Delaware Bankruptcy Litigation

The Second Largest Newspaper Publisher in the U.S., Affiliated Media, Files for Bankruptcy In Delaware

Jason Cornell, Esq. — Sun, 31 Jan 2010 20:35:25 -0500

On January 22nd, Affiliated Media, Inc. (the "Debtor" or "Affiliated"), filed a chapter 11 petition for bankruptcy in the United States Bankruptcy Court for the District of Delaware. According to documents filed with the Bankruptcy Court, the Debtor's operations include daily and weekly newspapers, "niche publications," internet websites, four radio stations and a television station in Alaska. Affiliated's bankruptcy follows a drop in revenue from $1.3 billion in 2007 to $1.06 billion in 2009. Advertising revenue, the largest component of Debtor's revenue, dropped 14% over the last year.

Prior to bankruptcy, Affiliated circulated a prepacked plan of reorganization and disclosure statement. Under the plan, Affiliated hopes to reduce approximately $930 million in debt down to $150 million. If all goes as planned, Affiliated plans to emerge from bankruptcy in a short amount of time "poised for future growth and stability." This bankruptcy proceeding is before the Honorable Kevin J. Carey, Chief Judge of the Delaware Bankruptcy Court. Judge Carey is also presiding over the Tribune bankruptcy, another major newspaper publisher seeking bankruptcy protection in Delaware.

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Jason Cornell is a bankruptcy attorney in the Wilmington, Delaware office of Fox Rothschild LLP. If you have questions regarding a Delaware bankruptcy proceeding, you may contact him at 302 427-5512, or jcornell@foxrothschild.com.

Fairfield Residential Files for Bankruptcy in Delaware and Begins Assumption of Certain Contracts and Leases

Jason Cornell, Esq. — Mon, 28 Dec 2009 20:15:35 -0500

Introduction

Fairfield Residential, one of the nation's largest developers of apartment communities, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on December 13, 2009. According to an affidavit filed by Fairfield's Chief Restructuring Officer (the "Affidavit"), the company employs approximately 2,000 individuals and operates in 40 real estate markets throughout the United States. (A copy of the Affidavit is available here). In the months leading up to bankruptcy, Fairfield listed assets of $958 million against liabilities of $835 million. These figures are down considerably compared to 2008 when Fairfield's assets were valued at $1.2 billion, against liabilities of $978 million.

Fairfield attributes its filing for bankruptcy to the "unprecedented collapse in the real estate and capital markets [which] have dramatically affected the Debtors." Like with many other developers, Fairfield relies on its ability to refinance or sell investments to generate capital. Capital markets began to tighten lending starting in the fourth quarter of 2008. With high concentrations of properties in California, Nevada and Florida, Fairfield also experienced loss in value of their properties. The drop in property values triggered defaults under various loans, in some cases releasing the lenders' obligations to fund payments to Fairfield. See Affidavit, pp. 19-20.

Objectives in Bankruptcy

As stated in Fairfield's Affidavit, the company hopes to win Court approval of a disclosure statement and plan of reorganization on an expedited basis. Pursuant to the proposed plan, a "New Fairfield" will be created that will assume certain executory contracts and operating liabilities of various rental properties. Those assets not transferred to the New Fairfield will be transferred to a liquidating trust that will liquidate the non-transferred assets for the benefit of unsecured creditors. See Affidavit, p. 29.

Fairfield has begun filing motions to assume executory contracts relating to its construction and development business. According to a recent motion to assume contracts, the company is required to assume certain contracts and agreements before January 27, 2010. (Read Fairfield's Twelfth Motion to Assume Executory Contracts and Leases here.)

This bankruptcy proceeding is before the Honorable Brendan L. Shannon.

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Jason Cornell is a bankruptcy attorney in Wilmington, Delaware with the law firm Fox Rothschild LLP. He may be reached at 302 427 5512, or jcornell@foxrothschild.com.

Grocery Retailer, Penn Traffic, Files for Bankruptcy With Hopes of Finding a Buyer

Jason Cornell, Esq. — Mon, 23 Nov 2009 20:57:17 -0500

Introduction

The Penn Traffic Company, the Syracuse, New York based grocery retailer, filed for Bankruptcy in Delaware on November 18, 2009. According to documents filed with the United States Bankruptcy Court for the District of Delaware, this is Penn Traffic's third time in bankruptcy within the last ten years. With annual revenues of $872 million, Penn Traffic is one of the largest food retailers in the Northeastern United States. Aside from operating 79 retail stores, Penn Traffic also provides transportation, warehousing, distribution and retail support for C&S Wholesale Grocers. (Click here to review a copy of Penn Traffic's Declaration filed in support of various bankruptcy motions).

Events Leading to Bankruptcy

Penn Traffic lists several reasons for its most recent bankruptcy filing. Like many debtors before it, Penn Traffic cites the "global economic downturn" as the leading cause if its financial difficulties. Despite the fact that the company cut costs by $6.2 million last year, Penn Traffic lost over $18.3 million in 2009 and $41.7 million in 2008. The company faces higher operational costs due to a continued decline in the number of customers that come in to its stores. Further, these customers are spending less per individual than in years past.

Besides the recession, Penn Traffic was also hit hard by litigation brought by the SEC in 2007. The SEC litigation followed a two year investigation of the company's accounting practices. In addition to the SEC civil litigation, the U.S. Attorney for the Southern District of New York brought criminal charges against certain officers of the company. These individuals were later terminated by Penn Traffic and a settlement in the civil action was reached almost a year ago. Even though the SEC litigation is over for the most part, Penn Traffic notes in its bankruptcy Declaration that "the effects of the significant legal and auditing costs continue to date."

Penn Traffic's Financials

Penn Traffic has two primary loans - a senior secured credit facility with a balance of $42 million and a supplemental real estate facility with a balance of $10 million. According to Penn Traffic's bankruptcy petition, the company's ten largest unsecured creditors include:

ABC Refrigeration ... $405,216
Coca Cola ... $343,102
Deli Boy Prov. Co. ... $326,623
EMC ... $183,846
G. Weston Bakeries ... $315,213
Karabus Management ... $437,328
Local 23 Health Fund ... $518,996
Nat'l Indus. Portfolio ... $344,183
New York State Fair ... $333,160
Stroehmann Bakeries ... $213,105

Objectives in Bankruptcy

The company sought, unsuccessfully, to find additional financing to help it reorganize. Through an agreement with its secured lenders, Penn Traffic is able to use cash collateral to fund its operations. However the continued use of cash collateral is contingent on the company seeking a sale under section 363 of the Bankruptcy Code. Without a sale, Penn Traffic believes it will have no choice but to close all 79 retail stores and 4 warehouses.

The United States Bankruptcy Court for the District of New Jersey, in a recent decision, spelled out the standard for a sale of a debtor's business outside the ordinary course of business. In re Congoleum Corp., 2007 WL 1428477 at 2 (Bankr.D. N.J. 2007). Under Congoleum, a debtor seeking to sell substantial assets must establish a "sound business purpose." Factors in support of a sound business purpose include: (i) a sound business reason; (ii) accurate and reasonable notice; (iii) adequate price; and, (iv) good faith. These factors will be relevant if Penn Traffic succeeds in finding a buyer for its assets.

This bankruptcy proceeding is before the Honorable Peter J. Walsh, a former Chief Judge of the United States Bankruptcy Court for the District of Delaware.

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Jason Cornell is a bankruptcy attorney in Wilmington, Delaware with the law firm Fox Rothschild LLP. If you have questions regarding a corporate bankruptcy matter, you may reach Jason at 302 427-5512 or jcornell@foxrothschild.com.

Manufactured Homebuilder, Champion Enterprises, Files for Bankruptcy Hoping to Find Buyer

Jason Cornell, Esq. — Wed, 18 Nov 2009 16:04:08 -0500

Introduction

On November 15, 2009, Champion Enterprises filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware. According to Champion's Declaration in Support of First Day Bankruptcy Motions (the "Declaration"), the company's bankruptcy is the result of an overall decline in the demand for manufactured housing and tightening of credit for potential home buyers. Based in Troy, Michigan, Champion manufacturers homes at 22 home building facilities in 13 states. At the time it filed for bankruptcy, Champion employed 1994 employees.

The Company's Financials

Champion lost $52 million in 2008, compared to a profit of $3.9 million in 2007. Sales dropped by 23% during this same time period. For the second quarter of 2009, Champion's revenues dropped over 55%, down to $129.5 million compared to $289 million in the second quarter of 2008. According to its Declaration, the company's debt structure is as follows:

Term loans of $45 and $59 million;
Letters of credit for $40 and $43 million; and,
Convertible unsecured notes of $180 million.

First Steps in Bankruptcy

Champion's Declaration summarizes the various first day motions it filed at the same time that it filed for bankruptcy. One of the more significant "first day motions" is a motion to approve debtor in possession financing to fund Champion's restructuring. According to the Declaration, Champion considered seeking debtor in possession ("DIP") financing from third parties, however, Champion's prepetition lenders (with liens on substantially all of Champion's assets) rejected certain proposals for alternative financing. Champion weighed the risks associated with litigating with its prepetition lenders over third party financing and instead decided to borrow from its prepetition lenders. Under the DIP financing motion, Champion seeks $32 million in a "new money loan."

During the months leading up to bankruptcy, Champion attempted to find a suitable buyer for the company. As of the petition date, Champion had not found a buyer, but hopes to do so under the sale provisions of the Bankruptcy Code. This bankruptcy proceeding is before the Honorable Kevin Gross. Click here to review the Chamber Procedures for Judge Gross.

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Jason Cornell is a bankruptcy attorney at the law firm Fox Rothschild LLP in Wilmington, Delaware. If you have questions regarding a Delaware bankruptcy proceeding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com.

Trustees in the Pope & Talbot and Specialty Motors Bankruptcies File Hundreds of Preference Actions

Jason Cornell, Esq. — Wed, 18 Nov 2009 14:48:10 -0500

The Chapter 7 Trustees in the Pope & Talbot and Specialty Motors bankruptcies recently filed hundreds of complaints in the United States Bankruptcy Court for the District of Delaware. George Miller is the Chapter 7 Trustee in the Pope & Talbot bankruptcy while Jeoffrey Burtch is the Trustee in the Specialty Motors (aka "Von Weise Inc.") bankruptcy. Both groups of complaints seek the avoidance and recovery of alleged preferential transfers from various creditors of the debtors.

The adversary actions filed in both Pope and Specialty Motors are before the Honorable Christopher S. Sontchi. In prior preference actions, Judge Sontchi entered scheduling orders similar to the form scheduling order attached here. A copy of Judge Sontchi's Chamber Procedures are attached here.

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Jason Cornell is a bankruptcy attorney at the law firm Fox Rothschild LLP in Wilmington, Delaware. If you have questions regarding a Delaware bankruptcy proceeding, you can reach Jason at 302 427 5512, or jcornell@foxrothschild.com.

Decision in S-Tran Holdings Bankruptcy Looks at When a Letter of Credit Constitutes Property of the Estate

Jason Cornell, Esq. — Sat, 24 Oct 2009 14:18:40 -0500

Introduction

Judge Kevin J. Carey, Chief Judge of the Delaware Bankruptcy Court, issued a decision recently in the S-Tran Holdings bankruptcy that addresses whether letters of credit constitute property of the bankruptcy estate. The Court's decision in S-Tran Holdings is worth review as letters of credit are a common part of a debtor's pre and post-petition financing. Recent decisions hold that certain components of letters of credit (such as the proceeds drawn from the letter of credit) are estate property, while other components (like the collateral pledged for the letter of credit) are not estate property. S-Tran explains why. (A copy of the decision in S-Tran is available here).

Background

The debtor in S-Tran sued its insurer in an effort to recover the proceeds from a letter of credit and a cash deposit, both held by the insurer. In order for the insurer to provide coverage to S-Tran, S-Tran had to provide a $477,000 cash deposit and letters of credit totaling $3.5 million. A week prior to S-Tran's bankruptcy filing, the debtor's insurer drew on portions of the letter of credit to pay third parties and placed the remaining proceeds from the letter of credit in a loss reserve account. After filing for bankruptcy, S-Tran demanded the insurer return the proceeds from the letters of credit, however, the insurer refused.

Whether Letter's of Credit are Property of the Estate

The Court in S-Tran did not have to look far for case law regarding the treatment of letters of credit in the bankruptcy context. In 2006, Judge Walsh issued an opinion in Oakwood Homes recognizing the "well established" rule that letters of credit, and the proceeds they generate, are not property of the estate. OHC Liquidation Trust v. Discover Re (In re Oakwood Homes Corp.), 342 B.R. 59, 67 (Bankr.D.Del. 2006). However, citing the Third Circuit, the court in Oakwood Homes also held that "the collateral pledged as a security interest for the letter of credit is [property of the estate]." Id., citing Int'l Fin. Corp. v. Kaiser Group Int'l Inc. (In re Kaiser Group Int'l Inc.) 399 F.3d 558, 566 (3d Cir. 2005)(citations omitted).

Applying Oakwood and Kaiser, the Court in S-Tran found that the issuers of the letters of credit paid S-Tran's insurer the proceeds of the letters of credit, which the insurer then used to pay third parties and create a reserve account. "Because the letter of credit proceeds were not paid with or secured by the Debtors' property, the fact that the proceeds were paid prior to the bankruptcy filing does not transform those entire proceeds into property of the estate." S-Tran Holdings, et al., v. Protective Insurance Company, at *8, Adv. No. 07-51341, Oct. 5, 2009 (Bankr. D.Del.).

Conclusion

Like the debtor in Oakwood Homes, S-Tran sought to recover the proceeds from the letter of credit under section 542 of the Bankruptcy Code alleging claims for turnover of estate property. However, like the court in Oakwood Homes, the Court in S-Tran held that section 542 is a remedy that is available only for debtors seeking to recover what is acknowledged to be estate property. Section 542 is not appropriate, however, if a debtor seeks to recover claims that remain unliquidated or in dispute. Although S-Tran might have a claim for excess letter of credit proceeds, the Debtor cannot recover such excess under section 542 until the amount of the claim has been liquidated.

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Jason Cornell is a bankruptcy attorney in Wilmington, Delaware with the law firm Fox Rothschild LLP. If you have questions regarding a Delaware bankruptcy proceeding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com.

Accuride Corporation Files for Bankruptcy in Delaware Hoping to Win Approval of Pre-Arranged Restructing Plan

Jason Cornell, Esq. — Sat, 17 Oct 2009 20:09:47 -0500

Introduction

Accuride Corporation, the Indiana-based manufacturer of heavy and medium-duty wheels, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on October 8, 2009. According to Accuride's Declaration in Support of First Day Motions, the company filed for bankruptcy in order to reduce its debt through confirmation of a pre-arranged restructuring plan. Specifically, Accuride seeks approval of a plan of reorganization that (i) extends the maturity date on its loans to 2013; (ii) cancels notes in exchange for 98% of the common stock of reorganized Accuride; (iii) offers new senior secured notes worth $140 million; and, (iv) provides current stockholders with 2% of the stock issued for reorganized Accuride.

Accuride's Business

Accuride and Accuride Canada were formed in 1986 for the purpose of acquiring all of the assets of a division of Firestone. Two years after formation, Phelps Dodge Corporation purchased Accuride. One year after Phelps' purchase, Kohlberg Kravis Roberts & Co. acquired a controlling interest in Accuride. As stated in Accuride's Bankruptcy Declaration, Accuride's stock originally traded on the New York Stock Exchange, however, it was subsequently delisted and now trades in the over-the-counter market.

The Company's Financials

In its Petition for Bankruptcy, Accuride lists its assets at $682 million, against liabilities of $847 million. Accuride's sales reached $1.4 billion in 2006, however, by 2008 sales were down to $931 million. The company's senior credit facility includes a term loan with a balance of $303 million and a revolving credit facility with a principal balance of $100 million. In addition to its credit facility, the company issued notes worth $275 million. According to Accuride's Petition for Bankruptcy, its ten largest unsecured trade creditors are as follows:

Matalco Inc. ... $1.1 million
Joseph Tryerson ... $804,609
Ryerson ... $791,756
Gallatin Steel ... $557,663
American Colloid ... $323,409
PrimeTrade Inc. ... $321,506
Anixter Fasteners ... $248,044
Foseco Metallurgical $236,594
Hydro Aluminum $230,801
B&B Metals Processing ... $228,683

Events Leading to Bankruptcy

Accuride is one of several auto parts suppliers that filed for bankruptcy in recent months. As with other parts manufacturers, Accuride attributes it bankruptcy filing to the global economic downturn. In its Bankruptcy Declaration, Accuride cites an industry publication that reports a drop in demand for trucking vehicles by 23% in the first half of 2007. Forecasts predict further declines for 2009. Given the poor economic outlook for the last three years, Accuride's stock price fell from $16.91 in 2007 to $.36 per share at the time it filed for bankruptcy.

This bankruptcy proceeding is before the Honorable Brendan L. Shannon.

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Jason Cornell is a bankruptcy attorney in Wilmington, Delaware with the law firm Fox Rothschild LLP. If you have questions regarding this bankruptcy, or any other Delaware bankruptcy proceeding, you can contact Jason at 302 427-5512, or jcornell@foxrothschild.com.

A Tale of Two Bankruptcy Auctions

Jason Cornell, Esq. — Sun, 04 Oct 2009 15:23:32 -0500

Introduction

In recent months, bankruptcy auctions went forward in two different bankruptcy proceedings that illustrate the extent to which auctions can vary both procedurally and substantively. One auction involved the sale of a single asset and lasted less than an hour, while the second auction involved the sale of the debtor's entire business and lasted over the course of several days. This post is intended to provide a brief "compare and contrast" of these two auctions in an effort to provide insight into a process that is a common component of corporate bankruptcies.

Two Different Auctions

For the sake of clarity, the auctions referenced in this post will be named "Short Auction" and "Long Auction," referring to time required to complete each auction. Short Auction was part of a chapter 11 bankruptcy of a multi-national corporation with assets valued in the hundreds of millions of dollars. Short Auction involved the sale of a large piece of commercial real estate, whereas Long Auction involved the sale of the debtor's entire business. The debtor selling assets in the Long Auction also filed under Chapter 11, however, its total assets were a fraction of the size of the debtor involved in the Short Auction.

Short Auction began at 8:00 in the morning at the Delaware offices of the debtor's attorney. Several parties were present at the auction, including representatives for the two bidders for the debtor's asset and counsel for the debtor. A court reporter was also present to make a record of the auction process. Long Auction, in contrast, started at 8:00 p.m. and included counsel for the creditors' committee, debtors and counsel for the bidders. In Short Auction, a successful bidder emerged within 30 minutes of the commencement of the auction. Long Auction, on the other hand, went late in the night and was adjourned for several days while bidders explored additional financing.

Take Aways from Both Auctions

Why was Short Auction short and Long Auction long? The answer is rather straight forward - Short Auction involved the sale of a small component of the debtor's overall business, whereas Long Auction sought to sell all of debtor's business. Further, the buyers in Short Auction came to the table with cash compared to the Long Auction that included credit bids and other contingencies that complicated the process.

In Short Auction, there was only one "break out session" where a bidder sought higher authority from a decision maker who was available by phone. Long Auction, on the other hand, had several break out sessions, some lasting close to an hour. The point of all this is that auctions in bankruptcy vary as to duration and result, however, at the end of the day parties will want to make sure the auction was fair and the result of arms-length negotiations (as was the case in both Short and Long Auctions). And although the debtor's decision to sell its assets outside the ordinary course of business fall under the broad discretion of the business judgment rule, the Bankruptcy Court will nevertheless scrutinize the successful bid to insure that it is in the best interest of the bankruptcy estate and the result of a good faith negotiations by the parties.

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Jason Cornell is a bankruptcy attorney in the Wilmington, Delaware office of Fox Rothschild LLP. If you have questions regarding a chapter 7 or 11 bankruptcy proceeding, you are welcome to contact Jason at 302 427-5512, or Jcornell@foxrothschild.com.

Samsonite Files for Bankruptcy and Plans to Reject Up to 84 Store Leases

Jason Cornell, Esq. — Thu, 17 Sep 2009 21:28:20 -0500

Samsonite Corporation, one of the world's largest luggage manufacturers, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on September 2, 2009. According to Samsonite's Declaration in Support of First Day Motions, the company "does not anticipate that any of its customers or suppliers will be materially affected by this [bankruptcy] filing." While this is good news for Samsonite's customers, the outcome for the company's landlords is less certain.

As stated in its Declaration, Samsonite leases 173 retail stores in 38 states. Due to a sudden drop in consumer demand for travel products, Samsonite experienced a significant reduction in its cash flow. As a result, the company engaged in a restructuring process that culminated in the filing of its bankruptcy petition in Delaware. Through bankruptcy, Samsonite intends to reject up to 84 leases for those stores the company deems unprofitable.

Landlords dealing with commercial tenants in bankruptcy face a host of issues, including administrative rent, rejection damages and adequate assurance. A previous post on this blog titled "Ten Things Every Commercial Landlord Should Know About a Tenant in Bankruptcy" provides a good introduction to the issues that confront a landlord when a commercial tenant files for bankruptcy. Judge Peter J. Walsh, a former Chief Judge of the Delaware Bankruptcy Court, recently issued an opinion in the Sportsman's Warehouse bankruptcy that provides a very helpful understanding of how bankruptcy courts approach claims for administrative rent and taxes that arise under a lease. Landlords in Samsonite may find Judge Walsh's decision particularly relevant as Judge Walsh is also the judge presiding over the Samsonite bankruptcy.

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Jason Cornell is a bankruptcy attorney with Fox Rothschild LLP in Wilmington, Delaware. If you have questions regarding this or any other Delaware bankruptcy proceeding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com.

Metal Manufacturer, Barzel Industries, Files Bankruptcy Seeking To Sell Majority of Assets

Jason Cornell, Esq. — Thu, 17 Sep 2009 19:51:46 -0500

Introduction

Barzel Industries, the Massachusetts-based metal manufacturer, filed for bankruptcy on September 14, 2009, in the United States Bankruptcy Court for the District of Delaware. One of the initial documents Barzel filed with the Bankruptcy Court is a Declaration in Support of First Day Pleadings (the "Declaration"). According to the Declaration, as of the petition date Barzel has 600 employees working at 15 different manufacturing and distribution facilities in the U.S. and Canada.

Events Leading to Bankruptcy

According to the Declaration, Barzel's bankruptcy was the result of operating losses that began in 2008 and continued in to 2009. Barzel ties its losses directly to the "current global economic recession and credit crisis, and the resulting dramatic downturn in the automotive, transportation, manufacturing and construction industries in the United States and Canada." These industries account for much of Barzel's business. Barzel's problems worsened following a drop in the price of steel. With prices and demand both down, Barzel sought to reduce expenses and improve its operations by closing 6 facilities and reducing its workforce by 350 employees.

Barzel's cost-cutting measures were not enough and in May of this year, the company missed an interest payment due on its Senior Secured Notes, two-thirds of which are held by JPMorgan Chase. With few options remaining, Barzel began looking for potential purchasers of the company. As a result of its marketing efforts, 72 parties executed confidentiality agreements and 12 made offers to pursue a purchase transaction.

On September 14, 2009, Barzel entered into an asset purchase agreement with Chriscott USA Inc. and 4513614 Canada. Under the APA, Barzel will sell substantially all of its assets for $65 million unless a better offer comes about through the bankruptcy auction process. Barzel's lenders have agreed to finance its bankruptcy proceeding through December 11, 2009, while Barzel completes the auction process.

According to Barzel's Bankruptcy Petition, its assets total $365 million against debts totaling $384 million. This bankruptcy is before the Honorable Christopher S. Sontchi.

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Jason Cornell is a bankruptcy attorney with Fox Rothschild LLP in Wilmington, Delaware. If you have questions regarding this or any other bankruptcy proceeding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com.

Whitehall Jewelers Files Over 90 Preference Actions in Delaware Bankruptcy Court

Jason Cornell, Esq. — Fri, 04 Sep 2009 22:23:13 -0500

Introduction

In June of last year, retailer Whitehall Jewelers filed for Bankruptcy in the United States Bankruptcy Court for the District of Delaware. Last month, 14 months after filing for bankruptcy, Whitehall filed over 90 adversary actions in Delaware seeking to recovery payments the company made to various creditors during the 90 days prior to its filing for bankruptcy.

Debtors in bankruptcy (or their assignee) routinely seek to recover what they allege are "avoidable transfers" from the creditors who received payments as the debtor slides into bankruptcy. While "ordinary course of business" and "new value" are core defenses frequently relied upon by defendants in a preference action, there are less common defenses that should not be overlooked.

This post will look briefly at the "mere conduit" defense. Although the mere conduit defense is not always available to certain creditors, it is helpful to have an understanding of how the mere conduit defense has been applied by bankruptcy courts in both the District of Delaware and other jurisdictions.

The Elements of a Preference Action

Congress provides a debtor in bankruptcy with a cause of action for preference payments pursuant to section 547(b) of the United States Bankruptcy Code. Under section 547(b), a debtor in bankruptcy may "avoid any transfer of an interest of the debtor in property (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor for such transfer was made; (3) made while the debtor was insolvent; (4) made (A) on or within 90 days before the date of the filing of the petition ..."

Mere Conduit Defense

Congress also provided parties who received alleged "preference payments" with several defenses. The "mere conduit" defense is set forth under section 550(a)(1) of the Bankruptcy Code and provides an exception to a debtor's ability to recover preferential transfers:

Except as otherwise provided in this section, to the extent a transfer is avoided under section ... 547 ... the [debtor] may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from -

(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made ...

Application of the Mere Conduit Defense

Courts deciding whether to apply the mere conduit defense look to whether the defendant who allegedly received the preferential transfers had "dominion and control" over the payments. U.S. Interactive v. Sampson Travel Agency (In re U.S. Interactive), 321 B.R. 388, 395 (Bankr. D. Del. 2005). For a defendant to establish the mere conduit defense, it must show that the payments received from the debtor "merely slipped through his hands to another party." Id., citing Bailey v. Big Sky Motors, Ltd. (in re Ogden), 314 F.3d 1190, 1196 (10th Cir. 2002); see also, Christy v. Alexander & Alexander of New York Inc., (In re Finley, et al.), 130 F.3d 52, 58 (2d Cir. 1997). If the defendant had the right to put the money to its use as it saw appropriate, the mere conduit defense does not apply. Official Comm. of Unsecured Creditors v. Guardian Ins. 401 (In re Parcel Consultants, Inc.), 287 B.R. 41, 46 (Bankr. D. N.J. 2002).

In U.S. Interactive, the court found that the defendant, a travel agent, did not satisfy the mere conduit defense because the defendant was able to deposit the funds into its own checking account and do with the money as it saw fit. Instead, what is required to satisfy the mere conduit defense is evidence that the initial recipient of the payments lacked the power to decide who to pay with the funds. The decision in U.S. Interactive suggests that if the initial recipient of the money received from the debtor is required to deposit the funds in a separate account (versus its general operating account), and those funds are subsequently forwarded to a third party, the defense may apply.

Conclusion

Clearly, the mere conduit defense has limited application to parties who are defending a preference action. However, for those defendants whose circumstances show they lacked "dominion and control" over the payments, and instead forwarded the payments to a third party, the defense can be a valuable tool in reducing or eliminating exposure in a preference action.

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Jason Cornell is an attorney who practices in Fox Rothschild's Wilmington, Delaware office. If you have questions regarding this, or any other bankruptcy matter, you may contact Jason directly at 302 427-5512, or jcornell@foxrothschild.com. Please be advised that Fox Rothschild LLP does not represent Whitehall Jewelers in this bankruptcy proceeding. Click here if you would like to read other posts on this blog regarding issues that arise in preference litigation.

Payment Processor, Cynergy Data, Files for Bankruptcy Seeking to Sell Substantially All of its Assets

Jason Cornell, Esq. — Wed, 02 Sep 2009 21:32:08 -0500

Introduction

Less than two years after its formation, credit card processor, Cynergy Data, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware. According to Cynergy's Declaration in Support of Chapter 11 Petitions and First Day Motions, the company processes over $10 billion in credit payments over a twelve month period. Cynergy's card volume is the result of transactions with over 80,000 merchants.

Cynergy filed for bankruptcy in order to receive bankruptcy court approval of the sale of substantially all of its assets to the ComVest Group under section 363 of the United States Bankruptcy Code. Cynergy and ComVest entered into an asset purchase agreement following an auction process wherein Cynergy contacted over 48 different parties that might have an interest in purchasing its assets. In response to its marketing efforts, 24 parties executed confidentiality agreements allowing them to review Cynergy's books and records in order to submit a bid. Three final offers were submitted and ComVest and Cynergy executed an asset purchase agreement on August 26, 2009.

Sale Process

At the same time that it filed for bankruptcy, Cynergy also filed a motion approving bid procedures and the sale of substantially all of its assets. Included in the sale motion are procedures to designate those contracts that will be assumed and assigned under the asset purchase agreement. Cynergy proposes sending "Cure Notices" which will identify the contracts to be assigned, as well as the cure amount for any defaults, as provided for under section 365 of the Bankruptcy Code. The sale motion also spells out how parties can file objections to the Cure Notice.

Creditors whose contracts are assumed and assigned to the purchaser of Cynergy's assets may stand in a substantially better position than those creditors whose contracts or leases are not assumed and assigned. Under section 365 of the Bankruptcy Code, a debtor in bankruptcy must "cure" defaults under a contract , or provide adequate assurance that the debtor will promptly cure, before the contract can be assumed and assigned to a third party.

Cynergy's Financials

According to Cynergy's Petition for Bankruptcy, the company has assets of $109 million against debts of $186 million. As stated in the Declaration, Cynergy entered into a senior credit facility for $39.8 million with Comerica Bank as agent, and a junior credit facility for $80 million with Dymas Funding Company as agent (both credit agreements are prepetition). The company lists its 10 largest unsecured creditors as follows:

Process America ... $2.8 million
Paymentech ... $2.6 million
TSYS ... $1.4 million
wwwmygrantsitenet ... $1.4 million
Second Source ... $1.1 million
DJM*Lifstylefit.com ... $900,764
wwwfedgrantusa.com ... $812,629
Merchant Processing Services ... $756,782
Pivotal Payments ... $509,068
Fast Transact ... $503,110

This bankruptcy proceeding is before the Honorable Kevin Gross.

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Jason Cornell is a bankruptcy attorney in the Wilmington, Delaware office of Fox Rothschild LLP. If you have questions regarding this or any other Delaware bankruptcy proceding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com. Fox Rothschild LLP does not represent Cynergy Data LLC in this bankruptcy proceeding.

Freedom Communications Files for Bankruptcy in Delaware Following Decline in Advertising Revenue

Jason Cornell, Esq. — Wed, 02 Sep 2009 19:47:13 -0500

Introduction

Freedom Communications Holdings, the Orange County, California newspaper publisher, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on September 1, 2009. (You can review a copy of Freedom's Petition for Bankruptcy here.) According to the Declaration of Freedom's Chief Financial Officer, the company's decision to file for bankruptcy was based on several factors, most notably the continual decline of advertising revenues in the newspaper industry and increased competition in web-based advertising.

In September of 2008, Freedom defaulted under is prepetition credit agreement with its lenders. Although the lenders agreed to several loan amendments, Freedom eventually realized that an out-of-court workout would not resolve its financial problems. Besides declining ad revenue, Freedom's finances were further weakened by the settlement of a class action brought by various newspaper carriers. Pursuant to the terms of the class action settlement, Freedom was obligated to pay over $28 million into an escrow account to fund the settlement. The terms of the settlement agreement provided that the class action settlement would not become final until September 14, 2009. By filing for bankruptcy before September 14th, Freedom contends that the "settlement funds have become property of the chapter 11 estate and, therefore, are subject to immediate return to the [company]." (More information regarding the reasons behind Freedom's decision to file for bankruptcy are available in Freedom's Declaration in Support of Chapter 11 Petitions and First Day Pleadings)

Debtor's Operations

Freedom Communications' origins go back to 1935 when R.C. Hoiles purchased The Orange County Register. From its beginnings through 2000, the company purchased newspapers and other publications in the states of Arizona, California, Colorado, Florida, Illinois, Indiana, Missouri, New Mexico, North Carolina, Ohio and Texas. According to Freedom's Declaration, as of its petition date, the company owns 90 daily or weekly publications and 30 daily newspapers. In addition to print publications, Freedom also owns eight television stations, most of which are either ABC or CBS affiliates. Including contractors, Freedom employs over 8,200 individuals.

Debtor's Financials

Freedom lists its assets with a book value of $757 million, against liabilities totaling over $1 billion. Included in Freedom's debt is its credit agreement of approximately $770 million. The remaining $306 million in liabilities includes trade claims, contract claims, lease claims, non qualified retirement plan claims and litigation claims. According to Freedom's Petition for Bankruptcy, the company's ten largest unsecured creditors include:

JP Morgan (unsecured loan) ... $770 million
Class Action Plaintiffs ... $28.9 million
Kingworld Productions, Inc. ... $1.5 million
North Pacific Paper ... $1.2 million
Bowater America, Inc. ... $753,326
Inland Empire Paper ... $590,502
SP Newsprint Co. ... $548,151
Vertis Inc. ... $381,416
Impression Inks West ... $374,591
Abitibi Consolidated Sales ... $356,630

Conclusion

This bankruptcy proceeding is before the Honorable Brendan L. Shannon. There has been substantial activity in this case within the first 24 hours of the petition date. Included among the company's "first day" bankruptcy motions is a motion to pay certain critical vendors, a motion seeking administrative claim status of postpetition goods and a motion to establish procedures for the rejection of executory contracts and leases. (To read a prior post on issues relevant to lease rejection, click here).

Many debtors file for bankruptcy in an effort to sell-off assets under the protection of section 363 of the United States Bankruptcy Code. Freedom states in its Declaration that it filed for bankruptcy in order to restructure its debt under a plan of reorganization. To that end, the company intends to file a disclosure statement and plan of reorganization within 45 days from the date it filed for bankruptcy.

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Jason Cornell is a bankruptcy attorney who practices in Wilmington, Delaware with Fox Rothschild LLP. If you have questions regarding this or any other Delaware bankruptcy proceeding, you may contact Jason at 302 427-5512, or jcornell@foxrothschild.com. Fox Rothschild LLP does not represent Freedom Communications Holdings in this bankruptcy proceeding.

Auto Parts Manufacturer, Proliance International, Files for Bankruptcy 18 Months After a Tornado Destroys Distribution Facility

Jason Cornell, Esq. — Mon, 10 Aug 2009 21:33:20 -0500

Introduction

Proliance International ("Proliance" or "Debtor"), an automotive heating and cooling parts manufacturer, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on July 12, 2009. The Debtor is represented by Jones Day of New York. This bankruptcy proceeding is before the Honorable Christopher S. Sontchi of the Delaware Bankruptcy Court. A review of the docket shows that the Court recently entered several of the Debtor's "first day motions" including a motion allowing the Debtor to honor certain pre-bankruptcy obligations and customer programs. The United States Trustee has scheduled a meeting of creditors for August 14, 2009 at 4:00 p.m. (click here to read a prior post on section 341 meeting of creditors).

Debtor's Business

According to Proliance's Declaration in Support of First Day Motions (the "Declaration"), the company's origins go back to 1915 when it began manufacturing radiators for automobiles and fire engines. Proliance today is the product of a merger between Transpro Inc. and Modine Aftermarket Holdings, Inc.. There are two primary component's to the Debtor's business - domestic and international operations.

On February 5, 2008, a tornado destroyed Proliance's domestic distribution center in Southaven, Mississippi. The tornadoes ruined a substantial portion of Proliance's auto and truck heat exchange inventory. With the loss of this inventory, Proliance encountered "severe liquidity constraints" which the company views as "one of the major precipitating factors for these cases." See Debtors' Declaration at p. 5.

Debtor's Financials

Within the U.S., Proliance is one of the largest manufacturers of heat exchange products. The company list net sales for 2008 of $350 million. According to the Declaration, sales for 2008 were down 11.1% when compared to 2007. The Debtor attributes most of its drop in sales in 2008 to the destruction of its Mississippi distribution center.

In 2007, Proliance entered into a prepetition credit agreement with Silver Point Finance as administrative agent and collateral agent for the prepetition lenders. Although the prepetition credit facility provides up to $100 million in debt, going into bankruptcy the company owed $33.6 million under a term loan and $6.5 million under a revolving loan facility.

The Debtor estimates its trade debt totals $51.7 million. This amount includes moneys owed to both domestic and foreign vendors. According to Proliance's Bankruptcy Petition, its ten largest unsecured creditors include the following:

Enterex Industrial ... $17.1 million
Transtec Global ... $11.8 million
U&C Auto Parts ... $2.6 million
Alcoa Mill Products ... $1.8 million
Luvata Netherlands ... $1.3 million
Foshan Guang Dong Automotive ... $1.2 million
President Automotive Industries ... $1.2 million
Lumei Auto Radiator ... $1.1 million
Sapa/Norca Heat Transfer ... $918,685
Tianjin Xinyue Auto Part Co. ...$878,026

The company lists total assets of $160 million against debts totaling $133 million.

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Jason Cornell is a bankruptcy attorney with the law firm Fox Rothschild LLP in Wilmington, Delaware. If you have questions regarding this or any other Delaware legal proceeding, you may contact Jason at (302) 427-5512 or jcornell@foxrothschild.com.

A Closer Look at the Cooper-Standard Automotive Bankruptcy

Jason Cornell, Esq. — Tue, 04 Aug 2009 20:50:12 -0500

Introduction

With over $1.1 billion in debt, Cooper-Standard Automotive filed for bankruptcy on August 3, 2009 in the United States Bankruptcy Court for the District of Delaware. Based in Novi, Michigan, Cooper labels itself "a leading global manufacturer of fluid handling, body sealing, and noise, vibration and harshness control components ... for use in passenger vehicles." (See Cooper's Declaration in Support of Chapter 11 Petitions).

Like with many of the "mega" bankruptcy cases filed in Delaware, Cooper filed several "first day" motions contemporaneous with filing its bankruptcy petition (you can read Cooper's Voluntary Petition for Bankruptcy here). Through its first day motions, Cooper seeks authority from the Bankruptcy Court to allow it to incur $200 million in bankruptcy financing. In order to insure continued operations at Cooper's seventy-eight manufacturing and design centers worldwide, Cooper also filed a motion seeking authority to pay employee wage and benefit obligations. Certain vendors of Cooper will benefit from the company's motion to pay the pre-bankruptcy claims of vendors, shippers and other suppliers.

The Debtors' Financials

According to Cooper's Petition for Bankruptcy, the company's ten largest unsecured creditors are as follows:

Senior Subordinated Notes Due 2014 ... $313 million;
Senior Notes Due 2012 ... $200 million
State of Ohio EPA ... $2.7 million
Robert Bosch LLC ... $713,782
Gil-Mar Manufacturing ... $477,815
Summit Metals ... $449,326
EMS Chemie NA ... $448,778
Evonik Degussa Corp. ... $437,456
TSM Corporation ... $395,688
Premier Tool & Die ... $375,451

According to its Declaration, Cooper's earnings (not sales) in 2008 were $218 million, an 8% drop compared to 2007 earnings of $285 million. The company admits in court papers that the drop in production in the auto industry left Cooper "overleveraged." Cooper initially sought to restructure outside of bankruptcy. In the year prior to bankruptcy, Cooper reduced its workforce by 1,300 salaried employees. To reduce its debt load, Cooper hired Lazard to assist in negotiations with its lenders. Cooper's lenders agreed to a forbearance agreement in July and extended the agreement through August 14, 2009. During these negotiations, Cooper and its lenders agreed to enter into debtor in possession financing whereby the lenders agreed to provide a "superpriority senior secured postpetition credit facility."

Corporate History

This bankruptcy proceeding is filed under the caption "Cooper-Standard Holdings, Inc., et. al." As stated in the Declaration, CSA Acquisition Corp. was formed in 2004 as a Delaware corporation through a joint venture between The Cypress Group LLC and Goldman Sachs. CSA Acquisition then entered into a stock purchase agreement with Cooper Tire & Rubber Company and Cooper Tyre & Rubber Company UK Limited. The venture purchased Cooper for $1.165 billion in cash.

This bankruptcy proceeding is before the Honorable Peter J. Walsh, former Chief Judge of the Delaware Bankruptcy Court.

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Jason Cornell is a bankruptcy attorney at the law firm Fox Rothschild LLP in Wilmington, Delaware. If you have questions regarding this, or any other Delaware bankruptcy proceeding, you may contact Jason at (302) 427-5512 or jcornell@foxrothschild.com.

Creditors Committee in American Home Mortgage Bankruptcy Files Over 90 Preference Actions

Jason Cornell, Esq. — Sat, 01 Aug 2009 22:51:10 -0500

Introduction

Earlier this month, the Official Committee of Unsecured Creditors (the "Committee") for American Home Mortgage ("AMH") filed over ninety (90) adversary actions (review one of the Committee's Complaints here). As reflected in the Complaint, the Committee alleges that various creditors of AMH received preferential and/or fraudulent transfers pursuant to 11 U.S.C. sections 547, 548, 550 and 551.

Procedural Posture of These Cases

At the time of this posting, the Committee had not filed the summonses which would contain information regarding service of process and the initial pretrial conference scheduled by the Court. Approximately three weeks before filing the preference actions, the Committee sent out demand letters to those parties who its claimed received avoidable preferences during the ninety days prior to AMH's petition date.

AMH filed for bankruptcy on August 6, 2007. Therefore, the Committee has until early August to file the adversary actions in order to satisfy the statute of limitations. Although preference actions are often filed by a debtor, the Committee was assigned the right to pursue AMH's preference claims pursuant to the Amended Chapter 11 Plan of Liquidations filed by AMH on November 25, 2008.

These adversary actions are before the Honorable Christopher S. Sontchi of the United States Bankruptcy Court for the District of Delaware. For prior posts on this blog regarding issues that arise in preference actions, click here. To read a post regarding a recent decision by Judge Sontchi in the American Home Mortgage bankruptcy, click here.

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Jason Cornell is a bankruptcy attorney at the law firm Fox Rothschild LLP in Wilmington, Delaware. If you have questions regarding this or any other Delaware bankruptcy proceeding, you may contact Jason at (302) 427-5512 or jcornell@foxrothschild.com.

Direct Satellite TV Provider, ProtoStar, Files for Bankruptcy Following Defaults on Loan Agreements

Jason Cornell, Esq. — Sat, 01 Aug 2009 21:43:36 -0500

Introduction

ProtoStar Ltd. ("ProtoStar"), a satellite operator that provides television and internet access throughout Asia, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on June 29, 2009. As reflected in ProtoStar's Declaration in Support of First Day Bankruptcy Motions, the company's satellites provide "direct-to-home" satellite television and internet connectivity to billions of users throughout India, Indonesia, Taiwan, the Philippines and Southeast Asia. Starting in 2008, ProtoStar launched two satellites into orbit - the PS I and PS II Satellites.

Events Leading to Bankruptcy

The ProtoStar I satellite originally provided satellite services to Agrani Satellite Services Limited ("Agrani"). According to ProtoStar's Declaration, on April 1, 2009, Agrani sent a notice to ProtoStar claiming to terminate the parties' Satellite Capacity Agreement originally entered by the parties in November of 2007. Two days later, ProtoStar received a termination notice from the Intersputnik International Organization of Space Communications ("Intersputnik"), the organization that provided ProtoStar with its orbital rights pursuant to a sponsorship from the Republic of Belarus. Like the Agrani termination notice, ProtoStar challenges the validity of the Intersputnik termination notice.

On April 17, 2009, two weeks after receiving the termination notice from Intersputnik, ProtoStar received a notice of default from the agent for one of its prepetition lenders. During this same time period, the company failed to make interest payments due on its secured notes.

Debtors' Financials

ProtoStar's revenues for 2008 totaled $3.1 million. According to its petition for bankruptcy, the company's ten largest trade creditors include:

Philippine Telephone Co. ... $27.5 million
Agrani Satellite Services Ltd. ... $8.1 million
ILS International Launch Services ... $5.7 million
Boeing Satellite Systems ... $5.5 million
PT Media Citra Indostar ... $5.0 million
Arianespace ... $4.0 million
Space Systems/Loral ... $3.6 million
Integral Systems ... $2.4 million
SingTel ... $1.0 million
Aon Risk Services ... $348,287

(Read ProtoStar's List of 20 Largest Unsecured Claims here).

ProtoStar and the Bank of New York Mellon entered into a prepetition loan facility in March 2007 with a principal balance of $10 million. According to the Declaration, the company issued $160 million in senior secured convertible notes that are due in 2012. Finally, in March 2008 ProtoStar entered into a loan agreement with Credit Suisse. As of the date the company filed for bankruptcy, the Credit Suisse loan had a principal amount outstanding of $240 million.

First Steps in Bankruptcy

The company filed several "first day" motions seeking relief from the Delaware Bankruptcy Court so that it may transition into a debtor in possession. Among these motions, ProtoStar seeks an order appointing a claims agent and an order approving an "Essential Vendors Motion." Under the Vendor Motion, ProtoStar seeks to pay certain prepetition claims of vendors the company believes provides "essential goods and services." In addition to these motions, ProtoStar seeks approval of debtor in possession financing totaling $16 million.

This bankruptcy proceeding is before the Honorable Mary F. Walrath, former Chief Judge of the United States Bankruptcy Court for the District of Delaware.

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JL French Automotive Castings Files for Bankruptcy Three Months After the Close of its 2006 Bankruptcy

Jason Cornell, Esq. — Mon, 27 Jul 2009 22:01:36 -0500

Introduction

JL French Automotive ("JLF"), the Wisconsin-based automotive supplier, filed for bankruptcy on July 13, 2009. JLF filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware. According to the Declaration in Support of First Day Motions (the "Declaration"), JLF previously filed for bankruptcy in Delaware in February of 2006. On April 17, 2009, less than three months before JLF commenced its current bankruptcy proceeding, the Delaware Bankruptcy Court entered final orders closing the bankruptcy proceeding that began in 2006.

JLF's Business

As stated in its Declaration, JLF designs and produces high pressure, aluminum die-castings. JLF began as a family-owned business in 1968, manufacturing die-castings at its facility in Sheboygan, Wisconsin. Eventually, JLF opened a second manufacuturing facility in Wisconsin and a third facility in Kentucky. With the expansion of its operations, JLF's product offering grew to include engine blocks, oil pans, transmission cases, engine covers, bedplates and cam covers.

In addition to manufacturing automotive parts, JLF operates an aluminum smelting facility which provides JLF with aluminum needed for its die-casting operations. In order to meet expected production capacity, JLF made significant investments in aluminum separation and shredding equipment. JLF invested in the new equipment to meet its own aluminum requirements, as well as provide aluminum to third party manufacturers.

Events Leading to Bankruptcy

Like the auto part suppliers that filed for bankruptcy before it, JLF's revenues are closely tied to the auto industry. According to its Declaration, 95% of JLF's revenue comes from four customers: Ford, GM, Chrysler and Magna International. JLF designs its products for a particular auto manufacturer's vehicle. To tailor its products to one manufacturer's design requires JLF to make substantial investments years prior to production.

In papers filed with the Bankruptcy Court, JLF cites forecasts for the auto industry predicting vehicle sales in 2009 to drop to 4.2 million vehicles, representing a 44% drop in production compared to 2008, and a 55% drop compared to 2007. JLF made considerable investment in die-casting and smelting equipment in the years leading up to the present recession assuming its production would grow. Instead, the company is faced with drops in revenue that leave JLF unable to satisfy its debt obligations (JLF's secured debt at the time it filed for bankruptcy totals $264 million).

Conclusion

Days prior to filing for bankruptcy, JLF entered into a "Restructuring Lock-up Agreement" with its first and second lien lenders. Under the agreement, JLF intends to convert the lenders' debt to equity in the reorganized company. JLF intends to file its plan and disclosure statement soon after the commencement of its bankruptcy. This proceeding is before the Honorable Kevin Gross.

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Diabetes Supply Company, Chronic Care Solutions, Files for Bankruptcy in Delaware

Jason Cornell, Esq. — Sun, 12 Jul 2009 19:58:07 -0500

Introduction

CCS Medical Holdings ("CCS" or the "Debtor"), the parent of Chronic Care Solutions, KeyMed, TotalCare Wholesale, and other diabetes and chronic care suppliers, filed for bankruptcy on July 8, 2009. CCS filed its bankruptcy petition in the United States Bankruptcy Court for the District of Delaware. According to CCS's Declaration in Support of its First Day Pleadings (the "Declaration"), CCS provides testing and insulin pump supplies to diabetes patients. Besides diabetes equipment and supplies, CCS also sells urology, wound and respiratory care equipment.

Going into bankruptcy, CCS has 1,600 employees, most of whom work in CCS's call centers addressing the needs of the Debtor's 400,000 patient-customers. CCS's operations include patient enrollment, patient support, shipping and billing. Based in Clearwater, Florida, CCS operates distribution centers in Florida, Virgnia, California, Colorado, Georgia and Texas. Besides its distribution centers, CCS operates 37 offices in 17 states.

First Steps in Bankruptcy

Nine days after filing for bankruptcy, CCS filed its proposed disclosure statement and plan of reorganization. According to its Declaration, the terms of the CCS plan is "supported by over 70% in amount of the outstanding obligations under the First Lien Credit Agreement." Further, Debtors contend that the "purpose of the plan is to provide for the restructuring of the Debtors' liabilities in a manner designed to maximize recovery to all stakeholders and to enhance the financial viability of the Debtors upon emergence from chapter 11."

Conclusion

CCS's prepetition debt totals $519 million, $329 million of which arises from a first lien revolver and term loan originated in September of 2005. The company attributes its bankruptcy to lower than expected earnings that arose, in part, from reductions in Medicare reimbursement rates.

This bankruptcy proceeding is before the Honorable Christopher S. Sontchi.

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Decision in Spansion Finds That Debtors Did Not Demonstrate Sound Business Judgment in Settlement of Patent Litigation

Jason Cornell, Esq. — Fri, 10 Jul 2009 22:30:19 -0500

Introduction

On June 2, 2009, Judge Kevin J. Carey, Chief Judge of the United States Bankruptcy Court for the District of Delaware, issued an opinion in the Spansion bankruptcy finding that the Debtors' settlement of various patent cases was not the result of the "sound exercise of the Debtors' business judgment." Judge Carey's decision in Spansion is helpful as it provides analysis of what is required in order for a debtor to meet its burden when seeking bankruptcy court approval of a settlement.

Background

Spansion filed for bankruptcy on March 1, 2009. Approximately two weeks after filing for bankruptcy, Spansion entered into a settlement agreement with Samsung Electronics Co. settling two patent infringement cases commenced by Spansion and settling one patent infringement case commenced by Samsung against Spansion. Pursuant to the parties' settlement agreement, Samsung agreed to pay Spansion $70 million.

Spansion sought approval of the settlement agreement pursuant to Fed.R.Bankr.P. 9019. In response to Spansion's settlement motion, an ad hoc consortium of senior secured noteholders (the "Noteholders") filed an objection listing various reasons why the Court should not approve the settlement. After conducting an evidentiary hearing, the Court issued its opinion.

Arguments For and Against the Settlement

Spansion argued that the Court should approve the settlement as it (i) was the product of good faith negotiations; (ii) allowed Spansion to avoid costly and time consuming litigation; (iii) allowed Spansion to avoid naming customers in the patent litigation, potentially harming these relationships; and, (iv) provided Spansion with cash now, instead of waiting years to potentially recover through litigation.

In opposing the settlement, the Noteholders argued that the settlement was both structurally flawed and lacked sufficient information in order for the Noteholders to determine if the settlement amount was fair. Regarding the structural flaws, the Noteholders argued that the settlement provided unbalanced rights to the parties.

Court's Analysis

The Court began its analysis by noting that under Key3Media Group, settlements under Fed.R.Bankr.P. 9019 are subject to the sound discretion of the Court. Key3Media Group, Inc., v. Pulver.com, Inc. (In re Key3Media Group, Inc.), 336 B.R. 87, 92 (Bankr. D. Del. 2005). Further, the role of the bankruptcy court in reviewing a 9019 motion is to determine whether "the compromise is fair, reasonable and in best interests of the estate." In re TSIC, Inc., 393 B.R. 71, 78 (Bankr. D. Del. 2008). In order to make its determination, the Court applied the Third Circuit's analysis in Myers v. Martin (In re Martin), 91 F.3d 389, 393 (3d Cir. 1996). Under Martin, courts should consider the following factors in deciding whether a settlement is in the best interest of the estate:

Probability of success in the underlying litigation;
Difficulties in collection;
Complexity of the litigation involved, including the expense, inconvenience and delay arising from the litigation; and,
Interest of the creditors.

Before applying the factors provided under Martin, the Court noted that it does not have to be convinced that the "settlement is the best possible compromise." Instead, the Court must decide whether the settlement "is within the reasonable range of litigation possibilities," citing In re World Health Alternatives, Inc., 34 B.R. 291, 296 (Bankr. D. Del. 2006). Further, Debtors carry the burden of persuading the Court that the settlement falls within the reasonable range of settlement possibilities.

Starting with the first prong of the Martin analysis (probability of success on the merits), the Court noted that its task is to consider the issues presented in the underlying patent litigation and determine whether Spansion's settlement with Samsung "falls below the lowest point in the range of reasonableness." The Court found that Spansion had not satisfied the "merits prong" of Martin as evidence presented during the hearing showed that Spansion entered the settlement in order to "negotiate a quick settlement," instead of considering the settlement by evaluating the merits of the patent cases.

Turning to the second prong under Martin, difficulties in collection, the Court found that Spansion provided no evidence to suggest that Spansion might have trouble collecting a judgment against Samsung.

The third prong of the Court's Martin analysis looked at the complexity of the litigation involved, including the costs and inconvenience caused by the delay. Citing Nutraquest, the Court recognized that settlements almost always reduce the "complexity and inconvenience of litigation." Will v. Northwestern Univ. (In re Nutraquest, Inc.), 434 F.3d 639, 645 (3d Cir. 2006). What is required, however, is a comparison of the complexity of the underlying litigation to the likelihood of success. Since the Court found Spansion had not presented evidence sufficient to consider a "likelihood of success," the Court could not determine whether the settlement is better than the expense and inconvenience caused by the continuation of the litigation.

Finally, the Court considered under Martin the "paramount interest of creditors." Here, the Court found that the Noteholders "vigorously opposed the settlement agreement." Further, evidence presented at the evidentiary hearing demonstrated that Spansion did not have sufficient information to determine the reasonableness of the patent litigation settlement.

Conclusion

The Spansion decision provides guidance for what is required for a debtor to obtain approval of a litigation settlement. Here, the Court found it significant that the settlement agreement contained a "perpetual license to Samsung of the Debtor's future patents." The Court agreed with the Noteholders that the settlement lacked mutuality between the parties - the agreement appeared to provide more favorable terms to Samsung than Spansion. The decision does not suggest that settlement agreements must always contain mutual releases between the parties. Instead, debtors should be prepared to present evidence demonstrating why the settlement is in the best interests of the creditors and that a reasonable determination was made by the debtor that the proposed settlement is preferable to continued litigation expense and delay.