Daniel A. Lowenthal, Partner

This post originally appeared in Norton Journal of Bankruptcy Law and Practice.

Bankruptcy court approval is required when a debtor wants to sell property outside the ordinary course of its business. Courts will allow transactions that reflect a debtor’s informed business judgment. When courts consider the rationale and evidence a debtor submits, they will sometimes cite the business judgment test as it has been articulated by the Delaware Supreme Court in cases involving consideration of corporate officers’ fiduciary duties. But, in practice, bankruptcy courts apply a different bankruptcy law business judgment standard when reviewing a debtor’s proposed sale of estate property. In the corporate law context, judges will not question a board’s decision if there is no evidence of flaws in the decision making process. But in the bankruptcy context, judges will make sure a debtor has a valid business reason for the proposed sale of estate property.

Courts reviewing a bankruptcy court’s decision to approve a chapter 11 reorganization plan over the objections of an interested party must consider not only the merits, but also (if implementation of the plan was not stayed) potential injury to the reliance interests of other parties relying on the plan. These issues are confronted in Drivetrain, LLC v. Kozel (In re Abengoa Bioenergy Biomass of Kansas), 2020 WL 2121449 (10th Cir. May 5, 2020), a recent Tenth Circuit decision holding, based on circuit precedent, that an objector’s challenge to a chapter 11 plan that had already been implemented was barred under the doctrine of equitable mootness. Nonetheless, the decision noted that the doctrine is controversial and open to question.

Most bankruptcy courts have altered their practices and procedures in light of COVID-19.  Below is a summary of the changes to practices and procedures in the United States Bankruptcy Courts for the Southern District of New York, the Eastern District of New York, the District of Delaware, and the Southern District of Texas.  We will aim to update this report as courts revise their procedures, but given the fluidity of the situation and the frequency of COVID-19-related updates, please also consult the relevant court’s website. 

COVID-19 is taking an alarming and unfortunate toll on our country’s population. Each day, we collectively face daunting health risks, and the economic cost to individuals and businesses alike has already been, and will continue to be, staggering. Accordingly, more than at any point in the past decade, both debtors and creditors should consider the potential benefits of the bankruptcy process. This post discusses four basic bankruptcy concepts that always merit consideration, especially in these trying times.

When there are large numbers of substantial individual tort claims against a debtor, potentially involving claimants unknowable to the debtor who themselves may not know they have a claim, the bankruptcy process faces special problems.  One objective of bankruptcy is to afford final relief to the debtor from the debtor’s debts, but discharging the claims of those unknown claimants without notice and a hearing poses due process problems.  A standard way to address this issue, which has arisen prominently in asbestos cases, is for the debtor to create and fund a trust to provide for tort claims brought in the future, with the court issuing an injunction channeling such claims to the trust rather than the reorganized entity.  See, e.g., 11 U.S.C. § 524(g) (providing for such trusts for asbestos-related litigation).  But are such trusts the only way to resolve such claims?  This question is raised by the Third Circuit’s recent decision in In re Energy Future Holdings Corp, No. 19-1430, 2020 U.S. App. LEXIS 4947 (Feb. 18, 2020).  The debtor instead devised a process reliant on Rule 3003(c)(3) of the Federal Rules of Bankruptcy Procedure, which authorizes a court to extend the time for filing a claim “for cause shown.”  In the circumstances of that case, and with publication notice to potential claimants, the Third Circuit held that this approach comported with due process.

When a debtor files for bankruptcy, the Bankruptcy Code provides for an automatic stay of almost all proceedings to recover property from the debtor.  See 11 U.S.C. § 362(a).  A party in interest can seek an order exempting it from the automatic stay for cause.  11 U.S.C. § 362(d).  A creditor that fails to obtain relief from the stay is limited to the claim-adjudication process in bankruptcy court.  What happens if the bankruptcy court rules against a creditor seeking relief from the automatic stay, and the creditor seeks to appeal?  Can the creditor appeal immediately or must it wait until its claim is fully adjudicated in bankruptcy court?  The question turns on the interpretation of the federal statute governing bankruptcy appeals, which provides that appeals may be taken from “final judgments, orders and decrees . . . entered in cases and proceedings.”  28 U.S.C. § 158(a) (emphasis added).  An automatic stay does not finally resolve a bankruptcy “case,” but does it finally resolve a bankruptcy “proceeding”?  On January 14, the Supreme Court resolved that question affirmatively in an opinion by Justice Ginsburg, ruling that a creditor who is denied relief from the automatic stay may appeal immediately.

Section 303 of the Bankruptcy Code allows creditors to initiate an involuntary bankruptcy case against a debtor. The petition initiating the case must be filed by creditors holding claims aggregating to at least $10,000, and those claims must not be “contingent as to liability or the subject of a bona fide dispute as to liability or amount.” 11 U.S.C. § 303(b)(1). Courts have disagreed as to how this provision applies when a portion of a claim is undisputed. Some courts have held that, when the undisputed portion of a claim is sufficient for the aggregated claims to reach $10,000, a dispute about the remainder of the claim does not disqualify the claim as a whole. Other courts have held that any bona fide dispute about the amount of a claim is a “bona fide dispute as to liability or amount” that prevents a claim from being used to support an involuntary bankruptcy petition. On November 26, in Montana Department of Revenue v. Blixseth, 942 F.3d 1179 (9th Cir. 2019), the Ninth Circuit embraced the second position, ruling against a state tax agency that had a large tax claim against the debtor, most of which was subject to bona fide dispute but $200,000 of which was not.

The Bankruptcy Code gives a trustee powers to avoid certain pre-bankruptcy transfers of the debtor’s property to other entities. For example, a trustee can avoid transfers made with the intent to impair the ability of creditors to collect on their debts. 11 U.S.C. § 548(a)(1)(A). The Code gives the trustee the power to recover the transferred property from the initial recipient, and also from subsequent recipients, “to the extent the transfer is avoided.” 11 U.S.C. § 550(a). Courts have split on whether this language requires a trustee to get a judgment avoiding a transfer prior to recovering from a subsequent transferee, or whether a trustee can simply show that the transfer is avoidable as part of the action against the subsequent transferee. A related question, however, concerns what happens when a trustee has gotten a judgment avoiding a transfer, and then seeks to recover from subsequent transferees. Can those transferees challenge whether the original transfer was avoidable? This question is the central issue in a recent decision from the United States Bankruptcy Court for the Southern District of Florida. Yip v. Google LLC (In re Student Aid Ctr., Inc.), Adv. Proc. No. 18-1493, 2019 Bankr. LEXIS 3310 (Bankr. S.D. Fla. Oct. 22, 2019).

Section 548 of the Bankruptcy Code enables trustees to avoid certain pre-bankruptcy transfers of “an interest of the debtor in property,” where the transfer was intended to defraud creditors or where the transfer was made while the debtor was insolvent and was not for reasonably equivalent value.   11 U.S.C. § 548(a).  Section 544 of the Bankruptcy Code enables trustees to avoid a transfer of “property of the debtor” where a creditor of the debtor would have such a right under state law.  11 U.S.C. § 544(a).  The statutory requirement that the transfer be “of an interest of the debtor” or “property of the debtor” (emphasis added) has important implications for claims brought under sections 544 and 548 in the aftermath of a merger or acquisition.  This point is illustrated by a recent decision from the District Court of Delaware, affirming the dismissal of fraudulent transfer claims brought under sections 544 and 548 for failure to allege transfer of property by a debtor.  Miller v. Matco Electric Corp. (In re NewStarcom Holdings), Civ. No. 17-309 (D. Del. Sept. 6, 2019).

Chapter 15 of the Bankruptcy Code, added in 2005, provides a route for debtors to obtain US recognition of their insolvency proceedings in other countries.  A foreign proceeding can be recognized under chapter 15 as either a “foreign main proceeding” or a “foreign nonmain proceeding.”  11 U.S.C. § 1517.  Recognition as a foreign main proceeding entitles a debtor to certain rights, such as the automatic stay of actions against the debtor that would normally be imposed in a bankruptcy case filed in the United States.  11 U.S.C. § 1520.  To obtain recognition of a foreign proceeding as a foreign main proceeding, the foreign proceeding must be pending in the country where the debtor has the “center of its main interests” (usually abbreviated “COMI”).  The precise meaning of this somewhat elusive phrase is still being worked out by judicial decision.  On August 12, 2019, the Bankruptcy Court for the Southern District of New York issued another entry in the body of case law concerning this provision, ruling that an investment fund organized under Cayman Islands law, and involved in a liquidation proceeding there, had its COMI in the Cayman Islands rather than New York.

Here’s an update on recent political, social, and economic developments in Venezuela.  From our perspective as a blog focused on insolvency and restructuring topics, the upshot of what’s been taking place in Venezuela is that the chances of a debt restructuring in the coming months remain slim. 

Delaware Bankruptcy Judged Brendan Shannon granted mechanic’s lien claimants $1.6 million for making a substantial contribution in a case by “demonstrably and materially facilitating the process of reorganization.”  In re M & G USA Corp., No. 17-12307, 2019 Bankr. LEXIS 1398 (Bankr. D. Del. May 6, 2019).

Last year, we discussed a decision by Judge Sean Lane of the United States Bankruptcy Court for the Southern District of New York concerning section 109(a) of the Bankruptcy Code.  In a recent cross-border case, In re PT Bakrie Telecom Tbk, Judge Lane again addressed section 109(a) and held that an obligor on an indenture that contains New York governing law and forum selection clauses satisfies the eligibility requirement for filing a chapter 15 case in New York. 

Two weeks ago, we discussed asset sales under Bankruptcy Code section 363.  As that post noted, section 363 requires court approval for asset sales outside the ordinary course of business, with courts ensuring that sales reflect a reasonable business judgment and have an articulated business justification.  Debtors may choose to sell assets via a public auction or through a private sale.  In our last post, we considered a case where a debtor initially arranged for a public auction and then decided to sell the property via a private sale.  What about the reverse case—what if a debtor agrees to sell property to a particular entity via a private sale, but then changes course and decides to hold a public auction instead?  On Wednesday, the Fifth Circuit Court of Appeals considered such a case in In re VCR I, LLC, No. 18-60368 (May 1, 2019).  The Fifth Circuit held that the prior agreement did not bar the change of course.

We now address assets sales under Bankruptcy Code section 363.  The statute allows debtors to use, sell, or lease their property in the ordinary course of business without court permission.  But a debtor’s use, sale, or lease of property outside the ordinary course of business requires court approval.  And courts will usually approve a debtor’s disposition of property if it reflects the debtor’s reasonable business judgment and an articulated business justification.

It’s time for a primer on the Wagoner rule and the in pari delicto defense, two concepts that arise when a debtor’s fraud leads to bankruptcy.  Trustees who replace a debtor’s management often sue those involved in the corporation’s misdeeds.  But the Wagoner rule and the in pari delicto defense can shield third-party defendants from liability.

Indentures often provide that an indenture trustee’s expenses incurred after an event of default constitute administration expenses under applicable bankruptcy law. However, § 503(b)(5) requires indenture trustees to show that they have made a “substantial contribution” in a case in order to receive their fees and costs. This means that a trustee is held to a higher standard than the “actual, necessary” standard that other administrative expense claimants must satisfy pursuant to § 503(b)(1)(A). Even so, some courts permit trustees to be paid from estate funds under the terms of a chapter 11 plan without satisfying the substantial-contribution standard, although the case law is not uniform.

A court in New York has allowed offshore debtors to take control of an investment account in the U.S. over the objection of a shareholder.   At stake was the court’s discretion to permit chapter 15 debtors to access the funds and to transfer them outside the U.S.  The shareholder asserted that its interests weren’t fully protected, but the court ruled that on balance the debtors’ need for the money outweighed the shareholder’s concerns.

A sex-abuse scandal has landed another organization in bankruptcy court.  USA Gymnastics (“USAG”) filed chapter 11 last week in Indiana following a team doctor’s conviction for abusing hundreds of girls.

Defendants in a lawsuit didn’t waive their right to arbitrate even after moving to dismiss and answering a complaint, a court held last week.  Arbitration wasn’t waived because the defendants hadn’t filed affirmative defenses or counterclaims and had taken no discovery. Trevino v. Select Portfolio Servicing, Inc. (In re Jose Sr. Trevino), Adv. Pro. No. 16-7024, 2018 Bankr. LEXIS 3605 (Bankr. S.D. Tex. Nov. 14, 2018).

It’s hard to find something positive to write about Venezuela.  Some basic facts tell the story of the misery there.

Consumer prices this year might rise one million percent.  The minimum wage was increased by 3,000 percent so that seven million workers will now receive $20 a month.  And many others live on just $2 to $8 a month and eat one meal a day.  The poverty rate is a crushing 82 percent.  Medicine is scarce.

The Third Circuit denied a $275 million break-up fee to a bidder that was unsuccessful in its attempt to buy the crown-jewel assets in the high-profile EFH bankruptcy case.  In re Energy Future Holdings Corp., No 18-1109, 2018 U.S. App. LEXIS 25945 (3^rd Cir. Sept. 13, 3018).  The court held that the bidder’s efforts didn’t result in a benefit to the debtors’ estates.  Therefore, the bidder’s request for an administrative expense in the form of the fee was rejected. 

The Bankruptcy Court in Delaware recently denied a request for an administrative expense claim to an entity that tried but failed to buy a debtor’s key assets.  The decision arises out of the first of three attempts by entities to purchase Oncor Electric Delivery Company LLC (“Oncor”) in the complex Energy Future Holdings Corp. bankruptcy cases.  In re Energy Future Holdings Corp., 2018 Bankr. LEXIS 2257 (Bankr. D. Del. Aug. 1, 2018).

Section 327(a) of the Bankruptcy Code imposes restrictions on the employment of professionals to assist a trustee, requiring that such professionals “not hold or represent an interest adverse to the estate” and be “disinterested persons.” Section 363(b) permits the trustee, after notice and a hearing, to “use, sell, or lease, other than in the ordinary course of business, property of the estate,” and does not impose restrictions on employment comparable to those of section 327(a). On Monday, in In re Nine West Holdings, Inc., Case No. 18-10947 (SCC), Judge Shelley C. Chapman of the Bankruptcy Court for the Southern District of New York considered the relationship between those provisions in deciding on an application to retain a management consultancy firm that had already been assisting the debtors prior to the bankruptcy petition. Judge Chapman held that the application was properly considered under section 363(b) rather than section 327(a). Applying the business judgment standard under 363(b) rather than the more stringent standard under 327(a), Judge Chapman approved the application.