Second Circuit Rules that Bankruptcy Courts May Award Appellate Legal Fees as Sanction for Contempt

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.

 

When Benefit Corporations File For Bankruptcy, Will Anything Be Different?

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 Unwritten Law of Corporate Reorganizations

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).

 

Texas Two-Stepping Out of Bankruptcy

By Michael A. Francus (Harvard Law School)

Michael Francus

Johnson & Johnson’s use of the Texas Two-Step to manage its talc liabilities has put the company, and the Two-Step, front and center in the roiling debates over aggressive uses of the bankruptcy system. Those debates have led to scholarly criticism, congressional hearings, and proposed legislation that would curtail debtors’ ability to so use the bankruptcy courts.

My Essay details the mechanics of the Two-Step. Beginning with the Texas divisive merger, the funding agreement, and forum shopping for the Fourth Circuit, the Essay fleshes out precisely how the Two-Step boxes in tort claimants. Like other scholarship, this Essay identifies the risk that such maneuvering effects a fraudulent transfer. It also goes a step further, arguing that the point of the Two-Step is not to succeed, but to delay. Fraudulent-transfer litigation in a bankruptcy consumes time because it requires an adversary proceeding, and that delay pressures tort claimants to settle. So the Two-Step can succeed as long as claimants cannot wait out the course of the bankruptcy, even if a court never declares the particular Two-Step to be a proper use of divisive merger law rather than an improper fraudulent transfer.

Instead of playing into this delay game, this Essay argues, courts should evaluate the Texas Two-Step for good faith. Tort claimants can raise such challenges as a motion to dismiss (as some have) and thus avoid the need for a fraudulent-transfer adversary proceeding. And under current doctrine, the Two-Step likely qualifies as a bad-faith filing: In most cases, the Two-Step is a litigation tactic. And the Two-Step, invariably, is filed by an entity created solely to file for bankruptcy. Both of those are doctrinal hallmarks of bad-faith bankruptcies.

More broadly, the Essay explains, the Two-Step and good-faith challenges to it underscore the continuing role of common law in bankruptcy. The Code does not define good-faith filing, so courts have developed the doctrine case by case. They may yet find an acceptable form of Two-Step, one which yields tort claimants the rights they would receive in, say, a Johnson & Johnson bankruptcy, without hurting Johnson & Johnson’s ability to do business by forcing the whole company into bankruptcy. Along the way, though, a vigilant common-law gatekeeping is warranted, and judges should not hesitate to dismiss Two-Steps thinking that a later ruling on a fraudulent-transfer adversary proceeding can adequately safeguard tort claimants from an improper use of the bankruptcy system.

The full essay will be available at 121 Mich. L. Rev. Online __ (forthcoming 2022) and can be accessed here.

Congressional Committees Propose Changes to Bankruptcy Code Prohibiting Non-Consensual Releases of Third Parties and Limiting Other Important Bankruptcy Tools

By Michael J. Cohen, Michael A. Rosenthal & Matthew J. Williams (Gibson Dunn)

The recent decision in In re Purdue Pharma did not uphold the third-party releases in the bankruptcy court’s approved plan. This post discuss the third-party releases issue.

— Harvard Law School Bankruptcy Roundtable Editors

Michael J. Cohen
Michael A. Rosenthal
Matthew J. Williams

On July 28, 2021, certain Democratic members of Congress, primarily in response to the $4.325 billion contribution made by the Sackler family to fund the settlement underpinning Purdue Pharma’s chapter 11 plan, introduced the Nondebtor Release Prohibition Act of 2021 (the “NRPA”), which proposes to amend the Bankruptcy Code to (i) prohibit the use of non-consensual third party releases in chapter 11 plans, (ii) limit so-called “Section 105” injunctions to stay lawsuits against third parties to a period no greater than 90 days after the commencement of a bankruptcy case, and (iii) provide a ground for dismissing a bankruptcy case commenced by a debtor that was formed within 10 years prior to such case via a divisional merger that separated material assets from liabilities.

When viewed against the backdrop of current complex chapter 11 practice, the NRPA is a flawed remedy for issues for which alternative means of redress already exist. First, the proposed elimination of the important bankruptcy tools of non-consensual third party releases and Section 105 injunctions – each of which is extraordinary in nature and only permitted in the rarest of circumstances – is a blunt force measure that threatens to vitiate the longstanding bankruptcy policy of favoring settlements over interminable value-destructive litigation.  Second, the loss of these tools may cause inequitable disruption in currently pending cases and stymie the implementation of critical creditor-supported strategies to resolve the most difficult cases going forward.  Moreover, a per se prohibition against non-debtor releases would contravene core bankruptcy principles by elevating the interests of a minority of creditors who would otherwise be bound to the terms of a chapter 11 plan containing such a release that is supported by the requisite majorities required under the Bankruptcy Code.  Third, while the disincentive against divisional mergers would affect a far more limited set of cases, it appears that the harm raised by some divisional mergers that are followed by bankruptcy may be adequately addressed through clarifying the applicability of fraudulent transfer law to challenge these transactions.

On November 3, 2021, the House Judiciary Committee sent the NRPA to the House floor for further consideration; the Senate Judiciary Committee has yet to act on the bill.  For more detail on the NRPA and our analysis of the bill, please find the full article here.

Mandatory Aggregation of Mass Tort Litigation in Bankruptcy

By Ralph Brubaker (James H.M. Sprayregen Professor of Law, University of Illinois College of Law)

The recent decision in In re Purdue Pharma did not uphold the third-party releases in the bankruptcy court’s approved plan. This post discuss the third-party releases issue.

— Harvard Law School Bankruptcy Roundtable Editors

Ralph Brubaker

This response to Professor Lindsey Simon’s Bankruptcy Grifters article challenges the controversial practice at the epicenter of the bankruptcy grifter phenomenon that Simon critiques: so-called nonconsensual nondebtor (or third-party) “releases” and “channeling” injunctions that discharge the mass tort obligations of solvent nondebtor entities who have not themselves filed bankruptcy. These nondebtor releases are an illegitimate and unconstitutional exercise of substantive lawmaking powers by the federal courts that contravenes the separation-of-powers limitations embedded in both the Bankruptcy Clause and Erie’s constitutional holding. The federal courts have manufactured out of whole cloth the unique, extraordinary power to impose mandatory non-opt-out settlement of a nondebtor’s mass tort liability on unconsenting tort victims through the bankruptcy proceedings of a codefendant. The bankruptcy “necessity” that supposedly justifies this astounding and unique settlement power—to mandate nonconsensual non-opt-out “settlements” that are otherwise impermissible and unconstitutional—is (at best) naive credulity or (at worst) specious sophistry.

Nonconsensual nondebtor releases are not “necessary” for the bankruptcy process to facilitate efficient aggregate settlements of the mass tort liability of both bankruptcy debtors and nondebtor codefendants. The bankruptcy jurisdiction, removal, and venue provisions of the Judicial Code already contain the essential architecture for mandatory, universal consolidation of tort victims’ claims against both bankruptcy debtors and nondebtor codefendants. Bankruptcy can be an extremely powerful aggregation process that facilitates efficient (and fair) settlements of the mass tort liability of nondebtors, even (and especially) without nonconsensual nondebtor releases, particularly if the Supreme Court elucidates the full expanse of federal bankruptcy jurisdiction. Nondebtor releases are an illicit and unconstitutional means of forcing mandatory settlement of unconsenting tort victims’ claims against solvent nondebtors, and the Supreme Court should finally resolve the longstanding circuit split over the permissibility of nonconsensual nondebtor releases by categorically renouncing them.

The full article is available here and is forthcoming in the Yale Law Journal Forum.

Bankruptcy Grifters

By Lindsey Simon (University of Georgia School of Law)

The recent decision in In re Purdue Pharma did not uphold the third-party releases in the bankruptcy court’s approved plan. This post discuss the third-party releases issue.

— Harvard Law School Bankruptcy Roundtable Editors

Lindsey Simon

Grifters take advantage of situations, latching on to others for benefits they do not deserve. Bankruptcy has many desirable benefits, especially for mass-tort defendants. Bankruptcy provides a centralized proceeding for resolving claims and a forum of last resort for many companies to aggregate and resolve mass-tort liability. For the debtor-defendant, this makes sense. A bankruptcy court’s tremendous power represents a well-considered balance between debtors who have a limited amount of money and many claimants seeking payment.

But courts have also allowed the Bankruptcy Code’s mechanisms to be used by solvent, nondebtor companies and individuals facing mass-litigation exposure. These “bankruptcy grifters” act as parasites, receiving many of the substantive and procedural benefits of a host bankruptcy, but incurring only a fraction of the associated burdens. In exchange for the protections of bankruptcy, a debtor incurs the reputational cost and substantial scrutiny mandated by the bankruptcy process. Bankruptcy grifters do not. This dynamic has become evident in a number of recent, high-profile bankruptcies filed in the wake of pending mass-tort litigation, such as the Purdue Pharma and USA Gymnastics cases.

This Article is the first to call attention to the growing prevalence of bankruptcy grifters in mass-tort cases. By charting the progression of nondebtor relief from asbestos and product-liability bankruptcies to cases arising out of the opioid epidemic and sex-abuse scandals, this Article explains how courts allowed piecemeal expansion to fundamentally change the scope of bankruptcy protections. This Article proposes specific procedural and substantive safeguards that would deter bankruptcy-grifter opportunism and increase transparency, thereby protecting victims as well as the bankruptcy process.

The full article is available here and is forthcoming in the Yale Law Journal.

Chapter 11’s Descent into Lawlessness

By Lynn M. LoPucki (Security Pacific Bank Distinguished Professor of Law, UCLA School of Law)

Lynn M. LoPucki

The bankruptcy courts that compete for big cases frequently ignore the Bankruptcy Code and Rules. This Article documents that lawlessness through a detailed examination of the court file in Belk, Inc.—a one-day Chapter 11—and a series of empirical studies.

Chapter 11’s lawlessness reached a new extreme in Belk. Belk filed in Houston on the evening of February 23, 2021. The court confirmed the plan at ten o’clock the next morning, and the parties consummated the plan that same afternoon. Almost none of Chapter 11’s procedural requirements were met. The court did not give creditors notice of the disclosure statement or plan confirmation hearings until after those hearings were held. Belk filed no list of creditors’ names and addresses, no schedules, no statement of financial affairs, and no monthly operating reports.  No creditors’ committee was appointed, no meeting of creditors was held, and none of the professionals filed fee applications. The ad hoc groups that negotiated the plan failed to file Rule 2019 disclosures. Because no schedules were filed, no proofs of claim were deemed filed. Only eighteen of Belk’s ninety-thousand creditors filed proofs of claim, and Belk apparently just made distributions to whomever Belk considered worthy. 

The procedural failures in Belk are just the tip of the iceberg.  The competing courts are ignoring impermissible retention bonuses, refusing to appoint mandatory examiners, failing to monitor venue or transfer cases, granting every request to reject collective bargaining agreements, and providing debtors with critical-vendor slush funds. The article is available here

What’s Done is Done: Third Circuit Upholds Equitable Mootness and Rules Out Possibility of Individualized Relief for Timely Objecting Party

By Robert Lemons (Weil) and Patrick Feeney (Weil)

Robert Lemons
Patrick Feeney

Over the past several years, certain circuits criticized the Equitable Mootness doctrine for its lack of statutory basis and effect of avoiding review of chapter 11 plans on the merits.  However, the Third Circuit recently held in In re Nuverra Environmental Solutions, Inc. v. Hargreaves, Case No. 18-3084, 834 Fed. Appx. 729 (3d Cir. Jan. 6, 2021), that the Equitable Mootness doctrine is still alive and well.

 The Third Circuit rejected the appeal of Hargreaves, a creditor who timely objected to the chapter 11 plan and timely appealed the bankruptcy court’s entry of the plan’s confirmation order, because the plan was already substantially consummated and could not be unwound.  Further, the Third Circuit held that it could not grant Hargreaves “individualized relief” because such relief would violate Bankruptcy Code § 1123(a)(4)’s restriction on preferential treatment of class members and § 1129(b)(1)’s prohibition on unfair discrimination between classes. 

 In a concurring opinion, Judge Krause rejected the application of Equitable Mootness, finding the majority did not sufficiently analyze whether disparate treatment of creditors within a class is permissible on appeal when parties choose not to object to, or appeal confirmation of, the plan.  Judge Krause also noted that denial of the appeal on Equitable Mootness grounds precluded consideration of substantive arguments and development of the Third Circuit’s bankruptcy jurisprudence.  

While Judge Krause’s concurring opinion highlights difficulties plan objectors face when appealing plan confirmation, the majority opinion signals that Equitable Mootness is still a healthy doctrine in the Third Circuit.

The full article is available here.

The Municipal Bond Cases Revisited

By Allison Buccola (Independent) and Vince Buccola (Assistant Professor, The Wharton School)

Allison Buccola
Vince Buccola

Puerto Rico’s Title III proceedings under PROMESA mark the return of debt repudiation as a feature of the government debt restructuring landscape. Backed by an official committee, the Federal Oversight and Management Board has argued that some $6 billion of bonds the Commonwealth issued are void and worthless. According to the Board, the bonds were sold illegally, in contravention of a constitutional debt limit, so that (also according to the Board) they cannot bind the Commonwealth. A similar argument was lodged in Detroit’s bankruptcy. For the better part of a century before that, however, repudiation was mostly unheard of in the United States. 

The invocation of ultra vires to escape bond obligations is nothing new, though. In the second half of the nineteenth century, municipal debtors frequently welched on their debts. In the 1850s and 1860s, cities, towns, and counties across the Midwest and West issued bonds to finance the construction of railroads and other infrastructure. Many ultimately defaulted. Rather than simply announce that they couldn’t or wouldn’t pay, however, they often contended that they needn’t pay: for one or another reason, the relevant bonds had been issued ultra vires and so were no obligation of the municipality at all. Litigation in the federal courts was common. Several hundred repudiation disputes made their way to the Supreme Court in the forty years starting 1859.

With an eye to the modern cases, we set out to understand how the Court reckoned with repudiation. We read every one of the 196 cases in which the Justices opined on bond validity (i.e. the enforceability of a bond in the hands of innocent purchasers). In a recently published article, we correct received wisdom about the cases and remark on the logical structure of the Court’s reasoning.

To the extent the municipal bond cases are remembered, modern scholars usually think of them as exemplary instances of a political model of judging. The caricature has the Court siding with bondholders even when the law called on them to rule for the repudiating municipalities. The Justices—or a majority of them—are imagined as staunch political allies of the capitalist class, set against the institutions of state government and their regard for agricultural interests. We find that this picture is inconsistent with reality. In fact, the Court ruled for the repudiating municipality in a third of all the validity cases. As importantly, the Court’s decisions reflected a readily articulable formal logic, a logic the Justices seem, to our eyes, to have applied soundly.

The Court’s analytical approach traded on a distinction between legal and factual bases for repudiation. A municipality might repudiate either on a theory that no legal authority permitted the contested bond to be issued under the circumstances the bondholder alleged or, alternatively, on a theory that the circumstances alleged did not in fact pertain. Where the theory of repudiation turned on a legal predicate, the Court simply proceeded to the merits, comparing the bond to the powers granted to the issuer by state law at the time of issuance. Repudiating municipalities often prevailed.

Where the theory of repudiation turned on a factual predicate, by contrast, bondholders fared much better. The defining theme in such cases was a procedural mechanism that precluded assessment of the merits, namely the adaptation of estoppel doctrine to the municipal context. It was, and still is, customary for bonds to recite circumstances relevant to issuance. Estoppel allowed buyers in the secondary market to credit whatever facts—but only facts—the issuer declared true at the time of issuance. In a number of debt-limit cases reminiscent of Puerto Rico, this logic propelled bondholders to a judgment. Estoppel did not resolve all fact-based repudiation arguments. It did not foreclose a trial if, for example, the contested bond failed to recite a predicate fact. Nevertheless estoppel was an important feature of the bond cases, one which, given the profound asymmetry of information that prevailed with respect to matters of fact, probably helped to sustain the bond market as a source of capital for municipal development.

The article can be found here.

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