Texas Supreme Court Resolves Good Faith Value Defense Issue For Fifth Circuit

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By Michael L. Cook, Schulte Roth & Zabel LLP

The Uniform Fraudulent Transfer Act (“UFTA”) (§ 8(a)), like Bankruptcy Code 548(c), provides a complete defense for a “good faith” transferee who gives “reasonably equivalent value” when receiving cash from a fraudulent debtor. Courts have been split as to whether the good faith defense is available to transferees of Ponzi scheme debtors in the fraudulent transfer context. Thus, the Fifth Circuit held an advertising firm in an SEC receiver’s Texas fraudulent transfer suit liable for $5.9 million it had received in good faith from a Ponzi scheme debtor. Janvey v. Golf Channel Inc., 780 F.3d 641, 646-47 (5th Cir. 2015 (advertising services had “no value” to Ponzi scheme creditors although services might be “quite valuable” to creditors of a legitimate business; reversed district court’s holding that defendant “looks more like an innocent trade creditor than a salesman…extending [debtor’s] Ponzi scheme.”)

The Fifth Circuit vacated its decision three months later and certified the question of “what showing of ‘value’ under [the Texas version of the [UFTA]] is sufficient for a transferee to prove…the [good-faith] affirmative defense….” 2016 WL 1268188, at *2. The Texas Supreme Court answered the question on April 1, 2016, after discussing the statutory purpose and reviewing what other federal and state courts have done. According to the court, the UFTA “does not contain separate standards for accessing ‘value’ and ‘reasonably equivalent value’ based on whether the debtor was operating a Ponzi scheme…. Value must be determined objectively at the time of the transfer and in relation to the individual exchange at hand rather than viewed in the context of the debtor’s enterprise.”

The full memo is available here: Texas Supreme Court Resolves Good Faith Defense Issue for Fifth Circuit

Third Circuit holds Sec. 1113 of the Bankruptcy Code applicable to already-expired CBAs

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By Mark A. Salzberg and Jill S. Kirila of Squire Patton Boggs

The Bankruptcy Code prohibits a debtor from unilaterally rejecting a collective bargaining agreement (CBA). Instead, in order for a debtor employer to be able to reject a CBA, the debtor must comply with the procedural and substantive requirements of Sec. 1113 of the Bankruptcy Code and then obtain authority from the Bankruptcy Court. What is less clear is whether Sec. 1113 applies to a CBA that has already expired by its own terms. This is a crucial question since, under the National Labor Relations Act, an employer cannot unilaterally change the terms and conditions of a CBA even after its expiration. Instead, the employer must continue to perform in accordance with the expired CBA until a new CBA is negotiated or an impasse is reached.

Earlier this year, the Third Circuit Court of Appeals became the first circuit level court to address the question of whether Sec. 1113 is applicable to an already-expired CBA. The Court ruled in favor of the employer, Trump Entertainment Resorts, Inc., and held that Sec. 1113 applied to expired CBAs and that Trump Entertainment could reject the CBA because it had complied with the requirements of Sec. 1113. This ruling is certain to have a significant effect on labor issues arising in Chapter 11 bankruptcy cases.

The full memo is available here: Third Circuit holds Sec. 1113 of the Bankruptcy Code applicable to already-expired CBAs

S.D.N.Y. Holds that Avoidance Powers Can be Applied Extraterritorially

By Fredric Sosnick, Douglas P. Bartner, Joel Moss, Solomon J. Noh and Ned S. Schodek of Shearman & Sterling LLP

On January 4, 2016, in one of the recent decisions In re Lyondell Chemical Company, et al., the U. S. Bankruptcy Court for the Southern District of New York deviated from S.D.N.Y. precedent and held that, despite the absence of clear Congressional intent, the avoidance powers provided for under Section 548 of the Bankruptcy Code can be applied extraterritorially. As a result, a fraudulent transfer of property of a debtor’s estate that occurs outside of the United States can be recovered under Sec. 550 of the Bankruptcy Code.

The lack of clear Congressional intent that avoidance powers apply to foreign transactions was the basis for prior decisions in the S. D. N. Y., which took the opposite view and held that the avoidance powers only apply domestically.  Those courts reasoned that if Congress intended for the avoidance powers to have extraterritorial reach, it could have so stated either the relevant statutory provisions governing avoidance actions under the Bankruptcy Code or in Sec. 541 itself.  In the current decision In re Lyondell, judge Gerber expressed his respectful disagreement to the extent that his decision is inconsistent with prior decisions recognizing the general presumption against extraterritoriality absent explicit language to the contrary. This ruling furthers uncertainty in the S. D. N. Y. as to whether transfers that occur abroad may be avoided in a Chapter 7 or 11 case.

The full memo is available here.

Second Circuit Says Section 546 of Bankruptcy Code Preempts State Law Constructive Fraud Claims

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By Donald Bernstein, Elliot Moskowitz, Damian Schaible, Eli Vonnegut, Alicia Llosa Chang, and Tina Hwa Joe of Davis Polk & Wardwell LLP

On March 29, 2016, the United States Court of Appeals for the Second Circuit issued an important opinion that limits the ability of creditors to assert constructive fraudulent transfer claims in major bankruptcy cases.  In a unanimous opinion, the Circuit held that in circumstances where Section 546 of the Bankruptcy Code bars estate representatives from asserting constructive fraudulent conveyance claims under state law, the statute likewise prevents individual creditors from bringing those claims after the estate’s time to do so expires.  In several recent Chapter 11 cases, individual creditors argued that the statute should only preclude a “trustee” – the term used in the statutory text – from bringing such claims, not individual creditors.  The Circuit’s ruling in In re: Tribune Company Fraudulent Conveyance Litigation, No. 13-3992, and summary order in related case Whyte v. Barclays Bank, 13-2653, were the first decisions from a circuit court on the issue and settled a conflict among its lower courts.  In a 53-page decision, the Circuit rejected the argument that the text of the statute only bars constructive fraud claims brought by a trustee or other estate representative, instead holding that the doctrine of implied preemption protects settlement payments and swap transactions from constructive fraud claims brought by any party.  The decision may put an end to recent attempts by creditors to circumvent Section 546(e) and related provisions in bringing such claims.

The full memo is available here.

Tighter Standards Emerge For Pleading Intentional Fraudulent Transfer Claims

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By Mark Chehi, Robert Weber and Stephen Della Penna of Skadden, Arps, Slate, Meagher & Flom LLP

The U.S. Bankruptcy Court for the Southern District of New York recently dismissed intentional fraudulent transfer claims asserted against former shareholders of Lyondell Chemical Company. Weisfelner v. Fund 1 (In re Lyondell Chemical Co.), 541 B.R. 172 (Bankr. S.D.N.Y. 2015) (“Lyondell II”). The Bankruptcy Court opinion adopts a strict view of what constitutes “intent,” and thereby tightens pleading standards applicable to complaints asserting intentional fraudulent transfers.

The intentional fraudulent transfer claims at issue focused on Basell AFSCA’s 2007 leveraged acquisition of Lyondell Chemical Company. As is typical in LBO transactions, Lyondell itself borrowed money to finance the LBO and pay its former shareholders for their Lyondell shares. Just 13 months later, Lyondell filed a voluntary chapter 11 petition.

A bankruptcy trustee subsequently asserted fraudulent transfer claims against the former Lyondell shareholders to recover the LBO payments received by them. The litigation asserted that the 2007 LBO transaction was avoidable as an intentional fraudulent transfer. The Bankruptcy Court dismissed the claims and adopted a restrictive pleading standard that requires an intentional fraudulent transfer plaintiff to plead facts that show “actual intent, as opposed to implied or presumed intent.” The plaintiff must allege some sort of “intentional action to injure creditors.” Alleging “[o]ther wrongful acts that . . . may be seriously prejudicial to creditors” – such as negligence or a breach of fiduciary duty – will not support an intentional fraudulent transfer claim.

The full article is available here.

The Abolition of Dysfunctional Contracts in Bankruptcy Reorganizations

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By Jay Lawrence Westbrook and Kelsi Marie Stayart, University of Texas at Austin School of Law

A traditional case law test has limited the application of bankruptcy contract rules to contracts that have a certain nearly mystical quality of “executoriness.” Contracts that fail the “Countryman” test are deemed not subject to those value-maximizing rules. Courts treat these contracts in a variety of ways, but often these contracts are removed entirely from the bankruptcy estate, destroying value and crippling reorganization efforts. These effects are especially serious with regard to less-traditional types of contracts, including IP licenses, options, and LLC operating agreements. The application of the test undercuts almost every policy underlying the Bankruptcy Code, including the fresh start and equal treatment of creditors. The test also gives judges an unpredictable and nearly unlimited discretion in resolving contracts often worth huge amounts of money.

Section 365 of the Bankruptcy Code allows a trustee or debtor-in-possession to assume or reject “executory contracts.” Assumption permits the estate to take on profitable contracts and make the contract counterparty perform, while elevating the counterparty to an administrative claimant. Rejection permits the bankruptcy estate to escape unprofitable or ill-advised contracts, leaving the contract counterparty with a damage claim payable in small Bankruptcy Dollars. The effect is to spread losses among all unsecured creditors while minimizing the overall loss. The existing approach prevents the achievement of these important results.

We propose an abolition of the requirement of “executoriness,” thus subjecting virtually all contracts to Section 365. In its place, we offer a simple approach to analyzing contracts in bankruptcy that aligns with and advances the fundamental principles of bankruptcy reorganization.

For the full article, see here.

10th Circuit Holds That First Time Transaction Falls Within 11 U.S.C. 547 (c)(2), Ordinary Course of Business Defense

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By Purvi Shah and Michelle McMahon of Bryan Cave

In re C.W. Mining. Co., the United Stated Circuit Court of Appeals for the Tenth Circuit affirmed the lower courts’ decisions holding that in a proceeding seeking to avoid and recover a payment made on account of a first time transaction between a debtor and creditor such payment can be defended under the ordinary course of business defense provided in 11 U.S.C. § 547(c)(2). In reaching its decision, the Tenth Circuit focused on the language of the statute and held that 11 U.S.C. § 547(c)(2) protects payments made in the ordinary course of business or financial affairs of the debtor and the transferee, not between the debtor and transferee. With this decision, the Tenth Circuit joined the Sixth, Seventh and Ninth Circuits that have held first time transactions defensible under 11 U.S.C. § 547(c)(2). In this context, the Ninth Circuit previously explained that “[a] first-time debt must be ordinary in relation to this debtor’s and this creditor’s past practices when dealing with other, similarly situated parties.” Wood v. Stratos Prod. Dev., LLC (In re Ahaza Sys. Inc.), 482 F.3d 1118, 1126 (9th Cir. 2007).

The full article is available here.

Earth to Creditors: Triangular Payment Arrangements May Constitute “Reasonably Equivalent Value”

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By Bryce Suzuki and Amanda Cartwright of Bryan Cave

The Eleventh Circuit Court of Appeals recently clarified the meaning of “reasonably equivalent value” in a complex fraudulent transfer case. In In re PSN USA, Inc., Case No. 14-15352 (11th Cir. Sept. 4, 2015), the Court found that payments made to fulfill contractual obligations of third parties were not fraudulent transfers where an economic benefit was directly or indirectly conferred upon the transferor.

This decision provides particular insight into fraudulent transfers in the context of parent-subsidiary and other triangular payment arrangements. Even though the debtor, a cable television channel, was not a party to the underlying satellite services contract at issue, the Court held that payments made from the debtor to the satellite services company pursuant to its parent company’s contracts constituted “reasonably equivalent value” and could not be avoided as constructive fraudulent transfers.

The Court’s opinion hinged on benefits derived by the debtor from those contracts.  Specifically, the satellite services contracts, to which the debtor was not party, permitted the debtor to operate a television channel and earn a service fee from that operation. The indirect benefit to the debtor through the contracts was sufficient to satisfy the “reasonably equivalent value” requirement, and the Eleventh Circuit affirmed the bankruptcy court’s order that the transfers were not avoidable.

The full article is available here.

Rights of Creditors Will be Determined by Contract Terms and Fraudulent Conveyance Statutes—Quadrant v. Vertin

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By Abigail Pickering Bomba, Steven Epstein, Arthur Fleischer, Jr., Peter S. Golden, Brian T. Mangino, J.Christian Nahr, Philip Richter, Brad Eric Scheler, Robert C. Schwenkel, Gail Weinstein of Fried, Frank, Harris, Shriver & Jacobson LLP

In Quadrant Structured Prods. Co., Ltd. v. Vertin, No. 6990-VCL, 2015 WL 6157759 (Del. Ch. Oct. 20, 2015), the Delaware Court of Chancery emphasized that creditors’ rights will flow from the contractually agreed terms of the debt, and that creditors’ derivative claims for breach of fiduciary duty will rarely succeed.

Fried Frank discusses whether there are circumstances under which a creditor’s claim for breach of fiduciary duty might succeed. Based on Vertin and a prior opinion in the case, it can be argued that a creditor’s fiduciary duty claim regarding a company’s post-insolvency adoption of an equity value maximization plan can succeed only if the directors were so uncareful or disloyal in formulating the plan, or the plan was so patently flawed, that the plan would not pass muster under the business judgment rule. Moreover, although the transactions in Vertin did not support a claim for breach of fiduciary duty, the opinion leaves open whether affiliated transactions may give rise to a creditor’s claim for breach of fiduciary duty.

For the full memo, please click here.

The Problem With Preferences

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By Daniel J. Bussel, UCLA School of Law

BusselBrook Gotberg in Conflicting Preferences does a great service in lucidly identifying the problem with preference law as currently configured. But she errs in diagnosing the cause and prescribing the treatment. As to cause, preference law is not and should not be a single-minded pursuit of equality of distribution without consideration of complementary, and even countervailing policies. To the contrary, the recent arc of preference law is strongly driven by refocusing on culpable opt-out behavior, and the goal of ratable distribution has been sharply subordinated to other objectives.

Repealing preference law in Chapter 11 would be counterproductive. Blanket repeal of preference law in Chapter 11, while simultaneously enhancing preference recovery in Chapter 7, insulates, indeed rewards, affirmative pre-bankruptcy opt-out behavior by insiders and creditors with superior knowledge or leverage, while undermining the reorganization objectives of Chapter 11. It will encourage, and in some instances require, liquidations that would not otherwise be necessary or desirable. Raising (not abandoning) the floor on preference recovery, bolstering (not eliminating) trade creditors’ ordinary course and new value defenses, and limiting or eliminating the safe harbors for financial contracts, all without discriminating between Code chapters, would reduce arbitrariness and unfairness in preference law. These more modest reforms would enable preference law to continue to police the most extreme forms of opt-out behavior, while fostering reorganizations where such reorganizations remain viable and desirable notwithstanding eve-of-bankruptcy opt-out actions by creditors and insiders.

For the full article see The Problem With Preferences, 100 Iowa L. Rev. Bull. 11, available here.

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