Bankruptcy Update

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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.

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

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).

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New York Bankruptcy Court Issues Ruling on Recognition of Foreign Proceedings

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.

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Supreme Court Decides Civil Contempt Standard for Violations of Discharge Orders

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?

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Another Ruling on Public Auctions Versus Private Sales Under Section 363

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.

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

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).

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

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.

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

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”).

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

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.

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

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.

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Bankruptcy Court Rules Section 327 Inapplicable to Certain Management Consultant Retentions

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.

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

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.

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

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.

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

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.

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

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).

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Eighth Circuit rejects foreseeability test for notice to unknown creditors

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.

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Court Holds that Bankruptcy Judges Cannot Impose Punitive Sanctions

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.

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Solicitor General recommends US Supreme Court review in dischargeability case

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.

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