademark area.

Trademark licensee's special risk. With no special protection, the trademark licensee faces the risk of having its license, usually considered to be an executory contract, rejected by the trademark owner in bankruptcy. If the trademark owner decides that the license is now unfavorable and a better deal can be had under a new license agreement with someone else, the trademark owner likely will reject the existing trademark license agreement and, generally, terminate the licensee’s rights to use the mark. The enforceability of phase-out provisions, which allow a licensee to continue to use a mark for a limited time period after a license is terminated, is unclear. Regardless, most courts hold that the trademark licensee eventually will lose its rights to the trademark following rejection. In some cases the ability to re-license can be of great value to a trademark owner in bankruptcy, and thus to its creditors, but it puts the licensee at substantial risk. For more on this topic, you may find this earlier blog post on the trademark licensee's predicament of interest.

The Third Circuit's Exide Decision. In a June 1, 2010 decision in In re: Exide Technologies (a copy of the decision is available by clicking on the preceding link), the Third Circuit examined a series of agreements, determined to constitute one integrated agreement, pursuant to which Exide Technologies sold an industrial battery business, and licensed certain trademark rights, to EnerSys. When Exide filed Chapter 11 bankruptcy in 2002, it sought to reject the agreement as an executory contract. The bankruptcy court granted Exide's motion to reject the agreement, and that decision was affirmed by the district court. On appeal to the Third Circuit, that court held that under New York law, which governed the agreement, once a party has substantially performed, a later breach by that party does not excuse performance. The Third Circuit further held that EnerSys had substantially performed the agreement in the more than ten years since it was signed, rendering the agreement no longer an executory contract.

The Third Circuit held that EnerSys had substantially performed by paying the full purchase price and operating under the agreement for ten years, as well as assuming certain liabilities related to the business EnerSys purchased when it obtained the trademark license.
The Court of Appeals also held that EnerSys's obligation not to use the trademark outside of the licensed business was not a material obligation because it was a condition subsequent and, in any event, did not relate to the agreement's purpose -- the transfer of the industrial battery business in return for a $135 million payment.
Likewise, the Third Circuit concluded that a quality standards provision was minor because it related only to the standards of the mark for each battery produced and not to the transfer of industrial battery business that was the agreement's purpose.
In addition, an indemnity obligation that had subsequently expired, and a further assurances obligation where no remaining required cooperation was identified, were held not to outweigh the factors supporting a finding of substantial performance.

A Concurring Opinion On The Effect Of Rejection. Judge Ambro wrote a concurring opinion to address the bankruptcy court's conclusion that rejection of a trademark license left EnerSys without the right to use the Exide mark. In his concurrence, Judge Ambro analyzed the history of Section 365(n), disagreed that the exclusion of trademarks from its reach created a negative inference that rejection of a trademark license should be tantamount to termination, and stated that courts should be able to prevent the extinguishment of all rights upon rejection. As Judge Ambro wrote in his conclusion:

Courts may use § 365 to free a bankrupt trademark licensor from burdensome duties that hinder its reorganization. They should not—as occurred in this case—use it to let a licensor take back trademark rights it bargained away. This makes bankruptcy more a sword than a shield, putting debtor-licensors in a catbird seat they often do not deserve.

It will be interesting to see whether other courts follow Judge Ambro's views or continue to hold that trademark licensees whose licenses have been rejected no longer retain any rights to use the trademarks at issue.

A New Argument For Trademark Licensees? For trademark licensees looking to preserve their rights in the face of a motion to reject a trademark license, the Exide Technologies decision may provide some additional support.

However, before breathing a sigh of relief, trademark licensees should remember that the decision involved a series of agreements that had been largely performed over the decade since they were signed. In many ways, the trademark licensee was just a part of what the Third Circuit found was, chiefly, an agreement to sell a business division. In essence, although the trademark itself was not sold, the trademark license rights went along with the business.
Typically, trademark licenses more often arise not in connection with a sale of a business but as a separate, often stand-alone, license of certain trademarks for commercial exploitation by the licensee. In that context, it may be far more difficult to establish that the agreement has been substantially performed such that it is no longer an executory contract.

Still, for those situations in which the argument is available, the Third Circuit's decision in Exide Technologies underscores that all trademark licenses are not executory contracts and, at least in some cases, the trademark licensee might just get to keep the license rights after all, even in the face of a rejection motion in bankruptcy.

Official Bankruptcy Forms Revised To Reflect April 1, 2010 Dollar Amount Adjustments

Bob Eisenbach — Fri, 02 Apr 2010 07:00:16 -0800

As discussed in an earlier post called "On The Rise: Bankruptcy Dollar Amounts Will Increase On April 1, 2010," various dollar amounts in the Bankruptcy Code and related statutory provisions were increased for cases filed on or after April 1, 2010. Now several official bankruptcy forms have been revised to reflect these new dollar amounts.

The updated forms include the official Proof of Claim form (click the prior link for a copy of the revised form), as well as a number of other commonly used bankruptcy forms.
Follow the link in this sentence for information about, and access to, all newly revised official bankruptcy forms.

Remember, the increased dollar amounts reflected on these forms apply only to cases filed on or after April 1st.

California Court of Appeal Provides Guidance For Directors Of Financially Distressed California Corporations

Bob Eisenbach — Tue, 23 Mar 2010 12:08:09 -0800

As I have reported over the past several years, Delaware courts, including the Delaware Supreme Court, have addressed the nature of a director's fiduciary duties when a Delaware corporation is insolvent or in the "zone of insolvency," most notably with the 2007 decision in North American Catholic Educational Programming, Inc. v. Gheewalla, et al., 930 A.2d 92 (Del. 2007). To read that decision, click on the case name in the prior sentence. For a discussion of that case, you may find this earlier post of interest: "Delaware Supreme Court Addresses, For The First Time, Whether Creditors Can Sue Directors For Breach Of Fiduciary Duty When The Corporation Is Insolvent Or In The Zone Of Insolvency."

California courts, however, did not have occasion to consider fiduciary duty issues involving directors of financially distressed California corporations until recently. In a decision called Berg & Berg Enterprises, LLC v. Boyle, the California Court of Appeal for the Sixth Appellate District has provided directors of California corporations facing potential insolvency with meaningful guidance on the scope of their fiduciary duties, including the application of California's "trust fund doctrine."

Click on the link in this sentence for a complete discussion of this California decision and the guidance it gives directors of distressed California corporations, which we recently published at the Bankruptcy & Restructuring group of Cooley Godward Kronish LLP.
Follow the link this sentence for a copy of the Berg & Berg Enterprises decision itself.

It will be interesting to see whether other California courts, perhaps eventually including the California Supreme Court, will have opportunity in the months and years ahead to consider these important issues to directors and officers.

Recent Decision Holds That Section 503(b)(9) "20 Day" Claims Can Be Used As Part Of New Value Preference Defense

Bob Eisenbach — Mon, 22 Mar 2010 07:30:45 -0800

Earlier this year, the U.S. Bankruptcy Court for the Middle District of Tennessee issued a decision holding that creditors sued for preferences can assert a new value defense based on the goods provided to a debtor in the 20 days before the bankruptcy case was filed. The debtor had challenged the effort to use those 20 day goods as new value because they are entitled to administrative claim priority under Section 503(b)(9) of the Bankruptcy Code.

For more information on this decision, read this informative CooleyAlert! prepared by the Bankruptcy & Restructuring group at Cooley Godward Kronish LLP, of which I am a member.
You can also follow the link in this sentence for a copy of the Bankruptcy Court's 11 page decision.

The law in this area continues to develop and trade vendors and suppliers of goods will find this update of particular interest.

Winter 2010 Edition Of Bankruptcy Resource Now Available

Bob Eisenbach — Fri, 12 Mar 2010 07:29:42 -0800

The Winter 2010 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:

The Third Circuit's consideration of credit bidding in Chapter 11 plan sales;
The ability of unsecured creditors to recover postpetition attorney's fees;
The increase in "prepackaged" bankruptcy filings; and
Section 503(b)(9) administrative claim developments.

This edition also reports on some of our recent representations, including the successful Chapter 11 reorganization of our client, retailer 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, Uno Restaurant Holdings, Ritz Camera, Filene's Basement, BT Tires Group, Gottschalk's, Bernie's Audio Video TV Appliance, G.I. Joe's, Against All Odds, Samsonite Company Stores, Mervyn's Holdings, The Ski Market, and Lenox Sales, among others.

I hope you find the latest edition of Absolute Priority to be of interest.

On The Rise: Bankruptcy Dollar Amounts Will Increase On April 1, 2010

Bob Eisenbach — Tue, 02 Mar 2010 07:20:55 -0800

It hasn't gotten much publicity yet, but certain dollar amounts in the Bankruptcy Code will be increased for cases filed on or after April 1, 2010. You can find a chart listing all of the changes on this Federal Register page, which printed last month's official notice from the Judicial Conference of the United States.

Among the most meaningful increases for Chapter 11 and other business bankruptcy cases:

The total amount of claims required to file an involuntary petition rises to $14,425 from $13,475;
The employee compensation priority under Section 507(a)(4) increases to $11,725 from $10,950;
The consumer deposit priority under Section 507(a)(7) rises to $2,600 from $2,425;
The dollar amount in the bankruptcy venue provision, 28 U.S.C. Section 1409(b), that requires actions for non-consumer, non-insider debt to be brought against defendants in the district in which they reside, has increased to $11,725 from $10,950; and
The minimum amount required to bring a preference claim against a defendant in a non-consumer debtor case, specified in Section 547(c)(9), rises from $5,475 to $5,850.

Other adjustments will affect consumers more than business debtors. For example, the debt limit for an individual to qualify to file a Chapter 13 bankruptcy case will rise to $1,081,400 of secured debt, and certain exemption amounts will also rise.

Although the changes aren't substantial, be sure to keep them in mind when assessing cases filed after April 1st.

Who's SARE Now? Bankruptcy's Single Asset Real Estate Rules And Their Impact On Commercial Real Estate

Bob Eisenbach — Wed, 17 Feb 2010 11:40:52 -0800

Given the state of commercial real estate, the prospect for defaults by commercial borrowers has greatly increased. The last time there was a significant downturn in the commercial real estate sector in the early 1990s, owners of buildings and other real estate often turned to Chapter 11 bankruptcy as a method of buying time and, in some cases, lowering or at least restructuring the amount of secured debt against the real property through a plan of reorganization. This raises the question -- will the same story play out again in this downturn?

Major Bankruptcy Law Changes In 2005. As many readers of this blog know, major amendments were made to the Bankruptcy Code in 2005 -- formally known as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) -- including ones that affect real estate. One of the better-known changes was the addition of strict limitations on the time bankrupt tenants could have to assume or reject commercial real estate leases.

However, there was another amendment that may have a significant impact on some owners of real estate in Chapter 11, and could complicate the prospects for using bankruptcy to restructure debt on certain distressed projects. This change was the elimination of a valuation cap that had previously limited the number of real estate debtors subject to the Bankruptcy Code's single asset real estate (“SARE”) rules, most notably provisions that impose special requirements on single asset real estate debtors to keep in place the benefits of bankruptcy's automatic stay.

The Bankruptcy Code's SARE Definition. Prior to BAPCPA, there were relatively few SARE cases because the definition was limited to debtors with less than $4 million of secured debt against the real property. This meant that only smaller real estate cases were covered by the more restrictive SARE rules. BAPCPA, however, removed the $4 million secured debt ceiling. As a result, a real estate entity owing hundreds of millions of dollars in secured debt may be subject to the SARE rules. Consequently, the number of real estate cases potentially subject to the SARE provisions has increased dramatically.

The Bankruptcy Code's current definition of SARE provides:

The term 'single asset real estate' means real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental.

11 U.S.C. §101 (51B).

Impact Of A SARE Designation. A SARE designation can have a big effect on the debtor. When a debtor states on its petition that it is a SARE, or a secured creditor files a motion and the Court rules that the debtor is in fact a SARE, the dynamics of the Chapter 11 case will change. As discussed below, a SARE debtor must either file a plan of reorganization with a reasonable chance of being confirmed within the later of (i) 90 days after the order for relief is entered in the case (in a voluntary bankruptcy case this is when the case is filed) or (ii) 30 days after the date the court determines that the debtor is subject to the provisions of SARE, or must start making monthly payments to the secured creditor at the loan's non-default interest rate. If a SARE debtor fails to satisfy these requirements, the court is likely to grant a secured creditor relief from stay to commence or continue with a foreclosure of the real property.

Who's A SARE? Not every owner of commercial real estate in bankruptcy will be a SARE debtor. To determine what types of commercial properties and developments qualify as a SARE case, courts focus on interpreting the meaning of “a single property or project.” In cases in which one debtor owns one piece of real property, this issue will likely be straightforward. In other cases, however, the question may be more difficult to determine. For example, a real estate business owning many interrelated projects through separate, multiple limited liability companies ("LLCs") or partnerships may be able to avoid a SARE ruling. On the other hand, an entity owning more than one property, if considered a single project, may be deemed to be a SARE. To read one court's analysis of these issues in a series of related bankruptcy cases involving multiple entities and properties, click here, here, and here.

If a single property or project is involved, courts then analyze whether the single real estate asset is used in the operation of a business or whether it is simply held for income. A SARE case usually involves passive rent collection without other active business activities that generate revenue for the debtor. The SARE standard is factually driven and generally looks to “whether [the debtors] conduct substantial business other than operating the real property.” In the Matter of Scotia Pacific Company, LLC, 508 F.3d 214, 221 (5th Cir. 2007) (debtor’s substantial entrepreneurial business operations went beyond mere passive collection of money). As the Scotia Pacific court held:

In order to be single asset real estate, the revenues received by the owner must be passive in nature; the owner must not be conducting any active business, other than merely operating the real property and activities incidental thereto. Under the prior jurisprudence, those passive types of activities are the mere receipt of rent and truly incidental activities such as arranging for maintenance or perhaps some marketing activity, or ... mowing the grass and waiting for the market to turn.

A business would not be a SARE if a reasonable and prudent business person would expect to generate substantial revenues from the operation activities--separate and apart from the sale or lease of the underlying real estate.

For example, a golf club where the owners are actively engaged in activities such as employing third party workers, selling club memberships and merchandise, and charging green fees, has been held not to be a SARE. Likewise, a debtor in the hotel or marina business also may not be held to be a SARE.

Limited Automatic Stay Benefits For SAREs. A SARE debtor cannot count on the automatic stay remaining in force for an extended period of time. Instead, to maintain the benefit of the automatic stay, Section 362(d)(3) of the Bankruptcy Code requires a SARE debtor, within 90 days after filing bankruptcy, to file a plan that has a reasonable possibility of being confirmed or commence regular payments to the secured creditor at the non-default interest rate.

A SARE debtor that is not in a position to file a plan will, in effect, have to pay for the continuation of the automatic stay. This can prove difficult for projects that are not producing significant cash flow.
If a plan is filed instead, the debtor does not have to establish that the proposed plan will in fact be confirmed but must show that the assumptions that underpin the plan are reasonable. What constitutes a reasonable time to confirm a plan will vary from case to case.
If the debtor fails to satisfy either of these requirements, the secured creditor will likely be able to obtain relief from the automatic stay to foreclose on the property.
These rules do not preclude a secured creditor from seeking relief from stay on other grounds, such as a lack of adequate protection or other cause.

Overall Impact On Commercial Real Estate. Owners of distressed commercial real estate projects that are SAREs may find Chapter 11 to be less useful than in past down cycles.

With careful planning, some SARE debtors will be able to restructure through bankruptcy. Yet as an interesting study shows, many SARE (and non-SARE) real estate cases in the past few years have ended with the secured creditor obtaining relief from the automatic stay to foreclose. Faced with this prospect, some owners have simply decided to turn over distressed real property to the lender, often through a deed in lieu of foreclosure before bankruptcy.
In today's environment, some lenders are willing to work with real property owners to extend loans and avoid foreclosure or taking back the property. However, if the SARE rules would apply in a potential bankruptcy, this fact may give the secured lender more leverage in those negotiations.

What's likely to be the end result of the SARE rules and the 2005 removal of the valuation cap? As single asset real estate projects face default, although some will certainly be able to restructure their debts, many may end up in the hands of lenders as real estate owned ("REO") properties. With distressed borrowers working through hundreds of billions of dollars in commercial real estate loan problems across the country, the negative impact defaulting commercial real estate loans and resulting REO may have on banks and other lenders could end up being the bigger part of this SARE story.

Two More Decisions Issued On Whether Bankruptcy Rule 2019 Requires Informal Groups To Disclose Their Trades

Bob Eisenbach — Tue, 09 Feb 2010 07:29:42 -0800

The First Two Delaware Decisions. In the past two months, I have reported on decisions by two Delaware bankruptcy judges in the In re Washington Mutual, Inc. case and in In re Premier International Holdings, Inc. (aka, the Six Flags case), taking opposing views on whether Federal Rule of Bankruptcy Procedure 2019 requires ad hoc committees and informal groups to disclose their trading activities. The Court in the Washington Mutual case held that it does, while the Court in the Six Flags case came out strongly with the opposite view. Follow the links in the prior sentence for more on both decisions, including copies of the respective opinions, as well as the earlier Northwest Airlines and Scotia Pacific decisions from the Southern Districts of New York and Texas, respectively.

A Third Delaware Decision. Two days after the Six Flags opinion was issued, Delaware Bankruptcy Judge Brendan L. Shannon issued a short order granting a motion to compel an Ad Hoc Noteholder Group in the In re Accuride Corporation Chapter 11 case to disclose details of their trades. A copy of Judge Shannon's two-page order is available by clicking on the link in this sentence. The ruling reflects the Court's comments from the bench agreeing with the conclusions in the Northwest Airlines and Washington Mutual decisions, although Judge Shannon stated that he did not necessarily concur that fiduciary obligations arise in this context, as the Washington Mutual opinion had stated.

The Philadelphia Newspapers Court Weighs In. Then last week, on February 4, 2010, Judge Stephen Raslavich, Chief Judge of the U.S. Bankruptcy Court for the Eastern District of Pennsylvania, issued another opinion on the issue, this time involving a "Steering Group of Pre-petition Lenders" in the In re Philadelphia Newspapers, LLC Chapter 11 bankruptcy case. After reviewing the analysis in each of the prior decisions from the Delaware, New York, and Texas courts, Chief Judge Raslavich held that Rule 2019 does not require such disclosure by the Steering Committee, essentially agreeing with the reasoning of Delaware Bankruptcy Judge Sontchi in the Six Flags case. Follow the link in this sentence for a copy of Chief Judge Raslavich's 28-page opinion in the Philadelphia Newspapers case.

More To Come? We have now had six opinions or orders on the Rule 2019 issue involving ad hoc committees or informal groups, with three judges holding disclosure is required (Northwest Airlines, Washington Mutual, and Accuride Corporation) and three holding it is not (Scotia Pacific, Six Flags, and Philadelphia Newspapers). Although the issue may gain more clarity on appeal or the question may be superseded by an amended version of Rule 2019, now under consideration by the Advisory Committee, in the meantime more courts will likely be asked to decide this thorny Rule 2019 issue. Given the split in authority -- with each judge finding that the "plain meaning" of Rule 2019 supports its view -- it has become even more difficult to predict how the next court will rule.

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.