By Stacey L. Corr-Irvine and Mark G. Douglas (Jones Day)
It is generally well understood that an “oversecured” creditor is entitled to interest and, to the extent provided for under a loan agreement, related fees and charges as part of its secured claim in a bankruptcy case. Although section 506(b) of the Bankruptcy Code provides that fees, costs or charges allowed as part of a secured claim must be “reasonable,” the provision does not expressly impose any restrictions on the amount or nature of interest allowable as part of a secured claim. A Bankruptcy Appellate Panel for the Eighth Circuit recently considered whether a secured creditor is entitled to contractual default-rate interest under section 506(b).
In In re Family Pharmacy, Inc., 614 B.R. 58 (B.A.P. 8th Cir. 2020), the panel reversed a bankruptcy court’s order disallowing a secured creditor’s claim for interest at the default rate under the parties’ contract using a penalty-type analysis generally applied to liquidated damages provisions. According to the panel, such an analysis cannot be applied to default interest provisions. The panel also held that the bankruptcy court erred when it held that the default interest rate was unenforceable based on “equitable considerations.”
Valuation is a critical and indispensable part of the bankruptcy process. How collateral and other estate assets (and even creditor claims) are valued will determine a wide range of issues, from a secured creditor’s right to adequate protection, postpetition interest, or relief from the automatic stay to a proposed chapter 11 plan’s satisfaction of the “best interests” test or whether a “cram-down” plan can be confirmed despite the objections of dissenting creditors. Depending on the context, bankruptcy courts rely on a wide variety of standards to value estate assets, including retail, wholesale, liquidation, forced sale, going-concern, or reorganization value. Certain assets, however, may be especially difficult to value because valuation depends on factors that may be difficult to quantify, such as the likelihood of success in litigating estate causes of action.
The U.S. Court of Appeals for the First Circuit recently addressed this issue in In re Montreal, Maine & Atlantic Railway, Ltd., 956 F.3d 1 (1st Cir. 2020) (“MMA Railway”). The First Circuit affirmed a ruling that a secured creditor failed to satisfy its burden of establishing that collateral in the form of indemnification claims settled by the estate had any value entitled to adequate protection. According to the court, with respect to a disputed claim, a showing of possible damages is not enough. Instead, the creditor must establish the likely validity of the claim and the likelihood of recovery.
MMA Railway is a cautionary tale for secured creditors. Creditors bear the ultimate burden of proof in establishing the value of their collateral under section 506(a) of the Bankruptcy Code—a determination that has important consequences in many contexts in a bankruptcy case. The First Circuit’s ruling highlights the importance of building a strong evidentiary record to support valuation. It also indicates that certain types of collateral (e.g., disputed litigation claims) are more difficult to value than others.
In In re Energy Future Holdings Corp., 773 Fed. Appx. 89, 2019 WL 2535700 (3d Cir. June 19, 2019), a panel of the U.S. Court of Appeals for the Third Circuit ruled that adequate protection payments made during a bankruptcy case and distributions under a chapter 11 plan are not distributions of collateral for purposes of a “waterfall” provision in an intercreditor agreement. The ruling is a reminder that intercreditor agreements will apply only in accordance with their terms.Although the parties could have drafted the intercreditor agreement to apply to any consideration received from the debtor by the noteholders, they did not. Therefore, the intercreditor agreement did not apply to the adequate protection payments and plan distributions made to the noteholders.Creditors have recently learned similar lessons in other cases. Because the ruling was unpublished, the decision is not binding on courts in the Third Circuit.
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.
The Bankruptcy Code creates a rebuttable presumption that a proof of claim is prima facie evidence of the claim’s validity and amount. Courts disagree, however, over whether that presumption also applies in a proceeding to determine the secured amount of the creditor’s claim. The U.S. Bankruptcy Court for the Eastern District of California weighed in on this issue in In re Bassett, 2019 WL 993302 (Bankr. E.D. Cal. Feb. 26, 2019). The court broadened the divide in the debate by holding that the presumption that a filed claim is valid does not create a presumption that the claim is secured to the extent specified in a proof of claim.
Valuation is a critical and indispensable part of the bankruptcy process. How collateral and other estate assets are valued will determine a wide range of issues, from a secured creditor’s right to adequate protection, postpetition interest, or relief from the automatic stay to a proposed chapter 11 plan’s satisfaction of the “best interests” test or whether a “cram-down” plan can be confirmed despite the objections of dissenting creditors. Bassett and other court rulings addressing the valuation of secured claims illustrate the importance of developing an adequate evidentiary record to support or refute a proposed valuation.
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.
by Charles M. Oellermann and Mark G. Douglas (Jones Day).
The ability to avoid fraudulent or preferential transfers is a fundamental part of U.S. bankruptcy law. However, when a transfer by a U.S. entity takes place outside the U.S. to a non-U.S. transferee—as is increasingly common in the global economy—courts disagree as to whether the Bankruptcy Code’s avoidance provisions apply extraterritorially to avoid the transfer and recover the transferred assets. Several bankruptcy courts have addressed this issue in recent years, with inconsistent results.
In a recent example, in In re CIL Limited, 582 B.R. 46 (Bankr. S.D.N.Y. 2018), the U.S. Bankruptcy Court for the Southern District of New York, disagreeing with other courts both within and outside its own district, ruled that the “transfer of an equity interest in a U.K. entity to a Marshall Islands entity was a foreign transfer” and that the Bankruptcy Code’s avoidance provisions do not apply extraterritorially because “[n]othing in the language of sections 544, 548 and 550 of the Bankruptcy Code suggests that Congress intended those provisions to apply to foreign transfers.”
The decision further muddies the waters on an issue that has become increasingly prominent as the volume of cross-border bankruptcy cases continues to grow and cross-border transactions become ubiquitous. The split on this issue exists not merely between courts in different jurisdictions, but also among courts in the Southern District of New York, where the majority of cross-border bankruptcy cases have traditionally been filed.
by Charles M. Oellermann and Mark G. Douglas (Jones Day).
In their annual chronicle of business bankruptcy, financial, economic, and related developments in the U.S., Charles M. Oellermann and Mark G. Douglas of Jones Day review the most significant events of 2017, including business bankruptcy filing statistics and industry trends; newsworthy developments regarding sovereign and commonwealth debt; the top 10 public-company bankruptcies of the year; notable private and cross-border bankruptcy cases; significant business bankruptcy and U.S. Supreme Court bankruptcy rulings; bankruptcy-related legislative and regulatory developments; noteworthy chapter 11 plan confirmations and exits from bankruptcy; and more.
By Jane Rue Wittstein and Mark G. Douglas (Jones Day)
Courts disagree as to whether the amount that a bankruptcy trustee or chapter 11 debtor-in-possession can recover in fraudulent transfer avoidance litigation should be capped at the total amount of unsecured claims against the estate. The U.S. Bankruptcy Court for the District of Delaware recently weighed in on this issue in PAH Litigation Trust v. Water Street Healthcare Partners, L.P. (In re Physiotherapy Holdings, Inc.), 2017 WL 5054308 (Bankr. D. Del. Nov. 1, 2017). Noting the absence of any guidance on the question from the U.S. Court of Appeals for the Third Circuit, the bankruptcy court ruled that, unlike most state fraudulent transfer laws, which limit a creditor’s recovery to the amount of its unpaid claim against the transferor, section 550 of the Bankruptcy Code imposes no such limitation on the estate’s recovery. The ruling reinforces the idea that federal and state fraudulent transfer avoidance laws are intended to be remedial rather than punitive. Under state law, this understandably means that an avoidance recovery is limited to the amount necessary to make an injured creditor whole. Under federal bankruptcy law, recoveries must benefit the bankruptcy estate, which includes the interests of creditors and other stakeholders.
By Charles M. Oellermann and Mark G. Douglas (Jones Day)
Many chapter 11 plans include nonconsensual third-party releases that preclude certain non-debtors from pursuing claims against other non-debtors as part of a restructuring deal in which such releases are a quid pro quo for financial contributions made by prepetition lenders or old equity holders. However, bankruptcy and appellate courts disagree as to whether such non-consensual plan releases should be permitted due, among other things, to concerns regarding the scope of a bankruptcy court’s subject matter jurisdiction and constitutional authority. Several court rulings handed down in 2017 addressed these concerns.
For example, In In re Midway Gold US, Inc., 575 B.R. 475 (Bankr. D. Colo. 2017), the court held that, although Tenth Circuit law does not categorically forbid third-party releases in chapter 11 plans, it lacked jurisdiction to “adjudicate” plan releases of claims against non-debtors because the underlying claims should not be considered as part of the proceedings to confirm the plan and were not within either its “core” or “related to” jurisdiction. In addition, in In re SunEdison, Inc., 2017 BL 401968 (Bankr. S.D.N.Y. Nov. 8, 2017), the court ruled that, as a matter of contract law, merely implied consent for plan releases is insufficient, and it lacked subject matter jurisdiction to approve releases that were overly broad.
By contrast, in In re Millennium Lab Holdings II, LLC, 2017 WL 4417562 (Bankr. D. Del. Oct. 3, 2017), the court held that it had the constitutional jurisdiction to authorize nonconsensual releases, despite the existence of litigation in another forum to adjudicate one of the claims to be released. A discussion of the court’s ruling in Millennium is available here.