Bankruptcy Update

Bankruptcy Update Blog provides current news and analysis of key bankruptcy cases and developments in US and cross-border matters. Patterson Belknap’s Business Reorganization and Creditors’ Rights attorneys represent creditors’ committees, trade creditors, indenture trustees, and bankruptcy trustees and examiners in US and international insolvency cases. Our team includes highly skilled and experienced attorneys who represent clients in some of the most complex cases in courts throughout the US and elsewhere.

Bankruptcy Sales Under Section 363: The Business Judgment Test That Judges Often Cite Isn’t Always the One They Use

by Jonah Wacholder and Daniel A. Lowenthal on June 1, 2020

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.

Federal Appeals Court Addresses Equitable Mootness Doctrine

by Jonah Wacholder and Daniel A. Lowenthal on May 8, 2020

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.

Third Circuit Addresses the Due Process Rights of Asbestos Claimants

by Jonah Wacholder and Daniel A. Lowenthal on February 21, 2020

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.

Supreme Court Resolves the Appealability of Orders Denying Relief from the Automatic Stay

by Jonah Wacholder and Daniel A. Lowenthal on January 24, 2020

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.

Federal Appeals Court Rules on Requirements for Involuntary Bankruptcy

by Jonah Wacholder and Daniel A. Lowenthal on December 26, 2019

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.

Bankruptcy Court Addresses Standard For Recovery Of An Alleged Fraudulent Transfer From A Subsequent Transferee

by Daniel A. Lowenthal and Jonah Wacholder on October 30, 2019

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).

District Court Rules on Property of the Debtor Requirement for Fraudulent Transfer Claims

by Jonah Wacholder and Daniel A. Lowenthal on September 20, 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).

New York Bankruptcy Court Issues Ruling on Recognition of Foreign Proceedings

by Jonah Wacholder and Daniel A. Lowenthal on August 22, 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.

Supreme Court Decides Civil Contempt Standard for Violations of Discharge Orders

by Jonah Wacholder and Daniel A. Lowenthal on June 14, 2019

Successful bankruptcy cases typically end with a court order releasing a debtor from liability for most pre-bankruptcy debts. This order, generally known as a “discharge order,” prohibits the debtor’s creditors from trying to collect on those now-discharged debts. See 11 U.S.C. § 524(a)(2). But it is not always clear which debts are covered by a discharge order. Some pre-bankruptcy debts are exempted from discharge by the Bankruptcy Code. For example, section 523 of the Bankruptcy Code exempts certain debts of individual debtors from discharge, and section 1141 exempts certain debts of corporate debtors from discharge under chapter 11. See 11 U.S.C. §§ 523(a), 1141(d)(6). For other debts, it may be unclear whether they arose before or after the bankruptcy. See In re Ybarra, 424 F.3d 1018 (9th Cir. 2005) (considering under what circumstances a discharge order covers an attorney’s fee award for fees incurred post-petition in an action brought before the bankruptcy petition). Courts enforcing a discharge order’s prohibition on debt collection have thus struggled with the appropriate standard for holding a person in contempt for attempting to collect on a discharged debt. Does it require that the person knew that the discharge applied to the debt, or is it sufficient that the discharge did in fact apply to the debt?

Another Ruling on Public Auctions Versus Private Sales Under Section 363

by Jonah Wacholder and Daniel A. Lowenthal on May 3, 2019

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.

Bankruptcy Court Applies Automatic Stay to Continuation of Removed State-Court Action Against Debtor

by Jonah Wacholder and Daniel A. Lowenthal on March 29, 2019

When a debtor files for bankruptcy, almost all proceedings to recover property from the debtor are automatically stayed by force of law. See 11 U.S.C. § 362(a). This provision, known as the automatic stay, is a central feature of the bankruptcy process, but uncertainty remains about aspects of its scope. Last month, we wrote about a decision from a New Mexico bankruptcy court holding that the automatic stay was not applicable to the removal of a state court action to bankruptcy court and to the continuation of that there. Earlier this week, in response to a motion for reconsideration, the court partially reversed itself, again holding that the automatic stay is not applicable to removal or to motions to remand the action back to state court, but holding that continuation of the action, beyond mere consideration of a motion to remand, was barred by the automatic stay. In re Cashco Inc., No. 18-11968-j7 (Bankr. D.N.M. March 26, 2019).

Bankruptcy Court Holds Automatic Stay Inapplicable to Removal of State Court Action Against Debtor

by Daniel A. Lowenthal and Jonah Wacholder on February 28, 2019

When a party files for bankruptcy, the Bankruptcy Code imposes an automatic stay of litigation against a debtor for claims arising prior to the commencement of the bankruptcy case. See 11 U.S.C. § 362(a). Where there is a basis for bankruptcy jurisdiction in federal court, federal law also permits parties to a state court action to remove the state court action to the federal district court for the district in which the state court action is pending. See 28 U.S.C. § 1452(a). (Usually, the action will then be automatically referred to a bankruptcy court in that federal judicial district.) Absent court action to modify the automatic stay, does the automatic stay block parties from carrying out such removal of state court actions against a bankruptcy debtor? In In re Cashco Inc., No. 18-11968-j7 (Bankr. D.N.M. December 12, 2018), a bankruptcy court considered an objection to removal on this ground by a chapter 7 trustee (“the Trustee”). While noting that courts have split on this issue, the bankruptcy court ruled that the automatic stay does not apply to removing a case to the bankruptcy court where the bankruptcy case is pending, nor to other proceedings in that court, including continuation of the removed action.

Fifth Circuit Rejects “Futility” Defense in a State-Law Fraudulent Transfer Action

by Jonah Wacholder and Daniel A. Lowenthal on January 18, 2019

Fraudulent transfer law allows creditors and bankruptcy trustees, under certain circumstances, to sue transferees to recover funds received where a debtor’s transfers to the transferees actually or constructively defrauded its creditors. Under both the Uniform Fraudulent Transfer Act adopted by most states and the fraudulent transfer action created by federal bankruptcy law, a transferee of an alleged fraudulent transfer may assert a defense from such liability by establishing that it received the transfer in good faith and for reasonably equivalent value. See 11 U.S.C. § 548(c); Tex. Bus. & Com. Code § 24.009(a). Many courts have held that a transferee lacks good faith if it has “inquiry notice,” that is, if it has knowledge that would make a reasonable person suspicious and suggest a need for further investigation, even if it lacks actual knowledge of the fraudulent nature of the transfer. But some courts have held that even a transferee with inquiry notice can maintain a good faith defense if it establishes that an investigation into the facts would have been futile because it would not have revealed the fraud. In Javney v. GMAG, L.L.C., No. 17-11526, 2019 U.S. App. LEXIS 759 (Jan. 9, 2019), the Fifth Circuit held that such a futility defense was not available under the Texas Uniform Fraudulent Transfer Act (“TUFTA”).

Bankruptcy Court Finds Arbitration Clause in Consumer Loan Contract to be Sufficient Cause to Grant Relief from Automatic Stay

by Jonah Wacholder and Daniel A. Lowenthal on September 28, 2018

When a bankruptcy petition is filed, an automatic stay comes into effect staying proceedings against the debtor or the debtor’s property. 11 U.S.C. § 362(a). The stay centralizes litigation regarding the debtor and its property in the debtor’s bankruptcy case. When contract entered into pre-bankruptcy contains an arbitration clause, a bankruptcy court will consider if the stay should be enforced or if the parties can resolve the matter in arbitration. In In re Argon Credit, LLC, No. 16-39654 (Bankr. N.D. Ill. Sept. 21, 2018), a bankruptcy court considered this question in a dispute between two non-debtor parties concerning the validity of loans issued by the debtor and part of the debtor’s estate. The bankruptcy court ruled that the arbitration clause was binding and ordered the stay lifted to permit arbitration to go forward.

Third Circuit Enforces Plan Releases Against Later-Purchasing Shareholders Bringing Claims Concerning Post-Confirmation Conduct

by Jonah Wacholder and Daniel A. Lowenthal on August 24, 2018

Bankruptcy plans often include provisions releasing debtors and their officers and directors from certain potential liability. In Zardinovsky v. Arctic Glacier Income Fund, No. 17-2522 (3d Cir. Aug. 20, 2018), the United States Court of Appeals for the Third Circuit held that such a provision bound shareholders who purchased the shares after confirmation, as to post-confirmation claims including securities fraud and breach of fiduciary duty. Because this decision was at the motion to dismiss stage, what follows are the court’s characterization of the facts as alleged in the complaint.

Bankruptcy Court Rules Section 327 Inapplicable to Certain Management Consultant Retentions

by Jonah Wacholder and Daniel A. Lowenthal on July 9, 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.

Supreme Court Resolves Circuit Split on the Dischargeability of Debts Obtained by Oral Misrepresentations

by Jonah Wacholder and Daniel A. Lowenthal on June 14, 2018

On June 4, the Supreme Court decided Lamar, Archer & Cofrin, LLP v. Appling, No. 16-1215, in a unanimous opinion by Justice Sotomayor. The Court affirmed the Eleventh Circuit and resolved a circuit split about the meaning of “statement respecting the debtor’s . . . financial condition” in section 523(a)(2) of the Bankruptcy Code.

Bankruptcy Court Holds That Transferee Not Liable For Intentional Fraudulent Transfer Where Funds Were Returned To Debtor

by Jonah Wacholder and Daniel A. Lowenthal on May 10, 2018

Section 544 of the Bankruptcy Code permits a bankruptcy trustee to avoid any transfer that would be avoidable by creditors under state fraudulent transfer law. Section 550 of the Bankruptcy Code permits the bankruptcy trustee to recover from the transferee the transferred property in a fraudulent transfer avoided under section 550. Where funds were transferred in an intentional fraudulent transfer, but subsequently an equal or greater quantity of funds were transferred back to the debtor from the transferee, can the trustee still recover from the transferee? The Bankruptcy Court for the Eastern District of Pennsylvania recently considered this question in In re Incare LLC, Adv. No. 14-0248, 2018 Bankr. LEXIS 1339 (E.D. Pa. May 7, 2018), and held that the answer was no, the trustee cannot recover.

Delaware District Court Dismisses Appeal by Creditors’ Committee After Case is Converted from Chapter 11 to Chapter 7

by Jonah Wacholder and Daniel A. Lowenthal on March 29, 2018

The Bankruptcy Code provides for the appointment of a creditors’ committee in chapter 11 bankruptcy cases. See 11 U.S.C. § 1102. There is no parallel provision applicable to chapter 7 cases. When a bankruptcy case is converted from chapter 11 to chapter 7 while the creditors’ committee is pursuing an appeal, what happens to that appeal? In In re Constellation Enterprises LLC, Civ. No. 17-757-RGA, 2018 U.S. Dist. LEXIS 47153 (D. Del. Mar. 22, 2018), the United States District Court for the District of Delaware held that such an appeal should be dismissed because the appellant, the creditors’ committee, had been dissolved by the conversion.

Bankruptcy court holds that state consumer fraud claims against corporations are dischargeable in bankruptcy

by Jonah Wacholder and Daniel A. Lowenthal on February 27, 2018

Section 1141(d)(6)(A) and section 523(a)(2) of the Bankruptcy Code together provide that debts owed by a corporation to a government entity are not dischargeable if such debts were obtained by false representations. Does this rule apply to claims by government entities seeking to enforce consumer fraud laws, where the government entities were not themselves the victims of the fraud? On February 14, 2018, the United States Bankruptcy Court for the District of Delaware held that it does not, ruling that such claims against corporations brought by states on behalf of their citizens are dischargeable in bankruptcy. In re TK Holdings Inc., Case No. 17-11375, 2018 Bankr. LEXIS 414 (Bankr. D. Del. Feb. 14, 2018).

Eighth Circuit rejects foreseeability test for notice to unknown creditors

by Jonah Wacholder and Daniel A. Lowenthal on February 1, 2018

In Dahlin v. Lyondell Chemical Co., 2018 U.S. App. LEXIS 1956 (8th Cir. Jan. 26, 2018), the Eighth Circuit Court of Appeals rejected an argument that bankruptcy debtors were required by due process to provide more prominent notice of a case filing than they did, such that the notice might have been seen by unknown creditors with claims to assert.

Court Holds that Bankruptcy Judges Cannot Impose Punitive Sanctions

by Jonah Wacholder and Daniel A. Lowenthal on December 21, 2017

Bankruptcy courts lack the power to impose serious punitive sanctions, a federal district judge ruled recently in PHH Mortgage Corporation v. Sensenich, 2017 U.S. Dist. LEXIS 207801 (D. Vt. Dec. 18, 2018). Judge Geoffrey Crawford reversed a bankruptcy judge’s ruling that had imposed sanctions against a creditor based on Rule 3002.1(i) of the Rules of Bankruptcy Procedure, the bankruptcy court’s inherent authority, and Bankruptcy Code section 105.

Solicitor General recommends US Supreme Court review in dischargeability case

by Jonah Wacholder and Daniel A. Lowenthal on November 27, 2017

On November 9, responding to a request from the U.S. Supreme Court, the Solicitor General filed a brief at the Court recommending that the petition for writ of certiorari in Lamar, Archer & Cofrin, LLP v. Appling, No. 16-11911, be granted. The petition, seeking review of a unanimous panel decision of the Eleventh Circuit, presents the question of “whether (and, if so, when) a statement concerning a specific asset can be a ‘statement respecting the debtor's . . . financial condition’ within Section 523(a)(2) of the Bankruptcy Code.” There is a circuit split on this question, though the parties dispute its extent and its ripeness.