Successor Liability in § 363 Sales

By Michael L. Cook of Schulte, Roth & Zabel LLP

Bankruptcy Code §363(f)(1) empowers a bankruptcy court to order a debtor’s assets sold “free and clear of any interest in such property.” Courts in the business bankruptcy context have been wrestling with successor liability, i.e., whether an asset buyer can be held liable for the debtor-seller’s liabilities. In 2009, the Second Circuit affirmed a bankruptcy court order barring creditors of the selling debtor from pursuing the asset buyer “for product defects in vehicles produced by” the debtor. In re Chrysler LLC, 576 F.3d 108, 123-24 (2d Cir. 2009), vacated as moot, 558 U.S. 1087 (2009) (held, successor liability claims are interests covered by a sale order under Code § 363(f)(1)).

Most recently, on July 13, 2016, the Second Circuit held that the bankruptcy court’s asset sale order in the General Motors reorganization case limiting specific pre-bankruptcy product liability claims required prior “actual or direct mail notice” to claimants when the debtor “knew or reasonably should have known about the claims.” In re Motors Liquidation Co., 2016 U.S. App. LEXIS 12848, *46-47 (2d Cir. July 13, 2016). Although the substance of the sale order may have been enforceable otherwise, “mere publication notice” to known or knowable claimants was insufficient. Had the complaining product liability claimants received adequate notice, reasoned the court, they “could have had some negotiating leverage [regarding the terms of any sale order] . . . and [a meaningful] opportunity to participate in the proceedings.” Id. at *61. The court noted a “trend…toward a more expansive reading of ‘interests in property’ which encompasses other obligations that may flow from ownership of the property.” Id., at 124, citing In re Trans World Airlines, Inc., 322 F. 3d 283, 285-90 (3d Cir. 2003).

The full memo is available here.

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

posted in: Avoidance | 0

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

Fifth Circuit Affirms Secured Lender Surcharge

posted in: Cramdown and Priority | 0

By Michael L. Cook, Schulte Roth & Zabel LLP

The cost of maintaining a secured lender’s collateral is usually borne by the unencumbered assets of the debtor’s bankruptcy estate.  In other words, administrative expenses of the debtor’s estate (e.g., professional fees) cannot be recovered from the secured lender’s collateral because the trustee or Chapter 11 debtor-in-possession acts for the benefit of unsecured creditors, not the secured creditor.  Bankruptcy Code §506(c) provides an exception to the general rule, however, when the trustee incurs properly identified preservation expenses that primarily benefit the secured lender if the lender has either caused or consented to the accrual of these expenses.

The Fifth Circuit, on December 29, 2015, required a secured lender to “pay the [encumbered] property’s maintenance expenses incurred while the [bankruptcy] trustee was trying to sell the property.”  In re Domistyle, Inc., 811 F.3d 691 (5th Cir. 2015).  Explaining the Code’s “narrow” and “extraordinary” exception to the general rule meant to prevent a windfall to a secured creditor at the expense of unsecured creditors, the court rejected the lender’s argument that it had not benefited from the expenses paid by the trustee to preserve the property.  On the facts of the case, the court found that all of the surcharged expenses related only to preserving the property’s value and preparing it for sale – e.g., security expenses, lawn mowing and roof repairs.

This article briefly summarizes those appellate decisions explaining why courts usually deny surcharge requests.  It also describes the few cases permitting surcharge.

The full article can be found here.

Bankruptcy Court Approves Non-Market Cramdown Rate on Momentive Secured Creditors

posted in: Valuation | 0

By Adam C. Harris and Karen S. Park of Schulte Roth & Zabel LLP

A recent decision from the Bankruptcy Court for the Southern District of New York provides guidance on the “fair and equitable” requirement as it relates to secured creditors in a so-called “cramdown plan.” Section 1129(b) of the Bankruptcy Code provides the means by which a Chapter 11 debtor may obtain confirmation of a plan of reorganization over the objection of a dissenting class of creditors, including secured creditors.  To cram down a plan on a class of secured creditors, the plan must be “fair and equitable” to that class.  One way to meet the “fair and equitable” requirement is to provide that the secured creditors retain their liens and receive deferred cash payments having a present value equal to the allowed amount of their secured claims.

In In re MPM Silcones LLC, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014), the Bankruptcy Court held that the interest rates on secured claims in a “fair and equitable plan” should be derived using a formula that starts with a “risk free” Treasury rate for similar duration instruments, and adds a risk premium generally in the range of 1%-3%.  Importantly, the Bankruptcy Court rejected the objecting secured credtiors’ arguments that the interest rates should be based on the market, i.e., the rates that would be charged to the same debtor entity for a loan having the same terms and duration by a third party lender.

The Bankruptcy Court’s ruling has been appealed.  If upheld, the decision could have far-reaching implications for distressed debt investors as well as on the availability and pricing of capital for borrowers.

Please find a full-length version of the article here.

Court of Appeals Vacates DIP Financing Order for Lender’s Lack of Good Faith

By Michael L. Cook, Schulte Roth & Zabel LLP

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The Bankruptcy Code encourages lenders to make debtor-in-possession (“DIP”) loans to Chapter 11 debtors. Because of Bankruptcy Code § 364(e), an appeal from a financing order will ordinarily be moot when the lender acted “in good faith” unless the appellant obtains a stay pending appeal.  It is hence noteworthy when appellate courts overturn DIP financing orders that were not stayed pending the appeal.

The Fifth Circuit, on September 3, 2014, vacated five bankruptcy court and district court DIP financing orders due to (1) the lender’s lack of good faith in relying on a third party’s shares of stock as collateral; and (2) the bankruptcy court’s lack of subject matter jurisdiction to authorize a lien on third party collateral subject to disputed ownership claims.   In re TMT Procurement Corp., 2014 WL 4364894 (5th Cir. Sept. 3, 2014).  On October 23, 2014 the Fifth Circuit denied the petition for panel rehearing.

The Fifth Circuit rejected the debtors’ argument that the appeals were moot because of the lower courts’ repeated findings that the lender had made the loan in good faith.  TMT provides a new test regarding the Code’s “good faith” requirement for lenders, based on the lender’s knowledge of possible insider manipulation of the bankruptcy process.  The court also found a lack of subject matter jurisdiction because the debtors’ insiders used the bankruptcy financing process to “interfere with” unrelated state court litigation against the debtors’ controlling shareholder.

The full version of the article was recently published in The Bankruptcy Strategist. It is available online here.

Another Court of Appeals Broadly Reads Settlement Payment Safe Harbor

By Michael L. Cook, Schulte Roth & Zabel LLP

The Courts of Appeals, with few exceptions, have broadly read the safe harbor defense contained in Bankruptcy Code §546(e) over the past 24 years.  It insulates a “settlement payment” or “margin payment” on a “securities contract,” “commodity contract” or “forward contract” from a trustee’s fraudulent transfer or preference claims unless the debtor makes the payment with “actual intent to hinder, delay or defraud creditors.”  Despite policy arguments by lower courts, trustees, creditors and commentators, the appellate courts have claimed to rely on the Code’s “plain language” to deny recovery.  In this Article, we discuss a recent Seventh Circuit decision that (a) reversed a district court’s “policy” decision purporting to divine Congress’s intent as to the proper application of the safe harbor provision; (b) rejected decisions by the Fifth and Ninth Circuits that refused to apply the safe harbor in the context of a Ponzi scheme; and (c) followed recent decisions of the Second and Fourth Circuits.

We discuss the Seventh Circuit’s close reading and application of the statutory language, “clearly and predictably using well established principles of statutory construction.”  Citing Supreme Court precedent, the court refused to rely on legislative history that was “neither passed by a majority of either House nor signed into law.”  Instead, the court explained why the safe harbor in the case before it yielded a sensible result, avoiding instability and uncertainty in the securities business.

We also review recent conflicting decisions in the lower courts that have resulted from imaginative attempts by lawyers to avoid application of the safe harbor defense.  Finally, we discuss another case pending in the Second Circuit that pushes the safe harbor defense to its outer limits.  That case asks (a) whether an intermediary is required in a safe harbor case, and (b) whether the defendant must show an adverse effect on financial markets.

Schulte Roth & Zabel Client Alert, April 3, 2014:  http://www.srz.com/Seventh_Circuit_Reads_Bankruptcy_Safe_Harbor_Broadly_to_Insulate_Preferential_Settlement_Payment_to_Commodity_Broker/