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.

Conflicting Preferences: Avoiding Proceedings in Bankruptcy Liquidation and Reorganization

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By Brook Gotberg, J. Reuben Clark Law School, Brigham Young University

GotbergThe law of preferential transfers permits the trustee of a bankruptcy estate to avoid transfers made by the debtor to a creditor on account of a prior debt in the 90 days leading up to the bankruptcy proceeding.  The standard for avoiding these preferential transfers is one of strict liability, on the rationale that preference actions exist to ensure that all general creditors of the bankruptcy estate recover the same proportional amount, regardless of the debtor’s intent to favor any one creditor or the creditor’s intent to be so favored.  But preference law also permits certain exceptions to strict preference liability and gives the estate trustee discretion in pursuing preference actions. This undermines the policy of equal distribution by permitting some creditors to fare better than others in the bankruptcy distribution.  However, these practices are arguably necessary to promote the conflicting bankruptcy policies that seek to maximize the value of the estate for the benefit of creditors and also encourage the survival of struggling businesses.

As a result, the law of preferences is internally inconsistent and controversial, attempting unsuccessfully to serve multiple policy masters simultaneously.  Much of the analysis on preferences up to now has proposed amending preference law generally in an attempt to satisfy these often conflicting demands.  This article recommends a more dramatic approach; returning preference law to a mechanism of equal distribution in liquidation proceedings (Chapter 7) by eliminating true exceptions to the rule, and doing away with preference law in the context of bankruptcy reorganization (Chapter 11).

For the full article see here.

Next week we will be featuring another article on this topic, Professor Daniel J. Bussel’s The Problem with Preferences.

Delaware District Court Affirms Order Approving Gifting In Chapter 11 Case

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Author: Mindy Mora of Billzin Sumberg Baena Price & Axelrod, LLP

In an unusual but practical decision, the U.S. District Court for the District of Delaware affirmed a bankruptcy court order which approved both a sale of the debtors’ assets and the establishment of an escrow account to provide a “gift” to fund a distribution to the debtors’ unsecured creditors.  What is significant about this decision is that it approved the use of gifting in a chapter 11 bankruptcy case.  LCI Holding Company, Inc., civ. no. 13-924 (D. Del. March 10, 2014).

The concept of gifting in a bankruptcy case allows a secured creditor or purchaser to overcome objections to a sale of assets interposed by the debtor’s unsecured creditors.  Often, the gift consists of a pool of funds for distribution to the debtors’ unsecured creditors, and bypasses the claims of priority creditors with more senior claims.  See In re SPM Mfg. Corp., 984 F.2d 1305 (1st Cir. 1993).

A distribution that bypasses priority claims raises the issue of whether gifting is permissible in a chapter 11 case, based upon the requirement that distributions under a plan of reorganization must comply with the Bankruptcy Code, including the priority scheme for distributions to creditors and the absolute priority rule set forth in Bankruptcy Code § 1129(b)(2)(B).  This type of compliance is not mandated in chapter 7 cases, in which bankruptcy courts have authorized gifting more regularly.  See id.  Apparently in Delaware, gifting is permitted in a chapter 11 case, so long as the sale of assets is followed by a dismissal of the case without the confirmation of a plan.

Link to full articlehttp://www.financeandrestructuringblog.com/2014/06/delaware-district-court-affirms-order-approving-gifting-in-chapter-11-case/

Eighth Circuit Expands Subsequent New Value Preference Defense in Cases Involving Three-Party Relationships

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Authors:  Charles M. Oellermann and Mark G. Douglas

A bankruptcy trustee or chapter 11 debtor-in-possession has the power under section 547 of the Bankruptcy Code to avoid a transfer made immediately prior to bankruptcy if the transfer unfairly prefers one or more creditors over the rest of the creditor body. However, not every payment made by a debtor on the eve of bankruptcy can be avoided merely because it appears to be preferential. Indeed, section 547 provides several statutory defenses to preference liability. The Eighth Circuit Court of Appeals recently addressed one such defense to preference avoidance—the “subsequent new value” exception. In Stoebner v. San Diego Gas & Electric Co. (In re LGI Energy Solutions, Inc.), 746 F.3d 350 ( (8th Cir. 2014), the court, in a matter of first impression, ruled that “new value” (either contemporaneous or subsequent) for purposes of section 547(c) can be provided by an entity other than the transferee.

LGI Energy is a positive development for those doing business with financially troubled entities because it expands the scope of the subsequent new value defense to encompass payment relationships involving multiple parties. In one sense, the ruling can be viewed as an instance of judicial activism directed at harmonizing the Bankruptcy Code with the realities of complex financial transactions. However, it could be argued that the Eighth Circuit’s decision was motivated more by equitable and policy considerations than by a careful examination of the plain meaning of section 547(c)(4).

The full-length article can be found here.

Preference Recovery: You May Be More Exposed Than You Think

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Author: Vicki R. Harding, Pepper Hamilton LLP

Imagine a $2 million property that secures a $1.75 million senior loan and a $500,000 junior loan.  The owner files bankruptcy, and during the 90 days prior to bankruptcy the senior lender received payments totaling $250,000.  Does the senior lender have preference exposure?

A typical assessment is that because the senior lender is over-secured, it did not receive a preference because it did not receive more than it would have in a chapter 7.  However, it can be argued that the payments constitute a preference to the junior lender since it will receive more than in a chapter 7 as a result:  Without the payments, only $250,000 would be left after payment of the senior lender, but with the payments, $500,000 is left.  And the senior lender could be liable in a recovery action as the transferee of the preference under Section 550.

But wait, isn’t that a Deprizio argument, and didn’t Congress fix the Code to preclude this result? The answer is no: Deprizio and Section 550(c) address transfers benefitting insiders made between 90 days and a year prior to bankruptcy.  It does not protect a lender for claims based on transfers made during the 90 days prior to bankruptcy.  Unfortunately for senior lenders, this is not a fanciful hypothetical, but rather the approach taken in Gladstone v. Bank of America, N.A. (In re Vassau), 499 B.R. 864 (Bankr. S.D. Cal. 2013), discussed more in Preferences:  Surprise – Being Fully Secured May Not Be A Complete Defense.

 

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