Second Circuit Rules that Bankruptcy Courts May Award Appellate Legal Fees as Sanction for Contempt
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Jurisprudence, Statutory Interpretation | 0

By Charles M. Oellermann and Mark G. Douglas (Jones Day)

Charles M. Oellermann
Mark 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.

Click here to read the full article.

 

Bankruptcy-Remote Structuring: Reallocating Risk Through Law
by | posted in: Bankruptcy, Corporate Governance, Priority, Special Purpose Entities and Securitization | 0

By Steven Schwarcz (Stanley A. Star Distinguished Professor of Law & Business, Duke University School of Law)

Steven Schwarcz

Bankruptcy-remote structuring, a legal strategy with potential public policy implications, is crucial both to a range of important financial transactions—including securitization, project finance, covered bonds, oil-and-gas and mineral production payments, and other forms of structured financing—and to the ring-fencing of utilities and other publicly essential firms. In finance, the goal is contractually to reallocate risk by structuring securities-issuing entities that, absent the bankruptcy risks inherent to operating businesses, can attract investments based on specified cash flows. In ring-fencing, the goal is contractually to structure firms to minimize bankruptcy risks, thereby assuring their continued business operations.

Parties engaging in bankruptcy-remote structuring usually seek to reallocate risk more optimally, including by reducing information asymmetry and assigning higher risk to yield-seeking investors, thereby enabling firms to diversify and lower their costs of capital. In reality, bankruptcy-remote structuring can sometimes create harmful externalities. Some blame bankruptcy-remote securitization transactions, for example, for triggering the 2007-08 global financial crisis by shifting risk from contracting parties to the public.

This Article undertakes a normative analysis of bankruptcy-remote structuring, examining the extent to which parties should have the right to reallocate bankruptcy risk. It is the first to do so both from the standpoint of public policy—examining how bankruptcy-law policy should limit freedom of contract; and also from the standpoint of cost-benefit analysis (“CBA”)—examining how externalities should limit freedom of contract.

Traditionally, CBA weighs overall costs and benefits regardless of who pays the costs and who receives the benefits. That model makes sense for a neutral governmental assessment of costs and benefits, such as deciding whether to enact new regulation. In bankruptcy-remote structuring, however, the contracting parties both advocate and significantly stand to gain from the project. From a public policy standpoint, an impartial assessment of these private actions should weigh the socially relevant costs and benefits.

In that weighing, the Article explains why the socially relevant benefits of project finance that is used to facilitate the construction of critical infrastructure projects like powerplants and toll roads, as well as the socially relevant benefits of ring-fencing that is used to protect critical utilities, should exceed the socially relevant costs. However, for more generic structured finance transactions, like securitization, the CBA weighing is more difficult. These types of bankruptcy-remote transactions have valuable public benefits that are difficult to quantify. Their social costs are also difficult to quantify. Given these difficulties, the Article merely categorizes the benefits and costs without purporting to conclude how they balance. This approach has important precedent, including for assessing the costs and benefits of the Volcker Rule.

Finally, the Article examines how to reform bankruptcy-remote structuring to reduce its externalities, thereby rebalancing the costs and benefits to try to achieve net positive benefits.

Among other things, it compares the European Union’s regulatory framework that creates incentives for simple, transparent, and standardized (“STS”) securitization transactions and urges U.S. lawmakers to consider similar securitization reforms.

The full article is available here.

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.

 

Changes and Convergence of Bankruptcy Law: Recent Experience in Brazil
by | posted in: Bankruptcy, Bankruptcy Reform, International and Comparative | 0

By Joao Guilherme Thiesi da Silva (Cleary Gottlieb Steen & Hamilton LLP)

Joao Guilherme Thiesi da Silva

Bankruptcy regimes across the globe have been constantly changing in response to new market demands and the evolution of insolvency law principles and objectives. Part of the academic community argues that such changes may lead to a convergence of domestic bankruptcy laws, as a result of globalization and market integration. Scholars have reviewed the phenomena of changes and convergence of bankruptcy laws in Europe, East Asia and Africa. However, little attention has been given to Latin American countries, such as Brazil. This paper aims at contributing to the discussion on changes and convergence of bankruptcy law, by focusing on four recent experiences within the Brazilian legal system, namely (i) the recent adoption of the UNCITRAL Model Law on Cross-Border Insolvency, (ii) the ability of creditors to propose a competing plan of reorganization, (iii) the adoption of pre-insolvency procedures, and (iv) the recognition of bondholders’ right to vote on a plan of reorganization. This paper concludes that there are indicia of a continuous convergence of Brazilian bankruptcy law with foreign and international norms, as changes in Brazilian bankruptcy law have increasingly mirrored the law and practice of certain metropolitan nations, as well as global norms and soft laws developed by international organizations and standard setting bodies. This paper further discusses the diverse array of processes through which convergence has taken place in Brazilian bankruptcy law, as well as the main driving forces underlying this convergence, such as the increasing influence of cross-border investments and international market players.

The full article is available here.

The Cannabis Conundrum: Can Cannabis Companies File Chapter 15?
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Chapter 15, International and Comparative, Statutory Interpretation | 0

By Colin Davidson and Catherine Jun (Sheppard, Mullin, Richter & Hampton LLP)

Colin Davidson
Catherine 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.

Click here to read the full article.

 

When Benefit Corporations File For Bankruptcy, Will Anything Be Different?
by | posted in: Bankruptcy, Corporate Governance, Fiduciary Duties, Jurisprudence | 0

By Christopher D. Hampson (University of Florida Levin College of Law)

Christopher D. Hampson

Social entrepreneurs and lawyers gave birth to the benefit corporation out of frustration with the Delaware law that governs fiduciary duties during insolvency.  The benefit corporation statutes require directors to consider general and specific public benefit alongside the interests of shareholders.  While legal scholars have grappled with whether the benefit corporation form works well to preserve social commitments, we have not yet explored fully what would happen when a benefit corporation files for bankruptcy.

I attempt to answer that question in Bankruptcy & the Benefit Corporation.  As I see it, during good times, the benefit corporation may not improve on traditional corporate forms.  After all, wise leaders can balance short-term and long-term goals and weigh the interests of shareholders against stakeholders, within the space provided by the business judgment rule.  Whether those leaders are indeed wise is probably more important than the corporate form itself.  But during bad times, the law tightens around directors, and that’s where the benefit corporation form provides extra protection for directors committed to both doing well and doing good.

My analysis of duty-based, utility-based, and character-based approaches indicates that we should want commitments to public benefit to persist into bankruptcy.  Drawing from Carl E. Schneider’s “channelling” function of law, I argue that the benefit corporation stands as a meaningful “third way” for entrepreneurs, investors, and employees, a corporate form that attracts those interested in pursuing profit while accomplishing some social goal.

When it comes to bankruptcy, some scholars are quite pessimistic about the benefit corporation’s fate.  After all, the U.S. Supreme Court has told us that the trustee in bankruptcy has a duty to maximize the value of the estate, and that duty might replace or wash out the fiduciary duties of the directors of a benefit corporation.  I am more optimistic.  The duty of the trustee in bankruptcy is famously underdefined (what kind of value?  value to whom?).   Against the Supreme Court’s vague pronouncements, 28 U.S.C. § 959 and the Butner principle suggest that state law innovations, like the benefit corporation, should control.

The remainder of the article explores the complexity of running that argument through the reticulated, multiplayer world of an insolvency case, because — well, this is bankruptcy.  Rules like adequate protection and absolute priority serve as guardrails that state law fiduciary duties cannot override.

I might be wrong, and it could be some time before we know one way or the other.  By publication, I had found one filing by a benefit corporation, Medolac Laboratories in the District of Nevada, and it didn’t raise the issues I explore in the article.  When more data comes in from benefit corporation filings, we may find out what bankruptcy courts think about the newest corporate entities to face financial distress.

The full article has been published in the American Bankruptcy Law Journal (96 Am. Bankr. L.J. 93 (2022)) and is available here.

The Fee Hike Dilemma: The U.S. Supreme Court Resolves Fee Dispute and Holds Fee Hike Unconstitutional
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Chapter 11, Reorganization, Supreme Court, Venue | 0

By Brigid K. Ndege (Lewis Brisbois Bisgaard & Smith LLP) and Christian Conway (Clark Hill PLC)

Brigid Ndege
Christian 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.

Read the full article here.

 

The Unwritten Law of Corporate Reorganizations
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Chapter 11, Corporate Governance, fraudulent transfer, Jurisprudence | 0

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.

The book can be purchased here.

[1] 11 U.S.C. §1129.

[2] See Louisville Trust Co. v. Louisville, New Albany & Chicago Railway Co., 174 U.S. 674, 688 (1899).

[3] See Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973, 987 (2017).

[4] Northern Pacific Railway Co. v. Boyd, 228 U.S. 482, 508 (1913).

 

Who’s Down with OCC(‘s Definition of “Banks”)?
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Chapter 11, Financial Firms and Safe Harbors | 0

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.

***

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!

 

Third-Party Releases Under Continued Fire in E.D. Va. Decision
by | posted in: Bankruptcy, Bankruptcy Administration and Jurisdiction, Chapter 11, Third-Party Releases, Venue | 0

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.

The U.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 contained impermissible 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 the Richmond Division demands even greater scrutiny of the propriety of such releases.” 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.

Read the full article here.

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