Ultra III: Law Firm Perspectives

By Xiao Ma (Harvard Law School)

Xiao Ma

On November 26, 2019, the Fifth Circuit granted a petition for rehearing en banc and issued a revised opinion in In re Ultra Petroleum Corp., No. 17-20793 (5th Cir. Nov. 26, 2019). The new opinion reaffirmed the court’s prior holding that the alternation of a claim by the Bankruptcy Code does not render a claim impaired under 11 U.S.C. § 1124(1), while withdrew the court’s earlier guidance that make-whole premium was the “economic equivalent of ‘interest’” together with its prior suggestion on setting the appropriate post-petition interest rate via reference to general post-judgment interest statute or bankruptcy court’s equitable discretion.

Noting that issues relating to make-whole premiums is a common dispute in modern bankruptcy, the Fifth Circuit retracted its dicta and emphasized in the revised opinion that specific facts are essential in determining the difficult question of whether any premiums are effectively unmatured interest. The court concluded that “[t]he bankruptcy court is often best equipped to understand these individual dynamics – at least in the first instance.”

Firms took notice of the issues remain unsolved and offered perspectives on implications of this case. Morgan Lewis specifically notes that the revised opinion did not alter the original opinion’s reversal of the bankruptcy court’s ruling that creditors who are unimpaired in a bankruptcy plan pursuant to section 1124(a)(1) must receive the full amount of their claim under state law. Weil finds the opinion “does not answer the question of whether, or when, a make-whole may be payable in the Fifth Circuit”, but acknowledges that the ruling is “viewed by some as a victory” for certain creditors. Cleary highlights that the court’s revised opinion “withdrew essentially all of the guidance it had offered in its prior opinion” which had cast doubt on the enforceability of make-whole claims in bankruptcy. “Given the legal and economic significance of the questions left to be resolved”, debtors and creditors alike are likely to watch closely how the questions will proceed at the bankruptcy court, says Mayer Brown.

An earlier post on the Roundtable, Fifth Circuit’s Ultra Petroleum Decision Suggests Make-Wholes are Unenforceable in Bankruptcy, Questions Collectability of Contract Rate Postpetition Interest, discussed the original opinion on Ultra by the Fifth Circuit dated Jan. 17, 2019.

Tribune II: Law Firm Perspectives

By Xiao Ma (Harvard Law School)

Xiao Ma

On December 19, 2019, the Second Circuit issued its amended opinion in In re Tribune Company Fraudulent Conveyance Litigation, 2019 WL 6971499 (2d Cir. Dec. 19, 2019), which held the “safe harbor” provision in section 546(e) of the Bankruptcy Code covers Tribune Company’s payments made to public shareholders as Tribune constitutes a “financial institution” in pursuance with the Bankruptcy Code definition, and such definition includes the “customer” of a financial institution when the financial institution acts as the customer’s “agent or custodian…in connection with a securities contract”.

The Second Circuit’s opinion was controversial in light of the Supreme Court’s recent ruling in Merit Management Group, LP v. FTI Consulting, Inc., 138 S.Ct. 883 (2018) on the scope of safe harbor, with law firms perceiving it as moving away from the position of Merit by opening new room for application of safe harbor protection. Jones Day suggests that the Tribune’s reasoning “avoided the strictures of Merit”, while Nelson Mullins finds it “shifting the focus from the financial institution as a ‘mere conduit’ to an ‘agent’.” Kramer Levin comments that the decision represents a “dramatic, and perhaps unexpected, extension of the safe harbor from the position it occupied in the immediate aftermath of Merit.” Weil calls it throwing the 546(e) safe harbor a lifeline.

Firms also find the case paving a way to protect LBO payments from subsequent attacks. King & Spalding notes that the Second Circuit’s opinion provides protection for recipients involved in LBO transaction where the debtor is the “customer” of the intermediary financial institutions. Cadwalader believes that the decision may “narrow the impact” of Merit, as market participants could structure their transaction to involve a financial institution thereby bypassing the “mere conduit” carve-out. Skadden agrees on the likely trend of structured LBOs, highlights that the customer defense is “likely to continue gaining momentum” after the Second Circuit’s decision. Parties would ensure they meet the “financial institution” and “customer” criteria methodically articulated in Tribune. “An appropriately structured principal/agent relationship could continue to shelter transfers or distributions within the ambit of section 546(e) safe harbors,” says Weil, adding that the operative facts will be key to strengthen the position.

Finally, Gibson Dunn notes that Tribune is not binding on other circuits. It remains to be seen whether such holding will be extended to different circumstances by other courts. “Some courts may find (in contrast to the Second Circuit) that the Supreme Court in Merit could not possibly have intended that its narrowing of the section 546(e) safe harbor be so easily vitiated by an argument that the Court itself acknowledged in a footnote,” says Kramer Levin.

In a prior Roundtable post, Professor Bussel noted that a plain meaning interpretation of the term “financial institution” should not include the customers of commercial banks, thus precluding a sharp change from Merit.

For Roundtable’s other posts on Tribune, see Bankruptcy Court Disagrees with Second Circuit’s Holding in Tribune, Tribune Fraudulent Conveyance Litigation Roundup. For Roundtable discussions relating to the 546(e) safe harbor, please refer to the tag #Safe Harbors.

Updated Overview of the Jevic Files: How Courts Are Interpreting and Applying the Supreme Court’s Ruling on Structured Dismissals and Priority Skipping

By Shane G. Ramsey and John T. Baxter (Nelson Mullins)

Shane G. Ramsey
John T. Baxter

The U.S. Supreme Court in Czyzewski v. Jevic Holding Corp., 137 S.Ct. 973 (2017), addressed the issue of chapter 11 debtors using structured dismissals to end-run the statutory priority rules. The Court’s ruling preserved the priority system, holding that the bankruptcy court could not approve a structured dismissal of a chapter 11 case that provided for distributions that failed to follow the standard priority rules unless the affected creditors consented to such treatment. Although the Bankruptcy Code does not expressly apply its priority distribution scheme to a structured dismissal, the Court clarified that courts should do so.

As a way to track how bankruptcy courts across the country are applying the ruling in Jevic, the Nelson Mullins Bankruptcy Protector has introduced a new periodic series: the Jevic Files. As of December 31, 2019, the Jevic Files has collected and summarized twenty-one cases across nineteen jurisdictions. While the majority of the cases involved structured dismissals in the context of a chapter 11 case, courts have also applied the ruling in Jevic to the dismissal of chapter 13 plans; the priority of trustee payments in a chapter 7 case; and even a state court foreclosure hearing that came on the heels of a dismissed chapter 11 case. As Jevic continues to be interpreted and applied in bankruptcy (and other) courts throughout the country, we will continue to keep an updated summary of cases through the Jevic Files.

The article is available here.

Will Bankruptcy Preference Lawsuits Decline due to Statutory Changes?

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.

Second Circuit Fumbles Tribune on Reconsideration

Daniel J. Bussel

By Daniel J. Bussel (UCLA School of Law)

The Second Circuit recently issued its revised opinion in Tribune Company Fraudulent Conveyance Litigation, determining that a debtor-transferor that effectuates a transfer involving a securities contract in its capacity as the customer of a commercial bank is itself a “financial institution” within the meaning of the Bankruptcy Code section 101(22)(A) and therefore the transfer is protected under section 546(e).

This ruling has critically important implications for the avoiding powers of the bankruptcy trustee. Section 546(e) insulates all transfers involving securities by or to a financial institution from avoidance except as an “actual fraud” under section 548(a)(1)(A). Virtually all transferors are customers of commercial banks and almost any transfer can be effectuated with funds transferred through the agency or in the possession of a commercial bank. The result is the virtual repeal of the avoiding powers as to any transfer involving securities that is not an actual fraud on creditors, undoing centuries of fraudulent transfer and preference law.

These considerations are powerful enough that the Second Circuit, if necessary in light of the statute’s plain language, should have striven mightily to avoid interpreting the term “financial institution” so as to include the customers of commercial banks. The Code’s avoiding power sections read as a whole make no sense if limited only to cases involving transfers by entities that are not customers of commercial banks. Moreover, such a reading of section 101(22) flies in the face of Merit Management, the recent, directly applicable, Supreme Court precedent.

The full article is available here.

For more posts on the scope of section 546(e), see Ralph Brubaker, Understanding the Scope of the § 546(e) Securities Safe Harbor Through the Concept of the “Transfer” Sought to Be Avoided.

Recent Developments in Cross-Border Insolvency and Recognition of Foreign Bankruptcy Proceedings in the US Bankruptcy Courts

By Mark G. Douglas and Dan T. Moss (Jones Day)

Mark G. Douglas
Dan T. Moss
Dan T. Moss

On July 25, 2019, the Judicial Insolvency Network announced its adoption of the Modalities of Court-to-Court Communication (the “Modalities”), which “apply to direct communications (written or oral) between courts in specific cases of cross-border proceedings relating to insolvency or adjustment of debt opened in more than one jurisdiction.” The Modalities are intended to facilitate implementation of the Guidelines for Communication and Cooperation Between Courts in Cross-Border Insolvency Matters, which since 2017 have been adopted by courts in several countries, including the Supreme Court of Singapore, the U.S. Bankruptcy Courts for the District of Delaware, the Southern District of New York and the Southern District of Florida, and courts in the United Kingdom, Australia, The Netherlands, South Korea, Canada, Bermuda, and the Eastern Caribbean. The U.S. Bankruptcy Court for the District of Delaware adopted the Modalities on an interim basis on July 25, 2019. It is anticipated that other courts will do so as well in the near term.

Mark G. Douglas (Jones Day) summarized key features of the Modalities and other developments since the Guidelines for Communication and Cooperation Between Courts in Cross-Border Insolvency Matters as developed and implemented by JIN (the judicial Insolvency Network) here.

In In re PT Bakrie Telecom Tbk, 601 B.R. 707 (Bankr. S.D.N.Y. 2019), the U.S. Bankruptcy Court for the Southern District of New York provided a primer on several important issues that a court may have to consider in ruling on a petition for recognition of a foreign bankruptcy proceeding under chapter 15 of the Bankruptcy Code. These include the requirement that a foreign debtor have property in the United States before being eligible for chapter 15, the rules regarding the appointment of a “foreign representative” for the debtor, what qualifies as a “collective proceeding” for the purpose of chapter 15 recognition, and the “public policy” exception to recognition. One notable conclusion by the court is that merely because a foreign proceeding has concluded does not prevent the later appointment of a foreign representative.

An examination of all of the issues highlighted by PT Bakrie entails a detailed factual analysis and careful application of the provisions of chapter 15 consistent with its underlying principles and purpose in providing assistance to foreign tribunals overseeing cross-border bankruptcy cases. Dan T. Moss and Mark G. Douglas (Jones Day) provided such a close examination and detailed analysis of the case here.

Make-Whole Claims in Bankruptcy

By Sam Lawand (White & Case LLP)

The well-established “perfect tender in time rule” dictates that debt must be repaid only upon maturity, and no earlier. Under this rule, early repayments of debt are prohibited absent a contrary provision under the debt instrument. Debt instruments bar early repayments altogether through a “nocall” provision or permit early repayments through a “make-whole” provision. By modifying the “perfect tender in time rule,” make-whole provisions allow debtors to repay debt in advance of stated maturity, in exchange for a predetermined premium, usually based on the discounted value of the stream of future scheduled interest payments.

To determine whether make-whole claims are allowed in bankruptcy, courts undertake a two-pronged analysis. Because make-whole provisions are contractual, courts rely on contract construction principles to determine whether the debt instrument contains a make-whole provision, and, if so, the circumstances in which such provision is triggered. If a make-whole provision is triggered, courts then proceed to determine whether such provision is enforceable under state law.

If the make-whole provision is enforceable under state law, courts proceed to determine whether such provision is enforceable under bankruptcy law. Section 101(5)(A) of the Bankruptcy Code defines “claim” as a “right to payment,” which encompasses make-whole claims. Section 502(a) provides that “claims” are allowed, except to the extent disallowed under section 502(b). In turn, section 502(b)(1) disallows “claims” that are “unenforceable . . . under any agreement or applicable law,” and section 502(b)(2) disallows “claims” on account of “unmatured interest.” In certain circumstances, section 506(b) allows “secured claims” to include “interest” and “any reasonable fees, costs, or charges provided for under an agreement or State statute.” The confluence of these Bankruptcy Code provisions is murky.

Given that make-whole provisions, in essence, liquidate damages arising out of the loss of future scheduled “interest” payments, which by definition are “unmatured,” the allowance of make-whole claims in bankruptcy compels a demanding analysis.

In resolving whether make-whole claims are allowed in bankruptcy, this article examines the application of contract construction principles, reconciles conflicting precedent on such  principles, and construes applicable Bankruptcy Code provisions. This article recognizes that, in applying the provisions of the Bankruptcy Code, bankruptcy courts are courts of equity and that considerations of bankruptcy and commercial policies, including practicality and predictability, bear on the application of such provisions. This article concludes that make-whole claims are generally not allowed in bankruptcy, unless (1) the default or “early repayment” by the debtor is “voluntary”; or (2) the debt instrument contains a “clear and unambiguous” provision calling for a make-whole payment in all circumstances of early repayment.

In accordance with this two-pronged analysis, the first-half of this article covers the state-law analysis, and the second-half of this article covers the bankruptcy-law analysis.

The complete article is available for download here.

Fifth Circuit Rules That Corporate Charter Provision Requiring Shareholder Consent for Bankruptcy Filing Is Enforceable but Declines to Rule on Validity of “Golden Shares”

By Mark A. Cody and Mark G. Douglas (Jones Day).

In a highly anticipated decision, the U.S. Court of Appeals for the Fifth Circuit affirmed a bankruptcy court order dismissing a chapter 11 case filed by a corporation without obtaining—as required by its corporate charter—the consent of a preferred shareholder that was also controlled by a creditor of the corporation. In Franchise Services of North America, Inc. v. Macquarie Capital (USA), Inc. (In re Franchise Services of North America, Inc.), 891 F.3d 198 (5th Cir. 2018), a Fifth Circuit panel ruled that: (i) state law determines who has the authority to file a voluntary bankruptcy petition on behalf of a corporation; (ii) federal law does not strip a bona fide equity holder of its preemptive voting rights merely because it is also a creditor; and (iii) the preferred shareholder-creditor was not a controlling shareholder under applicable state law such that it had a fiduciary duty to the corporation which would impact any decision to approve or prevent a bankruptcy filing.

However, to the disappointment of many observers, the Fifth Circuit declined to decide whether “blocking provisions” and “golden shares”—either generally or when wielded by a party that is both a creditor and an equity holder—are valid and enforceable. Such provisions have been increasingly relied upon by creditors, including private equity sponsors and other investors who take both equity and debt positions in a portfolio company, as a means of managing or limiting access to bankruptcy protection, but with mixed results in the courts. Franchise Services does little to remedy the unsettled state of bankruptcy jurisprudence regarding this important issue. Moreover, because the case involved a minority shareholder-creditor without any fiduciary obligations, the decision did not involve many of the more difficult questions posed by other cases involving these issues.

The article is available here.

A New Approach to Executory Contracts

By John A. E. Pottow (University of Michigan Law School)

Few bankruptcy topics have bedeviled courts—and busied commentators—as much as executory contracts. Perhaps the most nettlesome challenge is the problem of defining “executoriness,” which serves as the statutory gatekeeper to Section 365 of the Bankruptcy Code and its extraordinary powers. Elite lawyers, who are the closest approximation to chapter 11 repeat players, have no ex ante incentive to fix a definition; in part succumbing to a vividness bias, they want to exploit executoriness’s inherent ambiguity to select the definition perceived to be most advantageous in any given case ad hoc. From Westbrook to Countryman before, authors have struggled to find a coherent and normatively defensible definition of executoriness (including Westbrook’s call for its abolition) that would stop this gamesmanship, and even the American Bankruptcy Institute’s Review Commission has now entered the debate.

This article takes a new approach. It suggests abandoning the bootless task of finding the right test and concedes that executoriness is here to stay. This new approach focuses on the residuum of the “non-executory contract.” Using the policies, structure, and text of the Code, it argues that many of Section 365’s provisions can be synthetically replicated elsewhere. Doing so will blunt the strategic incentive to invest resources fighting the absence or presence of executoriness ab initio by scuttling the payoff. Concomitant gains will accrue to all.

The full article is available here.

Applying Jevic: How Courts Are Interpreting and Applying the Supreme Court’s Ruling on Structured Dismissals and Priority Skipping

By Shane G. Ramsey and John T. Baxter (Nelson Mullins).

The U.S. Supreme Court in Czyzewski v. Jevic Holding Corp., 137 S.Ct. 973 (2017), addressed the issue of chapter 11 debtors using structured dismissals to end-run the statutory priority rules. The Court’s ruling preserved the priority system, holding that the bankruptcy court could not approve a structured dismissal of a chapter 11 case that provided for distributions that failed to follow the standard priority rules unless the affected creditors consented to such treatment. Although the Bankruptcy Code does not expressly apply its priority distribution scheme to a structured dismissal, the Court clarified that courts should do so.

As a way to track how bankruptcy courts across the country are applying the ruling in Jevic, the Nelson Mullins Bankruptcy Protector has introduced a new periodic series: the Jevic Files. As of February 19, 2018, the Jevic Files has collected and summarized thirteen cases across twelve jurisdictions. While the majority of the cases involved structured dismissals in the context of a chapter 11 case, courts have also applied the ruling in Jevic to the dismissal of chapter 13 plans; the priority of trustee payments in a chapter 7 case; and even a state court foreclosure hearing that came on the heels of a dismissed chapter 11 case. As Jevic continues to be interpreted and applied in bankruptcy (and other) courts throughout the country, we will continue to keep an updated summary of cases through the Jevic Files.

The article is available here.

The Roundtable has posted on Jevic before, including a report of the case by Melissa Jacoby & Jonathan Lipson and a roundup of law firm perspectives on the Court’s decision and an initial scholarly take on the opinion from Nicholas L. Georgakopoulos. For other Roundtable posts related to priority, see Casey & Morrison, “Beyond Options”; Baird, “Priority Matters”; and Roe & Tung, “Breaking Bankruptcy Priority,” an article that the Jevic opinion referred to.

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