Preference Due Diligence in the Crypto Winter
by | posted in: Avoidance, Bankruptcy, Chapter 11, Fiduciary Duties, Preference | 0

By Michael Rosella (Katten Muchin Rosenman LLP) and Dan McElhinney (Stretto)

Michael Rosella
Dan McElhinney

The crypto winter has arrived! Among many other issues of first impression for bankruptcy courts is the question of how the increased due diligence standards for preference actions set forth in the Small Business Reorganization Act of 2019 (the “SBRA”) will play out in a crypto case. The SBRA raised the bar on the due diligence needed to pursue preference litigation, requiring the debtor or trustee to assess “known or reasonably knowable affirmative defenses” before moving forward.

This article first assesses lingering disagreements related to the “heightened” pleading standard as applied to preference causes of action set forth in In re Valley Media and its progeny. Next, we delve into the cases interpreting the new due diligence standard set forth in the SBRA, as there is already disagreement on how to interpret the SBRA. Certain courts suggest the new due diligence standard constitutes an element of a preference claim that must be specifically pled in a complaint in order to avoid dismissal; others do not. Yet courts in this latter group, while eschewing the idea of a new element, do consider any information regarding pre-complaint due diligence efforts in the complaint, nonetheless. We then consider the issues unique to the opaque world of a cryptocurrency debtor that may impact the debtor or trustee’s ability to satisfy a heightened due diligence standard. Questions relating to the potential differences in assessing cash vs. crypto transfers and whether debtors or trustees will have access to key demographic and transaction data are considered. For example, whereas a debtor dealing in cash transfers would likely have bank statements, canceled checks, and access to accounting systems with basic transferee information, debtors transferring cryptocurrency to the independent digital wallet of a customer or counterparty would be less likely to have access to basic information necessary to satisfy a heightened due diligence standard.

We also provide key takeaways that highlight measures that cryptocurrency debtors should take to comply with the pleading and due diligence requirements. For example, a debtor in a cryptocurrency case should include in the complaint a recitation of its efforts to conduct reasonable due diligence — including efforts to obtain information needed to consider affirmative defenses, as well as reference to demand letters sent inviting the transferee to assert such defenses—to minimize any dismissal risk.

Click here to read the full article.

 

Critical Vendor Order Insufficient to Protect Critical Vendors Against Preference Claims
by | posted in: Avoidance, Bankruptcy Roundtable Updates, Chapter 11, Preference | 0

By Nicholas A. Koffroth (Fox Rothschild)

Nicholas A. Koffroth

In Insys Liquidation Trust v. MeKesson Corporation (In re Insys Therapeutics, Inc.), No. 21-50176 (JTD), No. 21-50176, 2021 WL 3083325 (Bankr. D. Del. July 21, 2021), the United States Bankruptcy Court for the District of Delaware reminded practitioners to exercise caution when analyzing the scope of protections offered by critical vendor orders.  The order at issue in Insys Therapeutics provided that “[t]he Debtors are authorized, but not directed . . . to maintain and administer the Customer Programs” and that “[n]othing contained . . . in this Final Order is intended to be or shall be construed as . . . (c) a waiver of any claims or causes of action that may exist against any creditor or interest holder.”  These common provisions proved critical in the Court’s holding that “something more is required” to insulate critical vendors from preference liability.

In the opinion, the Court denied a motion to dismiss the complaint brought by a group of critical vendors for three reasons.  First, the Court held that preferential payments that occur before the entry of a critical vendor order cannot be protected by a subsequent authorization to pay outstanding prepetition claims unless specifically provided in the order.  Second, the permissive language of the critical vendor order did not support the vendors’ claim that the prepetition payments would necessarily have been authorized had they been made postpetition.  Third, the critical vendor order expressly preserved the estates’ claims against critical vendors.  Additionally, the Court analyzed and rejected application of the limited “critical vendor defense.”

The article discusses the Court’s holding in greater detail and offers practical considerations for practitioners. The full article is available here.

Structuring and Practice for Aircraft Leases to Prevent Lease Payments from Being Clawed Back in a Lessee Bankruptcy
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Preference | 0

By Stewart B. Herman (Katten) and Timothy J. Lynes (Katten)

Stewart B. Herman
Timothy J. Lynes

In King v. Bombardier Aerospace Corporation et al., the trustee sought under 11 U.S.C. §§ 547(b) and 550(a) to have the lessor disgorge rent that the debtor lessee had paid to the lessor under an English-law aircraft lease during the prepetition preference period using funds advanced to the debtor by its shareholder. Pursuant to §547(b), the trustee argued that the debtor had made the payment for an antecedent debt; the loan balance on what was alleged to be disguised secured financing rather than a true lease. The lessor asserted (i) the trustee had not sufficiently shown the nature and amount of the antecedent debt as required under § 547(b)(2), (ii) under § 547(c)(4) the lessor had provided the debtor subsequent new value after the debtor made the payment, (iii) under § 547(c)(2) that the debtor had made the payment in the ordinary course of business, and (iv) that under the earmarking doctrine the payment should not be clawed back because the payment had been funded by a loan from a third party (the debtor’s shareholder). The court found (i) the trustee had not satisfactorily shown the nature and amount of the antecedent debt, (ii) the lessor had sufficiently shown it added subsequent new value to the debtors, (iii) the lessor had not sufficiently shown the payment was in the ordinary course of business, under either the subjective test or the objective test, and (iv) the lessor had not sufficiently shown facts to support an earmarking defense. The article concludes by offering suggestions for structuring leases to survive preference claims. The full article is available here.

Second Circuit Affirms Enforceability of Swaps’ Flip Provisions
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Cramdown and Priority, Derivatives, fraudulent transfer, Preference | 0

By Shmuel Vasser (Dechert)

Shmuel Vasser

Swaps, like other financial contracts (repurchase agreements, securities contracts, commodities contracts, forward agreements and master netting agreements), receive special treatment under the Bankruptcy Code.  Their acceleration, liquidation and termination is not prohibited as an ipso facto clause and the exercise of setoff rights is not subject to the automatic stay.  Transfers made in connection with these contracts are also exempt from avoidance as preferences and constructive fraudulent transfers as well as actual fraudulent transfer under state law.  But their scope is not always free from doubt.  Are provisions that modify the debtor’s priority of payment upon bankruptcy protected as well?  Are provisions that the swap incorporates by reference protected?  Must the swap counterparty itself exercise the right to liquidate, terminate and accelerate the swap?  The Second Circuit just answered these questions.

The full article is available here.

Will Bankruptcy Preference Lawsuits Decline due to Statutory Changes?
by | posted in: Bankruptcy Roundtable Updates, Legislation, Preference, Statutory Interpretation | 0
Lisa P. Sumner
Lisa P. Sumner

By Lisa P. Sumner (Nexsen Pruet)

Two recent amendments to the U.S. Bankruptcy Code impose new hurdles for debtors and trustees to clear before filing an action against a creditor to recover the value of preferential transfers that the debtor made to the creditor prior to filing a bankruptcy petition. One amendment requires debtors and trustees to conduct a due diligence review of the circumstances surrounding a particular transfer and probable affirmative defenses before filing suit. The other amendment increases the amount that debtors and trustees must seek to recover in a preference action if they want to file the action in the court where the bankruptcy case is pending rather than in the court where the creditor is located. These creditor-friendly amendments will take effect in early 2020, and may discourage debtors and trustees from filing some preference actions.

The full article is available here.

Optimal Deterrence and the Preference Gap
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Preference | 0

By Brook Gotberg (University of Missouri School of Law)

It is generally understood that the way to discourage particular behavior in individuals is to punish that behavior, on the theory that rational individuals seek to avoid punishment. Laws aimed at deterring behavior operate on the assumption that increasing the likelihood of punishment, the severity of punishment, or both, will decrease the behavior. The success of these laws is also evaluated by how much the targeted behavior decreases. The law of preferential transfers, which effectively punishes creditors who have been paid prior to the bankruptcy has been defended on the grounds that it deters a race to collect from a struggling debtor. However, deterrence theory suggests that the low likelihood of punishment and the cap on punishment associated with preference law make it a very poor deterrence. Further, statements pulled from interviews with affected creditors, debtors, and attorneys demonstrate that in practice, preference law does little or nothing to deter targeted behavior, and in the process imposes significant costs. The weaknesses of preference law call for its significant revision to place a greater focus on specific categories of creditors to be punished on account of their pre-bankruptcy activities.

The full article is available here.