By Jeanne L. Schroeder and David Gray Carlson (Benjamin N. Cardozo School of Law)
Jeanne L. SchroederDavid Gray Carlson
Courts have struggled toward a unified theory to explain when the trustee has exclusive jurisdiction to sue a third party for harms done to a bankrupt debtor, and when creditors have exclusive jurisdiction to sue the third party. Courts have proclaimed that when every creditor can sue the third party, then none of them can, and the right belongs solely to the trustee. Creditor rights are “generalized.” If only a proper subset of creditors can sue the third party, then the trustee is not able to subrogate to the subset. Such creditors are “particularized.” This paper proclaims the test a failure. It announces the result rather than producing it. There are no generalized creditor rights or particularized creditor rights. There are only creditor rights and causes of action that are property of the estate. As for creditor rights, the trustee is subrogated to fraudulent transfer avoidance rights under Bankruptcy Code § 544(b)(1). Otherwise, the trustee is not subrogated. “Piercing the corporate veil” is not a generalized creditor right and not a cause of action at all. It is the assertion that two persons are the same person. If the corporate veil can be pierced, property of the apparent third person is actually property of the bankruptcy estate. For this reason, the trustee has control and the creditors are kept at bay by bankruptcy’s “automatic stay.” The article defends the recent settlement with the Sackler family in the historic Purdue Pharmacy opioid bankruptcy as entirely within the province of the bankruptcy estate.
Note: Last week the Roundtable concluded its series on crypto bankruptcies. We will resume our regular posts beginning with this week’s post, featuring an article by attorney Michael L. Cook.
By Michael L. Cook (Schulte Roth & Zabel LLP)
Michael L. Cook
This essay shows why a bankruptcy court preliminary injunction should be reviewable on appeal by an Article III court. District courts are split on the issue, often declining to review these rulings on the grounds that they are not “final” and that review is unwarranted. Although the Third, Seventh and Eighth Circuits hold that the Judicial Code authorizes appellate review, only the Second Circuit disagrees, based on a blinkered reading of the Judicial Code and U.S. Supreme Court precedent.
A district court’s preliminary injunction ruling (granting or denying) is concededly subject to review by a court of appeals under the explicit terms of the Judicial Code. Sound policy reasons, common sense and the obligation of the federal courts to hear cases within their statutory jurisdiction also show that bankruptcy court injunction rulings should not be insulated from appellate review. No sound reason exists for treating these bankruptcy court rulings differently from an identical district court ruling.
By Diane Lourdes Dick and Christopher K. Odinet (University of Iowa)
Diane Lourdes DickChristopher K. Odinet
Note: This post is the third post in a series of posts on bankruptcies of cryptocurrency companies and the emerging issues they pose. Previous posts in the series include:
This series is being managed by the Bankruptcy Roundtable and Xiao Ma, SJD at Harvard Law School, xma [at] sjd [dot] law [dot] harvard [dot] edu.
Check the HLS Bankruptcy Roundtable periodically for additional contributing posts by academics and practitioners from institutions across the country.
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Bankruptcy has a public and a private side. The reorganization of a private company in chapter 11 has implications for the public, and, in some reorganizations, the public interest is quite substantial. The recent bankruptcy of the third largest crypto exchange in the world, FTX, represents just the kind of corporate restructuring where the public interest is front and center. Yet the public priority embedded in these proceedings has the potential to be overlooked. In this work, we aim to change that by shining light on the stakes, the costs, and the allocative decisions to be made in what will no doubt be described as one of the most consequential legal proceedings to happen in the world of crypto. Specifically, the outcome of these proceedings will help clear up what it means to hold crypto as a form of property, as well as the custodial v. proprietary nature of the relationship between crypto exchange companies and their customers as to rights in crypto assets. The answers to these questions will not only help resolve this bankruptcy but they will also guide lawmakers and regulators as they seek a way to regulate and police the crypto market in the future. As such, we question whether the private value capturing model that is chapter 11 is the right framework—particularly when it comes to the allocation of who bears the costs—for these largely public-oriented matters.
By Charles M. Oellermann and Mark G. Douglas (Jones Day)
Charles M. OellermannMark G. Douglas
Courts disagree whether a bankruptcy court, in exercising its broad equitable powers, has the authority to award appellate legal fees as a sanction for contempt. The U.S. Court of Appeals for the Second Circuit recently weighed in on this issue as an apparent matter of first impression. In Law Offices of Francis J. Reilly, Esq. v. Selene Finance, L.P. (In re DiBattista), 33 F.4th 698 (2d Cir. 2022), the Second Circuit held that a bankruptcy court erroneously concluded that it did not have the power to award attorney fees incurred on appeal by a debtor seeking to enforce a contempt order for violations of a bankruptcy discharge order.
The Second Circuit explained that it is well settled that a bankruptcy court, exercising its broad equitable powers under section 105(a), “may compensate a debtor for a creditor’s violation of [a] discharge order” entered under section 524(a). These provisions, the court wrote, which “‘bring with them the old soil that has long governed how courts enforce injunctions,’” authorize a court to impose civil contempt sanctions to coerce compliance with an injunction or to compensate a complainant for losses arising from noncompliance. “[I]n line with long-established practice,” the Ninth Circuit explained, a bankruptcy court’s contempt power includes the authority to compensate a party for damages arising from noncompliance with an injunction, “even if those losses take the form of appellate litigation fees.”
The Second Circuit rejected the argument that the “American Rule” precludes an award of appellate fees “absent explicit statutory authority.” According to the court, an exception to the American Rule has long been recognized that permits a court to award legal fees for willful disobedience of an order entered as part of a fine levied on a contemnor.
By Colin Davidson and Catherine Jun (Sheppard, Mullin, Richter & Hampton LLP)
Colin DavidsonCatherine Jun
Cannabis is now legal in 19 states and Washington D.C., driving the growth of a legal cannabis industry estimated to be valued at $33 billion this year—up 32% from 2021—and expected to reach $52 billion by 2026. This growth in the cannabis industry, of course, also means that operators and their investment partners face increased commercial risk, including insolvency. Cannabis companies have thus far been precluded from accessing federal bankruptcy protection—i.e., chapter 7 or chapter 11—largely due to the status of cannabis as an illegal substance under federal law. The legal framework used in the United States, where cannabis is illegal federally but has been legalized by many states, differs greatly from the framework in Canada. In Canada the federal Cannabis Act 2018 legalized cannabis nationwide, while the provinces maintain certain regulatory powers related to the distribution, sale and use of cannabis. This suggests that for cross-border operators one potential route to U.S. bankruptcy relief is for the company to first commence an insolvency proceeding in Canada and then seek recognition of that foreign proceeding in a U.S. bankruptcy court under chapter 15 of the Bankruptcy Code. We examine the viability of chapter 15 as an alternative avenue to the U.S. bankruptcy courts and the challenges that a cannabis company may face in an article originally published by Cannabis Business Executive.
By Brigid K. Ndege (Lewis Brisbois Bisgaard & Smith LLP) and Christian Conway (Clark Hill PLC)
Brigid NdegeChristian Conway
Parties have long questioned whether the existence of two programs—the Bankruptcy Administrator program and the U.S. Trustee program—to administer bankruptcy cases fails to meet the U.S. Constitutional requirement for uniformity in bankruptcy law. In 2017, an increase in quarterly fees by Congress brought this dormant constitutional issue to the forefront because it illustrated the lack of uniformity between these two programs. After the fee hike, debtors in regions administered by the U.S. Trustee program paid significantly more in quarterly fees than debtors in regions administered by the Bankruptcy Administrator program. The drastic difference in fees for debtors in the two programs resulted in legal challenges to the constitutional uniformity of the fee hike. This eventually led to a circuit split, with the Fifth and Fourth circuits holding that the fee increase was constitutional and the Second and Third circuits holding that the fee increase was not constitutional. Although the U.S. Supreme Court resolved this ensuing circuit split in Siegel v. Fitzgerald, by unanimously holding that the fee hike was unconstitutional, the Court declined to address whether the dual bankruptcy system was constitutional and the appropriate remedy for debtors who paid more fees under the fee increase.
Note: The Harvard Law School Bankruptcy Roundtable is pleased to resume regular weekly posts for the academic year.
By Douglas G. Baird (University of Chicago Law School)
Negotiations are the lifeblood of Chapter 11, and a large part of the bankruptcy judge’s job is to police them. Bankruptcy judges are not dispensers of Solomonic wisdom. They are referees who ensure a level playing field. They insist that the parties follow the rules, but they do not enforce rules for their own sake nor do they allow their oversight to interfere with the flow of play. Their job is to give parties a chance to work together on equal terms to find a path forward.
Notwithstanding the centrality of negotiations, little of the written law says much about how bankruptcy judges should oversee them. The few explicit statutory mandates are pitched at a high level of abstraction. They require little more than that judges ensure that bargains be proposed in “good faith” and meet certain substantive conditions to be considered “fair and equitable,” without defining how the bargaining process could meet these standards.[1] Precedent is similarly unhelpful. One can exhaust virtually all the guidance the Supreme Court has offered over the last century and a half in a few sentences: The judge cannot be a “silent registrar of agreements.”[2] Nor can the judge approve deals that “alter the balance” of substantive rights set out in the statute.[3] At the same time, the judge should not come to the aid of a creditor who declines a “fair offer.”[4] Lower courts are similarly silent. Among the many hundreds of volumes of reported opinions, few provide much guidance.
Much less is up in the air than it first seems, however. The judge is bound by a coherent set of unwritten principles that derive from the Statute of 13 Elizabeth and fraudulent conveyance law as it was received in this country in the late eighteenth century. Over the course of the nineteenth century, judges drew on this uncodified power to craft an approach to policing negotiations between creditors and a financially distressed debtor. The legal reforms of the 1930s and the 1970s drew again on these same principles. This unwritten law remains central to modern reorganization practice.
The Unwritten Law of Corporate Reorganizations traces this long arc of reorganization law in the United States. It uncovers a history rich with interesting characters, including Founding Father Alexander Hamilton, corporate law giant Paul Cravath, and SEC chairman and Supreme Court justice William O. Douglas. Their stories illuminate the way bankruptcy judges have long used a set of unwritten rules, derived from fraudulent conveyance principles, to oversee the reorganization process.
By Matthew A. Bruckner (Howard University School of Law)
Matthew A. Bruckner
The number and importance of fintech companies, such as Venmo, CashApp, SoFi, Square, PayPal, and Plaid, continue to rise. As they’ve expanded, some fintech companies have considered it useful to pursue bank charters. For example, Figure, Varo and SoFi have all received at least preliminary approval for a traditional national bank charter.
However, the Office of the Comptroller of the Currency (the OCC) has decided to offer a more limited form of bank charter—a special purpose national bank charter. And it’s been offering these so-called fintech charters to entities that are, at best, bank-like.
Other regulators, such as the New York State Department of Financial Services and the Conference of State Bank Supervisors, have been none too happy about this development. Both have repeatedly sued the OCC, claiming that the charter oversteps the OCC’s authority. That litigation has centered on whether these fintech companies are sufficiently bank-like to obtain an OCC charter. So far, the OCC has successfully fended off litigation because of plaintiff’s lack of standing, but further substantive litigation seems exceedingly likely.
In a new article, I explore the question of whether the OCC’s decision to grant bank charters to fintech companies makes them banks for bankruptcy purposes. The question matters because banks are ineligible for bankruptcy relief. This Article considers the legal and policy arguments that are likely to be presented to bankruptcy judges about whether special purpose national banks are banks within the meaning of the Bankruptcy Code. I conclude that bankruptcy judges are likely to disregard the OCC’s interpretation and conclude that special purpose national banks are not banks for bankruptcy purposes.
As non-banks, special purpose national banks are bankruptcy-eligible. This raises a host of issues that I address in this Article. These include that, in some cases, a special purpose national bank will be able to rush to bankruptcy court to take advantage of the automatic stay if the OCC tries to revoke its charter. Also, the bankruptcy process may supersede the OCC’s newly-created (and never yet used) special purpose national bank liquidation proceedings.
These and other issues are explored in more detail in the Article, which can be found here.
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Note: This is the Harvard Law School Bankruptcy Roundtable’s last scheduled post for the summer of 2022. The BRT intends to resume posting around mid-September. The BRT wishes all its readers an enjoyable remainder of the summer!
By Adam C. Harris, Douglas S. Mintz, Abbey Walsh, and Kelly (Bucky) Knight (Schulte Roth & Zabel)
Adam C. Harris
Douglas S. Mintz
Abbey Walsh
Kelly (Bucky) Knight
Earlier this year, a District Court in the Eastern District of Virginia vacated a Bankruptcy Court order confirming a plan that provided non-consensual third-party releases to certain of the debtor’s prepetition executives. This reversal followed on the heels of the Southern District of New York’s reversal of the Purdue Pharma plan, also on account of the inclusion of non-consensual third-party releases. As discussed in this article, these decisions may presage a growing willingness by Courts to curb the granting of these releases. The authors also provide practical considerations and takeaways from the decision for debtors, creditors and other estate constituents that are noteworthy.
TheU.S. District Court for the Eastern District of Virginia vacated the confirmation order in the Mahwah Bergen Retail Group, Inc. (f/k/a Ascena Retail Group, Inc.) Chapter 11 cases on the grounds that the plan containedimpermissible non-consensual third-party releases.While the Court did not find that non-consensual third-party releases are prohibited per se, it imposed stringent limitations on their availability and on the Bankruptcy Court’s ability to grant such releases if the scope of the release extends to non-bankruptcy claims. The Court attributed its ruling, in part, to the fact that the “ubiquity of third-party releases in theRichmond Division demands even greater scrutiny of the propriety of suchreleases.” The decision holds that third-party releases should be granted only “cautiously and infrequently” and sets up an onerous process for their consideration and approval, which may make many third-party releases practically unavailable, particularly if a plan seeks to release non-core claims.
By Ralph Brubaker (University of Illinois College of Law)
Note: This is the sixth in a series of posts on the Texas Two-Step, the bankruptcy of LTL Management, and the future of mass tort bankruptcies. Check the HLS Bankruptcy Roundtable throughout the summer for additional contributing posts by academics from institutions across the country.
Earlier posts in this series can be found here (by Jin Lee and Amelia Ricketts), here (by Jonathan C. Lipson), here (by Jared A. Ellias), here (by Anthony Casey and Joshua Macey), and here (by David Skeel).
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Ralph Brubaker
All of the posts in this series have been incredibly thoughtful and incisive in illuminating what’s at stake with the innovative new Texas Two-Step bankruptcy strategy.
As Professors Casey and Macey point out, by isolating and separating Defendant’s mass-tort liability (in a new BadCo) from its business operations (in a new GoodCo) and subjecting only the former to the bankruptcy process, the value of Defendant’s business (which must ultimately pay the mass-tort obligations, under a funding agreement between GoodCo and BadCo) is enhanced by avoiding all of the direct and indirect costs that a bankruptcy filing would entail. At the same time, though, Defendant can nonetheless take advantage of bankruptcy’s beneficial claims resolution process, which consolidates all of the mass-tort claims, both present and future claims, in one forum—the Bankruptcy Court.
That mandatory, universal consolidation of all mass-tort claims, which is entirely unique to the bankruptcy process, is tremendously powerful and is a huge boon to facilitating an aggregate settlement of Defendant’s mass-tort exposure. Indeed, bankruptcy can produce aggregate settlement of mass tort obligations much more effectively and efficiently than the only available nonbankruptcy alternative, so-called multi-district litigation (MDL) under the federal MDL statute.
Professors Casey and Macey acknowledge that the Texas Two-Step bankruptcy is an unalloyed good, however, only if it does not leave tort victims worse off. I share the fear of many that it will, though, and my concern derives from one of the most fundamental differences between the bankruptcy and nonbankruptcy systems for aggregate resolution of mass torts, giving rise to the vertical forum shopping that Professor Lipson highlights.
The due process clauses of the Constitution give an individual tort victim a property right in a cause of action against Defendant. Consequently, that individual must consent to a settlement of that tort claim (i.e., a voluntary transfer or sale of the claim to Defendant). The only circumstance in which a mandatory “settlement” of a damages claim can be imposed upon a nonconsenting claimant (i.e., the claimant’s property can be involuntarily expropriated) is when there is sufficient danger of a common-pool problem, or so-called “tragedy of the commons,” of the kind extremely familiar to bankruptcy scholars and professionals.
Outside bankruptcy, that common-pool problem is the impetus for a so-called “limited fund” class action, which takes away claimants’ unfettered control over their individual claims (i.e., their property) by allowing a fiduciary representative to assert and settle in the aggregate all of the common claims against a limited fund, whether or not individual claimants consent to that aggregate settlement. As the Supreme Court made clear in its Ortiz v. Fibreboard decision, though, if a mass-tort defendant’s resources do not constitute a limited fund that is insufficient to fully satisfy its mass-tort obligations, individual claimants retain an absolute constitutional right to opt out of any aggregate resolution process, as part of their due process property rights in their individual claims.
Bankruptcy, of course, is also designed to address such a common-pool problem, and the binding distribution scheme effectuated by a confirmed plan of reorganization is functionally identical to the mandatory non-opt-out settlement at issue in Ortiz. Both systems enable a mass-tort defendant to impose a judicially-approved hard cap on their aggregate mass-tort liability, without any opt-outs by nonconsenting claimants. That mandatory non-opt-out settlement power works a dramatic change in a mass-tort defendant’s ultimate aggregate liability and the complex bargaining dynamics by which that ultimate liability is determined.
I thus share the concern expressed by Professor Ellias about the prospect of solvent mass tort defendants using Texas Two-Step bankruptcies to resolve their mass-tort liability. And Professor Skeel is right to point out that Judge Kaplan’s LTL Management decision gives too much encouragement to that strategy, for example, by opining that “[t]here is nothing to fear in the migration of tort litigation out of the tort system and into the bankruptcy system” and “maybe the gates indeed should be opened.” Bankruptcy poses a substantial risk of systematically undercompensating mass-tort claimants relative to a nonbankruptcy baseline, particularly for future claimants. Perhaps that risk is acceptable when the debt overhang from massive disputed obligations presents a clear and present threat to entity viability and full payment of all claimants, problems that bankruptcy is designed to address. Absent that, however, the bankruptcy gates should not simply be swung open wide in an attempt to “fix” the mass-tort system, however “broken” it may or may not be. The mass-tort bankruptcy system itself could use some fixing.
If you would like to receive a copy of my current work-in-progress exploring these issues, email me at rbrubake [at] illinois [dot] edu.
