Recent Developments in Bankruptcy Law

By Richard Levin of Jenner & Block

The bankruptcy courts and their appellate courts continue to explore issues of interest to practitioners and academics. This quarterly summary of recent developments in bankruptcy law covers cases reported during the second quarter of 2016.

Cases of note include the Supreme Court’s invalidation of Puerto Rico’s homegrown restructuring statute and its surprising conclusion that an individual debtor’s debt to his corporation’s creditor might be nondischargeable for “obtain[ing] money or property” by “actual fraud” where the corporation transferred away property in an actual fraudulent transfer.

The Second Circuit upset GM’s 2009 bankruptcy sale by granting some ignition switch plaintiffs an exemption from the free and clear ruling because they didn’t have a chance to participate in sale process negotiations. The debate over whether the Code’s financial contracts safe harbor preempts creditors’ claims under state fraudulent transfer laws continues with a Delaware decision ruling against preemption.

A Delaware bankruptcy court (following a recent Illinois decision) invalidated an LLC agreement provision that allowed a creditor to veto a bankruptcy filing. In a boost for litigation funding, a Florida bankruptcy court found that communications with the funder might be subject to the common interest privilege.

And in a decision that should send shudders down the spine of every consumer bankruptcy lawyer, the Ninth Circuit BAP held that a chapter 7 trustee may reject a debtor’s prepaid retainer agreement with his lawyer to defend dischargeability litigation and recover “unused” fees.

The full memo is available here.

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We at the Bankruptcy Roundtable will take a break from posting for the next few weeks in August and hope that you too will be able to get away from your desk at work.  We’ll be back after Labor Day.

Supreme Court Resolves Circuit Split on Actual Fraud

By Richard Lear of Holland & Knight.

The Supreme Court held 7-1 in Husky Int’l Electronics v. Ritz that “actual fraud” under § 523(a)(2)(A) of the Bankruptcy Code does not require a false representation for a debt to be nondischargeable. In so holding, the Court resolved a split among the circuits.

Petitioner Husky International Electronics, Inc., argued that “actual fraud” under § 523(a)(2)(A) does not require a false representation, but instead encompasses other traditional forms of fraud, such as a fraudulent conveyance of property made to evade payment to creditors.

Acknowledging that “fraud” is difficult to define precisely, the Supreme Court nevertheless rejected the need to do so, stating that “[t]here is no need to adopt a definition for all times and all circumstances here because, from the beginning of English bankruptcy practice, courts and legislatures have used the term ‘fraud’ to describe a debtor’s transfer of assets that, like Ritz’s scheme, impairs a creditor’s ability to collect the debt.” The Supreme Court further recognized that the common law indicates that although fraudulent conveyances are “fraud,” fraudulent conveyances do not require a misrepresentation from a debtor to a creditor, because fraudulent conveyances are not “an inducement-based fraud.”

The full memo is available here.

Bankruptcy Code Amendments Pass the House in Appropriations Bill

On July 7, the House of Representatives passed an appropriations bill (H.R. 5485) that includes a revised version of H.R. 2947, the Financial Institution Bankruptcy Act (FIBA), which passed the House by voice vote earlier this year. This bill, which the Roundtable has covered previously (here and here), would add to Chapter 11 of the Bankruptcy Code a “Subchapter V” to facilitate the bankruptcy resolution of troubled financial institutions. The inclusion of FIBA in the appropriations bill suggests there could be a substantial effort to pass the bankruptcy bill this year.

The version of FIBA included in the appropriations bill is largely the same as the bill that was introduced in the House last July. Importantly, however, the current version of the bill, which passed the House by voice vote this past spring, no longer allows the Board of Governors of the Federal Reserve System (the Board) to force a financial institution into bankruptcy. The role of federal regulators in the initiation and conduct of bankruptcy proceedings has been a controversial issue in debates about how to adapt the Bankruptcy Code to handle failed financial institutions more effectively. As included in the appropriations bill, FIBA permits only the debtor to file for bankruptcy. At the same time, the current bill would still provide for federal financial regulators, including the Board, to appear and be heard in any case under Subchapter V.

Although the bill aims to make bankruptcy feasible for large financial institutions, Subchapter V has been designed to facilitate a two-day, single-point-of-entry (SPOE) resolution strategy. FIBA’s proposed changes to the Bankruptcy Code would not support financial institutions during a lengthier path through bankruptcy. As the two-day bankruptcy resolution of a large, complex firm has no precedent, it is unclear whether the resolution strategy contemplated by Subchapter V would prove workable in practice. Thus, FIBA may not go as far as its proponents claim in making bankruptcy feasible for systemically important financial institutions (SIFIs).

H.R. 5485 is now in the Senate, which will consider it after the summer recess.

For a link to the full text of H.R. 5485, click here.

(This post was authored by Rebecca Green, J.D. ’17.)